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, 1997
                          -----------------

                                       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                             (I.R.S. Employer
   incorporation or organization)                            Identification No.)

1195 River Road, Marietta, Pennsylvania                             17547
- ----------------------------------------                          ----------
(Address of principal executive offices)                          (Zip code)

Registrant's telephone number, including area code: (717) 426-1931
                                                    --------------

Securities registered pursuant to Section 12(b) of the Act: None.

           Securities registered pursuant to Section 12(g) of the Act:

                          Common Stock, $1.00 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  .
                                      ---    --

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 ]

On March 17, 1998, the aggregate market value (based on the closing sales price
on that date) of the voting stock held by non-affiliates of the Registrant was
$54,365,781.

Indicate the number of shares outstanding of each of the Registrant's classes of
common stock, as of the latest practicable date: 6,057,732 shares of Common
Stock outstanding on March 17, 1998.

                      DOCUMENTS INCORPORATED BY REFERENCE:

1.   Portions of the Registrant's annual report to stockholders for the
     fiscal year ended December 31, 1997 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 16, 1998 are incorporated by
     reference into Part III of this report.

                               DONEGAL GROUP INC.

                            INDEX TO FORM 10-K REPORT

                                                                         Page
                                                                         ----
I.    PART I.

      Item 1.    Business                                                  1
      Item 2.    Properties                                                21
      Item 3.    Legal Proceedings                                         22
      Item 4.    Submission of Matters to a Vote of
                   Security Holders                                        22

II.   PART II.

      Item 5.    Market for Registrant's Common Equity and
                   Related Stockholder Matters                             23
      Item 6.    Selected Financial Data                                   23
      Item 7.    Management's Discussion and Analysis of
                   Financial Condition and Results of
                   Operations                                              23
      Item 8.    Financial Statements and Supplementary
                   Data                                                    23
      Item 9.    Changes in and Disagreements with
                   Accountants on Accounting and
                   Financial Disclosure                                    23

III.  PART III.

      Item 10.   Directors and Executive Officers of the
                   Registrant                                              24
      Item 11.   Executive Compensation                                    24
      Item 12.   Security Ownership of Certain Beneficial
                   Owners and Management                                   24
      Item 13.   Certain Relationships and Related
                   Transactions                                            24

IV.   PART IV.

      Item 14.   Exhibits, Financial Statement Schedules
                   and Reports on Form 8-K                                 25

                                       (i)

                                     PART I

Item 1    Business.

   (a)   General Development of Business.

         Donegal Group Inc. is a regional insurance holding company formed in
August 1986 which is headquartered in Pennsylvania and engages, through its
subsidiaries, in the property and casualty insurance business. As used herein,
"DGI" or the "Company" refers to Donegal Group Inc. and its subsidiaries,
Atlantic States Insurance Company ("Atlantic States"), Southern Insurance
Company of Virginia ("Southern"), Delaware Atlantic Insurance Company ("Delaware
Atlantic"), Pioneer Insurance Company ("Pioneer") and Atlantic Insurance
Services, Inc. ("AIS"). DGI is currently 58.3% owned by Donegal Mutual Insurance
Company (the "Mutual Company"). DGI and its subsidiaries and the Mutual Company
underwrite a broad line of personal and commercial coverages, consisting of
private passenger and commercial automobile, homeowners, commercial multi-peril,
workers' compensation and other lines of insurance.

         Atlantic States, which DGI organized in September 1986, participates in
an underwriting pool whereby it cedes to the Mutual Company the premiums, losses
and loss adjustment expenses from all of its insurance business and assumes from
the Mutual Company a specified portion of the pooled business, which also
includes substantially all of the Mutual Company's property and casualty
insurance business. Effective as of October 1, 1986, DGI entered into a pooling
agreement with the Mutual Company whereby Atlantic States assumed 35% of the
pooled business written or in force on or after October 1, 1986. Pursuant to
amendments to the pooling agreement subsequent to October 1, 1986, the Mutual
Company, which is solely responsible for any losses in the pooled business with
dates of loss on or before the close of business on September 30, 1986, has
increased the percentage of retrocessions of the pooled business to Atlantic
States. Since January 1, 1996, 65% of the pooled business has been retroceded to
Atlantic States. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included in Item 7 hereof and Note 2 to the
Consolidated Financial Statements incorporated by reference herein.

         On December 29, 1988, DGI acquired all of the outstanding capital stock
of Southern in exchange for a $3,000,000 equity contribution to Southern. On
October 1, 1986, the Mutual Company and Southern's predecessor, Southern Mutual
Insurance Company, entered into a reinsurance agreement whereby such predecessor
ceded to the Mutual Company 80% of its direct premiums written, less outside
reinsurance, and retained 20%. Effective January 1, 1991, this percentage was
changed to 50% ceded to the Mutual Company and 50% retained by Southern. Because
the Mutual Company places substantially all of the business assumed from
Southern in the pool, from which DGI currently has a 65% allocation, DGI's
results of operations include approximately 80% of the business written by
Southern. See Note 2 to the Consolidated Financial Statements incorporated by
reference herein.

                                       -1-

         In January 1994, DGI organized AIS, which began business in that same
month. AIS is an insurance services organization currently providing inspection
and policy auditing information on a fee for service basis to its affiliates and
the insurance industry.

         As of December 31, 1995, the Company acquired all of the outstanding
capital stock of Delaware Atlantic pursuant to a Stock Purchase Agreement dated
as of December 21, 1995 between the Company and the Mutual Company. As part of
this transaction, the Mutual Company entered into an aggregate excess of loss
reinsurance agreement with Delaware Atlantic whereby the Mutual Company assumed
the risk of any loss from an adverse development in Delaware Atlantic's loss
and loss adjustment expense reserve at the end of 1995 compared to the end of
1996 and losses and loss adjustment expenses incurred by Delaware Atlantic
during the month of December 1995 and for the 1996 year by reason of the fact
that Delaware Atlantic's loss and loss adjustment expense ratio for those
periods exceeded the lesser of the loss and loss expense ratios of immediately
preceding periods or 60%. This agreement resulted in no additional payment from
the Mutual Company to Delaware Atlantic.

         On May 3, 1996, the Mutual Company formed Aberdeen Insurance Group,
Inc. ("Aberdeen"), which, pursuant to an Asset Purchase Agreement dated July 31,
1996, purchased all of the aggregate excess and surplus lines insurance agency
business of Thomas G. Downie Agency, Inc. d/b/a Aberdeen Insurance Group
("Downie Agency") for a purchase price of $100,000. As part of the agreement,
Aberdeen acquired, among other things, fixed assets, the right, title and
interest in and to the name "Aberdeen Insurance Group," all of Downie Agency's
books and records relating to its excess and surplus insurance lines agency
business and all intangible property rights and proprietary information of
Downie Agency relating to the operation of the excess and surplus lines
insurance agency business that was acquired.

         Effective July 1, 1996, the Mutual Company entered into retrocessional
reinsurance agreements with each of Southern, Delaware Atlantic and Pioneer
(individually, an "Affiliate"), whereby the Mutual Company agreed to reinsure
each Affiliate in respect of 100% of the net liability that may accrue to such
Affiliate from its insurance operations and retrocede 100% of the net liability
back to each Affiliate, which the Affiliate assumes.

         As of March 31, 1997, the Company acquired all of the outstanding
capital stock of Pioneer pursuant to a stock purchase agreement dated as of
April 7, 1997 between the Company and the Mutual Company. As part of this
transaction, the Mutual Company entered into an aggregate excess of loss
reinsurance agreement with Pioneer whereby the Mutual Company assumed the risk
of any loss from an adverse development in Pioneer's loss and loss adjustment
expense reserve at the end of 1996 compared to the end of 1998 by reason of the
fact that Pioneer's loss and loss adjustment expense ratio for those periods
exceeded the lesser of the loss and loss expense ratios of immediately preceding
periods or 60%. This reinsurance agreement resulted in additional payments of
$186,800 from the Mutual Company to Pioneer in 1997.

         Unless otherwise stated, all information in this report gives
retroactive effect to the four-for-three split of the Company's Common Stock
effected through a stock dividend

                                       -2-

of one share of Common Stock for each three shares outstanding, which was paid
on July 15, 1997 to stockholders of record on June 25, 1997.

         (b) Financial Information about Industry Segments.

         The Company is of the opinion that all of its operations are within one
industry segment and that no information as to industry segments is required
pursuant to Statement of Financial Accounting Standards No. 14 or Regulation
S-K.

         (c) Narrative Description of Business.

Relationship with the Mutual Company

         DGI's operations are interrelated with the operations of the Mutual
Company and, because of the percentage of the pooled business assumed by DGI,
DGI's results of operations are largely dependent upon the success of the Mutual
Company. In addition, various reinsurance agreements exist between the Company
and the Mutual Company. The Mutual Company is responsible for underwriting and
marketing the pooled business and provides facilities, employees and services
required to conduct the business of DGI on a cost allocated basis. The Mutual
Company owned 58.3% of DGI as of March 17, 1998.

         Through the pool, DGI writes personal and commercial property
and casualty insurance lines, including automobile, homeowners, commercial
multi-peril, workers' compensation and other lines of business. The insurance
agencies under contract with the Mutual Company serve as representatives for the
pool participants.

         Under the terms of the intercompany pooling agreement, which took
effect on October 1, 1986, Atlantic States cedes to the Mutual Company the
premiums, losses and loss expenses on all of its insurance business.
Substantially all of the Mutual Company's property and casualty insurance
business, including the business reinsured from Southern, written or in force on
or after October 1, 1986, is also included in the pooled business. Pursuant to
amendments to the pooling agreement subsequent to October 1, 1986, the Mutual
Company, which is solely responsible for any losses in the pooled business with
dates of loss on or before the close of business on September 30, 1986, has
increased the percentage of retrocessions of the pooled business to Atlantic
States. Since January 1, 1996, 65% of the pooled business has been retroceded to
Atlantic States. All premiums, losses, loss expenses, other underwriting
expenses and policy dividends are prorated among the parties on the basis of
their participation in the pool. The pooling agreement may be amended or
terminated at the end of any calendar year by agreement of the parties. The
Company does not intend to terminate its participation in the pooling agreement.
The allocations of pool participation percentages between the Mutual Company and
Atlantic States are based on the pool participants' relative amounts of capital
and surplus and expectations of future relative amounts of capital and surplus.
The pooling agreement does not legally discharge Atlantic States from its
primary liability for the full amount of the policies ceded. However, it makes
the Mutual Company liable to Atlantic States to the extent of the business
ceded.

                                       -3-

         All of DGI's officers are officers of the Mutual Company, and five of
DGI's seven directors are directors of the Mutual Company. A Coordinating
Committee, which consists of two outside directors from each of DGI and the
Mutual Company, none of whom hold seats on both Boards, reviews and approves
changes in the pooling agreement and is responsible for matters involving actual
or potential conflicts of interest. The decisions of the Coordinating Committee
are binding on the two companies. DGI's members must conclude that intercompany
transactions are fair and reasonable in order for such transactions to be
approved.

         The underwriting pool is intended to produce a more uniform and stable
underwriting result from year to year for the companies in the pool than they
would experience individually and to spread the risk of loss among all the
participants. Each company participating 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. The additional capacity
exists because such policy exposures are spread among the pool participants
which each have their own capital and surplus.

         In addition to the underwriting pool, through the retrocessional
reinsurance agreements with each of Southern, Delaware Atlantic and Pioneer, the
Mutual Company agreed to reinsure each Affiliate in respect of 100% of the net
liability that may accrue to such Affiliate from its insurance operations and
retrocede 100% of the net liability back to each Affiliate, which the Affiliate
assumes as part of the retrocession.

DGI's Business Strategy

         DGI, in conjunction with the Mutual Company, has multiple strategies
which the management of DGI believes have resulted in underwriting results that
are favorable when compared to those of the property and casualty insurance
industry in general over the past five years. The principal strategies comprise
the following:

          o       A regional company concept designed to provide the
                  advantages of local marketing, underwriting and
                  claims servicing with the economies of scale from
                  centralized accounting, administrative, investment,
                  data processing and other services.

          o       An underwriting program and product mix designed to
                  produce a Company-wide underwriting profit, i.e., a
                  combined ratio of less than 100%, from careful risk
                  selection and adequate pricing.

          o       A goal of a closely balanced ratio between commercial
                  business and personal business.

          o       An agent selection process that focuses on appointing
                  agencies with proven market strategies for the
                  development of profitable business and an agent
                  compensation plan providing for additional
                  commissions based

                                       -4-

                  upon premium volume and profitability and the right
                  to participate in the Company's Agency Stock Purchase
                  Plan.

          o       Gradual expansion into adjacent states, including
                  Indiana, New York, Tennessee and North Carolina.

          o       A continuing effort to attract and retain qualified
                  employees who receive incentive compensation based
                  upon historical results.

Property and Casualty Insurance Products and Services

         The following table indicates the percentage of DGI's net premiums
written represented by commercial lines and by personal lines for the years
ended December 31, 1997, 1996 and 1995:

                                                Year Ended December 31,
                                       -------------------------------------
                                       1997             1996           1995
                                       -----            -----         -----
Net Premiums Written:
    Commercial.....................    41.0%            44.3%         45.5%
    Personal.......................    59.0%            55.7%         54.5%

         The commercial lines consist primarily of automobile, multi-peril and
workers' compensation insurance. The personal lines consist primarily of
automobile and homeowners insurance. These types of insurance are described in
greater detail below:

         Commercial

              o     Commercial automobile -- policies that provide
                    protection against liability for bodily injury and
                    property damage arising from automobile accidents,
                    and provide protection against loss from damage to
                    automobiles owned by the insured.

              o     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.

              o     Commercial multi-peril -- policies that provide
                    protection to businesses against many perils, usually
                    combining liability and physical damage coverages.

                                       -5-

         Personal

              o     Private passenger automobile -- policies that provide
                    protection against liability for bodily injury and
                    property damage arising from automobile accidents,
                    and provide protection against loss from damage to
                    automobiles owned by the insured.

              o     Homeowners -- policies that provide coverage for
                    damage to residences and their contents from a broad
                    range of perils, including, fire, lightning,
                    windstorm and theft. These policies also cover
                    liability of the insured arising from injury to other
                    persons or their property while on the insured's
                    property and under other specified conditions.

         The following table sets forth the combined ratios of DGI, prepared in
accordance with generally accepted accounting principles and statutory
accounting principles prescribed or permitted by state insurance authorities.
The combined ratio is a traditional measure of underwriting profitability. When
the combined ratio is under 100%, underwriting results are generally considered
profitable. Conversely, when the combined ratio is over 100%, underwriting
results are generally considered unprofitable. The combined ratio does not
reflect investment income, federal income taxes or other non-operating income
or expense. DGI's operating income depends on income from both underwriting
operations and investments.

                                                                     Year Ended December 31,
                                                               ---------------------------------
                                                                1997          1996          1995
                                                               ------        ------        ------
                                                                                 
GAAP Combined Ratio.....................................        97.6%        100.4%         98.6%
Statutory operating ratios:
         Loss ratio.....................................        64.0          68.4          66.3
         Expense ratio..................................        34.0          31.1          31.9
         Dividend ratio.................................         1.2           1.5           1.2
         Statutory combined ratio.......................        99.2%        101.0%         99.4%
                                                               =====        ======         =====
         Industry statutory combined ratio..............       101.6(1)      107.0(1)      105.0(2)
                                                               =====        ======         =====

- --------------

(1)    Source:  A.M. Best Co.
(2)    Source:  Insurance Information Institute

         DGI is required to participate in involuntary insurance programs for
automobile insurance, as well as other property and casualty insurance lines, in
states in which DGI operates. 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. Generally, state law

                                       -6-

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 in the voluntary market. The
impact of these involuntary programs on DGI has been immaterial.

         The following table sets forth the net premiums written and combined
ratios by line of insurance for the business of DGI, prepared in accordance with
statutory accounting practices prescribed or permitted by state insurance
authorities, for the periods indicated.

                                             Year Ended December 31,
                                      -------------------------------------
                                        1997           1996           1995
                                      --------       --------       -------
                                             (dollars in thousands)
Net Premiums Written:
Commercial:
  Automobile .....................    $ 10,522       $ 10,149       $ 8,306
  Workers' compensation ..........      15,590         17,998        17,661
  Commercial multi-peril .........      16,357         17,153        14,775
  Other ..........................       1,612          3,127         2,813
                                      --------       --------       -------
    Total commercial .............      44,081         48,427        43,555
                                      --------       --------       -------

Personal:
  Automobile .....................      38,989         37,739        32,330
  Homeowners .....................      19,939         18,979        15,961
  Other ..........................       4,597          4,070         3,938
                                                                    -------
    Total personal ...............      63,525         60,788        52,229
                                      --------       --------       -------
Total business ...................    $107,606       $109,215       $95,784
                                      ========       ========       =======

Statutory Combined Ratios:
Commercial:
  Automobile .....................        89.9%          97.6%         92.9%
  Workers compensation ...........        89.5           67.2          77.0
  Commercial multi-peril .........       103.0          106.4         109.3
  Other ..........................        57.7           42.8          77.2
    Total commercial .............        93.5           86.5          92.9

Personal:
  Automobile .....................        98.7%         100.7%        100.1%
  Homeowners .....................       116.4          139.1         119.3
  Other ..........................        87.6          109.6         108.5
    Total personal ...............       103.4          112.7         106.3

Total business ...................        99.2          101.0          99.4%

Property and Casualty Underwriting

         The underwriting department is responsible for the establishment of
underwriting and risk selection guidelines and criteria for the various
insurance products written by DGI. The underwriting department, in conjunction
with the marketing representatives, works closely

                                       -7-

with DGI's independent agents to insure a comprehensive knowledge on the part of
the agents of DGI's underwriting requirements and risk selection process.

         DGI's underwriting and pricing strategy is designed to produce an
underwriting profit resulting in a Company-wide combined ratio below 100%. DGI
and the Mutual Company have a conservative underwriting philosophy, which, in
the opinion of management, is one of the prime reasons for DGI's favorable loss
ratios relative to the property and casualty insurance industry over the last
five years.

         The underwriting department has over time initiated risk inspection
procedures and underwriting analysis on a per risk and class of business basis.
It has also automated underwriting processing utilizing technology such as bar
coding. Management has established monitoring and auditing processes to verify
compliance with underwriting requirements and procedures.

         The underwriting department and the research and development section
are responsible for the development of new insurance products and enhancements
of existing products. Underwriting profitability is enhanced by the creation of
niche products focused on classes of business which traditionally have provided
underwriting profits.

Marketing

         DGI's insurance products, together with the products of the Mutual
Company and their respective subsidiaries, are marketed through approximately
2,300 independent insurance agents associated with approximately 700 insurance
agencies. Business is written by either DGI or the Mutual Company depending upon
geographic location, agency license and product. Management has developed an
agency appointment procedure that focuses on appointing agencies with proven
marketing strategies for the development of profitable business. DGI regularly
evaluates its agency force and continues to strive to obtain and retain a
significant position within each agency relative to the amount of business
similar to that of DGI placed by the agency with other insurers. DGI and the
Mutual Company have developed a successful 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 written by DGI and
the Mutual Company. Management believes the contingent commission program and
the Company's Agency Stock Purchase Plan have enhanced the ability of DGI and
the Mutual Company to write profitable business.

         DGI has granted certain agents the authority to bind insurance within
underwriting and pricing limits specified by DGI without the prior approval of
DGI. However, DGI generally reviews all coverages placed by its agents and,
subject to applicable insurance regulations, may cancel the coverage if it is
inconsistent with DGI's guidelines.

         DGI believes that its regional structure enables it to compete
effectively with large national companies. This regional structure permits DGI
to take advantage of its knowledge

                                       -8-

of local operating territories and the opportunity to form strong, long-term
relationships with the agents that represent DGI and the Mutual Company.

         DGI and the Mutual Company have developed comprehensive growth
strategies for each of the commercial and personal lines of insurance business.
DGI has focused on the small- to medium-sized commercial insurance markets,
which have traditionally been a stable and profitable segment of the property
and casualty insurance business. Commercial lines marketing is characterized by
account selling, in which multiple lines of insurance are offered to a single
policyholder.

         DGI believes that competitive and comprehensive products targeted to
selected classes of personal lines business, along with excellent service to
agents and policyholders, will provide growth with profitability. As is
customary in the industry, insureds are encouraged to place both their
homeowners and personal automobile insurance with DGI or the Mutual Company and
are offered a discount for doing so.

Claims

         The claims department develops and implements policies and procedures
for the establishment of claim reserves and the timely resolution and payment of
claims. The management and staff of the department resolve policy coverage
issues, manage and process reinsurance recoveries and handle salvage and
subrogation matters.

         Insurance claims are normally investigated and adjusted by internal
claims adjusters and supervisory personnel. Independent adjusters are employed
as needed to handle claims in territories in which the volume of claims is not
sufficient to justify hiring internal claims adjusters. The litigation and
personal injury sections manage all claims litigation, and all claims above
$25,000 require home office review and settlement authorization.

         Field office staffs are supported by home office technical, litigation,
material damage, subrogation and medical audit personnel who provide specialized
claims support. An investigative unit attempts to prevent fraud and abuse and to
control losses.

Liabilities for Losses and Loss Expenses

         Liabilities for losses and loss expenses are estimates at a given point
in time of what the insurer expects to pay to claimants, based on facts and
circumstances then known, and it can be expected that the ultimate liability
will exceed or be less than such estimates. Liabilities are based on estimates
of future trends and claims severity, judicial theories of liability and other
factors. However, during the loss adjustment period, additional facts regarding
individual claims may become known, and consequently it often becomes necessary
to refine and adjust the estimates of liability. Any adjustments are reflected
in operating results in the year in which the changes are made.

                                       -9-

         DGI maintains 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. The amount of
liability for reported losses is primarily based upon a case-by-case evaluation
of the type of risk involved and knowledge of the circumstances surrounding each
claim and the insurance policy provisions relating to the type of loss. The
amount of liability for unreported claims and loss expenses is determined on the
basis of historical information by line of insurance. Inflation is implicitly
provided for in the reserving function through analysis of costs, trends and
reviews of historical reserving results. Liabilities are closely monitored and
are recomputed periodically by the Company and the Mutual Company using new
information on reported claims and a variety of statistical techniques.
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 DGI's loss and loss expenses and have an adverse effect on DGI's results
of operations and financial condition. As is the case for virtually all property
and casualty insurance companies, DGI has found it necessary in the past to
revise in non-material amounts estimated future liabilities for losses and loss
expenses, and further adjustments could be required in the future. However, on
the basis of DGI's internal procedures, which analyze, among other things, DGI's
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, management of DGI believes
that adequate provision has been made for DGI's liability for loss and loss
expenses.

         Differences between liabilities reported in DGI's financial statements
prepared on the basis of generally accepted accounting principles and financial
statements prepared on a statutory accounting basis result from reducing
statutory liabilities for anticipated salvage and subrogation recoveries. These
differences amounted to $6,155,467, $5,170,486 and $4,103,285 at December 31,
1997, 1996 and 1995, respectively.

                                      -10-

         The following tables set forth a reconciliation of the beginning and
ending net liability for unpaid losses and loss expenses for the periods
indicated on a GAAP basis for the Company.

                                                  Year Ended December 31,
                                          -------------------------------------
                                            1997           1996           1995
                                          -------        -------        -------
                                                      (in thousands)
Net liability for unpaid losses
  and loss expenses at
  beginning of year ...............       $75,428        $71,155        $63,317
                                          -------        -------        -------
Provision for net losses and
  loss expenses for claims
  incurred in the current year ....        69,040         73,212         61,163
Increase (decrease) in provision
  for estimated net losses and loss
  expenses for claims
  incurred in prior years .........        (1,384)        (2,791)        (3,093)
                                          -------        -------        -------

Total incurred ....................        67,656         70,421         58,070
Net losses and loss payments
  for claims incurred during:
The current year ..................        39,133         42,669         30,832
Prior years .......................        26,477         23,479         19,400
                                          -------        -------        -------

Total paid ........................        65,610         66,148         50,232

Net liability for unpaid losses
  and loss expenses at
  end of year .....................       $77,474        $75,428        $71,155
                                          =======        =======        =======

         The following table sets forth the development of the liability for net
unpaid losses and loss expenses for DGI on a GAAP basis from 1987 (the first
full year of DGI's operations) to 1997, with supplemental loss data for 1997 and
1996.

         "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 "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 1990 liability has developed an excess after
seven years, in that reestimated net losses and loss expenses are expected to be
less than the estimated liability initially established in 1990 of $31,898 by
$2,481.

                                      -11-

         The "Cumulative deficiency (excess)" shows the cumulative deficiency or
excess at December 31, 1997 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
1990 column indicates that as of December 31, 1997, payments equal to $28,627 of
the currently reestimated ultimate liability for net losses and loss expenses of
$29,417 had been made.

                                      -12-

                                                                          Year Ended December 31
                                                 --------------------------------------------------------------------------
                                                   1987         1988         1989         1990         1991         1992   
                                                 -------      -------      -------      -------      -------      -------  
                                                                               (in thousands)
                                                                                                      
Net liability at end of
 year for unpaid losses
 and loss expenses...........................    $11,878      $20,734      $27,767      $31,898      $36,194      $44,339  
 Net liability
  reestimated as of:
   One year later............................     12,678       21,598       29,175       32,923       37,514       45,408  
   Two years later...........................     12,949       20,475       28,861       33,550       37,765       42,752  
   Three years later.........................     12,692       19,823       28,545       32,803       35,446       40,693  
   Four years later..........................     12,160       19,296       27,717       31,004       33,931       38,375  
   Five years later..........................     11,799       18,796       26,759       30,041       32,907       37,096
   Six years later...........................     11,857       18,457       26,180       29,595       32,234
   Seven years later.........................     11,782       18,189       25,971       29,417
   Eight years later.........................     11,722       18,117       25,828
   Nine years later..........................     11,655       18,050
   Ten years later...........................     11,611
Cumulative deficiency
   (excess)..................................    $  (267)     $(2,684)     $(1,939)     $(2,481)     $(3,960)     $(7,243) 
                                                 =======      =======      =======      =======      =======      =======  

Cumulative amount of liability paid through:
  One year later.............................    $ 5,891      $ 8,855      $11,401      $13,003      $13,519       16,579  
  Two years later............................      8,472       12,280       17,421       19,795       20,942       24,546  
  Three years later..........................      9,988       14,912       20,986       24,178       25,308       29,385  
  Four years later...........................     10,774       16,292       23,268       26,413       27,826       32,925  
  Five years later...........................     11,209       17,201       24,331       27,439       29,605       34,757
  Six years later............................     11,388       17,706       24,909       28,157       30,719
  Seven years later..........................     11,484       17,782       25,280       28,627
  Eight years later..........................     11,544       17,884       25,599
  Nine years later...........................     11,563       17,986
  Ten years later............................     11,594

                                                                   Year Ended December 31
                                                 ------------------------------------------------------
                                                   1993         1994         1995       1996       1997
                                                 --------      -------      -------    -------    ------
                                                                        (in thousands)
                                                                                       
Net liability at end of
 year for unpaid losses
 and loss expenses...........................    $ 52,790      $63,317      $71,155    $75,428    $77,474
 Net liability
  reestimated as of:
   One year later............................      50,583       60,227       68,348     74,044
   Two years later...........................      48,132       56,656       66,520
   Three years later.........................      44,956       54,571
   Four years later..........................      42,157
   Five years later..........................    
   Six years later...........................    
   Seven years later.........................    
   Eight years later.........................    
   Nine years later..........................    
   Ten years later...........................    
Cumulative deficiency
   (excess)..................................    $(10,633)     $(8,746)     $(4,635)   $(1,384)
                                                 ========      =======      =======    =======

Cumulative amount of liability paid through:
  One year later.............................     16,126        19,401       23,479     26,477
  Two years later............................     25,393        30,354       37,078
  Three years later..........................     32,079        38,684
  Four years later...........................     36,726
  Five years later...........................    
  Six years later............................    
  Seven years later..........................    
  Eight years later..........................    
  Nine years later...........................    
  Ten years later............................    

