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WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 [Fee Required] for the fiscal year ended
December 31, 2002, or
[ ] Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 [No Fee Required] for the transition period
from ________ to _________.
Commission file number: 001-16533
ProAssurance Corporation
-------------------------
(Exact name of registrant as specified in its charter)
Delaware 63-1261433
- --------------------------- -----------------------------------
(State of incorporation (I.R.S. Employer Identification No.)
or organization)
100 Brookwood Place, Birmingham, AL 35209
----------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(205) 877-4400
- -------------------------------------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class On Which Registered
------------------- -----------------------
Common Stock, par value $0.01 per share New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None.
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. [ ]
The aggregate market value of voting stock held by non-affiliates of the
registrant at March 19, 2003 was $672,619,509.
As of March 19, 2003, the registrant had outstanding approximately 28,880,185
shares of its common stock.
Exhibit Index at page 104
Page 1 of 106 pages
Documents incorporated by reference in this Form 10-K:
(i) The definitive proxy statement for the 2003 Annual Meeting of
the Stockholders of ProAssurance Corporation (Commission File
No. 001-16533) is incorporated by reference into Part III of
this report.
(ii) The Registration Statement on Form S-4 with respect to the
Common Stock of ProAssurance Corporation (Commission File No.
333-49378) is incorporated by reference into Part IV of this
report.
(iii) The ProAssurance Corporation Form 8-K/A for event occurring
May 10, 2001 (Commission File No. 001-12129) is incorporated
by reference into Part IV of this report.
(iv) Registration Statement on Form S-4 with respect to the Common
Stock of MAIC Holdings, Inc. (Commission File No. 33-91508) is
incorporated by reference into Part IV of this report.
(v) The MAIC Holdings, Inc. Definitive Proxy Statement for the
1996 Annual Meeting (Commission File No. 0-19439) is
incorporated by reference into Part IV of this report.
(vi) The Registration Statement on Form S-4 with respect to the
Common Stock of Professionals Group, Inc. (Commission File No.
333-3138) is incorporated by reference into Part IV of this
report.
(vii) The Registration Statement on Form S-4 with respect to the
Common Stock of MEEMIC Holdings, Inc. (Commission File No.
333-66671) is incorporated by reference into Part IV of this
report.
(viii) The ProAssurance Corporation Quarterly Report on Form 10-Q for
the quarter ended June 30, 2001 (Commission File No.
001-16533) is incorporated by reference into Part IV of this
report.
(ix) The ProAssurance Corporation Quarterly Report on Form 10-Q for
the quarter ended September 30, 2001 (Commission File No.
001-16533) is incorporated by reference into Part IV of this
report.
(x) The ProAssurance Corporation Annual Report on Form 10-K for
the year ended December 31, 2001 (Commission File No.
001-16533) is incorporated by reference into Part IV of this
report.
(xi) The ProAssurance Corporation Quarterly Report on Form 10-Q for
the quarter ended June 30, 2002 (Commission File No.
001-16533) is incorporated by reference into Part IV of this
report.
(xii) The Registration Statement on Form S-3 with respect to the
Common Stock of ProAssurance Corporation (Commission File No.
333-100526) is incorporated by reference into Part IV of this
report.
2
PART I
ITEM 1. BUSINESS
GENERAL
We are a holding company for specialty property and casualty insurance
companies focused on the professional liability and the personal lines insurance
markets. Our executive offices are located at 100 Brookwood Place, Birmingham,
Alabama 35209. Our telephone number is (205) 877-4400 and our website is
www.ProAssurance.com. Our stock trades on the New York Stock Exchange under the
symbol "PRA."
We have a regional orientation, applying a focused underwriting
strategy to local markets where we have built a strong reputation among our
customers and producers. Our professional liability business is concentrated in
the southeast and midwest and serves physicians, dentists, other healthcare
providers and healthcare facilities. We believe we are the third largest active
writer of medical professional liability insurance in the United States. Our
personal lines segment is solely in Michigan, focusing on educators and their
families. We believe we are the tenth largest writer of personal automobile
insurance in Michigan.
By concentrating on specialty markets where customers have specialized
needs, we seek to provide value added solutions through our underwriting
expertise and our emphasis on strong customer service. Our regional presence
allows us to maintain active relationships with our customers and be more
responsive to their needs. We seek to maintain a strong financial position to
protect our customers. We believe these factors have allowed us to establish a
leading position in our markets, enabling us to compete on a basis other than
just price.
For the year ended December 31, 2002, we generated $636.2 million of
gross premiums written, $477.4 million of net premiums earned and $555.8 million
of total revenues. As of December 31, 2002, we had cash and invested assets of
$1.8 billion, total assets of $2.6 billion and stockholders' equity of $505.2
million. At December 31, 2002 our cash and invested assets totaled $63.12 per
outstanding share.
CORPORATE ORGANIZATION AND HISTORY
We were incorporated in Delaware to serve as the holding company for
Medical Assurance in connection with its acquisition of Professionals Group in
June 2001. Our principal operating subsidiaries are The Medical Assurance
Company, Inc., ProNational Insurance Company, Medical Assurance of West
Virginia, Inc., Red Mountain Casualty Insurance Company, Inc., and MEEMIC
Insurance Company. Our financial statements and other financial information
include Professionals Group only from the date of acquisition in compliance
with purchase accounting rules.
We are the successor to 11 insurance organizations. Our predecessor
company, Medical Assurance, was founded by physicians as a mutual company in
Alabama and began in 1977. We demutualized and became a public company in 1991.
Medical Assurance expanded through internal growth and the acquisition of
professional liability insurance companies with strong regional identities in
West Virginia, Indiana and Missouri, along with books of business in Ohio and
Missouri.
Professionals Group traces its roots to the Brown-McNeeley Fund, which
was founded by the State of Michigan in 1975 to provide medical professional
liability insurance to physicians. Physicians Insurance Company of Michigan,
which ultimately became ProNational, was founded in 1980 to assume the business
of the Fund. That company also expanded through internal growth and the
acquisition of books of business in Illinois and Indiana and the acquisition of
a professional liability insurer in Florida.
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MEEMIC Insurance was founded as a mutual company by Michigan teachers
and has provided personal lines insurance to the education community in that
state since 1950. Professionals Group became affiliated with MEEMIC in 1997 and
acquired majority ownership of MEEMIC Holdings, Inc. (MEEMIC Holdings) in 1999.
In each acquisition we retained key personnel, allowing us to maintain
a local presence and preserve important institutional knowledge in claims
management and underwriting. Our successful integration of each organization
demonstrates our ability to grow effectively through acquisitions.
SEGMENT OVERVIEW
We conduct our business through two operating segments, each of which
maintains a strong position in its local markets:
- Our professional liability segment, which represents our
commercial lines business, primarily focuses on providing
medical professional liability insurance. We provide
protection against claims arising out of the death, injury or
disablement of a person resulting from a negligent deviation
from the standard of care by physicians and other healthcare
professionals.
- Our personal lines segment offers personal automobile, and to
a lesser extent, homeowners, boat and umbrella insurance
primarily to teachers, administrators, professors and other
members of the educational community and their families in
Michigan. Personal lines insurance provides policyholders with
protection against claims resulting from bodily injury and
property damage liability and physical damage to property.
The following table illustrates our gross premiums written for our two
primary segments for each of the periods indicated:
Year Ended December 31
2002 2001 2000
---------------------- ---------------------- ----------------------
$ % $ % $ %
--------- ----- --------- ----- --------- -----
Professional liability $ 461,715 73% $ 315,698 81% $ 223,871 100%
Personal lines 174,441 27% 73,285 19% -- --
--------- ----- --------- ----- --------- -----
Total $ 636,156 100% $ 388,983 100% $ 223,871 100%
========= ===== ========= ===== ========= =====
4
Professional Liability Segment:
In our professional liability segment, our top five states represented
73% of gross premiums written for the year ended December 31, 2002. The
following table displays the distribution of our gross premiums written in
states that represent 6% or more of our business in the professional liability
segment.
Year Ended December 31
2002 2001 2000
------------------ ------------------ ------------------
$ % $ % $ %
------- --- ------- --- ------- ---
Ohio 91,571 20% 51,520 16% 30,357 14%
Alabama 83,818 18% 74,917 24% 66,123 30%
Florida 71,366 15% 29,519 9% 7,636 3%
Michigan 52,203 11% 22,404 7% -- --
Indiana 41,925 9% 25,130 8% 13,667 6%
All other states 120,832 27% 112,208 36% 106,088 47%
------- --- ------- --- ------- ---
Total 461,715 100% 315,698 100% 223,871 100%
======= === ======= === ======= ===
For the year ended December 31, 2002, our professional liability
segment produced a combined ratio of 125%. The combined ratio is the sum of the
underwriting expense ratio (the ratio of underwriting expenses to earned
premiums) and net loss ratio (the ratio of losses and loss adjustment expenses
to earned premiums).
A combined ratio below 100% generally indicates profitable underwriting
prior to the consideration of investment income. However, if investment income
is considered, companies writing professional liability insurance may be
profitable with combined ratios above 100%. This is due to the "long tail"
nature of this line of business.
The term "long-tail" refers to the long period of time between
collecting the premium for insuring a risk and the ultimate payment of losses,
often exceeding five years. This "long tail" allows us to invest the premiums we
collect until we pay losses, which results in a higher level of invested assets
and investment income as compared to other lines of property and casualty
business.
The combined ratio may not always be indicative of our ultimate results
because of the "long tail" nature of the professional liability business.
We also measure our results by calculating our operating ratio, which
is the combined ratio offset by the benefit of investment income generated from
our cash and invested assets, also expressed as a percentage of net premiums
earned. For the year ended December 31, 2002 our professional liability segment
produced an operating ratio of 104%. A ratio below 100% indicates profitability.
Personal Lines Segment:
Business in our personal lines segment is currently confined to
Michigan. The following table displays gross premiums written in this segment.
Years Ended December 31
2002 2001 2000
------------------- ------------------- ----------------
$ % $ % $ %
-------- --- -------- --- ----- -----
Personal lines 174,441 100% 73,285 100% - --
-------- --- -------- --- ----- -----
Total $174,441 100% $ 73,285 100% $ -- --
======== === ======== === ===== =====
5
Personal lines insurance is generally referred to as "short tail", due
to shorter time periods between insuring the risk and the ultimate payment of
claims. As a result, there is less time to invest premiums collected, which
makes it necessary to achieve an underwriting profit in order to generate a
satisfactory return on equity. For the year ended December 31, 2002, MEEMIC
reported a combined ratio of 88%.
RECENT EVENTS
Purchase of Minority Shares of MEEMIC:
On January 29, 2003 MEEMIC Holdings, the parent company of MEEMIC
Insurance Company, purchased all of the issued and outstanding shares of its
common stock, other than those held by ProAssurance's subsidiary, ProNational
Insurance Company (ProNational). MEEMIC Holdings used its internal funds in the
approximate amount of $34.1 million to acquire all of the 1,062,298 shares of
its common stock not owned by ProNational, to pay for outstanding options for
120,000 shares, and to pay the expenses of the transaction. The funds were
derived from MEEMIC Holdings' cash and investment resources.
As a result of the transaction, MEEMIC Holdings was delisted from the
NASDAQ stock market, and MEEMIC Insurance Company became a wholly-owned
subsidiary of ProNational.
Follow-On Public Offering:
In the fourth quarter of 2002 ProAssurance sold 3,025,000 shares of
common stock at a price of $16.55 per share in an underwritten public offering.
ProAssurance received net proceeds from the offering in the amount of
approximately $46.5 million. ProAssurance is using the proceeds from the
offering to support the growth of the professional liability insurance business
and for general corporate purposes.
MANAGEMENT
Our senior management team is led by A. Derrill Crowe, M.D., our
Chairman and Chief Executive Officer, and Victor T. Adamo, Esq., our President
and Chief Operating Officer. Dr. Crowe has acted as the Chief Executive Officer
of Medical Assurance since its founding in 1977. He has applied a hands-on
management style in developing our underwriting and claims strategies and was
instrumental in establishing us as a leading professional liability specialist.
Mr. Adamo has held various positions with Professionals Group since 1985,
becoming its CEO in 1987 and being named President in 1989. He is largely
responsible for building Professionals Group into a successful regional
professional liability company.
Dr. Crowe practiced medicine as his principal occupation for more than
25 years and Mr. Adamo was in the private practice of law for 10 years,
providing them with knowledge of medical and legal issues that are critical to
our insurance operations. We also have a knowledgeable and experienced
management team with established track records in building and managing
successful insurance operations. In total, our senior management team has
average experience in the insurance industry of 22 years.
CORPORATE STRATEGY
Our objective is to build value for our stockholders through superior
underwriting of classes of business in which we have a comprehensive
understanding and which offer us the opportunity to generate competitive returns
on capital. We target a return on equity of 12% to 14% over the long term. Over
the five years ending December 31, 2002, however, we achieved an average return
on equity of 8.3%, with a high of 15.0% in 1998 and a low of 2.1% in 2002. The
major elements of our strategy are:
6
Adhere to a Strict Underwriting Philosophy:
We emphasize disciplined underwriting and do not manage our business to
achieve a certain level of premium growth or market share. In our professional
liability business, we apply our local knowledge to individual risk selection,
and determine the appropriate price based on our assessment of the specific
characteristics of each risk. In our personal lines business, we target the
educational community, which we believe provides a preferred, stable and
predictable group of risks.
Aggressively Manage Policyholder Claims:
In addition to prudent risk selection, we seek to control our
underwriting results through effective claims management. We investigate each
professional liability claim and have fostered a strong culture of aggressively
defending those claims that we believe have no merit. We manage these claims at
the local level, tailoring claims handling to the legal climate of each state,
which we believe differentiates us from national writers. In our personal lines
business, we seek to quickly and efficiently settle claims through an
established network of auto repair shops and other repair facilities, focusing
on minimizing the cost of handling each claim.
Operate Through Regional Offices in Local Markets:
By concentrating on specialty markets where customers have specialized
needs, we seek to provide value added solutions through our underwriting
expertise and our emphasis on strong customer service. Through our regional
underwriting and claims office structure, we are able to gain a strong
understanding of local market conditions and efficiently adapt our underwriting
and claims strategies to regional conditions. Our regional presence also allows
us to maintain active relationships with our customers and be more responsive to
their needs. We believe these factors have allowed us to establish a leading
position in our markets, enabling us to compete on a basis other than just
price.
Expand Our Position in Regional Markets:
Our goal is to build upon our position as a leading writer of
professional liability and personal lines insurance and expand within a defined
geographic area, while maintaining our commitment to disciplined underwriting
and aggressive claims management. We believe we are the third largest active
medical liability insurance writer in the nation, and we believe we are the
largest medical liability writer in our states of operation. The withdrawal and
reduced capacity of several competitors in the medical professional liability
market has provided new business opportunities. We believe that our strong
reputation in our regional markets, combined with our financial strength, strong
customer service and proven ability to manage claims, should enable us to
profitably expand our position in select states. In our personal lines business,
we estimate that we currently insure approximately 23% of educational
professionals in Michigan. We expect to increase our penetration of the
educational community by appointing additional agents and broadening our
existing relationships with educational institutions and their employees.
Pursue Consolidating Acquisitions:
We have successfully acquired and integrated companies and books of
business in the past and believe our financial size and strength make us an
attractive acquirer. We continually evaluate opportunities to acquire
professional liability companies or books of business that leverage our core
underwriting and claims expertise.
7
Maintain Our Financial Strength and Security:
We have sustained our financial stability during difficult market
conditions through responsible pricing and loss reserving practices. We are
committed to maintaining prudent operating and financial leverage and
conservatively investing our assets. We recognize the importance of our "A-"
(Excellent) A.M. Best rating to our customers and producers and intend to manage
our business to protect our financial security.
PRODUCTS AND SERVICES
Professional Liability Segment:
We offer professional liability insurance for providers of medical and
other healthcare services. Although we generate a majority of our premiums from
individual and small group practices, we also insure several major physician
groups as well as several hospitals. We also offer professional liability
insurance for providers of legal services, and we offer professional office
package and workers' compensation insurance products, primarily in connection
with our professional liability products. We believe our size, financial
strength and flexibility of distribution differentiates us from our competitors.
The following table illustrates the distribution of our gross premiums written
of our professional liability segment by type of coverage for the periods
indicated.
Years ended December 31
2002 2001 2000
--------------------- --------------------- ---------------------
$ % $ % $ %
--------- ---- --------- ---- --------- ----
Professional Liability--
Physicians & Dentists $ 410,560 89% $ 228,139 72% $ 161,113 72%
Professional Liability--Other (1) 37,576 8% 39,080 12% 18,175 8%
--------- ---- --------- ---- --------- ----
Total Medical Professional Liability 448,136 97% 267,219 84% 179,288 80%
Professional Liability--Legal 5,968 1% 2,134 1% -- --
Other Commercial Lines (2) 7,611 2% 46,345 15% 44,583 20%
--------- ---- --------- ---- --------- ----
Total Commercial Liability 13,579 3% 48,479 16% 44,583 20%
--------- ---- --------- ---- --------- ----
Professional Liability total $ 461,715 100% $ 315,698 100% $ 223,871 100%
========= ==== ========= ==== ========= ====
(1) Primarily includes miscellaneous healthcare providers, hospitals and
other health care facilities.
(2) Primarily includes workers' compensation and commercial multi-peril
coverages.
There are two predominant types of professional liability insurance
policies, occurrence and claims-made. Occurrence coverage provides permanent
insurance protection against claims arising from incidents that occur during the
policy period, regardless of when these claims may be reported. Due to the
long-tail nature of our business, it may be many years before we become aware of
claims under occurrence policies. Claims-made coverage provides protection
against only those claims reported during the policy period, resulting from
incidents that occurred while continuously insured on a claims-made basis.
Therefore, most claims are known, although not resolved, at the end of the
policy period. This allows us to estimate our loss reserves for claims-made
coverage with more certainty. The basic claims-made policy does not provide
protection against claims which are reported after the policy period ends; the
insured must either continue to renew the claims-made policy or purchase
extended reporting coverage in order to have permanent protection. In the event
of death, disability or qualified retirement, most insureds receive extended
reporting coverage as part of the policy terms. Approximately 86% of our direct
premiums written for the year ended December 31, 2002 were for claims-made
policies.
8
We previously offered accident and health and workers' compensation
insurance and reinsurance through various programs to entities and individuals
other than healthcare providers. We ceased our marketing of these programs in
order to focus on our core professional liability products. We began terminating
these programs in 2000 and substantially completed our withdrawal from this
business in 2002.
In October 2002, we started offering professional liability insurance
to medical and other healthcare professionals who generally do not qualify for
standard coverage because of their claim history or other factors. We write this
business on an excess and surplus lines basis, which provides us with greater
flexibility in establishing prices and terms of coverage. While we do not expect
this class of insured to become a major portion of our business, we believe this
provides profitable opportunities to expand our business. In 2002 this line of
business produced $3.0 million in premiums. This business is written primarily
through our subsidiary Red Mountain Casualty Insurance Company, Inc.
Personal Lines Segment:
Our personal lines business is written through our subsidiary, MEEMIC,
which primarily serves educational employees and their families in Michigan.
Private passenger automobile insurance is our primary line of business. To
provide for the other insurance needs of our auto customers, we also offer
homeowners, boat and umbrella policies. The following table illustrates our
gross premiums written for each of our personal lines classes of business for
each of the periods indicated.
Years Ended December 31
2002 2001 (1)
--------------------- ---------------------
$ % $ %
--------- ---- --------- ----
Personal Automobile $ 147,168 84% $ 62,422 85%
Homeowners 26,600 16% 10,637 15%
Boat (2) 497 * 163 *
Umbrella (2) 176 * 63 *
--------- ---- --------- ----
Total $ 174,441 100% $ 73,285 100%
========= ==== ========= ====
(1) The year ended December 31, 2001 includes gross premiums written since
June 27, 2001, the date of consolidation of Professionals Group and
Medical Assurance.
(2) Less than 1%
MARKETING
Professional Liability Segment:
We primarily write insurance in the southeast and midwest and are
licensed to do business in every state but Connecticut, Maine, New Hampshire,
New York and Vermont. Based on gross premiums written in 2002, Ohio, Alabama,
Florida, Michigan, and Indiana represented our five largest states.
We utilize direct marketing and independent agents to write business.
In Alabama, we rely solely on direct marketing, and in Florida and Missouri,
direct marketing accounts for a majority of our business. We use independent
agents to market our professional liability insurance products in other markets.
For the year ended December 31, 2002, we estimate that approximately 60% of our
gross professional liability premiums written were produced through independent
insurance agencies. These local agencies usually have one to three producers who
specialize in professional liability insurance and who we believe are able to
convey the factors that differentiate our professional liability insurance
product. No single agent or agency accounts for more than 10% of our total
direct premiums written.
9
We focus our marketing efforts on sole practitioners and small groups
of physicians. We generally do not target large groups or facilities because of
the difficulty in underwriting the individual risks and because their purchasing
decision is usually based primarily on price. Our marketing efforts
differentiate our professional liability insurance products by emphasizing
claims service and the other services and communications we provide to our
customers including:
- the sponsorship of risk management education seminars as an
accredited provider of continuing medical education.
- risk management consultation, loss prevention seminars and
other educational programs;
- legislative oversight and active support of opposition to
proposed legislation relating to liability issues affecting
the healthcare industry;
- the preparation and dissemination of newsletters and other
printed material with information of interest to the
healthcare industry; and
- endorsements by, and attendance at meetings of, the state and
local medical societies and related organizations.
These communications and services have helped us gain exposure among
potential insureds and demonstrate our understanding of the insurance needs of
the healthcare industry and promote a commonality of interest among us and our
insureds.
Personal Lines Segment:
We market our personal lines insurance products, personal automobile,
homeowners, boat and umbrella policies, to members of the educational community
and their families in Michigan. Our policies are sold through our exclusive
agents who are typically current or former teachers, school administrators or
other education professionals. We currently are licensed in Minnesota, Michigan,
and Ohio, but write insurance only in Michigan.
Our sales representatives also have access to other insurance products
underwritten by other carriers in Michigan who pay us commissions for such
sales. In general, these carriers offer products that we do not currently offer,
or insure a class of business that does not meet our underwriting guidelines. By
offering complementary insurance products, our sales representatives provide our
customers with the convenience of being able to purchase a full range of
insurance products through a single agent, thus allowing our representatives to
compete with independent agents. We benefit by having potential customers for
products we may offer in the future.
We conduct quarterly meetings with our sales representatives, establish
benchmarks and goals, and conduct technical training and sponsor continuing
education programs. Our representatives provide us with important information
about market conditions and feedback from our customers regarding their
insurance requirements and our level of service provided. This information is
used to develop new products and new product features. We recruit and train new
sales representatives to work in under-represented areas of the state. Sales
representatives are paid a fixed commission with some opportunity for contingent
bonuses, based upon the representative's production and loss ratios.
For the year ended December 31, 2002, one sales representative
accounted for approximately 5% of our direct premiums written within our
personal lines segment. No other sales representative accounted for more than 4%
of our direct premiums written in 2002. The top 10 sales representatives
accounted for approximately 35% of our direct premiums written in 2002.
10
We provide personal computer software that allows sales representatives
to quote rates for auto, homeowners and boat insurance. In addition, we have a
web site on the internet for the public that is periodically updated with
pertinent information on MEEMIC, its products, and how to locate a sales
representative.
UNDERWRITING
Professional Liability Segment:
Because we focus our primary efforts on sole practitioners and small
groups, our underwriting process is driven by individual risk selection rather
than by account, and our pricing decisions are focused on achieving rate
adequacy. We assess the quality and pricing of the risk, primarily emphasizing
loss history, practice specialty and location of practice in making our
underwriting decision. Our underwriters work closely with our local claims
departments. This includes consulting with staff about claims histories and
patterns of practice in a particular locale as well as monitoring claims
activity.
Our underwriting focuses on knowledge of local market conditions and
legal environment. Through our five local underwriting offices located in
Alabama, Florida, Indiana, Missouri and Michigan, we have established a local
presence within our targeted markets to obtain better information more quickly.
These offices are staffed by underwriting professionals who report to the branch
vice presidents of their respective local office. The underwriting offices each
report to a regional vice president who is ultimately responsible for the
pricing and underwriting decisions in their region.
Our underwriting department establishes guidelines to classify risks by
practice specialty and by location. Our underwriters work with our field
marketing force to identify business that meets these established underwriting
standards and to develop specific strategies to write the desired business. In
performing this assessment, our underwriters may also consult with internal
actuaries regarding loss trends and pricing and utilize loss-rating models to
assess the projected underwriting results of certain insured risks. Our agents
are permitted to bind professional liability coverage within our underwriting
guidelines, but binding authority is exercised only after authorization from our
underwriting staff.
