Procentury 10-Q Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2006

OR

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

For the transition period from                                        to                                        .

000-50641
(Commission File Number)

PROCENTURY CORPORATION

(Exact name of Registrant as specified in its charter)

Ohio	31-1718622
(State or other jurisdiction of	(I.R.S. Employer Identification No.)
incorporation or organization)
465 Cleveland Avenue	43082
Westerville, Ohio	(Zip Code)
(Address of principal executive offices)

(614) 895-2000
(Registrant’s telephone number, including area code)

     Indicate by check mark whether 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 report(s)), and (2) has been subject to such filing requirements for the past 90 days.

YESþ NOo

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filero          Accelerated filerþ          Non-accelerated filero

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

o Yesþ No

     As of May 10, 2006, the registrant had 13,211,019 outstanding Common Shares, without par value.

PROCENTURY CORPORATION

QUARTERLY REPORT ON FORM 10-Q
For the Quarterly Period Ended March 31, 2006

INDEX

	Page
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements		3
Consolidated Condensed Statements of Operations — For the three months ended March 31, 2006 and 2005		3
Consolidated Condensed Balance Sheets – March 31, 2006 and December 31, 2005		4
Consolidated Condensed Statements of Shareholders’ Equity and Comprehensive Income (Loss) — For the three months ended March 31, 2006 and 2005		5
Consolidated Condensed Statements of Cash Flows — For the three months ended March 31, 2006 and 2005		6
Notes to Consolidated Condensed Financial Statements — March 31, 2006		7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		18
Item 3. Quantitative and Qualitative Disclosures About Market Risk		27
Item 4. Controls and Procedures		27
PART II: OTHER INFORMATION
Item 1. Legal Proceedings		28
Item 1A. Risk Factors		28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		28
Item 3. Defaults Upon Senior Securities		28
Item 4. Submission of Matters to a Vote of Security Holders		28
Item 5. Other Information		28
Item 6. Exhibits		28
SIGNATURES		30
EX-31.1
EX-31.2
EX-32.1
EX-32.2

2

PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

PROCENTURY CORPORATION AND SUBSIDIARIES

Consolidated Condensed Statements of Operations
(Unaudited)
(In thousands, except per share data)

	Three Months Ended March 31,
	2006		2005
Premiums earned	$	49,002		41,520
Net investment income		4,426		3,159
Net realized investment gains (losses)		21		(59	)
Total revenues		53,449		44,620
Losses and loss expenses		30,439		25,727
Amortization of deferred policy acquisition costs		12,066		10,220
Other operating expenses		3,923		3,065
Severance expense		—		793
Interest expense		543		417
Total expenses		46,971		40,222
Income before income tax expense		6,478		4,398
Income tax expense		1,878		1,319
Net income	$	4,600		3,079
Basic net income per share	$	0.35		0.24
Diluted net income per share	$	0.35		0.23
Weighted average of shares outstanding — basic		13,100,705		13,046,339
Weighted average of shares outstanding — diluted		13,200,571		13,129,546

See accompanying notes to the unaudited consolidated condensed financial statements.

3

PROCENTURY CORPORATION AND SUBSIDIARIES

Consolidated Condensed Balance Sheets
(Unaudited)
(In thousands, except share data)

	March 31,			December 31,
	2006			2005
Assets
Investments
Fixed maturities:
Available-for-sale, at fair value (amortized cost 2006, $325,642; 2005, $306,237)	$	318,836			302,632
Held-to-maturity, at amortized cost (fair value 2006, $1,101; 2005, $1,118)		1,125			1,128
Equities (available-for-sale):
Equity securities, at fair value (cost 2006, $28,657; 2005, $27,521)		28,401			26,941
Bond mutual funds, at fair value (cost 2006, $15,732; 2005, $18,516)		15,221			17,852
Short-term investments, at amortized cost		12,499			12,229
Total investments		376,082			360,782
Cash and equivalents		6,189			5,628
Premiums in course of collection, net		13,098			14,849
Deferred policy acquisition costs		21,418			20,649
Prepaid reinsurance premiums		10,691			10,989
Reinsurance recoverable on paid losses, net		7,703			6,422
Reinsurance recoverable on unpaid losses, net		39,179			37,448
Deferred federal income tax asset		10,687			9,151
Other assets		8,292			8,227
Total assets	$	493,339			474,145
Liabilities and Shareholders’ Equity
Loss and loss expense reserves	$	223,780			211,647
Unearned premiums		96,763			95,631
Long term debt		25,000			25,000
Accrued expenses and other liabilities		7,223			6,893
Reinsurance balances payable		3,724			2,572
Collateral held		10,513			11,014
Income taxes payable		2,365			185
Total liabilities		369,368			352,942
Shareholders’ equity:
Common stock, without par value:
Common shares — Issued and outstanding 13,211,019 shares at March 31, 2006 and December 31, 2005		—			—
Additional paid-in capital		99,841			100,202
Retained earnings		29,050			24,846
Unearned compensation		—			(695	)
Accumulated other comprehensive loss, net of taxes		(4,920	)		(3,150	)
Total shareholders’ equity		123,971			121,203
Total liabilities and shareholders’ equity	$	493,339			474,145

See accompanying notes to the unaudited consolidated condensed financial statements.

4

PROCENTURY CORPORATION AND SUBSIDIARIES

Consolidated Condensed Statements of Shareholders’ Equity
and Comprehensive Income (Loss)
(Unaudited)
(In thousands)

	Three Months Ended March 31,
	2006			2005
Shareholders’ Equity
Capital stock:
Beginning of period	$	—			—
Stock issued		—			—
End of period		—			—
Additional paid-in capital:
Beginning of period		100,202			100,103
Impact of adoption of SFAS 123R		(695	)		—
Shares issued under share compensation plans		302			36
Tax benefit on share compensation plans		32			—
End of period		99,841			100,139
Retained earnings:
Beginning of period		24,846			15,727
Net income		4,600			3,079
Dividend declared (2006, $0.03/share and 2005, $0.02/share)		(396	)		(265	)
End of period		29,050			18,541
Unearned share compensation:
Beginning of period		(695	)		(1,413	)
Impact of adoption of SFAS 123R		695			322
End of period		—			(1,091	)
Accumulated other comprehensive loss, net of taxes:
Beginning of period		(3,150	)		820
Unrealized holding losses arising during the period, net of reclassification adjustment		(1,770	)		(3,135	)
End of period		(4,920	)		(2,315	)
Total shareholders’ equity	$	123,971			115,274
Comprehensive Income (Loss)
Net income	$	4,600			3,079
Other comprehensive loss:
Unrealized losses on securities:
Unrealized holding losses arising during the period:
Gross		(2,703	)		(4,881	)
Related federal income tax benefit		947			1,708
Net unrealized losses		(1,756	)		(3,173	)
Reclassification adjustment for gains (losses) included in net income
Gross		21			(59	)
Related federal income tax (expense) benefit		(7	)		21
Net reclassification adjustment		14			(38	)
Other comprehensive loss		(1,770	)		(3,135	)
Total comprehensive income (loss)	$	2,830			(56	)

See accompanying notes to the unaudited consolidated condensed financial statements.

5

PROCENTURY CORPORATION AND SUBSIDIARIES

Consolidated Condensed Statements of Cash Flows
(Unaudited)
(In thousands)

	Three Months Ended March 31,
	2006			2005
Cash flows provided by operating activities:
Net income	$	4,600			3,079
Adjustments:
Net realized investment (gains) losses		(21	)		59
Deferred federal income tax benefit		(583	)		(572	)
Share-based compensation expense		302			358
Changes in assets and liabilities:
Premiums in course of collection, net		1,751			(3,610	)
Deferred policy acquisition costs		(769	)		(95	)
Prepaid reinsurance premiums		298			312
Reinsurance recoverable on paid and unpaid losses, net		(3,012	)		(2,393	)
Income taxes payable		2,180			(1,390	)
Losses and loss expense reserves		12,133			12,500
Unearned premiums		1,132			454
Other, net		807			3,009
Net cash provided by operating activities		18,818			11,711
Cash flows used in investing activities:
Purchases of equity securities		(3,178	)		(31,159	)
Purchases of fixed maturity securities available-for-sale		(29,175	)		(35,034	)
Proceeds from sales of equity securities		4,627			18,935
Proceeds from sales and maturities of fixed maturities available-for-sale		9,481			31,673
Change in receivable/payable for securities		622			2,043
Net proceeds from sale of short-term investments		(270	)		(1,017	)
Net cash used in investing activities		(17,893	)		(14,559	)
Cash flows used in financing activities:
Dividend paid to shareholders		(396	)		(265	)
Tax benefit on share compensation plans		32			—
Net cash used in financing activities		(364	)		(265	)
Decrease in cash and equivalents		561			(3,113	)
Cash and equivalents at beginning of year		5,628			6,681
Cash and equivalents at end of period	$	6,189			3,568
Supplemental disclosure of cash flow information:
Interest paid	$	548			417
Federal income taxes paid	$	250			3,281

See accompanying notes to the unaudited consolidated condensed financial statements.

