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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
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, 2004, 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 or organization) (I.R.S. Employer Identification No.)
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. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes X No
----- -----
The aggregate market value of voting stock held by non-affiliates of the
registrant at June 30, 2004 was $995,191,723.
As of December 31, 2004, the registrant had outstanding approximately 29,204,463
shares of its common stock.
Exhibit Index at page 103
Page 1 of 108 pages
Documents incorporated by reference in this Form 10-K
(i) The definitive proxy statement for the 2005 Annual Meeting of the
Stockholders of ProAssurance Corporation (File No. 001-16533) is
incorporated by reference into Part III of this report.
(ii) Registration Statement on Form S-4 of MAIC Holdings, Inc. (File No.
33-91508) is incorporated by reference into Part IV of this report.
(iii) The MAIC Holdings, Inc. Definitive Proxy Statement for the 1996 Annual
Meeting (File No. 0-19439) is incorporated by reference into Part IV of
this report.
(iv) The Registration Statement on Form S-4 of Professionals Group, Inc. (File
No. 333-3138) is incorporated by reference into Part IV of this report.
(v) The Registration Statement on Form S-4 of ProAssurance Corporation (File
No. 333-49378) is incorporated by reference into Part IV of this report.
(vi) 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.
(vii) 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.
(viii) 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.
(ix) 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.
(x) The Registration Statement on Form S-3 of ProAssurance Corporation
(Commission File No. 333-100526) is incorporated by reference into Part IV
of this report.
(xi) The ProAssurance Annual Report on Form 10-K for the year ended December 31,
2002 (File No. 001-16533) is incorporated in Part IV of this report.
(xii) The ProAssurance Corporation Quarterly Report on Form 10-Q for the quarter
ended June 30, 2003 (File No. 001-16533) is incorporated in Part IV of this
report.
(xiii) The Registration Statement on Form S-3 of ProAssurance Corporation (File
No. 333-109972) is incorporated by reference in Part IV of this report.
(xiv) The ProAssurance Corporation Quarterly Report on form 10-Q for the quarter
ended June 30, 2004 (File No. 001-16533) is incorporated by reference into
Part IV of this report.
(xv) The ProAssurance Corporation Quarterly Report on form 10-Q for the quarter
ended March 31, 2004 (File No. 001-16533) is incorporated by reference into
Part IV of this report.
(xvi) The ProAssurance Corporation Report on Form 8-K for event occurring on
February 28, 2005 (File No. 001-16533) is incorporated by reference into
Part IV of this report.
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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 and our telephone number is (205) 877-4400. Our stock trades on
the New York Stock Exchange under the symbol "PRA."
Our website is www.ProAssurance.com. On our website we make available
all of the reports that we file with the Securities and Exchange Commission (the
SEC), including our annual report on Form 10K, our quarterly reports on Form 10Q
and our current reports on Form 8K. We provide access to these reports, as well
as Forms 3, 4 and 5 detailing stock trading by corporate insiders, through our
website as soon as reasonably practical after they are filed with the SEC. We
provide access to these reports for at least one year after their filing. We
also provide similar access to Company news releases, and to major investor
presentations made by our executives.
Our Board of Directors has adopted a Policy Regarding Determination of
Director Independence, including categorical standards to assist in determining
independence, has amended the charter of our Audit Committee and has adopted
charters for our Compensation and Nominating/Corporate Governance Committees as
well as our Corporate Governance Principles and our Code of Ethics and Conduct.
Copies of all these documents are available on our website at
http://www.proassurance.com. Printed copies of our committee charters, Corporate
Governance Principles, Code of Ethics and Conduct, and our Policy Regarding
Determination of Director Independence may be obtained by writing to: Frank
O'Neil, Senior Vice President, ProAssurance Corporation, either by mail or at
P.O. Box 590009, Birmingham, Alabama 35259-0009, or by telephone at (205)
877-4400 or (800) 282-6242.
Because the insurance business uses certain terms and phrases that
carry special and specific meaning, we urge you to read the Glossary included
at the end of Item I, prior to reading this report.
Our insurance companies are regionally-oriented. We sell professional
liability insurance to physicians, dentists, other healthcare providers and
healthcare facilities, principally in the midwest and southeast and automobile,
homeowners and associated coverages to educators and their families in Michigan.
We rigorously underwrite our risks and are focused on maintaining
adequate pricing for the risks. By ensuring that we charge an adequate rate, we
seek to maintain a strong financial position to protect our customers. Our
regional presence and service commitment allow 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.
For the year ended December 31, 2004, we generated $789.7 million of
gross premiums written, $696.0 million of net premiums earned and $794.6 million
of total revenues. As of December 31, 2004, we had cash and invested assets of
$2.5 billion, total assets of $3.2 billion and stockholders' equity of $611.0
million.
CORPORATE ORGANIZATION AND HISTORY
We were incorporated in Delaware to serve as the holding company for
Medical Assurance, Inc. (Medical Assurance) in connection with its acquisition
of Professionals Group, Inc. (Professionals Group) in June 2001. Our core
operating subsidiaries are The Medical Assurance Company, Inc., ProNational
Insurance Company, Red Mountain Casualty Insurance Company, Inc., and MEEMIC
Insurance Company. We also write a limited amount of professional
3
liability insurance through Medical Assurance of West Virginia, Inc., which we
consider to be a non-core operating subsidiary.
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 a book of business in Illinois and the acquisition of
professional liability insurers in Florida and Indiana.
MEEMIC Insurance Company was founded as a mutual company by Michigan
teachers and has provided personal lines insurance to the educational 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 2003, we increased our ownership of MEEMIC to 100%.
In each acquisition we retained key personnel, allowing us to maintain
a local presence and preserve important institutional knowledge in claims
management and underwriting. We believe that this ability to utilize local
knowledge in claims and underwriting is a critical factor in the operation of
our companies. Our successful integration of each organization demonstrates our
ability to grow effectively through acquisitions.
BUSINESS OVERVIEW
In each of our segments we maintain a strong position in our local
markets. In our professional liability segment we focus on providing medical
professional liability insurance. In our personal lines segment we offer
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.
In professional liability, our top five states represented 71% of
gross premiums written for the year ended December 31, 2004. Our personal lines
business was substantially confined to Michigan in 2004. The following table
shows our gross premiums written in these lines and key states for each of the
periods indicated.
Gross Written Premiums-Years Ended December 31
($ in thousands)
--------------------------------------------------------
Professional Liability
--------------------------------------------------------
2004 2003 2002
-------------- ---------------------- --------------
Ohio $149,269 26% $123,205 23% $ 91,571 20%
Alabama 111,582 19% 106,437 20% 83,818 18%
Florida 69,899 12% 80,549 15% 71,366 15%
Michigan 45,578 8% 54,727 10% 52,203 11%
Missouri 35,217 6% 33,987 6% 23,786 5%
All other states 162,047 29% 144,418 26% 138,971 31%
-------- --- -------- --- -------- ---
Total $573,592 100% $543,323 100% $461,715 100%
======== === ======== === ======== ===
Personal Lines Premiums
---------------------------------------------------------
2004 2003 2002
-------------- ----------------------- --------------
Michigan $216,068 100% $196,787 100% $174,441 100%
======== === ======== === ======== ===
4
For the year ended December 31, 2004, professional liability produced
a combined ratio of 104.8% and personal lines reported a combined ratio of
83.4%.
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%. Thus, the combined
ratio may not always be indicative of our ultimate results because of the
"long-tail" nature of the professional liability business.
In order to measure the effect of investment income, we also measure
our results by calculating our operating ratio.
Recent Transactions
In April and May 2004, we received $44.9 million from the issuance of
$46.4 million of trust preferred securities. These securities were issued by
specially-created business trusts created solely for the purpose of issuing the
trust preferred securities. 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 a substantial portion of the net proceeds from
the sale of the Convertible Debentures to repay our outstanding term loan. We
are using the balance of the net proceeds from the sale of the Convertible
Debentures and the trust preferred securities for general corporate purposes,
including contributions to the capital of our insurance subsidiaries to support
the growth in insurance operations. See Note 10 to our Consolidated Financial
Statements for more information regarding the Convertible Debentures and the
trust preferred securities.
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 used the proceeds from the offering to
support the growth of the professional liability insurance business and for
general corporate purposes.
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
became a wholly-owned subsidiary of ProNational.
Proposed Transaction
On February 28, 2005 ProAssurance Corporation and NCRIC Group, Inc.
(NASDAQ: NCRI) reached an agreement to merge NCRIC into ProAssurance in a $69.6
million, all-stock transaction which values NCRIC at $10.10 per share, based on
the closing price of ProAssurance common stock on February 25, 2005. See Note 19
of our Consolidated Financial Statements included herein for more information
regarding the merger.
5
PRODUCTS AND SERVICES
The following table shows Gross Written Premiums for our main lines of
business.
Years Ended December 31
($ in thousands)
------------------------------------------------
2004 2003 2002
-------------- -------------- --------------
Medical Professional Liability $561,907 71% $531,033 72% $448,136 70%
Professional Liability-Other(1) 11,685 2% 12,290 1% 13,579 3%
Private Passenger Auto 174,654 22% 161,399 22% 147,168 23%
Personal Lines - Other(2) 41,414 5% 35,388 5% 27,273 4%
-------- --- -------- --- -------- ---
$789,660 100% $740,110 100% $636,156 100%
======== === ======== === ======== ===
(1) Includes legal professional liability, workers' compensation and commercial
multi-peril coverages.
(2) Primarily homeowners coverage, but also includes boat, snowmobile and
personal umbrella coverage.
In professional liability we believe our size, financial strength and
flexibility of distribution differentiates us from our competitors. We primarily
offer 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 major physician groups as well as hospitals. While
most of our business is written in the standard market, we do offer medical
professional liability insurance on an excess and surplus lines basis to
healthcare professionals who generally do not qualify for standard coverage
because of their claim history or other factors. Red Mountain Casualty Insurance
Company, Inc. is the main subsidiary in which this business is written and we
believe it provides profitable opportunities to expand our business. We also
offer professional office package and workers' compensation insurance products
in connection with our medical professional liability products.
We write legal professional liability insurance in Michigan, Ohio and
Indiana, but that is a small percentage of our professional liability business.
In personal lines, 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.
MARKETING
In professional liability, 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 2004, Ohio, Alabama, Florida, Michigan, and Missouri represented our
five largest states. In personal lines, we market our products to members of the
educational community and their families in Michigan and Wisconsin.
We utilize direct marketing and independent agents to write
professional liability 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, 2004, we
estimate that approximately 65% 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.
Our marketing is primarily directed to physicians. We generally do not
target large physician groups or facilities because of the difficulty in
underwriting the individual risks and because their purchasing decision is more
focused on price. Our marketing efforts differentiate our professional liability
insurance products by emphasizing:
6
- excellent claims service and the other services and communications we
provide to our customers,
- 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 proposed legislation we
believe will have a positive effect on 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 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.
We sell our personal lines coverage through exclusive sales
representatives who produce business primarily for MEEMIC. Our representatives
are able to sell coverages that
MEEMIC does not underwrite. Those policies are written through MEEMIC's
wholly-owned insurance agency; both MEEMIC and our representatives receive
compensation from the companies that write those coverages.
For the year ended December 31, 2004, one sales representative
accounted for approximately 5% of our direct premiums written within our
personal lines segment. The top 10 sales representatives accounted for
approximately 34% of our direct premiums written in 2004.
UNDERWRITING
Our underwriting process is driven by individual risk selection rather
than by account. 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 professional liability underwriting focuses on knowledge of local
market conditions and legal environment. Through our five regional 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.
Our professional liability underwriting department classifies 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.
These 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.
In personal lines 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. Our underwriters then evaluate and accept applications for insurance
submitted by the sales representatives based on underwriting guidelines.
7
CLAIMS MANAGEMENT
In each of our segments our claims departments establish the
appropriate case reserves for each claim and monitor the level of each case
reserve as circumstances require.
In professional liability 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.
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.
We also offer professional liability claims management to
self-insuring entities on a fee-for-service basis. While we do not expect this
to become a major source of revenue for us, we believe it allows us to leverage
our claims-management expertise to produce some additional income as larger
groups and facilities decide to self-insure their malpractice risk.
Our personal lines claims operation is centralized in Auburn Hills,
Michigan, with 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 needed.
In responding to claims in personal lines, 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 which enables us to
quickly complete initial claim handling and ultimately reduces indemnity
payments such as rental and storage.
We have also established relationships with 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. Historically, less than 1% of all claims
result in litigation.
8
INVESTMENTS
We manage our investments at the holding company level, but allocate
portfolio assets and earnings to the individual segments. Our overall investment
strategy is to focus on maximizing current income from our investment portfolio
while maintaining safety, liquidity, duration and portfolio diversification. The
portfolio is generally managed by professional third party asset managers whose
results are evaluated periodically by management. The asset managers typically
have the authority to make investment decisions, subject to investment policies,
within the asset class they are responsible for managing. See Note 3 to our
Consolidated Financial Statements for more detail on our investments.
RATING AGENCIES
Our principal insurance subsidiaries are rated "A-" (Excellent) by
A.M. Best, its fourth highest category out of 15 categories. Best maintained a
"Stable" Outlook on these subsidiaries at December 31, 2004. Standard & Poor's
rates our principal insurance subsidiaries "A-" (Strong), its seventh highest
category out of 21 categories, and maintained a "Stable" outlook on the rating
at December 31, 2004.
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.
Our West Virginia-based subsidiary, Medical Assurance of West Virginia
(MAWV), which accounts for less than two percent of ProAssurance's book of
business, is rated "B" (Fair) by Best with a "Positive" outlook. Best downgraded
MAWV on December 24, 2003 as a result of our decision to terminate a reinsurance
contract between MAWV and our Alabama-based subsidiary, The Medical Assurance
Company, Inc. Standard & Poor's downgraded MAWV on December 19, 2003 and then
withdrew the rating at our request.
As a result of our proposed transaction with NCRIC, as discussed under
"Recent Transactions", A.M. Best has placed the financial strength rating of
ProAssurance Group under review with negative implications. The negative
implications signal that the ratings could either remain the same or be
downgraded following the completion of the under review process.
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 beyond our
control. However, for those factors within our 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.
In professional liability we compete with insurance companies and
self-insuring entities 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 resources
than we do.
Self-insuring entities are emerging as an alternative to the
traditional insurance market as insureds seek greater control over the
professional liability premiums. We assist groups with the formation and
administration of self-insuring entities, and earn fee income for the management
and services we provide. We do not expect this to become a major source of
revenue for us. However, we hope to produce additional income to offset some of
the potential lost business as growth in this segment of the market removes
potential insureds from the traditional insurance market.
9
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. We have achieved these advantages
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 the
states where we are currently writing insurance.
Beginning in 1999, insurance companies focused on medical professional
liability coverage experienced higher claim costs on business written in prior
years than they had reserved for initially. In many cases this resulted in
significant losses and reduced the capital available to support current and
future business. This led many professional liability carriers focused on
medical professional liability coverages to withdraw from, or limit new business
in, one or more markets.
In 2002 several medical liability insurance companies were forced from
the market due to financial difficulties. The St. Paul Companies, then the
leading writer of medical professional liability insurance withdrew from the
market. In 2003 Farmers Insurance Company exited medical professional liability
insurance and The Reciprocal of America was placed under regulatory supervision.
We believe these events have heightened the sensitivity of our target market to
this issue.
Given this reduction in capacity and the uncertainty surrounding
several writers in the medical professional liability market, we believe there
has been a "flight to quality" as insureds place greater emphasis on financial
strength and stability. We believe this trend will continue through 2005.
However, small competitors, focused on limited pools of risk or geographic
areas, are entering the market in a few areas and as a result we cannot be
certain how long current market conditions will persist.
Our personal lines insurance subsidiary operates in a highly
competitive market and some of our 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.
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.
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
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insurance holding company systems, including acquisitions, the payment of
dividends, the terms of affiliate transactions, and other related matters. Our
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.
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 or 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 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 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 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 principal 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 are 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.
11
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 a detriment 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. At December 31,
2004, all of 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. We believe that our operating subsidiaries
are in compliance with state investment regulations.
Guaranty Funds
Admitted insurance companies are required to be members of guaranty
associations which administer state Guaranty Funds. 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
State insurance regulations may force us 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.
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.
Several of the states in which we operate, notably Ohio and West
Virginia, have passed Tort Reform, but these laws have yet to materially affect
our business. However, we believe they will be challenged in court and past
history tells us that they may be invalidated in the appeals process. Because we
cannot predict with any certainty how appellate courts will rule on these laws
we do not take them into account in our rate-making assumptions, except in
Florida where such credit is required by law.
Legislatures in other states in which we operate are currently
considering, or being asked to consider Tort Reform, but we cannot predict in
which states those efforts will be successful. In certain states, Tort Reform
may also place limits on the ability of medical liability insurers to raise
12
or maintain rates at adequate levels. We continue to monitor developments on a
state-by-state basis, and make business decisions accordingly.
The professional liability market in Florida is also likely to be
changed by three constitutional amendments that were approved by voters in
November 2004. The first amendment places limits on fees plaintiff attorneys may
collect in medical liability cases and could result in fewer malpractice claims
being filed.
The second amendment would take away the license of any physician who
has three malpractice judgments or adverse findings by a licensing review
organization. We believe this could cause physicians to demand settlements in
malpractice cases which could generate more lawsuits and drive up costs.
The third amendment gives the public greater rights to see previously
confidential state complaints filed against doctors and institutions, incident
reports filed after medical errors, and documents from error reviews done by
hospitals. This could have a detrimental effect on peer review activities.
All three amendments are being challenged in court and are subject to
further legislative interpretation. We are unable to predict how they will
affect our business until we know exactly how and when they will be implemented.
There are also Tort Reform proposals being considered at the Federal
level. This legislation has the backing of the Bush administration and has
repeatedly passed the House of Representatives. The legislation has never been
approved in the Senate and while there are more Republicans now serving in the
Senate, we do not know if there are enough votes to enact these reforms. As in
the states, passage of a federal Tort Reform package would likely be subject to
judicial challenge and we cannot be certain that it would be upheld by the
courts.
In addition, several committees of Congress have made inquiries and
conducted hearings as part of a broad study on 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. 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.
EMPLOYEES
At December 31, 2004, we employed 632 persons. None of our employees
are 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 are identified by
words such as, but not limited to, "believe", "expect", "intend", "anticipate",
"estimate", "project" and other analogous expressions. Forward-looking
statements relating to our business 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 or performance of our obligations under the debentures,
payment of dividends, and other matters. In addition, forward-looking statements
may also relate to the proposed merger between ProAssurance and NCRIC Group,
Inc. as well as the goals, plans, objectives, intentions, expectations,
financial condition, results of operations, future performance and business of
the combined company including, without limitation, statements relating to the
benefits of the merger, such as future financial and operating results, cost
savings, enhanced revenues and the accretion to reported earnings that may be
realized from the merger and statements regarding certain
13
of ProAssurance's and/or NCRIC's goals and expectations with respect to
earnings, earnings per share, revenue, expenses and the growth rate in such
items, as well as other measures of economic performance.
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.
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.
Risks that could adversely affect our proposed transaction with NCRIC
include but are not limited to the following:
- the business of ProAssurance and NCRIC may not be combined
successfully, or such combination may take longer to accomplish than
expected;
- the cost savings from the merger may not be fully realized or may take
longer to realize than expected;
- operating costs, customer loss and business disruption following the
merger, including adverse effects on relationships with employees, may
be greater than expected;
- governmental approvals of the merger may not be obtained, or adverse
regulatory conditions may be imposed in connection with governmental
approvals of the merger;
- there may be restrictions on our ability to achieve continued growth
through expansion into other states or through acquisitions or
business combinations; and
- the stockholders of NCRIC may fail to approve the merger.
14
GLOSSARY OF SELECTED INSURANCE AND RELATED FINANCIAL TERMS
In an effort to help our investors and other interested parties better
understand our report, we are providing a Glossary of Selected Insurance Terms.
These definitions are taken from recognized industry sources such as A. M. Best
and The Insurance Information Institute. This list is intended to be informative
and explanatory, but we do not represent that it is a comprehensive glossary.
Accident year ...................... The accounting period in which an insured
event becomes a liability of the insurer.
Admitted company; admitted basis ... An insurance company licensed and
authorized to do business in a particular
state. An admitted company doing business
in a state is said to operate on "an
admitted basis" and is subject to all
state insurance laws and regulations
pertaining to its operations. (See:
Non-admitted company)
Adverse selection .................. The tendency of those exposed to a higher
risk to seek more insurance coverage than
those at a lower risk. Insurers react
either by charging higher premiums or not
insuring at all, as in the case of
floods. Adverse selection can be seen as
concentrating risk instead of spreading
it.
Agent .............................. An individual or firm that represents an
insurer under a contractual or employment
agreement for the purpose of selling
insurance. There are two types of agents:
independent agents, who represent one or
more insurance companies but are not
employed by those companies and are paid
on commission, and exclusive or captive
agents, who by contract are required to
represent or favor only one insurance
company and are either salaried or work
on commission. Insurance companies that
use employee or captive agents are called
direct writers. Agents are compensated
by the insurance company whose products
they sell. By definition, with respect to
a given insurer, an agent is not a broker
(See: Brokers)
Alternative markets ................ Mechanisms used to fund self-insurance.
This includes captives, which are
insurers owned by one or more
non-insurers to provide owners with
coverage. Risk-retention groups, formed
by members of similar professions or
businesses to obtain liability insurance,
are also a form of self-insurance.
Assets; admitted; non-admitted ..... Property owned, in this case by an
insurance company, including stocks,
bonds, and real estate. Because insurance
accounting is concerned with solvency and
the ability to pay claims, insurance
regulators require a conservative
valuation of assets, prohibiting
insurance companies from listing assets
on their balance sheets whose values are
uncertain, such as furniture, fixtures,
debit balances, and accounts receivable
that are more than 90 days past due
(these are non-admitted assets). Admitted
assets are those assets that can be
easily sold in the event of
15
liquidation or borrowed against, and
receivables for which payment can be
reasonably anticipated.
Broker ............................. An intermediary between a customer and an
insurance company. Brokers typically
search the market for coverage
appropriate to their clients and they
usually sell commercial, not personal,
insurance. Brokers are compensated by the
insureds on whose behalf they are
working. With respect to a given insurer,
a broker is not an agent. (See: Agent)
Bulk reserves ...................... Reserves for losses that have occurred
but have not been reported as well as
anticipated changes to losses on reported
claims. Bulk reserves 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 and incurred but not
reported claims, including amounts
already paid. (See: Case Reserves)
Capacity ........................... For an individual insurer, the maximum
amount of premium or risk it can
underwrite based on its financial
condition. The adequacy of an insurer's
capital relative to its exposure to loss
is an important measure of solvency.
Capital ............................ Stockholder's equity (for publicly-traded
insurance companies) and policyholders'
surplus (for mutual insurance companies).
