DONEGAL GROUP INC 10-Q

Item 1. Financial Statements Donegal Group Inc. and Subsidiaries Consolidated Balance Sheets September 30, 2022 December 31, 2021 (Unaudited) Assets Investments Fixed maturities Held to maturity, at amortized cost $ 696,391,647 $ 668,104,568 Available for sale, at fair value 500,896,200 532,629,015 Equity securities, at fair value 46,775,667 63,419,973 Short-term investments, at cost, which approximates fair value 36,660,795 12,692,341 Total investments 1,280,724,309 1,276,845,897 Cash 26,661,329 57,709,375 Accrued investment income 9,823,949 8,214,971 Premiums receivable 181,744,555 168,862,580 Reinsurance receivable 451,846,555 455,411,009 Deferred policy acquisition costs 74,383,642 68,028,373 Deferred tax asset, net 22,690,132 6,685,619 Prepaid reinsurance premiums 165,713,125 176,935,842 Property and equipment, net 2,798,113 2,956,930 Accounts receivable - securities 3,825 2,252 Federal income taxes recoverable 9,441,203 5,290,938 Receivable from Michigan Catastrophic Claims Association — 18,112,800 Due from affiliate 3,264,838 1,922,717 Goodwill 5,625,354 5,625,354 Other intangible assets 958,010 958,010 Other 1,172,770 1,612,732 Total assets $ 2,236,851,709 $ 2,255,175,399 Liabilities and Stockholders’ Equity Liabilities Losses and loss expenses $ 1,108,125,594 $ 1,077,620,301 Unearned premiums 595,353,323 572,958,422 Accrued expenses 4,310,945 4,028,659 Reinsurance balances payable 3,929,410 3,946,105 Borrowings under lines of credit 35,000,000 35,000,000 Cash dividends declared to stockholders — 4,915,268 Cash refunds due to Michigan policyholders — 18,112,800 Other 8,929,038 7,557,757 Total liabilities 1,755,648,310 1,724,139,312 Stockholders’ Equity Preferred stock, $ 0.01 par value, authorized 2,000,000 shares; none issued — — Class A common stock, $ 0.01 par value, authorized 50,000,000 shares, issued 29,839,927 and 28,756,203 shares and outstanding 26,837,339 and 25,753,615 shares 298,400 287,562 Class B common stock, $ 0.01 par value, authorized 10,000,000 shares, issued 5,649,240 shares and outstanding 5,576,775 shares 56,492 56,492 Additional paid-in capital 321,363,789 304,889,481 Accumulated other comprehensive (loss) income ( 46,971,052 ) 3,283,551 Retained earnings 247,682,127 263,745,358 Treasury stock, at cost ( 41,226,357 ) ( 41,226,357 ) Total stockholders’ equity 481,203,399 531,036,087 Total liabilities and stockholders’ equity $ 2,236,851,709 $ 2,255,175,399 See accompanying notes to consolidated financial statements. 1 Index Donegal Group Inc. and Subsidiaries Consolidated Statements of Loss (Unaudited) Three Months Ended September 30, 2022 2021 Revenues: Net premiums earned $ 206,121,826 $ 196,234,626 Investment income, net of investment expenses 8,568,671 7,763,562 Net investment losses (includes $ 371,194 and $ 26,163 accumulated other comprehensive income reclassifications) ( 2,357,634 ) ( 1,570,476 ) Lease income 91,679 107,977 Installment payment fees 413,706 570,492 Total revenues 212,838,248 203,106,181 Expenses: Net losses and loss expenses 155,754,256 148,142,237 Amortization of deferred policy acquisition costs 35,513,000 31,778,000 Other underwriting expenses 33,411,529 30,101,717 Policyholder dividends 1,239,154 1,287,147 Interest 71,430 209,547 Other expenses, net 218,083 217,209 Total expenses 226,207,452 211,735,857 Loss before income tax benefit ( 13,369,204 ) ( 8,629,676 ) Income tax benefit (includes $ 77,951 and $ 5,494 income tax expense from reclassification items) ( 2,993,333 ) ( 1,917,698 ) Net loss $ ( 10,375,871 ) $ ( 6,711,978 ) Loss per common share: Class A common stock - basic and diluted $ ( 0.33 ) $ ( 0.22 ) Class B common stock - basic and diluted $ ( 0.30 ) $ ( 0.20 ) Donegal Group Inc. and Subsidiaries Consolidated Statements of Comprehensive Loss (Unaudited) Three Months Ended September 30, 2022 2021 Net loss $ ( 10,375,871 ) $ ( 6,711,978 ) Other comprehensive loss, net of tax Unrealized loss on securities: Unrealized holding loss during the period, net of income tax benefit of $ 4,572,428 and $ 432,664 ( 17,201,046 ) ( 1,627,641 ) Reclassification adjustment for gains included in net loss, net of income tax expense of $ 77,951 and $ 5,494 ( 293,243 ) ( 20,669 ) Other comprehensive loss ( 17,494,289 ) ( 1,648,310 ) Comprehensive loss $ ( 27,870,160 ) $ ( 8,360,288 ) See accompanying notes to consolidated financial statements. 2 Index Donegal Group Inc. and Subsidiaries Consolidated Statements of (Loss) Income (Unaudited) Nine Months Ended September 30, 2022 2021 Revenues: Net premiums earned $ 609,498,939 $ 575,974,891 Investment income, net of investment expenses 24,631,398 22,926,320 Net investment (losses) gains (includes $ 824,409 and $ 476,188 accumulated other comprehensive income reclassifications) ( 10,810,594 ) 5,139,609 Lease income 294,529 323,782 Installment payment fees 1,161,842 1,857,420 Total revenues 624,776,114 606,222,022 Expenses: Net losses and loss expenses 415,245,619 381,318,636 Amortization of deferred policy acquisition costs 104,867,000 95,060,000 Other underwriting expenses 106,753,031 100,113,444 Policyholder dividends 4,176,649 4,210,667 Interest 464,188 739,163 Other expenses, net 991,671 962,278 Total expenses 632,498,158 582,404,188 (Loss) income before income tax (benefit) expense ( 7,722,044 ) 23,817,834 Income tax (benefit) expense (includes $ 173,126 and $ 99,999 income tax expense from reclassification items) ( 2,283,445 ) 3,835,928 Net (loss) income $ ( 5,438,599 ) $ 19,981,906 (Loss) earnings per common share: Class A common stock - basic and diluted $ ( 0.17 ) $ 0.66 Class B common stock - basic and diluted $ ( 0.16 ) $ 0.59 Donegal Group Inc. and Subsidiaries Consolidated Statements of Comprehensive (Loss) Income (Unaudited) Nine Months Ended September 30, 2022 2021 Net (loss) income $ ( 5,438,599 ) $ 19,981,906 Other comprehensive loss, net of tax Unrealized loss on securities: Unrealized holding loss during the period, net of income tax benefit of $ 13,185,692 and $ 1,046,983 ( 49,603,320 ) ( 3,929,262 ) Reclassification adjustment for gains included in net income, net of income tax expense of $ 173,126 and $ 99,999 ( 651,283 ) ( 376,189 ) Other comprehensive loss ( 50,254,603 ) ( 4,305,451 ) Comprehensive (loss) income $ ( 55,693,202 ) $ 15,676,455 See accompanying notes to consolidated financial statements. 