                                                                          Year Ended December 31
                                                ---------------------------------------------------------------------
                                                  1992          1993         1994        1995       1996       1997
                                                -------       -------      -------      -------   --------   --------
                                                                              (in thousands)
                                                                                                
Gross liability at end of year..............    $57,777       $70,093      $88,484      $98,894   $114,622   $118,112
Reinsurance recoverable.....................     13,438        17,303       25,167       27,739     39,194     40,638
Net liability at end of year................     44,339        52,790       63,317       71,155     75,428     77,474
Gross reestimated liability -- latest.......     59,122        58,183       78,823       93,611    113,559
Reestimated recoverable -- latest...........     22,026        16,026       24,252       27,091     39,515
Net reestimated liability -- latest.........     37,096        42,157       54,571       66,520     74,044
Gross cumulative deficiency (excess)........      1,345       (11,910)      (9,661)      (5,283)    (1,063)

                                      -13-

Reinsurance

         DGI and the Mutual Company use several different reinsurers, all of
which have a Best rating of A- or better or, with respect to foreign reinsurers,
have a financial condition which, in the opinion of management, is equivalent to
a company with at least an A- rating.

         The external reinsurance purchased by DGI and the Mutual Company
includes "excess treaty reinsurance" under which losses are automatically
reinsured over a set retention ($250,000 for 1997) and "catastrophic
reinsurance" under which the reinsured recovers 90% of an accumulation of many
losses resulting from a single event, including natural disasters (for 1997,
$3,000,000 retention), DGI's principal reinsurance agreement, other than that
with the Mutual Company, is an excess of loss treaty in which the reinsurers are
Continental Casualty Company, Employers Reinsurance Corporation and Dorinco
Reinsurance Company. Reinsurance is also purchased on an individual policy
basis to reinsure losses that may occur from large risks, specific risk types or
specific locations. 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. For property insurance, excess of loss treaties provide for coverage
up to $1,000,000. For liability insurance, excess of loss treaties provide for
coverage up to $30,000,000. Property catastrophe contracts provide coverage up
to $50,000,000 resulting from one event. On both property and casualty
insurance, DGI and the Mutual Company purchase facultative reinsurance to cover
exposures from losses that exceed the limits provided by their respective treaty
reinsurance. In addition, the Company and the Mutual Company maintain various
reinsurance agreements between themselves in addition to the pooling agreement.
Atlantic States and the Mutual Company have a catastrophe reinsurance agreement
which limits the maximum liability for losses from any one catastrophe
occurrence to $400,000 for Atlantic States and $700,000 for a catastrophe
involving more than one of the Company's subsidiaries. Southern and the Mutual
Company have an excess of loss reinsurance agreement in which the Mutual Company
assumes up to $150,000 of losses in excess of $100,000. Southern and the Mutual
Company also have a catastrophe reinsurance agreement which limits Southern's
liability to $300,000 from any one catastrophe occurrence. Delaware Atlantic and
the Mutual Company have an excess of loss reinsurance agreement in which the
Mutual Company assumes up to $200,000 for losses in excess of $50,000. Delaware
Atlantic and the Mutual Company also have a catastrophe reinsurance agreement
which limits Delaware Atlantic's liability to $300,000 from any one catastrophe
occurrence. Delaware Atlantic and the Mutual Company also have a reinsurance
agreement whereby Delaware Atlantic cedes 70% of its workers' compensation
business to the Mutual Company. Pioneer and the Mutual Company have an excess of
loss reinsurance agreement in which the Mutual Company assumes up to $200,000
for losses in excess of $50,000. Each of Southern, Delaware Atlantic and Pioneer
also have a retrocessional reinsurance agreement with the Mutual Company whereby
the Mutual Company indemnifies each of these companies in respect of 100% of the
net liability that may accrue to such companies from its insurance operations
and retrocedes 100% of the net liability back to each such company, which each
such company assumes as part of the retrocession.

                                      -14-

Competition

         The property and casualty insurance industry is highly competitive on
the basis of both price and service. There are numerous companies competing for
this business in the geographic areas where the Company operates, many of which
are substantially larger and have greater financial resources than DGI, and no
single company dominates. In addition, because the insurance products of DGI and
the Mutual Company are marketed exclusively through independent insurance
agencies, most of which represent more than one company, DGI faces competition
to retain qualified independent agencies, as well as competition within
agencies.

Investments

         DGI's return on invested assets is an important element of its
financial results. Currently, the investment objective is to maintain a widely
diversified fixed maturities portfolio structured to maximize after-tax
investment income while minimizing credit risk through investments in high
quality instruments. At December 31, 1997, all debt securities were rated
investment grade with the exception of one unrated obligation of $250,000, and
the investment portfolio did not contain any mortgage loans or any
non-performing assets.

         The following table shows the composition of the debt securities
investment portfolio (at carrying value), excluding short-term investments, by
rating as of December 31, 1997:

                                                          December 31, 1997
                                                     ---------------------------
Rating(1)                                             Amount             Percent
- ---------                                            --------            -------
                                                        (dollars in thousands)
U.S. Treasury and U.S.
   agency securities(2)                              $ 94,301              53.9%
Aaa or AAA...................................          45,392              25.9
Aa or AA.....................................          25,380              14.5
A............................................           9,796               5.6
BBB..........................................              98               0.1
Not rated(3).................................              10                --
                                                     --------             -----
     Total...................................        $174,977             100.0%
                                                     ========             =====
- ----------
(1)      Ratings assigned by Moody's Investors Services, Inc. or Standard &
         Poor's Corporation.

(2)      Includes mortgage-backed securities of $12,445.

                                      -15-

(3)      Represents one unrated obligation of The Lancaster County Hospital
         Authority Mennonite Home Project, which management of DGI believes to
         be equivalent to investment grade securities with respect to repayment
         risk.

         DGI invests in both taxable and tax-exempt securities as part of its
strategy to maximize after-tax income. Such strategy considers, among other
factors, the alternative minimum tax. Tax-exempt securities made up
approximately 34.3%, 36.4% and 37.8% of the total investment portfolio at
December 31, 1997, 1996 and 1995, respectively.

                                      -16-

                  The following table shows the classification of the
investments (at carrying value) of DGI and its subsidiaries at December 31,
1997, 1996 and 1995.

                                                                         December 31,
                                         --------------------------------------------------------------------------
                                                  1997                       1996                     1995
                                         ----------------------     ---------------------     ---------------------
                                                        Percent                   Percent                   Percent
                                                          of                        of                        of
                                          Amount         Total       Amount        Total       Amount        Total
                                         --------       -------     --------      -------     --------      -------
                                                                   (dollars in thousands)
                                                                                              
Fixed maturities(1):
 Held to maturity:
 U.S. Treasury securities
 and obligations of U.S. 
 government corporations
 and agencies .....................      $ 41,450         20.2%    $ 38,647         20.1%    $ 20,580         12.2%
Obligations of states and
 political subdivisions ...........        57,621         28.1       57,095         29.6       53,186         31.6
Corporate securities ..............         7,250          3.5        5,917          3.1        4,266          2.6
Mortgage-backed
 securities .......................        10,925          5.4       12,680          6.6       16,655          9.9
                                         --------        -----     --------        -----     --------        -----
  Total held to
  maturity ........................       117,246         57.2      114,339         59.4       94,687         56.3
                                         --------        -----     --------        -----     --------        -----
Available for sale:
 U.S. treasury securities
 and obligations of U.S. 
 government corporations
 and agencies .....................        40,197         19.6       35,507         18.4       37,775         22.5
Obligations of states and political
 subdivisions .....................        12,762          6.2       12,987          6.8       10,427          6.2
Corporate securities ..............         3,252          1.6        3,436          1.8        4,711          2.8
Mortgage-backed
 securities .......................         1,520          0.8        1,606          0.8        2,265          1.3
                                         --------        -----     --------        -----     --------        -----
  Total available for sale ........        57,731         28.2       53,536         27.8       55,178         32.8
                                         --------        -----     --------        -----     --------        -----
  Total fixed maturities ..........       174,977         85.4      167,875         87.2      149,865         89.1
  Equity securities(2) ............         7,275          3.5        3,143          1.6        3,272          1.9
  Short-term investments(3) .......        22,713         11.1       21,471         11.2       15,079          9.0
                                         --------        -----     --------        -----     --------        -----
  Total investments ...............      $204,965        100.0%    $192,489        100.0%    $168,216        100.0%
                                         ========        =====     ========        =====     ========        =====

                                      -17-

(1)      The Company accounts for its 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 held to maturity are valued at amortized cost;
         those fixed maturities available for sale are valued at fair value.
         Total fair value of fixed maturities held to maturity was $120,882,886
         at December 31, 1997. The amortized cost of fixed maturities available
         for sale was $56,922,342 at December 31, 1997.

(2)      Equity securities are valued at fair value. Total cost of equity
         securities was $6,551,020 at December 31, 1997, $2,774,946 at December
         31, 1996 and $2,959,087 at December 31, 1995.

(3)      Short-term investments are valued at cost, which approximates market.

         The following table sets forth the maturities (at carrying value) in
the fixed maturity and short-term investment portfolio at December 31, 1997,
December 31, 1996 and December 31, 1995.

                                                             December 31,
                            -----------------------------------------------------------------------------
                                      1997                      1996                       1995
                            -----------------------    -----------------------    -----------------------
                                            Percent                    Percent                    Percent
                                              of                         of                         of
                             Amount          Total      Amount          Total      Amount          Total
                            --------       --------    -------         -------    --------        -------
                                                       (dollars in thousands)
                                                                                    
Due in:(1)
One year or less .....        36,013          18.2%    $ 34,836          18.4%    $ 35,374          21.5%
Over one year
 through three years .        30,910          15.6       26,392          13.9       21,184          12.8
Over three years
 through five years ..        20,303          10.3       21,163          11.2       10,537           6.4
Over five years
 through ten years ...        65,122          32.9       45,370          24.0       36,620          22.2
Over ten years
 through fifteen years        32,384          16.4       46,248          24.4       40,123          24.3
Over fifteen years ...           513           0.3        1,051           0.6        2,185           1.3
Mortgage-backed
 securities ..........        12,445           6.3       14,286           7.5       18,921          11.5
                            --------         -----     --------         -----     --------         -----
                            $197,690         100.0%    $189,346         100.0%    $164,944         100.0%
                            ========         =====     ========         =====     ========         =====

- ----------
(1)      Based on stated maturity dates with no prepayment assumptions. Actual
         maturities will differ because borrowers may have the right to call or
         prepay obligations with or without call or prepayment penalties.

         As shown above, the Company held investments in mortgage-backed
securities having a carrying value of $12,445,321 at December 31, 1997. Included
in these investments are collateralized mortgage obligations ("CMOs") with a
carrying value of $11,931,721 at December 31, 1997. The Company has attempted to
reduce the prepayment risks associated with mortgage-backed securities by
investing approximately 99%, as of December 31, 1997,

                                      -18-

of the Company's holdings of CMOs in planned amortization and very accurately
defined tranches. Such investments are designed to alleviate the risk of
prepayment by providing predictable principal prepayment schedules within a
designated range of prepayments. If principal is repaid earlier than originally
anticipated, investment yields may decrease due to reinvestment of the proceeds
at lower current interest rates and capital gains or losses may be realized
since the book value of securities purchased at premiums or discounts may be
different from the prepayment amount.

         Investment results of DGI and its subsidiaries for the years ended
December 31, 1997, 1996 and 1995 are shown in the following table:

                                                 Year Ended December 31,
                                          -------------------------------------
                                            1997          1996           1995
                                          --------      --------       --------
                                                  (dollars in thousands)
Invested assets(1)......................  $202,283      $183,401       $161,901
Investment income(2)....................    11,507        10,799          9,714
Average yield...........................       5.7%          5.9%           6.0%

- ----------

(1)      Average of the aggregate invested amounts at the beginning and end of
         the period, including cash.

(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

         In 1997, the Best rating of the Mutual Company, Atlantic States,
Southern, Delaware Atlantic and Pioneer was "A", based upon their respective
current financial conditions and historical statutory results of operations.
Management believes that this Best rating is an important factor in marketing
DGI's products to its agents and customers. 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. 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). Best's ratings are based
upon factors relevant to policyholders and are not directed toward the
protection of investors. According to Best, an "excellent" rating is assigned to
those companies which, in 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 relates
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 which delegate regulatory, supervisory and administrative
authority to state insurance departments. Accordingly, the authority of the
state insurance departments includes the establishment of standards of solvency
which must be met

                                      -19-

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 which 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, in
December 1993 the National Association of Insurance Commissioners (the "NAIC")
adopted a risk-based capital system for assessing the adequacy of statutory
capital and surplus which augments the states' current fixed dollar minimum
capital requirements for insurance companies. At December 31, 1997, DGI exceeded
the required levels of capital. There can be no assurance that the capital
requirements applicable to DGI's business will not increase in the future.

         The states in which Atlantic States (Pennsylvania, Maryland and
Delaware), the Mutual Company (Pennsylvania, Ohio, Maryland, New York, Virginia,
Delaware and North Carolina), Southern (Virginia and Pennsylvania), Delaware
Atlantic (Delaware, Maryland and Pennsylvania) and Pioneer (Ohio and
Pennsylvania) do business have guaranty fund laws under which insurers doing
business in such states 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. The
Mutual Company, Atlantic States, Southern, Delaware Atlantic and Pioneer have
made accruals for their portion of assessments related to such insolvencies
based upon the most current information furnished by the guaranty associations.
During the five years ended December 31, 1997, the amount of such insolvency
assessments paid by Atlantic States, Southern, the Mutual Company, Delaware
Atlantic and Pioneer was not material.

         The property and casualty insurance industry has recently received a
considerable amount of publicity because of rising insurance costs and the
unavailability of insurance. New regulations and legislation are being proposed
to limit damage awards, to control plaintiffs' counsel fees, to bring the
industry under regulation by the federal government and to control premiums,
policy terminations and other policy terms. It is not possible to predict
whether, in what form or in what jurisdictions any of these proposals might be
adopted or the effect thereof, if any, on the 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 the Mutual Company, the
Company and their respective insurance subsidiaries 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.

                                      -20-

         All transactions within the holding company system affecting the Mutual
Company and the Company's insurance subsidiaries must be fair and equitable.
Approval of the applicable insurance commissioner is 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 is presumed to be
a change in control. These 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.

         The Company's 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 the Company 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 a certain date, or the net income or net investment income not
including realized capital gains of the subsidiary for the preceding year. As of
December 31, 1997, amounts available for payment of dividends in 1997 without
the prior approval of the various insurance commissioners were $7,349,284 from
Atlantic States, $703,727 from Southern, $1,070,463 from Delaware Atlantic and
$542,799 from Pioneer. See Note 11 to the Consolidated Financial Statements
incorporated by reference herein.

The Mutual Company

         The Mutual Company, which was organized in 1889, has a Best rating of A
(Excellent). At December 31, 1997, the Mutual Company had admitted assets of
$185 million and policyholders' surplus of $101 million. At December 31, 1997,
the Mutual Company had no debt and, of its total liabilities of $83 million,
reserves for net losses and loss expenses accounted for $46 million and unearned
premiums accounted for $21 million. Of the Mutual Company's investment portfolio
of $138 million at December 31, 1997, investment-grade bonds accounted for $42
million, cash and short-term investments accounted for $7 million and mortgages
accounted for $7 million. At December 31, 1997, the Mutual Company owned
3,512,356 shares of the Company's Common Stock, which were carried on the Mutual
Company's books at $78 million. The foregoing financial information is
presented on the statutory basis of accounting.

Employees

         As of December 31, 1997, the Mutual Company had 376 employees. The
Mutual Company's employees provide a variety of services to DGI, Atlantic
States, Delaware Atlantic, Southern and Pioneer as well as to the Mutual Company
and its subsidiaries.

Item 2. Properties.

         DGI shares headquarters with the Mutual Company in a building owned by
the Mutual Company. The Mutual Company charges DGI for an appropriate portion of
the building expenses under an intercompany allocation agreement which is
consistent with the terms of the pooling agreement. The headquarters of the
Mutual Company have approximately 140,000 square feet of office space. Southern
has a facility of approximately 10,000 square feet in Glen Allen, Virginia which
it owns. Delaware Atlantic has a facility of approximately 2,800 square feet in
Wilmington, Delaware which it leases. Pioneer has a facility of approximately
8,000 square feet in Greenville, Ohio which it owns.

                                       21

Item 3. Legal Proceedings.

         DGI is a party to numerous lawsuits arising in the ordinary course of
its insurance business. DGI believes that the resolution of these lawsuits will
not have a material adverse effect on its 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 the Company's Common
Stock during the fourth quarter of 1997.

Executive Officers of the Company

      Name                 Age                    Position
      ----                 ---                    --------
                                
Donald H. Nikolaus         55        President and Chief Executive Officer since 1981

Ralph G. Spontak           45        Senior Vice President since 1991; Chief Financial Officer
                                     and Vice President since 1983; Secretary since 1988

Cyril J. Greenya           53        Senior Vice President - Commercial Underwriting since
                                     1997; Vice President - Commercial Underwriting for five
                                     years prior thereto; Manager - Commercial Underwriting
                                     for nine years prior thereto

Frank J. Wood              64        Senior Vice President - Marketing since 1997; Vice-President -
                                     Marketing for nine years prior thereto; Manager -
                                     Marketing for one year prior thereto

James B. Price             62        Senior Vice President - Claims since 1997; Vice President -
                                     Claims for 25 years prior thereto

Robert G. Shenk            45        Senior Vice President - Claims since 1997; Vice President -
                                     Claims for five years prior thereto

William H. Shupert         71        Senior Vice President - Underwriting since 1991; Vice
                                     President - Underwriting for 18 years prior thereto

Daniel J. Wagner           37        Treasurer since 1993; Controller for five years prior
                                     thereto

                                      -22-

                                     PART II

Item 5. Market for the Registrant's Common Equity and Related Stockholder
        Matters.

         The answer to this Item is incorporated in part by reference to page 29
of the Company's Annual Report to Stockholders for the year ended December 31,
1997, which is included as Exhibit (13) to this Form 10-K Report. As of March
17, 1998, the Company had approximately 480 holders of record of its Common
Stock. The Company declared dividends of $.33 per share in 1996 and $.39 per
share in 1997.

Item 6. Selected Financial Data.

         The answer to this Item is incorporated by reference to page 1 of the
Company's Annual Report to Stockholders for the year ended December 31, 1997,
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 answer to this Item is incorporated by reference to pages 10
through 12 of the Company's Annual Report to Stockholders for the year ended
December 31, 1997, which is included as Exhibit (13) to this Form 10-K Report.

Item 8. Financial Statements and Supplementary Data.

         The answer to this Item is incorporated by reference to pages 13
through 26 of the Company's Annual Report to Stockholders for the year ended
December 31, 1997, 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.

                                      -23-

                                    PART III

Item 10. Directors and Executive Officers of the Company.

         The answer to this Item with respect to the Company's directors is
incorporated by reference to pages 5 through 8 of the Company's proxy statement
relating to the Company's annual meeting of stockholders to be held April 16,
1998. The response to this Item with respect to the Company's executive officers
is incorporated by reference to Part I of this Form 10-K Report.

Item 11. Executive Compensation.

         The answer to this Item is incorporated by reference to pages 9 through
14 of the Company's proxy statement relating to the Company's annual meeting of
stockholders to be held April 16, 1998, except for the Compensation Committee
Report and the Performance Graph, which are not incorporated herein by
reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management.

         The answer to this Item is incorporated by reference to pages 2 through
3 of the Company's proxy statement relating to the Company's annual meeting of
stockholders to be held April 16, 1998.

Item 13. Certain Relationships and Related Transactions.

         The answer to this Item is incorporated by reference to pages 3 through
5 and page 14 of the Company's proxy statement relating to the Company's annual
meeting of stockholders to be held April 16, 1998.

                                      -24-

                                     PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.

         (a) Financial statements, financial statement schedules and exhibits
filed:

         (1) Consolidated Financial Statements
                                                                          Page*
                                                                          -----

         Report of Independent Auditors ..................................   27

         Donegal Group Inc. and Subsidiaries:
          Consolidated Balance Sheets as of
            December 31, 1997 and 1996 ...................................   13
          Consolidated Statements of Income
            for the three years ended
            December 31, 1997, 1996 and 1995 .............................   14
          Consolidated Statements of Stockholders'
            Equity for the three years ended
            December 31, 1997, 1996 and 1995..............................   15
          Consolidated Statements of Cash Flows
            for the three years ended
            December 31, 1997, 1996 and 1995..............................   16
          Notes to Consolidated Financial Statements......................17-26

         (2)    Financial Statement Schedules

                                                                           Page
                                                                           ----
         Donegal Group Inc. and Subsidiaries:

         Report of Independent Auditors on Schedules......................   30
         Schedule I.            Summary of Investments - Other
                                than Investments in Related
                                Parties...................................   31
        Schedule II.            Condensed Financial Information
                                of Parent Company.........................   33
        Schedule III.           Supplementary Insurance
                                Information...............................   34
        Schedule IV.            Reinsurance...............................   36
        Schedule VI.            Supplemental Insurance Information
                                Concerning Property and Casualty
                                Subsidiary................................   37

         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 the respective page of Donegal Group Inc.'s 1997 Annual
         Report to Stockholders. The Consolidated Financial Statements and
         Notes to Consolidated Financial Statements

                                      -25-

and Auditor's Report thereon on pages 13 through 27 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, 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 Securities Exchange Act of 1934.

        (3)    Exhibits

Exhibit No.     Description of Exhibits                                Reference
- -----------     -----------------------                                ---------

(3)(i)     Certificate of Incorporation of                                (a)
           Registrant

(3)(ii)    Amended and Restated By-laws of                                (b)
           Registrant

(4)        Form of Registrant's Common Stock                              (a)
           Certificate

Management Contracts and Compensatory Plans or Arrangements

(10)(A)    Donegal Mutual Insurance Company                               (a)
           Money Purchase Pension Plan and
           Trust dated March 12, 1985

(10)(B)    Donegal Mutual Insurance Company                               (a)
           Profit Sharing Plan and Trust
           dated March 12, 1985

(10)(C)    Donegal Group Inc. Key Executive                               (c)
           Incentive Bonus Plan dated
           September 29, 1986

(10)(D)    Donegal Group Inc. Employee Stock                              (c)
           Purchase Plan, as amended

(10)(E)    Donegal Group Inc. Equity Incentive                            (c)
           Plan, as amended

(10)(F)    Donegal Group Inc. Agency                                      (j)
           Stock Purchase Plan

(10)(G)    Donegal Group Inc. Amended and                                 (b)
           Restated 1996 Equity Incentive
           Plan

(10)(H)    Donegal Group Inc. Amended                             filed herewith
           and Restated 1996 Equity Incentive
           Plan for Directors

                                      -26-

(10)(I)    Donegal Group Inc. Executive                                   (b)
           Restoration Plan

Other Material Contracts

(10)(J)    Tax Sharing Agreement dated                                    (a)
           September 29, 1986 between Donegal
           Group Inc. and Atlantic States
           Insurance Company

(10)(K)    Services Allocation Agreement dated                            (a)
           September 29, 1986 between Donegal
           Mutual Insurance Company, Donegal
           Group Inc. and Atlantic States
           Insurance Company

(10)(L)    Proportional Reinsurance Agreement                             (a)
           dated September 29, 1986 between
           Donegal Mutual Insurance Company
           and Atlantic States Insurance Company

(10)(M)    Amendment dated October 1, 1988 to                             (d)
           Proportional Reinsurance Agreement
           between Donegal Mutual Insurance Company
           and Atlantic States Insurance Company

(10)(N)    Multi-Line Excess of Loss Reinsurance                          (f)
           Agreement effective January 1, 1993
           between Donegal Mutual Insurance Company, Southern
           Insurance Company of Virginia, Atlantic States
           Insurance Company and Pioneer Mutual Insurance
           Company, and Christiana General Insurance Corporation
           of New York, Cologne Reinsurance Company of America,
           Continental Casualty Company, Employers Reinsurance
           Corporation and Munich American Reinsurance Company

(10)(O)    Amendment dated July 16, 1992 to Propor-                       (e)
           tional Reinsurance Agreement between
           Donegal Mutual Insurance Company and
           Atlantic States Insurance Company

(10)(P)    Amendment dated as of December 21, 1995                        (g)
           to Proportional Reinsurance Agreement
           between Donegal Mutual Insurance Company
           and Atlantic States Insurance Company

                                      -27-

(10)(Q)    Credit Agreement dated as of December 29,                      (g)
           1995 between Donegal Group Inc. and Fleet
           National Bank of Connecticut

(10)(R)    Stock Purchase Agreement dated as of                           (g)
           December 21, 1995 between Donegal Mutual
           Insurance Company and Donegal Group Inc.

(10)(S)    Donegal Group Inc. 1996 Employee Stock                         (h)
           Purchase Plan.

(10)(T)    Reinsurance and Retrocession Agree-                            (b)
           ment dated May 21, 1996 between
           Donegal Mutual Insurance Company
           and Pioneer Insurance Company.

(10)(U)    Reinsurance and Retrocession Agree-                            (b)
           ment dated May 21, 1996 between
           Donegal Mutual Insurance Company and
           Delaware American Insurance Company.

(10)(V)    Reinsurance and Retrocession Agree-                            (b)
           ment dated May 21, 1996 between
           Donegal Mutual Insurance Company and
           Southern Insurance Company of Virginia.

(13)       1997 Annual Report to Stockholders                     filed herewith
           (electronic filing contains only
           those portions incorporated by
           reference into this Form 10-K
           report).

                                      -28-

(20)       Proxy Statement relating to the Annual                 filed herewith
           Meeting of Stockholders to be held on
           April 16, 1998, provided, however, that
           the Compensation Committee Report and the
           Performance Graph shall not be deemed filed
           as part of this Form 10-K Report

(21)       Subsidiaries of Registrant                             filed herewith

(23)       Consent of Independent Auditors                        filed herewith

(27)       Financial Data Schedule                                filed herewith

- ------------

(a)      Such exhibit is hereby incorporated by reference to the like-described
         exhibits in Registrant's Form S-1 Registration Statement No. 33-8533
         declared effective October 29, 1986.

(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, 1996.

(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, 1986.

(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, 1988.

(e)      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.

(f)      Such exhibit is hereby incorporated by reference to the like-described
         exhibit in Registrant's Form S-2 Registration Statement No. 33-67346
         declared effective September 29, 1993.

(g)      Such exhibit is hereby incorporated by reference to the like-described
         exhibit in Registrant's Form 8-K Report dated December 21, 1995.

(h)      Such exhibit is hereby incorporated by reference to the like-described
         exhibit in Registrant's Form S-8 Registration Statement No. 333-1287
         filed February 29, 1996.

(i)      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, 1995.

(j)      Such exhibit is hereby incorporated by reference to the like-described
         exhibit in Registrant's Form S-2 Registration Statement No. 333-06787
         declared effective August 1, 1996.