Capital adequacy is linked to the
riskiness of an insurer's business. (See:
Risk-Based Capital, Surplus, Solvency)
Case reserves ...................... Reserves for future losses for reported
claims as established by an insurer's
claims department.
Casualty insurance ................. Insurance which is primarily concerned
with the losses caused by injuries to
third persons (in other words, persons
other than the policyholder) and the
legal liability imposed on the insured
resulting therefrom. (See: Professional
liability insurance, Medical professional
liability insurance)
Catastrophe ........................ Term used for statistical recording
purposes to refer to a single incident or
a series of closely related incidents
causing severe insured property losses
totaling more than a given amount.
Catastrophe Reinsurance ............ Reinsurance (insurance for insurers) for
catastrophic losses.
Cede, cedant; ceding company ....... When a party reinsures its liability with
another, it "cedes" business and is
referred to as the "cedant" or "ceding
company."
Claims-made policy; coverage ....... A form of insurance that pays claims
presented to the insurer during the term
of the policy or within a specific term
after its expiration. It limits liability
insurers' exposure to unknown future
liabilities. Under a claims-made policy,
an insured event becomes a liability when
the event is first reported to the
insurer.
16
Combined ratio ..................... The sum of the underwriting expense ratio
and net loss ratio, determined in
accordance with either statutory
accounting principles (SAP) or GAAP.
Commission ......................... Fee paid to an agent or insurance
salesperson as a percentage of the policy
premium. The percentage varies widely
depending on coverage, the insurer, and
the marketing methods.
Direct premiums written ............ Premiums charged by an insurer for the
policies that it underwrites, excluding
any premiums that it receives as a
reinsurer.
Direct writer(s) ................... Insurance companies that sell directly to
the public using exclusive agents or
their own employees.
Domestic insurance company ......... Term used by a state to refer to any
company incorporated there.
Excess & Surplus Lines;
Surplus lines ...................... Property/casualty insurance coverage that
isn't generally available from insurers
licensed in the state (See: Admitted
companies) and must be purchased from a
"non-admitted company". Examples include
risks of an unusual nature that require
greater flexibility in policy terms and
conditions than exist in standard forms
or where the highest rates allowed by
state regulators are considered
inadequate by admitted companies. Laws
governing surplus lines vary by state.
Excess coverage; excess limits ..... An insurance policy that provides
coverage limits above another policy with
similar coverage terms, or above a
self-insured amount.
Extended Reporting Endorsement...... Also known as a "tail policy" or "tail
premium." Tail coverage provides
protection for future claims filed after
a claims-made policy has lapsed.
Typically requires payment of an
additional premium, the "tail premium."
"Tail coverage" may also be granted if
the insured becomes disabled, dies or
permanently retired from the covered
occupation (i.e., the practice of
medicine in medical liability policies.)
Facultative reinsurance ............ A generic term describing reinsurance
where the reinsurer assumes all or a
portion of a single risk. Each risk is
separately evaluated and each contract is
separately negotiated by the reinsurer.
Frequency .......................... Number of times a loss occurs per unit of
risk or exposure. One of the criteria
used in calculating premium rates.
Front, fronting .................... A procedure in which a primary insurer
acts as the insurer of record by issuing
a policy, but then passes all or
virtually all of the risk to a reinsurer
in exchange for a commission. Often, the
fronting insurer is licensed to do
business in a state or country where the
risk is located, but the reinsurer is
not. The reinsurer in this scenario is
often a captive or an independent
insurance company that cannot sell
insurance directly in a particular
country.
17
Gross premiums written ............. Total premiums for direct insurance
written and assumed reinsurance during a
given period. The sum of direct and
assumed premiums written.
Guaranty Fund; assessment(s) ....... The mechanism by which solvent insurers
ensure that some of the policyholder and
third party claims against insurance
companies that fail are paid. Such funds
are required in all 50 states, the
District of Columbia and Puerto Rico, but
the type and amount of claim covered by
the fund varies from state to state.
Homeowners insurance ............... The typical homeowners insurance policy
covers the house, the garage and other
structures on the property, as well as
personal possessions inside the house
such as furniture, appliances and
clothing, against a wide variety of
perils including windstorms, fire and
theft. The extent of the perils covered
depends on the type of policy. An
all-risk policy offers the broadest
coverage. This covers all perils except
those specifically excluded in the policy.
Incurred but not reported (IBNR) ... Actuarially estimated reserves for
estimated losses that have been incurred
by insureds and reinsureds but not yet
reported to the insurer or reinsurer
including unknown future developments on
losses which are known to the insurer or
reinsurer. Insurance companies regularly
adjust reserves for such losses as new
information becomes available.
Incurred losses .................... Losses covered by the insurer within a
fixed period, whether or not adjusted or
paid during the same period, plus changes
in the estimated value of losses from
prior periods.
Insolvent; insolvency .............. Insurer's inability to pay debts.
Typically the first sign of problems is
inability to pass the financial tests
regulators administer as a routine
procedure. (See: Risk-based capital)
Investment income .................. Income generated by the investment of
assets. Insurers have two sources of
income, underwriting (premiums less
claims and expenses) and investment
income.
Liability insurance ................ A line of casualty insurance for amounts
a policyholder is legally obligated to
pay because of bodily injury or property
damage caused to another person. (See:
Casualty insurance, Professional
liability insurance, Medical professional
liability insurance)
Limits ............................. Maximum amount of insurance that can be
paid for a covered loss.
Long-tail; short-tail .............. The long period of time between
collecting the premium for insuring a
risk and the ultimate payment of losses.
This allows insurance companies to invest
the premiums until losses are paid, thus
producing a higher level of invested
assets and investment income as compared
to other lines of property and casualty
business. Medical professional liability
is considered a
18
long tail line of insurance. Personal
lines is primarily considered a short
tail line of insurance 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. (See:
Medical professional liability,
Professional liability)
Loss adjustment expenses (LAE) ..... The expenses of settling claims,
including legal and other fees and the
portion of general expenses allocated to
claim settlement costs.
Loss costs ......................... The portion of an insurance rate used to
cover claims and the costs of adjusting
claims. Insurance companies typically
determine their rates by estimating their
future loss costs and adding a provision
for expenses, profit, and contingencies.
Loss ratio ......................... Percentage of each premium dollar an
insurer spends on claims.
Loss reserves ...................... Liabilities established by insurers and
reinsurers to reflect the estimated cost
of claims payments and the related
expenses that the insurer or reinsurer
will ultimately be required to pay in
respect of insurance or reinsurance it
has written. They represent a liability
on the insurer's balance sheet.
Medical professional
liability insurance ................ Insurance against the legal liability of
an insured (and against loss, damage or
expense incidental to a claim of such
liability) arising out of death, injury
or disablement of a person as the result
of negligent deviation from the standard
of care or other misconduct in rendering
professional service.
NAIC ............................... The National Association of Insurance
Commissioners is the organization of
insurance regulators from the 50 states,
the District of Columbia and the four
U.S. territories. The NAIC provides a
forum for the development of uniform
policy when uniformity is appropriate.
Net loss ratio ..................... The net loss ratio measures the ratio of
net losses to earned premiums determined
in accordance with SAP or GAAP.
Net premium earned ................. The portion of net premium written that
is recognized for accounting purposes as
income during a particular period. Equal
to net premiums written plus the change
in net unearned premiums during the
period.
Net premiums written ............... Gross premiums written for a given period
less premiums ceded to reinsurers during
such period.
Non-admitted company; basis ........ Insurers licensed in some states, but not
others. States where an insurer is not
licensed call that insurer
"non-admitted." Non-admitted companies
sell coverage that is unavailable from
licensed insurers within a state and are
generally exempt from most state laws and
regulations related to rates and
19
coverages. Policyholders of such
companies generally do not have the same
degree of consumer protection and
financial recourse as policyholders of
admitted companies. Non-admitted
companies are said to operate on a
"non-admitted" basis.
Occurrence policy; coverage......... Insurance that pays claims arising out of
incidents that occur during the policy
term, even if they are filed many years
later. Under an occurrence policy the
insured event becomes a liability when
the event takes place.
Operating ratio .................... The operating ratio is the combined
ratio, less the ratio of investment
income (exclusive of realized gains and
losses) to net earned premiums, if
determined in accordance with GAAP. While
the combined ratio strictly measures
underwriting profitability, the operating
ratio incorporates the effect of
investment income.
Personal lines insurance ........... Property and casualty insurance written
for an individual and on the personal and
real property of an individual such as
homeowners insurance and personal
automobile insurance.
Policy ............................. A written contract for insurance between
an insurance company and policyholder
stating details of coverage.
Premium ............................ The price of an insurance policy,
typically charged annually or
semiannually.
Premiums written ................... The total premiums on all policies
written by an insurer during a specified
period of time, regardless of what
portions have been earned.
Premium tax ........................ A state tax on premiums for policies
issued in the state, paid by insurers.
Primary Company .................... In a reinsurance transaction, the
insurance company that is reinsured.
Professional liability insurance ... Covers professionals for negligence and
errors or omissions that cause injury or
economic loss to their clients. (See:
Casualty insurance, Liability insurance,
Medical professional liability insurance)
Property/casualty insurance ........ Covers damage to or loss of
policyholders' property and legal
liability for damages caused to other
people or their property.
Rate ............................... The cost of insurance for a specific unit
of exposure, such as for one physician.
Rates are based on historical loss
experience for similar risks and may be
regulated by state insurance offices.
Rating agencies .................... These agencies assess insurers' financial
strength and viability to meet
claims obligations. Some of the factors
considered include company earnings,
capital adequacy, operating leverage,
liquidity, investment performance,
reinsurance programs, and management
ability, integrity and experience. A high
financial rating is not the same as a
high consumer satisfaction rating.
20
Reinsurance ........................ Insurance bought by insurance companies.
In a reinsurance contract the reinsurer
agrees to indemnify another insurance or
reinsurance company, the ceding company,
against all or a portion of the insurance
or reinsurance risks underwritten by the
ceding company under one or more policies.
Reinsurers may have their own reinsurers,
called retrocessionaires. Reinsurers don't
pay policyholder claims. Instead, they
reimburse insurers for claims paid.
Reinsured layer; retained layer ... The retained layer is the cumulative
portion of each loss, on a per-claim
basis, which is less than an insurer's
reinsurance retention for a given coverage
year. Likewise, the reinsured layer is the
cumulative portion of each loss that
exceeds the reinsurance retention. (See:
Reinsurance, Retention)
Reserves .......................... A company's best estimate of what it will
pay, at some point in the future, for
claims for which it is currently
responsible.
Retention ......................... The amount or portion of risk that an
insurer retains for its own account.
Losses in excess of the retention level up
to the outer limit, if any, are paid by
the reinsurer. In proportional treaties,
the retention may be a percentage of the
original policy's limit. In excess of loss
business, the retention is a dollar amount
of loss, a loss ratio or a percentage.
Risk-Based Capital (RBC) .......... A regulatory measure of the amount of
capital required for an insurance company,
based upon the volume and inherent
riskiness of the insurance sold, the
composition of its investment portfolio
and other financial risk factors.
Higher-risk types of insurance, liability
as opposed to property business, generally
necessitate higher levels of capital. 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. (See: NAIC)
Risk management ................... Management of the varied risks to which a
business firm or association might be
subject. It includes analyzing all
exposures to gauge the likelihood of loss
and choosing options to better manage or
minimize loss. These options typically
include reducing and eliminating the risk
with safety measures, buying insurance,
and self-insurance.
Self-insurance .................... The concept of assuming a financial risk
oneself, instead of paying an insurance
company to take it on. Every policyholder
is a self-insurer in terms of paying a
deductible and co-payments. Larger
policyholders often self-insure frequent
or predictable losses to avoid insurance
overhead expenses.
Severity .......................... The average claim cost, statistically
determined by dividing dollars of losses
by the number of claims.
21
Solvent, solvency ................. Insurance companies' ability to pay the
claims of policyholders. Regulations to
promote solvency include minimum capital
and surplus requirements, statutory
accounting conventions, limits to
insurance company investment and corporate
activities, financial ratio tests, and
financial data disclosure.
Statutory Accounting Principles;
SAP ............................ More conservative standards than under
GAAP accounting rules, they are imposed by
state laws that emphasize the present
solvency of insurance companies. SAP helps
ensure that the company will have
sufficient funds readily available to meet
all anticipated insurance obligations by
recognizing liabilities earlier or at a
higher value than GAAP and assets later or
at a lower value. For example, SAP
requires that selling expenses be recorded
immediately rather than amortized over the
life of the policy. (See: Generally
Accepted Accounting Principles, Admitted
assets)
Surplus; statutory surplus ........ The excess of admitted assets over total
liabilities (including loss reserves) that
protects policyholders in case of
unexpectedly high claims. "Statutory
Surplus" is determined in accordance with
Statutory Accounting Principles.
Tail .............................. The period of time that elapses between
the occurrence of the loss event and the
payment in respect thereof.
Third-party coverage .............. Liability coverage purchased by the
policyholder as a protection against
possible lawsuits filed by a third party.
The insured and the insurer are the first
and second parties to the insurance
contract.
Treaty reinsurance ................ The reinsurance of a specified type or
category of risks defined in a reinsurance
agreement (a "treaty") between a primary
insurer or other reinsured and a
reinsurer. Typically, in treaty
reinsurance, the primary insurer or
reinsured is obligated to offer and the
reinsurer is obligated to accept a
specified portion of all such type or
category of risks originally written by
the primary insurer or reinsured.
Umbrella coverage ................. Insurance protection for all classes of
business, including automobile, fire,
general liability, homeowners, multiple
peril, burglary, and glass, combining the
coverages for these classes of business
into one insurance contract. Typically
provides coverage limits in excess of
other insurance policies.
Underwriting ...................... The insurer's or reinsurer's process of
reviewing applications submitted for
insurance coverage, deciding whether to
accept all or part of the coverage
requested and determining the applicable
premiums.
Underwriting expense ratio ........ The ratio of underwriting, acquisition and
other insurance expenses incurred to net
premiums earned (for statutory purposes,
the ratio of underwriting expenses
incurred to net premiums written.)
22
Underwriting expenses ............. The aggregate of policy acquisition costs,
including commissions, and the portion of
administrative, general and other expenses
attributable to underwriting operations.
Underwriting income; loss ......... The insurer's profit on the insurance sale
after all expenses and losses have been
paid, before investment income or income
taxes. When premiums aren't sufficient to
cover claims and expenses, the result is
an "underwriting loss."
Underwriting profit ............... The amount by which net earned premiums
exceed Underwriting Income; the sum of
losses, loss adjustment expenses and
underwriting expenses (See: Underwriting
Income)
Unearned premium .................. The portion of premium that represents the
consideration for the assumption of risk
in the future. Such premium is not yet
earned since the risk has not yet been
assumed. May also be defined as the
pro-rata portion of written premiums that
would be returned to policyholders if all
policies were terminated by the insurer on
a given date.
23
ITEM 2. PROPERTIES
We own a 156,000 square foot office building located in Birmingham,
Alabama where we currently occupy approximately 78,000 square feet. 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 corporate offices in Auburn Hills, Michigan. In 2005 MEEMIC plans to begin
construction of new corporate offices on an 11.5-acre vacant parcel of land
currently owned in Auburn Hills, Michigan. We lease other office facilities in
various locations and lease computer and operating equipment under cancelable
and non-cancelable agreements.
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.
See Note 8 to our Consolidated Financial Statements included herein.
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.
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 (Age 68) 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 (Age 57) 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.
Here are the other executive officers of ProAssurance and a brief
description of their principal occupation and employment during the last five
years.
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. (Age 64)
24
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 46)
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 56)
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 51)
EDWARD L. RAND Mr. Rand was appointed as our Senior Vice President of
Finance in November 2004. Prior to joining ProAssurance Mr.
Rand was the Chief Accounting Officer and Head of Corporate
Finance for PartnerRe Ltd. Prior to that time Mr. Rand
served as the Chief Financial Officer of Atlantic American
Corporation. (Age 38)
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 53)
ProAssurance has adopted a code of ethics that applies to its directors and
executive officers, including its principal executive officers, principal
financial officer, and principal accounting officer. See Item 1 for information
regarding the availability of the Code of Ethics.
25
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
At March 2, 2005, ProAssurance Corporation (PRA) had 3,535 stockholders
of record and 29,205,007 shares of common stock outstanding. ProAssurance's
common stock currently trades on The New York Stock Exchange (NYSE) under the
symbol "PRA".
2004 2003
--------------- ---------------
Quarter HIGH LOW High Low
- ------- ------ ------ ------ ------
First $35.00 $30.33 $23.92 $20.69
Second 37.42 32.83 30.50 23.40
Third 35.20 30.20 28.90 24.50
Fourth 40.57 33.48 32.97 26.86
ProAssurance has not paid any cash dividends on its common stock and
does not currently have a policy to pay regular dividends.
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 "Insurance Regulatory
Matters-Regulation of Dividends and Other Payments from Our Operating
Subsidiaries" in Item 1 on page 11 of this 10-K.
26
ITEM 6. SELECTED FINANCIAL DATA
Year ended December 31
---------------------------------------------------------------
SELECTED FINANCIAL DATA (1) 2004 2003 2002 2001 2000
- --------------------------- ---------- ----------- ---------- ---------- ----------
(In thousands except per share data)
Gross premiums written $ 789,660 $ 740,110 $ 636,156 $ 388,983 $ 223,871
Net premiums written 717,059 668,909 537,123 310,291 194,279
Premiums earned 765,643 698,347 576,414 381,510 216,297
Premiums ceded (69,623) (74,833) (99,006) (68,165) (38,701)
Net premiums earned 696,020 623,514 477,408 313,345 177,596
Net investment income 87,225 73,619 76,918 59,782 41,450
Net realized investment gains (losses) 7,609 5,992 (5,306) 5,441 913
Other income 3,699 6,515 6,747 3,987 2,630
Total revenues 794,553 709,640 555,767 382,555 222,589
Net losses and loss adjustment expenses 572,881 551,376 448,029 298,558 155,710
Income before cumulative effect
of accounting change 72,811 38,703 10,513 12,450 24,300
Net income (2) 72,811 38,703 12,207 12,450 24,300
Income per share before cumulative
effect of accounting change (3)
Basic $ 2.50 $ 1.34 $ 0.40 $ 0.51 $ 1.04
Diluted $ 2.37 $ 1.32 $ 0.39 $ 0.51 $ 1.04
Net income per share: (2) (3)
Basic $ 2.50 $ 1.34 $ 0.47 $ 0.51 $ 1.04
Diluted $ 2.37 $ 1.32 $ 0.46 $ 0.51 $ 1.04
Weighted average number of
shares outstanding: (3)
Basic 29,164 28,956 26,231 24,263 23,291
Diluted 31,984 30,389 26,254 24,267 23,291
BALANCE SHEET DATA (as of December 31)
Total investments $2,455,053 $2,055,672 $1,679,497 $1,521,279 $ 796,526
Total assets 3,239,198 2,879,352 2,586,650 2,238,325 1,122,836
Reserve for losses and loss
adjustment expenses 2,029,592 1,814,584 1,622,468 1,442,341 659,659
Long-term debt 151,480 104,789 72,500 82,500 -
Total liabilities 2,628,179 2,333,047 2,055,086 1,802,606 777,669
Total capital 611,019 546,305 505,194 413,231 345,167
Total capital per share of common
stock outstanding $ 20.92 $ 18.77 $ 17.49 $ 16.02 $ 15.22
Common stock outstanding at
end of year 29,204 29,105 28,877 25,789 22,682
(1) Includes Professionals Group since the date of consolidation, June 27,
2001.
(2) 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 13 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.
(3) Diluted net income per share for 2003 has been restated to reflect
implementation of Emerging Issues Task Force 04-8, "The Effect of
Contingently Convertible Debt on Diluted Earnings per Share". The
restatement reduced previously reported diluted net income per share by
$0.01.
27
ITEM 7. 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 in the United States of America
(GAAP). 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 affected by the need to make accounting
adjustments reflecting changes in these estimates and assumptions. Management
considers an accounting policy to be critical if it involves significant
judgment by management and if the effect of those judgments could result in a
material effect on the financial statements.
We believe the following critical accounting 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 the investigation and
settlement of claims. These estimates consist of case reserves and bulk
reserves. 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 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. 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. Our 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 then current operations. Due to the size
of our reserves, even a small percentage adjustment to these estimates could
have a material effect on our results of operations for the period in which the
adjustment is made. See the discussion under "Overview" in this section for a
history of our loss reserve development.
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 payable to reinsurers
are regularly reviewed and updated by management as new data becomes available.
Our assessment of the collectibility of the
28
recorded amounts receivable from reinsurers is based primarily upon public
financial statements and rating agency data. 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 adjustment is
made. At December 31, 2004, we considered all of our receivables 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. Both available-for-sale and trading portfolio securities are carried
at fair value. Positive and negative changes in the market value (unrealized
gains and losses) of available-for-sale securities are included, net of the
related tax effect, in accumulated comprehensive income, a component of
stockholders' equity, and are excluded from current period net income. Positive
and negative changes in the market value of trading portfolio securities are
included in current period net income as a component of net realized investment
gains (losses).
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
issuer's 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.
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 income statement 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.
Deferred Policy Acquisition Costs
Policy acquisition costs, primarily commissions, premium taxes and
underwriting salaries, vary directly with, and are primarily related to, the
acquisition of new and renewal premiums. Such costs are capitalized and charged
to expense as the related premium revenue is recognized. We evaluate the
recoverability of our deferred policy acquisition costs based on our estimates
of the profitability of the underlying business and any amounts estimated to be
unrecoverable are charged to expense in the current period.
Goodwill
In accordance with Statement of Financial Accounting Standards No. 142
"Goodwill and Other Intangible Assets" we make an annual assessment by reporting
unit as to whether the value of our goodwill assets is impaired. We completed
such assessments in 2004 and 2003 and concluded that the value of our goodwill
assets of approximately $23.7 million was not impaired. We use both market-based
valuation models and a capital assets pricing model to estimate the fair value
of each reporting unit. These models require the use of numerous assumptions
regarding market perceptions of value as related to our consolidated and
reporting unit historical and projected operating results and those of other
economically similar entities. Changes to these assumptions could significantly
lower our estimates of fair value and result in a determination that goodwill
has suffered impairment in value.
29
LIQUIDITY AND CAPITAL RESOURCES AND FINANCIAL CONDITION
ProAssurance Corporation is a legal entity separate and distinct from
its subsidiaries. Because the parent holding company has no other business
operations, dividends from its operating subsidiaries represent a significant
source of funds for its obligations, including debt service. The ability of
those insurance subsidiaries to pay dividends is subject to limitation by state
insurance regulations. See our discussions under "Regulation of Dividends...from
Our Operating Subsidiaries" in Part I, and in Note 16 of our Notes to the
Consolidated Financial Statements for additional information regarding dividend
limitations.