3 Index Donegal Group Inc. and Subsidiaries Consolidated Statement of Stockholders’ Equity (Unaudited) Nine Months Ended September 30, 2022 Class A Shares Class B Shares Class A Amount Class B Amount Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Treasury Stock Total Stockholders’ Equity Balance, December 31, 2021 28,756,203 5,649,240 $ 287,562 $ 56,492 $ 304,889,481 $ 3,283,551 $ 263,745,358 $ ( 41,226,357 ) $ 531,036,087 Issuance of common stock (stock compensation plans) 33,407 — 335 — 423,665 — — — 424,000 Share-based compensation 900 — 9 — 256,451 — — — 256,460 Net income — — — — — — 13,145,029 — 13,145,029 Cash dividends declared — — — — — — ( 5,490 ) — ( 5,490 ) Grant of stock options — — — — 98,409 — ( 98,409 ) — — Other comprehensive loss — — — — — ( 20,590,225 ) — — ( 20,590,225 ) Balance, March 31, 2022 28,790,510 5,649,240 $ 287,906 $ 56,492 $ 305,668,006 $ ( 17,306,674 ) $ 276,786,488 $ ( 41,226,357 ) $ 524,265,861 Issuance of common stock (stock compensation plans) 54,743 — 547 — 736,349 — — — 736,896 Share-based compensation 775,898 — 7,759 — 11,476,429 — — — 11,484,188 Net loss — — — — — — ( 8,207,757 ) — ( 8,207,757 ) Cash dividends declared — — — — — — ( 5,086,617 ) — ( 5,086,617 ) Grant of stock options — — — — 59,216 — ( 59,216 ) — — Other comprehensive loss — — — — — ( 12,170,089 ) — — ( 12,170,089 ) Balance, June 30, 2022 29,621,151 5,649,240 $ 296,212 $ 56,492 $ 317,940,000 $ ( 29,476,763 ) $ 263,432,898 $ ( 41,226,357 ) $ 511,022,482 Issuance of common stock (stock compensation plans) 23,454 — 235 — 270,887 — — — 271,122 Share-based compensation 195,322 — 1,953 — 3,013,995 — — — 3,015,948 Net loss — — — — — — ( 10,375,871 ) — ( 10,375,871 ) Cash dividends declared — — — — — — ( 5,235,993 ) — ( 5,235,993 ) Grant of stock options — — — — 138,907 — ( 138,907 ) — — Other comprehensive loss — — — — — ( 17,494,289 ) — — ( 17,494,289 ) Balance, September 30, 2022 29,839,927 5,649,240 $ 298,400 $ 56,492 $ 321,363,789 $ ( 46,971,052 ) $ 247,682,127 $ ( 41,226,357 ) $ 481,203,399 See accompanying notes to consolidated financial statements. 4 Index Donegal Group Inc. and Subsidiaries Consolidated Statement of Stockholders’ Equity (Unaudited) Nine Months Ended September 30, 2021 Class A Shares Class B Shares Class A Amount Class B Amount Additional Paid-In Capital Accumulated Other Comprehensive Income Retained Earnings Treasury Stock Total Stockholders’ Equity Balance, December 31, 2020 27,651,774 5,649,240 $ 276,518 $ 56,492 $ 289,149,567 $ 11,130,612 $ 258,387,288 $ ( 41,226,357 ) $ 517,774,120 Issuance of common stock (stock compensation plans) 33,336 — 334 — 419,454 — — — 419,788 Share-based compensation 346,124 — 3,461 — 4,719,388 — — — 4,722,849 Net income — — — — — — 10,529,848 — 10,529,848 Cash dividends declared — — — — — — ( 5,000 ) — ( 5,000 ) Grant of stock options — — — — 109,184 — ( 109,184 ) — — Other comprehensive loss — — — — — ( 4,207,115 ) — — ( 4,207,115 ) Balance, March 31, 2021 28,031,234 5,649,240 $ 280,313 $ 56,492 $ 294,397,593 $ 6,923,497 $ 268,802,952 $ ( 41,226,357 ) $ 529,234,490 Issuance of common stock (stock compensation plans) 49,613 — 496 — 730,005 — — — 730,501 Share-based compensation 539,019 — 5,390 — 7,313,031 — — — 7,318,421 Net income — — — — — — 16,164,036 — 16,164,036 Cash dividends declared — — — — — — ( 4,840,629 ) — ( 4,840,629 ) Grant of stock options — — — — 69,995 — ( 69,995 ) — — Other comprehensive income — — — — — 1,549,974 — — 1,549,974 Balance, June 30, 2021 28,619,866 5,649,240 $ 286,199 $ 56,492 $ 302,510,624 $ 8,473,471 $ 280,056,364 $ ( 41,226,357 ) $ 550,156,793 Issuance of common stock (stock compensation plans) 24,619 — 246 — 292,302 — — — 292,548 Share-based compensation 54,680 — 547 — 946,004 — — — 946,551 Net loss — — — — — — ( 6,711,978 ) — ( 6,711,978 ) Cash dividends declared — — — — — — ( 4,902,188 ) — ( 4,902,188 ) Grant of stock options — — — — 95,569 — ( 95,569 ) — — Other comprehensive loss — — — — — ( 1,648,310 ) — — ( 1,648,310 ) Balance, September 30, 2021 28,699,165 5,649,240 $ 286,992 $ 56,492 $ 303,844,499 $ 6,825,161 $ 268,346,629 $ ( 41,226,357 ) $ 538,133,416 See accompanying notes to consolidated financial statements. 5 Index Donegal Group Inc. and Subsidiaries Consolidated Statements of Cash Flows (Unaudited) Nine Months Ended September 30, 2022 2021 Cash Flows from Operating Activities: Net (loss) income $ ( 5,438,599 ) $ 19,981,906 Adjustments to reconcile net (loss) income to net cash provided by operating activities: Depreciation, amortization and other non-cash items 3,747,654 4,492,720 Net investment losses (gains) 10,810,594 ( 5,139,609 ) Changes in assets and liabilities: Losses and loss expenses 30,505,293 88,155,724 Unearned premiums 22,394,901 61,442,456 Premiums receivable ( 12,881,975 ) ( 11,948,363 ) Deferred acquisition costs ( 6,355,269 ) ( 11,239,809 ) Deferred income taxes ( 2,645,695 ) 900,430 Reinsurance receivable 3,564,454 ( 47,742,018 ) Prepaid reinsurance premiums 11,222,717 ( 14,935,811 ) Accrued investment income ( 1,608,978 ) ( 1,170,798 ) Due from affiliate ( 1,342,121 ) ( 3,979,682 ) Reinsurance balances payable ( 16,695 ) 710,021 Current income taxes ( 4,150,265 ) ( 3,267,599 ) Accrued expenses 282,286 ( 18,768,686 ) Other, net 1,811,243 973,775 Net adjustments 55,338,144 38,482,751 Net cash provided by operating activities 49,899,545 58,464,657 Cash Flows from Investing Activities: Purchases of fixed maturities, held to maturity ( 68,902,605 ) ( 106,290,824 ) Purchases of fixed maturities, available for sale ( 101,328,478 ) ( 118,899,756 ) Purchases of equity securities, available for sale ( 12,488,733 ) ( 25,354,790 ) Maturity of fixed maturities: Held to maturity 41,194,285 31,914,527 Available for sale 60,346,490 140,908,191 Sales of fixed maturities securities, available for sale 6,568,154 6,281,963 Sales of equity securities, available for sale 17,498,036 17,391,396 Net sales of property and equipment 28,289 934,297 Net (purchases) sales of short-term investments ( 23,968,454 ) 16,206,434 Net cash used in investing activities ( 81,053,016 ) ( 36,908,562 ) Cash Flows from Financing Activities: Cash dividends paid ( 15,243,368 ) ( 14,184,118 ) Issuance of common stock 15,348,793 13,438,245 Payment on subordinated debentures — ( 5,000,000 ) Payments on lines of credit — ( 50,000,000 ) Net cash provided by (used in) financing activities 105,425 ( 55,745,873 ) Net decrease in cash ( 31,048,046 ) ( 34,189,778 ) Cash at beginning of period 57,709,375 103,094,236 Cash at end of period $ 26,661,329 $ 68,904,458 Cash paid during period - Interest $ 464,188 $ 993,769 Net cash paid during period - Taxes $ 4,500,000 $ 6,200,000 See accompanying notes to consolidated financial statements. 6 Index DONEGAL GROUP INC. AND SUBSIDIARIES (Unaudited) Notes to Consolidated Financial Statements 1 - Organization Donegal Mutual Insurance Company (“Donegal Mutual”) organized us as an insurance holding company on August 26, 1986. Our insurance subsidiaries, Atlantic States Insurance Company (“Atlantic States”), Southern Insurance Company of Virginia (“Southern”), the Peninsula Insurance Group (“Peninsula”), which consists of Peninsula Indemnity Company and The Peninsula Insurance Company and Michigan Insurance Company (“MICO”), and our affiliates write personal and commercial lines of property and casualty coverages exclusively through a network of independent insurance agents in certain Mid-Atlantic, Midwestern, New England, Southern and Southwestern states. At September 30, 2022, we had three segments: our investment function, our commercial lines of insurance and our personal lines of insurance. 