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Table of Contents
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM
10-K
 
 
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2020
OR
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
                    
to
                    
Commission file number
0-15341
 
 
DONEGAL GROUP INC.
(Exact name of registrant as specified in its charter)
 
 
 
Delaware
 
23-2424711
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
1195 River Road, Marietta, Pennsylvania
 
17547
(Address of principal executive offices)
 
(Zip code)
Registrant’s telephone number, including area code:
(800877-0600
Securities registered pursuant to Section 12(b) of the Act:
 
Title of Each Class
 
Trading
Symbols
 
Name of Each Exchange
on Which Registered
Class A Common Stock, $.01 par value
 
DGICA
 
The NASDAQ Global Select Market
Class B Common Stock, $.01 par value
 
DGICB
 
The NASDAQ Global Select Market
 
 
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark whether the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act:    Yes  ☐.    No  ☒.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes  ☐.    No  ☒.
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  ☒.    No  ☐.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of
Regulation S-T
(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒.    No  ☐.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated
filer, a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule
12b-2
of the Act. (Check one):
 
Large accelerated filer    ☐   Accelerated filer    ☒  
Non-accelerated
filer    ☐
  Smaller reporting company    
Emerging growth company    
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☐.
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.    Yes  .    No  ☐.
Indicate by check mark whether the registrant is a shell company (as defined in Rule
12b-2
of the Act).    Yes  ☐.    No  .
State the aggregate market value of the voting and
non-voting
common equity held by
non-affiliates
computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. $216,494,411.
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date: 24,699,005 shares of Class A common stock and 5,576,775 shares of Class B common stock outstanding on March 1, 2021.
Documents Incorporated by Reference
The registrant incorporates by reference portions of the registrant’s definitive proxy statement relating to registrant’s annual meeting of stockholders to be held April 15, 2021 into Part III of this report.
 
 
 
 

Table of Contents
DONEGAL GROUP INC.
INDEX TO FORM
10-K
REPORT
 
 
  
 
  
 
Page
 
 
  
 
  
 
 
 
  
 
  
     
     
Item 1.
  
  
 
1
 
     
Item 1A.
  
  
 
30
 
     
Item 1B.
  
  
 
44
 
     
Item 2.
  
  
 
44
 
     
Item 3.
  
  
 
44
 
     
Item 4.
  
  
 
44
 
     
  
 
  
     
     
Item 5.
  
  
 
45
 
     
Item 6.
  
  
 
47
 
     
Item 7.
  
  
 
48
 
     
Item 7A.
  
  
 
64
 
     
Item 8.
  
  
 
67
 
     
Item 9.
  
  
 
116
 
     
Item 9A.
  
  
 
116
 
     
Item 9B.
  
  
 
116
 
     
  
 
  
     
     
Item 10.
  
  
 
119
 
     
Item 11.
  
  
 
120
 
     
Item 12.
  
  
 
121
 
     
Item 13.
  
  
 
121
 
     
Item 14.
  
  
 
121
 
     
  
 
  
     
     
Item 15.
  
  
 
122
 
     
Item 16.
  
  
 
125
 
 
(i)

Table of Contents
PART I
 
Item 1.    Business.
Introduction
Donegal Group Inc., or DGI, is an insurance holding company whose insurance subsidiaries and affiliates offer personal and commercial lines of property and casualty insurance to businesses and individuals in 24
Mid-Atlantic,
Midwestern, New England, Southern and Southwestern states. DGI has no significant business operations and is separate and distinct from its insurance subsidiaries. As used in this Form
10-K
Report, the terms “we,” “us” and “our” refer to Donegal Group Inc. and its insurance subsidiaries. Our Class A common stock and our Class B common stock trade on the NASDAQ Global Select Market under the symbols “DGICA” and “DGICB,” respectively.
Donegal Mutual Insurance Company, or Donegal Mutual, organized us as an insurance holding company on August 26, 1986. At December 31, 2020, Donegal Mutual held approximately 42% of our outstanding Class A common stock and approximately
84% of our outstanding Class B common stock. Donegal Mutual’s ownership provides Donegal Mutual with approximately 71% of the combined voting power of our outstanding shares of Class A common stock and our outstanding shares of Class B common stock. Our insurance subsidiaries and Donegal Mutual have interrelated operations due to an intercompany pooling agreement and other intercompany agreements and transactions we describe in Note 3 of the Notes to Consolidated Financial Statements. While maintaining the separate corporate existence of each company, our insurance subsidiaries conduct business together with Donegal Mutual and its insurance subsidiaries as the Donegal Insurance Group. The Donegal Insurance Group is not a legal entity, is not an insurance company and does not issue or administer insurance policies. Rather, it is a trade name that refers to the group of insurance companies that are affiliated with Donegal Mutual.
At December 31, 2020, we had three segments: our investment function, our commercial lines of insurance and our personal lines of insurance. We set forth financial information about these segments in Note 19 of the Notes to Consolidated Financial Statements. The commercial lines products of our insurance subsidiaries consist primarily of commercial automobile, commercial multi-peril and workers’ compensation policies. The personal lines products of our insurance subsidiaries consist primarily of homeowners and private passenger automobile policies.
Our insurance subsidiaries and Donegal Mutual provide their policyholders with a selection of insurance products at competitive rates, while pursuing profitability by adhering to a strict underwriting discipline. Our insurance subsidiaries derive a substantial portion of their insurance business from smaller to
mid-sized
regional communities. We believe this focus provides our insurance subsidiaries with competitive advantages in terms of local market knowledge, marketing, underwriting, claims servicing and policyholder service. At the same time, we believe our insurance subsidiaries have cost advantages over many smaller regional insurers that result from economies of scale our insurance subsidiaries realize through centralized accounting, administrative, data processing, investment and other services.
We believe we have a substantial opportunity, as a well-capitalized regional insurance holding company with a solid business strategy, to grow profitably and compete effectively with larger national property and casualty insurers. Our downstream holding company structure, with Donegal Mutual holding approximately 71% of the combined voting power of our common stock, has proven its effectiveness and success over the 34 years of our existence. Over that time period, we have grown significantly in terms of revenue and financial strength, and the Donegal Insurance Group has developed an excellent reputation as a regional group of property and casualty insurers.
We have been an effective consolidator of smaller “main street” property and casualty insurance companies, and we pursue opportunities to acquire other insurance companies to expand our business in a given region. Since 1998, we and Donegal Mutual have completed seven transactions involving acquisitions of property and casualty insurance companies or participation in the business of property and casualty insurance companies through Donegal Mutual’s entry into quota-share reinsurance agreements with them.
 
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Table of Contents
Donegal Mutual completed the merger of Mountain States Mutual Casualty Company, or Mountain States, with and into Donegal Mutual effective May 25, 2017. Donegal Mutual was the surviving company in the merger, and Mountain States’ insurance subsidiaries, Mountain States Indemnity Company and Mountain States Commercial Insurance Company (collectively, the “Mountain States insurance subsidiaries”), became insurance subsidiaries of Donegal Mutual upon completion of the merger. Upon completion of the merger, Donegal Mutual assumed all of the policy obligations of Mountain States and began to market its products together with the Mountain States insurance subsidiaries as the Mountain States Insurance Group in four Southwestern states. Donegal Mutual also entered into a 100% quota-share reinsurance agreement with the Mountain States insurance subsidiaries on the merger date. Beginning with policies effective in 2021, Donegal Mutual began to place the business of the Mountain States Insurance Group into the underwriting pool we describe in “History and Organizational Structure.” As a result, our consolidated financial results through December 31, 2020 excluded the results of the Mountain States Insurance Group operations in those Southwestern states.
We and Donegal Mutual sold Donegal Financial Services Corporation (“DFSC”) to Northwest Bancshares, Inc. (“Northwest”) on March 8, 2019, resulting in proceeds valued at approximately $85.8 million in a combination of cash and Northwest common stock. DFSC was a grandfathered unitary savings and loan holding company that owned Union Community Bank, a state savings bank. Immediately prior to the closing of the merger, DFSC paid a dividend of approximately $29.2 million to us and Donegal Mutual. As the owner of 48.2% of DFSC’s common stock, we received a dividend payment from DFSC of approximately $14.1 million and consideration from Northwest that included a combination of cash in the amount of $20.5 million and Northwest common stock with a fair value at the closing date of $20.9 million. We recorded a gain of $12.7 million from the sale of DFSC in our results of operations during 2019. We sold the Northwest common stock that we received as part of the consideration during 2019. This transaction represented the culmination of a banking strategy that began with the formation of DFSC in 2000.
Effective December 1, 2019, our insurance subsidiaries Le Mars Insurance Company (“Le Mars”) and Sheboygan Falls Insurance Company (“Sheboygan Falls”) merged with and into Atlantic States Insurance Company (the “Mergers”). As a result of the Mergers, the separate corporate existences of Le Mars and Sheboygan Falls ceased and Atlantic States Insurance Company (“Atlantic States”) continued as the surviving insurance company. Atlantic States placed the business of Le Mars and Sheboygan Falls, as their policies renewed subsequent to the effective date of the Mergers, into the underwriting pool.
Available Information
You may obtain our Annual Reports on Form
10-K,
including this Form
10-K
Report, our quarterly reports on Form
10-Q,
our current reports on Form
8-K,
our proxy statement and our other filings pursuant to the Securities Exchange Act of 1934, or the Exchange Act, without charge by viewing our website at
www.donegalgroup.com
. You may also view our Code of Business Conduct and Ethics and the charters of the executive committee, the audit committee, the compensation committee and the nominating committee of our board of directors on our website. Upon request to our corporate secretary, we will also provide printed copies of any of these documents to you without charge. We have provided the address of our website solely for the information of investors. We do not intend the reference to our website address to be an active link or to otherwise incorporate the contents of our website into this Form
10-K
Report. In addition to our website, the Securities and Exchange Commission (the “SEC”) maintains an Internet site at
www.sec.gov
that contains our reports, proxy and information statements and other information that we electronically file with, or furnish to, the SEC.
History and Organizational Structure
In the
mid-1980’s,
Donegal Mutual, as a mutual insurance company, recognized the desirability of developing additional sources of capital and surplus so it could remain competitive, expand its business and ensure its long-term viability. Accordingly, Donegal Mutual determined that the implementation of a downstream holding company structure was a viable business strategy to accomplish that objective. Thus, in 1986, Donegal Mutual formed us as a downstream holding company. After Donegal Mutual formed us, we in turn formed Atlantic States as our wholly owned property and casualty insurance company subsidiary.
 