Within our operating subsidiaries our primary need for liquid funds is
to pay losses and operating expenses in the ordinary course of business. Our
operating activities provided positive cash flow of $373.5 million for the year
ended December 31, 2004 as compared to $282.8 million for the year ended
December 31, 2003. As in the prior year, the primary sources of our operating
cash flows are net investment income and 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. A general measure of this timing delay is the
paid loss ratio, which is computed by dividing paid losses for the year by net
earned premium. Our paid loss ratios for the years ended December 31, 2004 and
2003 are 46% and 55%, respectively. This timing delay is more evident in periods
of premium growth, regardless of whether that growth is the result of additional
business or rate increases.
We believe that premium adequacy is critical to our long-term
liquidity. We continually review rates and submit requests for rate increases to
state insurance departments as we consider necessary to maintain rate adequacy.
We are unable to predict whether we will continue to receive approval for our
rate filings.
We held cash and cash equivalents of approximately $30.1 million at
December 31, 2004 as compared to $42.0 million at December 31, 2003. We transfer
most of the cash generated from operations into our investment portfolio.
We primarily invest in fixed maturity securities and in 2004 our
investment in fixed maturity securities grew by $467.2 million or 26%. The
growth is primarily due to the investment of funds generated from operations,
but also includes net proceeds of $44.9 million from the sale of trust preferred
securities having a face value of $46.4 million, and funds transferred to fixed
maturities from short-term investments, cash and cash equivalents. Offsetting
these increases is a $14.9 million decline in fixed maturity unrealized gains.
Substantially all of our fixed maturities are either United States
government 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 December 31, 2004. 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 December 31, 2004 is 3.81
years. 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. Net unrealized gains
related to our available-for-sale securities decreased by $15.4 million at
December 31, 2004 as compared to December 31, 2003 primarily because average
bond yields increased and prices declined during 2004.
At December 31, 2004, equity investments represented approximately
1.6% of our total investments, and approximately 6.4% of our capital. Our equity
investments are diversified primarily among domestic growth and value holdings
through common and preferred stock.
For a more detailed discussion of the effect of changes in interest
rates on our investment portfolio see "Item 7A Quantitative and Qualitative
Disclosures about Market Risk."
30
Our net reserves for losses (net of amounts receivable from
reinsurers) at December 31, 2004 are approximately $1.6 billion, an increase of
$250 million over net reserves at December 31, 2003. Substantially all of this
increase is in our professional liability segment, a long-tailed business.
Because of this characteristic, it is not unusual for reserves to increase,
especially during periods of business growth. Activity in the net reserve for
losses during 2004 and 2003 is summarized below:
Year Ended December 31
------------------------------------
2004 2003 2002
---------- ---------- ----------
In thousands
Balance, beginning of year $1,814,584 $1,622,468 $1,442,341
Less reinsurance recoverables 444,811 462,012 374,056
---------- ---------- ----------
Net balance, beginning of year 1,369,773 1,160,456 1,068,285
Incurred related to:
Current year 589,497 562,256 439,600
Prior years (16,616) (10,880) 8,429
---------- ---------- ----------
Total incurred 572,881 551,376 448,029
Paid related to:
Current year (92,361) (94,824) (84,376)
Prior years (230,040) (247,235) (271,482)
---------- ---------- ----------
Total paid (322,401) (342,059) (355,858)
---------- ---------- ----------
Net balance, end of year 1,620,253 1,369,773 1,160,456
Plus reinsurance recoverables 409,339 444,811 462,012
---------- ---------- ----------
Balance, end of year $2,029,592 $1,814,584 $1,622,468
========== ========== ==========
As of December 31, 2004, our insurance subsidiaries had consolidated
reserves for losses on a GAAP basis that exceeded those on a statutory basis by
approximately $21.2 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.
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.
31
At December 31, 2004 our receivable from reinsurers approximated $409
million. The following table identifies our reinsurers from which our
recoverables (net of amounts due to the reinsurer) are $10 million or more as of
December 31, 2004:
A. M. Best Net Amounts Due
Reinsurer Company Rating From Reinsurer
- --------- -------------- ---------------
Michigan Catastrophic Claims Association * Not rated $115,126
Hannover Ruckversicherung AG A $ 50,544
General Reinsurance Corp A++ $ 31,059
PMA Capital Insurance Company B+ $ 23,196
American Re-Insurance Company A $ 13,960
Lloyd's Syndicate 435 A $ 12,556
AXA Re A- $ 11,582
Dorinco Reinsurance Company A- $ 10,744
* The Michigan Catastrophic Claims Association (MCCA) is an unincorporated
nonprofit association created by Michigan law, and every insurer engaged in
writing personal protection auto insurance coverage in Michigan is required
to be a member of the MCCA. Although the MCCA acts in the same manner as a
reinsurer, it is not an insurance company and hence is not rated by A.M.
Best.
We have not experienced any difficulties in collecting amounts due
from reinsurers due to the financial condition of the reinsurer. 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. In recent years, we have taken
actions to obtain additional capital for general corporate purposes, including
supporting growth by our insurance subsidiaries.
In late 2002, we raised $46.5 million through the sale of our common
stock in an underwritten public offering. In July 2003 we received $104.6
million from the issuance of twenty-year 3.9% Convertible Debentures Due June
2023 (the Convertible Debentures); and in April and May 2004, we received net
proceeds of $44.9 million from the sale of trust preferred securities having a
face value of $46.4 million. See note 10 of the Notes to the Consolidated
Financial Statements included herein for a more detailed description of the
Convertible Debentures and the Trust Preferred Subordinated Debentures. During
the three year period ended December 31, 2004, we repaid bank debt of $67.5
million and contributed $39.8 million on a net basis to our insurance
subsidiaries.
We have on file 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. 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.
32
Off Balance Sheet Arrangements /Guarantees
In April and May 2004, we formed two business trusts (the Trusts) with
the sole purpose of the Trusts being to issue, in private placement
transactions, $45.0 million of trust preferred stock (TPS), and use the proceeds
thereof; together with the equity proceeds that we contributed upon formation of
the Trusts, to purchase our $46.4 million variable rate subordinated debentures
(Trust Preferred Subordinated Debentures or Subordinated Debentures), which are
the only assets of the Trusts. The terms and maturities of the Subordinated
Debentures mirror those of the TPS. The Trusts will meet the obligations of the
TPS with the interest and principal we pay to the Trusts related to the
Subordinated Debentures.
In accordance with the guidance given in Financial Accounting
Standards Board Interpretation No. 46R, "Variable Interest Entities" (FIN 46R)
the Trusts are not included in our consolidated financial statements because we
are not the primary beneficiary of either of the Trusts.
The Subordinated Debentures are payable to the Trusts and are included
in our condensed consolidated financial statements as long-term debt. We have
issued guarantees that amounts paid to the Trusts related to the Subordinated
Debentures will subsequently be remitted to the holders of the TPS. The amounts
guaranteed are not expected to at any time exceed our obligations under the
Subordinated Debentures, and we have not recorded any additional liability
related to the TPS or the guarantee.
Contractual Obligations
A schedule of our non-cancelable contractual obligations at December
31, 2004 follows:
Payments due by period
--------------------------------------------------------
Less than More than
Total 1 year 1-3 years 3-5 years 5 years
-------- --------- --------- --------- ---------
In thousands
Long-term debt obligations $151,480 $ -- $ -- $ -- $151,480
Operating lease obligations 8,723 3,786 3,880 936 121
-------- ------ ------ ---- --------
Total $160,203 $3,786 $3,880 $936 $151,601
======== ====== ====== ==== ========
Our long-term debt obligations above include the repayment of
principal on our Convertible Debentures and our Subordinated Debentures. Our
operating lease obligations are primarily for the rental of office space, office
equipment, and communications lines and equipment.
OVERVIEW
We are an insurance holding company and our operating results are
almost entirely derived from the operations of our insurance subsidiaries. In
2004, the professional liability segment contributed approximately 75% of our
total revenues and the personal lines segment contributed approximately 25% of
total revenues. ProAssurance's professional liability segment primarily provides
medical professional liability insurance to physicians and physician groups. The
personal lines segment primarily provides auto insurance to members of the
Michigan educational community and their families.
Corporate Strategy
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.
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
33
national writers. In our personal lines business, we seek to quickly and
efficiently resolve claims through an established network of auto repair shops
and other repair facilities, focusing on minimizing the cost of handling each
claim.
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. We also believe that our presence in local markets allows us to monitor
and understand changes in the liability climate and thus develop better business
strategies in a more timely manner than our competitors.
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. According to A.M. Best, based on 2003 data we
are the 4th largest active medical liability insurance writer in the nation, and
we believe we are the largest medical liability writer in our collective states
of operation. 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 17% of the educational community (active and retired teaching
professionals and service employees) 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.
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. The current professional liability climate may also provide
us with the opportunity to undertake additional mergers or acquisitions of
companies or books of business within or adjacent to, our states of operation.
We continually evaluate these opportunities to leverage our core underwriting
and claims expertise.
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 that our
customers and producers place on the strong ratings of our principal insurance
subsidiaries and we intend to manage our business to protect our financial
security.
Growth Opportunities and Outlook
We expect our future growth in professional liability will be
supported by controlled expansion in states where we are already writing
business and into additional states within, or adjacent to, our existing
business footprint. We also believe there may be additional opportunities for
profitable expansion of our professional liability business as insurers continue
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 are viewed as a market leader because of our financial
strength and stability, and our ability to deliver excellent service at the
local level. Our 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.
In 2004 and 2003, our professional liability segment achieved average
gross price increases of approximately 19% and 28%, respectively, on renewal
business (weighted by premium volume). In 2005 we expect professional liability
pricing to continue to increase, albeit at a much slower pace. We believe our
balance sheet strength will continue to be a differentiating factor in the
market. Additionally, we plan to appoint new agents in underserved areas in the
states where we write business and we believe that will bring us additional
business as well.
34
In the personal lines segment, our strong capitalization provides
operational flexibility allowing growth and expansion in Michigan and adjacent
states.
We believe we can take advantage of growth opportunities in both
segments while continuing to maintain our combined ratio. As with all property
and casualty companies, we expect the beneficial impact of price increases to be
fully reflected in our financial results over time as premiums written at the
higher prices are earned which generally occurs over the course of the year
after the policy is issued.
Losses and Reinsurance
Losses are the largest component of expense for both the professional
liability segment and the personal lines segment. As discussed in critical
accounting policies, net losses in any period reflect our estimate of net losses
related to the premiums earned in that period as well as any changes to our
estimates of the reserve established for net losses of prior periods.
The estimation of medical professional liability losses is inherently
difficult. Injuries may not be discovered until years after an incident, or the
claimant may delay pursuing the recovery of damages. Ultimate loss costs, even
for similar events, vary significantly depending upon many factors, including
but not limited to the nature of the injury and the personal situation of the
claimant or the claimants' family, the judicial climate where the insured event
occurred, general economic conditions and the trend of health care costs.
Medical liability claims are typically resolved over an extended period of time,
often five years or more. The combination of changing conditions and the
extended time required for claim resolution results in a loss cost estimation
process that requires actuarial skill and the application of judgment, and such
estimates require periodic revision.
Losses for the personal lines segment primarily result from property
claims. Such claims are typically settled and paid without litigation within one
year after the claim is reported. The personal lines segment also incurs losses
due to personal liability claims. Personal liability losses more closely
resemble medical professional liability losses and are more complex to estimate.
Injuries and their severity are subject to litigation and may take some years to
determine.
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.
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.
We reinsure professional liability 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 of $1 million per claim, up to the
maximum individual limit offered (currently $16 million). 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. Periodically, we provide insurance to policyholders above the maximum
limits of our primary 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.
We currently reinsure our personal lines risks in excess of $250,000
per loss. Individual property risks are covered up to $1 million per risk and
casualty risks are covered on an excess of loss basis up to $3 million per
occurrence. As a member of the MCCA, we receive coverage for auto personal
liability losses in excess of $350,000 per loss. 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. Our personal lines segment is further covered by catastrophe
reinsurance which provides additional protection from significant aggregate
physical damage exposure arising from a single event such as windstorm, hail,
tornado, earthquake, riot, blizzard, freezing temperatures or other
extraordinary events. Our catastrophe coverage is up to $34.5 million in excess
of $1.5 million subject to retention of 5%. We also cede 95% of our umbrella
policy liabilities under a quota share reinsurance arrangement.
35
Our risk retention level is dependent upon numerous factors including
the price and availability of reinsurance, volume of business, level of
experience, our analysis of the potential underwriting results within each state
and our assessment of our financial capacity to assume greater risk. Our
2004-2005 reinsurance treaties renewed with minimal change in terms or
conditions from the prior year. We have structured the program to include a
broader participation of reinsurers to further diversify our credit risk.
The following table, known as the Loss Reserve Development Table,
presents information over the preceding ten years regarding the payment of our
losses as well as changes to (the development of) our estimates of losses during
that time period.
The table includes losses on both a direct and an assumed basis and is
net of reinsurance recoverables. The gross liability for losses 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 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.
The following may be helpful in understanding the Loss Reserve
Development Table:
- The line entitled "Reserve for losses, undiscounted and net of
reinsurance recoverables" reflects the Company's reserve for losses
and loss adjustment expense, less the receivables from reinsurers,
each as showing in the Company's consolidated financial statements 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.
36
ANALYSIS OF LOSSES AND LOSS RESERVE DEVELOPMENT
(IN THOUSANDS)
DECEMBER 31,
-------------------------------------------------------------------
1994 1995 1996 1997 1998 1999
-------- -------- --------- --------- --------- ---------
Reserve for losses,
undiscounted and net of
reinsurance recoverables $295,541 $352,521 $ 440,040 $ 464,122 $ 480,741 $ 486,279
Cumulative net paid, as of:
One Year Later 24,102 27,532 48,390 67,383 89,864 133,832
Two Years Later 42,115 58,769 98,864 128,758 192,716 239,872
Three Years Later 58,793 80,061 136,992 194,139 257,913 313,993
Four Years Later 65,520 107,005 173,352 227,597 308,531 358,677
Five Years Later 76,291 120,592 191,974 252,015 331,796 387,040
Six Years Later 81,722 129,043 204,013 266,056 346,623
Seven Years Later 82,605 135,620 212,282 276,052
Eight Years Later 84,649 138,534 218,919
Nine Years Later 85,008 140,712
Ten Years Later 85,333
Re-estimated Net Liability as of:
End of Year 295,541 352,521 440,040 464,122 480,741 486,279
One Year Later 268,154 325,212 393,363 416,814 427,095 463,779
Two Years Later 239,243 280,518 347,258 364,196 398,308 469,934
Three Years Later 200,311 237,280 294,675 333,530 400,333 488,416
Four Years Later 157,836 190,110 264,714 323,202 414,008 487,366
Five Years Later 122,570 173,148 259,195 320,888 415,381 485,719
Six Years Later 105,779 168,828 248,698 321,232 412,130
Seven Years Later 99,787 160,784 250,927 321,959
Eight Years Later 94,192 161,717 251,584
Nine Years Later 95,625 158,743
Ten Years Later 94,399
Net cumulative redundancy (deficiency) $201,142 $193,778 $ 188,456 $ 142,163 $ 68,611 $ 560
======== ======== ========= ========= ========= =========
Original gross liability - end of year $355,735 $432,937 $ 548,732 $ 614,720 $ 660,631 $ 665,786
Less: reinsurance recoverables (60,194) (80,416) (108,692) (150,598) (179,890) (179,507)
-------- -------- --------- --------- --------- ---------
Original net liability - end of year $295,541 $352,521 $ 440,040 $ 464,122 $ 480,741 $ 486,279
======== ======== ========= ========= ========= =========
Gross re-estimated liability - latest $123,173 $182,961 $ 295,291 $ 416,516 $ 517,812 $ 587,501
Re-estimated reinsurance recoverables (28,774) (24,218) (43,707) (94,557) (105,682) (101,782)
-------- -------- --------- --------- --------- ---------
Net re-estimated liability - latest $ 94,399 $158,743 $ 251,584 $ 321,959 $ 412,130 $ 485,719
======== ======== ========= ========= ========= =========
Gross cumulative redundancy (deficiency) $232,562 $249,976 $ 253,441 $ 198,204 $ 142,819 $ 78,285
======== ======== ========= ========= ========= =========
DECEMBER 31,
-------------------------------------------------------------
2000 2001 2002 2003 2004
--------- ---------- ---------- ---------- ----------
Reserve for losses,
undiscounted and net of
reinsurance recoverables $ 493,457 $1,068,286 $1,160,456 $1,369,773 $1,620,253
Cumulative net paid, as of:
One Year Later 143,892 271,482 247,235 230,040
Two Years Later 251,855 468,630 425,190
Three Years Later 321,957 599,432
Four Years Later 367,810
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 493,457 1,068,286 1,160,456 1,369,773
One Year Later 507,275 1,076,714 1,149,575 1,353,157
Two Years Later 529,698 1,069,435 1,149,092
Three Years Later 527,085 1,078,936
Four Years Later 534,382
Five Years Later
Six Years Later
Seven Years Later
Eight Years Later
Nine Years Later
Ten Years Later
Net cumulative redundancy (deficiency) $ (40,925) $ (10,650) $ 11,364 $ 16,616
========= ========== ========== ==========
Original gross liability - end of year $ 659,659 $1,442,341 $1,622,468 $1,814,584
Less: reinsurance recoverables (166,202) (374,055) (462,012) (444,811)
--------- ---------- ---------- ----------
Original net liability - end of year $ 493,457 $1,068,286 $1,160,456 $1,369,773
========= ========== ========== ==========
Gross re-estimated liability - latest $ 625,782 $1,403,927 $1,529,546 $1,758,903
Re-estimated reinsurance recoverables (91,400) (324,991) (380,454) (405,746)
--------- ---------- ---------- ----------
Net re-estimated liability - latest $ 534,382 $1,078,936 $1,149,092 $1,353,157
========= ========== ========== ==========
Gross cumulative redundancy (deficiency) $ 33,877 $ 38,414 $ 92,922 $ 55,681
========= ========== ========== ==========
37
In years 2001 and thereafter the table reflects the reserves of
ProAssurance, formed in 2001 in order to merge Medical Assurance and
Professionals Group, and includes both professional liability segment and
personal lines segment reserves. Amounts shown in the table for years prior to
2001 relate only to the reserves of Medical Assurance.
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.
Factors that have contributed to the variation in loss development
include the following:
- 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. 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. 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.
- The professional liability legal environment deteriorated once again
in the late 1990's. 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 and 2002. We have
addressed these trends through increased rates, stricter underwriting
and modifications to claims handling procedures.
- Beginning in 2001 the table includes reserves for personal liability
losses which are also initially difficult to estimate. We established
reserves for these claims at levels that we consider reasonable but
prudent, given rising medical costs and unpredictable litigation
trends. As the claims matured, our reserve estimates were adjusted to
reflect actual loss costs experienced.
38
RESULTS OF OPERATIONS - YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEAR ENDED
DECEMBER 31, 2003
Selected financial data for each period is summarized in the table below.
Year Ended December 31
---------------------- Increase
2004 2003 (Decrease)
-------- -------- ----------
In Thousands
Revenues:
Gross premiums written $789,660 $740,110 $49,550
======== ======== =======
Net premiums written $717,059 $668,909 $48,150
======== ======== =======
Premiums earned $765,643 $698,347 $67,296
Premiums ceded (69,623) (74,833) 5,210
-------- -------- -------
Net premiums earned 696,020 623,514 72,506
Net investment income 87,225 73,619 13,606
Net realized investment gains (losses) 7,609 5,992 1,617
Other income 3,699 6,515 (2,816)
-------- -------- -------
Total revenues 794,553 709,640 84,913
-------- -------- -------
Expenses:
Losses and loss adjustment expenses 596,070 576,043 20,027
Reinsurance recoveries (23,189) (24,667) 1,478
-------- -------- -------
Net losses and loss adjustment expenses 572,881 551,376 21,505
Underwriting, acquisition and insurance expenses 117,689 104,216 13,473
Loss on early extinguishment of debt -- 305 (305)
Interest expense 6,515 3,409 3,106
-------- -------- -------
Total expenses 697,085 659,306 37,779
-------- -------- -------
Income before income taxes and minority interest 97,468 50,334 47,134
Income taxes (benefit) 24,657 11,450 13,207
-------- -------- -------
Income before minority interest 72,811 38,884 33,927
Minority interest -- (181) 181
-------- -------- -------
Net Income $ 72,811 $ 38,703 $34,108
======== ======== =======
Net loss ratio 82.3% 88.4% (6.1%)
Underwriting expense ratio 16.9% 16.7% 0.2%
-------- -------- -------
Combined ratio 99.2% 105.1% (5.9%)
Less: Investment income ratio 12.5% 11.8% 0.7%
-------- -------- -------
Operating ratio 86.7% 93.3% (6.6%)
======== ======== =======
Return on equity * 12.6% 7.4% 5.2%
======== ======== =======
* Net income divided by the average of beginning and ending stockholders'
equity.
39
We measure performance in a number of ways, but particularly focus on
the combined ratio and investment returns which directly affect our return on
equity (ROE). We target a return on equity of 12% to 14%.
Our earnings are almost entirely derived from the operations of our
insurance subsidiaries. We manage our insurance operations at a segment level
because of the differing operating characteristics of each segment. We believe
that a focus on a premium adequacy, selective underwriting and effective claims
management is required if we are to achieve our ROE targets and we closely
monitor premium revenues, losses and loss adjustment costs, and acquisition,
underwriting and insurance expenses at the segment level.
Investment income and net realized investment gains and losses are
managed and monitored both at the segment level and on a consolidated basis in
order to meet the liquidity and profitability needs of each insurance company as
well as to maximize after-tax income investment returns at a corporate level.
Our segments engage in activities that generate other income. Such
activities, principally fee generating and agency services, do not constitute a
significant source of revenues or profits on either a segment or a consolidated
basis.
The 2004 increase in our ROE is primarily attributable to our success
in reducing our net loss ratio. Both segments showed improvement in their net
loss ratio. The improvement in the professional liability ratio had the most
pronounced effect on ROE because 74% of 2004 consolidated net earned premiums
are attributable to this segment.
Our 2004 operating results also benefited from additional investment
income earned as a result of the growth in our invested assets.
40
PREMIUMS
Gross Premiums Written
Year Ended December 31
---------------------- Increase Increase
2004 2003 (Decrease) (Decrease)
-------- ------- ---------- ----------
In thousands %
Gross premiums written:
Professional liability $573,592 $543,323 $30,269 5.6%
Personal lines 216,068 196,787 19,281 9.8%
-------- -------- -------
$789,660 $740,110 $49,550 6.7%
======== ======== =======
Professional liability written premiums vary from period to period for
a number of reasons. Some of the more common differences result from changes to
premium rates, the volume of new business written during the period, the loss of
business to competitors or due to our own underwriting decisions, and the
percentage of our policies that renew, which may also affect the level of tail
premiums written. Strategic factors, such as our decision to convert our
remaining occurrence policies to claims-made coverage, and market factors, such
as the entry or exit of a competitor in a given market, may also affect written
premiums from period to period. The effect of any of these changes also varies
by the proportion of policies written or renewed during each period in the
various geographical regions and classes of business in which we operate.
