SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                                    FORM 10-K

            [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 1996
                                       OR

          [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________________ to _________________
Commission file number 0-15341

                               DONEGAL GROUP INC.
              ----------------------------------------------------
             (Exact name of registrant as specified in its charter)

             Delaware                                          23-2424711
 -------------------------------                           -------------------
 (State or other jurisdiction of                            (I.R.S. Employer
  incorporation or organization)                           Identification No.)

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

Registrant's telephone number, including area code:   (717) 426-1931
Securities registered pursuant to Section 12(b) of the Act:  None.

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

                          Common Stock, $1.00 par value
                          -----------------------------
                                (Title of class)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes X . No  .
                                      ---    ---

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]

On March 14, 1997, the aggregate market value (based on the closing sales price
on that date) of the voting stock held by non-affiliates of the Registrant was
$42,732,252.

Indicate the number of shares outstanding of each of the Registrant's classes of
common stock, as of the latest practicable date: 4,479,557 shares of Common
Stock outstanding on March 14, 1997.

                      DOCUMENTS INCORPORATED BY REFERENCE:

1. Portions of the Registrant's annual report to stockholders for the fiscal
year ended December 31, 1996 are incorporated by reference into Parts I, II and
IV of this report.

2. Portions of the Registrant's proxy statement relating to the annual meeting
of stockholders to be held April 17, 1997 are incorporated by reference into
Part III of this report.

                               DONEGAL GROUP INC.

                            INDEX TO FORM 10-K REPORT

                                                                           Page
                                                                           ----
I.    PART I.

      Item 1.      Business................................................  3
      Item 2.      Properties.............................................. 23
      Item 3.      Legal Proceedings....................................... 23
      Item 4.      Submission of Matters to a Vote of
                    Security Holders....................................... 23

II.   PART II.

      Item 5.      Market for Registrant's Common Equity and
                    Related Stockholder Matters............................ 25
      Item 6.      Selected Financial Data................................. 25
      Item 7.      Management's Discussion and Analysis of
                    Financial Condition and Results of
                    Operations............................................. 25
      Item 8.      Financial Statements and Supplementary
                    Data................................................... 25
      Item 9.      Changes in and Disagreements with
                    Accountants on Accounting and
                    Financial Disclosure................................... 25

III   PART III.

      Item 10.     Directors and Executive Officers of the
                    Registrant............................................. 26
      Item 11.     Executive Compensation.................................. 26
      Item 12.     Security Ownership of Certain Beneficial
                    Owners and Management.................................. 26
      Item 13.     Certain Relationships and Related
                    Transactions........................................... 26

IV.   PART IV.

      Item 14.     Exhibits, Financial Statement Schedules
                     and Reports on Form 8-K............................... 27

                                     PART I

Item 1.           Business.

         (a)      General Development of Business.

                  Donegal Group Inc. is a regional insurance holding company
formed in August 1986 which is headquartered in Pennsylvania and engages,
through its subsidiaries, in the property and casualty insurance business. As
used herein, "DGI" or the "Company" refers to Donegal Group Inc. and its
subsidiaries, Atlantic States Insurance Company ("Atlantic States"), Southern
Insurance Company of Virginia ("Southern"), Delaware Atlantic Insurance Company,
formerly known as Delaware American Insurance Company ("Delaware Atlantic"), and
Atlantic Insurance Services, Inc. ("AIS"). DGI is currently 58.5% owned by
Donegal Mutual Insurance Company (the "Mutual Company"). The Mutual Company's
principal subsidiaries are Pioneer Insurance Company ("Pioneer") and Aberdeen
Insurance Group, Inc. ("Aberdeen"). DGI and the Mutual Company and their
subsidiaries underwrite a broad line of personal and commercial coverages,
consisting of private passenger and commercial automobile, homeowners,
commercial multi-peril, workers' compensation and other lines of insurance.

                  Atlantic States, which DGI organized in September 1986,
participates in an underwriting pool whereby it cedes to the Mutual Company the
premiums, losses and loss expenses from all of its insurance business and
assumes from the Mutual Company a specified portion of the pooled business,
which also includes substantially all of the Mutual Company's property and
casualty insurance business. Effective as of October 1, 1986, DGI entered into a
pooling agreement with the Mutual Company whereby Atlantic States assumed 35% of
the pooled business written or in force on or after October 1, 1986. Effective
October 1, 1988, the pooling agreement was amended to provide for the assumption
by Atlantic States of 50% of the pooled business written or in force on or after
October 1, 1988. Effective January 1, 1993, the pooling agreement was further
amended to provide for the assumption by Atlantic States of 60% of the pooled
business written or in force on or after January 1, 1993. Effective January 1,
1996, the pooling agreement was further amended to provide for the assumption by
Atlantic States of 65% of the pooled business written or in force on or after
January 1, 1996. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included in Item 7 hereof and Note 2 to the
Consolidated Financial Statements incorporated by reference herein.

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

                                       -3-

include approximately 80% of the business written by Southern. See Note 2 to the
Consolidated Financial Statements incorporated by reference herein.

                  As of March 31, 1993, the Mutual Company converted Pioneer
Mutual Insurance Company into Pioneer, a stock insurance company, which writes
property and casualty insurance in Ohio, and acquired all of Pioneer's capital
stock. Pioneer does not currently participate in the pooling agreement. In
connection with the Pioneer transaction, the Mutual Company was admitted in Ohio
and began active marketing of its insurance products in Ohio in the fourth
quarter of 1993.

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

                  In December 1994, the Superintendent of Insurance of the State
of Ohio issued an order permitting the sale by the Mutual Company to DGI of all
of the outstanding capital stock of Pioneer at the independently determined fair
market value thereof at the date of sale. It is anticipated that this sale will
occur on or before March 31, 1997. Pioneer and the Mutual Company are parties to
an excess of loss reinsurance agreement whereby the Mutual Company reinsures
Pioneer for losses in excess of $100,000 up to a limit of $150,000, and a
property catastrophe excess of loss reinsurance agreement whereby the Mutual
Company reinsures Pioneer for catastrophe losses in excess of $200,000 up to a
limit of $2,800,000.

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

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

                                       -4-

property rights and proprietary information of Downie Agency relating to the
operation of the excess and surplus lines insurance agency business that was
acquired.

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

         (b)      Financial Information about Industry Segments.

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

         (c)      Narrative Description of Business.

Relationship with the Mutual Company

                  DGI's operations are interrelated with the operations of the
Mutual Company and, because of the percentage of the pooled business assumed by
DGI, DGI's results of operations are largely dependent upon the success of the
Mutual Company. In addition, various reinsurance agreements exist between the
Company and the Mutual Company. The Mutual Company is responsible for
underwriting and marketing the pooled business and provides facilities,
employees and services required to conduct the business of DGI on a cost
allocated basis. The Mutual Company owned 58.5% of DGI as of March 14, 1997.

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

                  Under the terms of the intercompany pooling agreement, which
took effect on October 1, 1986, Atlantic States cedes to the Mutual Company the
premiums, losses and loss expenses on all of its insurance business.
Substantially all of the Mutual Company's property and casualty insurance
business, including the business reinsured from Southern, written or in force on
or after October 1, 1986 is also included in the pooled business. The Mutual
Company retroceded 35% of the pooled business to Atlantic States and retained
65% until October 1, 1988 when Atlantic States assumed 50% of the pooled
business written or in force on or after October 1, 1988. Effective January 1,
1993, Atlantic States assumed 60% of the pooled business written or in force on
or after January 1, 1993, and, effective January 1, 1996, Atlantic States
assumed 65% of the pooled business written or in force on or after January 1,
1996. All premiums, losses, loss expenses, other underwriting expenses and
policy dividends are prorated among the parties on the basis of their

                                       -5-

participation in the pool. The pooling agreement may be amended or terminated at
the end of any calendar year by agreement of the parties. The Company does not
intend to terminate its participation in the pooling agreement. The allocations
of pool participation percentages between the Mutual Company and the Company are
based on the pool participants' relative amounts of capital and surplus and
expectations of future relative amounts of capital and surplus. The pooling
agreement does not legally discharge Atlantic States from its primary liability
for the full amount of the policies ceded. However, it makes the Mutual Company
liable to Atlantic States to the extent of the business ceded.

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

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

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

DGI's Business Strategy

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

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

                                      -6-

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

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

                  o       An agent selection process that focuses on appointing
                          agencies with proven market strategies for the devel-
                          opment of profitable business and an agent compensa-
                          tion plan providing for additional commissions based
                          upon premium volume and profitability and the right
                          to participate in the Company's Agency Stock Purchase
                          Plan.

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

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

Property and Casualty Insurance Products and Services

                  The following table indicates the percentage of DGI's net
premiums written represented by commercial lines and by personal lines for the
years ended December 31, 1996, 1995 and 1994:

                                           Year Ended December 31
                                   --------------------------------------
                                   1996            1995              1994
                                   ----            ----              ----

Net Premiums Written:          
  Commercial...................   45.2%            46.8%            43.6%
  Personal.....................   54.8             53.2             56.4

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

         Commercial

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

                  o        Workers' compensation -- policies purchased by 
                           employers to provide benefits to employees for
                           injuries sustained during employment. The extent of
                           coverage

                                       -7-

                           is established by the workers' compensation laws of
                           each state.

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

         Personal

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

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

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

                                         Year Ended December 31,
                                    --------------------------------
                                    1996          1995          1994
                                    ----          ----          ----

GAAP Combined Ratio..........       99.4%         97.3%         101.7%
Statutory operating ratios:
  Loss ratio.................       67.7          65.6           68.9
  Expense ratio..............       30.9          31.6           31.3
  Dividend ratio.............        1.5           1.2            1.7
                                   -----         -----          -----
  Statutory combined ratio...      100.1          98.4          101.9
Industry statutory combined
  ratio......................      107.0(1)      105.0(2)       109.6(2)
- ----------
(1)      Source:  A.M. Best Co.
(2)      Source:  Insurance Information Institute

                                       -8-

                  DGI is required to participate in involuntary insurance
programs for automobile insurance, as well as other property and casualty
insurance lines, in states in which DGI operates. These programs include joint
underwriting associations, assigned risk plans, fair access to insurance
requirements ("FAIR") plans, reinsurance facilities and windstorm plans.
Legislation establishing these programs requires all companies that write lines
covered by these programs to provide coverage (either directly or through
reinsurance) for insureds who cannot obtain insurance in the voluntary market.
The legislation creating these programs usually allocates a pro rata portion of
risks attributable to such insureds to each company on the basis of direct
premiums written or the number of automobiles insured. Generally, state law
requires participation in such programs as a condition to doing business. The
loss ratio on insurance written under involuntary programs has traditionally
been greater than the loss ratio on insurance in the voluntary market. The
impact of these involuntary programs on DGI has been immaterial.

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

                                               Year Ended December 31,
                                       ------------------------------------
                                          1996         1995          1994
                                          ----         ----          ----
                                                  (in thousands)
Net Premiums Written:
Commercial:
  Automobile.....................      $ 10,149       $ 8,306       $ 6,133
  Workers' compensation..........        17,327        17,607        15,110
  Commercial multi-peril.........        16,975        14,598        11,028
  Other..........................         2,823         2,422         2,251
                                       --------       -------       -------
   Total commercial .............        47,274        42,933        34,522
                                       --------       -------       -------

Personal:
  Automobile.....................        36,331        31,060        29,263
  Homeowners.....................        18,008        14,932        12,850
  Other..........................         3,057         2,746         2,598
                                       --------       -------       -------
    Total personal...............        57,396        48,738        44,711
                                       --------       -------       -------
Total business...................      $104,670       $91,671       $79,233
                                       ========       =======       =======

Statutory Combined Ratios:
Commercial:
  Automobile.....................         97.6%         92.9%        116.1%
  Workers' compensation..........         66.6          76.9          80.0
  Commercial multi-peril.........        106.5         110.0          95.0
  Other..........................         65.1          88.2          92.4
    Total commercial.............         87.0%         91.6%         92.0%

                                       -9-

Personal:
  Automobile.....................         99.9%         98.7%         92.3%
  Homeowners.....................        136.4         118.7         147.5
  Other..........................         99.6          90.8         111.4
    Total personal...............        111.2%        104.1%        109.3%
Total business...................        100.1%         98.4%        101.9%

Property and Casualty Underwriting

                  The underwriting department is responsible for the
establishment of underwriting and risk selection guidelines and criteria for the
various insurance products written by DGI. The underwriting department, in
conjunction with the marketing representatives, works closely with DGI's
independent agents to insure a comprehensive knowledge on the part of the agents
of DGI's underwriting requirements and risk selection process.

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

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

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

Marketing

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

                                      -10-

by DGI and the Mutual Company. Management believes the contingent commission
program and the Company's Agency Stock Purchase Plan have enhanced the ability
of DGI and the Mutual Company to write profitable business.

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

                  DGI believes that its regional structure enables it to compete
effectively with large national companies. This regional structure permits DGI
to take advantage of its knowledge of local operating territories and the
opportunity to form strong, long-term relationships with the agents that
represent DGI and the Mutual Company.

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

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

Claims

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

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

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

                                      -11-

Liabilities for Losses and Loss Expenses

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

                  DGI maintains liabilities for the eventual payment of losses
and loss expenses with respect to both reported and unreported claims.
Liabilities for loss expenses are intended to cover the ultimate costs of
settling all losses, including investigation and litigation costs from such
losses. The amount of liability for reported losses is primarily based upon a
case-by-case evaluation of the type of risk involved and knowledge of the
circumstances surrounding each claim and the insurance policy provisions
relating to the type of loss. The amount of liability for unreported claims and
loss expenses is determined on the basis of historical information by line of
insurance. Inflation is implicitly provided for in the reserving function
through analysis of costs, trends and reviews of historical reserving results.
Liabilities are closely monitored and are recomputed periodically by the Company
and the Mutual Company using new information on reported claims and a variety of
statistical techniques. Liabilities for losses are not discounted.

                  The establishment of appropriate liabilities is an inherently
uncertain process, and there can be no assurance that the ultimate liability
will not exceed DGI's loss and loss expenses and have an adverse effect on DGI's
results of operations and financial condition. As is the case for virtually all
property and casualty insurance companies, DGI has found it necessary in the
past to revise in non-material amounts estimated future liabilities for losses
and loss expenses, and further adjustments could be required in the future.
However, on the basis of DGI's internal procedures, which analyze, among other
things, DGI's experience with similar cases and historical trends such as
reserving patterns, loss payments, pending levels of unpaid claims and product
mix, as well as court decisions, economic conditions and public attitudes,
management of DGI believes that adequate provision has been made for DGI's
liability for loss and loss expenses.

                  Differences between liabilities reported in DGI's financial
statements prepared on the basis of generally accepted accounting principles and
financial statements prepared on a statutory accounting basis result from
reducing statutory liabilities for anticipated salvage and subrogation
recoveries. These differences amounted to $4,918,547, $3,880,621 and $2,730,112
at December 31, 1996, 1995 and 1994, respectively.

                                      -12-

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

                                                                               Year Ended December 31,
                                                               ----------------------------------------------------
                                                                 1996                    1995                1994
                                                               --------                --------             -------
                                                                                    (in thousands)
                                                                                                       
Net liability for unpaid losses
 and loss expenses at
 beginning of year.....................................         $70,041                 $62,577             $52,298
                                                                -------                 -------             -------
Acquisition of Delaware Atlantic.......................           ---                     ---                 5,670
                                                                -------                 -------             -------
New balance beginning of year..........................          70,041                  62,577              57,968
                                                                -------                  ------             -------
Provision for net losses and
 loss expenses for claims
 incurred in the current year..........................          69,206                  58,354              55,941
Increase (decrease) in provision
 for estimated net losses and
 loss expenses for claims
 incurred in prior years...............................          (2,595)                 (2,947)             (3,084)
                                                                -------                 -------             -------

Total incurred.........................................          66,611                  55,407              52,857

Net losses and loss payments for claims incurred during:
 The current year......................................          39,988                  28,834              30,544
 Prior years...........................................          22,889                  19,009              17,704
                                                                -------                 -------             -------

Total paid.............................................          62,877                  47,943              48,248

Net liability for unpaid losses
 and loss expenses at
 end of year...........................................         $73,774                 $70,040             $62,577
                                                                =======                 =======             =======

                  The following table sets forth the development of the
liability for net unpaid losses and loss expenses for DGI on a GAAP basis from
1987 (the first full year of DGI's operations) to 1996, with supplemental loss
data for 1996 and 1995.

                  "Net liability at end of year for unpaid losses and loss
expenses" sets forth the estimated liability for net unpaid losses and loss
expenses recorded at the balance sheet date for each of the indicated years.
This liability represents the estimated amount of net losses and loss expenses
for claims arising in the current and all prior years that are unpaid at the
balance sheet date including losses incurred but not reported.

                  The "Liability reestimated as of" portion of the table shows
the reestimated amount of the previously recorded liability based on experience
for each succeeding year. The estimate is increased or decreased as payments are
made and more information becomes known about the severity of the remaining
unpaid claims. For example, the 1990 liability has developed an excess after six
years, in that reestimated net losses and loss expenses are expected

                                      -13-

to be less than the estimated liability initially established in 1990
of $31,898,000 by $2,303,000.

                  The "Cumulative deficiency (excess)" shows the cumulative
deficiency or excess at December 31, 1996 of the liability estimate shown on the
top line of the corresponding column. An excess in liability means that the
liability established in prior years exceeded actual net losses and loss
expenses or were reevaluated at less than the original amount. A deficiency in
liability means that the liability established in prior years was less than
actual net losses and loss expenses or were reevaluated at more than the
original amount.

                  The "Cumulative amount of liability paid through" portion of
the table shows the cumulative net losses and loss expense payments made in
succeeding years for net losses incurred prior to the balance sheet date. For
example, the 1990 column indicates that as of December 31, 1996, payments equal
to $28,157,000 of the currently reestimated ultimate liability for net losses
and loss expenses of $29,595,000 had been made.

                                      -14-

                                                                    Year Ended December 31
                         -----------------------------------------------------------------------------------------------------------
                           1987       1988       1989       1990       1991      1992       1993       1994        1995       1996
                         --------   --------   --------   --------   --------   --------   --------   --------   --------   --------
                                                                        (in thousands)
                                                                                                   
Net liability at end of
 year for unpaid losses
 and loss expenses ....  $ 11,878   $ 20,734   $ 27,767   $ 31,898   $ 36,194   $ 43,449   $ 52,298   $ 62,577   $ 70,040   $ 73,774
 Net liability
  reestimated as of:
   One year later .....    12,678     21,598     29,175     32,923     37,514     44,713     50,223     59,630     67,445
   Two years later ....    12,949     20,475     28,861     33,550     37,765     42,053     47,820     56,123
   Three years later ..    12,692     19,823     28,545     32,803     35,446     40,077     44,674
   Four years later ...    12,160     19,296     27,717     31,004     33,931     37,791
   Five years later ...    11,799     18,796     26,759     30,041     32,907
   Six years later ....    11,857     18,457     26,180     29,595
   Seven years later ..    11,782     18,189     25,971
   Eight years later ..    11,722     18,117
   Nine years later ...    11,655
Cumulative deficiency
   (excess) ...........  $   (223)  $ (2,617)  $ (1,796)  $ (2,303)  $ (3,287)  $ (5,658)  $ (7,624)  $ (6,454)  $ (2,595)
                         ========   ========   ========   ========   ========   ========   ========   ========   ========

Cumulative amount of
  liability paid
  through:
  One year later ......  $  5,891   $  8,855   $ 11,401   $ 13,003   $ 13,519   $ 16,087   $ 15,947   $ 19,009   $ 22,889
  Two years later .....     8,472     12,280     17,421     19,795     20,942     24,010     25,128     29,892
  Three years later ...     9,988     14,912     20,986     24,178     25,308     28,802     31,837
  Four years later ....    10,774     16,292     23,268     26,413     27,826     32,368
  Five years later ....    11,209     17,201     24,331     27,439     29,605
  Six years later .....    11,388     17,706     24,909     28,157
  Seven years later ...    11,484     17,782     25,280
  Eight years later ...    11,544     17,884
  Nine years later ....    11,563

                                                      Year Ended December 31
                                       ---------------------------------------------------
                                         1992      1993       1994       1995       1996
                                       --------  --------   --------   --------   --------
                                                                        
Gross liability at end of year ......  $ 55,870  $ 69,442   $ 87,744   $ 97,733   $110,023
Reinsurance recoverable .............    12,421    17,144     25,167     27,693     36,248
Net liability at end of year ........    43,449    52,298     62,577     70,040     73,775
Gross reestimated liability -- latest    57,534    63,006     80,472     93,852
Reestimated recoverable -- latest ...    19,743    18,332     24,349     26,407
Net reestimated liability -- latest .    37,791    44,674     56,123     67,445
Gross cumulative deficiency (excess)      1,664    (6,436)    (7,272)    (3,881)

                                      -15-

Reinsurance

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

                  The external reinsurance purchased by DGI and the Mutual
Company includes "excess treaty reinsurance" under which losses are
automatically reinsured over a set retention ($250,000 for 1996) and
"catastrophic reinsurance" under which the reinsured recovers 90% of an
accumulation of many losses resulting from a single event, including natural
disasters (for 1996, $3,000,000 retention), DGI's principal reinsurance
agreement, other than that with the Mutual Company, is an excess of loss treaty
in which the reinsurers are Continental Casualty Company, Employers Reinsurance
Corporation and Dorinco Reinsurance Company. Reinsurance is also purchased on an
individual policy basis to reinsure losses that may occur from large risks,
specific risk types or specific locations. The amount of coverage provided under
each of these types of reinsurance depends upon the amount, nature, size and
location of the risk being reinsured. For property insurance, excess of loss
treaties provide for coverage up to $1,000,000. For liability insurance, excess
of loss treaties provide for coverage up to $30,000,000. Property catastrophe
contracts provide coverage up to $50,000,000 resulting from one event. On both
property and casualty insurance, DGI and the Mutual Company purchase facultative
reinsurance to cover exposures from losses that exceed the limits provided by
their respective treaty reinsurance. In addition, the Company and the Mutual
Company maintain various reinsurance agreements between themselves in addition
to the pooling agreement. Atlantic States and the Mutual Company have a
catastrophe reinsurance agreement which limits the maximum liability for losses
from any one catastrophe occurrence to $400,000 for Atlantic States and $700,000
for a catastrophe involving more than one of the Company's subsidiaries.
Southern and the Mutual Company have an excess of loss reinsurance agreement in
which the Mutual Company assumes up to $150,000 for losses in excess of
$100,000. Southern and the Mutual Company also have a catastrophe reinsurance
agreement which limits Southern's liability to $300,000 from any one catastrophe
occurrence. Delaware Atlantic and the Mutual Company have an excess of loss
reinsurance agreement in which the Mutual Company assumes up to $200,000 for
losses in excess of $50,000. Delaware Atlantic and the Mutual Company also have
a Catastrophe Reinsurance Agreement which limits Delaware Atlantic's liability
to $300,000 from any one catastrophe occurrence. Delaware Atlantic and the
Mutual Company also have a reinsurance contract whereby Delaware Atlantic cedes
70% of its workers' compensation business to the Mutual Company. Each of
Southern, Delaware Atlantic and Pioneer also have a Retrocessional Reinsurance
Agreement with the Mutual Company whereby the Mutual Company indemnifies each
Affiliate in respect of 100% of the net liability that may accrue to such
Affiliate from its insurance operations and retrocedes 100% of the net liability
back to each Affiliate, which the Affiliate assumes as part of the retrocession.

                                      -16-

Competition

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

Investments

                  DGI's return on invested assets is an important element of its
financial results. Currently, the investment objective is to maintain a widely
diversified fixed maturities portfolio structured to maximize after-tax
investment income while minimizing credit risk through investments in high
quality instruments. At December 31, 1996, all debt securities were rated
investment grade with the exception of one unrated obligation of $250,000, and
the investment portfolio did not contain any mortgage loans or any
non-performing assets.

                  The following table shows the composition of the debt
securities investment portfolio (at carrying value), excluding short-term
investments, by rating as of December 31, 1996:

                                                      December 31, 1996
                                                 ----------------------------
     Rating(1)                                    Amount             Percent
- ---------------------                            --------           ---------
                                                     (dollars in thousands)

U.S. Treasury and U.S.
  agency securities(2) .......................   $ 83,645             51.9%
Aaa or AAA ...................................     43,857             27.2
Aa or AA .....................................     25,879             16.0
A ............................................      7,442              4.6
BBB ..........................................         97              0.1
Not rated(3) .................................        250              0.2%
                                                 --------            -----
    Total ....................................   $161,170            100.0%
                                                 ========            =====
- ----------

(1)      Ratings assigned by Moody's Investors Services, Inc. or Standard
         & Poor's Corporation.

(2)      Includes mortgage-backed securities of $13,542,146.

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

                                      -17-

                  DGI invests in both taxable and tax-exempt securities as part
of its strategy to maximize after-tax income. Such strategy considers, among
other factors, the alternative minimum tax. Tax-exempt securities made up
approximately 37.0%, 38.5% and 26.4% of the total investment portfolio at
December 31, 1996, 1995 and 1994, respectively.

                  The following table shows the classification of the
investments (at carrying value) of DGI and its subsidiaries at December 31,
1996, 1995 and 1994.

                                                                                December 31
                                              ----------------------------------------------------------------------------------
                                                      1996                          1995                         1994
                                              ---------------------         ----------------------       -----------------------
                                                             Percent                        Percent                       Percent
                                                               of                             of                            of
                                              Amount          Total         Amount           Total        Amount           Total
                                              ------          -----         ------           -----        ------           -----
                                                                           (dollars in thousands)
                                                                                                         
Fixed maturities(1):
 Held to maturity:
  U.S. Treasury securities
   and obligations of U.S.
   government corporations
   and agencies ..........................   $ 37,394           20.2%      $ 19,676           12.2%      $ 14,271            9.8%
  Obligations of states and
   political subdivisions ................     55,989           30.2         52,081           32.3         32,110           22.1
  Corporate securities ...................      5,767            3.1          3,816            2.4          2,994            2.1
  Mortgage-backed
   securities ............................     12,431            6.7         16,406           10.1         20,783           14.2
                                             --------          -----       --------          -----       --------          -----
    Total held to
     maturity ............................    111,581           60.2         91,979           57.0         70,158           48.2
                                             --------          -----       --------          -----       --------          ----- 
Available for sale:
  U.S. treasury securities
   and obligations of U.S.
   government corporations
   and agencies ..........................     32,709           17.6         35,421           21.9         33,429           22.9
  Obligations of states and
   political subdivisions ................     12,682            6.8         10,120            6.3          6,357            4.4
  Corporate securities ...................      3,087            1.7          4,348            2.7          3,734            2.6
  Mortgage-backed
   securities ............................      1,111            0.6          1,758            1.1            202            0.1
                                             --------          -----       --------          -----       --------          -----
    Total available
     for sale ............................     49,589           26.7         51,647           32.0         43,722           30.0
                                             --------          -----       --------          -----       --------          -----
    Total fixed
     maturities ..........................    161,170           86.9        143,626           89.0        113,880           78.2
Equity securities(2) .....................      3,134            1.7          3,264            2.0          4,202            2.9
Short-term
 investments(3) ..........................     21,207           11.4         14,498            9.0         27,485           18.9
                                             --------          -----       --------          -----       --------          -----

Total investments ........................   $185,511          100.0%      $161,388          100.0%      $145,567          100.0%
                                             ========          =====       ========          =====       ========          =====

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

(1)      The Company accounts for investments in accordance with Statement of
         Financial Accounting Standards (SFAS) No. 115, "Accounting For Certain
         Investments in Debt and Equity Securities."  See

                                      -18-

         Notes 1 and 3 to the Consolidated Financial Statements incorporated by
         reference herein. Fixed maturities held to maturity are valued at
         amortized cost; those fixed maturities available for sale are valued at
         fair value. Total fair value of fixed maturities held to maturity was
         $113,461,217 at December 31, 1996. The amortized cost of fixed
         maturities available for sale was $49,314,520 at December 31, 1996.

(2)      Equity securities are valued at fair value. Total cost of equity
         securities was $2,770,346 at December 31, 1996, $2,954,487 at December
         31, 1995 and $4,897,115 at December 31, 1994.

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

                  The following table sets forth the maturities (at carrying
value) in the fixed maturity and short-term investment portfolio at December 31,
1996, December 31, 1995 and December 31, 1994.

                                                                                     December 31
                                                ---------------------------------------------------------------------------------
                                                         1996                           1995                        1994
                                                ----------------------         -----------------------       --------------------
                                                                Percent                         Percent                    Percent
                                                                  of                              of                         of
                                                Amount           Total         Amount            Total        Amount        Total
                                                ------           -----         ------            -----        ------        -----
                                                                                (dollars in thousands)
                                                                                                          
Due in:(1)
One year or less ......................        $ 12,615             7.8%      $ 34,493            21.8%      $ 35,803        25.3
Over one year
 through three years ..................          24,686            15.3         19,546            12.4         34,204        24.2
Over three years
 through five years ...................          20,150            12.5          9,559             6.0          5,346         3.8
Over five years
 through ten years ....................          43,626            27.1         35,005            22.1          9,846         7.0
Over ten years
 through fifteen
 years ................................          45,500            28.2         39,172            24.8         29,665        21.0
Over fifteen years ....................           1,051             0.7          2,185             1.4          5,968         4.2
Mortgage-backed
 securities ...........................          13,542             8.4         18,164            11.5         20,534        14.5
                                               --------           -----       --------           -----       --------       -----
                                               $161,170           100.0%      $158,124           100.0%      $141,366       100.0%
                                               ========           =====       ========           =====       ========       =====

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

                  As shown above, the Company held investments in
mortgage-backed securities having a carrying value of $13,542,146 at December
31, 1996. Included in these investments are collateralized mortgage

                                      -19-

obligations ("CMOs") with a carrying value of $12,730,101 at December 31, 1996.
The Company has attempted to reduce the prepayment risks associated with
mortgage-backed securities by investing approximately 87.8%, as of December 31,
1996, of the Company's holdings of CMOs in planned amortization and very
accurately defined tranches. Such investments are designed to alleviate the risk
of prepayment by providing predictable principal prepayment schedules within a
designated range of prepayments. If principal is repaid earlier than originally
anticipated, investment yields may decrease due to reinvestment of these funds
at lower current interest rates and capital gains or losses may be realized
since the book value of securities purchased at premiums or discounts may be
different from the prepayment amount.

                  Investment results of DGI and its subsidiaries for the years
ended December 31, 1996, 1995 and 1994 are shown in the following table:

                                                 Year Ended December 31,
                                           ----------------------------------
                                           1996           1995           1994
                                           ----           ----           ----
                                                  (dollars in thousands)

Invested assets(1) ................      $175,780       $155,093       $134,636
Investment income(2) ..............        10,316          9,270          7,778
Average yield .....................           5.9%           6.0%           5.8%
- ----------------

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

(2)      Investment income is net of investment expenses and does not include
         realized investment gains or losses or provision for income taxes.

A.M. Best Rating

                  In 1996, the Best rating of the Mutual Company, Atlantic
States, Southern and Delaware Atlantic was "A", based upon their respective
current financial conditions and historical statutory results of operations.
Management believes that this Best rating is an important factor in marketing
DGI's products to its agents and customers. Best's ratings are industry ratings
based on a comparative analysis of the financial condition and operating
performance of insurance companies as determined by their publicly available
reports. Best's classifications are A++ and A+ (Superior), A and A-
(Excellent), B++ and B+ (Very Good), B and B- (Good), C++ and C+ (Fair), C and
C- (Marginal), D (below minimum standards) and E and F (Liquidation). Best's
ratings are based upon factors relevant to policyholders and are not directed
toward the protection of investors. According to Best, an "excellent" rating is
assigned to those companies which, in Best's opinion, have achieved excellent
overall performance when compared to the norms of the property and casualty

                                      -20-

insurance industry and have generally demonstrated a strong ability to meet
policyholder and other contractual obligations.

Regulation

                  Insurance companies are subject to supervision and regulation
in the states in which they transact business. Such supervision and regulation
relates to numerous aspects of an insurance company's business and financial
condition. The primary purpose of such supervision and regulation is the
protection of policyholders. The extent of such regulation varies, but generally
derives from state statutes which delegate regulatory, supervisory and
administrative authority to state insurance departments. Accordingly, the
authority of the state insurance departments includes the establishment of
standards of solvency which must be met and maintained by insurers, the
licensing to do business of insurers and agents, the nature of and limitations
on investments, premium rates for property and casualty insurance, the
provisions which insurers must make for current losses and future liabilities,
the deposit of securities for the benefit of policyholders, the approval of
policy forms, notice requirements for the cancellation of policies and the
approval of certain changes in control. State insurance departments also conduct
periodic examinations of the affairs of insurance companies and require the
filing of annual and other reports relating to the financial condition of
insurance companies.

                  In addition to state-imposed insurance laws and regulations,
in December 1993 the National Association of Insurance Commissioners (the
"NAIC") adopted a new risk-based capital system for assessing the adequacy of
statutory capital and surplus which augments the states' current fixed dollar
minimum capital requirements for insurance companies. At December 31, 1996, DGI
exceeded the required levels of capital. There can be no assurance that the
capital requirements applicable to DGI's business will not increase in the
future.

                  The states in which Atlantic States (Pennsylvania, Maryland
and Delaware), the Mutual Company (Pennsylvania, Ohio, Maryland, New York,
Virginia and Delaware), Southern (Virginia) and Delaware Atlantic (Delaware,
Maryland and Pennsylvania) do business have guaranty fund laws under which
insurers doing business in such states can be assessed on the basis of premiums
written by the insurer in that state in order to fund policyholder liabilities
of insolvent insurance companies. Under these laws in general, an insurer is
subject to assessment, depending upon its market share of a given line of
business, to assist in the payment of policyholder claims against insolvent
insurers. The Mutual Company, Atlantic States, Southern and Delaware Atlantic
have made accruals for their portion of assessments related to such insolvencies
based upon the most current information furnished by the guaranty associations.
During the five years ended December 31, 1996, the amount of such insolvency
assessments paid by Atlantic States, Southern, the Mutual Company and Delaware
Atlantic was not material.

                                      -21-

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

                  Most states have enacted legislation that regulates insurance
holding company systems. Each insurance company in the holding company system is
required to register with the insurance supervisory agency of its state of
domicile and furnish information concerning the operations of companies within
the holding company system that may materially affect the operations, management
or financial condition of the insurers within the system. Pursuant to these
laws, the respective insurance departments may examine the Mutual Company, the
Company and their respective insurance subsidiaries at any time, require
disclosure of material transactions by the holding company and require prior
notice or prior approval of certain transactions, such as "extraordinary
dividends" from the insurance subsidiaries to the holding company.

                  All transactions within the holding company system affecting
the Mutual Company and the Company's insurance subsidiaries must be fair and
equitable. Approval of the applicable insurance commissioner is required prior
to consummation of transactions affecting the control of an insurer. In some
states, including Pennsylvania, the acquisition of 10% or more of the
outstanding capital stock of an insurer or its holding company is presumed to be
a change in control. These laws also require notice to the applicable insurance
commissioner of certain material transactions between an insurer and any person
in its holding company system and, in some states, certain of such transactions
cannot be consummated without the prior approval of the applicable insurance
commissioner.

                  The Company's insurance subsidiaries are restricted by the
insurance laws of their respective states of domicile as to the amount of
dividends or other distributions they may pay to the Company without the prior
approval of the respective state regulatory authorities. Generally, the maximum
amount that may be paid by an insurance subsidiary during any year after notice
to, but without prior approval of, the insurance commissioners of these states
is limited to a stated percentage of that subsidiary's statutory capital and
surplus as of a certain date, or the net income or net investment income not
including realized capital gains of the subsidiary for the preceding year. As of
December 31, 1996, amounts available for payment of dividends in 1997 without
the prior approval of the various insurance commissioners were $5,410,536 from
Atlantic States, $255,480 from Southern and $1,120,952 from Delaware Atlantic.
See Note 11 to the Consolidated Financial Statements incorporated by reference
herein.

                                      -22-

The Mutual Company

                  The Mutual Company, which was organized in 1889, has a Best
rating of A (Excellent). At December 31, 1996, the Mutual Company had admitted
assets of $158 million and policyholders' surplus of $75 million. At December
31, 1996, the Mutual Company had no debt and, of its total liabilities of $83
million, reserves for net losses and loss expenses accounted for $48 million and
unearned premiums accounted for $21 million. Of the Mutual Company's investment
portfolio of $133 million at December 31, 1996, investment-grade bonds
accounted for $48 million, cash and short-term investments accounted for $1
million and mortgages accounted for $7 million. At December 31, 1996, the Mutual
Company owned 2,621,633 shares of the Company's Common Stock, which were carried
on the Mutual Company's books at $54 million. The foregoing financial
information is presented on the statutory basis of accounting.

