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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended MARCH 31, 2004 or
______
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ______ to ______.
Commission file number 0-16533
ProAssurance Corporation
----------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 63-1261433
- ------------------------------------ -----------------------------------
(State or other jurisdiction of (IRS Employer Identification ID No.)
incorporation of organization)
100 Brookwood Place, Birmingham, AL 35209
- --------------------------------------- ----------------------------
(Address of principal executive offices) (Zip Code)
(205) 877-4400
--------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (l) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes X No.
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act.) Yes X No.
--- ---
As of March 31, 2004 there were 29,156,316 shares of the registrant's common
stock outstanding.
Page 1 of 37
ProAssurance Corporation
Form 10Q
Table of Contents
Part I - Financial Information
Item 1. Condensed Consolidated Balance Sheets..................................................... 3
Condensed Consolidated Statements of Changes in Capital............................................ 4
Condensed Consolidated Statements of Income........................................................ 5
Condensed Consolidated Statements of Comprehensive Income.......................................... 6
Condensed Consolidated Statements of Cash Flows.................................................... 7
Notes to Condensed Consolidated Financial Statements............................................... 8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..... 16
Item 3. Quantitative and Qualitative Disclosures about Market Risk................................ 32
Item 4. Controls and Procedures................................................................... 34
Forward-Looking Statements......................................................................... 35
Part II - Other Information
Item 1. Legal Proceedings......................................................................... 36
Item 6. Exhibits and Reports on 8-K............................................................... 36
Signature ......................................................................................... 37
PROASSURANCE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
MARCH 31 December 31
-------- -----------
2004 2003
-----------------------------
ASSETS
Investments:
Fixed maturities available for sale, at fair value $ 1,970,857 $ 1,790,778
Equity securities available for sale, at fair value 39,437 42,136
Equity securities, trading portfolio, at fair value 6,863 5,863
Real estate, net 17,617 17,262
Short-term investments 53,056 109,680
Other 41,499 38,247
Business owned life insurance 52,360 51,706
----------- -----------
Total investments 2,181,689 2,055,672
Cash and cash equivalents 31,961 47,132
Premiums receivable 141,553 132,255
Receivable from reinsurers on unpaid losses and
loss adjustment expenses 435,366 444,811
Prepaid reinsurance premiums 19,803 17,651
Deferred taxes 69,652 73,118
Other assets 118,719 108,713
----------- -----------
$ 2,998,743 $ 2,879,352
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Policy liabilities and accruals:
Reserve for losses and loss adjustment expenses $ 1,860,282 $ 1,814,584
Unearned premiums 320,332 290,134
Reinsurance premiums payable 73,544 68,510
----------- -----------
Total policy liabilities 2,254,158 2,173,228
Other liabilities 64,348 55,030
Long-term debt 104,863 104,789
----------- -----------
Total liabilities 2,423,369 2,333,047
Commitments and contingencies -- --
Stockholders' Equity:
Common stock, par value $0.01 per share
100,000,000 shares authorized; 29,278,081 and
29,226,774 shares issued, respectively 293 292
Additional paid-in capital 313,703 312,030
Accumulated other comprehensive income, net of deferred tax
expense of $24,683 and $18,537, respectively 45,836 34,422
Retained earnings 215,598 199,617
----------- -----------
575,430 546,361
Less treasury stock, at cost, 121,765 shares (56) (56)
----------- -----------
Total stockholders' equity 575,374 546,305
----------- -----------
$ 2,998,743 $ 2,879,352
=========== ===========
See accompanying notes.
3
PROASSURANCE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN CAPITAL (UNAUDITED)
(IN THOUSANDS)
ACCUMULATED OTHER
COMPREHENSIVE RETAINED OTHER CAPITAL
TOTAL INCOME EARNINGS ACCOUNTS
---------- ----------------- -------- -------------
Balance at December 31, 2003 $ 546,305 $ 34,422 $ 199,617 $312,266
Net income 15,981 - 15,981 -
Change in fair value of securities available
for sale, net of reclassification adjustments
and deferred taxes 11,414 11,414 - -
Common stock issued for compensation 1,593 - - 1,593
Common stock options exercised 81 - - 81
---------- --------- --------- ---------
Balance at March 31, 2004 $ 575,374 $ 45,836 $ 215,598 $ 313,940
========== ========= ========= =========
Accumulated Other
Comprehensive Retained Other Capital
Total Income Earnings Accounts
---------- ----------------- --------- -------------
Balance at December 31, 2002 $ 505,194 $ 35,545 $ 160,914 $ 308,735
Net income 6,349 -- 6,349 --
Change in fair value of securities available
for sale, net of reclassification adjustments,
deferred taxes (193) (193) -- --
Acquisition of minority interest 886 886 -- --
Common stock issued for compensation 942 -- -- 942
---------- --------- --------- ---------
Balance at March 31, 2003 $ 513,178 $ 36,238 $ 167,263 $ 309,677
========== ========= ========= =========
See accompanying notes.
4
PROASSURANCE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED
MARCH 31
----------------------------
2004 2003
--------- ----------
Revenues:
Gross premiums written $ 218,726 $ 202,660
========= ==========
Net premiums written $ 195,462 $ 178,936
========= ==========
Premiums earned $ 188,528 $ 161,153
Premiums ceded (20,686) (22,957)
--------- ----------
Net premiums earned 167,842 138,196
Net investment income 19,851 17,248
Net realized investment gains (losses) 3,657 1,007
Other income 1,010 1,659
--------- ----------
Total revenues 192,360 158,110
Expenses:
Losses and loss adjustment expenses 152,673 145,646
Reinsurance recoveries (10,753) (20,598)
--------- ----------
Net losses and loss adjustment expenses 141,920 125,048
Underwriting, acquisition and insurance expenses 27,973 24,422
Interest expense 1,143 578
--------- ----------
Total expenses 171,036 150,048
Income before income taxes and minority interest 21,324 8,062
Provision for income taxes:
Current expense 5,326 558
Deferred expense 17 974
--------- ----------
5,343 1,532
--------- ----------
Income before minority interest 15,981 6,530
Minority interest - (181)
--------- ----------
Net income $ 15,981 $ 6,349
========= ==========
Earnings per share:
Basic $ 0.55 $ 0.22
========= ==========
Diluted $ 0.54 $ 0.22
========= ==========
Weighted average number of common share outstanding:
Basic 29,118 28,893
========= ==========
Diluted 29,361 29,003
========= ==========
See accompanying notes.
5
PROASSURANCE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31
---------------------
2004 2003
-------- --------
Comprehensive income:
Net income $ 15,981 $ 6,349
Change in fair value of securities available for sale,
net of deferred taxes and minority interest 13,320 462
Reclassification adjustment for realized investment
(gains)losses included in income, net of deferred
taxes (1,906) (655)
-------- --------
Comprehensive income $ 27,395 $ 6,156
======== ========
See accompanying notes.
6
PROASSURANCE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31
------------------------
2004 2003
---------- ---------
OPERATING ACTIVITIES
Net cash provided (used) by operating activities $ 94,719 $ 72,522
INVESTING ACTIVITIES
Purchases of available-for-sale securities:
Fixed maturities (370,081) (352,899)
Equity (149) (404)
Proceeds from sale or maturity of available-for-sale securities:
Fixed maturities 205,203 129,116
Equities 3,291 1,895
Purchase of other investments (3,125) --
Net decrease in short-term investments 56,631 80,422
Other (1,671) 8,219
--------- ---------
Net cash provided (used) by investing activities (109,901) (133,651)
--------- ---------
FINANCING ACTIVITIES
Purchase of minority interest - (33,248)
Repayment of debt - (2,500)
Other 11 -
--------- ---------
Net cash provided (used) by financing activities 11 (35,748)
--------- ---------
Increase (decrease) in cash and cash equivalents (15,171) (96,877)
Cash and cash equivalents at beginning of period 47,132 143,306
--------- ---------
Cash and cash equivalents at end of period $ 31,961 $ 46,429
========= =========
See accompanying notes.