6

PROCENTURY CORPORATION AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements

March 31, 2006

(Unaudited)

(1)	Basis of Presentation
	The accompanying interim unaudited consolidated condensed financial statements and notes include the accounts of ProCentury Corporation, (the “Company” or “ProCentury”) and its wholly owned insurance subsidiary, Century Surety Company (“Century”). The interim unaudited consolidated condensed financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Article 10 of Regulation S-X. Accordingly, the interim unaudited consolidated condensed financial statements do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation of results for the interim periods have been included. These interim unaudited consolidated condensed financial statements and related notes should be read in conjunction with the consolidated financial statements and related notes in the Company’s audited consolidated financial statements, included in the Company’s annual report on Form 10-K for the year ended December 31, 2005. The Company’s results of operations for interim periods are not necessarily indicative of the results to be expected for the entire year.
	In preparing the interim unaudited consolidated condensed financial statements, management was required to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the interim unaudited consolidated condensed financial statements, and the reported amounts of revenue and expenses for the reporting period. Actual results could differ significantly from those estimates.
	Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of loss and loss expense reserves, the recoverability of deferred policy acquisition costs, the determination of federal income taxes, the net realizable value of reinsurance recoverables and the determination of other-than-temporary declines in the fair value of investments. Although considerable variability is inherent in these estimates, management believes that the amounts provided are reasonable. These estimates are continually reviewed and adjusted as necessary. Such adjustments are reflected in current operations.
	All significant intercompany balances and transactions have been eliminated.
	Share Option Accounting
	Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R),Share-Based Payment(“SFAS No. 123R”), using the modified prospective application transition method. SFAS No. 123R revises SFAS No. 123,Accounting for Stock-Based Compensation(“SFAS No. 123”). The Company previously followed the provisions of Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees(“APB 25”), the Financial Accounting Standards Board (“FASB”) Interpretation No. 44,Accounting for Certain Transactions involving Stock Compensation (an interpretation of APB Opinion No. 25), and other related accounting interpretations for the Company’s share option and restricted common share plans utilizing the “intrinsic value method.” The Company also followed the disclosure provisions of SFAS No. 123,Accounting for Stock-Based Compensation,for the Company’s share option grants, as amended by SFAS No. 148,Accounting for Stock-Based Compensation – Transition and Disclosure; an amendment of FASB Statement No. 123.
	Under the modified prospective method, all unvested employee share options and restricted stock are being expensed over the remaining vesting period based on the fair value at the date the options were granted. In addition, SFAS No. 123R requires us to estimate forfeitures in calculating the expense relating to stock-based compensation as opposed to recognizing these forfeitures and the corresponding reduction in expense as they occur. In addition, SFAS No. 123R requires the Company to reflect the tax savings resulting from tax deductions in excess of compensation expense reflected in its financial statements as a cash inflow from financing activities in its statement of cash flows rather than as an operating cash flow as in prior periods.
	If the Company recorded compensation expense for it share grants based on the intrinsic value method as previously required by APB Opinion No. 25, the Company’s following financial information for the three months ended March 31, 2006 would have been adjusted to the pro forma amounts as indicated in the following table:

7

	Three Months Ended March
	31, 2006
	(In thousands, except per share
	data)
	As reported			ProForma
Income before income tax	$	6,478			6,518
Net income		4,600			4,626
Net cash provided by operating activities		18,818			18,786
Net cash used in financing activities		(364	)		(396	)
Basic net income per share	$	0.35			0.35
Diluted net income per share	$	0.35			0.35

If the Company recorded compensation expense for its share option grants based on the “fair value method” as previously required by SFAS No. 123, the Company’s net income and earnings per share for the three months ended March 31, 2005 would have been adjusted to the pro forma amounts as indicated in the following table:

	Three
	Months
	Ended March
	31,
	2005
	(In thousands,
	except per
	share data)
Net income:
As reported	$	3,079
Add: Share-based employee compensation expense included in reported net income, net of related tax effects		232
Less: Additional share-based employee compensation expense determined under fair value-based method for all awards, net of related tax effects		(592	)
Pro forma	$	2,719
Basic income per common share:
As reported	$	0.24
Pro forma	$	0.21
Diluted income per common share:
As reported	$	0.23
Pro forma	$	0.21

The fair values of the share options are estimated on the dates of grant using the Black-Scholes option pricing model with the following weighted average assumptions:

	Three Months Ended
	March 31, 2005
Risk free interest rate		3.69	%
Dividend yield		0.76	%
Volatility factor		0.231
Weighted average expected option life		6.1	Years

(2) Income per Common Share

8

Basic income per share (“EPS”) excludes dilution and is calculated by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the dilution that could occur if securities or other contracts to issue common shares (common share equivalents) were exercised. When inclusion of common share equivalents increases the EPS or reduces the loss per share, the effect on earnings is antidilutive. Under these circumstances, diluted net income or net loss per share is computed excluding the common share equivalents.

Based on the above and pursuant to disclosure requirements contained in SFAS No. 128,Earnings Per Share, the following information represents a reconciliation of the numerator and denominator of the basic and diluted EPS computations contained in the Company’s interim unaudited consolidated condensed financial statements.

	Three Months Ended March 31, 2006
	(In thousands, except per share data)
	Income		Shares		Per Share
	(Numerator)		(Denominator)		Amount
Basic Net Income Per Share
Net income	$	4,600		13,100,705	$	0.35
Effect of Dilutive Securities
Restricted common shares and share options		—		99,866		—
Diluted EPS
Net income	$	4,600		13,200,571	$	0.35

	Three Months Ended March 31, 2005
	(In thousands, except per share data)
	Income		Shares		Per Share
	(Numerator)		(Denominator)		Amount
Basic Net Income Per Share
Net income	$	3,079		13,046,339	$	0.24
Effect of Dilutive Securities
Restricted common shares and share options		—		83,207		0.01
Diluted EPS
Net income	$	3,079		13,129,546	$	0.23

(3)	Investments
	The Company invests primarily in investment-grade fixed maturities. The amortized cost, gross unrealized gains and losses and estimated fair value of fixed maturities classified as held-to-maturity were as follows:

	March 31, 2006
	(In thousands)
			Gross		Gross			Estimated
	Amortized		unrealized		unrealized			fair
	cost		gains		losses			value
U.S. Treasury securities	$	89		9		—			97
Agencies not backed by the full faith and credit of the U.S. Government		1,036		—		(32	)		1,004
Total	$	1,125		9		(32	)		1,101

9

	December 31, 2005
	(In thousands)
			Gross		Gross			Estimated
	Amortized		unrealized		unrealized			fair
	cost		gains		losses			value
U.S. Treasury securities	$	89		13		—			102
Agencies not backed by the full faith and credit of the U.S. Government		1,039		—		(23	)		1,016
Total	$	1,128		13		(23	)		1,118

The amortized cost, gross unrealized gains and losses, and estimated fair value of fixed-maturity and equity securities classified as available-for-sale were as follows:

	March 31, 2006
	(In thousands)
			Gross		Gross
	Amortized		Unrealized		Unrealized			Estimated
	Cost		Gains		Losses			Fair Value
Fixed maturities:
U.S. Treasury securities	$	3,673		—		(80	)		3,593
Agencies not backed by the full faith and credit of the U.S. Government		14,532		—		(450	)		14,082
Obligations of states and political subdivisions		153,876		100		(2,490	)		151,486
Corporate securities		35,642		32		(1,115	)		34,559
Mortgage-backed securities		39,439		26		(1,420	)		38,045
Collateralized mortgage obligations		34,203		55		(944	)		33,314
Asset-backed securities		44,277		269		(789	)		43,757
Total fixed maturities		325,642		482		(7,288	)		318,836
Equities:
Equity securities		28,657		353		(609	)		28,401
Bond mutual funds		15,732		30		(541	)		15,221
Total equities		44,389		383		(1,150	)		43,622
Total	$	370,031		865		(8,438	)		362,458

10

	December 31, 2005
	(In thousands)
			Gross		Gross
	Amortized		Unrealized		Unrealized			Estimated
	Cost		Gains		Losses			Fair Value
Fixed maturities:
U.S. Treasury securities	$	3,688		1		(53	)		3,636
Agencies not backed by the full faith and credit of the U.S. Government		14,526		—		(230	)		14,296
Obligations of states and political subdivisions		142,932		387		(1,037	)		142,282
Corporate securities		36,689		40		(876	)		35,853
Mortgage-backed securities		40,910		31		(880	)		40,061
Collateralized mortgage obligations		27,943		15		(606	)		27,352
Asset-backed securities		39,549		238		(635	)		39,152
Total fixed maturities		306,237		712		(4,317	)		302,632
Equities:
Equity securities		27,521		215		(795	)		26,941
Bond mutual funds		18,516		15		(679	)		17,852
Total equities		46,037		230		(1,474	)		44,793
Total	$	352,274		942		(5,791	)		347,425

Other-than-temporary impairment losses result in a permanent reduction to the cost basis of the underlying investment and are recorded as a realized loss in the interim unaudited consolidated condensed statements of operations. No other-than-temporary declines were realized during the three months ended March 31, 2006 or 2005.