Employees

                  As of December 31, 1996, the Mutual Company had 376 employees.
The Mutual Company's employees provide a variety of services to DGI, Atlantic
States, Delaware Atlantic and Southern as well as to the Mutual Company and its
subsidiaries.

Item 2.           Properties.

                  DGI shares headquarters with the Mutual Company in a building
owned by the Mutual Company. The Mutual Company charges DGI for an appropriate
portion of the building expenses under an intercompany allocation agreement
which is consistent with the terms of the pooling agreement. The headquarters of
the Mutual Company have approximately 82,000 square feet of office space, with
an additional 40,000 square feet of office space currently under construction.
Southern has a facility of approximately 10,000 square feet in Glen Allen,
Virginia which it leases. Delaware Atlantic has a facility of approximately
2,800 square feet in Wilmington, Delaware, which it leases.

Item 3.           Legal Proceedings.

                  DGI is a party to numerous lawsuits arising in the ordinary
course of its insurance business. DGI believes that the resolution of these
lawsuits will not have a material adverse effect on its financial condition or
results of operations.

Item 4.           Submission of Matters to a Vote of Security Holders.

                  No matter was submitted to a vote of holders of the Company's
Common Stock during the fourth quarter of 1996.

                                      -23-

Executive Officers of the Company

      Name                        Age                 Position
      ----                        ---                 --------

Donald H. Nikolaus                54        President and Chief Executive
                                            Officer since 1981

William H. Shupert                70        Senior Vice President -
                                            Underwriting since 1991; Vice
                                            President - Underwriting for
                                            18 years prior thereto

Ralph G. Spontak                  44        Senior Vice President since
                                            1991; Chief Financial Officer
                                            and Vice President since 1983;
                                            Secretary since 1988; KMG Main
                                            Hurdman for nine years to 1983

Frank J. Wood                     63        Vice President - Marketing
                                            since 1988; Manager - Marketing
                                            for one year prior thereto

James B. Price                    61        Vice President - Claims since 1972

Robert G. Shenk                   44        Vice President - Claims since
                                            1992

Daniel J. Wagner                  36        Treasurer since 1993; Controller for
                                            five years prior thereto

                                      -24-

                                     PART II

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

                  The answer to this Item is incorporated in part by reference
to page 24 of the Company's Annual Report to Stockholders for the year ended
December 31, 1996, which is included as Exhibit (13) to this Form 10-K Report.
As of March 14, 1997, the Company had approximately 363 holders of record of its
Common Stock. The Company declared dividends of $.40 per share in 1995 and $44
per share in 1996.

Item 6.           Selected Financial Data.

                  The answer to this Item is incorporated by reference to page 2
of the Company's Annual Report to Stockholders for the year ended December 31,
1996, which is included as Exhibit (13) to this Form 10-K Report.

Item 7.           Management's Discussion and Analysis of Financial
                  Condition and Results of Operations.

                  The answer to this Item is incorporated by reference to pages
7 through 9 of the Company's Annual Report to Stockholders for the year ended
December 31, 1996, which is included as Exhibit (13) to this Form 10-K Report.

Item 8.           Financial Statements and Supplementary Data.

                  The answer to this Item is incorporated by reference to pages
10 through 23 of the Company's Annual Report to Stockholders for the year ended
December 31, 1996, which is included as Exhibit (13) to this Form 10-K Report.

Item 9.           Changes in and Disagreements with Accountants on
                  Accounting and Financial Disclosure.

                  None.

                                      -25-

                                    PART III

Item 10.          Directors and Executive Officers of the Company.

                  The answer to this Item with respect to the Company's
directors is incorporated by reference to pages 5 through 8 of the Company's
proxy statement relating to the Company's annual meeting of stockholders to be
held April 17, 1997. The response to this Item with respect to the Company's
executive officers is incorporated by reference to Part I of this Form 10-K
Report.

Item 11.          Executive Compensation.

                  The answer to this Item is incorporated by reference to pages
10 through 14 of the Company's proxy statement relating to the Company's annual
meeting of stockholders to be held April 17, 1997, except for the Compensation
Committee Report and the Performance Graph, which are not incorporated herein by
reference.

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

                  The answer to this Item is incorporated by reference to pages
2 through 3 of the Company's proxy statement relating to the Company's annual
meeting of stockholders to be held April 17, 1997.

Item 13.          Certain Relationships and Related Transactions.

                  The answer to this Item is incorporated by reference to pages
3 through 5 and page 14 of the Company's proxy statement relating to the
Company's annual meeting of stockholders to be held April 17, 1997.

                                      -26-

                                     PART IV

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

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

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

        Report of Independent Auditors............................          23

        Donegal Group Inc. and Subsidiaries:
          Consolidated Balance Sheets as of
            December 31, 1996 and 1995 ...........................          10
          Consolidated Statements of Income
            for the three years ended
            December 31, 1996, 1995 and 1994 .....................          11
          Consolidated Statements of Stockholders'
            Equity for the three years ended
            December 31, 1996, 1995 and 1994......................          12
          Consolidated Statements of Cash Flows
            for the three years ended
            December 31, 1996, 1995 and 1994......................          13
          Notes to Consolidated Financial Statements..............       14-22

         (2)      Financial Statement Schedules
                                                                          Page
                                                                          ----
         Donegal Group Inc. and Subsidiaries:

        Report of Independent Auditors on Schedules...............          33
        Schedule I.    Summary of Investments - Other
                       than Investments in Related
                       Parties....................................          34
        Schedule II.   Condensed Financial Information
                       of Parent Company..........................          35
        Schedule III.  Supplementary Insurance
                       Information................................          39
        Schedule IV.   Reinsurance................................          41
        Schedule VI.   Supplemental Insurance Information
                       Concerning Property and Casualty
                       Subsidiary.................................          42

                  All other schedules have been omitted since they are not
required, not applicable or the information is included in the financial
statements or notes thereto.

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

* Refers to the respective page of Donegal Group Inc.'s 1996 Annual Report to
Stockholders. The Consolidated Financial Statements and Notes to Consolidated
Financial Statements and Auditor's Report thereon on pages 10 through 23 are
incorporated herein by reference.

                                      -27-

With the exception of the portions of such Annual Report specifically
incorporated by reference in this Item and Items 5, 6, 7 and 8, such Annual
Report shall not be deemed filed as part of this Form 10-K Report or otherwise
subject to the liabilities of Section 18 of the Securities Exchange Act of 1934.

                  (3)      Exhibits

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

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

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

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

Management Contracts and Compensatory Plans or Arrangements
- -----------------------------------------------------------

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

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

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

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

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

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

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

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

(10)(I)       Donegal Group Inc. Executive                      filed herewith
              Restoration Plan

                                      -28-

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

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

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

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

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

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

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

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

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

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

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

                                      -29-

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

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

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

(13)      1996 Annual Report to Stockholders                      filed herewith
          (electronic filing contains only
          those portions incorporated by
          reference into this Form 10-K
          report).

(20)      Proxy Statement relating to the Annual                  filed herewith
          Meeting of Stockholders to be held on April 17, 1997,
          provided, however, that the Compensation Committee
          Report and the Performance Graph shall not be deemed
          filed as part of this Form 10-K Report

(21)      Subsidiaries of Registrant                                   (h)

(23)      Consent of Independent Auditors                         filed herewith

(27)      Financial Data Schedule                                 filed herewith

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

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

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

(c)            Such exhibit is hereby incorporated by reference to the
               like-described exhibit in Registrant's Form 10-K Report for
               the year ended December 31, 1988.

(d)            Such exhibit is hereby incorporated by reference to the
               like-described exhibit in Registrant's Form 10-K Report for
               the year ended December 31, 1992.

(e)            Such exhibit is hereby incorporated by reference to the
               like-described exhibit in Registrant's Form S-2 Registration

                                      -30-

               Statement No. 33-67346 declared effective September 29,
               1993.

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

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

(h)            Such exhibit is hereby incorporated by reference to the
               like-described exhibit in Registrant's Form 10-K Report for
               the year ended December 31, 1995.

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

                                      -31-

                                   SIGNATURES

                  Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this report to
be signed on its behalf by the undersigned thereunto duly authorized.

                                              DONEGAL GROUP INC.

Date:  March 27, 1997                         By: /s/ Donald H. Nikolaus
                                                 -----------------------
                                                 Donald H. Nikolaus, President

              Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.

         Signature                     Title                   Date
         ---------                     -----                   ----

/s/Donald H. Nikolaus             President and a           March 27, 1997
- ---------------------------       Director (principal 
Donald H. Nikolaus                executive officer)  

/s/Ralph G. Spontak               Senior Vice President     March 27, 1997
- ---------------------------       and Secretary (principal 
Ralph G. Spontak                  financial and accounting 
                                  officer)                 

- ---------------------------       Director                  March   , 1997
Robert S. Bolinger

- ---------------------------       Director                  March   , 1997
Thomas J. Finley

/s/Patricia A. Gilmartin          Director                  March 27, 1997
- ---------------------------
Patricia A. Gilmartin

/s/Philip H. Glatfelter,II        Director                  March 27, 1997
- ---------------------------
Philip H. Glatfelter, II

/s/C. Edwin Ireland               Director                  March 27, 1997
- ----------------------------
C. Edwin Ireland

/s/R. Richard Sherbahn            Director                  March 27, 1997
- ----------------------------
R. Richard Sherbahn

                                      -32-

              Independent Auditors' Consent and Report on Schedules

The Board of Directors
Donegal Group Inc.:

The audits referred to in our report dated March 3, 1997, included the related
financial statement schedules as of December 31, 1996, and for each of the years
in the three-year period ended December 31, 1996, incorporated by reference in
Form 10-K. These financial statement schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statement schedules based on our audits. In our opinion, such
financial statement schedules, when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly in all
material respects the information set forth therein.

We consent to the use of our reports incorporated by reference in the
registration statements (Nos. 333-06681, 33-85128 and 33-31287) on Form S-8 of
Donegal Group Inc. 

                                                  KPMG PEAT MARWICK LLP

Harrisburg, Pennsylvania
March 27, 1997

                                      -33-

                       DONEGAL GROUP INC. AND SUBSIDIARIES

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

                                December 31, 1996

                                                                                                                   Amount at Which
                                                                                               Fair                 Shown in the
                                                                        Cost                   Value                Balance Sheet
                                                                    ------------            ------------            ------------
                                                                                                                    
Fixed Maturities:
 Held to maturity:
   United States government
    and governmental agencies
    and authorities including
    obligations of states and
    political subdivisions .................................        $ 93,383,066            $ 95,014,669            $ 93,383,066
   All other corporate bonds ...............................           5,766,899               6,036,500               5,766,899
   Mortgage-backed securities ..............................          12,431,197              12,410,048              12,431,197
                                                                    ------------            ------------            ------------
    Total fixed maturities
     held to maturity ......................................         111,581,162             113,461,217             111,581,162
                                                                    ------------            ------------            ------------
 Available for sale:
   United States government
    and governmental agencies
    and authorities including
    obligations of states and
    political subdivisions .................................          45,111,935              45,390,594              45,390,594
   All other corporate bonds ...............................           3,107,680               3,087,000               3,087,000
   Mortgage-backed securities ..............................           1,094,905               1,110,949               1,110,949
                                                                    ------------            ------------            ------------
    Total fixed maturities
     available for sale ....................................          49,314,520              49,588,543              49,588,543
                                                                    ------------            ------------            ------------
      Total fixed
       maturities ..........................................         160,895,682             163,049,760             161,169,705
                                                                    ------------            ------------            ------------

Equity Securities:
 Preferred stocks
  Public utilities .........................................             500,000                 507,188                 507,188
  Banks ....................................................             812,500                 825,187                 825,187
  Industrial and
   miscellaneous ...........................................           1,389,000               1,349,250               1,349,250
                                                                    ------------            ------------            ------------
     Total preferred stocks ................................           2,701,500               2,681,625               2,681,625
                                                                    ------------            ------------            ------------

 Common stocks
  Banks and insurance companies ............................               8,596                 395,073                 395,073
  Industrial and
   miscellaneous ...........................................              60,250                  57,500                  57,500
                                                                    ------------            ------------            ------------
    Total common stocks ....................................              68,846                 452,573                 452,573
                                                                    ------------            ------------            ------------
     Total equity securities ...............................           2,770,346               3,134,198               3,134,198
                                                                    ------------            ------------            ------------

Short-term investments .....................................          21,207,503              21,207,503              21,207,503
                                                                    ------------            ------------            ------------
  Total investments ........................................        $184,873,531            $187,391,461            $185,511,406
                                                                    ============            ============            ============

                                      -34-

                       DONEGAL GROUP INC. AND SUBSIDIARIES

         SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY

                            Condensed Balance Sheets
                                ($ in thousands)
                           December 31, 1996 and 1995

                                     ASSETS
                                                             1996        1995
                                                            -------     -------

Investment in subsidiaries (equity method) ...........      $88,594     $75,236

Short-term investments, at cost,
  which approximates market ..........................            7       1,117

Cash .................................................          427         147

Property and equipment ...............................        1,248       1,355

Current income taxes .................................          158         341

Loan costs ...........................................          246         280
Other receivables ....................................           30           4
                                                            -------     -------
           Total assets ..............................      $90,710     $78,480
                                                            =======     =======

                      LIABILITIES AND STOCKHOLDERS' EQUITY

                                                              1996        1995
                                                            -------     -------

Cash dividends declared to stockholders ..............      $   493     $   428

Accounts payable and accrued expenses ................          174         317

Deferred income taxes ................................          266         250

Payable to affiliates ................................         --           202
Line of credit .......................................        8,500       5,000
                                                            -------     -------
           Total liabilities .........................        9,433       6,197

Stockholders' equity
    Preferred stock, $1.00 par value,
        authorized 1,000,000 shares,
        none issued
    Common stock, $1.00 par value,
        authorized 10,000,000 shares,
        issued 4,540,569 and 4,326,362
        shares and outstanding 4,471,782
        and 4,261,314 shares .........................        4,540       4,327

  Additional paid-in capital .........................       37,316      35,018

  Net unrealized gains
        on investments ...............................          421         819

                                      -35-

  Retained earnings, including equity
      in undistributed net income of
      subsidiaries ($45,957 and 37,202)                      39,892      32,939
  Treasury stock at cost                                       (892)       (820)
                                                            -------     -------

Total stockholders' equity                                   81,277      72,283
                                                            -------     -------

Total liabilities and
    stockholders' equity                                    $90,710     $78,480
                                                            =======     =======

                                      -36-

                       DONEGAL GROUP INC. AND SUBSIDIARIES

         SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY

                         Condensed Statements of Income
                                ($ in thousands)

                  Years ended December 31, 1996, 1995 and 1994

                                                1996         1995         1994
                                               -------      -------      -------

Revenues

    Dividends-subsidiary .................     $     0      $   900      $   900
    Lease income .........................         541          491          463
    Investment income ....................          31           13           12
                                               -------      -------      -------
        Total revenues ...................         572        1,404        1,375
                                                                         -------

Expenses

  Operating expenses .....................         548          411          418
  Interest ...............................         416            4           10
                                               -------      -------      -------
      Total expenses .....................         964          415          428
                                               -------      -------      -------

Income (loss) before income
    tax benefit and equity in
    undistributed net income
    of subsidiaries ......................        (392)         989          947

Income tax (benefit) .....................        (533)        (298)          16
                                               -------      -------      -------

Income before equity in
    undistributed net
    income of subsidiaries ...............         141        1,287          931

Equity in undistributed net
    income of subsidiaries ...............       8,755        8,571        4,109
                                               -------      -------      -------

Net income ...............................     $ 8,896      $ 9,858      $ 5,040
                                               =======      =======      =======

                                      -37-

                       DONEGAL GROUP INC. AND SUBSIDIARIES

              SCHEDULE II - CONDENSED INFORMATION OF PARENT COMPANY

                       Condensed Statements of Cash Flows
                                ($ in thousands)
                  Years ended December 31, 1996, 1995 and 1994

                                                   1996       1995       1994
                                                  -------    -------    -------

Cash flows from operating activities:
    Net income ................................   $ 8,896    $ 9,858    $ 5,040
                                                  -------    -------    -------
    Adjustments to reconcile net
    income to net cash provided by
    operating activities:
        Equity in undistributed net
           income of subsidiaries .............    (8,755)    (8,571)    (4,109)
        Change in accounts
           payable and accrued expenses .......      (143)       225         22
        Depreciation and amortization .........       309        264        257
        Change in deferred income tax .........        16         15         21
        Change in current
           income tax receivable ..............       183       (332)        (2)
        Change in other receivables ...........         8       (284)      --
                                                  -------    -------    -------
        Net adjustments .......................    (8,382)    (8,683)    (3,811)
                                                  -------    -------    -------
    Net cash provided by
        operating activities ..................       514      1,175      1,229
                                                  -------    -------    -------

Cash flows from investing activities:
    Net sales (purchases) of short-term
        investments ...........................     1,110       (744)       447
    Net purchase of property and equipment ....      (203)      (279)      (110)
    Capital contribution to subsidiaries ......    (5,000)
    Net purchases of long-term investments ....      --         --         (200)
    Acquisition of Delaware Atlantic ..........      (202)    (5,300)      --
                                                  -------    -------    -------
    Net cash provided by (used in)
     investing activities .....................    (4,295)    (6,323)       137
                                                  -------    -------    -------

Cash flows from financing activities:
    Cash dividends paid .......................    (1,879)    (1,622)    (1,433)
    Issuance of common stock ..................     2,512      1,723        125

    Purchase of treasury stock ................       (72)      --         --
    Line of credit, net .......................     3,500      5,000       --
                                                  -------    -------    -------
    Net cash provided by (used in)
        financing activities ..................     4,061     (5,101)    (1,308)
                                                  -------    -------    -------

Net change in cash ............................       280        (47)        58
        Cash beginning ........................       147        194        136
                                                  -------    -------    -------
        Cash ending ...........................   $   427    $   147    $   194
                                                  =======    =======    =======

                                      -38-

                       DONEGAL GROUP INC. AND SUBSIDIARIES

               SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION

                                                                           Amortization
                                                              Net           of Deferred
                               Net           Net             Losses            Policy          Other           Net
                             Earned       Investment        and Loss        Acquisition     Underwriting     Premiums
     Segment                Premiums        Income          Expenses           Costs          Expenses       Written
     -------                --------      ----------        --------        ------------    ------------     -------

   Year Ended
December 31, 1996
- -----------------

Property and casualty      $99,982,042     $10,285,617     $66,611,233       $17,032,000     $14,174,023   $104,669,903

Parent                         ---              30,851         ---               ---             ---            ---
                           -----------     -----------     -----------       -----------     -----------   ------------
                           $99,982,042     $10,316,468     $66,611,233       $17,032,000     $14,174,023   $104,669,903
                           ===========     ===========     ===========       ===========     ===========   ============

   Year Ended
December 31, 1995
- -----------------

Property and casualty      $86,277,852     $ 9,256,960     $55,407,254       $14,412,000     $13,049,188    $91,671,128

Parent                         ---              12,924         ---               ---             ---             ---
                           -----------     -----------     -----------       -----------     -----------    --------
                           $86,277,852     $ 9,269,884     $55,407,254       $14,412,000     $13,049,188    $91,671,128
                           ===========     ===========     ===========       ===========     ===========    ===========

   Year Ended
December 31, 1994
- -----------------

Property and casualty      $77,232,889     $ 7,765,950     $52,857,302       $12,055,000     $12,278,473    $79,233,963

Parent                         ---              12,214         ---               ---             ---             ---
                           -----------     -----------     -----------       -----------     -----------    --------

                           $77,232,889     $ 7,778,164     $52,857,302       $12,055,000     $12,278,473    $79,233,963
                           ===========     ===========     ===========       ===========     ===========    ===========

                                      -39-

                       DONEGAL GROUP INC. AND SUBSIDIARIES

               SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
               --------------------------------------------------

                                          At December 31,
                            Deferred        Liability                     Other Policy
                             Policy         for Losses                     Claims and
                           Acquisition       and Loss        Unearned       Benefits
      Segment                 Costs          Expenses        Premiums        Payable
      -------              -----------    ---------------    --------     ------------

       1996
       ----

Property and Casualty     $ 7,837,899      $110,022,886    $66,184,188      $   ---

       1995
       ----

Property and casualty     $ 6,902,218      $ 97,733,851    $54,377,239      $   ---

                                      -40-

                       DONEGAL GROUP INC. AND SUBSIDIARIES

                            SCHEDULE IV - REINSURANCE

                                      Ceded        Assumed                  Percentage
                        Gross       To Other      From Other       Net       Assumed
                        Amount      Companies     Companies       Amount      to Net
                        ------      ---------     ---------       ------      ------
   Year Ended
December 31, 1996
- -----------------

Property and
 casualty premiums   $45,159,197   $38,827,050   $93,649,895   $99,982,042      94%
                     ===========   ===========   ===========   ===========     ====

   Year Ended
December 31, 1995
- -----------------

Property and
 casualty premiums   $40,552,497   $29,099,448   $74,824,803   $86,277,852      87%
                     ===========   ===========   ===========   ===========     ====

   Year Ended
December 31, 1994
- -----------------

Property and
 casualty premiums   $35,275,866   $24,365,441   $66,322,464   $77,232,889      86%
                     ===========   ===========   ===========   ===========     ====

                                      -41-

                       DONEGAL GROUP INC. AND SUBSIDIARIES

                SCHEDULE VI - SUPPLEMENTARY INSURANCE INFORMATION
                  CONCERNING PROPERTY AND CASUALTY SUBSIDIARIES
                  ---------------------------------------------

                                                    Discount,
                     Deferred      Liability        if any,
                      Policy       for Losses       Deducted
                    Acquisition     and Loss         From           Unearned
                       Costs        Expenses        Reserves        Premiums
                       -----        --------        --------        --------

At December 31,

     1996          $ 7,837,899    $110,022,886    $    ---       $66,184,188
                   ===========    ============    ===========    ===========

     1995          $ 6,902,218    $ 97,733,851    $    ---       $54,377,239
                   ===========    ============    ===========    ===========

                                      -42-

                       DONEGAL GROUP INC. AND SUBSIDIARIES

                SCHEDULE VI - SUPPLEMENTARY INSURANCE INFORMATION
                  CONCERNING PROPERTY AND CASUALTY SUBSIDIARIES
                  ---------------------------------------------

                                                          Losses and Loss          Amortization
                                                        Expenses Related to        of Deferred        Net
                          Net                           (1)              (2)         Policy       Paid Losses       Net
                         Earned      Investment       Current           Prior      Acquisition      and Loss      Premiums
                        Premiums       Income           Year            Years          Costs        Expenses      Written
                        --------     ----------       -------         ---------    ------------   ------------    -------
                                                                                                    
  Year Ended
December 31, 1996     $99,982,042    $10,285,617    $69,206,233    $(2,595,000)     $17,032,000    $62,877,258   $10,466,990
                      ===========    ===========    ===========    ============     ===========    ===========   ===========

  Year Ended
December 31, 1995     $86,277,852    $ 9,256,960    $58,354,254    $(2,947,000)     $14,412,000    $47,943,360   $91,671,128
                      ===========    ===========    ===========    ============     ===========    ===========   ===========

   Year Ended
December 31, 1994     $77,232,889    $ 7,765,950    $55,941,502    $(3,084,000)     $12,055,000    $48,248,316   $79,233,963
                      ===========    ===========    ===========    ============     ===========    ===========   ===========

                                      -43-

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

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

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

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

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

Management Contracts and Compensatory Plans or Arrangements
- -----------------------------------------------------------

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

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

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

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

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

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

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

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

(10)(I)         Donegal Group Inc. Executive                      filed herewith
                Restoration Plan

Other Material Contracts

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

(10)(K)         Services Allocation Agreement dated                      (a)

                                               -44-

                September 29, 1986 between Donegal
                Mutual Insurance Company, Donegal
                Group Inc. and Atlantic States
                Insurance Company

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

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

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

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

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

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

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

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

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

(10)(U)         Reinsurance and Retrocession Agree-               filed herewith
                ment dated May 21, 1996, between
                Donegal Mutual Insurance Company and

                                               -45-

                Delaware American Insurance Company.

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

(13)            1996 Annual Report to Stockholders                filed herewith
                (electronic filing contains only
                those portions incorporated by
                reference into this Form 10-K
                report.)

(20)            Proxy Statement relating to the Annual            filed herewith
                Meeting of Stockholders to be held on
                April 17, 1997, provided, however, that
                the Compensation Committee Report and the
                Performance Graph shall not be deemed
                filed as part of this Form 10-K Report

(21)            Subsidiaries of Registrant                              (h)

(23)            Consent of Independent Auditors                   filed herewith

(27)            Financial Data Schedule                           filed herewith

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

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

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

(c)             Such exhibit is hereby incorporated by reference to the
                like-described exhibit in Registrant's Form 10-K Report for
                the year ended December 31, 1988.

(d)             Such exhibit is hereby incorporated by reference to the
                like-described exhibit in Registrant's Form 10-K Report for
                the year ended December 31, 1992.

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

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

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

                                      -46-

(h)              Such exhibit is hereby incorporated by reference to the
                 like-described exhibits in Registrant's Form 10-K Report
                 for the year ended December 31, 1995.

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

                                      -47-

                              AMENDED AND RESTATED
                                     BY-LAWS
                                       of
                        DONEGAL MUTUAL INSURANCE COMPANY

                                    Article 1
                                 COMPANY OFFICE

         Section 1.1.  Principal Office.  The principal office of the
Company shall be in Marietta, Pennsylvania.

         Section 1.2. Other Offices. The Company may also have offices at such
other places as the Board of Directors may from time to time designate or the
business of the Company may from time to time require.

                                    Article 2
                                   MEMBERSHIP

         Section 2.1. Members. Every policyholder of the Company, except a
holder of a policy or contract of reinsurance, is a member of the Company while
the policy is in force, and is entitled to one vote, and no more, regardless of
the amount of insurance held by such policyholder, the number of policies in
force in the name of such policyholder or the amount of premiums paid by such
policyholder. Policyholder means the person or group of persons identified as
the named insured on the declarations page of a policy of insurance of the
Company. Membership begins on the effective date of the policy and continues
until the earlier of the termination date, cancellation date or lapse date of
the policy. In the case of a surety bond, the

                                       -1-

principal upon the bond shall be deemed to be the policyholder. In the case of a
group policy, the member shall be the holder of the master policy, and the
holder of any certificate or contract issued subordinate to such master policy
shall not be a member unless it makes specific provision for such membership.

         In the event the policyholder consists of more than one named insured,
it shall be presumed that the first named insured is entitled to vote on behalf
of all the named insureds unless the Company is otherwise notified in writing.

         Section 2.2. Rights of Members. Each member shall have such rights as
are prescribed by law for members of mutual insurance companies organized under
the laws of the Commonwealth of Pennsylvania, the Articles of Agreement of the
Company, these By-laws and any policy of insurance issued by the Company and
held by the member.

         Section 2.3. Limit of Members' Liability. The policies of the Company
shall be non-assessable, and members shall have no contingent liability with
respect thereto. Members shall not be liable for losses, expenses or any
indebtedness of the Company.

                                    Article 3
                                MEMBERS' MEETINGS

         Section 3.1.  Annual Meetings.  The annual meeting of the
members shall be held on the third Thursday in February in each year
at 9:30 A.M. at the principal office of the Company, 1195 River Road,
Marietta, Pennsylvania.

         At such annual meeting, the members shall elect successors to the
directors whose terms shall expire that year to serve for the

                                       -2-

following three years and until their successors shall have been duly elected
and qualified or until their earlier resignation or removal. The members also
shall transact such other business as may properly be brought before the
meeting.

         Section 3.2. Nomination and Election of Directors. Nominations by and
of a member for election as director shall be filed in writing. Such written
nomination shall be directed to the Nominating Committee of the Board of
Directors of the Company care of the Secretary of the Company and shall be
received in the Company's principal office no less than thirty days prior to the
annual meeting of the members at which such election is to be held, and no
person not so nominated shall be eligible for election at such meeting or any
adjournment thereof.

         Section 3.3. Special Meetings. Special meetings of the members for any
purpose or purposes may be called at any time by the President of the Company,
and shall be called by the Secretary of the Company at the request in writing of
a majority of the Board of Directors or at least one-fifth of the members
entitled to vote thereat. Any request for a special meeting of the members shall
be signed by the person or persons making the request and shall state the
purpose or purposes of the proposed meeting. Upon receipt of any such request,
it shall be the duty of the Secretary of the Company to call a special meeting
of the members to be held at such time, not less than ten nor more than sixty
days thereafter, as the Secretary of the Company may fix. If the Secretary of
the Company shall neglect or refuse to issue such call within five days from the
receipt of such request, the person or persons making the request may do so.
Business transacted at any special meeting of the members

                                       -3-

shall be limited to the purposes stated in the notice of meeting or a duly
executed waiver of notice thereof.

         Section 3.4. Notice of Meetings. Public notice of all meetings of the
members, stating the place, date and hour, and, in the case of meetings of the
members called for the purpose of amending the Articles of Agreement, the
purpose or purposes thereof, shall be given by advertisement once a week for
four weeks in at least two daily or weekly newspapers published in Lancaster
County, Pennsylvania, and in the legal periodical designated by the courts of
Lancaster County, Pennsylvania, for the publication of legal notices, and all
such four published notices shall occur more than thirty days prior to the date
of such meeting, or by circular mailed to the address of each member. Such
notices may be given at the discretion of, or in the name of the Board of
Directors, the President, any Vice President, the Secretary or any Assistant
Secretary of the Company. When a meeting is adjourned, it shall not be necessary
to give any notice of the adjourned meeting or of the business to be transacted
at the adjourned meeting, other than by announcement at the meeting at which
such adjournment is taken.

         Section 3.5. Participation in Meetings by Conference Telephone. One or
more members may participate in any meeting of the members by means of
conference telephone or similar communications equipment which enables all
persons participating in the meeting to hear one another, and such person or
persons shall be counted for purposes of a quorum.

         Section 3.6.  Quorum of and Action by the Members.  The presence, in
person, by proxy or by telephonic or similar communications equipment, of three
members entitled to cast a vote on

                                       -4-

the particular matter shall constitute a quorum for purposes of considering such
matter, and, unless otherwise specifically provided by statute, the acts of such
members at a duly organized meeting shall be the acts of the members with
respect to such matter.

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

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

         Section 3.7. Voting. Except as may be otherwise provided by statute or
by these By-laws, at every meeting of the members, every policyholder of the
Company shall have the right to one vote regardless of the amount of insurance
held by the individual, partnership or corporate entity, the number of policies
in force or the amount of premiums paid.

         When a quorum exists at any meeting, the oral vote of the majority of
the members present in person, by proxy or by telephonic or similar
communications equipment shall decide any question brought before such meeting,
unless the question is one for which, by express provision of statute or of
these By-laws, a different vote is

                                       -5-

required. Upon demand made by a member at any election of directors before the
voting begins, the election shall be by ballot, in which event the vote shall be
taken by written ballot, and the judge or judges of election or, if none, the
Secretary of the meeting, shall tabulate and certify the results of such vote.

         Section 3.8. Quorum and Adjourned Meeting. Notwithstanding Sections 3.6
and 3.7 of these By-laws: (a) Any meeting at which directors are to be elected
may be adjourned only from day to day, or for such longer periods not exceeding
fifteen days each as the members present and entitled to vote shall direct; and
(b) Those members entitled to vote who attend a meeting called for election of
directors that has been previously adjourned for lack of a quorum, although less
than a quorum as fixed in the By-laws, shall constitute a quorum for the purpose
of electing directors.

         Section 3.9. Voting by Proxy. Every member entitled to vote at a
meeting of the members or to express consent or dissent to Company action in
writing without a meeting may authorize another person or persons to act for him
by proxy. Every proxy shall be executed in writing or authorized in a policy for
insurance by the member or his duly authorized attorney-in-fact and filed with
the Secretary of the Company. A proxy may also be authorized in a policy of
insurance issued by the Company or may be authorized in an application for
insurance for which a policy is issued by the Company. A proxy, unless coupled
with an interest, shall be revocable at will, notwithstanding any other
agreement or any provision in the proxy to the contrary, but the revocation of a
proxy shall not be effective until written notice thereof has been given to the
Secretary of the Company. No unrevoked proxy, unless coupled with an interest,
shall

                                       -6-

be valid after eleven months from the date of its execution. A proxy shall not
be revoked by the death or incapacity of the maker, unless, before the vote is
counted or the authority is exercised, written notice of such death or
incapacity is given to the Secretary of the Company. A proxy shall be deemed to
be coupled with an interest if given in connection with a policy of insurance or
an application therefor for as long as such insurance policy, or any renewal
policy, remains in force.

         Section 3.10. Record Date. The Board of Directors may fix a time, not
more than sixty nor less than ten days prior to the date of any meeting of the
members, as the record date for the determination of the members entitled to
notice of, or to vote at, such meeting. In such case, only such members as shall
be members on the date so fixed shall be entitled to notice of, or to vote at,
such meeting.

         Section 3.11. Judges of Election. In advance of any meeting of the
members, the Board of Directors may appoint judges of election, who need not be
members, to act at such meeting or any adjournment thereof. If judges of
election are not so appointed, the chairman of any such meeting may, and on the
request of any member or his proxy, shall make such appointment at the meeting.
The number of judges shall be one or three judges. If appointed at a meeting on
the request of one or more members or proxies, the majority of members present
and entitled to vote shall determine whether one or three judges are to be
appointed. No person who is a candidate for office shall act as a judge.

         The judges of election shall do all such acts as may be proper to
conduct the election or vote and such other duties as may be prescribed by
statute with fairness to all members and, if requested

                                       -7-

by the chairman of the meeting or any member or his proxy, shall make a written
report of any matter determined by them and execute a certificate as to any fact
found by them. If there are three judges of election, the decision, act or
certificate of a majority shall be the decision, act or certificate of all.

                                    Article 4
                                    DIRECTORS

         Section 4.1.  Powers.

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

         (b) Specific Powers. Without limiting the general powers conferred by
clause (a) hereof and the powers conferred by the Articles of Agreement and
these By-laws of the Company, it is hereby expressly declared that the Board of
Directors shall have the following powers:

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

                     (ii) To appoint a person or persons to vote shares of
another corporation held and owned by the Company;

                     (iii) By resolution adopted by a majority of the whole
Board of Directors, to designate one or more committees as set forth
in Section 4.13 of this Article 4;

                                       -8-

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

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

         Section 4.2. Number and Terms of Directors. The number of directors
which shall constitute the whole Board of Directors shall be not less than seven
nor more than twelve. All directors of the Company shall be natural persons not
less than 21 years old, shall be members of the Company and two-thirds of the
whole Board of Directors shall be citizens of the United States of America. Not
less than one third of the whole Board of Directors shall be persons who are not
officers or employees of the Company or of any entity controlling, controlled by
or under common control with the Company and who are not beneficial owners of a
controlling interest in the voting stock of the Company or any such entity.
Within the limits above specified, the number of directors shall be determined
by resolution of the Board of Directors. Except as hereinafter provided in the
case of vacancies, directors shall be elected by the members, and each director
shall be elected for a three-year term and until his successor shall be elected,
subject to removal as provided by statute.

         Section 4.3. Classes. The Board of Directors shall be divided into
three classes: Class A, Class B and Class C. Class A shall initially consist of
three members whose terms shall expire at the 1993 annual meeting of members.
Class B shall initially consist of three members whose terms shall expire at the
1994 annual meeting of members. Class C shall initially consist of two members
whose terms shall expire at the 1992 annual meeting of members. At each annual

                                       -9-

meeting of members, the successors to the directors of the class whose terms
shall expire in that year shall be elected for a term of three years so that the
term of office of one class of directors shall expire in each year. The number
of directors in each class shall be as nearly equal as possible so that, except
for temporary vacancies, the number in any class shall not exceed the number in
any other class by more than one.

         Section 4.4. Powers and Duties of the Chairman of the Board of
Directors. The Board of Directors shall appoint one of their number as a
Chairman of the Board who shall preside at all meetings of the Board of
Directors and who shall have such other powers and duties as may be assigned to
him from time to time by the Board of Directors.

         Section 4.5. Powers and Duties of the Vice Chairman of the Board of
Directors. The Board of Directors may, in its discretion, appoint one of its
number as a Vice Chairman of the Board of Directors. In the absence of the
Chairman of the Board of Directors, the Vice Chairman of the Board of Directors
shall preside at all meetings of the Board of Directors. In addition, the Vice
Chairman of the Board of Directors shall have such other powers and duties as
may be assigned to him from time to time by the Board of Directors.

         Section 4.6. Vacancies. Vacancies on the Board of Directors, including
vacancies resulting from an increase in the number of directors, shall be filled
by a majority of the remaining members of the Board of Directors, though less
than a quorum, or by the sole remaining director, as the case may be,
irrespective of whether the members of the Company are entitled to elect one or
more directors to fill such vacancies or newly created directorships at the next
annual meeting of members. Each person so elected shall be a director until

                                      -10-

his successor is elected by the members at the annual meeting of members at
which the directorship to which he was elected is up for election or at any
special meeting of members prior thereto duly called for that purpose.