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. At September 30, 2022, Donegal Mutual held approximately 42 % of our outstanding Class A common stock and approximately 84 % of our outstanding Class B common stock. This ownership provides Donegal Mutual with approximately 71 % of the total voting power of our common stock. Our insurance subsidiaries and Donegal Mutual have interrelated operations due to a pooling agreement and other intercompany agreements and transactions. While each company maintains its separate corporate existence, our insurance subsidiaries and Donegal Mutual conduct business together as the Donegal Insurance Group. As such, Donegal Mutual and our insurance subsidiaries share the same business philosophy, the same management, the same employees and the same facilities and offer the same types of insurance products. Atlantic States, our largest subsidiary, participates in a proportional reinsurance agreement, or pooling agreement, with Donegal Mutual. 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. In addition, Donegal Mutual has a 100 % quota-share reinsurance agreement with Southern Mutual Insurance Company, or Southern Mutual. Donegal Mutual places its assumed business from Southern Mutual into the underwriting pool. 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. The same executive management and underwriting personnel administer products, classes of business underwritten, pricing practices and underwriting standards of Donegal Mutual and our insurance subsidiaries. In addition, as the Donegal Insurance Group, Donegal Mutual and our insurance subsidiaries share a combined business plan to achieve market penetration and underwriting profitability objectives. The products our insurance subsidiaries and Donegal Mutual market are generally complementary, thereby allowing the Donegal Insurance Group to offer a broader range of products to a given market and to expand the Donegal Insurance 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 versus 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. 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. 7 Index 2 - Basis of Presentation Our financial information for the interim periods included in this Form 10-Q Report is unaudited; however, our financial information we include in this Form 10-Q Report reflects all adjustments, consisting only of normal recurring adjustments that, in the opinion of our management, are necessary for a fair presentation of our financial position, results of operations and cash flows for those interim periods. Our results of operations for the nine months ended September 30, 2022 are not necessarily indicative of the results of operations we expect for the year ending December 31, 2022. We recommend you read the interim financial statements we include in this Form 10-Q Report in conjunction with the financial statements and the notes to our financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2021. 3 - (Loss) Earnings Per Share We have two classes of common stock, which we refer to as our Class A common stock and our Class B common stock. Our certificate of incorporation provides that whenever our board of directors declares a dividend on our Class B common stock, our board of directors shall simultaneously declare a dividend on our Class A common stock that is payable to the holders of our Class A common stock at the same time and as of the same record date at a rate that is at least 10 % greater than the rate at which our board of directors declared a dividend on our Class B common stock. Accordingly, we use the two-class method to compute our (loss) earnings per common share. The two-class method is an earnings allocation formula that determines (loss) earnings per share separately for each class of common stock based on dividends we have declared and an allocation of our remaining undistributed (loss) earnings using a participation percentage that reflects the dividend rights of each class. The table below presents for the periods indicated a reconciliation of the numerators and denominators we used to compute basic and diluted net (loss) income per share for our Class A common stock and our Class B common stock: Three Months Ended September 30, 2022 2021 Class A Class B Class A Class B (in thousands, except per share data) Basic loss per share: Numerator: Allocation of net loss $ ( 8,714 ) $ ( 1,662 ) $ ( 5,592 ) $ ( 1,120 ) Denominator: Weighted-average shares outstanding 26,781 5,577 25,676 5,577 Basic loss per share $ ( 0.33 ) $ ( 0.30 ) $ ( 0.22 ) $ ( 0.20 ) Diluted loss per share: Numerator: Allocation of net loss $ ( 8,714 ) $ ( 1,662 ) $ ( 5,592 ) $ ( 1,120 ) Denominator: Number of shares used in basic computation 26,781 5,577 25,676 5,577 Weighted-average shares effect of dilutive securities: Director and employee stock options — — — — Number of shares used in diluted computation 26,781 5,577 25,676 5,577 Diluted loss per share $ ( 0.33 ) $ ( 0.30 ) $ ( 0.22 ) $ ( 0.20 ) 8 Index Nine Months Ended September 30, 2022 2021 Class A Class B Class A Class B (in thousands, except per share data) Basic (loss) earnings per share: Numerator: Allocation of net (loss) income $ ( 4,529 ) $ ( 910 ) $ 16,682 $ 3,300 Denominator: Weighted-average shares outstanding 26,216 5,577 25,265 5,577 Basic (loss) earnings per share $ ( 0.17 ) $ ( 0.16 ) $ 0.66 $ 0.59 Diluted (loss) earnings per share: Numerator: Allocation of net (loss) income $ ( 4,529 ) $ ( 910 ) $ 16,682 $ 3,300 Denominator: Number of shares used in basic computation 26,216 5,577 25,265 5,577 Weighted-average shares effect of dilutive securities: Director and employee stock options — — 179 — Number of shares used in diluted computation 26,216 5,577 25,444 5,577 Diluted (loss) earnings per share $ ( 0.17 ) $ ( 0.16 ) $ 0.66 $ 0.59 We did not include outstanding options to purchase the following number of shares of Class A common stock in our computation of diluted earnings per share because the exercise price of the options exceeded the average market price of our Class A common stock during the applicable periods. Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Number of options to purchase Class A shares excluded — — — 4,839,910 We did not include any effect of dilutive securities in the computation of diluted (loss) earnings per share for the three and nine months ended September 30, 2022 because we sustained a net loss for these periods. 