Table of Contents
FORM 10-Q 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION 
WASHINGTON, D.C. 20549 
(Mark One) 
[x]       	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934	
For the quarterly period ended June 30, 2004 
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, P.O. Box 302, Marietta, PA 17547-0302 

(Address of principal executive offices)            (Zip code)
(717) 426-1931 

(Registrant’s telephone number, including area code)
Not applicable 

(Former name, former address and former fiscal year, if changed since last report)
     Indicate by check mark whether 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [ ]. No [x]. 
     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 10,124,548 shares of Class A Common Stock, par value $0.01 per share, and 3,100,398 shares of Class B Common Stock, par value $0.01 per share, outstanding on August 3, 2004. 

TABLE OF CONTENTS
									
Part I. Financial Information	
	Item 1. Financial Statements	
		Consolidated Balance Sheets	
		Consolidated Statements of Income	
		Consolidated Statements of Comprehensive Income	
		Consolidated Statement of Stockholders’ Equity	
		Consolidated Statements of Cash Flows	
		Summary Notes to Consolidated Financial Statements	
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	
	Item 3. Quantitative and Qualitative Disclosures About Market Risk	
	Item 4. Controls and Procedures	
Part II. Other Information	
	Item 1. Legal Proceedings	
	Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities	
	Item 3. Defaults upon Senior Securities	
	Item 4. Submission of Matters to a Vote of Security Holders	
	Item 5. Other Information	
	Item 6. Exhibits and Reports on Form 8-K	
Signatures	
CERTIFICATION OF CHIEF EXECUTIVE OFFICER	
CERTIFICATION OF CHIEF FINANCIAL OFFICER	
STATEMENT OF CEO PURSUANT TO 18 U.S.C SECTION 1350	
STATEMENT OF CFO PURSUANT TO 18 U.S.C SECTION 1350	

Table of Contents
Part I. Financial Information 
Item 1. Financial Statements. 
Donegal Group Inc. and Subsidiaries 
Consolidated Balance Sheets
 	 	 	 	 	 	 	 	 	
 	 	June 30, 2004
	 	December 31, 2003
	
 	 	(Unaudited)	 	 	 	 	
Assets	 	 	 	 	 	 	 	 	
Investments	 	 	 	 	 	 	 	 	
Fixed maturities	 	 	 	 	 	 	 	 	
Held to maturity, at amortized cost	 	$	179,356,615	 	 	$	113,050,784	 	
Available for sale, at market value	 	 	221,701,437	 	 	 	198,433,337	 	
Equity securities, available for sale, at market	 	 	48,168,309	 	 	 	31,448,221	 	
Short-term investments, at cost, which approximates market	 	 	32,304,320	 	 	 	78,344,125	 	

 	 	
Total investments	 	 	481,530,681	 	 	 	421,276,467	 	
Cash	 	 	5,271,527	 	 	 	5,908,521	 	
Accrued investment income	 	 	4,709,480	 	 	 	3,752,075	 	
Premiums receivable	 	 	43,595,327	 	 	 	29,016,940	 	
Reinsurance receivable	 	 	94,321,903	 	 	 	81,009,106	 	
Deferred policy acquisition costs	 	 	20,688,496	 	 	 	16,223,765	 	
Deferred federal income taxes	 	 	12,650,150	 	 	 	7,032,409	 	
Prepaid reinsurance premiums	 	 	38,660,491	 	 	 	30,691,654	 	
Property and equipment, net	 	 	5,592,904	 	 	 	4,151,671	 	
Accounts receivable - securities	 	 	713,433	 	 	 	1,524,384	 	
Due from affiliate	 	 	1,816,092	 	 	 	—	 	
Federal income taxes recoverable	 	 	1,140,185	 	 	 	—	 	
Other	 	 	2,226,923	 	 	 	1,449,050	 	

 	 	
Total assets	 	$	712,917,592	 	 	$	602,036,042	 	

 	 	
Liabilities and Stockholders’ Equity	 	 	 	 	 	 	 	 	
Liabilities	 	 	 	 	 	 	 	 	
Losses and loss expenses	 	$	260,555,519	 	 	$	217,914,057	 	
Unearned premiums	 	 	173,761,271	 	 	 	134,028,035	 	
Accrued expenses	 	 	9,607,113	 	 	 	7,769,879	 	
Reinsurance balances payable	 	 	2,981,576	 	 	 	1,355,796	 	
Federal income taxes payable	 	 	—	 	 	 	315,808	 	
Cash dividend declared to stockholders	 	 	—	 	 	 	1,378,993	 	
Subordinated debentures	 	 	30,929,000	 	 	 	25,774,000	 	
Accounts payable - securities	 	 	1,826,625	 	 	 	2,438,784	 	
Due to affiliate	 	 	—	 	 	 	904,452	 	
Drafts payable	 	 	2,674,145	 	 	 	—	 	
Other	 	 	3,040,298	 	 	 	1,507,006	 	

 	 	
Total liabilities	 	 	485,375,547	 	 	 	393,386,810	 	

 	 	
Stockholders’ Equity	 	 	 	 	 	 	 	 	
Preferred stock, $1.00 par value, authorized 2,000,000 shares; none issued	 	 	—	 	 	 	—	 	
Class A common stock, $.01 par value, authorized 30,000,000 shares, issued 10,189,064 and 9,880,506 shares and outstanding 10,107,540 and 9,798,982 shares	 	 	101,891	 	 	 	98,805	 	
Class B common stock, $.01 par value, authorized 10,000,000 shares, issued 3,140,494 and 3,051,811 shares and outstanding 3,099,732 and 3,011,049 shares	 	 	31,405	 	 	 	30,518	 	
Additional paid-in capital	 	 	128,560,614	 	 	 	122,744,905	 	
Accumulated other comprehensive income	 	 	1,436,515	 	 	 	5,290,923	 	
Retained earnings	 	 	98,303,368	 	 	 	81,375,829	 	
Treasury stock	 	 	(891,748	)	 	 	(891,748	)	

 	 	
Total stockholders’ equity	 	 	227,542,045	 	 	 	208,649,232	 	

 	 	
Total liabilities and stockholders’ equity	 	$	712,917,592	 	 	$	602,036,042	 	

 	 	
See accompanying notes to consolidated financial statements. 
1 

Table of Contents
Donegal Group Inc. and Subsidiaries 
Consolidated Statements of Income
(Unaudited)
 	 	 	 	 	 	 	 	 	
 	 	Six Months Ended June 30,
	
 	 	2004
	 	2003
	
Revenues:	 	 	 	 	 	 	 	 	
Net premiums earned	 	$	128,197,880	 	 	$	96,362,570	 	
Investment income, net of investment expenses	 	 	7,622,591	 	 	 	6,680,228	 	
Realized investment gains	 	 	643,998	 	 	 	85,890	 	
Lease income	 	 	439,243	 	 	 	413,732	 	
Service charge income	 	 	1,790,371	 	 	 	1,263,967	 	
Other income	 	 	—	 	 	 	205,850	 	

 	 	
Total revenues	 	 	138,694,083	 	 	 	105,012,237	 	

 	 	
Expenses:	 	 	 	 	 	 	 	 	
Net losses and loss expenses	 	 	80,332,078	 	 	 	61,508,981	 	
Amortization of deferred policy acquisition costs	 	 	18,287,000	 	 	 	14,987,000	 	
Other underwriting expenses	 	 	19,156,895	 	 	 	14,292,423	 	
Policy dividends	 	 	461,766	 	 	 	469,157	 	
Interest	 	 	697,426	 	 	 	521,531	 	
Other expenses	 	 	1,081,083	 	 	 	675,228	 	

 	 	
Total expenses	 	 	120,016,248	 	 	 	92,454,320	 	

 	 	
Income before income taxes and extraordinary item	 	 	18,677,835	 	 	 	12,557,917	 	
Income taxes	 	 	5,621,012	 	 	 	3,444,532	 	

 	 	
Income before extraordinary item	 	$	13,056,823	 	 	$	9,113,385	 	
Extraordinary gain - unallocated negative goodwill	 	 	5,445,670	 	 	 	—	 	