The fair values and gross unrealized losses for securities held by the Company and assessed as temporarily impaired by management, categorized by the length of time that the individual securities have been in a continuous unrealized loss position, as of March 31, 2006 and 2005 are as follows:

	March 31, 2006
	Less than 12 months				12 months or longer					Total
	Estimated		Gross		Estimated		Gross			Estimated		Gross
	fair		unrealized		fair		unrealized			fair		unrealized
	value		loss		value		loss			value		loss
	(In thousands)
Fixed Maturity Securities:
U.S. Treasury Securities	$	—		—		1,004		(32	)		1,004		(32	)
Total	$	—		—		1,004		(32	)		1,004		(32	)

The estimated fair value, related gross unrealized losses, and the length of time that the securities have been impaired for available-for-sale securities that are considered temporarily impaired are as follows:

11

	March 31, 2006
	Less Than 12 Months					12 Months or Longer					Total
	Estimated		Gross			Estimated		Gross			Estimated		Gross
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Loss			Value		Loss			Value		Loss
	(In thousands)
Fixed maturity securities:
U.S. Treasury securities	$	2,276		(37	)		1,317		(43	)		3,593		(80	)
Obligations of U.S. government corporations and agencies		8,456		(225	)		5,626		(225	)		14,082		(450	)
Obligations of states and political subdivisions		116,937		(1,842	)		22,205		(648	)		139,142		(2,490	)
Corporate securities		11,286		(307	)		20,089		(808	)		31,375		(1,115	)
Mortgage-backed securities		21,615		(754	)		15,927		(666	)		37,542		(1,420	)
Collateralized mortgage obligations		18,603		(507	)		12,882		(437	)		31,485		(944	)
Asset-backed securities		22,097		(521	)		7,143		(268	)		29,240		(789	)
Total		201,270		(4,193	)		85,189		(3,095	)		286,459		(7,288	)
Equities:
Equity securities		12,284		(331	)		4,286		(278	)		16,570		(609	)
Bond mutual funds		8,564		(275	)		6,189		(266	)		14,753		(541	)
Total		20,848		(606	)		10,475		(544	)		31,323		(1,150	)
Grand Total	$	222,118		(4,799	)		95,664		(3,639	)		317,782		(8,438	)

	At March 31, 2006, the Company had 109 fixed income securities and 12 equity securities that have been in an unrealized loss position for one year or longer. Of the fixed income securities, 108 are investment grade, of which 104 of these securities are rated A1/A or better (including 69 securities which are rated AAA). The one remaining non-investment grade fixed income security is rated BB+ and has a fair value equal to 98.3% of its book value as of March 31, 2006. One of the equity securities that has been in an unrealized loss position for one year or longer relates to a closed end preferred stock fund which continues to pay its regular dividend on a monthly basis and also has an underlying net asset value per share that exceeds its price per share as of March 31, 2006. One of the equity securities relates to an investment in an open end high quality short duration bond fund, of which the underlying assets are all rated AAA. Finally, the ten remaining equity securities that have been in an unrealized loss position for one year or longer relate to preferred share investments in issuers each of which has shown an improved financial performance during the past twelve months. In addition, these ten equity securities have an aggregate fair market value equal to 95.4% of their book value as of March 31, 2006. All 109 of the fixed income securities are current on interest and principal and all 12 of the equity securities continue to pay dividends at a level consistent with the prior year. Management believes the declines are temporary and are not indicative of other-than-temporary impairments.
(4)	Loss and Loss Expense Reserves
	Liability for losses and loss expenses represents the Company’s best estimate of the ultimate amounts needed to pay both reported and unreported claims. These estimates are based on quarterly internal actuarial studies and certified on an annual basis by an independent actuary. The Company continually reviews these estimates and, based on new developments and information, the Company includes adjustments of the probable ultimate liability in the operating results for the periods in which the adjustments are made.
	Net loss and loss expenses incurred were $30.4 million for the quarter ended March 31, 2006, compared to $25.7 million for the quarter ended March 31, 2005. In the first quarter of 2006, the Company recorded $29.7 million of incurred losses and loss expenses attributable to the 2006 accident year and $702,000 attributable to events of prior years. In the first quarter of 2005, the Company recorded $23.8 million of incurred losses and loss expenses attributable to the 2005 accident year and $1.9 million attributable to events of prior years.
	The increases for the first quarter of 2006 related to prior years were due to incurred amounts above our expectations in our casualty business included in our property and casualty segment. The increases were primarily due to reported incurred amounts above our expectations for the 2004 and 2003 accident year, an increase in our legal reserves related to expected arbitration with our reinsurers over a disputed claim and an increase in reserves for accident years 1996 and 1997 as a result of higher than anticipated loss, legal and settlement costs. The increase in casualty reserves was partially offset by favorable development in our 2004 and 2005 property line included in our property and casualty segment.

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	The increases for the first quarter of 2005 related to prior year resulted principally from construction defect claims within the casualty line of business included in our property and casualty segment. During the first three months of 2005, the Company established reserves for two contribution action settlements that were anticipated to be paid within the year. This development was slightly offset by favorable claim count development, while claim severities continued to be within the Company’s expectations. Prior year development for construction defect claims was $1.4 million for the three months ended March 31, 2005.
	Management believes the loss and loss expense reserves make a reasonable provision for expected losses, however, ultimate settlement of this amount could vary significantly from that recorded.
(5)	Reinsurance
	In the ordinary course of business, Century assumes and cedes reinsurance with other insurers and reinsurers. These arrangements provide greater diversification of business and limit the maximum net loss potential on large risks. There have been no significant changes in the Company’s reinsurance program. The amounts of ceded loss and loss expense reserves and ceded unearned premiums would represent a liability of the Company in the event that its reinsurers would be unable to meet existing obligations under reinsurance agreements.
	The effects of assumed and ceded reinsurance on premiums written, premiums earned and loss and loss expenses incurred were as follows:

	For the Three Months
	Ended March 31,
	2006			2005
Premiums written:
Direct	$	57,275			47,318
Assumed		754			314
Ceded		(7,597	)		(5,346	)
Net premiums written	$	50,432			42,286
Premiums earned:
Direct		56,085			46,963
Assumed		812			215
Ceded		(7,895	)		(5,658	)
Net premiums earned	$	49,002			41,520
Losses and loss expenses incurred:
Direct	$	34,294			31,894
Assumed		104			(270	)
Ceded		(3,959	)		(5,897	)
Net losses and loss expenses incurred	$	30,439			25,727

	In 1998 and 1999, the Company had its quota share and excess of loss reinsurance agreements with three reinsurance companies for its the workers’ compensation line of business. These agreements were entered into through an intermediary, which was ordered into liquidation in 2000. Since that time, the Company attempted to collect the losses directly from one of the reinsurers. On March 22, 2006, the Company’s effort to vacate an adverse award received in arbitration related to this reinsurer proved unsuccessful. As such, the Company is currently in the process of turning the claims over to the liquidator of the intermediary and increased the Company’s reserve to $1.5 million from $1.3 million in the event the Company is unable to fully collect the amounts due. As of March 31, 2006, the Company had approximately $2.9 million of recoverables related to these reinsurance agreements, of which $1.1 million related to the quota share agreements and $1.8 million related to the excess of loss agreements.
	In addition, in 2005, the Company notified its reinsurers of a claim in the amount of $4.0 million for which coverage is now being disputed by certain reinsurers. The Company has filed a notice of arbitration against one of its reinsurers on this claim and may file for arbitration against the others if current negotiations are not successful. On March 31, 2006, the Company established a $250,000 reserve related to the potential arbitrations.
(6)	Deferred Policy Acquisition Costs
	The following reflects the amounts of policy acquisition costs deferred and amortized:

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	For the Three Months
	Ended March 31,
	2006			2005
Balance at beginning of year	$	20,649			17,411
Policy acquisition costs deferred		12,835			10,315
Amortization of deferred policy acquisition costs		(12,066	)		(10,220	)
Balance at end of quarter	$	21,418			17,506

(7)	Federal Income Taxes
	The income tax provision for the three months ended March 31, 2006 and 2005 has been computed based on our estimated annual effective tax rate of 29.0% and 30.0%, respectively, which differs from the federal income tax rate of 35% principally because of tax-exempt investment income.
(8)	Commitments and Contingencies
	The Company is a defendant in various lawsuits in the ordinary course of its business. In the opinion of management, the effects, if any, of such lawsuits are not expected to be material to the Company’s consolidated financial position or results from operations.
(9)	Employee Benefits
	During 2004, the Company adopted and the shareholders approved a stock option plan that provided tax-favored incentive stock options (qualified options), non-qualified share options to employees and qualified board members that do not qualify as tax-favored incentive share options (non-qualified options), time-based restricted shares that vest solely on service provided and restricted shares that vest based on achieved performance metrics. Any compensation cost is recorded in the same captions as the salary expense of the employee (i.e. the compensation cost for the Chief Investment Officer is recorded in net investment income).
	With respect to qualified options, an employee may be granted an option to purchase shares at the grant date fair market value, payable as determined by the Company’s board of directors. An optionee must exercise an option within 10 years from the grant date. Full vesting of options granted occurs at the end of four years.
	With respect to non-qualified options, an employee or a board member may be granted an option to purchase shares at the grant date fair market value, payable as determined by the Company’s board of directors. An optionee must exercise an option within 10 years from the grant date. Full vesting of options granted occurs at the end of three years.
	For both non-qualified and qualified options, the option exercise price equals the stock’s fair market value on the date of the grant. In accordance with SFAS No. 123R, compensation expense is recorded over the service period based on the grant date fair market value of the options. The fair market value is determined by the Company using the Black-Scholes option pricing model. Prior to the adoption of SFAS 123R, in accordance with APB No. 25, no compensation was recorded for the qualified and non-qualified share options as the market value on the grant dates equaled the exercise price.
	The time-based restricted shares are granted to key executives and vest in equal installments upon the lapse of a period of time, typically over, four and five year periods and include both monthly and annual vesting periods. Compensation expense for time-based restricted shares is measured on the grant date at the current market value and then recognized over the respective service period, which typically matches the vesting period.
	The performance-based restricted shares are granted to key executives and vest annually over a four year period based on achieved specified performance metrics. In accordance with SFAS 123R, compensation cost is measured on the grant date at the grant date market value and recorded over the service period. Prior to the adoption of SFAS 123R, compensation expense for performance-based restricted share awards was recognized based on the fair value of the awards at the end of the period.
	The Company may grant options for up to 1.2 million shares under the plan. Through December 31, 2005, the Company had granted 287,000 non-qualified options, 95,000 qualified options, 156,000 time-based restricted shares and 55,024 performance-based restricted shares under the share plan. On January 3, 2006, the Company granted an additional 112,500 qualified options.

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A summary of the status of the option plan for the three months ended March 31, 2006 and for the year ended December 31, 2005 are presented in the following table:

	March 31, 2006				December 31, 2005
			Weighted-				Weighted-
	Number of		Average		Number of		Average
	Shares		Exercise Price		Shares		Exercise Price
Outstanding at beginning of year		382,000	$	10.49		364,000	$	10.50
Granted		112,500		10.64		18,000		10.30
Exercised		—		—		—		—
Forfeited		—		—		—		—
Outstanding at end of period		494,500	$	10.52		382,000	$	10.49
Exercisable at end of period		253,684	$	10.50		217,393	$	10.50
Weighted-average fair value of options granted during year			$	3.07			$	2.99

The fair market value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 2006 and 2005:

	Three Months
	Ended			Year Ended
	March 31,			December 31
	2006			2005
Risk free interest rate		4.06	%		4.03	%
Dividend yield		0.95	%		0.76	%
Volatility factor		23.1	%		23.14	%
Weighted average expected option life		7	Years		7	Years

Information on the range of exercise prices for options outstanding as of March 31, 2006, is as follows:

	Options Outstanding						Options Excercisable
			Weighted
			Average		Weighted				Weighted
			Remaining		Average		Exercisable		Average
	Outstanding		Contract		Exercise		as of		Exercise
Price Range	Options		Life		Price		March 31, 2006		Price
$10.20		12,000		9.2	$	10.20		3,330	$	10.20
$10.50		370,000		8.1	$	10.50		242,714	$	10.50
$10.64		112,500		9.8	$	10.64		7,634	$	10.64

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A summary of all employee time-based restricted share activity during the three months ended March 31, 2006 and the year ended December 31, 2005 are as follows:

	2006					2005
				Weighted					Weighted
	Number of			Average		Number of			Average
	Shares			Grant Price		Shares			Grant Price
Beginning of year		68,033		$	10.22		137,049		$	10.31
Add (deduct):
Granted		—			—		—			—
Vested		(2,742	)		10.58		(31,593	)		10.28
Cancelled		—			—		(37,423	)		10.50
End of year		65,291		$	10.20		68,033		$	10.22

In January 2005 and September 2005, the Company modified two executives’ time-based restricted share awards in connection with the termination of their employment to accelerate the vesting period. As such, the Company accounted for the modifications as cancellations of a fixed award and a grant of a variable award, which are valued at the fair market value on the monthly vesting date. During 2005, the Company recorded $231,924 of compensation expense related to the January modification and $42,617 related to the September modification. During the first three months of 2006, the Company recorded no compensation expense related the January modification and $50,722 related to the September modification. All shares related to the January modification have vested as of December 31, 2005 and 8,170 shares related to the September modification remain unvested at March 31, 2006.

A summary of all employee performance-based restricted share activity during the quarters ended March 31, 2006 and 2005 are as follows:

	2006					2005
				Weighted					Weighted
	Number of			Average		Number of			Average
	Shares			Grant Price		Shares			Grant Price
Beginning of year		37,365		$	10.50		—		$	—
Add (deduct):
Granted		—			—		55,024			10.50
Vested		(9,341	)		10.50		—			—
Cancelled		—			—		(17,659	)		10.50
End of year		28,024		$	10.50		37,365		$	10.50

	Of the performance-based restricted share awards granted in March of 2005, an award for 17,659 shares was modified in accordance with the agreement entered into in connection with the termination of an executive officer’s employment in September 2005. As such, the award was treated as cancelled on September 30, 2005 due to a modification of the award to accelerate the vesting of the shares, change the vesting from annual vesting to monthly vesting and remove the performance based restrictions. As such, the award is treated as a variable award which is valued at the fair market value on the monthly vesting date. During 2005, the Company recorded $46,058 compensation expense related to the restricted shares. During the first three months of 2006, the Company recorded $54,818 compensation expense related to the restricted shares and 8,829 shares remain unvested at March 31, 2006.
(10)	Segment Reporting Disclosures
	The Company operates in the Property and Casualty Lines (“P/C”) (including general liability, multi-peril, commercial property and garage liability).
	The Company’s other (including exited lines) include the surety business and the Company’s exited lines, such as workers’ compensation and commercial auto/trucking. A limited amount of surety business is written in order to maintain Century’s U.S. Treasury listing.
	All investment activities are included in the investing operating segment.

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The Company considers many factors, including economic similarity, the nature of the underwriting units’ insurance products, production sources, distribution strategies and regulatory environment in determining how to aggregate operating segments.

Segment profit or loss for each of the Company’s segments is measured by underwriting profit or loss. The property and casualty insurance industry commonly defines underwriting profit or loss as earned premium net of loss and loss expenses and underwriting, acquisition and insurance expenses. Underwriting profit or loss does not replace operating income or net income computed in accordance with GAAP as a measure of profitability. Segment profit for the Investing operating segment is measured by net investment income and net realized gains or losses. The Company does not allocate assets, including goodwill, to the P/C and Other operating segments for management reporting purposes. The total investment portfolio and cash are allocated to the Investing operating segment.