4 - Reinsurance Atlantic States and Donegal Mutual have participated in a pooling agreement since 1986 under which they pool their direct premiums written, and Atlantic States and Donegal Mutual then share the underwriting results of the pool in accordance with the terms of the pooling agreement. Atlantic States has an 80 % share of the results of the pool, and Donegal Mutual has a 20 % share of the results of the pool. Donegal Mutual began placing the business of the Mountain States Insurance Group into the pool beginning with policies effective in 2021. Our insurance subsidiaries and Donegal Mutual participate in a consolidated third-party reinsurance program. The coverage and parameters of the program are common to all of our insurance subsidiaries and Donegal Mutual. The program utilizes several different reinsurers. They require their reinsurers to maintain an A.M. Best rating of A- (Excellent) or better or, with respect to foreign reinsurers, have a financial condition that, in the opinion of our management, is equivalent to a company with at least an A- rating from A.M. Best. The following information describes the external reinsurance Donegal Mutual and our insurance subsidiaries have in place for 2022: 9 Index • excess of loss reinsurance, under which Donegal Mutual and our insurance subsidiaries recover losses over a set retention of $ 2.0 million; and • catastrophe reinsurance, under which Donegal Mutual and our insurance subsidiaries recover 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 have excess of loss reinsurance that provide for coverage of $ 38.0 million per loss over a set retention of $ 2.0 million. For liability insurance, our insurance subsidiaries have excess of loss reinsurance that provide for coverage of $ 73.0 million per occurrence over a set retention of $ 2.0 million. For workers’ compensation insurance, our insurance subsidiaries have excess of loss reinsurance that provide for coverage of $ 18.0 million on any one life over a set retention of $ 2.0 million. In addition to the pooling agreement and third-party reinsurance, our insurance subsidiaries have a catastrophe reinsurance agreement with Donegal Mutual, under which each of our insurance subsidiaries recovers 100 % of an accumulation of multiple losses resulting from a single event, including natural disasters, over a set retention of $ 2.0 million up to aggregate losses of $ 13.0 million per occurrence. The agreement also provides additional coverage for an accumulation of losses from a single event including a combination of our insurance subsidiaries over a combined retention of $ 5.0 million. Our insurance subsidiaries and Donegal Mutual also purchase facultative reinsurance to cover certain exposures, including property exposures that exceeded the limits provided by their respective treaty reinsurance. In order to write automobile insurance in the state of Michigan, MICO is required to be a member of the Michigan Catastrophic Claims Association (“MCCA”). The MCCA provides reinsurance to MICO for personal automobile and commercial automobile personal injury claims in the state of Michigan over a set retention. In November 2021, the MCCA approved the return of approximately $ 3.0 billion of its estimated surplus to its member insurance companies and provided guidance to those companies with respect to the payment of refunds to Michigan policyholders in the first half of 2022. We recorded a receivable from the MCCA and a corresponding payable for cash refunds due to Michigan policyholders in the amount of $ 18.1 million on our balance sheet as of December 31, 2021. In March 2022, we received such payment from the MCCA and subsequently paid the refunds due to our Michigan policyholders. 5 - Investments The amortized cost and estimated fair values of our fixed maturities at September 30, 2022 were as follows: Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value (in thousands) Held to Maturity U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 103,894 $ — $ 11,082 $ 92,812 Obligations of states and political subdivisions 389,864 1,138 71,368 319,634 Corporate securities 189,799 — 23,743 166,056 Mortgage-backed securities 12,835 — 748 12,087 Totals $ 696,392 $ 1,138 $ 106,941 $ 590,589 10 Index Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value (in thousands) Available for Sale U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 48,343 $ — $ 5,455 $ 42,888 Obligations of states and political subdivisions 50,777 28 6,929 43,876 Corporate securities 227,827 5 16,820 211,012 Mortgage-backed securities 228,642 — 25,522 203,120 Totals $ 555,589 $ 33 $ 54,726 $ 500,896 At September 30, 2022, our holdings of obligations of states and political subdivisions included general obligation bonds with an aggregate fair value of $ 234.3 million and an amortized cost of $ 286.8 million. Our holdings at September 30, 2022 also included special revenue bonds with an aggregate fair value of $ 129.2 million and an amortized cost of $ 153.8 million. With respect to both categories of those bonds at September 30, 2022, we held no securities of any issuer that comprised more than 10 % of our holdings of either bond category. Education bonds and water and sewer utility bonds represented 47 % and 37 %, respectively, of our total investments in special revenue bonds based on the carrying values of these investments at September 30, 2022. Many of the issuers of the special revenue bonds we held at September 30, 2022 have the authority to impose ad valorem taxes. In that respect, many of the special revenue bonds we held at September 30, 2022 are similar to general obligation bonds. The amortized cost and estimated fair values of our fixed maturities at December 31, 2021 were as follows: Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value (in thousands) Held to Maturity U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 89,268 $ 1,923 $ 1,015 $ 90,176 Obligations of states and political subdivisions 371,436 17,857 948 388,345 Corporate securities 191,147 11,576 773 201,950 Mortgage-backed securities 16,254 676 — 16,930 Totals $ 668,105 $ 32,032 $ 2,736 $ 697,401 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value (in thousands) Available for Sale U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 32,501 $ 144 $ 461 $ 32,184 Obligations of states and political subdivisions 55,459 2,002 83 57,378 Corporate securities 215,669 6,817 874 221,612 Mortgage-backed securities 219,664 3,001 1,210 221,455 Totals $ 523,293 $ 11,964 $ 2,628 $ 532,629 At December 31, 2021, our holdings of obligations of states and political subdivisions included general obligation bonds with an aggregate fair value of $ 284.9 million and an amortized cost of $ 272.7 million. Our holdings also included special revenue bonds with an aggregate fair value of $ 160.8 million and an amortized cost of $ 154.2 million. With respect to both categories of bonds, we held no securities of any issuer that comprised more than 10 % of that category at December 31, 2021. Education bonds and water and sewer utility bonds represented 48 % and 35 %, respectively, of our total investments in special revenue bonds based on their carrying values at December 31, 2021. Many of the issuers of the special revenue bonds we held at December 31, 2021 have the authority to impose ad valorem taxes. In that respect, many of the special revenue bonds we held at December 31,2021 are similar to general obligation bonds. 