Professional liability premiums exhibited strong growth in 2004;
however, the growth was at a slower pace than in 2003 primarily because we
implemented smaller rate increases in 2004 as compared to 2003. Our rates are
based on our expected losses for the coverages provided; the cumulative effect
of the rate increases we have obtained in the past several years allowed us to
pursue lower rate increases in some states in 2004. On average, renewals during
the year ended December 31, 2004 have been at rates that are approximately 19%
higher than expiring rates. Rate increases on 2003 renewals, on average, were at
rates that were 28% higher than expiring rates. New business written in 2004 was
largely offset by business that did not renew, including business that we
selectively chose not to renew. We continue to aggressively pursue only that
business that we believe we can write at a profitable rate.
Virtually all of the growth that we experienced in 2004 was related to
physician coverages. This growth included an increase of approximately $5.0
million related to physician tail policies. Tail policies are written to
physicians that are discontinuing their claims-made coverage with us. We prefer
not to write tail coverage due to the occurrence-like loss liability that it
creates, but the decision to purchase this coverage is at the option of the
departing policyholder. Premiums written for this coverage can vary
significantly from year to year.
In the latter half of 2003, we began the process of converting our
professional liability occurrence coverages to claims-made coverages and
completed this process in 2004. First-year claims-made coverage has a
significantly lower premium than occurrence coverage due to lower loss exposure,
but steps through an increasing rate progression from first-year to mature, over
a multi-year period which is generally five years. This increasing rate
progression is the result of our increasing exposure to loss. During the period
of rate progression, all else being equal, our premiums and our losses will
increase.
Personal lines premium revenues are almost entirely comprised of auto
and homeowners premiums with auto premiums representing 81% of 2004 written
premiums and 82% of 2003 written premiums. During the year ended December 31,
2004 auto premiums increased by $13.3 million while homeowner premiums grew by
$5.9 million. The growth of auto premiums is primarily attributable to rate
increases and to increases in the value of insured autos and a small increase in
the number of autos insured. The growth in homeowner premiums is due to
increases in the number of insured homes, rate increases, and an increase in the
value of the homes insured with no one factor predominating.
41
Premiums Earned
Year Ended December 31
---------------------- Increase Increase
2004 2003 (Decrease) (Decrease)
-------- -------- ---------- ----------
In thousands %
Premiums earned:
Professional liability $555,524 $509,260 $46,264 9.1%
Personal lines 210,119 189,087 21,032 11.1%
-------- -------- -------
$765,643 $698,347 $67,296 9.6%
======== ======== =======
Premiums are earned pro rata over the entire policy period (generally
one year) after the policy is written. Thus the increase in 2004 earned premiums
reflects on a pro rata basis the changes in written premiums that occurred
during both 2004 and 2003.
Premiums ceded
Year Ended December 31
---------------------- Increase Increase
2004 2003 (Decrease) (Decrease)
------- -------- ---------- ----------
In thousands %
Premiums ceded:
Professional liability $42,869 $56,014 $(13,145) (23.5%)
Personal lines 26,754 18,819 7,935 42.2%
------- ------- --------
$69,623 $74,833 $ (5,210) (7.0%)
======= ======= ========
Premiums ceded represent the portion of earned premiums that we must
ultimately pay to our reinsurers for their assumption of a portion of our
losses.
In both 2004 and 2003, we reduced our estimates of prior year gross
losses in our professional liability segment. As a result, we also reduced our
estimates of ultimate ceded premiums. The reduction was $8.9 million in 2004 and
$5.4 million in 2003. Professional liability premiums ceded were also reduced by
$1.6 million in 2004 due to the commutation of reinsurance treaties with
Gerling. Additionally, as premium rates have risen, our insureds have purchased
policies with lower coverage limits. We do not cede these premiums, and as a
result, premiums ceded have declined.
Personal lines premiums ceded primarily increased because of a
significant rise in the per car assessment charged by the MCCA, and also as a
result of growth in the volume of premiums written.
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 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.
42
Net Losses
The following table summarizes net losses and net loss ratios for the
years ended December 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.
DECEMBER 31, 2004 December 31, 2003 Net Loss
--------------------- --------------------- Ratio
NET LOSS Net Loss Increase
NET LOSSES RATIO Net Losses Ratio (Decrease)
---------- -------- ---------- -------- ----------
In thousands except percentage amounts
Net losses - calendar year
Professional liability $460,437 89.8% $439,368 96.9% (7.1%)
Personal lines 112,444 61.3% 112,008 65.8% (4.5%)
-------- --------
$572,881 82.3% $551,376 88.4% (6.1%)
======== ========
Net losses current accident year
Professional liability $469,151 91.5% $439,418 96.9% (5.4%)
Personal lines 120,346 65.6% 122,838 72.1% (6.5%)
-------- --------
$589,497 84.7% $562,256 90.2% (5.5%)
======== ========
Change in prior accident year losses (favorable):
Professional liability $ (8,714) (1.7%) $ (50) --% (1.7%)
Personal lines (7,902) (4.3%) (10,830) (6.4%) 2.1%
-------- --------
$(16,616) (2.4%) $(10,880) (1.8%) (0.6%)
======== ========
Current accident year net losses in the professional liability segment
increased by 6.8% or $29.7 million in 2004 as compared to 2003. During 2004, we
have continued to see an increase in loss severity, which has increased loss
costs. Professional liability current accident year net loss ratios are lower in
2004 than in 2003 primarily because loss costs, while continuing to increase,
have increased at a slower pace than premium rates. Loss ratios have also
improved because we converted our occurrence policies to claims-made coverage as
discussed under premiums. Generally, loss ratios associated with claims-made
coverage are initially lower than those associated with occurrence coverage.
We decreased our estimate of professional liability prior year net
losses by $8.7 million in 2004 and $50,000 in 2003. The 2004 amount represents
0.7% of 2003 professional liability net reserves. These adjustments were in
response to actuarial evaluations of loss reserves performed during the period.
No change was made to our estimates of the reserves required for death,
disability and retirement during 2004 or 2003.
Personal lines losses have remained relatively stable, even though the
number of insured risks has increased. We experienced an overall reduction in
the frequency of auto collision and comprehensive claims reported in 2004, which
more than offset increased water damage claims from severe thunderstorms in May
2004. The reduction in frequency is the primary reason that loss ratios improved
in 2004.
As a result of favorable development related to the frequency and
severity of prior year auto liability reserves, we reduced personal lines prior
year net losses during both 2004 and 2003.
43
Gross Losses and Reinsurance Recoveries
The effect of adjustments made to reinsured losses is mitigated by the
corresponding adjustment that is made to insurance recoveries. Thus, in any
given year, we may make significant adjustments to gross losses that have little
effect on our net losses. The following table reflects our losses by segment on
both a gross and a net basis:
Year ended December 31
--------------------------------
Increase
2004 2003 (Decrease)
-------- -------- ----------
In thousands
Gross Losses:
Professional liability $447,521 $414,828 $ 32,693
Personal lines 148,549 161,215 (12,666)
-------- -------- --------
596,070 576,043 20,027
Reinsurance Recoveries:
Professional liability $(12,916) $(24,540) $ 11,624
Personal lines 36,105 49,207 (13,102)
-------- -------- --------
23,189 24,667 (1,478)
Net Losses:
Professional liability $460,437 $439,368 $ 21,069
Personal lines 112,444 112,008 436
-------- -------- --------
$572,881 $551,376 $ 21,505
======== ======== ========
When discussing losses that are reinsured and losses that are
retained, it is common to refer to "layers" of loss. The retained layer is the
cumulative portion of each loss, on a per-claim basis, which is less than our
reinsurance retention for a given coverage year. Likewise, the reinsured layer
is the cumulative portion of each loss that exceeds the reinsurance retention.
In 2004, as was also the case in 2003, our actuarial analysis of our
professional liability reserves indicates that our claims severity has continued
to increase as expected in our retained layers. However, we have not experienced
the high level of losses in our reinsured layers that we originally anticipated
and for which we established reserves. Accordingly, we reduced our estimates of
prior accident year gross losses by approximately $60.4 million during the year
ended December 31, 2004 and $74.2 million during the year ended December 31,
2003. These losses were heavily reinsured; therefore, we reduced expected
reinsurance recoveries by $51.7 million in 2004 and $74.1 million in 2003. As
previously discussed, these changes to prior year estimates reduced net losses
by $8.7 million in 2004 and nominally reduced net losses in 2003. In both 2004
and 2003, the decrease to reinsurance recoveries for prior accident years more
than offset reinsurance recoveries for current accident years resulting in a
non-traditional relationship between gross losses and recoveries.
Our personal lines segment gross losses and reinsurance recoveries
also reflect large adjustments for heavily reinsured losses. We increased our
loss estimates for auto personal injury losses ceded to the MCCA by
approximately $15.3 million during the year ended December 31, 2004 and $30.0
million during the year ended December 31, 2003. In both years, these
unfavorable adjustments were offset by favorable adjustments made to losses that
were not heavily reinsured, primarily auto liability reserves. As previously
discussed, these reserve adjustments decreased net losses by $7.9 million in
2004 and $10.8 million in 2003.
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.
44
NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS (LOSSES)
Net investment income is primarily derived from the interest income
earned by our fixed maturity securities and 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.
%
Increase Increase
2004 2003 (Decrease) (Decrease)
------- ------- ---------- ----------
In thousands except percentage amounts
Net investment income:
Professional liability $75,029 $63,099 $11,930 18.9%
Personal lines 10,879 10,253 626 6.1%
Not attributed to segments 1,317 267 1,050 > 100%
------- ------- -------
$87,225 $73,619 $13,606 18.5%
======= ======= =======
The increase in our net investment income in 2004 as compared to 2003
is due to higher average invested funds in 2004, offset by a slight decline in
the yield of our fixed maturity securities. While prevailing market interest
rates have remained historically low, changes in the duration and asset mix of
the portfolio have helped to stabilize the yield of the portfolio. We have
increased the weighted average duration of the portfolio from 3.54 years at
December 31, 2003 to 3.81 years at December 31, 2004 in order to take advantage
of improved yields on certain longer-term securities. We have also increased the
proportion of the portfolio that is invested in tax-exempt securities because of
the higher after-tax yields available on these securities. However, we have
continued to see some decline in our income yields as older, higher yielding
securities mature or are sold. Our average income yield, on a consolidated
basis, was 4.1% for the year ended December 31, 2004 as compared to 4.4% for the
year ended December 31, 2003. Our average tax equivalent income yield on a
consolidated basis was 4.5% for the year ended December 31, 2004 as compared to
4.8% for the year ended December 31, 2003.
Investment income is a more substantial revenue source for the
professional liability segment both because of significantly higher premium
collections and because, on average, professional liability premiums are
collected some years before the related losses are paid. As a result, investment
income is a less significant component of revenues for the personal lines
segment than for the professional liability segment because the length of time
between the collection of premiums and the settlement of claims is generally
short. Thus premium growth, as compared to the professional liability segment,
generally has a less significant effect on average invested funds. Personal
lines investment income has increased due to higher average invested funds;
however the improvement is less pronounced in this segment.
The components of net realized investment gains are shown in the
following table.
Year Ended December 31
-----------------------
2004 2003
------ ------
In thousands
Net gains (losses) from sales $5,323 $5,991
Other-than-temporary impairment losses (611) (322)
Trading portfolio gains (losses) 2,897 323
------ ------
Net realized investment gains (losses) $7,609 $5,992
====== ======
45
UNDERWRITING, ACQUISITION AND INSURANCE EXPENSES
Underwriting, acquisition and insurance 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, and facility costs assessments.
Underwriting, acquisition and insurance expenses increased in 2004 in both
segments primarily because of higher variable costs. Underwriting, acquisition
and insurance expenses increased in both segments, primarily due to additional
commission expense incurred as a result of premium growth. In the professional
liability segment, changes in the mix of premiums by state and coverage type
also increased commission expense. Both segments also experienced increases in
costs for salaries, benefits and professional fees, most significantly those
fees related to Sarbanes-Oxley compliance. The expense ratio for the
professional liability segment increased by 0.3% because of higher commission
costs; there was no notable change in the personal lines expense ratio.
Expense Ratio
-----------------------------------
Year Ended December 31 Year Ended December 31
---------------------- Increase ----------------------- Increase
2004 2003 (Decrease) 2004 2003 (Decrease)
-------- -------- ---------- ---- ---- ----------
In thousands
Underwriting, acquisition and
insurance expenses:
Professional liability $ 77,141 $ 66,638 $10,503 15.0% 14.7% 0.3%
Personal lines 40,548 37,578 2,970 22.1% 22.1% --
-------- -------- -------
$117,689 $104,216 $13,473 16.9% 16.7% 0.2%
======== ======== =======
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, but
remained low throughout both 2004 and 2003. Guaranty fund assessments were
approximately $396,000 for the year ended December 31, 2004 as compared to
approximately $321,000 for the year ended December 31, 2003.
INTEREST EXPENSE
Interest expense increased in 2004 as compared to 2003 primarily
because the average amount of debt outstanding was higher in 2004 but also
because interest was paid at a higher rate in the first half of 2004 as compared
to the first half of 2003. In the first half of 2003 our only debt was an
outstanding bank term loan. In July 2003 we issued $107.6 million of Convertible
Debentures at a fixed rate of 3.9% and repaid a $67.5 million bank term loan
which carried a variable rate. We increased our debt again in April and May of
2004, when we issued Subordinated Debentures of $46.5 million.
TAXES
Our effective tax rate for each period is significantly lower than the
35% statutory rate because a considerable portion of our net investment income
is from tax-exempt interest and dividends. The effect of tax-exempt income on
our effective tax rate is shown in the table below:
Year ended December 31
----------------------
2004 2003
---- ----
Statutory rate 35% 35%
Tax-exempt income (7%) (11%)
Other (3%) (1%)
--- ---
Effective tax rate 25% 23%
=== ===
46
RESULTS OF OPERATIONS - YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED
DECEMBER 31, 2002
Selected financial data for each period is summarized in the table
below.
Year Ended December 31
---------------------- Increase
2003 2002 (Decrease)
-------- --------- ----------
In thousands
Revenues:
Gross premiums written $740,110 $ 636,156 $103,954
======== ========= ========
Net premiums written $668,909 $ 537,123 $131,786
======== ========= ========
Premiums earned $698,347 $ 576,414 $121,933
Premiums ceded (74,833) (99,006) 24,173
-------- --------- --------
Net premiums earned 623,514 477,408 146,106
Net investment income 73,619 76,918 (3,299)
Net realized investment gains (losses) 5,992 (5,306) 11,298
Other income 6,515 6,747 (232)
-------- --------- --------
Total revenues 709,640 555,767 153,873
-------- --------- --------
Expenses:
Losses and loss adjustment expenses 576,043 569,099 6,944
Reinsurance recoveries (24,667) (121,070) 96,403
-------- --------- --------
Net losses and loss adjustment expenses 551,376 448,029 103,347
Underwriting, acquisition and insurance expenses 104,216 91,253 12,963
Loss on early extinguishment of debt 305 - 305
Interest expense 3,409 2,875 534
-------- --------- --------
Total expenses 659,306 542,157 117,149
-------- --------- --------
Income before income taxes 50,334 13,610 36,724
Income taxes (benefit) 11,450 (188) 11,638
-------- --------- --------
Income before minority interest and
cumulative effect of accounting change 38,884 13,798 25,086
Minority interest (181) (3,285) 3,104
-------- --------- --------
Income before cumulative effect of
accounting change 38,703 10,513 28,190
Cumulative effect of accounting change,
net of tax -- 1,694 (1,694)
-------- --------- --------
Net Income $ 38,703 $ 12,207 $ 26,496
======== ========= ========
Net loss ratio 88.4% 93.8% (5.4%)
Underwriting expense ratio 16.7% 19.1% (2.4%)
-------- --------- --------
Combined ratio 105.1% 112.9% (7.8%)
Less: Investment income ratio 11.8% 16.1% (4.3%)
-------- --------- --------
Operating ratio 93.3% 96.8% (3.5%)
======== ========= ========
Return on equity * 7.4% 2.7% 4.7%
======== ========= ========
* Net income divided by the average of beginning and ending stockholders'
equity.
Our ROE improved in 2003 primarily because we reduced our net loss
ratio by more than five points as compared to 2002. The net loss ratio of our
professional liability segment, which produced 73% of 2003 net earned premiums,
was reduced from 107.2% to 96.9%; this improvement contributed significantly to
the increase in our 2003 ROE.
47
PREMIUMS
GROSS PREMIUMS WRITTEN
Year Ended December 31
---------------------- Increase Increase
2003 2002 (Decrease) (Decrease)
-------- -------- ---------- ----------
In thousands %
Gross premiums written:
Professional liability $543,323 $461,715 $ 81,608 18%
Personal lines 196,787 174,441 22,346 13%
-------- -------- --------
$740,110 $636,156 $103,954 16%
======== ======== ========
The increase in professional liability gross written premiums is
principally due to rate increases. On average, renewals during the year ended
December 31, 2003 were at rates that were approximately 28% higher than expiring
rates. We also experienced premium growth in 2003 from new business in states
where competitors had left the professional liability market. The growth in new
business was largely offset by policies that did not renew due to higher rates
or our own underwriting decisions.
In addition, in 2003 we were able to convert a substantial majority of
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, and the conversion reduced 2003 premiums written as
compared to 2002 by approximately $13.5 million.
The 2003 increase in personal lines gross premiums written reflects a
$14.2 million increase in auto premiums, primarily due to increases in the
number and value of autos insured. Homeowner premiums increased by $8.0 million
due to higher premium rates and increases in the number and value of insured
homes.
PREMIUMS EARNED
Year Ended December 31
---------------------- Increase Increase
2003 2002 (Decrease) (Decrease)
-------- -------- ---------- ----------
In thousands %
Premiums earned:
Professional liability $509,260 $412,656 $ 96,604 23%
Personal lines 189,087 163,758 25,329 15%
-------- -------- --------
$698,347 $576,414 $121,933 21%
======== ======== ========
Premiums are earned pro rata over the entire policy period (generally
one year) after the policy is written. The increase in 2003 earned premiums
therefore reflects on a pro rata basis the changes in written premiums that
occurred during both 2003 and 2002.
PREMIUMS CEDED
Year Ended December 31
---------------------- Increase Increase
2003 2002 (Decrease) (Decrease)
------- ------- ---------- ----------
In thousands %
Premiums ceded:
Professional liability $56,014 $85,011 $(28,997) (34%)
Personal lines 18,819 13,995 4,824 34%
------- ------- --------
$74,833 $99,006 $(24,173) (24%)
======= ======= ========
Under reinsurance contracts that became effective in October 2002, our
retention levels for insured medical liability events became $1.0 million in all
states whereas previously our retention in many states was as low as $250,000.
The change in retention reduced premiums ceded in our professional liability
segment in 2003, both in total dollars and as a percentage of premiums earned.
48
Additionally in 2003, as discussed in more detail under "Losses and
Loss Adjustment Expenses" we reduced our estimates of certain prior year gross
losses, as well as the related reinsurance recoveries. Some of our reinsurance
agreements adjust the premium due to the reinsurer based upon the losses
reimbursed under the agreement. Consequently the estimate of ultimate ceded
premiums was reduced by $5.4 million as a result of this change.
Personal lines premiums ceded increased due to the increased volume of
our business and increased rates charged by our reinsurers.
LOSSES AND LOSS ADJUSTMENT EXPENSES
Net Losses
The following table summarizes net losses and net loss ratios for the
years ended December 31, 2003 and 2002 by separating losses between the current
accident year and all prior accident years. The net loss ratios shown are
calculated by dividing the applicable net losses by calendar year net premiums
earned.
($ in thousands)
--------------------------------------------- Net Loss
DECEMBER 31, 2003 December 31, 2002 Ratio
--------------------- --------------------- ----------
NET LOSS Net Loss Increase
NET LOSSES RATIO Net Losses Ratio (Decrease)
---------- -------- ---------- -------- ----------
Net losses - calendar year
Professional liability $439,368 96.9% $351,320 107.2% (10.3%)
Personal lines 112,008 65.8% 96,709 64.6% 1.2%
-------- --------
$551,376 88.4% $448,029 93.8% (5.4%)
======== ========
Net losses - current accident
year
Professional liability $439,418 96.9% $333,160 101.7% (4.8%)
Personal lines 122,838 72.2% 106,440 71.1% 1.1%
-------- --------
$562,256 90.2% $439,600 92.1% (1.9%)
======== ========
Change in prior accident year
losses (favorable):
Professional liability $ (50) -- $ 18,160 5.5% (5.5%)
Personal lines (10,830) (6.4%) (9,731) (6.5%) 0.1%
-------- --------
$(10,880) (1.8%) $ 8,429 1.7% (3.5%)
======== ========
Current accident year net losses for the professional liability
segment have increased in 2003 as compared to 2002 by $106.3 million or 31.9%.
There is little change in the number of insured risks during 2003 as compared to
2002; net losses increased during 2003 primarily because of higher loss costs.
The current accident year net loss ratio for the year ended December 31, 2003
decreased to 96.9% as compared to 101.7% for the same period in 2002. The 2003
loss ratio is lower than the 2002 ratio because premium rates increased at a
faster pace than did loss costs.
Personal lines current accident year net losses are $16.4 million
higher than 2002 losses, a 15.4% increase. Net losses increased in 2003
primarily due to growth in the number of insureds but also due to higher loss
costs for auto liability coverages and higher homeowner losses from an isolated
ice storm and the August 2003 Midwestern power outage. The current accident year
net loss ratios for 2003 reflect the beneficial effect of rate increases, which
were more than offset by the previously listed increases to loss costs.
49
Change in Prior Accident Year Losses and Change in DDR Reserves
We decreased our estimate of professional liability prior year net
losses by $50,000 in 2003 and increased our estimates by $18.2 million in 2002.
These adjustments were in response to actuarial evaluations of loss reserves
performed during the period. No significant change was made to our estimates of
the reserves required for death, disability and retirement during 2003 or 2002.
In our personal lines segment, we reduced net losses by $10.8 million
in 2003 and $9.7 million in 2002 as a result of favorable developments in our
estimates of prior years' auto liability reserves. We established initial
reserves, particularly liability reserves, at levels that considered our
estimates of rising costs and unpredictable litigation trends. More favorable
results are recognized if and when they materialize.