Our underwriters are also assisted by our local medical advisory
committees that we have established in our key states. These committees are
comprised of local physicians, dentists and representatives of hospitals and
healthcare entities and help us maintain close ties to the medical communities
in these states, provide information on the practice of medicine in each state
and provide guidance on critical underwriting and claims issues.
Personal Lines Segment:
We rely to a significant degree on information provided by our sales
representatives in underwriting risks. The majority of our sales representatives
are, or were, teachers. This enhances the sales representatives' ability to act
as field underwriters since they have a general understanding of lifestyles and
insurance needs within the educational community to effectively pre-screen
applicants. We believe that the educational community in Michigan provides
better than average risk-selection, which contributes to our historically
profitable underwriting results.
Our underwriters then evaluate and accept applications for insurance
submitted by the sales representatives based on consistently applied
underwriting guidelines. Our processing system allows for some modification of
these guidelines by individual underwriters, and underwriting supervisors
regularly audit their work and ensure these exceptions fall within acceptable
limits. Our underwriters monitor policyholder deviations from the underwriting
guidelines to assist in decisions related to cancellation and non-renewal.
11
CLAIMS MANAGEMENT
Professional Liability Segment:
We have claims offices throughout the states in which we write business
in order to provide localized and timely attention to claims. Our claims
department investigates the circumstances surrounding a medical incident from
which a covered claim arises against an insured. Upon investigation, and in
consultation with the insured and appropriate experts, we evaluate the merit of
the claim and either seek reasonable settlement or aggressively defend the
claim. If the claim is defended, our claims department manages the case,
including selecting defense attorneys who specialize in medical liability cases,
planning the defense and obtaining medical and/or other professional experts to
assist in the analysis and defense of the claim.
Our claims department establishes the appropriate case reserves for
each claim and monitors the level of each case reserve as circumstances require.
The department also decides when and if to settle all but the most
significant claims, which are currently reviewed by an internal committee made
up of our Chairman and Chief Executive Officer, our Senior Vice President -
Claims, and our outside legal counsel. In each of the states in which we
operate, we meet regularly with our local medical advisory committees to examine
claims, attempt to identify potentially troubling practice patterns and make
recommendations to our staff.
We aggressively defend claims against our insureds that we believe have
no merit or those we believe cannot be reasonably settled. As a result of this
policy, many of our claims are litigated, and we engage experienced trial
attorneys in each venue to handle the litigation in defense of our
policyholders.
Our aggressive claims management approach generally results in
increased loss adjustment expenses compared to those of other property and
casualty lines or other companies specializing in professional liability
insurance. However, we believe that our approach contributes to lower overall
loss costs and results in greater customer loyalty. The success of this claims
philosophy is based on our ability to develop relationships with attorneys who
have significant experience in the defense of professional liability claims and
who are able to defend claims in an aggressive, cost-efficient manner.
Personal Lines Segment:
In responding to claims, we emphasize timely investigation, evaluation
and fair settlement while controlling claims expense and maintaining adequate
reserves. We have a year-round, 24-hour claim reporting telephone service for
insureds and third-party claimants. This reporting methodology enables us to
more quickly complete initial claim handling and ultimately reduce indemnity
payments such as rental and storage.
Our claims operation is centralized in Auburn Hills, Michigan, but we
also employ resident adjusters located in cities throughout Michigan. These
employee adjusters settle a majority of our claims, and independent multi-line
adjusters are used on a contract basis when claim volume rises. We have also
established a network of auto repair shops and other repair facilities that
provide damage appraisals and repairs according to established company
guidelines. An inspection audit program ensures that repairs are completed
timely, economically and to the satisfaction of the customer.
Audits of liability claim files are conducted regularly by claims
department managers and reinsurers. We decide which claims we seek to settle and
which claims we defend. We believe that less than 1% of all claims result in
litigation.
12
Our claims department actively monitors all litigation including
selecting defense attorneys who specialize in insurance defense cases, planning
the defense, and obtaining professional experts to assist in the analysis and
defense of the claim. The department establishes the appropriate case reserves
for each claim and monitors the level of each case reserve as circumstances
require.
LOSS RESERVES
We establish our reserves based on our estimates of the future amounts
necessary to pay claims and expenses associated with the investigation and
settlement of claims. Losses and loss adjustment expenses (LAE) reserves are
determined on the basis of individual claims and actuarially determined
estimates of future losses based on our past loss experience, available industry
data and projections as to future claims frequency, severity, inflationary
trends, judicial trends, legislative changes and settlement patterns.
Many of these items are not definitively quantifiable. Additionally,
there may be significant reporting lags between the occurrence of an insurable
event and the time it is reported to us. The assumptions used in establishing
our reserves are regularly reviewed and updated by management as new data
becomes available. The reserves for losses and LAE of each of our insurance
subsidiaries are reviewed by its independent actuaries for each year. The
independent actuaries prepare reports that include recommendations as to the
level of reserves. We consider these recommendations as well as other factors,
such as known, anticipated or estimated changes in frequency and severity of
claims and loss retention levels and premium rates, in establishing the amount
of our reserves for losses and LAE. The statutory filings of each insurance
company with the insurance regulators must be accompanied by an actuary's
certification as to its reserves in accordance with the requirements of the
National Association of Insurance Commissioners (the "NAIC").
We believe the methods we use to establish our reserves for losses and
LAE are reasonable and appropriate. However, estimating reserves, especially
professional liability reserves, is a complex process heavily dependent on
judgment. We believe that past experience, adjusted for the effects of current
developments and anticipated trends, is an appropriate and reasonable basis for
evaluating the adequacy of our loss reserves. There is no precise method for
evaluating the adequacy of reserves and changes are made to the amount of the
reserves as estimates change based on current information. Changes in the amount
of reserves for losses and LAE are reflected in current earnings. Because of the
size of our reserves, a small percentage change in the amount of the reserves
can have a material effect on our results of operations for the period in which
the change is made.
We believe we do not have any exposure to asbestos claims that are
currently prevalent in the insurance industry. Although our policies do not
contain specific terrorism exclusions we do not believe we have a material
exposure to terrorism losses.
13
CLAIMS RECONCILIATION
The following table reconciles beginning and ending reserves for losses
and LAE as shown in our consolidated financial statements for the years
indicated. As of December 31, 2002, our insurance subsidiaries had consolidated
reserves for losses and LAE on a GAAP basis that exceeded those on a statutory
basis by approximately $19.5 million, which is principally due to the portion of
GAAP reserves that are reflected for statutory accounting purposes as unearned
premiums. These unearned premiums are applicable to extended reporting
endorsements ("tail" coverage) issued without a premium charge upon death,
disability, or retirement of an insured.
2002 2001 2000
----------- ----------- ---------
Balance, beginning of year $ 1,442,341 $ 659,659 $ 665,786
Less reinsurance recoverables 374,056 166,202 179,507
----------- ----------- ---------
Net balance, beginning of year 1,068,285 493,457 486,279
Net reserves acquired from Professionals Group -- 557,284 --
Incurred related to:
Current year 439,600 303,387 178,210
Prior years 8,429 13,818 (12,500)
Change in death, disability and retirement reserve -- (18,647) (10,000)
----------- ----------- ---------
Total incurred 448,029 298,558 155,710
Paid related to:
Current year (84,376) (137,121) (14,909)
Prior years (271,482) (143,893) (133,623)
----------- ----------- ---------
Total paid (355,858) (281,014) (148,532)
----------- ----------- ---------
Net balance, end of year 1,160,456 1,068,285 493,457
Plus reinsurance recoverables 462,012 374,056 166,202
----------- ----------- ---------
Balance, end of year $ 1,622,468 $ 1,442,341 $ 659,659
=========== =========== =========
14
LOSS RESERVE DEVELOPMENT TABLE
The Loss Reserve Development Table includes information regarding the
development of our reserves for the liability of unpaid losses and LAE for the
years ended December 31, 1992 through 2002. The table includes losses and LAE on
both a direct and an assumed basis and is net of reinsurance recoverables. The
following definitions may be helpful in understanding the Loss Reserve
Development Table:
- The line entitled "Losses and LAE Reserves, undiscounted and
net of reinsurance recoverables" reflects the amount recorded
as the reserve for liability for unpaid losses and LAE in the
consolidated balance sheet at the end of each year (the
Balance Sheet Reserves).
- The section entitled "Cumulative net paid, as of" reflects the
cumulative amounts paid as of the end of each succeeding year
with respect to the previously recorded Balance Sheet
Reserves.
- The section entitled "Re-estimated net liability as of"
reflects the re-estimated amount of the liability previously
recorded as Balance Sheet Reserves that includes the
cumulative amounts paid and an estimate of additional
liability based upon claims experience as of the end of each
succeeding year (the Net Re-estimated Liability).
- The line entitled "Net cumulative redundancy, (deficiency)"
reflects the difference between the previously recorded
Balance Sheet Reserve for each applicable year and the Net
Re-estimated Liability relating thereto as of the end of the
most recent fiscal year.
The gross liability for losses and LAE before reinsurance, as shown on
the balance sheet, and the reconciliation of that gross liability to amounts net
of reinsurance are reflected below the table. We do not discount our reserves to
present value.
Information presented in the following table is cumulative and,
accordingly, each amount includes the effects of all changes in amounts for
prior years. The table presents the development of our balance sheet reserves;
it does not present accident year or policy year development data. Conditions
and trends that have affected the development of liabilities in the past may not
necessarily occur in the future. Accordingly, it may not be appropriate to
extrapolate future redundancies or deficiencies based on this table.
In each year reflected in the table, we have utilized actuarial
methodologies, including incurred loss development, paid loss development and
frequency-severity projections, to estimate reserves. These techniques are
applied to the data and the resulting projections are evaluated by management to
establish the estimate of reserves.
15
ANALYSIS OF LOSSES AND LOSS RESERVE DEVELOPMENT
(IN THOUSANDS)
December 31,
1992 (a) 1993 (a) 1994 (a) 1995 (a) 1996 (a) 1997 (a)
-------- -------- -------- -------- -------- --------
Losses and LAE Reserves,
undiscounted and net of
reinsurance recoverables $252,739 $272,392 $295,541 $352,521 $440,040 $464,122
Cumulative net paid
as of:
One Year Later 19,752 21,296 24,102 27,532 48,390 67,383
Two Years Later 36,185 40,988 42,115 58,769 98,864 128,758
Three Years Later 52,550 53,186 58,793 80,061 136,992 194,139
Four Years Later 58,526 61,153 65,520 107,005 173,352 227,597
Five Years Later 63,325 66,419 76,291 120,592 191,974 252,015
Six Years Later 68,021 73,308 81,722 129,043 204,013
Seven Years Later 71,466 76,716 82,605 135,620
Eight Years Later 72,352 76,821 84,649
Nine Years Later 72,305 77,713
Ten Years Later 73,149
Re Estimated Net Liability As Of:
End of Year $252,739 $272,392 $295,541 $352,521 $440,040 $464,122
One Year Later 241,655 251,445 268,154 325,212 393,363 416,814
Two Years Later 221,236 220,385 239,243 280,518 347,258 364,196
Three Years Later 190,744 194,213 200,311 237,280 294,675 333,530
Four Years Later 167,062 159,096 157,836 190,110 264,714 323,202
Five Years Later 136,996 126,379 122,570 173,148 259,195 320,888
Six Years Later 108,862 106,403 105,779 168,828 248,698
Seven Years Later 94,908 92,954 99,787 160,784
Eight Years Later 84,719 88,828 94,192
Nine Years Later 79,788 83,251
Ten Years Later 76,086
Net cumulative redundancy
(deficiency) 176,653 189,141 201,349 191,737 191,342 143,234
======== ======== ======== ======== ======== ========
Original gross liability - end of year 311,394 355,735 432,937 548,732 614,720
Less: reinsurance recoverables (39,002) (60,194) (80,416) (108,692) (150,598)
-------- -------- -------- -------- --------
Original net liability - end of year 272,392 295,541 352,521 440,040 464,122
======== ======== ======== ======== ========
Gross re-estimated liability - latest 92,070 124,809 188,809 299,934 418,566
Re-estimated reinsurance recoverables (8,819) (30,617) (28,025) (51,236) (97,678)
-------- -------- -------- -------- --------
Net re-estimated liability - latest 83,251 94,192 160,784 248,698 320,888
======== ======== ======== ======== ========
Gross cumulative redundancy
(deficiency) 219,324 230,926 244,128 248,798 196,154
======== ======== ======== ======== ========
December 31,
1998 (a) 1999 (a) 2000 (a) 2001 (b) 2002 (b)
-------- --------- --------- ----------- ----------
Losses and LAE Reserves,
undiscounted and net of
reinsurance recoverables $480,741 $ 486,279 $ 493,457 $ 1,068,285 $1,160,456
Cumulative net paid
as of:
One Year Later 89,864 133,832 143,892 271,482
Two Years Later 192,716 239,872 251,855
Three Years Later 257,913 313,993
Four Years Later 308,531
Five Years Later
Six Years Later
Seven Years Later
Eight Years Later
Nine Years Later
Ten Years Later
Re Estimated Net
Liability As Of:
End of Year $480,741 $ 486,279 $ 493,457 $ 1,068,285
One Year Later 427,095 463,779 507,275 1,076,714
Two Years Later 398,308 469,934 529,698
Three Years Later 400,333 488,426
Four Years Later 414,008
Five Years Later
Six Years Later
Seven Years Later
Eight Years Later
Nine Years Later
Ten Years Later
Net cumulative redundancy
(deficiency) 66,733 (2,147) (36,241) (8,429)
======== ========= ========= ===========
Original gross liability - end of year 660,631 665,786 659,659 1,442,341
Less: reinsurance recoverables (179,890) (179,507) (166,202) (374,056)
-------- --------- --------- -----------
Original net liability - end of year 480,741 486,279 493,457 1,068,285
======== ========= ========= ===========
Gross re-estimated liability - latest 547,964 624,886 666,822 1,464,052
Re-estimated reinsurance recoverables (133,956) (136,460) (137,124) (387,338)
-------- --------- --------- -----------
Net re-estimated liability - latest 414,008 488,426 529,698 1,076,714
======== ========= ========= ===========
Gross cumulative redundancy
(deficiency) 112,667 40,900 (7,163) (21,711)
======== ========= ========= ===========
(a) Reflects reserves of Medical Assurance excluding Professionals Group
reserves, which were acquired on June 27, 2001. Accordingly, the gross
and net reserve development (reserves recorded at the end of the year,
as originally estimated, less reserves re-estimated as of subsequent
years) relates only to the operations of Medical Assurance and does not
include Professionals Group.
(b) Reflects combined reserves of Medical Assurance and Professionals
Group.
Losses and LAE reserves associated with medical professional liability
coverage tend to be higher than those associated with most other types of
property and casualty insurance for two primary reasons. First, overall costs of
providing professional liability insurance coverage historically have been among
the highest of the property and casualty insurance lines. These costs can be
attributed principally to increases in both the frequency and severity of
professional liability claims. Second, the complexity of professional liability
claims increases LAE. In addition, delays between the collection of premiums and
the payment of losses are generally longer for professional liability insurance
than other property and casualty lines. Frequently, injuries are not discovered
until years after an incident, or the claimant may delay pursuing the recovery
of damages. As a result of the delay, a component of the loss reserves for
occurrence coverage and "tail" coverage includes an estimate of the claims that
have been incurred but not yet reported (IBNR).
16
Medical professional liability loss experience is volatile and
cyclical. Over the past twenty-five years, the industry has experienced several
periods of increasing claim frequency and severity, followed by periods of
relative stability. At other times, due to tort reform, favorable judicial
decisions, favorable economic conditions or other unknown factors, claim
frequency or severity have decreased. Malpractice claims generally require an
extended period of time to resolve, and the average life of a claim can be five
years or more. The combination of changing conditions and the extended time
required for claim resolution result in a loss cost estimation process that
requires actuarial skill and the application of judgment, and such estimates
require periodic revision. We believe it is prudent to establish initial losses
and LAE reserves that are reasonable and are based on historical experience as
well as on facts and circumstances known at the balance sheet date. To the
extent that actual results deviate from expectations, reserve estimates are
subsequently adjusted and ultimate paid losses and LAE are more or less than the
original estimates.
Prior to 2001, our reserves were solely for the Professional Liability
Segment. Our losses and LAE reserves developed favorably in many prior years for
several reasons:
- Substantially all of our business was derived from medical
professional liability insurance written in Alabama until we
began to geographically expand our business in the mid to late
1990s. We utilized a rigorous and disciplined approach to
investigating, managing and defending claims. This philosophy
generally produced results in Alabama that were better than
industry averages in terms of loss payments and the proportion
of claims closed without indemnity payment.
- Our volume of business in the late 1980's and early 1990's,
while substantial, was not of a sufficient size to fully
support the actuarial projection process; thus, our data was
supplemented with industry-based data. Ultimately, actual
results proved better than the industry data, creating
redundancies.
- Our reserves established in the late 1980's and early 1990's
were strongly influenced by the dramatically increased
frequency and severity that we, and the industry as a whole,
experienced during the mid-1980s. Some of these trends
moderated, and in some cases, reversed, by the late 1980s or
early 1990s. However, the ability to recognize the improved
environment was delayed due to the extended time required for
claims resolution. When these negative trends moderated, the
reserves we established during those periods proved to be
redundant.
- We prudently established accident year loss reserves,
resulting in some initial accident year net loss ratios that
were higher than industry averages. In some instances, these
net loss and LAE ratios proved to be accurate, while in other
cases, experience has been better than we expected and
redundancies developed.
The professional liability legal environment deteriorated once again
during the past several years. Beginning in 2000, we recognized adverse trends
in claim severity, causing increased estimates of certain loss liabilities. As a
result, favorable development of prior year loss reserves slowed in 2000 and
reversed in 2001. We have addressed these trends through increased rates,
stricter underwriting and modifications to claims handling procedures.
Due to the size of our reserves, even a small percentage adjustment can
have a material effect on our results of operations for the period in which the
change is made.
17
REINSURANCE
General:
We use reinsurance to provide capacity to write large limits of
liability, to reduce losses of a catastrophic nature and to stabilize
underwriting results in those years in which such losses occur. The purchase of
reinsurance does not relieve us from the ultimate risk on our policies, but it
does provide reimbursement from the reinsurer for certain losses paid by us.
The effective transfer of risk is dependent on the creditworthiness of
the reinsurer. We purchase reinsurance from a number of individual companies to
avoid concentrations of credit risk. Our reinsurance brokers assist us in the
analysis of the credit quality of our reinsurers.
We have not experienced any difficulties in collecting amounts due from
reinsurers. As of December 31, 2002 we do not believe we have any reinsurance
recoverables that are uncollectible. Should future events lead us to believe
that any reinsurer is unable to meet its obligations to us, adjustments to the
amounts recoverable would be reflected in the results of then current
operations.
The following table identifies our reinsurers from which our
recoverables are $10 million or more as of December 31, 2002:
A. M. Best Amounts Due
Reinsurer Company Rating From Reinsurer
--------- -------------- --------------
Michigan Catastrophic Claims Association Not rated $56,769
Hannover Ruckversicherungs Ag A+ $51,889
PMA Capital Insurance Company A- $35,236
General Reinsurance Corp A++ $34,115
Continental Casualty Company A $31,144
Gerling Global Reins Corp Not rated $28,268
Transatlantic Reins Company A++ $18,572
Lloyds Syndicate 435 A- $13,808
Converium Rein North America Inc. A $11,763
St. Paul Reinsurance Company Ltd. A $11,121
18
Recently, there has been public speculation about the ability of
Gerling Global Reinsurance Corporation of America (Gerling) to pay claims.
Gerling is not accepting new business, and is therefore not rated by A.M. Best.
Gerling does not participate in our current reinsurance treaties, however it has
been part of previous reinsurance programs. At December 31, 2002 our recorded
receivable from them was $28.3 million of which approximately 85% related to our
estimates of IBNR and its allocation to the various reinsurance treaties. Based
upon information available to us, including statements made by Gerling, we
anticipate that Gerling will meet its obligations to us.
Professional Liability Segment:
We reinsure risks under treaties pursuant to which the reinsurer agrees
to assume all or a portion of all risks that we insure above our individual risk
retention and up to the maximum individual limit offered (currently $16
million). Periodically, we provide insurance to policyholders above the maximum
limits of our reinsurance treaties. In those situations, we reinsure the excess
risk above the limits of our reinsurance treaties on a facultative basis,
whereby the reinsurer agrees to insure a particular risk up to a designated
limit.
Our risk retention level is dependent upon numerous factors including
the price and availability of reinsurance, volume of business, level of
experience and our analysis of the potential underwriting results within each
state. Historically, per claim retention levels have varied between the first
$200,000 and the first $2 million depending on the coverage year and the state
in which business was written.
Effective October 1, 2002, the professional liability segment has a
uniform retention of $1,000,000.
Personal Lines Segment:
The Michigan Catastrophic Claims Association (MCCA) covers all
automobile related personal injury incurred losses in excess of $300,000. The
MCCA is an unincorporated nonprofit association created by Michigan law, and
every insurer engaged in writing personal protection automobile insurance
coverage in Michigan is required to be a member of the MCCA. The MCCA charges an
annual assessment, based on the number of vehicles for which coverage is
written, to cover the losses reported by all member companies. Michigan law
provides that the MCCA assessments charged to member companies for this
protection can be recognized in the rate-making process and passed on to
policyholders. We treat any amounts due from the MCCA as reinsurance and the
assessments due to MCCA as ceded premiums.
We currently reinsure our other personal lines risks in excess of
$250,000 per loss. Individual property risks are covered up to $1 million per
risk and casualty risks other than personal automobile are covered on an excess
of loss basis up to $3 million per occurrence.
Catastrophic reinsurance provides additional protection from
significant aggregate loss exposure arising from a single event such as
windstorm, hail, tornado, earthquake, riot, blizzard, freezing temperatures or
other extraordinary events. We have purchased catastrophe reinsurance for
automobile physical damage, homeowners and boat property damage in four layers
up to $15,000,000 in excess of $1,000,000 with each layer subject to a retention
of 5%. Since we began offering umbrella policies in 2000, we have a quota share
reinsurance arrangement under which we retain 5% and cede 95% of our liability
on these policies.
19
INVESTMENTS
Our overall investment strategy is to focus on maximizing current
income from our investment portfolio while maintaining safety, liquidity,
duration of liabilities and portfolio diversification. Although fixed maturity
securities are purchased with the initial intent to hold such securities until
their maturity, disposals of securities prior to their respective maturities may
occur if management believes such disposals are consistent with our overall
investment strategy, including maximizing after-tax yields. This investment
strategy is implemented through investment guidelines that are established from
time to time by our board of directors with the assistance of outside
consultants.
Our investment portfolio had an estimated fair value of $1,409 million
at December 31, 2002. The portfolio is generally managed by professional
third party asset managers whose results are evaluated periodically by
management and its consultants. The asset managers typically have the authority
to make investment decisions, subject to investment policies, within the asset
class they are responsible for managing.
We categorize our marketable securities as debt securities (cash
equivalents, debt instruments, convertible debentures and preferred stocks
having scheduled redemption provisions) and equity securities (common stocks,
convertible preferred stocks and preferred stocks that do not have mandatory
redemption provisions).
We currently classify all debt and equity securities as
available-for-sale and report such investments at market value.
At December 31, 2002 we held investments, excluding real estate, with a
market value of $1,409 million and a net unrealized gain of $35.5 million. The
fixed maturity securities in our investment portfolio had a dollar weighted
average rating of "AA," a weighted average modified duration of 3.7 years and an
average yield of 5.2% before investment expenses at December 31, 2002. Average
yield is calculated by dividing annualized investment income from fixed
maturities by the book value of fixed maturities.
Because most of our investment portfolio is comprised of fixed maturity
securities, periodic changes in interest rate levels generally affect our
financial results to the extent that reinvestment yields are different than the
original yields on maturing securities. For a more detailed discussion of the
impact of changes in interest rates on our investment portfolio see
"Management's Discussion and Analysis -- Market Sensitive Instruments --
Interest Rate Risk."
20
The following table reflects the amortized cost and fair market value
of the investment portfolio for both of our segments at December 31, 2002:
Amortized Estimated Percentage of
Cost Fair Value Fair Value
---------- ---------- -------------
($ in thousands)
Fixed maturities
U.S. Treasury Securities.................... $ 234,745 $ 241,180 17%
State and Municipal Bonds................... 399,899 416,788 30
Corporate Bonds............................. 442,653 466,176 33
Asset Backed Securities..................... 197,638 204,183 14
Certificates of Deposit..................... 570 570 *
Total Fixed Maturities............ 1,275,505 1,328,897 94
Equity Securities............................... 77,556 80,197 6
Total Investments................. $1,353,061 $1,409,094 100%
---------- ---------- ---
* Less than 0.1%.
Substantially all of the fixed maturities are either United States
government or agency obligations or investment grade securities as determined by
national rating agencies. Although accounted for as available-for-sale, our
fixed maturities are purchased with the intent to hold such investments to
maturity. Our investment policies implement an asset allocation that uses length
to maturity as one method of managing our long term rate of return. The
following table reflects the estimated fair value of our fixed maturities by
contractual maturity at December 31, 2002.