11 Index We have segregated within accumulated other comprehensive (loss) income the net unrealized losses of $ 15.1 million arising prior to the November 30, 2013 reclassification date for fixed maturities reclassified from available for sale to held to maturity. We are amortizing this balance over the remaining life of the related securities as an adjustment of yield in a manner consistent with the accretion of discount on the same fixed maturities. We recorded amortization of $ 415,153 and $ 738,815 in other comprehensive loss during the nine months ended September 30, 2022 and 2021, respectively. At September 30, 2022 and December 31, 2021, net unrealized losses of $ 4.8 million and $ 5.2 million, respectively, remained within accumulated other comprehensive (loss) income. We show below the amortized cost and estimated fair value of our fixed maturities at September 30, 2022 by contractual maturity. Expected maturities may differ from contractual maturities because issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties. Amortized Cost Estimated Fair Value (in thousands) Held to maturity Due in one year or less $ 35,415 $ 35,679 Due after one year through five years 84,141 80,782 Due after five years through ten years 243,912 211,985 Due after ten years 320,089 250,056 Mortgage-backed securities 12,835 12,087 Total held to maturity $ 696,392 $ 590,589 Available for sale Due in one year or less $ 17,077 $ 16,946 Due after one year through five years 166,510 155,243 Due after five years through ten years 112,426 100,226 Due after ten years 30,934 25,361 Mortgage-backed securities 228,642 203,120 Total available for sale $ 555,589 $ 500,896 The cost and estimated fair values of our equity securities at September 30, 2022 were as follows: Cost Gross Gains Gross Losses Estimated Fair Value (in thousands) Equity securities $ 39,581 $ 9,084 $ 1,889 $ 46,776 The cost and estimated fair values of our equity securities at December 31, 2021 were as follows: Cost Gross Gains Gross Losses Estimated Fair Value (in thousands) Equity securities $ 43,263 $ 20,413 $ 256 $ 63,420 12 Index We present below gross gains and losses from investments and the change in the difference between fair value and cost of investments: Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 (in thousands) Gross realized gains: Fixed maturities $ 326 $ 86 $ 998 $ 610 Equity securities 400 — 1,243 626 Real estate — — 477 — 726 86 2,718 1,236 Gross realized losses: Fixed maturities 73 82 173 156 Equity securities 249 — 1,073 354 322 82 1,246 510 Net realized gains 404 4 1,472 726 Gross unrealized gains on equity securities 117 — 123 4,662 Gross unrealized losses on equity securities ( 2,879 ) ( 1,574 ) ( 12,406 ) ( 248 ) Net investment (losses) gains $ ( 2,358 ) $ ( 1,570 ) $ ( 10,811 ) $ 5,140 We held fixed maturities with unrealized losses representing declines that we considered temporary at September 30, 2022 as follows: Less Than 12 Months More Than 12 Months Fair Value Unrealized Losses Fair Value Unrealized Losses (in thousands) U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 95,235 $ 7,142 $ 40,464 $ 9,395 Obligations of states and political subdivisions 282,073 62,899 42,755 15,398 Corporate securities 328,432 30,756 46,631 9,807 Mortgage-backed securities 159,877 15,675 55,330 10,595 Totals $ 865,617 $ 116,472 $ 185,180 $ 45,195 We held fixed maturities with unrealized losses representing declines that we considered temporary at December 31, 2021 as follows: Less Than 12 Months More Than 12 Months Fair Value Unrealized Losses Fair Value Unrealized Losses (in thousands) U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 27,691 $ 412 $ 28,426 $ 1,064 Obligations of states and political subdivisions 56,655 899 7,091 132 Corporate securities 92,737 1,610 1,463 37 Mortgage-backed securities 90,006 1,128 2,361 82 Totals $ 267,089 $ 4,049 $ 39,341 $ 1,315 13 Index We make estimates concerning the valuation of our investments and the recognition of other-than-temporary declines in the value of our investments. For equity securities, we measure investments at fair value, and we recognize changes in fair value in our results of operations. With respect to a debt security that is in an unrealized loss position, we first assess if we intend to sell the debt security. If we determine we intend to sell the debt security, we recognize the impairment loss in our results of operations. If we do not intend to sell the debt security, we determine whether it is more likely than not that we will be required to sell the debt security prior to recovery. If we determine it is more likely than not that we will be required to sell the debt security prior to recovery, we recognize the impairment loss in our results of operations. If we determine it is more likely than not that we will not be required to sell the debt security prior to recovery, we then evaluate whether a credit loss has occurred with respect to that security. We determine whether a credit loss has occurred by comparing the amortized cost of the debt security to the present value of the cash flows we expect to collect. If we expect a cash flow shortfall, we consider that a credit loss has occurred. If we determine that a credit loss has occurred, we consider the impairment to be other than temporary. We then recognize the amount of the impairment loss related to the credit loss in our results of operations, and we recognize the remaining portion of the impairment loss in our other comprehensive income, net of applicable taxes. In addition, we may write down securities in an unrealized loss position based on a number of other factors, including when the fair value of an investment is significantly below its cost, when the financial condition of the issuer of a security has deteriorated, the occurrence of industry, issuer or geographic events that have negatively impacted the value of a security and rating agency downgrades. We held 919 debt securities that were in an unrealized loss position at September 30, 2022. Based upon our analysis of general market conditions and underlying factors impacting these debt securities, we considered these declines in value to be temporary. We amortize premiums and discounts on debt securities over the life of the security as an adjustment to yield using the effective interest method. We compute realized investment gains and losses using the specific identification method. We amortize premiums and discounts on mortgage-backed debt securities using anticipated prepayments. 