 	 	
Net income	 	$	18,502,493	 	 	$	9,113,385	 	

 	 	
Basic earnings per common share:	 	 	 	 	 	 	 	 	
Income before extraordinary item	 	$	1.00	 	 	$	0.99	 	
Extraordinary item	 	 	0.42	 	 	 	—	 	

 	 	
Net income	 	$	1.42	 	 	$	0.99	 	

 	 	
Diluted earnings per common share:	 	 	 	 	 	 	 	 	
Income before extraordinary item	 	$	0.96	 	 	$	0.97	 	
Extraordinary item	 	 	0.40	 	 	 	—	 	

 	 	
Net income	 	$	1.36	 	 	$	0.97	 	

 	 	
Consolidated Statements of Comprehensive Income 
(Unaudited)
 	 	 	 	 	 	 	 	 	
 	 	Six Months Ended June 30,
	
 	 	2004
	 	2003
	
Net income	 	$	18,502,493	 	 	$	9,113,385	 	
Other comprehensive income (loss), net of tax	 	 	 	 	 	 	 	 	
Unrealized gains (losses) on securities:	 	 	 	 	 	 	 	 	
Unrealized holding gain (loss) during the period, net of income tax	 	 	(3,435,809	)	 	 	1,465,540	 	
Reclassification adjustment, net of income tax	 	 	(418,599	)	 	 	(55,829	)	
Other comprehensive income (loss)	 	 	(3,854,408	)	 	 	1,409,711	 	

 	 	
Comprehensive income	 	$	14,648,085	 	 	$	10,523,096	 	

 	 	
See accompanying notes to consolidated financial statements. 
2 

Table of Contents
Donegal Group Inc. and Subsidiaries 
(Unaudited)
 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended June 30,
	
 	 	2004
	 	2003
	
Revenues:	 	 	 	 	 	 	 	 	
Net premiums earned	 	$	65,498,402	 	 	$	48,433,689	 	
Investment income, net of investment expenses	 	 	3,842,574	 	 	 	3,315,710	 	
Realized investment gains	 	 	175,555	 	 	 	216,370	 	
Lease income	 	 	219,417	 	 	 	211,115	 	
Service charge income	 	 	956,474	 	 	 	649,934	 	

 	 	
Total revenues	 	 	70,692,422	 	 	 	52,826,818	 	

 	 	
Expenses:	 	 	 	 	 	 	 	 	
Net losses and loss expenses	 	 	39,961,021	 	 	 	29,658,466	 	
Amortization of deferred policy acquisition costs	 	 	9,942,000	 	 	 	7,545,000	 	
Other underwriting expenses	 	 	10,098,595	 	 	 	7,269,206	 	
Policy dividends	 	 	94,114	 	 	 	227,314	 	
Interest	 	 	360,031	 	 	 	306,790	 	
Other expenses	 	 	497,913	 	 	 	344,652	 	

 	 	
Total expenses	 	 	60,953,674	 	 	 	45,351,428	 	

 	 	
Income before income taxes	 	 	9,738,748	 	 	 	7,475,390	 	
Income taxes	 	 	2,968,561	 	 	 	2,206,437	 	

 	 	
Net income	 	$	6,770,187	 	 	$	5,268,953	 	

 	 	
Net income per common share:	 	 	 	 	 	 	 	 	
Basic	 	$	0.52	 	 	$	0.57	 	

 	 	
Diluted	 	$	0.50	 	 	$	0.56	 	

 	 	
Consolidated Statements of Comprehensive Income 
(Unaudited)
 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended June 30,
	
 	 	2004
	 	2003
	
Net income	 	$	6,770,187	 	 	$	5,268,953	 	
Other comprehensive income (loss), net of tax	 	 	 	 	 	 	 	 	
Unrealized gains (losses) on securities:	 	 	 	 	 	 	 	 	
Unrealized holding gain (loss) during the period, net of income tax	 	 	(4,596,440	)	 	 	1,566,233	 	
Reclassification adjustment, net of income tax	 	 	(114,111	)	 	 	(140,641	)	

 	 	
Other comprehensive income (loss)	 	 	(4,710,551	)	 	 	1,425,592	 	

 	 	
Comprehensive income	 	$	2,059,636	 	 	$	6,694,545	 	

 	 	
See accompanying notes to consolidated financial statements. 
3 

Table of Contents
Donegal Group Inc. and Subsidiaries 
Consolidated Statement of Stockholders’ Equity
(Unaudited)
Six Months Ended June 30, 2004
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Class A Shares
	 	Class B Shares
	 	Class A Amount
	 	Class B Amount
	
Balance, December 31, 2003	 	 	9,880,506	 	 	 	3,051,811	 	 	$	98,805	 	 	$	30,518	 	
Issuance of common stock	 	 	28,765	 	 	 	 	 	 	 	288	 	 	 	 	 	
Net income	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Cash dividends	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Exercise of stock options	 	 	279,793	 	 	 	88,683	 	 	 	2,798	 	 	 	887	 	
Grant of stock options	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Tax benefit on exercise of stock options	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Other comprehensive loss	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	

 	 	 	 	

Balance, June 30, 2004	 	 	10,189,064	 	 	 	3,140,494	 	 	$	101,891	 	 	$	31,405	 	

 	 	 	 	

     
[Additional columns below]
[Continued from above table, first column(s) repeated] 
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	Accumulated	 	 	 	 	 	 	 	 	 	 	
 	 	Additional	 	Other	 	 	 	 	 	 	 	 	 	Total	
 	 	Paid-In	 	Comprehensive	 	Retained	 	Treasury	 	Stockholders'	
 	 	Capital
	 	Income
	 	Earnings
	 	Stock
	 	Equity
	
Balance, December 31, 2003	 	$	122,744,905	 	 	$	5,290,923	 	 	$	81,375,829	 	 	$	(891,748	)	 	$	208,649,232	 	
Issuance of common stock	 	 	499,774	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	500,062	 	
Net income	 	 	 	 	 	 	 	 	 	 	18,502,493	 	 	 	 	 	 	 	18,502,493	 	
Cash dividends	 	 	 	 	 	 	 	 	 	 	(1,519,487	)	 	 	 	 	 	 	(1,519,487	)	
Exercise of stock options	 	 	3,952,294	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	3,955,979	 	
Grant of stock options	 	 	55,467	 	 	 	 	 	 	 	(55,467	)	 	 	 	 	 	 	—	 	
Tax benefit on exercise of stock options	 	 	1,308,174	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	1,308,174	 	
Other comprehensive loss	 	 	 	 	 	 	(3,854,408	)	 	 	 	 	 	 	 	 	 	 	(3,854,408	)	

 	 	 	 	

 	 	
Balance, June 30, 2004	 	$	128,560,614	 	 	$	1,436,515	 	 	$	98,303,368	 	 	$	(891,748	)	 	$	227,542,045	 	

 	 	 	 	

 	 	
See accompanying notes to consolidated financial statements. 
4 

Table of Contents
Donegal Group Inc. and Subsidiaries 
Consolidated Statements of Cash Flows
(Unaudited)
 	 	 	 	 	 	 	 	 	
 	 	Six Months Ended June 30,
	
 	 	2004
	 	2003
	
Cash Flows from Operating Activities:	 	 	 	 	 	 	 	 	
Net income	 	$	18,502,493	 	 	$	9,113,385	 	