Estimated Percent
Fair Value of Total
---------- --------
($ in thousands)
Due in one year or less $ 49,993 4%
Due after one year through five years 361,789 27
Due after five years through ten years 395,162 30
Due after ten years 317,770 24
Asset-backed securities 204,183 15
---------- ---
Total $1,328,897 100%
The table below shows investment income information for the years ended
December 31, 2002 and December 31, 2001. The yield on fixed maturity securities
is calculated by dividing gross earnings on fixed maturity securities by the
average of the quarterly ending book value balances of such securities.
21
We have significant amounts invested in tax-exempt state and municipal
bonds. These bonds pay lower interest rates than securities that are subject to
federal income taxes. We have, therefore, calculated a tax equivalent yield. The
gross earnings on fixed maturity securities is increased to calculate gross
earnings as though all of our fixed maturity securities are taxable. The tax
adjusted gross earnings are divided by the average of the quarterly ending book
value balances of fixed maturity securities to determine the tax equivalent
yield on fixed maturity securities.
Year Ended Year Ended
December 31, December 31,
2002 2001
------------ ------------
($ in thousands)
Net Investment Income $ 76,918 $ 59,782
Net Realized Investment (Losses) Gains (5,306) 5,441
Yield on Fixed Maturity Securities 5.5% 5.6%
Tax Equivalent Yield on Fixed Maturity Securities 6.1% 6.6%
Our current investment policy requires that the market value of our
equity investment portfolio not to exceed 50% of our capital at the end of the
prior year. At December 31, 2002, equity investments represented 6% of the total
market value of our portfolio, and 16% of our capital. Our equity investments
are diversified primarily among domestic growth and value holdings through
common and convertible preferred stock.
RATING AGENCIES
Our insurance subsidiaries are all rated "A-" (Excellent) by A.M. Best,
its fourth highest category out of 15 categories. They are rated "A-" (Strong)
with a negative outlook by Standard & Poor's, its seventh highest category out
of 21 categories. In developing these ratings, A.M. Best and Standard & Poor's
evaluate an insurer's ability to meet its obligations to policyholders, and are
not directed toward the protection of stockholders. These ratings are neither
ratings of securities nor a recommendation to buy, hold or sell any security.
COMPETITION
Competition depends on several factors including pricing, size, name
recognition, service quality, market commitment, breadth and flexibility of
coverage, method of sale, financial stability and ratings assigned by A.M. Best
and Standard & Poor's. Many of these factors, such as market conditions, the
ratings assigned by rating agencies, and regulatory conditions are out of our
control. However, for those factors over which we do have control, such as
service quality, market commitment, financial strength and stability, we believe
we have competitive strengths that make us a viable competitor in those states
where we are currently writing insurance.
Professional Liability Segment:
We compete with insurance companies and self-insuring entities in the
medical professional liability market. Many of the competing companies
concentrate on a single state and have an extensive knowledge of the local
markets. We also compete with large national insurers that may have greater
financial strength and other resources than we do.
22
We believe that we have a competitive advantage in the current market
due to our size, geographic scope and name recognition, as well as our heritage
as a policyholder-founded company with a long-term commitment to the
professional liability insurance industry. These advantages have been achieved
through our balance sheet strength, claims defense expertise, strong ratings and
ability to deliver a high level of service to our insureds and agents. We
believe that these competitive strengths make us a viable competitor in those
states where we are currently writing insurance.
Since 1999, insurance companies focused on medical professional
liability coverage have experienced higher claim costs on business written in
prior years than they had reserved for initially. This has resulted in
significant losses, reduced capital to support current and future business, and
higher premium rates to meet expected higher claims costs.
Reduced profitability, reductions in surplus and capacity constraints
have led many professional liability carriers focused on medical professional
liability coverages to withdraw from, or limit new business in, one or more
markets. Given the continued reduction in capacity and the uncertainty
surrounding several writers in the medical professional liability market, we
believe there will be a "flight to quality" as insurers place greater emphasis
on financial strength and stability. We believe this trend will continue at
least until 2004.
Personal Lines Segment:
Personal lines insurance is highly competitive and some of these
competitors are substantially larger than we are and have much greater
financial, technical and operating resources. Competition depends on several
factors including the price and quality of insurance products, the quality and
speed of service and claims response, financial strength, sales and marketing
capability, technical expertise and ratings assigned by A.M. Best and Standard &
Poor's.
Our strong capitalization provides operational flexibility allowing
growth and expansion capabilities for current and new product lines. Offsetting
these strengths is our geographic concentration in a single state (Michigan) and
our increasing exposure to large weather-related losses due to our growing
homeowners book of business.
GROWTH OPPORTUNITIES AND OUTLOOK
We expect to achieve our growth primarily as a result of (i) the
withdrawal of competitors from actively writing business in certain states, (ii)
increased prices in our professional liability business and (iii) expansion of
our personal lines business in Michigan.
We believe we are viewed as a market leader because of our financial
strength and stability, and our ability to deliver excellent service at the
local level. This reputation allows us to take advantage of marketing conditions
that are improving as price increases are implemented and earned. Our stability
also makes us an attractive insurer in light of the highly publicized
insolvencies in our industry, as well as the regulatory actions taken against
several former competitors.
We expect the growth of our professional liability business will be
primarily generated through increased pricing across our book of business. In
2002, we achieved average gross price increases of approximately 28% on renewal
business (weighted by premium volume). In 2001 we achieved average gross renewal
price increases of approximately 23% (weighted by premium volume).
We expect our future growth will also be supported by controlled
expansion in our primary market area and in states where we have recently
commenced writing business but have little or no presence. These states include
Arkansas and Virginia, where The St. Paul Companies was a leading writer prior
to its departure from the market and which we believe have favorable medical and
legal climates.
23
We also believe there will be additional opportunities for profitable
expansion as a number of insurers are experiencing financial difficulties,
requiring them to reduce their business or completely exit the marketplace. This
may also lead to opportunities to expand through the acquisition of other
companies or books of business.
We believe we can achieve our growth while improving our combined
ratio. Based on price increases achieved to date, our objective is to achieve a
combined ratio on our professional liability business of 102% or lower. This
takes into account expected increases in the cost of claims and reinsurance
protection purchased. As with all property and casualty companies, we expect the
beneficial impact of price increases and any development of losses to be fully
reflected in our financial results over time. We recognize the impact of higher
prices as the associated premiums are earned which generally occurs over the
course of the year after the policy is written. In our personal lines business
our objective is to achieve an underwriting profit, which is in line with our
historical financial results.
INSURANCE REGULATORY MATTERS
We are subject to regulation under the insurance and insurance holding
company statutes, of various jurisdictions, including the domiciliary states of
our insurance subsidiaries and other states in which our insurance subsidiaries
do business.
General:
Insurance companies are also affected by a variety of state and federal
legislative and regulatory measures and judicial decisions that define and
qualify the risks and benefits for which insurance is sought and provided. These
include redefinitions of risk exposure in such areas as medical liability,
product liability, environmental damage and workers compensation. In addition,
individual state insurance departments may prevent premium rates for some
classes of insureds from reflecting the level of risk assumed by the insurer for
those classes. Although there is limited federal regulation of the insurance
business, each state has a comprehensive system for regulating insurers
operating in that state. In addition, these insurance regulators periodically
examine each insurer's financial condition, adherence to statutory accounting
practices, and compliance with insurance department rules and regulations.
Our operating subsidiaries are required to file detailed annual
reports with the state insurance regulators in each of the states in which they
do business. The laws of the various states establish supervisory agencies with
broad authority to regulate, among other things, licenses to transact business,
premium rates for certain types of coverage, trade practices, agent licensing,
policy forms, underwriting and claims practices, reserve adequacy, transactions
with affiliates, and insurer solvency. Many states also regulate investment
activities on the basis of quality, distribution and other quantitative
criteria. States have also enacted legislation regulating insurance holding
company systems, including acquisitions, the payment of dividends, the terms of
affiliate transactions, and other related matters. Our principal insurance
subsidiaries are domiciled in Michigan, Alabama and West Virginia.
Applicable state insurance laws, rather than federal bankruptcy laws,
apply to the liquidation or reorganization of insurance companies.
24
Insurance Regulation Concerning Change or Acquisition of Control:
The insurance regulatory codes in our operating subsidiaries'
respective domiciliary states each contain similar provisions (subject to
certain variations) to the effect that the acquisition of "control" of a
domestic insurer or of any person that directly or indirectly controls a
domestic insurer cannot be consummated without the prior approval of the
domiciliary insurance regulator. In general, a presumption of "control" arises
from the direct or indirect ownership, control, possession with the power to
vote or possession of proxies with respect to 10% (5% in Alabama) or more of the
voting securities of a domestic insurer or of a person that controls a domestic
insurer. A person seeking to acquire control, directly or indirectly, of a
domestic insurance company or of any person controlling a domestic insurance
company must generally file an application for approval of the proposed change
of control with the relevant insurance regulatory authority.
In addition, certain state insurance laws contain provisions that
require pre-acquisition notification to state agencies of a change in control of
a non-domestic insurance company admitted in that state. While such
pre-acquisition notification statutes do not authorize the state agency to
disapprove the change of control, such statutes do authorize certain remedies,
including the issuance of a cease and desist order with respect to the
non-domestic admitted insurer's doing business in the state if certain
conditions exist, such as undue market concentration.
Statutory Accounting and Reporting:
Insurance companies are required to file detailed annual reports with
the state insurance regulators in each of the states in which they do business,
and their business and accounts are subject to examination by such regulators at
any time. The financial information in these reports is prepared in accordance
with the accounting requirements of the state regulatory authorities. The
accounting principles differ from Generally Accepted Accounting Principles
("GAAP") and are referred to as Statutory Accounting Practices ("SAP").
Insurance regulators periodically examine each insurer's financial condition,
adherence to SAP, and compliance with insurance department rules and
regulations.
Regulation of Dividends and Other Payments from Our Operating Subsidiaries:
We are a legal entity separate and distinct from our subsidiaries. As a
holding company with no other business operations, our primary sources of cash
to meet our obligations, including principal and interest payments with respect
to indebtedness, are available dividends and other statutorily permitted
payments, such as tax allocation payments and management and other fees, from
our operating subsidiaries.
Our operating subsidiaries are subject to various state statutory and
regulatory restrictions, applicable generally to any insurance company in its
state of domicile, which limit the amount of dividends or distributions an
insurance company may pay to its stockholders without prior regulatory approval.
The restrictions are generally based on certain levels or percentages of
surplus, investment income and operating income, as determined in accordance
with SAP. Generally, dividends may be paid only out of earned surplus. In every
case, surplus subsequent to the payment of any dividends must be reasonable in
relation to an insurance company's outstanding liabilities and must be adequate
to meet its financial needs.
State insurance holding company acts generally require domestic
insurers to obtain prior approval of extraordinary dividends. Under the
insurance holding company acts governing our principle operating subsidiaries, a
dividend is considered to be extraordinary if the combined dividends and
distributions to the parent holding company in any 12 month period is more than
the greater of either the insurer's net income for the prior fiscal year or 10%
of its surplus at the end of the prior fiscal year.
25
If insurance regulators determine that payment of a dividend or any
other payments to an affiliate (such as payments under a tax-sharing agreement
or payments for employee or other services) would, because of the financial
condition of the paying insurance company or otherwise, be hazardous to such
insurance company's policyholders, the regulators may prohibit such payments
that would otherwise be permitted without prior approval.
Risk-Based Capital:
In order to enhance the regulation of insurer solvency, the National
Association of Insurance Commissioners (NAIC) specifies risk-based capital (RBC)
requirements for property and casualty insurance companies. These RBC
requirements are designed to monitor capital adequacy and to raise the level of
protection that statutory surplus provides for policyholders. The NAIC's RBC
model law stipulates four levels of regulatory action with the degree of
regulatory intervention increasing as the level of surplus falls below a minimum
amount as determined under the model law. At December 31, 2002, all
ProAssurance's insurance subsidiaries exceeded the minimum level and, as a
result, no regulatory response or action was required.
Investment Regulation:
Our operating subsidiaries are subject to state laws and regulations
that require diversification of investment portfolios and that limit the amount
of investments in certain investment categories. Failure to comply with these
laws and regulations may cause non-conforming investments to be treated as
non-admitted assets for purposes of measuring statutory surplus and, in some
instances, would require divestiture.
Guaranty Funds:
All fifty states have separate insurance guaranty fund laws requiring
admitted property and casualty insurance companies doing business within their
respective jurisdictions to be members of their guaranty associations.
These associations are organized to pay covered claims (as defined and
limited by the various guaranty association statutes) under insurance policies
issued by insurance companies that become insolvent. Such guaranty association
laws create post-assessment associations, which make assessments against member
insurers to obtain funds to pay association covered claims after the insolvency
of an insurer occurs. These associations levy assessments (up to prescribed
limits) on all member insurers in a particular state on the basis of the
proportionate share of the premiums written by member insurers in the covered
lines of business in that state. Maximum assessments permitted by law in any one
year generally vary between 1% and 2% of annual premiums written by a member in
that state. Some states permit member insurers to recover assessments paid
through surcharges on policyholders or through full or partial premium tax
offsets, while other states permit recovery of assessments through the rate
filing process.
Shared Markets:
Our operating subsidiaries are required to participate in mandatory
property and casualty shared market mechanisms or pooling arrangements that
provide certain insurance coverage to individuals or other entities that are
otherwise unable to purchase such coverage in the commercial insurance
marketplace. Our operating subsidiaries' participation in such shared markets or
pooling mechanisms is not material to our business at this time.
26
Possible Legislative and Regulatory Changes:
In recent years, the insurance industry has been subject to increased
scrutiny by regulators and legislators. The NAIC and a number of state
legislatures have considered or adopted legislative proposals that alter and, in
many cases, increase the authority of state agencies to regulate insurance
companies and insurance holding company systems.
In addition, several committees of Congress have made inquiries and
conducted hearings as part of a broad study of the regulation of insurance
companies, and legislation has been introduced in several of the past sessions
of Congress which, if enacted, could result in the federal government assuming
some role in the regulation of the insurance industry. Although the federal
government does not regulate the business of insurance directly, federal
initiatives often affect the insurance business in a variety of ways. Current
and proposed federal measures that may significantly affect the insurance
business include changes in medical patient protection laws such as the
"Patients Bill of Rights," tort reform and environmental laws.
The Legislatures in various states are currently considering, or being
asked to consider, changes to the laws governing medical liability lawsuits. The
changes are collectively called Tort Reforms. There are also Tort Reform
proposals being considered at the Federal level. In general, the changes would
place limits of non-economic damages, allow insurers more flexibility in paying
large judgments, and would alter some of the rules governing legal proceedings
and qualification of expert witnesses. In certain states, Tort Reform
legislation may also place limits on the ability of medical liability insurers
to raise or maintain rates at adequate levels.
We do not believe it is possible to predict the outcome of any of the
foregoing legislative, administrative or congressional activities or the
potential effects thereof on us.
EMPLOYEES
At December 31, 2002, we employed 580 persons, including 386 employees
in our Professional Liability segment and 194 employees at MEEMIC. None of our
employees is represented by a labor union. We consider our employee relations to
be good.
FORWARD-LOOKING STATEMENTS
Any written or oral statements made by us or on our behalf may include
forward-looking statements that reflect our current views with respect to future
events and financial performance. Forward-looking statements (identified by
words such as, but not limited to, "believe", "expect", "intend", "anticipate",
"estimate", "project" and other analogous expressions) include among other
things statements concerning: liquidity and capital requirements, return on
equity, financial ratios, net income, premiums, losses and loss reserves,
premium rates and retention of current business, competition and market
conditions, the expansion of product lines, the development or acquisition of
business in new geographical areas, the availability of acceptable reinsurance,
actions by regulators and rating agencies, the effect of the consolidation of
Medical Assurance and Professionals Group into ProAssurance, the effects of the
merger of MEEMIC into ProAssurance , compliance with our credit agreement,
payment of dividends, and other matters.
These forward-looking statements are based upon our estimates and
anticipation of future events that are subject to certain risks and
uncertainties that could cause actual results to vary materially from the
expected results described in the forward-looking statements. Due to such risks
and uncertainties, you are urged not to place undue reliance on forward-looking
statements. All forward-looking statements included in this document are based
upon information available to us on the date hereof, and we undertake no
obligation to publicly update or revise any forward-looking statements, whether
as a result of new information, future events or otherwise.
27
Risks that could adversely affect our operations or cause actual
results to differ materially from anticipated results include, but are not
limited to, the following:
- underwriting losses on the risks we insure are higher or lower
than expected;
- unexpected changes in loss trends and reserving assumptions
which might require the reevaluation of the liability for loss
and loss adjustment expenses, thus resulting in an increase or
decrease in the liability and a corresponding adjustment to
earnings;
- our ability to retain current business, acquire new business,
expand product lines and a variety of other factors affecting
daily operations such as, but not limited to, economic, legal,
competitive and market conditions which may be beyond our
control and are thus difficult or impossible to predict;
- changes in the interest rate environment and/or the securities
markets that adversely impact the fair value of our
investments or our income;
- inability on our part to achieve continued growth through
expansion into other states or through acquisitions or
business combinations;
- general economic conditions that are worse than anticipated;
- inability on our part to obtain regulatory approval of, or to
implement, premium rate increases;
- the effects of weather-related events;
- changes in the legal system, including retroactively applied
decisions that affect the frequency and severity of claims;
- significantly increased competition among insurance providers
and related pricing weaknesses in some markets;
- changes in the availability, cost, quality or collectibility
of reinsurance;
- changes to our ratings by rating agencies;
- regulatory and legislative actions or decisions that adversely
affect us; and
- our ability to utilize loss carryforwards and other deferred
tax assets.
ITEM 2: PROPERTIES
We own a 156,000 square foot office building located in Birmingham,
Alabama where we currently occupy approximately 55,000 square feet and plan to
occupy approximately 14,500 square feet of additional office space. The
remaining office space is leased to unaffiliated persons or is available to be
leased. We also own a 53,000 square foot office building in Okemos, Michigan
that we fully occupy. Both buildings are currently unencumbered. MEEMIC leases
its principal executive offices in Auburn Hills, Michigan. MEEMIC owns,
primarily for investment purposes, an 11.5-acre vacant parcel of land in Auburn
Hills, Michigan. We lease other office facilities in various locations and lease
computer and operating equipment under cancelable and non-cancelable agreements.
28
ITEM 3: LEGAL PROCEEDINGS
Our insurance subsidiaries are involved in various legal actions,
a substantial number of which arise from claims made under insurance policies.
While the outcome of all legal actions is not presently determinable, management
and its legal counsel are of the opinion that these actions will not have a
material adverse effect on our financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
EXECUTIVE OFFICERS OF PROASSURANCE CORPORATION
The executive officers of ProAssurance serve at the pleasure of the
Board of Directors. Set forth below are the current executive officers of
ProAssurance and a brief description of their principal occupation and
employment during the last five years.
A. DERRILL CROWE, M.D. Dr. Crowe has served as Chairman of our Board and our
Chief Executive Officer since we began operations in
June 2001. Dr. Crowe has also served as President,
Chairman of the Board and Chief Executive Officer of
Medical Assurance since its formation in 1995, and as
President, Chief Executive Officer, and a director of
Medical Assurance Company since its founding in 1977.
Dr. Crowe also serves as chairman of the board of
MEEMIC Holdings. (Age 66)
VICTOR T. ADAMO, ESQ. Mr. Adamo has served as our Vice Chairman, President,
and Chief Operating Officer since we began operations
in June 2001. Mr. Adamo also serves as President,
Chief Executive Officer and a director of
Professionals Group. Mr. Adamo has served as a
director of ProNational since 1990, and was its Chief
Executive Officer since 1987. Mr. Adamo is the Chief
Executive Officer and a director of MEEMIC Holdings.
(Age 55)
29
PAUL R. BUTRUS Mr. Butrus has served as our Vice Chairman and a
director of ProAssurance since we began operations in
June 2001. Mr. Butrus has been Executive Vice
President and a director of Medical Assurance since
its incorporation in 1995. Mr. Butrus has been
employed by Medical Assurance Company and its
subsidiaries since 1977, most recently as Executive
Vice President and Chief Operating Officer since
1993. (Age 62)
HOWARD H. FRIEDMAN Mr. Friedman was appointed as our Senior Vice
President, Chief Financial Officer, and Secretary in
June 2001. Mr. Friedman has served in a number of
positions for Medical Assurance since 1996, most
recently as Senior Vice President, Corporate
Development of Medical Assurance. Mr. Friedman is an
Associate of the Casualty Actuarial Society. He also
serves as a director of MEEMIC. (Age 44)
JAMES J. MORELLO Mr. Morello was appointed as our Senior Vice
President, Chief Accounting Officer and Treasurer in
June 2001. Mr. Morello has been Senior Vice President
and Treasurer for Medical Assurance since its
formation in 1995. Mr. Morello has been employed as
Treasurer and Chief Financial Officer of Medical
Assurance Company since 1984. He also serves as a
director of Medical Assurance's insurance
subsidiaries and as treasurer for ProNational. Mr.
Morello is a certified public accountant. (Age 54)
30
FRANK B. O'NEIL Mr. O'Neil was appointed as our Senior Vice President
of Corporate Communications and Investor Relations in
September 2001. Mr. O'Neil has been Senior Vice
President of Corporate Communications for Medical
Assurance since 1997 and employed by Medical
Assurance Company and its subsidiaries since 1987.
(Age 49)
WILLIAM P. SABADOS Mr. Sabados has served as our Chief Information
Officer since we began operations in June 2001 and
for Professionals Group since July 1998. Mr. Sabados
has been Senior Vice President and Chief Information
Officer of MEEMIC since 1997. In addition, he
currently serves as director and Chief Information
Officer for ProNational. (Age 53)
LYNN M. KALINOWSKI Mr. Kalinowski has been President of MEEMIC Holdings
and MEEMIC since September 2001. Mr. Kalinowski
previously served as President of MEEMIC from January
1993 to May 1997 and as Executive Vice President of
MEEMIC from May 1997 to September 2001. Prior to
joining MEEMIC in 1993, Mr. Kalinowski was the
President of Southern Michigan Mutual Insurance
Company and previously served as Director of
Financial Analysis for the Michigan Insurance Bureau
(now the State of Michigan Office of Financial and
Insurance Services). Mr. Kalinowski has been a
director of MEEMIC Holdings since 1998. (Age 50)
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
At March 17, 2003, ProAssurance Corporation (PRA) had 3,736
stockholders of record and 28,880,185 shares of common stock outstanding.
ProAssurance's common stock currently trades on The New York Stock Exchange
(NYSE) under the symbol "PRA".
ProAssurance had no outstanding shares prior to the completion of the
consolidation of Medical Assurance, Inc. (NYSE:MAI) and Professionals Group,
Inc. (NASDAQ:PICM) on June 27, 2001. As a result of the consolidation, each
share of Medical Assurance stock was converted to a share of stock in
ProAssurance; the conversion ratio of Professionals Group shares was based on
the market value of Medical Assurance stock during a period immediately
preceding the consolidation. Shares of Medical Assurance and Professionals Group
ceased trading and were delisted from their respective public markets following
the close of business on June 27, 2001.
31
ProAssurance common stock began trading on the NYSE on June 28, 2001.
Because the NYSE considered the consolidation as the formation of a holding
company for Medical Assurance and a change of its corporate name, the quotations
below reflect prices for Medical Assurance common stock prior to June 28, 2001,
and for ProAssurance common stock from that date forward. All quotations reflect
trading on the NYSE.
QUARTER 2002 2001
- ------- -------------------- ------------------------
HIGH LOW HIGH LOW
------ ------ ------ ------
First $18.22 $15.99 $18.06 $12.00
Second 19.70 16.01 16.49 12.30
Third 18.00 14.20 19.13 14.50
Fourth 21.11 15.78 17.99 13.49
Neither Medical Assurance nor ProAssurance has paid any cash dividends
on its common stock and ProAssurance does not currently have a policy to pay
regular dividends. ProAssurance is limited in its ability to pay cash dividends
by certain covenants in its credit agreement with the banks that provided
financing for the consolidation. Generally, ProAssurance may not, without the
consent of the lending bankers, declare any cash dividends or repurchase its
stock if the total funds to be expended would exceed 25% of its cumulative net
income earned after June 27, 2001.
ProAssurance's insurance subsidiaries are subject to restrictions on
the payment of dividends to the parent. Information regarding restrictions on
the ability of the insurance subsidiaries to pay dividends is incorporated by
reference from the paragraphs under the caption "Regulation - Restrictions on
Dividends" in Item 1 on page 25 of this Form 10-K.