7
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2004
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
include the accounts of ProAssurance Corporation and its subsidiaries
(collectively "ProAssurance"). The financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and notes required by accounting principles generally accepted in
the United States for complete financial statements. In the opinion of
management, all adjustments, consisting of normal recurring adjustments,
considered necessary for a fair presentation have been included. Operating
results for the three month period ended March 31, 2004 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2004. The accompanying condensed consolidated financial statements should be
read in conjunction with the consolidated financial statements and notes
contained in ProAssurance's December 31, 2003 report on Form 10K.
Stock-Based Compensation
ProAssurance grants stock options to key employees under its Incentive
Compensation Stock Plan ("the ProAssurance Plan") and accounts for such stock
options under the recognition and measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related Interpretations ("APB
25"). The following table illustrates the effect on net income (in thousands)
and earnings per share as if ProAssurance had applied the fair value recognition
provisions of Statement of Financial Accounting Standard (SFAS) No. 123,
Accounting for Stock-Based Compensation, to options granted under the
ProAssurance Plan.
THREE MONTHS ENDED
MARCH 31
--------------------
2004 2003
--------------------
Net income, as reported $ 15,981 $ 6,349
Add: Stock-based employee compensation expense
recognized under APB 25 related to the exercise of
options, net of related tax effects 64 -
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (259) (150)
-------- --------
Pro forma net income $ 15,786 $ 6,199
======== ========
Earnings per share:
Basic -- as reported $ 0.55 $ 0.22
======== ========
Basic -- pro forma $ 0.54 $ 0.21
======== ========
Diluted -- as reported $ 0.54 $ 0.22
======== ========
Diluted -- pro forma $ 0.54 $ 0.21
======== ========
ProAssurance granted 237,500 options with an exercise price of $33.28
per share under the plan in March 2004. The estimated fair value of each option
is $13.02, using the Black-Scholes option pricing model and the following model
assumptions: risk-free interest rate of 3.4%; volatility of 0.34; expected life
of 6 years; and dividend yield of 0%.
8
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2004
2. SEGMENT INFORMATION
ProAssurance operates in the United States of America in two reportable
industry segments: the professional liability insurance segment and the personal
lines segment.
The professional liability insurance segment principally provides
professional liability insurance for providers of health care services, and to a
limited extent, providers of legal services. The professional liability segment
includes the operating results of three significant insurance companies: The
Medical Assurance Company, Inc, ProNational Insurance Company, and Red Mountain
Casualty Insurance Company, Inc. ProAssurance also writes professional liability
insurance through Medical Assurance of West Virginia Inc.
The personal lines segment provides personal auto, homeowners, boat and
umbrella coverages primarily to educational employees and their families through
a single insurance company, MEEMIC Insurance Company.
The accounting policies of the segments are consistent with those
described in the Notes to the Consolidated Financial Statements included in
ProAssurance's December 31, 2003 Annual Report on Form 10-K. Other than cash and
marketable securities owned directly by the parent company, the identifiable
assets of ProAssurance are allocated to the reportable operating segments.
Except for 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 effects of
transactions between segments have been eliminated.
9
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2004
2. SEGMENT INFORMATION (CONTINUED)
The table below provides a reconciliation of segment information to
total consolidated information (in thousands).
THREE MONTHS ENDED
MARCH 31
--------------------------
2004 2003
--------------------------
Revenues:
Professional liability lines $ 144,206 $ 114,874
Personal lines 47,399 43,174
Corporate investment income 755 62
---------- ---------
Total $ 192,360 $ 158,110
========== =========
Net income (loss):
Professional liability lines $ 8,845 $ 1,805
Personal lines 7,384 4,879
Corporate (248) (335)
---------- ---------
Total $ 15,981 $ 6,349
========== =========
MARCH 31 December 31
2004 2003
-------- -----------
Identifiable Assets:
Professional liability lines $2,539,635 $2,413,043
Personal lines 435,570 431,264
Corporate 23,538 35,045
---------- ----------
Total assets $2,998,743 $2,879,352
========== ==========
10
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2004
3. INVESTMENTS
The amortized cost of available for sale fixed maturities and equity
securities was $1.940 billion and $1.780 billion at March 31, 2004 and December
31, 2003, respectively. Proceeds from sales of fixed maturities and equity
securities during the three month period ended March 31, 2004 and 2003 are
$155.2 million and $79.4 million, respectively.
Net realized investment gains (losses) are comprised of the following
(in thousands):
THREE MONTHS ENDED
MARCH 31
------------------------
2004 2003
------------------------
Gross realized gains (losses) $ 3,029 $ 1,827
Gross realized (losses) (90) (531)
Other than temporary impairment (losses) -- (289)
Trading portfolio gains (losses) 718 --
--------- ---------
Net realized investment gains (losses) $ 3,657 $ 1,007
========= =========
4. RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
ProAssurance establishes its reserve for losses and loss adjustment
expenses based on 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. ProAssurance believes that the methods it uses
to establish reserves are reasonable and appropriate. However, estimating
reserves, especially professional liability reserves, is a complex process.
Claims may be resolved over an extended period of time, often five years or
more, and may be subject to litigation. Estimating losses for liability claims
requires ProAssurance to make and revise judgments and assessments regarding
multiple uncertainties over an extended period of time. 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 then current operations.
ProAssurance's management believes the unearned premiums under
contracts together with the related anticipated investment income to be earned
are adequate to discharge the related contract liabilities.
5. 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. Amortization of
deferred policy acquisition costs, net of ceding commissions earned, amounted to
approximately $15.5 million and $12.0 million for the three months ended March
31, 2004 and 2003, respectively.
11
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2004
6. INCOME TAXES
The provision for income taxes is different from that which would be
obtained by applying the statutory Federal income tax rate to income before
taxes because a portion of ProAssurance's investment income is tax-exempt.
7. LONG-TERM DEBT
Long-term debt is comprised of 3.90% Convertible Debentures (the
Debentures) having a face value of $107.6 million issued in July 2003 that
mature on June 30, 2023. The Debentures are carried net of the unamortized
original issuers' discount of $2.7 million at March 31, 2004 and $2.8 million at
December 31, 2003.
The Debentures are unsecured obligations and rank equally in right of
payment with all other existing and future unsecured and unsubordinated
obligations. The Debentures are not guaranteed by any of ProAssurance's
subsidiaries and are effectively subordinated to the indebtedness and other
liabilities of ProAssurance's subsidiaries, including insurance policy-related
liabilities.
Holders may convert the Debentures at any time prior to stated maturity
from and after the date of the following events: if ProAssurance calls the
Debentures for redemption; upon the occurrence of certain corporate
transactions, including a change of control; or if the sale price of
ProAssurance's common stock exceeds 120% of the then conversion price for at
least 20 trading days in a 30 day trading period as defined in the Debenture
agreement of a specified period. The conversion price was initially established
at $41.83 per common share or 23.9037 shares per $1,000 principal amount of
Debentures surrendered for conversion, and may be adjusted for certain reasons.
ProAssurance has the right to deliver cash in lieu of common stock for all or a
portion of the Debentures converted.
Holders of the Debentures may require ProAssurance to repurchase all or
a portion of the holder's Debentures on June 30, 2008, June 30, 2013 and June
30, 2018 at a purchase price equal to the principal amount of the Debentures
plus accrued and unpaid interest, including contingent interest, if any, to the
date of repurchase. ProAssurance may choose to pay the purchase price in cash,
shares of common stock, or a combination of cash and shares of common stock.