 	 	
Adjustments to reconcile net income to net cash provided by operating activities:	 	 	 	 	 	 	 	 	
Extraordinary gain - unallocated negative goodwill	 	 	(5,445,670	)	 	 	—	 	
Depreciation and amortization	 	 	1,311,755	 	 	 	794,070	 	
Realized investment gains	 	 	(643,998	)	 	 	(85,890	)	
Changes in assets and liabilities:	 	 	 	 	 	 	 	 	
Losses and loss expenses	 	 	6,718,885	 	 	 	(1,042,301	)	
Unearned premiums	 	 	19,304,986	 	 	 	11,110,934	 	
Premiums receivable	 	 	(5,966,727	)	 	 	(2,867,431	)	
Deferred acquisition costs	 	 	(4,464,731	)	 	 	(953,883	)	
Deferred income taxes	 	 	(348,800	)	 	 	(386,069	)	
Reinsurance receivable	 	 	(5,245,360	)	 	 	4,342,062	 	
Prepaid reinsurance premiums	 	 	(5,311,319	)	 	 	(3,949,295	)	
Accrued investment income	 	 	(251,478	)	 	 	216,861	 	
Due from affiliate	 	 	(2,720,544	)	 	 	(1,415,581	)	
Reinsurance balances payable	 	 	688,493	 	 	 	360,245	 	
Current income taxes	 	 	(421,819	)	 	 	(585,468	)	
Accrued expenses	 	 	(1,399,865	)	 	 	(388,819	)	
Drafts payable	 	 	143,219	 	 	 	—	 	
Other, net	 	 	1,682,141	 	 	 	83,668	 	

 	 	
Net adjustments	 	 	(2,370,832	)	 	 	5,233,103	 	

 	 	
Net cash provided by operating activities	 	 	16,131,661	 	 	 	14,346,488	 	

 	 	
Cash Flows from Investing Activities:	 	 	 	 	 	 	 	 	
Purchase of fixed maturities:	 	 	 	 	 	 	 	 	
Held to maturity	 	 	(52,706,119	)	 	 	(24,963,165	)	
Available for sale	 	 	(53,927,281	)	 	 	(42,998,272	)	
Purchase of equity securities, available for sale	 	 	(25,700,923	)	 	 	(8,240,320	)	
Maturity of fixed maturities:	 	 	 	 	 	 	 	 	
Held to maturity	 	 	14,150,067	 	 	 	10,692,008	 	
Available for sale	 	 	35,946,347	 	 	 	49,017,841	 	
Sale of fixed maturities:	 	 	 	 	 	 	 	 	
Available for sale	 	 	27,813,091	 	 	 	4,297,187	 	
Sale of equity securities, available for sale	 	 	9,745,318	 	 	 	8,261,206	 	
Purchase of Le Mars Insurance Company	 	 	(11,816,523	)	 	 	—	 	
Purchase of Peninsula Insurance Group	 	 	(21,912,629	)	 	 	—	 	
Net purchases of property and equipment	 	 	(396,089	)	 	 	(167,274	)	
Net sales (purchases) of short-term investments	 	 	55,323,525	 	 	 	(16,322,845	)	

 	 	
Net cash used in investing activities	 	 	(23,481,216	)	 	 	(20,423,634	)	

 	 	
Cash Flows from Financing Activities:	 	 	 	 	 	 	 	 	
Cash dividends paid	 	 	(2,898,480	)	 	 	(1,877,533	)	
Issuance of common stock	 	 	4,456,041	 	 	 	1,156,072	 	
Issuance of subordinated debentures	 	 	5,155,000	 	 	 	15,000,000	 	
Line of credit, net	 	 	—	 	 	 	(7,000,000	)	

 	 	
Net cash provided by financing activities	 	 	6,712,561	 	 	 	7,278,539	 	

 	 	
Net increase (decrease) in cash	 	 	(636,994	)	 	 	1,201,393	 	
Cash at beginning of period	 	 	5,908,521	 	 	 	1,124,604	 	

 	 	
Cash at end of period	 	$	5,271,527	 	 	$	2,325,997	 	

 	 	
Cash paid during period - Interest	 	$	683,751	 	 	$	368,581	 	
Net cash paid during period - Taxes	 	$	6,405,000	 	 	$	4,330,000	 	
See accompanying notes to consolidated financial statements. 
5 

Table of Contents
DONEGAL GROUP INC. AND SUBSIDIARIES
(Unaudited) 
Summary Notes to Consolidated Financial Statements
1 - Organization 
     We were organized as a regional insurance holding company by Donegal Mutual Insurance Company (the “Mutual Company”) on August 26, 1986. We operate predominantly as an underwriter of personal and commercial lines of property and casualty insurance through our subsidiaries. Our personal lines products consist primarily of homeowners and private passenger automobile insurance policies. Our commercial lines products consist primarily of commercial automobile, commercial multiple peril and workers’ compensation insurance policies. We distribute our products exclusively through a network of independent insurance agents in the Mid-Atlantic, Midwest and Southeastern states. Our wholly owned insurance subsidiaries include Atlantic States Insurance Company (“Atlantic States”), Southern Insurance Company of Virginia (“Southern”), and, since January 1, 2004, Le Mars Insurance Company (“Le Mars”) and the Peninsula Insurance Group (“Peninsula”), which consists of Peninsula Indemnity Company and The Peninsula Insurance Company. We also own 47.5% of the outstanding stock of Donegal Financial Services Corporation (“DFSC”), a thrift holding company. The Mutual Company owns the remaining 52.5% of the outstanding stock of DFSC. 
     At June 30, 2004, the Mutual Company held approximately 41% of our outstanding Class A common stock and approximately 63% of our outstanding Class B common stock. We refer to the Mutual Company and our insurance subsidiaries as the Donegal Insurance Group. 
     Atlantic States, our largest subsidiary, and the Mutual Company have a pooling agreement under which both companies are allocated a given percentage of their combined underwriting results, excluding certain reinsurance assumed by the Mutual Company from our insurance subsidiaries. Atlantic States has a 70% share of the results of the pool, and the Mutual Company has a 30% share of the results of the pool. 
     In addition to the pooling agreement and third-party reinsurance, Atlantic, Southern and Le Mars have various reinsurance arrangements with the Mutual Company. These agreements include: 
•	 	catastrophe reinsurance agreements with Atlantic, Southern and Le Mars;	
•	 	an excess of loss reinsurance agreement with Southern;	
•	 	a workers’ compensation reallocation agreement with Southern; and	
•	 	a 100% retrocessional agreement with Southern and Le Mars.	
     The retrocessional agreements are intended to ensure that Southern and Le Mars receive the same A.M. Best rating, currently A (Excellent), as the Mutual Company. The retrocessional agreements do not otherwise provide for pooling or reinsurance with or by the Mutual Company and do not transfer insurance risk. 
     In June 2002, the Mutual Company consummated an affiliation with Le Mars. As part of the affiliation, the Mutual Company entered into a management agreement with and made a $4.0 million surplus note investment in Le Mars. During 2003, Le Mars’ board of directors adopted a plan of conversion to convert to a stock insurance company. Following policyholder and regulatory approval of the plan of conversion, we acquired all of the outstanding stock of Le Mars as of January 1, 2004 for approximately $12.9 million in cash, including payment of the surplus note ($4.0 million) and accrued interest ($392,740) to the Mutual Company. The results of Le Mars have been included in our consolidated financial statements since January 1, 2004. 
     The acquisition of Le Mars enables us to conduct our insurance business in four Midwest states. Le Mars, which was organized under the laws of Iowa in 1901, operates as a property and casualty insurer in Iowa, Nebraska, Oklahoma and South Dakota. Personal lines coverages represent a majority of Le Mars’ premiums written, with the balance coming from farmowners and mercantile and service businesses. Le 
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Mars’ largest lines of business are private passenger automobile liability and physical damage; its other principal lines are homeowners and commercial multiple peril. Le Mars had net premiums earned of $20.5 million in 2002 and $17.9 million in 2003. Le Mars’ surplus and total admitted assets on a statutory basis as of December 31, 2003 were $12.0 million and $37.0 million, respectively. The purchase price of Le Mars was based upon an independent valuation as of July 31, 2003. In applying GAAP purchase accounting standards as of January 1, 2004, we recognized an extraordinary gain in the amount of $5.4 million related to unallocated negative goodwill resulting from this acquisition. A substantial portion of this unallocated negative goodwill was generated by the recognition of anticipated federal income tax benefits that we expect to realize over the allowable twenty-year carryover period by offsetting the net operating loss carryover obtained as part of the acquisition of Le Mars against taxable income generated by our other consolidated affiliates. We have determined that a valuation allowance is required for a portion of the acquired net operating loss carryover, because federal tax laws limit the amount of such carryover that can be utilized. Other factors that generated negative goodwill include favorable operating results and increases in the market values of invested assets in the period between the valuation date and the acquisition date. 
     As of January 1, 2004, we purchased all of the outstanding stock of Peninsula Indemnity Company and The Peninsula Insurance Company, both of which are organized under Maryland law, with headquarters in Salisbury, Maryland, from Folksamerica Holding Company, Inc. (“Folksamerica”), a part of the White Mountains Insurance Group, Ltd., for a price in cash equal to 107.5% of Peninsula’s GAAP stockholders’ equity as of the closing of the acquisition, or approximately $23.4 million. The results of Peninsula have been included in our consolidated financial statements since January 1, 2004. 
     Peninsula expands our presence in existing markets, operating primarily in Maryland, Delaware and Virginia. Peninsula specializes in private passenger automobile coverages and also writes homeowners, commercial multiple peril, workers’ compensation and commercial automobile coverages. For the years ended December 31, 2002 and 2003, Peninsula had net premiums earned of $29.7 million and $32.7 million, respectively. Peninsula’s surplus and total admitted assets on a statutory basis as of December 31, 2003 were $19.5 million and $52.6 million, respectively. We recorded goodwill of $374,968 related to this acquisition, none of which is expected to be deductible for federal income tax purposes. Pursuant to terms of the purchase agreement, Folksamerica has guaranteed us against any deficiency in the loss and loss expense reserves of Peninsula as of January 1, 2004 in excess of $1.5 million. Any such deficiency will be based on a final actuarial review of the development of such reserves to be conducted four years after January 1, 2004. The maximum obligation of Folksamerica to us under this guarantee is $4.0 million. 
     The following table presents financial information related to the results of operations of Le Mars and Peninsula for the three and six months ended June 30, 2004. Prior to our acquisition of Le Mars and Peninsula, their quarterly financial statements were prepared in accordance with statutory accounting practices (SAP). Therefore, financial information prepared in accordance with generally accepted accounting principles (GAAP) necessary to prepare supplemental pro forma information was unavailable for the three and six months ended June 30, 2003. 
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended	 	Six Months Ended	
 	 	June 30,
	 	June 30,
	