32
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
(in thousands, except per share amounts)
Gross premiums written(C) $ 636,156 $ 388,983 $ 223,871 $ 201,593 $ 192,479
Net premiums written 537,123 310,291 194,279 156,923 141,787
Premiums earned(C) 576,414 381,510 216,297 207,492 195,515
Premiums ceded(C) (99,006) (68,165) (38,701) (43,068) (54,199)
Net premiums earned(C) 477,408 313,345 177,596 164,424 141,316
Net investment income(C) 76,918 59,782 41,450 39,273 39,402
Net realized investment gains (losses) (5,306) 5,441 913 1,787 11,281
Other income(C) 6,747 3,987 2,630 2,545 1,604
Total revenues 555,767 382,555 222,589 208,029 193,603
Net losses and loss
adjustment expenses(C) 448,029 298,558 155,710 104,657 93,893
Income before cumulative effect of
accounting change(C) 10,513 12,450 24,300 46,700 48,523
Net income(A)(C)(D) 12,207 12,450 24,300 46,700 47,400
Income per share before cumulative
effect of accounting change(C)
Basic $ 0.40 $ 0.51 $ 1.04 $ 1.95 $ 1.96
Diluted $ 0.39 $ 0.51 $ 1.04 $ 1.95 $ 1.96
Net income per share:(B)(C)
Basic $ 0.47 $ 0.51 $ 1.04 $ 1.95 $ 1.92
Diluted $ 0.46 $ 0.51 $ 1.04 $ 1.95 $ 1.92
Weighted average number
of shares outstanding:(B)
Basic 26,231 24,263 23,291 23,992 24,729
Diluted 26,254 24,267 23,291 24,008 24,731
BALANCE SHEET DATA:
(as of December 31)
Total investments $1,679,497 $1,521,279 $ 796,526 $ 761,918 $ 791,579
Total assets 2,586,650 2,238,325 1,122,836 1,117,668 1,132,239
Reserve for losses and
loss adjustment expenses 1,622,468 1,442,341 659,659 665,792 660,640
Long-term debt 72,500 82,500 -- -- --
Total liabilities 2,055,086 1,802,606 777,669 791,944 808,059
Total capital 505,194 413,231 345,167 325,724 324,180
Total capital per share of
common stock outstanding(B) $ 17.49 $ 16.02 $ 15.22 $ 13.92 $ 13.24
Common stock outstanding
at end of year(B) 28,877 25,789 22,682 23,401 24,477
- ---------------
(A) Net income for 1998 was reduced by $1.1 million, which represents the
cumulative effect (net of tax) of an accounting change for guaranty
fund assessments due to the adoption of the American Institute of
Certified Public Accountants' Statement of Position 97-3. The
cumulative effect reduced net income per share of common stock (basic
and diluted) by $0.04 per share.
(B) The Board of Directors declared special stock dividends in December
1999 (5%) and 1998 (10%). All net income per share and total capital
per share data on this page has been restated as if the dividends had
been declared on January 1, 1998. Additionally, treasury stock is
excluded from the date of acquisition for purposes of determining the
weighted average number of shares outstanding used in the computation
of net income per share of common stock.
(C) Operating results include the operating results of Professionals Group
since the date of consolidation, June 27, 2001. See Note 2 to the
Consolidated Financial Statements.
(D) Net Income for the year ended December 31, 2002 was increased by $1.7
million due to the adoption of SFAS 141 and 142. See Note 10 to our
consolidated financial statements. In accordance with SFAS 142, we
wrote off the unamortized balance of deferred credits that related to
business combinations completed prior to July 1, 2001. The cumulative
effect increased net income per share (basic and diluted) by $0.07 per
share.
33
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES AND FINANCIAL CONDITION
We need liquid funds to pay losses and loss adjustment expenses (losses
and LAE) and operating expenses in the ordinary course of business and to meet
our debt service requirements. Cash provided by our operating activities was
sufficient to meet those needs in 2002, 2001 and 2000. We believe that our
operating activities will provide sufficient cash to meet our liquidity needs
during 2003.
During the fourth quarter of 2002, ProAssurance sold 3,025,000 shares
at $16.55 per share in a public offering that generated additional capital of
$46.5 million. As of December 31, 2002, we have increased the statutory surplus
of our professional liability segment by $36 million in support of the growth of
that segment and expect to use the remaining proceeds from the sale to support
additional growth of our professional liability insurance business and for
general corporate purposes.
Our positive cash flow from operations of $195 million plus the $46.5
million proceeds from the public offering are the principal reasons for the
$248.4 million increase during 2002 in our Invested Assets and Cash and Cash
Equivalents.
Our reserves for net losses and loss adjustment expenses (net of
amounts receivable from reinsurers) at December 31, 2002 increased approximately
$92.2 million over those at December 31, 2001. Substantially all of this
increase is in our professional liability segment, a "long tailed" business. A
characteristic of a "long tailed" business is that there is a long length of
time between the occurrence of an insured event and significant payment on that
event. Because of this characteristic, it is not unusual for reserves to
increase as our business increases.
At December 31, 2002 we have a term loan balance of $72.5 million
remaining from the $110 million that we borrowed in order to fund the cash
requirements of the consolidation with Professionals Group. We are required to
pay quarterly principal repayments of $2.5 million, and beginning in 2003, an
additional annual principal payment equal to the lower of either 50% of our
parent company only operating cash flow for the preceding year or $15 million.
We have made all quarterly payments on the loan, and we also made a $22.5
million optional prepayment in September 2001. The term loan bears interest at a
variable rate based on the London Interbank Offered Rate (LIBOR) or the bank's
base rate at our election. At December 31, 2002 the interest rate was 2.9%.
The credit agreement also provides for a revolving line of credit in
the amount of $40 million. The revolving line of credit is available for our
operating and working capital requirements. We have not borrowed any funds under
the line and expect to renew the line at the same or a greater amount of credit
when the line expires in May 2003.
The borrowings under the credit agreement are secured by a pledge of
the outstanding stock of all of our significant subsidiaries other than MEEMIC
Holdings and its subsidiaries. The credit agreement for the term loan, as is
customary for credit agreements of this size and nature, requires that
ProAssurance maintain certain financial standards, otherwise known as loan
covenants. As of December 31, 2002 we were in compliance with all loan
covenants.
34
See Notes 2 and 12 to our Consolidated Financial Statements for more
information regarding the consolidation transaction and the terms of the credit
agreement, including the financial covenants.
ProAssurance did not repurchase any shares of our common stock during
the year ended December 31, 2002. Our board has authorized stock repurchases of
up to approximately one million shares.
At December 31, 2002 ProAssurance indirectly owned 84% of MEEMIC
Holdings, Inc. On January 29, 2003 MEEMIC Holdings, the parent company of
MEEMIC Insurance Company, purchased all of the issued and outstanding shares
of its common stock, other than those held by ProAssurance's subsidiary,
ProNational Insurance Company (ProNational). MEEMIC Holdings used its internal
funds in the approximate amount of $34.1 million to acquire all of the
1,062,298 shares of its common stock not owned by ProNational, to pay for
outstanding options for 120,000 shares, and to pay the expenses of the
transactions. The funds were derived from MEEMIC Holdings' cash and investment
resources.
OVERVIEW
ProAssurance commenced operations on June 27, 2001 through a
transaction that joined Medical Assurance and Professionals Group as the wholly
owned subsidiaries of ProAssurance. The consolidation of Medical Assurance into
ProAssurance was in the form of a corporate reorganization and the assets,
liabilities, stockholders' equity and results of operations of Medical Assurance
are included in ProAssurance's consolidated financial statements for the
entirety of all periods presented. Prior to June 27, 2001 ProAssurance's
consolidated financial statements do not include the assets, liabilities or
results of operations of Professionals Group because the consolidation of
Professionals Group into ProAssurance was in the form of a purchase transaction.
For additional information about the consolidation, see Note 2 to the
Consolidated Financial Statements.
Segment Overview:
We operate in two industry segments: professional liability insurance
and personal lines insurance. Prior to the consolidation, we operated only in
the professional liability segment. Our operations have included a personal
lines segment since June 27, 2001, when MEEMIC Insurance Company was acquired as
a part of the Professionals Group consolidation transaction.
Our professional liability insurance segment principally provides
liability insurance and reinsurance for providers of health care services, and,
to a limited extent, providers of legal services. The principal operating
insurance subsidiaries of this segment are: The Medical Assurance Company, Inc.,
Medical Assurance of West Virginia, Inc, ProNational Insurance Company and Red
Mountain Casualty Insurance Company, Inc.
Our personal lines insurance segment provides personal property and
casualty insurance to individuals. Our personal lines segment includes the
operations of a single insurance company, MEEMIC Insurance Company.
All of our revenues and expenses are allocated to the operating
segments, other than investment income earned directly by the parent holding
company and interest expense related to long-term debt held by the parent.
35
CRITICAL ACCOUNTING POLICIES
We are required to make estimates and assumptions in certain
circumstances that affect amounts reported in our consolidated financial
statements and related footnotes. We evaluate these estimates and assumptions on
an on-going basis based on historical developments, market conditions, industry
trends and other information that we believe to be reasonable under the
circumstances. There can be no assurance that actual results will conform to our
estimates and assumptions, and that reported results of operations will not be
materially adversely affected from time to time by the need to make accounting
adjustments reflecting changes in these estimates and assumptions. We believe
the following policies are the most sensitive to estimates and judgments.
Premium Income: We recognize insurance premium income on a monthly pro
rata basis over the respective terms of the policies in force. Unearned premiums
represent the portion of premiums written applicable to the unexpired terms of
the policies in force.
Reserve for Losses and Loss Adjustment Expenses ("losses and LAE"): Our
reserve for losses and LAE represents our estimate of the future amounts
necessary to pay claims and expenses associated with investigation and
settlement of claims. These estimates consist of case reserves and bulk
reserves. Case reserves are estimates of future losses and LAE for reported
claims and are established by our claims departments. Bulk reserves, which
include a provision for losses that have occurred but have not been reported to
us as well as development on reported claims, are the difference between (i) the
sum of case reserves and paid losses and (ii) an actuarially determined estimate
of the total losses and LAE necessary for the ultimate settlement of all
reported claims and incurred but not reported claims, including amounts already
paid. The estimates take into consideration our past loss experience, available
industry data and projections as to future claims frequency, severity,
inflationary trends and settlement patterns. Independent actuaries review our
reserves for losses and LAE each year and prepare reports that include
recommendations as to the level of reserves. We consider these recommendations
as well as other factors, such as known, anticipated or estimated changes in
frequency and severity of claims and loss retention levels and premium rates, in
establishing the amount of our reserves for losses and loss adjustment expenses.
Estimating reserves is a complex process that is heavily dependent on judgment
and involves many uncertainties. This is particularly true of our professional
liability reserves since these claims are typically resolved over a long period
time, often exceeding five years. As a result, reserve estimates may vary
significantly from the eventual outcome. The assumptions used in establishing
our reserves are regularly reviewed and updated by management as new data
becomes available. Any adjustments necessary are reflected in current
operations. Due to the size of our reserves, even a small percentage adjustment
to the assumptions can have a material effect on our results of operations for
the period in which the change is made.
Reinsurance: Loss recoveries and receivables from reinsurers are
estimates of the ultimate amount of our losses and LAE that will be reimbursed
by reinsurers. We also estimate premiums ceded under reinsurance agreements that
provide wherein the premium, subject to certain maximums and minimums, due to
the reinsurer is a percentage of the losses paid under the agreement. These
estimates are based upon our estimates of the ultimate losses and LAE that we
expect to incur and the portion of those losses that we expect to be allocable
to reinsurers based upon the terms of our reinsurance agreements. Given the
uncertainty of the ultimate amounts of our losses and LAE, these estimates may
vary significantly from the eventual outcome. Our estimates of the amounts
receivable from and due to reinsurers are regularly reviewed and updated by
management as new data becomes available. Any adjustments necessary are
reflected in then current operations.
36
Investments: We consider our fixed maturity and equity securities as
available-for-sale, which means they are available to be sold in response to our
liquidity needs, changes in market interest rates and investment management
strategies, among others. Available-for-sale securities are recorded at fair
value, with unrealized gains and losses, net of the related income tax effect,
excluded from income and reported as a separate component of shareholders'
equity.
We evaluate the securities in our investment portfolio on at least a
quarterly basis for declines in market value below cost for the purpose of
determining whether these declines represent other than temporary declines. The
evaluation involves judgment by management. Some of the factors we consider in
the evaluation of our investments are:
- the extent to which the market value of the security is less
than its cost basis
- the length of time for which the market value of the security
has been less than its cost basis
- the financial condition and near-term prospects of the
security's issuer, taking into consideration the economic
prospects of the issuers' industry and geographical region, to
the extent that information is publicly available
- ProAssurance's ability and intent to hold the investment for a
period of time sufficient to allow for any anticipated
recovery in market value
A decline in the fair value of an available-for-sale security below
cost that we judge to be other than temporary is realized as a loss in the
current period and reduces the cost basis of the security. In subsequent
periods, we base any measurement of gain or loss or decline in value upon the
adjusted cost basis of the security.
37
RESULTS OF OPERATIONS--YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED
DECEMBER 31, 2001
Our consolidated income before cumulative effect of accounting change
is $10.5 million, or $0.40 per share, for the year ended December 31, 2002. The
operating results of each of our reportable industry segments are discussed
separately in the following sections.
The year ended December 31, 2002 includes Professionals Group activity
for the entire period, while the year ended December 31, 2001 includes
Professionals Group activity only since June 27, 2001. Thus, when the two
periods are compared, significant variances are created because 2001 operating
results do not include Professionals Group operating results for the first six
months of 2001.
Net income for 2002 was reduced by net realized investment losses of
$5.3 million while net income for 2001 was increased by net realized investment
gains of $5.4 million. During 2002, we recognized losses of $21.3 million for
other than temporary declines in the market value of our equity and fixed
maturity securities. Approximately $18.2 million of the impairment losses
related to our investments in common stock. Gains realized during 2002 from
sales of fixed maturity securities largely offset the impairment losses. We
purchase fixed maturity securities with the initial intent to hold such
securities until their maturity; however, we may dispose of securities prior to
their respective maturities if we believe such disposals are consistent with our
overall investment objectives, including maximizing total yields over time,
maximizing after-tax profits and disposing of securities that no longer meet our
risk management criteria. Throughout 2002 but particularly in the latter half of
2002, bond prices increased substantially, both in response to historically low
market interest rates and in response to uncertainty in the equity market. In
response to these market conditions, we undertook a significant restructuring of
our fixed maturity portfolio during the fourth quarter and sold $304.5 million
of fixed maturity securities for net gains of approximately $16.5 million. These
sales contributed to the shortening of our investment portfolio and reduced the
weighted average yield of our fixed maturity portfolio.
Interest expense of $2.9 million in 2002 and $2.6 million in 2001
relates entirely to the bank loan that provided financing for the consolidation
with Professionals Group. The debt bears interest at a variable rate based on
the London Interbank Offered Rate (LIBOR), or at our election, the bank's base
rate. The interest rate is 2.9% on December 31, 2002. We initially borrowed $110
million on June 27, 2001 to finance the consolidation. Because the cash
requirements of the consolidation were lower than we originally anticipated, we
made a $22.5 million prepayment on the loan in September 2001.
Interest expense increased during 2002 as compared to 2001 because
there was no outstanding loan balance for the first six months of 2001. The
increase was limited to approximately $284,000 because interest rates were lower
throughout 2002 as compared to 2001 and we repaid principal during 2002 as
required under the loan agreement.
We recognized tax benefits of $188,000 and $2.9 million for the years
ended December 31, 2002 and 2001, respectively. Our effective rate for both
years is significantly lower than the expected 35% statutory rate because
approximately 25% in 2002 and 37% in 2001 of our investment income was earned
from tax-exempt sources. After adjustment for tax-exempt income, we experienced
a taxable loss for the years ended December 31, 2002 and 2001.
38
Minority interest in both 2002 and 2001 relates entirely to the
minority interest in MEEMIC Holdings. This minority interest was purchased on
January 29, 2003 as discussed under "Liquidity and Capital Resources."
After adjustment for our tax liability for the year ended December 31,
2002, we have available approximately $10.1 million in Federal tax loss
carryforwards related to tax years ending on or before December 31, 2001 that
will expire in the year 2021. We also have available approximately $7.9 million
in Alternative Minimum tax carryforwards that can be applied against any future
regular tax payable. The Alternative Minimum tax carryforwards have no
expiration date.
PROFESSIONAL LIABILITY INSURANCE SEGMENT
Operating results for our professional liability insurance segment for
the years ended December 31, 2002 and 2001 are summarized in the table below
(dollars in thousands).
YEAR ENDED
DECEMBER 31
-----------------------------------------
INCREASE
2002 2001 (DECREASE)
-------- ------- ----------
Gross premiums written $461,715 315,698 $146,017
======== ======== ========
Net premiums written $376,702 238,867 $137,835
======== ======== ========
Revenues:
Premiums earned $412,656 310,222 $102,434
Premiums ceded 85,011 66,307 18,704
-------- -------- --------
Net premiums earned 327,645 243,915 83,730
Net investment income 66,790 54,339 12,451
Net realized investment
gains (losses) (6,099) 5,441 (11,540)
Other income 4,960 3,130 1,830
-------- -------- --------
Total revenues 393,296 306,825 86,471
Expenses:
Net losses and loss
adjustment expenses 351,320 250,257 101,063
Underwriting, acquisition
and insurance expenses 56,613 55,021 1,592
-------- -------- --------
Total expenses 407,933 305,278 102,655
-------- -------- --------
Income (loss)
before income taxes $(14,637) $ 1,547 $(16,184)
======== ======== ========
Net loss and LAE ratio 107.2% 102.6% 4.6%
Underwriting expense ratio 17.3% 22.6% (5.3)%
-------- -------- --------
Combined ratio 124.5% 125.2% (0.7)%
======== ======== ========
DECEMBER 31
---------------------------
2002 2001
---------- ----------
Net reserves for loss and LAE $1,096,205 $1,004,462
========== ==========
39
PREMIUMS
Premiums written:
Our professional liability insurance segment principally provides
liability insurance for providers of medical and other healthcare services, and
to a limited extent providers of legal services (Professional Coverages). The
professional liability segment also includes accident and health and workers'
compensation insurance (Other Coverages).
Premiums written for the professional liability segment for the year
ended December 31, 2002 were $461.7 million, which is an increase of $146.0
million as compared to the same period of 2001. This increase is comprised of a
$184.7 million increase related to Professional Coverages offset by a $38.7
million decrease related to Other Coverages.
Professional Coverages premiums written increased to $457.2 million for
the year ended December 31, 2002. The increase is primarily due to the
consolidation with Professionals Group but also reflects the beneficial effect
of rate increases implemented during 2002 and 2001. We have implemented and we
plan to continue to implement rate increases based on loss trends, subject to
our receipt of regulatory approval. We have experienced some loss of insureds
due to the higher rates. However, to date, our premium renewals and new business
at the higher rates have more than offset the effect of non-renewals. We
estimate that, on average, 2002 renewals were at rates that were approximately
28% higher than 2001 rates.
Gross written premiums for Other Coverages were approximately $4.5
million for the year ended December 31, 2002 as compared to $43.2 million for
the same period in 2001. Our Other Coverages premiums were primarily written in
conjunction with and through third parties as a means of utilizing our capital.
During the latter half of 2000 we decided to significantly decrease our
commitment to these programs and have since allowed existing contractual
relationships to expire. The decline in Other Coverages premiums is the expected
result of this decision.
Premiums earned:
Premiums earned for the year ended December 31, 2002 increased by
$102.4 million as compared to the year ended December 31, 2001. As with written
premiums, this increase is comprised of an increase related to Professional
Coverages offset by a decrease related to Other Coverages.
Our Professional Coverages premiums earned for the year ended December
31, 2002 increased by $139.4 million to $404.0 million. The increase is
primarily due to the additional premiums earned as a result of the consolidation
but, as with written premiums, also reflects the beneficial impact of rate
increases. Rate increases implemented after January 1, 2002 have not yet been
fully reflected in premiums earned since premiums are earned over the entire
policy period (usually one year) after the policy is written.
Other Coverages premiums earned for the year ended December 31, 2002
were $8.7 million, a decrease of $37.0 million as compared to the year ended
December 31, 2001, reflecting our decreased commitments to the programs that
generated these premiums, as previously discussed. We do not expect to earn any
significant amount of Other Coverage premiums in 2003.
40
Premiums ceded:
Premiums ceded for the year ended December 31, 2002 increased by $18.7
million as compared to the year ended December 31, 2001. The increase is
comprised of a $23.4 million increase related to Professional Coverages offset
by a $4.7 million decrease related to Other Coverages.
Professional Coverages premiums ceded were $78.4 million for the year
ended December 31, 2002. The primary reasons for the increase are the growth in
premiums earned that resulted from the consolidation with Professionals Group
and rate increases.
Other Coverages premiums ceded were $6.6 million for the year ended
December 31, 2002, reflecting the decline in related earned premiums, as
previously discussed.
LOSSES AND LOSS ADJUSTMENT EXPENSES
As discussed in our critical accounting policies, our reserve for
losses and loss adjustment expenses represents our estimate of the future
amounts necessary to pay claims and expenses associated with investigation and
settlement of claims. The resulting net losses and loss adjustment expenses
(hereafter referred to as "net losses") may be summarized into three components
of these estimates: (i) actuarial evaluation of incurred loss levels for the
current accident year; (ii) actuarial re-evaluation of incurred loss levels for
prior accident years and (iii) actuarial re-evaluation of the reserve for the
death, disability and retirement provision.
Accident year refers to the period in which the insured event becomes a
liability of the insurer. For occurrence policies the insured event becomes a
liability when the event takes place; for claims - made policies the insured
event becomes a liability when the event is first reported to the insurer. We
believe that measuring losses on an accident year basis is the most indicative
measure of the underlying profitability of the premiums earned in that period,
since it associates policy premiums earned with our estimate of the losses
incurred related to those policy premiums
41
The following table summarizes net losses and net loss ratios for 2002
and 2001 by type of coverage and by separating losses between the current
accident year and all prior years (dollars in thousands). The net loss ratios
shown are calculated by dividing the applicable net losses by current calendar
year net premiums earned.
Year ended
December 31
------------------------
2002 2001
-------- --------
Current accident year net losses
and LAE:
Professional Coverages $331,494 $231,489
Other Coverages 1,666 23,597
Change in prior accident
year net losses(1) 18,160 13,818
Change in death, disability and
retirement reserves -- (18,647)
-------- --------
Calendar year net losses $351,320 $250,257
======== ========
Current accident year net loss ratio:
Professional Coverages 101.8% 108.8%
Other Coverages 77.9% 75.9%
Net loss ratio attributable to:
Current accident year net losses 101.7% 104.6%
Prior accident year net losses 5.5% 5.7%
Change in death, disability
and retirement reserves -- (7.7)%
-------- --------
107.2% 102.6%
======== ========
- ---------------
(1) All losses incurred in 2001 related to the book of business acquired
from Professionals Group are considered to be current accident year
losses because there was no liability for these losses prior to the
consolidation transaction.
PROFESSIONAL COVERAGES
Current accident year net losses related to Professional Coverages for
the year ended December 31, 2002 increased by $100.0 million as compared to the
year ended December 31, 2001. Our consolidation with Professionals Group and the
resulting increase in premiums is the primary reason for the increase. The
current accident year net loss ratio for Professional Coverages for the year
ended December 31, 2002 as compared to the same period in 2001 has decreased
from 108.8% to 101.8%. The improvement in the loss ratio primarily reflects the
effects of a more adequate premium structure as a result of rate increases
implemented during 2002 and 2001.
OTHER COVERAGES
Current accident year net losses related to Other Coverages decreased
by $21.9 million year ended December 31, 2002 as compared to the same periods of
2001. The decrease resulted from the termination of the programs that generated
these losses, as previously discussed with respect to Other Coverages premiums.
42
PRIOR YEAR NET LOSSES/CHANGE IN DEATH, DISABILITY AND RETIREMENT RESERVES
We increased our estimates of professional liability prior accident
year net losses by $18.2 million during 2002. In 2001, we increased our
estimates of prior year losses by $13.8 million. In both periods, our estimates
of losses related to prior year were adjusted based upon actuarial evaluations
performed during the period.
In 2001, we decreased our estimate of the reserves required for death,
disability and retirement by $18.6 million. The decrease was primarily related
to the ProNational book of business and was principally the result of an
increase in the premium rate loads and a decrease in the number of insureds.
The assumptions used in establishing our reserves are regularly
reviewed and updated by management as new data becomes available. Any
adjustments necessary are reflected in current operations. Due to the size of
our reserves, even a small percentage adjustment to the assumptions can have a
material effect on our results of operations for the period in which the change
is made.