                                      -29-

                       DONEGAL GROUP INC. AND SUBSIDIARIES

                       SCHEDULE I - SUMMARY OF INVESTMENTS
                    OTHER THAN INVESTMENTS IN RELATED PARTIES

                                December 31, 1997

                                                                        Amount at Which
                                                          Fair           Shown in the
                                         Cost             Value          Balance Sheet
                                     ------------      ------------     ---------------
                                                                           
Fixed Maturities:
 Held to maturity:
   United States government
   and governmental agencies
   and authorities including
   obligations of states and
   political subdivisions .....      $ 99,071,055      $102,267,924        $ 99,071,055
   All other corporate bonds ..         7,249,829         7,570,500           7,249,829
   Mortgage-backed securities .        10,925,321        11,044,462          10,925,321
                                     ------------      ------------        ------------
   Total fixed maturities
    held to maturity ..........       117,246,205       120,882,886         117,246,205
                                     ------------      ------------        ------------
 Available for sale:
   United States government
   and governmental agencies
   and authorities including
   obligations of states and
   political subdivisions .....        52,175,532        52,958,751          52,958,751
   All other corporate bonds ..         3,247,602         3,252,500           3,252,500
   Mortgage-backed securities .         1,499,208         1,520,000           1,520,000
                                     ------------      ------------        ------------
   Total fixed maturities
    available for sale ........        56,922,342        57,731,251          57,731,251
                                     ------------      ------------        ------------
   Total fixed maturities .....       174,168,547       178,614,137         174,977,456
                                     ------------      ------------        ------------
Equity Securities:
   Preferred stocks
    Public utilities ..........           250,000           255,000             255,000
   Banks ......................         1,112,500         1,148,191           1,148,191
   Industrial and
    miscellaneous .............           987,500         1,064,128           1,064,128
                                     ------------      ------------        ------------
   Total preferred stocks .....         2,350,000         2,467,319           2,467,319
                                     ------------      ------------        ------------
 Common stocks
  Banks and insurance companies           858,276         1,334,430           1,334,430
   Industrial and
    miscellaneous .............         3,342,744         3,472,813           3,472,813
                                     ------------      ------------        ------------
   Total common stocks ........         4,201,020         4,807,243           4,807,243
                                     ------------      ------------        ------------
   Total equity securities ....         6,551,020         7,274,562           7,274,562
                                     ------------      ------------        ------------
Short-term investments ........        22,712,787        22,712,787          22,712,787
                                     ------------      ------------        ------------
   Total investments ..........       203,432,354       208,601,486         204,964,805
                                     ============      ============        ============

                                      -30-

                       DONEGAL GROUP INC. AND SUBSIDIARIES

         SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY

                            Condensed Balance Sheets
                                ($ in thousands)
                           December 31, 1997 and 1996

                                     ASSETS
                                                         1997            1996
                                                      ---------        --------

Investment in subsidiaries (equity method)            $  99,857        $ 88,916
Short-term investments, at cost,
  which approximates market                                   3               7
Cash                                                        730             427
Property and equipment                                    2,139           1,248
Current income taxes                                        243             158
Loan costs                                                  205             246
Other receivables                                          --                30
                                                      ---------        --------
           Total assets                               $ 103,177        $ 91,032
                                                      =========        ========

                      LIABILITIES AND STOCKHOLDERS' EQUITY

                                                         1997            1996*
                                                      ---------        --------

Cash dividends declared to stockholders               $     604        $    493
Accounts payable and accrued expenses                       208             174
Deferred income taxes                                       268             266
Line of credit                                           10,500           8,500
                                                      ---------        --------
           Total liabilities                             11,580           9,433

Stockholders' equity
    Preferred stock, $1.00 par value,
        authorized 1,000,000 shares,
        none issued
    Common stock, $1.00 par value,
        authorized 10,000,000 shares,
        issued 6,122,431 and 4,540,569
        shares and outstanding 6,030,715
        and 4,471,782 shares                              6,123           4,540
  Additional paid-in capital                             38,932          37,863
  Net unrealized gains
        on investments                                    1,012             423
  Retained earnings, including equity
      in undistributed net income of
      subsidiaries ($56,082 and $45,730)                 46,422          39,665
  Treasury stock at cost                                   (892)           (892)
                                                      ---------        --------
Total stockholders' equity                               91,597          81,599
                                                      ---------        --------
Total liabilities and
    stockholders' equity                              $ 103,177        $ 91,032
                                                      =========        ========

*RESTATED

                                      -31-

                       DONEGAL GROUP INC. AND SUBSIDIARIES

         SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY

                         Condensed Statements of Income
                                ($ in thousands)

                  Years ended December 31, 1997, 1996 and 1995

                                              1997           1996*        1995*
                                            -------        --------      ------
        Revenues

            Dividends-subsidiary            $   950        $    0        $  900
            Lease income                        643           541           491
            Investment income                    15            31            13
                                            -------        ------        ------
                Total revenues                1,608           572         1,404

        Expenses

          Operating expenses                    643           548           411
          Interest                            1,022           416             4
                                            -------        ------        ------
              Total expenses                  1,665           964           415
                                            -------        ------        ------

        Income (loss) before income
          tax benefit and equity in
          undistributed net income
          of subsidiaries                       (57)         (392)          989

        Income tax (benefit)                   (346)         (533)         (298)
                                            -------        ------        ------

        Income before equity in
          undistributed net
          income of subsidiaries                289           141         1,287

        Equity in undistributed net
          income of subsidiaries             10,352         8,417         8,273
                                            -------        ------        ------

        Net income                          $10,641        $8,558        $9,560
                                            =======        ======        ======

*RESTATED

                                      -32-

                       DONEGAL GROUP INC. AND SUBSIDIARIES

              SCHEDULE II - CONDENSED INFORMATION OF PARENT COMPANY

                       Condensed Statements of Cash Flows
                                ($ in thousands)
                  Years ended December 31, 1997, 1996 and 1995

                                                   1997          1996*        1995*
                                                --------       --------      -------
                                                                        
Cash flows from operating activities:
    Net income                                  $ 10,641       $ 8,558       $ 9,560
                                                --------       -------       -------
    Adjustments to reconcile net
    income to net cash provided by
    operating activities:
        Equity in undistributed net
           income of subsidiaries                (10,352)       (8,417)       (8,273)
        Change in accounts
           payable and accrued expenses               34          (143)          225
        Depreciation and amortization                401           309           264
        Change in deferred income tax                  2            16            15
        Change in current
           income tax receivable                     (85)          183          (332)
        Change in other receivables                   30             8          (284)
                                                --------       -------       -------
        Net adjustments                           (9,970)       (8,044)       (8,385)
                                                --------       -------       -------
    Net cash provided by
        operating activities                         671           514         1,175
                                                --------       -------       -------

Cash flows from investing activities:
    Net sales (purchases) of short-term
        investments                                    4         1,110          (744)
    Net purchase of property and equipment        (1,251)         (203)         (279)
    Capital contribution to subsidiaries                        (5,000)
    Acquisition of Delaware Atlantic                --            (202)       (5,300)
                                                --------       -------       -------
    Net cash provided by (used in)
     investing activities                         (1,247)       (4,295)       (6,323)
                                                --------       -------       -------

Cash flows from financing activities:
    Cash dividends paid                           (2,252)       (1,879)       (1,622)
    Issuance of common stock                       1,131         2,512         1,723

    Purchase of treasury stock                      --             (72)         --
    Line of credit, net                            2,000         3,500         5,000
                                                --------       -------       -------
    Net cash provided by (used in)
        financing activities                         879         4,061        (5,101)
                                                --------       -------       -------

Net change in cash                                   303           280           (47)
        Cash beginning                               427           147           194
                                                --------       -------       -------
        Cash ending                             $    730       $   427       $   147
                                                ========       =======       =======

*RESTATED

                                      -33-

                       DONEGAL GROUP INC. AND SUBSIDIARIES

               SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION

                                                                               Amortization
                                                                  Net          of Deferred
                                Net              Net            Losses           Policy            Other              Net
                              Earned         Investment        and Loss        Acquisition      Underwriting        Premiums
     Segment                 Premiums          Income          Expenses           Costs           Expenses          Written
     -------               ------------      -----------      -----------      -----------      ------------      ------------
   Year Ended
December 31, 1997
- -----------------
                                                                                                         
Property and casualty      $107,302,168      $11,492,012      $67,656,518      $18,696,000      $ 17,058,668      $107,604,989

Parent                               --           15,265               --               --                --                --
                           ------------      -----------      -----------      -----------      ------------      ------------
                           $107,302,168      $11,507,277      $67,656,518      $18,696,000      $ 17,058,668      $107,604,989
                           ============      ===========      ===========      ===========      ============      ============
   Year Ended
December 31, 1996
- -----------------
Property and casualty      $104,527,038      $10,768,518      $70,420,924      $17,032,000      $ 15,876,797      $109,169,176

Parent                               --           30,851               --               --                --                --
                           ------------      -----------      -----------      -----------      ------------      ------------
                           $104,527,038      $10,799,369      $70,420,924      $17,032,000      $ 15,876,797      $109,169,176
                           ============      ===========      ===========      ===========      ============      ============
   Year Ended
December 31, 1995
- -----------------
Property and casualty      $ 89,522,203      $ 9,700,820      $58,069,695      $14,412,000      $ 14,702,852      $ 95,784,490

Parent                               --           12,924               --               --                --                --
                           ------------      -----------      -----------      -----------      ------------      ------------
                           $ 89,522,203      $ 9,713,744      $58,069,695      $14,412,000      $ 14,702,852      $ 95,784,490
                           ============      ===========      ===========      ===========      ============      ============

                                      -34-

                       DONEGAL GROUP INC. AND SUBSIDIARIES

               SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION

                                                                         At December 31,
                                          -------------------------------------------------------------------------------
                                           Deferred             Liability                                    Other Policy
                                            Policy              for Losses                                    Claims and
                                          Acquisition            and Loss             Unearned                Benefits
      Segment                                Costs               Expenses             Premiums                 Payable
      ------                              -----------          ------------          -----------             ------------
                                                                                                      
       1997
       ----
Property and casualty                      $8,448,060          $118,112,390          $71,367,691                $  --

       1996
       ----
Property and casualty                      $7,837,899          $114,621,961          $70,555,906                $  --

                                      -35-

                       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, 1997
- -----------------
Property and
 casualty premiums             $51,753,477       $51,753,477         $107,302,168       $107,302,168       100%
                               ===========       ===========         ============       ============       ===
   Year Ended
December 31, 1996
- -----------------
Property and
 casualty premiums             $49,802,516       $41,185,853         $ 95,910,375       $104,527,038        92%
                               ===========       ===========         ============       ============       ===
   Year Ended
December 31, 1995
- -----------------
Property and
 casualty premiums             $44,243,538       $29,546,138         $ 74,824,803        $89,522,203        84%
                               ===========       ===========         ============        ===========       ===

                                      -36-

                       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
                                   Costs               Expenses             Reserves           Premiums
                                ----------           ------------          ---------         -----------
                                                                                         
At December 31,
- ---------------
     1997                       $8,448,060           $118,112,390            $   --          $71,367,691
                                ==========           ============            ======          ===========

     1996                       $7,837,899           $114,621,961            $   --          $70,555,906
                                ==========           ============            ======          ===========

                                      -37-

                       DONEGAL GROUP INC. AND SUBSIDIARIES

                SCHEDULE VI - SUPPLEMENTARY INSURANCE INFORMATION
                  CONCERNING PROPERTY AND CASUALTY SUBSIDIARIES

                                                            Losses and Loss
                                                           Expenses Related to        Amortization
                                                       --------------------------      of Deferred           Net
                          Net                              (1)            (2)            Policy          Paid Losses       Net
                         Earned        Investment        Current         Prior         Acquisition         and Loss      Premiums
                        Premiums         Income            Year          Years            Costs            Expenses      Written
                      ------------     -----------     -----------    -----------     ------------       -----------   ------------
                                                                                                          
  Year Ended
December 31, 1997     $107,302,168     $11,492,012     $69,040,518    $(1,384,000)     $18,696,000       $65,610,249   $107,604,989
                      ============     ===========     ===========    ===========      ===========       ===========   ============

  Year Ended
December 31, 1996     $104,527,038     $10,768,518     $73,211,924    $(2,791,000)     $17,032,000       $66,148,749   $109,169,176
                      ============     ===========     ===========    ===========      ===========       ===========   ============

   Year Ended
December 31, 1995     $ 89,522,203     $ 9,700,820     $61,162,695    $(3,093,000)     $14,412,000       $50,231,653    $95,784,490
                      ============     ===========     ===========    ===========      ===========       ===========    ===========

                                  -38-

                                   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.

Date: March 30, 1998                        By: /s/ Donald H. Nikolaus
                                                -----------------------------
                                                Donald H. Nikolaus, President

         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
- -----------------------------         (principal executive officer)             March 30, 1998
Donald H. Nikolaus                    

/s/ Ralph G. Spontak                  Senior Vice President and                 March 30, 1998
- -----------------------------         Secretary (principal financial        
Ralph G. Spontak                      and accounting officer)        

/s/ Robert S. Bolinger                Director                                  March 30, 1998
- -----------------------------
Robert S. Bolinger

                                      Director                                  March   , 1998
- -----------------------------       
Thomas J. Finley

/s/ Patricia A. Gilmartin             Director                                  March 30, 1998
- -----------------------------
Patricia A. Gilmartin

/s/ Philip H. Glatfelter, II          Director                                  March 30, 1998
- -----------------------------
Philip H. Glatfelter, II

/s/ C. Edwin Ireland                  Director                                  March 30, 1998
- -----------------------------
C. Edwin Ireland

- -----------------------------         Director                                  March   , 1998
R. Richard Sherbahn

                                      -39-

                                  EXHIBIT INDEX
                    (Pursuant to Item 601 of Regulation S-K)

Exhibit No.            Description of Exhibits                        Reference
- -----------            -----------------------                        ---------

(3)(i)            Certificate of Incorporation of                         (a)
                  Registrant

(3)(ii)           Amended and Restated By-laws of                         (b)
                  Registrant

(4)               Form of Registrant's Common Stock                       (a)
                  Certificate

Management Contracts and Compensatory Plans or Arrangements

(10)(A)           Donegal Mutual Insurance Company                        (a)
                  Money Purchase Pension Plan and
                  Trust dated March 12, 1985

(10)(B)           Donegal Mutual Insurance Company                        (a)
                  Profit Sharing Plan and Trust
                  dated March 12, 1985

(10)(C)           Donegal Group Inc. Key Executive                        (c)
                  Incentive Bonus Plan dated
                  September 29, 1986

(10)(D)           Donegal Group Inc. Employee Stock                       (c)
                  Purchase Plan, as amended

(10)(E)           Donegal Group Inc. Equity Incentive                     (c)
                  Plan, as amended

(10)(F)           Donegal Group Inc. Agency                               (j)
                  Stock Purchase Plan

(10)(G)           Donegal Group Inc. Amended and                          (b)
                  Restated 1996 Equity Incentive
                  Plan

(10)(H)           Donegal Group Inc. Amended and                  filed herewith
                  Restated 1996 Equity Incentive
                  Plan for Directors

(10)(I)           Donegal Group Inc. Executive                            (b)
                  Restoration Plan

                                      -40-

Other Material Contracts
- ------------------------

(10)(J)           Tax Sharing Agreement dated                             (a)
                  September 29, 1986 between Donegal
                  Group Inc. and Atlantic States
                  Insurance Company

(10)(K)           Services Allocation Agreement dated                     (a)
                  September 29, 1986 between Donegal
                  Mutual Insurance Company, Donegal
                  Group Inc. and Atlantic States
                  Insurance Company

(10)(L)           Proportional Reinsurance Agreement                      (a)
                  dated September 29, 1986 between
                  Donegal Mutual Insurance Company
                  and Atlantic States Insurance Company

(10)(M)           Amendment dated October 1, 1988 to                      (d)
                  Proportional Reinsurance Agreement
                  between Donegal Mutual Insurance Company
                  and Atlantic States Insurance Company

(10)(N)           Multi-Line Excess of Loss Reinsurance                   (f)
                  Agreement effective January 1, 1993
                  between Donegal Mutual Insurance Company, Southern
                  Insurance Company of Virginia, Atlantic States
                  Insurance Company and Pioneer Mutual Insurance
                  Company, and Christiana General Insurance
                  Corporation of New York, Cologne Reinsurance
                  Company of America, Continental Casualty Company,
                  Employers Reinsurance Corporation and Munich
                  American Reinsurance Company

(10)(O)           Amendment dated July 16, 1992 to Propor-                (e)
                  tional Reinsurance Agreement between
                  Donegal Mutual Insurance Company and
                  Atlantic States Insurance Company

                                      -41-

(10)(P)           Amendment dated as of December 21, 1995                 (g)
                  to Proportional Reinsurance Agreement
                  between Donegal Mutual Insurance Company
                  and Atlantic States Insurance Company

(10)(Q)           Credit Agreement dated as of December 29,               (g)
                  1995 between Donegal Group Inc. and Fleet
                  National Bank of Connecticut

(10)(R)           Stock Purchase Agreement dated as of                    (g)
                  December 21, 1995 between Donegal Mutual
                  Insurance Company and Donegal Group Inc.

(10)(S)           Donegal Group Inc. 1996 Employee Stock                  (h)
                  Purchase Plan.

(10)(T)           Reinsurance and Retrocession                            (b)
                  Agreement dated May 21, 1996 between
                  Donegal Mutual Insurance Company
                  and Pioneer Insurance Company.

(10)(U)           Reinsurance and Retrocession Agree-                     (b)
                  ment dated May 21, 1996 between
                  Donegal Mutual Insurance Company and
                  Delaware American Insurance Company.

(10)(V)           Reinsurance and Retrocession Agree-                     (b)
                  ment dated May 21, 1996 between
                  Donegal Mutual Insurance Company and
                  Southern Insurance Company of Virginia.

(13)              1997 Annual Report to Stockholders              filed herewith
                  (electronic filing contains only
                  those portions incorporated by
                  reference into this Form 10-K
                  report).

(20)              Proxy Statement relating to the Annual          filed herewith
                  Meeting of Stockholders to be held on
                  April 16, 1998, provided, however, that
                  the Compensation Committee Report and the
                  Performance Graph shall not be deemed filed
                  as part of this Form 10-K Report

(21)              Subsidiaries of Registrant                      filed herewith

(23)              Consent of Independent Auditors                 filed herewith

                                      -42-

(27)              Financial Data Schedule                         filed herewith

- ------------------

(a)      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.

(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, 1996.

(c)      Such exhibit is hereby incorporated by reference to the like-described
         exhibits in Registrant's Form 10-K Report for the year ended December
         31, 1986.

(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, 1988.

(e)      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.

(f)      Such exhibit is hereby incorporated by reference to the like-described
         exhibit in Registrant's Form S-2 Registration Statement No. 33-67346
         declared effective September 29, 1993.

(g)      Such exhibit is hereby incorporated by reference to the like-described
         exhibit in Registrant's Form 8-K Report dated December 21, 1995.

(h)      Such exhibit is hereby incorporated by reference to the like-described
         exhibit in Registrant's Form S-8 Registration Statement No. 333-1287
         filed February 29, 1996.

(i)      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, 1995.

(j)      Such exhibit is hereby incorporated by reference to the like-described
         exhibit in Registrant's Form S-2 Registration Statement No. 333-06787
         declared effective August 1, 1996.

                                      -43-

                                                                    

                               DONEGAL GROUP INC.
                               AMENDED & RESTATED
                           1996 EQUITY INCENTIVE PLAN
                                  FOR DIRECTORS
                                  -------------

         DONEGAL GROUP INC., a corporation organized under the laws of the State
of Delaware, hereby sets forth the 1996 Equity Incentive Plan for Directors. The
Plan provides for the grant of (i) Options to Outside Directors of the Company
and the Mutual Company and (ii) Restricted Stock Awards to Directors of the
Company and the Mutual Company, as each of such capitalized terms is hereinafter
defined.

         1. DEFINITIONS. Whenever the following terms are used in the Plan they
shall have the meanings specified below unless the context clearly indicates to
the contrary:

         "Board" shall mean the Board of Directors of the Company.

         "Code" shall mean the Internal Revenue Code of 1986, as amended.
Reference to a specific section of the Code shall include such section, any
valid regulation promulgated thereunder and any comparable provision of any
future legislation amending, supplementing or superseding such section.

         "Common Stock" shall mean the Common Stock, $1.00 par value, of the
Company.

         "Company" shall mean Donegal Group Inc., a Delaware corporation.

         "Director" shall mean a member of the Board of Directors of the Company
and/or the Mutual Company.

         "Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended.

         "Fair Market Value" of the Common Stock on any date shall mean the
closing price of the Common Stock for such date, as reported in The Wall Street
Journal, or if not so reported, as otherwise reported by the National
Association of Securities Dealers Automated Quotation ("Nasdaq") System, or if
the Common Stock is not reported by Nasdaq, the fair market value shall be as
determined by the Board. If no closing price is reported quoted for such date,
the next preceding date for which such sale prices are quoted shall be used.

         "Grantee" shall mean a Director to whom a Restricted Stock Award is
granted.

         "Mutual Company" shall mean Donegal Mutual Insurance Company.

                                       -1-

         "Option" shall mean a nonqualified stock option granted under the
provisions of Section 4 of the Plan to purchase Common Stock of the Company.

         "Optionee" shall mean an Outside Director to whom an Option is granted.

         "Outside Director" shall mean a Director who is not also an employee of
the Company, the Mutual Company or any affiliate of the Company or the Mutual
Company.

         "Plan" shall mean this 1996 Equity Incentive Plan for Directors.

         "Restricted Stock Award" shall mean a restricted stock award granted
under the provisions of Section 5 of the Plan.

         "Secretary" shall mean the Secretary of the Company.

         "Termination of Service" shall mean such time as a Director shall cease
to serve as a member of the Board of Directors of the Company or the Mutual
Company, whether as a result of resignation, failure to be reelected, removal
for cause, death or any other reason.

         2. ADMINISTRATION.

         (a) ADMINISTRATION BY THE BOARD. The Plan shall be administered by the
Board.

         (b) DUTY AND POWERS OF THE BOARD. It shall be the duty of the Board to
conduct the general administration of the Plan in accordance with its
provisions. The Board shall have the power to interpret the Plan, the Options
and the Restricted Stock Awards and to adopt rules for the administration,
interpretation and application of the Plan as are consistent therewith and to
interpret, amend or revoke any such rules. The Board shall have the discretion
to determine who will be granted Options and to determine the number of Options
to be granted to any Outside Director, the timing of such grant and the terms of
exercise. The Board shall not have any discretion to determine who will be
granted Restricted Stock Awards under the Plan.

         (c) BOARD ACTIONS. The Board may act either by vote of a majority of
its members present at a meeting of the Board at which a quorum is present or by
a memorandum or other written instrument signed by all members of the Board.

         (d) COMPENSATION; PROFESSIONAL ASSISTANCE; GOOD FAITH ACTIONS. Members
of the Board shall not receive any compensation for their services in admin-
istering the Plan, but all expenses and liabilities they incur in connection
with the administration of the Plan shall be borne by the Company. The Board may
employ attorneys, consultants, accountants or other persons. The Board, the
Company and

                                       -2-

the officers and directors of the Company shall be entitled to rely upon the
advice, opinions or valuations of any such persons. All actions taken and all
interpretations and determinations made by the Board in good faith shall be
final and binding upon all Optionees and Grantees, the Company and all other
interested persons. No member of the Board shall be personally liable for any
action, determination or interpretation made in good faith with respect to the
Plan, and all members of the Board shall be fully protected and indemnified by
the Company in respect to any such action, determination or interpretation.

         3. SHARES SUBJECT TO THE PLAN.

         (a) LIMITATIONS. The shares of stock issuable pursuant to Options or
Restricted Stock Awards shall be shares of the Common Stock. The total number
of such shares that may be issued pursuant to Options or Restricted Stock Awards
granted under the Plan shall not exceed 200,000 in the aggregate.

         (b) EFFECT OF UNEXERCISED OR CANCELLED OPTIONS. If an Option expires or
is cancelled for any reason without having been fully exercised or vested, the
number of shares subject to such Option that were not purchased or did not vest
prior to such expiration or cancellation may again be made subject to an Option
or Restricted Stock Award granted hereunder.

         (c) CHANGES IN CAPITALIZATION. Subject to any required action by the
stockholders of the Company, the number of shares of Common Stock covered by
each outstanding Option and Restricted Stock Award and the number of shares of
Common Stock that have been authorized for issuance under the Plan but as to
which no Options or Restricted Stock Awards have yet been granted or which have
been returned to the Plan upon cancellation or expiration of an Option, as well
as the price per share of Common Stock covered by each such outstanding Option,
shall be proportionately adjusted for any increase or decrease in the number of
issued shares of Common Stock resulting from a stock split, reverse stock split,
stock dividend, combination or reclassification of the Common Stock, or any
other increase or decrease in the number of issued shares of Common Stock
effected without receipt of consideration by the Company; provided, however,
that conversion of any convertible securities of the Company shall not be deemed
to have been "effected without receipt of consideration." Such adjustment shall
be made by the Board, whose determination in that respect shall be final,
binding and conclusive. Except as expressly provided herein, no issuance by the
Company of shares of stock of any class, or securities convertible into shares
of stock of any class, shall affect, and no adjustment by reason thereof shall
be made with respect to, the number or price of shares of Common Stock subject
to an Option or Restricted Stock Award.

         (d) DISSOLUTION OR LIQUIDATION. In the event of the proposed
dissolution or liquidation of the Company, all outstanding Options will
terminate immediately prior to the consummation of such proposed action, unless
otherwise provided by the

                                       -3-

Board. The Board may, in the exercise of its discretion in such instances,
declare that any Option shall terminate as of a date fixed by the Board and give
each Option holder the right to exercise his Option as to all or any part of the
shares of Common Stock covered by the Option, including shares as to which the
Option would not otherwise be exercisable.

         (e) SALE OR MERGER. In the event of a proposed sale of all or
substantially all of the assets of the Company, or the merger of the Company
with or into another corporation, the Board, in the exercise of its sole
discretion, may take such action as it deems desirable, including, but not
limited to: (i) causing an Option to be assumed or an equivalent option to be
substituted by the successor corporation or a parent or subsidiary of such
successor corporation, (ii) providing that each Option holder shall have the
right to exercise his Option as to all of the shares of Common Stock covered by
the Option, including shares as to which the Option would not otherwise be
exercisable, or (iii) declaring that an Option shall terminate at a date fixed
by the Board, provided that the Option holder is given notice and opportunity to
exercise the then exercisable portion of his Option prior to such date.

         4. STOCK OPTIONS.

         (a) GRANTING OF OPTIONS.

             (i) ELIGIBILITY. Each Outside Director shall be eligible to be
granted Options.

             (ii) GRANTING OF OPTIONS. Options may be granted by the Board at
any time and from time to time while the Plan shall be in effect. The Board
shall have the authority to determine the Outside Directors to whom Options are
granted, the number of Options to be granted to each and the timing and vesting
of each grant. The Board's determinations with respect to Options granted under
the Plan need not be uniform and may be made selectively among Outside Directors
as the Board, in its discretion, shall determine.

             (iii) TYPE OF OPTIONS. All Options granted under the Plan shall be
options not intended to qualify as incentive stock options under Section 422 of
the Code.

         (b) TERMS OF OPTIONS.

             (i) OPTION AGREEMENT. Each Option shall be evidenced by a written
stock option agreement that shall be executed by the Optionee and on behalf of
the Company and that shall contain such terms and conditions as the Board
determines are required or appropriate under the Plan.

                                       -4-

             (ii) OPTION PRICE. The exercise price of the shares subject to each
Option shall be not less than 100% of the Fair Market Value for such shares on
the date the Option is granted.

             (iii) DATE OF GRANT. The date on which an Option shall be deemed to
have been granted under the Plan shall be the date of the Board's authorization
of the Option or such later date as may be determined by the Board at the time
the Option is authorized.

             (iv) EXERCISE TERM. Each stock option agreement shall state the
period or periods of time within which the Option may be exercised, in whole or
in part, as determined by the Board, provided that no Option shall be
exercisable after ten years from the date of grant thereof. The Board shall have
the power to permit an acceleration of previously established exercise terms,
subject to the requirements set forth herein, upon such circumstances and
subject to such terms and conditions as the Board deems appropriate.

             (v) RIGHTS UPON TERMINATION OF SERVICE. Upon an Optionee's
Termination of Service, for any reason other than death, the Optionee shall have
the right to exercise the Option during its term within a period of three months
after such termination to the extent that the Option was exercisable at the time
of termination, or within such other period, and subject to such terms and
conditions, as may be specified by the Board. In the event that an Optionee dies
prior to the expiration of his Option and without having fully exercised his
Option, the Optionee's representative or successor shall have the right to
exercise the Option during its term within a period of one year after
Termination of Service due to death to the extent that the Option was
exercisable at the time of Termination of Service, or within such other period,
and subject to such terms and conditions, as may be specified by the Board.

         (c) EXERCISE OF OPTIONS.

             (i) PERSON ELIGIBLE TO EXERCISE. During the lifetime of the
Optionee, only the Optionee may exercise an Option or any portion thereof. After
the death of the Optionee, any exercisable portion of an Option may be exercised
by the Optionee's personal representative or by any person empowered to do so
under the deceased Optionee's will or under the then applicable laws of descent
and distribution. The Company may require appropriate proof from any such person
of such person's right to exercise the Option or any portion thereof.