Following is a summary of segment disclosures:

	For the Three Months
	Ended March 31,
	2006		2005
	(In thousands)
Segment revenue:
P/C	$	48,343		41,513
Investing		4,447		3,100
Other (including exited lines)		659		7
Segment revenue	$	53,449		44,620
Segment profit (loss):
P/C	$	2,288		2,938
Investing		4,447		3,100
Other (including exited lines)		377		(561	)
Segment profit	$	7,113		5,477
Segment assets:
Investing	$	376,082		318,436
Assets not allocated		117,257		90,981
Total consolidated assets	$	493,339		409,417

The following summary reconciles significant segment items to the Company’s interim unaudited consolidated condensed financial statements:

	For the Three Months
	Ended March 31,
	2006			2005
	(In thousands)
Income before income taxes:
Segment profit	$	7,113			5,477
Unallocated amounts:
Corporate expenses		(92	)		(662	)
Interest expense		(543	)		(417	)
Income before income taxes	$	6,478			4,398

The following is a summary of segment earned premium by group of products:

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	Property		Casualty		Other		Consolidated
	(In thousands)
Three Months Ended March 31, 2006
P/C	$	14,433		33,910		—		48,343
Other (including exited lines)		—		—		659		659
Earned premiums	$	14,433		33,910		659		49,002
Three Months Ended March 31, 2005
P/C	$	14,416		27,097		—		41,513
Other (including exited lines)		—		—		7		7
Earned premiums	$	14,416		27,097		7		41,520

	The Company does not manage property and casualty products at this level of detail.
(11)	Dividend to Common Shareholders
	On March 13, 2006, the Board of Directors declared a dividend of $0.03 per common share that was paid on April 17, 2006 to shareholders of record as of March 27, 2006. The dividends were accrued in the accompanying March 31, 2006 interm unaudited consolidated condensed balance sheet in the caption accrued expenses and other liabilities.

Item 2. Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

     The following discussion of our financial condition and results of operations should be read in conjunction with our interim unaudited consolidated condensed financial statements and the notes to those statements included in this Form 10-Q. Some of the statements in this report, including those set forth in the discussion and analysis below, are “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are derived from information that we currently have and assumptions that we make and may be identified by words such as “believes,” “anticipates,” “expects,” “plans,” “should,” “estimates” and similar expressions. We cannot assure you that anticipated results will be achieved, since actual results may differ materially because of both known and unknown risks and uncertainties we face. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Factors that could cause actual results to differ materially from our forward-looking statements are described under the heading “Risks Related to Our Business and Industry” in our Annual Report on Form 10-K for the year ended December 31, 2005, and elsewhere in this report, and include, but are not limited to, the following factors:

• our actual incurred losses may be greater than our loss and loss expense reserves, which could cause our future earnings, liquidity and financial rating to decline.

• a decline in our financial rating assigned by A.M. Best may result in a reduction of new or renewal business;

• we are subject to extensive regulation and judicial decisions affecting insurance and tort law, which may adversely affect our ability to achieve our business objectives. In addition, if we fail to comply with certain regulations, we may be subject to penalties, including fines and suspensions, which may adversely affect our financial condition and results of operations;

• our general agents may exceed their authority and bind us to policies outside our underwriting guidelines, and until we effect a cancellation, we may incur loss and loss expenses related to those policies;

• if we lose key personnel or are unable to recruit qualified personnel, our ability to implement our business strategies could be delayed or hindered;

• our investment results and, therefore, our financial condition may be impacted by changes in the business, financial condition or operating results of the entities in which we invest, as well as changes in government monetary policies, general economic conditions and overall market conditions, all of which impact interest rates;

• we distribute our products through a select group of general agents, five of which account for a significant part of our business, and such relationships could be discontinued or cease to be profitable;

• our reinsurers may not pay claims made by us on losses in a timely fashion or may not pay some or all of these claims, in each case causing our costs to increase and our revenues to decline;

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• if we are not able to renew our existing reinsurance or obtain new reinsurance, either our net exposure would increase or we would have to reduce the level of our underwriting commitment;

• our business is cyclical in nature, which will affect our financial performance and may affect the price of our common shares;

• if we are unable to compete effectively with the large number of companies in the insurance industry for underwriting revenues, we may incur increased costs and our underwriting revenues and net income may decline;

• severe weather conditions and other catastrophes may result in an increase in the number and amount of claims experienced by our insureds; and

• as a holding company, we are dependent on the results of operations of our insurance subsidiary and the regulatory and contractual capacity of our subsidiary to pay dividends to us. Some states limit the aggregate amount of dividends our subsidiary may pay to us in any twelve-month period, thereby limiting our funds to pay expenses and dividends.

     You are cautioned not to place undue reliance on forward-looking statements, which speak only as of their respective dates.

Overview

     ProCentury is a holding company that underwrites selected property and casualty and surety insurance through its subsidiaries collectively known as the Century Insurance Group^®. As a “niche” company, we offer specialty insurance products designed to meet specific insurance needs of targeted insured groups. The excess and surplus lines market provides an alternative market for customers with hard-to-place risks and risks that insurance companies licensed by the state in which the insurance policy is sold, which are also referred to as “admitted insurers,” specifically refuse to write. When we underwrite within the excess and surplus lines market, we are selective in the lines of business and types of risks we choose to write. Typically, the development of these specialty insurance products is generated through proposals brought to us by an agent or broker seeking coverage for a specific group of clients.

     We evaluate our insurance operations by monitoring key measures of growth and profitability. We measure our growth by examining gross written premiums. We generally measure our operating results by examining our net income, return on equity and loss, expense and combined ratios. The following provides further explanation of the key measures that we use to evaluate our results:

     Gross Written Premiums.Gross written premiums are the sum of direct written premiums and assumed written premiums. We use gross written premiums, which excludes the impact of premiums ceded to reinsurers, as a measure of the underlying growth of our insurance business from period to period.

     Net Written Premiums.Net written premiums are the sum of direct written premiums and assumed written premiums less ceded written premiums. We use net written premiums, primarily in relation to gross written premiums, to measure the amount of business retained after cessions to reinsurers.

     Earned Premiums.Earned premiums are the portion of a premium paid by an insured that has been allocated to our revenue, loss experience, expenses, and year to date profit.

     Loss Ratio.Loss ratio is the ratio (expressed as a percentage) of losses and loss expenses incurred to premiums earned. Loss ratio generally is measured on both a gross (direct and assumed) and net (gross less ceded) basis. We use the gross loss ratio as a measure of the overall underwriting profitability of the insurance business we write and to assess the adequacy of our pricing. Our net loss ratio, which is net of ceded reinsurance, is meaningful in evaluating our financial results, as reflected in our consolidated financial statements.

     Expense Ratio.Expense ratio is the ratio (expressed as a percentage) of net operating expenses to premiums earned and measures a company’s operational efficiency in producing, underwriting and administering its insurance business. We reduce our operating expenses by ancillary income (excluding net investment income and realized gains (losses) on securities) to calculate our net operating expenses. Due to our historically high levels of reinsurance, we calculate our expense ratio on both a gross basis (before the effect of ceded reinsurance) and a net basis (after the effect of ceded reinsurance). Although the net basis is meaningful in evaluating our financial results that are net of ceded reinsurance, as reflected in our consolidated financial statements, we believe the gross expense ratio better reflects the operational efficiency of the underlying business and is a better measure of future trends. Interest expense is not included in the calculation of the expense ratio.

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     Combined Ratio.Combined ratio is the sum of the loss ratio and the expense ratio and measures a company’s overall underwriting profit. If the combined ratio is at or above 100, an insurance company cannot be profitable without investment income (and may not be profitable if investment income is insufficient). We use the combined ratio in evaluating our overall underwriting profitability and as a measure for comparing our profitability relative to the profitability of our competitors.

Critical Accounting Policies

     It is important to understand our accounting policies in order to understand our financial statements. Management considers certain of these policies to be critical to the presentation of our financial results, since they require management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the financial reporting date and throughout the period being reported upon. Certain of the estimates result from judgments that can be subjective and complex and consequently actual results may differ from these estimates, which would be reflected in future periods.

     Our most critical accounting policies involve the reporting of loss and loss expense reserves (including losses that have occurred but were not reported to us by the financial reporting date), reinsurance recoverables, the impairment of investments, deferred policy acquisition costs and federal income taxes.