NET INVESTMENT INCOME
Our professional liability segment investment income is primarily
derived from the interest income earned by our fixed maturity securities but
also includes interest income from short-term and cash equivalent investments,
dividend income from equity securities, and rental income earned by our
commercial real estate holdings. Investment fees and expenses and real estate
expenses are deducted from investment income. Our net investment income for the
year ended December 31, 2002 increased by $12.5 million as compared to the same
period in 2001. The primary reason for the increase is the additional investment
income earned as a result of the consolidation with Professionals Group.
During 2002, we experienced a decline in overall investment yields as a
result of lower market interest rates, both short and long-term. Our investment
opportunities for new and matured funds have been at rates that are less
favorable than the rates available in recent years. Our average investment in
lower yielding short-term and overnight cash investments increased during 2002
due to a lack of more desirable long-term investment opportunities.
Additionally, as we have invested new and matured funds, we have utilized
shorter maturities. We believe a shorter, more liquid portfolio is currently
advantageous, even preferable, although such a strategy reduces current yields.
Interest income from fixed maturity investments comprised 93% of our
total investment income in 2002 and 88% of our total investment income in 2001.
The weighted average tax equivalent book yield (tax adjusted gross earnings
divided by the average quarterly ending book value) of our professional
liability segment fixed maturity investments was 6.1% for 2002 as compared to
6.6% for the year ended December 31, 2001. The weighted average tax equivalent
book yield of the securities in our fixed maturity portfolio at December 31,
2002 was 6.3%.
43
NET REALIZED INVESTMENT GAINS (LOSSES)
Net realized investment gains (losses) includes gains and losses
realized on sales of investment securities and realized losses for other than
temporary impairments in the fair value of investment securities, as shown in
the following table.
2002 2001
-------- ------
Net gains from sales $ 15,205 $5,850
Other than temporary impairment losses (21,304) (409)
-------- ------
Net realized investment gains (losses) $ (6,099) $5,441
======== ======
Approximately $18.2 million of the impairments recognized during 2002
were related to our equity securities; approximately $3.1 million of the
impairments were related to fixed maturity securities.
Approximately $14.7 million of our net gains from sales were from sales
of fixed maturity securities. We purchase fixed maturity securities with the
initial intent to hold such securities until their maturity, however, we may
dispose of securities prior to their respective maturities if we believe such
disposals are consistent with our overall investment objectives, including
maximizing total yields over time, maximizing after-tax profits and disposing of
securities that no longer meet our risk management criteria. Throughout 2002 but
particularly in the latter half of 2002, bond prices increased substantially,
both in response to historically low market interest rates and in response to
uncertainty in the equity market. In response to these market conditions we
undertook a significant restructuring of our fixed maturity portfolio during the
fourth quarter. Most of the gains recognized for 2002 resulted from these
restructuring activities.
UNDERWRITING, ACQUISITION AND INSURANCE EXPENSES
Underwriting, acquisition and insurance expenses increased by $1.6
million for the year ended December 31, 2002 as compared to the same period in
2001. Expenses related to Professional Coverages premiums earned increased by
$15.9 million, however, this increase was largely offset by a $14.3 million
decrease in expenses related to Other Coverages premiums earned. The increase in
Professional Coverages expenses primarily reflects the additional six months of
Professionals Group activity that is included in 2002. The decrease in Other
Coverages expenses is due to the termination of these programs as previously
discussed.
The underwriting expense ratio (underwriting, acquisition and insurance
expenses divided by net premiums earned) decreased as compared to 2001. The
ratio for the year ended December 31, 2002 is 17.3% as compared to 22.6% for the
same period in 2001. The decrease in Other Coverages acquisition costs discussed
above reduced the ratio by 3.5%. The remaining 1.8% decrease in the ratio is
primarily due to operating efficiencies realized in 2002 and the effect of rate
increases.
Guaranty fund assessments for the years ended December 31, 2002 and
2001 were approximately $1.9 million and $1.3 million, respectively. We are
required by most states to be a member of its insolvency or guaranty fund
association and, as such, must make payments to the association when so assessed
by the state. Such assessments can and do vary from year to year.
44
PERSONAL LINES INSURANCE SEGMENT
Our personal lines segment is comprised of the operations of a single
insurance company, MEEMIC Insurance Company, acquired on June 27, 2001 as a part
of the consolidation with Professionals Group. The year ended December 31,
2002 includes twelve months of MEEMIC operations while the year ended December
31, 2001 includes only six months of MEEMIC operations. Selected financial data
for our personal lines insurance segment is summarized in the table below
(dollars in thousands).
YEAR ENDED
DECEMBER 31
----------------------------------------
INCREASE
2002 2001 (DECREASE)
-------- ------- --------
Gross premiums written $174,441 $73,285 $101,156
======== ======= ========
Net premiums written $160,421 $71,424 $ 88,997
======== ======= ========
Revenues:
Premiums earned $163,758 $71,288 $ 92,470
Premiums ceded 13,995 1,858 12,137
-------- ------- --------
Net premiums earned 149,763 69,430 80,333
Net investment income 10,071 5,003 5,068
Net realized investment
gains (losses) 793 -- 793
Other income 1,787 857 930
-------- ------- --------
Total revenues 162,414 75,290 87,124
Expenses:
Net losses and loss
adjustment expenses 96,709 48,301 48,408
Underwriting, acquisition
and insurance expenses 34,640 15,416 19,224
-------- ------- --------
Total expenses 131,349 63,717 67,632
-------- ------- --------
Income (loss)
before income taxes
and minority interest $ 31,065 $11,573 $ 19,492
======== ======= ========
Net loss and LAE ratio 64.6% 69.6% (5.0)%
Underwriting expense ratio 23.1% 22.2% 0.9%
-------- ------- --------
Combined ratio 87.7% 91.8% (4.1)%
======== ======= ========
DECEMBER 31
---------------------
2002 2001
------- -------
Net reserves for loss and LAE $64,251 $63,823
======= =======
45
PREMIUMS
Premiums written:
Gross written premiums increased by $101.2 million to $174.4 million
for the year ended December 31, 2002 as compared to the year ended December 31,
2001. For all lines, the principal reason for the increase is the inclusion of
an additional six months of MEEMIC activity in 2002. Premiums by line of
business for each year are as follows (dollars in thousands):
YEAR ENDED DECEMBER 31
-------------------------------------------------
2002 2001
--------------------- --------------------
AMOUNT % AMOUNT %
-------- ----- ------- -----
Automobile $147,168 84.4% $62,422 85.2%
Homeowners 26,600 15.2% 10,637 14.5%
Boat, umbrella and other 673 0.4% 226 0.3%
-------- ----- ------- -----
$174,441 100.0% $73,285 100.0%
======== ===== ======= =====
Automobile premiums also increased due to growth in the number of
policyholders, an increase in the value of autos insured and an increase in the
MCCA mandatory statutory assessments that are passed through to automobile
policyholders. During 2002 the number of vehicles insured grew by approximately
4.5%.
Homeowner premiums also increased due to average rate increases of
approximately 20%, an increase in the value of homes insured and growth in the
number of policyholders. During 2002 the number of homes insured grew by
approximately 14.5%.
Premiums earned:
Premiums earned for the year ended December 31, 2002 increased by $92.5
million as compared to the year ended December 31, 2001. As with written
premiums, this increase is primarily due to the inclusion of an additional six
months of MEEMIC activity in 2002 but also increased due to the effects of rate
increases and growth in the number of insureds.
Premiums ceded:
Premiums ceded are the portion of our earned premiums due to reinsurers
in return for the transfer of a portion of our risk to them. Premiums ceded for
the year ended December 31, 2002 increased by $12.1 million as compared to the
year ended December 31, 2001. Approximately $11.2 million of this increase is
attributable to an increase in the premiums due to a single reinsurer, the MCCA.
The remainder of the increase is primarily attributable to the additional six
months of MEEMIC activity in 2002.
46
LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table summarizes personal lines net losses and net loss
ratios for 2002 and 2001 by separating losses between the current accident year
and all prior accident years (dollars in thousands). The net loss ratios shown
are calculated by dividing the applicable net losses by current calendar year
net premiums earned.
Year ended
December 31
------------------------
2002 2001
-------- -------
Net losses and LAE:
Current accident year $106,440 $48,301
Prior accident years (1) (9,731) --
-------- -------
Calendar year net losses and LAE $ 96,709 $48,301
======== =======
Net loss ratio attributable to:
Current accident year net losses and LAE 71.1% 69.6%
Prior accident year net losses and LAE (6.5)% --
-------- -------
Calendar year net loss ratio 64.6% 69.6%
======== =======
- ---------------
(1) All losses incurred in 2001 are considered to be current accident year
losses because there was no liability for personal lines losses prior
to the consolidation transaction.
Calendar year net losses and loss adjustment expenses increased from
$48.3 million for the year ended December 31, 2001 to $96.7 million for the year
ended December 31, 2002, an increase of $48.4 million. The principal reason for
the increase is the inclusion of an additional six months of MEEMIC activity in
2002. The 2002 current accident year net loss ratio (current accident year
losses divided by net earned premiums) is 71.1% and reflects decreases in both
the frequency and severity of auto liability claims and the positive effect of
mild weather conditions during 2002.
We reduced losses during 2002 by $9.7 million as a result of favorable
developments in our estimates of prior years' auto liability reserves. This was
primarily the result of lower-than-expected claims frequency, which is a
continuing result of the 1994 legislative tort reforms in the State of Michigan.
This legislation has had the effect of reducing frequency and shortening the
reporting pattern of claims. While the legislation became effective in 1996, the
effects were uncertain for several years and could be changed through additional
legislation or court decisions. We established initial reserves that considered
the various possible outcomes and recognize favorable results as they
materialize. Uncertainties inherent in the loss estimation process will
invariably cause differences in actual ultimate liabilities from estimates.
47
NET INVESTMENT INCOME
Our net investment income is comprised of the interest and dividend
income from our fixed maturity, short-term, cash equivalent and equity
investments, net of investment expenses. Net investment income increased by
approximately $5.1 million for the year ended December 31, 2002 as compared to
the year ended December 31, 2001, primarily because 2001 includes only six
months of personal lines activity.
Interest income from fixed maturity investments represents more than
86% of our net investment income. The tax equivalent book yield (tax adjusted
gross earnings divided by the average quarterly ending book value) of the
personal lines segment fixed maturity investments for the year ended December
31, 2002 is 6.1% as compared to 6.2% for the year ended December 31, 2001. The
average yield is reduced because market rates available for the investment of
new and matured funds were lower in 2002. The weighted average tax equivalent
book yield of the fixed maturity securities that we held at December 31, 2002
is 6.5%.
NET REALIZED INVESTMENT GAINS (LOSSES)
Net realized investment gains and losses for the year ended December
31, 2002 of $793,000 did not include any realized losses for other than
temporary impairments.
UNDERWRITING, ACQUISITION AND INSURANCE EXPENSES
Underwriting, acquisition and insurance expenses consist of normal,
recurring expenses such as commissions, salaries and other expenses.
Underwriting, acquisition and insurance expenses for the year ended December 31,
2002 were $34.6 million as compared to $15.4 million for the year ended
December 31, 2001. The increase is primarily due to the additional six months of
MEEMIC activity in 2002 but also is due to higher underwriting and acquisition
costs resulting from premium growth. The underwriting expense ratio
(underwriting, acquisition and insurance expenses divided by net premiums
earned) for the year ended December 31, 2002 was 23.1% as compared to 22.2% for
the year ended December 31, 2001. The increase in the ratio is primarily due
to an increase in our statutory and guaranty fund assessments in 2002.
Guaranty fund assessments total $331,000 in 2002; there were no
guaranty fund assessments in 2001.
48
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Our consolidated income before cumulative effect was $12.5 million, or
$0.51 per share, for the year ended December 31, 2001. The operating results of
our reportable industry segments are discussed separately in the following
discussion.
Interest expense for the year ended December 31, 2001 of $2.6 million
relates entirely to the term loan obtained in order to finance our consolidation
with Professionals Group. The debt bears interest at a variable rate based on
LIBOR or the bank's base rate. At December 31, 2001 the interest rate was 3.4%.
We recognized a tax benefit of $2.8 million for the year ended December
31, 2001 as compared to a tax expense of $4.0 million for the year ended
December 31, 2000. Our tax-exempt investment income is the primary reason that
our effective rates for both years are significantly lower than the expected
statutory rate of 35%. We earned tax-exempt investment income of approximately
$18.7 million in 2001 and $17.4 million in 2000. Because tax-exempt income is
not included as taxable income, we experienced a taxable loss for the year ended
December 31, 2001 as compared to taxable income for the year ended December 31,
2000.
49
PROFESSIONAL LIABILITY SEGMENT
We have summarized the operating results for our professional liability
segment for the years ended December 31, 2001 and 2000 in the table below.
YEAR ENDED
DECEMBER 31
-------------------------------------------
Increase
2001 2000 (Decrease)
--------- --------- ---------
Gross premiums written $ 315,698 $ 223,871 $ 91,827
========= ========= =========
Revenues:
Premiums earned $ 310,222 $ 216,297 $ 93,925
Premiums ceded (66,307) (38,701) (27,606)
--------- --------- ---------
Net premiums earned 243,915 177,596 66,319
Net investment income 54,339 41,450 12,889
Net realized investment
gains (losses) 5,441 913 4,528
Other income 3,130 2,630 500
--------- --------- ---------
Total revenues 306,825 222,589 84,236
Expenses:
Net losses and LAE 250,257 155,710 94,547
Underwriting, acquisition
and insurance expenses 55,021 38,579 16,442
--------- --------- ---------
Total expenses 305,278 194,289 110,989
--------- --------- ---------
Income
before income taxes $ 1,547 $ 28,300 $ (26,753)
========= ========= =========
Net loss and LAE ratio 102.6% 87.7% 14.9%
Underwriting expense ratio 22.6 21.7 0.9
--------- --------- ---------
Combined ratio 125.2% 109.4% 15.8%
========= ========= =========
PREMIUMS
Gross Premiums Written:
Professional liability segment gross premiums written for the year
ended December 31, 2001 increased by $91.8 million as compared to 2000. Our
consolidation with Professionals Group is the primary reason that our gross
premiums written increased. Our rate increases implemented during 2001 also
contributed to the increase.
We implemented rate increases on our Professional Coverages averaging
approximately 23% on 2001 renewals weighted by premium volume. We plan to
continue to implement rate increases based on loss trends, subject to
regulatory approval. To date, premiums renewed at the higher rates coupled with
new business have more than offset the effect of premiums lost due to decreased
retention of insureds. However, the higher rates may result in a greater loss
of insureds in future periods.
50
Premiums Earned:
As with gross premiums written, the increase in premiums earned for the
year ended December 31, 2001 as compared to 2000 is primarily attributable to
our consolidation with Professionals Group. The beneficial impact of rate
increases will be reflected in our financial results over time. Rate increases
implemented after January 1, 2001 have not yet been fully reflected in premiums
earned since premiums are earned over the entire policy period (usually one
year) after the policy is written.
Reinsurance premiums ceded are estimated based on the terms of the
respective reinsurance agreements. We continually review the estimated expense
and any adjustments that we believe necessary are included in current
operations. Several factors contributed to the increase in reinsurance premiums
ceded for 2001 as compared to 2000. The increase in premiums earned as a result
of the consolidation accounted for approximately 30% of the increase. During the
fourth quarter of 2000, we increased the amount of reinsurance coverage in
certain markets which resulted in more of our premiums earned being ceded to
reinsurers in 2001. Also, in 2001 more premiums were earned in markets where we
rely more heavily on reinsurance.
Net premiums earned for the years ended December 31, 2001, and 2000
include Other Coverages of approximately $38.8 million and $34.8 million,
respectively. We have historically written accident and health, workers
compensation and multi-line premiums from time to time as favorable
opportunities arose to utilize capital. During 2000 we decided to decrease our
commitment to these programs. However, we continued to write and earn premiums
for Other Coverages during 2001 and 2000 to honor existing contractual
relationships. Our premiums during 2001 reflect both volume increases and higher
rates charged on Other Coverages.
51
LOSSES AND LOSS ADJUSTMENT EXPENSES
Professional liability segment losses and loss adjustment expenses and
the related current accident year net loss and LAE ratio are summarized in the
following table.
YEAR ENDED
DECEMBER 31
---------------------------
2001 2000
---------- ---------
Incurred losses and LAE related to:
Current accident year $ 255,086 $ 178,210
Prior accident years 13,818 (12,500)
Change in death, disability and
retirement reserves (18,647) (10,000)
---------- ---------
Net incurred losses and LAE $ 250,257 $ 155,710
========== =========
Net loss and LAE ratio:
Current accident
year net loss ratio 104.6% 100.3%
Prior accident years ratio 5.7 (7.0)
Change in death, disability
and retirement reserves
ratio (7.7) (5.6)
---------- ---------
Total calendar year net loss
and LAE ratio 102.6% 87.7%
========== =========
During 2001, we recognized $13.8 million of additional net losses
related to prior accident years. This represented approximately 1.4% of our
December 31, 2001 professional liability segment net reserves of $1.0 billion.
In 2001, the $18.6 million decrease in our reserve for death, disability and
retirement is principally the result of an increase in premium rate loads and a
decrease in the number of insureds primarily related to the ProNational book of
business.
The current accident year net loss and LAE ratio in the table above is
calculated by dividing current accident year incurred losses by net premiums
earned. The principal reason for the increase in that ratio in 2001 is the
effect of the inclusion of Professionals Group's premiums and losses.
NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS (LOSSES)
Earnings on our professional liability segment investment portfolio
increased by $12.9 million as compared to the year ended December 31, 2000. The
increase is primarily due to the net increase in the investment portfolio as a
result of the consolidation with Professionals Group.
52
At December 31, 2001, our professional liability segment investment
portfolio of approximately $1.3 billion consisted of 78% taxable securities and
22% tax-exempt securities.
Net realized investment gains increased from approximately $900,000 in
2000 to $5.4 million in 2001. This increase primarily resulted from additional
sales of investment securities related to our efforts to restructure our
professional liability segment investment portfolio.
UNDERWRITING, ACQUISITION AND INSURANCE EXPENSES
Underwriting, acquisition and insurance expenses increased
approximately $16.4 million for the year ended December 31, 2001 as compared to
2000 due to our consolidation with Professionals Group. The underwriting expense
ratio also increased to 22.6% for 2001 as compared to 21.7% for 2000. The
increase in the ratio is primarily due to an increase in guaranty fund
assessments. The remaining increase is due to normal fluctuations in acquisition
expenses between years.
Guaranty fund assessments for the year ended December 31, 2001 were
$1.3 million. There were no significant guaranty fund charges in 2000. We are
required by most states to be a member of the state's insolvency or guaranty
fund association and, as such, we must make payments to the association when so
assessed by the state.
53
PERSONAL LINES SEGMENT
Our personal lines segment is comprised of the operations of a single
insurance company, MEEMIC Insurance Company, acquired on June 27, 2001.
Operating results for our personal lines segment for the six months ended
December 31, 2001 are summarized in the table below.
SIX MONTHS ENDED
DECEMBER 31
2001
----------------
Gross premiums written $ 73,285
========
Revenues:
Premiums earned $ 71,288
Premiums ceded (1,858)
--------
Net premiums earned 69,430
Net investment income 5,003
Net realized investment
gains (losses) --
Other income 857
--------
Total revenues 75,290
Expenses:
Net losses and LAE 48,301
Underwriting, acquisition
and insurance expenses 15,416
--------
Total expenses 63,717
--------
Income before income taxes and
minority interest $ 11,573
========
Net loss and LAE ratio 69.6%
Underwriting expense ratio 22.2
--------
Combined ratio 91.8%
========
PREMIUMS
Gross premiums written were $73.3 million and net premiums earned were
$69.4 million related to our personal lines segment for the six months ended
December 31, 2001. Gross premiums written for personal automobile coverage
represent approximately 85.2% of the total, and premiums from homeowners
coverage represent approximately 14.5% of the total.
54
LOSSES AND LOSS ADJUSTMENT EXPENSES
Net losses and LAE incurred related to our personal lines segment were
$48.3 million for the six months ended December 31, 2001. The incurred loss and
LAE ratio was 69.6% during the six months ended December 31, 2001.
NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS (LOSSES)
Our net investment income is comprised of the earnings on our personal
lines segment investment portfolio and totaled $5.1 million for the six months
ended December 31, 2001.
At December 31, 2001, our personal lines segment investment portfolio
consisted of 48% taxable securities and 52% tax-exempt securities. At December
31, 2001, the average yield of our personal lines segment fixed maturity
investments was 5.0%.
Net realized investment gains (losses) are insignificant during the six
months ended December 31, 2001.
UNDERWRITING, ACQUISITION AND INSURANCE EXPENSES
Underwriting, acquisition and insurance expenses related to our
personal lines segment were $15.4 million for the period ended December 31,
2001, consisting of normal, recurring expenses such as commissions, salaries and
other expenses. The underwriting expense ratio was 22.2% for the six months
ended December 31, 2001. No guaranty fund assessments were included in
underwriting, acquisition and insurance expenses in 2001.
55
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
We believe that we are principally exposed to three types of market
risk related to our investment operations. These risks are interest rate risk,
credit risk and equity price risk.
The term market risk refers to the risk of loss arising from adverse
changes in market rates and prices, such as interest rates, equity prices and
foreign currency exchange rates.
All market sensitive instruments discussed here relate to our
investment assets which are classified as available for sale.
As of December 31, 2002, our fair value investment in fixed income
securities was $1,329 million. These securities are subject primarily to
interest rate risk and credit risk. We have not and currently do not intend to
enter into derivative transactions.
Interest Rate Risk
- ------------------
Our fixed maturities portfolio is exposed to interest rate risk.
Fluctuations in interest rates have a direct impact on the market valuation of
these securities. As interest rates rise, market values of fixed income
portfolios fall and vice versa. We believe we are in a position to keep our
fixed income investments until maturity as we do not invest in fixed maturity
securities for trading purposes.
Portfolio Change in Modified
Interest Value Value Duration
Rates $ Millions $ Millions Years
------------------------- ---------- ---------- --------
200 basis point rise $ 1,227 $ (102) 4.31
100 basis point rise 1,281 (48) 4.00
Current rate* 1,329 -- 3.72
100 basis point decline 1,379 50 3.67
200 basis point decline 1,430 101 3.91
*Current rates are as of December 31, 2002.
At December 31, 2002, the fair value of our investment in preferred
stocks was $33.6 million, including net unrealized gains of $0.8 million.
Preferred stocks are primarily subject to interest rate risk because they bear a
fixed rate of return. The investments in the above table do not include
preferred stocks.
Computations of prospective effects of hypothetical interest rate
changes are based on numerous assumptions, including the maintenance of the
existing level and composition of fixed income security assets, and should not
be relied on as indicative of future results.
Certain shortcomings are inherent in the method of analysis presented
in the computation of the fair value of fixed rate instruments. Actual values
may differ from those projections presented should market conditions vary from
assumptions used in the calculation of the fair value of individual securities,
including non-parallel shifts in the term structure of interest rates and
changing individual issuer credit spreads.
56
Credit Risk
- -----------
We have exposure to credit risk primarily as a holder of fixed income
securities. We control this exposure by emphasizing investment grade credit
quality in the fixed income securities we purchase.
As of December 31, 2002, 99.4% of our fixed income portfolio consisted
of securities rated investment grade. We believe that this concentration in
investment grade securities reduces our exposure to credit risk in these fixed
income investments to an acceptable level. However, in the current environment
even investment grade securities can rapidly deteriorate and result in
significant losses.
Equity Price Risk
- -----------------
At December 31, 2002 the fair value of our investment in common
stocks, excluding preferred stocks as discussed in the preceding paragraphs, was
$46.5 million, which included net unrealized gains of $1.9 million. These
securities are subject to equity price risk, which is defined as the potential
for loss in market value due to a decline in equity prices. A hypothetical 10%
increase in the market prices as of December 31, 2002 would increase the fair
value of these securities to $51.2 million; a hypothetical 10% decrease in the
price of each of these marketable securities would reduce the fair value to
$41.9 million. The selected hypothetical change does not reflect what could be
considered the best or worst scenarios.
ProAssurance's cash and short-term investment portfolio at December
31, 2002 was on a cost basis which approximates its fair value. This portfolio
lacks significant market rate sensitivity due to its short duration.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Consolidated Financial Statements and Financial Statement Schedules
of ProAssurance Corporation and subsidiaries listed in Item 14(a) have been
included herein beginning on page 64. The Supplementary Financial Information
required by Item 302 of Regulation S-K is included in Note 17 of the Notes to
Consolidated Financial Statements of ProAssurance and its subsidiaries.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not Applicable.
57
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item regarding executive officers is
included in Part I of the Form 10K (Pages 29, 30 and 31) in accordance with
Instruction 3 of the Instructions to Paragraph (b) of Item 401 of Regulation
S-K.