         Section 4.7. Organization Meetings. The organization meeting of each
newly elected Board of Directors shall be held immediately following the meeting
of members at which such directors were elected without the necessity of notice
to such directors to constitute a legally convened meeting and at such time and
place as may be fixed by a notice, or a waiver of notice, or a consent signed by
all of such directors. At such meeting, the Board of Directors shall elect the
officers of the Company provided for in Article 6 of these By-laws.

         Section 4.8. Regular Meetings. The Board of Directors shall have the
power to fix by resolution the place, date and hour of regular meetings of the
Board of Directors. The Board of Directors shall hold at least four regularly
scheduled quarterly meetings during each calendar year.

         Section 4.9. Special Meetings. Special meetings of the Board of
Directors may be called by the President of the Company on one day's notice to
each director, either personally or by mail, telephone or telegram. Special
meetings of the Board of Directors shall be called by the President or the
Secretary of the Company in like manner and on like notice upon the written
request of any five directors. Any action without a meeting of the Board shall
be limited to those situations where time is of the essence and not in lieu of a
regularly scheduled meeting.

                                      -11-

         Section 4.10. Notices of Meetings. All meetings of the Board of
Directors may be held at such times and places as may be specified in the notice
of meeting or in a duly executed waiver of notice thereof. Notice of regular
meetings of the Board of Directors shall be given to each director at least
three days before each meeting either personally or by mail, telegram or
telephone. One or more directors may participate in any meeting of the Board of
Directors, or of any committee thereof, by means of a conference telephone or
similar communications equipment which enables all persons participating in the
meeting to hear one another, and such participation in a meeting shall
constitute presence in person at the meeting.

         Section 4.11. Quorum. At all meetings of the Board of Directors, the
presence, in person or by telephonic or similar communications equipment, of not
less than five members of the Board of Directors, including at least one member
who is not an officer or employee of the Company or any entity controlling,
controlled by or under common control with the Company and who is not the
beneficial owner of a controlling interest in the voting stock of the Company or
any such entity, shall constitute a quorum for the transaction of business, and
the acts of a majority of the directors present at a duly convened meeting at
which a quorum is present shall be the acts of the Board of Directors, except as
may be otherwise specifically provided by statute, by the Articles of Agreement
of the Company or by these By-laws. If a quorum shall not be present, in person
or by telephonic or similar communications equipment, at any meeting of the
Board of Directors, the directors present may adjourn the meeting

                                      -12-

from time to time, without notice other than announcement at the meeting, until
a quorum shall be so present.

         Section 4.12. Compensation. Directors, as such, may receive a stated
salary for their services, or a fixed sum and expenses for attendance at regular
or special meetings of the Board of Directors, or any committee thereof, or any
combination of the foregoing as may be determined from time to time by
resolution of the Board of Directors, and nothing contained herein shall be
construed to preclude any director from serving the Company in any other
capacity and receiving compensation therefor.

         Section 4.13.  Committees of the Board of Directors.

         (a) Committees.  The Board of Directors, by vote of a majority of the
whole Board of Directors, may from time to time designate committees of the
Board of Directors as specifically provided for herein and such other committees
as the Board of Directors may, in its discretion, determine from time to time,
with such lawfully delegable powers and duties as the Board of Directors thereby
confers, to serve at the pleasure of the Board of Directors and shall, for each
such committee, appoint no less than three directors to serve as members and
designate, if it desires, one or more directors as alternate members who may
replace any absent or disqualified member at any meeting of a committee. At any
meeting of any committee so appointed, a quorum shall be determined as provided
in Section 4.11 of these By-laws with the members of the committee being
substituted for the Board of Directors. At least one third of the total number
of the members of each committee so appointed shall be persons who are not
officers or employees of the Company or any entity controlling, controlled by or
under common control with the

                                      -13-

Company and who are not the beneficial owners of a controlling interest in the
voting stock of the Company or any such entity. In the absence or
disqualification of any member of any committee and any alternate member in his
place, the member or members of the committee present at any meeting and not
disqualified from voting, whether or not he or they constitute a quorum, may
unanimously appoint another member of the Board of Directors to act at the
meeting in the place of any such absent or disqualified member. The Board of
Directors may, from time to time, suspend, alter, continue or terminate any
committee or the powers and functions thereof.

         (b) Executive Committee. Subject to the requirements of paragraph (a)
hereof, the Executive Committee shall consist of the President of the Company
and no fewer than two other members of the Board of Directors. The Executive
Committee shall have the power to exercise the authority of the full Board of
Directors in the management of all business of the Company between meetings of
the Board of Directors to the extent consistent with Pennsylvania law. It shall
report to the Board of Directors actions taken in the exercise of such power.

         (c) Audit Committee. Subject to the requirements of paragraph (a)
hereof, the Audit Committee shall consist of no fewer than three members of the
Board of Directors, none of whom shall be an officer or employee of the Company
or of any entity controlling, controlled by or under common control with the
Company and who are not beneficial owners of a controlling interest in the
voting stock of the Company or any such entity. The Audit Committee shall
recommend the selection of independent certified public accountants and review

                                      -14-

the scope and results of the independent audit and the management
recommendations made by the independent auditor.

         (d) Nominating Committee. Subject to the requirements of paragraph (a)
hereof, the Nominating Committee shall consist of no fewer than three members of
the Board of Directors, none of whom shall be an officer or employee of the
Company or of any entity controlling, controlled by or under common control with
the Company and who are not beneficial owners of a controlling interest in the
voting stock of the Company or any such entity. The Nominating Committee shall
nominate persons for election for director by policyholders and shall review and
report on the qualifications of candidates otherwise nominated for director. The
President of the Company shall be an ex-officio member of the Nominating
Committee.

         (e) Compensation Committee. Subject to the requirements of paragraph
(a) hereof, the Compensation Committee shall consist of no fewer than three
members of the Board of Directors, none of whom shall be an officer or employee
of the Company or of any entity controlling, controlled by or under common
control with the Company and who are not beneficial owners of a controlling
interest in the voting stock of the Company or any such entity. The Compensation
Committee shall evaluate the performance of officers deemed to be executive
officers of the Company and recommend to the Board of Directors compensation of
the executive officers. The President of the Company shall attend all meetings
of the Compensation Committee.

                                      -15-

                                    Article 5
                             LIABILITY OF DIRECTORS

         Section 5.1. Fiduciary Duty. A director of the Company shall stand in a
fiduciary relation to the Company and shall perform his duties as a director,
including his duties as a member of any committee of the Board of Directors upon
which he may serve, in good faith, in a manner he reasonably believes to be in
the best interests of the Company, and with such care, including reasonable
inquiry, skill and diligence, as a person of ordinary prudence would use under
similar circumstances. In performing his duties, a director shall be entitled to
rely in good faith on information, opinions, reports or statements, including
financial statements and other financial data, in each case prepared or
presented by any of the following: (a) one or more officers or employees of the
Company whom the director reasonably believes to be reliable and competent in
the matters presented; (b) legal counsel, public accountants or other persons as
to matters which the director reasonably believes to be within the professional
or expert competence of such persons or (c) a committee of the Board of
Directors upon which he does not serve, duly designated in accordance with law,
as to matters within its designated authority, which committee the director
reasonably believes to merit confidence. A director shall not be considered to
be acting in good faith if he has knowledge concerning the matter in question
that would cause his reliance to be unwarranted.

         Section 5.2.  Pertinent Factors.  In discharging the duties of their
respective positions, the Board of Directors, committees of the Board of
Directors and individual directors may, in considering the best interests of the
Company, consider the effects of any action

                                      -16-

upon employees, suppliers and customers of the Company and communities in which
offices or other establishments of the Company are located, and all other
pertinent factors. The consideration of these factors shall not constitute a
violation of Section 5.1 hereof.

         Section 5.3. Presumption of Best Interests. Absent breach of fiduciary
duty, lack of good faith or self-dealing, actions taken as a director or any
failure to take any action shall be presumed to be in the best interests of the
Company.

         Section 5.4. No Personal Liability. A director of the Company shall not
be personally liable, as such, for monetary damages for any action taken, or any
failure to take any action, unless: (a) the director has breached or failed to
perform the duties of his office under Sections 5.1 through 5.3 hereof and (b)
the breach or failure to perform constitutes self-dealing, willful misconduct or
recklessness.

         Section 5.5.  Exceptions.  The provisions of Section 5.4 hereof
shall not apply to: (a) the responsibility or liability of a director
pursuant to any criminal statute or (b) the liability of a director
for the payment of taxes pursuant to local, state or federal law.

         Section 5.6. Amendment. Notwithstanding any other provisions of these
By-laws, the approval of members shall be required to amend, repeal or adopt any
provision as part of these By-laws that is inconsistent with the purpose or
intent of Sections 5.1, 5.2, 5.3, 5.4, 5.5 or 5.6 of this Article 5, and, if any
such action shall be taken, it shall become effective only on a prospective
basis from and after the date of such member approval.

                                      -17-

                                    Article 6
                                    OFFICERS

         Section 6.1. Election and Office. The officers of the Company shall be
elected annually by the Board of Directors at its organization meeting and shall
consist of a President, a Secretary and a Treasurer. The Board of Directors may
also elect one or more Vice Presidents and such other officers and appoint such
agents as it shall deem necessary. Each officer of the Company shall hold office
for such term, have such authority and perform such duties as set forth in these
By-laws or as may from time to time be prescribed by the Board of Directors in
consultation with the President. The offices of President, Secretary and
Treasurer must be held by different persons.

         Section 6.2.  Salaries.  The salaries of all officers of the
Company shall be fixed by the Board of Directors.

         Section 6.3. Removal and Vacancies. The Board of Directors may remove
any officer or agent elected or appointed at any time and within the period, if
any, for which such person was elected or employed whenever in the judgment of
the Board of Directors it is in the best interests of the Company, and all
persons shall be elected and employed subject to the provisions hereof. If the
office of any officer becomes vacant for any reason, the vacancy shall be filled
by the Board of Directors, though less than a quorum, or by a sole remaining
director, and each person so selected shall be an officer to serve for the
balance of the unexpired term.

         Section 6.4.  Powers and Duties of the President.  The President shall
be a director of the Corporation.  Unless otherwise determined by the Board of
Directors, the President shall have the usual duties

                                      -18-

of a chief executive officer with general supervision over and direction of the
affairs of the Company. In the exercise of these duties and subject to the
limitations of the laws of the Commonwealth of Pennsylvania, these By-laws and
the actions of the Board of Directors, he may appoint, suspend and discharge
employees, agents and officers, may fix the compensation of all officers and
assistant officers, shall preside at all meetings of the members at which he
shall be present, and, unless there is a Chairman of the Board of Directors or a
Vice Chairman of the Board of Directors appointed as provided in Article 4 of
these By-laws, shall preside at all meetings of the Board of Directors and shall
be a member of all committees. He shall also do and perform such other duties as
from time to time may be assigned to him by the Board of Directors.

         Unless otherwise determined by the Board of Directors, the President
shall have full power and authority on behalf of the Company to attend and to
act and to vote at any meeting of the stockholders of any corporation in which
the Company may hold stock, and, at any such meeting, shall possess and may
exercise any and all of the rights and powers incident to the ownership of such
stock and which, as the owner thereof, the Company might have possessed and
exercised.

         Section 6.5. Powers and Duties of Vice Presidents. Each Vice President
shall have such duties as may be assigned to him from time to time by the Board
of Directors, the Executive Committee or the President. Any Vice President may,
in the discretion of the Board of Directors be designated as "executive",
"senior" or by departmental or functional classification. In the event of a
temporary absence of the President on vacation or business, the President may
designate a

                                      -19-

Vice President or Vice Presidents who will perform the duties of the President
in such absence. In the event of a prolonged absence of the President due to
illness or disability or for any other reason, the Board of Directors shall
designate a Vice President or Vice Presidents who will perform the duties of the
President during such absence.

         Section 6.6. Powers and Duties of the Secretary. The Secretary of the
Company shall attend all meetings of the Board of Directors and of the members
and shall keep accurate records thereof in one or more minute books kept for
that purpose, shall give, or cause to be given, the required notice of all
meetings of the members and of the Board of Directors, shall keep in safe
custody the seal of the Company and affix the same to any instrument requiring
it, and when so affixed, it shall be attested by his signature or by the
signature of the Treasurer or any Assistant Secretary or Assistant Treasurer of
the Company, and shall perform such other duties as may be assigned to him by
the President. The Secretary shall be a director of the Company.

         Section 6.7. Powers and Duties of the Treasurer. The Treasurer shall be
a natural person of full age. The Treasurer of the Company shall have the
custody of the Company's funds and securities, shall keep full and accurate
accounts of receipts and disbursements in books belonging to the Company, shall
deposit all moneys and other valuable effects in the name and to the credit of
the Company in such depositories as shall be designated by the President, shall
disburse the funds of the Company as may be ordered by the President or Board of
Directors, taking proper vouchers for such disbursements, shall render to the
President and the Board of Directors, at the regular

                                      -20-

meetings of the Board of Directors or whenever they may require it, an account
of all his transactions as Treasurer and of the financial condition of the
Company and shall have the right to affix the seal of the Company to any
instrument requiring it, and to attest to the same by his signature and, if so
required by the Board of Directors, he shall give bond in such sum and with such
surety as the Board of Directors may from time to time direct.

         Section 6.8. Designation of a Chief Financial Officer. The Board of
Directors shall have the power to designate from among the President, any Vice
President or the Treasurer of the Company a Chief Financial Officer who shall be
deemed the principal financial and accounting officer and who shall have the
ultimate responsibility to oversee the financial operation and performance of
the Company. In the event that the Treasurer is not designated by the Board of
Directors as the Chief Financial Officer, the Treasurer shall report to the
Chief Financial Officer from time to time concerning all duties which the
Treasurer is obligated to perform and the Chief Financial Officer shall, subject
to the reasonable direction of the President or the Board of Directors, at his
election, assume such of the duties of the Treasurer as are provided in Section
6.9 hereof as he shall deem appropriate.

                                    Article 7
                                 INDEMNIFICATION

         Section 7.1.  Indemnification.  The Company shall indemnify any
director or officer, and may indemnify any other employee or agent, who was
or is a party to, or is threatened to be made a party to, or who is called as a
witness in connection with, any threatened,

                                      -21-

pending or completed action, suit or proceeding, whether civil, criminal,
administrative or investigative, including an action by or in the right of the
Company, by reason of the fact that he is or was a director, officer, employee
or agent of the Company, or is or was serving at the request of the Company as a
director, officer, employee or agent of another domestic or foreign corporation
for profit or not-for-profit, partnership, joint venture, trust or other
enterprise, against expenses, including attorneys' fees, judgments, fines and
amounts paid in settlement, actually and reasonably incurred by him in
connection with such action, suit or proceeding unless the act or failure to act
giving rise to the claim for indemnification is determined by a court to have
constituted willful misconduct or recklessness.

         Section 7.2. Additional Rights. The indemnification and advancement of
expenses provided by, or granted pursuant to, this Article 7 shall not be deemed
exclusive of any other rights to which those seeking indemnification or
advancement of expenses may be entitled under any By-law, agreement, contract,
vote of members or directors or otherwise, both as to action in his official
capacity and as to action in another capacity while holding such office. It is
the policy of the Company that indemnification of, and advancement of expenses
to, directors and officers of the Company shall be made to the fullest extent
permitted by law. To this end, the provisions of this Article 7 shall be deemed
to have been amended for the benefit of directors and officers of the Company
effective immediately upon any modification of the Pennsylvania Business
Corporation Law of 1988 (the "BCL") or the Insurance Company Law or any
modifications, or adoption of any other law that expands or

                                      -22-

enlarges the power or obligation of companies governed by the BCL to indemnify
or advance expenses to directors and officers of the Company.

         Section 7.3. Advances. The Company shall pay expenses incurred by an
officer or director, and may pay expenses incurred by any other employee or
agent, in defending any action, or proceeding referred to in this Article 7 in
advance of the final disposition of such action or proceeding upon receipt of an
undertaking by or on behalf of such person to repay such amount if it shall
ultimately be determined that he is not entitled to be indemnified by the
Company.

         Section 7.4. Term of Indemnification. The indemnification and
advancement of expenses provided by or granted pursuant to this Article 7 shall,
unless otherwise provided when authorized or ratified, continue as to a person
who has ceased to be a director, officer, employee or agent and shall inure to
the benefit of the heirs, executors and administrators of such person.

         Section 7.5. Indemnification Fund. The Company shall have the authority
to create a fund of any nature, which may, but need not be, under the control of
a trustee, or otherwise secure or insure in any manner, its indemnification
obligations, whether arising under these By-laws or otherwise. This authority
shall include, without limitation, the authority to: (i) deposit funds in trust
or in escrow; (ii) establish any form of self insurance; (iii) secure its
indemnification obligations by granting a security interest, mortgage or other
lien on the assets of the Company or (iv) establish a letter of credit,
guarantee or surety arrangement for the benefit of such person in connection
with the anticipated indemnification or advancement of expenses contemplated by
this Article 7. The

                                      -23-

provisions of this Article 7 shall not be deemed to preclude the indemnification
of, or the advancement of expenses to, any person who is not specified in
Section 7.1 of this Article 7 but whom the Company has the power or obligation
to indemnify, or to advance expenses for, under the provisions of the BCL, the
Insurance Company Law or otherwise. The authority granted by this Section 7.5
shall be exercised by the Board of Directors of the Company.

         Section 7.6. Indemnification by Agreement. The Company shall have the
authority to enter into a separate indemnification agreement with any officer,
director, employee or agent of the Company or any subsidiary providing for such
indemnification of such persons as the Board of Directors shall determine to the
fullest extent permitted by law.

         Section 7.7. Notice to Company. As soon as practicable after receipt by
any person specified in Section 7.1 of this Article 7 of notice of the
commencement of any action, suit or proceeding specified in Section 7.1 of this
Article 7, such person shall, if a claim with respect thereto may be made
against the Company under Article 7 of these By-laws, notify the Company in
writing of the commencement or the threat thereof; however, the omission so to
notify the Company shall not relieve the Company of any liability under Article
7 of these By-laws unless the Company shall have been prejudiced thereby or from
any other liability which it may have to such person other than under Article 7
of these By-laws. With respect to any such action as to which such person
notifies the Company of the commencement or threat thereof, the Company may
participate therein at its own expense and, except as otherwise provided herein
to the extent that it desires, the Company, jointly

                                      -24-

with any other indemnifying party similarly notified, shall be entitled to
assume the defense thereof, with counsel selected by the Company to the
reasonable satisfaction of such person. After notice from the Company to such
person of its election to assume the defense, the Company shall not be liable to
such person under Article 7 of these By-laws for any legal or other expenses
subsequently incurred by such person in connection with the defense thereof
otherwise than as provided herein. Such person shall have the right to employ
his own counsel in such action, but the fees and expenses of such counsel
incurred after notice from the Company of its assumption of the defense thereof
shall be at the expense of such person unless: (i) the employment of counsel by
such person shall have been authorized by the Company, (ii) such person shall
have reasonably concluded that there may be a conflict of interest between the
Company and such person in the conduct of the defense of such proceeding or
(iii) the Company shall not in fact have employed counsel to assume the defense
of such action. The Company shall not be entitled to assume the defense of any
proceeding brought by or on behalf of the Company or as to which such person
shall have reasonably concluded that there may be a conflict of interest. If
indemnification under Article 7 of these By-laws or advancement of expenses are
not paid or made by the Company, or on its behalf, within ninety days after a
written claim for indemnification or a request for an advancement of expenses
has been received by the Company, such person may, at any time thereafter, bring
suit against the Company to recover the unpaid amount of the claim or the
advancement of expenses. The right to indemnification and advancement of
expenses provided hereunder shall be enforceable by

                                      -25-

such person in any court of competent jurisdiction. The burden of proving that
indemnification is not appropriate shall be on the Company. Expenses reasonably
incurred by such person in connection with successfully establishing the right
to indemnification or advancement of expenses, in whole or in part, shall also
be indemnified by the Company.

         Section 7.8. Insurance. The Company shall have the power to purchase
and maintain insurance on behalf of any person who is or was a director,
officer, employee or agent of the Company, or is or was serving at the request
of the Company as a director, officer, employee or agent of another domestic or
foreign corporation for profit or not-for-profit, partnership, joint venture,
trust or other enterprise against any liability asserted against him or incurred
by him in any such capacity, or arising out of his status as such, whether or
not the Company would have the power to indemnify him against such liability
under the provisions of this Article 7.

         Section 7.9. Amendment. Notwithstanding any other provisions of these
By-laws, the approval of members shall be required to amend, repeal or adopt any
provision as part of these By-laws which is inconsistent with the purpose or
intent of this Article 7, and, if any such action shall be taken, it shall
become effective only on a prospective basis from and after the date of such
member approval.

                                    Article 8
                           FINANCIAL REPORT TO MEMBERS

         The President of the Company and the Board of Directors shall present
at each annual meeting of the members a full and complete statement of the
business and affairs of the Company for the

                                      -26-

preceding year. Such statement shall be prepared and presented in whatever
manner the Board of Directors shall deem advisable and need not be verified by a
certified public accountant or sent to the members of the Company.

                                    Article 9
                                CHECKS AND NOTES

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

                                   Article 10
                                   FISCAL YEAR

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

                                   Article 11
                                      SEAL

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

                                      -27-

                                   Article 12
                                   AMENDMENTS

         Section 12.1. Amendment by Members. Except as provided in Sections 5.6
and 7.9 hereof, these By-laws may be amended or repealed, and new By-laws
adopted, by the affirmative vote of a majority of the votes cast by the members
at any regular or special meeting.

         Section 12.2. Amendment by Board of Directors. Except as provided in
Sections 5.6 and 7.9 hereof, and except as provided in Section 1504(b) of the
BCL, these By-laws may be amended or repealed and new By-laws adopted, by the
affirmative vote of a majority of the members of the Board of Directors at any
regular or special meeting duly convened, subject to the power of the members to
change such action of the Board of Directors.

                                   Article 13
                            INTERPRETATION OF BY-LAWS

         All words, terms and provisions of these By-laws shall be interpreted
and defined by and in accordance with the BCL and the Pennsylvania Insurance
Company Law, as the same may be amended from time to time hereafter, and any
other applicable Pennsylvania laws, as the same may be amended from time to time
hereafter.

As amended through February 20, 1997.

                                      -28-

                               DONEGAL GROUP INC.

                              AMENDED AND RESTATED
                           1996 EQUITY INCENTIVE PLAN

     1. Purpose. The purpose of the Donegal Group Inc. Amended and Restated 1996
Equity Incentive Plan (the "Plan") is to further the growth, development and
financial success of Donegal Group Inc. (the "Company"), its parent and the
subsidiaries of the Company and its parent by providing additional incentives to
those officers and key employees who are responsible for the management of the
business affairs of the Company, its parent and/or subsidiaries of the Company
or its parent, which will enable them to participate directly in the growth of
the capital stock of the Company. The Company intends that the Plan will
facilitate securing, retaining and motivating management employees of high
caliber and potential. To accomplish these purposes, the Plan provides a means
whereby management employees may receive stock options ("Options") to purchase
the Company's Common Stock, $1.00 par value (the "Common Stock").

     2. Administration.

     (a) Composition of the Committee. The Plan shall be administered by a
committee (the "Committee"), which shall be appointed by, and serve at the
pleasure of, the Company's Board of Directors (the "Board"). The Committee shall
be comprised of two or more members of the Board, each of whom shall be a
"non-employee director" within the meaning of Rule 16b-3 under the Securities
Exchange Act of 1934 (the "Exchange Act"). In addition, each member of the
Committee shall be an "outside director" within the meaning of Section 162(m) of
the Internal Revenue Code of 1986, as amended (the "Code"). Subject to the
foregoing, from time to time the Board may increase or decrease the size of the
Committee, appoint additional members thereof, remove members (with or without
cause), appoint new members, fill vacancies or remove all members of the
Committee and thereafter directly administer the Plan.

     (b) Authority of the Committee. The Committee shall have full and final
authority, in its sole discretion, to interpret the provisions of the Plan and
to decide all questions of fact arising in its application; to determine the
employees to whom Options shall be granted and the type, amount, size and terms
of each such grant; to determine the time when Options shall be granted; and to
make all other determinations necessary or advisable for the administration of
the Plan. All decisions, determinations and interpretations of the Committee
shall be final and binding on all optionees and all other holders of Options
granted under the Plan.

     (c) Authority of the Board. Notwithstanding anything to the contrary set
forth in the Plan, all authority granted hereunder to the Committee may be
exercised at any time and from time to time by the Board at its election. All
decisions, determinations and interpretations of the Board shall be final and
binding on all optionees and all other holders of Options granted under the
Plan.

                                       -1-

     3. Stock Subject to the Plan. Subject to Section 16 hereof, the shares that
may be issued under the Plan shall not exceed in the aggregate 695,850 shares of
Common Stock. Such shares may be authorized and unissued shares or shares issued
and subsequently reacquired by the Company. Except as otherwise provided herein,
any shares subject to an Option that for any reason expires or is terminated
unexercised as to such shares shall again be available under the Plan.

     4. Eligibility To Receive Options. Persons eligible to receive Options
under the Plan shall be limited to those officers and other key employees of the
Company, its parent and any subsidiary of the Company or its parent (as defined
in Section 425 of the Code or any amendment or substitute thereto) who are in
positions in which their decisions, actions and counsel significantly impact
upon the profitability and success of the Company, its parent or any subsidiary
of the Company or its parent. Directors of the Company who are not also officers
or employees of the Company, its parent or any subsidiary of the Company or its
parent shall not be eligible to participate in the Plan. Notwithstanding
anything to the contrary set forth in the Plan, the maximum number of shares of
Common Stock for which Options may be granted to any employee in any calendar
year shall be 100,000 shares.

     5. Types of Options. Grants may be made at any time and from time to time
by the Committee in the form of stock options to purchase shares of Common
Stock. Options granted hereunder may be Options that are intended to qualify as
incentive stock options within the meaning of Section 422 of the Code or any
amendment or substitute thereto ("Incentive Stock Options") or Options that are
not intended to so qualify ("Nonqualified Stock Options").

     6. Option Agreements. Options for the purchase of Common Stock shall be
evidenced by written agreements in such form not inconsistent with the Plan as
the Committee shall approve from time to time. The Options granted hereunder may
be evidenced by a single agreement or by multiple agreements, as determined by
the Committee in its sole discretion. Each option agreement shall contain in
substance the following terms and conditions:

     (a) Type of Option. Each option agreement shall identify the Options
represented thereby either as Incentive Stock Options or Nonqualified Stock
Options, as the case may be.

     (b) Option Price. Each option agreement shall set forth the purchase price
of the Common Stock purchasable upon the exercise of the Option evidenced
thereby. Subject to the limitation set forth in Section 6(d)(ii) of the Plan,
the purchase price of the Common Stock subject to an Incentive Stock Option
shall be not less than 100% of the fair market value of such stock on the date
the Option is granted, as determined by the Committee, but in no event less than
the par value of such stock. The purchase price of the Common Stock subject to a
Nonqualified Stock Option shall be not less than 100% of the fair market value
of such stock on the date the Option is granted, as determined by the Committee.
For this purpose, fair market value on any date shall mean the closing price of
the Common Stock, as reported in The Wall Street Journal, or if not so reported,
as otherwise reported by the National Association of Securities Dealers
Automated Quotation ("Nasdaq"), or if the Common Stock is not reported by
Nasdaq, the fair market value shall be as determined by the Committee pursuant
to Section 422 of the Code.

                                       -2-

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

     (d) Incentive Stock Options. In the case of an Incentive Stock Option, each
option agreement shall contain such other terms, conditions and provisions as
the Committee determines to be necessary or desirable in order to qualify such
Option as a tax-favored Option (within the meaning of Section 422 of the Code or
any amendment or substitute thereto or regulation thereunder) including without
limitation, each of the following, except that any of these provisions may be
omitted or modified if it is no longer required in order to have an Option
qualify as a tax-favored Option within the meaning of Section 422 of the Code or
any substitute therefor:

        (i) The aggregate fair market value (determined as of the date the
Option is granted) of the Common Stock with respect to which Incentive Stock
Options are first exercisable by any employee during any calendar year (under
all plans of the Company) shall not exceed $100,000.

        (ii) No Incentive Stock Options shall be granted to any employee if at
the time the Option is granted to the individual who owns stock possessing more
than 10% of the total combined voting power of all classes of stock of the
Company or its subsidiaries unless at the time such Option is granted the Option
price is at least 110% of the fair market value of the stock subject to the
Option and, by its terms, the Option is not exercisable after the expiration of
five years from the date of grant.

        (iii) No Incentive Stock Options shall be exercisable more than three
months (or one year, in the case of an employee who dies or becomes disabled
within the meaning of Section 72(m)(7) of the Code or any substitute therefor)
after termination of employment.

     (e) Substitution of Options. Options may be granted under the Plan from
time to time in substitution for stock options held by employees of other
corporations who are about to become, and who do concurrently with the grant of
such options become, employees of the Company, its parent or a subsidiary of the
Company or its parent as a result of a merger or consolidation of the employing
corporation with the Company, its parent or a subsidiary of the Company or its
parent, or the acquisition by the Company, its parent or a subsidiary of the
Company or its parent of the assets or capital stock of the employing
corporation. The terms and conditions of the substitute options so granted may
vary from the terms and conditions set forth in this Section 6 to such extent as
the Committee at the time of grant may deem appropriate to conform, in whole or
in part, to the provisions of the stock options in substitution for which they
are granted.

     7. Date of Grant. The date on which an Option shall be deemed to have been
granted under the Plan shall be the date of the Committee's authorization of the
Option or such later date

                                       -3-

as may be determined by the Committee at the time the Option is authorized.
Notice of the determination shall be given to each individual to whom an Option
is so granted within a reasonable time after the date of such grant.

     8. Exercise and Payment for Shares. Options may be exercised in whole or in
part, from time to time, by giving written notice of exercise to the Secretary
of the Company, specifying the number of shares to be purchased. The purchase
price of the shares with respect to which an Option is exercised shall be
payable in full with the notice of exercise in cash, Common Stock at fair market
value, or a combination thereof, as the Committee may determine from time to
time and subject to such terms and conditions as may be prescribed by the
Committee for such purpose. The Committee may also, in its discretion and
subject to prior notification to the Company by an optionee, permit an optionee
to enter into an agreement with the Company's transfer agent or a brokerage firm
of national standing whereby the optionee will simultaneously exercise the
option and sell the shares acquired thereby through the Company's transfer agent
or such a brokerage firm and either the Company's transfer agent or the
brokerage firm executing the sale will remit to the Company from the proceeds of
sale the exercise price of the shares as to which the option has been exercised.

     9. Rights upon Termination of Employment. In the event that an optionee
ceases to be an employee of the Company, its parent or any subsidiary of the
Company or its parent for any reason other than death, retirement, as
hereinafter defined, or disability (within the meaning of Section 72(m)(7) of
the Code or any substitute therefor), the optionee shall have the right to
exercise the Option during its term within a period of three months after such
termination to the extent that the Option was exercisable at the time of
termination, or within such other period, and subject to such terms and
conditions, as may be specified by the Committee. In the event that an optionee
dies, retires or becomes disabled prior to the expiration of his Option and
without having fully exercised his Option, the optionee or his successor shall
have the right to exercise the Option during its term within a period of one
year after termination of employment due to death, retirement or disability to
the extent that the Option was exercisable at the time of termination, or within
such other period, and subject to such terms and conditions, as may be specified
by the Committee. As used in this Section 9, "retirement" means a termination of
employment by reason of an optionee's retirement at or after his earliest
permissible retirement date pursuant to and in accordance with his employer's
regular retirement plan or personnel practices. Notwithstanding the provisions
of Section 6(d)(iii) hereof, if the term of an Incentive Stock Option continues
for more than three months after termination of employment due to retirement or
more than one year after termination of employment due to death or disability,
such Op tion shall thereupon lose its status as an Incentive Stock Option and
shall be treated as a Nonqualified Stock Option.

     10. General Restrictions. Each Option granted under the Plan shall be
subject to the requirement that, if at any time the Committee shall determine
that (i) the listing, registration or qualification of the shares of Common
Stock subject or related thereto upon any securities exchange or under any state
or federal law, or (ii) the consent or approval of any government regulatory
body, or (iii) the satisfaction of any tax payment or withholding obligation, or
(iv) an agreement by the recipient of an Option with respect to the disposition
of shares of Common

                                       -4-

Stock, is necessary or desirable as a condition of or in connection with the
granting of such Option or the issuance or purchase of shares of Common Stock
thereunder, such Option shall not be consummated in whole or in part unless such
listing, registration, qualification, consent, approval or agreement shall have
been effected or obtained free of any conditions not acceptable to the
Committee.

     11. Rights of a Stockholder. The recipient of any Option under the Plan,
unless otherwise provided by the Plan, shall have no rights as a stockholder
unless and until certificates for shares of Common Stock are issued and
delivered to him.

     12. Right to Terminate Employment. Nothing contained in the Plan or in any
option agreement entered into pursuant to the Plan shall confer upon any
optionee the right to continue in the employment of the Company, its parent or
any subsidiary of the Company or its parent or affect any right that the
Company, its parent or any subsidiary of the Company or its parent may have to
terminate the employment of such optionee.

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

     14. Non-Assignability. No Option under the Plan shall be assignable or
transferable by the recipient thereof except by will or by the laws of descent
and distribution or by such other means as the Committee may approve. During the
life of the recipient, such Option shall be exercisable only by such person or
by such person's guardian or legal representative.

     15. Non-Uniform Determinations. The Committee's determinations under the
Plan (including without limitation determinations of the persons to receive
Options, the form, amount and timing of such grants, the terms and provisions of
Options, and the agreements evidencing same) need not be uniform and may be made
selectively among persons who receive, or are eligible to receive, grants of
Options under the Plan whether or not such persons are similarly situated.

                                       -5-

     16. Adjustments.

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

     (b) Dissolution or Liquidation. In the event of the proposed dissolution or
liquidation of the Company, all outstanding Options will terminate immediately
prior to the consummation of such proposed action, unless otherwise provided by
the Committee. The Committee may, in the exercise of its discretion in such
instances, declare that any Option shall terminate as of a date fixed by the
Committee and give each Option holder the right to exercise his Option as to all
or any part of the shares of Common Stock covered by the Option, including
shares as to which the Option would not otherwise be exercisable.

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

     17. Amendment. The Committee may terminate or amend the Plan at any time,
with respect to shares as to which Options have not been granted, subject to any
required stockholder approval or any stockholder approval that the Board may
deem to be advisable for any reason, such as for the purpose of obtaining or
retaining any statutory or regulatory benefits under tax, securities or other
laws or satisfying any applicable stock exchange listing requirements. The
Committee may not, without the consent of the holder of an Option, alter or
impair any Option previously granted under the Plan, except as specifically
authorized herein.

                                       -6-

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

     19. Effect on Other Plans. Participation in the Plan shall not affect an
employee's eligibility to participate in any other benefit or incentive plan of
the Company, its parent or any subsidiary of the Company or its parent. Any
Options granted pursuant to the Plan shall not be used in determining the
benefits provided under any other plan of the Company, its parent or any
subsidiary of the Company or its parent unless specifically provided.

     20. Duration of the Plan. The Plan shall remain in effect until all Options
granted under the Plan have been satisfied by the issuance of shares, but no
Option shall be granted more than ten years after the earlier of the date the
Plan is adopted by the Company or is approved by the Company's stockholders.

     21. Forfeiture for Dishonesty. Notwithstanding anything to the contrary in
the Plan, if the Committee finds, by a majority vote, after full consideration
of the facts presented on behalf of both the Company and any optionee, that the
optionee has been engaged in fraud, embezzlement, theft, commission of a felony
or dishonest conduct in the course of his employment or retention by the
Company, its parent or any subsidiary of the Company or its parent that damaged
the Company, its parent or any subsidiary of the Company or its parent or that
the optionee has disclosed confidential information of the Company, its parent
or any subsidiary of the Company or its parent, the optionee shall forfeit all
unexercised Options and all exercised Options under which the Company has not
yet delivered the certificates. The decision of the Committee in interpreting
and applying the provisions of this Section 21 shall be final. No decision of
the Committee, however, shall affect the finality of the discharge or
termination of such optionee by the Company, its parent or any subsidiary of the
Company or its parent in any manner.

     22. No Prohibition on Corporate Action. No provision of the Plan shall be
construed to prevent the Company or any officer or director thereof from taking
any action deemed by the Company or such officer or director to be appropriate
or in the Company's best interest, whether or not such action could have an
adverse effect on the Plan or any Options granted hereunder, and no optionee or
optionee's estate, personal representative or beneficiary shall have any claim
against the Company or any officer or director thereof as a result of the taking
of such action.