     Loss and Loss Expense Reserves.Loss and loss expense reserves represent an estimate of the expected cost of the ultimate settlement and administration of losses, based on facts and circumstances then known. We use actuarial methodologies to assist us in establishing these estimates, including judgments relative to estimates of future claims severity and frequency, length of time to develop to ultimate resolution, the effect of changes in the law or unexpected judicial and other third-party factors that are often beyond our control. Due to the inherent uncertainty associated with the cost of unsettled and unreported claims, the ultimate liability may be different from the original estimate. Such estimates are regularly reviewed and updated and any resulting adjustments are included in the current period’s results. See Note 4 to our interim unaudited consolidated condensed financial statements included in this Form 10-Q.

     Reinsurance Recoverables.Reinsurance recoverables on paid and unpaid losses, net, are established for the portion of our loss and loss expense reserves that are ceded to reinsurers. Reinsurance recoverables are determined based in part on the terms and conditions of reinsurance contracts which could be subject to interpretations that differ from our own based on judicial theories of liability. In addition, we bear credit risk with respect to our reinsurers which can be significant considering that certain of the reserves remain outstanding for an extended period of time. We are required to pay losses even if a reinsurer fails to meet its obligations under the applicable reinsurance agreement. See Note 5 to our interim unaudited consolidated condensed financial statements included in this Form 10-Q.

     Impairment of Investments.Impairment of investment securities results in a charge to operations when a market decline below cost is deemed to be other-than-temporary. Under the Company’s accounting policy for equity securities and fixed-maturity securities, an impairment is deemed to be other-than-temporary unless the Company has both the ability and intent to hold the investment for a reasonable period until the security’s forecasted recovery and evidence exists indicating that recovery will occur in a reasonable period of time.

     For other fixed-maturity and equity securities, an other-than-temporary impairment charge is taken when the Company does not have the ability and intent to hold the security until the forecasted recovery or if it is no longer probable that the Company will recover all amounts due under the contractual terms of the security. Many criteria are considered during this process including, but not limited to, the current fair value as compared to amortized cost or cost, as appropriate, of the security; the amount and length of time a security’s fair value has been below amortized cost or cost; specific credit issues and financial prospects related to the issuer; the Company’s ability and intent to hold or dispose of the security; and current economic conditions. Other-than-temporary impairment losses result in a permanent reduction to the cost basis of the underlying investment.

     Additionally, for certain securitized financial assets with contractual cash flows (including asset-backed securities), FASB Emerging Task Force (EITF) 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets”, requires us to periodically update our best estimate of cash flows over the life of the security. If management determines that the fair value of a securitized financial asset is less than its carrying amount and there has been a decrease in the present value of the estimated cash flows since the last revised estimate, considering both timing and amount, then an other –than-temporary impairment is recognized.

     For additional detail regarding our investment portfolio at March 31, 2006 and December 31, 2005, including disclosures regarding other-than-temporary declines in investment value, see Note 3 to our interim unaudited consolidated condensed financial statements included in this Form 10-Q.

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     Deferred Policy Acquisition Costs.We defer commissions, premium taxes and certain other costs that vary with and are primarily related to the acquisition of insurance contracts. These costs are capitalized and charged to expense in proportion to premium revenue recognized. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, anticipated losses and settlement expenses and certain other costs expected to be incurred as the premium is earned. Judgments as to ultimate recoverability of such deferred costs are highly dependent upon estimated future loss costs associated with the written premiums. See Note 6 to our interim unaudited consolidated condensed financial statements included in this Form 10-Q.

     Federal Income Taxes.The Company provides for federal income taxes based on amounts the Company believes it ultimately will owe. Inherent in the provision for federal income taxes are estimates regarding the deductibility of certain items and the realization of certain tax credits. In the event the ultimate deductibility of certain items or the realization of certain tax credits differs from estimates, the Company may be required to significantly change the provision for federal income taxes recorded in the consolidated financial statements. Any such change could significantly affect the amounts reported in the consolidated statements of income.

     We utilize the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce the deferred tax assets to the amounts more likely than not to be realized. See Note 7 to our interim unaudited consolidated condensed financial statements included in this Form 10-Q.

Results of Operations

     The table below summarizes certain operating results and key measures we use in monitoring and evaluating operations. The information is intended to summarize and supplement information contained in the interim unaudited consolidated condensed financial statements and to assist the reader in gaining a better understanding of results of operations.

	For the Three Months
	Ended March 31,
	2006			2005
	(In thousands)
Selected Financial Data:
Gross written premiums	$	58,029			47,632
Premiums earned		49,002			41,520
Net investment income		4,426			3,159
Net realized investment gains (losses)		21			(59	)
Total revenues		53,449			44,620
Total expenses		46,971			40,222
Net income		4,600			3,079
Key Financial Ratios:
Loss and loss expense ratio		62.1	%		62.0	%
Expense ratio		32.6	%		33.9	%
Combined ratio		94.7	%		95.9	%

Overview of Operating Results

     For the three months ended March 31, 2006, net income was $4.6 million compared to net income of $3.1 million for the three months ended March 31, 2005. The growth in our overall net income is a direct result of an 18.0% growth in our earned premium as a result of favorable market conditions in the southeast and growth in program business that began in 2005.

     More specifically, premiums earned increased over the same period in 2005 approximately $7.5 million, or 18.0%, principally from an increase in the volume of business which was offset by slight rate declines in both property and casualty lines of business. Net investment income for the three months ended March 31, 2006 was $4.4 million compared to $3.2 million for the three months ended March 31, 2005, which was due to higher invested assets as a result of our operating cash

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flows, as well as a higher yield on invested assets. Our taxable equivalent yield increased to 5.7% at March 31, 2006 from 5.1% at March 31, 2005.

     The increase in total revenue was partially offset by an increase in total expenses. Loss and loss expenses and amortization of deferred acquisition costs increased approximately $4.7 million and $1.9 million, respectively, for the first quarter of 2006 compared to the same quarter in 2005 due to the continued growth in premiums. The loss and loss expense ratios for the three months ended March 31, 2006 and 2005 were 62.1% and 62.0%, respectively. The expense ratios for the three months ended March 31, 2006 and 2005 were 32.6% and 33.9%, respectively. The decrease in the expense ratio for the quarter is a direct result of the severance expense that occurred in the first quarter of 2005. No severance expense was incurred in the first three months of 2006.

Revenues

     Premiums

     Premiums include insurance premiums underwritten by Century (which are referred to as direct premiums) and insurance premiums assumed from other insurers generally in states where Century is not licensed (which are referred to as assumed premiums). We refer to direct and assumed premiums together as gross premiums.

     Written premiums are the total amount of premiums billed to the policyholder less the amount of premiums returned, generally as a result of cancellations, during a given period. Written premiums become premiums earned over the policy period. Barring premium changes, if an insurance company writes the same mix of business each year, written premiums and premiums earned will be equal, and the unearned premium reserve will remain constant. During periods of growth, the unearned premium reserve will increase, causing premiums earned to be less than written premiums. Conversely, during periods of decline in written premiums, the unearned premium reserve will decrease, causing premiums earned to be greater than written premiums.

     We have historically relied on quota share, excess of loss, and catastrophe reinsurance primarily to manage our regulatory capital requirements and also to limit our exposure to loss. Generally, we have ceded a significant portion of our premiums to unaffiliated reinsurers in order to maintain a net written premiums to statutory surplus ratio of less than 2-to-1.

     Our underwriting business is currently divided into two primary segments:

• property/casualty; and

• other (including exited lines).

     Our property/casualty segment primarily includes general liability, commercial property, multi-peril and garage liability insurance for small and mid-sized businesses. The other (including exited lines) segment primarily includes our surety business, including landfill and specialty surety that is written in order to maintain Century’s U.S. Treasury listing, workers’ compensation, which was exited in January 2002, and commercial auto/trucking, which was exited in May 2000.

     The following table presents our gross written premiums in our primary segments and provides a summary of gross, ceded and net written premiums and net premiums earned for the periods indicated.

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	For the Three Months
	Ended March 31,
	2006			2005
	(In thousands)
Gross written premiums
Property/casualty	$	57,090			47,575
Other (including exited lines)		939			57
Total gross written premiums		58,029			47,632
Ceded written premiums		7,597			5,346
Net written premiums	$	50,432			42,286
Net premiums earned	$	49,002			41,520
Net written premiums to gross written premiums		86.9	%		88.8	%
Net premiums earned to net written premiums		97.2	%		98.2	%
Net writings ratio (1)		1.6			1.4

(1) The ratio of net written premiums to our insurance subsidiaries’ combined statutory surplus. Management believes this measure is useful in gauging our exposure to pricing errors in the current book of business. It may not be comparable to the definition of net writings ratio used by other companies.