             (ii) FRACTIONAL SHARES. The Company shall not be required to issue
fractional shares on exercise of an Option.

             (iii) MANNER OF EXERCISE. Options may be exercised in whole or in
part, from time to time, by giving written notice of exercise to the Secretary,
specifying the number of shares to be purchased. The purchase price of the
shares with respect to

                                       -5-

which an Option is exercised shall be payable in full with the notice of
exercise in cash, Common Stock at Fair Market Value, or a combination thereof,
as the Board may determine from time to time and subject to such terms and
conditions as may be prescribed by the Board for such purpose. The Board may
also, in its discretion and subject to prior notification to the Company by an
Optionee, permit an Optionee to enter into an agreement with the Company's
transfer agent or a brokerage firm of national standing whereby the Optionee
will simultaneously exercise the Option and sell the shares acquired thereby
through the Company's transfer agent or such a brokerage firm and either the
Company's transfer agent or the brokerage firm executing the sale will remit to
the Company from the proceeds of sale the exercise price of the shares as to
which the Option has been exercised.

             (iv) RIGHTS OF STOCKHOLDERS. An Optionee shall not be, nor have any
of the rights of, a stockholder of the Company in respect to any shares that may
be purchased upon the exercise of any Option or portion thereof unless and until
certificates representing such shares have been issued by the Company to such
Optionee.

             (v) GENERAL RESTRICTIONS. Each Option granted under the Plan shall
be subject to the requirement that, if at any time the Board shall determine
that (i) the listing, registration or qualification of the shares of Common
Stock subject or related thereto upon any securities exchange or under any state
or federal law, or (ii) the consent or approval of any government regulatory
body, or (iii) the satisfaction of any tax payment or withholding obligation, or
(iv) an agreement by the Optionee with respect to the disposition of shares of
Common Stock, is necessary or desirable as a condition of or in connection with
the granting of such Option or the issuance or purchase of shares of Common
Stock thereunder, such Option shall not be consummated in whole or in part
unless such listing, registration, qualification, consent, approval, payment,
withholding or agreement shall have been effected or obtained free of any
conditions not acceptable to the Board.

         5. RESTRICTED STOCK AWARDS.

         (a) GRANTING OF AWARDS.

             (i) ELIGIBILITY. Each Director shall be eligible to be granted
Restricted Stock Awards.

             (ii) GRANTING OF AWARDS. Each Director shall be granted annual
Restricted Stock Awards consisting of 100 shares of Common Stock, such
Restricted Stock Awards to be made on the first business day of January in each
year, commencing January 2, 1997, provided that the Director served as a member
of the Board or of the Board of Directors of the Mutual Company during any
portion of the preceding calendar year.

                                       -6-

          (b) TERMS OF RESTRICTED STOCK AWARDS.

             (i) RESTRICTED STOCK AGREEMENT. Each Restricted Stock Award shall
be evidenced by a written restricted stock agreement that shall be executed by
the Grantee and the Company and that shall contain such restrictions, terms and
conditions as are required by the Plan.

             (ii) RESTRICTIONS ON TRANSFER. The shares of Common Stock compris-
ing the Restricted Stock Awards may not be sold or otherwise transferred by the
Grantee until one year after the date of grant. Although the shares of Common
Stock comprising each Restricted Stock Award shall be registered in the name of
the Grantee, the Company reserves the right to place a restrictive legend on the
stock certificate. None of such shares of Common Stock shall be subject to
forfeiture.

             (iii) RIGHTS AS STOCKHOLDER.

                   (a) Subject to the restrictions on transfer set forth in 
Section 5(b)(ii) hereof, a Grantee shall have all the rights of a stockholder
with respect to the shares of Common Stock issued pursuant to Restricted Stock
Awards made hereunder, including the right to vote the shares and receive all
dividends and other distributions paid or made with respect to the shares.

                   (b) In the event of changes in the capital stock of the
Company by reason of stock dividends, split-ups or combinations of shares,
reclassifications, mergers, consolidations, reorganizations or liquidations
while the shares comprising a Restricted Stock Award shall be subject to
restrictions on transfer, any and all new, substituted or additional securities
to which the Grantee shall be entitled by reason of the ownership of a
Restricted Stock Award shall be subject immediately to the terms, conditions and
restrictions of the Plan.

                   (c) If a Grantee receives rights or warrants with respect to 
any shares comprising a Restricted Stock Award, such rights or warrants or any
shares or other securities acquired by the exercise of such rights or warrants
may be held, exercised, sold or otherwise disposed of by the Grantee free and
clear of the restrictions and obligations set forth in the Plan.

             (iv) GENERAL RESTRICTIONS. Each Restricted Stock Award granted
under the Plan shall be subject to the requirement that if, at any time the
Board shall determine that (i) the listing, registration or qualification of the
shares of Common Stock subject or related thereto upon any securities exchange
or under any state or federal law, or (ii) the consent or approval of any
government regulatory body, or (iii) the satisfaction of any tax payment or
withholding obligation, or (iv) an agreement by the Grantee with respect to the
disposition of shares of Common Stock, is necessary or desirable as a condition
of or in connection with the granting of such Restricted Stock Award, such
Restricted Stock Award shall not be consummated in whole or in

                                       -7-

part unless such listing, registration, qualification, consent, approval or
agreement shall have been effected or obtained free of any conditions not
acceptable to the Board.

         6. MISCELLANEOUS PROVISIONS.

         (a) NO ASSIGNMENT OR TRANSFER. No Option or interest or right therein
or part thereof, and, for a period of one year after the date of grant, no
Restricted Stock Award or any interest therein or part thereof, shall be liable
for the debts, contracts, or engagements of the Optionee or Grantee or his
successors in interest nor shall they be subject to disposition by transfer,
alienation, anticipation, pledge, encumbrance, assignment or any other means,
whether such disposition is voluntary or involuntary or by operation of law by
judgment, levy, attachment, garnishment or any other legal or equitable
proceedings (including bankruptcy), and any attempted disposition thereof shall
be null and void and of no effect; provided, however, that nothing in this
Section 6(a) shall prevent transfers by will or by the applicable laws of
descent and distribution.

         (b) AMENDMENT, SUSPENSION OR TERMINATION OF THE PLAN. The Plan may be
wholly or partially amended or otherwise modified, suspended or terminated at
any time or from time to time by the Board, subject to any required stockholder
approval or any stockholder approval that the Board may deem advisable for any
reason, such as for the purpose of obtaining or retaining any statutory or
regulatory benefits under tax, securities or other laws or satisfying any
applicable stock exchange listing requirements. Neither the amendment,
suspension nor termination of the Plan shall, without the consent of the
Optionee or Grantee, alter or impair any rights or obligations under any
outstanding Option or Restricted Stock Award. No Option or Restricted Stock
Award may be granted during any period of suspension nor after termination of
the Plan.

         (c) WITHHOLDING. Whenever the Company proposes or is required to issue
or transfer shares of Common Stock under the Plan, the Company shall have the
right to require the recipient to remit to the Company an amount sufficient to
satisfy any federal, state or local withholding tax requirements prior to the
delivery of any certificate for such shares. If and to the extent authorized by
the Board, in its sole discretion, an Optionee may make an election, by means of
a form of election to be prescribed by the Board, to have shares of Common Stock
that are acquired upon exercise of an Option withheld by the Company or to
tender other shares of Common Stock or other securities of the Company owned by
the Optionee to the Company at the time of exercise of an Option to pay the
amount of tax that would otherwise be required by law to be withheld by the
Company as a result of any exercise of an Option. Any such election shall be
irrevocable and shall be subject to termination by the Board, in its sole
discretion, at any time. Any securities so withheld or tendered will be valued
by the Board as of the date of exercise.

                                       -8-

         (d) RESERVATION OF SHARES. The Company, during the term of the Plan,
will at all times reserve and keep available such number of shares as shall be
sufficient to satisfy the requirements of the Plan. Inability of the Company to
obtain authority from any regulatory body having jurisdiction, which authority
is deemed by the Company's counsel to be necessary to the lawful issuance and
sale of any shares hereunder, shall relieve the Company of any liability for the
failure to issue or sell such shares as to which such requisite authority shall
not have been obtained.

         (e) DURATION OF THE PLAN. The Plan shall remain in effect until all
Options granted under the Plan have been satisfied by the issuance of shares,
but no Option or Restricted Stock Award shall be granted more than ten years
after the earlier of the date the Plan is adopted by the Company or is approved
by the Company's stockholders.

         (f) NO PROHIBITION ON CORPORATE ACTION. No provision of the Plan shall
be construed to prevent the Company or any officer or director thereof from
taking any action deemed by the Company or such officer or director to be
appropriate or in the Company's best interest, whether or not such action could
have an adverse effect on the Plan or any Options or Restricted Stock Awards
granted hereunder, and no Director or Director's estate, personal representative
or beneficiary shall have any claim against the Company or any officer or
director thereof as a result of the taking of such action.

         (g) INDEMNIFICATION. With respect to the administration of the Plan,
the Company shall indemnify each present and future member of the Board against,
and each member of the Board shall be entitled without further action on his
part to indemnity from the Company for, all expenses (including the amount of
judgments and the amount of approved settlements made with a view to the
curtailment of costs of litigation, other than amounts paid to the Company
itself) reasonably incurred by him in connection with or arising out of, any
action, suit or proceeding in which he may be involved by reason of his being or
having been a member of the Board, whether or not he continues to be such member
at the time of incurring such expenses; provided, however, that such indemnity
shall not include any expenses incurred by any such member of the Board (i) in
respect of matters as to which he shall be finally adjudged in any such action,
suit or proceeding to have been guilty of gross negligence or willful misconduct
in the performance of his duty as such member of the Board; or (ii) in respect
of any matter in which any settlement is effected for an amount in excess of the
amount approved by the Company on the advice of its legal counsel; and provided
further that no right of indemnification under the provisions set forth herein
shall be available to or enforceable by any such member of the Board unless,
within 60 days after institution of any such action, suit or proceeding, he
shall have offered the Company in writing the opportunity to handle and defend
same at its own expense. The foregoing right of indemnification shall inure to
the benefit of the heirs, executors or administrators of each such member of the
Board and shall be in addition

                                       -9-

to all other rights to which such member may be entitled as a matter of law,
contract or otherwise.

         (h) COMPLIANCE WITH PLAN PROVISIONS. No Optionee or Grantee shall have
any right with respect to the Plan, the Common Stock reserved for issuance under
the Plan or in any Option or Restricted Stock Award until a written stock option
agreement or a written restricted stock agreement, as the case may be, shall
have been executed on behalf of the Company and by the Optionee or Grantee, and
all the terms, conditions and provisions of the Plan and the Option or
Restricted Stock Award applicable to such Optionee or Grantee (and each person
claiming under or through him) have been met.

         (i) APPROVAL OF COUNSEL. In the discretion of the Board, no shares of
Common Stock, other securities or property of the Company or other forms of
payment shall be issued hereunder with respect to any Option or Restricted Stock
Award unless counsel for the Company shall be satisfied that such issuance will
be in compliance with applicable federal, state, local and foreign legal,
securities exchange and other applicable requirements.

         (j) EFFECTS OF ACCEPTANCE. By accepting any Option or Restricted Stock
Award or other benefit under the Plan, each Optionee and Grantee and each person
claiming under or through him shall be conclusively deemed to have indicated his
acceptance and ratification of, and consent to, any action taken under the Plan
by the Company, the Board or its delegates.

         (k) CONSTRUCTION. The masculine pronoun shall include the feminine and
neuter, and the singular shall include the plural, where the context so
indicates.

         (l) COMPLIANCE WITH RULE 16b-3. To the extent that Rule 16b-3 under the
Exchange Act applies to Options or Restricted Stock Awards granted under the
Plan, it is the intention of the Company that the Plan comply in all respects
with the requirements of Rule 16b-3, that any ambiguities or inconsistencies in
construction of the Plan be interpreted to give effect to such intention and
that if the Plan shall not so comply, whether on the date of adoption or by
reason of any later amendment to or interpretation of Rule 16b-3, the provisions
of the Plan shall be deemed to be automatically amended so as to bring them into
full compliance with such rule.

         (m) STOCKHOLDER APPROVAL. Except with respect to the Restricted Stock
Awards to be granted on January 2, 1997, no Option may be exercised and no Re-
stricted Stock Award may be granted until the Plan shall have been approved by
the affirmative vote of the holders of a majority of the shares of the Company's
outstanding Common Stock present or represented and entitled to vote at a duly
convened meeting of stockholders held on or before December 31, 1997. The
failure of the stockholders of the Company to approve the Plan shall in no way
terminate or

                                      -10-

otherwise impair the Restricted Stock Awards granted to Directors hereunder on
January 2, 1997.

         (n) TITLES. Titles are provided herein for convenience only and are not
to serve as a basis for interpretation or construction of the Plan.

Adopted by the Board of Directors on December 19, 1996.

Approved by the Stockholders on April 17, 1997.

Amended by the Board of Directors on March 16, 1998.

Amended by the Stockholders on April ___, 1998.

                                      -11-

FINANCIAL HIGHLIGHTS

Year Ended December 31,           1997            1996*            1995*            1994*           1993*   

Income Statement Data
- ------------------------------------------------------------------------------------------------------------
                                                                                          
   Net premiums earned       $107,302,168     $104,527,038      $89,522,203      $79,026,809     $71,466,765
- ------------------------------------------------------------------------------------------------------------
   Investment income           11,507,277       10,799,369        9,713,744        8,188,852       6,842,392
- ------------------------------------------------------------------------------------------------------------
   Total revenues             121,327,606      117,581,664      101,615,698       88,607,550      80,165,058
- ------------------------------------------------------------------------------------------------------------
   Net income                  10,641,186        8,557,774        9,559,610        4,589,397       6,777,461
- ------------------------------------------------------------------------------------------------------------
   Net income per common share
- ------------------------------------------------------------------------------------------------------------
        Basic                        1.77             1.46             1.72              .84            1.56
- ------------------------------------------------------------------------------------------------------------
       Diluted                       1.77             1.45             1.68              .82            1.53
- ------------------------------------------------------------------------------------------------------------

Balance Sheet Data
- ------------------------------------------------------------------------------------------------------------
   Total assets              $304,104,505     $287,990,994     $244,943,598     $215,013,165    $176,979,530
- ------------------------------------------------------------------------------------------------------------
   Stockholders' equity        91,596,663       81,599,274       73,020,689       61,338,761      58,872,709
- ------------------------------------------------------------------------------------------------------------
   Book value per share             15.19            13.69            12.85            11.23           10.79
- ------------------------------------------------------------------------------------------------------------

Management's Discussion and Analysis of Results of Operation and Financial
Condition

Donegal Group Inc. ("DGI" or the "Company") is a regional insurance holding
company doing business in Pennsylvania, Maryland, Delaware, Virginia and Ohio
through its four wholly owned property-casualty insurance subsidiaries, Atlantic
States Insurance Company ("Atlantic States"), Southern Insurance Company of
Virginia ("Southern"), Delaware Atlantic Insurance Company ("Delaware") and
Pioneer Insurance Company ("Pioneer") (collectively "Insurance Subsidiaries").
The Company's major lines of business in 1997 and their percentage of total net
earned premiums were Automobile Liability (27.8%), Workers' Compensation
(15.9%), Automobile Physical Damage (17.1%), Homeowners (17.6%), and Commercial
Multiple Peril (15.6%). The Insurance Subsidiaries are subject to regulation by
Insurance Departments in those states in which they operate and undergo periodic
examination by those departments. The Insurance Subsidiaries are also subject to
competition from other insurance carriers in their operating areas. DGI was
formed in September 1986 by Donegal Mutual Insurance Company (the "Mutual
Company"), which owns 58.2% of the outstanding common shares of the Company as
of December 31, 1997.

   On July 15, 1997, the Company issued a 4 for 3 stock split in the form of a
33 1/3% stock dividend to stockholders of record as of June 25, 1997. Per share
information prior to July 15, 1997, has been restated for this change.

   Atlantic States participates in an intercompany pooling arrangement with the
Mutual Company and assumes 65% (60% in 1995) of the pooled business. Southern
cedes 50% of its business to the Mutual Company and Delaware cedes 70% of its
Workers' Compensation business to the Mutual Company. Because the Mutual Company
places substantially all of the business assumed from Southern and Delaware into
the pool, from which the Company has a 65% allocation, the Company's results of
operations include approximately 83% of the business written by Southern and
approximately 76% of the Workers' Compensation business written by Delaware.

   In March 1997, the Company acquired all of the outstanding stock of Pioneer.
This transaction was accounted for as if it were a "pooling of interest," and as
such the Company's financial statements have been restated to include Pioneer as
a consolidated subsidiary from January 1, 1993, to the present.

   In addition to the Company's insurance subsidiaries, it also owns all of the
outstanding stock of Atlantic Insurance Services, Inc. ("AIS"), an insurance
services organization currently providing inspection and policy auditing
information on a fee for service basis to its affiliates and the insurance
industry.

Results of Operation 1997 Compared to 1996

Total revenues for 1997 were $121,327,606 which were $3,745,942, or 3.2%,
greater than 1996. Net premiums earned increased to $107,302,168, an increase of
$2,775,130, or 2.7%, over 1996. Direct premiums written by the combined pool of
Atlantic States and the Mutual Company decreased $107,786, with Workers'
Compensation decreasing $4,052,981, or 19.5%, due to a mandatory rate rollback
for that line in Pennsylvania. A 12.4% increase in the direct premiums written
of Southern, a 6.6% increase in the direct premiums written of Delaware and an
18.5% decrease in the direct premiums written of Pioneer accounted for the
majority of the remaining increase. The Company reported realized investment
gains of $314,136, compared to realized investment gains of $172,734 in 1996.
Gains in both years resulted from normal turnover of the Company's investment
portfolio. As of December 31, 1997, 99.9% of the Company's bond portfolio was
classified as Class 1 (highest quality) by the National Association of Insurance
Commissioners' Security Valuation Office. Investment income increased $707,908.
An increase in the average invested assets from $180,352,394 to $198,727,027,
offset by a decrease in the average yield to 5.8% from 6.0% in 1996, accounted
for the change.

   The GAAP combined ratio of insurance operations was 97.6% in 1997, compared
to 100.4% in 1996. The GAAP combined ratio is the sum of the ratios of incurred
losses and loss adjustment expense to premiums earned (loss ratio), underwriting
expenses to premiums earned (expense ratio) and policyholder dividends to
premiums earned (dividend ratio). The loss ratio in 1997 was 63.1%, compared to
67.4% in 1996, accounting for the majority of the change in the combined ratio.
This decrease in the loss ratio resulted from a return to more normal weather
patterns in 1997, compared to severe winter weather experienced in the primary
operating areas of the Company in the first quarter of 1996. The expense ratio
for 1997 was 33.3%, compared to 31.5% in 1996, with the dividend ratio
decreasing from 1.5% in 1996 to 1.2% in 1997 due primarily to the rate rollback
in Workers' Compensation in 1997.

10--The 1997 Donegal Group Annual Report

Results of Operation 1996 Compared to 1995

Total revenues for 1996 were $117,581,664 which were $15,965,966, or 15.7%,
greater than 1995. Net premiums earned increased to $104,527,038, an increase of
$15,004,835, or 16.8%, over 1995. An increase in Atlantic States' share of the
pool with the Mutual Company, from 60% to 65% effective January 1, 1996
accounted for $6,701,309, or 7.5%, of this increase. A 1.9% increase in the
direct premiums written by the combined pool of Atlantic States and the Mutual
Company, a 15.8% increase in the direct premiums written of Southern, a 6.3%
increase in the direct premiums written of Delaware and an 11.3% increase in the
direct premiums written of Pioneer accounted for the majority of the remaining
increase. The Company reported realized investment gains of $172,734, compared
to realized investment gains of $399,706 in 1995. Gains in both years resulted
from normal turnover of the Company's investment portfolio. As of December 31,
1996, 99.9% of the Company's bond portfolio was classified as Class 1 (highest
quality) by the National Association of Insurance Commissioners' Security
Valuation Office. Investment income increased $1,085,625. An increase in the
average invested assets from $159,823,000 to $180,352,394, offset by a decrease
in the average yield to 6.0% from 6.1% in 1995, accounted for the change.

   The GAAP combined ratio of insurance operations was 100.4% in 1996, compared
to 98.6% in 1995. The GAAP combined ratio is the sum of the ratios of incurred
losses and loss adjustment expense to premiums earned (loss ratio), underwriting
expenses to premiums earned (expense ratio) and policyholder dividends to
premiums earned (dividend ratio). The loss ratio in 1996 was 67.4%, compared to
64.9% in 1995, accounting for the change. This increase in the loss ratio
resulted from increased claim activity due to severe winter weather in the
primary operating areas of the Company in the first quarter of 1996. The loss
ratio in the first quarter was 72.4%, compared to 65.7% for the rest of the
year. The expense ratio for 1996 was 31.5%, compared to 32.5% in 1995, with the
dividend ratio increasing from 1.2% in 1995 to 1.5% in 1996 due to improved loss
ratios in Workers' Compensation in 1996.

Liquidity and Capital Resources

The Company generates sufficient funds from its operations and maintains a high
degree of liquidity in its investment portfolio. The primary source of funds to
meet the demands of claim settlements and operating expenses are premium
collections, investment earnings and maturing investments. As of December 31,
1997, the Company had no material commitment for capital expenditures.

   In investing funds made available from operations, the Company maintains
securities' maturities consistent with its projected cash needs for the payment
of claims and expenses. The Company maintains a portion of its investment
portfolio in relatively short-term and highly liquid assets to ensure the
availability of funds.

   As of December 31, 1997, pursuant to a credit agreement dated December 29,
1995, with Fleet National Bank of Connecticut, the Company had unsecured
borrowings of $10.5 million. Such borrowings were made in connection with the
acquisition of Delaware and a $5 million capital contribution to Atlantic States
in 1996. Per the terms of the credit agreement, the Company may borrow up to $20
million at interest rates equal to the bank's then current prime rate or the
then current London interbank Eurodollar bank rate plus 1.70%. At December 31,
1997, the interest rate on the outstanding balance was 7.60625%. In addition,
the Company will pay a non-use fee at a rate of 3/10 of 1% per annum on the
average daily unused portion of the bank's commitment. On each December 29,
commencing December 29, 1999, the credit line will be reduced by $4 million. Any
outstanding loan in excess of the remaining credit line after such reduction
will then be payable.

   The Company issued a note for $5,191,774 to the Mutual Company in connection
with the purchase of Pioneer. This note, which was due December 31, 1997, was
replaced by a similar note effective December 31, 1997, and payable December 31,
1998. Interest is payable on the new note on a quarterly basis at a rate of 7%
per annum.

   The Company's principal sources of cash with which to meet obligations and
pay stockholder dividends are dividends from the Insurance Subsidiaries which
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. The Insurance Subsidiaries are also subject to
Risk Based Capital (RBC) requirements which may further impact their ability to
pay dividends. At December 31, 1997, all four companies' statutory capital and
surplus were substantially above the RBC requirements. At December 31, 1997,
amounts available for distribution as dividends to DGI without prior approval of
the insurance regulatory authorities were $7,349,284 from Atlantic States,
$703,727 from Southern, $1,070,463 from Delaware and $542,799 from Pioneer.

   Net unrealized gains resulting from fluctuations in the fair value of
investments reported in the balance sheet at fair value were $1,011,417 (net of
applicable federal income tax) at December 31, 1997, and $422,916 (net of
applicable federal income tax) at December 31, 1996.

                                        The 1997 Donegal Group Annual Report--11

Credit Risk

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

   The Company's Insurance Subsidiaries have reinsurance agreements in place
with the Mutual Company, as described in Note 2 of the financial statements, and
with a number of other major authorized reinsurers, as described in Note 8 of
the financial statements.

Impact of Inflation

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

Year 2000 Issues

The year 2000 issue (i.e. the ability of computer systems to properly process
information which contains dates beginning with January 1, 2000 and thereafter)
affects virtually all companies. All computer systems used for processing of
business for the Company are owned and operated by the Mutual Company. Certain
of these computer systems utilized by the Mutual Company to process information
use only two digits to identify a year. Because of this, the year 2000 would be
represented in the system as "00" and would in most cases be interpreted by the
computer as "1900" rather than "2000", resulting in processing errors.

   The ability to process information in a timely and accurate manner is vital
to the Company's property and casualty insurance business. The Company
recognizes that the systems used to process its business must be able to
accurately identify and process information containing year 2000 dates by the
end of 1998. The Mutual Company has a vigorous and comprehensive project
underway to ensure compliance in time to meet this deadline. This project was
initiated as part of a review of the main application systems in 1995. The
Mutual Company is taking the steps it deems appropriate to meet this challenge,
including migrating to the most current version of vendors' software, which
improves functionality in addition to being year 2000 compliant, replacing
existing software with new software systems and rewriting existing computer
programs. The goal of this project is to be substantially year 2000 compliant by
the end of 1998.

Impact of New Accounting Standards

Disclosure of Information about Capital Structure

In February 1997, the Financial Accounting Standards Board issued SFAS No. 129,
"Disclosure of Information about Capital Structure." SFAS No. 129 establishes
standards for disclosing information about an entity's capital structure. SFAS
No. 129 contains no change in disclosure requirements for entities that were
previously subject to the requirements of APB Nos. 10 and 15 and SFAS No. 47,
and as such the adoption of SFAS No. 129 did not have any effect on the
Company's reporting.

Reporting Comprehensive Income

SFAS No. 130, "Reporting Comprehensive Income", requires enterprises to include
a Statement of Comprehensive Income as part of their full set of financial
statements for fiscal years beginning after December 15, 1997, with earlier
adoption permitted. The Company intends to adopt SFAS No. 130 in 1998.

Disclosures about Segments of an Enterprise and Related Information

SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information", requires enterprises to provide disclosures about operating
segments using the "management approach" for fiscal years beginning after
December 15, 1997, with earlier adoption permitted. The Company intends to adopt
SFAS No. 131 in 1998. The Company has not yet determined what its operating
segments will be under SFAS No. 131.

Employers' Disclosures about Pensions and Other Postretirement Benefits

SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement
Benefits," revises employer's disclosures about pensions and other
postretirement benefit plans. It does not change the measurement or recognition
of these plans. SFAS No. 132 is effective for fiscal years beginning after
December 15, 1997, with earlier adoption permitted. The Company intends to adopt
SFAS No. 132 in 1998.

12--The 1997 Donegal Group Annual Report

Donegal Group Inc.
Consolidated Balance Sheets

December 31,                                                                                             1997             1996*
- -----------------------------------------------------------------------------------------------------------------------------------
                                                                                                                
Assets
Investments

    Fixed maturities
        Held to maturity, at amortized cost (fair value $120,882,886 and $116,264,317)             $ 117,246,205      $ 114,339,006
        Available for sale, at fair value (amortized cost $56,922,342 and $53,264,748)                57,731,251         53,536,543
    Equity securities, available for sale, at fair value (cost $6,551,020 and $2,774,946)              7,274,562          3,142,944
    Short-term investments, at cost, which approximates fair value                                    22,712,787         21,470,757
- -----------------------------------------------------------------------------------------------------------------------------------
        Total investments                                                                            204,964,805        192,489,250
Cash                                                                                                   3,413,315          3,700,163
Accrued investment income                                                                              2,741,207          2,628,563
Premiums receivable                                                                                   11,244,628         11,075,415
Reinsurance receivable                                                                                40,953,032         40,875,009
Deferred policy acquisition costs                                                                      8,448,060          7,837,899
Federal income taxes receivable                                                                           56,454                 --
Deferred tax asset, net                                                                                3,302,043          3,613,307
Prepaid reinsurance premiums                                                                          22,882,283         22,373,319
Property and equipment, net                                                                            4,938,524          2,622,399
Accounts receivable--securities                                                                          456,493             98,622
Due from affiliate                                                                                       141,313                 --
Other                                                                                                    562,348            677,048
- -----------------------------------------------------------------------------------------------------------------------------------
        Total assets                                                                               $ 304,104,505      $ 287,990,994
===================================================================================================================================

Liabilities and Stockholders' Equity
Liabilities

    Losses and loss expenses                                                                       $ 118,112,390      $ 114,621,961
    Unearned premiums                                                                                 71,367,691         70,555,906
    Accrued expenses                                                                                   3,214,767          2,387,040
    Current income taxes                                                                                      --            644,529
    Reinsurance balances payable                                                                         735,009            746,935
    Cash dividend declared to stockholders                                                               604,054            492,619
    Line of credit                                                                                    10,500,000          8,500,000
    Accounts payable--securities                                                                       2,499,059          2,748,838
    Other                                                                                                283,098            204,989
    Due to affiliate - Pioneer acquisition                                                             5,191,774          5,191,774
    Due to affiliate - other                                                                                  --            297,129
- -----------------------------------------------------------------------------------------------------------------------------------
        Total liabilities                                                                            212,507,842        206,391,720
- -----------------------------------------------------------------------------------------------------------------------------------

Stockholders' Equity

    Preferred stock, $1.00 par value, authorized 1,000,000 shares; none issued
    Common stock, $1.00 par value, authorized 10,000,000 shares,
        issued 6,122,431 and 4,540,569 shares and outstanding
        6,030,715 and 4,471,782 shares                                                                 6,122,431          4,540,569
    Additional paid-in capital                                                                        38,932,117         37,862,715
    Net unrealized gains on investments available for sale, net of taxes                               1,011,417            422,916
    Retained earnings                                                                                 46,422,454         39,664,830
    Treasury stock, at cost                                                                             (891,756)          (891,756)
- -----------------------------------------------------------------------------------------------------------------------------------
        Total stockholders' equity                                                                    91,596,663         81,599,274
- -----------------------------------------------------------------------------------------------------------------------------------
        Total liabilities and stockholders' equity                                                 $ 304,104,505      $ 287,990,994
===================================================================================================================================

* Restated

See accompanying notes to consolidated financial statements.