     23. Indemnification. With respect to the administration of the Plan, the
Company shall indemnify each present and future member of the Committee and the
Board against, and each member of the Committee and the Board shall be entitled
without further action on his part to indemnity from the Company for, all
expenses (including the amount of judgments and the amount of approved
settlements made with a view to the curtailment of costs of litigation, other
than amounts paid to the Company itself) reasonably incurred by him in
connection with or arising out of, any action, suit or proceeding in which he
may be involved by reason of his being or

                                       -7-

having been a member of the Committee or the Board, whether or not he continues
to be such member at the time of incurring such expenses; provided, however,
that such indemnity shall not include any expenses incurred by any such member
of the Committee or the Board (i) in respect of matters as to which he shall be
finally adjudged in any such action, suit or proceeding to have been guilty of
gross negligence or willful misconduct in the performance of his duty as such
member of the Committee or the Board; or (ii) in respect of any matter in which
any settlement is effected for an amount in excess of the amount approved by the
Company on the advice of its legal counsel; and provided further that no right
of indemnification under the provisions set forth herein shall be available to
or enforceable by any such member of the Committee or the Board unless, within
60 days after institution of any such action, suit or proceeding, he shall have
offered the Company in writing the opportunity to handle and defend same at its
own expense. The foregoing right of indemnification shall inure to the benefit
of the heirs, executors or administrators of each such member of the Committee
or the Board and shall be in addition to all other rights to which such member
may be entitled as a matter of law, contract or otherwise.

     24. Miscellaneous Provisions.

     (a) Compliance with Plan Provisions. No optionee or other person shall have
any right with respect to the Plan, the Common Stock reserved for issuance under
the Plan or in any Option until a written option agreement shall have been
executed by the Company and the optionee and all the terms, conditions and
provisions of the Plan and the Option applicable to such optionee (and each
person claiming under or through him) have been met.

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

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

     (d) Effects of Acceptance of Option. By accepting any Option or other
benefit under the Plan, each optionee and each person claiming under or through
him shall be conclusively deemed to have indicated his acceptance and
ratification of, and consent to, any action taken under the Plan by the Company,
the Board and/or the Committee or its delegates.

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

                                       -8-

     25. Stockholder Approval. The exercise of any Option granted under the Plan
shall be subject to the approval of the Plan by the affirmative vote of the
holders of a majority of the outstanding shares of the Common Stock present, or
represented, and entitled to vote at a meeting duly held.

                                       -9-

                               DONEGAL GROUP INC.

                           1996 EQUITY INCENTIVE PLAN
                                  FOR DIRECTORS

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

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

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

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

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

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

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

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

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

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

     "Mutual Company" shall mean Donegal Mutual Insurance Company.

                                       -1-

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

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

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

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

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

     "Secretary" shall mean the Secretary of the Company.

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

     2. Administration.

     (a) Administration by the Board. The Plan shall be administered by the
Board.

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

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

     (d) Compensation; Professional Assistance; Good Faith Actions. Members of
the Board shall not receive any compensation for their services in admin
istering the Plan, but all expenses and liabilities they incur in connection
with the administration of the Plan shall be borne by the Company. The Board may
employ attorneys, consultants, accountants or other persons. The Board, the
Company and

                                       -2-

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

     3. Shares Subject to the Plan.

     (a) Limitations. The shares of stock issuable pursuant to Options or
Restricted Stock Awards shall be shares of the Common Stock. The total number
of such shares that may be issued pursuant to Options or Restricted Stock Awards
granted under the Plan shall not exceed 90,000 in the aggregate.

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

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

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

                                       -3-

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

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

     4. Stock Options.

     (a) Granting of Options.

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

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

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

     (b) Terms of Options.

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

                                       -4-

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

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

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

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

     (c) Exercise of Options.

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

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

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

                                       -5-

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

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

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

     5. Restricted Stock Awards.

     (a)    Granting of Awards.

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

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

                                       -6-

     (b) Terms of Restricted Stock Awards.

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

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

        (iii) Rights as Stockholder.

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

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

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

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

                                       -7-

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

     6. Miscellaneous Provisions.

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

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

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

                                       -8-

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

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

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

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

                                       -9-

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

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

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

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

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

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

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

                                      -10-

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

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

                                      -11-

                        DONEGAL MUTUAL INSURANCE COMPANY

                           EXECUTIVE RESTORATION PLAN

                                TABLE OF CONTENTS
                                -----------------

                                                          Page
                                                          ----

Section 1     Definitions................................  1

Section 2     Eligibility................................  5

Section 3     Benefits...................................  5

Section 4     Accounts...................................  8

Section 5     Distributions..............................  9

Section 6     Pre-Retirement Death Benefit............... 12

Section 7     Vesting.................................... 13

Section 8     Funding.................................... 14

Section 9     Administration............................. 14

Section 10    Amendment.................................. 14

Section 11    Termination................................ 14

Section 12    Miscellaneous.............................. 15

                                       (i)

                        DONEGAL MUTUAL INSURANCE COMPANY
                        --------------------------------

                           EXECUTIVE RESTORATION PLAN
                           --------------------------

         In recognition of the services provided to Donegal Mutual Insurance
Company (the "Employer"), its Board of Directors (the "Board") wishes to restore
certain retirement benefits to those individuals (individually an "Employee")
for whom contributions to the Donegal Mutual Insurance Company Money Purchase
Pension and Profit Sharing Plans (hereinafter together referred to as the
"Retirement Plans") are restricted as a result of the application of Sections
401(a)(17) and 415 of the Internal Revenue Code of 1986, as amended (the
"Code"). It is the intent of the Board to provide these benefits under the terms
and conditions hereinafter set forth.

                                    SECTION 1

                                   DEFINITIONS
                                   -----------

         1.1 Each capitalized term used in this Plan (as hereinafter defined)
which is a defined term in either of the Retirement Plans and which is not
separately defined in this Plan shall have the same meaning herein as assigned
to it under the provisions of the Retirement Plans unless otherwise qualified by
the context.
         1.2 The following additional defined terms as used herein shall have
the following meanings unless a different meaning is required by the context:
             1.2.1 "Accrued Benefit" means the balance in a Participant's
Individual Account.
             1.2.2 "Administrator" means the Employer or any person or committee
designated by the Employer to provide for the general administration of this
Plan pursuant to Section 9 hereof.

                                       -1-

             1.2.3 "Annuity Starting Date" means (i) the first day of the first
period for which an amount is payable as an annuity or (ii) in the case of a
benefit not payable in the form of an annuity, the first day on which all events
have occurred which entitle the Participant to the benefit.
             1.2.4 "Beneficiary" means the person(s) designated by a Participant
to receive any benefits payable under this Plan subsequent to the Participant's
death. In the event a Participant has not filed a beneficiary designation with
the Employer, the Beneficiary shall be the Participant's surviving spouse or, if
there is no surviving spouse, his estate.
             1.2.5 "Earliest Retirement Age" means, solely for purposes of
Section 1.2.11 hereof, the earliest date on which, under this Plan, the
Participant could elect to receive benefits if the Participant terminated
employment or any earlier date determined by the Administrator.
             1.2.6 "Effective Date" means January 1, 1994.
             1.2.7 "Individual Account" means the account established and
maintained in accordance with the provisions of Sections 3 and 4 hereof. 
             1.2.8 "Participant" means any Employee who satisfies the 
eligibility and other requirements set forth in Section 2 hereof. In the event
of the death or the incompetency of a Participant, the term shall mean his or
her personal representative or guardian.
             1.2.9 "Plan" means the Donegal Mutual Insurance Company Executive
Restoration Plan as set forth herein and as it may be amended or supplemented
from time to time.
             1.2.10 "Plan Year" means the calendar year.

                                       -2-

             1.2.11 "Qualified Domestic Relations Order" means a judgment,
decree or order (including approval of a property settlement agreement) made
pursuant to a state domestic relations law (including a community property law)
which (a) relates to the provision of child support, alimony payments or marital
property rights to a spouse, former spouse, child or other dependent of a
Participant (the "Alternate Payee"); (b) creates or recognizes the existence of
the Alternate Payee's right to, or assigns to the Alternate Payee the right to,
receive all or a portion of the benefits payable to a Participant under this
Plan; (c) specifies (i) the name and last known mailing address (if any) of the
Participant and each Alternate Payee covered by the order, (ii) the amount or
percentage of the Participant's Plan benefits to be paid to the Alternate Payee,
or the manner in which such amount or percentage is to be determined, and (iii)
the number of payments or the period to which the order applies and each plan to
which the order relates; and (d) does not require this Plan to (i) provide any
type or form of benefit, or any option not otherwise provided under this Plan,
(ii) provide increased benefits, or (iii) pay benefits to the Alternate Payee
that are required to be paid to another Alternate Payee under a prior Qualified
Domestic Relations Order. Notwithstanding the foregoing, a Qualified Domestic
Relations Order may provide that distribution commence on or after the date on
which the Participant attains, or would have attained, his Earliest Retirement
Age regardless of whether the Participant has terminated service on that date,
if the Order directs (i) that the payment of the benefits be determined as if
the Participant had retired on the date on which payment is to begin under such
Order, taking into account only the balance standing to the Participant's credit
in his Individual Account on such date, and (ii)

                                       -3-

that the payment be made in any form in which such benefits may be paid under
this Plan to the Participant.
             1.2.12 "Salary" means a Participant's base salary actually paid to
the Participant for the calendar year ending with each Plan Year and shall not
include any amounts contributed by the Employer under the Retirement Plans, any
amounts paid by the Employer pursuant to this Plan, any form of bonus or
incentive compensation and any disability payments, taxable fringe benefits,
non-taxable fringe benefits, amounts realized from the exercise of stock
options, or when restricted stock (or property) held by the Participant either
becomes freely transferable or is no longer subject to a substantial risk of
forfeiture, and amounts realized from the sale, exchange or other disposition of
stock options shall be excluded from Salary. The foregoing notwithstanding,
Salary shall include any amount which is contributed by the Employer pursuant to
a salary reduction agreement and which is not includable in the gross income of
the Participant under Section 125 or 402(e)(3) of the Code, provided that this
provision shall not cause a Participant's Salary to exceed his or her base
salary amount in effect before any such reduction.
             1.2.13 "Trust" means each of the trusts established pursuant to the
Trust Agreement (as defined herein) for the purpose of receiving and holding
Plan assets.
             1.2.14 "Trust Agreement" means the agreement between the Trustee
and the Employer entered into for the purpose of holding, managing and
administering all property held by the Trustee for the benefit of each
Participant and his or her Beneficiary.
             1.2.15 "Trustee" means CoreStates Hamilton Bank or any successor
designated by the Employer.

                                       -4-

             1.2.16 "Valuation Date" means the last day of each Plan Year or
such other interim dates which shall be designated as such by the Administrator.

                                    SECTION 2

                                   ELIGIBILITY
                                   -----------

         2.1 Any Employee who is a participant in one or both of the Retirement
Plans on the Effective Date and for whom employer contributions have been
restricted by reason of the limitations imposed by Section 401(a)(17) or 415 of
the Code shall participate in this Plan.
         2.2 Following the Effective Date, Employees who are participants in one
or both of the Retirement Plans and for whom the amount of their employer
contributions is limited by Section 401(a)(17) or 415 of the Code shall
automatically become a Participant in this Plan.
         2.3 Notwithstanding any other provision of this Section 2 to the
contrary, no Employee will be eligible to participate in or receive benefits
from this Plan if he or she violates the terms and conditions of any employment
contract, service contract, or any other agreement relating to confidential
matters of the Employer.

                                    SECTION 3

                                    BENEFITS
                                    --------

         3.1 The Employer shall create and maintain an Individual Account for
each Participant and except as otherwise provided in Sections 3.2 and 3.3
hereof, it shall deposit and credit to the Individual Account of each
Participant an amount for each Plan Year that is equal to the sum of (a) and (b)
where:
             (a) is the amount of the employer contribution that was not
contributed to the Donegal Mutual Insurance Company Money Purchase Pension Plan
on behalf of the Participant during the corresponding Plan

                                       -5-

Year, taking into account the Participant's Salary, as a result of the operation
of the limitations set forth in Code Sections 401(a)(17) and 415; and
             (b) is the amount of the employer contribution, if any, that would
have been allocated to the Donegal Mutual Insurance Company Profit Sharing Plan
on behalf of the Participant during the corresponding Plan Year, taking into
account the Participant's Salary, but for the limitations set forth in Code
Sections 401(a)(17) and 415. 
         3.2 Notwithstanding the foregoing provisions of Section 3.1 hereof,
the sum of (i) the annual additions made to a Participant's accounts under the
Retirement Plans with respect to any Plan Year, as determined in accordance with
Section 415(b) of the Code, and (ii) the amounts to be deposited and credited to
a Participant's Individual Account pursuant to Section 3.1 hereof shall not
exceed an amount equal to twenty-five percent (25%) of the Participant's
compensation taken into account for purposes of Code Section 415 for such Plan
Year. In the event that such limitation would be exceeded with respect to any
Plan Year, the amount to be deposited and credited under Sections 3.1(a) and (b)
hereof to the Participant's Individual Account shall be reduced to the extent
necessary (but not below zero) in order to satisfy the twenty-five percent (25%)
limitation.
         3.3 In no event shall a Participant's Individual Account be credited
with a contribution pursuant to Sections 3.1 (a) and (b) hereof unless the
Participant completed at least 1,000 Hours of Service during the Plan Year.
         3.4 The payments required by Section 3.1 hereof shall be deemed to have
been made on the last day of the Plan Year to which they relate regardless of
when actually calculated by the Employer, provided that

                                       -6-

such payments shall in no event be made later than sixty (60) days after the end
of the Plan Year.
         3.5 At such time as the Employer shall determine, in its sole
discretion, but in no event later than one month before the latest time
prescribed in Section 3.4 hereof for the making of contributions, the Employer
shall make a payment available to each Participant with respect to each Plan
Year in an amount equal to the sum of (i) the amount required pursuant to this
Section 3 to be contributed to the Participant's Individual Account for the Plan
Year in accordance with Sections 3.1(a) and (b) hereof (the "Section 3 Payment")
and (ii) the amount necessary to pay all applicable federal, state and local
income taxes due on the Section 3 Payment (assuming the highest applicable
marginal rates (including any surtax rate as well as the Medicare health
insurance tax rate imposed on employees under the Federal Insurance
Contributions Act) for federal and state purposes and the highest marginal local
rate in effect at the Employer's headquarters) so that after the payment of such
taxes the Section 3 Payment will have remained intact and will not have had to
have been reduced by such taxes (the "Tax Gross-Up"). In accordance with
procedures adopted by the Administrator, a Participant may elect to receive the
Section 3 Payment and the Tax Gross-Up directly in cash or alternatively may
direct the Employer (as his or her agent) to deposit the Section 3 Payment into
the Trust on behalf of the Participant and to pay the Tax Gross-Up directly to
the Participant. In the event that for any Plan Year a Participant elects to
receive the Section 3 payment directly instead of having the Section 3 Payment
deposited in the Trust, the Participant shall no longer be entitled to receive
any further Tax Gross-Up amounts.

                                       -7-

                                    SECTION 4

                                    ACCOUNTS
                                    --------

         4.1 In order to implement this Plan, the Employer has entered into a
Trust Agreement so that the Plan assets shall be segregated from the Employer's
own assets and held in trust for the exclusive benefit of the Participants.
         4.2 Apart from a Section 3 payment which a Participant elects to
receive pursuant to Section 3.5 hereof, all amounts paid by the Employer
pursuant to this Plan shall be paid over to the Trustee. Such amounts and all
cash, securities or properties and income therefrom received by the Trustee
shall constitute assets of the Trust.
         4.3 The Trustee shall have the sole investment responsibility for the
assets of the Trust unless the Administrator makes the election provided under
Section 4.6 hereof. The execution of the Trust Agreement by the Trustee shall
evidence such Trustee's acceptance of his or its fiduciary capacity and
agreement to the allocation of fiduciary responsibilities, obligations and
duties contained in this Plan and the Trust Agreement.
         4.4 Each Individual Account shall constitute a separate trust. The
assets of each Trust shall be revalued by the Trustee at each Valuation Date at
their market value, taking into account capital appreciation or depreciation in
such assets whether or not realized.
         4.5 The Administrator shall establish or provide for the establishment
of accounting procedures for the purpose of making the allocations, valuations
and adjustments to the Individual Accounts provided for in this Section 4.
         4.6 Each Participant shall be permitted to direct the Trustee as to
the investments or investment media or funds in which the assets

                                       -8-

credited to the Participant's Individual Account shall be invested. All such
directed investments shall be made and implemented in accordance with the rules
and procedures established by the Administrator.
         4.7 At the same time that the election is provided for in accordance
with Section 3.5 hereof, the Trustee, unless the Trustee receives a Participant
waiver of his right to receive an annual distribution of income from his Trust
pursuant to Article VI of the Trust Agreement, shall distribute the Trust's
income to the Participant in the manner provided in Article VI of the Trust
Agreement. Moreover, the annual income from the Trust which must be taken into
income by each Participant may, in the sole discretion of the Employer, be the
subject of a tax gross-up payment in the same manner as is provided in
accordance with Section 3.5 hereof.

                                    SECTION 5

                                  DISTRIBUTIONS
                                  -------------

         5.1 A Participant's Accrued Benefit shall be paid to the Participant
within sixty (60) days after the Valuation Date immediately following the date
on which his or her employment with the Employer terminates, provided that in no
event shall the payment be made before the end of the 45-day election period
provided for in Section 5.4(b) hereof unless agreed to by the Participant. If
the Participant is entitled to a payment pursuant to Section 3.1 hereof for the
Plan Year in which he or she terminates employment, that additional contribution
will be paid to him or her along with the Participant's Accrued Benefit.
         5.2  A Participant who has a Spouse on his or her Annuity Starting
Date shall receive benefits in the form of a joint and survivor annuity

                                       -9-

unless pursuant to Section 5.4 hereof he or she elects to receive his or her
benefit in another form. Such annuity shall pay monthly retirement benefits to
the Participant for life and, after his or her death, to the Participant's
Spouse in an amount equal to 50% of the benefit payable to the Participant. The
amount of such annuity shall be such as can be obtained with the balance in the
Participant's Individual Account on the Annuity Starting Date.
         5.3 In the absence of an election pursuant to Section 5.4 hereof a
Participant who does not have a Spouse on his or her Annuity Starting Date shall
receive a retirement benefit in the form of a single life annuity. Such annuity
shall be in the amount which can be obtained with the balance in the
Participant's Individual Account on the Annuity Starting Date.
         5.4 In lieu of the forms of benefit provided in Sections 5.2 and 5.3
hereof and subject to the spousal consent requirements of Section 5.6 hereof, a
Participant may elect to have his or her Accrued Benefit distributed in one or
both of the following forms:
             (a) a lump sum cash payment; or
             (b) five (5) substantially equal, annual cash installments of
his or her Accrued Benefit (or such portion which is not received as a lump sum)
plus any earnings credited to the Participant's Individual Account as of any
payment date following distribution of the initial installment. The election
must be made within the 45-day period following the date of the Participant's
termination of employment and any such election may be revoked at any time
during the election period. The Participant's Individual Account shall continue
to be credited with earnings pursuant to Section 4 hereof for so long as there
exists any unpaid balance. In the event that the Participant

                                      -10-

shall die before receiving all installments elected by the Participant, the
balance of such unpaid installments shall be paid in a single sum to the
Participant's Beneficiary or, in the absence of such Beneficiary, to the
Participant's estate.
          5.5 No less than 30 days and no more than 90 days before the Annuity
Starting Date, the Administrator shall mail or personally deliver to the
Participant a written explanation of (i) the terms and conditions of the normal
forms of benefit as described in Sections 5.2 and 5.3 hereof, including (a) a
general explanation of the relative financial effect on the Participant's
benefit of an election under Section 5.4 to waive the normal form of benefit and
to elect an optional form, (b) a general description of the eligibility
conditions and other material features of each optional form of benefit and (c)
sufficient additional information to explain the relative value of each optional
form of benefit available under Section 5.4 hereof, (ii) the Participant's right
to elect each optional form of benefit and the effect of such an election, (iii)
the rights of the Participant's Spouse under Section 5.6 hereof, and (iv) the
right to make, and the effect of, a revocation of an election hereunder.
          5.6 If a married Participant elects an optional form of benefit as
provided in Section 5.4 hereof, the Spouse of the Participant must consent in
writing to the election on a form provided by the Administrator, which consent
shall be irrevocable. The consent shall acknowledge the effect of the election
on the Spouse's right to benefits under this Plan and shall be witnessed by a
notary public. The spousal consent requirement may be waived if it is
established, to the satisfaction of the Administrator, that the consent may not
be obtained because there is no Spouse, because the Spouse cannot be

                                      -11-

located or because of such other circumstances as may be prescribed by
applicable regulations.

                                    SECTION 6

                          PRE-RETIREMENT DEATH BENEFIT
                          ----------------------------

         6.1 If a Participant dies before his Annuity Starting Date, the then
value of the Participant's Individual Account shall be distributed in the form
and manner provided in Section 6.3 or 6.4 hereof, whichever may be applicable.
The Administrator may require such proper proof of death and such evidence of
the right of any person to receive payment of the Individual Account of a
deceased Participant as the Administrator may deem desirable. The
Administrator's determination of death and of the right of any person to receive
payment shall be final.
         6.2 Each Participant shall, by written notice to the Administrator,
designate a Beneficiary or Beneficiaries to receive any payment to which the
Participant may be entitled under this Plan at the time of his or her death
before the Annuity Starting Date, provided that a married Participant must
designate his or her Spouse as Beneficiary. If a married Participant wants to
designate a Beneficiary other than his or her Spouse, the Spouse of the
Participant must consent in writing to such Beneficiary designation on a form
provided by the Administrator, which consent shall be irrevocable. The consent
shall acknowledge the financial effect of the election on the Spouse's right to
death benefits under this Plan and shall be witnessed by a notary public. Both
the Participant's designation and the Spouse's consent shall state the specific
non-Spouse Beneficiary (including any class of Beneficiaries or any contingent
Beneficiaries) who will receive the death benefit provided hereunder. The
spousal consent requirement may be waived if it is established, to the
satisfaction of the Administra-

                                      -12-

tor, that the consent may not be obtained because there is no Spouse or because
the Spouse cannot be located. Any Beneficiary designation made by a Participant
which does not meet the requirements of this Section 6.2 and any Beneficiary
designation made by an unmarried Participant who later marries shall be deemed
null and void. The Participant shall have the right to change a Beneficiary
designation or any subsequent Beneficiary designation, subject to the spousal
consent provisions of this Section 6.2.
         6.3 Except as provided in Section 6.4 hereof with respect to a
surviving Spouse, the death benefit provided under this Section 6 payable to a
Beneficiary, including a Participant's Spouse, shall be paid in the form of a
lump sum. If the Beneficiary dies prior to receiving the death benefit, the
balance shall be paid to the Beneficiary's estate in a lump sum.
         6.4 In lieu of receiving a death benefit in the form of payment
provided in Section 6.3 hereof, a Participant's surviving Spouse may elect to
have the death benefit paid in the form of an immediate single life annuity.
Such annuity shall be in the amount which can be obtained with the balance in
the Participant's Individual Account at the date of the Participant's death.

                                    SECTION 7

                                     VESTING
                                     -------

         7.1 A Participant's Accrued Benefit shall be 100% vested and
nonforfeitable at all times.

                                      -13-

                                    SECTION 8

                                     FUNDING
                                     -------

         8.1 A Trust shall serve as the funding vehicle for the benefits
provided by this Plan with respect to each Participant.

                                    SECTION 9

                                 ADMINISTRATION
                                 --------------

         9.1 The Administrator, or its designee, shall have the full power and
authority to interpret and administer this Plan and the Administrator's actions
in doing so shall be final and binding on all persons interested in this Plan.
The Administrator shall have the same powers and authority as are set forth in
the Retirement Plans. The Administrator may from time to time adopt additional
or supplemental rules and regulations governing the administration of this Plan.

                                   SECTION 10

                                    AMENDMENT
                                    ---------

         10.1 The Board shall have the right to amend or modify this Plan at any
time in any manner whatsoever; provided, however, that no amendment shall
operate to reduce the Accrued Benefit to which any Participant who is
participating in this Plan at the time the amendment is adopted would otherwise
be entitled at that time.

                                   SECTION 11

                                   TERMINATION
                                   -----------

         11.1 The Board shall have the right at any time to terminate or
discontinue contributions to this Plan for any reason; provided, however, that
such termination or discontinuance shall not operate to reduce the Accrued
Benefit to which any Participant who is participating in this Plan at the time
the termination or discontinuance is adopted would otherwise be entitled at that
time.

                                      -14-

                                   SECTION 12

                                  MISCELLANEOUS
                                  -------------

         12.1 Nothing contained in this Plan shall be deemed to exclude a
Participant from any compensation, bonus, pension, insurance, severance pay or
other benefit to which he or she is or might otherwise become entitled as an
Employee, nor shall any provision of this Plan be construed as conferring upon
an Employee the right to continue in the employ of the Employer.
         12.2 Any amounts payable by the Employer hereunder shall not be deemed
salary or other compensation to a Participant for the purposes of computing
benefits to which he or she may be entitled under any other plan or arrangement
established by the Employer for the benefit of its employees, unless such plan
or arrangement specifically provides to the contrary.
         12.3 The rights and obligations created hereunder shall be binding on a
Participant's heirs, executors and administrators and on the successors and
assigns of the Employer.
         12.4 Except insofar as Pennsylvania law has been pre-empted by federal
law, this Plan shall be construed in accordance with and governed by the
internal laws of the Commonwealth of Pennsylvania.
         12.5 Except in the event of bad faith, willful misconduct or
negligence, neither the Employer nor any member of the Board shall be
responsible or liable in any manner to any Participant, beneficiary or any
person claiming through them for any benefit or action taken or omitted in
connection with the granting of benefits, the continuation of benefits, or the
interpretation and administration of this Plan.
         12.6 Except with respect to income tax withholding requirements and
employment taxes due with respect to the contributions and other

                                      -15

payments made hereunder, no amount payable under this Plan shall be subject in
any manner to anticipation, alienation, sale, transfer, assignment, pledge,
encumbrance, charge or seizure; and no such amount shall be in any manner
subject to the debts, contracts, liabilities, engagements or torts of any
Participant or his or her Beneficiary. Notwithstanding the foregoing, the
Administrator shall direct the Trustee to comply with Federal tax liens and
Qualified Domestic Relations Orders. Upon receipt of any judgment, decree or
order (including approval of a property settlement agreement) relating to the
provision of payment by this Plan to an Alternate Payee pursuant to a state
domestic relations law, the Administrator shall promptly notify the affected
Participant and any Alternate Payee of the receipt of such judgment, decree or
order and shall notify the affected Participant and any Alternate Payee of the
Administrator's procedure for determining whether or not the judgment, decree or
order is a Qualified Domestic Relations Order. The Administrator shall establish
a procedure to determine the status of a judgment, decree or order as a
Qualified Domestic Relations Order and to administer Plan distributions in
accordance with Qualified Domestic Relations Orders. Such procedure shall be in
writing, shall include a provision specifying the notification requirements
enumerated above, shall permit an Alternate Payee to designate a representative
for receipt of communications from the Administrator and shall include such
other provisions as the Administrator shall determine, including provisions
required under applicable regulations.
         12.7 The named fiduciaries of this Plan shall be the Trustee, the
Administrator, and any other person designated by the Administrator as a named
fiduciary.

                                      -16-

         12.8 In the event of a claim by a Participant or his or her Beneficiary
as to the amount of any distribution or its method of payment, such Participant
or Beneficiary shall present the reason for his or her claim in writing to the
Administrator. The Administrator shall, within 90 days after the receipt of such
written claim, send written notification to the Participant or Beneficiary as to
its disposition. In the event the claim is wholly or partially denied, such
written notification shall (i) state the specific reason or reasons for the
denial, (ii) make specific reference to pertinent Plan provisions on which the
denial is based, (iii) provide a description of any additional material or
information necessary for the Participant or Beneficiary to perfect the claim
and an explanation of why such material or information is necessary and (iv) set
forth the procedure by which the Participant or Beneficiary may appeal the
denial of his or her claim. In the event a Participant or Beneficiary wishes to
appeal the denial of his or claim, he or she may request a review of such denial
by making application in writing to the Administrator within 60 days after
receipt of such denial. Such Participant or Beneficiary (or his or her duly
authorized representative) may, upon written request to the Administrator,
review any documents pertinent to his or her claim and submit in writing issues
and comments in support of his or her position. Within 60 days after receipt of
the written appeal (unless an extension of time is agreed to by the parties, but
in no event more than 120 days after such receipt), the Administrator shall
notify the Participant or Beneficiary of its final decision. Such final decision
shall be in writing and shall include specific reasons for the decision, written
in a manner calculated to be understood by the

                                      -17-

claimant, and specific references to the pertinent Plan provisions on
which the decision is based.
         TO RECORD the adoption of this Plan, the Employer has caused this
document to be executed by its duly authorized officers on this 15th day of
December, 1994.

Attest:                              DONEGAL MUTUAL INSURANCE
                                     COMPANY

 /s/ Ralph G. Spontak                By:/s/ Donald H. Nikolaus
- ---------------------------          ----------------------------          
Secretary                            Title:  President

                                      -18-

                        INTEREST AND LIABILITIES CONTRACT
                                       TO
                       RETROCESSIONAL REINSURANCE CONTRACT
                                     BETWEEN
                            PIONEER INSURANCE COMPANY
                                       AND
                        DONEGAL MUTUAL INSURANCE COMPANY

It is hereby agreed by and between Pioneer American Insurance Company (Pioneer)
and Donegal Mutual Insurance Company (Donegal) that Donegal will assume and
retrocede a 100% share and Pioneer will assume a 100% share of the retrocession
of the Interests and Liabilities as set forth in the attached Retrocessional
Reinsurance Agreement effective July 1, 1996 until terminated.

This Contract made and executed in duplicate this 21st day of May, 1996

PIONEER INSURANCE COMPANY

/s/ RALPH G. SPONTAK
- -----------------------------------
RALPH G. SPONTAK, SECRETARY

DONEGAL MUTUAL INSURANCE COMPANY

/s/ RALPH G. SPONTAK
- -----------------------------------
RALPH G. SPONTAK, SECRETARY

                     REINSURANCE AND RETROCESSION AGREEMENT

                                     between

                            PIONEER INSURANCE COMPANY

                                       and

                        DONEGAL MUTUAL INSURANCE COMPANY

Article 1      BUSINESS COVERED

This Agreement, subject to the terms and conditions herein contained, is for
Donegal Mutual Insurance Company (Donegal) to indemnify Pioneer Insurance
Company (Pioneer) in respect of the net liability as herein provided and
specified which may accrue to Pioneer as a result of any loss or losses which
may occur during the term of this Agreement under any and all binders, policies,
and contracts of insurance or reinsurance (hereinafter referred to as "policy"
or "policies") heretofore or hereafter issued or.entered into by or on behalf of
the Pioneer and for Donegal to retrocede the net liability back to Pioneer and
Pioneer to assume the net liability back from Donegal as part of the
retrocession.

Article 2      Territory

This Agreement shall cover wherever the Pioneer's policies cover.

Article 3      Exclusions

This Agreement shall not cover:

A. Business classified by the Reinsured as:

(1)

Overhead transmission and distribution lines and their supporting structures
other than those on or within 150 meters (or 500 feet) of the insured premises.
It is understood and agreed that public utilities extension and/or suppliers
extension and/or contingent business interruption coverage are not subject to
this exclusion provided that these are not part of a transmitter's or
distributor's policy.

(2)

Pools, Associations, or Syndicates, including State Insurance Guaranty
Associations. However, such operations which Pioneer is obliged to cover by
reason of membership or participation in any Automobile Assigned Risk Pool, Plan
or Facility, any FAIR Plan, or any Coastal Pool are not to be excluded.
Furthermore, this exclusion shall not apply to any Inter-Company Pooling.

(3) Insurance on Growing and/or Standing Crops.

(4)

Reinsurance of any kind assumed by the Reinsured, except local agency
reinsurance accepted in the normal course of business.

(5)

Bridges, tunnels and art collections valued at over $150,000,000.

(6) Aviation.

(7) Insolvency Funds, as per clause attached.

(8) Flood, when written as such.

B.  Extra Contractual Obligations and Loss in Excess of Original Policy
Limits -- "Extra Contractual Obligations" are defined as those liabilities not
covered under any other provision of this Agreement and which arise from the
handling of any claim on business covered hereunder, such liabilities arising
because of, but not limited to, the following: failure by Pioneer to settle
within the policy limit, or by reason of alleged or actual negligence, fraud or
bad faith in rejecting an offer of settlement or in the preparation of the
defense or in the trial of any action against its Insured or Reinsured or in the
preparation or prosecution of an appeal consequent upon such action.

The term "Loss in Excess of Original Policy Limits" shall mean a net loss
of Pioneer which is in excess of the limit of its original policy, such loss in
excess of the limit having been incurred because of the following: failure by
Pioneer to settle within the policy limit or by reason of alleged or actual
negligence, fraud or bad faith in rejecting an offer or settlement or in the
preparation of the defense or in the trial of any action against its Insured or
Reinsured or in the preparation or prosecution of an appeal consequent upon such
action.

C.  Fidelity, Surety, Credit, Title, Insolvency and Financial Guaranty.

D.  Loss or Liability excluded by the provisions of the Nuclear Incident
Exclusion Clause - Physical Damage - Reinsurance, as per clause attached hereto.

E.  War, as defined in the original policy.

F.  Ocean Marine

Article 4      Term

This Agreement shall become effective on July 1, 1996 at 12:01 A.M. Standard
Time. It is unlimited as to its duration and may be terminated by either party
upon giving ninety (90) days notice of cancellation in writing. In the event
either party terminates in accordance with the above, it is understood that all
transactions coming within the terms of this Agreement will continue in effect
within the said ninety (90) days.

Article 5      DEFINITION OF LOSS OCCURRENCE

The term "Loss Occurrence" shall mean any one occurrence or series of
occurrences arising out of one event.

Article 6      NET RETAINED LINES

This Agreement applies only to that portion of any insurance or reinsurance
covered by this Agreement which Pioneer retains net for its own account, and in
calculating the amount of any loss hereunder and also in computing the amount in
excess of which this Agreement attaches, only loss or losses in respect of that
portion of any insurance or reinsurance which Pioneer retains net for its own
account shall be included. It being understood and agreed that the amount of
Donegal's liability hereunder in respect of any loss or losses shall not be
increased by reason of the inability of the Pioneer to collect from any other
reinsurer, whether specific or general any amounts which may have become due
from them whether such inability arises from the insolvency of such other
reinsurer or otherwise.

Article 7      ULTIMATE NET LOSS INCURRED

The term "Ultimates Net Loss Incurred" shall be understood to mean the actual
loss or losses incurred or to be incurred by Pioneer under its policies, such
loss or losses to include expenses of litigation, if any, interest accrued where
such interest is part of the judgment and all other loss expenses of Pioneer
including legal expenses and costs incurred in connection with coverage and
validity questions and legal actions connected thereto which are allocable only
to a specific claim or action on policies covered hereunder less proper
deductions for all recoveries (including amounts recoverable under other
reinsurance) and salvages actually made by the Pioneer; provided always that
nothing in this Article shall be construed to mean that losses under this
Agreement are not recoverable until Pioneer's ultimate net loss has been
ascertained.

All salvages, recoveries and payments recovered or received subsequent to a
loss settlement under this Agreement shall be applied as if recovered or
received prior to the said settlement and all necessary adjustments shall be
made by the parties hereto.

Article 8      CEDING AND RETROCEDING NET LOSS

(a) As of the effective date and time of this agreement Pioneer will cede and
Donegal will accept 100% of Pioneer's Net Liability for losses. Thereafter
Pioneer will cede and Donegal will accept 100% of Pioneer's Net Losses Incurred,
including allocated loss adjusting expense incurred. (b) As of the effective
date and time of this agreement Donegal will retrocede and Pioneer will accept
100% of the net liability for losses Donegal assumed from Pioneer and,
thereafter, Donegal will retrocede 100% of the Net Incurred Losses it assumed
from Pioneer including allocated loss adjusting expenses incurred.

Article 9      RATE AND PREMIUM

Pioneer shall pay to Donegal and Donegal will retrocede to Pioneer during the
term of this Agreement Net Earned Premium Income of Pioneer during such term in
respect of business the subject matter of this Agreement.

The term "Net Earned Premium Income" as used herein shall be understood to mean
gross premiums earned by Pioneer less premiums for reinsurance which inure to
the benefit of this Agreement. 

All premiums and losses paid under this Agreement shall be made in United States
currency.

Article 10     ACCESS TO RECORDS

Pioneer and Donegal, by their duly appointed representatives, shall have the
right at any reasonable time, to examine all papers in the possession of the
other referring to business effected hereunder.