     Gross Written Premiums

     Gross written premiums increased to $58.0 million for the quarter ended March 31, 2006, an increase of 21.8% from $47.6 million for the same period in 2005. This fluctuation was primarily due to an increase in volume of our property/casualty segment which was slightly offset by minimal rate declines across our book of business. Gross written premiums for our casualty and property lines of businesses increased $4.2 million and $5.3 million, respectively, in the first quarter of 2006.

     Net Written Premiums and Premiums Earned

     Net written premiums for the three months ended March 31, 2006 were $50.4 million, representing an increase of 19.3% compared to the same period in 2005. Net written premiums represented 86.9% of gross written premiums for the three months ended March 31, 2006. This is lower than the relationship of net written premiums to gross written premiums for the three months ended March 31, 2005, reflecting an increase in ceded premium in the current year resulting from higher reinsurance costs and an increase in the amount of facultative reinsurance that is directly related to the increase in property accounts.

     Premiums earned were $49.0 million for the three months ended March 31, 2006, or 97.2% of net written premiums. The relationship of premiums earned to net written premiums during the same period in 2005 increased, reflecting a higher growth rate of premiums in the first quarter of 2006 compared to the first quarter of 2005.

     Net Investment Income

     Our investment portfolio generally consists of liquid, readily marketable and investment-grade fixed-maturity and equity securities. Net investment income is comprised of interest and dividends earned on these securities, net of related investment expenses.

     Net investment income increased to $4.4 million for the three months ended March 31, 2006, compared to $3.2 million for the same period in 2005. The increase was due to an increase in invested assets, including cash, and higher investment yields. Invested assets, including cash, increased by $15.9 million to $382.3 million as of March 31, 2006 from $366.4 million as of December 31, 2005. The pre-tax investment yield for the three months ended March 31, 2006 was 4.9%, compared to 4.5% for the same period in 2005. In addition, our tax equivalent yield increased to 5.7% as of March 31, 2006 from 5.1% as of March 31, 2005.

     Realized Gains (Losses) on Securities

     Realized gains and losses on securities are principally affected by changes in interest rates, the timing of sales of investments and changes in credit quality of the securities we hold as investments.

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     We realized net investment gains of $21,000 on the sale of securities for the three months ended March 31, 2006 compared to $59,000 of net investment losses for the quarter ended March 31, 2005. No other-than-temporary declines were realized in the first quarters of 2006 or 2005.

Expenses

     Losses and Loss Expenses

     Losses and loss expenses represent our largest expense item and include (1) payments made to settle claims, (2) estimates for future claim payments and changes in those estimates for current and prior periods, and (3) costs associated with settling claims. The items that influence the incurred losses and loss expenses for a given period include, but are not limited to, the following:

• the number of exposures covered in the current year;

• trends in claim frequency and claim severity;

• changes in the cost of adjusting claims;

• changes in the legal environment relating to coverage interpretation, theories of liability and jury determinations; and

• the re-estimation of prior years’ reserves in the current year.

     We establish or adjust (for prior accident quarters) our best estimate of the ultimate incurred losses and loss expenses to reflect loss development information and trends that have been updated for the most recent quarter’s activity through quarterly internal actuarial analysis. As of December 31 of each year, we have an independent actuarial analysis performed of the adequacy of our reserves. Our estimate of ultimate loss and loss expenses is evaluated and re-evaluated by accident year and by major coverage grouping and changes in estimates are reflected in the period the additional information becomes known.

     Our reinsurance program significantly influences our net retained losses. In exchange for premiums ceded to reinsurers under quota share and excess of loss reinsurance agreements, our reinsurers assume a portion of the losses and loss expenses incurred. We remain obligated for amounts ceded in the event that the reinsurers do not meet their obligations under the agreements (due to, for example, disputes with the reinsurer or the reinsurer’s insolvency).

     Net losses and loss expenses increased to $30.4 million for the three months ended March 31, 2006 from $25.7 million for the same period in 2005. Net losses and loss expense ratios for the three months ended March 31, 2006 and 2005 were 62.1% and 62.0%, respectively.

     Our reserve for losses and loss expenses at March 31, 2006 was $223.8 million (before the effects of reinsurance) and $184.6 million (after the effects of reinsurance), as estimated through our actuarial analysis. During the first quarter of 2006, we concluded through our actuarial analysis that the December 31, 2005 reserve for losses and loss expenses of $211.6 million (after the effects of reinsurance) was deficient by $702,000 primarily in our casualty business, which was partially offset by favorable development in our property reserves.

     Our reserve for losses and loss expenses (net of the effects of reinsurance) at March 31, 2006 and December 31, 2005 by line was as follows:

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	March 31		December 31
	2006		2005
	(In thousands)
Property/casualty:
Casualty	$	155,071		142,451
Property		25,547		27,972
Other (including exited lines):
Commercial auto		1,065		936
Workers’ compensation		2,636		2,657
Other		282		183
Net reserves for losses and loss expenses		184,601		174,199
Plus reinsurance recoverables on unpaid losses at end of period		39,179		37,448
Gross reserves for losses and loss expenses	$	223,780		211,647

The increase in net loss and loss expenses during the first quarter of 2006 is primarily attributable to our continued growth, an increase in the cost to settle claims and the premium pricing declines experienced throughout 2005 and into 2006.

The increases for the first quarter of 2006 related to prior years were due to incurred amounts above our expectations in our casualty business included in our property and casualty segment. The increases were primarily due to reported incurred amounts above our expectations for the 2003 accident year, an increase in our legal reserves related to expected arbitration with our reinsurers over a disputed claim and an increase in reserves for accident years 1996 and 1997 as a result of higher than anticipated legal and settlement costs. The increase in casualty reserves was offset by favorable development in our 2004 and 2005 property line of the property and casualty segment.

     Operating Expenses

     Operating expenses include the costs to acquire a policy (included in amortization of deferred policy acquisition costs), other operating expenses (including corporate expenses) and interest expense. The following table presents our amortization of deferred policy acquisition costs, other operating expenses and related ratios and interest expense for the periods indicated:

	For the Three Months
	Ended March 31,
	2006			2005
	(In thousands)
Amortization of deferred policy acquisition costs (“ADAC”)	$	12,066			10,220
Other operating expenses		3,923			3,065
ADAC and other operating expenses		15,989			13,285
Severance expense		—			793
Interest expense		543			417
Total operating expenses	$	16,532			14,495
Expense ratio:
ADAC		24.6	%		24.6	%
Other operating expenses		8.0	%		7.4	%
Severence		—	%		1.9	%
Total expense ratio (1)		32.6	%		33.9	%

(1) Interest expense is not included in the calculation of the expense ratio.

     Operating expenses increased $2.0 million, to $16.5 million for the three months ended March 31, 2006 from the same period in 2005. The increase is primarily attributable to an increase in ADAC as a result of an increase in the volume of insurance written. The ADAC ratio of 24.6% was consistent for the three months ended March 31, 2006 and 2005.

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     The other operating expenses for the three months ended March 31, 2006 compared to the three months ended March 31, 2005 remained stable. The overall expense ratio for the three months ended March 31, 2006 was 32.6%, which is 1.3 percentage points lower than that of the same period in 2005. The decrease in the expense ratio for the three months ended March 31, 2006 when compared to the three months ended March 31, 2005 primarily resulted from the impact of the severance agreement with our former Chief Operating Officer during the first quarter of 2005.

     Interest expense continues to increase based on the increase in interest rates on our Trust Preferred securities, due to the increasing interest rate environment.

Income Taxes

     The income tax provision for the three months ended March 31, 2006 and 2005, has been computed based on our estimated annual effective tax rate of 29.0% and 30.0%, respectively, which differ from the federal income tax rate of 35% principally because of tax-exempt investment income. The decrease in our estimated annual effective tax rate for 2006 compared to 2005 is primarily due to the effect of tax-exempt investment income.

Liquidity and Capital Resources

     ProCentury is a holding company, the principal asset of which is the common shares of Century. Although we have the capacity to generate cash through loans from banks and issuances of equity securities, our primary source of funds to meet our short-term liquidity needs, including the payment of dividends to our shareholders and corporate expenses, is dividends from Century. Century’s principal sources of funds are underwriting operations, investment income and proceeds from sales and maturities of investments. Century’s primary use of funds is to pay claims and operating expenses, to purchase investments and to make dividend payments to us. ProCentury’s future liquidity is dependent on the ability of Century to pay dividends.