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Table of Contents
In connection with the formation of Atlantic States and the establishment of our downstream insurance holding company system, Donegal Mutual and Atlantic States entered into a proportional reinsurance agreement, or pooling agreement. Under the pooling agreement, Donegal Mutual and Atlantic States contribute substantially all of their respective premiums, losses and loss expenses to the underwriting pool, and the underwriting pool, acting through Donegal Mutual, then allocates 80% of the pooled business to Atlantic States. Thus, Donegal Mutual and Atlantic States share the underwriting results of the pooled business in proportion to their respective participation in the underwriting pool.
Donegal Mutual and our insurance subsidiaries share a combined business plan to enhance market penetration and underwriting profitability objectives. We believe Donegal Mutual’s majority interest in the combined voting power of our Class A common stock and of our Class B common stock fosters our ability to implement our business philosophies, enjoy management continuity, maintain superior employee relations and provide a stable environment within which we can grow our businesses.
The products Donegal Mutual and our insurance subsidiaries offer are generally complementary, which permits the Donegal Insurance Group to offer a broad range of products in a given market and to expand the Donegal Insurance Group’s ability to service an entire personal lines or commercial lines account. Distinctions within the products Donegal Mutual and our insurance subsidiaries offer generally relate to specific risk profiles within similar classes of business, such as preferred tier products versus standard tier products. Donegal Mutual and we do not allocate all of the standard risk gradients to one company. As a result, the underwriting profitability of the business the individual companies write directly will vary. However, the underwriting pool homogenizes the risk characteristics of all business that Donegal Mutual and Atlantic States write directly. The business Atlantic States derives from the underwriting pool represents a significant percentage of our total consolidated revenues.
As the capital of Atlantic States and our other insurance subsidiaries has increased, the underwriting capacity of our insurance subsidiaries has increased proportionately. The size of the underwriting pool has also increased substantially. Therefore, as we originally planned in the
mid-1980s,
Atlantic States has successfully raised the capital necessary to support the growth of its direct business as well as to accept increases in its allocation of business from the underwriting pool. The portion of the underwriting pool allocated to Atlantic States has increased from an initial allocation of 35% in 1986 to an 80% allocation since March 1, 2008. We do not anticipate any further change in the pooling agreement between Atlantic States and Donegal Mutual, including any change in the percentage participation of Atlantic States in the underwriting pool.
In addition to Atlantic States, our insurance subsidiaries are Southern Insurance Company of Virginia, or Southern, The Peninsula Insurance Company and its wholly owned subsidiary, Peninsula Indemnity Company, or collectively, Peninsula, and Michigan Insurance Company, or MICO. Donegal Mutual has a 100% quota-share reinsurance agreement with Southern Mutual Insurance Company, or Southern Mutual, and Donegal Mutual places its assumed business from Southern Mutual into the underwriting pool. Donegal Mutual wholly owns and has a 100% quota-share reinsurance agreement with the Mountain States insurance subsidiaries. Beginning with policies effective in 2021, Donegal Mutual places its assumed business from Mountain States insurance subsidiaries into the underwriting pool.
 
-3-

Table of Contents
The following chart depicts our organizational structure, including all of our property and casualty insurance subsidiaries and affiliates:
 

 
(1)
Because of the different relative voting power of our Class A common stock and our Class B common stock, our public stockholders hold approximately 29% of the combined voting power of our Class A common stock and our Class B common stock and Donegal Mutual holds approximately 71% of the combined voting power of our Class A common stock and our Class B common stock.
 
-4-

Table of Contents
Relationship with Donegal Mutual
Donegal Mutual provides facilities, personnel and other services to us and our insurance subsidiaries. Donegal Mutual allocates certain related expenses to Atlantic States in proportion to its participation in the underwriting pool. Our insurance subsidiaries other than Atlantic States reimburse Donegal Mutual for their respective personnel costs and bear their proportionate share of information services costs based on each subsidiaries’ respective percentage of the total net premiums written of the Donegal Insurance Group. Charges for these services to Atlantic States and our other insurance subsidiaries totaled $153.9 million, $134.1 million and $126.2 million for 2020, 2019 and 2018, respectively.
Donegal Mutual is the employer of record for all personnel who provide services for our insurance subsidiaries. Donegal Mutual strives to maintain a culture that is based on integrity and respect, with an environment designed to facilitate excellent service to the agents and customers of Donegal Mutual and our insurance subsidiaries. At December 31, 2020, Donegal Mutual had 879 employees, of which 519 were based in its Marietta, Pennsylvania headquarters and 360 were based in regional offices or were permanent remote employees. There were 866 full-time employees and 13 part-time employees. Since March 2020, approximately 90% of Donegal Mutual’s employees have been working remotely from their homes due to health and safety concerns related to the
COVID-19
pandemic. Donegal Mutual will continue to evaluate developments related to the pandemic to determine if and when it is safe for employees to return to its headquarters and regional offices. Donegal Mutual provides employee compensation that is competitive and consistent with an employee’s position, knowledge, experience and skill level. Donegal Mutual provides annual wage increases that are based on merit. Donegal Mutual provides an annual cash incentive plan for all of its employees that provides an opportunity for Donegal Mutual’s employees to earn a bonus as a percentage of their annual wages that varies based on the level of underwriting profit Donegal Insurance Group achieves for a calendar year. In addition, Donegal Mutual provides to its full-time employees a comprehensive employee benefits program, including medical, dental and vision insurance, paid time off, and a 401(k) retirement plan that includes company matching provisions. Donegal Mutual also provides substantial training, development and wellness programs and resources to its employees.
Our insurance subsidiaries have various reinsurance arrangements with Donegal Mutual. These agreements include:
 
   
a catastrophe reinsurance agreement with Atlantic States, MICO, Peninsula and Southern pursuant to which Donegal Mutual provides coverage for losses related to any catastrophic occurrence over a set retention of $2.0 million for each participating insurance subsidiary, with a combined retention of $5.0 million for a catastrophe involving a combination of participating insurance subsidiaries, up to the amount Donegal Mutual and our insurance subsidiaries retain under catastrophe reinsurance agreements with unaffiliated reinsurers; and
 
   
quota-share reinsurance agreements with MICO and Peninsula.
The purpose of the catastrophe reinsurance agreement is to lessen the effects of an accumulation of losses arising from one event to levels that are appropriate given each subsidiary’s size, underwriting profile and surplus.
The purpose of the quota-share reinsurance agreement with Peninsula is to transfer to Donegal Mutual 100% of the premiums and losses related to the workers’ compensation product line of Peninsula in certain states, which provides the availability of an additional workers’ compensation tier for Donegal Mutual’s commercial accounts. Donegal Mutual places its assumed business from Peninsula into the underwriting pool.
The purpose of the quota-share reinsurance agreement with MICO is to transfer to Donegal Mutual 25% of the premiums and losses related to MICO’s business. Donegal Mutual places its assumed business from MICO into the underwriting pool.
We and Donegal Mutual have maintained a coordinating committee since our formation in 1986. The coordinating committee consists of two members of our board of directors, neither of whom is a member of Donegal Mutual’s board of directors, and two members of Donegal Mutual’s board of directors, neither of whom is a member of our board of directors. The purpose of the coordinating committee is to establish and maintain a process for an ongoing evaluation of the transactions between Donegal Mutual, our insurance subsidiaries and us. The coordinating committee considers the fairness of each intercompany transaction to Donegal Mutual and its policyholders and to us and our stockholders.
 
-5-

Table of Contents
A new agreement or any change to a previously approved agreement must receive coordinating committee approval. The approval process for a new agreement between Donegal Mutual and us or one of our insurance subsidiaries or a change in such an agreement is as follows:
 
   
both of our members on the coordinating committee must determine that the new agreement or the change in an existing agreement is fair and equitable to us and in the best interests of our stockholders;
 
   
both of Donegal Mutual’s members on the coordinating committee must determine that the new agreement or the change in an existing agreement is fair and equitable to Donegal Mutual and in the best interests of its policyholders;
 
   
our board of directors must approve the new agreement or the change in an existing agreement; and
 
   
Donegal Mutual’s board of directors must approve the new agreement or the change in an existing agreement.
The coordinating committee also meets annually to review each existing agreement between Donegal Mutual and us or our insurance subsidiaries, including all reinsurance agreements between Donegal Mutual and our insurance subsidiaries. The purpose of this annual review is to examine the results of the agreements over the past year and, in the case of reinsurance agreements, over several years and to determine if the results of the existing agreements remain fair and equitable to us and our stockholders and fair and equitable to Donegal Mutual and its policyholders or if Donegal Mutual and we should mutually agree to certain adjustments to the terms of the agreements. In the case of these reinsurance agreements, the annual adjustments typically relate to the reinsurance premiums, losses and reinstatement premiums. These agreements are ongoing in nature and will continue in effect throughout 2021 in the ordinary course of our business.
Our members on the coordinating committee, as of the date of this Form
10-K
Report, are Barry C. Huber and Richard D. Wampler, II. Donegal Mutual’s members on the coordinating committee as of such date are Michael W. Brubaker and Cyril J. Greenya. We refer to our proxy statement for our annual meeting of stockholders to be held on April 15, 2021 for further information about the members of the coordinating committee.
We believe our relationships with Donegal Mutual offer us and our insurance subsidiaries a number of competitive advantages, including the following:
 
   
enabling our stable management, the consistent underwriting discipline of our insurance subsidiaries, external growth, long-term profitability and financial strength;
 
   
creating operational and expense synergies from the combination of resources and integrated operations of Donegal Mutual and our insurance subsidiaries;
 
   
producing more stable and uniform underwriting results for our insurance subsidiaries over extended periods of time than we could achieve without our relationship with Donegal Mutual;
 
   
providing opportunities for growth because of the ability of Donegal Mutual to affiliate and enter into reinsurance agreements with, or otherwise acquire control of, mutual insurance companies and place the business it assumes into the underwriting pool; and
 
   
providing Atlantic States with a significantly larger underwriting capacity because of the underwriting pool Donegal Mutual and Atlantic States have maintained since 1986.
 