Gross Losses and Reinsurance Recoveries
Year ended December 31
---------------------- Increase
2003 2002 (Decrease)
-------- -------- ----------
In thousands
Gross Losses:
Professional liability segment $414,828 $460,289 $ (45,461)
Personal lines segment 161,215 108,810 52,405
-------- -------- ---------
576,043 569,099 6,944
Reinsurance Recoveries:
Professional liability segment $(24,540) $108,969 $(133,509)
Personal lines segment 49,207 12,101 37,106
-------- -------- ---------
24,667 121,070 (96,403)
Net Losses:
Professional liability segment $439,368 $351,320 $ 88,048
Personal lines segment 112,008 96,709 15,299
-------- -------- ---------
$551,376 $448,029 $ 103,347
======== ======== =========
Our actuarial analysis of our professional liabilities reserve
indicates that our claims severity has continued to increase as expected in our
retained layers. However, we have not experienced the high level of losses in
our reinsured layers that we originally anticipated and for which we established
reserves. Accordingly we reduced our estimates of prior accident year gross loss
and loss adjustment expenses by approximately $74.2 million during the year
ended December 31, 2003. Since these losses were reinsured, we reduced expected
reinsurance recoveries by approximately the same amount. The reduction of $74.1
million for prior accident years more than offset current accident year
recoveries of $49.6 million, thus creating a non-traditional relationship
between gross losses and recoveries for 2003. These changes in estimates had a
nominal effect on 2003 net losses.
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.
50
NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS (LOSSES)
Our net 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. Our consolidated net investment income for 2003 is
comprised of the following:
Increase Increase
2003 2002 (Decrease) (Decrease)
------- ------- ---------- ----------
In thousands
Net investment income:
Professional liability segment $63,099 $66,790 $(3,691) (5.5%)
Personal lines segment 10,253 10,071 182 1.8%
Not attributed to segments 267 57 210 >100%
------- ------- -------
$73,619 $76,918 $(3,299) (4.3%)
======= ======= =======
The decrease in our net investment income in 2003 as compared to 2002
is primarily due to lower fixed maturity yields. Prevailing market interest and
equity yields were at historically low levels throughout 2003 and 2002. The low
market rates available for the investment of new and matured funds have reduced
average yields. As a result, net investment income is lower even though our
average invested funds increased. Our average tax equivalent income yield of our
fixed maturity investments is 4.8% for the year ended December 31, 2003 as
compared to 6.2% for the same period in 2002. Also, in the fourth quarter of
2002 we sold a significant portion of our fixed maturity portfolio in order to
realize capital gains and these proceeds were reinvested during 2003 at
substantially lower rates.
Investment income is a more substantial revenue source for the
professional liability segment than for the personal lines segment. The
professional liability segment writes, and therefore collects, significantly
more premiums and those premiums are collected some years before the related
losses are paid. In the personal lines segment, the length of time between the
collection of premiums and the settlement of claims is generally short. The
decline in yields has had a more pronounced effect on our professional liability
segment because the professional liability segment holds significantly more
investments than the personal lines segment. At December 31, 2003 the
professional liability segment held fixed maturity securities having a book
value of $1.502 billion; the personal lines segment held fixed maturity
securities having a book value of $234.6 million.
The components of net realized investment gains (losses) are shown in
the following table.
Year ended December 31
----------------------
2003 2002
------ --------
In thousands
Net gains (losses) from sales $5,991 $ 15,998
Other than temporary impairment losses (322) (21,304)
Trading portfolio gains/losses 323 --
------ --------
Net realized investment gains (losses) $5,992 $ (5,306)
====== ========
UNDERWRITING, ACQUISITION AND INSURANCE EXPENSES
Underwriting, acquisition and insurance expenses are comprised of
variable costs, such as commissions and premium taxes that are directly related
to premiums earned, and fixed costs that have no direct relationship to premium
volume, such as salaries, benefits, facility costs and guaranty fund
assessments. Underwriting, acquisition and insurance expenses by segment for the
years ending December 31, 2003 and 2002 are as follows:
51
Expense Ratio
-----------------------------------
Year Ended December 31 Year Ended December 31
---------------------- Increase ---------------------- Increase
2003 2002 (Decrease) 2003 2002 (Decrease)
-------- ------- ---------- ---- ---- ----------
In thousands
Underwriting, acquisition and
insurance expenses:
Professional liability $ 66,638 $56,613 $10,025 14.7% 17.3% (2.6%)
Personal lines 37,578 34,640 2,938 22.1% 23.1% (1.0%)
-------- ------- -------
$104,216 $91,253 $12,963 16.7% 19.1% (2.4%)
======== ======= =======
Underwriting, acquisition and insurance expenses increased in 2003 in
both segments primarily because of higher variable costs, due largely to
additional commission expense incurred as a result of premium growth.
In the professional liability segment, the increased premium related
costs were offset by a $1.8 million reduction in guaranty fund assessments.
Also, late in the second quarter of 2003 we ceased to provide medical
credentialing services. Expenses associated with this business activity were
$1.4 million for the year ended December 31, 2003 as compared to $2.8 million
for the year ended December 31, 2002. In our personal lines segment, the
increase in premium related costs was partially offset by a decline in the
amount of mandatory statutory assessments.
Our underwriting expense ratio decreased in the professional liability
segment because there was no significant change in our fixed costs, other than
the previously discussed decrease in guaranty fund assessments, while premiums
earned increased significantly in 2003. The personal lines ratio is lower for
2003 due to operating efficiencies and a decrease in mandatory statutory
assessments.
Guaranty fund assessments vary widely from year to year. Guaranty fund
assessments totaled $321,000 for the year ended December 31, 2003 as compared to
$2.2 million for the year ended December 31, 2002.
INTEREST EXPENSE
Interest expense increased to $3.4 million for the year ended December
31, 2003 as compared to $2.9 million for the same period in 2002. The increase
results from higher costs during the third and fourth quarters of 2003 as
compared to 2002 because the debentures issued in July 2003 carried a higher
rate than did the bank term loan and because the total outstanding amount of
debt increased. Management elected to replace the term loan with the debentures
because the debentures provided a longer-term source of capital at a fixed
interest rate. Interest expense was lower in the first six months of 2003 as
compared to 2002 because both the average outstanding balance on the term loan
and the variable interest rate on the term loan were lower in 2003.
TAXES
Our effective tax rate for each period is significantly lower than the
35% statutory rate because a considerable portion of our net investment income
is from tax-exempt interest and dividends. The effect of tax-exempt income on
our effective tax rate is shown in the table below.
Year ended December 31
----------------------
2003 2002
---- ----
Statutory rate 35% 35%
Tax-exempt income (11%) (42%)
Other (1%) 6%
---- ----
Effective tax rate 23% (1%)
==== ====
52
MINORITY INTEREST
Minority interest in both 2003 and 2002 relates entirely to the
minority interest in the income of MEEMIC Holdings. As discussed under
"Liquidity and Capital Resources and Financial Condition" we purchased this
minority interest on January 29, 2003. In 2003, earnings were allocable to the
minority interest only for the period from January 1 to January 29. In 2002,
earnings were allocable to the minority interest for the entire period.
53
ITEM 7A. 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 December 31, 2004, our fair value investment in fixed maturity
securities was $2,258 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.
2004 2003
---------------------------------- ---------------------
PORTFOLIO CHANGE IN MODIFIED Portfolio Modified
VALUE VALUE DURATION Value Duration
Interest Rates $ MILLIONS $ MILLIONS YEARS $ Millions Years
- -------------- ---------- ---------- -------- ---------- --------
200 basis point rise $2,082 $(176) 4.11 $1,664 3.73
100 basis point rise $2,170 $ (88) 4.00 $1,727 3.63
Current rate * $2,258 $ -- 3.81 $1,791 3.54
100 basis point decline $2,344 $ 86 3.70 $1,854 3.45
200 basis point decline $2,434 $ 176 3.79 $1,919 3.52
* Current rates are as of December 31, 2004 and 2003
At December 31, 2004, the fair value of our investment in preferred
stocks was $21.2 million, including net unrealized gains of $725 thousand.
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 December
31, 2004 was on a cost basis which approximates its fair value. This portfolio
lacks significant interest rate sensitivity due to its short duration.
54
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, 2004, 99.6% 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 December 31, 2004 the fair value of our investment in common stocks
was $18.2 million, which included net unrealized gains of $3 million and net
holding gains of approximately $410 thousand. 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, 2004 would increase the fair value of these securities
to $20.0 million; a hypothetical 10% decrease in the price of each of these
marketable securities would reduce the fair value to $16.4 million. The selected
hypothetical change does not reflect what could be considered the best or worst
scenarios.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Consolidated Financial Statements and Financial Statement
Schedules of ProAssurance Corporation and subsidiaries listed in Item 15(a) have
been included herein beginning on page 61. The Supplementary Financial
Information required by Item 302 of Regulation S-K is included in Note 18 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.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls
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.
Management's Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining
adequate internal control over financial reporting, as such term is defined in
Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, we conducted an evaluation of the effectiveness of our
internal control over financial reporting as of December 31, 2004 based on the
framework in Internal Control-Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Based on that
evaluation, our management concluded that our internal control over financial
reporting was effective as of December 31, 2004.
55
Management's assessment of the effectiveness of our internal control
over financial reporting as of December 31, 2004 has been audited by Ernst &
Young LLP, an independent registered public accounting firm, as stated in their
report which is included elsewhere herein.
56
Report of Independent Registered Public Accounting Firm on Internal Control over
Financial Reporting
The Board of Directors and Shareholders of ProAssurance Corporation
We have audited management's assessment, included in the accompanying
Management's Annual Report on Internal Control over Financial Reporting, that
ProAssurance Corporation and subsidiaries maintained effective internal control
over financial reporting as of December 31, 2004, based on criteria established
in Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). ProAssurance
Corporation's management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to express an
opinion on management's assessment and an opinion on the effectiveness of the
company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management's assessment, testing
and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company's internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that ProAssurance Corporation
and subsidiaries maintained effective internal control over financial reporting
as of December 31, 2004, is fairly stated, in all material respects, based on
the COSO criteria. Also, in our opinion, ProAssurance Corporation and
subsidiaries maintained, in all material respects, effective internal control
over financial reporting as of December 31, 2004, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheets of ProAssurance Corporation and subsidiaries as of December 31, 2004 and
2003, and the related consolidated statements of income, changes in capital and
cash flow for each of the three years in the period ended December 31, 2004, and
our report dated March 14, 2005 expressed an unqualified opinion thereon.
Ernst & Young LLP
Birmingham, Alabama
March 14, 2005
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 24 and 25) 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 2005 Annual Meeting of its
Stockholders to be filed with the Securities and Exchange Commission pursuant to
Regulation 14A on or before April 29, 2005.
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 2005 Annual Meeting of its Stockholders to be filed with
the Securities and Exchange Commission pursuant to Regulation 14A on or before
April 29, 2005.
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 2005 Annual Meeting of its Stockholders to be filed with
the Securities and Exchange Commission pursuant to Regulation 14A on or before
April 29, 2005.
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 2005 Annual Meeting of its Stockholders to be filed with
the Securities and Exchange Commission pursuant to Regulation 14A on or before
April 29, 2005.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
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 2005 Annual Meeting of its Stockholders to be filed with
the Securities and Exchange Commission pursuant to Regulation 14A on or before
April 29, 2005.
58
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(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, 2004 and 2003
Consolidated Statements of Changes in Capital - years ended December
31, 2004, 2003 and 2002
Consolidated Statements of Income - years ended December 31, 2004,
2003 and 2002
Consolidated Statements of Cash Flows - years ended December 31, 2004,
2003 and 2002
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 (Registrant Only)
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 exhibits required to be filed by Item 15(b) 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 14th day of
March 2005.
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. Chairman of the Board and March 14, 2005
- ------------------------------------ Chief Executive Officer
A. Derrill Crowe, M.D. (Principal Executive Officer)
and Director
/s/ Howard H. Friedman Senior Vice President, March 14, 2005
- ------------------------------------ Chief Financial Officer and
Howard H. Friedman Secretary
(Principal Financial and
Accounting Officer)
/s/ Victor T. Adamo, Esq. Director March 14, 2005
- ------------------------------------
Victor T. Adamo, Esq.
/s/ Paul R. Butrus Director March 14, 2005
- ------------------------------------
Paul R. Butrus
/s/ Lucian F. Bloodworth Director March 14, 2005
- ------------------------------------
Lucian F. Bloodworth
/s/ Robert E. Flowers, M.D. Director March 14, 2005
- ------------------------------------
Robert E. Flowers, M.D.
/s/ John J. McMahon, Jr., Esq. Director March 14, 2005
- ------------------------------------
John J. McMahon, Jr., Esq.
/s/ John P. North, Jr. Director March 14, 2005
- ------------------------------------
John P. North, Jr.
/s/ Ann F. Putallaz, Ph.D. Director March 14, 2005
- ------------------------------------
Ann F. Putallaz, Ph.D.
/s/ William H. Woodhams, M.D. Director March 14, 2005
- ------------------------------------
William H. Woodhams, M.D.
/s/ Wilfred W. Yeargan, Jr., M.D. Director March 14, 2005
- ------------------------------------
Wilfred W. Yeargan, Jr., M.D.
60
ProAssurance Corporation and Subsidiaries
Consolidated Financial Statements
Years ended December 31, 2004, 2003 and 2002
TABLE OF CONTENTS
Report of Independent Registered Public
Accounting Firm................................. 62
Audited Consolidated Financial Statements
Consolidated Balance Sheets..................... 63
Consolidated Statements of Changes in Capital... 65
Consolidated Statements of Income............... 66
Consolidated Statements of Cash Flow............ 67
Notes to Consolidated Financial Statements ..... 68
61
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON CONSOLIDATED
FINANCIAL STATEMENTS
To the Board of Directors and Shareholders of
ProAssurance Corporation
We have audited the accompanying consolidated balance sheets of
ProAssurance Corporation and subsidiaries as of December 31, 2004 and 2003, and
the related consolidated statements of changes in capital, income and cash flow
for each of the three years in the period ended December 31, 2004. Our audits
also included the financial statement schedules listed in the Index at Item
15(a). These financial statements and schedules are the responsibility of the
Company'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 the standards of the Public
Company Accounting Oversight Board (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 financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
ProAssurance Corporation and subsidiaries at December 31, 2004 and 2003, and the
consolidated results of their operations and their cash flow for each of the
three years in the period ended December 31, 2004, in conformity with U.S.
generally accepted accounting principles. 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 13 to the consolidated financial statements, in 2002
ProAssurance changed its method of accounting for goodwill and intangible
assets.
We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the effectiveness of
ProAssurance Corporation's internal control over financial reporting as of
December 31, 2004, based on criteria established in Internal Control--Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated March 14, 2005 expressed an unqualified opinion
thereon.
Ernst & Young LLP
Birmingham, Alabama
March 14, 2005
62
PROASSURANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE DATA)
DECEMBER 31 December 31
2004 2003
------------- -------------
ASSETS
Investments:
Fixed maturities available for sale, at fair value $ 2,257,985 $ 1,790,778
Equity securities available for sale, at fair value 35,230 42,136
Equity securities, trading portfolio, at fair value 4,150 5,863
Real estate, net 19,244 17,262
Short-term investments 41,423 114,767
Business owned life insurance 54,138 51,706
Other 42,883 38,247
------------- -------------
Total investments 2,455,053 2,060,759
Cash and cash equivalents 30,084 42,045
Premiums receivable 131,736 132,255
Receivable from reinsurers on unpaid losses
and loss adjustment expenses 409,339 444,811
Prepaid reinsurance premiums 18,888 17,651
Deferred taxes 80,107 73,118
Other assets 113,991 108,713
------------- -------------
$ 3,239,198 $ 2,879,352
============= =============
See accompanying notes.
63
PROASSURANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE DATA)
DECEMBER 31 December 31
2004 2003
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Policy liabilities and accruals:
Reserve for losses and loss adjustment expenses $ 2,029,592 $ 1,814,584
Unearned premiums 314,179 290,134
Reinsurance premiums payable 69,507 68,510
------------- -------------
Total policy liabilities 2,413,278 2,173,228
Other liabilities 63,421 55,030
Long-term debt 151,480 104,789
------------- -------------
Total liabilities 2,628,179 2,333,047
Commitments and contingencies - -
Stockholders' Equity:
Common stock, par value $0.01 per share
100,000,000 shares authorized;
29,326,228 and 29,226,774 shares
issued, in 2004 and 2003, respectively 293 292
Additional paid-in capital 313,957 312,030
Accumulated other comprehensive income, net of
deferred tax expense of $13,139 and $18,537,
respectively 24,397 34,422
Retained earnings 272,428 199,617
------------- -------------
611,075 546,361
Less treasury stock, at cost, 121,765 shares (56) (56)
------------- -------------
Total stockholders' equity 611,019 546,305
------------- -------------
$ 3,239,198 $ 2,879,352
============= =============
See accompanying notes.
64
PROASSURANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN CAPITAL
(IN THOUSANDS)
Accumulated
Additional Other
Common Paid-in Comprehensive Retained Treasury
Stock Capital Income (Loss) Earnings Stock Total
------- ---------- ------------- ---------- -------- ----------
Balance at January 1, 2002 $ 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
------- ---------- ------------- ---------- -------- ----------
Common stock issued for compensation - 1,061 - - - 1,061
Stock options exercised 2 2,468 - - - 2,470
Change in minority interest - - 886 - - 886
Comprehensive income:
Change in fair value of securities available
for sale, net of deferred taxes, and
reclassification adjustments - - (2,009) - -
Net Income - - - 38,703 -
Total comprehensive income 36,694
------- ---------- ------------- ---------- -------- ----------
Balance at December 31, 2003 292 312,030 34,422 199,617 (56) 546,305
Common stock issued for compensation 1 1,710 - - - 1,711
Stock options exercised - 217 - - - 217
Comprehensive income:
Change in fair value of securities available
for sale, net of deferred taxes, and
reclassification adjustments - - (10,025) - -
Net Income - - - 72,811 -
Total comprehensive income 62,786
------- ---------- ------------- ---------- -------- ----------
Balance at December 31, 2004 $ 293 $ 313,957 $ 24,397 $ 272,428 $ (56) $ 611,019
======= ========== ============= ========== ======== ==========
See accompanying notes.
65
PROASSURANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS EXCEPT PER SHARE DATA)
Year ended December 31
2004 2003 2002
---------- ---------- ----------
Revenues:
Gross premiums written $ 789,660 $ 740,110 $ 636,156
========== ========== ==========
Net premiums written $ 717,059 $ 668,909 $ 537,123
========== ========== ==========
Premiums earned $ 765,643 $ 698,347 $ 576,414
Premiums ceded (69,623) (74,833) (99,006)
---------- ---------- ----------
Net premiums earned 696,020 623,514 477,408
Net investment income 87,225 73,619 76,918
Net realized investment gains (losses) 7,609 5,992 (5,306)
Other income 3,699 6,515 6,747
---------- ---------- ----------
Total revenues 794,553 709,640 555,767
Expenses:
Losses and loss adjustment expenses 596,070 576,043 569,099
Reinsurance recoveries (23,189) (24,667) (121,070)
---------- ---------- ----------
Net losses and loss adjustment expenses 572,881 551,376 448,029
Underwriting, acquisition and insurance expenses 117,689 104,216 91,253
Loss on early extinguishment of debt - 305 -
Interest expense 6,515 3,409 2,875
---------- ---------- ----------
Total expenses 697,085 659,306 542,157
---------- ---------- ----------
Income before income taxes, minority interest and
cumulative effect of accounting change 97,468 50,334 13,610
Provision for income taxes:
Current expense (benefit) 23,550 11,357 (275)
Deferred expense (benefit) 1,107 93 87
---------- ---------- ----------
24,657 11,450 (188)
---------- ---------- ----------
Income before minority interest and cumulative
effect of accounting change 72,811 38,884 13,798
Minority interest - (181) (3,285)
---------- ---------- ----------
Income before cumulative effect of accounting change 72,811 38,703 10,513
Cumulative effect of accounting change, net of tax - - 1,694
---------- ---------- ----------
Net income $ 72,811 $ 38,703 $ 12,207
========== ========== ==========
Earnings per share (basic):
Income before cumulative effect of accounting change $ 2.50 $ 1.34 $ 0.40
Cumulative effect of accounting change, net of tax - - 0.07
---------- ---------- ----------
Net income $ 2.50 $ 1.34 $ 0.47
========== ========== ==========
Earnings per share (diluted):
Income before cumulative effect of accounting change $ 2.37 $ 1.32 $ 0.39
Cumulative effect of accounting change, net of tax - - 0.07
---------- ---------- ----------
Net income $ 2.37 $ 1.32 $ 0.46
========== ========== ==========
Weighted average number of common shares outstanding
Basic 29,164 28,956 26,231
========== ========== ==========
Diluted 31,984 30,389 26,254
========== ========== ==========
See accompanying notes.
66
PROASSURANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(IN THOUSANDS)
Year ended December 31
2004 2003 2002
---------- ------------ -----------
OPERATING ACTIVITIES
Net income $ 72,811 $ 38,703 $ 12,207
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation 3,880 3,804 4,337
Amortization 23,146 19,708 10,707
Increase in cash surrender value of business owned life insurance (2,432) (1,706) -
Net realized investment (gains) losses (7,609) (5,992) 5,306
Deferred income taxes 1,107 93 87
Policy acquisition costs deferred, net of related amortization (4,059) (874) (7,241)
Other (622) (577) (812)
Changes in assets and liabilities:
Trading portfolio securities, excluding net holding gains 4,610 (5,540) -
Premiums receivable 519 (21,227) (32,963)
Receivable from reinsurers 35,472 17,201 (87,956)
Prepaid reinsurance premiums (1,237) 3,643 (1,029)
Other assets (3,551) (4,777) 8,275
Reserve for losses and loss adjustment expenses 215,008 192,116 180,127
Unearned premiums 24,045 41,763 59,742
Reinsurance premiums payable 997 5,961 13,845
Other liabilities 11,456 321 9,044
Minority interest in net income - 181 3,285
---------- ------------ -----------
Net cash provided by operating activities 373,541 282,801 176,961
INVESTING ACTIVITIES
Purchases of:
Fixed maturities available for sale (1,196,991) (1,082,573) (897,928)
Equity securities available for sale (856) (3,019) (10,932)
Other investments (4,205) (19,110) (15,000)
Business owned life insurance - (50,000) -
Proceeds from sale or maturities of:
Fixed maturities available for sale 699,434 612,480 900,641
Equity securities available for sale 8,854 26,296 20,235
Net decrease (increase) in short-term investments 73,352 138,087 (116,841)
Other (10,032) (6,905) (2,785)
---------- ------------ -----------
Net cash (used by) investing activities (430,444) (384,744) (122,610)
FINANCING ACTIVITIES
Net proceeds from stock issuance - - 46,499
Net proceeds from long-term debt 44,907 104,641 -
Repayment of debt - (72,500) (10,000)
Purchase of minority interest - (33,304) (707)
Other 35 1,845 -
---------- ------------ -----------
Net cash provided by financing activities 44,942 682 35,792
---------- ------------ -----------
Increase (decrease) in cash and cash equivalents (11,961) (101,261) 90,143
Cash and cash equivalents at beginning of period 42,045 143,306 53,163
---------- ------------ -----------
Cash and cash equivalents at end of period $ 30,084 $ 42,045 $ 143,306
========== ============ ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Net cash paid (received) during the year for income taxes $ 23,081 $ 14,312 $ (8,884)
========== ============ ===========
Cash paid during the year for interest $ 5,501 $ 3,136 $ 2,714
========== ============ ===========
See accompanying notes.