 	 	Le Mars
	 	Peninsula
	 	Le Mars
	 	Peninsula
	
 	 	($ in thousands, except per share data)	
Total revenues	 	$	4,251	 	 	$	8,921	 	 	$	8,386	 	 	$	16,915	 	
Income before extraordinary item	 	 	(96	)	 	 	1,376	 	 	 	1,168	 	 	 	1,929	 	
Net income	 	 	(96	)	 	 	1,376	 	 	 	1,168	 	 	 	1,929	 	
Basic earnings per share	 	 	(0.01	)	 	 	0.10		 	 	0.09	 	 	 	0.15	 	
Diluted earnings per share	 	 	(0.01	)	 	 	0.10	 	 	 	0.09	 	 	 	0.14	 	
2 - Basis of Presentation 
     The financial information for the interim periods included herein is unaudited; however, such information reflects all adjustments, consisting only of normal recurring adjustments, that, in the opinion of management, are necessary for a fair presentation of our financial position, results of operations and cash 
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flows for the interim periods included herein. Our results of operations for the three and six months ended June 30, 2004 are not necessarily indicative of our results of operations to be expected for the twelve months ending December 31, 2004. 
     These interim financial statements should be read in conjunction with the financial statements and notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2003. 
3 - Earnings Per Share 
     The computation of basic and diluted earnings per share is as follows: 
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	Effect of	 	 	
 	 	 	 	 	 	 	 	Stock	 	 	
 	 	 	 	Basic
	 	Options
	 	Diluted
	
Three Months Ended June 30:	 	 	 	 	 	 	 	 	 	 	 	 	
2004		
 	 	Net income	 	$	6,770,187	 	 	$	—	 	 	$	6,770,187	 	

 	 	 	 	
 	 	
 	 	Weighted average shares outstanding	 	 	13,137,183	 	 	 	483,972	 	 	 	13,621,155	 	

 	 	 	 	
 	 	
 	 	Earnings per common share:	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Net income	 	$	0.52	 	 	$	(0.02	)	 	$	0.50	 	

 	 	 	 	
 	 	
2003		
 	 	Net income	 	$	5,268,953	 	 	$	—	 	 	$	5,268,953	 	

 	 	 	 	
 	 	
 	 	Weighted average shares outstanding	 	 	9,269,029	 	 	 	155,021	 	 	 	9,424,050	 	

 	 	 	 	
 	 	
 	 	Earnings per common share:	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Net income	 	$	0.57	 	 	$	(0.01	)	 	$	0.56	 	

 	 	 	 	
 	 	
Six Months Ended June 30:	 	 	 	 	 	 	 	 	 	 	 	 	
2004		
 	 	Income before extraordinary item	 	$	13,056,823	 	 	$	—	 	 	$	13,056,823	 	
 	 	Extraordinary item	 	 	5,445,670	 	 	 	—	 	 	 	5,445,670	 	

 	 	 	 	
 	 	
 	 	Net income	 	$	18,502,493	 	 	$	—	 	 	$	18,502,493	 	

 	 	 	 	
 	 	
 	 	Weighted average shares outstanding	 	 	13,013,503	 	 	 	551,339	 	 	 	13,564,842	 	

 	 	 	 	
 	 	
 	 	Earnings per common share:	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Income before extraordinary item	 	$	1.00	 	 	$	(0.04	)	 	$	0.96	 	
 	 	Extraordinary item	 	 	0.42	 	 	 	(0.02	)	 	 	0.40	 	

 	 	 	 	
 	 	
 	 	Net income	 	$	1.42	 	 	$	(0.06	)	 	$	1.36	 	

 	 	 	 	
 	 	
2003		
 	 	Income before extraordinary item	 	$	9,113,385	 	 	$	—	 	 	$	9,113,385	 	
 	 	Extraordinary item	 	 	—	 	 	 	—	 	 	 	—	 	

 	 	 	 	
 	 	
 	 	Net income	 	$	9,113,385	 	 	$	—	 	 	$	9,113,385	 	

 	 	 	 	
 	 	
 	 	Weighted average shares outstanding	 	 	9,239,878	 	 	 	137,736	 	 	 	9,377,614	 	

 	 	 	 	
 	 	
 	 	Earnings per common share:	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Income before extraordinary item	 	$	0.99	 	 	$	(0.02	)	 	$	0.97	 	
 	 	Extraordinary item	 	 	—	 	 	 	—	 	 	 	—	 	

 	 	 	 	
 	 	
 	 	Net income	 	$	0.99	 	 	$	(0.02	)	 	$	0.97	 	

 	 	 	 	
 	 	
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     The following options to purchase shares of Class A common stock were not included in the computation of diluted earnings per share because the exercise price of the options was greater than the average market price during the relevant period: 
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended	 	Six Months Ended	
 	 	June 30,
	 	June 30,
	
 	 	2004
	 	2003
	 	2004
	 	2003
	
Number of shares	 	 	7,500	 	 	 	1,117,500	 	 	 	7,500	 	 	 	1,117,500	 	

 	 	 	 	

4 - Segment Information 
     We evaluate the performance of our personal lines and commercial lines based upon underwriting results as determined under SAP, which is used by management to measure performance for our total business. Financial data by segment is as follows: 
 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended	
 	 	June 30,
	
 	 	2004
	 	2003
	
 	 	($ in thousands)	
Revenues:	 	 	 	 	 	 	 	 	
Premiums earned:	 	 	 	 	 	 	 	 	
Commercial lines	 	$	24,533	 	 	$	17,338	 	
Personal lines	 	 	41,993	 	 	 	31,096	 	

 	 	
Net SAP premiums earned	 	 	66,526	 	 	 	48,434	 	
GAAP adjustments	 	 	(1,028	)	 	 	—	 	

 	 	
Net GAAP premiums earned	 	 	65,498	 	 	 	48,434	 	
Net investment income	 	 	3,843	 	 	 	3,316	 	
Realized investment gains	 	 	176	 	 	 	216	 	
Other	 	 	1,175	 	 	 	861	 	