The information required by this Item regarding directors is
incorporated by reference pursuant to General Instruction G (3) of Form 10K from
ProAssurance's definitive proxy statement for the 2003 Annual Meeting of its
Stockholders to be filed with the Securities and Exchange Commission pursuant to
Regulation 14A on or before April 30, 2003.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference
pursuant to General Instruction G (3) of Form 10K from ProAssurance's definitive
proxy statement for the 2003 Annual Meeting of its Stockholders to be filed with
the Securities and Exchange Commission pursuant to Regulation 14A on or before
April 30, 2003.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item is incorporated by reference
pursuant to General Instruction G (3) of Form 10K from ProAssurance's definitive
proxy statement for the 2003 Annual Meeting of its Stockholders to be filed with
the Securities and Exchange Commission pursuant to Regulation 14A on or before
April 30, 2003.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is incorporated by reference
pursuant to General Instruction G (3) of Form 10K from ProAssurance's definitive
proxy statement for the 2003 Annual Meeting of its Stockholders to be filed with
the Securities and Exchange Commission pursuant to Regulation 14A on or before
April 30, 2003.
ITEM 14. CONTROLS AND PROCEDURES
Under the supervision and with the participation of management,
including the Chief Executive Officer and Chief Financial Officer, the Company
has evaluated the effectiveness of the design and operation of our disclosure
controls and procedures within ninety (90) days of the filing of this Annual
Report on Form 10-K. Based on that evaluation, the Chief Executive Officer and
Chief Financial Officer have concluded that these controls and procedures are
effective. There were no significant changes in the internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation.
Disclosure controls and procedures are the Company's controls and
other procedures that are designed to ensure that information, required to be
disclosed by the Company in the reports that it files or submits under the
Exchange Act, is accumulated and communicated to management, including the
Chief Executive Officer and Chief Financial Officer, as appropriate, to allow
timely decisions regarding required disclosure.
58
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Financial Statements. The following consolidated financial statements
of ProAssurance Corporation and subsidiaries are included herein in
accordance with Item 8 of Part II of this report.
Report of Independent Auditors
Consolidated Balance Sheets - December 31, 2002 and 2001
Consolidated Statements of Changes in Capital - years ended
December 31, 2002, 2001 and 2000
Consolidated Statements of Income - years ended December 31,
2002, 2001 and 2000
Consolidated Statements of Cash Flows - years ended December
31, 2002, 2001 and 2000
Notes to Consolidated Financial Statements.
Financial Statement Schedules. The following consolidated financial
statement schedules of ProAssurance Corporation and subsidiaries are
included herein in accordance with Item 14(d):
Schedule I - Summary of Investments - Other than Investments
in Related Parties.
Schedule II - Condensed Financial Information of ProAssurance
Corporation.
Schedule III - Supplementary Insurance Information.
Schedule IV - Reinsurance.
Schedule VI - Supplementary Property and Casualty Insurance
Information.
All other schedules to the consolidated financial statements required
by Article 7 of Regulation S-X are not required under the related
instructions or are inapplicable and therefore have been omitted.
(b) The registrant filed a report on Form 8-K to report a news release
issued on October 11, 2002 in accordance with Rule 100 of
Regulation F-D.
(c) The exhibits required to be filed by Item 15(c) are listed herein in
the Exhibit Index.
59
SIGNATURES
Pursuant to the requirements of Section 13 of 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, on this the 21st day of
March 2003.
PROASSURANCE CORPORATION
By:/s/ A. Derrill Crowe, M.D.
--------------------------
A. Derrill Crowe, M.D.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Name Title Date
- ---- ----- ----
/s/A. Derrill Crowe, M.D. Chief Executive March 21, 2003
- --------------------------- Officer (principal
A. Derrill Crowe, M.D. executive officer)
and Director
/s/Howard H. Friedman Chief Financial March 21, 2003
- --------------------------- Officer (principal
Howard H. Friedman financial officer)
/s/James J. Morello Chief Accounting March 21, 2003
- --------------------------- Officer (principal
James J. Morello accounting officer)
/s/Victor T. Adamo, Esq. Director March 21, 2003
- ---------------------------
Victor T. Adamo, Esq.
/s/Paul R. Butrus Director March 21, 2003
- ---------------------------
Paul R. Butrus
/s/Lucian Bloodworth Director March 21, 2003
- ---------------------------
Lucian F. Bloodworth
/s/Robert E. Flowers, M.D. Director March 21, 2003
- ---------------------------
Robert E. Flowers, M.D.
/s/Leon C. Hamrick, M.D. Director March 21, 2003
- --------------------------
Leon C. Hamrick, M.D.
60
/s/John J. McMahon Director March 21, 2003
- ----------------------------
John J. McMahon, Jr., Esq.
/s/John P. North, Jr. Director March 21, 2003
- ----------------------------
John P. North, Jr.
/s/Ann F. Putallaz, Ph.D. Director March 21, 2003
- ----------------------------
Ann F. Putallaz, Ph.D.
Director March 21, 2003
- ----------------------------
William H. Woodhams, M.D.
61
CERTIFICATIONS
I, A. Derrill Crowe, certify that:
1. I have reviewed this annual report on Form 10-K of ProAssurance
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 21, 2003
/s/ A. Derrill Crowe, M.D.
--------------------------
A. Derrill Crowe, M.D.
Chief Executive Officer
62
CERTIFICATIONS
I, Howard H. Friedman, certify that:
1. I have reviewed this annual report on Form 10-K of ProAssurance
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 21, 2003
/s/Howard H. Friedman
-----------------------
Howard H. Friedman
Chief Financial Officer
63
ProAssurance Corporation and Subsidiaries
Consolidated Financial Statements
Years ended December 31, 2002, 2001 and 2000
CONTENTS
Report of Independent Auditors.......................... 65
Audited Consolidated Financial Statements
Consolidated Balance Sheets............................. 66
Consolidated Statements of Changes in Capital........... 68
Consolidated Statements of Income....................... 69
Consolidated Statements of Cash Flows................... 70
Notes to Consolidated Financial Statements.............. 71
64
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
ProAssurance Corporation
We have audited the accompanying consolidated balance sheets of ProAssurance
Corporation and subsidiaries (ProAssurance) as of December 31, 2002 and 2001,
and the related consolidated statements of changes in capital, income and cash
flows for each of the three years in the period ended December 31, 2002. Our
audits also included the financial statement schedules listed in the Index at
Item 14(a). These financial statements and schedules are the responsibility of
ProAssurance's management. Our responsibility is to express an opinion on these
financial statements and schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. 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 consolidated financial position of
ProAssurance Corporation and subsidiaries at December 31, 2002 and 2001, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States. Also, in our opinion, the
related financial statement schedules, when considered in relation to the basic
financial statements taken as a whole, present fairly in all material respects
the information set forth therein.
As discussed in Note 10 to the consolidated financial statements, in 2002
ProAssurance changed its method of accounting for goodwill.
Ernst & Young LLP
February 21, 2003
Birmingham, Alabama
65
PROASSURANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 31 December 31
2002 2001
----------- -----------
ASSETS
Investments:
Fixed maturities available for sale, at fair value $1,328,897 $1,281,779
Equity securities available for sale, at fair value 80,197 85,550
Real estate, net 17,549 17,936
Short-term investments 252,854 136,014
---------- ----------
Total investments 1,679,497 1,521,279
Cash and cash equivalents 143,306 53,163
Premiums receivable 111,028 77,766
Receivable from reinsurers on unpaid losses and loss
adjustment expenses 462,012 374,056
Prepaid reinsurance premiums 21,294 20,265
Deferred taxes 73,091 90,565
Other assets 96,422 101,231
---------- ----------
$2,586,650 $2,238,325
========== ==========
See accompanying notes.
66
PROASSURANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 31 December 31
2002 2001
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Policy liabilities and accruals:
Reserve for losses and loss adjustment expenses $ 1,622,468 $ 1,442,341
Unearned premiums 248,371 188,630
Reinsurance premiums payable 62,549 48,704
----------- -----------
Total policy liabilities 1,933,388 1,679,675
Other liabilities 49,198 40,431
Long-term debt 72,500 82,500
----------- -----------
Total liabilities 2,055,086 1,802,606
Minority interest 26,370 22,488
Commitments and contingencies -- --
Stockholders' equity:
Common stock, par value $0.01 per share
100,000,000 shares authorized;
28,998,917 and 25,911,234 shares
issued in 2002 and 2001, respectively 290 259
Additional paid-in capital 308,501 260,788
Accumulated other comprehensive gain, net of
deferred tax expense of $19,612 and $2,208, respectively 35,545 3,533
Retained earnings 160,914 148,707
----------- -----------
505,250 413,287
Less treasury stock at cost, 121,765 shares (56) (56)
----------- -----------
Total stockholders' equity 505,194 413,231
----------- -----------
$ 2,586,650 $ 2,238,325
=========== ===========
See accompanying notes.
67
PROASSURANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN CAPITAL
(IN THOUSANDS)
Accumu-
lated
Other
Compre-
Additional hensive
Common Paid-In Income Retained Treasury
Stock Capital (Loss) Earnings Stock Total
-------- ---------- -------- -------- -------- ---------
Balance at January 1, 2000 25,103 231,941 (5,424) 111,957 (37,853) 325,724
Common stock issued for compensation 4 58 -- -- -- 62
Purchase of treasury stock -- -- -- -- (9,557) (9,557)
Sale of treasury stock -- (11) -- -- 79 68
Comprehensive income:
Change in fair value of securities
available for sale, net of deferred taxes -- -- 4,570 -- --
Net income -- -- -- 24,300 --
Total comprehensive income 28,870
-------- --------- -------- -------- -------- ---------
Balance at December 31, 2000 25,107 231,988 (854) 136,257 (47,331) 345,167
Common stock issued for compensation 1 184 -- -- -- 185
Purchase of treasury stock -- -- -- -- (1,337) (1,337)
Retirement of treasury stock (2,405) (46,207) -- -- 48,612 --
Conversion of par value to $0.01 (22,476) 22,476 -- -- -- --
Equity issued in consolidation:
Common stock issued to Professionals
Group shareholders 32 49,378 -- -- -- 49,410
Fair value of options assumed -- 2,952 -- -- -- 2,952
Stock options exercised -- 17 -- -- -- 17
Comprehensive income:
Change in fair value of securities
available for sale, net of deferred
taxes and minority interest -- -- 4,387 -- -- --
Net income -- -- -- 12,450 -- --
Total comprehensive income 16,837
-------- --------- -------- -------- -------- ---------
Balance at December 31, 2001 259 260,788 3,533 148,707 (56) 413,231
Common stock issued for compensation -- 980 -- 980
Stock options exercised -- 265 -- 265
Offering of common stock 31 46,468 -- 46,499
Comprehensive income:
Change in fair value of securities
available for sale, net of deferred
taxes, reclassification adjustments
and minority interest -- -- 32,012 -- -- --
Net income -- -- -- 12,207 -- --
Total comprehensive income 44,219
-------- --------- -------- -------- -------- ---------
Balance at December 31, 2002 $ 290 $ 308,501 $ 35,545 $160,914 $ (56) $ 505,194
======== ========= ======== ======== ======== =========
*Cash was paid in lieu of fractional shares
See accompanying notes.
68
PROASSURANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Year Ended December 31
2002 2001 2000
--------- --------- ---------
Revenues:
Gross premiums written $ 636,156 $ 388,983 $ 223,871
========= ========= =========
Net premiums written $ 537,123 $ 310,291 $ 194,279
========= ========= =========
Premiums earned $ 576,414 $ 381,510 $ 216,297
Premiums ceded (99,006) (68,165) (38,701)
--------- --------- ---------
Net premiums earned 477,408 313,345 177,596
Net investment income 76,918 59,782 41,450
Net realized investment (losses) gains (5,306) 5,441 913
Other income 6,747 3,987 2,630
--------- --------- ---------
Total revenues 555,767 382,555 222,589
Expenses:
Losses and loss
adjustment expenses 569,099 344,202 190,458
Reinsurance recoveries (121,070) (45,644) (34,748)
--------- --------- ---------
Net losses and loss
adjustment expenses 448,029 298,558 155,710
Underwriting, acquisition
and insurance expenses 91,253 70,437 38,579
Interest expense 2,875 2,591 --
--------- --------- ---------
Total expenses 542,157 371,586 194,289
--------- --------- ---------
Income before income taxes, minority interest
and cumulative effect of accounting change 13,610 10,969 28,300
Provision for income taxes:
Current expense (benefit) (275) (4,567) 3,146
Deferred expense 87 1,720 854
--------- --------- ---------
(188) (2,847) 4,000
--------- --------- ---------
Income before minority interest and
cumulative effect of accounting change 13,798 13,816 24,300
Minority interest (3,285) (1,366) --
--------- --------- ---------
Income before cumulative effect of accounting
change 10,513 12,450 24,300
Cumulative effect of accounting change, net of tax 1,694 -- --
--------- --------- ---------
Net income $ 12,207 $ 12,450 $ 24,300
========= ========= =========
Basic earnings per share:
Income before cumulative effect of accounting
change $ 0.40 $ 0.51 $ 1.04
Cumulative effect of accounting change, net of tax 0.07 -- --
--------- --------- ---------
Net income $ 0.47 $ 0.51 $ 1.04
========= ========= =========
Diluted earnings per share:
Income before cumulative effect of accounting
change $ 0.39 $ 0.51 $ 1.04
Cumulative effect of accounting change, net of tax 0.07 -- --
--------- --------- ---------
Net income $ 0.46 $ 0.51 $ 1.04
========= ========= =========
Weighted average number
of common shares outstanding:
Basic 26,231 24,263 23,291
========= ========= =========
Diluted 26,254 24,267 23,291
========= ========= =========
See accompanying notes.
69
PROASSURANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Year Ended December 31
2002 2001 2000
--------- --------- ---------
OPERATING ACTIVITIES
Net income $ 12,207 $ 12,450 $ 24,300
Adjustments to reconcile net income
to net cash provided by
operating activities:
Depreciation 4,337 3,243 1,833
Amortization 10,707 8,603 4,499
Net realized capital gains 5,306 (5,441) (913)
Deferred income taxes 87 1,720 854
Policy acquisition costs deferred,
net of related amortization (7,241) 545 (2,542)
Other (812) (655) (544)
Changes in assets and liabilities, net of the effects
from the consolidation with Professionals Group:
Premiums receivable (32,963) 18,726 (1,656)
Receivable from reinsurers (87,956) (8,633) 13,306
Prepaid reinsurance premiums (1,029) (9,496) 12,959
Other assets, excluding capital purchases 8,275 4,109 (1,486)
Reserve for losses and loss
adjustment expenses 180,127 21,148 (6,133)
Unearned premiums 59,742 7,471 7,570
Reinsurance premiums payable 13,845 12,236 (7,672)
Other liabilities 9,044 (6,131) (8,040)
Minority interest in net income 3,285 1,366 --
--------- --------- ---------
Net cash provided by operating activities 176,961 61,261 36,335
INVESTING ACTIVITIES
Purchases of:
Fixed maturities available for sale (897,928) (656,101) (94,775)
Equity securities available for sale (25,932) (5,797) (50,799)
Proceeds from sale or maturities of:
Fixed maturities available for sale 900,641 681,219 143,715
Equity securities available for sale 20,235 25,286 11,048
Net decrease (increase) in short-term investments (116,841) (15,801) (38,428)
Cash used in consolidation,
net of cash acquired of $72,245 -- (124,059) --
Other (2,785) (3,666) (8,398)
--------- --------- ---------
Net cash used by investing activities (122,610) (98,919) (37,637)
FINANCING ACTIVITIES
Proceeds from stock issuance 46,499 -- --
Proceeds from long term debt -- 110,000 --
Repayment of debt (10,000) (27,500) --
Purchases of treasury stock -- (1,337) (9,557)
Other (707) 1,108 --
--------- --------- ---------
Net cash provided by (used by) financing activities 35,792 82,271 (9,557)
--------- --------- ---------
Increase (decrease) in cash and cash equivalents 90,143 44,613 (10,859)
Cash and cash equivalents at beginning of period 53,163 8,550 19,409
--------- --------- ---------
Cash and cash equivalents at end of period $ 143,306 $ 53,163 $ 8,550
========= ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Net cash (received) paid during the year for income taxes $ (8,884) $ 706 $ 1,929
========= ========= =========
Net cash paid during the year for interest $ 2,714 $ 2,442 $ --
========= ========= =========
See accompanying notes.
70
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
1. ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
ProAssurance Corporation (a Delaware corporation) and its subsidiaries
("ProAssurance"). All significant intercompany accounts and transactions between
consolidated companies have been eliminated.
BASIS OF PRESENTATION
The preparation of financial statements in accordance with accounting principles
generally accepted in the United States (GAAP) requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Certain reclassifications have been made to conform the 2001 financial
statements to the 2002 presentation. These changes had no effect on previously
reported results of operations or shareholders' equity.
The significant accounting policies followed by ProAssurance that materially
affect financial reporting are summarized in these notes to the consolidated
financial statements.
SEGMENT INFORMATION
ProAssurance operates in the United States of America and in two reportable
industry segments. As discussed in Note 3, the professional liability segment
principally provides professional and general liability insurance for providers
of health care services, and to a lesser extent, providers of legal services.
The personal lines segment provides private passenger automobile, homeowner,
boat, and umbrella insurance products primarily for educational employees and
their families exclusively in the state of Michigan.
INVESTMENTS
ProAssurance considers all fixed maturity and equity securities as
available-for-sale. Available-for-sale securities are carried at fair value, and
unrealized gains and losses on such available-for-sale securities are excluded
from earnings and reported, net of tax effect, in stockholders' equity as
"Accumulated other comprehensive income (loss)" until realized. ProAssurance
invests only in fixed income securities that are investment grade at the time of
purchase.
Investment income includes amortization of premium and accretion of discount
related to debt securities acquired at other than par value. Debt securities and
mandatorily redeemable preferred stock with maturities beyond one year when
purchased are classified as fixed maturities.
71
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31,2002
1. ACCOUNTING POLICIES (CONTINUED)
Fair values for fixed maturity and equity securities are based on quoted market
prices, where available. For fixed maturity and equity securities not actively
traded, fair values are estimated using values obtained from independent pricing
services. The carrying amounts reported in the balance sheet for cash and cash
equivalents and short-term investments approximate their fair values. Real
estate is reported at cost, less allowances for depreciation. Short-term
investments, primarily composed of investments in United States (U.S.) Treasury
obligations and commercial paper, are reported at cost, which approximates fair
value.
In accordance with Statement of Financial Accounting Standard (SFAS) No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," ProAssurance
evaluates its investment securities on at least a quarterly basis for declines
in market value below cost for the purpose of determining whether these declines
represent other than temporary declines. A decline in the fair value of an
available-for-sale security below cost judged to be other than temporary is
recognized as a loss in the then current period and reduces the cost basis of
the security. In subsequent periods, ProAssurance measures any gain or loss or
decline in value against the adjusted cost basis of the security. The following
factors are considered in determining whether an investment's decline is other
than temporary:
- the extent to which the market value of the security is less
than its cost basis
- the length of time for which the market value of the security
has been less than its cost basis
- the financial condition and near-term prospects of the
security's issuer, taking into consideration the economic
prospects of the issuers' industry and geographical region, to
the extent that information is publicly available
- ProAssurance's ability and intent to hold the investment for a
period of time sufficient to allow for any anticipated
recovery in market value.
REAL ESTATE
Property and certain leasehold improvements are classified as investment real
estate. All balances are stated on the basis of cost. Depreciation is computed
over their estimated useful lives using the straight-line method. Accumulated
depreciation was approximately $7.9 million and $6.9 million at December 31,
2002 and 2001, respectively. Rental income and expenses are included in net
investment income.
CASH AND CASH EQUIVALENTS
For purposes of the consolidated balance sheets and statements of cash flows,
ProAssurance considers all demand deposits and overnight investments to be cash
equivalents.
72
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31,2002
1. ACCOUNTING POLICIES (CONTINUED)
INTANGIBLE ASSETS
Intangible assets consist primarily of the excess of cost over the fair value of
net assets acquired (i.e., goodwill). In accordance with SFAS No. 142, "Goodwill
and Other Intangible Assets", goodwill can no longer be amortized. It must,
however, be tested annually for impairment. ProAssurance regularly reviews its
goodwill and other intangibles to determine if any adverse conditions exist that
could indicate impairment. Conditions that could trigger an impairment include,
but are not limited to, a significant adverse change in legal factors or
business climate that could affect the value of an asset or an adverse action or
assessment by a regulator. ProAssurance does not believe that any of its
recorded goodwill or intangible assets has suffered impairment.
REINSURANCE
Certain premiums are assumed from and ceded to other insurance companies under
various reinsurance agreements. ProAssurance cedes reinsurance to provide for
greater diversification of business, allow management to control exposure to
potential losses arising from large risks, and provide additional capacity for
growth. A significant portion of the reinsurance is effected under reinsurance
contracts known as treaties and, in some instances, by negotiation on individual
risks.
Reinsurance expense is estimated based on the terms of the respective
reinsurance agreements. The estimated expense is continually reviewed and any
adjustments which become necessary are included in current operations. Amounts
recoverable from reinsurers are estimated in a manner consistent with the loss
liability associated with the reinsured policies.
DEFERRED POLICY ACQUISITION COSTS
Costs that vary with and are directly related to the production of new and
renewal premiums (primarily premium taxes, commissions and underwriting
salaries) are deferred to the extent they are recoverable against unearned
premiums and are amortized as related premiums are earned.
RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The reserve for losses and loss adjustment expenses represents management's
estimates, using methods it considers reasonable and appropriate, of the
ultimate cost of all losses incurred but unpaid. The estimated liability is
continually reviewed, and any adjustments which become necessary, are included
in current operations.
RECOGNITION OF REVENUES
Insurance premiums are recognized as revenues pro rata over the terms of the
policies.
73
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31,2002
1. ACCOUNTING POLICIES (CONTINUED)
STOCK OPTIONS
As allowed by SFAS No. 123, "Accounting for Stock-Based Compensation,"
ProAssurance elected to continue use of Accounting Principles Board Opinion
(APB) No. 25 "Accounting for Stock Issued to Employees" to measure employee
stock compensation expense with pro forma disclosure of net income and earnings
per share determined as if the fair value method had been applied in measuring
compensation cost.
The fair value method of SFAS 123 measures stock-based compensation expense
based on the fair value of options on the date of grant. During 2002, the
ProAssurance granted 415,000 stock options; no stock options were granted in
2001 and 2000. Had ProAssurance's determined compensation expense for these
options using the fair value method of SFAS No. 123 net income would have been
reduced by $0.6 million, or $0.2 earnings per share (basic and diluted) in 2002.
There would be no effect on net income or earnings per share in 2000 or 2001.
The effect on net income for 2002 is not representative of the pro forma effect
on net income for future years because additional stock option awards could be
made in future years.
INCOME TAXES
ProAssurance files a consolidated federal income tax return. Deferred income
taxes are provided for temporary differences between financial and income tax
reporting relating primarily to unrealized gains on securities, discounting of
losses and loss adjustment expenses for income tax reporting, and the limitation
of the unearned premiums deduction for income tax reporting.
EARNINGS PER SHARE
Earnings per share is computed by dividing net income by the weighted average
number of shares of common stock outstanding during each year after giving
effect to stock dividends and treasury shares.
ACCOUNTING CHANGES
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.
141 "Business Combinations." SFAS No. 141 requires that the purchase method of
accounting be used for all business combinations with a closing date after June
30, 2001. The FASB has also issued SFAS No. 142 "Goodwill and Other Intangible
Assets," which is effective for fiscal years beginning after December 15, 2001.
See Note 10 for the effects of ProAssurance's adoption of SFAS Nos. 141 and 142.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure," which amends the disclosure
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS 148
became effective for financial statements for fiscal years ending after December
15, 2002. ProAssurance has adopted the provisions of SFAS 148.
74
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31,2002
2. CONSOLIDATION OF MEDICAL ASSURANCE AND PROFESSIONALS GROUP
ProAssurance Corporation began operations on June 27, 2001 in a transaction
referred to hereafter as the consolidation ("consolidation").
The consolidation of Medical Assurance, Inc. into ProAssurance was in the form
of a corporate reorganization and was treated in a manner similar to a pooling
of interests. Upon consummation of the consolidation, each outstanding share of
Medical Assurance common stock, par value $1.00 per share, was converted into
one share of ProAssurance common stock, par value $0.01 per share. Approximately
22.6 million ProAssurance shares were issued to Medical Assurance shareholders.
The consolidation of Professionals Group, Inc. into ProAssurance was treated as
a purchase transaction. Each outstanding share of Professionals Group common
stock was converted into the right to receive, at the holder's election, either
(a) 0.897 of a share of ProAssurance common stock plus $13.47 in cash, or (b)
$27.47 in cash. Aggregate consideration paid to the Professionals Group
shareholders consisted of approximately $196 million in cash and 3.2 million
shares of ProAssurance common stock, valued at approximately $50 million. The
fair value of ProAssurance shares issued was $15.59 per share based on the
average Medical Assurance common stock price for a few days prior to June 27,
2001. ProAssurance funded the cash requirements of the consolidation with the
proceeds of a $110 million term loan facility (see Note 12) and with internal
funds generated from dividends paid to ProAssurance by Medical Assurance and
Professionals Group at the time of closing.