                                      The 1997 Donegal Group Annual Report -- 13

Donegal Group Inc.
Consolidated Statements of Income

Year Ended December 31,                                              1997                  1996*                   1995*
- --------------------------------------------------------------------------------------------------------------------------
                                                                                                      
   Revenues

      Premiums earned                                            $159,055,645           $145,712,891           $119,068,341
      Premiums ceded                                               51,753,477             41,185,853             29,546,138
- --------------------------------------------------------------------------------------------------------------------------
      Net premiums earned                                         107,302,168            104,527,038             89,522,203
      Investment income, net of investment expenses                11,507,277             10,799,369              9,713,744
      Installment payment fees                                        818,981                786,779                712,279
      Lease income                                                    643,183                541,010                491,115
      Service fees                                                    741,861                754,734                776,651
      Net realized investment gains                                   314,136                172,734                399,706
- --------------------------------------------------------------------------------------------------------------------------
           Total revenues                                         121,327,606            117,581,664            101,615,698
- --------------------------------------------------------------------------------------------------------------------------

   Expenses

      Losses and loss expenses                                     99,408,492             98,615,417             75,318,765
      Reinsurance recoveries                                       31,751,974             28,194,493             17,249,070
- --------------------------------------------------------------------------------------------------------------------------
      Net losses and loss expenses                                 67,656,518             70,420,924             58,069,695
      Amortization of deferred policy acquisition costs            18,696,000             17,032,000             14,412,000
      Other underwriting expenses                                  17,058,668             15,876,797             14,702,852
      Policy dividends                                              1,319,384              1,609,369              1,106,357
      Other                                                         1,513,256              1,530,635              1,256,839
      Interest                                                        910,237                375,311                  7,604
- --------------------------------------------------------------------------------------------------------------------------
           Total expenses                                         107,154,063            106,845,036             89,555,347
- --------------------------------------------------------------------------------------------------------------------------
           Income before income taxes                              14,173,543             10,736,628             12,060,351
   Income taxes                                                     3,532,357              2,178,854              2,500,741
- --------------------------------------------------------------------------------------------------------------------------
      Net income                                                $  10,641,186          $   8,557,774          $   9,559,610
===========================================================================================================================

   Net income per common share

      Basic                                                     $        1.77          $        1.46          $        1.72
===========================================================================================================================
      Diluted                                                   $        1.77          $        1.45          $        1.68
===========================================================================================================================

* Restated

See accompanying notes to consolidated financial statements.

14--The 1997 Donegal Group Annual Report

Donegal Group Inc.
Consolidated Statements of Stockholders' Equity

                                                      Preferred Stock                  Common Stock           Additional
                                                   ---------------------          ---------------------         Paid-in
                                                   Shares         Amount          Shares         Amount         Capital
- -------------------------------------------------------------------------------------------------------------------------
Balance,

     January 1, 1995*                                    0    $          0       4,162,770    $  4,162,770   $ 34,005,370
- -------------------------------------------------------------------------------------------------------------------------
Issuance of common stock                                                           163,592         163,592      1,559,422
Net income*
Change in unrealized gains
     (losses) on investments (Net of

     applicable federal income taxes)*
Cash dividends

     $.30 per share
- -------------------------------------------------------------------------------------------------------------------------
Balance,
     December 31, 1995*                                  0    $          0       4,326,362    $  4,326,362   $ 35,564,792
- -------------------------------------------------------------------------------------------------------------------------
Issuance of common stock                                                           214,207         214,207      2,297,923
Net income*
Change in unrealized gains
     (losses) on investments (Net of

     applicable federal income taxes)*
Purchase of 43,739 shares of treasury stock
Cash dividends

     $.33 per share
- -------------------------------------------------------------------------------------------------------------------------
Balance,
     December 31, 1996*                                  0    $          0       4,540,569    $  4,540,569   $ 37,862,715
- -------------------------------------------------------------------------------------------------------------------------
Issuance of common stock                                                            61,523          61,523      1,069,402
Net income
Change in unrealized gains
     on investments (Net of

     applicable federal income taxes)
Cash dividends

     $.39 per share
Stock dividend                                                                   1,520,339       1,520,339
- -------------------------------------------------------------------------------------------------------------------------
Balance,

     December 31, 1997                                   0    $          0       6,122,431    $  6,122,431   $ 38,932,117
=========================================================================================================================

                                                   Net Unrealized
                                                   Gains (Losses)
                                                   on Investments                                      Total
                                                      Available        Retained       Treasury      Stockholders'
                                                       for Sale        Earnings         Stock          Equity
- -----------------------------------------------------------------------------------------------------------------
Balance,

     January 1, 1995*                                $ (1,180,608)   $ 25,171,009   $   (819,780)   $ 61,338,761
- -----------------------------------------------------------------------------------------------------------------
Issuance of common stock                                                                               1,723,014
Net income*                                                             9,559,610                      9,559,610
Change in unrealized gains
     (losses) on investments (Net of

     applicable federal income taxes)*                  2,079,294                                      2,079,294
Cash dividends

     $.30 per share                                                    (1,679,990)                    (1,679,990)
- -----------------------------------------------------------------------------------------------------------------
Balance,
     December 31, 1995*                               $   898,686    $ 33,050,629    $   (819,780)   $73,020,689
- -----------------------------------------------------------------------------------------------------------------
Issuance of common stock                                                                               2,512,130
Net income*                                                             8,557,774                      8,557,774
Change in unrealized gains
     (losses) on investments (Net of

     applicable federal income taxes)*                   (475,770)                                      (475,770)
Purchase of 43,739 shares of treasury stock                                               (71,976)       (71,976)
Cash dividends

     $.33 per share                                                    (1,943,573)                    (1,943,573)
- -----------------------------------------------------------------------------------------------------------------
Balance,
     December 31, 1996*                              $    422,916    $ 39,664,830   $    (891,756)  $ 81,599,274
- -----------------------------------------------------------------------------------------------------------------
Issuance of common stock                                                                               1,130,925
Net income                                                             10,641,186                     10,641,186
Change in unrealized gains
     on investments (Net of

     applicable federal income taxes)                     588,501                                        588,501
Cash dividends

     $.39 per share                                                    (2,363,223)                    (2,363,223)
Stock dividend                                                         (1,520,339)
- -----------------------------------------------------------------------------------------------------------------
Balance,

     December 31, 1997                               $  1,011,417    $ 46,422,454   $    (891,756)  $ 91,596,663
=================================================================================================================

* Restated

                                      The 1997 Donegal Group Annual Report -- 15

Donegal Group Inc.
Consolidated Statements of Cash Flows

Year Ended December 31,                                               1997                      1996*                  1995*
- -------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities:

   Net income                                                     $10,641,186               $ 8,557,774            $ 9,559,610
- -------------------------------------------------------------------------------------------------------------------------------
                                                                                                              
   Adjustments to reconcile net income to net cash
           provided by operating activities:

      Depreciation and amortization                                   390,857                   256,694                402,367
      Realized investment gains                                      (314,136)                 (172,734)              (399,706)
   Changes in Assets and Liabilities:

      Losses and loss expenses                                      3,490,429                15,727,682             10,409,854
      Unearned premiums                                               811,785                13,923,360              8,499,300
      Accrued expenses                                                827,727                  (300,425)               980,274
      Premiums receivable                                            (169,213)                1,509,474             (2,925,535)
      Deferred policy acquisition costs                              (610,161)                 (935,681)            (1,350,349)
      Deferred income taxes                                             7,108                     3,380               (521,952)
      Reinsurance receivable                                          (78,023)              (12,649,518)            (2,533,170)
      Accrued investment income                                      (112,644)                 (124,330)              (388,711)
      Amounts due from affiliate                                     (438,442)                1,514,009                374,827
      Reinsurance balances payable                                    (11,926)                   64,586                (70,170)
      Prepaid reinsurance premiums                                   (508,964)               (9,281,222)            (2,237,013)
      Current income taxes                                           (700,983)                1,353,718               (821,857)
      Other, net                                                      192,808                    44,969               (121,725)
- -------------------------------------------------------------------------------------------------------------------------------
          Net adjustments                                           2,776,222                10,933,962              9,296,434
- -------------------------------------------------------------------------------------------------------------------------------
      Net cash provided by operating activities                    13,417,408                19,491,736             18,856,044
- -------------------------------------------------------------------------------------------------------------------------------

Cash Flows from Investing Activities:
   Purchase of fixed maturities

      Held to maturity                                            (15,834,418)              (30,795,475)           (26,505,938)
      Available for sale                                          (21,614,427)              (21,900,833)           (28,445,845)
   Purchase of equity securities                                  (10,598,546)               (9,077,146)            (6,072,439)
   Sale of fixed maturities
      Available for sale                                                   --                 7,247,675              5,327,499
   Maturity of fixed maturities
      Held to maturity                                             11,909,421                11,996,190             11,496,250
      Available for sale                                           18,860,222                17,634,933              6,631,844
   Sale of equity securities                                        6,695,236                 9,493,480              8,121,345
   Acquisition and assumption of Delaware                                  --                  (202,243)            (5,300,000)
   Purchase of property and equipment                              (2,758,851)                 (255,754)              (336,537)
   Net sales (purchases) of short-term investments                 (1,242,030)               (6,391,292)            11,763,556
- -------------------------------------------------------------------------------------------------------------------------------
      Net cash used in investing activities                       (14,583,393)              (22,250,465)           (23,320,265)
- -------------------------------------------------------------------------------------------------------------------------------

Cash Flows from Financing Activities:

   Issuance of common stock                                         1,130,925                 2,512,130              1,723,014
   Line of credit, net                                              2,000,000                 3,500,000              5,000,000
   Cash dividends paid                                             (2,251,788)               (1,878,648)            (1,621,631)
   Purchase of treasury stock                                              --                   (71,976)                    --
- -------------------------------------------------------------------------------------------------------------------------------
      Net cash provided by financing activities                       879,137                 4,061,506              5,101,383
- -------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash                                      (286,848)                1,302,777                637,162
Cash at beginning of year                                           3,700,163                 2,397,386              1,760,224
- -------------------------------------------------------------------------------------------------------------------------------
Cash at end of year                                              $  3,413,315              $  3,700,163           $  2,397,386
===============================================================================================================================

* Restated

See accompanying notes to consolidated financial statements.

16--The 1997 Donegal Group Annual Report

Notes to Consolidated Financial Statements

1--Summary of Significant Accounting Policies

Organization and Business

The Company was organized as a regional insurance holding company by Donegal
Mutual Insurance Company (the "Mutual Company") and operates in Pennsylvania,
Maryland, Delaware, Virginia and Ohio through its wholly owned stock insurance
companies, Atlantic States Insurance Company ("Atlantic States"), Southern
Insurance Company of Virginia ("Southern"), Delaware Atlantic Insurance Company
("Delaware"), and Pioneer Insurance Company ("Pioneer") (collectively "Insurance
Subsidiaries"). The Company's major lines of business in 1997 and their
percentages of total net earned premiums were Automobile Liability (27.8%),
Workers' Compensation (15.9%), Automobile Physical Damage (17.1%), Homeowners
(17.6%) and Commercial Multiple Peril (15.6%). The Insurance Subsidiaries are
subject to regulation by Insurance Departments in those states in which they
operate and undergo periodic examination by those departments. The Insurance
Subsidiaries are also subject to competition from other insurance carriers in
their operating areas. Atlantic States participates in an intercompany pooling
arrangement with the Mutual Company and assumes 65% (60% in 1995) of the pooled
business. Southern cedes 50% of its business to the Mutual Company and Delaware
cedes 70% of its Workers' Compensation business to the Mutual Company. At
December 31, 1997, the Mutual Company held 58.2% of the outstanding common stock
of the Company.

   On July 15, 1997, the Company issued a 4 for 3 stock split in the form of a
33 1/3% stock dividend to stockholders of record as of June 25, 1997. Per share
information prior to July 15, 1997, has been restated for this change.

   In March 1997, the Company acquired all of the outstanding stock of Pioneer.
This transaction was accounted for as if it were a "pooling of interest," and as
such the Company's financial statements have been restated to include Pioneer as
a consolidated subsidiary from January 1, 1993, to the present.

     In addition to the Company's insurance subsidiaries, it also owns all of
the outstanding stock of Atlantic Insurance Services, Inc. ("AIS"), an insurance
services organization currently providing inspection and policy auditing
information on a fee for service basis to its affiliates and the insurance
industry.

Basis of Consolidation

The consolidated financial statements, which have been prepared in accordance
with generally accepted accounting principles, include the accounts of Donegal
Group Inc. and its wholly owned subsidiaries. All significant inter-company
accounts and transactions have been eliminated in consolidation. The term
"Company" as used herein refers to the consolidated entity. Certain amounts in
the 1996 and 1995 financial statements have been reclassified to conform to the
current year presentation.

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.

     Material estimates that are particularly susceptible to significant change
in the near-term relate to the determination of the liabilities for losses and
loss expenses. While management uses available information to provide for such
liabilities, future additions to these liabilities may be necessary based on
changes in trends in claim frequency and severity.

Investments

The Company classifies its debt and equity securities into the following
categories:

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

     Available for Sale--Debt and equity securities not classified as either
     held-to-maturity or trading; 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 which is other than temporary, the
carrying value for investments in the held to maturity and available for sale
categories is reduced to fair value. Such decline in carrying value is
recognized as a realized loss and charged to income.

                                            1997 Dongeal Group Annual Report--17

     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 with significant changes in estimated prepayments
accounted for under the prospective method.

Fair Values of Financial Instruments

The Company has used the following methods and assumptions in estimating its
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.

     Line of Credit--The carrying amounts reported in the balance sheet for the
     line of credit approximates fair value due to the variable rate nature of
     the line of credit.

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.

     In addition, various Insurance Departments, as an integral part of their
examination process, periodically review the Company's liabilities for losses
and loss expenses. Such departments may require the Company to recognize
additions to the liabilities based on their judgements about information
available to them at the time of their examination.

     The Company has no material exposures to environmental liabilities.

Income Taxes

The Company and its subsidiaries currently file a consolidated federal income
tax return.

     The Company accounts 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 the Company's assets and liabilities at
enacted tax rates expected to be in effect when such amounts are realized or
settled.

Credit Risk

The Company provides property and liability coverages through its Insurance
Subsidiaries' independent agency systems located throughout its operating area.
The majority of this business is billed directly to the insured, although a
portion of the Company's commercial business is billed through its agents, who
are extended credit in the normal course of business.

     The Company's Insurance 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.

18--The 1997 Donegal Group Annual Report

Reinsurance Accounting and Reporting 

The Company relies upon reinsurance agreements to limit its maximum net loss
from large single risks or risks in concentrated areas, and to increase its
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, the Company is exposed to the risk of continued liability for such
losses. However, in an effort to reduce the risk of non-payment, the Company
requires all of its reinsurers to have an A.M. Best rating of A- or better or,
with respect to foreign reinsurers, to have a financial condition which, in the
opinion of management, is equivalent to a company with at least an A- rating. If
the Company's reinsurers incur losses from their reinsurance arrangements with
the Company, it is probable that the reinsurance premiums payable by the Company
in the future could increase. Estimated amounts of reinsurance recoverable are
reported as assets in the accompanying consolidated balance sheets as are
prepaid reinsurance premiums which represent the unearned portion of premiums
ceded.

Stock-Based Compensation

Stock-based compensation plans are accounted for under the provisions of
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees," and related interpretations. As such, compensation expense would
be recorded on the date of a stock option grant only if the current market price
of the underlying stock exceeded the exercise price. SFAS No. 123, "Accounting
for Stock-Based Compensation," permits entities to recognize as expense, over
the vesting period, the fair value of all stock-based awards on the date of the
grant. Alternatively, SFAS No. 123 allows entities to continue to apply the
provisions of APB Opinion No. 25 and provide pro forma net income and earnings
per share disclosures for employee stock option grants made in 1995 and future
years as if the fair-value-based method defined in SFAS No. 123 had been
applied. The Company has elected to continue to apply the provisions of APB
Opinion No. 25 and provide the pro forma disclosures under SFAS No. 123.

Net Income per Common Share

The Company adopted SFAS No. 128, "Earnings Per Share," which is effective for
financial statement periods ending after December 15, 1997, as of the end of
1997. The statement supersedes APB Opinion No. 15 and specifies that the
calculation of earnings per share be reported on both a basic and diluted basis.
Basic earnings per share are calculated by dividing income available to
stockholders 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. Diluted earnings per share is computed similarly to
fully diluted earnings per share under APB No. 15. All per share information
prior to the fourth quarter of 1997 has been restated to reflect the adoption of
SFAS No. 128.

2--Transactions with Affiliates

The Company conducts business and has various agreements with the Mutual Company
which 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 65% (60% in 1995) of the Mutual Company's total
pooled insurance business, including that assumed from Atlantic States and
substantially all of the business assumed and retained by the Mutual Company
from Southern and Delaware. Atlantic States, Southern, Delaware and Pioneer each
have a catastrophe reinsurance agreement with the Mutual Company which limits
the maximum liability under any one catastrophic occurrence to $400,000,
$300,000, $300,000 and $200,000, respectively, and $700,000 for a catastrophe
involving more than one of the companies. The Mutual Company and Delaware have
an excess of loss reinsurance agreement in which the Mutual Company assumes up
to $200,000 of losses in excess of $50,000 and workers' compensation quota share
agreement whereby Delaware cedes 70% of that business. The Mutual Company and
Pioneer have an excess of loss reinsurance agreement in which the Mutual Company
assumes up to $200,000 of losses in excess of $50,000. The Mutual Company and
Pioneer also have an aggregate excess of loss reinsurance agreement, entered
into as part of the sale of Pioneer from the Mutual Company to DGI, in which the
Mutual Company agrees to assume the adverse loss development of claims with
dates of loss prior to December 31, 1996, as developed through December 31,
1998, and to assume an amount equal to the loss and loss adjusting ratio in
excess of 60% through December 31, 1998. The Mutual Company and Southern have an
excess of loss reinsurance agreement in which the Mutual Company assumes up to
$25,000 of losses in excess of $100,000 and a quota share agreement whereby
Southern cedes 50% of its direct business less certain reinsurance to the Mutual
Company. Southern, Delaware and Pioneer

                                        The 1997 Donegal Group Annual Report--19

each have retrocessional reinsurance agreements effective July 1, 1996 with the
Mutual Company under which they cede, and then assume back, 100% of their
business net of other reinsurance.

     The following amounts represent reinsurance transactions with the Mutual
Company during 1997, 1996 and 1995. Amounts for losses and loss expenses exclude
salvage and subrogation recoverable because such amounts are determined on a net
basis only consistent with the Mutual Company's statutory records:

CEDED REINSURANCE:              1997           1996          1995
- ---------------------------------------------------------------------
Premiums written           $ 47,946,847   $ 46,443,220   $ 27,963,315
=====================================================================
Premiums earned            $ 47,488,716   $ 37,175,897   $ 25,787,237
=====================================================================
Losses and loss expenses   $ 28,582,315   $ 25,838,753   $ 14,439,306
=====================================================================
Unearned premiums          $ 22,131,526   $ 21,673,395   $ 12,406,072
=====================================================================
Liability for losses and
    loss expenses          $ 35,295,994   $ 33,850,684   $ 20,891,048
=====================================================================

ASSUMED REINSURANCE:
- ---------------------------------------------------------------------
Premiums written           $107,604,989   $108,982,894   $ 79,550,369
=====================================================================
Premiums earned            $107,302,168   $ 95,910,375   $ 74,824,803
=====================================================================
Losses and loss expenses   $ 68,104,859   $ 65,579,955   $ 49,332,144
=====================================================================
Unearned premiums          $ 48,485,408   $ 48,182,587   $ 35,110,068
=====================================================================
Liability for losses
    and loss expenses      $ 83,271,292   $ 80,203,642   $ 66,020,750
=====================================================================

     Losses and loss expenses assumed from the Mutual Company for 1997, 1996 and
1995 are reported net of inter-company catastrophe recoveries which amounted to
approximately $0, $9.5 million, and $0, respectively.

B. EXPENSE SHARING

The Mutual Company provides facilities, management and other services to the
Company, and the Company reimburses 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 the Company and the Mutual Company in
the pooling arrangement, and management of both the Company and the Mutual
Company consider this allocation to be reasonable. Charges for these services
totalled $21,739,911, $19,365,166 and $17,951,966 for 1997, 1996 and 1995,
respectively.

C. LEASE AGREEMENT

The Company leases office equipment and automobiles to the Mutual Company under
a 10-year lease dated January 1, 1990. Future annual commitments under these
leases are $723,000 for 1998, 1999 and 2000.

D. INSPECTION AND POLICY AUDITING SERVICES

AIS provides inspection and policy auditing services to the Mutual Company on a
fee for service basis. Charges for these services totalled $544,651, $600,453,
and $660,606 for 1997, 1996 and 1995, respectively.

3--Investments

The amortized cost and estimated fair values of fixed maturities and equity
securities at December 31, 1997 and 1996, are as follows:

                                               1997
- ------------------------------------------------------------------------------------------
                                                    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                 $ 41,450,057   $    341,162     $   99,819   $ 41,691,400
Obligations of states
    and political
    subdivisions                   57,620,998      2,955,526           --       60,576,524
Corporate securities                7,249,829        327,364          6,693      7,570,500
Mortgage-backed
    securities                     10,925,321        154,057         34,916     11,044,462
- ------------------------------------------------------------------------------------------
    Totals                       $117,246,205   $  3,778,109    $   141,428   $120,882,886
- ------------------------------------------------------------------------------------------ 

                                             1997
- ----------------------------------------------------------------------------------------
                                                   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                 $40,066,278   $   159,106   $    28,883   $40,196,501
Obligations of states
    and political
    subdivisions                  12,109,254       652,996            --    12,762,250
Corporate securities               3,247,602         8,412         3,514     3,252,500
Mortgage-backed
    securities                     1,499,208        20,792            --     1,520,000
Equity securities                  6,551,020       821,409        97,867     7,274,562
- ----------------------------------------------------------------------------------------
    Totals                       $63,473,362   $ 1,662,715   $   130,264   $65,005,813
========================================================================================

20--The 1997 Donegal Group Annual Report

                                         1996
- ------------------------------------------------------------------------------------
                                               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           $ 38,646,994   $    258,233   $    297,377   $ 38,607,850
Obligations of states
    and political
    subdivisions             57,094,620      1,792,187         75,388     58,811,419
Corporate securities          5,916,899        279,056          8,455      6,187,500
Mortgage-backed
    securities               12,680,493        128,691        151,636     12,657,548
- ------------------------------------------------------------------------------------
    Totals                 $114,339,006   $  2,458,167   $    532,856   $116,264,317
====================================================================================

                                            1996
- --------------------------------------------------------------------------------------
                                     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                 $35,624,984   $    44,880   $   162,770   $35,507,094
Obligations of states
    and political
    subdivisions                  12,586,391       414,299        13,190    12,987,500
Corporate securities               3,456,881         4,150        25,031     3,436,000
Mortgage-backed
    securities                     1,596,492        16,044         6,587     1,605,949
Equity securities                  2,774,946       479,311       111,313     3,142,944
- --------------------------------------------------------------------------------------
   Totals                        $56,039,694   $   958,684   $   318,891   $56,679,487
======================================================================================

     The amortized cost and estimated fair value of fixed maturities at December
31, 1997, 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                             $  5,848,961   $  5,837,500
Due after one year through five years                 25,200,668     25,766,300
Due after five years through ten years                49,608,748     51,266,351
Due after ten years                                   25,662,507     26,968,273
Mortgage-backed securities                            10,925,321     11,044,462
- -------------------------------------------------------------------------------
     Total held to maturity                         $117,246,205   $120,882,886
===============================================================================

Available for sale:

Due in one year or less                             $  7,451,076   $  7,451,500
Due after one year through five years                 25,934,215     26,013,001
Due after five years through ten years                15,150,229     15,572,750
Due after ten years                                    6,887,614      7,234,000
Mortgage-backed securities                             1,499,208      1,520,000
- -------------------------------------------------------------------------------
     Total available for sale                       $ 56,922,342   $ 57,731,251
===============================================================================

     The amortized cost of fixed maturities on deposit with various regulatory
authorities at December 31, 1997 and 1996, amounted to $2,785,752 and
$2,665,627, respectively.

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

                            1997           1996           1995
- ----------------------------------------------------------------
Fixed maturities        $10,703,397   $  9,924,660    $8,652,976
Equity securities           238,777        233,072       233,822
Short-term investments    1,141,834      1,091,855     1,237,888
Real estate                 127,250         81,650        81,350
- ----------------------------------------------------------------
Investment income        12,211,258     11,331,237    10,206,036
Investment expenses         703,981        531,868       492,292
- ----------------------------------------------------------------
Net investment income   $11,507,277    $10,799,369    $9,713,744
================================================================
                                                   
     Gross realized gains and losses from sales of investments during 1997, 1996
and 1995 are as follows:

                             1997          1996         1995
- --------------------------------------------------------------
Gross realized gains:

     Fixed maturities      $ 84,196      $ 29,206  $   348,139
     Equity securities      408,429       404,381      658,595
- --------------------------------------------------------------
                            492,625       433,587    1,006,734
- --------------------------------------------------------------
Gross realized losses:

     Fixed maturities           694           689        1,152
     Equity securities      177,795       260,164      605,876
- --------------------------------------------------------------
                            178,489       260,853      607,028
- --------------------------------------------------------------
Net realized gains         $314,136      $172,734  $   399,706
==============================================================

4--Deferred Policy Acquisition Costs

Changes in deferred policy acquisition costs are as follows:

                                 1997          1996          1995
- --------------------------------------------------------------------
Balance, January 1           $ 7,837,899   $ 6,902,218   $ 5,551,869
Acquisition costs deferred    19,306,161    17,967,681    15,762,349
Amortization charged
     to earnings              18,696,000    17,032,000    14,412,000
- --------------------------------------------------------------------
Balance, December 31         $ 8,448,060   $ 7,837,899   $ 6,902,218
====================================================================

5--Property and Equipment

Property and equipment at December 31, 1997 and 1996, consisted of the
following:

                                                             Estimated
                                                               Useful
                                   1997           1996          Life
- -----------------------------------------------------------------------
Cost--office equipment         $ 3,653,494    $ 2,434,436    5-15 years
      automobiles                  768,643        785,473     3 years
      leasehold improvements        59,233         81,719    15-40 years
      real estate                2,621,896      1,139,397    15-50 years
      software                      31,526         18,409     5 years
- -----------------------------------------------------------------------
                                 7,134,792      4,459,434
Accumulated depreciation        (2,196,268)    (1,837,035)
- -----------------------------------------------------------------------
                               $ 4,938,524    $ 2,622,399
=======================================================================

     Depreciation expense for 1997, 1996, and 1995 amounted to $442,726,
$384,154 and $364,904, respectively.