Article 11     ERRORS AND OMISSIONS

Any inadvertent delay, omission or error shall not be held to relieve either
party hereto from any liability which would attach to it hereunder if such
delay, omission or error had not been made. Such delay, omission or error shall
be rectified immediately upon discovery.

Article 12

As a precedent to any right of action hereunder, if any dispute shall arise
between Pioneer and Donegal with reference to the interpretation of this
Agreement or their rights with respect to any transaction involved, whether such
dispute arises before or after termination of this Agreement, such dispute upon
the written request of either party, shall be submitted to three

arbitrators, one to be chosen by each party, and the third by the two so
chosen. If either party refuses or neglects to appoint an arbitrator within
thirty days after the receipt of written notice from the other party requesting
it to do so, the requesting party may appoint two arbitrators. If the two
arbitrators fail to agree in the selection of a third arbitrator within thirty
days of their appointment, each of them shall name two, of whom the other shall
decline one and the decision shall be made by drawing lots. All arbitrators
shall be disinterested active or retired executive officers of insurance or
reinsurance companies or Underwriters at Lloyd's, London not under the control
of either party to this Agreement.

The Arbitrators shall interpret the Agreement and make their decision with
regard to the custom and usage of the insurance and reinsurance business. They
shall issue their decision in writing based upon a hearing in which evidence may
be introduced without following strict rules of evidence, but in which cross
examination and rebuttal shall be allowed. They shall make their award with a
view to effecting the general purpose of this Agreement in a reasonable manner
rather than in accordance with a literal interpretation of the language.

The decision in writing of any two arbitrators, when filed with the parties
hereto, shall be final and binding on both parties. Judgment may be entered upon
the final decision of the arbitrators in any court having jurisdiction. Each
party shall bear the expense of its own arbitrator and shall jointly and equally
bear with the other party the expense of the third arbitrator and of the
arbitration. Said arbitration shall take place in Marietta, Pennsylvania unless
some other place is mutually agreed upon by Pioneer and Donegal.

Article 13     INSOLVENCY FUNDS EXCLUSION CLAUSE

This Agreement excludes all liability of Pioneer arising, by contract,
operation of law, or otherwise, from its participation or membership, whether
voluntary or involuntary, in any insolvency fund. "Insolvency fund" includes any
guaranty fund, insolvency fund, plan, pool, association, fund or other
arrangement, howsoever denominated, established or governed; which provides for
any assessment of or payment or assumption by the Company of part or all of any
claim, debt, charge, fee, or other obligation of an insurer, or its successors
or assigns, which has been declared by any competent authority to be insolvent,
or which is otherwise deemed unable to meet any claim, debt, charge, fee or
other obligation in whole or in part.

                       INTEREST AND LIABILITIES CONTRACT
                                       TO
                      RETROCESSIONAL REINSURANCE CONTRACT
                                     BETWEEN
                       DELAWARE AMERICAN INSURANCE COMPANY
                                      AND
                        DONEGAL MUTUAL INSURANCE COMPANY

It is hereby agreed by and between Delaware American Insurance Company
(Delaware) and Donegal Mutual Insurance Company (Donegal) that Donegal will
assume and retrocede a 100% share and Delaware will assume a 100% share of the
retrocession of the Interests and Liabilities as set forth in the attached
Retrocessional Reinsurance Agreement effective July 1, 1996 until terminated.

This Contract made and executed in duplicate this 21st day of May, 1996

DELAWARE AMERICAN INSURANCE COMPANY

/s/ RALPH G. SPONTAK
- -----------------------------------
RALPH G. SPONTAK, SECRETARY

DONEGAL MUTUAL INSURANCE COMPANY

/s/ RALPH G. SPONTAK
- -----------------------------------
RALPH G. SPONTAK, SECRETARY

                     REINSURANCE AND RETROCESSION AGREEMENT

                                    between

                      DELAWARE AMERICAN INSURANCE COMPANY
                                      and

                        DONEGAL MUTUAL INSURANCE COMPANY

Article 1      BUSINESS COVERED

This Agreement, subject to the terms and conditions herein contained, is for
Donegal Mutual Insurance Company (Donegal) to indemnify Delaware American
Insurance Company (Delaware) in respect of the net liability as herein provided
and specified which may accrue to Delaware as a result of any loss or losses
which may occur during the term of this Agreement under any and all binders,
policies, and contracts of insurance or reinsurance (hereinafter referred to as
"policy" or "policies") heretofore or hereafter issued or entered into by or on
behalf of the Delaware and for Donegal to retrocede the net liability back to
Delaware and Delaware to assume the net liability back from Donegal as part of
the retrocession.

Article 2      Territory

This Agreement shall cover wherever the Delaware's policies cover.

Article 3      Exclusions

This Agreement shall not cover:

A.  Business classified by the Reinsured as:

(1)

Overhead transmission and distribution lines and their supporting structures
other than those on or within 150 meters (or 500 feet) of the insured premises.
It is understood and agreed that public utilities extension and/or suppliers
extension and/or contingent business interruption coverage are not subject to
this exclusion provided that these are not part of a transmitter's or
distributor's policy.

{2)

Pools, Associations, or Syndicates, including State Insurance Guaranty
Associations. However, such operations which Delaware is obliged to cover by
reason of membership or participation in any Automobile Assigned Risk Pool, Plan
or Facility, any FAIR Plan, or any Coastal Pool are not to be excluded.
Furthermore, this exclusion shall not apply to any Inter-Company Pooling.

(3) Insurance on Growing and/or Standing Crops.

(4)
Reinsurance of any kind assumed by the Reinsured, except local agency
reinsurance accepted in the normal course of business.

(5) Bridges, tunnels and art collections valued at over $150,000,000.

(6) Aviation.

(7) Insolvency Funds, as per clause attached.

(8) Flood, when written as such.

B.  Extra Contractual Obligations and Loss in Excess of Original Policy
Limits -- "Extra Contractual Obligations" are defined as those liabilities
not covered under any other provision of this Agreement and which arise from the
handling of any claim on business covered hereunder, such liabilities arising
because of, but not limited to, the following: failure by Delaware to settle
within the policy limit, or by reason of alleged or actual negligence, fraud or
bad faith in rejecting an offer of settlement or in the preparation of the
defense or in the trial of any action against its Insured or Reinsured or in the
preparation or prosecution of an appeal consequent upon such action.

The term "Loss in Excess of Original Policy Limits" shall mean a net loss of
Delaware which is in excess of the limit of its original policy, such loss in
excess of the limit having been incurred because of the following: failure by
Delaware to settle within the policy limit or by reason of alleged or actual
negligence, fraud or bad faith in rejecting an offer or settlement or in the
preparation of the defense or in the trial of any action against its Insured or
Reinsured or in the preparation or prosecution of an appea1 consequent upon such
action.

C.  Fidelity, Surety, Credit, Title, Insolvency and Financial Guaranty.

D. Loss or Liability excluded by the provisions of the Nuclear Incident
Exclusion Clause - Physical Damage - Reinsurance, as per clause attached hereto.

E. War, as defined in the original policy.

F. Ocean Marine

Article 4      Term

This Agreement shall become effective on July 1, 1996 at 12:01 A. M. Standard
Time. It is unlimited as to its duration and may be terminated by either party
upon giving ninety (90) days notice of cancellation in writing. In the event
either party terminates in accordance with the above, it is understood that all
transactions coming within the terms of this Agreement will continue in effect
within the said ninety (90) days.

Article 5      DEFINITION OF LOSS OCCURRENCE

The term "Loss Occurrence" shall mean any one occurrence or series of
occurrences arising out of one event.

ARTICLE 6      NET RETAINED LINES

This Agreement applies only to that portion of any insurance or reinsurance
covered by this Agreement which Delaware retains net for its own account, and in
calculating the amount of any loss hereunder and also in computing the amount in
excess of which this Agreement attaches, only loss or losses in respect of that
portion of any insurance or reinsurance which Delaware retains net for its own
account shall be included. It being understood and agreed that the amount of
Donegal's liability hereunder in respect of any loss or losses shall not be
increased by reason of the inability of the Delaware to collect from any other
reinsurer, whether specific or general any amounts which may have become due
from them whether such inability arises from the insolvency of such other
reinsurer or otherwise.

Article 7      ULTIMATE NET LOSS INCURRED

The term "Ultimate Net Loss Incurred" shall be understood to mean the actual
loss or losses incurred or to be incurred by Delaware under its policies, such
loss or losses to include expenses of litigation, if any, interest accrued where
such interest is part of the judgment and all other loss expenses of Delaware
including legal expenses and costs incurred in connection with coverage and
validity questions and legal actions connected thereto which are allocable only
to a specific claim or action on policies covered hereunder less proper
deductions for all recoveries (including amounts recoverable under other
reinsurance) and salvages actually made by the Delaware; provided always that
nothing in this Article shall be construed to mean that losses under this
Agreement are not recoverable until Delaware's ultimate net loss has been
ascertained. 

All salvages, recoveries and payments recovered or received subsequent to a loss
settlement under this Agreement shall be applied as if recovered or received
prior to the said settlement and all necessary adjustments shall be made by the
parties hereto.

ARTICLE 8      CEDING AND RETROCEDING NET LOSS

(a) As of the effective date and time of this agreement Delaware will cede and
Donegal will accept 100% of Delaware's Net Liability for losses. Thereafter
Delaware will cede and Donegal will accept 100% of Delaware's Net Losses
Incurred, including allocated loss adjusting expense incurred.

(b) As of the effective date and time of this agreement Donegal will
retrocede and Delaware will accept 100% of the net liability for losses Donegal
assumed from Delaware and, thereafter, Donegal will retrocede 100% of the Net
Incurred Losses it assumed from Delaware including allocated loss adjusting
expenses incurred.

ARTICLE 9      RATE AND PREMIUM

Delaware shall pay to Donegal and Donegal will retrocede to Delaware during the
term of this Agreement Net Earned Premium Income of Delaware during such term in
respect of business the subject matter of this Agreement.

The term "Net Earned Premium Income" as used herein shall be understood to mean
gross premiums earned by Delaware less premiums for reinsurance which inure to
the benefit of this Agreement.

All premiums and losses paid under this Agreement shall be made in United States
currency.

ARTICLE 10     ACCESS TO RECORDS

Delaware and Donegal, by their duly appointed representatives, shall have the
right at any reasonable time, to examine all papers in the possession of the
other referring to business effected hereunder.

ARTICLE  11    ERRORS AND OMISSIONS

Any inadvertent delay, omission or error shall not be held to relieve either
party hereto from any liability which would attach to it hereunder if such
delay, omission or error had not been made. Such delay, omission or error shall
be rectified immediately upon discovery.

ARTICLE 12

As a precedent to any right of action hereunder, if any dispute shall arise
between Delaware and Donegal with reference to the interpretation of this
Agreement or their rights with respect to any transaction involved, whether such
dispute arises before or after termination of this Agreement, such dispute upon
the written request of either party, shall be submitted to three

arbitrators, one to be chosen by each party, and the third by the two so
chosen. If either party refuses or neglects to appoint an arbitrator within
thirty days after the receipt of written notice from the other party requesting
it to do so, the requesting party may appoint two arbitrators. If the two
arbitrators fail to agree in the selection of a third arbitrator within thirty
days of their appointment, each of them shall name two, of whom the other shall
decline one and the decision shall be made by drawing lots. All arbitrators
shall be disinterested active or retired executive officers of insurance or
reinsurance companies or Underwriters at Lloyd's, London not under the control
of either party to this Agreement.

The Arbitrators shall interpret the Agreement and make their decision with
regard to the custom and usage of the insurance and reinsurance business. They
shall issue their decision in writing based upon a hearing in which evidence may
be introduced without following strict rules of evidence, but in which cross
examination and rebuttal shall be allowed. They shall make their award with a
view to effecting the general purpose of this Agreement in a reasonable manner
rather than in accordance with a literal interpretation of the language.

The decision in writing of any two arbitrators, when filed with the parties
hereto, shall be final and binding on both parties. Judgment may be entered upon
the final decision of the arbitrators in any court having jurisdiction. Each
party shall bear the expense of its own arbitrator and shall jointly and equally
bear with the other party the expense of the third arbitrator and of the
arbitration. Said arbitration shall take place in Marietta, Pennsylvania unless
some other place is mutually agreed upon by Delaware and Donegal.

ARTICLE 13     INSOLVENCY FUNDS EXCLUSION CLAUSE

This Agreement excludes all liability of Delaware arising, by contract,
operation of law, or otherwise, from its participation or membership, whether
voluntary or involuntary, in any insolvency fund. "Insolvency fund" includes any
guaranty fund, insolvency fund, plan, pool, association, fund or other
arrangement, howsoever denominated, established or governed; which provides for
any assessment of or payment or assumption by the Company of part or all of any
claim, debt, charge, fee, or other obligation of an insurer, or its successors
or assigns, which has been declared by any competent authority to be insolvent,
or which is otherwise deemed unable to meet any claim, debt, charge, fee or
other obligation in whole or in part.

                       INTEREST AND LIABILITIES CONTRACT

                                       TO

                      RETROCESSIONAL REINSURANCE CONTRACT

                                    BETWEEN

                     SOUTHERN INSURANCE COMPANY OF VIRGINIA

                                      AND

                        DONEGAL MUTUAL INSURANCE COMPANY

It is hereby agreed by and between Southern Insurance Company of Virginia
(Southern) and Donegal Mutual Insurance Company (Donegal) that Donegal will
assume and retrocede a 100% share and Southern will assume a 100% share of the
retrocession of the Interests and Liabilities as set forth in the attached
Retrocessional Reinsurance Agreement effective July 1, 1996 until terminated.

This Contract made and executed in duplicate this 21st day of May, 1996

SOUTHERN INSURANCE COMPANY OF VIRGINIA

/s/ RALPH G. SPONTAK
- -----------------------------------
RALPH G. SPONTAK, SECRETARY

DONEGAL MUTUAL INSURANCE COMPANY

/s/ RALPH G. SPONTAK
- -----------------------------------
RALPH G. SPONTAK, SECRETARY

                     REINSURANCE AND RETROCESSION AGREEMENT

                                    between

                     SOUTHERN INSURANCE COMPANY OF VIRGINIA

                                      and

                        DONEGAL MUTUAL INSURANCE COMPANY

Article 1      BUSINESS COVERED

This Agreement, subject to the terms and conditions herein contained, is for
Donegal Mutual Insurance Company (Donegal) to indemnify Southern Insurance
Company of Virginia (Southern) in respect of the net liability as herein
provided and specified which may accrue to Southern as a result of any loss or
losses which may occur during the term of this Agreement under any and all
binders, policies, and contracts of insurance or reinsurance (hereinafter
referred to as "policy" or "policies) heretofore or hereafter issued or entered
into by or on behalf of the Southern and for Donegal to retrocede the net
liability back to Southern and Southern to assume the net liability back from
Donegal as part of the retrocession.

Article 2      Territory

This Agreement shall cover wherever the Southern's policies cover.

Article 3      Exclusions

This Agreement shall not cover:

A.  Business classified by the Reinsured as:

(1)

Overhead transmission and distribution lines and their supporting structures
other than those on or within 150 meters (or 500 feet) of the insured premises.
It is understood and agreed that public utilities extension and/or suppliers
extension and/or contingent business interruption coverage are not subject to
this exclusion provided that these are not part of a transmitter's or
distributor's policy.

(2)

Pools, Associations, or Syndicates, including State Insurance Guaranty
Associations. However, such operations which Southern is obliged to cover by
reason of membership or participation in any Automobile Assigned Risk Pool, Plan
or Facility, any FAIR Plan, or any Coastal Pool are not to be excluded.
Furthermore, this exclusion shall not apply to any Inter-Company Pooling.

(3) Insurance on Growing and/or Standing Crops.

(4)

Reinsurance of any kind assumed by the Reinsured, except local agency
reinsurance accepted in the normal course of business.

(5) Bridges, tunnels and art collections valued at over $150,000,000.

(6) Aviation.

(7) Insolvency Funds, as per clause attached.

{8) Flood, when written as such.

B.  Extra Contractual Obligations and Loss in Excess of Original Policy
Limits -- "Extra Contractual Obligations" are defined as those liabilities
not covered under any other provision of this Agreement and which arise from the
handling of any claim on business covered hereunder, such liabilities arising
because of, but not limited to, the following: failure by Southern to settle
within the policy limit, or by reason of alleged or actual negligence, fraud or
bad faith in rejecting an offer of settlement or in the preparation of the
defense or in the trial of any action against its Insured or Reinsured or in the
preparation or prosecution of an appeal consequent upon such action.

The term "Loss in Excess of Original Policy Limits" shall mean a net loss of
Southern which is in excess of the limit of its original policy, such loss in
excess of the limit having been incurred because of the following: failure by
Southern to settle within the policy limit or by reason of alleged or actual
negligence, fraud or bad faith in rejecting an offer or settlement or in the
preparation of the defense or in the trial of any action against its Insured or
Reinsured or in the preparation or prosecution of an appeal consequent upon such
action.

C.  Fidelity, Surety, Credit, Title, Insolvency and Financial Guaranty.

D.  Loss or Liability excluded by the provisions of the Nuclear Incident
Exclusion Clause - Physical Damage - Reinsurance, as per clause attached hereto.

E.  War, as defined in the original policy.

F.  Ocean Marine

Article 4      Term

This Agreement shall become effective on July 1, 1996 at 12:01 A. M. Standard
Time. It is unlimited as to its duration and may be terminated by either party
upon giving ninety (90) days notice of cancellation in writing. In the event
either party terminates in accordance with the above, it is understood that all
transactions coming within the terms of this Agreement will continue in effect
within the said ninety (90) days.

Article 5      DEFINITION OF LOSS OCCURRENCE

The term "Loss Occurrence" shall mean any one occurrence or series of
occurrences arising out of one event.

ARTICLE 6      NET RETAINED LINES

This Agreement applies only to that portion of any insurance or reinsurance
covered by this Agreement which Southern retains net for its own account, and in
calculating the amount of any loss hereunder and also in computing the amount in
excess of which this Agreement attaches, only loss or losses in respect of that
portion of any insurance or reinsurance which Southern retains net for its own
account shall be included. It being understood and agreed that the amount of
Donegal's liability hereunder in respect of any loss or losses shall not be
increased by reason of the inability of the Southern to collect from any other
reinsurer, whether specific or general any amounts which may have become due
from them whether such inability arises from the insolvency of such other
reinsurer or otherwise.

Article 7      ULTIMATE NET LOSS INCURRED

The term "Ultimate Net Loss Incurred" shall be understood to mean the actual
loss or losses incurred or to be incurred by Southern under its policies, such
loss or losses to include expenses of litigation, if any, interest accrued where
such interest is part of the judgment and all other loss expenses of Southern
including legal expenses and costs incurred in connection with coverage and
validity questions and legal actions connected thereto which are allocable only
to a specific claim or action on policies covered hereunder less proper
deductions for all recoveries (including amounts recoverable under other
reinsurance) and salvages actually made by the Southern; provided always that
nothing in this Article shall be construed to mean that losses under this
Agreement are not recoverable until Southern's ultimate net loss has been
ascertained.

All salvages, recoveries and payments recovered or received subsequent to a loss
settlement under this Agreement shall be applied as if recovered or received
prior to the said settlement and all necessary adjustments shall be made by the
parties hereto.

ARTICLE 8      CEDING AND RETROCEDING NET LOSS

(a) As of the effective date and time of this agreement Southern will cede and
Donegal will accept 100% of Southern's Net Liability for losses. Thereafter
Southern will cede and Donegal will accept 100% of Southern's Net Losses
Incurred, including allocated loss adjusting expense incurred.

(b) As of the effective date and time of this agreement Donegal will
retrocede and Southern will accept 100% of the net liability for losses Donegal
assumed from Southern and, thereafter, Donegal will retrocede 100% of the Net
Incurred Losses it assumed from Southern including allocated loss adjusting
expenses incurred.

ARTICLE 9      RATE AND PREMIUM

Southern shall pay to Donegal and Donegal will retrocede to Southern during the
term of this Agreement Net Earned Premium Income of Southern during such term in
respect of business the subject matter of this Agreement.

The term "Net Earned Premium Income" as used herein shall be understood to mean
gross premiums earned by Southern less premiums for reinsurance which inure to
the benefit of this Agreement.

All premiums and losses paid under this Agreement shall be made in United States
currency.

ARTICLE 10     ACCESS TO RECORDS

Southern and Donegal, by their duly appointed representatives, shall have the
right at any reasonable time, to examine all papers in the possession of the
other referring to business effected hereunder.

ARTICLE 11     ERRORS AND OMISSIONS

Any inadvertent delay, omission or error shall not be held to relieve either
party hereto from any liability which would attach to it hereunder if such
delay, omission or error had not been made. Such delay, omission or error shall
be rectified immediately upon discovery.

ARTICLE 12

As a precedent to any right of action hereunder, if any dispute shall arise
between Southern and Donegal with reference to the interpretation of this
Agreement or their rights with respect to any transaction involved, whether such
dispute arises before or after termination of this Agreement, such dispute upon
the written request of either party, shall be submitted to three

arbitrators, one to be chosen by each party, and the third by the two so
chosen. If either party refuses or neglects to appoint an arbitrator within
thirty days after the receipt of written notice from the other party requesting
it to do so, the requesting party may appoint two arbitrators. If the two
arbitrators fail to agree in the selection of a third arbitrator within thirty
days of their appointment, each of them shall name two, of whom the other shall
decline one and the decision shall be made by drawing lots. All arbitrators
shall be disinterested active or retired executive officers of insurance or
reinsurance companies or Underwriters at Lloyd's, London not under the control
of either party to this Agreement.

The Arbitrators shall interpret the Agreement and make their decision with
regard to the custom and usage of the insurance and reinsurance business. They
shall issue their decision in writing based upon a hearing in which evidence may
be introduced without following strict rules of evidence, but in which cross
examination and rebuttal shall be allowed. They shall make their award with a
view to effecting the general purpose of this Agreement in a reasonable manner
rather than in accordance with a literal interpretation of the language.

The decision in writing of any two arbitrators, when filed with the parties
hereto, shall be final and binding on both parties. Judgment may be entered upon
the final decision of the arbitrators in any court having jurisdiction. Each
party shall bear the expense of its own arbitrator and shall jointly and equally
bear with the other party the expense of the third arbitrator and of the
arbitration. Said arbitration shall take place in Marietta, Pennsylvania unless
some other place is mutually agreed upon by Southern and Donegal.

ARTICLE 13     INSOLVENCY FUNDS EXCLUSION CLAUSE

This Agreement excludes all liability of Southern arising, by contract,
operation of law, or otherwise, from its participation or membership, whether
voluntary or involuntary, in any insolvency fund. "Insolvency fund" includes any
guaranty fund, insolvency fund, plan, pool, association, fund or other
arrangement, howsoever denominated, established or governed; which provides for
any assessment of or payment or assumption by the Company of part or all of any
claim, debt, charge, fee, or other obligation of an insurer, or its successors
or assigns, which has been declared by any competent authority to be insolvent,
or which is otherwise deemed unable to meet any claim, debt, charge, fee or
other obligation in whole or in part.

ITEM 5.

Board of Directors and Officers

Donegal Group Inc.

Board of Directors

Donald H. Nikolaus
President, Chief Executive
  Officer and a Director

C. Edwin Ireland
Chairman of the Board
  and a Director

Philip H. Glatfelter, II
Vice Chairman of the Board
  and a Director

Robert S. Bolinger
Director

Thomas J. Finley, Jr.
Director

Patricia A. Gilmartin
Director

R. Richard Sherbahn
Director

Officers

C. Edwin Ireland
Chairman of the Board

Philip H. Glatfelter, II
Vice Chairman of the Board

Donald H. Nikolaus
President and Chief
  Executive Officer

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

Daniel J. Wagner
Treasurer

Donegal Mutual

Board of Directors

Donald H. Nikolaus
President, Chief Executive
  Officer and a Director

C. Edwin Ireland
Chairman of the Board
  and a Director

Philip H. Glatfelter, II
Vice Chairman of the Board
  and a Director

Frederick W. Dreher
Director

Patricia A. Gilmartin
Director

Charles A. Heisterkamp, III
Director

John E. Hiestand
Director

R. Richard Sherbahn
Director

William H. Shupert
Senior Vice President
  of Underwriting and a Director

Ralph G. Spontak
Senior Vice President,
  Chief Financial Officer,
  Secretary and a Director

Other Officers

Daniel J. Wagner
Treasurer

Cyril J. Greenya
Vice President of Commercial
  Underwriting

James B. Price
Vice President of Claims

Robert G. Shenk
Vice President of Claims

Frank J. Wood
Vice President of Marketing

Corporate Information

Annual Meeting
April 17, 1997 at the Company's headquarters at 10:00 a.m.

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

Market Information
Donegal Group's common stock is traded on NASDAQ under the symbol "DGIC." During
1995 and 1996, the stock price ranged as follows:

                                                      Cash Dividend
                                                        Declared
           Quarter           High            Low        Per Share
           --------------------------------------------------------
           
           1995
           1st                15              13-15/16     --
           2nd                17-1/2          14          .10
           3rd                17-3/4          16          .10
           4th                19-1/4          17          .20
           
           1996
           1st                19-1/2          18-1/2       --
           2nd                19              16-3/4      .11
           3rd                18-3/4          16-1/4      .11
           4th                20-3/4          17-1/2      .22

Corporate Offices
1195 River Road
Box 302
Marietta, Pennsylvania 17547
(717) 426-1931

Transfer Agent
First Chicago Trust Company of New York
Mail Suite 4693
P.O. Box 2535
Jersey City, NJ 07303-2535
(201) 324-0313

Stockholders
The number of common stockholders of record as of December 31, 1996 was 363.

ITEM 6.

                                   [Graphic]

The printed document has four bar graphs, side by side and contain plot points
as indicated below:

        Total Assets  Book Value Per    Invested Assets      Total Revenue
         in dollars   Share dollars        in dollars         in dollars
         ----------   -------------     ---------------      -------------

1992    131,135,002      12.18             94,723,299          62,107,673
1993    169,460,466      14.03            122,221,131          77,698,608 
1994    207,721,362      14.78            147,050,375          86,354,530
1995    235,704,366      16.96            163,135,881          97,885,060
1996    273,128,543      18.18            188,423,528         112,519,031

Financial Highlights

Year Ended December 31,       1996           1995           1994           1993          1992     
- --------------------------------------------------------------------------------------------------

Income Statement Data
  Net premiums earned      $ 99,982,042  $ 86,277,852   $ 77,232,889  $ 69,415,874   $ 54,630,786
  Investment income          10,316,468     9,269,884      7,778,164     6,478,354      6,042,163
  Total revenues            112,519,031    97,885,060     86,354,530    77,698,608     62,107,673
  Net income                  8,896,113     9,857,950      5,039,948     6,382,449      4,948,744
  Net income
    per common share               2.01          2.31           1.20          1.92           1.65

Balance Sheet Data
  Total assets             $273,128,543  $235,704,366   $207,721,362  $169,460,466   $131,135,002
  Stockholders' equity       81,277,371    72,282,892     60,565,067    57,345,586     36,417,485
  Book value per share            18.18         16.96          14.78         14.03          12.18

ITEM 7.

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

Donegal Group Inc. ("DGI" or the "Company") is a regional insurance holding
company doing business in Pennsylvania, Maryland, Delaware, Virginia and Ohio
through its three wholly owned property-casualty insurance subsidiaries,
Atlantic States Insurance Company ("Atlantic States"), Southern Insurance
Company of Virginia ("Southern") and Delaware Atlantic Insurance Company
("Delaware") which changed its name from Delaware American Insurance Company
effective August 29, 1996 (collectively "Insurance Subsidiaries"). The Company's
major lines of business in 1996 and their percentage of total net earned
premiums were Automobile Liability (27.7%), Workers' Compensation (18.0%),
Automobile Physical Damage (16.0%), Homeowners (16.6%), and Commercial Multiple
Peril (16.0%). The Insurance Subsidiaries are subject to regulation by Insurance
Departments in those states in which they operate and undergo periodic
examination by those departments. The Insurance Subsidiaries are also subject to
competition from other insurance carriers in their operating areas. DGI was
formed in September 1986 by Donegal Mutual Insurance Company (the "Mutual
Company"), which owns 59% of the outstanding common shares of the Company as of
December 31, 1996.

     Atlantic States participates in an intercompany pooling arrangement with
the Mutual Company and assumes 65% (60% in 1995 and 1994) of the pooled
business. Southern cedes 50% of its business to the Mutual Company and Delaware
cedes 70% of its Workers' Compensation business to the Mutual Company. Because
the Mutual Company places substantially all of the business assumed from
Southern and Delaware into the pool, from which the Company has a 65%
allocation, the Company's results of operations include approximately 80% of the
business written by Southern and approximately 70% of the Workers' Compensation
business written by Delaware.

     In addition to the Company's insurance subsidiaries, it also owns all of
the outstanding stock of Atlantic Insurance Services, Inc. ("AIS"), which was
formed and began business in January 1994. AIS is an insurance services
organization currently providing inspection and policy auditing information on a
fee for service basis to its affiliates and the insurance industry.

Results of Operation 1996 Compared to 1995

Total revenues for 1996 were $112,519,031 which were $14,633,971, or 15.0%
greater than 1995. Net premiums earned increased to $99,982,042, an increase of
$13,704,190, or 15.9% over 1995. An increase in Atlantic States' share of the
pool with the Mutual Company, from 60% to 65% effective January 1, 1996
accounted for $6,701,309, or 7.8% of this increase. A 1.9% increase in the
direct premiums written by the combined pool of Atlantic States and the Mutual
Company, a 15.8% increase in the direct premiums written of Southern and a 6.3%
increase in the direct premiums written of Delaware accounted for a majority of
the remaining increase. The Company posted a realized gain of $172,734 compared
to a realized gain of $398,587 in 1995. Both gains resulted from normal turnover
of the Company's investment portfolio. As of December 31, 1996, 99.9% of the
Company's bond portfolio was classified as Class I (highest quality) by the
National Association of Insurance Commissioners' Security Valuation Office.
Investment income increased $1,046,584. An increase in the average invested
assets from $153,477,866 to $174,905,542, offset by a decrease in the average
yield to 5.9% from 6.0% in 1995, accounted for the change.

     The GAAP combined ratio of insurance operations was 99.4% in 1996, compared
to 97.3% in 1995. The GAAP combined ratio is the sum of the ratios of incurred
losses and loss adjustment expense to premiums earned (loss ratio), underwriting
expenses to premiums earned (expense ratio) and policyholder dividends to
premiums earned (dividend ratio). The loss ratio in 1996 was 66.6%, compared to
64.2% in 1995 accounting for the change. This increase in the loss ratio
resulted from increased claim activity due to severe winter weather in the
primary operating areas of the Company in the first quarter 1996. The loss ratio
in the first quarter

was 72.1% compared to 64.8% for the rest of the year. The expense ratio for
1996 was 31.2% compared to 31.8% in 1995 with the dividend ratio increasing from
1.3% in 1995 to 1.5% in 1996 due to improved loss ratios in workers'
compensation in 1996.

Results of Operation 1995 Compared to 1994

Total revenues for 1995 were $97,885,060 which were $11,530,530, or 13.4%
greater than 1994. Net premiums earned increased to $86,277,852, an increase of
$9,044,963, or 11.7% over 1994. A 12.0% increase in the direct premiums written
by the combined pool of Atlantic States and the Mutual Company, a 15.1% increase
in the direct premiums written of Southern and a 67.4% increase in the direct
premiums written of Delaware accounted for most of the increase. Premiums earned
in 1994 were offset by additional reinsurance premiums of approximately
$1 million which resulted from the reinstatement of catastrophic reinsurance
contracts which were impacted by severe weather which hit the northeast part of
the United States during the first quarter of that year. The increase in the
direct premiums written by the combined pool was distributed among a number of
the major lines, with Commercial Multiple Peril representing the largest
increase for any individual line, with a 28% increase over 1994. The Company
posted a realized gain of $398,587, compared to a realized gain of $34,333 in
1994. Both gains resulted from normal turnover of the Company's investment
portfolio. As of December 31, 1995, all of the Company's bond portfolio was
classified as Class I (highest quality) by the National Association of Insurance
Commissioners' Security Valuation Office. Investment income increased
$1,491,720. An increase in the average invested assets from $137,514,214 to
$153,477,866, and an increase in the average yield to 6.0% from 5.7% in 1994,
accounted for the increase.

     The GAAP combined ratio of insurance operations was 97.3% in 1995, compared
to 101.7% in 1994. The GAAP combined ratio is the sum of the ratios of incurred
losses and loss adjustment expense to premiums earned (loss ratio), underwriting
expenses to premiums earned (expense ratio) and policyholder dividends to
premiums earned (dividend ratio). The loss ratio in 1995 was 64.2% compared to
68.4% in 1994. The total effect of the first quarter storms in 1994 was an
increase in the loss for that year of 2.6%, which would have resulted in a loss
ratio of 65.8% for 1994 net of this effect. The expense ratio for 1995 was
31.8%, compared to 31.5% in 1994 with the dividend ratio going from 1.7% in 1994
to 1.3% in 1995, due to more stringent qualification requirements to earn a
dividend in 1995.

Liquidity and Capital Resources

The Company generates sufficient funds from its operations and maintains a high
degree of liquidity in its investment portfolio. The primary source of funds to
meet the demands of claim settlements and operating expenses are premium
collections, investment earnings and maturing investments. As of December 31,
1996, the Company had no material commitment for capital expenditures.

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

     As of December 31, 1996, pursuant to a credit agreement dated December 29,
1995, with Fleet National Bank of Connecticut, the Company had unsecured
borrowings of $8.5 million. Such borrowings were made in connection with the
acquisition of Delaware and a $5 million capital contribution to Atlantic
States. Per the terms of the credit agreement, the Company may borrow up to $20
million at interest rates equal to the bank's then current prime rate or the
then current London

interbank Eurodollar bank rate plus 1.70%. At December 31, 1996, the
interest rate on the outstanding balance was 7.325%. In addition, the Company
will pay a non-use fee at a rate of 3/10 of 1% per annum on the average daily
unused portion of the Bank's commitment. On each December 29, commencing
December 29, 1998, the credit line will be reduced by $4 million. Any
outstanding loan in excess of the remaining credit line, after such reduction,
will then be payable.

     The Company's principal sources of cash with which to meet obligations and
pay stockholder dividends are dividends from the Insurance Subsidiaries which
are required by law to maintain certain minimum surplus on a statutory basis and
are subject to regulations under which payment of dividends from statutory
surplus is restricted and may require prior approval of their domiciliary
insurance regulatory authorities. The Insurance Subsidiaries are also subject to
Risk Based Capital (RBC) requirements which may further impact their ability to
pay dividends. At December 31, 1996, all three Companies' statutory capital and
surplus were substantially above the RBC requirements. At December 31, 1996,
amounts available for distribution as dividends to Donegal Group without prior
approval of the insurance regulatory authorities are $5,410,536 from Atlantic
States, $255,480 from Southern and $1,120,952 from Delaware.

Net unrealized gains resulting from fluctuations in the fair value of
investments reported in the balance sheet at fair value were $420,998 (net of
applicable federal income tax) at December 31, 1996, and $819,213 (net of
applicable federal income tax) at December 31, 1995.

Credit Risk

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

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

Impact of Inflation

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

Impact of New Accounting Standards
Stock-Based Compensation

Stock-based compensation plans are accounted for under the provisions of
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees," and related interpretations. As such, compensation expense would
be recorded on the date of a stock option grant only if the current market price
of the underlying stock exceeded the exercise price. Statement of Financial
Accounting Standards (SFAS)No. 123, "Accounting for Stock-based Compensation" is
effective for 1996 and permits entities to recognize as expense, over the
vesting period, the fair value of all stock-based awards on the date of the
grant. Alternatively, SFAS No. 123 allows entities to continue to apply the
provisions of APB Opinion No. 25 and provide pro forma net income and earnings
per share disclosures for employee stock option grants made in 1995 and future
years as if the fair-value-based method defined in SFAS No. 123 had been
applied. The Company has elected to continue to apply the provisions of APB
Opinion No. 25 and provide the pro forma disclosures under SFAS No. 123.

ITEM 8.