 	 	
Total revenues	 	$	70,692	 	 	$	52,827	 	

 	 	
Income before income taxes:	 	 	 	 	 	 	 	 	
Underwriting income:	 	 	 	 	 	 	 	 	
Commercial lines	 	$	3,461	 	 	$	1,902	 	
Personal lines	 	 	767	 	 	 	1,329	 	

 	 	
SAP underwriting income	 	 	4,228	 	 	 	3,231	 	
GAAP adjustments	 	 	1,175	 	 	 	503	 	

 	 	
GAAP underwriting income	 	 	5,403	 	 	 	3,734	 	
Net investment income	 	 	3,843	 	 	 	3,316	 	
Realized investment gains	 	 	176	 	 	 	216	 	
Other	 	 	317	 	 	 	209	 	

 	 	
Income before income taxes	 	$	9,739	 	 	$	7,475	 	

 	 	
 	 	 	 	 	 	 	 	 	
 	 	Six Months Ended	
 	 	June 30,
	
 	 	2004
	 	2003
	
 	 	($ in thousands)	
Revenues:	 	 	 	 	 	 	 	 	
Premiums earned:	 	 	 	 	 	 	 	 	
Commercial lines	 	$	47,462	 	 	$	34,643	 	
Personal lines	 	 	83,448	 	 	 	61,720	 	

 	 	
Net SAP premiums earned	 	 	130,910	 	 	 	96,363	 	
GAAP adjustments	 	 	(2,712	)	 	 	—	 	

 	 	
Net GAAP premiums earned	 	 	128,198	 	 	 	96,363	 	
Net investment income	 	 	7,623	 	 	 	6,680	 	
Realized investment gains	 	 	644	 	 	 	86	 	
Other	 	 	2,229	 	 	 	1,883	 	

 	 	
Total revenues	 	$	138,694	 	 	$	105,012	 	

 	 	
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 	 	Six Months Ended	
 	 	June 30,
	
 	 	2004
	 	2003
	
 	 	($ in thousands)	
Income before income taxes and extraordinary items:	 	 	 	 	 	 	 	 	
Underwriting income:	 	 	 	 	 	 	 	 	
Commercial lines	 	$	5,093	 	 	$	4,255	 	
Personal lines	 	 	3,034	 	 	 	191	 	

 	 	
SAP underwriting income	 	 	8,127	 	 	 	4,446	 	
GAAP adjustments	 	 	1,833	 	 	 	659	 	

 	 	
GAAP underwriting income	 	 	9,960	 	 	 	5,105	 	
Net investment income	 	 	7,623	 	 	 	6,680	 	
Realized investment gains	 	 	644	 	 	 	86	 	
Other	 	 	451	 	 	 	687	 	

 	 	
Income before income taxes and extraordinary items	 	$	18,678	 	 	$	12,558	 	

 	 	
5- Subordinated Debentures 
     On May 15, 2003, we received $15.0 million in net proceeds from the issuance of subordinated debentures. The debentures mature on May 15, 2033 and are callable at our option, at par, after five years. The debentures carry an interest rate equal to the three-month LIBOR rate plus 4.10%, which is adjustable quarterly. At June 30, 2004, the interest rate on the debentures was 5.35%. 
     On October 29, 2003, we received $10.0 million in net proceeds from the issuance of subordinated debentures. The debentures mature on October 29, 2033 and are callable at our option, at par, after five years. The debentures carry an interest rate equal to the three-month LIBOR rate plus 3.85%, which is adjustable quarterly. At June 30, 2004, the interest rate on the debentures was 5.02%. 
     On May 24, 2004, we received $5.0 million in net proceeds from the issuance of subordinated debentures. The debentures mature on May 24, 2034 and are callable at our option, at par, after five years. The debentures carry an interest rate equal to the three-month LIBOR rate plus 3.85%, which is adjustable quarterly. At June 30, 2004, the interest rate on the debentures was 5.02%. 
6- Stock–Based Compensation Plans 
     We account for stock-based compensation plans under the provisions of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. During 2001, we adopted an Equity Incentive Plan for key employees that made 1,500,000 shares of Class A common stock available. The plan provides for the granting of awards by our board of directors in the form of stock options, stock appreciation rights, restricted stock or any combination of the above. During 2001, we also adopted an Equity Incentive Plan for Directors that made 200,000 shares of Class A common stock available. Awards may be made in the form of stock options, and the plan further provides for the issuance of 175 shares of restricted stock to each director on the first business day of January in each year. No stock-based employee compensation is reflected in income, except for expense associated with restricted stock issued, as all options granted under those plans had an exercise price equal to, or greater than, the market value of the underlying common stock on the date of the grant. The following table illustrates the effect on net income and earnings per share as if we had applied the provisions of Statement of Financial Accounting Standards (SFAS) No. 123 (as amended by SFAS No. 148), “Accounting for Stock-Based Compensation.” 
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Three Months Ended	 	Six Months Ended	
 	 	June 30,
	 	June 30,
	
 	 	2004
	 	2003
	 	2004
	 	2003
	
 	 	($ in thousands, except per share data)	
Net income, as reported	 	$	6,770	 	 	$	5,269	 	 	$	18,502	 	 	$	9,113	 	
Less:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects	 	 	(79	)	 	 	(91	)	 	 	(213	)	 	 	(104	)	

 	 	 	 	

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 	 	Three Months Ended	 	Six Months Ended	
 	 	June 30,
	 	June 30,
	
 	 	2004
	 	2003
	 	2004
	 	2003
	
 	 	($ in thousands, except per share data)	
Pro forma net income	 	$	6,691	 	 	$	5,178	 	 	$	18,289	 	 	$	9,009	 	

 	 	 	 	