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In the first quarter of 2021, our board of directors and the board of directors of Donegal Mutual each undertook a review of the relationships between Donegal Mutual and DGI and determined that continuing the current relationships and the current corporate structure of Donegal Mutual and DGI is in the best interests of DGI and its various constituencies.
Business Strategy
Our strategy is designed to allow our insurance subsidiaries to achieve their longstanding goal of outperforming the United States property and casualty insurance industry in terms of profitability and service, thereby providing value to the policyholders of our insurance subsidiaries and, ultimately, providing value to our stockholders. The annual net premiums earned of our insurance subsidiaries have increased from $301.5 million in 2006 to $742.0 million in 2020, a compound annual growth rate of 6.6%.
The combined ratio of our insurance subsidiaries and that of the United States property and casualty insurance industry as computed using United States generally accepted accounting principles, or GAAP, and statutory accounting principles, or SAP, for the years 2016 through 2020 are shown in the following table:
 
    
2020
   
2019
   
2018
   
2017
   
2016
 
Our GAAP combined ratio
     96.0     99.5     110.1     103.0     98.1
Our SAP combined ratio
     95.4       98.7       109.4       101.7       96.8  
Industry SAP combined ratio
(1)
     99.3      
99.2

      99.6       104.0       100.9  
 
(1)
As reported (projected for 2020) by A.M. Best Company.
We and Donegal Mutual believe we can continue to expand our insurance operations over time through organic growth and acquisitions of, or affiliations with, other insurance companies. We and Donegal Mutual have enhanced the performance of companies we have acquired, while leveraging the acquired companies’ core strengths and local market knowledge to expand their operations. Our insurance subsidiaries and Donegal Mutual also seek to increase their premium base by making quality independent agency appointments, enhancing their competitive position within each agency, introducing new and enhanced insurance products and developing and maintaining automated systems to improve service, communications and efficiency.
A detailed review of our business strategies follows:
 
 
 
Achieving underwriting profitability.
Our insurance subsidiaries seek to achieve consistent underwriting profitability. Underwriting profitability is a fundamental component of our long-term financial strength because it allows our insurance subsidiaries to generate profits without relying exclusively on their investment income for profitability. Our insurance subsidiaries seek to enhance their underwriting results by:
 
   
carefully selecting the product lines they underwrite;
 
   
carefully selecting the individual risks they underwrite;
 
   
utilizing data analytics and predictive modeling tools to inform risk selection and pricing decisions;
 
   
minimizing their individual exposure to catastrophe-prone areas; and
 
   
evaluating their claims history on a regular basis to ensure the adequacy of their underwriting guidelines and product pricing.
 
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Our insurance subsidiaries have no material exposures to asbestos or environmental liabilities. Our insurance subsidiaries seek to provide more than one policy to a given personal lines or commercial lines customer because this “account selling” strategy diversifies their risk and has historically improved their underwriting results. Our insurance subsidiaries also use reinsurance to manage their exposure and limit their maximum net loss from large single risks or risks in concentrated areas.
 
   
Pursuing profitable growth by organic expansion within the traditional operating territories of our insurance subsidiaries through developing and maintaining quality agency representation.
Continued expansion of our insurance subsidiaries within their existing markets will be a key source of their continued premium growth, and maintaining an effective network of independent agencies is integral to this expansion. Our insurance subsidiaries seek to be among the top three insurers within each of the independent agencies for the lines of business our insurance subsidiaries write by providing a consistent, competitive and stable market for their products. We believe that the consistency of the product offerings of our insurance subsidiaries enables our insurance subsidiaries to compete effectively for independent agents with other insurers whose product offerings may fluctuate based on industry conditions. Our insurance subsidiaries offer a competitive compensation program to their independent agents that rewards them for producing profitable growth for our insurance subsidiaries. Our insurance subsidiaries provide their independent agents with ongoing support to enable them to better attract and service customers, including:
 
   
fully automated underwriting and policy issuance systems for commercial and personal lines of insurance;
 
   
training programs;
 
   
marketing support;
 
   
availability of a service center that provides comprehensive service for our policyholders; and
 
   
accessibility to and regular interactions with marketing and underwriting personnel and senior management of our insurance subsidiaries.
Our insurance subsidiaries appoint independent agencies with a strong underwriting and growth track record. We believe that our insurance subsidiaries will drive continued long-term growth by carefully selecting, motivating and supporting their independent agencies.
 
 
 
Acquiring property and casualty insurance companies to augment the organic growth of our insurance subsidiaries.
We have been an effective consolidator of smaller “main street” property and casualty insurance companies, and we expect to continue to acquire other insurance companies to expand our business in a given region over time.
Since 1998, we and Donegal Mutual have completed seven transactions involving acquisitions of property and casualty insurance companies or participation in the business of property and casualty insurance companies through Donegal Mutual’s entry into quota-share reinsurance agreements with them. We and Donegal Mutual intend to continue our growth by pursuing affiliations and acquisitions that meet our criteria. Our primary criteria are:
 
   
location in regions where our insurance subsidiaries and Donegal Mutual are currently conducting business or that offer an attractive opportunity to conduct profitable business;
 
   
a mix of business similar to the mix of business of our insurance subsidiaries and Donegal Mutual;
 
   
annual premium volume between $50.0 million to $100.0 million; and
 
   
fair and reasonable transaction terms.
 
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We believe that our relationship with Donegal Mutual assists us in pursuing affiliations with, and subsequent acquisitions of, mutual insurance companies because, through Donegal Mutual, we understand the concerns and issues that mutual insurance companies face. In particular, Donegal Mutual has had success affiliating with underperforming mutual insurance companies, and we have either acquired them following their conversion to a stock company or benefited from their underwriting results as a result of Donegal Mutual’s entry into a 100% quota-share reinsurance agreement with them and placement of that assumed business into the pooling agreement. We have utilized our strengths and financial position to improve the operations of those underperforming insurance companies. We evaluate a number of areas for operational synergies when considering acquisitions, including product underwriting, expenses, the cost of reinsurance and technology.
We and Donegal Mutual have the ability to employ a number of acquisition and affiliation methods. Our prior acquisitions and affiliations have taken one of the following forms:
 
   
purchase of all of the outstanding stock of a stock insurance company;
 
   
purchase of a book of business;
 
   
quota-share reinsurance transaction;
 
   
merger of a mutual company into Donegal Mutual; or
 
   
two-step
acquisition of a mutual insurance company in which:
 
   
as the first step, Donegal Mutual purchases a surplus note from the mutual insurance company, Donegal Mutual enters into a services agreement with the mutual insurance company and Donegal Mutual’s designees become a majority of the members of the board of directors of the mutual insurance company; and
 
   
as the second step, the mutual insurance company enters into a quota-share reinsurance agreement with Donegal Mutual or demutualizes, or converts, into a stock insurance company. Upon the demutualization or conversion, we purchase the surplus note from Donegal Mutual and exchange it for all of the stock of the stock insurance company resulting from the demutualization or conversion.
We believe that our ability to make direct acquisitions of stock insurance companies and to make indirect acquisitions of mutual insurance companies through a sponsored conversion or a quota-share reinsurance agreement provides us with flexibility that is a competitive advantage in making acquisitions. We also believe our historic record demonstrates our ability to acquire control of an underperforming insurance company,
re-underwrite
its book of business, reduce its cost structure and return it to sustained profitability.
While Donegal Mutual and we generally engage in preliminary discussions with potential direct or indirect acquisition candidates from time to time, neither Donegal Mutual nor we make any public disclosure regarding a proposed acquisition until Donegal Mutual or we have entered into a definitive acquisition agreement.
The following table highlights our and Donegal Mutual’s history of insurance company acquisitions and affiliations since 1998:
 
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Company Name
  
State of Domicile
  
Year Control

Acquired
  
Method of Acquisition/Affiliation
Southern Heritage Insurance Company
(1)
   Georgia    1998    Purchase of stock by us in 1998.
       
Le Mars Mutual Insurance Company of Iowa and then Le Mars Insurance Company
(1)(2)
   Iowa    2002    Surplus note investment by Donegal Mutual in 2002; demutualization in 2004; acquisition of stock by us in 2004.
       
Peninsula Insurance Group
   Maryland    2004    Purchase of stock by us in 2004.
       
Sheboygan Falls Mutual Insurance Company and then Sheboygan Falls Insurance Company
(1)(2)
   Wisconsin    2007    Contribution note investment by Donegal Mutual in 2007; demutualization in 2008; acquisition of stock by us in 2008.
       
Southern Mutual Insurance Company
(3)
   Georgia    2009    Surplus note investment by Donegal Mutual and quota-share reinsurance in 2009.
       
Michigan Insurance Company
   Michigan    2010    Purchase of stock by us and surplus note investment by Donegal Mutual in 2010.
       
Mountain States Mutual Casualty Company
(4)
   New Mexico    2017    Merger with and into Donegal Mutual in 2017.
 
  (1)
To reduce administrative and compliance costs and expenses, these subsidiaries subsequently merged into one of our existing insurance subsidiaries.
  (2)
Each of these acquisitions initially took the form of an affiliation with Donegal Mutual. Donegal Mutual provided surplus note financing to the insurance company, and, in connection with that financing, sufficient designees of Donegal Mutual were appointed so as to constitute a majority of the members of the board of directors of the insurance company. Donegal Mutual and the insurance company simultaneously entered into a services agreement whereby Donegal Mutual provided services to improve the operations of the insurance company. Once the insurance company’s results of operations improved to the satisfaction of Donegal Mutual, Donegal Mutual sponsored the demutualization of the insurance company. Upon the consummation of the demutualization, Donegal Mutual converted the surplus note to capital stock of the newly demutualized insurance company. We then purchased all of the capital stock of the insurance company from Donegal Mutual and made an additional capital contribution in cash to provide adequate surplus to support the insurance company’s planned premium growth.
  (3)
Control acquired by Donegal Mutual.
  (4)
Donegal Mutual completed the merger of Mountain States with and into Donegal Mutual effective May 25, 2017. Donegal Mutual was the surviving company in the merger, and Mountain States insurance subsidiaries became insurance subsidiaries of Donegal Mutual upon completion of the merger. Donegal Mutual also entered into a 100% quota-share reinsurance agreement with the Mountain States insurance subsidiaries on the merger date. Beginning with policies effective in 2021, Donegal Mutual places the business of the Mountain States Insurance Group into the underwriting pool.
 
   
Providing responsive and friendly customer and agent service to enable our insurance subsidiaries to attract new policyholders and retain existing policyholders.
We believe that excellent policyholder service is important in attracting new policyholders and retaining existing policyholders. Our insurance subsidiaries work closely with their independent agents to provide a consistently responsive level of claims service, underwriting and customer support. Our insurance subsidiaries seek to respond expeditiously and effectively to address customer and independent agent inquiries in a number of ways, including:
 
   
availability of a customer call center, secure website and mobile application for claims reporting;
 
   
availability of a secure website and mobile application for access to policy information and documents, payment processing and other features;
 
   
timely replies to information requests and policy submissions; and
 
   
prompt responses to, and processing of, claims.
 
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Our insurance subsidiaries periodically conduct policyholder surveys to evaluate the effectiveness of their service to policyholders. The management of our insurance subsidiaries meets on a regular basis with the personnel of the independent insurance agents our insurance subsidiaries appoint to seek service improvement recommendations, react to service issues and better understand local market conditions.
 
   
Maintaining premium rate adequacy to enhance the underwriting results of our insurance subsidiaries, while maintaining their existing book of business and preserving their ability to write new business.
Our insurance subsidiaries maintain discipline in their pricing by effecting rate increases to sustain or improve their underwriting results without unduly affecting their customer retention. In addition to appropriate pricing, our insurance subsidiaries seek to ensure that their premium rates are adequate relative to the amount of risk they insure. Our insurance subsidiaries review loss trends on a regular basis to identify changes in the frequency and severity of their claims and to assess the adequacy of their rates and underwriting standards. Our insurance subsidiaries also carefully monitor and audit the information they use to price their policies for the purpose of enabling them to receive an adequate level of premiums for the risk they assume. For example, our insurance subsidiaries audit the payroll data of their workers’ compensation customers to verify that the assumptions used to price a particular policy were accurate. By implementing appropriate rate increases and understanding the risks our insurance subsidiaries agree to insure, our insurance subsidiaries seek to achieve consistent underwriting profitability.
 