Shares of common stock will be valued at 97.5 % of the average sale price of the
stock for a specified period prior to the redemption.
If there is an event of default under the Debentures, the principal
amount of the Debentures, plus accrued interest, including contingent interest,
if any, may be declared immediately due and payable. These amounts automatically
become due and payable if an event of default relating to certain events of
bankruptcy, insolvency or reorganization occurs. The Debentures do not require
ProAssurance to maintain minimum financial covenants.
ProAssurance may redeem some of all of the Debentures for cash on or
after July 7, 2008 with proper notice to the holders of the Debentures.
For additional information regarding the terms of the Debentures see
Note 11 of the Notes to the Consolidated Financial statements in ProAssurance's
December 31, 2003 Form 10K.
12
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2004
8. STOCKHOLDERS' EQUITY
At March 31, 2004 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 March 31, 2004 the Board of
Directors had not authorized the issuance of any preferred stock nor determined
any provisions for the preferred stock.
9. COMMITMENTS AND CONTINGENCIES
ProAssurance is involved in various legal actions arising primarily
from claims related to insurance policies and claims handling, including but not
limited to 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. However, to the extent that the
cost of resolving these actions exceeds the corresponding reserves, the legal
actions could have a material effect on ProAssurance's results of operations for
the period in which the any such action is resolved.
10. MINORITY INTEREST
On January 29, 2003 ProAssurance's indirect subsidiary, MEEMIC
Holdings, Inc. (MEEMIC Holdings) repurchased all of the outstanding shares of
its common stock that were not owned by ProAssurance's subsidiary, ProNational
Insurance Company. MEEMIC Holdings used its internal funds in the approximate
amount of $34.1 million to acquire 1,062,298 shares of its common stock, to pay
for outstanding options representing 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 is now a
wholly-owned indirect subsidiary of ProAssurance. ProAssurance recognized
goodwill of $7.6 million related to the transaction. Income for the nine months
ended September 30, 2003 was reduced by the income attributable (16%) to the
MEEMIC Holdings minority interest for the period from January 1, 2003 to January
29, 2003. MEEMIC Holdings is the 100% owner of MEEMIC Insurance Company.
13
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2004
11. EARNINGS PER SHARE
The following represents a reconciliation of the numerators and
denominators of the basic and diluted earnings per share computations (amounts
are in thousands, except per share data):
THREE MONTHS ENDED
MARCH 31
-------------------------------------------------------------
2004 2003
------------------------- -------------------------
BASIC DILUTED Basic Diluted
Numerator:
Net income $ 15,981 $ 15,981 $ 6,349 $ 6,349
========= ========= ======== =========
Denominator:
Weighted average number of common
shares outstanding 29,118 29,118 28,893 28,893
Assumed conversion of dilutive stock options
and awards -- 243 -- 110
--------- --------- -------- ---------
Total weighted average equivalent shares 29,118 29,361 28,893 29,003
========= ========= ======== =========
Earnings per share $ 0.55 $ 0.54 $ 0.22 $ 0.22
========= ========= ======== =========
In accordance with SFAS 128 "Earnings per Share", the diluted weighted
average number of shares outstanding includes an incremental adjustment for the
assumed conversion of dilutive stock options. Stock options are considered
dilutive stock options if the assumed conversion of the options, using the
treasury stock method as specified by SFAS 128, produces an increased number of
outstanding shares. Typically, options are not dilutive when the strike price of
the option is very close to or below the average share price during the quarter.
For the periods ending March 31, 2004 and 2003, approximately 238,000 and
328,000 employee stock options, respectively, were not considered to be dilutive
because the strike price of the options was below the average ProAssurance share
price during the quarter.
12. VARIABLE INTEREST ENTITIES
ProAssurance has adopted the provisions of Financial Accounting
Standards Board Interpretation No. 46 "Consolidation of Variable Interest
Entities" (FIN 46); however, the adoption has no significant effect on the
financial statements of ProAssurance.
ProAssurance holds passive investments in four limited
partnerships/limited liability companies that are considered to be variable
interest entities (VIE's) under FIN 46 guidance. ProAssurance is not the primary
beneficiary relative to these entities and is not required to consolidate the
entities under FIN 46. These investments are included in Other Investments and
total $39.0 million at March 31, 2004 and $37.1 million at December 31, 2003.
The entities are all non-public investment pools formed for the purpose of
achieving diversified equity and debt returns. For three of the entities,
ProAssurance's investment represents an ownership interests that is less than
10%. ProAssurance's investment in the remaining entity represents an ownership
interest of about 33%. ProAssurance's involvement with two of the entities
originated in 2000; one in 2002, and one in 2003. ProAssurance's maximum loss
exposure relative to each to the entity is limited to the carrying value of
ProAssurance`s investment in the entity.
14
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2004
13. SUBSEQUENT EVENT
In April 2004, ProAssurance raised additional capital through the
private placement of $13 million of trust preferred securities. The trust
preferred securities were issued by a wholly-owned trust (the Trust) that
ProAssurance formed specifically for that purpose. Concurrently, ProAssurance
issued a like amount of debentures (the 2004 debentures) that were purchased by
the Trust. ProAssurance received net proceeds from the transaction, after
commissions paid to the placement agents, of $12.6 million. The proceeds are
available for general corporate purposes, including providing statutory capital
to ProAssurance's professional liability insurance segment.
The 2004 debentures and the trust preferred securities have the same
maturities and other applicable terms and features. ProAssurance has guaranteed
that amounts paid to the Trust related to the 2004 debentures will be remitted
to the holders of the trust preferred securities. The 2004 debentures will be
included in the ProAssurance consolidated financial statements as long-term
debt. The Trust will not be consolidated by ProAssurance.
The 2004 debentures and the trust preferred securities are
uncollateralized and bear a floating interest rate equal to the three-month
LIBOR plus 3.85%, adjustable quarterly, with a maximum rate within the first
five years of 12.5%; the initial rate in April 2004 was 5.03%. The 2004
debentures and the trust preferred securities have stated maturities of thirty
years and are due in April 2034. The 2004 debentures do not require ProAssurance
to maintain minimum financial covenants.
ProAssurance has authorized the issuance of an additional $22 million
of debentures and related trust preferred securities in similarly structured
transactions which are expected to be sold in May 2004.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
consolidated financial statements and notes to the consolidated financial
statements appearing elsewhere in this report. Throughout the discussion,
references to ProAssurance, "we," "us" and "our" refers to ProAssurance
Corporation and its subsidiaries. The discussion contains certain
forward-looking information that involves risks and uncertainties. As discussed
under "Forward-Looking Statements," our actual financial condition and operating
results could differ significantly from these forward-looking statements.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements have been prepared in accordance
with accounting principles generally accepted (GAAP) in the United States of
America. Preparation of these financial statements requires us to make estimates
and assumptions in certain circumstances that affect the 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. Management considers an accounting estimate to be critical if:
- it requires assumptions to be made based on data that was not
final at the time the estimate was made; and
- changes in the estimate, or the selection of a different
estimate, could have a material effect on our consolidated
results of operations or financial condition.
We believe the following policies used in the preparation of the
consolidated financial statements are the most sensitive to estimates and
judgments.