Donegal Group Inc.
Consolidated Balance Sheets

December 31,                                                                                  1996              1995
- ------------------------------------------------------------------------------------------------------------------------------

Assets                                                                                                      
Investments                                                                                                 
  Fixed maturities                                                                                          
    Held to maturity, at amortized cost (fair value $113,461,217 and $95,357,840)         $111,581,162       $ 91,979,122
    Available for sale, at fair value (amortized cost $49,314,520 and $50,714,887)          49,588,543         51,646,730
  Equity securities, available for sale, at fair value (cost $2,770,346 and $2,954,487)      3,134,198          3,263,878
  Short-term investments, at cost, which approximates fair value                            21,207,503         14,498,579
                                                                                          ------------       ------------
      Total investments                                                                    185,511,406        161,388,309
Cash                                                                                         2,912,122          1,747,572
Accrued investment income                                                                    2,534,048          2,414,095
Premiums receivable                                                                         10,133,338         11,790,396
Reinsurance receivable                                                                      37,474,966         28,179,699
Deferred policy acquisition costs                                                            7,837,899          6,902,218
Federal income taxes receivable                                                                     --            551,990
Deferred tax asset, net                                                                      3,613,307          3,411,544
Prepaid reinsurance premiums                                                                20,174,981         13,055,893
Property and equipment, net                                                                  2,160,806          2,282,570
Accounts receivable -- securities                                                               98,622          2,702,895
Due from affiliate                                                                                  --            546,746
Other                                                                                          677,048            730,439
                                                                                          ------------       ------------
      Total assets                                                                        $273,128,543       $235,704,366
                                                                                          ============       ============
                                                                                                            
Liabilities and Stockholders' Equity                                                                        
Liabilities                                                                                                 
  Losses and loss expenses                                                                $110,022,886       $ 97,733,851
  Unearned premiums                                                                         66,184,188         54,377,239
  Accrued expenses                                                                           2,140,918          2,373,142
  Current income taxes                                                                         815,196                 --
  Reinsurance balances payable                                                                 697,764            634,731
  Cash dividend declared to stockholders                                                       492,619            427,694
  Line of credit                                                                             8,500,000          5,000,000
  Accounts payable -- securities                                                             2,498,838          2,491,148
  Other                                                                                        201,634            181,426
  Due to affiliate                                                                             297,129            202,243
                                                                                          ------------       ------------
      Total liabilities                                                                    191,851,172        163,421,474
                                                                                          ------------       ------------
Stockholders' Equity                                                                                        
  Preferred stock, $1.00 par value, authorized 1,000,000 shares; none issued                                
  Common stock, $1.00 par value, authorized 10,000,000 shares,                                              
    issued 4,540,569 and 4,326,362 shares and outstanding                                                   
     4,471,782 and 4,261,314 shares                                                          4,540,569          4,326,362
  Additional paid-in capital                                                                37,315,888         35,017,965
  Net unrealized gains (losses) on investments available for sale, net of taxes                420,998            819,213
  Retained earnings                                                                         39,891,672         32,939,132
  Treasury stock, at cost                                                                     (891,756)          (819,780)
                                                                                          ------------       ------------
      Total stockholders' equity                                                            81,277,371         72,282,892
                                                                                          ------------       ------------
      Total liabilities and stockholders' equity                                          $273,128,543       $235,704,366
                                                                                          ============       ============

See accompanying notes to consolidated financial statements.

Donegal Group Inc.

Consolidated Statements of Income

Year Ended December 31,                                   1996           1995           1994
- ------------------------------------------------------------------------------------------------
                                                                          
Revenues
  Premiums earned                                     $138,309,092   $115,377,302   $101,598,330
  Premiums ceded                                        38,327,050     29,099,450     24,365,441
                                                      ------------   ------------   ------------
  Net premiums earned                                   99,982,042     86,277,852     77,232,889
  Investment income, net of investment expenses         10,316,468      9,269,884      7,778,164
  Installment payment fees                                 752,043        670,971        611,296
  Lease income                                             541,010        491,115        462,587
  Service fees                                             754,734        776,651        235,261
  Net realized investment gains                            172,734        398,587         34,333
                                                      ------------   ------------   ------------
    Total revenues                                     112,519,031     97,885,060     86,354,530
                                                      ------------   ------------   ------------

Expenses
  Losses and loss expenses                              91,505,086     72,545,223     70,026,135
  Reinsurance recoveries                                24,893,853     17,137,969     17,168,633
                                                      ------------   ------------   ------------
  Net losses and loss expenses                          66,611,233     55,407,254     52,857,502
  Amortization of deferred policy acquisition costs     17,032,000     14,412,000     12,055,000
  Other underwriting expenses                           14,174,023     13,049,188     12,278,473
  Policy dividends                                       1,549,369      1,106,357      1,349,079
  Other                                                  1,530,635      1,256,839        702,038
  Interest                                                 375,311          7,604          9,459
                                                      ------------   ------------   ------------
    Total expenses                                     101,272,571     85,239,242     79,251,551
                                                      ------------   ------------   ------------
    Income before income taxes                          11,246,460     12,645,818      7,102,979
Income taxes                                             2,350,347      2,787,868      2,063,031
                                                      ------------   ------------   ------------
    Net income                                        $  8,896,113   $  9,857,950   $  5,039,948
                                                      ============   ============   ============
    Net income per common share                       $       2.01   $       2.31   $       1.20
                                                      ============   ============   ============

See accompanying notes to consolidated financial statements.

Donegal Group Inc.
Consolidated Statements of Stockholders' Equity

                                                                               Net Unrealized
                                                                               Gains (Losses)
                              Preferred Stock    Common Stock       Additional on Investments                           Total
                               -------------  -------------------     Paid-in    Available    Retained   Treasury  Stockholders'
                               Shares Amount   Shares     Amount      Capital     for Sale    Earnings     Stock      Equity
                               ------ ------  -------- ----------  -----------   ---------  -----------  --------- ------------
                                                                                        
Balance,
  January 1, 1994                   0   $ 0  4,153,081 $4,153,081  $33,342,911   $ 260,306  $21,196,450  $(819,780) $58,132,968
                                -----  ----- --------- ----------  -----------   ---------  -----------  ---------  -----------
Cumulative effect of adopting
  SFAS No. 115                                                                   1,349,670                            1,349,670
Issuance of common stock                         9,689      9,689      115,632                                          125,321
Net income                                                                                    5,039,948               5,039,948
Change in unrealized gains
  (losses) on investments (Net of
  applicable federal income taxes)                                              (2,607,614)                          (2,607,614)
Cash dividends
  $.36 per share                                                                             (1,475,226)             (1,475,226)
                                -----  ----  --------- ----------  -----------   ---------  -----------  ---------  -----------
Balance,
  December 31, 1994                 0   $ 0  4,162,770 $4,162,770  $33,458,543 $  (997,638) $24,761,172  $(819,780) $60,565,067
                                -----  ----  --------- ----------  -----------   ---------  -----------  ---------  -----------
Issuance of common stock                       163,592    163,592    1,559,422                                        1,723,014
Net income                                                                                    9,857,950               9,857,950
Change in unrealized gains
  (losses) on investments (Net of
  applicable federal income taxes)                                               1,816,851                            1,816,851
Cash dividends
  $.40 per share                                                                             (1,679,990)             (1,679,990)
                                -----  ----  --------- ----------  -----------   ---------  -----------  ---------  -----------
Balance,
  December 31, 1995                 0   $ 0  4,326,362 $4,326,362  $35,017,965   $ 819,213  $32,939,132  $(819,780) $72,282,892
                                -----  ----  --------- ----------  -----------   ---------  -----------  ---------  -----------
Issuance of common stock                       214,207    214,207    2,297,923                                        2,512,130
Net income                                                                                    8,896,113               8,896,113
Change in unrealized gains
  (losses) on investments (Net of
  applicable federal income taxes)                                                (398,215)                            (398,215)
Purchase of 3,739 shares of
  treasury stock                                                                                           (71,976)     (71,976)
Cash dividends
  $.44 per share                                                                             (1,943,573)             (1,943,573)
                                -----  ----  --------- ----------  -----------   ---------  -----------  ---------  -----------
Balance,
  December 31, 1996                 0   $ 0  4,540,569 $4,540,569  $37,315,888   $ 420,998  $39,891,672  $(891,756) $81,277,371
                                =====  ====  ========= ==========  ===========   =========  ===========  =========  ===========

See accompanying notes to consolidated financial statements.

Donegal Group Inc.
Consolidated Statements of Cash Flows

Year Ended December 31,                                       1996            1995           1994
- ------------------------------------------------------------------------------------------------------
                                                                                 
Cash Flows from Operating Activities:
  Net income                                              $  8,896,113    $  9,857,950    $  5,039,948
                                                          ------------    ------------    ------------
  Adjustments to reconcile net income to net cash
      provided by operating activities:
    Depreciation and amortization                              235,603         380,491         385,944
    Realized investment gains                                 (172,734)       (398,587)        (34,333)
  Changes in Assets and Liabilities:
    Losses and loss expenses                                12,289,035       9,989,914       7,788,953
    Unearned premiums                                       11,806,949       7,622,144       2,480,511
    Accrued expenses                                          (232,224)        829,125        (341,338)
    Premiums receivable                                      1,657,058      (2,635,090)       (245,408)
    Deferred policy acquisition costs                         (935,681)     (1,350,349)       (462,202)
    Deferred income taxes                                        3,380        (521,952)       (344,725)
    Reinsurance receivable                                  (9,295,267)     (2,526,020)     (3,179,767)
    Accrued investment income                                 (119,953)       (382,216)       (202,057)
    Amounts due from affiliate                                 843,875          44,961        (243,002)
    Reinsurance balances payable                                63,033         (81,460)        (62,793)
    Prepaid reinsurance premiums                            (7,119,088)     (2,228,868)       (479,438)
    Current income taxes                                     1,367,186        (675,677)        358,824
    Other, net                                                  73,599        (145,516)       (391,859)
                                                          ------------    ------------    ------------
      Net adjustments                                       10,464,771       7,920,900       5,027,310
                                                          ------------    ------------    ------------
    Net cash provided by operating activities               19,360,884      17,778,850      10,067,258
                                                          ------------    ------------    ------------
Cash Flows from Investing Activities:
  Purchase of fixed maturities
    Held to maturity                                       (30,595,807)    (26,057,540)     (5,139,055)
    Available for sale                                     (21,403,083)    (27,895,537)    (27,983,885)
  Purchase of equity securities                             (9,077,146)     (6,072,439)     (7,486,343)
  Sale of fixed maturities
    Available for sale                                       7,247,675       5,276,380      22,975,319
  Maturity of fixed maturities
    Held to maturity                                        11,596,190      10,996,250       2,637,135
    Available for sale                                      17,634,933       6,631,844       2,627,416
  Sale of equity securities                                  9,493,480       8,121,345       8,671,596
  Acquisition and assumption of Delaware                      (202,243)     (5,300,000)      5,513,259
  Purchase of property and equipment                          (242,915)       (334,894)       (338,804)
  Purchase of other assets                                          --              --        (131,625)
  Net sales (purchases) of short-term investments           (6,708,924)     12,018,979      (9,813,495)
                                                          ------------    ------------    ------------
    Net cash used in investing activities                  (22,257,840)    (22,615,612)     (8,468,482)
                                                          ------------    ------------    ------------
Cash Flows from Financing Activities:
  Issuance of common stock                                   2,512,130       1,723,014         125,321
  Line of credit, net                                        3,500,000       5,000,000              --
  Cash dividends paid                                       (1,878,648)     (1,621,631)     (1,433,270)
  Purchase of treasury stock                                   (71,976)             --              --
                                                          ------------    ------------    ------------
    Net cash provided by (used in) financing activities      4,061,506       5,101,383      (1,307,949)
                                                          ------------    ------------    ------------
Net increase in cash                                         1,164,550         264,621         290,827
Cash at beginning of year                                    1,747,572       1,482,951       1,192,124
                                                          ------------    ------------    ------------
Cash at end of year                                       $  2,912,122    $  1,747,572    $  1,482,951
                                                          ============    ============    ============

See accompanying notes to consolidated financial statements.

Donegal Group Inc.
Notes to Consolidated Financial Statements

1 -- Summary of Significant Accounting Policies

Organization and Business

The Company was organized as a regional insurance holding company by Donegal
Mutual Insurance Company (the "Mutual Company") and operates in Pennsylvania,
Maryland, Delaware, Virginia and Ohio through its wholly owned stock insurance
companies, Atlantic States Insurance Company ("Atlantic States"), Southern
Insurance Company of Virginia ("Southern"), and Delaware Atlantic Insurance
Company ("Delaware"), which changed its name from Delaware American Insurance
Company effective August 29, 1996 (collectively-Insurance Subsidiaries). The
Company's major lines of business in 1996 and their percentages of total net
earned premiums were Automobile Liability (27.7%), Workers' Compensation
(18.0%), Automobile Physical Damage (16.0%), Homeowners (16.6%) and Commercial
Multiple Peril (16.0%). The Insurance Subsidiaries are subject to regulation by
Insurance Departments in those states in which they operate and undergo periodic
examination by those departments. The Insurance Subsidiaries are also subject to
competition from other insurance carriers in their operating areas. Atlantic
States participates in an intercompany pooling arrangement with the Mutual
Company and assumes 65% (60% in 1995 and 1994) of the pooled business. Southern
cedes 50% of its business to the Mutual Company and Delaware cedes 70% of its
Workers' Compensation business to the Mutual Company. At December 31, 1996, the
Mutual Company held 59% of the outstanding common stock of the Company.

     In addition to the Company's insurance subsidiaries, it also owns all of
the outstanding stock of Atlantic Insurance Services, Inc. ("AIS"), which was
formed and began business in January 1994. AIS is an insurance services
organization currently providing inspection and policy auditing information on a
fee for service basis to its affiliates and the insurance industry.

Basis of Consolidation

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

Use of Estimates

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

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

Investments

The Company accounts for investments in accordance with the provisions of
Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," which was adopted January 1,
1994.

     SFAS No. 115 requires that investments in all debt securities and those
equity securities with readily determinable market values be classified into
three categories as follows:

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

     Trading -- Debt and equity securities that are bought and held principally
     for the purpose of selling them in the near term; reported at fair value,
     with unrealized gains and losses included in income.

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

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

     If there is a decline in fair value which is other than temporary, the
carrying value for investments in the held to maturity and available for sale
categories is reduced to fair value. Such decline in carrying value is
recognized as a realized loss and charged to income. Premiums and discounts on
debt securities are amortized over the life of the security as an adjustment to
yield using the effective interest method. Realized investment gains and losses
are computed using the specific identification method.

     Premiums and discounts for mortgaged-backed debt securities are amortized
using anticipated prepayments with significant changes in estimated prepayments
accounted for under the prospective method.

Fair Values of Financial Instruments

The Company has used the following methods and assumptions in estimating its
fair value disclosures:

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

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

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

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

Revenue Recognition

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

Policy Acquisition Costs

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

Property and Equipment

Property and equipment are reported at depreciated cost that is computed using
the straight-line method based upon estimated useful lives of the assets,
ranging from 3 to 15 years.

Losses and Loss Expenses

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

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

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

     The Company has no material exposures to environmental liabilities.

Income Taxes

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

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

Credit Risk

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

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

Reinsurance Accounting and Reporting

The Company relies upon reinsurance agreements to limit its maximum net loss
from large single risks or risks in concentrated areas, and to increase its
capacity to write insurance.

Reinsurance does not relieve the primary insurer from liability to its
policyholders. To the extent that a reinsurer may be unable to pay losses for
which it is liable under the terms of a reinsurance agreement, the Company is
exposed to the risk of continued liability for such losses. However, in an
effort to reduce the risk of non-payment, the Company requires all of its
reinsurers to have an A.M. Best rating of A- or better or, with respect to
foreign reinsurers, to have a financial condition which, in the opinion of
management, is equivalent to a company with at least an A- rating. If the
Company's reinsurers incur losses from their reinsurance arrangements with the
Company, it is probable that the reinsurance premiums payable by the Company in
the future could increase. Estimated amounts of reinsurance recoverable are
reported as assets in the accompanying consolidated balance sheets as are
prepaid reinsurance premiums which represent the unearned portion of premiums
ceded.

Stock-Based Compensation

Stock-based compensation plans are accounted for under the provisions of
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees," and related interpretations. As such, compensation expense would
be recorded on the date of a stock option grant only if the current market price
of the underlying stock exceeded the exercise price. Statement of Financial
Accounting Standards (SFAS) No. 123, "Accounting for Stock-based Compensation"
is effective for 1996 and permits entities to recognize as expense, over the
vesting period, the fair value of all stock-based awards on the date of the
grant. Alternatively, SFAS No. 123 allows entities to continue to apply the
provisions of APB Opinion No. 25 and provide pro forma net income and earnings
per share disclosures for employee stock option grants made in 1995 and future
years as if the fair-value-based method defined in SFAS No. 123 had been
applied. The Company has elected to continue to apply the provisions of APB
Opinion No. 25 and provide the pro forma disclosures under SFAS No. 123.

Net Income per Common Share

Net income per share is based upon the weighted average number of common shares
outstanding plus dilutive common equivalent shares from stock options using the
treasury stock method.

     The average common and common equivalent shares outstanding for the years
ended December 31, 1996, 1995 and 1994, were 4,425,652, 4,272,447 and 4,181,159,
respectively.

2 -- Transactions with Affiliates

The Company conducts business and has various agreements with the Mutual Company
which are described below.

a. Reinsurance Pooling and Other Reinsurance Arrangements

Atlantic States cedes to the Mutual Company all of its insurance business and
assumes from the Mutual Company 65% (60% in 1995 and 1994) of the Mutual
Company's total pooled insurance business, including that assumed from Atlantic
States and substantially all of the business assumed and retained by the Mutual
Company from Southern and Delaware. Atlantic States, Southern and Delaware each
have a catastrophe reinsurance agreement with the Mutual Company which limits
the maximum liability under any one catastrophic occurrence to $400,000,
$300,000 and $300,000, respectively, and $700,000 for a catastrophe involving
more than one of the companies. The Mutual Company and Delaware also have an
excess of loss reinsurance agreement in which the Mutual Company assumes up to
$200,000 of losses in excess of $50,000 and Workers' Compensation quota share
agreement whereby Delaware cedes 70% of that business. The Mutual Company and
Southern have an excess of loss reinsurance agreement in which the Mutual
Company assumes up to $25,000 of losses in excess of $100,000 and a quota share
agreement whereby Southern cedes 50% of its direct business less certain
reinsurance to the Mutual Company. Both Southern and Delaware have
retrocessional reinsurance agreements effective July 1, 1996 with the Mutual
Company under which they cede, and then assume back, 100% of their business net
of other reinsurance.

     The following amounts represent reinsurance transactions with the Mutual
Company during 1996, 1995 and 1994. Amounts for losses and loss expenses exclude
salvage and subrogation recoverable because such amounts are determined on a net
basis only consistent with the Mutual Company's statutory records:

Ceded reinsurance:                      1996            1995           1994
- -------------------------------------------------------------------------------
Premiums written                    $ 41,696,471     $27,731,104    $22,792,131
                                    ============     ===========    ===========
Premiums earned                     $ 34,602,528     $25,555,026    $21,274,804
                                    ============     ===========    ===========
Losses and loss expenses            $ 23,137,013     $14,336,897    $14,643,183
                                    ============     ===========    ===========
Unearned premiums                   $ 19,500,015     $12,406,072    $10,229,994
                                    ============     ===========    ===========
Liability for losses and
  loss expenses                     $ 31,381,875     $20,855,048    $18,476,791
                                    ============     ===========    ===========

Assumed reinsurance:
- -------------------------------------------------------------------------------

Premiums written                    $104,549,034     $79,550,369    $69,196,807
                                    ============     ===========    ===========
Premiums earned                     $ 93,649,895     $74,824,803    $66,322,464
                                    ============     ===========    ===========
Losses and loss expenses            $ 63,840,301     $49,332,144    $45,544,081
                                    ============     ===========    ===========
Unearned premiums                   $ 46,009,207     $35,110,068    $30,384,502
                                    ============     ===========    ===========
Liability for losses
  and loss expenses                 $ 78,341,967     $66,020,750    $57,267,708
                                    ============     ===========    ===========

     Losses and loss expenses assumed from the Mutual Company for 1996, 1995 and
1994 are reported net of intercompany catastrophe recoveries which amounted to
approximately $9.5 million, $0 and $2.8 million, respectively.

b. Expense Sharing

The Mutual Company provides facilities, management and other services to the
Company, and the Company reimburses the Mutual Company for such services on a
periodic basis under usage agreements and pooling arrangements. The charges are
based upon the relative participation of the Company and the Mutual Company in
the pooling arrangement, and management of both the Company and the Mutual
Company consider this allocation to be reasonable. Charges for these services
totalled $18,878,506, $16,886,631 and $13,708,490 for 1996, 1995 and 1994,
respectively.

c. Lease Agreement

The Company leases office equipment and automobiles to The Mutual Company under
a 10-year lease dated January 1, 1990.

     Future annual commitments under these leases are $537,000 for 1997, 1998
and 1999.

d. Inspection and Policy Auditing Services

AIS provides inspection and policy auditing services to the Mutual Company on a
fee for service basis.

3 -- Investments

The amortized cost and estimated fair values of fixed maturities and equity
securities at December 31, 1996 and 1995, are as follows:

                                                            1996
- -----------------------------------------------------------------------------------------
                                                     Gross        Gross       Estimated
                                     Amortized     Unrealized   Unrealized      Fair
HELD TO MATURITY                        Cost          Gains       Losses        Value
- -----------------------------------------------------------------------------------------
                                                                 
U.S. Treasury securities
  and obligations of
  U.S. government
  corporations
  and agencies                      $ 37,393,590   $  234,456     $292,696   $ 37,335,350

Obligations of states and
political subdivisions                55,989,476    1,764,831       74,988     57,679,319

Corporate securities                   5,766,899      278,056        8,455      6,036,500

Mortgage-backed securities            12,431,197      128,691      149,840     12,410,048
                                    ------------   ----------     --------   ------------
  Totals                            $111,581,162   $2,406,034     $525,979   $113,461,217
                                    ============   ==========     ========   ============

                                                            1996
- -----------------------------------------------------------------------------------------
                                                      Gross        Gross       Estimated
AVAILABLE                             Amortized     Unrealized   Unrealized      Fair
FOR SALE                                 Cost         Gains        Losses        Value
- -----------------------------------------------------------------------------------------
                                                                 
U.S. Treasury securities
  and obligations of
  U.S. government
  corporations
  and agencies                       $32,824,112     $ 34,564     $149,582    $32,709,094
Obligations of states
  and political
  subdivisions                        12,287,823      406,867       13,190     12,681,500
Corporate securities                   3,107,680           --       20,680      3,087,000
Mortgage-backed
  securities                           1,094,905       16,044           --      1,110,949
Equity securities                      2,770,346      475,165      111,313      3,134,198
                                     -----------     --------     --------    -----------
  Totals                             $52,084,866     $932,640     $294,765    $52,722,741
                                     ===========     ========     ========    ===========

                                                            1995
- -----------------------------------------------------------------------------------------
                                                     Gross        Gross       Estimated
                                     Amortized     Unrealized   Unrealized      Fair
HELD TO MATURITY                        Cost          Gains       Losses        Value
- -----------------------------------------------------------------------------------------

U.S. Treasury securities
  and obligations of
  U.S. government
  corporations
  and agencies                       $19,675,694   $  467,842     $ 48,036    $20,095,500
Obligations of states
  and political
  subdivisions                        52,080,590    2,378,670       29,155     54,430,105
Corporate securities                   3,816,309      380,980        2,289      4,195,000
Mortgage-backed
  securities                          16,406,529      288,082       57,376     16,637,235
                                     -----------   ----------     --------    -----------
  Totals                             $91,979,122   $3,515,574     $136,856    $95,357,840
                                     ===========   ==========     ========    ===========

                                                            1995
- -----------------------------------------------------------------------------------------
                                                     Gross         Gross       Estimated
AVAILABLE                             Amortized    Unrealized    Unrealized      Fair
FOR SALE                                 Cost        Gains         Losses        Value
- -----------------------------------------------------------------------------------------
                                                                 
U.S. Treasury securities
  and obligations of
  U.S. government
  corporations
  and agencies                       $35,057,293   $  374,436     $ 10,286    $35,421,443
Obligations of states
  and political
  subdivisions                         9,633,046      486,704           --     10,119,750
Corporate securities                   4,299,597       55,273        6,870      4,348,000
Mortgage-backed
  securities                           1,724,951       32,586           --      1,757,537
Equity securities                      2,954,487      413,878      104,487      3,263,878
                                     -----------   ----------     --------    -----------
  Totals                             $53,669,374   $1,362,877     $121,643    $54,910,608
                                     ===========   ==========     ========    ===========

     The amortized cost and estimated fair value of fixed maturities at December
31, 1996, by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.

                                                                     Estimated
                                                   Amortized            Fair
                                                      Cost              Value
- --------------------------------------------------------------------------------
Held to maturity
Due in one year or less                           $  5,615,296      $  5,661,000
Due after one year through five years               23,801,976        24,161,000
Due after five years through ten years              33,727,321        34,110,100
Due after ten years                                 36,005,372        37,119,069
Mortgage-backed securities                          12,431,197        12,410,048
                                                  ------------      ------------
  Total held to maturity                          $111,581,162      $113,461,217
                                                  ============      ============

Available for sale
Due in one year or less                           $  6,994,864      $  7,000,000
Due after one year through five years               21,090,113        21,033,594
Due after five years through ten years               9,867,026         9,899,000
Due after ten years                                 10,267,612        10,545,000
Mortgage-backed securities                           1,094,905         1,110,949
                                                  ------------      ------------
  Total available for sale                        $ 49,314,520      $ 49,588,543
                                                  ============      ============

     Net change in unrealized investment gains (losses) less applicable federal
income taxes is as follows:

                                      1996             1995             1994
- -------------------------------------------------------------------------------
Fixed maturities                  $  (657,819)     $ 1,657,442      $(2,664,358)
Equity securities                      54,461        1,004,643       (1,185,026)
Deferred federal income
  (taxes) benefit                     205,143         (845,234)       1,241,770
                                  -----------      -----------      -----------
Net change                        $  (398,215)     $ 1,816,851      $(2,607,614)
                                  ===========      ===========      ===========
Held to maturity                  $(1,498,661)     $ 6,252,155      $(6,949,719)
                                  ===========      ===========      ===========

     Unrealized investment gains (losses) less applicable federal income taxes
are as follows:

                                      1996             1995             1994
- -------------------------------------------------------------------------------
Fixed maturities
  Gains                             $ 457,475       $  948,999       $  112,093
  Losses                             (183,452)         (17,156)        (837,695)
Equity securities
  Gains                               475,165          413,877           49,075
  Losses                             (111,313)        (104,487)        (744,325)
                                    ---------       ----------       ----------
                                      637,875        1,241,233       (1,420,852)
Deferred federal
  income (taxes) benefit             (216,877)        (422,020)         423,214
                                    ---------       ----------       ----------
Net unrealized investment
  gains (losses)                    $ 420,998       $  819,213       $ (997,638)
                                    =========       ==========       ==========

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

                                       1996             1995             1994
- --------------------------------------------------------------------------------
Fixed maturities                   $ 9,513,417       $8,264,968       $6,681,435
Equity securities                      233,072          233,822          230,530
Short-term investments               1,034,246        1,194,082        1,286,290
Real estate                             29,250           29,250           29,310
                                   -----------       ----------       ----------
Investment income                   10,809,985        9,722,122        8,227,565
Investment expenses                    493,517          452,238          449,401
                                   -----------       ----------       ----------
Net investment income              $10,316,468       $9,269,884       $7,778,164
                                   ===========       ==========       ==========

     Proceeds and gross realized gains (losses) from sales of investments during
1996, 1995 and 1994 are as follows:

                                       1996             1995             1994
- --------------------------------------------------------------------------------
Proceeds                           $14,136,882      $13,409,224      $30,615,578
                                   -----------      -----------      -----------
Gross realized gains:
  Fixed maturities                      29,206          347,020          410,687
  Equity securities                    404,381          658,595          675,008
                                   -----------      -----------      -----------
                                       433,587        1,005,615        1,085,695
                                   -----------      -----------      -----------
Gross realized losses:
  Fixed maturities                         689            1,152          831,412
  Equity securities                    260,164          605,876          219,950
                                   -----------      -----------      -----------
                                       260,853          607,028        1,051,362
                                   -----------      -----------      -----------
Net realized gains                 $   172,734      $   398,587      $    34,333
                                   ===========      ===========      ===========

     During 1995, as permitted by the Financial Accounting Standards Board
"one-time window," the Company transferred $4,101,469 of investments from the
held to maturity to the available for sale portfolio. The fair value of such
investments was $4,381,217. This transfer was made to provide the Company with
increased flexibility in managing its liquidity position.

4 -- Deferred Policy Acquisition Costs

Changes in deferred policy acquisition costs are as follows:

                                       1996             1995             1994
- --------------------------------------------------------------------------------
Balance, January 1                 $ 6,902,218      $ 5,551,869      $ 5,089,667
Acquisition costs deferred          17,967,681       15,762,349       12,517,202
Amortization charged
  to earnings                       17,032,000       14,412,000       12,055,000
                                   -----------      -----------      -----------
Balance, December 31               $ 7,837,899      $ 6,902,218      $ 5,551,869
                                   ===========      ===========      ===========

5 -- Property and Equipment

Property and equipment at December 31, 1996 and 1995, consisted of the
following:

                                                    1996                1995
- --------------------------------------------------------------------------------
Cost -- office equipment                        $ 2,253,581         $ 2,204,608
        automobiles                                 769,767             721,565
        leasehold improvements                       81,719              81,719
        land                                        610,010             610,010
        software                                     18,409               2,067
                                                -----------         -----------
                                                  3,733,486           3,619,969
Accumulated depreciation                         (1,572,680)         (1,337,399)
                                                -----------         -----------
                                                $ 2,160,806         $ 2,282,570
                                                ===========         ===========

     Depreciation expense for 1996, 1995 and 1994 amounted to $364,679, $345,408
and $351,951, respectively.

6 -- Liability for Losses and Loss Expenses

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

                                     1996             1995             1994
- -------------------------------------------------------------------------------
Balance at January 1            $  97,733,851     $ 87,743,937     $ 69,441,728
  Less reinsurance
    recoverable                    27,693,106       25,167,086       17,143,860
                                -------------     ------------     ------------
Net Balance at January 1           70,040,745       62,576,851       52,297,868
                                -------------     ------------     ------------
Acquisition of Delaware
  American                               --               --          5,669,797
                                -------------     ------------     ------------
Net Balance at January 1
  as restated                      70,040,745       62,576,851       57,967,665
                                -------------     ------------     ------------
Incurred related to:
  Current year                     69,206,233       58,354,254       55,941,502
  Prior years                      (2,595,000)      (2,947,000)      (3,084,000)
                                -------------     ------------     ------------
Total incurred                     66,611,233       55,407,254       52,857,502
                                -------------     ------------     ------------
Paid related to:
  Current year                     39,988,258       28,934,360       30,544,316
  Prior years                      22,889,000       19,009,000       17,704,000
                                -------------     ------------     ------------
Total paid                         62,877,258       47,943,360       48,248,316
                                -------------     ------------     ------------
Net Balance at
    December 31                    73,774,720       70,040,745       62,576,851
  Plus reinsurance
    recoverable                    36,248,166       27,693,106       25,167,086
                                -------------     ------------     ------------
Balance at December 31          $ 110,022,886     $ 97,733,851     $ 87,743,937
                                =============     ============     ============

     The Company recognized a decrease in the liability for losses and loss
expenses (favorable development) of $2.6 million, $3.0 million and $3.1 million.
These favorable developments are primarily attributable to the Company's
strengthening of case reserves in prior years, the effects of which are being
recognized currently.

7 -- Line of Credit

At December 31, 1996, pursuant to a credit agreement dated December 29, 1995,
with Fleet National Bank of Connecticut, the Company had unsecured borrowings of
$8.5 million. Such borrowings were made in connection with the acquisition of
Delaware and a $5 million capital contribution to Atlantic States. Per the terms
of the credit agreement, the Company may borrow up to $20 million at interest
rates equal to the bank's then current prime rate or the then current London
interbank Eurodollar bank rate plus 1.70%. At December 31, 1996, the interest
rate on the outstanding balance was 7.325%. In addition, the Company will pay a
non-use fee at a rate of 3/10 of 1% per annum on the average daily unused
portion of the Bank's commitment. On each December 29, commencing December 29,
1998, the credit line will be reduced by $4 million. Any outstanding loan in
excess of the remaining credit line, after such reduction, will then be payable.

8 -- Unaffiliated Reinsurers

In addition to the primary reinsurance in place with the Mutual Company, the
Insurance Subsidiaries have other reinsurance in place principally with four
unaffiliated reinsurers. The following amounts represent statutory reinsurance
transactions with unaffiliated reinsurers during 1996, 1995 and 1994:

Ceded reinsurance:                       1996            1995            1994
- --------------------------------------------------------------------------------
Premiums written                      $3,749,667      $3,597,212      $3,062,180
                                      ==========      ==========      ==========
Premiums earned                       $3,724,522      $3,544,424      $4,090,637
                                      ==========      ==========      ==========
Losses and loss expenses              $1,756,840      $2,801,073      $2,531,806
                                      ==========      ==========      ==========
Unearned premiums                     $  674,966      $  649,821      $  597,031
                                      ==========      ==========      ==========
Liability for losses and
  loss expenses                       $4,866,291      $6,838,058      $6,690,295
                                      ==========      ==========      ==========

9 -- Federal Income Taxes

The provision for federal income tax consists of the following:

                                     1996             1995              1994
- -------------------------------------------------------------------------------
Current                           $2,346,967      $ 3,309,820       $ 2,407,756
Deferred                               3,380         (521,952)         (344,725)
                                  ----------      -----------       -----------
Federal tax provision             $2,350,347      $ 2,787,868       $ 2,063,031
                                  ==========      ===========       ===========

     The effective tax rate is different than the amount computed at the
statutory federal rate of 34% for 1996, 1995 and 1994. The reason for such
difference and the related tax effect are as follows:

                                       1996             1995            1994
- -------------------------------------------------------------------------------
Income before income taxes         $11,246,460      $12,645,818      $7,102,979
                                   ===========      ===========      ==========
Computed "expected"
  taxes at 34%                     $ 3,823,796      $ 4,299,578      $2,415,013
Tax-exempt interest                 (1,055,491)        (751,003)       (671,969)
Dividends received deduction           (48,108)         (46,789)        (52,993)
Deduction for exercise
  of options                          (399,904)        (324,254)           --
Other, net                              30,054           (5,998)        (16,659)
Delaware loss not
  providing current
  tax benefit                               --               --         356,321
Change in valuation
  allowance                                 --         (383,669)           --
                                   -----------      -----------      ----------
Federal income tax provision       $ 2,350,347      $ 2,787,868      $2,063,031
                                   ===========      ===========      ==========

     The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1996 and 1995, are as follows:

                                           1996             1995
- --------------------------------------------------------------------------------
Deferred tax assets:
  Unearned premium                      $3,128,626       $2,809,850
  Loss reserves                          3,910,691        3,810,076
                                        ----------       ----------
    Total                               $7,039,317       $6,619,926
                                        ==========       ==========

Deferred tax liabilities:
  Depreciation expense                  $  286,816       $  273,919
  Deferred policy acquisition costs      2,664,886        2,346,754
  Salvage receivable                       257,431          165,689
  Unrealized gain                          216,877          422,020
                                        ----------       ----------
    Total                               $3,426,010       $3,208,382
                                        ==========       ==========
    Net deferred tax assets             $3,613,307       $3,411,544
                                        ==========       ==========

     A valuation allowance is provided when it is more likely than not that some
portion of the tax asset will not be realized. Management has determined that it
is not required to establish a valuation allowance for the deferred tax asset of
$7,039,317 and $6,619,926 at December 31, 1996 and 1995 since it is more likely
than not that the deferred tax asset will be realized through reversals of
existing temporary differences, future taxable income, carryback to taxable
income in prior years, previously realized investment gains and the
implementation of tax planning strategies. The net change in the valuation
allowance for the year ended December 31, 1995 was a decrease of $383,669.

10 -- Stock Compensation Plans
The Company applies APB Opinion 25 in accounting for its stock-based
compensation plans. Accordingly, no compensation cost has been recognized for
its fixed stock option plans and certain of its stock purchase plans.
Compensation cost for these stock-based compensation plans determined under SFAS
No. 123 would not have had a material impact on net income and earnings per
share for 1996 or 1995.
     The calculation of pro forma net income reflects only options granted in
1996 and 1995. Therefore, the full impact of calculating compensation cost for
stock options under SFAS No. 123 is not reflected because compensation cost is
reflected over the options' vesting period and compensation cost for options
granted prior to January 1, 1995 is not considered.