   
Focusing on expense controls and utilization of technology to increase the operating efficiency of our insurance subsidiaries.
Our insurance subsidiaries maintain stringent expense controls under direct supervision of their senior management. We centralize the processing and administrative activities of our insurance subsidiaries to realize operating synergies and better expense control. Our insurance subsidiaries utilize technology to automate much of their underwriting and to facilitate agency and policyholder communications on an efficient, timely and cost-effective basis. Our insurance subsidiaries have increased their annual premium per employee, a measure of efficiency that our insurance subsidiaries use to evaluate their operations, from approximately $470,000 in 1999 to approximately $1.1 million in 2020.
Donegal Mutual and our insurance subsidiaries strive to maintain technology comparable to that of their larger competitors. “Ease of doing business” is an increasingly important component of an insurer’s value to an independent agency. Our insurance subsidiaries provide fully automated underwriting and policy issuance systems that substantially ease data entry and facilitate the quoting and issuance of policies for the independent agents of our insurance subsidiaries. As a result, applications of the independent agents for our insurance subsidiaries can result in policy issuance without further
re-entry
of information. These systems also interface with the policy management systems of the independent agents of our insurance subsidiaries.
 
   
Maintaining a conservative investment approach.
Return on invested assets is an important element of the financial results of our insurance subsidiaries. The investment strategy of our insurance subsidiaries is to generate an appropriate amount of
after-tax
income on invested assets while limiting the potential impact of equity market volatility and minimizing credit risk through investments in high-quality securities. As a result, our insurance subsidiaries seek to invest a high percentage of their assets in diversified, highly rated and marketable fixed-maturity instruments. The fixed-maturity portfolios of our insurance subsidiaries consist of both taxable and
tax-exempt
securities. Our insurance subsidiaries maintain a portion of their portfolios in short-term securities to provide liquidity for the payment of claims and operation of their respective businesses. Our insurance subsidiaries maintain a small percentage (4.8% at December 31, 2020) of their portfolios in equity securities that have a history of paying cash dividends or that our insurance subsidiaries expect will appreciate in value over time.
 
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Competition
The property and casualty insurance industry is highly competitive on the basis of both price and service. Numerous companies compete for business in the geographic areas where our insurance subsidiaries operate. Many of these other insurance companies are substantially larger and have greater financial resources than those of our insurance subsidiaries. In addition, because our insurance subsidiaries and Donegal Mutual market their respective insurance products exclusively through independent insurance agencies, most of which represent more than one insurance company, our insurance subsidiaries face competition within agencies, as well as competition to retain qualified independent agents.
Products and Underwriting
We report the results of our insurance operations in two segments: commercial lines of insurance and personal lines of insurance. The commercial lines our insurance subsidiaries write consist primarily of commercial automobile, commercial multi-peril and workers’ compensation insurance. The personal lines our insurance subsidiaries write consist primarily of private passenger automobile and homeowners insurance. We describe these lines of insurance in greater detail below:
Commercial
 
   
Commercial automobile — policies that provide protection against liability for bodily injury and property damage arising from automobile accidents and protection against loss from damage to automobiles owned by the insured.
 
   
Commercial multi-peril — policies that provide protection to businesses against many perils, usually combining liability and physical damage coverages.
 
   
Workers’ compensation — policies employers purchase to provide benefits to employees for injuries sustained during employment. The workers’ compensation laws of each state determine the extent of the coverage we provide.
Personal
 
   
Private passenger automobile — policies that provide protection against liability for bodily injury and property damage arising from automobile accidents and protection against loss from damage to automobiles owned by the insured.
 
   
Homeowners — policies that provide coverage for damage to residences and their contents from a broad range of perils, including fire, lightning, windstorm and theft. These policies also cover liability of the insured arising from injury to other persons or their property while on the insured’s property and under other specified conditions.
In recent years, we have taken actions to shift our business mix to a higher proportion of commercial business, where we believe we have greater opportunities to achieve profitable, sustainable long-term growth. The following table sets forth the net premiums written of our insurance subsidiaries by line of insurance for the periods indicated:
 
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Year Ended December 31,
 
    
2020
   
2019
   
2018
 
(dollars in thousands)   
Amount
    
%
   
Amount
    
%
   
Amount
    
%
 
Commercial lines:
               
Automobile
   $ 135,294      18.2   $ 122,142      16.2   $ 108,123      14.5
Workers’ compensation
     109,960      14.8     113,684      15.1     109,022      14.7
Commercial multi-peril
     147,993      19.9     138,750      18.5     117,509      15.8
Other
     32,739      4.5     30,303      4.0     15,241      2.0
  
 
 
    
 
 
   
 
 
    
 
 
   
 
 
    
 
 
 
Total commercial lines
     425,986      57.4     404,879      53.8     349,895      47.0
  
 
 
    
 
 
   
 
 
    
 
 
   
 
 
    
 
 
 
Personal lines:
               
Automobile
     184,602      24.9     210,507      28.0     249,275      33.5
Homeowners
     111,886      15.1     117,118      15.5     123,782      16.6
Other
     19,666      2.6     20,097      2.7     21,064      2.9
  
 
 
    
 
 
   
 
 
    
 
 
   
 
 
    
 
 
 
Total personal lines
     316,154      42.6     347,722      46.2     394,121      53.0
  
 
 
    
 
 
   
 
 
    
 
 
   
 
 
    
 
 
 
Total business
   $ 742,140      100.0   $ 752,601      100.0   $ 744,016      100.0
  
 
 
    
 
 
   
 
 
    
 
 
   
 
 
    
 
 
 
The commercial lines and personal lines underwriting departments of our insurance subsidiaries evaluate and select those risks that they believe will enable our insurance subsidiaries to achieve an underwriting profit. The underwriting departments have significant interaction with the independent agents regarding the underwriting philosophy and the underwriting guidelines of our insurance subsidiaries. Our underwriting personnel also assist in the development of quality products at competitive prices to promote growth and profitability.
We formally established an enterprise analytics function in early 2019. Our enterprise analytics team is responsible for core functions of ratemaking, predictive analytics, data governance and business intelligence. Those responsibilities include the development and expansion of risk-based pricing segmentation, analytical innovation, predictive modeling solutions, formal data strategies, performance monitoring and enhanced reporting mechanisms.
In order to achieve underwriting profitability on a consistent basis, our insurance subsidiaries:
 
   
assess and select primarily standard and preferred risks;
 
   
adhere to disciplined underwriting guidelines; and
 
   
utilize various types of risk management and loss control services.
Our insurance subsidiaries also review their existing policies and accounts to determine whether those risks continue to meet their underwriting guidelines. If a given policy or account no longer meets those underwriting guidelines, our insurance subsidiaries will take appropriate action regarding that policy or account, including raising premium rates or
non-renewing
the policy to the extent applicable law permits.
As part of the effort of our insurance subsidiaries to maintain acceptable underwriting results, they conduct annual reviews of agencies that have failed to meet their underwriting profitability criteria. The review process includes an analysis of the underwriting and
re-underwriting
practices of the agency, the completeness and accuracy of the applications the agency submits, the adequacy of the training of the agency’s staff and the agency’s record of adherence to the underwriting guidelines and service standards of our insurance subsidiaries. Based on the results of this review process, the marketing and underwriting personnel of our insurance subsidiaries develop, together with the agency, a plan to improve its underwriting profitability. Our insurance subsidiaries monitor the agency’s compliance with the plan and take other measures as required in the judgment of our insurance subsidiaries, including the termination to the extent applicable law permits of agencies that are unable to achieve acceptable underwriting profitability.
 
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Distribution
Our insurance subsidiaries market their products primarily in the
Mid-Atlantic,
Midwestern, New England, Southern and Southwestern regions through approximately 2,300 independent insurance agencies. At December 31, 2020, the Donegal Insurance Group actively wrote business in
24 states (Alabama, Colorado, Delaware, Georgia, Illinois, Indiana, Iowa, Maine, Maryland, Michigan, Nebraska, New Hampshire, New Mexico, North Carolina, Ohio, Pennsylvania, South Carolina, South Dakota, Tennessee, Texas, Utah, Vermont, Virginia, and Wisconsin). Prior to 2021, Donegal Mutual excluded the business it wrote directly and assumed from the Mountain States insurance subsidiaries in four Southwestern states (Colorado, New Mexico, Texas and Utah) from the pooling agreement between Donegal Mutual and Atlantic States. As a result, this business had no impact on our results of operations through December 31, 2020. We believe the relationships of our insurance subsidiaries with their independent agents are valuable in identifying, obtaining and retaining profitable business. Our insurance subsidiaries maintain a stringent agency selection procedure that emphasizes appointing agencies with proven marketing strategies for the development of profitable business, and our insurance subsidiaries only appoint agencies with a strong underwriting history and potential growth capabilities. Our insurance subsidiaries also regularly evaluate the independent agencies that represent them based on their profitability and performance in relation to the objectives of our insurance subsidiaries. Our insurance subsidiaries seek to be among the top three insurers within each of their agencies for the lines of business our insurance subsidiaries write.
The following table sets forth the percentage of direct premiums our insurance subsidiaries write, including 80% of the direct premiums Donegal Mutual and Atlantic States include in the underwriting pool, in each of the states where they conducted a significant portion of their business in 2020:
 
Pennsylvania
     34.7
Michigan
     15.2
Maryland
     9.3
Georgia
     7.2
Virginia
     6.9
Delaware
     6.5
Wisconsin
     3.8
Ohio
     3.2
Iowa
     2.3
Indiana
     2.2
Tennessee
     2.1
Other
     6.6
  
 
 
 
Total
     100.0
  
 
 
 
Our insurance subsidiaries employ a number of policies and procedures that we believe enable them to attract, retain and motivate their independent agents. We believe that the consistency of the product offerings of our insurance subsidiaries enables our insurance subsidiaries to compete effectively for independent agents with other insurers whose product offerings may fluctuate based upon industry conditions. Our insurance subsidiaries have a competitive compensation program for their independent agents that includes base commissions, growth incentive plans and a profit-sharing plan, consistent with applicable state laws and regulations, under which the independent agents may earn additional commissions based upon the volume of premiums produced and the profitability of the business our insurance subsidiaries receive from that agency.
 