Reserve for Losses and Loss Adjustment Expenses (reserve for losses)
Our reserve for losses 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 loss adjustment
expenses (losses) for reported claims and are established by our claims
departments. Bulk reserves, which include a provision for insured events 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
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 reserve for losses each year and
prepare reports that include recommendations as to the level of the reserve. 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 reserve
for losses. Estimating casualty insurance reserves, and particularly
professional liability reserves, is a complex process. These claims are
typically resolved over an extended period of time, often five years or more,
and estimating loss costs for these claims requires multiple judgments involving
many uncertainties made over an extended period of time. Our reserve estimates
may vary significantly from the eventual outcome. The assumptions used in
establishing our reserve are regularly reviewed and updated by management as new
data becomes available. Any adjustments necessary are reflected in then current
operations. Due to the size of our reserve, even a small
16
percentage adjustment to these estimates could have a material effect on our
results of operations for the period in which the change is made.
Reinsurance
Our receivable from reinsurers represents our estimate of the amount of
our future loss payments that will be recoverable from our reinsurers. These
estimates are based upon our estimates of the ultimate losses 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. We also estimate
premiums ceded under reinsurance agreements wherein the premium due to the
reinsurer, subject to certain maximums and minimums, is a percentage of the
losses reimbursed under the agreement. Given the uncertainty of the ultimate
amounts of our losses, 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. Our
assessment of the collectibility of the recorded amounts receivable from
reinsurers is based upon public financial statements and rating agency data as
well as our experience in collecting amounts billed to reinsurers. Any
adjustments necessary are reflected in then current operations. Due to the size
of our receivable from reinsurers, even a small adjustment to these estimates
could have a material effect on our results of operations for the period in
which the change is made. At March 31, 2004, we considered all of our receivable
from reinsurers to be collectible.
Investments
We consider our fixed maturity securities as available-for-sale and our
equity securities as either available-for-sale or trading portfolio securities.
Our available-for-sale securities are available to be sold in response
to a number of issues, including our liquidity needs, changes in market interest
rates and investment management strategies, among others. Available-for-sale
securities are recorded at fair value. The related unrealized gains and losses,
net of income tax effects, are excluded from net income and reported as a
component of stockholders' equity.
We evaluate the securities in our available-for-sale 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. 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, and
- our ability and intent to hold the investment for a period of
time sufficient to allow for any anticipated recovery in
market value.
17
A decline in the fair value of an available-for-sale security below
cost that we judge to be other than temporary is recorded as a net realized
investment loss in the current period statement of income 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.
Since January 1, 2003, we have designated certain of our equity
security purchases as trading portfolio securities. A trading portfolio is
carried at fair value with the holding gains and losses included in the current
period income statement as a component of net realized investment gains
(losses). Therefore, current period income reflects both positive and negative
changes in the market value of these securities.
LIQUIDITY AND CAPITAL RESOURCES AND FINANCIAL CONDITION
Our primary need for liquid funds is to pay losses and operating
expenses in the ordinary course of business and to meet our debt service
requirements.
Our operating activities provided positive cash flow of $94.7 million
for the three months ended March 31, 2004 as compared to $72.5 million for the
three months ended March 31, 2003. As in the prior year, our operating cash
flows are primarily derived from net investment income received and from the
excess of premiums collected over paid net losses and operating costs. Timing
delays exist between the collection of premiums and the payment of losses,
particularly so with regard to our professional liability premiums. In periods
of premium growth premium collections generally exceed losses paid. Premium
growth is the primary reason for the increase in our 2004 cash flow from
operating activities.
We believe that premium adequacy is critical to our long-term
liquidity. We continually review rates, particularly professional liability
rates, and submit requests for rate increases to state insurance departments as
we consider necessary to maintain rate adequacy. We achieved average overall
rate increases of 20% during the first quarter of 2004 and 28% during each of
the years ended December 31, 2003 and 2002. We are unable to predict whether we
will continue to receive approval for our rate filings.
We held cash and cash equivalents of approximately $32.0 million at
March 31, 2004 as compared to $47.1 million at December 31, 2003. We transfer
most of the cash generated from operations into our investment portfolio,
primarily into investment grade fixed maturity securities. At March 31, 2004 our
investments totaled $2.182 billion as compared to total investments of $2.056
billion at December 31, 2003. At March 31, 2004 total investments included net
before-tax unrealized gains of $70.5 million on available-for-sale securities;
at December 31, 2003 total investments included net before-tax unrealized gains
of $53.0 million on available-for-sale securities. Our investment of fixed
maturity securities had a fair value of $1.971 billion at March 31, 2004 as
compared to $1.791 billion at December 31, 2003. The increase in fair value
since December 31, 2003 reflects the investment of cash generated from
operations, the transfer of funds from short-term investments and cash and cash
equivalents to higher yielding fixed maturity investments, and an increase in
net before-tax unrealized gains due to higher bond prices at March 31, 2004.
Substantially all of our fixed maturities are either United States
government or agency obligations or investment grade securities as determined by
national rating agencies. The fixed maturity securities in our investment
portfolio had a dollar weighted average rating of "AA," at March 31, 2004. Our
fixed maturities are purchased with the intent to hold such investments to
maturity; however, we consider these securities as available-for-sale because we
may dispose of the securities prior to their maturity in order to meet the
Company's then current objectives. Our investment policies implement an asset
allocation that uses length to maturity as one method of managing our long-term
rate of return. The weighted average modified duration of our fixed maturity
securities at March 31, 2004 is 3.9 years. We regularly evaluate the interest
rate environment, and adjust our duration targets to maximize investment yield.
Changes in market interest rate levels generally affect our net income
to the extent that reinvestment yields are different than the original yields on
maturing securities. Additionally, changes in market interest rates may also
affect the fair value of our fixed maturity securities. For a more detailed
18
discussion of the effect of changes in interest rates on our investment
portfolio see "Item 7A -- Quantitative and Qualitative Disclosures about
Market Risk."
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 credit-worthiness of
the reinsurer. We purchase reinsurance from a number of companies to mitigate
concentrations of credit risk. Our reinsurance brokers assist us in the analysis
of the credit quality of our reinsurers. We base our reinsurance buying
decisions on an evaluation of the then current financial strength and stability
of prospective reinsurers. However, the financial strength of our reinsurers,
and their corresponding ability to pay us, may change in the future due to
forces or events we cannot control or anticipate.
We have not experienced any difficulties in collecting amounts due from
reinsurers due to financial instability of the reinsurer. As of March 31, 2004
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 current operations.
As our premiums have grown, so has our need for capital to support our
insurance operations and maintain our ratings. We have experienced significant
growth with respect to our professional liability premiums and expect continued
growth in 2004. This growth has primarily come as a result of increased prices
but is also a result of reduced competition in the professional liability
market. We have taken actions to obtain additional capital in order to support
growth by our insurance subsidiaries and believe we have the ability to raise
the capital required to support our current plans for growth.
In late 2002, we raised $46.5 million through the sale of our common
stock in an underwritten public offering. In early July 2003 we received $104.6
million from the issuance of 3.9% Convertible Debentures, due June 2023, having
a face value of $107.6 million. We utilized $67.5 million of the net proceeds to
repay our term loan and did not replace the related line of credit.
Through March 31, 2003 approximately $56.0 million has been contributed
to the capital of our professional liability insurance subsidiaries to support
the growth in insurance operations.
On February 9, 2004 we filed a universal shelf registration statement
with the Securities and Exchange Commission (SEC) that would allow us to offer
from time-to-time up to $250 million in common stock, preferred stock or debt
securities. We may sell any class of the registered securities or combinations
thereof in one or more separate offerings at a total price up to the amount
registered with the amount, price and terms of the securities sold in each
offering to be determined at the time of sale. We have no present commitments to
sell securities under the shelf registration. Our ability to sell any of these
securities will depend in part on our ability to continue profitable operations
and maintain the credit ratings assigned to us by A. M. Best and Standard &
Poor's. Any sale would require us to file a supplemental prospectus that
specifies the terms of the securities to be sold. If securities are sold, we
expect that the net proceeds will be used for general corporate purposes, which
may include contributions to the capital and surplus of our subsidiaries, the
repurchase of outstanding debt securities, or the repayment of other
indebtedness.