Basic earnings per share:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
As reported	 	$	0.52	 	 	$	0.57	 	 	$	1.42	 	 	$	0.99	 	
Pro forma	 	$	0.51	 	 	$	0.56	 	 	$	1.41	 	 	$	0.98	 	
Diluted earnings per share:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
As reported	 	$	0.50	 	 	$	0.56	 	 	$	1.36	 	 	$	0.97	 	
Pro forma	 	$	0.49	 	 	$	0.55	 	 	$	1.35	 	 	$	0.96	 	
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. 
Results of Operations - Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003 
     Net Premiums Written. Net premiums written for the three months ended June 30, 2004 were $73.8 million, compared to $53.2 million for the same period in 2003. Commercial lines net premiums written increased $9.2 million, or 47.7%, in the second quarter of 2004 compared to the comparable period in 2003. Personal lines net premiums written increased $11.4 million, or 33.6%, in the second quarter of 2004 compared to the comparable period in 2003. The acquisition of Le Mars and Peninsula as of January 1, 2004 accounted for approximately $14.8 million of net premiums written in the second quarter of 2004, or approximately 71.8% of the increase from the comparable period in 2003. We have also benefited during these periods, and expect to continue to benefit, from premium increases by our insurance subsidiaries that have resulted from rate filings approved by insurance regulatory authorities. These increases related primarily to private passenger automobile, commercial multiple peril, workers’ compensation and homeowners lines of business realized in most of the states in which we operate. In addition to the acquisitions and pricing increases, we have also benefited from organic growth in most of the states in which we operate. 
     Net Premiums Earned. Net premiums earned increased to $65.5 million for the second quarter of 2004, an increase of $17.1 million, or 35.2%, over the second quarter of 2003. Premiums are earned, or recognized as revenue, over the terms of our policies, which are one year or less in duration. Therefore, increases or decreases in net premiums earned will generally reflect increases or decreases in net premiums written in the preceding twelve-month period compared to the comparable period one year earlier. Earned premiums have grown during the 2004 period due to the acquisition of Le Mars and Peninsula as well as due to the increase in written premiums in the past year. Net premiums earned and amortization of deferred policy acquisition costs decreased $1.0 million during the second quarter of 2004 because of the application of purchase accounting methodology in the acquisition of Le Mars and Peninsula. Acquired deferred acquisition costs were netted from unearned premiums as of January 1, 2004. Since these costs were incurred prior to January 1, 2004, they were netted from the associated deferred revenues in estimating the fair value of the unearned premiums assumed in the acquisitions. As a result, the normal amortization of these costs was shown as a reduction of net premiums earned in the three months ended June 30, 2004. The amortization of deferred acquisition costs was correspondingly reduced, so that there was no impact on net income for the period. 
     Investment Income. For the three months ended June 30, 2004, our net investment income increased 15.9% to $3.8 million, compared to $3.3 million for the comparable period one year ago. An increase in average invested assets from $352.0 million in the second quarter of 2003 to $484.3 million in the second quarter of 2004 was offset by a decrease in the annualized average return on investments from 3.8% for the second quarter of 2003 to 3.2% for the second quarter of 2004. The decrease in our annualized average return reflects higher levels of short-term investments in our investment portfolio during 
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the second quarter of 2004 compared to the comparable period a year earlier and a declining interest rate environment in both periods. 
     Net Realized Investment Gains/Losses. Net realized investment gains in the second quarter of 2004 were $175,555, compared to $216,370 for the comparable period in 2003. No impairment charges were recognized in the second quarter of 2004, compared to impairment charges of $14,225 recognized in the second quarter of 2003. The impairment charges in 2003 were the result of declines in the market value of equity securities that we determined to be other than temporary. The remaining net realized investment gains and losses in both periods resulted from normal turnover within our investment portfolio. 
     Losses and Loss Expenses. Our loss ratio, which is the ratio of incurred losses and loss expenses to premiums earned, in the second quarter of 2004 was 61.0%, compared to 61.2% in the second quarter of 2003. The commercial lines loss ratio improved to 53.0% in the second quarter of 2004, compared to 57.2% in the second quarter of 2003 due to favorable experience in our commercial automobile and workers’ compensation lines of business. The personal lines loss ratio increased from 63.2% in the second quarter of 2003 to 66.2% in the second quarter of 2004, primarily due to an increase in our homeowners loss ratio that was largely attributable to claims from a severe weather event in the Midwest. Our loss ratios were also impacted in the second quarter of 2004 by the reduction in earned premiums during the second quarter of 2004 related to the application of purchase accounting methodology in the acquisition of Le Mars and Peninsula discussed above. 
     Underwriting Expenses. Our expense ratio, which is the ratio of policy acquisition costs and other underwriting expenses to premiums earned, for the second quarter of 2004 was 30.7%, compared to 30.6% in the second quarter of 2003. The increase in the second quarter of 2004 expense ratio reflects increased underwriting-based incentive costs, offset by a decrease in expenses related to the application of purchase accounting methodology in the acquisition of Le Mars and Peninsula discussed above. The acquired deferred acquisition costs were netted from unearned premiums as of the purchase date and, as a result, the amortization of these costs was shown as a reduction of earned premiums instead of being shown as a component of expenses in the current period. 
     Combined Ratio. The combined ratio was 91.8% and 92.3% for the three months ended June 30, 2004 and 2003, respectively. The combined ratio represents the sum of the loss ratio, expense ratio and dividend ratio, which is the ratio of workers’ compensation policy dividends incurred to premiums earned. The improvement in the combined ratio was largely attributable to the decreases in the loss and dividend ratios for the 2004 period compared to the 2003 period. 
     Interest Expense. Interest expense for the second quarter of 2004 was $360,031, compared to $306,790 for the second quarter of 2003, and reflected an increase in interest expense related to the issuance of $15.5 million of subordinated debentures in October 2003 and May 2004, offset by the fact that no borrowings were outstanding under our line of credit for the 2004 period compared to average borrowings of $17.5 million for the 2003 period. 
     Income Taxes. Income tax expense was $3.0 million for the second quarter of 2004, representing an effective tax rate of 30.5%, compared to $2.2 million for the second quarter of 2003, representing an effective tax rate of 29.5%. The change in effective tax rates is due to tax-exempt interest income representing a smaller proportion of net income before taxes in the 2004 period compared to the 2003 period. 
     Net Income and Earnings Per Share. Our net income for the second quarter of 2004 was $6.8 million, or $.50 per share on a diluted basis, an increase of 28.5% over the net income of $5.3 million, or $.56 per share on a diluted basis, reported for the second quarter of 2003. Our fully diluted shares outstanding for the second quarter of 2004 increased to 13.6 million, compared to 9.4 million for the second quarter of 2003, due primarily to a public stock offering of 3.45 million shares of Class A common stock that was completed in December 2003. 
Results of Operations - Six Months Ended June 30, 2004 Compared to Six Months Ended June 30, 2003 
     Net Premiums Written. Net premiums written for the six months ended June 30, 2004 were $142.2 million, compared to $103.5 million for the comparable period in 2003. Commercial lines net premiums 
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written increased $16.8 million, or 42.4%, in the first half of 2004 compared to the comparable period in 2003. Personal lines net premiums written increased $21.9 million, or 34.2%, in the first half of 2004 compared to the comparable period in 2003. The acquisition of Le Mars and Peninsula as of January 1, 2004 accounted for approximately $29.1 million of net premiums written in 2004, or approximately 75.2% of the increase from the comparable period in 2003. We have also benefited during these periods, and expect to continue to benefit, from premium increases by our insurance subsidiaries that have resulted from rate filings approved by insurance regulatory authorities. These increases related primarily to private passenger automobile, commercial multiple peril, workers’ compensation and homeowners lines of business realized in most of the states in which we operate. In addition to the acquisitions and pricing increases, we have also benefited from organic growth in most of the states in which we operate. 
     Net Premiums Earned. Net premiums earned increased to $128.2 million for the first half of 2004, an increase of $31.8 million, or 33.0%, over the first half of 2003. Premiums are earned, or recognized as revenue, over the terms of our policies, which are one year or less in duration. Therefore, increases or decreases in net premiums earned will generally reflect increases or decreases in net premiums written in the preceding twelve-month period compared to the comparable period one year earlier. Earned premiums have grown during the 2004 period due to the acquisition of Le Mars and Peninsula as well as due to the increase in written premiums in the past year. Net premiums earned and amortization of deferred policy acquisition costs decreased $2.7 million during the first half of 2004 because of the application of purchase accounting methodology in the acquisition of Le Mars and Peninsula. Acquired deferred acquisition costs were netted from unearned premiums as of January 1, 2004. Since these costs were incurred prior to January 1, 2004, they were netted from the associated deferred revenues in estimating the fair value of the unearned premiums assumed in the acquisitions. As a result, the normal amortization of these costs was shown as a reduction of net premiums earned in the first half of 2004. The amortization of deferred acquisition costs was correspondingly reduced, so that there was no impact on net income for the period. 
     Investment Income. For the six months ended June 30, 2004, our net investment income increased 14.1% to $7.6 million, compared to $6.7 million for the comparable period one year ago. An increase in average invested assets from $346.9 million in the first half of 2003 to $451.4 million in the first half of 2004 was offset by a decrease in the annualized average return on investments from 3.9% for the first half of 2003 to 3.4% for the first half of 2004. The decrease in our annualized average return reflects higher levels of short-term investments in our investment portfolio during the first half of 2004 compared to the comparable period a year earlier and a declining interest rate environment in both periods. 
     Net Realized Investment Gains/Losses. Net realized investment gains in the first half of 2004 were $643,998, compared to $85,890 for the comparable period in 2003. Impairment charges of $6,650 were recognized in the first half of 2004, compared to impairment charges of $267,724 recognized in the first half of 2003. The impairment charges for both periods were the result of declines in the market value of equity securities that we determined to be other than temporary. The remaining net realized investment gains and losses in both periods resulted from normal turnover within our investment portfolio. 
     Losses and Loss Expenses. Our loss ratio, which is the ratio of incurred losses and loss expenses to premiums earned, in the first half of 2004 was 62.7%, compared to 63.8% in the first half of 2003. The commercial lines loss ratio increased to 57.0% in the first half of 2004, compared to 54.9% in the first half of 2003. The personal lines loss ratio improved from 68.7% in the first half of 2003 to 66.1% in the first half of 2004. An increase in our workers’ compensation loss ratio was offset by favorable experience in our commercial automobile, commercial multiple peril, personal automobile and homeowners lines of business. Our loss ratios were also impacted in the first half of 2004 by the reduction in earned premiums during the first half of 2004 related to the application of purchase accounting methodology in the acquisition of Le Mars and Peninsula discussed above. 
     Underwriting Expenses. Our expense ratio, which is the ratio of policy acquisition costs and other underwriting expenses to premiums earned, for the first half of 2004 was 29.2%, compared to 30.4% for the first half of 2003. The improvement in our expense ratio reflects a decrease in expenses during the first half of 2004 related to the application of purchase accounting methodology in the acquisition of Le Mars and Peninsula discussed above. The acquired deferred acquisition costs were netted from unearned premiums as of January 1, 2004 and, as a result, the amortization of these costs was shown as a reduction of earned premiums instead of being shown as a component of expenses in the first half of 2004. 
     Combined Ratio. The combined ratio was 92.2% and 94.7% for the six months ended June 30, 2004 and 2003, respectively. The combined ratio represents the sum of the loss ratio, expense ratio and 
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dividend ratio, which is the ratio of workers’ compensation policy dividends incurred to premiums earned. The improvement in the combined ratio was largely attributable to the decreases in the loss and expense ratios for the 2004 period compared to the 2003 period. 
     Interest Expense. Interest expense for the first half of 2004 was $697,426, compared to $521,531 for the first half of 2003, and reflected an increase in interest expense related to the issuance of $15.5 million of subordinated debentures in October 2003 and May 2004, offset by the fact that no borrowings were outstanding under our line of credit for the 2004 period compared to average borrowings of $18.6 million for the 2003 period. 
     Income Taxes. Income tax expense was $5.6 million for the first half of 2004, representing an effective tax rate of 30.1%, compared to $3.4 million for the first half of 2003, representing an effective tax rate of 27.4%. The change in effective tax rates is due to tax-exempt interest income representing a smaller proportion of net income before taxes in the 2004 period compared to the 2003 period. 
     Net Income and Earnings Per Share. Our net income for the first half of 2004 was $18.5 million, or $1.36 per share on a diluted basis. The first half of 2004 net income included an extraordinary gain of $5.4 million related to unallocated negative goodwill associated with the Le Mars acquisition. Income before this extraordinary item was $13.1 million, or $.96 per share on a diluted basis, an increase of 43.3% over the net income of $9.1 million, or $.97 per share on a diluted basis, reported for the first half of 2003. Our fully diluted shares outstanding for the first half of 2004 increased to 13.6 million, compared to 9.4 million for the first half of 2003, due primarily to a public stock offering of 3.45 million shares of Class A common stock that was completed in December 2003. 
Liquidity and Capital Resources 
     Liquidity is a measure of an entity’s ability to secure enough cash to meet its contractual obligations and operating needs as they arise. Our major sources of funds from operations are the net cash flows generated from our insurance subsidiaries’ underwriting results, investment income and maturing investments. 
     We generate sufficient net positive cash flow from our operations to fund our commitments and build our investment portfolio, thereby increasing future investment returns. We maintain a high degree of liquidity in our investment portfolio in the form of readily marketable fixed maturities, equity securities and short-term investments. Net cash flows provided by operating activities in the first six months of 2004 and 2003 were $16.1 million and $14.3 million, respectively. 
     On May 15, 2003, we received $15.0 million in net proceeds from the issuance of subordinated debentures. The debentures mature on May 15, 2033 and are callable at our option, at par, after five years. The debentures carry an interest rate equal to the three-month LIBOR rate plus 4.10%, which is adjustable quarterly. At June 30, 2004, the interest rate on the debentures was 5.35%. 
     On October 29, 2003, we received $10.0 million in net proceeds from the issuance of subordinated debentures. The debentures mature on October 29, 2033 and are callable at our option, at par, after five years. The debentures carry an interest rate equal to the three-month LIBOR rate plus 3.85%, which is adjustable quarterly. At June 30, 2004, the interest rate on the debentures was 5.02%. 
     On November 25, 2003, we entered into a credit agreement with Manufacturers and Traders Trust Company (“M&T”) relating to a four-year $35.0 million unsecured, revolving line of credit. As of June 30, 2004, we may borrow up to $35.0 million at interest rates equal to M&T’s current prime rate or the then current LIBOR rate plus between 1.50% and 1.75%, depending on our leverage ratio. In addition, we pay a fee of 0.15% per annum on the loan commitment amount, regardless of usage. The agreement requires our compliance with certain covenants, which include minimum levels of our net worth, leverage ratio and statutory surplus and A.M. Best ratings of our subsidiaries. As of June 30, 2004, there were no borrowings outstanding under the credit agreement, and we were in compliance with all requirements of the credit agreement. 
     On May 26, 2004, we received $5.0 million in net proceeds from the issuance of subordinated debentures. The debentures mature on May 26, 2034 and are callable at our option, at par, after five years. The debentures carry an interest rate equal to the three-month LIBOR rate plus 3.85%, which is adjustable quarterly. At June 30, 2004, the interest rate on the debentures was 5.02%. 
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     The following table shows our significant contractual obligations as of June 30, 2004. 
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
($ in thousands)
	 	Total
	 	2004
	 	2005
	 	2006
	 	2007
	 	2008
	 	After 2008
	