The total cost of the purchase transaction of approximately $252 million has
been allocated to the assets acquired and the liabilities assumed based on
estimates of their respective fair values. The estimated fair value of
identifiable assets acquired totaled $1,165 million and the estimated fair value
of the liabilities assumed totaled $931 million. The estimated excess of the
total cost of the acquisition over the fair value of net assets acquired of
approximately $18.4 million was recorded as goodwill.
The preliminary fair value of Professionals Group's reserves for losses and loss
adjustment expenses and related reinsurance recoverables was estimated based on
the present value of the expected underlying cash flows of the loss reserves and
reinsurance recoverables and includes a risk premium and a profit margin. In
determining the preliminary fair value estimate, management discounted
Professionals Group's historical GAAP undiscounted net loss reserves to present
value assuming a 5% discount rate, which approximated the current U.S. Treasury
rate at the date of the consolidation. The discounting pattern was actuarially
developed from Professionals Group's historical loss data. An expected profit
margin of 5% was applied to the discounted loss reserves, which is consistent
with management's understanding of the returns anticipated by the reinsurance
market (the reinsurance market representing a willing party in the purchase of
loss reserves). Additionally, for the professional liability loss reserves of
Professionals Group, an estimated risk premium of 5% was applied to the
discounted reserves, which is deemed to be reasonable and consistent with
expectations in the marketplace given the long-tail nature and the related high
degree of uncertainty of such reserves. For the personal lines loss reserves
(homeowners and automobile) of Professionals Group, an estimated risk premium of
2% was applied to discounted loss reserves as such reserves develop over a much
shorter period of time and, generally, are less volatile than professional
liability reserves. ProAssurance has not recognized any adjustments to that
preliminary fair value.
75
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
2. CONSOLIDATION OF MEDICAL ASSURANCE AND PROFESSIONALS GROUP (CONTINUED)
ProAssurance was required to incorporate Professionals Group's activity
commencing upon the effective date of the acquisition. The unaudited pro forma
information below presents combined results of operations as if the acquisition
had occurred on January 1, 2001 after giving effect to certain adjustments,
including increased interest expense on debt related to the acquisition and
lower investment income due to cash used to fund a portion of the consolidation,
and related tax effects. Professionals Group's nonrecurring and transaction
related expenses were excluded from the pro forma financial information. The
unaudited pro forma information is not necessarily indicative of the results of
operations of the combined company had the acquisition occurred at the beginning
of the periods presented, nor is it necessarily indicative of future results (in
thousands, except per share data).
ProForma Results
Year Ended
December 31, 2001
-----------------
Revenues $ 533,310
==========
Net loss $ (4,992)
==========
Net loss per share:
Basic and diluted $ (0.18)
==========
76
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
3. SEGMENT INFORMATION
ProAssurance operates in the United States of America and, prior to the
consolidation, operated in only one reportable industry segment, the
professional liability insurance segment, that principally provides professional
liability insurance and reinsurance for providers of health care services, and
to a limited extent providers of legal services. The professional liability
segment includes the operating results of four significant insurance companies:
The Medical Assurance Company, Inc. ("MA-Alabama"), Medical Assurance of West
Virginia ("MA-West Virginia"), Inc., ProNational Insurance Company
("ProNational"), and Red Mountain Casualty Insurance Company, Inc. ("Red
Mountain").
As a result of the consolidation, ProAssurance is now engaged in an additional
segment, which is providing personal property and casualty insurance to
individuals (the personal lines segment). At December 31, 2002, ProAssurance
owned 84% of the stock of MEEMIC Holdings, Inc. ("MEEMIC Holdings"), a publicly
traded insurance holding company that provides personal auto, homeowners, boat
and umbrella coverages primarily to educational employees and their families
through its wholly-owned subsidiary, MEEMIC Insurance Company ("MEEMIC"). As
discussed in Note 18 of the Consolidated Financial Statements, ProAssurance
increased its ownership percentage of MEEMIC Holdings to 100% in January 2003.
The accounting policies of each segment are consistent with those described in
the basis of presentation footnote of ProAssurance's consolidated financial
statements. Identifiable assets of ProAssurance are primarily cash and
marketable securities. Other than cash and marketable securities owned directly
by the parent company, the identifiable assets of ProAssurance are allocated to
the reportable operating segments. Other than investment income earned directly
by the parent company and interest expense related to long-term debt held by the
parent company, all revenues and expenses of ProAssurance are allocated to the
operating segments for purposes of SFAS No. 131, Disclosures about Segments of
an Enterprise and Related Information. Revenue is primarily from unaffiliated
customers and the effect of transactions between segments has been eliminated.
77
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
3. SEGMENT INFORMATION (CONTINUED)
The table below provides a reconciliation of segment information to total
consolidated information (in millions).
Year ended
December 31
-------------------------------
2002 2001
-------- ----------
Revenues:
Professional liability lines $ 393.3 $ 306.8
Personal lines 162.4 75.3
Corporate investment income 0.1 0.5
-------- ---------
Total revenues $ 555.8 $ 382.6
======== =========
Income (loss) before cumulative
effect of accounting change:
Professional liability lines $ (6.3) $ 6.8
Personal lines 18.6 7.1
Corporate (1.8) (1.4)
-------- ---------
Total $ 10.5 $ 12.5
======== =========
Net income (loss):
Professional liability lines $ (4.6) $ 6.8
Personal lines 18.6 7.1
Corporate (1.8) (1.4)
-------- ---------
Total net income (loss) $ 12.2 $ 12.5
======== =========
Year ended
December 31
-------------------------------
2002 2001
-------- ----------
Identifiable assets:
Professional liability lines $2,184.6 $ 1,913.5
Personal lines 372.1 324.7
Corporate 30.0 0.1
-------- ----------
Total assets $2,586.7 $ 2,238.3
======== ==========
78
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
4. INVESTMENTS
The amortized cost and estimated fair value of fixed maturities and equity
securities (in thousands) are as follows:
DECEMBER 31, 2002
--------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
---------- ---------- ----------- ----------
U. S. Treasury securities $ 234,745 $ 6,454 $ (19) $ 241,180
State and municipal bonds 399,899 17,370 (481) 416,788
Corporate bonds 442,653 25,260 (1,737) 466,176
Asset-backed securities 197,638 6,612 (67) 204,183
Certificates of deposit 570 -- -- 570
---------- -------- ----------- ----------
1,275,505 55,696 (2,304) 1,328,897
Equity securities 77,556 4,401 (1,760) 80,197
---------- -------- ----------- ----------
$1,353,061 $ 60,097 $ (4,064) $1,409,094
========== ======== =========== ==========
DECEMBER 31, 2001
--------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
---------- ---------- ----------- ----------
U. S. Treasury securities $ 58,768 $ 905 $ (249) $ 59,424
State and municipal bonds 407,738 5,410 (2,149) 410,999
Corporate bonds 423,143 9,853 (2,508) 430,488
Asset-backed securities 379,817 4,079 (3,598) 380,298
Certificates of deposit 570 -- -- 570
---------- -------- ----------- ----------
1,270,036 20,247 (8,504) 1,281,779
Equity securities 90,985 5,080 (10,515) 85,550
---------- -------- ----------- ----------
$1,361,021 $ 25,327 $ (19,019) $1,367,329
========== ======== =========== ==========
79
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
4. INVESTMENTS (CONTINUED)
The amortized cost and estimated fair value of fixed maturities (in thousands)
at December 31, 2002, 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. ProAssurance uses the call date as the contractual maturity for
prerefunded state and municipal bonds which are 100% backed by U.S. Treasury
obligations.
ESTIMATED
AMORTIZED FAIR
COST VALUE
---------- ----------
Due in one year or less $ 49,189 $ 49,993
Due after one year through five years 349,006 361,789
Due after five years through ten years 372,554 395,162
Due after ten years 307,118 317,770
Asset-backed securities 197,638 204,183
---------- ----------
$1,275,505 $1,328,897
========== ==========
Excluding investments in bonds and notes of the U.S. Government, a U.S.
Government agency, or prerefunded state and municipal bonds which are 100%
backed by U.S. Treasury obligations, no investment in any person or its
affiliates exceeded 10% of stockholders' equity at December 31, 2002.
Amounts of investment income by investment category (in thousands) are as
follows:
Year ended December 31
2002 2001 2000
-------- -------- --------
Fixed maturities $ 73,008 $ 52,419 $ 34,370
Equities 3,435 3,062 3,408
Real estate 1,428 1,496 1,472
Short-term investments 2,922 4,786 3,961
Other 174 1,237 852
-------- -------- --------
80,967 63,000 44,063
Investment expenses (4,049) (3,218) (2,613)
-------- -------- --------
Net investment income $ 76,918 $ 59,782 $ 41,450
======== ======== ========
80
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
4. INVESTMENTS (CONTINUED)
Net realized investment gains and losses, including other than temporary
impairments, are as follows (in thousands):
Year ended December 31
2002 2001 2000
-------- ------- -------
Gross gains $ 26,040 $ 8,619 $ 3,542
Gross losses (10,042) (2,769) (2,629)
Other than temporary impairments (21,304) (409) --
-------- ------- -------
Net realized investment (losses) gains $ (5,306) $ 5,441 $ 913
======== ======= =======
The above gains and losses are primarily derived from sales of investment
securities and impairments. These realized gains and losses, net of related tax
expense (benefit) of ($1.9) million, $1.9 million, and $0.3 million,
respectively, were reclassified from "Accumulated other comprehensive income
(loss)" included in stockholders' equity to "Net realized investment gains
(losses)" in the Consolidated Statements of Income.
Proceeds from sales (excluding maturities and paydowns) of available-for-sale
securities were $646.4 million, $565.3 million and $108.5 million during 2002,
2001, and 2000, respectively.
At December 31, 2002 ProAssurance had investment securities with a carrying
value of $11.8 million on deposit with various state insurance departments to
meet regulatory requirements.
5. REINSURANCE
ProAssurance has various quota share, excess of loss assumption, and
cession reinsurance agreements. ProAssurance generally retains the risk for
losses between $250,000 and $1 million. ProAssurance reinsures individual risks
above the maximum limits of its reinsurance treaties on a facultative basis
whereby the reinsurer agrees to insure a particular risk up to a designated
limit.
The effect of reinsurance on premiums written and earned (in thousands) is as
follows:
2002 2001 2000
Premiums Premiums Premiums
Written Earned Written Earned Written Earned
--------- --------- --------- --------- --------- ---------
Direct $ 634,142 $ 573,423 $ 368,804 $ 358,183 $ 195,915 $ 190,664
Assumed 2,014 2,991 20,179 23,327 27,956 25,633
Ceded (99,033) (99,006) (78,692) (68,165) (29,592) (38,701)
--------- --------- --------- --------- --------- ---------
Net Premiums $ 537,123 $ 477,408 $ 310,291 $ 313,345 $ 194,279 $ 177,596
========= ========= ========= ========= ========= =========
81
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
5. REINSURANCE (CONTINUED)
Reinsurance contracts do not relieve ProAssurance from its obligations to
policyholders. A contingent liability exists with respect to reinsurance ceded
to the extent that any reinsurer does not meet the obligations assumed under
the reinsurance agreements. ProAssurance continually monitors its reinsurers to
minimize its exposure to significant losses from reinsurer insolvencies.
At December 31, 2002, all reinsurance recoverables are considered collectible;
the amounts as shown in the accompanying consolidated balance sheets
approximate the fair value of the amounts recoverable from reinsurers. As
required by the various state insurance laws, reinsurance recoverables totaling
approximately $12.7 million are collateralized by letters of credit or funds
withheld.
At December 31, 2002 amounts due from individual reinsurers that exceed 5% of
stockholders' equity are as follows (amounts in millions):
Amount Due
REINSURER From Reinsurer
--------------
Michigan Catastrophic Claims Association $56.8
Hannover Ruckversicherungs Ag $51.9
PMA Capital Insurance Company $35.2
General Reinsurance Corp $34.1
Continental Casualty Company $31.1
Gerling Global Reins Corp $28.3
6. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the amount of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Significant components of
ProAssurance's deferred tax liabilities and assets (in thousands) are as
follows:
82
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
6. INCOME TAXES (CONTINUED)
December 31
2002 2001
-------- --------
Deferred tax liabilities:
Deferred acquisition costs $ 7,727 $ 5,420
Unrealized gains on investments, net 19,612 2,208
Other -- 4,055
-------- --------
Total deferred tax liabilities 27,339 11,683
-------- --------
Deferred tax assets:
Unpaid loss discount 60,737 56,502
Unearned premium adjustment 17,266 12,836
Net operating losses 3,526 20,093
Alternative minimum tax credits 7,894 2,448
Tax basis in intangibles 10,337 10,369
Other 670 --
-------- --------
Total deferred tax assets 100,430 102,248
-------- --------
Net deferred tax assets $ 73,091 $ 90,565
======== ========
In the opinion of management, it is more likely than not that ProAssurance will
realize the benefit of the deferred tax assets, and therefore, no valuation
allowance has been established.
83
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
6. INCOME TAXES (CONTINUED)
A reconciliation of "expected" income tax expense (35% of income before income
taxes) to actual income tax expense in the accompanying financial statements
(in thousands) follows:
Year ended December 31
2002 2001 2000
------- ------- -------
Computed "expected" tax expense $ 4,764 $ 3,839 $ 9,905
Tax-exempt municipal and state bond income (5,757) (6,544) (6,082)
Other 805 (142) 177
------- ------- -------
Total $ (188) $(2,847) $ 4,000
======= ======= =======
ProAssurance, after adjustment for its tax liability for the year ended December
31, 2002, has available approximately $10.1 million in Federal tax loss
carryforwards that will expire in the year 2021 and approximately $7.9 million
in Alternative Minimum tax credit carryforwards that can be applied against any
future regular tax payable. The Alternative Minimum tax credit carryforwards
have no expiration date.
7. DEFERRED POLICY ACQUISITION COSTS
Underwriting and insurance costs directly related to the production of new and
renewal premiums are considered as acquisition costs and are capitalized and
amortized to expense over the period in which the related premiums are earned.
As is common practice within the industry, reinsurance ceding commissions due
ProAssurance are considered as a reduction of acquisition costs, and therefore
reduce the total amount capitalized.
Amortization of deferred acquisition costs amounted to approximately $41.8
million, $37.8 million, and $21.1 million for the years ended December 31,
2002, 2001 and 2000, respectively. Unamortized deferred acquisition costs are
included in other assets on the consolidated balance sheets and amounted to
approximately $22.7 million and $15.5 million at December 31, 2002 and 2001,
respectively.
8. RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
ProAssurance establishes reserves based on its estimates of the future amounts
necessary to pay claims and expenses associated with investigation and
settlement of claims. These estimates consist of case reserves and bulk
reserves. Case reserves are estimates of future losses and loss adjustment
expenses ("losses and LAE") for reported claims and are established by
ProAssurance's claims department. Bulk reserves, which include a provision for
losses that have occurred but have not been reported to ProAssurance as well as
development on reported claims, are the difference between (i) the sum of case
reserves and paid losses and (ii) an actuarially determined estimate of the
total losses and LAE necessary for the ultimate settlement of all reported
claims and incurred but not reported claims, including amounts already paid.
84
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
8. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES (CONTINUED)
Losses and LAE reserves are determined on the basis of individual claims and
actuarially determined estimates of future losses based on ProAssurance's past
loss experience, available industry data and projections as to future claims
frequency, severity, inflationary trends and settlement patterns. Estimating
reserves, especially professional liability reserves, is a complex process which
is heavily dependent on judgment and involves many uncertainties. As a result,
reserve estimates may vary significantly from the eventual outcome. The
assumptions used in establishing ProAssurance's reserves are regularly reviewed
and updated by management as new data becomes available. Any adjustments
necessary are reflected in current operations.
ProAssurance believes that the methods it uses to establish reserves are
reasonable and appropriate. Each year, ProAssurance obtains an independent
actuarial review of the reserves for losses and LAE of each insurance
subsidiary. The independent actuaries prepare reports that include
recommendations as to the level of reserves. ProAssurance considers these
recommendations as well as other factors, such as known, anticipated or
estimated changes in frequency and severity of claims and loss retention levels
and premium rates, in establishing the amount of its reserves for losses and
LAE. The statutory filings of each insurance company with the insurance
regulators must be accompanied by an actuary's certification as to their
respective reserves in accordance with the requirements of the National
Association of Insurance Commissioners (NAIC).
85
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
8. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES (CONTINUED)
Activity in the reserve for losses and loss adjustment expenses (reserves) is
summarized as follows (in thousands):
2002 2001 2000
----------- ----------- ---------
Balance, beginning of year $ 1,442,341 $ 659,659 $ 665,792
Less reinsurance recoverables 374,056 166,202 179,508
----------- ----------- ---------
Net balance, beginning of year 1,068,285 493,457 486,284
Net reserves acquired from Professionals Group -- 557,284 --
Incurred related to:
Current year 439,600 303,387 178,210
Prior years 8,429 13,818 (12,500)
Change in death, disability and retirement reserve (18,647) (10,000)
----------- ----------- ---------
Total incurred 448,029 298,558 155,710
Paid related to:
Current year (84,376) (137,121) (14,909)
Prior years (271,482) (143,893) (133,628)
----------- ----------- ---------
Total paid (355,858) (281,014) (148,537)
----------- ----------- ---------
Net balance, end of year 1,160,456 1,068,285 493,457
Plus reinsurance recoverables 462,012 374,056 166,202
----------- ----------- ---------
Balance, end of year $ 1,622,468 $ 1,442,341 $ 659,659
=========== =========== =========
Professional liability reserves comprise a substantial portion of ProAssurance's
reserves. Professional liability reserves established in the early 1990's were
strongly influenced by the dramatically increased frequency and severity
experienced by ProAssurance, and the industry as a whole, during the mid-1980's.
As a result, ProAssurance established prudent accident year reserves, resulting
in accident year loss ratios in excess of 100% of earned premium. Some of these
trends moderated, and in some cases, reversed, which in the past has resulted in
the recognition of redundancies related to prior accident year reserves.
The professional liability legal environment has deteriorated once again during
the past several years. Beginning in 2000, ProAssurance recognized adverse
trends in claim severity, causing increased estimates of certain loss
liabilities. As a result, favorable development of prior year loss reserves
slowed during 2000 and some amount of adverse development occurred during 2002
and 2001. ProAssurance's management believes the unearned premiums under
contracts, together with the related anticipated investment income to be
earned, is adequate to discharge the related contract liabilities.
86
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
9. COMMITMENTS AND CONTINGENCIES
ProAssurance is involved in various legal actions arising primarily from claims
related to insurance policies. At other times legal actions may arise from
claims asserted by policyholders. The legal actions arising from these claims
have been considered by ProAssurance in establishing its reserves. While the
outcome of all legal actions is not presently determinable, ProAssurance's
management is of the opinion, based on consultation with legal counsel, that
the settlement of these actions will not have a material adverse effect on
ProAssurance's financial position or results of operations.
10. CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
SFAS No. 141 eliminated the pooling-of-interest method of accounting for
business combinations. This statement also includes guidance on the initial
recognition and measurement of goodwill and other intangible assets in a
business combination. SFAS No. 142 addresses how goodwill and other intangible
assets should be accounted for in financial statements upon acquisition and how
these items should be accounted for subsequent to acquisition. SFAS No. 142
requires goodwill and intangible assets that have indefinite useful lives to be
tested at least annually for impairment. If goodwill and intangible assets are
deemed to be impaired, the change is included in then current operations.
ProAssurance adopted SFAS Nos. 141 and 142 effective January 1, 2002.
In accordance with SFAS Nos. 141 and 142, ProAssurance discontinued amortizing
its recorded goodwill and deferred credits and recognized the unamortized
balance of deferred credits of $1.7 million that existed at December 31, 2001
related to business combinations completed prior to July 1, 2001. The write-off
has been recognized as the cumulative effect of a change in accounting
principle. There is no tax effect related to the write-off because the deferred
credits were not amortizable for tax purposes.
87
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
10. CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE (CONTINUED)
The table below presents comparative income for the years ended December 31,
2002 and 2001, reflecting the pro forma effects of SFAS Nos. 141 and 142 on
2001 data:
Year ended
December 31
--------------------------
2002 2001
------- -------
Reported income before cumulative
effect of accounting change $10,513 $12,450
Amortization of deferred credits,
net of goodwill amortization -- 154
------- -------
Adjusted income before cumulative
effect of accounting change $10,513 $12,604
======= =======
Adoption of SFAS Nos. 141 and 142 did not have a significant per share effect.
At December 31, 2002 goodwill and intangible assets from business combinations,
net of accumulated amortization, are approximately $23.3 million. ProAssurance
does not believe that any of its recorded goodwill or intangible assets has
suffered impairment.
11. PENSION PLANS
ProAssurance and its subsidiaries currently maintain several defined
contribution employee benefit plans that are intended to provide additional
income to eligible employees upon retirement. ProAssurance's contributions to
these plans are primarily based on various percentages of compensation, and in
some instances are based upon the amount of the employees' contributions to the
plans. ProAssurance's expense under all benefit plans was $3.1 million, $2.3
million, and $1.2 million in 2002, 2001 and 2000, respectively.
88
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
12. LONG-TERM DEBT
On June 27, 2001, ProAssurance borrowed $110 million under a term loan facility
in order to fund the consolidation. The debt bears interest at a variable rate
based on the London Interbank Offered Rate (LIBOR) or the bank's base rate as
elected from time to time by ProAssurance. At December 31, 2002 the interest
rate was 2.9%.
The debt requires quarterly principal repayments of $2.5 million. Beginning in
2003, ProAssurance must also repay an additional annual installment equal to 50%
of the adjusted parent-only annual cash flow for the prior fiscal year, up to a
maximum of $15 million. ProAssurance has made all required quarterly repayments
on the loan and also made a $22.5 million optional prepayment on the loan in
September 2001. The required 2003 annual repayment based on adjusted parent only
cash flow is $0.
Excluding any required annual cash flow repayments, the aggregate remaining
amounts of maturities of long-term debt for the next five years are as follows:
$10 million each year from 2003 to 2005, and in 2006 the remaining balance
becomes due on May 31.
The term loan is part of a credit facility provided to ProAssurance by a bank
syndicate under the terms of a credit agreement that also provides for a line
of credit in the amount of $40 million. ProAssurance has not borrowed any funds
under the revolving line of credit. Should ProAssurance choose to do so, the
borrowed funds are repayable when the line expires in May 2003. ProAssurance
expects to renew the line at its expiration date.
The credit facility, as is customary for credit agreements of this size and
nature, requires that ProAssurance maintain certain financial standards,
otherwise known as loan covenants, including:
- a consolidated debt coverage ratio of 3.0 to 1;
- minimum consolidated tangible net worth equal to the sum of
(i) 90% of the consolidated net worth of ProAssurance as of
June 30, 2001, and (ii) 75% of cumulative consolidated net
income after June 30, 2001;
- a consolidated fixed charge coverage ratio of 1.5 to 1;
- a funded debt to adjusted statutory capital ratio of 0.35 to
1; and
- maintenance of statutory Risk-Based Capital ratios (as
defined by the NAIC) of 3.5 to 1 by two of its insurance
companies, The Medical Assurance Company, Inc. and
ProNational Insurance Company, Inc.
As of December 31, 2002, ProAssurance was in compliance with the aforementioned
loan covenants.
89
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
13. STOCKHOLDERS' EQUITY
On November 13, 2002, ProAssurance sold 2.65 million shares at an offering price
of $16.55 per share. The offering generated net proceeds of $40.6 million.
ProAssurance used the net proceeds from the sale of the newly issued shares to
support the growth of its professional liability insurance business and for
general corporate purposes. The underwriting agreement granted the underwriters
a thirty-day over-allotment option for up to 375,000 shares that was exercised
on December 4, 2002 and that generated additional net proceeds of $5.9 million.
At December 31, 2002 ProAssurance had 100 million shares of authorized common
stock and 50 million shares of authorized preferred stock. The Board of
Directors has the authorization to determine the provisions for the issuance of
shares of the preferred stock, including the number of shares to be issued and
the designations, powers, preferences and rights and the qualifications,
limitations or restrictions of such shares. At December 31, 2002, the Board of
Directors had not authorized the issuance of any preferred stock nor determined
any provisions for the preferred stock.
At December 31, 2002 approximately 2.1 million of ProAssurance's authorized
shares of common stock are reserved by the Board of Directors of ProAssurance
for the award or issuance of shares under the ProAssurance Incentive
Compensation Stock Plan and the Professionals Group, Inc.'s 1996 Long-term
Stock Incentive Plan, as discussed in Note 14.