                                        The 1997 Donegal Group Annual Report--21

6--Liability for Losses and Loss Expenses

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

                                 1997            1996             1995
- ---------------------------------------------------------------------------
Balance at January 1       $ 114,621,961    $  98,894,279    $  88,484,425
     Less reinsurance
       recoverable            39,194,405       27,738,898       25,167,086
- ---------------------------------------------------------------------------
Net balance at January 1      75,427,556       71,155,381       63,317,339
- ---------------------------------------------------------------------------
Incurred related to:

     Current year             69,040,518       73,211,924       61,162,695
     Prior years              (1,384,000)      (2,791,000)      (3,093,000)
- ---------------------------------------------------------------------------
Total incurred                67,656,518       70,420,924       58,069,695
- ---------------------------------------------------------------------------
Paid related to:
     Current year             39,133,249       42,669,749       30,831,653
     Prior years              26,477,000       23,479,000       19,400,000
- ---------------------------------------------------------------------------
Total paid                    65,610,249       66,148,749       50,231,653
- ---------------------------------------------------------------------------
Net balance at
       December 31            77,473,825       75,427,556       71,155,381
     Plus reinsurance
       recoverable            40,638,565       39,194,405       27,738,898
- ---------------------------------------------------------------------------
Balance at December 31     $ 118,112,390    $ 114,621,961    $  98,894,279
===========================================================================

     The Company recognized a decrease in the liability for losses and loss
adjustment expenses of prior years (favorable development) of $1.4 million, $2.8
million and $3.1 million in 1997, 1996 and 1995, respectively. These favorable
developments are primarily attributable to the Company's strengthening of case
reserves in prior years, the effects of which are being recognized currently.

7--Line of Credit

At December 31, 1997, pursuant to a credit agreement dated December 29, 1995,
with Fleet National Bank of Connecticut, the Company had unsecured borrowings of
$10.5 million. Such borrowings were made in connection with the acquisition of
Delaware and a $5 million capital contribution to Atlantic States in 1996. Per
the terms of the credit agreement, the Company may borrow up to $20 million at
interest rates equal to the bank's then current prime rate or the then current
London interbank Eurodollar bank rate plus 1.70%. At December 31, 1997, the
interest rate on the outstanding balance was 7.60625%. In addition, the Company
will pay a non-use fee at a rate of 3/10 of 1% per annum on the average daily
unused portion of the bank's commitment. On each December 29, commencing
December 29, 1999, the credit line will be reduced by $4 million. Any
outstanding loan in excess of the remaining credit line, after such reduction,
will then be payable.

8--Unaffiliated Reinsurers

In addition to the primary reinsurance in place with the Mutual Company, the
Insurance Subsidiaries have other reinsurance in place, principally with four
unaffiliated reinsurers. The following amounts represent statutory reinsurance
transactions with unaffiliated reinsurers during 1997, 1996 and 1995:

Ceded reinsurance:             1997          1996           1995
- -------------------------------------------------------------------
Premiums written           $4,315,594     $4,023,855     $3,819,834
===================================================================
Premiums earned            $4,264,761     $4,009,956     $3,758,901
===================================================================
Losses and loss expenses   $3,169,659     $2,355,740     $2,809,765
===================================================================
Unearned premiums          $  750,757     $  699,924     $  686,025
===================================================================
Liability for losses and                                
   loss expenses           $5,342,571     $5,343,721     $6,846,750
===================================================================

9--Federal Income Taxes

The provision for federal income tax consists of the following:

                            1997            1996            1995
- -------------------------------------------------------------------
Current                  $3,525,249      $2,175,474     $3,022,693
Deferred                      7,108           3,380       (521,952)
- -------------------------------------------------------------------
Federal tax provision    $3,532,357      $2,178,854     $2,500,741
==================================================================
                                                     
     The effective tax rate is different than the amount computed at the
statutory federal rate of 34% for 1997, 1996 and 1995. The reason for such
difference and the related tax effect are as follows:

                                    1997            1996           1995
- ---------------------------------------------------------------------------
Income before

   income taxes                $ 14,173,543    $ 10,736,628    $ 12,060,351
===========================================================================
Computed "expected"
   taxes at 34%                $  4,819,005    $  3,650,454    $  4,100,519
Tax-exempt interest              (1,130,311)     (1,076,764)       (770,084)
Dividends received deduction        (48,477)        (48,108)        (46,789)
Deduction for exercise
   of options                        (1,700)       (399,904)       (324,254)
Other, net                         (106,160)         53,176         (74,982)
Change in valuation
   allowance                           --              --          (383,669)
- ---------------------------------------------------------------------------
Federal income
   tax provision               $  3,532,357    $  2,178,854    $  2,500,741
===========================================================================

22--The 1997 Donegal Group Annual Report

The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities at December 31, 1997 and
1996, are as follows:

                                          1997         1996   
- --------------------------------------------------------------
Deferred tax assets:

    Unearned premium                   $3,297,008   $3,128,626
    Loss reserves                       4,064,877    3,910,691
- --------------------------------------------------------------
       Total                           $7,361,885   $7,039,317
==============================================================

Deferred tax liabilities:

    Depreciation expense              $   341,945  $   286,816
    Deferred policy acquisition costs   2,872,343    2,664,886
    Salvage receivable                    324,521      257,431
    Unrealized gain                       521,033      216,877
- --------------------------------------------------------------
       Total                           $4,059,842   $3,426,010
==============================================================
       Net deferred tax assets         $3,302,043   $3,613,307
==============================================================

    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 the deferred tax asset of
$7,361,885 and $7,039,317 at December 31, 1997 and 1996, since it is more likely
than not that the deferred tax asset will be realized through reversals of
existing temporary differences, future taxable income, carryback to taxable
income in prior years, previously realized investment gains and the
implementation of tax planning strategies.

10--Stock Compensation Plans

The Company applies APB Opinion No. 25 in accounting for its stock-based
compensation plans. Accordingly, no compensation cost has been recognized for
its fixed stock option plans and certain of its stock purchase plans.
Compensation cost for these stock-based compensation plans determined under SFAS
No. 123 would not have had a material impact on net income and earnings per
share for 1997, 1996 or 1995.

   The calculation of pro-forma net income reflects only options granted in
1997, 1996 and 1995. Therefore, the full impact of calculating compensation cost
for stock options under SFAS No. 123 is not reflected because compensation cost
is reflected over the options' vesting period and compensation cost for options
granted prior to January 1, 1995 is not considered.

Equity Incentive Plans

The Company has had an Equity Incentive Plan for key employees since 1986 and
adopted a nearly identical new plan in 1996. Both plans provide 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. During
1996 the new plan was adopted which made 345,850 shares available. The plan was
amended in 1997 making a total of 695,850 shares available. These shares were
adjusted for the Company's 4-for-3 stock split in July 1997, increasing the
number of shares available to 927,800. 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.

     Information regarding activity in the Company's stock option plans is
presented below:

                                                       Weighted Average
                                       Number of        Exercise Price
                                        Shares             Per Share
- ------------------------------------------------------------------------
Outstanding at December 31, 1994       360,650             $ 11.01
   Granted - 1995                           --                  --
   Exercised - 1995                    150,650               10.47
   Forfeited - 1995                      7,500               10.80
- ------------------------------------------------------------------------
Outstanding at December 31, 1995       202,500             $ 11.42
   Granted - 1996                           --                  --
   Exercised - 1996                    202,500               11.42
   Forfeited - 1996                         --                  --
- ------------------------------------------------------------------------
Outstanding at December 31, 1996            --             $    --
   Granted - 1997                      399,337               18.00
   Exercised - 1997                      2,222               18.00
   Forfeited - 1997                     10,224               18.00
- ------------------------------------------------------------------------
Outstanding at December 31, 1997       386,891             $ 18.00
========================================================================
Exercisable at:                                        
   December 31, 1995                   202,500             $ 11.42
========================================================================
   December 31, 1996                        --             $    --
========================================================================
   December 31, 1997                   130,000             $ 18.00
========================================================================
                                                 
   Shares available for future grants at December 31, 1997 are 540,909.

1996 Equity Incentive Plan For Directors

During 1996 the Company adopted an Equity Incentive Plan For Directors which
made 90,000 shares available for award. These shares were adjusted for the
Company's 4 for 3 stock split in July 1997, increasing the number of shares
available to 118,400. Awards may be made in the form of stock options, and the
plan additionally provides for the issuance of 100 shares of restricted stock to
each director on the first business day of January in each year, commencing
January 2, 1997. As of December 31, 1997, the Company has 60,003 unexercised
options under this plan. Additionally, 1,200 shares of restricted stock were
issued on January 2, 1997.

                                        The 1997 Donegal Group Annual Report--23

Employee Stock Purchase Plans

During 1996 the Company adopted the 1996 Employee Stock Purchase Plan which
replaced a similar plan that had been adopted effective January 1, 1988. The
1996 plan made 100,000 shares available for issuance. These shares were adjusted
for the Company's 4 for 3 stock split in July 1997, increasing the number of
shares available to 129,116.

   The 1996 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 the Company's common stock on the last day before
the first day of the enrollment period (June 1 and December 31). A summary of
plan activity follows:

                                            Shares Issued
                                        ---------------------
                                          Price        Shares
- -------------------------------------------------------------
January 1,1995                          11.90000        6,004
July 1, 1995                            10.62500        6,938
January 1, 1996                         14.23750        5,630
July 1, 1996                            14.66250        6,077
January 1, 1997                         14.66250        6,575
July 1, 1997                            12.35756        8,518

   On January 1, 1998, the Company issued an additional 6,676 shares at a price
of $15.53906 per share under this plan.

Agency Stock Purchase Plan

On December 31, 1996, the Company adopted the Agency Stock Purchase Plan which
made 300,000 shares available for issuance. These shares were adjusted for the
Company's 4 for 3 stock split in July 1997, increasing the number of shares
available to 395,589. The plan provides for agents of affiliated companies of
DGI 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 1997, 30,150 shares
were issued under this plan.

Pro-Forma Disclosures

The weighted average grant date fair value of options granted during 1997, 1996
and 1995 for the various plans was as follows:

                                   1997        1996        1995
- ------------------------------------------------------------------
Equity Incentive Plan             $4.75      $    --     $    --
1996 Equity Incentive Plan         
   for Directors                   4.75           --          --
Employee Stock Purchase Plans      3.12         3.27        2.78
Agency Stock Purchase Plan         3.41           --          --
                             
   The fair values above were calculated based upon risk-free interest rates of
5% for the Stock Purchase Plans and 6% for 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 34% and an expected dividend yield of
2.40%.

   Had the Company recognized stock compensation expense in accordance with SFAS
No. 123, net income and earnings per share would have been reduced to the
pro-forma amounts shown below:

                                    1997          1996        1995
- ------------------------------------------------------------------------
Net income:

   As reported                  $10,641,186    $8,557,774  $9,559,610
   Pro-forma                     10,263,965     8,530,468   9,536,550
Basic earnings per share:

   As reported                         1.77          1.46        1.72
   Pro-forma                           1.71          1.46        1.71
Diluted earnings per share:

   As reported                         1.77          1.45        1.68
   Pro-forma                           1.70          1.45        1.67

11--Statutory Net Income, Capital and Surplus and Dividend Restrictions

The following is selected information for the Insurance Subsidiaries as
determined in accordance with accounting practices prescribed or permitted by
insurance regulatory authorities:

                                   1997            1996           1995
- --------------------------------------------------------------------------
ATLANTIC STATES
Statutory capital
   and surplus                $ 56,606,354    $ 47,914,415    $ 40,726,246
                              ============================================
Statutory unassigned
   surplus                    $ 25,645,490    $ 16,953,551    $ 14,765,382
                              ============================================
Statutory net income          $  7,349,284    $  5,410,536    $  5,224,905
                              ============================================
- --------------------------------------------------------------------------
SOUTHERN

Statutory capital
   and surplus                $  7,069,112    $  6,608,944    $  6,380,420
                              ============================================
Statutory unassigned
   surplus                    $  2,316,842    $  1,856,674    $  2,378,150
                              ============================================
Statutory net income          $    703,727    $    255,480    $    679,335
                              ============================================
- --------------------------------------------------------------------------
DELAWARE

Statutory capital
   and surplus                $  7,657,691    $  6,798,477    $  5,695,634
                              ============================================
Statutory unassigned
   surplus                    $  2,457,691    $  1,598,477    $    495,634
                              ============================================
Statutory net income          $  1,070,463    $  1,120,952    $    494,576
                              ============================================
- --------------------------------------------------------------------------
PIONEER

Statutory capital
   and surplus                $  5,377,492    $  5,048,582    $  5,108,442
                              ============================================
Statutory unassigned
   surplus                    $ (1,622,508)   $ (1,951,418)   $ (1,391,558)
                              ============================================
Statutory net income (loss)   $    542,799    $   (367,614)   $   (439,335)
                              ============================================
- --------------------------------------------------------------------------

24--The 1997 Donegal Group Annual Report

   The Company's principal source of cash for payment of dividends are dividends
from its Insurance 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, Southern, Delaware and Pioneer are also subject to Risk Based
Capital (RBC) requirements which may further impact their ability to pay
dividends. At December 31, 1997, all four companies' statutory capital and
surplus were substantially above the RBC requirements. At December 31, 1997,
amounts available for distribution as dividends to DGI without prior approval of
insurance regulatory authorities are $7,349,284 from Atlantic States, $703,688
from Southern, $1,070,463 from Delaware and $542,799 from Pioneer.

12--Reconciliation of Statutory Filings to Amounts Reported Herein

The Company's Insurance 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,
                                --------------------------------------------
                                    1997            1996           1995
- ----------------------------------------------------------------------------
Statutory net income of
   insurance subsidiaries       $  9,666,273    $  6,419,354    $  5,959,481
Increases (decreases):
   Deferred policy
       acquisition costs             610,161         935,681       1,350,349
   Deferred federal
       income taxes                   (7,108)         (3,380)        521,952
   Salvage and subrogation
        recoverable                  984,981       1,067,201       1,291,504
   Consolidating eliminations
       and adjustments              (950,000)           --          (900,000)
   Parent-only net income            291,831         155,894       1,301,558
   Non-insurance subsidiary
       net income (loss)              45,048         (16,976)         34,766
- ----------------------------------------------------------------------------
Net income as
   reported herein              $ 10,641,186    $  8,557,774    $  9,559,610
============================================================================

                                                   December 31,
                                   --------------------------------------------
                                        1997            1996            1995
- -------------------------------------------------------------------------------
Statutory capital and surplus
    of insurance subsidiaries      $ 76,710,649    $ 66,370,418    $ 57,910,742
Increases (decreases):

   Deferred policy
       acquisition costs              8,448,060       7,837,899       6,902,218
   Deferred federal
       income taxes                   3,302,043       3,613,307       3,411,544
   Salvage and subrogation
       recoverable                    6,155,467       5,170,486       4,103,285
   Statutory reserves                 8,712,694      10,035,325       6,413,472
   Non-admitted assets and
       other adjustments, net           394,432         355,540         462,199
   Fixed maturities
       available for sale               808,908         271,795       1,008,225
   Consolidating eliminations
       and adjustments              (16,121,711)    (16,121,711)    (10,621,711)
   Parent-only equity                 2,953,248       3,878,390       3,225,914
   Non-insurance
       subsidiary equity                232,873         187,825         204,801
- -------------------------------------------------------------------------------
Stockholders' equity as
   reported herein                 $ 91,596,663    $ 81,599,274    $ 73,020,689
===============================================================================

13--Supplementary Information on Statement of Cash Flows

The following schedule reflects income taxes and interest paid during 1997, 1996
and 1995:

                                1997           1996            1995
- ----------------------------------------------------------------------
Income taxes                $4,094,338      $  825,136      $3,844,550
======================================================================
Interest                    $  904,385      $  369,869      $    7,229
======================================================================
                                                      
14--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
ending December 31, 1997, 1996 and 1995:

                                                   Weighted      
                                                    Average          Earnings
                                   Net              Shares              Per
                                 Income           Outstanding          Share
- -----------------------------------------------------------------------------
1997:                                                             
                                                                  
Basic                         $10,641,186          5,996,203           $1.77
Effect of stock options                --             30,955              --
- -----------------------------------------------------------------------------
Diluted                       $10,641,186          6,027,158           $1.77
=============================================================================

1996:                                                             
                                                                  
Basic                          $8,557,774          5,860,505           $1.46
Effect of stock options                --             40,364           (0.01)
- -----------------------------------------------------------------------------
Diluted                        $8,557,774          5,900,869           $1.45
=============================================================================
                                                                  
1995:                                                             
                                                                  
Basic                          $9,559,610          5,565,071           $1.72
Effect of stock options                --            131,525           (0.04)
- -----------------------------------------------------------------------------
Diluted                        $9,559,610          5,696,596           $1.68
=============================================================================

                                        The 1997 Donegal Group Annual Report--25

15--Condensed Financial Information of Parent Company

                                             CONDENSED BALANCE SHEETS
                                                 ($ in thousands)
                                              
December 31,                                    1997         1996*
- --------------------------------------------------------------------
ASSETS                                                   
                                                         
Investment in subsidiaries (equity method)    $ 99,857     $ 88,916
Cash                                               730          427
Property and equipment                           2,139        1,248
Other                                              451          441
- --------------------------------------------------------------------
         Total assets                         $103,177     $ 91,032
====================================================================
                                                       
LIABILITIES AND STOCKHOLDERS' EQUITY

Liabilities

   Cash dividends declared to stockholders$        604     $   493
   Line of credit                               10,500       8,500
   Other                                           476         440
- --------------------------------------------------------------------
         Total liabilities                      11,580       9,433
- --------------------------------------------------------------------
Stockholders' equity
   Preferred stock, $1.00 par value, authorized
         1,000,000 shares, none issued
   Commonstock, $1.00 par value, authorized 
         10,000,000 shares, issued 6,122,431
         and 4,540,569 shares and outstanding
         6,030,715 and 4,471,782 shares          6,123      4,540
   Additional paid-in capital                   38,932     37,863
   Net unrealized gains on investments           1,012        423
   Retained earnings, including equity in
         undistributed net income of
         subsidiaries($56,082 and $45,730)      46,422     39,665
   Treasury stock, at cost                        (892)      (892)
- --------------------------------------------------------------------
         Total stockholders' equity             91,597     81,599
- --------------------------------------------------------------------
         Total liabilities and stockholders' 
            equity                            $103,177   $ 91,032
====================================================================
* Restated

                         CONDENSED STATEMENTS OF INCOME
                                ($ in thousands)

Year Ended December 31,                    1997       1996*       1995*
- ------------------------------------------------------------------------
Revenues

   Dividends-subsidiaries               $    950    $      0    $    900
   Other                                     658         572         504
- ------------------------------------------------------------------------
         Total revenues                    1,608         572       1,404
- ------------------------------------------------------------------------
Expenses
   Operating expenses                        643         548         411
   Interest                                1,022         416           4
- ------------------------------------------------------------------------
         Total expenses                    1,665         964         415
- ------------------------------------------------------------------------
Income before income tax benefit
   and equity in undistributed net
   income of subsidiaries                    (57)       (392)        989
Income tax benefit                          (346)       (533)       (298)
- ------------------------------------------------------------------------
Income before equity in undistributed
   net income of subsidiaries                289         141       1,287
Equity in undistributed net income
   of subsidiaries                        10,352       8,417       8,273
- ------------------------------------------------------------------------
Net income                              $ 10,641    $ 18,558    $  9,560
========================================================================
* Restated

                       CONDENSED STATEMENTS OF CASH FLOWS
                                ($ in thousands)

Year Ended December 31,                     1997       1996*       1995*
- -------------------------------------------------------------------------
Cash flows from operating activities:
   Net income                            $ 10,641    $  8,558    $  9,560
- -------------------------------------------------------------------------
   Adjustments:
      Equity in undistributed net
         income of subsidiaries           (10,352)     (8,417)     (8,273)
      Other                                   382         373        (112)
- -------------------------------------------------------------------------
         Net adjustments                   (9,970)     (8,044)     (8,385)
- -------------------------------------------------------------------------
      Net cash provided                       671         514       1,175
- -------------------------------------------------------------------------
Cash flows from investing activities:
   Net purchase of property and
      equipment                            (1,251)       (203)       (279)
   Capital contributions to subsidiaries       --      (5,000)         --
   Acquisition of Delaware Atlantic            --        (202)     (5,300)
   Other                                        4       1,110        (744)
- -------------------------------------------------------------------------
      Net cash used                        (1,247)     (4,295)     (6,323)
- -------------------------------------------------------------------------
Cash flows from financing activities:
   Cash dividends paid                     (2,252)     (1,879)     (1,622)
   Issuance of common stock                 1,131       2,512       1,723
   Purchase of treasury stock                --           (72)       --
   Line of credit, net                      2,000       3,500       5,000
- -------------------------------------------------------------------------
      Net cash provided (used)                879        4061      (5,101)
- -------------------------------------------------------------------------
Net change in cash                            303         280         (47)
   Cash at beginning of year                  427         147         194
- -------------------------------------------------------------------------
   Cash at ending of year                $    730    $    427    $    147
=========================================================================
* Restated

16--Interim Financial Data (unaudited)

                                          1997
                  -----------------------------------------------------
                     First         Second        Third        Fourth
                    Quarter       Quarter       Quarter       Quarter
- -----------------------------------------------------------------------
Net premiums
   earned         $26,404,333   $26,823,505   $27,260,693   $26,813,637
Total revenues     29,823,371    30,253,860    30,909,916    30,340,459
Loss and loss
   adjusting
   expenses        16,912,543    17,329,403    17,111,129    16,303,443
Net income          2,562,433     2,400,597     2,911,728     2,766,428
Net income per
   common share
       Basic      $       .43   $       .40   $       .49   $       .46
       Diluted            .43           .40           .48           .45

                                         1996
                  -----------------------------------------------------
                     First        Second        Third         Fourth
                    Quarter       Quarter       Quarter       Quarter
- -----------------------------------------------------------------------
Net premiums
   earned         $25,835,495   $25,979,371   $26,260,774   $26,451,398
Total revenues     29,177,941    29,119,386    29,429,202    29,855,135
Loss and loss
   adjusting
   expenses        18,711,207    17,282,421    17,297,396    17,129,900
Net income          1,336,394     2,508,036     2,284,045     2,429,299
Net income per
   common share
       Basic      $       .23   $       .43   $       .39   $       .41
       Diluted            .23           .43           .38           .41

   Results for the first quarter of 1996 were adversely affected by the record
snowfall levels in the Company's operating area in January 1996. This resulted
in a loss ratio of 72.4% in the first quarter, compared to 65.7% for the rest of
the year.

26--The 1997 Donegal Group Annual Report

Donegal Group Inc.
Independent Auditors' Report

THE STOCKHOLDERS AND BOARD OF DIRECTORS

DONEGAL GROUP INC.

We have audited the accompanying consolidated balance sheets of Donegal Group
Inc. as of December 31, 1997 and 1996, and the related consolidated statements
of income, stockholders' equity, and cash flows for each of the years in the
three-year period ended December 31, 1997. 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 generally accepted auditing
standards. 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. as of December 31, 1997 and 1996, and the results of their operations
and their cash flows for each of the years in the three-year period ended
December 31, 1997 in conformity with generally accepted accounting principles.

                                                          KPMG PEAT MARWICK LLP

Harrisburg, Pennsylvania
February 27, 1998

Board of Directors and Officers

Donegal Group Inc.

                 Board of Directors

Donald H. Nikolaus          President, Chief Executive Officer
                            and a Director
                            
C. Edwin Ireland            Chairman of the Board and a Director
Philip H. Glatfelter, II    Vice Chairman of the Board and
                            a Director
                           
Robert S. Bolinger          Director
Thomas J. Finley, Jr.       Director
Patricia A. Gilmartin       Director
R. Richard Sherbahn         Director

                            Officers

C. Edwin Ireland            Chairman of the Board
Philip H. Glatfelter, II    Vice Chairman of the Board
Donald H. Nikolaus          President and Chief Executive Officer
Ralph G. Spontak            Senior Vice President, Chief Financial 
                            Officer, and Secretary
Daniel J. Wagner            Treasurer

                        Donegal Mutual Insurance Company

                            Board of Directors

Donald H. Nikolaus            President, Chief Executive Officer
                              and a Director
C. Edwin Ireland              Chairman of the Board
                              and a Director
Philip H. Glatfelter, II      Vice Chairman of the Board
                              and a Director
Frederick W. Dreher,III       Director
Patricia A. Gilmartin         Director
Charles A. Heisterkamp, III   Director
John E. Hiestand              Director
R. Richard Sherbahn           Director
William H. Shupert            Senior Vice President of Underwriting and a 
                              Director
Ralph G. Spontak              Senior Vice President
                              Chief Financial Officer,
                              Secretary and a Director

                                 Other Officers

David L. Douglass             Vice President of Commercial Underwriting
Kenneth L. Dull               Vice President of Research and Development
Cyril J. Greenya              Senior Vice President of Underwriting
David W. Plouse               Vice President of Investments
James B. Price                Senior Vice President of Claims
Robert G. Shenk               Senior Vice President of Claims
Daniel J. Wagner              Treasurer
Frank J. Wood                 Senior Vice President of Marketing

28--The 1997 Donegal Group Annual Report

Corporate Information

Annual Meeting

April 16, 1998 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 address listed below.

Market Information

Donegal Group's common stock is traded on NASDAQ under the symbol "DGIC." During
1996 and 1997, the stock price ranged as follows (information prior to July 15,
1997 restated for 4-for-3 stock split on that date):

                                            Cash Dividend
                                              Declared
Quarter        High          Low              Per Share

1996

1st*           14 5/8         13 7/8             --
2nd*           14 1/4         12 9/16           .0825
3rd*           14 1/16        12 3/16           .0825
4th*           15 9/16        13 1/8            .1650
                                                
1997                                            
                                                
1st*           18 15/16       15                 --
2nd*           19             17                .09
3rd*           21             18 1/4            .10
4th            22 1/4         20 1/4            .20

* Restated

Corporate Offices

1195 River Road
P.O. Box 302
Marietta, Pennsylvania 17547
(717) 426-1931

E-mail Address:     info@donegalgroup.com

Donegal Website:    http://www.donegalgroup.com

Transfer Agent

First Chicago Trust Company of New York
P.O. Box 2500
Jersey City, NJ 07303-2500
(800) 317-4445
E-mail Address:   fctc@em.fcnbd.com
FCTC Website:     http://www.fctc.com
Hearing Impaired: TDD:  201-222-4955

Dividend Reinvestment Plan

The Company offers a dividend reinvestment plan through its transfer agent.
For information contact:
Donegal Group Inc. Dividend Reinvestment Plan
c/o First Chicago Trust Company of New York
P.O. Box 2598
Jersey City, NJ 07303-2598
(800) 317-4445

Stockholders

The number of common stockholders of record as of December 31, 1997 was 476.

                               DONEGAL GROUP INC.
                          ---------------------------
 
                    NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
                           TO BE HELD APRIL 16, 1998
 
To the Stockholders of
DONEGAL GROUP INC.:
 
     The Annual Meeting of Stockholders of Donegal Group Inc. (the "Company")
will be held at 10:00 a.m., prevailing time, on April 16, 1998, at the Company's
offices, 1195 River Road, Marietta, Pennsylvania 17547, for the following
purposes:
 
          1. To elect two Class C directors to serve until the expiration of
     their three-year terms and until their successors are elected;
 
          2. To consider and vote upon a proposal to approve an amendment to the
     Company's Certificate of Incorporation to increase the authorized number of
     shares of the Company's Common Stock from 10,000,000 shares to 15,000,000
     shares;
 
          3. To consider and vote upon a proposal to approve an amendment to the
     Company's 1996 Equity Incentive Plan for Directors;
 
          4. To act upon the election of KPMG Peat Marwick LLP as independent
     public accountants for the Company for 1998; and
 
          5. To transact such other business as may properly come before the
     Annual Meeting and any adjournment, postponement or continuation thereof.
 