Equity Incentive Plans
The Company has had an Equity Incentive Plan for key employees since 1986 and
adopted a nearly identical new plan in 1996. Both plans provide for the granting
of awards by the Board of Directors in the form of stock options, stock
appreciation rights, restricted stock or any combination of the above. During
1994 the aggregate number of shares available as awards was increased from
450,000 to 700,000. During 1996 the new plan was adopted and it makes 345,850
shares available. The plans provide that stock options may become exercisable up
to 10 years from date of grant, with an option price not less than fair market
value on date of grant. The stock appreciation rights permit surrender of the
option and receipt of the excess of current market price over option price in
cash.
     Information regarding activity in the Company's stock option plans is
presented below:

                                                 Weighted Average
                                        Number of      Exercise Price
                                         Shares          Per Share
- -------------------------------------------------------------------------------
Outstanding at December 31, 1993         360,650          $ 11.01
 Granted -- 1994                              --               --
 Exercised -- 1994                            --               --
 Forfeited -- 1994                            --               --
                                         -------          -------
Outstanding at December 31, 1994         360,650          $ 11.01
 Granted -- 1995                              --               --
 Exercised -- 1995                       150,650            10.47
 Forfeited -- 1995                         7,500            10.80
                                         -------          -------
Outstanding at December 31, 1995         202,500          $ 11.42
 Granted -- 1996                              --               --
 Exercised -- 1996                       202,500            11.42
 Forfeited -- 1996                            --               --
                                         -------          -------
Outstanding at December 31, 1996              --          $    --
                                         =======          =======
Exercisable at:
 December 31, 1995                       202,500          $ 11.42
                                         =======          =======
 December 31, 1996                            --          $    --
                                         =======          =======

     As of December 31, 1996, the Company has no unexercised options under this
plan.

     Shares available for future grants at December 31, 1996, are 345,850.

1996 Equity Incentive Plan For Directors

During 1996 the Company adopted an Equity Incentive Plan For Directors which
makes 90,000 shares available for award. Awards may be made in the form of stock
options and additionally provides for the issuance of 100 shares of restricted
stock to each director on the first business day of January in each year,
commencing January 2, 1997. As of December 31, 1996 the Company has no
outstanding options under this plan.

Employee Stock Purchase Plans

During 1996 the Company adopted the 1996 Employee Stock Purchase Plan which
replaced a similar plan that had been adopted effective January 1, 1988. The
1996 plan makes 100,000 shares available for issuance.

     The 1996 Plan extends over a 10-year period and provides for shares to be
offered to all eligible employees at a purchase price equal to the lesser of 85
percent of the fair market value of the Company's common stock on the last day
before the first day of the enrollment period (June 1 and December 1) of the
plan or 85 percent of the fair market value of such share on the last day of the
subscription period (June 30 and December 31). A summary of plan activity
follows:

                                               Shares Issued
                                            -------------------
                                            Price        Shares
- --------------------------------------------------------------------------------
January 1, 1994                             13.175       4,205
July 1, 1994                                12.75        5,484
January 1, 1995                             11.90        6,004
July 1, 1995                                10.625       6,938
January 1, 1996                             14.2375      5,630
July 1, 1996                                14.6625      6,077

     On January 1, 1997, the Company issued an additional 6,575 shares at a
price of $14.6625 per share under this plan.

Agency Stock Purchase Plan

On December 31, 1996 the Company adopted the Agency Stock Purchase Plan which
makes 300,000 shares available for issuance. The plan provides for agents of
affiliated companies of Donegal Group Inc. to invest up to $12,000 per
subscription period (April 1 to September 30 and October 1 to March 31) under
various methods. Stock is issued at the end of the subscription period at a
price equal to 90% of the average market price during the last ten trading days
of the subscription period.

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

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

                              1996          1995          1994
- --------------------------------------------------------------------------------
ATLANTIC STATES
Statutory capital
  and surplus             $47,914,415   $40,726,246   $38,481,691
                          ===========   ===========   ===========
Statutory unassigned
  surplus                 $16,953,551   $14,765,382   $12,520,827
                          ===========   ===========   ===========
Statutory net income      $ 5,410,536   $ 5,224,905   $ 4,072,387
                          ===========   ===========   ===========

                              1996          1995          1994
- --------------------------------------------------------------------------------
SOUTHERN
Statutory capital
  and surplus              $6,608,944    $6,380,420    $5,833,556
                           ==========    ==========    ==========
Statutory unassigned
  surplus                  $1,856,674    $2,378,150    $1,831,285
                           ==========    ==========    ==========
Statutory net income       $  255,480    $  679,335    $  764,696
                           ==========    ==========    ==========

                              1996          1995          1994
- --------------------------------------------------------------------------------
DELAWARE
Statutory capital
  and surplus              $6,798,477    $5,695,634    $5,016,599
                           ==========    ==========    ==========
Statutory unassigned
  surplus                  $1,598,477    $  495,634    $ (183,401)
                           ==========    ==========    ==========
Statutory net income
 (loss)                    $1,120,952    $  494,576    $ (963,982)
                           ==========    ==========    ==========

     The Company's principal source of cash for payment of dividends are
dividends from its Insurance Subsidiaries which are required by law to maintain
certain minimum capital and surplus on a statutory basis and are subject to
regulations under which payment of dividends from statutory surplus is
restricted and may require prior approval of their domiciliary insurance
regulatory authorities. Atlantic States, Southern and Delaware are also subject
to risk based capital (RBC) requirements which may further impact their ability
to pay dividends. At December 31, 1996, all three Companies' statutory capital
and surplus were substantially above the RBC requirements. At December 31, 1996,
amounts available for distribution as dividends to Donegal Group Inc. without
prior approval of insurance regulatory authorities are $5,410,536 from Atlantic
States, $255,480 from Southern and $1,120,952 from Delaware.

12 -- Reconciliation of Statutory Filings to Amounts Reported Herein

The Company's Insurance Subsidiaries are required to file statutory financial
statements with state insurance regulatory authorities. Accounting principles
used to prepare these statutory financial statements differ from financial
statements prepared on the basis of generally accepted accounting principles.

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

                                       Year ended December 31,
- --------------------------------------------------------------------------------
                                   1996         1995         1994
- --------------------------------------------------------------------------------
Statutory net income of
  insurance subsidiaries        $6,786,968   $6,398,816   $3,873,101
Increases (decreases):
  Deferred policy
    acquisition costs              935,681    1,350,349      462,202
  Deferred federal
    income taxes                    (3,380)     521,952      344,725
  Salvage and subrogation
    recoverable                  1,037,926    1,150,509      337,188
  Consolidating eliminations
    and adjustments                     --     (900,000)    (900,000)
  Parent only net income           155,894    1,301,558      952,697
  Non-insurance subsidiary
    net income (loss)              (16,976)      34,766      (29,965)
                                ----------   ----------   ----------
Net income as
  reported herein               $8,896,113   $9,857,950   $5,039,948
                                ==========   ==========   ==========

                                                  December 31,
- --------------------------------------------------------------------------------
                                      1996            1995           1994
- --------------------------------------------------------------------------------
Statutory capital and surplus
  of insurance subsidiaries      $ 61,321,836     $52,802,300    $49,331,846
Increases (decreases):
  Deferred policy
    acquisition costs               7,837,899       6,902,218      5,551,869
  Deferred federal
    income taxes                    3,613,307       3,411,544      3,734,826
  Salvage and subrogation
    recoverable                     4,918,547       3,880,621      2,730,112
  Statutory reserves                9,835,700       6,413,472      3,446,574
  Non-admitted assets and
    other adjustments, net            339,781         440,116        374,009
  Fixed maturities
    available for sale                274,023         931,843       (725,600)
  Consolidating eliminations
    and adjustments               (10,929,937)     (5,929,937)    (5,871,578)
  Parent only equity                3,878,390       3,225,914      1,822,974
  Non-insurance
    subsidiary equity                 187,825         204,801        170,035
                                 ------------     -----------    -----------
Stockholders' equity as
  reported herein                $ 81,277,371     $72,282,892    $60,565,067
                                 ============     ===========    ===========

13 -- Supplementary Information on Statement of Cash Flows

The following schedule reflects income taxes and interest paid during 1996, 1995
and 1994:

                             1996            1995            1994
- --------------------------------------------------------------------------------
Income taxes               $983,161      $3,985,497      $2,072,512
                           ========      ==========      ==========
Interest                   $369,869        $  7,229      $    9,459
                           ========      ==========      ==========

14 -- Interim Financial Data (unaudited)

                                     1996
- --------------------------------------------------------------------------------
                    First     Second       Third      Fourth
                   Quarter    Quarter     Quarter     Quarter
- --------------------------------------------------------------------------------
Net premiums
  earned          $24,695,309    $24,835,041    $25,134,567    $25,317,125
Total revenues     27,898,782     27,857,986     28,176,395     28,585,868
Loss and loss
  adjusting
  expenses         17,793,237     16,147,754     16,185,048     16,485,194
Net income          1,410,932      2,720,429      2,485,311      2,279,441
Net income per
  common share           $.32           $.62           $.56           $.51

                                     1995
- --------------------------------------------------------------------------------
                      First       Second         Third        Fourth
                    Quarter       Quarter       Quarter      Quarter
- --------------------------------------------------------------------------------
Net premiums
  earned          $20,333,148   $21,353,648   $22,026,028   $22,565,028
Total revenues     23,008,266    24,312,402    25,034,119    25,530,273
Loss and loss
  adjusting
  expenses         12,455,415    14,215,193    14,240,198    14,496,448
Net income          2,430,125     2,500,700     2,349,118     2,578,007
Net income per
  common share          $ .58         $ .59         $ .55         $ .59

     Results for the first quarter of 1996 were adversely affected due to the
record snow levels in the Company's operating area that fell in January 1996.
This resulted in a loss ratio of 72.1% in the first quarter compared to 64.8%
for the rest of the year.

15 -- Pending Acquisition

On December 22, 1994, the Company announced its intent to purchase all of the
outstanding shares of Pioneer Insurance Company from the Mutual Company. The
purchase price is expected to approximate statutory book value, which at
December 31, 1996, was $5,048,582. The acquisition will be accounted for as if
it were a pooling of interests. It is anticipated that the acquisition will be
consummated on April 1, 1997.

Donegal Group Inc.

Independent Auditors' Report

The Stockholders and Board of Directors
Donegal Group Inc.

We have audited the accompanying consolidated balance sheets of Donegal Group
Inc. as of December 31, 1996 and 1995, and the related consolidated statements
of income, stockholders' equity, and cash flows for each of the years in the
three-year period ended December 31, 1996. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.

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

     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Donegal
Group Inc. as of December 31, 1996 and 1995, and the results of their operations
and their cash flows for each of the years in the three-year period ended
December 31, 1996 in conformity with generally accepted accounting principles.

                                                           KPMG Peat Marwick LLP

Harrisburg, Pennsylvania
March 3, 1997

                               DONEGAL GROUP INC.
                          ---------------------------
 
                    NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
                           TO BE HELD APRIL 17, 1997
                          ---------------------------
 
To the Stockholders of
DONEGAL GROUP INC.:
 
     The Annual Meeting of Stockholders of Donegal Group Inc. (the "Company")
will be held at 10:00 a.m., prevailing time, on April 17, 1997, at the Company's
offices, 1195 River Road, Marietta, Pennsylvania 17547, for the following
purposes:
 
          1. To elect two Class B directors to serve until the expiration of
     their three-year terms and until their successors are elected;
 
          2. To act upon the election of KPMG Peat Marwick LLP as independent
     public accountants for the Company for 1997;
 
          3. To consider and vote upon a proposal to adopt the Company's Amended
     and Restated 1996 Equity Incentive Plan for officers and key employees;
 
          4. To consider and vote upon a proposal to adopt the Company's 1996
     Equity Incentive Plan for Directors; and
 
          5. To transact such other business as may properly come before the
     Annual Meeting and any adjournment, postponement or continuation thereof.
 
     The Board of Directors has fixed the close of business on February 21, 1997
as the record date for the determination of the stockholders entitled to notice
of and to vote at the Annual Meeting.
 
     A copy of the Company's Annual Report for the year ended December 31, 1996
is being mailed to stockholders together with this Notice.
 
     Holders of Common Stock are requested to complete, sign and return the
enclosed form of proxy in the envelope provided whether or not they expect to
attend the Annual Meeting in person.
 
                                          By Order of the Board of Directors,
 
                                          /s/ Donald H. Nikolaus
                                          --------------------------------------
 
                                          Donald H. Nikolaus,
                                          President and Chief Executive Officer
 
March 24, 1997
Marietta, Pennsylvania

                               DONEGAL GROUP INC.
 
                          ---------------------------
 
     This Proxy Statement and the form of proxy enclosed herewith, which are
first being mailed to stockholders on or about March 24, 1997, are furnished in
connection with the solicitation by the Board of Directors of Donegal Group Inc.
(the "Company") of proxies to be voted at the Annual Meeting of Stockholders
(the "Annual Meeting") to be held at 10:00 a.m., prevailing time, on April 17,
1997, and at any adjournment, postponement or continuation thereof, at the
Company's principal executive offices, which are located at 1195 River Road,
Marietta, Pennsylvania 17547.
 
     Shares represented by proxies in the accompanying form, if properly signed
and returned, will be voted in accordance with the specifications made thereon
by the stockholders. Any proxy not specifying to the contrary will be voted in
favor of the adoption of the proposals referred to in the Notice of Annual
Meeting and for the election of the nominees for director named below. A
stockholder who signs and returns a proxy in the accompanying form may revoke it
at any time before it is voted by giving written notice of revocation or a duly
executed proxy bearing a later date to the Secretary of the Company or by
attending the Annual Meeting and voting in person.
 
     The cost of solicitation of proxies in the accompanying form will be borne
by the Company, including expenses in connection with preparing and mailing this
Proxy Statement. Such solicitation will be made by mail and may also be made on
behalf of the Company in person or by telephone or telegram by the Company's
regular officers and employees, none of whom will receive special compensation
for such services. The Company, upon request therefor, will also reimburse
brokers, nominees, fiduciaries and custodians and persons holding shares in
their names or in the names of nominees for their reasonable expenses in sending
proxies and proxy material to beneficial owners.
 
     Only holders of Common Stock of record at the close of business on February
21, 1997 will be entitled to notice of and to vote at the Annual Meeting. Each
share of Common Stock is entitled to one vote on all matters to come before the
Annual Meeting. Cumulative voting rights do not exist with respect to the
election of directors.
 
     As of the close of business on February 21, 1997, the Company had
outstanding 4,479,557 shares of Common Stock, $1.00 par value. A majority of the
outstanding shares will constitute a quorum at the Annual Meeting. As of
February 21, 1997, Donegal Mutual Insurance Company (the "Mutual Company") owned
2,621,633 shares of the Company's outstanding Common Stock, or approximately
58.5% of the Company's outstanding Common Stock. The Mutual Company has advised
the Company that the Mutual Company will vote its shares for the election of C.
Edwin Ireland and Donald H. Nikolaus as Class B directors, for the election of
KPMG Peat Marwick LLP as the Company's independent public accountants for 1997,
for the adoption of the Amended and Restated 1996 Equity Incentive Plan (the
"1996 Equity Incentive Plan") and for the adoption of the 1996 Equity Incentive
Plan for Directors (the "1996 Director Plan"). Accordingly, Messrs. Ireland and
Nikolaus will be elected as Class B directors, KPMG Peat Marwick LLP will be
elected as the Company's independent public accountants for 1997 and the 1996
Equity Incentive Plan and the 1996 Director Plan will be approved regardless of
the votes of the Company's stockholders other than the Mutual Company.
 
                                       1

                      BENEFICIAL OWNERSHIP OF COMMON STOCK
 
     The following table sets forth as of February 21, 1997 the amount and
percentage of the Company's outstanding Common Stock beneficially owned by 
(i) each person who is known by the Company to own beneficially more than 5% of
its outstanding Common Stock, (ii) each director and nominee for director, 
(iii) each executive officer named in the Summary Compensation Table and 
(iv) all executive officers and directors of the Company as a group.

                                                                      SHARES         PERCENT OF
                              NAME OF INDIVIDUAL                   BENEFICIALLY OUTSTANDING COMMON
                             OR IDENTITY OF GROUP                     OWNED(1)         STOCK(2)
                             --------------------                  -----------  -------------------
                                                                          
5% HOLDERS:
  Donegal Mutual Insurance Company...............................    2,621,633            58.5%
     1195 River Road
     Marietta, Pennsylvania 17547
DIRECTORS:
  C. Edwin Ireland...............................................        7,767(4)             --
  Donald H. Nikolaus.............................................       53,490(5)            1.2%
  Patricia A. Gilmartin..........................................        2,967(4)             --
  Philip H. Glatfelter, II.......................................        3,167(4)             --
  R. Richard Sherbahn............................................        1,867(4)             --
  Robert S. Bolinger.............................................        2,367(4)             --
  Thomas J. Finley, Jr...........................................        2,217(4)             --
EXECUTIVE OFFICERS (3):
  Ralph G. Spontak...............................................       20,083(6)             --
  William H. Shupert.............................................       10,106(7)             --
  Frank J. Wood..................................................        5,647(8)             --
  Robert Shenk...................................................        7,160(9)             --
  All directors and executive officers
     as a group (13 persons).....................................      128,644(10)            2.9%

- ------------------
 (1) Information furnished by each individual named. This table includes shares
     that are owned jointly, in whole or in part, with the person's spouse, or
     individually by his spouse.
 (2) Less than 1% unless otherwise indicated.
 (3) Excludes Executive Officers listed under "Directors."
 (4) Includes 1,667 shares of Common Stock the director has the option to
     purchase under the 1996 Director Plan, which become exercisable on and
     after April 30, 1997, subject to adoption of the 1996 Director Plan by the
     stockholders at the Annual Meeting.
 (5) Includes 25,000 shares of Common Stock Mr. Nikolaus has the option to
     purchase under the Company's 1996 Equity Incentive Plan, which become
     exercisable on and after April 30, 1997, subject to adoption of the 1996
     Equity Incentive Plan by the stockholders at the Annual Meeting.
 (6) Includes 12,500 shares of Common Stock Mr. Spontak has the option to
     purchase under the Company's 1996 Equity Incentive Plan, which become
     exercisable on and after April 30, 1997, subject to adoption of the 1996
     Equity Incentive Plan by the stockholders at the Annual Meeting.
 (7) Includes 7,000 shares of Common Stock Mr. Shupert has the option to
     purchase under the Company's 1996 Equity Incentive Plan, which become
     exercisable on and after April 30, 1997, subject to adoption of the 1996
     Equity Incentive Plan by the stockholders at the Annual Meeting.
 
                                       2

 (8) Includes 5,000 shares of Common Stock Mr. Wood has the option to purchase
     under the Company's 1996 Equity Incentive Plan, which become exercisable on
     and after April 30, 1997, subject to adoption of the 1996 Equity Incentive
     Plan by the stockholders at the Annual Meeting.
 (9) Includes 5,000 shares of Common Stock Mr. Shenk has the option to purchase
     under the Company's 1996 Equity Incentive Plan, which become exercisable on
     and after April 30, 1997, subject to adoption of the 1996 Equity Incentive
     Plan by the stockholders at the Annual Meeting.
(10) Includes 62,834 shares of Common Stock purchasable upon the exercise of
     options granted under the 1996 Equity Incentive Plan, which become
     exercisable on and after April 30, 1997, and 10,002 shares of Common Stock
     purchasable upon the exercise of options granted under the 1996 Director
     Plan, which become exercisable on and after April 30, 1997, subject to
     adoption of the 1996 Equity Incentive Plan and the 1996 Director Plan by
     the stockholders at the Annual Meeting.
 
            SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
 
     Section 16 of the Securities Exchange Act of 1934 (the "Exchange Act")
requires that the officers and directors of a corporation, such as the Company,
which has a class of equity securities registered under Section 12 of the
Exchange Act, as well as persons who own more than 10% of a class of equity
securities of such a corporation, file reports of their ownership of such
securities, as well as monthly statements of changes in such ownership, with the
corporation, the Securities and Exchange Commission (the "SEC") and Nasdaq.
Based upon written representations received by the Company from its officers and
directors, and the Company's review of the monthly statements of ownership
changes filed with the Company by its officers and directors during 1996, the
Company believes that all such filings required during 1996 were made on a
timely basis.
 
                      RELATIONSHIP WITH THE MUTUAL COMPANY
 
     The Company was formed by the Mutual Company in August 1986 and was a
wholly owned subsidiary of the Mutual Company until November 1986, when the
Company sold 600,000 shares of Common Stock in a public offering, thereby
reducing the Mutual Company's ownership of the Company's outstanding Common
Stock from 100% to approximately 79.5%, which subsequently increased to
approximately 84%. In September 1993, the Company sold 1,150,000 shares of
Common Stock in a public offering. At the same time, the Mutual Company sold
200,000 shares of the Company's Common Stock, reducing the Mutual Company's
ownership of the Company's outstanding Common Stock to approximately 57%.
Between December 22, 1994 and December 31, 1995, the Mutual Company purchased an
aggregate of 172,000 shares of the Company's Common Stock in the open market in
exempt transactions under SEC rule 10b-18 and in private transactions. Between
December 31, 1995 and December 31, 1996, the Mutual Company purchased an
aggregate of 114,000 shares of the Company's Common Stock in private
transactions. These purchases increased the Mutual Company's ownership of the
Company's Common Stock to 2,621,633 shares or approximately 58.5% of the
Company's outstanding Common Stock as of February 21, 1997.
 
     The Company's operations are interrelated with the operations of the Mutual
Company, and various reinsurance arrangements exist between the Company and the
Mutual Company. The Company believes that its various transactions with the
Mutual Company have been on terms no less favorable to the Company than the
terms that could have been negotiated with an independent third party.
 
                                       3

     The Mutual Company provides all personnel for the Company and its principal
insurance subsidiaries, Atlantic States Insurance Company ("Atlantic States"),
Delaware Atlantic Insurance Company, formerly known as Delaware American
Insurance Company ("Delaware Atlantic"), and Southern Insurance Company of
Virginia ("Southern"). Expenses are allocated to the Company, Delaware Atlantic
and Southern according to a time allocation and estimated usage agreement, and
to Atlantic States in relation to the relative participation of the Mutual
Company and Atlantic States in the pooling agreement described herein. Such
charges to the Company were $18,878,506 in 1996.
 
     On December 29, 1988, the Company acquired all of the outstanding common
stock of Southern, which converted from a mutual insurance company known as
Southern Mutual Insurance Company to a stock insurance company on the same date.
Since January 1, 1991, the Mutual Company has reinsured 50% of Southern's
business. Because the Mutual Company places substantially all of the business
assumed from Southern in the pool, from which the Company has an allocation
which is 65% from and after January 1, 1996, the Company's operations include
approximately 80% of the business written by Southern. Southern and the Mutual
Company settle the balances resulting from this reinsurance arrangement on a
monthly basis.
 
     Atlantic States participates in an underwriting pool with the Mutual
Company whereby Atlantic States cedes premiums, losses and loss adjustment
expenses on all of its business to the Mutual Company and assumes from the
Mutual Company a specified portion of the premiums, losses and loss adjustment
expenses of the Mutual Company and Atlantic States. Under the pooling agreement,
which became effective on October 1, 1986, Atlantic States cedes to the Mutual
Company all of its insurance business written on or after October 1, 1986.
Substantially all of the Mutual Company's property and casualty insurance
business written or in force on or after October 1, 1986 is also included in the
pooled business, including the business reinsured from Southern. Pursuant to an
amendment to the pooling agreement effective October 1, 1988, the Mutual
Company, which is solely responsible for any losses in the pooled business with
dates of loss on or before the close of business on September 30, 1986,
retroceded 50% of the pooled business to Atlantic States. From January 1, 1993
to December 31, 1995, 60% of the pooled business had been retroceded to Atlantic
States. Since January 1, 1996, 65% of the pooled business was retroceded to
Atlantic States. All premiums, losses, loss adjustment expenses and other
underwriting expenses are prorated among the parties on the basis of their
participation in the pool. The pooling agreement may be amended or terminated at
the end of any calendar year by agreement of the parties. The allocations of
pool participation percentages between the Mutual Company and the Company are
based on the pool participants' relative amounts of capital and surplus,
expectations of future relative amounts of capital and surplus and the ability
of the Company to raise capital for Atlantic States. The Company does not
currently anticipate a further increase in its percentage of participation in
the pool, nor does the Company intend to terminate its participation in the
pooling agreement. Additional information describing the pooling agreement is
contained in the Company's 1996 Annual Report to Stockholders, a copy of which
is enclosed with this Proxy Statement and to which reference is hereby made.
 
     As of December 31, 1995, the Company acquired all of the outstanding
capital stock of Delaware Atlantic pursuant to a Stock Purchase Agreement dated
as of December 21, 1995 between the Company and the Mutual Company. As part of
this transaction, the Mutual Company entered into an aggregate excess of loss
reinsurance agreement with Delaware Atlantic whereby the Mutual Company insured
the risk of any loss from an adverse development in Delaware Atlantic's loss and
loss adjustment expense reserve at the end of 1995 compared to the end of 1996
and losses and loss
 
                                       4

adjustment expenses incurred by Delaware Atlantic during the month of December
1995 and for the 1996 year by reason of the fact that Delaware Atlantic's loss
and loss adjustment expense ratio for those periods exceeded the lesser of the
loss and loss expense ratios of immediately preceding periods or 60%. This
reinsurance agreement did not result in any additional payment from the Mutual
Company to Delaware Atlantic.
 
     Effective July 1, 1996, the Mutual Company entered into Retrocessional
Reinsurance Contracts with each of Southern, Delaware Atlantic and Pioneer
Insurance Company, a wholly owned subsidiary of the Mutual Company,
(individually, an "Affiliate"), whereby the Mutual Company agreed to indemnify
each Affiliate in respect of 100% of the net liability that may accrue to such
Affiliate from its insurance operations and retrocede 100% of the net liability
back to each Affiliate, which the Affiliate assumes.
 
     All of the Company's officers are officers of the Mutual Company, five of
the Company's seven directors are directors of the Mutual Company and two of the
Company's executive officers are directors of the Mutual Company. The Company
and the Mutual Company maintain a Coordinating Committee, which consists of two
outside directors from each of the Company and the Mutual Company, none of whom
holds seats on both Boards, to review and evaluate the pooling agreement between
the Company and the Mutual Company and to be responsible for matters involving
actual or potential conflicts of interest between the Company and the Mutual
Company. The decisions of the Coordinating Committee are binding on the Company
and the Mutual Company. The Company's Coordinating Committee members must
conclude that intercompany transactions are fair and equitable to the Company.
The purpose of this provision is to protect the interests of the stockholders of
the Company other than the Mutual Company. The Coordinating Committee met two
times in 1996. The Company's members on the Coordinating Committee are Messrs.
Bolinger and Finley. See "Election of Directors." The Mutual Company's members
on the Coordinating Committee are John E. Hiestand and Dr. Charles A.
Heisterkamp, III.
 
     Mr. Hiestand, age 59, has been a director of the Mutual Company since 1983
and has been President of Hiestand Memorials, Inc., a manufacturer of cemetery
monuments, since 1977.
 
     Dr. Heisterkamp, age 64, has been a director of the Mutual Company since
1979 and has practiced as a surgeon in Lancaster, Pennsylvania for more than the
past five years.
 
                             ELECTION OF DIRECTORS
 
     The Company's Board of Directors consists of seven members. Each director
is elected for a three-year term and until his successor has been duly elected.
The current three-year terms of the Company's directors expire in the years
1997, 1998 and 1999, respectively.
 
     Two Class B directors are to be elected at the Annual Meeting. Unless
otherwise instructed, the proxy holders will vote the proxies received by them
for the election of the nominees named below, both of whom are currently
directors of the Company. If a nominee becomes unavailable for any reason, it is
intended that the proxies will be voted for a substitute nominee designated by
the Board of Directors. The Board of Directors has no reason to believe the
nominees named will be unable to serve if elected. Any vacancy occurring on the
Board of Directors for any reason may be filled by a majority of the directors
then in office until the expiration of the term of the class of directors in
which the vacancy exists. The two nominees for Class B director receiving a
plurality of the votes cast at the
 
                                       5

Annual Meeting will be elected as directors. Shares held by brokers or nominees
as to which voting instructions have not been received from the beneficial owner
or person otherwise entitled to vote and as to which the broker or nominee does
not have discretionary voting power, i.e., broker nonvotes, will be treated as
not present and not entitled to vote for nominees for election as Class B
directors. Abstentions from voting and broker nonvotes will have no effect on
the election of directors since they will not represent votes cast at the Annual
Meeting for the purpose of electing directors.
 
     The names of the nominees for Class B directors and the Class A and Class C
directors who will continue in office after the Annual Meeting until the
expiration of their respective terms, together with certain information
regarding them, are as follows:
 
                         NOMINEES FOR CLASS B DIRECTORS

                                                                                DIRECTOR    YEAR TERM
NAME                                                                    AGE       SINCE    WILL EXPIRE*
- ----                                                                 ---------  ---------  ------------
                                                                                  
C. Edwin Ireland...................................................     87        1986         2000
Donald H. Nikolaus.................................................     54        1986         2000

                         DIRECTORS CONTINUING IN OFFICE
 
CLASS C DIRECTORS

                                                                                DIRECTOR    YEAR TERM
NAME                                                                    AGE       SINCE    WILL EXPIRE
- ----                                                                 ---------  ---------  ------------
                                                                                  
Thomas J. Finley, Jr...............................................     76        1986         1998
R. Richard Sherbahn................................................     68        1986         1998

CLASS A DIRECTORS

                                                                                DIRECTOR    YEAR TERM
NAME                                                                    AGE       SINCE    WILL EXPIRE
- ----                                                                 ---------  ---------  ------------
                                                                                  
Robert S. Bolinger.................................................     60        1986         1999
Patricia A. Gilmartin..............................................     57        1986         1999
Philip H. Glatfelter, II...........................................     67        1986         1999

- ------------------
*If elected at the Annual Meeting
 
     Mr. Bolinger has been President and Chief Executive Officer of Susquehanna
Bancshares, Inc. since 1982 and of Farmers First Bank since 1976. Mr. Bolinger
is also a director of Susquehanna Bancshares, Inc.
 
     Mr. Finley retired in 1985 as President and Chief Executive Officer of the
Insurance Federation of Pennsylvania, a position he held for 18 years.
 
     Mrs. Gilmartin has been an employee since 1969 of Donegal Insurance Agency,
which has no affiliation with the Company except that Donegal Insurance Agency
receives insurance commissions in the ordinary course of business from the
Company's subsidiaries and affiliates in accordance with such subsidiaries' and
affiliates' standard commission schedules and agency contracts. Mrs. Gilmartin
has been a director of the Mutual Company since 1979.
 
                                       6

     Mr. Glatfelter retired in 1989 as a Vice President of Meridian Bank, a
position he held for more than five years prior to his retirement. Mr.
Glatfelter has been a director of the Mutual Company since 1981 and has been
Vice Chairman of the Mutual Company since 1991.
 
     Mr. Ireland is former Chairman of the Lancaster Industrial Development
Authority. He retired from Hamilton Watch Company in 1970. Prior thereto, he was
Vice President, Secretary and Treasurer of Hamilton Watch Company. Mr. Ireland
has been a director of the Mutual Company since 1972 and Chairman of its Board
of Directors since 1985. He has been Chairman of the Company's Board of
Directors since 1986.
 
     Mr. Nikolaus has been President of the Mutual Company since 1981 and a
director of the Mutual Company since 1972. He has been President of the Company
since 1986. Mr. Nikolaus has been a partner in the law firm of Nikolaus &
Hohenadel since 1972.
 
     Mr. Sherbahn has owned and operated Sherbahn Associates, Inc., a life
insurance and financial planning firm, since 1974. Mr. Sherbahn has been a
director of the Mutual Company since 1967.
 
                   THE BOARD OF DIRECTORS AND ITS COMMITTEES
 
     The Board of Directors met five times in 1996. The Board of Directors has
an Executive Committee, an Audit Committee, a Nominating Committee, a
Compensation Committee and, together with the Mutual Company, a four-member
Coordinating Committee.
 
     The Company's Executive Committee met 20 times in 1996. Messrs. Nikolaus,
Ireland and Glatfelter are the members of the Executive Committee. The Executive
Committee has the authority to take all action that can be taken by the full
Board of Directors, consistent with Delaware law, between Board of Directors'
meetings.
 
     The Audit Committee of the Company consists of Messrs. Bolinger, Glatfelter
and Ireland. The Audit Committee, which met one time in 1996, reviews audit
reports and management recommendations made by the Company's outside auditing
firm.
 
     The Nominating Committee of the Company consists of Messrs. Finley, Ireland
and Glatfelter. The Nominating Committee, which did not meet in 1996, is
responsible for the nomination of candidates to stand for election to the Board
of Directors at the Annual Meeting and the nomination of candidates to fill
vacancies on the Board of Directors between meetings of stockholders. The
Nominating Committee will consider written nominations for directors from
stockholders to the extent such nominations are made in accordance with the
Company's By-laws. The Company's By-laws require that any such nominations must
be sent to the Company at its principal executive offices, attention: Secretary,
not less than 30 days prior to the date of the stockholders meeting at which
directors are to be elected. Such written nomination must set forth the name,
age, address and principal occupation for the past five years of such nominee,
the number of shares of the Company's Common Stock beneficially owned by such
nominee and such other information about such nominee as would be required under
the proxy solicitation rules of the SEC if proxies were solicited for the
election of such nominee.
 
                                       7

     The Compensation Committee of the Company consists of Messrs. Ireland,
Sherbahn and Glatfelter. The Compensation Committee met two times in 1996 to
review and recommend compensation plans, approve certain compensation changes
and grant options under and determine participants in the Equity Incentive Plan.
 
COMPENSATION OF DIRECTORS
 
     Directors of the Company were paid an annual retainer of $14,000 in 1996
and were paid $500 for each meeting attended in excess of five per year.
Directors who are members of committees of the Board of Directors receive $250
for each committee meeting attended. If a director serves on the Board of
Directors of both the Mutual Company and the Company, the director receives only
one annual retainer. If the Boards of Directors of both companies meet on the
same day, directors receive only one meeting fee. In such event, the retainer
and meeting fees are allocated 35% to the Mutual Company and 65% to the Company.
 
     Pursuant to the 1996 Director Plan, each director of the Company and the
Mutual Company will receive annually restricted stock awards ("Restricted Stock
Awards") of 100 shares of the Company's Common Stock, provided that the director
served as a member of the Board of Directors of the Company or the Mutual
Company during any portion of the preceding calendar year, and each outside
director of the Company and the Mutual Company is eligible to receive
non-qualified stock options to purchase shares of Common Stock in an amount to
be determined by the Company's Board of Directors. In furtherance of the 1996
Director Plan, on January 2, 1997, each director of the Company and the Mutual
Company was granted a Restricted Stock Award of 100 shares of Common Stock and
each outside director of the Company and the Mutual Company was granted
non-qualified options to purchase 5,000 shares of Common Stock, subject to
adoption of the 1996 Director Plan by the Company's stockholders at the Annual
Meeting. The exercise price of each option granted under the 1996 Director Plan
was in excess of the fair market value of a share of the Company's Common Stock
on the date that the options were granted. See "Adoption of the 1996 Equity
Incentive Plan for Directors."
 
                                       8

                             EXECUTIVE COMPENSATION
 
SUMMARY COMPENSATION TABLE
 
     The following table sets forth the compensation paid by the Company and the
Mutual Company during each of the three fiscal years ended December 31, 1996 for
services rendered in all capacities to the chief executive officer of the
Company and the four other most highly compensated executive officers of the
Company whose compensation exceeded $100,000 in the fiscal year ended December
31, 1996.

                                                                                 LONG-TERM COMPENSATION
                                                                                 -----------------------
                                                                                         AWARDS
                                         ANNUAL COMPENSATION (1)                 -----------------------
                             ----------------------------------------------------  RESTRICTED  SECURITIES
NAME AND                                                          OTHER ANNUAL       STOCK     UNDERLYING        ALL OTHER
PRINCIPAL POSITION              YEAR     SALARY ($)   BONUS ($)  COMPENSATION ($)   AWARDS ($)  OPTIONS (#)  COMPENSATION ($)(3)
- ------------------           ---------  -----------  ---------  -----------------  ----------  -----------  -------------------
                                                                                       
Donald H. Nikolaus,             1996   $ 336,000   $       0      $   7,327          --              --        $  81,531(2)
  President and Chief           1995     311,000     100,369              0          --              --           85,430
  Executive Officer             1994     281,000           0              0          --              --           64,776

Ralph G. Spontak,               1996     220,000           0          2,747          --              --           44,495(2)
  Senior Vice President,        1995     204,000      57,133              0          --              --           46,205
  Chief Financial Officer       1994     184,000           0              0          --              --           34,496
  and Secretary

William H. Shupert,             1996     149,000           0              0          --              --           28,669(2)
  Senior Vice President,        1995     137,000      47,868              0          --              --           22,791
  Underwriting                  1994     122,000           0              0          --              --           19,244

Frank J. Wood                   1996     102,500           0              0          --              --           15,713(2)
  Vice President,               1995      95,000      18,530              0          --              --           13,576
  Marketing                     1994      86,500           0              0          --              --           16,424

Robert G. Shenk                 1996     118,000           0              0          --              --           13,614(2)
  Vice President,               1995     107,000      15,966              0          --              --           13,001
  Claims                        1994      96,000           0              0          --              --           12,415
 
- ------------------
(1) All compensation of officers of the Company is paid by the Mutual Company.
    Pursuant to the terms of an intercompany allocation agreement between the
    Company and the Mutual Company, the Company is charged for its proportionate
    share of all such compensation.
(2) Represents contributions made by the Company under its defined contribution
    pension plan of $14,140 for Mr. Nikolaus, $14,140 for Mr. Spontak, $14,040
    for Mr. Shupert, $10,940 for Mr. Shenk and $11,190 for Mr. Wood and
    contributions made by the Company under its profit-sharing plan of $3,163
    for Mr. Nikolaus, $3,163 for Mr. Spontak, $2,876 for Mr. Shupert, $2,244 for
    Mr. Shenk and $1,996 for Mr. Wood. In the case of Mr. Nikolaus, the total
    shown for 1996 also includes premiums paid under split-dollar life insurance
    policies of $23,276, premiums paid under a term life insurance policy of
    $2,448, directors and committee meeting fees of $20,000 and contributions
    made by the Company of $18,504 under the Company's Executive Restoration
    Plan, which is designed to restore certain retirement benefits to those
    individuals for whom contributions to the Company's pension and
    profit-sharing plans are restricted as a result of the application of
    Sections 401(a)(17) and 415 of the Internal Revenue Code. In the case of Mr.
    Spontak, the total shown for 1996 includes premiums paid under a
    split-dollar life insurance policy of $4,363, premiums paid under a term
    life insurance policy of $891, directors and committee meeting fees of
    $15,000 and contributions made by the Company of $6,938 under the Company's
    Executive Restoration Plan. In the case of Messrs. Shupert, Shenk and Wood,
    the totals shown for 1996 also include term life insurance premiums of
    $11,753, $430 and $2,527, respectively.
 