In April 2004 we raised additional capital through the private
placement of $13 million of trust preferred securities. The capital is available
for general corporate purposes, including providing statutory capital to support
growth in our professional liability insurance segment.
19
The trust preferred securities were issued by a subsidiary trust (the
Trust) that we formed specifically for that purpose. Our parent holding company
concurrently issued debentures (the debentures) totaling $13 million that the
Trust purchased with the proceeds from the trust preferred securities. The terms
and maturities of the debentures mirror those of the trust preferred securities.
The Trust will meet the obligations of the trust preferred securities with the
interest and principal we pay to the Trust related to the debentures.
Both the debentures and the trust preferred securities mature in April
2034 (thirty years), are callable after April 2009 (five years), and bear
interest, payable quarterly, at a variable rate based on the London Interbank
Offered Rate ("LIBOR") plus 3.85%. At the time the debentures were issued in
April 2004 the variable rate was 5.03%. See Note 13 of the Notes to the
Condensed Consolidated Financial statements included herein for a more detailed
description of the debentures.
We have obtained authorization to issue an additional $22 million of
debentures and related trust preferred securities in similarly structured
transactions that we expect to sell in May 2004. We may pursue other similar
opportunities later in 2004.
Off Balance Sheet Arrangements and Guarantees
In accordance with guidance given in Financial Accounting Standards
Board Interpretation No. 46, "Variable Interest Entities" we do not expect to
consolidate the Trust.
ProAssurance Holding has issued guarantees that amounts paid to the
Trust related to the debentures will subsequently be remitted to the holders of
the trust preferred securities. The amounts guaranteed are not expected to at
any time exceed ProAssurance Holdings' obligation under the debenture agreement,
and we do not expect to record any additional liability related to the
guarantee.
OVERVIEW
ProAssurance Corporation is an insurance holding company and its
operating results are almost entirely derived from the operations of its
insurance subsidiaries. ProAssurance operates in two industry segments:
professional liability insurance and personal lines insurance.
The professional liability segment is our largest segment, representing
over 78% of 2004 year-to- date written premiums and approximately 85% of total
assets at March 31, 2004. This segment principally provides liability insurance
for providers of health care services in the South and Midwest, and, to a
limited extent, providers of legal services in the Midwest. The principal
operating insurance subsidiaries of this segment are: The Medical Assurance
Company, Inc., ProNational Insurance Company and Red Mountain Casualty Insurance
Company, Inc. We also write professional liability insurance through Medical
Assurance of West Virginia, Inc.
Our personal lines segment provides personal property and casualty
insurance primarily to members of the educational community and their families
in the state of Michigan. Our personal lines segment includes the operations of
a single insurance company, MEEMIC Insurance Company (MEEMIC).
20
Revenues and expenses are attributable to the operating segments with
the exception of corporate income, which consists of investment income earned
directly by the parent holding company and interest expense related to long-term
debt held by the parent. Operating results by segment for the three months ended
March 31, 2004 and 2003 are summarized below.
Three Months Ended
March 31
---------------------------- Increase
2004 2003 (Decrease)
--------------------------------------------
In Thousands
Income before income taxes and minority interest:
Professional Liability Segment $ 10,856 $ 1,325 $ 9,531
Personal Lines Segment 10,856 7,253 3,603
Corporate (unallocated to segments) (388) (516) 128
---------- ----------- ----------
Consolidated $ 21,324 $ 8,062 $ 13,262
========== =========== ==========
Our professional liability segment operates in a challenging
environment. Beginning in 2000, virtually all providers of medical professional
liability began to recognize adverse trends in claim severity, causing increased
estimates of current and prior losses. Throughout the industry, premiums
previously considered adequate to cover expected losses and provide some profit
were found to be inadequate. We began to address these trends in 2000 by seeking
to increase premium rates in order to more closely align revenues with expected
losses. We have implemented rate increases in all states, even when this has
resulted in non-renewal of business. We have been more selective in our
underwriting criteria and have elected to not-renew business that we did not
expect to write profitably. At the same time, we have also worked to contain
losses and to improve operating efficiencies. Our ability to successfully
implement premium rate increases has been the most significant factor in
improving the underwriting results of this segment.
Investment income is a substantial revenue source for the professional
liability segment because, on average, premiums are collected several years
before the related losses are paid. Additionally, we consider realized capital
gains to be a significant part of our investment strategy and realized capital
gains and losses can have a substantial effect on our revenues. Prevailing
market interest rates have been at historically low levels in recent years which
has reduced our investment income. The decline in investment income somewhat
offsets any improvement that results from premium increases. In an attempt to
mitigate that risk, state regulators require us to take interest rates into
account as we develop our rates.
Our personal lines segment operates in a highly competitive environment
dominated by larger insurance organizations. We must provide a high level of
service while operating efficiently in order to competitively price our products
and obtain positive financial results.
Investment income is a less significant component of revenues for the
personal lines segment than for the professional lines segment because the
length of time between the collection of premiums and the settlement of claims
is generally short; approximately 75% of claims are paid within one year after
the claim is filed. Investment income has increased only slightly because
increases in the investment portfolio have been offset by declines in yields.
Losses are the largest component of expense for both the professional
liability segment and the personal lines segment. Our consolidated net loss
ratio (the income statement line "Net losses and loss adjustment expenses"
divided by the income statement line "Net premiums earned") for the three months
ended March 31, 2004 is 84.6%, reflecting a net loss ratio of 93.2% for the
professional liability segment and 60.3% for the personal lines segment. As
discussed in critical accounting policies, net losses in any period reflects our
estimate of net losses related to the premiums earned in that period as well as
any changes to our estimates of the reserve required for net losses of prior
periods.
21
RESULTS OF OPERATIONS -- THREE MONTHS ENDED MARCH 31, 2004 COMPARED TO THREE
MONTHS ENDED MARCH 31, 2003
Our consolidated net income is $16.0 million, or $0.54 per diluted
share, for the three months ended March 31, 2004 as compared to $6.3 million or
$0.22 per diluted share for the three months ended March 31, 2003. Results for
each period are summarized in the table below.
Three Months Ended
March 31
---------------------------- Increase
2004 2003 (Decrease)
----------------------------------------------
$ In Thousands
Revenues:
Gross premiums written $ 218,726 $ 202,660 $ 16,066
============== ============ ===========
Net premiums written $ 195,462 $ 178,936 $ 16,526
============== ============ ===========
Net premiums earned 167,842 138,196 29,646
Net investment income 19,851 17,248 2,603
Net realized investment gains (losses) 3,657 1,007 2,650
Other income 1,010 1,659 (649)
-------------- ------------ -----------
Total revenues 192,360 158,110 34,250
-------------- ------------ -----------
Expenses:
Net losses and loss adjustment expenses 141,920 125,048 16,872
Underwriting, acquisition and insurance expenses 27,973 24,422 3,551
Interest expense 1,143 578 565
-------------- ------------ -----------
Total expenses 171,036 150,048 20,988
-------------- ------------ -----------
Income before income taxes 21,324 8,062 13,262
Income taxes (benefit) 5,343 1,532 3,811
-------------- ------------ -----------
Income before minority interest 15,981 6,530 9,451
Less: minority interest -- 181 (181)
-------------- ------------ -----------
Net income $ 15,981 $ 6,349 $ 9,632
============== ============ ===========
Net loss ratio * 84.6% 90.5% (5.9%)
Underwriting expense ratio * 16.7% 17.7% (1.0%)
-------------- ------------ -----------
Combined ratio 101.3% 108.2% (6.9%)
Less: Investment income ratio * 11.8% 12.5% (0.7%)
-------------- ------------ -----------
Operating ratio 89.5% 95.7% (6.2%)
============== ============ ===========
MARCH 31 December 31
2004 2003
------------- ------------
Total assets $ 2,998,743 $ 2,879,352
============== ============
Net reserve for losses $ 1,424,916 $ 1,369,773
============== ============
* Ratios shown are expressed as a ratio of net premiums earned.