6 - Segment Information We evaluate the performance of our personal lines and commercial lines segments based upon the underwriting results of our insurance subsidiaries using statutory accounting principles (“SAP”) that various state insurance departments prescribe or permit. Our management uses SAP to measure the performance of our insurance subsidiaries instead of United States generally accepted accounting principles (“GAAP”). SAP financial measures are considered non-GAAP financial measures under applicable SEC rules because they include or exclude certain items that the most comparable GAAP financial measures do not ordinarily include or exclude. 14 Index Financial data by segment for the three and nine months ended September 30, 2022 and 2021 is as follows: Three Months Ended September 30, 2022 2021 (in thousands) Revenues: Premiums earned: Commercial lines $ 127,497 $ 119,709 Personal lines 78,625 76,526 GAAP premiums earned 206,122 196,235 Net investment income 8,569 7,764 Investment losses ( 2,358 ) ( 1,570 ) Other 505 677 Total revenues $ 212,838 $ 203,106 Loss before income tax benefit: Underwriting loss: Commercial lines $ ( 12,100 ) $ ( 10,962 ) Personal lines ( 9,126 ) ( 4,976 ) SAP underwriting loss ( 21,226 ) ( 15,938 ) GAAP adjustments 1,430 864 GAAP underwriting loss ( 19,796 ) ( 15,074 ) Net investment income 8,569 7,764 Investment losses ( 2,358 ) ( 1,570 ) Other 216 250 Loss before income tax benefit $ ( 13,369 ) $ ( 8,630 ) Nine Months Ended September 30, 2022 2021 (in thousands) Revenues: Premiums earned: Commercial lines $ 378,680 $ 344,234 Personal lines 230,819 231,741 GAAP premiums earned 609,499 575,975 Net investment income 24,631 22,926 Investment (losses) gains ( 10,811 ) 5,140 Other 1,457 2,181 Total revenues $ 624,776 $ 606,222 (Loss) income before income tax (benefit) expense: Underwriting (loss) income: Commercial lines $ ( 16,873 ) $ ( 17,437 ) Personal lines ( 12,654 ) 608 SAP underwriting loss ( 29,527 ) ( 16,829 ) GAAP adjustments 7,984 12,101 GAAP underwriting loss ( 21,543 ) ( 4,728 ) Net investment income 24,631 22,926 Investment (losses) gains ( 10,811 ) 5,140 Other 1 480 (Loss) income before income tax (benefit) expense $ ( 7,722 ) $ 23,818 15 Index 7 - Borrowings Lines of Credit In August 2020, we entered into a credit agreement with Manufacturers and Traders Trust Company (“M&T”) that related to a $ 20.0 million unsecured demand line of credit. The line of credit has no expiration date, no annual fees and no covenants. At September 30, 2022, we had no outstanding borrowings from M&T and had the ability to borrow up to $ 20.0 million at interest rates equal to the then-current LIBOR rate plus 2.00 %. Atlantic States is a member of the FHLB of Pittsburgh. Through its membership, Atlantic States has the ability to issue debt to the FHLB of Pittsburgh in exchange for cash advances. Atlantic States has a fixed-rate cash advance of $ 35.0 million that was outstanding at September 30, 2022. The cash advance carries a fixed interest rate of 1.74 % and is due in August 2024 . In March 2020, Atlantic States issued $ 50.0 million of debt to the FHLB of Pittsburgh in exchange for a cash advance in the same amount that carried a fixed interest rate of 0.83 %. Atlantic States obtained this contingent liquidity funding in light of uncertainty surrounding the economic impact of the COVID-19 pandemic. Atlantic States repaid this advance when it became due in March 2021 . The table below presents the amount of FHLB of Pittsburgh stock Atlantic States purchased, collateral pledged and assets related to Atlantic States’ membership in the FHLB of Pittsburgh at September 30, 2022. FHLB of Pittsburgh stock purchased and owned $ 1,573,300 Collateral pledged, at par (carrying value $ 43,360,439 ) 47,762,273 Borrowing capacity currently available 5,322,661 8 - Share–Based Compensation We measure all share-based payments to employees, including grants of stock options, and use a fair-value-based method for the recording of related compensation expense in our results of operations. In determining the expense we record for stock options granted to directors and employees of our subsidiaries and affiliates, we estimate the fair value of each option award on the date of grant using the Black-Scholes option pricing model. The significant assumptions we utilize in applying the Black-Scholes option pricing model are the risk-free interest rate, the expected term, the dividend yield and the expected volatility. We recorded compensation expense related to our stock compensation plans of $ 158,966 and $ 181,595 for the three months ended September 30, 2022 and 2021, respectively, with a corresponding income tax benefit of $ 33,383 and $ 38,135 , respectively. We recorded compensation expense related to our stock compensation plans of $ 644,751 and $ 778,763 for the nine months ended September 30, 2022 and 2021, respectively, with a corresponding income tax benefit of $ 135,398 and $ 163,540 , respectively. At September 30, 2022, we had $ 801,846 of unrecognized compensation expense related to nonvested share-based compensation granted under our stock compensation plans that we expect to recognize over a weighted average period of approximately 1.5 years. We received cash from option exercises under all stock compensation plans during the three months ended September 30, 2022 and 2021 of $ 2.9 million and $ 764,956 , respectively. We received cash from option exercises under all stock compensation plans during the nine months ended September 30, 2022 and 2021 of $ 14.1 million and $ 12.2 million, respectively. We realized actual tax benefits for the tax deductions related to those option exercises of $ 65,030 and $ 16,655 for the three months ended September 30, 2022 and 2021, respectively. We realized actual tax benefits for the tax deductions related to those option exercises of $ 329,842 and $ 437,790 for the nine months ended September 30, 2022 and 2021, respectively. 