Subordinated debentures	 	$	30,929	 	 	$	—	 	 	$	—	 	 	$	—	 	 	$	—	 	 	$	—	 	 	$	30,929	 	

 	 	 	 	

 	 	 	 	

Total contractual obligations	 	$	30,929	 	 	$	—	 	 	$	—	 	 	$	—	 	 	$	—	 	 	$	—	 	 	$	30,929	 	

 	 	 	 	

 	 	 	 	

     On July 15, 2004, we declared regular quarterly cash dividends of 12 cents per share for our Class A common stock and 10.5 cents per share for our Class B common stock, payable August 16, 2004 to stockholders of record as of the close of business on August 2, 2004. There are no regulatory restrictions on the payment of dividends to our stockholders, although there are state law restrictions on the payment of dividends from our insurance subsidiaries to us. Our insurance subsidiaries are required 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 the applicable domiciliary insurance regulatory authorities. Our insurance subsidiaries are subject to risk-based capital (RBC) requirements. At December 31, 2003, our insurance subsidiaries’ capital levels were each substantially above RBC requirements. At January 1, 2004, amounts available for distribution as dividends to us from our insurance subsidiaries without prior approval of their domiciliary insurance regulatory authorities were $13.3 million from Atlantic States, $4.1 from Southern, $1.2 million from Le Mars and $1.9 million from Peninsula, all of which remained available at June 30, 2004. 
     As of June 30, 2004, we had no material commitments for capital expenditures. 
Equity Price Risk 
     Our portfolio of marketable equity securities, which is carried on our consolidated balance sheets at estimated fair value, has exposure to the risk of loss resulting from an adverse change in prices. We manage this risk by performing an analysis of prospective investments and through regular reviews of our portfolio by our investment staff. 
Credit Risk 
     Our portfolio of fixed-maturity securities and, to a lesser extent, short-term investments is subject to credit risk. This risk is defined as the potential loss in market value resulting from adverse changes in the borrower’s ability to repay the debt. We manage this risk by performing an analysis of prospective investments and through regular reviews of our portfolio by our investment staff. We also limit the amount that any one security can constitute of our total investment portfolio. 
     We provide property and liability insurance coverages through independent insurance agencies located throughout our operating area. The majority of this business is billed directly to the insured, although a portion of our commercial business is billed through our agents who are extended credit in the normal course of business. 
     Because the pooling agreement does not relieve Atlantic States of primary liability as the originating insurer, we are subject to a concentration of credit risk arising from business ceded to the Mutual Company. Our insurance subsidiaries maintain reinsurance agreements in place with the Mutual Company and with a number of other major unaffiliated authorized reinsurers. 
Impact of Inflation 
     Property and casualty insurance premium rates are established before the amount of losses and loss settlement expenses, or the extent to which inflation may impact such expenses, are known. Consequently, we attempt, in establishing rates, to anticipate the potential impact of inflation. 
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 
     Our market risk generally represents the risk of gain or loss that may result from the potential change in the fair value of our investment portfolio as a result of fluctuations in prices and interest rates and, 
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to a lesser extent, our debt obligations. We attempt to manage our interest rate risk by maintaining an appropriate relationship between the average duration of the investment portfolio and the approximate duration of our liabilities, i.e., policy claims and debt obligations. 
     We have maintained approximately the same duration of our investment portfolio to our liabilities from December 31, 2003 to June 30, 2004. In addition, we have maintained approximately the same investment mix during this period. 
     There have been no material changes to our quantitative or qualitative market risk exposure from December 31, 2003 through June 30, 2004. 
Item 4. Controls and Procedures. 
Evaluation of Disclosure Controls and Procedures 
     We conducted an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information we (including our consolidated subsidiaries) are required to disclose in our periodic filings with the Securities and Exchange Commission is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. 
Changes in Internal Control Over Financial Reporting 
     There has been no change in our internal control over financial reporting during the quarter covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995 
     Certain forward-looking statements contained herein involve risks and uncertainties. These statements include certain discussions relating to underwriting, premium and investment income volume, business strategies and our business activities during 2004 and beyond. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “project,” “predict,” “potential” and similar expressions. These forward-looking statements reflect our current views about future events, are based on assumptions and are subject to known and unknown risks and uncertainties that may cause our actual results to differ materially from those anticipated by these forward-looking statements. Many of the factors that will determine future events or our future results of operations are beyond our ability to control or predict. 
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Part II. Other Information 
Item 1. Legal Proceedings. 
     None. 
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities. 
 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	(d) Maximum Number	
 	 	 	 	 	 	(c) Total Number of	 	(or Approximate	
 	 	 	 	 	 	Shares (or Units)	 	Dollar Value) of	
 	 	 	 	 	 	Purchased as Part	 	Shares (or Units)	
 	 	(a) Total Number of	 	(b) Average	 	of Publicly	 	that May Yet Be	
 	 	Shares (or Units)	 	Price Paid per	 	Announced Plans or	 	Purchased Under the	
Period
	 	Purchased
	 	Share (or Unit)
	 	Programs
	 	Plans or Programs
	