22
The operating results of each of our reportable industry segments are
discussed separately in the following sections. Revenues and expenses are
attributed to the operating segments with the exception of corporate income,
which consists of investment income earned directly by the parent holding
company and interest expense related to long-term debt held by the parent.
Our effective tax rate for each period is significantly lower than the
expected 35% statutory rate because we earned approximately 22% of our net
investment income from tax-exempt sources in 2004 and 24% in 2003.
Minority interest in 2003 relates entirely to the minority interest in
the income of MEEMIC Holdings for the period from January 1 to January 29, 2003.
We purchased this minority interest on January 29, 2003.
23
PROFESSIONAL LIABILITY SEGMENT
Operating results for our professional liability segment for the three
months ended March 31, 2004 and 2003 are summarized in the table below.
Three Months Ended
March 31
--------------------- Increase
2004 2003 (Decrease)
---- ---- ----------
$ In Thousands
Revenues:
Gross premiums written $169,737 $158,249 $ 11,488
======== ======== ========
Net premiums written $152,284 $138,823 $ 13,461
======== ======== ========
Premiums earned $138,424 $116,898 $ 21,526
Less: premiums ceded 14,867 18,661 (3,794)
-------- -------- --------
Net premiums earned 123,557 98,237 25,320
Net investment income 17,300 14,612 2,688
Net realized investment gains 2,927 832 2,095
Other income 422 1,193 (771)
-------- -------- --------
Total revenues 144,206 114,874 29,332
-------- -------- --------
Expenses:
Loss and loss adjustment expenses 123,808 114,002 9,806
Less: reinsurance recoveries 8,602 15,948 (7,346)
-------- -------- --------
Net losses and loss adjustment expenses 115,206 98,054 17,152
Underwriting, acquisition and insurance expenses 18,144 15,495 2,649
-------- -------- --------
Total expenses 133,350 113,549 19,801
-------- -------- --------
Income before income taxes $ 10,856 $ 1,325 $ 9,531
======== ======== ========
Net loss ratio * 93.2% 99.8% (6.6%)
Underwriting expense ratio * 14.7% 15.8% (1.1%)
-------- -------- --------
Combined ratio 107.9% 115.6% (7.7%)
Less: Investment income ratio * 14.0% 14.9% (0.9%)
-------- -------- --------
Operating ratio 93.9% 100.7% (6.8%)
======== ======== ========
MARCH 31 December 31
2004 2003
-------------- ------------
Identifiable segment assets $ 2,539,635 $ 2,413,043
============== ============
Net reserve for losses $ 1,355,929 $ 1,298,458
============== ============
* Ratios shown are expressed as a percentage of net premiums earned.
24
PREMIUMS
Premiums written
Premiums written for the professional liability segment increased by
$11.5 million for the three months ended March 31, 2004 as compared to the same
period in 2003, principally due to rate increases. We experienced premium growth
from new business in states where competitors have left the professional
liability market. The growth in new business has largely been offset by policies
that did not renew due to higher rates and our own underwriting decisions.
We have implemented rate increases based on loss trends and we plan to
continue to adjust rates as necessary. However, our ability to implement those
adjustments is subject to regulatory approval. Renewals to-date in 2004 have
been at rates that are approximately 20% higher than expiring rates. However, we
do not expect premium growth to reflect the full amount of the rate increases
because retention of our insureds may be reduced by the higher rates. We are
continuing to convert our remaining occurrence policies to claims-made policies.
First-year claims-made coverage has a significantly lower premium than
occurrence coverage due to lower loss exposure. We completed most of the
conversion in 2003 and expect the conversion process to be complete by September
30, 2004. To date, a substantial majority of our occurrence policyholders
accepted the conversion to claims-made coverage. The conversion reduced 2004
premiums written as compared to 2003 by approximately $7.2 million.
Premiums earned
Premiums earned for the professional liability segment increased $21.5
million for the three months ended March 31, 2004 as compared to the same period
in 2003. Premiums are earned pro rata over the entire policy period (generally
one year) after the policy is written. The increase in 2004 earned premiums
therefore reflects on a pro rata basis the changes in written premiums that
occurred during both 2004 and 2003. Thus earned premiums have increased for the
reasons discussed in the section on premiums written.
Premiums ceded
Premiums ceded represents the premiums we must ultimately pay to our
reinsurers for their assumption of a portion of our losses. Premiums ceded
decreased by $3.8 million for the three month period ended March 31, 2004 as
compared to the same period in 2003 primarily because we have reduced the
portion of our losses that we cede to our reinsurers. Beginning in October 2002
we increased our retention levels for virtually all medical liability losses
from as low as $250,000 to $1.0 million. This has the effect of reducing
ultimate premiums ceded. Premiums ceded for the quarter ended March 31, 2004
fully reflects the effects of this change in retention levels, whereas the
change had a less significant effect on premiums ceded for the quarter ended
March 31, 2003.
LOSSES AND LOSS ADJUSTMENT EXPENSES
Net Losses and Loss Adjustment Expenses
Calendar year losses may be divided into three components: (i)
actuarial evaluation of incurred losses for the current accident year; (ii)
actuarial re-evaluation of incurred losses for prior accident years; and (iii)
actuarial re-evaluation of the reserve for the death, disability and retirement
provision (DDR) in our claims-made policies.
Accident year refers to the accounting 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
25
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. Calendar year results include the operating
results for the current accident year and, as discussed in critical accounting
policies, any changes in estimates related to prior accident years.
During the three month periods ended March 31, 2004 and 2003, all net
losses recognized related to the current accident year. Net losses increased by
$17.2 million for the three months ended March 31, 2004 as compared to the three
months ended March 31, 2003. There is little change in the number of insured
risks during 2004 as compared to 2003; net losses increased during 2004
primarily because of higher loss costs. The current accident year net loss ratio
for the three months ended March 31, 2004 decreased to 93.2% as compared to
99.8% for the same period in 2003. The 2004 loss ratio is lower than the 2003
ratio because premium rates increased at a faster pace than did loss costs.
NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS (LOSSES)
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, increases in the cash surrender value of
business owned executive life insurance contracts, and rental income earned by
our commercial real estate holdings. Investment fees and expenses and real
estate expenses are deducted from investment income.
Investment income is a substantial revenue source for the professional
liability segment because, on average, premiums are collected some years before
the related losses are paid. Our net investment income increased by $2.7 million
for the three months ended March 31, 2004 as compared to the same period in
2003. The increase in investment income primarily resulted from higher average
invested funds in 2004. Offsetting the positive effect of additional invested
funds is a decline in our average yield on fixed maturity investments. 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 is 4.3% for the three months ended March 31,
2004 as compared to 5.2% for the same period in 2003. Because prevailing market
interest rates have remained low, new and matured funds have been invested at
yields that are lower than the average yield of our fixed maturity portfolio
which has resulted in a decline in the average yield of our fixed maturity
securities.
Investment income decreased from 14.9% of premiums earned in 2003 to
14.0% in 2004 for the reasons discussed above. Our operating ratio improved from
100.7% in 2003 to 93.9% in 2004. The decline in the investment ratio somewhat
offset the improvement in our combined ratio.