16 Index 9 - Fair Value Measurements We account for financial assets using a framework that establishes a hierarchy that ranks the quality and reliability of the inputs, or assumptions, we use in the determination of fair value, and we classify financial assets and liabilities carried at fair value in one of the following three categories: Level 1 – quoted prices in active markets for identical assets and liabilities; Level 2 – directly or indirectly observable inputs other than Level 1 quoted prices; and Level 3 – unobservable inputs not corroborated by market data. For investments that have quoted market prices in active markets, we use the quoted market price as fair value and include these investments in Level 1 of the fair value hierarchy. We classify publicly-traded equity securities as Level 1. When quoted market prices in active markets are not available, we base fair values on quoted market prices of comparable instruments or price estimates we obtain from independent pricing services and include these investments in Level 2 of the fair value hierarchy. We classify our fixed maturity investments and non-publicly traded equity securities as Level 2. Our fixed maturity investments consist of U.S. Treasury securities and obligations of U.S. government corporations and agencies, obligations of states and political subdivisions, corporate securities and mortgage-backed securities. We present our investments in available-for-sale fixed maturity and equity securities at estimated fair value. The estimated fair value of a security may differ from the amount that could be realized if we sold the security in a forced transaction. In addition, the valuation of fixed maturity investments is more subjective when markets are less liquid, increasing the potential that the estimated fair value does not reflect the price at which an actual transaction would occur. We utilize nationally recognized independent pricing services to estimate fair values or obtain market quotations for substantially all of our fixed maturity and equity investments. We generally obtain two prices per security. These pricing services utilize market quotations for fixed maturity and equity securities that have quoted prices in active markets. For fixed maturity securities that generally do not trade on a daily basis, the pricing services prepare estimates of fair value measurements based predominantly on observable market inputs. The pricing services do not use broker quotes in determining the fair values of our investments. Our investment personnel review the estimates of fair value the pricing services provide to verify that the estimates we obtain from the pricing services are representative of fair values based upon our investment personnel’s general knowledge of the market, their research findings related to unusual fluctuations in value and their comparison of such values to execution prices for similar securities. Our investment personnel monitor the market and are familiar with current trading ranges for similar securities and the pricing of specific investments. Our investment personnel review all pricing estimates that we receive from the pricing services against their expectations with respect to pricing based on fair market curves, security ratings, coupon rates, security types and recent trading activity. Our investment personnel periodically review documentation with respect to the pricing services’ pricing methodology that they obtain to determine if the primary pricing sources, market inputs and pricing frequency for various security types are reasonable. At September 30, 2022, we received two estimates per security from the pricing services, and we priced substantially all of our Level 1 and Level 2 investments using those prices. In our review of the estimates the pricing services provided at September 30, 2022, we did not identify any material discrepancies, and we did not make any adjustments to the estimates the pricing services provided. We present our cash and short-term investments at estimated fair value. We classify these items as Level 1. The carrying values we report in our balance sheet for premium receivables, reinsurance receivables related to paid losses and loss expenses and reinsurance balances payable approximate their fair values. The carrying amounts we report in our balance sheets for our subordinated debentures and borrowings under lines of credit approximate their fair values. We classify these items as Level 3. 17 Index We evaluate our assets and liabilities to determine the appropriate level at which to classify them for each reporting period. The following table presents our fair value measurements for our investments in available-for-sale fixed maturity and equity securities at September 30, 2022: Fair Value Measurements Using Fair Value Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) (in thousands) U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 42,888 $ — $ 42,888 $ — Obligations of states and political subdivisions 43,876 — 43,876 — Corporate securities 211,012 — 211,012 — Mortgage-backed securities 203,120 — 203,120 — Equity securities 46,776 44,492 2,284 — Total investments in the fair value hierarchy $ 547,672 $ 44,492 $ 503,180 $ — The following table presents our fair value measurements for our investments in available-for-sale fixed maturity and equity securities at December 31, 2021: Fair Value Measurements Using Fair Value Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) (in thousands) U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 32,185 $ — $ 32,185 $ — Obligations of states and political subdivisions 57,378 — 57,378 — Corporate securities 221,611 — 221,611 — Mortgage-backed securities 221,455 — 221,455 — Equity securities 63,420 61,130 2,290 — Totals $ 596,049 $ 61,130 $ 534,919 $ — 10 - Income Taxes At September 30, 2022 and December 31, 2021, respectively, we had no material unrecognized tax benefits or accrued interest and penalties. Tax years 2016 through 2021 remained open for examination at September 30, 2022. We provide a valuation allowance when we believe it is more likely than not that we will not realize some portion of our tax assets. We established a valuation allowance of $ 7.9 million for our net state operating loss carryforward. We have determined that we are not required to establish a valuation allowance for our other deferred tax assets of $ 41.5 million and $ 28.1 million at September 30, 2022 and December 31, 2021, respectively, because it is more likely than not that we will realize these deferred tax assets through reversals of existing temporary differences, future taxable income and the implementation of tax planning strategies. 11 - Liabilities for Losses and Loss Expenses The establishment of appropriate liabilities for losses and loss expenses is an inherently uncertain process, and we can provide no assurance that our insurance subsidiaries’ ultimate liabilities for losses and loss expenses will not exceed their loss and loss expense reserves and have an adverse effect on our results of operations and financial condition. Furthermore, we cannot predict the timing, frequency and extent of adjustments to our insurance subsidiaries’ estimated future liabilities, 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’ estimate of their liabilities for losses and loss expenses generally reflect actual payments and their evaluation of information received subsequent to the prior reporting period. 