67
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
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.
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 (U.S.) in two
reportable industry segments. As discussed in Note 2, 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.
Investments
Fixed Maturities and Equity Securities Available for Sale
ProAssurance considers all fixed maturity securities as
available-for-sale. Equity securities are considered as either
available-for-sale or trading portfolio securities. 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 included, net of
related tax effects, in stockholders' equity as "Accumulated other comprehensive
income (loss)" until realized.
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.
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.
68
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
1. ACCOUNTING POLICIES (CONTINUED)
Equity Securities, Trading Portfolio
ProAssurance has designated certain equity security purchases as trading
portfolio securities. A trading portfolio is carried at fair value with the
holding gains and losses included in realized investment gains and losses in the
current period. Fair values are based on quoted market prices.
Real Estate
Real estate properties are classified as investment real estate. All
balances are reported at cost, less allowances for depreciation. Depreciation is
computed over the estimated useful lives of the related property using the
straight-line method. Rental income and expenses are included in net investment
income.
Short-term Investments
Short-term investments, which have an original maturity of one year or
less, are primarily composed of investments in U.S. Treasury obligations and
commercial paper. All balances are reported at cost, which approximates fair
value.
Other Investments
Other investments are primarily comprised of equity interests in
non-public investment partnerships/limited liability companies. Interests where
ProAssurance has virtually no influence over the operating and financial
policies of the entity and for which there is no readily determinable fair value
are accounted for using the cost method. Interests where ProAssurance has a
greater than minor interest in the entity are accounted for using the equity
method.
Business Owned Life Insurance (BOLI)
ProAssurance owns life insurance contracts on certain key management
employees. The life insurance contracts are carried at their current cash
surrender value. Changes in the cash surrender value are included in income in
the current period as investment income. Death proceeds from the contracts are
recorded when the proceeds become payable under the policy terms.
Cash and Cash Equivalents
For purposes of the consolidated balance sheets and statements of cash
flow, ProAssurance considers all demand deposits and overnight investments to be
cash equivalents.
Realized Gains and Losses
Realized gains and losses on sales of investments are recognized on the
specific identification basis.
Reclassifications
Certain reclassifications have been made to the prior year balance sheet
and statement of cash flow to conform to the current year presentation.
69
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
1. ACCOUNTING POLICIES (CONTINUED)
Impairments
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 a 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 issuer's industry
and geographical region, to the extent that information is publicly
available, and
- ProAssurance's ability and intent to hold the investment for a period
of time sufficient to allow for any anticipated recovery in market value.
Reinsurance
ProAssurance enters into reinsurance agreements whereby other insurance
entities agree to assume a portion of the risk associated with the policies
issued by ProAssurance. In return, ProAssurance agrees to pay a premium to the
reinsurer. ProAssurance purchases (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.
Receivable from reinsurers is the estimated amount of future loss payments
that will be recoverable from reinsurers. Reinsurance recoveries are the portion
of losses incurred during the period that are estimated to be allocable to
reinsurers. Premiums ceded are the estimated premiums that will be due to
reinsurers with respect to premiums earned and losses incurred during the
period.
These estimates are based upon management's estimates of ultimate losses
and the portion of those losses that are allocable to reinsurers under the terms
of the related reinsurance agreements. Given the uncertainty of the ultimate
amounts of losses, these estimates may vary significantly from the eventual
outcome. Management regularly reviews these estimates and any adjustments
necessary are reflected in the period in which the estimate is changed. Due to
the size of the receivable from reinsurers, even a small adjustment to the
estimates could have a material effect on ProAssurance's results of operations
for the period in which the change is made.
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. Any
amount found to be uncollectible is written off in the period in which the
uncollectible amount is identified.
70
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
1. ACCOUNTING POLICIES (CONTINUED)
Goodwill
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 is not amortized. Goodwill is
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 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.
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 (Reserve for Losses)
ProAssurance establishes its reserve for loss and loss adjustment expenses
(reserve for losses) based on estimates of the future amounts necessary to pay
claims and expenses (losses) associated with the investigation and settlement of
claims. The reserve for losses is determined on the basis of individual claims
and payments thereon as well as actuarially determined estimates of future
losses based on past loss experience, available industry data and projections as
to future claims frequency, severity, inflationary trends, judicial trends,
legislative changes and settlement patterns.
ProAssurance believes that the methods it uses to establish the reserve
for losses are reasonable and appropriate. Independent actuaries review the
reserve for losses of each insurance subsidiary at least semi-annually and
prepare reports that include recommendations as to the level of reserves.
ProAssurance considers these recommendations and other factors, such as known,
anticipated or estimated changes in frequency and severity of claims, loss
retention levels and premium rates in establishing its reserves. Estimating
casualty insurance reserves, and particularly 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. Reserve
estimates and the assumptions on which these estimates are predicated are
regularly reviewed and updated as new information becomes available. Any
adjustments necessary are reflected in then current operations. Due to the size
of ProAssurance's reserve for losses, even a small percentage adjustment to
these estimates could have a material effect on earnings in the period in which
the adjustment is made.
The effect of adjustments made to reinsured losses is mitigated by the
corresponding adjustment that is made to insurance recoveries. Thus, in any
given year, the Company may make significant adjustments to gross losses that
have little effect on its net losses.
Recognition of Revenues
Insurance premiums are recognized as revenues pro rata over the terms of
the policies.
71
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
1. ACCOUNTING POLICIES (CONTINUED)
Stock-Based Compensation
ProAssurance accounts for stock options under the recognition and
measurement principles of Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations (APB 25). The
following table illustrates the effect on net income and earnings per share as
if ProAssurance had applied the fair value recognition provisions of SFAS No.
123, Accounting for Stock-Based Compensation, to outstanding options. See Note
12 for additional information regarding outstanding options.
YEAR ENDED DECEMBER 31
2004 2003 2002
-------- -------- ----------
In thousands except per share data
Net income as reported $ 72,811 $ 38,703 $ 12,207
Add: Stock-based employee compensation expense recognized
under APB 25 related to the exercise of options, net of
related tax effects 218 130 -
Deduct: Total stock-based employee compensation expense
determined under fair value based method
for all awards, net of related tax effects (1,234) (697) (564)
-------- -------- ----------
Pro forma net income $ 71,795 $ 38,136 $ 11,643
======== ======== ==========
Earnings per share:
Basic--as reported $ 2.50 $ 1.34 $ 0.47
======== ======== ==========
Basic--pro forma $ 2.46 $ 1.32 $ 0.44
======== ======== ==========
Diluted--as reported $ 2.37 $ 1.32 $ 0.46
======== ======== ==========
Diluted--pro forma $ 2.34 $ 1.30 $ 0.44
======== ======== ==========
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 for income tax reporting, and the limitation of the unearned premiums
deduction for income tax reporting.
72
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
1. ACCOUNTING POLICIES (CONTINUED)
Accounting Changes
On December 16, 2004 the Financial Accounting Standards Board (FASB)
issued SFAS 123(revised 2004), Share-Based Payment, hereafter referred to as
SFAS 123(R), which is a revision of SFAS 123, Accounting for Stock-Based
Compensation. SFAS 123(R) supersedes APB 25, Accounting for Stock Issued to
Employees , and amends SFAS 95, Statement of Cash Flows. SFAS 123(R) requires
all share-based payments to employees, including grants of employee stock
options, to be recognized in the financial statements based on their fair
values. SFAS 123(R) is effective for public companies at the beginning of the
first interim or annual period beginning after June 15, 2005; early adoption is
permitted. ProAssurance plans to adopt SFAS 123(R) on its effective date using
the "modified prospective" method permitted by the statement.
Under the "modified prospective" method stock based compensation is
recognized (a) under the requirements of SFAS 123(R) for all share-based
payments granted after the effective data of SFAS 123(R) and (b) under the
requirements of SFAS 123 for all non-vested share-based payments granted
prior to the adoption of SFAS 123(R).
As permitted by SFAS 123, ProAssurance currently accounts for stock
options awarded to employees using APB 25's intrinsic value method and, as such,
generally recognizes no compensation cost related to such awards. SFAS 123(R)
differs from SFAS 123 in several key computational areas, and implementation of
SFAS 123(R) will require ProAssurance to select among various assumptions in
order to perform the computations required under SFAS 123(R). Those assumptions
have not yet been selected, thus the effect that SFAS 123(R) would have had on
prior periods has not been computed. The effect of adoption of SFAS 123 (R) on
future operating results cannot be predicted at this time because the effect
will depend on the levels of share based payments granted in the future and the
methods and assumptions used to determine the fair value of those share based
payments. SFAS 123(R) also requires the benefits of tax deductions in excess of
recognized compensation cost to be reported as a financing cash flow, rather
than as an operating cash flow as required under current literature.
In September, 2004 the Emerging Issues Task Force of the FASB reached a
consensus regarding Issue 04-08-"Accounting Issues Related to Certain Features
of Contingently Convertible Debt and the Effect on Diluted EPS" ("EITF 04-8").
Under the new guidance, issuers of contingently convertible (Co-Co) debt
instruments must include the potential common shares underlying the Co-Co (the
Co-Co shares) in diluted earnings per share computations (if dilutive)
regardless of whether the market price contingency has been met or not. The
consensus is effective for financial statements ending after December 15, 2004
and is to be retroactively applied to all periods presented. Previously,
following commonly accepted interpretations of SAFS 128, "Earnings Per Share",
ProAssurance did not include the potential common shares underlying its
Convertible Debentures in the calculation of diluted earnings per share because
the market price contingency had not been met. Implementation of EITF 04-8
reduced diluted net income per share by $0.11 and $0.01 per share for the years
ended December 31, 2004 and 2003, respectively.
73
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
2. SEGMENT INFORMATION
ProAssurance operates in the U.S. 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
principally in the Southeast and Midwest. 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 principally in the state of Michigan primarily to educational
employees and their families through a single insurance company, MEEMIC
Insurance Company (MEEMIC).
The accounting policies of each segment are consistent with those
described in the summary of significant accounting policies in Note 1. Other
than cash and securities owned directly by the parent company, the assets of
ProAssurance are attributable to the reportable operating segments. Other than
investment income earned directly by the parent company and interest expense
attributable to long-term debt held by the parent company, all revenues and
expenses of ProAssurance are attributable 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.
74
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
2. SEGMENT INFORMATION (CONTINUED)
The table below provides a reconciliation of segment information to total
consolidated information.
Year ended December 31
2004 2003 2002
------------ ------------ ----------
In thousands
Revenues:
Professional liability segment:
Net premiums earned $ 512,655 $ 453,246 $ 327,645
Net investment income 75,029 63,099 66,790
Other revenues 6,173 10,318 (1,139)
------------ ------------ ----------
Total segment revenues $ 593,857 $ 526,663 $ 393,296
Personal lines segment:
Net premiums earned 183,365 170,268 149,763
Net investment income 10,879 10,253 10,071
Other revenues 2,395 2,189 2,580
------------ ------------ ----------
Total segment revenues 196,639 182,710 162,414
Corporate (not attributed to segments) 4,057 267 57
------------ ------------ ----------
Total revenues $ 794,553 $ 709,640 $ 555,767
============ ============ ==========
Income (loss) before taxes, minority interest
and cumulative effect of accounting change:
Professional liability $ 56,279 $ 20,657 $ (14,637)
Personal lines 43,647 33,124 31,065
Corporate (not attributed to segments) (2,458) (3,447) (2,818)
------------ ------------ ----------
Income before taxes, minority interest and
cumulative effect of accounting changes $ 97,468 $ 50,334 $ 13,610
============ ============ ==========
December 31
2004 2003
------------ ------------
In thousands
Assets:
Professional liability $ 2,682,987 $ 2,413,043
Personal lines 495,903 431,264
Corporate (not attributed to segments) 60,308 35,045
------------ ------------
Total assets $ 3,239,198 $ 2,879,352
============ ============
75
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
3. INVESTMENTS
The amortized cost and estimated fair value of available-for-sale fixed
maturities and equity securities are as follows:
DECEMBER 31, 2004
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS (LOSSES) VALUE
------------- ----------- ------------- -------------
IN THOUSANDS
Fixed Maturities
U.S. Treasury securities $ 171,256 $ 1,167 $ (1,076) $ 171,347
State and municipal bonds 823,951 16,503 (1,533) 838,921
Corporate bonds 658,177 19,601 (3,439) 674,339
Asset-backed securities 570,744 4,696 (2,062) 573,378
------------- ----------- ------------- -------------
2,224,128 41,967 (8,110) 2,257,985
Equity securities 31,548 3,878 (196) 35,230
------------- ----------- ------------- -------------
$ 2,255,676 $ 45,845 $ (8,306) $ 2,293,215
============= =========== ============= =============
December 31, 2003
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
------------- ----------- ------------ -------------
In thousands
Fixed Maturities
U.S. Treasury securities $ 305,564 $ 2,471 $ (839) $ 307,196
State and municipal bonds 377,833 18,053 (211) 395,675
Corporate bonds 597,514 26,919 (2,752) 621,681
Asset-backed securities 460,048 6,215 (1,107) 465,156
Other 1,069 1 - 1,070
------------- ----------- ------------ -------------
1,742,028 53,659 (4,909) 1,790,778
Equity securities 37,923 4,303 (90) 42,136
------------- ----------- ------------ -------------
$ 1,779,951 $ 57,962 $ (4,999) $ 1,832,914
============= =========== ============ =============
ProAssurance held certain available-for-sale securities in an unrealized
loss position at December 31, 2004, as summarized in the following table. After
an evaluation of each security, Management concluded that these securities have
not suffered an other than temporary impairment in value. Each fixed maturity
security has paid all scheduled contractual payments. Management believes that
each issuer has the capacity to meet the remaining contractual obligations of
the security, including payment at maturity, and that ProAssurance has the
capacity to hold the security until the scheduled maturity date. Management also
believes each of the equity securities, given the characteristics of the
underlying company, industry, and price volatility of the security, has a
reasonable expectation of being valued at or above book value in the near term.
76
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
3. INVESTMENTS (CONTINUED)
TOTAL LESS THAN 12 MONTHS MORE THAN 12 MONTHS
----------------------- -------------------------- ----------------------
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSS VALUE LOSS VALUE LOSS
----------- ---------- ----------- ------------ --------- -----------
IN THOUSANDS
Fixed maturities, available for sale
U.S. Treasury securities $ 104,993 $ (1,076) $ 95,180 $ (803) $ 9,813 $ (273)
State and municipal bonds 184,136 (1,533) 180,268 (1,426) 3,868 (107)
Corporate bonds 256,105 (3,439) 208,521 (1,924) 47,584 (1,515)
Asset-backed securities 267,806 (2,062) 247,354 (1,710) 20,452 (352)
----------- ---------- ----------- ------------ --------- -----------
813,040 (8,110) 731,323 (5,863) 81,717 (2,247)
Equity securities available for sale 3,746 (196) 3,614 (184) 132 (12)
----------- ---------- ----------- ------------ --------- -----------
Available for sale securities held
with unrealized losses $ 816,786 $ (8,306) $ 734,937 $ (6,047) $ 81,849 $ (2,259)
=========== ========== =========== ============ ========= ===========
The amortized cost and estimated fair value of fixed maturities at
December 31, 2004, 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
------------- ---------
IN THOUSANDS
Due in one year or less $ 95,979 $ 96,375
Due after one year through five years 578,222 585,478
Due after five years through ten years 542,354 561,087
Due after ten years 436,829 441,667
Asset-backed securities 570,744 573,378
------------- -------------
$ 2,224,128 $ 2,257,985
============= ==============
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, 2004.
77
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
3. INVESTMENTS (CONTINUED)
At December 31, 2004 ProAssurance had available-for-sale securities with a
carrying value of $12.8 million on deposit with various state insurance
departments to meet regulatory requirements.
Business Owned Life Insurance
During 2003 ProAssurance purchased BOLI policies on executive employees at
a cost of approximately $50 million. The primary purpose of the program is to
offset future employee benefit expenses through earnings on the cash value of
the policies. ProAssurance is the owner and principal beneficiary of these
policies; however, $50,000 of each death benefit is payable to beneficiaries
designated by the insured employee.
Real Estate
Real estate consists of two properties currently in use as corporate
offices and a parcel of land expected to be developed as an additional corporate
office. One property includes 78,000 square feet of office space which is leased
or available for lease. Accumulated depreciation was approximately $9.8 million
and $8.7 million at December 31, 2004 and 2003, respectively.
78
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
3. INVESTMENTS (CONTINUED)
Net Investment Income / Net Realized Investment Gains (Losses)
Investment income by investment category is as follows:
Year ended December 31
2004 2003 2002
-------- -------- --------
In thousands
Fixed maturities $ 80,830 $ 68,381 $ 73,008
Equities 1,831 2,510 3,435
Real estate 1,078 1,120 1,428
Short-term investments 1,585 2,637 2,922
Other invested assets 4,592 1,664 -
Business owned life insurance 2,432 1,706 -
Other 4 - 174
-------- -------- --------
92,352 78,018 80,967
Investment expenses (5,127) (4,399) (4,049)
-------- -------- --------
Net investment income $ 87,225 $ 73,619 $ 76,918
======== ======== ========
Gross investment gains and losses are primarily from sales of investment
securities. Net realized investment gains (losses) are as follows:
Year ended December 31
2004 2003 2002
-------- -------- --------
In thousands
Gross gains $ 7,066 $ 9,388 $ 26,040
Gross losses (1,743) (3,397) (10,042)
Other than temporary impairments (611) (322) (21,304)
Trading portfolio gains 2,897 323 -
-------- -------- --------
Net realized investment gains (losses) $ 7,609 $ 5,992 $ (5,306)
======== ======== ========
Net gains related to fixed maturities included in the above table are $3.7
million, $2.3 million and $11.7 million during 2004, 2003 and 2002,
respectively.
ProAssurance's net realized investment gains and losses on
available-for-sale securities are shown in the table below. The amounts
recognized in the income statement were reclassified from "Other Accumulated
Comprehensive Income (Loss)" in accordance with the provisions of SFAS 115.
Year ended December 31
2004 2003 2002
-------- ------- --------
In thousands
Net realized investment gains (losses) $ 5,315 $ 5,458 $ (5,306)
Related tax expense (benefit) 1,860 1,910 (1,857)
-------- ------- --------
Reclassified gains (losses) $ 3,455 $ 3,548 $ (3,449)
======== ======= ========
Proceeds from sales (excluding maturities and paydowns) of
available-for-sale securities were $505.7 million, $358.5 million and $646.4
million during 2004, 2003 and 2002, respectively.
79
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
4. REINSURANCE
ProAssurance has various quota share, excess of loss, and cession
reinsurance agreements. Historically, professional liability 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. ProAssurance
also insures some large professional liability risks that are above the limits
of its basic reinsurance treaties. These risks are reinsured on a facultative
basis, whereby the reinsurer agrees to insure a particular risk up to a
designated limit. Personal lines retention levels historically have been
$250,000 per loss. Individual property risks are covered up to $1 million per
risk and casualty risks are covered on an excess of loss basis up to $3 million
per occurrence, with catastrophe reinsurance arrangements in place to provide
coverage for aggregate property loss events.
The effect of reinsurance on premiums written and earned is as follows:
2004 PREMIUMS 2003 Premiums 2002 Premiums
WRITTEN EARNED Written Earned Written Earned
--------- --------- --------- --------- --------- ---------
In thousands
Direct $ 789,564 $ 765,547 $ 737,602 $ 695,839 $ 634,142 $ 573,423
Assumed 96 96 2,508 2,508 2,014 2,991
Ceded (72,601) (69,623) (71,201) (74,833) (99,033) (99,006)
--------- --------- --------- --------- --------- ---------
Net premiums $ 717,059 $ 696,020 $ 668,909 $ 623,514 $ 537,123 $ 477,408
========= ========= ========= ========= ========= =========
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, 2004, all reinsurance recoverables are considered
collectible. As required by the various state insurance laws, reinsurance
recoverables totaling approximately $32.7 million are collateralized by letters
of credit or funds withheld.
At December 31, 2004 amounts due from individual reinsurers that exceed 5%
of stockholders' equity are as follows:
Amount Due
Reinsurer From Reinsurer
- ---------------------------------------- --------------
In millions
Michigan Catastrophic Claims Association $115.1
Hannover Ruckversicherung AG $ 50.5
General Reinsurance Corp $ 31.0
During 2004, ProAssurance commuted (terminated) its various agreements
with one of its reinsurers, Gerling Global Reinsurance Corporation of America.
As a result of that commutation, ProAssurance reduced its receivable from
reinsurers by approximately $5.6 million (net of $12.3 million cash received)
and reduced its reinsurance liabilities by approximately $1.6 million.
80
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
5. 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 are as follows:
December 31
2004 2003
-------- --------
In thousands
Deferred tax assets
Unpaid loss discount $ 72,151 $ 64,843
Unearned premium adjustment 22,166 20,186
Alternative minimum tax credits - 8,440
Tax basis in intangibles 8,943 9,588
Other 6,032 3,697
-------- --------
Total deferred tax assets 109,292 106,754
-------- --------
Deferred tax liabilities
Deferred acquisition costs 9,682 8,261
Unrealized gains on investments, net 13,139 18,537
Other 6,364 6,838
-------- --------
Total deferred tax liabilities 29,185 33,636
-------- --------
Net deferred tax assets $ 80,107 $ 73,118
======== ========
In management's opinion, 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.
A reconciliation of "expected" income tax expense (35% of income before
income taxes) to actual income tax expense in the accompanying financial
statements follows:
Year ended December 31
2004 2003 2002
-------- -------- --------
In thousands
Computed "expected" tax expense $ 34,114 $ 17,617 $ 4,764
Tax-exempt income (6,830) (5,307) (5,757)
Other (2,627) (860) 805
-------- -------- --------
Actual tax (benefit) $ 24,657 $ 11,450 $ (188)
======== ======== ========
81
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
6. 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.
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 $63.4
million, $54.9 million, and $41.8 million for the years ended December 31, 2004,
2003 and 2002, respectively. Unamortized deferred acquisition costs are included
in other assets on the consolidated balance sheets and amounted to approximately
$27.7 million and $23.6 million at December 31, 2004 and 2003, respectively.
7. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
ProAssurance establishes its reserve for losses based on estimates of the
future amounts necessary to pay claims and expenses associated with the
investigation and settlement of claims. These estimates consist of case reserves
and bulk reserves. Case reserves are estimates of future losses 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 anticipated changes to losses 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 and incurred but not reported claims,
including amounts already paid.