     Century is restricted by statute as to the amount of dividends it may pay without the prior approval of regulatory authorities. Century may pay dividends to ProCentury without advance regulatory approval only from unassigned surplus and only to the extent that all dividends in the current twelve months do not exceed the greater of 10% of total statutory surplus as of the end of the prior fiscal year or statutory net income for the prior year. Using these criteria, the available ordinary dividend payable by Century to ProCentury in 2006 is $12.1 million. Century paid ordinary dividends of $1.3 million for the three months ended March 31, 2006. Century did not pay ProCentury any dividends in the first quarter of 2005.

     Century is required by law to maintain a certain minimum level of surplus on a statutory basis. Surplus is calculated by subtracting total liabilities form total admitted assets. The National Association of Insurance Commissioners (“NAIC”) has a risk-based capital standard designed to identify property and casualty insurers that may be inadequately capitalized based on inherent risks of each insurer’s assets and liabilities and its mix of net written premiums. Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action. At December 31, 2005, the statutory surplus of Century was in excess of the prescribed risk-based capital requirements that correspond to any level of regulatory action. Century’s statutory surplus at December 31, 2005 was $121.8 million and the authorized control level was $33.6 million. Century’s statutory surplus at March 31, 2006 was $124.7 million.

     Consolidated net cash provided by operating activities was $18.8 million for the first three months of 2006, compared to $11.7 million for the same period in 2005. The increase is a direct result of the current year growth in premiums.

     Consolidated net cash used by investing activities was $17.9 million for the first three months of 2006, compared to $14.6 million for the same period in 2005. The increase resulted from our ability to invest the continued increase in net cash provided by operating activities.

     Consolidated net cash used in financing activities was $364,000 for the first three months of 2006, compared to net cash used in financing activities of $265,000 for the same period in 2005. This increase is a result of the increase in the quarterly dividend from $0.02 per share in 2005 to $0.03 per share in 2006.

     Interest on our debt issued to a related party trust is variable and resets quarterly based on a spread over three-month London Interbank Offered Rates (“LIBOR”). As part of our asset/liability matching program, we have short-term investments, investments in bond mutual funds, as well as available cash balances from operations and investment maturities, that are available for reinvestment during periods of rising or falling interest rates.

     Our contractual obligations and commercial commitments have not materially changed from that reported in our most recent Form 10-K.

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     Given our historical cash flow, we believe cash flow from operating activities in 2006 will provide sufficient liquidity for our operations, as well as to satisfy debt service obligations and to pay other operating expenses. Although we anticipate that we will be able to meet our cash requirements, we cannot give assurances in this regard.

Investment Portfolio

     Our investment strategy is designed to capitalize on our ability to generate positive cash flow from our underwriting activities. Preservation of capital is our first priority, with a secondary focus on maximizing appropriate risk adjusted return. We seek to maintain sufficient liquidity from operations, investing and financing activities to meet our anticipated insurance obligations and operating and capital expenditure needs. The majority of our fixed-maturity portfolio is rated investment grade to protect investments. Our investment portfolio is managed by three outside independent investment managers that operate under investment guidelines approved by Century’s investment committee. Century’s investment committee meets at least quarterly and reports to ProCentury’s board of directors. In addition, we employ stringent diversification rules and balance our investment credit risk and related underwriting risks to minimize total potential exposure to any one security. In limited circumstances, we will invest in non-investment grade fixed-maturity securities that have an appropriate risk adjusted return, subject to satisfactory credit analysis performed by us and our investment managers.

     Our cash and investment portfolio increased to $382.3 million at March 31, 2006 from $366.4 million at December 31, 2005 and is summarized by type of investment in Note 3 to the interim unaudited consolidated condensed financial statements included in this Form 10-Q filing. The Company’s taxable equivalent yield increased to 5.7% at March 31, 2006 from 5.2% at December 31, 2005. The increase in the taxable equivalent yield during the first three months of 2006 was a result of the investment of proceeds from maturities and operating cash flows at higher interest rates, which were partially driven by the overall rise in market interest rates. The fair value of our fixed maturities at March 31, 2006 increased to $319.9 million from $303.8 million at December 31, 2005. The fair value of our equity securities decreased to $43.6 million at March 31, 2006 from $44.8 million at December 31, 2005. As of March 31, 2006, the duration of the fixed income portfolio was 4.5 years, unchanged from December 31, 2005. The overall credit quality of the portfolio remained investment grade.

Accounting Standards

     In February 2006, the Financial Accounting Standards Board (“FASB”) issued statement No. 155, “Accounting for Certain Hybrid Financial Instruments” (“SFAS No. 155”). Under current generally accepted accounting principles an entity that holds a financial instrument with an embedded derivative must bifurcate the financial instrument, resulting in the host and the embedded derivative being accounted for separately. SFAS No. 155 permits, but does not require, entities to account for financial instruments with an embedded derivative at fair value thus negating the need to bifurcate the instrument between its host and the embedded derivative. SFAS No. 155 is effective as of the beginning of the first annual reporting period that begins after September 15, 2006. We expect that SFAS No. 155 will not have a material effect on our consolidated financial condition or results of operations.

     In March 2006, the FASB issued statement No. 156, “Accounting for Servicing of Financial Assets” (“SFAS No. 156”). SFAS No. 156 amends FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, to require that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. SFAS No. 156 permits, but does not require, the subsequent measurement of separately recognized servicing assets and servicing liabilities at fair value. An entity that uses derivative instruments to mitigate the risks inherent in servicing assets and servicing liabilities is required to account for those derivative instruments at fair value. SFAS No. 156 is effective as of the beginning of the first annual reporting period that begins after September 15, 2006. We expect that SFAS No. 156 will not have a material effect on our financial condition or results of operations.

Item 3. Quantitative And Qualitative Disclosures About Market Risk

     The Company is exposed to market risk, which is the potential economic loss principally arising from adverse changes in the fair value of financial instruments. The major components of market risk affecting us are credit risk, equity price risk and interest rate risk.

     As of March 31, 2006, there had not been a material change in any of the market risk information disclosed by the Company under Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” in its Annual Report on Form 10-K for the year ended December 31, 2005.

Item 4. Controls And Procedures

     As of the end of the period covered by this quarterly report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Chairman and Chief Executive Officer (“CEO”) and

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the Chief Financial Officer (“CFO”) and Treasurer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Securities Exchange Act Rule 13a-15 (“Disclosure Controls”).

     The Company’s management, including the CEO and CFO, does not expect that its Disclosure Controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

     Based on management’s evaluation of the Company’s Disclosure Controls as of March 31, 2006, management concluded that they provide reasonable assurance that information required to be disclosed by the Company in its periodic reports is accumulated and communicated to management, including the CEO and CFO, as appropriate to allow timely decisions regarding disclosure and is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

     There were no changes in the Company’s internal control over financial reporting during the Company’s most recent fiscal quarter that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II: OTHER INFORMATION

Item 1. Legal Proceedings

     The Company’s subsidiaries are regularly engaged in the defense of claims arising out of the conduct of the insurance business. The Company does not believe that such litigation, individually or in the aggregate, will have a material effect on its consolidated financial condition or results of operations.

Item 1A. Risk Factors

     The risks related to our business and industry have not materially changed from those identified in the Company’s annual report on Form 10-K for the year ended December 31, 2005.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     Not applicable.

Item 3. Defaults Upon Senior Securities

     Not applicable.

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

     Not applicable.

Item 5. Other Information

     Not applicable.

Item 6. Exhibits

3.1	Amended and Restated Articles of Incorporation of ProCentury (Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2004, filed with the Securities and Exchange Commission “SEC” on September 4, 2004.)
3.2	Amended and Restated Code of Regulations of ProCentury (Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2004, filed with the SEC on September 4, 2004.)

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31.1	Certification of Principal Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act
31.2	Certification of Principal Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act
32.1	Certification of Principal Executive Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1)
32.2	Certification of Principal Financial Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1)

(1) These certifications are not deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section. These certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates them by reference.

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf of the undersigned thereunto duly authorized.

	PROCENTURY CORPORATION
Date May 10, 2006	By:	/s/ Erin E. West
		Erin E. West
		Chief Financial Officer and Treasurer
		(Principal Financial and Accounting Officer)

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EXHIBIT INDEX

3.1	Amended and Restated Articles of Incorporation of ProCentury (Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2004, filed with the Securities and Exchange Commission (“SEC”) on September 4, 2004.)
3.2	Amended and Restated Code of Regulations of ProCentury (Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2004, filed with the SEC on September 4, 2004.)
31.1	Certification of Principal Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act
31.2	Certification of Principal Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act
32.1	Certification of Principal Executive Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1)
32.2	Certification of Principal Financial Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1)

(1) These certifications are not deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section. These certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates them by reference.

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