18 Index We summarize activity in our insurance subsidiaries’ liabilities for losses and loss expenses as follows: Nine Months Ended September 30, 2022 2021 (in thousands) Balance at January 1 $ 1,077,620 $ 962,007 Less reinsurance recoverable ( 451,261 ) ( 404,818 ) Net balance at January 1 626,359 557,189 Incurred related to: Current year 445,855 407,193 Prior years ( 30,609 ) ( 25,874 ) Total incurred 415,246 381,319 Paid related to: Current year 209,051 183,165 Prior years 170,129 149,910 Total paid 379,180 333,075 Net balance at end of period 662,425 605,433 Plus reinsurance recoverable 445,701 444,730 Balance at end of period $ 1,108,126 $ 1,050,163 Our insurance subsidiaries recognized a decrease in their liabilities for losses and loss expenses of prior years of $ 30.6 million and $ 25.9 million for the nine months ended September 30, 2022 and 2021, respectively. 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 2022 development represented 4.9 % of the December 31, 2021 net carried reserves and resulted primarily from lower-than-expected loss emergence or severity in nearly all lines of business. The majority of the 2022 development related to decreases in the liabilities for losses and loss expenses of prior years for Atlantic States and MICO. The 2021 development represented 4.6 % of the December 31, 2020 net carried reserves and resulted primarily from lower-than-expected loss emergence or severity in nearly all lines of business. The majority of the 2021 development related to decreases in the liabilities for losses and loss expenses of prior years for Atlantic States and MICO. Short-duration contracts are contracts for which our insurance subsidiaries receive premiums that they recognize as revenue over the period of the contract in proportion to the amount of insurance protection our insurance subsidiaries provide. Our insurance subsidiaries consider the policies they issue to be short-duration contracts. We consider the material lines of business of our insurance subsidiaries to be personal automobile, homeowners, commercial automobile, commercial multi-peril and workers’ compensation. Our insurance subsidiaries determine incurred but not reported (“IBNR”) reserves by subtracting the cumulative loss and loss expense amounts our insurance subsidiaries have paid and the case reserves our insurance subsidiaries have established at the balance sheet date from their actuaries’ estimate of the ultimate cost of losses and loss expenses. Accordingly, the IBNR reserves of our insurance subsidiaries include their actuaries’ projections of the cost of unreported claims as well as their actuaries’ projected development of case reserves on known claims and reopened claims. Our insurance subsidiaries’ methodology for estimating IBNR reserves has been in place for many years, and their actuaries made no significant changes to that methodology during the nine months ended September 30, 2022. 19 Index The actuaries for our insurance subsidiaries generally prepare an initial estimate for ultimate losses and loss expenses for the current accident year by multiplying earned premium by an ‘‘a priori,’’ or expected, loss ratio for each line of business our insurance subsidiaries write. Expected loss ratios represent the actuaries’ expectation of losses at the time our insurance subsidiaries price and write their policies and before the emergence of any actual claims experience. The actuaries determine an expected loss ratio by analyzing historical experience and adjusting for loss cost trends, loss frequency and severity trends, premium rate level changes, reported and paid loss emergence patterns and other known or observed factors. The actuaries use a variety of actuarial methods to estimate the ultimate cost of losses and loss expenses. These methods include paid loss development, incurred loss development and the Bornhuetter-Ferguson method from which the actuaries select loss development factor assumptions. The actuaries base their selection of a point estimate on a judgmental weighting of the estimates each of these methods produce. The actuaries consider loss frequency and severity trends when they develop expected loss ratios and point estimates. Loss frequency is a measure of the number of claims per unit of insured exposure, and loss severity is a measure of the average size of claims. Factors that affect loss frequency include changes in weather patterns and economic activity. Factors that affect loss severity include changes in policy limits, reinsurance retentions, inflation rates and judicial interpretations. Our insurance subsidiaries create a claim file when they receive notice of an actual demand for payment, an event that may lead to a demand for payment or when they otherwise determine that a demand for payment could potentially lead to a future demand for payment on another coverage under the same policy or another policy they have issued. In recent years, our insurance subsidiaries have noted an increase in the period of time between the occurrence of a casualty loss event and the date at which they receive notice of a liability claim. Changes in the length of time between the loss occurrence date and the claim reporting date affect the actuaries’ ability to predict loss frequency accurately and the amount of IBNR reserves our insurance subsidiaries require. Our insurance subsidiaries generally create a claim file for a policy at the claimant level by type of coverage and generally recognize one count for each claim event. In certain lines of business where it is common for multiple parties to claim damages arising from a single claim event, our insurance subsidiaries recognize one count for each claimant involved in the event. Atlantic States recognizes one count for each claim event, or claimant involved in a multiple-party claim event, related to losses Atlantic States assumes through its participation in its pooling agreement with Donegal Mutual. Our insurance subsidiaries accumulate the claim counts and report them by line of business. 12 - Impact of New Accounting Standards In September 2016, the FASB issued guidance that amends previous guidance on the impairment of financial instruments by adding an impairment model that requires an entity to recognize expected credit losses as an allowance rather than impairments as credit losses are incurred. The intent of this guidance is to reduce complexity and result in a more timely recognition of expected credit losses. In November 2019, the FASB issued guidance that delays the effective date for “smaller reporting companies,” as defined in Item 10(f)(1) of Regulation S-K, to annual and interim reporting periods beginning after December 15, 2022 from December 15, 2019. We are a smaller reporting company and are in the process of evaluating our investment portfolio, reinsurance receivable and premiums receivable, including a review of historical credit loss data and issuer credit standing and using a probability of default methodology, to determine the impact of the adoption of this guidance on our financial position, results of operations and cash flows. 20 Index