The reserve for losses is established based on estimates 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, and particularly 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. Changes to estimates of
previously established reserves are included in earnings in the period in which
the estimate is changed.
ProAssurance believes that the methods it uses to establish reserves are
reasonable and appropriate. Each year, ProAssurance obtains an independent
actuarial review of the reserve for losses 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 reserve for losses. 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).
82
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
7. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES (CONTINUED)
Activity in the reserve for losses and loss adjustment expenses is
summarized as follows:
Year ended December 31
2004 2003 2002
-------------- ------------- --------------
In thousands
Balance, beginning of year $ 1,814,584 $ 1,622,468 $ 1,442,341
Less reinsurance recoverables 444,811 462,012 374,056
-------------- ------------- --------------
Net balance, beginning of year 1,369,773 1,160,456 1,068,285
Net losses:
Current year 589,497 562,256 439,600
Unfavorable (favorable) development of reserves
established in prior years (16,616) (10,880) 8,429
--------------- ------------- --------------
Total 572,881 551,376 448,029
Paid related to:
Current year (92,361) (94,824) (84,376)
Prior years (230,040) (247,235) (271,482)
-------------- ------------- --------------
Total paid (322,401) (342,059) (355,858)
-------------- ------------- --------------
Net balance, end of year 1,620,253 1,369,773 1,160,456
Plus reinsurance recoverables 409,339 444,811 462,012
-------------- ------------- --------------
Balance, end of year $ 2,029,592 $ 1,814,584 $ 1,622,468
============== ============= ==============
As discussed in Note 1, estimating liability reserves is complex and
requires the use of many assumptions. As time passes and ultimate losses for
prior years are either known or become subject to a more definite estimation,
ProAssurance increases or decreases the reserve estimates established in prior
periods. The prior year development recognized in 2004 and 2003 decreased the
net loss reserve at the end of the prior year by 1.2% and 0.9% and increased the
net loss reserve at end of the prior year in 2002 by 0.8%. This development was
recognized in response to annual actuarial reviews that resulted in estimates of
ultimate loss costs for prior years that differed from the prior estimates of
those loss costs.
83
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
8. 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 resolution 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 any such action is resolved.
ProAssurance is involved in a number of operating leases primarily for
office space, office equipment, and communication lines. The following is a
schedule of future minimum lease payments for operating leases that had initial
or remaining noncancelable lease terms in excess of one year as of December 31,
2004.
Operating Leases
- -----------------------------------------
In thousands
2005 $ 3,786
2006 3,004
2007 876
2008 658
2009 278
Thereafter 121
---------
Total minimum lease payments $ 8,723
=========
ProAssurance had rent expense of $4.1 million in the year ended December
31, 2004 and $4.3 million in the years ended December 31, 2003 and 2002.
9. 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 cash and investment resources of approximately
$34.1 million to complete the transaction. ProAssurance recognized goodwill of
$7.6 million related to the transaction. Income for the year ended December 31,
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.
84
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
10. LONG-TERM DEBT
Outstanding long-term debt, as of December 31, 2004 and December 31, 2003,
consisted of the following:
December 31
2004 2003
--------------------------
$ In thousands
Convertible Debentures due June 30, 2023, unsecured
and bearing a fixed interest rate of 3.9%, net of
unamortized original issuer's discounts of $2,515
and $2,811 at December 31, 2004 and December 31,
2003, respectively. $ 105,085 $ 104,789
Trust Preferred Subordinated Debentures, unsecured,
and bearing floating interest rate, adjustable
quarterly, at three-month LIBOR plus 3.85%.
Due December 31, 2004 Rate
April 29, 2034 6.14% 13,403 -
May 12, 2034 6.14% 10,310 -
May 12, 2034 6.14% 22,682 -
------------ -----------
$ 151,480 $ 104,789
============ ===========
Convertible Debentures Due June 30, 2023
In early July 2003, ProAssurance issued $107.6 million of 3.9% Convertible
Debentures in a Private Offering transaction, net of an initial purchaser's
discount of $3.0 million. ProAssurance used the net proceeds to pay off its
existing term loan having an outstanding principal balance of $67.5 million.
Summarized information regarding the structure and terms of the
Convertible Debentures follows:
Issue Price. The Convertible Debentures were issued at 100.0% of their
principal amount and each Convertible Debenture has a principal amount at
maturity of $1,000.
Maturity Date. June 30, 2023.
Ranking. The Convertible Debentures are unsecured obligations and rank
equally in right of payment with all other existing and future unsecured
and unsubordinated obligations. The Convertible Debentures are not
guaranteed by any of ProAssurance's subsidiaries.
85
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
10. LONG-TERM DEBT (CONTINUED)
and, accordingly, the Convertible Debentures are effectively subordinated
to the indebtedness and other liabilities of ProAssurance's subsidiaries,
including insurance policy-related liabilities.
Interest. Interest is payable on June 30 and December 30 of each year,
beginning December 30, 2003, at an annual rate of 3.90%. In addition,
ProAssurance may be required to pay contingent interest, as set forth
below under Contingent Interest.
Contingent Interest. Contingent interest is due to the holders of the
Convertible Debentures during any six-month period from June 30 to
December 29 and from December 30 to June 29 commencing with the six-month
period beginning June 30, 2008, if the average market price of a
Convertible Debenture for the five trading days ending on the second
trading day immediately preceding the relevant six-month period equals
120% or more of the principal amount of the Convertible Debentures. The
amount of contingent interest payable in respect of any six-month period
will equal 0.1875% of the average market price of a Convertible Debenture
for the five trading day period referred to above.
Conversion Rights. At December 31, 2004 the Convertible Debentures are not
eligible for conversion; however, holders may convert the Convertible
Debentures at any time prior to stated maturity from and after the date of
the following events:
- if the sale price of ProAssurance's common stock for at least
20 trading days in the 30 trading-day period ending on the
last trading day of the immediately preceding fiscal quarter
exceeds 120% of the conversion price on that 30th trading day,
- if ProAssurance calls the Convertible Debentures for
redemption, or
- upon the occurrence of certain corporate transactions.
For each $1,000 principal amount of Convertible Debentures surrendered for
conversion, holders initially will receive 23.9037 shares of common stock.
This represents an initial conversion price of approximately $41.83 per
share of common stock. The conversion rate may be adjusted for certain
reasons, but will not be adjusted for accrued interest or contingent
interest, if any. Upon conversion, holders will generally not receive any
cash payment representing accrued interest or contingent interest, if any.
Instead, accrued interest and contingent interest will be deemed paid by
the common stock received by the holders on conversion. Convertible
Debentures called for redemption may be surrendered for conversion until
the close of business two business days prior to the redemption date.
Upon conversion, ProAssurance has the right to deliver, in lieu of common
stock, cash or a combination of cash and shares of common stock.
Payment at Maturity. Each holder of $1,000 Convertible Debentures will be
entitled to receive $1,000 at maturity, plus accrued interest, including
contingent interest, if any.
Sinking Fund. None.
Optional Redemption. ProAssurance may not redeem the Convertible
Debentures prior to July 7, 2008. ProAssurance may redeem some or all of
the Convertible Debentures for cash on or after July 7, 2008, upon at
least 30 days but not more than 60 days notice by mail to holders at par.
86
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
Repurchase Right of Holders. Each holder of the Convertible Debentures may
require ProAssurance to repurchase all or a portion of the holder's
Convertible Debentures on June 30, 2008, June 30, 2013 and June 30, 2018
at a purchase price equal to the principal amount of the Convertible
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. If ProAssurance elects to pay all or a
portion of the repurchase price in common stock, the shares of common
stock will be valued at 97.5% of the average sale price for the 20 trading
days immediately preceding and including the third day prior to the
repurchase date.
Change of Control. Upon a change of control of ProAssurance, holders may
require ProAssurance, subject to conditions, to repurchase all or a
portion of the Convertible Debentures. Depending upon the date at which
the change of control occurs, ProAssurance will pay a purchase price equal
to a varying percentage of the applicable principal amount of such
Convertible Debentures plus accrued and unpaid interest, including
contingent interest and additional amounts, if any. The percentage ranges
from 108% for dates before June 29, 2005 to 100% for dates after June 30,
2008. ProAssurance may choose to pay the repurchase price in cash, shares
of common stock, shares of common stock of the surviving corporation or a
combination of cash and shares of the applicable common stock. If
ProAssurance elects to pay all or a portion of the repurchase price in
shares of common stock, the shares of the applicable common stock will be
valued at 97.5% of the average sale price of the applicable common stock
for 20 trading days commencing after the third trading day following
notice of the occurrence of a change of control.
Events of Default. If there is an event of default under the Convertible
Debentures, the principal amount of the Convertible 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.
Registration Rights. On December 15, 2003 ProAssurance filed a shelf
registration statement with the SEC with respect to the resale of the
Convertible Debentures and the shares of common stock issuable upon
conversion of the Convertible Debentures pursuant to a registration rights
agreement. ProAssurance has agreed to keep the shelf registration
statement effective until the earliest of:
- two years after the last date of original issuance of any of
the Convertible Debentures,
- the date when the holders of the Convertible Debentures and
common stock issuable upon conversion of the Convertible
Debentures are able to sell all such securities immediately
pursuant to Rule 144 under the Securities Act,
- the date when all of the Convertible Debentures and common
stock issuable upon conversion of the Convertible Debentures
are registered upon the shelf registration statement and sold
in accordance with it, or
- the date when all of the Convertible Debentures and common
stock issuable upon conversion of the Convertible Debentures
have ceased to be outstanding.
The Convertible Debentures do not require ProAssurance to maintain minimum
financial covenants.
87
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
10. LONG-TERM DEBT (CONTINUED)
Trust Preferred Subordinated Debentures
In April and May 2004, ProAssurance formed two business trusts,
ProAssurance Capital Trust I and ProAssurance Capital Trust II (the Trusts), as
the holder of all voting securities issued by the Trusts, for the sole purpose
of issuing, in private placement transactions, $45.0 million of trust preferred
securities (TPS) and using the proceeds thereof, together with the equity
proceeds received from ProAssurance in the initial formation of the Trusts, to
purchase subordinated debentures issued by ProAssurance. The only assets of the
Trusts are $46.4 million variable rate ProAssurance subordinated debentures
(Subordinated Debentures). The terms and maturities of the Subordinated
Debentures mirror those of the TPS. The Trusts will meet the obligations of the
TPS with the interest and principal ProAssurance pays to the Trusts on the
Subordinated Debentures. ProAssurance is not the primary beneficiary of the
Trusts, and therefore, in accordance with the provisions of FIN 46, the Trusts
are not consolidated by ProAssurance. ProAssurance's equity investment in the
Trusts is included in other assets and the Subordinated Debentures payable to
the Trusts are included as long-term debt in the accompanying Condensed
Consolidated Balance Sheets.
The Subordinated Debentures and the TPS have the same maturities and other
applicable terms and features. They are uncollateralized and bear a floating
interest rate equal to the three-month LIBOR plus 3.85%, adjustable and payable
quarterly, with a maximum rate within the first five years of 12.5%.
ProAssurance has the right under the Subordinated Debentures to extend interest
payment periods up to twenty consecutive quarterly periods, and as a
consequence, dividends on the preferred securities may be deferred (but will
continue to accumulate, together with additional dividends on any accumulated
but unpaid dividends at the dividend rate) during any such extended interest
payment periods. ProAssurance may not pay any stockholder dividends during any
extended interest payment period or at any time ProAssurance is in default under
the Subordinated Debentures. The Subordinated Debentures and the TPS have stated
maturities of thirty years but may be redeemed at any time after five years. The
Subordinated Debentures do not require ProAssurance to maintain minimum
financial covenants.
ProAssurance received net proceeds from the TPS transactions, after
commissions and other costs of issuance, of $44.9 million. Issue costs of $1.5
million were capitalized and are being amortized over five years as a component
of amortization expense. The proceeds are available for general corporate
purposes, including providing statutory capital for ProAssurance's professional
liability insurance subsidiaries.
ProAssurance has guaranteed that amounts paid to the Trusts related to the
Subordinated Debentures will be remitted to the holders of the TPS. The
guarantee, when taken together with the obligations of ProAssurance under the
Subordinated Debentures, the Indenture pursuant to which the Subordinated
Debentures were issued, and the related trust agreements (including its
obligations to pay related trust cost, fees, expenses, debts and other
obligations of the Trusts other than with respect to the TPS and the common
securities of the Trusts), provides a full and unconditional guarantee of
amounts due on the TPS. The amounts guaranteed are not expected to at any time
exceed the obligations of the Subordinated Debentures, and no additional
liability has been recorded related to the TPS or the guarantee.
At December 31, 2004 the fair value of our Convertible Debentures is
approximately 114.5% of face value based on available independent market quotes.
The fair value of our Subordinated Debentures approximates the face value of
those debentures.
88
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
11. STOCKHOLDERS' EQUITY
At December 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, the
designations, powers, preferences and rights, and the qualifications,
limitations or restrictions of such shares. At December 31, 2004, the Board of
Directors had not authorized the issuance of any preferred stock nor determined
any provisions for the preferred stock.
At December 31, 2004 approximately 2.9 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 incentive compensation
plans as described in Note 12. Additionally, approximately 1.1 million common
shares are reserved for the exercise of outstanding options, also discussed in
Note 12.
"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.
On November 13, 2002, ProAssurance sold 2.65 million common 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.
ProAssurance has on file a universal shelf registration statement with the
Securities and Exchange Commission, allowing up to $250 million in common stock,
preferred stock or debt securities. ProAssurance 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.
ProAssurance has no present commitments to sell securities under the shelf
registration.
12. STOCK OPTIONS
ProAssurance provides performance-based stock compensation to employees
under the ProAssurance 2004 Equity Incentive Plan (the 2004 Plan) and the
ProAssurance Corporation Incentive Compensation Stock Plan (the 1995 Plan). The
2004 Plan was adopted in May 2004 and is intended as a replacement for the 1995
Plan. Under both plans, the terms and conditions of all grants are at the
discretion of the compensation committee. At December 31, 2004 there were 10,000
options outstanding under the 2004 Plan and 1,039,337 options outstanding under
the 1995 Plan. All options have been granted at a price equal to the market
price of the stock on the date of grant. The stock options granted in 2004, 2003
and 2002 expire ten years after the grant date and vest at a rate of 20% each
year, beginning six months after the grant date. The remaining options
outstanding under the plan were granted in 1997, 1998 and 1999; these options
expire ten years after the grant date and were fully vested at the grant date.
As a part of the consolidation with Professionals Group, ProAssurance
assumed all options outstanding under Professionals Group, Inc.'s 1996 Long-term
Stock Incentive Plan (the Professionals Plan). The options assumed were fully
vested. At December 31, 2004 there were 56,036 options outstanding under the
Professionals Plan. No additional options are expected to be issued related to
the Professionals Plan.
89
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
12. STOCK OPTIONS (CONTINUED)
Information regarding ProAssurance's outstanding options for the years
ending December 31, 2004, 2003, and 2002 follows:
WEIGHTED Weighted Weighted
AVERAGE Average Average
EXERCISE Exercise Exercise
SHARES PRICE Shares Price Shares Price
--------------------- --------------------- ---------------------
2004 2003 2002
--------------------- --------------------- ---------------------
Outstanding at beginning of year 993,576 $ 20.72 1,103,037 $ 19.46 719,313 $ 20.82
Granted 291,329 $ 33.28 303,000 $ 22.00 415,000 $ 16.80
Exercised (141,832) $ 19.50 (348,815) $ 18.23 (31,276) $ 15.54
Forfeited (37,700) $ 26.58 (63,646) $ 18.72 - -
----------- ---------- ----------
Outstanding at end of year 1,105,373 $ 24.03 993,576 $ 20.72 1,103,037 $ 19.46
=========== ========== ==========
Options exercisable at end of year 585,994 $ 22.74 552,176 $ 21.75 771,037 $ 20.60
=========== ========== ==========
Outstanding ProAssurance options as of December 31, 2004 consisted of the
following:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------- -------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF CONTRACTUAL EXERCISE EXERCISE
EXERCISE PRICES NUMBERS LIFE PRICE NUMBER PRICE
- ----------------------- --------- ----------- -------- ------- --------
$ 9.57 - $ 14.27 19,096 2.9 YEARS $ 12.98 19,096 $ 12.98
$ 16.80 - $ 17.38 288,684 6.5 YEARS $ 16.87 142,684 $ 16.93
$ 18.66 - $ 21.01 38,247 4.4 YEARS $ 20.75 38,247 $ 20.75
$ 22.00 - $ 22.00 213,000 8.7 YEARS $ 22.00 63,000 $ 22.00
$ 24.68 - $ 26.03 270,517 3.1 YEARS $ 24.89 270,517 $ 24.89
$ 33.28 - $ 33.28 262,250 9.7 YEARS $ 33.28 52,450 $ 33.28
$ 36.46 - $ 38.52 13,579 8.3 YEARS $ 37.00 - -
--------- -------
ALL 1,105,373 6.7 YEARS $ 24.03 585,994 $ 22.74
========= =======
The weighted average fair value of options granted during 2004, 2003 and
2002 was $13.10, $8.46 and $6.97, respectively. The fair values have been
estimated as of the date of grant using the Black-Scholes option pricing model,
based on the following assumptions (on a weighted-average basis):
2004 2003 2002
----- ----- ----
Risk-free interest rate 3.4% 3.1% 4.6%
Expected volatility 0.34 0.34 0.34
Dividend yield 0% 0% 0%
Expected average term (in years) 6 6 6
90
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
13. CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
ProAssurance adopted SFAS No. 142 "Goodwill and Other Intangible Assets"
on January 1, 2002.
In accordance with SFAS No. 142, as of January 1, 2002 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.
14. 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
2004 2003 2002
-------- -------- --------
In thousands except per share data
Basic earnings per share calculation:
Numerator:
Income before cumulative effect of accounting change $ 72,811 $ 38,703 $ 10,513
Cumulative effect of accounting change - - 1,694
-------- -------- --------
Net income $ 72,811 $ 38,703 $ 12,207
======== ======== ========
Denominator:
Weighted average number of common shares outstanding 29,164 28,956 26,231
======== ======== ========
Basic earnings per share:
Income before cumulative effect of accounting change $ 2.50 $ 1.34 $ 0.40
Cumulative effect of accounting change - - 0.07
-------- -------- --------
Net income $ 2.50 $ 1.34 $ 0.47
======== ======== ========
Diluted earnings per share calculation:
Numerator:
Income before cumulative effect of accounting change $ 72,811 $ 38,703 $ 10,513
Effect of MEEMIC Holdings stock options held by
minority stockholders - - (210)
Effect of assumed conversion of contingently convertible
debt instruments 2,967 1,425 -
-------- -------- --------
Income before cumulative effect of accounting change -
diluted computation 75,778 40,128 10,303
Cumulative effect of accounting change -- -- 1,694
-------- -------- --------
Net income-diluted computation $ 75,778 $ 40,128 $ 11,997
======== ======== ========
Denominator:
Weighted average number of common shares outstanding 29,164 28,956 26,231
Assumed conversion of dilutive stock options and awards 248 188 23
Assumed conversion of contingently convertible
debt instruments 2,572 1,245 -
-------- -------- --------
Diluted weighted average equivalent shares 31,984 30,389 26,254
======== ======== ========
Diluted earnings per share:
Income before cumulative effect of accounting change $ 2.37 $ 1.32 0.39
Cumulative effective of accounting change - - 0.07
-------- -------- --------
Net income $ 2.37 $ 1.32 $ 0.46
======== ======== ========
91
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
14. EARNINGS PER SHARE (CONTINUED)
In accordance with SFAS 128 "Earnings per Share", the diluted weighted
average number of shares outstanding includes an incremental adjustment for the
assumed exercise of dilutive stock options. The adjustment is computed
quarterly; the annual incremental adjustment is the average of the quarterly
adjustments. 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. Options are not
dilutive when the exercise price of the option is below the average share price
during the quarter. During years ended December 31, 2004, 2003 and 2002 certain
of ProAssurance's outstanding options were not considered to be dilutive,
because the strike price of the options was below the average ProAssurance share
price during the quarter. The number of options not considered to be dilutive
during the years ended December 31, 2004, 2003, and 2002 averaged 126,400,
83,500 and 638,000, respectively.
In compliance with the consensus reached in EITF 04-8, ProAssurance has
assumed conversion of its outstanding convertible debt in the computation of
diluted earnings per share for the year ended December 31, 2004 and has restated
diluted earnings per share for the year ending December 31, 2003 to assume
conversion of its convertible debt for the period in which the debt was
outstanding in 2003. The restatement reduced previously reported diluted
earnings per share for the year ending December 31, 2003 by $0.01. Diluted
earnings per share for the year ending December 31, 2002 was not restated
because there was no outstanding convertible debt in 2002.
15. BENEFIT PLANS
ProAssurance currently maintains several defined contribution employee
benefit plans that are intended to provide additional income to eligible
employees upon retirement. ProAssurance's contributions to the plans are
primarily based upon employee contributions to the plans. ProAssurance's expense
under these benefit plans was $3.3 million during the year ended December 31,
2004 and $3.1 million during each of the years ended December 31, 2003 and 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) investments in
affiliates which are valued and carried on the cost or equity method for
statutory purposes but consolidated under GAAP; and (c) deferred income taxes
which are recorded under GAAP but not for statutory purposes.
92
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
16. STATUTORY ACCOUNTING AND DIVIDEND RESTRICTIONS (CONTINUED)
The NAIC specifies risk-based capital requirements for property and
casualty insurance providers. At December 31, 2004, 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, 2004 and 2003 are as follows:
STATUTORY
STATUTORY SURPLUS NET INCOME (LOSS)
AS OF FOR THE YEAR ENDED
DECEMBER 31, 2004 DECEMBER 31, 2004
----------------- ------------------
In thousands
The Medical Assurance Company, Inc. $276,909 $ 17,555
ProNational Insurance Company 241,825 32,448
Red Mountain Casualty Insurance Company, Inc. 16,511 1,233
Medical Assurance of West Virginia, Inc. 8,285 (2,608)
MEEMIC Insurance Company 142,753 24,033
Statutory
Statutory Surplus Net Income (Loss)
as of for the year ended
December 31, 2003 December 31, 2003
----------------- ------------------
In thousands
The Medical Assurance Company, Inc. $238,740 $ 11,719
ProNational Insurance Company 187,937 (8,971)
Red Mountain Casualty Insurance Company, Inc. 16,785 963
Medical Assurance of West Virginia, Inc. 10,202 (42)
MEEMIC Insurance Company 116,780 17,677
Consolidated retained earnings are comprised primarily of subsidiaries'
retained earnings. ProAssurance's insurance subsidiaries are permitted to pay
dividends of approximately $58 million during the next year to ProAssurance or
its directly owned non-insurance subsidiaries 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.