Net realized investment gains increased by $2.1 million for the three
months ended March 31, 2004 as compared to the same period in 2003. The increase
primarily resulted from gains realized on the sale of fixed maturity securities.
We sell these securities from time to time in order to manage our liquidity
needs and to achieve various investment management objectives, including
maximizing total yields on certain securities. The components of net realized
investment gains are shown in the following table.
Three months Ended
March 31
2004 2003
------- -------
$ In Thousands
Net gains from sales $ 2,919 $ 1,121
Other-than-temporary impairment losses - (289)
Holding gains on trading portfolio 8 -
------- -------
Net realized investment gains $ 2,927 $ 832
======= =======
26
UNDERWRITING, ACQUISITION AND INSURANCE EXPENSES
Underwriting, acquisition and insurance expenses increased by $2.6
million for the three months ended March 31, 2004 as compared to the same period
in 2003. These expenses are comprised of variable costs, such as commissions and
premium taxes that are directly related to premiums earned, and fixed costs that
have an indirect relationship to premium volume, such as salaries, benefits,
facility costs and guaranty fund assessments. The 2004 increase in expenses is
primarily due to higher variable costs incurred as a result of premium growth.
The underwriting expense ratio is the total of underwriting,
acquisition and insurance expenses divided by net premiums earned. This ratio is
14.7% for the three months ended March 31, 2004 as compared to 15.8% for the
same period in 2003. The ratio decreased because there was no significant change
in our fixed costs, while premiums earned increased in 2004.
Guaranty fund assessments are amounts we are required to contribute to
state insolvency or guaranty fund associations when so assessed by the state.
Such assessments can and do vary significantly from period to period. Guaranty
fund assessments were insignificant for the three month periods ended March 31,
2004 and 2003--$159,000 and $111,000, respectively.
27
PERSONAL LINES SEGMENT
Our personal lines segment is comprised of the operations of a single
insurance company, MEEMIC Insurance Company. Selected financial data for our
personal lines segment is summarized in the table below.
Three Months Ended
March 31
-------------------- Increase
2004 2003 (Decrease)
------- ------- --------
$ In Thousands
Revenues:
Gross premiums written $48,989 $44,411 $ 4,578
======= ======= =======
Net premiums written $43,178 $40,113 $ 3,065
======= ======= =======
Premiums earned $50,104 $44,255 $ 5,849
Less: Premiums ceded 5,819 4,296 1,523
------- ------- -------
Net premiums earned 44,285 39,959 4,326
Net investment income 2,506 2,574 (68)
Net realized investment gains 20 175 (155)
Other income 588 466 122
------- ------- -------
Total revenues 47,399 43,174 4,225
------- ------- -------
Expenses:
Loss and loss adjustment expenses 28,865 31,644 (2,779)
Less: Reinsurance recoveries 2,151 4,650 2,499
------- ------- -------
Net losses and loss adjustment expenses 26,714 26,994 (280)
Underwriting, acquisition and insurance expenses 9,829 8,927 902
------- ------- -------
Total expenses 36,543 35,921 622
------- ------- -------
Income before income taxes and minority interest $10,856 $ 7,253 $ 3,603
======= ======= =======
Net Loss ratio * 60.3% 67.6% (7.3%)
Underwriting expense ratio * 22.2% 22.3% (.1%)
------- ------- -------
Combined ratio 82.5% 89.9% (7.4%)
Less: Investment income ratio * 5.7% 6.4% (0.7%)
------- ------- -------
Operating ratio 76.8% 83.5% (6.7%)
======= ======= =======
MARCH 31 December 31
2004 2003
---------- ----------
Identifiable segment assets $ 435,570 $ 431,264
Net reserves for losses $ 68,986 $ 71,315
* Ratios shown are expressed as a percentage of net premiums earned.
28
PREMIUMS
Premiums written
Gross premiums written for the three months ended March 31, 2004,
increased by $4.6 million as compared to the three months ended March 31, 2003.
Premiums by line of business for each period are as follows.
Three Months Ended
March 31
------------------
2004 2003
--------- --------
In Millions
Automobile $ 41.4 $ 38.2
Homeowners 7.5 6.1
Boat, umbrella, and other 0.1 0.1
--------- --------
$ 49.0 $ 44.4
========= ========
Automobile premiums increased in 2004 primarily because the number of
vehicles insured increased by 5%, but also because the values of insured autos
increased and because of a 0.6% rate increase that became effective on October
1, 2003.
Homeowners premiums increased during 2004 due to 11% growth in the
number of homes insured, increases in the value of those homes, and a homeowners
rate increase of 7.6% that became effective April 1, 2003.
Premiums earned
Premiums earned increased by $5.8 million for the three months ended
March 31, 2004 as compared to the same period in 2003. Premiums are earned pro
rata over the entire policy period after the policy is written. The increase in
2004 earned premiums therefore reflects on a pro rata basis the changes in
written premiums that occurred during both 2004 and 2003. Thus earned premiums
have increased as discussed in the section on premiums written.
Premiums ceded
Premiums ceded represents the premiums we must ultimately pay to our
reinsurers for their assumption of a portion of our losses. Premiums ceded
increased for the three months ended March 31, 2004 as compared to the same
period in 2003. The increase is due to the increased volume of our business and
increased rates charged by our reinsurers.
29
LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table summarizes personal lines net losses and net loss
ratios for the three months ended March 31, 2004 and 2003 by separating losses
between the current accident year and all prior accident years. The net loss
ratios shown are calculated by dividing the applicable net losses by calendar
year net premiums earned.
Three Months Ended
March 31
------------------
2004 2003
--------- ---------
$ In Thousands
Net losses:
Current accident year $ 29,208 $ 28,382
Change in prior accident years net losses (2,494) (1,388)
--------- ---------
Calendar year net losses $ 26,714 $ 26,994
========= =========
Net loss ratio attributable to:
Current accident year 65.9% 71.0%
Change in prior accident years losses (5.6%) (3.4%)
--------- ---------
Calendar year net loss ratio 60.3% 67.6%
========= =========
Current accident year net losses for the three months ended March 31,
2004 are $29.2 million, an increase of $825,000 as compared to the three months
ended March 31, 2003. The increase in the total amount of net losses is due to a
greater number of insureds in 2004. The net loss ratio for the 2004 accident
year decreased from 71.0% in 2003 to 65.9% in 2004 primarily due to a reduction
in the number of auto collision claims during the first three months of 2004,
relative to the level of premiums earned.
We reduced prior accident years' net losses by $2.5 million and $1.4
million, respectively, during the three months ended March 31, 2004 and 2003, as
a result of favorable developments in our estimates of prior years' auto
liability reserves.
NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS (LOSSES)
Our net investment income is comprised of the interest and dividend
income from our fixed maturity, short-term, cash equivalents and equity
investments, net of investment expenses. Investment income for the three months
ended March 31, 2004 declined from 6.4% of premiums earned in 2003 to 5.7% in
2004, primarily because declines in yields more than offset increases in the
size of the portfolio. Our operating ratio improved from 83.5% in 2003 to 76.8%
in 2004. The decline in the investment ratio somewhat offset the improvement in
our combined ratio.
The weighted average tax equivalent book yield (tax adjusted gross
earnings divided by the average quarterly ending book value) of the personal
lines segment fixed maturity investments is 5.1% for the three months ended
March 31, 2004 as compared to 6.0%, for the three months ended March 31, 2003.
The average yield is reduced as compared to 2003 because market rates available
for the investment of new and matured funds were lower in 2004.
Net realized investment gains and losses for the three months ended
March 31, 2004 and 2003 did not include any realized losses for
other-than-temporary impairments.