Month #1 	 	Class A – None 	 	Class A – None 	 	Class A – None 	 	Class A – None	
April 1-30, 2004 	 	Class B – None 	 	Class B – None 	 	Class B – None 	 	Class B – None	
 	 	 	 	 	 	 	 	 	
Month #2 	 	Class A – 14,072 	 	Class A – $19.54 	 	Class A – None (1) 	 	Class A – None	
May 1-31, 2004 	 	Class B – 6,331 	 	Class B – $22.00 	 	Class B – None (2) 	 	Class B – None	
 	 	 	 	 	 	 	 	 	
Month #3 	 	Class A – None 	 	Class A – None 	 	Class A – None 	 	Class A – None	
June 1-30, 2004 	 	Class B – 666 	 	Class B – $21.54 	 	Class B – None (2) 	 	Class B – None	
 	 	 	 	 	 	 	 	 	
	 	Class A – 14,072 	 	Class A – $19.54 	 	Class A – None 	 	Class A – None	
Total 	 	Class B – 6,997 	 	Class B – $21.95 	 	Class B – None (2) 	 	Class B – None	
(1)	 	These shares were purchased by the Mutual Company through its participation in our Dividend Reinvestment and Stock Purchase Plan. These purchases were not pursuant to a publicly announced plan or program.		
 	
(2)	 	These shares were purchased by the Mutual Company in privately negotiated non-market transactions directly with its employees. These purchases were not pursuant to a publicly announced plan or program.		
Item 3. Defaults upon Senior Securities. 
     None. 
Item 4. Submission of Matters to a Vote of Security Holders. 
     Annual Stockholders meeting held April 19, 2004. 
 	 	 	 	 	
Directors elected at meeting:	 	 	 	 	
John J. Lyons	 	Votes for - 3,517,704, Votes withheld - 3,942	
R. Richard Sherbahn	 	Votes for - 3,512,429, Votes withheld - 9,216	
Richard D. Wampler, II	 	Votes for - 3,517,722, Votes withheld - 3,924	
Item 5. Other Information. 
     None. 
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Item 6. Exhibits and Reports on Form 8-K. 
     (a) Exhibits 
 	 	 	
Exhibit No.
	 	Description
	
Exhibit 31.1 	 	Certification of Chief Executive Officer	
  	 	 	
Exhibit 31.2 	 	Certification of Chief Financial Officer	
  	 	 	
Exhibit 32.1 	 	Statement of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 of Title 18 of the United States Code	
  	 	 	
Exhibit 32.2 	 	Statement of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 of Title 18 of the United States Code	
     (b) Reports on Form 8-K: 
On April 21, 2004, we filed a report on Form 8-K including as an exhibit our first quarter 2004 earnings press release. 
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Signatures 
     Pursuant to the requirements 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.	
 	 	 	 	 	
August 9, 2004 	 	By: 	 	/s/ Donald H. Nikolaus	

	 	 	 	Donald H. Nikolaus, President	
	 	 	 	 and Chief Executive Officer	
 	 	 	 	 	
August 9, 2004 	 	By: 	 	/s/ Ralph G. Spontak	

	 	 	 	Ralph G. Spontak, Senior Vice President,	
	 	 	 	 Chief Financial Officer and Secretary	
19 
 
Exhibit 31.1 
Certification 
     I, Donald H. Nikolaus, certify that: 
     1. I have reviewed this quarterly report on Form 10-Q of Donegal Group Inc.; 
     2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 
     3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 
     4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: 
(a)	 	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;		
 	
(b)	 	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and		
 	
(c)	 	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and		
     5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function): 
(a)	 	all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting that are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and		
 	
(b)	 	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting.		
 	 	 	
Date: August 9, 2004 	 	/s/ Donald H. Nikolaus	

	 	Donald H. Nikolaus	
	 	President and Chief Executive Officer	
20 
 
Exhibit 31.2 
Certification 
     I, Ralph G. Spontak, certify that: 
     1. I have reviewed this quarterly report on Form 10-Q of Donegal Group Inc.; 
     2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 
     3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 
     4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: 
(a)	 	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;		
 	
(b)	 	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and		
 	
(c)	 	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and		
     5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function): 
(a)	 	all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting that are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and		
 	
(b)	 	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting.		
 	 	 	
Date: August 9, 2004 	 	/s/ Ralph G. Spontak	

	 	Ralph G. Spontak	
	 	Senior Vice President and Chief Financial Officer	
21 
 
Exhibit 32.1 
Statement of Chief Executive Officer
Pursuant to Section 1350 of Title 18 of the United States Code 
           Pursuant to Section 1350 of Title 18 of the United States Code, the undersigned, Donald H. Nikolaus, the President and Chief Executive Officer of Donegal Group Inc., hereby certifies that, to the best of his knowledge: 
1.	 	Our Form 10-Q Quarterly Report for the period ended June 30, 2004 (the “Report”) fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and	
2.	 	The information contained in the Report fairly presents, in all material respects, our financial condition and results of operations.	
 	 	 	
Dated: August 9, 2004 	 	/s/ Donald H. Nikolaus	

	 	Donald H. Nikolaus, President	
	 	and Chief Executive Officer	
22 
 
Exhibit 32.2 
Statement of Chief Financial Officer
Pursuant to Section 1350 of Title 18 of the United States Code 
           Pursuant to Section 1350 of Title 18 of the United States Code, the undersigned, Ralph G. Spontak, the Senior Vice President and Chief Financial Officer of Donegal Group Inc., hereby certifies that, to the best of his knowledge: 
1.	 	Our Form 10-Q Quarterly Report for the period ended June 30, 2004 (the “Report”) fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and	
2.	 	The information contained in the Report fairly presents, in all material respects, our financial condition and results of operations.	
 	 	 	
Dated: August 9, 2004 	 	/s/ Ralph G. Spontak	

	 	Ralph G. Spontak,	
	 	Senior Vice President and Chief Financial Officer	
23