     The Board of Directors has fixed the close of business on February 20, 1998
as the record date for the determination of the stockholders entitled to notice
of and to vote at the Annual Meeting.
 
     A copy of the Company's Annual Report for the year ended December 31, 1997
is being mailed to stockholders together with this Notice.
 
     Holders of Common Stock are requested to complete, sign and return the
enclosed form of proxy in the envelope provided whether or not they expect to
attend the Annual Meeting in person.
 
                                          By Order of the Board of Directors,
 
                                          /s/ Donald H. Nikolaus
                                          -------------------------------------
                                          Donald H. Nikolaus,
                                          President and Chief Executive Officer
 
March 23, 1998
Marietta, Pennsylvania

                               DONEGAL GROUP INC.

                          ---------------------------
 
     This Proxy Statement and the form of proxy enclosed herewith, which are
first being mailed to stockholders on or about March 23, 1998, are furnished in
connection with the solicitation by the Board of Directors of Donegal Group Inc.
(the "Company") of proxies to be voted at the Annual Meeting of Stockholders
(the "Annual Meeting") to be held at 10:00 a.m., prevailing time, on April 16,
1998, and at any adjournment, postponement or continuation thereof, at the
Company's principal executive offices, which are located at 1195 River Road,
Marietta, Pennsylvania 17547.
 
     Shares represented by proxies in the accompanying form, if properly signed
and returned, will be voted in accordance with the specifications made thereon
by the stockholders. Any proxy not specifying to the contrary will be voted in
favor of the adoption of the proposals referred to in the Notice of Annual
Meeting and for the election of the nominees for director named below. A
stockholder who signs and returns a proxy in the accompanying form may revoke it
at any time before it is voted by giving written notice of revocation or a duly
executed proxy bearing a later date to the Secretary of the Company or by
attending the Annual Meeting and voting in person.
 
     The cost of solicitation of proxies in the accompanying form will be borne
by the Company, including expenses in connection with preparing and mailing this
Proxy Statement. Such solicitation will be made by mail and may also be made on
behalf of the Company in person or by telephone or telegram by the Company's
regular officers and employees, none of whom will receive special compensation
for such services. The Company, upon request therefor, will also reimburse
brokers, nominees, fiduciaries and custodians and persons holding shares in
their names or in the names of nominees for their reasonable expenses in sending
proxies and proxy material to beneficial owners.
 
     Only holders of Common Stock of record at the close of business on February
20, 1998 will be entitled to notice of and to vote at the Annual Meeting. Each
share of Common Stock is entitled to one vote on all matters to come before the
Annual Meeting. Cumulative voting rights do not exist with respect to the
election of directors.
 
     As of the close of business on February 20, 1998, the Company had
outstanding 6,057,732 shares of Common Stock, $1.00 par value. A majority of the
outstanding shares will constitute a quorum at the Annual Meeting. As of
February 20, 1998, Donegal Mutual Insurance Company (the "Mutual Company") owned
3,529,091 shares of the Company's outstanding Common Stock, or approximately
58.3% of the Company's outstanding Common Stock. The Mutual Company has advised
the Company that the Mutual Company will vote its shares for the election of
Thomas J. Finley, Jr. and R. Richard Sherbahn as Class C directors, for the
proposal to approve an amendment to the Company's Certificate of Incorporation
to increase the Company's authorized Common Stock, for the proposal to approve
an amendment to the 1996 Equity Incentive Plan for Directors (the "Director
Plan") and for the election of KPMG Peat Marwick LLP as the Company's
independent public accountants for 1998. Accordingly, Messrs. Finley and
Sherbahn will be elected as Class C directors, the amendment to the Certificate
of Incorporation will be approved, the amendment to the Director Plan will be
approved and KPMG Peat Marwick LLP will be elected as the Company's independent
public accountants for 1998, irrespective of the votes cast by the stockholders
of the Company other than the Mutual Company.
 
     Unless otherwise stated, all information in this Proxy Statement gives
retroactive effect to the four-for-three split of the Company's Common Stock
effected through a stock dividend of one share of Common Stock for each three
shares outstanding, which was paid on July 15, 1997 to stockholders of record on
June 25, 1997.
 
                                       1

                      BENEFICIAL OWNERSHIP OF COMMON STOCK
 
     The following table sets forth as of February 20, 1998 the amount and
percentage of the Company's outstanding Common Stock beneficially owned by (i)
each person who is known by the Company to own beneficially more than 5% of its
outstanding Common Stock, (ii) each director and nominee for director, (iii)
each executive officer named in the Summary Compensation Table and (iv) all
executive officers and directors of the Company as a group.

                                                              SHARES            PERCENT OF
                   NAME OF INDIVIDUAL                      BENEFICIALLY         OUTSTANDING
                  OR IDENTITY OF GROUP                       OWNED(1)         COMMON STOCK(2)
                  --------------------                     ------------       ---------------
                                                                        
5% HOLDERS:
  Donegal Mutual Insurance Company.......................   3,529,091              58.3%
     1195 River Road
     Marietta, Pennsylvania 17547
 
  Wellington Management Company, LLP.....................     365,462(3)           6.03%
     75 State Street
     Boston, MA 02109

DIRECTORS:
  C. Edwin Ireland.......................................      12,711(4)             --
  Donald H. Nikolaus.....................................     107,026(5)            1.7%
  Patricia A. Gilmartin..................................       6,310(4)             --
  Philip H. Glatfelter, II...............................       6,576(4)             --
  R. Richard Sherbahn....................................       4,844(4)             --
  Robert S. Bolinger.....................................       5,511(4)             --
  Thomas J. Finley, Jr...................................       5,311(4)             --

EXECUTIVE OFFICERS (6):
  Ralph G. Spontak.......................................      43,954(7)             --
  William H. Shupert.....................................      23,177(8)             --
  Robert G. Shenk........................................      16,588(9)             --
  Frank J. Wood..........................................      14,935(10)            --
  All directors and executive officers
     as a group (14 persons).............................     288,166(11)           4.6%

- ------------------
 (1) Information furnished by each individual named. This table includes shares
     that are owned jointly, in whole or in part, with the person's spouse, or
     individually by his or her spouse.
 (2) Less than 1% unless otherwise indicated.
 (3) As reported by Wellington Management Company, LLP as of December 31, 1997
     in a filing made with the Securities and Exchange Commission (the "SEC").
 (4) Includes 4,445 shares of Common Stock the director has the option to
     purchase under the Director Plan that are currently exercisable or that
     become exercisable within 60 days after the date of this Proxy Statement.
 (5) Includes 66,667 shares of Common Stock Mr. Nikolaus has the option to
     purchase under the Company's 1996 Equity Incentive Plan that are currently
     exercisable or that become exercisable within 60 days after the date of
     this Proxy Statement.
 (6) Excludes Executive Officers listed under "Directors."
 
                                       2

 (7) Includes 33,333 shares of Common Stock Mr. Spontak has the option to
     purchase under the Company's 1996 Equity Incentive Plan that are currently
     exercisable or that become exercisable within 60 days after the date of
     this Proxy Statement.
 (8) Includes 18,667 shares of Common Stock Mr. Shupert has the option to
     purchase under the Company's 1996 Equity Incentive Plan that are currently
     exercisable or that become exercisable within 60 days after the date of
     this Proxy Statement.
 (9) Includes 13,333 shares of Common Stock Mr. Shenk has the option to purchase
     under the Company's 1996 Equity Incentive Plan that are currently
     exercisable or that become exercisable within 60 days after the date of
     this Proxy Statement.
(10) Includes 13,333 shares of Common Stock Mr. Wood has the option to purchase
     under the Company's 1996 Equity Incentive Plan that are currently
     exercisable or that become exercisable within 60 days after the date of
     this Proxy Statement.
(11) Includes 180,886 shares of Common Stock purchasable upon the exercise of
     options granted under the 1996 Equity Incentive Plan that are currently
     exercisable or that become exercisable within 60 days after the date of
     this Proxy Statement, and 26,670 shares of Common Stock purchasable upon
     the exercise of options granted under the Director Plan that are currently
     exercisable or that become exercisable within 60 days after the date of
     this Proxy Statement.
 
            SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
 
     Section 16 of the Securities Exchange Act of 1934 (the "Exchange Act")
requires that the officers and directors of a corporation, such as the Company,
which has a class of equity securities registered under Section 12 of the
Exchange Act, as well as persons who own more than 10% of a class of equity
securities of such a corporation, file reports of their ownership of such
securities, as well as monthly statements of changes in such ownership, with the
corporation, the SEC and the Nasdaq Stock Market. Based upon written
representations received by the Company from its officers and directors, and the
Company's review of the monthly statements of ownership changes filed with the
Company by its officers and directors during 1997, the Company believes that all
such filings required during 1997 were made on a timely basis.
 
                      RELATIONSHIP WITH THE MUTUAL COMPANY
 
     The Company was formed by the Mutual Company in August 1986 and was a
wholly owned subsidiary of the Mutual Company until November 1986, when the
Company sold 600,000 shares of Common Stock in a public offering, thereby
reducing the Mutual Company's ownership of the Company's outstanding Common
Stock from 100% to approximately 79.5%, which subsequently increased to
approximately 84%. In September 1993, the Company sold 1,150,000 shares of
Common Stock in a public offering. At the same time, the Mutual Company sold
200,000 shares of the Company's Common Stock, reducing the Mutual Company's
ownership of the Company's outstanding Common Stock to approximately 57%.
Between December 22, 1994 and December 31, 1995, the Mutual Company purchased an
aggregate of 172,000 shares of the Company's Common Stock in the open market in
exempt transactions under SEC Rule 10b-18 and in private transactions. Between
December 31, 1995 and December 31, 1996, the Mutual Company purchased an
aggregate of 114,000 shares of the Company's Common Stock in private
transactions. On November 14, 1997 and February 17, 1998, the Mutual Company
purchased 16,846 shares and 16,735 shares, respectively, of the Company's Common
Stock pursuant to the Company's Dividend Reinvestment Plan, which was adopted in
July 1997. These purchases increased the Mutual Company's ownership of the
Company's
 
                                       3

Common Stock to 3,529,091 shares, or approximately 58.3% of the Company's
outstanding Common Stock as of February 20, 1998.
 
     The Company's operations are interrelated with the operations of the Mutual
Company, and various reinsurance arrangements exist between the Company and the
Mutual Company. The Company believes that its various transactions with the
Mutual Company have been on terms no less favorable to the Company than the
terms that could have been negotiated with an independent third party.
 
     The Mutual Company provides all personnel for the Company and its principal
insurance subsidiaries, Atlantic States Insurance Company ("Atlantic States"),
Delaware Atlantic Insurance Company ("Delaware Atlantic"), Southern Insurance
Company of Virginia ("Southern") and Pioneer Insurance Company ("Pioneer").
Expenses are allocated to the Company, Delaware Atlantic, Southern and Pioneer
according to a time allocation and estimated usage agreement, and to Atlantic
States in relation to the relative participation of the Mutual Company and
Atlantic States in the pooling agreement described herein. Expenses allocated to
the Company were $21,739,911 in 1997.
 
     Atlantic States participates in an underwriting pool with the Mutual
Company whereby Atlantic States cedes premiums, losses and loss adjustment
expenses on all of its business to the Mutual Company and assumes from the
Mutual Company a specified portion of the premiums, losses and loss adjustment
expenses of the Mutual Company and Atlantic States. Under the pooling agreement,
which became effective on October 1, 1986, Atlantic States cedes to the Mutual
Company all of its insurance business written on or after October 1, 1986.
Substantially all of the Mutual Company's property and casualty insurance
business written or in force on or after October 1, 1986 is also included in the
pooled business, including the business reinsured from Southern. Pursuant to
amendments to the pooling agreement subsequent to October 1, 1986, the Mutual
Company, which is solely responsible for any losses in the pooled business with
dates of loss on or before the close of business on September 30, 1986, has
increased the percentage of retrocessions of the pooled business to Atlantic
States. Since January 1, 1996, 65% of the pooled business has been retroceded to
Atlantic States. All premiums, losses, loss adjustment expenses and other
underwriting expenses are prorated among the parties on the basis of their
participation in the pool. The pooling agreement may be amended or terminated at
the end of any calendar year by agreement of the parties. The allocations of
pool participation percentages between the Mutual Company and Atlantic States
are based on the pool participants' relative amounts of capital and surplus,
expectations of future relative amounts of capital and surplus and the ability
of the Company to raise capital for Atlantic States. The Company does not
currently anticipate a further increase in Atlantic States' percentage of
participation in the pool, nor does the Company intend to terminate the
participation of Atlantic States in the pooling agreement. Additional
information describing the pooling agreement is contained in the Company's 1997
Annual Report to Stockholders, a copy of which is enclosed with this Proxy
Statement and to which reference is hereby made.
 
     On December 29, 1988, the Company acquired all of the outstanding common
stock of Southern, which converted from a mutual insurance company known as
Southern Mutual Insurance Company to a stock insurance company on the same date.
Since January 1, 1991, the Mutual Company has reinsured 50% of Southern's
business. Because the Mutual Company places substantially all of the business
assumed from Southern in the pool, from which the Company has an allocation of
65% from and after January 1, 1996, the Company's operations include
approximately 80% of the business written by Southern. Southern and the Mutual
Company settle the balances resulting from this reinsurance arrangement on a
monthly basis.
 
                                       4

     As of December 31, 1995, the Company acquired all of the outstanding
capital stock of Delaware Atlantic pursuant to a Stock Purchase Agreement dated
as of December 21, 1995 between the Company and the Mutual Company. As part of
this transaction, the Mutual Company entered into an aggregate excess of loss
reinsurance agreement with Delaware Atlantic whereby the Mutual Company assumed
the risk of any loss from an adverse development in Delaware Atlantic's loss and
loss adjustment expense reserve at the end of 1995 compared to the end of 1996
and losses and loss adjustment expenses incurred by Delaware Atlantic during the
month of December 1995 and for the 1996 year by reason of the fact that Delaware
Atlantic's loss and loss adjustment expense ratio for those periods exceeded the
lesser of the loss and loss expense ratios of immediately preceding periods or
60%. This reinsurance agreement did not result in any additional payment from
the Mutual Company to Delaware Atlantic.
 
     Effective July 1, 1996, the Mutual Company entered into retrocessional
reinsurance contracts with each of Southern, Delaware Atlantic and Pioneer,
which was then a wholly owned subsidiary of the Mutual Company, (individually,
an "Affiliate"), whereby the Mutual Company agreed to reinsure each Affiliate in
respect of 100% of the net liability that may accrue to such Affiliate from its
insurance operations and retrocede 100% of the net liability back to each
Affiliate, which the Affiliate assumes.
 
     As of March 31, 1997, the Company acquired all of the outstanding capital
stock of Pioneer pursuant to a Stock Purchase Agreement dated as of April 7,
1997 between the Company and the Mutual Company. As part of this transaction,
the Mutual Company entered into an aggregate excess of loss reinsurance
agreement with Pioneer whereby the Mutual Company assumed the risk of any loss
from an adverse development in Pioneer's loss and loss adjustment expense
reserve at the end of 1996 compared to the end of 1998 and losses and loss
adjustment expenses incurred by Pioneer during the years ending December 31,
1997 and December 31, 1998 by reason of the fact that Pioneer's loss and loss
adjustment expense ratio for those periods exceeded the lesser of the loss and
loss expense ratios of immediately preceding periods or 60%. This reinsurance
agreement resulted in additional payments of $186,800 from the Mutual Company to
Pioneer in 1997.
 
     All of the Company's officers are officers of the Mutual Company, five of
the Company's seven directors are directors of the Mutual Company and three of
the Company's executive officers are directors of the Mutual Company. The
Company and the Mutual Company maintain a Coordinating Committee, which consists
of two outside directors from each of the Company and the Mutual Company, none
of whom holds seats on both Boards, to review and evaluate the pooling agreement
between the Company and the Mutual Company and to be responsible for matters
involving actual or potential conflicts of interest between the Company and the
Mutual Company. The decisions of the Coordinating Committee are binding on the
Company and the Mutual Company. The Company's Coordinating Committee members
must conclude that intercompany transactions are fair and equitable to the
Company. The purpose of this provision is to protect the interests of the
stockholders of the Company other than the Mutual Company. The Coordinating
Committee met one time in 1997. The Company's members on the Coordinating
Committee are Messrs. Bolinger and Finley. See "Election of Directors." The
Mutual Company's members on the Coordinating Committee are John E. Hiestand and
Dr. Charles A. Heisterkamp, III.
 
     Mr. Hiestand, age 60, has been a director of the Mutual Company since 1983
and has been President of Hiestand Memorials, Inc., a manufacturer of cemetery
monuments, since 1977.
 
     Dr. Heisterkamp, age 65, has been a director of the Mutual Company since
1979 and has practiced as a surgeon in Lancaster, Pennsylvania for more than the
past five years.
 
                                       5

                             ELECTION OF DIRECTORS
 
     The Company's Board of Directors consists of seven members. Each director
is elected for a three-year term and until his successor has been duly elected.
The current three-year terms of the Company's directors expire in the years
1998, 1999 and 2000, respectively.
 
     Two Class C directors are to be elected at the Annual Meeting. Unless
otherwise instructed, the proxies solicited by the Board of Directors will be
voted for the election of the nominees named below, both of whom are currently
directors of the Company. If a nominee becomes unavailable for any reason, it is
intended that the proxies will be voted for a substitute nominee designated by
the Board of Directors. The Board of Directors has no reason to believe the
nominees named will be unable to serve if elected. Any vacancy occurring on the
Board of Directors for any reason may be filled by a majority of the directors
then in office until the expiration of the term of the class of directors in
which the vacancy exists. The two nominees for Class C director receiving the
highest number of votes cast at the Annual Meeting will be elected as directors.
Shares held by brokers or nominees as to which voting instructions have not been
received from the beneficial owner or person otherwise entitled to vote and as
to which the broker or nominee does not have discretionary voting power, i.e.,
broker non-votes, will be treated as not present and not entitled to vote for
nominees for election as Class C directors. Votes withheld and broker non-votes
will have no effect on the election of directors because they will not represent
votes cast at the Annual Meeting for the purpose of electing directors.
 
     The names of the nominees for Class C directors and the Class A and Class B
directors who will continue in office after the Annual Meeting until the
expiration of their respective terms, together with certain information
regarding them, are as follows:
 
NOMINEES FOR CLASS C DIRECTORS

                                                                       DIRECTOR        YEAR TERM
NAME                                                         AGE        SINCE         WILL EXPIRE*
- ----                                                         ---       --------       ------------
                                                                             
Thomas J. Finley, Jr.....................................    77          1986             2001
R. Richard Sherbahn......................................    69          1986             2001

                         DIRECTORS CONTINUING IN OFFICE
 
CLASS A DIRECTORS

                                                                       DIRECTOR        YEAR TERM
NAME                                                         AGE        SINCE         WILL EXPIRE
- ----                                                         ---       --------       ------------
                                                                             
Robert S. Bolinger.......................................    61          1986             1999
Patricia A. Gilmartin....................................    58          1986             1999
Philip H. Glatfelter, II.................................    68          1986             1999

CLASS B DIRECTORS

                                                                       DIRECTOR        YEAR TERM
NAME                                                         AGE        SINCE         WILL EXPIRE
- ----                                                         ---       --------       ------------
                                                                             
C. Edwin Ireland.........................................    88          1986             2000
Donald H. Nikolaus.......................................    55          1986             2000

- ------------------
*If elected at the Annual Meeting
 
                                       6

     Mr. Bolinger has been President and Chief Executive Officer of Susquehanna
Bancshares, Inc. since 1982 and of Farmers First Bank since 1976. Mr. Bolinger
is also a director of Susquehanna Bancshares, Inc.
 
     Mr. Finley retired in 1985 as President and Chief Executive Officer of the
Insurance Federation of Pennsylvania, a position he held for 18 years prior to
his retirement.
 
     Mrs. Gilmartin has been an employee since 1969 of Donegal Insurance Agency,
which has no affiliation with the Company, except that Donegal Insurance Agency
receives insurance commissions in the ordinary course of business from the
Company's subsidiaries and affiliates in accordance with such subsidiaries' and
affiliates' standard commission schedules and agency contracts. Mrs. Gilmartin
has been a director of the Mutual Company since 1979.
 
     Mr. Glatfelter retired in 1989 as a Vice President of Meridian Bank, a
position he held for more than five years prior to his retirement. Mr.
Glatfelter has been a director of the Mutual Company since 1981 and has been
Vice Chairman of the Mutual Company since 1991.
 
     Mr. Ireland is former Chairman of the Lancaster Industrial Development
Authority. He retired from Hamilton Watch Company in 1970. Prior thereto, he was
Vice President, Secretary and Treasurer of Hamilton Watch Company. Mr. Ireland
has been a director of the Mutual Company since 1972 and Chairman of its Board
of Directors since 1985. He has been Chairman of the Company's Board of
Directors since 1986.
 
     Mr. Nikolaus has been President of the Mutual Company since 1981 and a
director of the Mutual Company since 1972. He has been President of the Company
since 1986. Mr. Nikolaus has been a partner in the law firm of Nikolaus &
Hohenadel since 1972.
 
     Mr. Sherbahn has owned and operated Sherbahn Associates, Inc., a life
insurance and financial planning firm, since 1974. Mr. Sherbahn has been a
director of the Mutual Company since 1967.
 
                   THE BOARD OF DIRECTORS AND ITS COMMITTEES
 
     The Board of Directors met seven times in 1997. The Board of Directors has
an Executive Committee, an Audit Committee, a Nominating Committee, a
Compensation Committee and, together with the Mutual Company, a four-member
Coordinating Committee.
 
     The Company's Executive Committee met 22 times in 1997. Messrs. Nikolaus,
Ireland and Glatfelter are the members of the Executive Committee. The Executive
Committee has the authority to take all action that can be taken by the full
Board of Directors, consistent with Delaware law, between meetings of the Board
of Directors.
 
     The Audit Committee of the Company consists of Messrs. Bolinger, Glatfelter
and Ireland. The Audit Committee, which met one time in 1997, reviews audit
reports and management recommendations made by the Company's independent
auditing firm.
 
     The Nominating Committee of the Company consists of Messrs. Finley, Ireland
and Glatfelter. The Nominating Committee, which did not meet in 1997, is
responsible for the nomination of candidates to stand for election to the Board
of Directors at the Annual Meeting and the nomination of candidates to fill
vacancies on the Board of Directors between meetings of stockholders. The
Nominating Committee will consider written nominations for directors from
stockholders to the extent
 
                                       7

such nominations are made in accordance with the Company's By-laws. The
Company's By-laws require that any such nominations must be sent to the Company
at its principal executive offices, attention: Secretary, not less than 30 days
prior to the date of the stockholders meeting at which directors are to be
elected. Such written nomination must set forth the name, age, address and
principal occupation for the past five years of such nominee, the number of
shares of the Company's Common Stock beneficially owned by such nominee and such
other information about such nominee as would be required under the proxy
solicitation rules of the SEC if proxies were solicited for the election of such
nominee.
 
     The Compensation Committee of the Company consists of Messrs. Ireland,
Sherbahn and Glatfelter. The Compensation Committee met one time in 1997 to
review and recommend compensation plans, approve certain compensation changes
and grant options under and determine participants in the 1996 Equity Incentive
Plan.
 
COMPENSATION OF DIRECTORS
 
     Directors of the Company were paid an annual retainer of $15,000 in 1997
and were paid $500 for each meeting attended in excess of five per year.
Directors who are members of committees of the Board of Directors receive $250
for each committee meeting attended. If a director serves on the Board of
Directors of both the Mutual Company and the Company, the director receives only
one annual retainer. If the Boards of Directors of both companies meet on the
same day, directors receive only one meeting fee. In such event, the retainer
and meeting fees are allocated 35% to the Mutual Company and 65% to the Company.
 
     Pursuant to the Director Plan, each director of the Company and the Mutual
Company receives an annual restricted stock award ("Restricted Stock Award") of
133 shares of the Company's Common Stock, provided that the director served as a
member of the Board of Directors of the Company or the Mutual Company during any
portion of the preceding calendar year. Pursuant to the Director Plan, each
outside director of the Company and the Mutual Company is also eligible to
receive non-qualified options to purchase shares of Common Stock in an amount
determined by the Company's Board of Directors from time to time. See "Amendment
of the 1996 Equity Incentive Plan for Directors."
 
                                       8

                             EXECUTIVE COMPENSATION
 
SUMMARY COMPENSATION TABLE
 
     The following table sets forth the compensation paid by the Company and the
Mutual Company during each of the three fiscal years ended December 31, 1997 for
services rendered in all capacities to the chief executive officer of the
Company and the four other most highly compensated executive officers of the
Company whose compensation exceeded $100,000 in the fiscal year ended December
31, 1997.

                                                                                     LONG-TERM
                                                                                COMPENSATION AWARDS
                                       ANNUAL COMPENSATION (1)                ------------------------
                           ------------------------------------------------   RESTRICTED   SECURITIES
NAME AND                                                     OTHER ANNUAL       STOCK      UNDERLYING       ALL OTHER
PRINCIPAL POSITION         YEAR   SALARY ($)   BONUS ($)   COMPENSATION ($)   AWARDS ($)   OPTIONS (#)   COMPENSATION ($)
- ------------------         ----   ----------   ---------   ----------------   ----------   -----------   ----------------
                                                                                    
Donald H. Nikolaus,        1997    $356,000    $137,807         $7,725         2,050             --          $ 95,010(2)
  President and Chief      1996     336,000          --          7,327          --               --            81,531
  Executive Officer        1995     311,000     100,369             --          --               --            85,430

Ralph G. Spontak,          1997     235,000      78,444          2,943         2,050             --            50,636(2)
  Senior Vice President,   1996     220,000          --          2,747          --               --            44,495
  Chief Financial          1995     204,000      57,133             --          --               --            46,205
  Officer and
  Secretary

William H. Shupert,        1997     160,000      65,723             --          --               --            49,075(2)
  Senior Vice President,   1996     149,000          --             --          --               --            28,669
  Underwriting             1995     137,000      47,868             --          --               --            22,791

Robert G. Shenk            1997     130,000      19,417             --          --               --            15,153(2)
  Senior Vice President,   1996     118,000          --             --          --               --            13,614
  Claims                   1995     107,000      15,966             --          --               --            13,001

Frank J. Wood              1997     110,500      25,441             --          --               --            21,064(2)
  Senior Vice President,   1996     102,500          --             --          --               --            15,713
  Marketing                1995      95,000      18,530             --          --               --            13,576

- ------------------
(1) All compensation of officers of the Company is paid by the Mutual Company.
    Pursuant to the terms of an intercompany allocation agreement between the
    Company and the Mutual Company, the Company is charged for its proportionate
    share of all such compensation.
(2) Represents contributions made by the Company under its defined contribution
    pension plan of $15,140 for Mr. Nikolaus, $15,140 for Mr. Spontak, $15,089
    for Mr. Shupert, $12,085 for Mr. Shenk and $10,147 for Mr. Wood and
    contributions made by the Company under its profit-sharing plan of $3,200
    for Mr. Nikolaus, $3,200 for Mr. Spontak, $3,190 for Mr. Shupert, $2,589 for
    Mr. Shenk and $2,201 for Mr. Wood. In the case of Mr. Nikolaus, the total
    shown for 1997 also includes premiums paid under split-dollar life insurance
    policies of $25,535, premiums paid under a term life insurance policy of
    $3,825, directors and committee meeting fees of $23,900 and contributions
    made by the Company of $23,410 under the Company's Executive Restoration
    Plan, which is designed to restore certain retirement benefits to those
    individuals for whom contributions to the Company's pension and
    profit-sharing plans are restricted as a result of the application of
    Sections 401(a)(17) and 415 of the Internal Revenue Code of 1986, as amended
    (the "Code"). In the case of Mr. Spontak, the total shown for 1997 includes
    premiums paid under a split-dollar life insurance policy of $4,700, premiums
    paid under a term life insurance policy of $1,479, directors and committee
    meeting fees of $17,200 and contributions made by the Company of $8,917
    under the Company's Executive Restoration Plan. In the case of Messrs.
    Shupert, Shenk and Wood, the totals shown for 1997 also include term life
    insurance premiums of $12,746, $479 and $2,752, respectively.
 