30
UNDERWRITING, ACQUISITION AND INSURANCE EXPENSES
Underwriting, acquisition and insurance expenses consist of normal,
recurring expenses such as commissions, salaries and other expenses. These
expenses increased by approximately $0.9 million for the three months ended
March 31, 2004 as compared to the three months ended March 31, 2003, primarily
due to higher underwriting and acquisition costs from premium growth. The
underwriting expense ratio (underwriting, acquisition and insurance expenses
divided by net premiums earned) is 22.2% for the three months ended March 31,
2004 and 22.3% for the three months ended March 31, 2003. Guaranty fund
assessments total $125,000 for each of the three month periods ended March 31,
2004 and 2003, respectively.
CORPORATE
We do not allocate certain revenues and expenses to our operating
segments: investment income earned directly by the parent holding company, net
realized investment gains or losses, interest expense and other debt costs
related to long-term debt held by the parent holding company. Unallocated
amounts are summarized below.
Three Months Ended
March 31
----------------------- Increase
2004 2003 (Decrease)
-------- ------- -----------
In Thousands
Revenues:
Net investment income $ 45 $ 62 $ (17)
Net realized investment gains 710 - 710
Expenses:
Interest expense 1,143 578 565
------- ------- ---------
Unallocated expense in excess
of unallocated revenues $ 388 $ 516 $ (128)
======= ======= =========
Net realized investment gains consist of net holding gains on trading
portfolio securities owned by our parent holding company.
Interest expense increased to $1.1 million for the three months ended
March 31, 2004 as compared to $0.6 million for the same period in 2003 because
the debentures issued in July 2003 increased the amount of outstanding long-term
debt and carry a higher interest rate than did the bank term loan that was
repaid.
31
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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.
As of March 31, 2004, our fair value investment in fixed maturity
securities was $1,971 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.
MARCH 31, 2004 December 31, 2003
----------------------------------- ----------------------
PORTFOLIO CHANGE IN MODIFIED Portfolio Modified
VALUE VALUE DURATION Value Duration
Interest Rates $ MILLIONS $ MILLIONS YEARS $ Millions Years
- -------------- ---------- ---------- ----- ---------- -----
200 basis point rise $ 1,822 $ (149) 4.07 $ 1,664 3.73
100 basis point rise $ 1,896 $ (75) 3.97 $ 1,727 3.63
Current rate * $ 1,971 $ -- 3.86 $ 1,791 3.54
100 basis point decline $ 2,046 $ 75 3.78 $ 1,854 3.45
200 basis point decline $ 2,124 $ 153 3.84 $ 1,919 3.52
*Current rates are as of March 31, 2004 and December 31, 2003
At March 31, 2004, the fair value of our investment in preferred stocks
was $23.6 million, including net unrealized gains of $1.2 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.
ProAssurance's cash and short-term investment portfolio at March 31,
2004 was on a cost basis which approximates its fair value. This portfolio lacks
significant interest rate sensitivity due to its short duration.
32
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 March 31, 2004, 99.9% 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 on 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 March 31, 2004 the fair value of our investment in common stocks was
$22.7 million, which included net unrealized gains of $3.1 million and net
holding gains of approximately $1.0 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 March 31, 2004 would increase the fair value of these securities to
$24.9 million; a hypothetical 10% decrease in the price of each of these
marketable securities would reduce the fair value to $20.4 million. The selected
hypothetical change does not reflect what could be considered the best or worst
scenarios.
33
ITEM 4. CONTROLS AND PROCEDURES
The Chief Executive Officer and Chief Financial Officer of the Company
evaluated the effectiveness of our disclosure controls and procedures (as
defined in SEC Rule 13a-15(e)) as of March 31, 2004. Based on that evaluation,
the Chief Executive Officer and Chief Financial Officer have concluded that our
disclosure controls and procedures are effective.
During the quarter ended March 31, 2004, there was no change in our
internal control over financial reporting (as defined in Rule 13a-15(f)) that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.
34
FORWARD-LOOKING STATEMENTS
The U.S. securities laws, including the Private Securities Litigation
Reform Act of 1995, provide a "safe harbor" for certain forward-looking
statements. This report and the documents incorporated by reference herein
contain statements concerning our future results and performance and other
matters that are "forward-looking" statements within the meaning of Section 27A
of the Securities Act and Section 21E of the Exchange Act. The words
"anticipates," "believes," "estimates," "expects," "plans," "intends" and
similar expressions are intended, but are not the exclusive means, to identify
these forward-looking statements. These forward-looking statements 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, 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 historical
or 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.
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;
- a verdict against one of our insureds that is in excess of policy
limits could expose us to bad faith litigation by the insured;
- significantly increased competition among insurance providers and
related pricing weaknesses in some markets;
- the loss of an agent or agents who produce a significant portion of
our business;
- 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.
All forward-looking statements included in this document are based upon
information available to us on the date hereof, and we undertake no obligation,
other than as may be required under the federal securities laws, to publicly
update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise. We do not assume responsibility for the
accuracy and completeness of the forward-looking statements.
We caution you that these risk factors may not be exhaustive. We
operate in a continually changing business environment, and new risk factors
emerge from time to time. We cannot predict such new risk factors, nor can we
assess the impact, if any, of such new risk factors on our businesses or the
extent to which any factor or combination of factors may cause actual results to
differ materially from those expressed or implied by any forward-looking
statements. In light of these risks, uncertainties and assumptions, the
forward-looking events discussed in this prospectus might not occur.
For these statements, we claim the protection of the safe harbor for
forward-looking statements contained in Section 27A of the Securities Act.
35
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Note 9 to the condensed consolidated financial statements.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
4.1 ProAssurance Corporation Floating Rate Junior
Subordinated Debenture due 2034 issued as on
April 29, 2004 in original principal amount of
$13,403,000
4.2 Indenture between ProAssurance Corporation and
Wilmington Trust Company as Trustee dated as of
April 29, 2004
4.3 Certificate for 13,000 Preferred Securities of
ProAssurance Capital Trust I (Liquidation Amount
$1,000 per Preferred Security) issued on April 29,
2004
4.4 Amended and Restated Declaration of Trust of
ProAssurance Capital Trust I dated as of April 29,
2004
4.5 Preferred Securities Guarantee Agreement ProAssurance
Capital Trust I dated as of April 29, 2004
31.1 Certification of Principal Executive Officer of
ProAssurance as required under SEC rule 13a-14(a)
31.2 Certification of Principal Financial Officer of
ProAssurance as required under SEC rule 13a-14(a)
32.1 Certification of Principal Executive Officer of
ProAssurance as required under SEC Rule 13a-14(b) and
Section 1350 of Chapter 63 of Title 18 of the United
States Code, as amended (18 U.S.C. 1350)
32.2 Certification of Principal Financial Officer of
ProAssurance as required under SEC Rule 13a-14(b) and
Section 1350 of Chapter 63 of Title 18 of the United
States Code, as amended (18 U.S.C. 1350)
(b) Reports on Form 8-K.
ProAssurance filed a Current Report on Form 8-K on February
23, 2004 that furnished information publicly released on that
same day announcing its financial results for its year and
quarter ended December 31, 2003.
ProAssurance filed a Current Report on Form 8-K on March 4,
2004 that furnished the information publicly released on that
same day regarding its announcement of a renewal rights
transaction between ProAssurance Corporation and OHIC
Insurance Company.
(c) The exhibits required to be filed by Item 15(c) are listed
herein in the Exhibit Index.
36
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PROASSURANCE CORPORATION
May 3, 2004
/s/ Howard H. Friedman
-----------------------------------------
Howard H. Friedman, Chief Financial Officer
(Duly authorized officer and principal
financial officer)
37