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Our insurance subsidiaries encourage their independent agents to focus on “account selling,” or serving all of a particular insured’s property and casualty insurance needs, which our insurance subsidiaries believe generally results in more favorable loss experience than covering a single risk for an individual insured.
Technology
Donegal Mutual owns the technology systems our insurance subsidiaries use. The technology systems consist primarily of an integrated central processing computer system, a series of server-based computer networks and various communication systems that allow the home office and branch offices of Donegal Mutual and our insurance subsidiaries to utilize the same systems for the processing of business. Donegal Mutual maintains backup facilities and systems at the office of one of our insurance subsidiaries and tests these backup facilities and systems on a regular basis. Our insurance subsidiaries bear their proportionate share of information services expenses based on their respective percentage of the total net premiums written of the Donegal Insurance Group during the preceding calendar year.
The business strategy of our insurance subsidiaries depends on the use, development and implementation of integrated technology systems. These systems enable our insurance subsidiaries to provide quality service to agents and policyholders by processing business in a timely and efficient manner, communicating and sharing data with agents, providing a variety of methods for the payment of premiums and allowing for the accumulation and analysis of information for the management of our insurance subsidiaries.
We believe the availability and use of these technology systems has resulted in improved service to agents and policyholders, increased efficiencies in processing the business of our insurance subsidiaries and lower operating costs. Key components of these integrated technology systems are the agency interface system, the automated underwriting and policy issuance systems, a claims processing system and an imaging system. The agency interface system provides our insurance subsidiaries with a high level of data sharing both to and from agents’ systems and also provides agents with an integrated means of processing new business. The automated underwriting and policy issuance systems provide agents with the ability to generate underwritten quotes and automatically issue policies that meet the underwriting guidelines of our insurance subsidiaries with limited or no intervention by their personnel. The claims processing system allows our insurance subsidiaries to process claims efficiently and in an automated environment. The imaging system eliminates the need to handle paper files, while providing greater access to the same information by a variety of personnel. We believe our agency-facing technology systems compare favorably to those of many national property and casualty insurance carriers in terms of quality and service levels. In 2018, Donegal Mutual initiated a multi-year systems modernization project to replace its remaining legacy systems, streamline our business processes and workflows and enhance our data analytics and modeling capabilities. In February 2020, Donegal Mutual implemented the first release of new systems related to the project, and our insurance subsidiaries began to issue workers’ compensation policies from the new systems in the second quarter of 2020. Over the next several years, Donegal Mutual expects to implement new systems for the remaining lines of business Donegal Mutual and our insurance subsidiaries offer currently. The next release of new systems related to the project will include three personal lines of business and is scheduled for phased implementation beginning in the third quarter of 2021.
Claims
The management of claims is a critical component of the philosophy of our insurance subsidiaries to achieve underwriting profitability on a consistent basis and is fundamental to the successful operations of our insurance subsidiaries and their dedication to excellent service. Our senior claims management oversees the claims processing units of each of our insurance subsidiaries to assure consistency in the claims settlement process. The field office staff of our insurance subsidiaries receives support from home office technical, litigation, material damage, subrogation and medical audit personnel.
 
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The claims departments of our insurance subsidiaries rigorously manage claims to assure that they settle legitimate claims quickly and fairly and that they identify questionable claims for defense. In the majority of cases, the personnel of our insurance subsidiaries, who have significant experience in the property and casualty insurance industry and know the service philosophy of our insurance subsidiaries, adjust claims. Our insurance subsidiaries provide various means of claims reporting on a
24-hours
a day, seven-days a week basis, including toll-free numbers and electronic reporting through our website and mobile application. Our insurance subsidiaries strive to respond to notifications of claims promptly, generally within the day reported. Our insurance subsidiaries believe that, by responding promptly to claims, they provide quality customer service and minimize the ultimate cost of the claims. Our insurance subsidiaries engage independent adjusters as needed to handle claims in areas in which the volume of claims is not sufficient to justify the hiring of internal claims adjusters by our insurance subsidiaries. Our insurance subsidiaries also employ private adjusters and investigators, structural experts and outside legal counsel to supplement their internal staff and to assist in the investigation of claims. Our insurance subsidiaries have a special investigative unit primarily staffed by former law enforcement officers that attempts to identify and prevent fraud and abuse and to investigate questionable claims.
The management of the claims departments of our insurance subsidiaries develops and implements policies and procedures for the establishment of adequate claim reserves. Our insurance subsidiaries employ an actuarial staff that regularly reviews their reserves for incurred but not reported claims. The management and staff of the claims departments resolve policy coverage issues, manage and process reinsurance recoveries and handle salvage and subrogation matters. The litigation and personal injury sections of our insurance subsidiaries manage all claims litigation. Branch office claims above certain thresholds require home office review and settlement authorization. Our insurance subsidiaries provide their claims adjusters reserving and settlement authority based upon their experience and demonstrated abilities. Larger or more complicated claims require consultation and approval of senior claims department management.
Liabilities for Losses and Loss Expenses
Liabilities for losses and loss expenses are estimates at a given point in time of the amounts an insurer expects to pay with respect to incurred policyholder claims based on facts and circumstances the insurer knows at that point in time. For example, legislative, judicial and regulatory actions may expand coverage definitions, retroactively mandate coverage or otherwise require our insurance subsidiaries to pay losses for damages that their policies explicitly excluded or did not intend to cover. At the time of establishing its estimates, an insurer recognizes that its ultimate liability for losses and loss expenses will exceed or be less than such estimates. Our insurance subsidiaries base their estimates of liabilities for losses and loss expenses on assumptions as to future loss trends, expected claims severity, judicial theories of liability and other factors. However, during the loss adjustment period, our insurance subsidiaries may learn additional facts regarding individual claims, and, consequently, it often becomes necessary for our insurance subsidiaries to refine and adjust their estimates for these liabilities. We reflect any adjustments to the liabilities for losses and loss expenses of our insurance subsidiaries in our consolidated results of operations in the period in which our insurance subsidiaries make adjustments to their estimates.
Our insurance subsidiaries maintain liabilities for the payment of losses and loss expenses with respect to both reported and unreported claims. Our insurance subsidiaries establish these liabilities for the purpose of covering the ultimate costs of settling all losses, including investigation and litigation costs. Our insurance subsidiaries base the amount of their liability for reported losses primarily upon a
case-by-case
evaluation of the type of risk involved, knowledge of the circumstances surrounding each claim and the insurance policy provisions relating to the type of loss the policyholder incurred. Our insurance subsidiaries determine the amount of their liability for unreported claims and loss expenses on the basis of historical information by line of insurance. Our insurance subsidiaries account for inflation in the reserving function through analysis of costs and trends and reviews of historical reserving results. Our insurance subsidiaries monitor their liabilities closely and recompute them periodically using new information on reported claims and a variety of statistical techniques. Our insurance subsidiaries do not discount their liabilities for losses and loss expenses.
Reserve estimates can change over time because of unexpected changes in assumptions related to our insurance subsidiaries’ external environment and, to a lesser extent, assumptions related to our insurance subsidiaries’ internal operations. For example, our insurance subsidiaries have experienced an increase in claims severity and a lengthening of the claim
 
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settlement periods on bodily injury claims during the past several years. In addition, the
COVID-19
pandemic and related government mandates and restrictions resulted in various changes from historical claims reporting and settlement trends during 2020. These trend changes give rise to greater uncertainty as to the pattern of future loss settlements on bodily injury claims. Related uncertainties regarding future trends include social inflation, the rate of plaintiff attorney involvement in claims and the cost of medical technologies and procedures. Assumptions related to our insurance subsidiaries’ external environment include the absence of significant changes in tort law and the legal environment that increase liability exposure, consistency in judicial interpretations of insurance coverage and policy provisions and the rate of loss cost inflation. Internal assumptions include consistency in the recording of premium and loss statistics, consistency in the recording of claims, payment and case reserving methodology, accurate measurement of the impact of rate changes and changes in policy provisions, consistency in the quality and characteristics of business written within a given line of business and consistency in reinsurance coverage and collectability of reinsured losses, among other items. To the extent our insurance subsidiaries determine that underlying factors impacting their assumptions have changed, our insurance subsidiaries make adjustments in their reserves that they consider appropriate for such changes. Accordingly, our insurance subsidiaries’ ultimate liability for unpaid losses and loss expenses will likely differ from the amount recorded at December 31, 2020. For every 1% change in our insurance subsidiaries’ loss and loss expense reserves, net of reinsurance recoverable, the effect on our
pre-tax
results of operations would be approximately $5.6 million.
The establishment of appropriate liabilities is an inherently uncertain process and we can provide no assurance that our insurance subsidiaries’ ultimate liability will not exceed our insurance subsidiaries’ loss and loss expense reserves and have an adverse effect on our results of operations and financial condition. Furthermore, we cannot predict the timing, frequency and extent of adjustments to our insurance subsidiaries’ estimated future liabilities, because the historical conditions and events that serve as a basis for our insurance subsidiaries’ estimates of ultimate claim costs may change. As is the case for substantially all property and casualty insurance companies, our insurance subsidiaries have found it necessary in the past to increase their estimated future liabilities for losses and loss expenses in certain periods and, in other periods, their estimated future liabilities for losses and loss expenses have exceeded their actual liabilities for losses and loss expenses. Changes in our insurance subsidiaries’ estimates of their liability for losses and loss expenses generally reflect actual payments and their evaluation of information received subsequent to the prior reporting period. Our insurance subsidiaries recognized a decrease in their liability for losses and loss expenses of prior years of $12.9 million in each of 2020 and 2019. Our insurance subsidiaries recognized an increase in their liability for losses and loss expenses of prior years of $35.6 million in 2018. Our insurance subsidiaries made no significant changes in their reserving philosophy or claims management personnel, and they have made no significant offsetting changes in estimates that increased or decreased their loss and loss expense reserves in those years. The 2020 development represented 2.6% of the December 31, 2019 net carried reserves and resulted primarily from lower-than-expected severity in the workers’ compensation and personal automobile lines of business, partially offset by higher-than-expected severity in the commercial automobile and commercial multi-peril lines of business, for accident years prior to 2020. The majority of the 2020 development related to decreases in the liability for losses and loss expenses of prior years for Atlantic States and MICO. The 2019 development represented 2.7% of the December 31, 2018 net carried reserves and resulted primarily from lower-than-expected severity in the workers’ compensation line of business, partially offset by higher-than-expected severity in the commercial automobile and commercial multi-peril lines of business, for accident years prior to 2019. The majority of the 2019 development related to decreases in the liability for losses and loss expenses of prior years for Atlantic States and MICO. The 2018 development represented 9.3% of the December 31, 2017 net carried reserves and resulted primarily from higher-than-expected severity in the commercial multi-peril, personal automobile and commercial automobile lines of business, offset by lower-than-expected severity in the workers’ compensation line of business, for accident years prior to 2018. The majority of the 2018 development related to increases in the liability for losses and loss expenses of prior years for Atlantic States and Southern. During 2018, our insurance subsidiaries received new information on previously-reported commercial automobile and personal automobile claims that led our insurance subsidiaries to conclude that their prior actuarial assumptions did not fully anticipate recent changes in severity and reporting trends. As a result, our insurance subsidiaries’ actuaries increased their projections of the ultimate cost of our insurance subsidiaries’ prior-year personal automobile and commercial automobile losses, and our insurance subsidiaries added $17.7 million to their reserves for personal automobile and $20.8 million to their reserves for commercial automobile for accident years prior to 2018.
Excluding the impact of severe weather events and the
COVID-19
pandemic, our insurance subsidiaries have noted stable amounts in the number of claims incurred and the number of claims outstanding at period ends relative to their premium base in
 