"Accumulated other comprehensive income (loss)" shown in the Consolidated
Statements of Changes in Capital is solely comprised of net unrealized gains
(losses) on securities available for sale, net of taxes.
14. STOCK OPTIONS
ProAssurance has an Incentive Compensation Stock Plan (the "ProAssurance Plan")
available to provide performance-based compensation to employees of
ProAssurance and its subsidiaries. All terms and conditions of any grants under
the ProAssurance Plan are at the discretion of the compensation committee.
During 2002, the ProAssurance Plan granted 415,000 stock options, 83,000 of
which are exercisable as of December 31, 2002. No stock options were granted in
2001 and 2000. All options have been granted at a price equal to the market
price of the stock on the date of grant. The stock options that were granted
during 2002 vest at a rate of 20% each July 15, beginning with July 15, 2002
and expire after ten years. The remaining options expire in ten years and were
fully vested at the grant date.
Additionally, as a part of the consolidation with Professionals Group,
ProAssurance assumed all options previously granted under Professionals Group,
Inc.'s 1996 Long-term Stock Incentive Plan. Each outstanding and unexercised
option was converted into an option to purchase 1.76 shares of ProAssurance
Common Stock at an option price to be determined by dividing the option price
for the subject share of Professionals Group common stock by the exchange ratio
of 1.76, resulting in 458,680 options outstanding after conversion. The options
assumed were fully vested. No additional options are expected to be issued
related to the Professionals Group, Inc.'s 1996 Long-term Stock Incentive Plan.
90
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
14. STOCK OPTIONS (CONTINUED)
Information regarding ProAssurance outstanding options under both plans for the
year ending December 31, 2002 follows:
2002
------------------------------
WEIGHTED
AVERAGE
EXERCISE
SHARES PRICE
---------- --------
Outstanding at beginning of year 719,313 $20.82
Granted 415,000 $16.80
Exercised (31,276) $15.54
Canceled -- --
---------- ------
Outstanding at end of year 1,103,037 $19.46
========== ======
Options exercisable at end of year 771,037 $20.60
========== ======
Outstanding ProAssurance options as of December 31, 2002 consisted of the
following:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------------------------------- ------------------------
WEIGHTED
RANGE AVERAGE WEIGHTED WEIGHTED
OF REMAINING AVERAGE AVERAGE
EXERCISE CONTRACTUAL EXERCISE EXERCISE
PRICES NUMBER LIFE PRICE NUMBER PRICE
-------------- --------- ----------- -------- ------- --------
$9.23 - $26.03 1,103,037 6.8 years $ 19.46 771,037 $ 20.60
========= ========= ======= ======= =======
The fair value of options granted during 2002 was $6.97 per share, and was
estimated using the Black-Scholes option pricing model based on the following
weighted average assumptions: risk-free interest rate of 4.6%; volatility of
0.34; expected life of 6 years; and dividend yield of 0%.
91
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
14. STOCK OPTIONS (CONTINUED)
ProAssurance applies APB Opinion 25 and related interpretations in accounting
for these plans. Accordingly, no compensation cost has been recognized for
these stock option plans. Had compensation cost for these plans been determined
based on the fair value at the grant dates for awards under those plans
consistent with the method of SFAS No. 123, ProAssurance's net income would
have been reduced by $0.6 million, or $0.02 earnings per share (basic and
diluted) in 2002. There would be no effect on net income or earnings per share
in 2000 or 2001. The effect on net income for 2002 is not representative of the
pro forma effect on net income for future years because additional stock option
awards could be made in future years.
92
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
15. EARNINGS PER SHARE
The following represents a reconciliation from the basic to the diluted
numerator and denominator used in calculating the diluted earnings per share:
Year ended December 31
2002 2001 2000
-------- -------- -------
BASIC EARNINGS PER SHARE CALCULATION:
Numerator:
Income before cumulative effect
of accounting change $ 10,513 $ 12,450 $24,300
Cumulative effect of accounting change 1,694 -- --
-------- -------- -------
Net income $ 12,207 $ 12,450 $24,300
======== ======== =======
Denominator:
Weighted average number of
common shares outstanding 26,231 24,263 23,291
======== ======== =======
Basic earnings per share:
Income before cumulative effect
of accounting change $ 0.40 $ 0.51 $ 1.04
Cumulative effect of accounting change 0.07 -- --
-------- -------- -------
Net income $ 0.47 $ 0.51 $ 1.04
======== ======== =======
DILUTED EARNINGS PER SHARE CALCULATION:
Numerator:
Income before cumulative effect
of accounting change $ 10,513 $ 12,450 $24,300
Effect of MEEMIC Holdings stock
options on minority interest (210) (82) --
-------- -------- -------
Income before cumulative effect
of accounting change -- diluted
computation 10,303 12,368 24,300
Cumulative effect of accounting change 1,694 -- --
-------- -------- -------
Net income -- diluted computation $ 11,997 $ 12,368 $24,300
======== ======== =======
Denominator:
Weighted average number of
common shares outstanding 26,231 24,263 23,291
Assumed conversion of dilutive stock
options and awards 23 4 --
-------- -------- -------
Diluted weighted average number of
common shares outstanding 26,254 24,267 23,291
======== ======== =======
Diluted earnings per share:
Income before cumulative effect
of accounting change $ 0.39 $ 0.51 $ 1.04
Cumulative effect of accounting change 0.07 -- --
-------- -------- -------
Net income $ 0.46 $ 0.51 $ 1.04
======== ======== =======
Approximately 411,000, 588,000 and 399,000 employee stock options were
excluded from the computation of diluted earnings per share for the years
ending December 31, 2002, 2001 and 2000, respectively, because the effect of
including the options would have been antidilutive.
93
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
16. STATUTORY ACCOUNTING AND DIVIDEND RESTRICTIONS
ProAssurance's insurance subsidiaries are required to file statutory financial
statements with state insurance regulatory authorities. GAAP differs from
statutory accounting practices prescribed or permitted by regulatory
authorities. Differences between financial statement net income and statutory
net income are principally due to: (a) policy acquisition costs which are
deferred under GAAP but expensed for statutory purposes; (b) statutory
accounting prescribes the method for valuing investments in affiliates and does
not permit consolidation; and (c) deferred income taxes which are recorded
under GAAP but not for statutory purposes.
The NAIC specifies risk-based capital requirements for property and casualty
insurance providers. At December 31, 2002, statutory capital for each insurance
subsidiary was sufficient to satisfy regulatory requirements. Statutory surplus
and net income (loss) for each of ProAssurance's insurance subsidiaries for the
years ended December 31, 2002 and 2001 are as follows (in thousands):
Statutory
Statutory Surplus Net Income (Loss)
as of for the year ended
December 31, 2002 December 31, 2002
----------------- ------------------
The Medical Assurance Company, Inc. $193,335 $(19,096)
ProNational Insurance Company 196,955 9,915
Red Mountain Casualty Insurance Company, Inc. 15,829 767
Medical Assurance of West Virginia, Inc. 9,998 563
MEEMIC Insurance Company 95,514 15,870
Statutory
Statutory Surplus Net Income (Loss)
as of for the year ended
December 31, 2001 December 31, 2001**
----------------- -------------------
The Medical Assurance Company, Inc. $172,841 $ (5,874)
ProNational Insurance Company 175,874 18,966
Red Mountain Casualty Insurance Company, Inc. 12,007 203
Medical Assurance of West Virginia, Inc. 10,301 1,918
MEEMIC Insurance Company 80,093 7,017
**ProNational Insurance Company, ProNational Casualty Company (now known as Red
Mountain Casualty Insurance Company, Inc.) and MEEMIC Insurance Company were
acquired as a result of the consolidation with Professionals Group and are
included in the consolidated results of operations only since the date of
consolidation. The statutory income shown in the table is the income for the
period since June 27, 2001.
94
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
16. STATUTORY ACCOUNTING AND DIVIDEND RESTRICTIONS (CONTINUED)
Consolidated retained earnings are comprised primarily of subsidiaries'
retained earnings. ProAssurance's insurance subsidiaries are permitted to pay
dividends of approximately $40 million during the next year without prior
approval. However, the payment of any dividend requires prior notice to the
insurance regulator in the state of domicile and the regulator may prevent the
dividend if, in its judgment, payment of the dividend would have an adverse
effect on the surplus of the insurance subsidiary.
17. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of unaudited quarterly results of operations (in
thousands, except per share amounts) for 2002 and 2001:
2002
1st 2nd 3rd 4th
-------- -------- --------- --------
Net premiums earned $110,489 $113,594 $ 121,947 $131,378
Net losses and LAE 107,199 107,064 115,868 117,898
Income (loss) before cumulative effect 1,978 1,084 (4,524) 11,975
Net income (loss) 3,672 1,084 (4,524) 11,975
Basic earnings per share:
Income before cumulative effect 0.08 0.04 (0.18) 0.44
Diluted earnings per share:
Income before cumulative effect 0.08 0.04 (0.18) 0.43
2001
1st 2nd 3rd 4th
------- ------- -------- --------
Net premiums earned $49,545 $46,677 $105,492 $111,631
Net losses and LAE 46,986 43,803 101,339 106,430
Income before cumulative effect 2,273 2,987 2,936 4,254
Net income 2,273 2,987 2,936 4,254
Basic and diluted earnings per share 0.10 0.13 0.11 0.16
The sum of the above amounts may vary from the annual amounts because of
rounding.
95
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
18. SUBSEQUENT EVENTS
At December 31, 2002 ProAssurance indirectly owned 84% of MEEMIC Holdings. On
January 29, 2003 MEEMIC Holdings, the parent company of MEEMIC Insurance
Company, purchased all of the issued and outstanding shares of its common stock,
other than those held by ProAssurance's subsidiary, ProNational Insurance
Company (ProNational). MEEMIC Holdings used its internal funds in the
approximate amount of $34.1 million to acquire all of the 1,062,298 shares of
its common stock not owned by ProNational, to pay for outstanding options for
120,000 shares, and to pay the expenses of the transaction. The funds were
derived from MEEMIC Holdings' cash and investment resources.
96
PROASSURANCE CORPORATION AND SUBSIDIARIES
SCHEDULE I -- SUMMARY OF INVESTMENTS -- OTHER THAN
INVESTMENTS IN RELATED PARTIES
December 31, 2002
(in thousands)
Cost Amount
or at Which
Amortized Fair Shown in the
Type of Investment Cost Value Balance Sheet
------------------ ---------- ---------- -------------
Fixed Maturities:
Bonds:
U.S. Treasury securities ..... $ 234,745 $ 241,180 $ 241,180
State and municipal bonds .... 399,899 416,788 416,788
Corporate bonds .............. 442,653 466,176 466,176
Asset-backed securities ...... 197,638 204,183 204,183
Certificates of deposit ...... 570 570 570
---------- ---------- ----------
Total fixed maturities ... 1,275,505 $1,328,897 1,328,897
==========
Equity securities ................ 77,556 $ 80,197 80,197
==========
Real estate, net ................. 17,549 17,549
Short-term investments ........... 252,854 252,854
---------- ----------
Total investments ........ $1,623,464 $1,679,497
========== ==========
97
PROASSURANCE CORPORATION AND SUBSIDIARIES
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PROASSURANCE CORPORATION
CONDENSED BALANCE SHEETS--REGISTRANT ONLY
(IN THOUSANDS)
December 31
----------------------------
2002 2001
-------- --------
Assets
Investment in subsidiaries - at equity $532,119 $481,444
Cash 30,013 47
Other assets 19,467 19,754
-------- --------
$581,599 $501,245
======== ========
Liabilities and stockholders' equity
Payable to subsidiaries $ 3,506 $ 4,960
Other liabilities 399 554
Long-term debt 72,500 82,500
Stockholders' equity
Common stock 290 259
Other stockholders' equity, including unrealized
gains or losses on securities of subsidiaries 504,904 412,971
-------- --------
Total stockholders' equity 505,194 413,231
-------- --------
$581,599 $501,245
======== ========
PROASSURANCE CORPORATION
CONDENSED STATEMENTS OF INCOME--REGISTRANT ONLY
(IN THOUSANDS)
Year ended December 31
-----------------------------
2002 2001
-------- --------
Revenues:
Investment income $ 57 $ 440
Expenses:
Interest expense 2,875 2,591
Other expenses 1,441 466
-------- --------
4,316 3,057
Loss before income tax (benefit) and equity in
undistributed net income of subsidiaries (4,259) (2,617)
Federal and state income tax (benefit) (1,491) (835)
-------- --------
Loss before equity in
net income of subsidiaries (2,768) (1,782)
Equity in net income of subsidiaries 14,975 14,232
-------- --------
Net income $ 12,207 $ 12,450
======== ========
98
PROASSURANCE CORPORATION AND SUBSIDIARIES
SCHEDULE II --CONTINUED
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PROASSURANCE CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS--REGISTRANT ONLY
DECEMBER 31, 2002 AND 2001
(IN THOUSANDS)
YEAR ENDED DECEMBER 31
------------------------------
2002 2001
-------- ---------
Cash used by operating activities $ (6,533) $ (2,325)
Investing activities
Cash distribution to
Professionals Group shareholders -- (196,304)
Cash dividends from subsidiaries -- 116,274
Cash received from stock offering 46,499 --
-------- ---------
46,499 (80,030)
-------- ---------
Financing activities
Proceeds from long term debt -- 110,000
Principal payments on long-term debt (10,000) (27,500)
Other -- (98)
-------- ---------
(10,000) 82,402
-------- ---------
Increase in cash 29,966 47
Cash, beginning of period 47 --
-------- ---------
Cash, end of period $ 30,013 $ 47
======== =========
Notes to Condensed Financial Statements
1. Formation of ProAssurance Corporation
ProAssurance Corporation was formed in October 2000 as a holding company
(ProAssurance Holding Company) for the purpose of consolidating Medical
Assurance, Inc. (Medical Assurance) and Professionals Group, Inc. (Professionals
Group). ProAssurance Holding Company did not commence operations until
completion of the consolidation on June 27, 2001. The consolidation of
ProAssurance Holding Company and Medical Assurance was in the form of a
corporate reorganization and was accounted for in a manner similar to a pooling
of interests. The consolidation was a non-cash transaction whereby one share of
ProAssurance common stock was exchanged for each outstanding share of Medical
Assurance stock. The consolidation with Professionals Group was accounted for as
a purchase transaction and involved the exchange of ProAssurance stock and cash,
or cash only, as elected by the shareholder, for each share of Professionals
Group stock.
2. Basis of Presentation
ProAssurance Holding Company's initial investment in Medical Assurance is valued
at the net book value of Medical Assurance on the consolidation date, June 27,
2001. The consolidation with Professionals Group was accounted for as a purchase
transaction and involved the exchange of ProAssurance stock and cash, or cash
only, as elected by the shareholder, for each share of Professionals Group
stock. ProAssurance Holding Company's initial investment in Professionals Group
is valued at the fair value of the net assets acquired on the consolidation date
of June 27, 2001. At December 31, 2002 and 2001 ProAssurance Holding Company's
investment in subsidiaries is stated at the initial values described plus equity
in the undistributed earnings of subsidiaries since the date of acquisition less
dividends received from the subsidiaries. Goodwill of approximately $18.2
million was recorded related to the consolidation with Professionals Group and
is included in other assets. The parent-only financial statements should be read
in conjunction with ProAssurance's consolidated financial statements.
99
PROASSURANCE CORPORATION AND SUBSIDIARIES
SCHEDULE II --CONTINUED
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED)
3. Related Party Transactions
ProAssurance Holding Company received no cash dividends during 2002 and
received cash dividends of $70.8 million from Medical Assurance and $41.6
million from Professionals Group during the year ended December 31, 2001.
All of ProAssurance Holding Company's treasury shares are owned by its
subsidiaries. In the parent-only financial statements, stockholders' equity has
been reduced by the cost of these treasury shares and ProAssurance Holding
Company's investment in subsidiaries has been reduced by the cost of the
treasury shares owned by the subsidiaries.
4. Income Taxes
Under terms of ProAssurance's tax sharing agreement with its subsidiaries,
income tax provisions for individual companies are computed on a separate
company basis.
100
PROASSURANCE CORPORATION AND SUBSIDIARIES
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(IN THOUSANDS)
2002 2001 2000
---------- ---------- --------
Deferred policy acquisition costs ..................... $ 22,729 $ 15,489 $ 10,350
Reserve for losses and loss adjustment expenses ....... 1,622,468 1,442,341 659,659
Unearned premiums ..................................... 248,371 188,630 78,495
Net premiums earned ................................... 477,408 313,345 177,596
Premiums assumed from other companies ................. 2,991 23,327 25,633
Net investment income ................................. 76,918 59,782 41,450
Net losses and loss adjustment expenses ............... 448,029 298,558 155,710
Underwriting, acquisition and insurance expenses:
Amortization of deferred policy acquisition costs 41,800 37,792 21,077
Other underwriting, acquisition
and insurance expenses ...................... 49,453 32,645 17,502
Net premiums written .................................. 537,123 310,291 194,279
101
PROASSURANCE CORPORATION AND SUBSIDIARIES
SCHEDULE IV - REINSURANCE
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(DOLLARS IN THOUSANDS)
2002 2001 2000
--------- --------- ---------
PROPERTY & CASUALTY
Premiums earned $ 573,091 $ 357,394 $ 185,141
Premiums ceded (98,918) (67,650) (33,549)
Premiums assumed 2,516 7,129 11,312
--------- --------- ---------
Net premiums earned $ 476,689 $ 296,873 $ 162,904
========= ========= =========
Percentage of amount assumed to net 0.53% 2.40% 6.94%
========= ========= =========
ACCIDENT AND HEALTH
Premiums earned $ 332 $ 789 $ 5,528
Premiums ceded (88) (515) (5,152)
Premiums assumed 475 16,198 14,316
--------- --------- ---------
Net premiums earned $ 719 $ 16,472 $ 14,692
========= ========= =========
Percentage of amount assumed to net 66.06% 98.34% 97.44%
========= ========= =========
OTHER
Premiums earned -- -- --
Premiums ceded -- -- --
Premiums assumed -- -- --
--------- --------- ---------
Net premiums earned $ -- $ -- $ --
========= ========= =========
Percentage of amount assumed to net 0.00% 0.00% 0.00%
========= ========= =========
Total net premiums earned $ 477,408 $ 313,345 $ 177,596
========= ========= =========
102
PROASSURANCE CORPORATION AND SUBSIDIARIES
SCHEDULE VI - SUPPLEMENTARY PROPERTY AND CASUALTY INSURANCE INFORMATION
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(IN THOUSANDS)
2002 2001 2000
----------- ----------- ---------
Deferred policy acquisition costs $ 22,729 $ 15,489 $ 10,350
Reserve for losses and loss adjustment expenses 1,622,468 1,442,341 659,659
Unearned premiums 248,371 188,630 78,495
Net premiums earned 477,408 313,345 177,596
Net investment income 76,918 59,782 41,450
Losses and loss adjustment expenses incurred
related to current year, net of reinsurance 439,600 284,740 178,210
Losses and loss adjustment expenses incurred
related to prior year, net of reinsurance 8,429 13,818 (22,500)
Amortization of deferred policy acquisition costs 41,800 37,792 21,077
Paid losses and loss adjustment expenses related to
current year losses, net of reinsurance (84,376) (137,121) (14,909)
Paid losses and loss adjustment expenses related to
prior year losses, net of reinsurance (271,482) (143,893) (133,623)
103
EXHIBIT INDEX
Exhibit
Number Description
- ------ -----------
2.1 Agreement to Consolidate by and between Medical Assurance, Inc. and
Professionals Group, Inc. dated June 22, 2000 as amended as of
November 1, 2000. (1)
2.2 Agreement and Plan of Merger dated as of July 9, 2002 among
ProNational Insurance Company, MEEMIC Merger Corp. and MEEMIC Holdings
(2)
2.2(a) Amendment No. 1 to Agreement and Plan of Merger dated as of July 9,
2002 among ProNational Insurance Company, MEEMIC Merger Corp. and
MEEMIC Holdings, Inc. made on September 18, 2002
3.1(a) Certificate of Incorporation of ProAssurance (1)
3.1(b) Certificate of Amendment of ProAssurance (3)
3.2 Bylaws of ProAssurance (1)
4.1 Credit Agreement among ProAssurance and lending banks (4)
10.1(a) Amendment and Assumption Agreement by and between ProAssurance and
Medical Assurance, Inc. (3)
10.1(b) Medical Assurance, Inc. Incentive Compensation Stock Plan (formerly
known as the Mutual Assurance, Inc. 1995 Stock Award Plan) (5)
10.1(c) Amendment and Assumption Agreement by and between Mutual Assurance,
Inc. and MAIC Holdings, Inc. dated April 8, 1996 (6)
10.2 Professionals Insurance Company Management Group 1996 Long Term
Incentive Plan (7)
10.3 MEEMIC Holdings Stock Compensation Plan (8)
10.4 MEEMIC Incentive Plan Trust (3)
10.5(a) Release and Severance Agreement between Victor T. Adamo and
ProAssurance (9)
10.5(b) Amendment to Release and Severance Compensation Agreement of Victor T.
Adamo (10)
10.5(c) Release and Severance Agreement between William P. Sabados and
ProAssurance (11)
10.5(d) Release and Severance Agreement between Lynn M. Kalinowski and
ProAssurance (11)
104
10.5(e) Release and Severance Agreement between Howard H. Friedman and
ProAssurance (10)
10.5(f) Release and Severance Agreement between James J. Morello and
ProAssurance (10)
10.5(g) Release and Severance Agreement between Frank B. O'Neil and
ProAssurance
10.6 Employment Agreement of A. Derrill Crowe, as amended (10)
10.7 Form of Indemnification Agreement between ProAssurance and each of the
following named executive officers and directors of ProAssurance:
Victor T. Adamo
Lucian F. Bloodworth
Paul R. Butrus
A. Derrill Crowe
Robert E. Flowers
Howard H. Friedman
Leon C. Hamrick
Lynn M. Kalinowski
John J. McMahon
James J. Morello
Drayton Nabers
John P. North
Frank B. O'Neil
Ann F. Putallaz
William P. Sabados
William H. Woodhams
21 Subsidiaries of ProAssurance Corporation
23 Consent of Ernst & Young
99.1 Certification of Chief Executive Officer required under 18 U.S.C. ss.
1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
99.2 Certification of Chief Financial Officer required under 18 U.S.C. ss.
1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
Footnotes:
(1) Filed as an Exhibit to ProAssurance's Registration Statement on Form
S-4 (Commission File No. 333-49378) and incorporated herein by
reference pursuant to Rule 12b-32 of the Securities and Exchange
Commission.
(2) Filed as an Exhibit to ProAssurance's Quarterly Report on Form 10-Q
for the period ended June 30, 2002 (File No. 001-16533) and
incorporated herein by reference pursuant to Rule 12b-32 of the
Securities and Exchange Commission.
105
(3) Filed as an Exhibit to ProAssurance's Annual Report on Form 10-K for
the year ended December 31, 2001 (Commission File No. 001-16533) and
incorporated herein by reference pursuant to Rule 12b-32 of the
Securities and Exchange Commission.
(4) Filed as an Exhibit to ProAssurance's Form 8-K/A for event occurring
May 10, 2000 (Commission File No. 001-12129) and incorporated herein
by this reference pursuant to Rule 12b-32 of the Securities and
Exchange Commission.
(5) Filed as an Exhibit to MAIC Holding's Registration Statement on Form
S-4 (Commission File No. 33-91508) and incorporated herein by
reference pursuant to Rule 12b-32 of the Securities and Exchange
Commission.
(6) Filed as an Exhibit to MAIC Holding's Proxy Statement for the 1996
Annual Meeting (Commission File No. 0-19439) is incorporated herein by
reference pursuant to Rule 12b-32 of the Securities and Exchange
Commission.
(7) Filed as an Exhibit to Professionals Group's Registration Statement on
Form S-4 (Commission File No. 333-3138) and incorporated herein by
reference pursuant to Rule 12b-32 of the Securities and Exchange
Commission.
(8) Filed as an Exhibit to MEEMIC Holding's Registration Statement on Form
S-4 (Commission File No. 333-66671) and incorporated herein by
reference pursuant to Rule 12b-32 of the Securities and Exchange
Commission.
(9) Filed as an Exhibit to ProAssurance's Form 10-Q (Commission File No.
001-16533) for the quarter ended June 30, 2001 and incorporated herein
by reference pursuant to Rule 12b-32 of the Securities and Exchange
Commission.
(10) Filed as an Exhibit to ProAssurance's Registration Statement on Form
S-3 (Commission File No. 333-100526), as amended, and incorporated
herein by reference pursuant to Rule 12b-32 of the Securities and
Exchange Commission.
(11) Filed as an Exhibit to ProAssurance's Form 10-Q (Commission File No.
001-16533) for the quarter ended September 30, 2001 and incorporated
herein by reference pursuant to Rule 12b-32 of the Securities and
Exchange Commission.
106