                                       9

     No options were granted by the Company during the year ended December 31,
1996 to any of the persons named in the Summary Compensation Table.
 
     The following table sets forth information with respect to options
exercised during the year ended December 31, 1996 and held on December 31, 1996
by the persons named in the Summary Compensation Table.
 
                AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
                       AND FISCAL YEAR END OPTION VALUES

                                                                                     VALUE OF UNEXERCISED
                                                          NUMBER OF SECURITIES           IN-THE-MONEY
                                                           UNDERLYING OPTIONS       OPTIONS AT FISCAL YEAR
                                SHARES                     AT FISCAL YEAR END                 END
                              ACQUIRED ON     VALUE    --------------------------  -------------------------
NAME                           EXERCISE     REALIZED   EXERCISABLE  UNEXERCISABLE  EXERCISABLE  UNEXERCISABLE
- ----                         -------------  ---------  -----------  -------------  -----------  ------------
                                                                              
Donald H. Nikolaus.........       65,000    $ 382,500          --            --     $      --    $       --
Ralph G. Spontak...........       53,000      365,700          --            --            --            --
William H. Shupert.........           --           --          --            --            --            --
Frank J. Wood..............       10,000       53,750          --            --            --            --
Robert Shenk...............       10,000       61,875          --            --            --            --

REPORT OF THE COMPENSATION COMMITTEE OF DONEGAL GROUP INC.
 
     THE FOLLOWING REPORT OF THE COMPANY'S COMPENSATION COMMITTEE AND THE
PERFORMANCE GRAPH THAT IMMEDIATELY FOLLOWS SUCH REPORT SHALL NOT BE DEEMED PROXY
SOLICITATION MATERIAL, SHALL NOT BE DEEMED FILED WITH THE SEC UNDER THE EXCHANGE
ACT OR INCORPORATED BY REFERENCE IN ANY DOCUMENT SO FILED AND SHALL NOT
OTHERWISE BE SUBJECT TO THE LIABILITIES OF SECTION 18 OF THE EXCHANGE ACT.
 
     Under rules established by the SEC, the Company is required to provide
certain information about the compensation and benefits provided to the
Company's President and Chief Executive Officer and the other executive officers
listed in the Summary Compensation Table. The disclosure requirements as to
these officers include the use of specified tables and a report of the Company's
Compensation Committee reviewing the factors that resulted in compensation
decisions affecting these officers and the Company's other executive officers.
The Compensation Committee of the Board of Directors has furnished the following
report in fulfillment of the SEC's requirements.
 
     The Compensation Committee reviews the general compensation policies of the
Company, including the compensation plans and compensation levels for executive
officers, and administers the Company's 1996 Equity Incentive Plan and the cash
incentive compensation program in which the Company's executive officers
participate. No members of the Compensation Committee are former or current
officers of the Company, or have other interlocking relationships as defined by
the SEC.
 
                                       10

     Compensation of the Company's executive officers has two principal
elements: (i) an annual portion, consisting of a base salary that is reviewed
annually and cash bonuses based on the Company's underwriting results, and 
(ii) a long-term portion, consisting of stock options. In general, the executive
compensation program of the Company has been designed to:
 
            (i) Attract and retain executive officers who contribute to the
                long-term success of the Company;
 
           (ii) Motivate key senior executive officers to achieve strategic
                business objectives and reward them for the achievement of these
                objectives; and
 
          (iii) Support a compensation policy that differentiates in
                compensation amounts based on corporate and individual
                performance and responsibilities.
 
     A major component of the Company's compensation policy, which has been
approved by the Compensation Committee, is that a significant portion of the
aggregate annual compensation of the Company's executive officers should be
based upon the Company's underwriting results as well as the contribution of the
individual officer. For a number of years, the Company has maintained a cash
incentive compensation program for the Company's executive officers. This
program provides a formula pursuant to which a fixed percentage of the Company's
underwriting results for the year is computed, as specified in the program, and
then allocated among the executive officers selected to participate in the
program for the particular year. The identity of the executive officers selected
to participate in the program for the particular year as well as their
participation in the amount determined by application of the fixed formula is
based upon recommendations submitted by the Company's senior executive officers
to the Compensation Committee. The Compensation Committee reviews those
recommendations and fixes the percentage participation of the Company's
executive officers in the program. The portion of the total compensation of the
executive officers named in the Summary Compensation Table arising from the cash
incentive compensation program formula was zero in 1996 compared to the
indicated bonuses paid in 1995 because the Company's underwriting income in 1996
was substantially less than its underwriting income in 1995 as a result of
losses caused by the severe winter storms during the first quarter of 1996. The
Compensation Committee therefore believes that the amount of the incentive
payments are tied directly to the Company's performance.
 
     The principal factors considered by the Company when it established the
cash incentive compensation program were:
 
           (i) achievement of the Company's long-term underwriting objectives;
               and
 
          (ii) the Company's long-term underwriting results compared to the
               long-term underwriting results of other property and casualty
               insurance companies.
 
     Such factors as continued cost control and reductions in the Company's
expense ratio, enhancement of the skills of the Company's workforce, the
development of opportunities to expand the geographic reach of the Company's
service area on a profitable basis and the commencement of a construction
program to increase the efficiency of the Company's operations as well as a
subjective analysis of Mr. Nikolaus' performance were considered by the
Committee in establishing the compensation of Mr. Nikolaus for 1996. Mr.
Nikolaus did not receive any award for 1996 under the Company's cash incentive
compensation program because of the losses the Company incurred in the first
quarter of 1996 as the result of severe winter weather.
 
                                       11

     The Company's executive officers participate in the Company's 1996 Equity
Incentive Plan, under which stock options are granted from time to time at the
fair market value of the Company's Common Stock on the date of grant. The
options typically vest over three years. The primary purpose of the 1996 Equity
Incentive Plan is to provide an incentive for the Company's long-term
performance. Such stock options provide an incentive for the creation of
stockholder value over the long-term because the full benefit of the options can
be realized only if the price of the Company's Common Stock appreciates over
time. No stock options were granted to the Company's executive officers under
the 1996 Equity Incentive Plan during 1996.
 
     The Compensation Committee believes the compensation of Mr. Nikolaus and
the other executive officers of the Company is reasonable in view of the
Company's performance and the contribution of those officers to that performance
in 1996, as well as the performance of the Company in 1996 compared to the
performance of other property and casualty insurance companies in 1996.
 
     Section 162(m) of the Internal Revenue Code, applicable for 1994 and
subsequent years, generally disallows a tax deduction to publicly held companies
for compensation of more than $1 million paid to the company's chief executive
officer or any executive officer named in its Summary Compensation Table.
Qualifying performance-based compensation will not be subject to the deduction
limit if certain requirements are met. The policy of the Compensation Committee
is to structure the compensation of the Company's executive officers, including
Mr. Nikolaus, to avoid the loss of the deductibility of any compensation,
although Section 162(m) will not preclude the Compensation Committee from
awarding compensation in excess of $1 million, if it should be warranted in the
future. The Company believes that Section 162(m) will not have any effect on the
deductibility of the compensation of Mr. Nikolaus and the other executive
officers named in the Summary Compensation Table for 1996.
 
                              DONEGAL GROUP INC. COMPENSATION COMMITTEE
 
                              C. Edwin Ireland
                              R. Richard Sherbahn
                              Philip H. Glatfelter, II
 
                                       12

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

                COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN*
Donegal Group, Russell 2000 Index and Value Line Insurance: Property/Casualty
                                     Index
                     (Performance Results Through 12/31/96)

                                   [GRAPHIC]

In the printed version there appears a line graph depiciting the following plot
points:

                         1991      1992      1993      1994      1995     1996
                         ----      ----      ----      ----      ----     ----
Donegal Group           $100.00   $112.07  $180.17   $157.35   $208.58   $233.51
Russell 2000 Index      $100.00   $118.41  $140.80   $138.01   $177.26   $206.48
Insurance: Prop/Cas     $100.00   $125.15  $123.81   $124.60   $165.24   $183.72

Assumes $100 invested at the close of trading 12/91 in Donegal Group Inc. Common
Stock, Russell 2000 Index and Insurance Property/Casualty.

*Cumulative total return assumes reinvestment of dividends.

                                       13

CERTAIN TRANSACTIONS
 
     Donald H. Nikolaus, President and a director of the Company and the Mutual
Company, is also a partner in the law firm of Nikolaus & Hohenadel. Such firm
has served as general counsel to the Mutual Company since 1970 and to the
Company since 1986, principally in connection with the defense of claims
litigation arising in Lancaster, Dauphin and York counties. Such firm is paid
its customary fees for such services.
 
     Patricia A. Gilmartin, a director of the Company and the Mutual Company, is
an employee of Donegal Insurance Agency, which has no affiliation with the
Company except that Donegal Insurance Agency receives insurance commissions in
the ordinary course of business from the Company's subsidiaries and affiliates
in accordance with such subsidiaries' and affiliates' standard commission
schedules and agency contracts.
 
     Frederick W. Dreher, a director of the Mutual Company, is a partner in the
law firm of Duane, Morris & Heckscher, which represents the Company in numerous
legal matters. Such firm is paid its customary fees for such services.
 
     During 1996, certain executive officers of the Company exercised options
held by them pursuant to the Company's 1986 Equity Incentive Plan and thereafter
sold the shares of the Company's Common Stock thereby acquired to the Mutual
Company. In each case, the price paid was the closing bid price of the Company's
Common Stock on May 3, 1996, three days prior to the date of the sale. From the
sale proceeds, the Mutual Company paid the exercise price of the options
exercised to the Company, made the appropriate withholding deduction for income
tax purposes and remitted the remaining balance to the selling executive
officer. Certain information concerning these transactions is as follows:

                                                                   NUMBER OF          NET
                         NAME OF SELLER                           SHARES SOLD  PROCEEDS RECEIVED
                         --------------                           -----------  -----------------
                                                                         
Donald H. Nikolaus..............................................     60,000         $331,250
Ralph G. Spontak................................................     50,000         $335,000

                                APPROVAL OF THE
                   ELECTION OF INDEPENDENT PUBLIC ACCOUNTANTS
 
     Unless instructed to the contrary, it is intended that votes will be cast
pursuant to the proxies for the election of KPMG Peat Marwick LLP as the
Company's independent public accountants for 1997. The Company has been advised
by KPMG Peat Marwick LLP that none of its members has any financial interest in
the Company. Election of KPMG Peat Marwick LLP will require the affirmative vote
of a majority of the shares of Common Stock represented in person or by proxy at
the Annual Meeting.
 
     A representative of KPMG Peat Marwick LLP will attend the Annual Meeting,
will have the opportunity to make a statement, if he desires to do so, and will
be available to respond to any appropriate questions presented by stockholders
at the Annual Meeting.
 
                                       14

                        ADOPTION OF AMENDED AND RESTATED
                           1996 EQUITY INCENTIVE PLAN
 
     The Board of Directors amended the 1996 Equity Incentive Plan and approved
an Amended and Restated 1996 Equity Incentive Plan on December 19, 1996, subject
to stockholder approval at the Annual Meeting, to: (i) increase the total number
of shares for which grants may be made to 695,850 shares, in order to make
additional shares available under the 1996 Equity Incentive Plan in the future
for officers and key employees, (ii) limit to 100,000 shares the total number of
shares of Common Stock for which stock options (the "Options") to purchase
Common Stock of the Company may be granted to any employee in any calendar year
and (iii) make other non-material changes with respect to the administration of
the 1996 Equity Incentive Plan. If the Amended and Restated 1996 Equity
Incentive Plan is not approved by the stockholders at the Annual Meeting, the
1996 Equity Incentive Plan will remain in force in its current form. However,
because the Mutual Company will vote for approval of the Amended and Restated
1996 Equity Incentive Plan, the Amended and Restated 1996 Equity Incentive Plan
will be approved regardless of the votes of the Company's stockholders other
than the Mutual Company.
 
     The purpose of the 1996 Equity Incentive Plan is to further the growth,
development and financial success of the Company, the Mutual Company and the
subsidiaries of the Company and the Mutual Company by providing additional
incentives to those officers and key employees who are responsible for the
management and affairs of the Company, the Mutual Company and the subsidiaries
of the Company and the Mutual Company, which will enable them to participate in
any increase in value of the Common Stock of the Company.
 
     The 1996 Equity Incentive Plan permits the granting of Options, including
Options intended to qualify as incentive stock options under the Internal
Revenue Code ("Incentive Stock Options") and Options not intended to so qualify
("Non-Qualified Options") to those officers and key employees of the Company,
the Mutual Company and the subsidiaries of the Company and the Mutual Company
who are in positions in which their decisions, actions and counsel significantly
impact upon the profitability and success of the Company, the Mutual Company and
the subsidiaries of the Company and the Mutual Company. Directors of the Company
who are not also officers or employees of the Company, the Mutual Company or the
subsidiaries of the Company and the Mutual Company are not eligible to
participate in the 1996 Equity Incentive Plan. Nothing contained in the 1996
Equity Incentive Plan affects the right of the Company, the Mutual Company or
any subsidiary of the Company or the Mutual Company to terminate the employment
of any employee.
 
     The total number of shares of Common Stock that may be the subject of
Options granted under the 1996 Equity Incentive Plan may not currently exceed
345,850 shares in the aggregate. As of February 1, 1997 Options for the purchase
of an aggregate of 299,500 shares were outstanding. Therefore, a total of only
46,350 shares of Common Stock are currently available for grants under the 1996
Equity Incentive Plan.
 
     The amendment will increase the number of shares currently available for
grants under the 1996 Equity Incentive Plan in furtherance of the purposes of
the plan for the next several years. No determination has been made as to the
allocation of grants with respect to the additional shares to specific
employees. The Company believes that the additional shares will be required to
satisfy anticipated annual Option grants over the next several years.
 
                                       15

     The number of persons who are eligible to participate in the 1996 Equity
Incentive Plan is approximately 345, including executive officers of the
Company, the Mutual Company and the subsidiaries of the Company and the Mutual
Company. Through February 21, 1997: (i) Non-Qualified Options to purchase an
aggregate of 167,500 shares were granted to executive officers of the Company,
which included the following: Mr. Nikolaus, 60,000 shares; Mr. Spontak, 30,000
shares; Mr. Shupert, 18,000 shares; Mr. Wood, 13,500 shares and Mr. Shenk,
13,500 shares and (ii) Incentive Stock Options to purchase an aggregate of
31,000 shares were granted to executive officers of the Company, which included
the following: Mr. Nikolaus, 15,000 shares; Mr. Spontak, 7,500 shares; Mr.
Shupert, 3,000 shares; Mr. Wood, 1,500 shares and Mr. Shenk, 15,000 shares.
 
     On March 3, 1997, the closing price of the Company's Common Stock as
reported on the Nasdaq National Market was $24.50 per share.
 
     No Options may be granted under the 1996 Equity Incentive Plan after
February 15, 2006. If an Option expires or is terminated for any reason without
having been fully exercised, the number of shares subject to such Option which
have not been purchased may again be made subject to an Option under the 1996
Equity Incentive Plan. Appropriate adjustments to outstanding Options and to the
number or kind of shares subject to the 1996 Equity Incentive Plan are provided
for in the event of a stock split, reverse stock split, stock dividend, share
combination or reclassification and certain other types of corporate
transactions involving the Company, including a merger or a sale of
substantially all of the assets of the Company. As amended, the maximum number
of shares of Common Stock for which Options may be granted under the 1996 Equity
Incentive Plan to any officer or employee in any calendar year is 100,000
shares.
 
     As amended, the 1996 Equity Incentive Plan may be administered by the Board
of Directors of the Company or a committee of two or more members, each of whom
must be a "non-employee director" within the meaning of rule 16b-3 under the
Exchange Act (the "Committee"), and is currently administered by the
Compensation Committee of the Board of Directors, consisting of Messrs. Ireland,
Sherbahn and Glatfelter. See "Election of Directors -- Meetings and Committees
of the Board." The Committee is authorized to (i) interpret the provisions of
the 1996 Equity Incentive Plan and decide all questions of fact arising in its
application; (ii) select the employees to whom Options are granted and determine
the timing, type, amount, size and terms of each such grant and (iii) to make
all other determinations necessary or advisable for the administration of the
1996 Equity Incentive Plan.
 
INCENTIVE AND NON-QUALIFIED OPTIONS
 
     The exercise price of shares subject to Options granted under the 1996
Equity Incentive Plan will be set by the Committee but may not be less than 100%
of the fair market value per share of Common Stock on the date the Option is
granted as determined by the Committee.
 
     Options will be evidenced by written agreements in such form not
inconsistent with the 1996 Equity Incentive Plan as the Committee shall approve
from time to time. Each agreement will state the period or periods of time
within which the Option may be exercised. The Committee may accelerate the
exercisability of any Option upon such circumstances and subject to such terms
and conditions as the Committee deems appropriate. Unless the Committee
accelerates exercisability, no Option that is unexercisable at the time of the
optionee's termination of employment may thereafter become exercisable. No
Option may be exercised after ten years from the date of grant.
 
                                       16

     An outstanding Non-Qualified Option that has become exercisable generally
terminates one year after the termination of employment due to death, retirement
or total disability and three months after employment termination for any reason
other than retirement, total disability or death. Incentive Stock Options that
have become exercisable generally will terminate one year after termination of
employment due to total disability or death and three months after an employment
termination for any other reason. No Option may be assigned or transferred,
except by will or by the applicable laws of descent and distribution. During the
lifetime of the optionee, an Option may be exercised only by the optionee.
 
     The Committee will determine whether Options granted are to be Incentive
Stock Options meeting the requirements of Section 422 of the Code. Incentive
Stock Options may be granted only to eligible employees. Any such optionee must
own less than 10% of the total combined voting power of the Company or of any of
its subsidiaries unless at the time such Incentive Stock Option is granted the
option price is at least 110% of the fair market value of the Common Stock
subject to the Option and, by its terms, the Incentive Stock Option is not
exercisable after the expiration of five years from the date of grant. An
optionee may not receive Incentive Stock Options for shares that first become
exercisable in any calendar year with an aggregate fair market value determined
at the date of grant in excess of $100,000.
 
     The option price must be paid in full at the time of exercise unless
otherwise determined by the Committee. Payment must be made in cash, in shares
of Common Stock valued at their then fair market value, or a combination
thereof, as determined in the discretion of the Committee. It is the policy of
the Committee that any taxes required to be withheld must also be paid at the
time of exercise. The Committee may, in its discretion, allow an optionee to
enter into an agreement with the Company's transfer agent or a brokerage firm of
national standing whereby the optionee will simultaneously exercise the Option
and sell the shares acquired thereby and either the Company's transfer agent or
the brokerage firm executing the sale will remit to the Company from the
proceeds of sale the exercise price of the shares as to which the Option has
been exercised.
 
AMENDMENT AND TERMINATION
 
     The Committee may terminate or amend the 1996 Equity Incentive Plan at any
time with respect to shares as to which Options have not been granted, subject
to any required stockholder approval or any stockholder approval that the Board
may deem to be advisable for any reason, such as for the purpose of obtaining or
retaining any statutory or regulatory benefits under tax, securities or other
laws or satisfying any applicable stock exchange listing requirements. No
modification, amendment or termination may be made to the 1996 Equity Incentive
Plan, without the consent of an optionee, if such modification, amendment or
termination will affect the rights of the optionee under an Option previously
granted.
 
FEDERAL INCOME TAX CONSEQUENCES
 
     The 1996 Equity Incentive Plan is not a qualified plan under Section 401(a)
of the Code. The following description, which is based on existing laws, sets
forth generally certain of the federal income tax consequences of the Options
under the 1996 Equity Incentive Plan. This description may differ from the
actual tax consequences of participation in the 1996 Equity Incentive Plan.
 
                                       17

     An employee receiving an Option will not recognize taxable income upon the
grant of the Option, nor will the Company be entitled to any deduction on
account of such grant. In the case of Non-Qualified Stock Options, the employee
will recognize ordinary income upon the exercise of the Non-Qualified Stock
Option in an amount equal to the difference between the option price and the
fair market value of the shares on the date of exercise. When the employee
disposes of the shares acquired upon exercise of the Option, the employee will
generally recognize capital gain or loss equal to the difference between (i) the
selling price of the shares and (ii) the sum of the option price and the amount
included in his or her income when the Option was exercised. Such gain will be
long-term or short-term depending upon whether the shares were held for at least
one year after the date of exercise.
 
     Incentive Stock Options granted under the 1996 Equity Incentive Plan are
intended to qualify as incentive stock options under Section 422 of the Code. A
purchase of shares upon exercise of an Incentive Stock Option will not result in
recognition of income at that time. However, the excess of the fair market value
of the shares purchased over the exercise price will constitute an item of tax
preference. This tax preference will be included in the employee's computation
of the employee's alternative minimum tax.
 
     If the optionee does not dispose of the shares issued to the optionee upon
the exercise of an Incentive Stock Option within one year of such issuance or
within two years from the date of the grant of such Option, whichever is later,
then any gain or loss realized by the optionee on a later sale or exchange of
such shares generally will be a long-term capital gain or a long-term capital
loss. If the optionee sells the shares during such period, the sale will be
deemed a "disqualifying disposition." In that event, the optionee will recognize
ordinary income for the year in which the disqualifying disposition occurs equal
to the amount, if any, by which the lesser of the fair market value of such
shares on the date of exercise of such Option or the amount realized from the
sale exceeded the amount the optionee paid for such shares. Any additional gain
realized generally will be capital gain, which will be long-term or short-term
depending on the holding period for the shares. If the optionee disposes of the
shares by gift during such period, the transfer will be treated as a
disqualifying disposition subject to the rules described herein.
 
     If the purchase price upon exercise of an Option is paid with shares
already owned by the optionee, generally no gain or loss will be recognized with
respect to the shares used for payment and the additional shares received will
be taxed as described herein. However, if payment of the purchase price upon
exercise of an Incentive Stock Option is made with shares acquired upon exercise
of an Incentive Stock Option before the shares used for payment have been held
for the two-year or one-year period described herein, use of such shares as
payment will be deemed a "disqualifying disposition" of the shares used for
payment subject to the rules described herein.
 
     Under current law, any gain realized by an optionee, other than long-term
capital gain, is taxable at a maximum federal income tax rate of 39.6%.
Long-term capital gain is taxable at a maximum federal income tax rate of 28%.
 
     The Company will be entitled to a tax deduction in connection with an
Option under the 1996 Equity Incentive Plan in an amount equal to the ordinary
income realized by the optionee and at the time such optionee recognizes such
income. The federal, state and local income tax consequences to any particular
taxpayer will depend upon the taxpayer's individual circumstances. In addition,
various tax legislative proposals are introduced in the Congress from time to
time, and it is not possible to predict which of the various proposals
introduced will be enacted into law, the form in which they
 
                                       18

finally may be enacted, the effective dates thereof or the effect on the tax
consequences of participation in the 1996 Equity Incentive Plan.
 
VOTE REQUIRED
 
     Adoption of the Amended and Restated 1996 Equity Incentive Plan will
require the affirmative vote of the holders of a majority of the outstanding
shares of the Company's Common Stock present in person or represented by proxy
at the Annual Meeting and entitled to vote. Abstentions are considered shares of
stock present in person or represented by proxy at the meeting and entitled to
vote and are counted in determining the number of votes necessary for a
majority. An abstention therefore will have the practical effect of voting
against adoption of the Amended and Restated 1996 Equity Incentive Plan because
it represents one fewer vote for adoption of the Amended and Restated 1996
Equity Incentive Plan. Broker non-votes are not considered shares present in
person or represented by proxy and entitled to vote on the Amended and Restated
1996 Equity Incentive Plan and will have no effect on the vote. The Board of
Directors recommends that the stockholders vote FOR the adoption of the Amended
and Restated 1996 Equity Incentive Plan.
 
                                ADOPTION OF THE
                    1996 EQUITY INCENTIVE PLAN FOR DIRECTORS
 
DESCRIPTION OF THE 1996 DIRECTOR PLAN
 
     The Board of Directors of the Company (the "Board") adopted the 1996
Director Plan on December 19, 1996, subject to stockholder approval at the
Annual Meeting. The purpose of the 1996 Director Plan is to enhance the ability
of the Company and the Mutual Company to attract and retain highly qualified
directors, to compensate them for their services to the Company and the Mutual
Company, as the case may be, and, in so doing, to strengthen the alignment of
the interests of the directors with the interests of the stockholders by
ensuring ongoing ownership of the Company's Common Stock.
 
     The 1996 Director Plan provides for: (i) the grant of non-qualified options
("Director Options") to outside directors (an "Outside Director") of the Company
and the Mutual Company and (ii) an annual grant to each director of the Company
and the Mutual Company (a "Director") of a restricted stock award (a "Restricted
Stock Award") of 100 shares of Common Stock to be issued on the first business
day of January in each year, commencing January 2, 1997, provided that the
Director served as a member of the Board or the Board of Directors of the Mutual
Company during any portion of the prior year. Director Options and Restricted
Stock Awards collectively are hereinafter referred to as "Stock Rights."
Restricted Stock Awards are made automatically, and no action by the Board or
the Board of Directors of the Mutual Company will be required. The number of
shares of Common Stock that may be the subject of grants under the 1996 Director
Plan may not exceed 90,000 shares in the aggregate.
 
     The number of persons who are eligible to participate in the 1996 Director
Plan is currently 12, consisting of directors of the Company and the Mutual
Company. As of March 1, 1997, Director Options to purchase 45,000 shares of
Common Stock, in the aggregate, have been granted to Outside Directors and
Restricted Stock Awards of 1,200 shares, in the aggregate, have been granted to
the Directors under the 1996 Director Plan. The issuance of Stock Rights is
subject to approval of the 1996 Director Plan by the stockholders of the Company
at the Annual Meeting.
 
                                       19

     Appropriate adjustments to outstanding Options and to the number or kind of
shares subject to the 1996 Director Plan are provided for in the event of a
stock split, reverse stock split, stock dividend, share combination or
reclassification and certain other types of corporate transactions involving the
Company, including a merger or a sale of substantially all of the assets of the
Company.
 
     The 1996 Director Plan is administered by the Board. The Board has the
power to interpret the 1996 Director Plan, the Director Options and the
Restricted Stock Awards, and, subject to the terms of the 1996 Director Plan, to
determine who will be granted Director Options, the number of Director Options
to be granted to any Outside Director, the timing of such grant and the terms of
exercise. The Board also has the power to adopt rules for the administration,
interpretation and application of the 1996 Director Plan. The Board does not
have any discretion to determine who will be granted Restricted Stock Awards
under the 1996 Director Plan, to determine the number of Restricted Stock Awards
to be granted to each Director or to determine the timing of such grants.
 
RESTRICTED STOCK AWARDS
 
     Restricted Stock Awards consist of shares of Common Stock that are issued
in the name of the Director but that may not be sold or otherwise transferred by
the grantee until one year after the date of grant. Upon the issuance of shares
under a Restricted Stock Award, the Director will have all rights of a
stockholder with respect to the shares, except that such shares may not be sold,
transferred or otherwise disposed of until one year after the date of grant.
 
     Restricted Stock Awards will be evidenced by written agreements in such
form not inconsistent with the 1996 Director Plan as the Board shall approve
from time to time. Each agreement shall contain such restrictions, terms and
conditions as are required by the 1996 Director Plan. Although the Common Stock
comprising each Restricted Stock Award will be registered in the name of the
grantee, a restrictive legend shall be placed on the stock certificate.
 
NON-QUALIFIED STOCK OPTIONS
 
     The exercise price of Director Options granted under the 1996 Director Plan
will be set by the Board and may not be less than 100% of the fair market value
per share of the Common Stock on the date that the Director Option is granted.
 
     Director Options will be evidenced by written agreements in such form not
inconsistent with the 1996 Director Plan as the Board shall approve from time to
time. Each agreement will state the period or periods of time within which the
Director Option may be exercised. The Board may accelerate the exercisability of
any Director Options upon such circumstances and subject to such terms and
conditions as the Board deems appropriate. Unless the Board accelerates
exercisability, no Director Option that is unexercisable at the time of the
optionee's termination of service as a Director may thereafter become
exercisable. No Director Option may be exercised after ten years from the date
of grant. If a Director Option expires or is canceled for any reason without
having been fully exercised or vested, the number of shares subject to such
Director Option that had not been purchased or become vested may again be made
subject to a Director Option under the 1996 Director Plan.
 
     The option price must be paid in full at the time of exercise unless
otherwise determined by the Board. Payment must be made in cash, in shares of
Common Stock valued at their then fair market value, or a combination thereof,
as determined in the discretion of the Board. It is the policy of the Board that
any taxes required to be withheld must also be paid at the time of exercise. The
Board may,
 
                                       20

in its discretion, allow an optionee to enter into an agreement with the
Company's transfer agent or a brokerage firm of national standing whereby the
optionee will simultaneously exercise the Director Option and sell the shares
acquired thereby and either the Company's transfer agent or the brokerage firm
executing the sale will remit to the Company from the proceeds of sale the
exercise price of the shares as to which the Director Option has been exercised
as well as the required amount of withholding.
 
     An outstanding Director Option that has become exercisable generally
terminates one year after termination of a Director's service as a Director due
to death and three months after termination of a Director's service as a
Director for any reason other than death. A Director Option granted under the
1996 Director Plan may be exercised during the lifetime of the optionee only by
the optionee.
 
AMENDMENT OR TERMINATION
 
     The 1996 Director Plan will remain in effect until all Director Options
granted under the 1996 Director Plan have been satisfied by the issuance of
shares, except that no Stock Rights may be granted under the 1996 Director Plan
after December 19, 2006. The Board may terminate, modify, suspend or amend the
1996 Director Plan at any time, subject to any required stockholder approval or
any stockholder approval that the Board may deem to be advisable for any reason,
such as for the purpose of obtaining or retaining any statutory or regulatory
benefits under tax, securities or other laws or satisfying any applicable stock
exchange listing requirements. No modification, amendment or termination to the
1996 Director Plan will alter or impair any rights or obligations under any
outstanding Stock Right without the consent of the optionee or grantee, as the
case may be. No Stock Right may be granted during any period of suspension nor
after termination of the 1996 Director Plan.
 
FEDERAL INCOME TAX CONSEQUENCES
 
     The 1996 Director Plan is not a qualified plan under Section 401(a) of the
Code. The following description, which is based on existing laws, sets forth
generally certain of the federal income tax consequences of Stock Rights granted
under the 1996 Director Plan. This description may differ from the actual tax
consequences of participation in the 1996 Director Plan.
 
     An optionee will not recognize income for federal income tax purposes upon
the receipt of a Director Option, nor will the Company be entitled to any
deduction on account of such grant. Such optionee will recognize ordinary
taxable income for federal income tax purposes at the time of exercise in the
amount by which the fair market value of such shares then exceeds the option
price. When the optionee disposes of the shares acquired upon exercise of the
Director Option, the optionee will generally recognize capital gain or loss
equal to the difference between (i) the amount received upon disposition of the
shares, and (ii) the sum of the option price and the amount included in the
optionee's income when the Director Option was exercised. Such gain will be
long-term or short-term depending upon whether the shares were held for at least
one year after the date of exercise.
 
                                       21

     A grantee of shares of restricted stock pursuant to a Restricted Stock
Award will recognize ordinary income for federal income tax purposes in the year
of receipt, measured by the value of the shares received determined without
regard to the transfer restriction or other restrictions relating to such issue.
Any gain or loss recognized upon the sale of the shares will generally be
treated as capital gain or loss and will be long-term or short-term depending
upon the holding period of the shares.
 
     Under current law, any gain realized by a optionee or a grantee, as the
case may be, other than long-term capital gain is taxable at a maximum federal
income tax rate of 39.6%. Long-term capital gain is taxable at a maximum federal
income tax rate of 28%.
 
     The Company will be entitled to a tax deduction in connection with Stock
Rights under the 1996 Director Plan in an amount equal to the ordinary income
realized by the optionee or grantee, as the case may be, and at the time he or
she recognizes such income.
 
VOTE REQUIRED
 
     Adoption of the 1996 Director Plan will require the affirmative vote of the
holders of a majority of the outstanding shares of the Company's Common Stock
present in person or represented by proxy at the Annual Meeting and entitled to
vote. Abstentions are considered shares of stock present in person or
represented by proxy at the meeting and entitled to vote and are counted in
determining the number of votes necessary for a majority. An abstention will
therefore have the practical effect of voting against adoption of the 1996
Director Plan because it represents one fewer vote for adoption of the 1996
Director Plan. Broker non-votes are not considered shares present in person or
represented by proxy and entitled to vote on the 1996 Director Plan and will
have no effect on the vote. The Board of Directors recommends that the
stockholders vote FOR the adoption of the 1996 Director Plan.
 
                                 ANNUAL REPORT
 
     A copy of the Company's Annual Report for 1996 is being mailed to the
Company's stockholders with this Proxy Statement.
 
                             STOCKHOLDER PROPOSALS
 
     Any stockholder who, in accordance with and subject to the provisions of
the proxy rules of the SEC, wishes to submit a proposal for inclusion in the
Company's proxy statement for its 1998 Annual Meeting of Stockholders must
deliver such proposal in writing to the Company's Secretary at the Company's
principal executive offices at 1195 River Road, Marietta, Pennsylvania 17547,
not later than November 24, 1997.
 
                                       22

                                OTHER PROPOSALS
 
     The Board of Directors does not know of any matters to be presented for
consideration at the Annual Meeting other than the matters described in the
Notice of Annual Meeting, but if any matters are properly presented, it is the
intention of the persons named in the accompanying proxy to vote on such matters
in accordance with their judgment.
 
                                          By Order of the Board of Directors,
 
                                          /s/ Donald H. Nikolaus
                                          --------------------------------------
                                          Donald H. Nikolaus,
                                          President and Chief Executive Officer
 
March 24, 1997
 
                                       23

             Independent Auditors' Consent and Report on Schedules

The Board of Directors
Donegal Group Inc.:

The audits referred to in our report dated March 3, 1997, included the related
financial statement schedules as of December 31, 1996, and for each of the years
in the three-year period ended December 31, 1996, incorporated by reference in
Form 10-K. These financial statement schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statement schedules based on our audits. In our opinion, such
financial statement schedules, when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly in all
material respects the information set forth therein.

We consent to the use of our reports incorporated by reference in the
registration statements (Nos. 333-06681, 33-85128 and 33-31287) on Form S-8 of
Donegal Group Inc.

                                                  KPMG PEAT MARWICK LLP

Harrisburg, Pennsylvania
March 27, 1997

         7

                   YEAR
               DEC-31-1996
                    DEC-31-1996
                                  49,588,543
                                111,581,162
                                  113,461,217
                                             3,134,198
                                                     0
                                                  0
                                       185,511,406
                                                 2,912,122
                                             0
                                 7,837,899
                                       273,128,543
                                      110,022,886
                                   66,184,188
                                                 0
                                          0
                                        8,500,000
                                          0
                                                    0
                                               4,540,569
                                            76,736,802
                         273,128,543
                                            99,982,042
                                   10,316,468
                                       172,734
                                         2,047,787
                                            66,611,233
                           17,032,000
                                  14,174,023
                                       11,246,460
                                           2,350,347
                                    8,896,113
                                                 0
                                                0
                                                      0
                                           8,896,113
                                                201
                                                201
                                        70,040,745
                                   69,206,233
                                     (2,595,000)
                                    39,988,258
                                      22,889,000
                                       73,774,720
                               (2,595,000)