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recent years across most of their lines of business. However, the amount of the average claim outstanding has increased gradually over the past several years due to various factors such as rising medical loss costs and increased litigation trends. We have also experienced a general slowing of settlement rates in litigated claims. Our insurance subsidiaries could have to make further adjustments to their estimates in the future. However, on the basis of our insurance subsidiaries’ internal procedures, which analyze, among other things, their prior assumptions, their experience with similar cases and historical trends such as reserving patterns, loss payments, pending levels of unpaid claims and product mix, as well as court decisions, economic conditions and public attitudes, we believe that our insurance subsidiaries have made adequate provision for their liability for losses and loss expenses.
Atlantic States’ participation in the underwriting pool with Donegal Mutual exposes Atlantic States to adverse loss development on the business that Donegal Mutual contributes to the underwriting pool. However, pooled business represents the predominant percentage of the net underwriting activity of both companies, and Donegal Mutual and Atlantic States share proportionately any adverse risk development relating to the pooled business. The business in the underwriting pool is homogeneous, and each company has a
pro-rata
share of the entire underwriting pool. Since the predominant percentage of the business of Atlantic States and Donegal Mutual is pooled and the results shared by each company according to its participation level under the terms of the pooling agreement, the intent of the underwriting pool is to produce a more uniform and stable underwriting result from year to year for each company than either would experience individually and to spread the risk of loss between the companies.
Donegal Mutual and our insurance subsidiaries operate together as the Donegal Insurance Group and share a combined business plan designed to achieve market penetration and underwriting profitability objectives. The products our insurance subsidiaries and Donegal Mutual offer are generally complementary, thereby allowing Donegal Insurance Group to offer a broader range of products to a given market and to expand Donegal Insurance Group’s ability to service an entire personal lines or commercial lines account. Distinctions within the products of Donegal Mutual and our insurance subsidiaries generally relate to specific risk profiles targeted within similar classes of business, such as preferred tier products compared to standard tier products, but we do not allocate all of the standard risk gradients to one company. Therefore, the underwriting profitability of the business the individual companies write directly will vary.
Differences between liabilities reported in our financial statements prepared on a GAAP basis and our insurance subsidiaries’ financial statements prepared on a SAP basis result from anticipating salvage and subrogation recoveries for GAAP but not for SAP. These differences amounted to $21.0 million, $20.2 million and $20.0 million at December 31, 2020, 2019 and 2018, respectively.
 
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The following table sets forth a reconciliation of the beginning and ending GAAP net liability of our insurance subsidiaries for unpaid losses and loss expenses for the periods indicated:
 
    
Year Ended December 31,
 
(in thousands)   
2020
    
2019
    
2018
 
Gross liability for unpaid losses and loss expenses at beginning of year
   $ 869,674    $ 814,665    $ 676,672
Less reinsurance recoverable
     362,768      339,267      293,271
  
 
 
    
 
 
    
 
 
 
Net liability for unpaid losses and loss expenses at beginning of year
     506,906      475,398      383,401
  
 
 
    
 
 
    
 
 
 
Provision for net losses and loss expenses for claims incurred in the current year
     472,709      519,320      540,827
Change in provision for estimated net losses and loss expenses for claims incurred in prior years
     (12,945      (12,932      35,631
  
 
 
    
 
 
    
 
 
 
Total incurred
     459,764      506,388      576,458
  
 
 
    
 
 
    
 
 
 
Net losses and loss expense payments for claims incurred during:
        
The current year
     236,984      278,924      308,578
Prior years
     172,497      195,956      175,883
  
 
 
    
 
 
    
 
 
 
Total paid
     409,481      474,880      484,461
  
 
 
    
 
 
    
 
 
 
Net liability for unpaid losses and loss expenses at end of year
     557,189      506,906      475,398
Plus reinsurance recoverable
     404,818      362,768      339,267
  
 
 
    
 
 
    
 
 
 
Gross liability for unpaid losses and loss expenses at end of year
   $ 962,007    $ 869,674    $ 814,665
  
 
 
    
 
 
    
 
 
 
The following table sets forth the development of the liability for net unpaid losses and loss expenses of our insurance subsidiaries from 2010 to 2020. Loss data in the table includes business Atlantic States received from the underwriting pool.
“Net liability at end of year for unpaid losses and loss expenses” sets forth the estimated liability for net unpaid losses and loss expenses recorded at the balance sheet date for each of the indicated years. This liability represents the estimated amount of net losses and loss expenses for claims arising in the current and all prior years that are unpaid at the balance sheet date, including losses incurred but not reported.
The “Net liability
re-estimated
as of” portion of the table shows the
re-estimated
amount of the previously recorded liability based on experience for each succeeding year. The estimate increases or decreases as payments are made and more information becomes known about the severity of the remaining unpaid claims. For example, the 2010 liability has developed a deficiency after ten years because we expect the
re-estimated
net losses and loss expenses to be $989,000 more than the estimated liability we initially established in 2010 of $217.9 million.
The “Cumulative deficiency (excess)” shows the cumulative deficiency or excess at December 31, 2020 of the liability estimate shown on the top line of the corresponding column. A deficiency in liability means that the liability established in prior years was less than the amount of actual payments and currently
re-estimated
remaining unpaid liability. An excess in liability means that the liability established in prior years exceeded the amount of actual payments and currently
re-estimated
unpaid liability remaining.
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 2010 column indicates that at December 31, 2020 payments equal to $213.3 million of the currently
re-estimated
ultimate liability for net losses and loss expenses of $218.9 million had been made.
 
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Year Ended December 31,
 
(in thousands)
  
2010
    
2011
    
2012
    
2013
    
2014
    
2015
    
2016
    
2017
    
2018
   
2019
   
2020
 
Net liability at end of year for unpaid losses and loss expenses
   $ 217,896    $ 243,015    $ 250,936    $ 265,605    $ 292,301    $ 322,054    $ 347,518    $ 383,401    $ 475,398   $ 506,906   $ 557,189
Net liability
re-estimated
as of:
                              
One year later
     217,728      250,611      261,294      280,074      299,501      325,043      354,139      419,032      462,466     493,961  
Two years later
     217,355      255,612      268,877      281,782      299,919      329,115      375,741      413,535      450,862    
Three years later
     218,449      257,349      270,473      281,666      304,855      338,118      376,060      404,902       
Four years later
     218,514      256,460      270,794      284,429      307,840      339,228      372,230          
Five years later
     218,202      255,660      271,954      285,130      310,354      338,020             
Six years later
     217,430      256,388      272,553      287,439      310,380                
Seven years later
     217,703      257,132      274,111      287,063                   
Eight years later
     218,173      257,935      274,472                      
Nine years later
     218,603      258,272                         
Ten years later
     218,885                            
Cumulative deficiency (excess)
     989      15,257      23,536      21,458      18,079      15,966      24,712      21,501      (24,536     (12,945  
  
 
 
    
 
 
    
 
 
    
 
 
    
 
 
    
 
 
    
 
 
    
 
 
    
 
 
   
 
 
   
Cumulative amount of liability paid through:
                              
One year later
   $ 96,202    $ 119,074    $ 126,677    $ 131,766    $ 131,779    $ 149,746    $ 163,005    $ 175,883    $ 195,956   $ 172,497  
Two years later
     148,140      181,288      191,208      194,169      206,637      228,506      250,678      276,331      275,993    
Three years later
     178,073      217,138      225,956      233,371      251,654      274,235      306,338      317,447       
Four years later
     195,948      234,392      245,094      255,451      274,248      300,715      324,628          
Five years later
     203,633      241,538      254,502      265,841      287,178      309,630             
Six years later
     206,731      245,774      259,437      272,431      292,327                
Seven years later
     209,527      248,195      263,386      275,357                   
Eight years later
     210,982      250,272      265,026                      
Nine years later
     212,340      251,696                         
Ten years later
     213,333                            
 
    
Year Ended December 31,
 
(in thousands)
  
2012
    
2013
    
2014
    
2015
    
2016
    
2017
    
2018
   
2019
   
2020
 
Gross liability at end of year
   $ 458,827    $ 495,619    $ 538,258    $ 578,205    $ 606,665    $ 676,672    $ 814,665   $ 869,674   $ 962,007
Reinsurance recoverable
     207,891      230,014      245,957      256,151      259,147      293,271      339,266     362,768     404,818
Net liability at end of year
     250,936      265,605      292,301      322,054      347,518      383,401      475,398     506,906     557,189
Gross
re-estimated
liability
     492,274      519,465      560,090      592,023      629,162      692,908      782,595     838,833  
Re-estimated
recoverable
     217,802      232,402      249,710      254,003      256,932      288,006      331,733     344,872  
Net
re-estimated
liability
     274,472      287,063      310,380      338,020      372,230      404,902      450,862     493,961  
Gross cumulative deficiency (excess)
     33,447      23,846      21,832      13,818      22,497      16,236      (32,070     (30,841  
Third-Party Reinsurance
Our insurance subsidiaries and Donegal Mutual purchase certain third-party reinsurance on a combined basis. Our insurance subsidiaries use several different reinsurers, all of which, consistent with the requirements of our insurance subsidiaries and Donegal Mutual, have an A.M. Best rating of
A-
(Excellent) or better or, with respect to foreign reinsurers, have a financial condition that, in the opinion of our management, is equivalent to a company with at least an
A-
(Excellent) rating from A.M. Best.
 
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The external reinsurance our insurance subsidiaries and Donegal Mutual purchased for 2020 included:
 
   
excess of loss reinsurance, under which the losses of Donegal Mutual and our insurance subsidiaries were automatically reinsured, through a series of contracts, over a set retention of $2.0 million; and
 
   
catastrophe reinsurance, under which Donegal Mutual and our insurance subsidiaries recovered, through a series of reinsurance agreements, 100% of an accumulation of many losses resulting from a single event, including natural disasters, over a set retention of $15.0 million up to aggregate losses of $185.0 million per occurrence.
For property insurance, our insurance subsidiaries had excess of loss treaties that provided for coverage of $33.0 million per loss over a set retention of $2.0 million. For liability insurance, our insurance subsidiaries had excess of loss treaties that provided for coverage of $58.0 million per occurrence over a set retention of $2.0 million. For workers’ compensation insurance, our insurance subsidiaries had excess of loss treaties that provided for coverage of $13.0 million on any one life over a set retention of $2.0 million.
Our insurance subsidiaries and Donegal Mutual also purchased facultative reinsurance to cover certain exposures, including property exposures that exceeded the limits provided by their respective treaty reinsurance.
Investments
At December 31, 2020, 99.8% of all debt securities our insurance subsidiaries held had an investment-grade rating. The investment portfolios of our insurance subsidiaries did not contain any mortgage loans or any
non-performing
assets at December 31, 2020.
 