93
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
17. VARIABLE INTEREST ENTITIES
ProAssurance holds passive investments in four limited
partnerships/limited liability companies that are considered to be VIE's under
FIN 46(R) guidance. ProAssurance is not the primary beneficiary relative to
these entities and is not required to consolidate the entities under FIN 46(R).
These investments are included in Other Investments and total $39.3 million at
December 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. ProAssurance's investment in one of the entities
approximates $6.1 million ( a 31% interest) and is accounted for using the
equity method of accounting; this investment was acquired in 2002. The remaining
three investments each represent less than 10% interests in the investee, and
ProAssurance uses the cost method of accounting. These investments were acquired
between 2001 and 2003. ProAssurance's maximum loss exposure relative to each of
the entities is limited to the carrying value of ProAssurance`s investment in
the entity.
ProAssurance also holds all the voting securities issued by two Trusts,
ProAssurance Capital Trust I and ProAssurance Capital Trust II, that are
considered to be VIE's. See Note 10. The Trusts are not consolidated because
ProAssurance is not the primary beneficiary of either trust. Accordingly, within
the accompanying December 31, 2004 condensed consolidated balance sheet, the
Subordinated Debentures issued by ProAssurance to the Trusts are included in
long-term debt, and ProAssurance's $1.4 million equity investment in the Trusts
is included in Other Assets.
18. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of unaudited quarterly results of operations
for 2004 and 2003:
2004
----------------------------------------------------
1st 2nd 3rd 4th
---------- ---------- --------- ----------
IN THOUSANDS EXCEPT PER SHARE DATA
Net premiums earned $ 167,842 $ 165,897 $ 175,346 $ 186,934
Net losses and loss adjustment expenses 141,920 136,779 144,281 149,901
Net income 15,981 15,804 19,518 21,509
Basic earnings per share 0.55 0.54 0.67 0.74
Diluted earnings per share 0.52 0.52 0.63 0.69
Diluted earnings per share, as reported prior NOT
to the implementation of EITF 04-08 0.54 0.54 0.66 APPLICABLE
2003
----------------------------------------------------
1st 2nd 3rd 4th
---------- ---------- --------- ----------
Net premiums earned $ 138,196 $ 147,684 $ 165,430 $ 172,204
Net losses and loss adjustment expenses 125,048 131,300 145,783 149,245
Net income 6,349 8,792 9,735 13,827
Basic earnings per share 0.22 0.30 0.34 0.48
Diluted earnings per share 0.22 0.30 0.33 0.46
Diluted earnings per share, as reported prior
to the implementation of EITF 04-08 0.22 0.30 0.33 0.47
The sum of the above amounts may vary from the annual amounts because of
rounding.
As discussed in Note 1, ProAssurance has adopted the provisions of EITF
04-08 and diluted earnings per share for all periods presented includes the
dilutive effect of common shares potentially issuable related to ProAssurance's
contingently convertible debt. ProAssurance had no contingently convertible debt
outstanding in the 1st and 2nd quarters of 2003.
94
PROASSURANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
19. SUBSEQUENT EVENTS
On February 28, 2005 ProAssurance Corporation and NCRIC Group, Inc.
(NASDAQ: NCRI) reached an agreement to merge NCRIC into ProAssurance in a $69.6
million, all-stock transaction which values NCRIC at $10.10 per share, based on
the closing price of ProAssurance common stock on Friday, February 25, 2005.
Under the terms of the agreement each holder of common stock of NCRIC will
have the right to receive 0.25 of a share of ProAssurance common stock for each
share of NCRIC common stock. This exchange ratio is subject to adjustment in the
event that the market price of the ProAssurance stock prior to the closing
either exceeds $44 or is less than $36 such that the exchange ratio would then
be adjusted such that the value per NCRIC share would neither exceed $11 nor be
less than $9, respectively. The transaction is subject to required regulatory
approvals and a vote of NCRIC stockholders and is expected to close early in the
third quarter of 2005.
The proposed transaction will be submitted to NCRIC Group's stockholders
for their consideration. ProAssurance and NCRIC Group will file with the SEC a
registration statement and a proxy statement/prospectus and other relevant
documents concerning the proposed transaction.
95
ProAssurance Corporation and Subsidiaries
Schedule I - Summary of Investments - Other Than Investments in Related Parties
December 31, 2004
COST AMOUNT
OR AT WHICH
AMORTIZED FAIR SHOWN IN THE
TYPE OF INVESTMENT COST VALUE BALANCE SHEET
- ------------------ ----------- ----------- -------------
In thousands
Fixed Maturities:
U.S. Treasury securities $ 171,256 $ 171,347 $ 171,347
State and municipal bonds 823,951 838,921 838,921
Corporate bonds 658,177 674,339 674,339
Asset-backed securities 570,744 573,378 573,378
Certificates of deposit - - -
----------- ----------- -------------
Total fixed maturities 2,224,128 $ 2,257,985 2,257,985
===========
Equity securities:
Available for sale 31,548 35,230 35,230
Trading 3,739 4,150 4,150
----------- ----------- -------------
Total equity securities 35,287 $ 39,380 39,380
===========
Real Estate, net 19,244 19,244
Short-term investments 41,423 41,423
Other invested assets 42,883 42,883
Business owned life insurance 54,138 54,138
----------- -------------
Total investments $ 2,417,103 $ 2,455,053
=========== =============
97
PROASSURANCE CORPORATION AND SUBSIDIARIES
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
ProAssurance Corporation - Registrant Only
Condensed Balance Sheet
December 31
2004 2003
--------- ---------
In thousands
ASSETS
Investment in subsidiaries, at equity $ 661,575 $ 610,297
Fixed maturities available for sale, at fair value 56,889 5,501
Equity securities, trading portfolio, at fair value - 5,226
Short-term investments 2,676 23,440
Cash and cash equivalents 743 878
Due from subsidiaries 11,956 -
Other assets 29,827 30,215
--------- ---------
$ 763,666 $ 675,557
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Payable to subsidiaries $ - $ 23,868
Other liabilities 1,167 595
Long-term debt 151,480 104,789
--------- ---------
152,647 129,252
Stockholders' Equity:
Common stock 293 292
Other stockholders' equity, including
unrealized gains (losses) on securities
of subsidiaries 610,726 546,013
--------- ---------
Total stockholders' equity 611,019 546,305
--------- ---------
$ 763,666 $ 675,557
========= =========
ProAssurance Corporation - Registrant Only
Condensed Statements of Income
Year ended December 31
2004 2003 2002
---- ---- ----
In thousands
Revenues:
Investment income $ 1,317 $ 267 $ 57
Other Income 2,779 308 -
--------- --------- ---------
4,096 575 57
Expenses:
Loss on early extinguishment of debt - 305 -
Interest expense 6,515 3,409 2,875
Other expenses 3,882 1,702 1,441
--------- --------- ---------
10,397 5,416 4,316
--------- --------- ---------
Loss before income tax (benefit) and equity in
net income of subsidiaries (6,301) (4,841) (4,259)
Income tax (benefit) (2,319) (967) (1,491)
--------- --------- ---------
Loss before equity in net income of subsidiaries (3,982) (3,874) (2,768)
Equity in net income of subsidiaries 76,793 42,577 14,975
--------- --------- ---------
Net income $ 72,811 $ 38,703 $ 12,207
========= ========= =========
98
PROASSURANCE CORPORATION AND SUBSIDIARIES
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
ProAssurance Corporation - Registrant Only
Condensed Statements of Cash Flow
Year ended December 31
2004 2003 2002
--------- --------- ---------
In thousands
Cash used by operating activities $ (11,896) $ (9,733) $ (6,533)
Investing activities
Purchases of fixed maturities (101,172) (134,661) -
Proceeds from sale or maturities of :
Fixed maturities available for sale 50,480 129,160 -
Equity securities available for sale 7,791 - -
Net decrease/increase in short-term investments 20,764 (23,440) -
Dividends from subsidiaries 28,350 - -
Contribution of capital to subsidiaries (38,000) (25,483) -
Other (1,395) - -
--------- --------- ---------
(33,182) (54,424) -
--------- --------- ---------
Financing activities
Proceeds from long-term debt 44,907 104,641 -
Repayment of debt - (72,500) (10,000)
Proceeds from stock offering - - 46,499
Other 36 2,881 -
--------- --------- ---------
44,943 35,022 36,499
--------- --------- ---------
Increase (decrease) in cash and cash equivalents (135) (29,135) 29,966
Cash and cash equivalents, beginning of period 878 30,013 47
--------- --------- ---------
Cash and cash equivalents, end of period $ 743 $ 878 $ 30,013
========= ========= =========
NOTES TO CONDENSED FINANCIAL STATEMENTS OF REGISTRANT
1. Basis of Presentation
ProAssurance Corporation (PRA Holding) was formed for the purpose of
consolidating Medical Assurance, Inc. (Medical Assurance) and Professionals
Group, Inc. (Professionals Group); the consolidation date was June 27, 2001. The
registrant-only financial statements should be read in conjunction with
ProAssurance's consolidated financial statements. At December 31, 2004 and 2003
PRA Holding's investment in subsidiaries is stated at the initial consolidation
value plus equity in the undistributed earnings of subsidiaries since the date
of acquisition less dividends received from the subsidiaries.
2. Other Assets
Other assets includes goodwill of $15.6 million related to PRA Holding's
acquisition of Professionals Group and goodwill of $7.6 million related to the
2003 acquisition of the minority interest of MEEMIC Holdings, Inc., a subsidiary
of Professionals Group.
99
PROASSURANCE CORPORATION AND SUBSIDIARIES
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
NOTES TO CONDENSED FINANCIAL STATEMENTS OF REGISTRANT (CONTINUED)
3. Long-term Debt
Outstanding long-term debt, as of December 31, 2004 and December 31, 2003,
consisted of the following:
December 31
2004 2003
--------- ---------
$ In thousands
Convertible Debentures due June 30, 2023 (Convertible Debentures),
unsecured and bearing a fixed interest rate of 3.9%, net of
unamortized original issuer's discounts of $2,515 and $2,811 at
December 31, 2004 and December 31, 2003, respectively. $ 105,085 $ 104,789
Trust Preferred Subordinated Debentures (Subordinated Debentures),
unsecured, and bearing floating interest rate, adjustable
quarterly, at three-month LIBOR plus 3.85%.
Due December 31, 2004 Rate
April 29, 2034 6.14% 13,403 -
May 12, 2034 6.14% 10,310 -
May 12, 2034 6.14% 22,682 -
--------- ---------
$ 151,480 $ 104,789
========= =========
PRA Holding issued $107.6 million of 3.9% Convertible Debentures in a Private
Offering transaction, net of an initial purchaser's discount of $3.0 million, in
July 2003. The Convertible Debentures are due June 30, 2023 but may be repaid or
called prior to that date. PRA Holding used the net proceeds of the Convertible
Debentures to pay off its existing term loan having an outstanding principal
balance of $67.5 million.
In April and May 2004, PRA Holding formed two business trusts (the Trusts), as
the holder of all voting securities issued by the Trusts, for the sole purpose
of issuing, in private placement transactions, $45.0 million of trust preferred
securities (TPS) and using the proceeds thereof, together with the equity
proceeds received from ProAssurance in the initial formation of the Trusts, to
purchase Subordinated Debentures issued by ProAssurance. The Subordinated
Debentures and the TPS have the same maturities and other applicable terms and
features. They are uncollateralized and bear a floating interest rate equal to
the three-month LIBOR plus 3.85%, adjustable and payable quarterly, with a
maximum rate within the first five years of 12.5%.
See Note 10 of the Notes to the consolidated financial statements of
ProAssurance and its subsidiaries included herein for a detailed description of
the terms of the Convertible Debentures and the Subordinated Debentures.
4. Related Party Transactions
PRA Holding received dividends of $28.4 million from its subsidiaries in 2004.
No dividends were received in 2003. PRA Holding contributed capital of $18
million in 2004 to its subsidiaries. In 2003, PRA Holding contributed $45
million to its subsidiaries, of which $20 million was paid in 2004.
All of PRA Holding's treasury shares are owned by its subsidiaries. In the
registrant-only financial statements, stockholders' equity has been reduced by
the cost of these treasury shares and PRA Holding's investment in subsidiaries
has been reduced by the cost of the treasury shares owned by the subsidiaries.
5. Income Taxes
Under terms of PRA Holding's tax sharing agreement with its subsidiaries, income
tax provisions for individual companies are allocated on a separate company
basis.
100
PROASSURANCE CORPORATION AND SUBSIDIARIES
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
2004 2003 2002
----------- ------------ -----------
In thousands
Deferred policy acquisition costs...................... $ 27,662 $ 23,603 $ 22,729
Reserve for losses and loss adjustment expenses........ 2,029,592 1,814,584 1,622,468
Unearned premiums...................................... 314,179 290,134 248,371
Net premiums earned.................................... 696,020 623,514 477,408
Premiums assumed from other companies.................. 96 2,508 2,991
Net investment income.................................. 87,225 73,619 76,918
Net losses and loss adjustment expenses................ 572,881 551,376 448,029
Underwriting, acquisition and insurance expenses:
Amortization of deferred policy acquisition costs... 63,370 54,863 41,800
Other underwriting, acquisition and
insurance expenses................................ 54,319 49,353 49,453
Net premiums written................................... 717,059 668,909 537,123
101
PROASSURANCE CORPORATION AND SUBSIDIARIES
SCHEDULE IV - REINSURANCE
YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
2004 2003 2002
----------- ------------- ------------
In thousands
PROPERTY AND CASUALTY
Premiums earned $ 765,547 $ 695,839 $ 573,091
Premiums ceded (69,623) (74,833) (98,918)
Premiums assumed 280 2,495 2,516
----------- ------------- ------------
Net premiums earned $ 696,204 $ 623,501 $ 476,689
=========== ============= ============
Percentage of amount assumed to net 0.04% 0.40% 0.53%
=========== ============= ============
ACCIDENT AND HEALTH
Premiums earned - - 332
Premiums ceded - - (88)
Premiums assumed (184) 13 475
----------- ------------- ------------
Net premiums earned $ (184) $ 13 $ 719
=========== ============= ============
Percentage of amount assumed to net 100% 100% 66.06%
=========== ============= ============
Total net premiums earned $ 696,020 $ 623,514 $ 477,408
=========== ============= ============
102
PROASSURANCE CORPORATION AND SUBSIDIARIES
SCHEDULE VI - SUPPLEMENTARY PROPERTY AND CASUALTY INSURANCE INFORMATION
YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
2004 2003 2002
------------- ------------- -------------
In thousands
Deferred policy acquisition costs ..................... $ 27,662 $ 23,603 $ 22,729
Reserve for losses and loss adjustment expenses ....... 2,029,592 1,814,584 1,622,468
Unearned premiums ..................................... 314,179 290,134 248,371
Net premiums earned ................................... 696,020 623,514 477,408
Net investment income ................................. 87,225 73,619 76,918
Losses and loss adjustment expenses incurred
related to current year, net of reinsurance ........ 589,497 562,256 439,600
Losses and loss adjustment expenses incurred
related to prior year, net of reinsurance .......... (16,616) (10,880) 8,429
Amortization of deferred policy acquisition costs ..... 63,370 54,863 41,800
Paid losses and loss adjustment expenses related to
current year losses, net of reinsurance ............ (92,362) (94,824) (84,376)
Paid losses and loss adjustment expenses related to
prior year losses, net of reinsurance .............. (230,040) (247,235) (271,482)
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)
2.3 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)
2.4 Agreement and Plan of Merger among ProAssurance, NCRIC Group, Inc.
and NCP Merger Corporation, dated February 28, 2005 (4)
3.1(a) Certificate of Incorporation of ProAssurance (1)
3.1(b) Certificate of Amendment of ProAssurance (5)
3.2 Bylaws of ProAssurance
4.1 Purchase Agreement, dated July 1, 2003, between Registrant and the
representatives of the initial purchasers of the Debentures (without
exhibits) (6)
4.2 Indenture dated July 7, 2003, between and among Registrant and the
initial purchasers of the Debentures (7)
4.3 Registration Rights Agreement, dated July 7, 2003, between and among
Registrant and the initial purchasers of the Debentures (7)
4.4 ProAssurance Corporation Floating Rate Junior Subordinated Debenture
due 2034 issued as on April 29, 2004 in original principal amount of
$13,403,000 (8)
4.5 Indenture between ProAssurance Corporation and Wilmington Trust
Company as Trustee dated as of April 29, 2004 (8)
4.6 Certificate for 13,000 Preferred Securities of ProAssurance Capital
Trust I (Liquidation Amount $1,000 per Preferred Security) issued on
April 29, 2004 (8)
4.7 Amended and Restated Declaration of Trust of ProAssurance Capital
Trust I dated as of April 29, 2004 (8)
4.8 Preferred Securities Guarantee Agreement ProAssurance Capital Trust
I dated as of April 29, 2004 (8)
104
4.9 ProAssurance Corporation Floating Rate Junior Subordinated Debenture
due 2034 issued as on May 26, 2004 in original principal amount of
$22,682,000 (9)
4.10 ProAssurance Corporation Floating Rate Junior Subordinated Debenture
due 2034 issued as on May 12, 2004 in original principal amount of
$10,310,000 (9)
4.11 Amended and Restated Declaration of Trust of ProAssurance Capital
Trust II dated as of May 12, 2004 (9)
4.12 Preferred Securities Guarantee Agreement ProAssurance Capital Trust
II dated as of May 12, 2004 (9)
4.13 Indenture between ProAssurance Corporation and Wilmington Trust
Company as Trustee dated as of May 12, 2004 (9)
10.1(a) Medical Assurance, Inc. Incentive Compensation Stock Plan (formerly
known as the Mutual Assurance, Inc. 1995 Stock Award Plan) (10)
10.1(b) Amendment and Assumption Agreement by and between ProAssurance and
Medical Assurance, Inc. (5)
10.1(c) Amendment and Assumption Agreement by and between Mutual Assurance,
Inc. and MAIC Holdings, Inc. dated April 8, 1996 (11)
10.2 Professionals Insurance Company Management Group 1996 Long Term
Incentive Plan (12)
10.3 ProAssurance Corporation 2004 Equity Incentive Plan (13)
10.4(a) Release and Severance Agreement between Victor T. Adamo and
ProAssurance (14)
10.4(b) Amendment to Release and Severance Compensation Agreement of Victor
T. Adamo (15)
10.4(c) Release and Severance Agreement between Lynn M. Kalinowski and
ProAssurance (16)
10.4(d) Release and Severance Agreement between Howard H. Friedman and
ProAssurance (15)
10.4(e) Release and Severance Agreement between James J. Morello and
ProAssurance (15)
10.4(f) Release and Severance Agreement between Frank B. O'Neil and
ProAssurance (3)
10.5 Employment Agreement of A. Derrill Crowe, as amended (15)
105
10.6 Form of Indemnification Agreement between ProAssurance and each of
the following named executive officers and directors of
ProAssurance: (3)
Victor T. Adamo
Lucian F. Bloodworth
Paul R. Butrus
A. Derrill Crowe
Robert E. Flowers
Howard H. Friedman
Lynn M. Kalinowski
John J. McMahon
James J. Morello
John P. North
Frank B. O'Neil
Ann F. Putallaz
Edward N. Rand
10.7 ProAssurance Group Employee Benefit Plan which includes the
Executive Supplemental Life Insurance Program (Article VIII)
10.8 ProAssurance Group 2004 Deferred Compensation Plan dated October 11,
2004, of which A. Derrill Crowe is the sole participant
10.9 Development Agreement Between Kero Development LLC and MEEMIC
Insurance Company dated November 18, 2004 (without Rider and
Exhibits)
21.1 Subsidiaries of ProAssurance Corporation
23.1 Consent of Ernst & Young - Report on Consolidated Financial
Statements of Registrant and Subsidiaries
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
Corporation 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)
106
Footnotes
(1) Filed as an Exhibit to ProAssurance's Registration Statement on Form S-4
(File No. 333-49378) and incorporated herein by reference pursuant to Rule
12b-32 of the Securities and Exchange Commission ("SEC").
(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 SEC Rule 12b-32.
(3) Filed as an Exhibit to ProAssurance's Annual Report on Form 10-K for the
year ended December 31, 2002 (Commission File No. 001-16533) and
incorporated herein by reference pursuant to SEC Rule 12b-32.
(4) Filed as an Exhibit to ProAssurance's Current Report on Form 8-K for event
occurring on February 28, 2005 (File No. 001-16533) and incorporated
herein by reference pursuant to SEC Rule 12b-32
(5) Filed as an Exhibit to ProAssurance's Annual Report on Form 10-K for the
year ended December 31, 2001 (File No. 001-16533) and incorporated herein
by reference pursuant to SEC Rule 12b-32.
(6) Filed as an Exhibit to ProAssurance's Registration Statement on Form S-3
(File No. 333-109972) and incorporated by reference pursuant to SEC Rule
12b-32.
(7) Filed as an Exhibit to ProAssurance's Quarterly Report on Form 10-Q for
the period ended June 30, 2003 (File No. 001-16533) and incorporated by
reference pursuant to SEC Rule 12b-32.
(8) Filed as an Exhibit to ProAssurance's Quarterly Report on Form 10-Q for
the quarter ended March 31, 2004 (File No. 001-16533) and incorporated
herein by this reference pursuant to SEC Rule 12b-32.
(9) Filed as an Exhibit to ProAssurance's Quarterly Report on Form 10-Q for
the quarter ended June 30, 2004 (File No. 001-16533) and incorporated
herein by this reference pursuant to SEC Rule 12b-32.
(10) Filed as an Exhibit to MAIC Holding's Registration Statement on Form S-4
(File No. 33-91508) and incorporated herein by reference pursuant to SEC
Rule 12b-32.
(11) Filed as an Exhibit to MAIC Holding's Proxy Statement for the 1996 Annual
Meeting (File No. 0-19439) is incorporated herein by reference pursuant to
SEC Rule 12b-32.
(12) Filed as an Exhibit to Professionals Group's Registration Statement on
Form S-4 (File No. 333-3138) and incorporated herein by reference pursuant
to SEC Rule 12b-32.
(13) Filed as an Exhibit to ProAssurance's Definitive Proxy Statement (File No.
001-165333) on April 16, 2004 and incorporated herein by reference
pursuant to SEC Rule 12b-32.
107
(14) Filed as an Exhibit to ProAssurance's Form 10-Q (File No. 001-16533) for
the quarter ended June 30, 2001 and incorporated herein by reference
pursuant to SEC Rule 12b-32.
(15) Filed as an Exhibit to ProAssurance's Registration Statement on Form S-3
(File No. 333-100526) and incorporated herein by reference pursuant to SEC
Rule 12b-32.
(16) Filed as an Exhibit to ProAssurance's Form 10-Q (File No. 001-16533) for
the quarter ended September 30, 2001 and incorporated herein by reference
pursuant to SEC Rule 12b-32.
108