                                       9

     The following tables sets forth information with respect to options granted
during the fiscal year ended December 31, 1997 to the persons named in the
Summary Compensation Table.
 
                       OPTION GRANTS IN LAST FISCAL YEAR

                                     INDIVIDUAL GRANTS                                        POTENTIAL REALIZABLE
- -------------------------------------------------------------------------------------------         VALUE AT
                                                         % OF TOTAL                              ASSUMED ANNUAL
                                            NUMBER OF     OPTIONS                                 RATE OF STOCK
                                           SECURITIES    GRANTED TO                            PRICE APPRECIATION
                                           UNDERLYING    EMPLOYEES    EXERCISE                   FOR OPTION TERM
                                             OPTIONS     IN FISCAL     PRICE     EXPIRATION   ---------------------
NAME                                       GRANTED (#)      YEAR       ($/SH)       DATE       5% ($)      10% ($)
- ----                                       -----------   ----------   --------   ----------   ---------   ---------
                                                                                        
Donald H. Nikolaus.......................    100,000(1)      25        18.00      1/2/2002     163,000     677,000
Ralph G. Spontak.........................     50,000(1)      13        18.00      1/2/2002      81,500     338,500
William H. Shupert.......................     28,000(1)       7        18.00      1/2/2002      45,640     189,560
Robert G. Shenk..........................     20,000(1)       5        18.00      1/2/2002      32,600     135,400
Frank J. Wood............................     20,000(1)       5        18.00      1/2/2002      32,600     135,400

 ------------------
(1) These options vest in three substantially equal cumulative annual
    installments on April 30, 1997, April 30, 1998 and April 30, 1999,
    respectively.
 
     The following table sets forth information with respect to options
exercised during the year ended December 31, 1997 and held on December 31, 1997
by the persons named in the Summary Compensation Table.
 
                AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
                       AND FISCAL YEAR END OPTION VALUES

                                                                   NUMBER OF SECURITIES          VALUE OF UNEXERCISED
                                                                   UNDERLYING OPTIONS AT             IN-THE-MONEY
                                         SHARES                       FISCAL YEAR END         OPTIONS AT FISCAL YEAR END
                                        ACQUIRED      VALUE     ---------------------------   ---------------------------
NAME                                   ON EXERCISE   REALIZED   EXERCISABLE   UNEXERCISABLE   EXERCISABLE   UNEXERCISABLE
- ----                                   -----------   --------   -----------   -------------   -----------   -------------
                                                                                          
Donald H. Nikolaus..................       --           --        33,333         66,667        $137,499       $275,001
Ralph G. Spontak....................       --           --        16,667         33,333          68,751        137,499
William H. Shupert..................       --           --         9,333         18,667          38,499         77,001
Robert G. Shenk.....................       --           --         6,667         13,333          27,501         54,999
Frank J. Wood.......................       --           --         6,667         13,333          27,501         54,999

REPORT OF THE COMPENSATION COMMITTEE OF DONEGAL GROUP INC.
 
     THE FOLLOWING REPORT OF THE COMPANY'S COMPENSATION COMMITTEE AND THE
PERFORMANCE GRAPH THAT IMMEDIATELY FOLLOWS SUCH REPORT SHALL NOT BE DEEMED PROXY
SOLICITATION MATERIAL, SHALL NOT BE DEEMED FILED WITH THE SEC UNDER THE EXCHANGE
ACT OR INCORPORATED BY REFERENCE IN ANY DOCUMENT SO FILED AND SHALL NOT
OTHERWISE BE SUBJECT TO THE LIABILITIES OF SECTION 18 OF THE EXCHANGE ACT.
 
     Under the rules established by the SEC, the Company is required to provide
certain information about the compensation and benefits provided to the
Company's President and Chief Executive Officer and the other executive officers
listed in the Summary Compensation Table. The disclosure requirements as to
these officers include the use of specified tables and a report of the Company's
 
                                       10

Compensation Committee reviewing the factors that resulted in compensation
decisions affecting these officers and the Company's other executive officers.
The Compensation Committee of the Board of Directors has furnished the following
report in fulfillment of the SEC's requirements.
 
     The Compensation Committee reviews the general compensation policies of the
Company, including the compensation plans and compensation levels for executive
officers, and administers the Company's 1996 Equity Incentive Plan and the cash
incentive compensation program in which the Company's executive officers
participate. No members of the Compensation Committee are former or current
officers of the Company, or have other interlocking relationships as defined by
the SEC.
 
     Compensation of the Company's executive officers has two principal
elements: (i) an annual portion, consisting of a base salary that is reviewed
annually and cash bonuses based on the Company's underwriting results, and (ii)
a long-term portion, consisting of stock options. In general, the executive
compensation program of the Company has been designed to:
 
            (i) Attract and retain executive officers who contribute to the
                long-term success of the Company;
 
           (ii) Motivate key senior executive officers to achieve strategic
                business objectives and reward them for the achievement of these
                objectives; and
 
          (iii) Support a compensation policy that differentiates in
                compensation amounts based on corporate and individual
                performance and responsibilities.
 
     A major component of the Company's compensation policy, which has been
approved by the Compensation Committee, is that a significant portion of the
aggregate annual compensation of the Company's executive officers should be
based upon the Company's underwriting results as well as the contribution of the
individual officer. For a number of years, the Company has maintained a cash
incentive compensation program for the Company's executive officers. This
program provides a formula pursuant to which a fixed percentage of the Company's
underwriting results for the year is computed, as specified in the program, and
then allocated among the executive officers selected to participate in the
program for the particular year. The identity of the executive officers selected
to participate in the program for the particular year as well as their
participation in the amount determined by application of the fixed formula is
based upon recommendations submitted by the Company's senior executive officers
to the Compensation Committee. The Compensation Committee reviews those
recommendations and fixes the percentage participation of the Company's
executive officers in the program. The portion of the total compensation of the
executive officers named in the Summary Compensation Table arising from the cash
incentive compensation program formula was $326,832 in 1997 compared to zero in
1996 because the Company's underwriting income in 1997 was substantially greater
than its underwriting income in 1996, as a result of losses caused by the severe
winter storms during the first quarter of 1996. The Compensation Committee
therefore believes that the amount of the incentive payments are tied directly
to the Company's performance.
 
     The principal factors considered by the Company when it established the
cash incentive compensation program were:
 
           (i) achievement of the Company's long-term underwriting objectives;
               and
 
          (ii) the Company's long-term underwriting results compared to the
               long-term underwriting results of other property and casualty
               insurance companies.
 
                                       11

     Such factors as the Company's improved underwriting results, continued cost
control and reductions in the Company's expense ratio, enhancement of the skills
of the Company's workforce, the development of opportunities to expand the
geographic reach of the Company's service area on a profitable basis, oversight
of the reinspection of all properties covered by the Company's homeowners'
business and the completion of a construction program to increase the efficiency
of the Company's operations, as well as a subjective analysis of Mr. Nikolaus'
performance, were considered by the Compensation Committee in approving Mr.
Nikolaus' participation percentage under the Company's cash incentive program
for 1997.
 
     The Company's executive officers participate in the Company's 1996 Equity
Incentive Plan, under which stock options are granted from time to time at the
fair market value of the Company's Common Stock on the date of grant. The
options typically vest over three years. The primary purpose of the 1996 Equity
Incentive Plan is to provide an incentive for the Company's long-term
performance. Such stock options provide an incentive for the creation of
stockholder value over the long-term because the full benefit of the options can
be realized only if the price of the Company's Common Stock appreciates over
time. Stock options exercisable for the purchase of 100,000 shares and 251,333
shares of the Company's Common Stock, respectively, were granted to Mr. Nikolaus
and to all of the Company's executive officers as a group under the 1996 Equity
Incentive Plan during 1997.
 
     The Compensation Committee believes the compensation of Mr. Nikolaus and
the other executive officers of the Company is reasonable in view of the
Company's performance and the contribution of those officers to that performance
in 1997, as well as the performance of the Company in 1997 compared to the
performance of other property and casualty insurance companies in 1997.
 
     Section 162(m) of the Code generally disallows a tax deduction to publicly
held companies for compensation of more than $1 million paid to a company's
chief executive officer or any executive officer named in its Summary
Compensation Table. Qualifying performance-based compensation is not subject to
the deduction limit if certain requirements are met. The policy of the
Compensation Committee is to structure the compensation of the Company's
executive officers, including Mr. Nikolaus, to avoid the loss of the
deductibility of any compensation, although Section 162(m) will not preclude the
Compensation Committee from awarding compensation in excess of $1 million, if it
should be warranted in the future. The Company believes that Section 162(m) will
not have any effect on the deductibility of the compensation of Mr. Nikolaus and
the other executive officers named in the Summary Compensation Table for 1997.
 
                              DONEGAL GROUP INC. COMPENSATION COMMITTEE
 
                              C. Edwin Ireland
                              R. Richard Sherbahn
                              Philip H. Glatfelter, II
 
                                       12

COMPARISON OF TOTAL RETURN ON THE COMPANY'S COMMON STOCK WITH CERTAIN AVERAGES
 
     The following graph provides an indicator of cumulative total stockholder
returns on the Company's Common Stock compared to the Russell 2000 Index and a
peer group of property and casualty insurance companies selected by Value Line,
Inc. The members of the peer group are as follows: 20th Century Industries, ACE
Limited, Allmerica Financial Corporation, Allstate Corporation, American
Financial Group Inc., W.R. Berkley Corporation, The Chubb Corporation,
Cincinnati Financial Corporation, USF&G Corporation, Fremont General
Corporation, Frontier Insurance Group, Inc., Gainsco Inc., General Reinsurance
Corporation, Hartford Financial Services Group, Markel Corporation, Mercury
General Corporation, NAC Re Corporation, Old Republic International Corporation,
Orion Capital Corporation, Ohio Casualty Corporation, The Progressive
Corporation, SAFECO Corporation, Selective Insurance Group, Inc., The St. Paul
Companies, Inc. and Transatlantic Holdings, Inc.

                                   [GRAPHIC]

              In the printed version of the document, a line graph
                appears which depicts the following plot points:

                          Comparison of Five-Year Cumulative Total Return*
                          ------------------------------------------------------
                           1992      1993      1994      1995      1996      1997
                          -------   -------   -------   -------   -------   -------
                                                          
Donegal Group, Inc.       $100.00   $160.76   $140.40   $186.11   $208.36   $306.04
Russel 2000 Index         $100.00   $118.91   $116.55   $149.70   $174.30   $213.00
Insurance (Prop/Casualty) $100.00   $102.18   $101.16   $142.15   $181.74   $280.29

Assumes $100 invested at the close of trading on 12/92 in Donegal Group, Inc.
common stock, Russell 2000 index and insurance (Prop/Casualty).
*Cumulative total return assumes reinvestment of dividends.

                                       13

CERTAIN TRANSACTIONS
 
     Donald H. Nikolaus, President and a director of the Company and the Mutual
Company, is also a partner in the law firm of Nikolaus & Hohenadel. Such firm
has served as general counsel to the Mutual Company since 1970 and to the
Company 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.
 
     Patricia A. Gilmartin, a director of the Company and the Mutual Company, is
an employee of Donegal Insurance Agency, which has no affiliation with the
Company except that Donegal Insurance Agency receives insurance commissions in
the ordinary course of business from the Company's subsidiaries and affiliates
in accordance with such subsidiaries' and affiliates' standard commission
schedules and agency contracts.
 
     Frederick W. Dreher, a director of the Mutual Company, is a partner in the
law firm of Duane, Morris & Heckscher LLP, which represents the Company and the
Mutual Company in certain legal matters. Such firm is paid its customary fees
for such services.
 
                   AMENDMENT TO CERTIFICATE OF INCORPORATION
               TO INCREASE THE AUTHORIZED SHARES OF COMMON STOCK
 
     At the Annual Meeting, the stockholders will be asked to vote on a proposal
to approve an amendment to Article 4(a) of the Company's Certificate of
Incorporation to increase the number of authorized shares of Common Stock from
10,000,000 shares to 15,000,000 shares. As of February 20, 1998, 6,057,732
shares of Common Stock were outstanding, 91,716 shares of Common Stock were held
in treasury and 2,245,538 shares of Common Stock were reserved for issuance upon
the exercise of options granted and to be granted under the Company's 1996
Equity Incentive Plan, Director Plan, 1996 Employee Stock Purchase Plan and the
Agency Stock Purchase Plan, leaving 1,605,014 shares of Common Stock available
for issuance.
 
     The increase in the authorized number of shares of the Company's Common
Stock is being proposed because the Board of Directors believes that it is
advisable to have a greater number of authorized but unissued shares of Common
Stock available for various corporate programs and purposes. The Company may
from time to time consider acquisitions, stock dividends or stock splits, and
public or private financings to provide the Company and its subsidiaries with
capital, all of which may involve the issuance of additional shares of Common
Stock or securities convertible into Common Stock. Also, additional shares of
Common Stock may be necessary to meet anticipated future obligations under the
Company's employee and agent benefit plans. The Board of Directors believes that
having authority to issue additional shares of Common Stock will avoid the
possible delay of calling and holding a special meeting of stockholders to
increase its authorized capital stock at the time a transaction may be proposed,
so as to enhance the Company's ability to take prompt advantage of market
conditions and to respond promptly to any future acquisition opportunities.
 
     The Company has no present plan, understanding or arrangement to issue any
of the additional shares of Common Stock that will be authorized if the
amendment is approved.
 
     If the proposal is approved, the Board of Directors will not solicit
stockholder approval to issue the additional authorized shares except to the
extent that such approval may be required by law or the rules of The Nasdaq
Stock Market, and such shares may be issued for such consideration, cash or
 
                                       14

otherwise, at such times and in such amounts as the Board of Directors in its
discretion may determine, without further action by the stockholders. The future
issuance by the Company of shares of Common Stock may dilute the equity
ownership position of current holders of Common Stock. Under the Nasdaq rules
applicable to the Company, stockholder approval must be obtained prior to the
issuance of shares for certain purposes, including the issuance of shares in an
amount equal to or in excess of 20% of the Company's then outstanding shares in
connection with a future acquisition by the Company.
 
     Although the Board of Directors currently intends to utilize the additional
shares of Common Stock solely for the purposes set forth above, such shares
could also be used by the Board of Directors to dilute the stock ownership of
persons seeking to obtain control of the Company, thereby possibly discouraging
or deterring a non-negotiated attempt to obtain control of the Company and
making removal of incumbent management more difficult. The proposal, however, is
not a result of, nor does the Board of Directors have knowledge of, any effort
to accumulate the Company's capital stock or to obtain control of the Company by
means of a merger, tender offer, solicitation in opposition to the Board of
Directors or otherwise.
 
     The holders of Common Stock have no preemptive rights.
 
     The Company's Certificate of Incorporation also authorizes the issuance of
1,000,000 shares of Series Preferred Stock, which the Board of Directors has the
power to issue in one or more series and to fix the number of shares of each
series and all designations, relative rights, preferences, qualifications,
limitations and restrictions of the shares in each series. The proposed
amendment does not increase or otherwise affect the Company's authorized Series
Preferred Stock.
 
     The text of Article 4(a) of the Company's Certificate of Incorporation, as
proposed to be amended, is as follows:
 
          "4.(a) The aggregate number of shares which the Corporation shall have
     authority to issue is: Fifteen Million (15,000,000) shares of Common Stock
     of the par value of One Dollar ($1.00) per share (the "Common Stock") and
     One Million shares of Series Preferred Stock of the par value of One Dollar
     ($1.00) per share (the "Preferred Stock")."
 
     Approval of the proposed amendment to the Certificate of Incorporation will
require the affirmative vote of the holders of a majority of the shares of the
Company's Common Stock outstanding and entitled to vote. Abstentions and broker
non-votes are considered shares of stock outstanding and entitled to vote and
are counted in determining the number of votes necessary for such majority. An
abstention or broker non-vote will therefore have the practical effect of voting
against approval of the amendment because it represents one fewer vote for
approval of the amendment.
 
                                AMENDMENT OF THE
                    1996 EQUITY INCENTIVE PLAN FOR DIRECTORS
 
AMENDMENT OF THE DIRECTOR PLAN
 
     The Director Plan provides for: (i) the grant of non-qualified options
("Director Options") to outside directors ("Outside Directors") of the Company
and the Mutual Company at the discretion of the Board of Directors and (ii) an
annual grant to each director of the Company and the Mutual Company
("Directors") of a Restricted Stock Award of 133 shares of Common Stock to be
issued on
 
                                       15

the first business day of January in each year, commencing January 2, 1997,
provided that the Director served as a member of the Board or the Board of
Directors of the Mutual Company during any portion of the prior year. Director
Options and Restricted Stock Awards collectively are hereinafter referred to as
"Stock Rights."
 
     The total number of shares of Common Stock that may be the subject of
grants of Stock Rights under the Director Plan may not exceed 119,600 shares in
the aggregate. As of March 1, 1998, Director Options to purchase 60,003 shares
of Common Stock, in the aggregate, have been granted to Outside Directors under
the Director Plan, and Restricted Stock Awards of 2,796 shares, in the
aggregate, have been granted to the Directors under the Director Plan, leaving
56,801 shares of Common Stock available for future awards under the Director
Plan.
 
     The purpose of the Director Plan is to enhance the ability of the Company
and the Mutual Company to attract and retain highly qualified directors, to
compensate them for their services to the Company and the Mutual Company, as the
case may be, and, in so doing, to strengthen the alignment of the interests of
the Directors with the interests of the stockholders by ensuring ongoing
ownership of the Company's Common Stock. In order to continue to provide these
benefits, on March 16, 1998, the Board of Directors of the Company approved an
amendment to the Director Plan to increase the number of shares of Common Stock
available for awards thereunder from 119,600 shares to 200,000 shares.
 
     The Director Plan is administered by the Board. The Board has the power to
interpret the Director Plan, the Director Options and the Restricted Stock
Awards, and, subject to the terms of the Director Plan, to determine who will be
granted Director Options, the number of Director Options to be granted to any
Outside Director, the timing of such grant and the terms of exercise. The Board
also has the power to adopt rules for the administration, interpretation and
application of the Director Plan. The Board does not have any discretion to
determine who will be granted Restricted Stock Awards under the Director Plan,
to determine the number of Restricted Stock Awards to be granted to each
Director or to determine the timing of such grants.
 
RESTRICTED STOCK AWARDS
 
     Restricted Stock Awards consist of shares of Common Stock that are issued
in the name of the Director but that may not be sold or otherwise transferred by
the grantee until one year after the date of grant. Upon the issuance of shares
under a Restricted Stock Award, the Director has all rights of a stockholder
with respect to the shares, except that such shares may not be sold, transferred
or otherwise disposed of until one year after the date of grant.
 
     Restricted Stock Awards are evidenced by written agreements in such form
not inconsistent with the Director Plan as the Board shall approve from time to
time. Each agreement contains such restrictions, terms and conditions as are
required by the Director Plan. Although the Common Stock comprising each
Restricted Stock Award is registered in the name of the grantee, a restrictive
legend is placed on the stock certificate.
 
NON-QUALIFIED STOCK OPTIONS
 
     The exercise price of Director Options granted under the Director Plan will
be set by the Board and may not be less than 100% of the fair market value per
share of the Common Stock on the date that the Director Option is granted.
 
                                       16

     Director Options are evidenced by written agreements in such form not
inconsistent with the Director Plan as the Board shall approve from time to
time. Each agreement will state the period or periods of time within which the
Director Option may be exercised. The Board may accelerate the exercisability of
any Director Options upon such circumstances and subject to such terms and
conditions as the Board deems appropriate. Unless the Board accelerates
exercisability, no Director Option that is unexercisable at the time of the
optionee's termination of service as a Director may thereafter become
exercisable. No Director Option may be exercised after ten years from the date
of grant. If a Director Option expires or is canceled for any reason without
having been fully exercised or vested, the number of shares subject to such
Director Option that had not been purchased or become vested may again be made
subject to a Director Option under the Director Plan.
 
     The option price must be paid in full at the time of exercise unless
otherwise determined by the Board. Payment must be made in cash, in shares of
Common Stock valued at their then fair market value, or a combination thereof,
as determined in the discretion of the Board. It is the policy of the Board that
any taxes required to be withheld must also be paid at the time of exercise. The
Board may, in its discretion, allow an optionee to enter into an agreement with
the Company's transfer agent or a brokerage firm of national standing whereby
the optionee will simultaneously exercise the Director Option and sell the
shares acquired thereby and either the Company's transfer agent or the brokerage
firm executing the sale will remit to the Company from the proceeds of sale the
exercise price of the shares as to which the Director Option has been exercised
as well as the required amount of withholding.
 
     An outstanding Director Option that has become exercisable generally
terminates one year after termination of a Director's service as a Director due
to death and three months after termination of a Director's service as a
Director for any reason other than death. A Director Option granted under the
Director Plan may be exercised during the lifetime of the optionee only by the
optionee.
 
     Appropriate adjustments to outstanding Options and to the number or kind of
shares subject to the Director Plan are provided for in the event of a stock
split, reverse stock split, stock dividend, share combination or
reclassification and certain other types of corporate transactions involving the
Company, including a merger or a sale of substantially all of the assets of the
Company.
 
AMENDMENT OR TERMINATION
 
     The Director Plan will remain in effect until all Director Options granted
under the Director Plan have been satisfied by the issuance of shares, except
that no Stock Rights may be granted under the Director Plan after December 19,
2006. The Board may terminate, modify, suspend or amend the Director Plan at any
time, subject to any required stockholder approval or any stockholder approval
that the Board may deem to be advisable for any reason, such as for the purpose
of obtaining or retaining any statutory or regulatory benefits under tax,
securities or other laws or satisfying any applicable stock exchange listing
requirements. No modification, amendment or termination of the Director Plan
will alter or impair any rights or obligations under any outstanding Stock Right
without the consent of the grantee. No Stock Right may be granted during any
period of suspension nor after termination of the Director Plan.
 
                                       17

FEDERAL INCOME TAX CONSEQUENCES
 
     The Director Plan is not a qualified plan under Section 401(a) of the Code.
The following description, which is based on existing laws, sets forth generally
certain of the federal income tax consequences of Stock Rights granted under the
Director Plan. This description may differ from the actual tax consequences of
participation in the Director Plan.
 
     An optionee will not recognize income for federal income tax purposes upon
the receipt of a Director Option, nor will the Company be entitled to any
deduction on account of such grant. Such optionee will recognize ordinary
taxable income for federal income tax purposes at the time of exercise in the
amount by which the fair market value of such shares then exceeds the option
price. When the optionee disposes of the shares acquired upon exercise of the
Director Option, the optionee will generally recognize capital gain or loss
equal to the difference between (i) the amount received upon disposition of the
shares, and (ii) the sum of the option price and the amount included in the
optionee's income when the Director Option was exercised. Such gain will be
long-term or short-term depending upon whether the shares were held for at least
one year after the date of exercise.
 
     A grantee of shares of restricted stock pursuant to a Restricted Stock
Award will recognize ordinary income for federal income tax purposes in the year
of receipt, measured by the value of the shares received determined without
regard to the transfer restriction or other restrictions relating to such issue.
Any gain or loss recognized upon the sale of the shares will generally be
treated as capital gain or loss and will be long-term or short-term depending
upon the holding period of the shares.
 
     Under current law, any gain realized by an optionee or a grantee, as the
case may be, other than long-term capital gain, is taxable at a maximum federal
income tax rate of 39.6%. Long-term capital gain is taxable at a maximum federal
income tax rate of 28% (20% if the holding period is at least 18 months).
 
     The Company will be entitled to a tax deduction in connection with Stock
Rights under the Director Plan in an amount equal to the ordinary income
realized by the grantee at the time he or she recognizes such income.
 
VOTE REQUIRED
 
     Approval of the amendment to the Director Plan will require the affirmative
vote of the holders of a majority of the outstanding shares of the Company's
Common Stock present in person or represented by proxy at the Annual Meeting and
entitled to vote. Abstentions are considered shares of stock present in person
or represented by proxy at the meeting and entitled to vote and are counted in
determining the number of votes necessary for such majority. An abstention will
therefore have the practical effect of voting against adoption of the Director
Plan because it represents one fewer vote for adoption of the Director Plan.
Broker non-votes are not considered shares present in person or represented by
proxy and entitled to vote on the Director Plan and will have no effect on the
vote. The Board of Directors recommends that the stockholders vote FOR the
approval of the amendment to the Director Plan.
 
                                       18

                   ELECTION OF INDEPENDENT PUBLIC ACCOUNTANTS
 
     Unless instructed to the contrary, it is intended that votes will be cast
pursuant to the proxies for the election of KPMG Peat Marwick LLP as the
Company's independent public accountants for 1998. The Company has been advised
by KPMG Peat Marwick LLP that none of its members has any financial interest in
the Company. Election of KPMG Peat Marwick LLP will require the affirmative vote
of the holders of a majority of the shares of the Company's Common Stock present
in person or represented by proxy at the Annual Meeting.
 
     A representative of KPMG Peat Marwick LLP will attend the Annual Meeting,
will have the opportunity to make a statement, if he desires to do so, and will
be available to respond to any appropriate questions presented by stockholders
at the Annual Meeting.
 
                                 ANNUAL REPORT
 
     A copy of the Company's Annual Report for 1997 is being mailed to the
Company's stockholders with this Proxy Statement.
 
                             STOCKHOLDER PROPOSALS
 
         Any stockholder who, in accordance with and subject to the provisions 
of the proxy rules of the SEC, wishes to submit a proposal for inclusion in the
Company's proxy statement for its 1999 Annual Meeting of Stockholders must
deliver such proposal in writing to the Company's Secretary at the Company's 
principal executive offices at 1195 River Road, Marietta, Pennsylvania 17547, 
not later than November 23, 1998.  

                                OTHER PROPOSALS

     The Board of Directors does not know of any matters to be presented for 
consideration at the Annual Meeting other than the matters described in the
Notice of Annual Meeting, but if any matters are properly presented, it is 
the intention of the persons named in the accompanying proxy to vote on such
matters in accordance with their judgment.

                                     By Order of the Board of Directors

                                     /s/ Donald H. Nikolaus
                                     ------------------------------------------
                                     Donald H. Nikolaus
                                     President and Chief Executive Officer

March 23, 1998

 
                                       19

                           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

Pioneer Insurance Company                                Ohio

Delaware Atlantic Insurance Company                      Delaware

         Registrant owns 100% of the outstanding stock of the following business
corporation:

               Name                                   State of Formation
               ----                                   ------------------

Atlantic Inspection Services, Inc.                       Maryland

              Independent Auditors' Consent and Report on Schedules

The Board of Directors
Donegal Group Inc.:

The audits referred to in our report dated February 27, 1998, included the
related financial statement schedules as of December 31, 1997, and for each of
the years in the three-year period ended December 31, 1997, incorporated by
reference in 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 the use of our reports incorporated by reference in the
registration statements (Nos. 333-1287, 333-06681, 33-25541 and 33-26693) on
Form S-8 and in the registration statement (No. 333-36585) on Form S-3 of
Donegal Group Inc.

                                            KPMG PEAT MARWICK LLP

Harrisburg, Pennsylvania
March 27, 1998

         7

                      YEAR
                                         DEC-31-1997
                                              DEC-31-1997
                                       57,731,251
                                     117,246,205
                                       120,882,886
                                                  7,274,562
                                                          0
                                                       0
                                            204,964,805
                                                      3,413,315
                                                  0
                                      8,448,060
                                            304,104,505
                                           118,112,390
                                        71,367,691
                                                      0
                                               0
                                            10,500,000
                                               0
                                                         0
                                                    6,122,431
                                                 85,474,232
                              304,104,505
                                                107,302,168
                                        11,507,277
                                            314,136
                                              2,204,025
                                                 67,656,518
                                18,696,000
                                       17,058,668
                                            14,173,543
                                                3,532,357
                                        10,641,186
                                                      0
                                                     0
                                                           0
                                               10,641,186
                                                    1.77
                                                    1.77
                                             75,427,556
                                        69,040,518
                                          (1,384,000)
                                         39,133,249
                                           26,477,000
                                            77,473,825
                                    (1,384,000)