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The following table shows the composition of the debt securities (at carrying value) in the investment portfolios of our insurance subsidiaries, excluding short-term investments, by rating at December 31, 2020:
 
(dollars in thousands)
  
December 31, 2020
 
Rating
(1)
  
Amount
    
Percent
 
U.S. Treasury and U.S. agency securities
(2)
   $ 374,483      32.8
Aaa or AAA
     23,734      2.1
Aa or AA
     315,352      27.6
A
     211,456      18.5
BBB
     214,719      18.8
B
     2,001      0.2
  
 
 
    
 
 
 
Total
   $ 1,141,745      100.0
  
 
 
    
 
 
 
 
(1)
Ratings assigned by Moody’s Investors Services, Inc. or Standard & Poor’s Corporation.
(2)
Includes mortgage-backed securities of $249.2 million.
 
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Our insurance subsidiaries invest in both taxable and
tax-exempt
securities as part of their strategy to maximize
after-tax
income.
Tax-exempt
securities made up approximately
22.9%, 18.7% and 19.7% of the fixed-maturity securities in the combined investment portfolios of our insurance subsidiaries at December 31, 2020, 2019 and 2018, respectively.
 
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The following table shows the classification of our investments and the investments of our insurance subsidiaries at December 31, 2020, 2019 and 2018 (at carrying value):
 
    
December 31,
 
    
2020
   
2019
   
2018
 
(dollars in thousands)   
Amount
    
Percent of
Total
   
Amount
    
Percent of
Total
   
Amount
    
Percent of
Total
 
Fixed maturities
(1)
:
               
Held to maturity:
               
U.S. Treasury securities and obligations of U.S. government corporations and agencies
   $ 77,435      6.3   $ 82,916      7.5   $ 76,223      7.4
Obligations of states and political subdivisions
     312,319      25.6     204,634      18.4     159,292      15.5
Corporate securities
     173,270      14.2     156,399      14.1     127,010      12.3
Mortgage-backed securities
     23,585      1.9     32,145      2.9     40,274      3.9
  
 
 
    
 
 
   
 
 
    
 
 
   
 
 
    
 
 
 
Total held to maturity
     586,609      48.0     476,094      42.9     402,799      39.1
  
 
 
    
 
 
   
 
 
    
 
 
   
 
 
    
 
 
 
Available for sale:
               
U.S. Treasury securities and obligations of U.S. government corporations and agencies
     47,815      3.9     19,364      1.7     44,210      4.3
Obligations of states and political subdivisions
     68,965      5.7     56,796      5.1     75,216      7.3
Corporate securities
     212,708      17.4     159,244      14.3     137,833      13.4
Mortgage-backed securities
     225,648      18.5     329,548      29.7     269,299      26.1
  
 
 
    
 
 
   
 
 
    
 
 
   
 
 
    
 
 
 
Total available for sale
     555,136      45.5     564,952      50.8     526,558      51.1
  
 
 
    
 
 
   
 
 
    
 
 
   
 
 
    
 
 
 
Total fixed maturities
     1,141,745      93.5     1,041,046      93.7     929,357      90.2
Equity securities
(2)
     58,556      4.8     55,477      5.0     43,667      4.2
Investment in affiliate
(3)
     —          —         —          —         41,026      4.0
Short-term investments
(4)
     20,901      1.7     14,030      1.3     16,749      1.6
  
 
 
    
 
 
   
 
 
    
 
 
   
 
 
    
 
 
 
Total investments
   $ 1,221,202      100.0   $ 1,110,553      100.0   $ 1,030,799      100.0
  
 
 
    
 
 
   
 
 
    
 
 
   
 
 
    
 
 
 
 
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(1)
We refer to Notes 1 and 4 to our Consolidated Financial Statements. We value those fixed maturities we classify as held to maturity at amortized cost; we value those fixed maturities we classify as available for sale at fair value. The total fair value of fixed maturities we classified as held to maturity was $632.6 million at December 31, 2020, $500.3 million at December 31, 2019 and $405.0 million at December 31, 2018. The amortized cost of fixed maturities we classified as available for sale was $535.0 million at December 31, 2020, $556.8 million at December 31, 2019 and $535.1 million at December 31, 2018.
(2)
We value equity securities at fair value. The total cost of equity securities was $42.4 million at December 31, 2020, $43.4 million at December 31, 2019 and $40.9 million at December 31, 2018.
(3)
We valued our investment in our affiliate at cost, adjusted for our share of earnings and losses of our affiliate as well as changes in equity of our affiliate due to unrealized gains and losses.
(4)
We value short-term investments at cost, which approximates fair value.
 
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The following table sets forth the maturities (at carrying value) in the fixed maturity portfolio of our insurance subsidiaries at December 31, 2020, 2019 and 2018:
 
    
December 31,
 
    
2020
   
2019
   
2018
 
(dollars in thousands)   
Amount
    
Percent of
Total
   
Amount
    
Percent of
Total
   
Amount
    
Percent of
Total
 
Due in
(1)
:
               
One year or less
   $ 73,166      6.4   $ 29,209      2.8   $ 39,282      4.2
Over one year through three years
     85,805      7.5     71,738      6.9     74,773      8.1
Over three years through five years
     111,258      9.8     93,982      9.0     84,987      9.1
Over five years through ten years
     341,947      30.0     297,836      28.6     256,267      27.6
Over ten years through fifteen years
     139,604      12.2     116,368      11.2     117,875      12.7
Over fifteen years
     140,732      12.3     70,220      6.8     46,600      5.0
Mortgage-backed securities
     249,233      21.8     361,693      34.7     309,573      33.3
  
 
 
    
 
 
   
 
 
    
 
 
   
 
 
    
 
 
 
   $ 1,141,745      100.0   $ 1,041,046      100.0   $ 929,357      100.0
  
 
 
    
 
 
   
 
 
    
 
 
   
 
 
    
 
 
 
 
(1)
Based on stated maturity dates with no prepayment assumptions. Actual maturities will differ because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
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As shown above, our insurance subsidiaries held investments in mortgage-backed securities having a carrying value of $249.2 million at December 31, 2020. The mortgage-backed securities consist primarily of investments in governmental agency balloon pools with stated maturities between one and
37 years. The stated maturities of these investments limit the exposure of our insurance subsidiaries to extension risk in the event that interest rates rise and prepayments decline. Our insurance subsidiaries perform an analysis of the underlying loans when evaluating a mortgage-backed security for purchase, and they select those securities that they believe will provide a return that properly reflects the prepayment risk associated with the underlying loans.
The following table sets forth the investment results of our insurance subsidiaries for the years ended December 31, 2020, 2019 and 2018:
 
    
Year Ended December 31,
 
(dollars in thousands)   
2020
   
2019
   
2018
 
Invested assets
(1)
   $ 1,165,878   $ 1,070,676   $ 1,018,334
Investment income
(2)
     29,504     29,515     26,908
Average yield
     2.5     2.8     2.6
Average
tax-equivalent
yield
     2.7     2.9     2.8
 
(1)
Average of the aggregate invested amounts at the beginning and end of the period.
(2)
Investment income is net of investment expenses and does not include investment gains or losses or provision for income taxes.
A.M. Best Rating
Donegal Mutual and our insurance subsidiaries have an A.M. Best rating of A (Excellent), based upon the respective current financial condition and historical statutory results of operations of Donegal Mutual and our insurance subsidiaries. We believe that the A.M. Best rating of Donegal Mutual and our insurance subsidiaries is an important factor in their marketing of their products to their agents and customers. A.M. Best’s ratings are industry ratings based on a comparative analysis of the financial condition and operating performance of insurance companies. A.M. Best’s classifications are A++ and A+ (Superior), A and
A-
(Excellent), B++ and B+ (Good), B and
B-
(Fair), C++ and C+ (Marginal), C and
C-
(Weak), D (Poor), E (Under Regulatory Supervision), F (Liquidation) and S (Suspended). A.M. Best bases its ratings upon factors relevant to the payment of claims of policyholders and are not directed toward the protection of investors in insurance companies. According to A.M. Best, the “Excellent” rating that the Donegal Insurance Group maintains is assigned to those companies that, in A.M. Best’s opinion, have an excellent ability to meet their ongoing insurance obligations.
Regulation
The supervision and regulation of insurance companies consists primarily of the laws and regulations of the various states in which the insurance companies transact business, with the primary regulatory authority being the insurance regulatory authorities in the state of domicile of the insurance company. Such supervision and regulation relate to numerous aspects of an insurance company’s business and financial condition. The primary purpose of such supervision and regulation is the protection of policyholders. The authority of the state insurance departments includes the establishment of standards of solvency that insurers must meet and maintain, the licensing of insurers and insurance agents to do business, the nature of, and limitations on, investments, premium rates for property and casualty insurance, the provisions that insurers must make for current losses and future liabilities, the deposit of securities for the benefit of policyholders, the approval of policy forms, notice requirements for the cancellation of policies and the approval of certain changes in control. State insurance departments also conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to the financial condition of insurance companies.
 
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In addition to state-imposed insurance laws and regulations, the National Association of Insurance Commissioners, or the NAIC, maintains a risk-based capital system, or RBC, for assessing the adequacy of the statutory capital and surplus of insurance companies that augments the states’ current fixed dollar minimum capital requirements for insurance companies. At December 31, 2020, our insurance subsidiaries and Donegal Mutual each exceeded the minimum levels of statutory capital the RBC rules require by a substantial margin.
Generally, every state has guaranty fund laws under which insurers licensed to do business in that state can be assessed on the basis of premiums written by the insurer in that state in order to fund policyholder liabilities of insolvent insurance companies. Under these laws in general, an insurer is subject to assessment, depending upon its market share of a given line of business, to assist in the payment of policyholder claims against insolvent insurers. Our insurance subsidiaries and Donegal Mutual have made accruals for their portion of assessments related to such insolvencies based upon the most current information furnished by the guaranty associations.
We are part of an insurance holding company system of which Donegal Mutual is the ultimate controlling person. All of the states in which our insurance companies and Donegal Mutual maintain a domicile have legislation that regulates insurance holding company systems. Each insurance company in the insurance holding company system must register with the insurance supervisory agency of its state of domicile and furnish information concerning the operations of companies within the insurance holding company system that may materially affect the operations, management or financial condition of the insurers within the system. Pursuant to these laws, the respective insurance departments in which our subsidiaries and Donegal Mutual maintain a domicile may examine our insurance subsidiaries or Donegal Mutual at any time, require disclosure of material transactions by the holding company with another member of the insurance holding company system and require prior notice or prior approval of certain transactions, such as “extraordinary dividends” from the insurance subsidiaries to the holding company. We have insurance subsidiaries domiciled in Michigan, Pennsylvania and Virginia.
The Pennsylvania Insurance Holding Companies Act, which generally applies to Donegal Mutual, us and our insurance subsidiaries, requires that all transactions within an insurance holding company system to which an insurer is a party must be fair and reasonable and that any charges or fees for services performed must be reasonable. Any management agreement, service agreement, cost sharing arrangement and material reinsurance agreement must be filed with the Pennsylvania Insurance Department, or the Department, and is subject to the Department’s review. We have filed with the Department the pooling agreement between Donegal Mutual and Atlantic States that established the underwriting pool and all material agreements between Donegal Mutual and our insurance subsidiaries.
Approval of the applicable insurance commissioner is also required prior to consummation of transactions affecting the control of an insurer. In virtually all states, including the states where our insurance subsidiaries are domiciled, the acquisition of 10% or more of the outstanding capital stock of an insurer or its holding company or the intent to acquire such an interest creates a rebuttable presumption of a change in control. Pursuant to an order issued in April 2003, the Department approved Donegal Mutual’s ownership of up to 70% of our outstanding Class A common stock and Donegal Mutual’s ownership of up to 100% of our outstanding Class B common stock.
Our insurance subsidiaries have the legal obligation under state insurance laws to participate in involuntary insurance programs for automobile insurance, as well as other property and casualty insurance lines, in the states in which they conduct business. These programs include joint underwriting associations, assigned risk plans, fair access to insurance requirements plans, reinsurance facilities, windstorm plans and tornado plans. Legislation establishing these programs requires all companies that write lines covered by these programs to provide coverage, either directly or through reinsurance, for insureds who are unable to 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 the direct premiums it has written in that state or the number of automobiles it insures in that state. Generally, state law requires participation in these programs as a condition to obtaining a certificate of authority. Our loss ratio on insurance we write under these involuntary programs has traditionally been significantly greater than our loss ratio on insurance we voluntarily write in those states.
 
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Regulatory requirements, including RBC requirements, may impact our insurance subsidiaries’ ability to pay dividends. The amount of statutory capital and surplus necessary for our insurance subsidiaries to satisfy regulatory requirements, including RBC requirements, was not significant in relation to our insurance subsidiaries’ statutory capital and surplus at December 31, 2020. Generally, the maximum amount that one of our insurance subsidiaries may pay to us as ordinary dividends during any year after notice to, but without prior approval of, the insurance commissioner of its domiciliary state is limited to a stated percentage of that subsidiary’s statutory capital and surplus at December 31 of the preceding fiscal year or the net income of that subsidiary for its preceding fiscal year. Our insurance subsidiaries paid dividends to us of $14.0 million, $4.0 million and $11.0 million in 2020, 2019 and 2018, respectively. At December 31, 2020, the amount of ordinary dividends our insurance subsidiaries could pay to us during 2021, without the prior approval of their respective domiciliary insurance commissioners, is shown in the following table.
 
Name of Insurance Subsidiary
  
Ordinary

Dividend Amount
 
Atlantic States
   $ 27,979,670
MICO
     12,236,054
Peninsula
     10,907,098
Southern
     300,409
  
 
 
 
Total
   $ 51,423,231
  
 
 
 
Donegal Mutual Insurance Company
Donegal Mutual organized as a mutual fire insurance company in Pennsylvania in 1889. At December 31, 2020, Donegal Mutual had admitted assets of $759.5 million and policyholders’ surplus of $319.4 million. At December 31, 2020, Donegal Mutual had total liabilities of $440.1 million, including reserves for net losses and loss expenses of $187.4 million and unearned premiums of $89.2 million. Donegal Mutual’s investment portfolio of $423.0 million at December 31, 2020 consisted primarily of investment-grade bonds of $183.0 million and its investment in our Class A common stock and our Class B common stock. At December 31, 2020, Donegal Mutual owned 10,267,692 shares, or approximately 42%, of our Class A common stock, which Donegal Mutual carried on its books at $146.7 million, and 4,654,339 shares, or approximately 84%, of our Class B common stock, which Donegal Mutual carried on its books at $66.5 million. We present Donegal Mutual’s financial information in accordance with SAP as the NAIC Accounting Practices and Procedures Manual requires. Donegal Mutual does not, nor is it required to, prepare financial statements in accordance with GAAP.
Cautionary Statement Regarding Forward-Looking Statements
This Form
10-K
Report and the documents we incorporate by reference in this Form
10-K
Report contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include certain discussions relating to underwriting, premium and investment income volumes, business strategies, reserves, profitability and business relationships and our other business activities during 2020 and beyond. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “objective,” “project,” “predict,” “potential,” “goal” and similar expressions. These forward-looking statements reflect our current views about future events and our current assumptions, and are subject to known and unknown risks and uncertainties that may cause our results, performance or achievements to differ materially from those we anticipate or imply by our forward-looking statements. We cannot control or predict many of the factors that could determine our future financial condition or results of operations. Such factors may include those we describe under “Risk Factors.” The forward-looking statements contained in this Form
10-K
Report reflect our views and assumptions only as of the date of this Form
10-K
Report. Except as required by law, we do not intend to update, and we assume no responsibility for updating, any forward-looking statements we have made. We qualify all of our forward-looking statements by these cautionary statements.
 
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Item 1A.    Risk Factors.
Risk Factors
Risks Relating to the Property and Casualty Insurance Industry
Industry trends, such as increasing loss severity due to higher rates of litigation against the insurance industry and individual insurers, the willingness of courts to expand covered causes of loss, rising jury awards, escalating medical costs and other factors may contribute to increased costs and result in ultimate loss settlements that exceed the reserves of our insurance subsidiaries.
Loss severity in the property and casualty insurance industry has increased in recent years, principally driven by factors such as distracted driving, larger court judgments, higher jury awards and increasing medical and automobile repair costs. In addition, many classes of complainants have brought legal actions and proceedings that tend to increase the size of judgments. The propensity of policyholders and third-party claimants to litigate and the willingness of courts to expand causes of loss and the size of awards, to eliminate exclusions and to increase coverage limits may result in ultimate settlements of current and future losses that exceed the loss reserves of our insurance subsidiaries.
Our insurance subsidiaries are subject to catastrophe losses and losses from other severe weather events, which are unpredictable and may adversely affect our results of operations, liquidity and financial condition.
Our property and casualty insurance operations expose us to claims arising from catastrophic events affecting multiple policyholders. Such catastrophic events consist of various natural disasters, including, but not limited to, hurricanes, tropical storms, tornadoes, windstorms, hailstorms, fires and wildfires, landslides, earthquakes, severe winter weather events and
man-made
disasters such as terrorist attacks, explosions and infrastructure failures. Historically, our insurance subsidiaries have experienced weather-related losses from hurricanes and tropical storms in
Mid-Atlantic
and Southern states, tornadoes and hailstorms in
Mid-Atlantic,
Midwestern and Southern states and severe winter weather events in
Mid-Atlantic,
Midwestern and New England states.
Losses from catastrophic events are a function of both the extent of our insurance subsidiaries’ exposures, the frequency and severity of the events themselves and the level of reinsurance coverage our insurance subsidiaries purchase. Our ability to appropriately manage catastrophe risk depends partially on catastrophe models, which may be affected by inaccurate or incomplete data, the uncertainty of the frequency and severity of future events and the uncertain impact of climate change. The underwriting results of our insurance subsidiaries are subject to weather and other conditions that may adversely affect our financial condition, liquidity or results of operations. Because the occurrence and severity of catastrophes are inherently unpredictable and may vary significantly from year to year and region to region, our historical results of operations may not be indicative of our future results of operations. Our insurance subsidiaries seek to reduce their exposure to catastrophe losses through their underwriting strategies and their purchase of catastrophe reinsurance. Nevertheless, reinsurance may prove inadequate under certain circumstances.
The increased frequency and severity of weather-related catastrophes and other losses, such as from wildfires, incurred by the industry in 2020 and in prior years may be indicative of changing weather patterns due to climate change. While the emerging science regarding climate change and its connection to extreme weather events continues to be studied, climate change, to the extent it produces rising temperatures and changes in weather patterns, could affect the frequency and severity of weather events and wildfires and thus impact the affordability and availability of catastrophe reinsurance coverage for our insurance subsidiaries. In particular, increased weather-related catastrophes in the states in which our insurance subsidiaries operate would lead to higher overall losses if they were unable to offset such losses through pricing actions.
 
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Our insurance subsidiaries must establish premium rates and loss and loss expense reserves from forecasts of the ultimate costs they expect will arise from risks underwritten during the policy period, and the profitability of our insurance subsidiaries could be adversely affected if their premium rates or reserves are insufficient to satisfy their ultimate costs.
One of the distinguishing features of the property and casualty insurance industry is that it prices its products before it knows its costs, since insurers generally establish their premium rates before they know the amount of losses they will incur. Accordingly, our insurance subsidiaries establish premium rates from forecasts of the ultimate costs they expect to arise from risks they have underwritten during the policy period. These premium rates may not be sufficient to cover the ultimate losses our insurance subsidiaries incur. Further, our insurance subsidiaries must establish reserves for losses and loss expenses as balance sheet liabilities based upon estimates involving actuarial and statistical projections at a given time of what our insurance subsidiaries expect their ultimate liability to be. Significant periods of time often elapse between the occurrence of an insured loss, the reporting of the loss and the settlement of that loss. It is possible that our insurance subsidiaries’ ultimate liability could exceed these estimates because of the future development of known losses, the existence of losses that have occurred but are currently unreported and larger than historical settlements of pending and unreported claims. The process of estimating reserves is inherently judgmental and can be influenced by a number of factors, including the following:
 
   
trends in claim frequency and severity;
 
   
changes in operations;
 
   
emerging economic and social trends;
 
   
inflation; and
 
   
changes in the regulatory and litigation environments.
If our insurance subsidiaries determine that their reserves are insufficient to cover their ultimate liability, they will increase their reserves. An increase in reserves results in an increase in losses and a reduction in net income for the period in which our insurance subsidiaries recognize a deficiency in reserves. Accordingly, an increase in reserves may adversely impact the business, liquidity, financial condition and results of operations of our insurance subsidiaries.
The financial results of our insurance subsidiaries depend primarily on their ability to underwrite risks effectively and to charge adequate rates to policyholders.
The financial condition, cash flows and results of operations of our insurance subsidiaries depend on their ability to underwrite and set rates accurately for a full spectrum of risks across a number of lines of insurance. Rate adequacy is necessary to generate sufficient premium to pay losses, loss adjustment expenses and underwriting expenses and to realize a profit.
The ability to underwrite and set rates effectively is subject to a number of risks and uncertainties, including: