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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q/A
Amendment No. 1
x Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarterly Period Ended March 31, 2004
Commission File Number 0-22280
PHILADELPHIA CONSOLIDATED HOLDING CORP.
PENNSYLVANIA | 23-2202671 | |
(State of Incorporation) | (IRS Employer Identification No.) |
One Bala Plaza, Suite 100
Bala Cynwyd, Pennsylvania 19004
(610) 617-7900
including area code, of registrant’s principal executive offices)
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.
YESx NO:o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
YESx NO:o
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of April 30, 2004.
Common Stock, no par value, 22,032,397 shares outstanding
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EXPLANATORY NOTE
The Company has included its restated consolidated balance sheets as of March 31, 2004 and December 31, 2003, restated consolidated statement of operations and comprehensive income for the three months ended March 31, 2004, restated consolidated statement of changes in shareholders’ equity for the three months ended March 31, 2004 and the year ended December 31, 2003, and restated consolidated statement of cash flows for the three months ended March 31, 2004 in this Form 10-Q/A. The restatement records in prior periods a portion of the revenue and net income arising from profit commissions under two reinsurance contracts, one of which originally had been recorded in the fourth quarter 2003 and the other of which should have been recorded in previous periods. These profit commissions were due to the Company from reinsurers under a quota share reinsurance contract effective during the period April 1, 2003 through December 31, 2003 and an excess catastrophe reinsurance contract effective during the period June 1, 2003 through May 31, 2004. The restatement is more fully described in Part I herein under “Item 2-Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and in Item 1 of Part I in our consolidated unaudited financial statements and related notes, including, without limitation, in Note 2. Any amounts shown herein as restated are the restated amounts.
This Amendment No. 1 to Quarterly Report on Form 10-Q/A amends Part I, Items 1, 2 and 4 and, Part II, Item 6, of the Company’s previously filed Quarterly Report on Form 10-Q for the Quarterly Period Ended March 31, 2004 to reflect the aforementioned restatement and related changes. The applicable rules require that each of these Items be entirely restated upon amendment. Items other than those listed above have not been changed and therefore have not been included in this Amendment No. 1 to Quarterly Report on Form 10-Q/A.
In addition, as required by Rule 12b-15 under the Securities Exchange Act of 1934, as amended, new certifications by the Company’s principal executive officer and principal financial officer are being filed with this Form 10-Q/A.
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PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
INDEX
For the Quarterly Period Ended March 31, 2004
Part I - Financial Information | ||||||||
Item 1. Financial Statements: | ||||||||
4 | ||||||||
5 | ||||||||
6 | ||||||||
7 | ||||||||
8-15 | ||||||||
16-23 | ||||||||
24 | ||||||||
25 | ||||||||
26 | ||||||||
CERTIFICATION OF THE COMPANY'S CHIEF EXECUTIVE OFFICER | ||||||||
CERTIFICATION OF THE COMPANY'S CHIEF FINANCIAL OFFICER | ||||||||
CERTIFICATION OF THE COMPANY'S CEO, SECTION 906 | ||||||||
CERTIFICATION OF THE COMPANY'S CFO, SECTION 906 |
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PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of | ||||||||
March 31, | ||||||||
2004 | December 31, | |||||||
(Restated) | 2003 | |||||||
(Unaudited) | (Restated) | |||||||
ASSETS | ||||||||
INVESTMENTS: | ||||||||
FIXED MATURITIES AVAILABLE FOR SALE AT MARKET (AMORTIZED COST $1,162,540 AND $1,066,523) | $ | 1,186,934 | $ | 1,081,694 | ||||
EQUITY SECURITIES AT MARKET (COST $99,939 AND $79,813) | 111,125 | 90,358 | ||||||
TOTAL INVESTMENTS | 1,298,059 | 1,172,052 | ||||||
CASH AND CASH EQUIVALENTS | 64,743 | 73,942 | ||||||
ACCRUED INVESTMENT INCOME | 12,195 | 11,008 | ||||||
PREMIUMS RECEIVABLE | 165,281 | 179,509 | ||||||
PREPAID REINSURANCE PREMIUMS AND REINSURANCE RECEIVABLES | 287,208 | 292,157 | ||||||
DEFERRED INCOME TAXES | 13,218 | 18,147 | ||||||
DEFERRED ACQUISITION COSTS | 69,357 | 56,288 | ||||||
PROPERTY AND EQUIPMENT, NET | 18,027 | 16,821 | ||||||
GOODWILL | 25,724 | 25,724 | ||||||
OTHER ASSETS | 24,890 | 25,293 | ||||||
TOTAL ASSETS | $ | 1,978,702 | $ | 1,870,941 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
POLICY LIABILITIES AND ACCRUALS: | ||||||||
UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES | $ | 673,535 | $ | 627,086 | ||||
UNEARNED PREMIUMS | 433,809 | 422,589 | ||||||
TOTAL POLICY LIABILITIES AND ACCRUALS | 1,107,344 | 1,049,675 | ||||||
FUNDS HELD PAYABLE TO REINSURER | 115,353 | 110,011 | ||||||
LOANS PAYABLE | 47,062 | 48,482 | ||||||
PREMIUMS PAYABLE | 39,887 | 35,044 | ||||||
OTHER LIABILITIES | 88,976 | 82,083 | ||||||
TOTAL LIABILITIES | 1,398,622 | 1,325,295 | ||||||
COMMITMENTS AND CONTINGENCIES | ||||||||
SHAREHOLDERS’ EQUITY: | ||||||||
PREFERRED STOCK, $.01 PAR VALUE, 10,000,000 SHARES AUTHORIZED, NONE ISSUED AND OUTSTANDING | — | — | ||||||
COMMON STOCK, NO PAR VALUE, 100,000,000 SHARES AUTHORIZED, 22,033,897 AND 22,007,552 SHARES ISSUED AND OUTSTANDING | 281,951 | 281,088 | ||||||
NOTES RECEIVABLE FROM SHAREHOLDERS | (5,046 | ) | (5,444 | ) | ||||
ACCUMULATED OTHER COMPREHENSIVE INCOME | 23,127 | 16,715 | ||||||
RETAINED EARNINGS | 280,048 | 253,287 | ||||||
TOTAL SHAREHOLDERS’ EQUITY | 580,080 | 545,646 | ||||||
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | $ | 1,978,702 | $ | 1,870,941 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
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PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME
(Unaudited)
For the Three Months | ||||||||
Ended March 31, | ||||||||
2004 | 2003 | |||||||
(Restated) | | |||||||
REVENUE: | ||||||||
NET EARNED PREMIUMS | $ | 171,422 | $ | 148,362 | ||||
NET INVESTMENT INCOME | 9,973 | 9,805 | ||||||
NET REALIZED INVESTMENT GAIN (LOSS) | 1,778 | (1,133 | ) | |||||
OTHER INCOME | 1,382 | 661 | ||||||
TOTAL REVENUE | 184,555 | 157,695 | ||||||
LOSSES AND EXPENSES: | ||||||||
LOSS AND LOSS ADJUSTMENT EXPENSES | 130,686 | 103,085 | ||||||
NET REINSURANCE RECOVERIES | (34,443 | ) | (12,725 | ) | ||||
NET LOSS AND LOSS ADJUSTMENT EXPENSES | 96,243 | 90,360 | ||||||
ACQUISITION COSTS AND OTHER UNDERWRITING EXPENSES | 47,354 | 46,420 | ||||||
OTHER OPERATING EXPENSES | 1,769 | 1,674 | ||||||
TOTAL LOSSES AND EXPENSES | 145,366 | 138,454 | ||||||
INCOME BEFORE INCOME TAXES | 39,189 | 19,241 | ||||||
INCOME TAX EXPENSE (BENEFIT): | ||||||||
CURRENT | 10,950 | 7,764 | ||||||
DEFERRED | 1,478 | (1,756 | ) | |||||
TOTAL INCOME TAX EXPENSE | 12,428 | 6,008 | ||||||
NET INCOME | $ | 26,761 | $ | 13,233 | ||||
OTHER COMPREHENSIVE INCOME, (LOSS), NET OF TAX: | ||||||||
HOLDING GAIN, (LOSS) ARISING DURING PERIOD | $ | 7,568 | $ | (3,941 | ) | |||
RECLASSIFICATION ADJUSTMENT | (1,156 | ) | 736 | |||||
OTHER COMPREHENSIVE INCOME, (LOSS) | 6,412 | (3,205 | ) | |||||
COMPREHENSIVE INCOME | $ | 33,173 | $ | 10,028 | ||||
PER AVERAGE SHARE DATA: | ||||||||
BASIC EARNINGS PER SHARE | $ | 1.22 | $ | 0.61 | ||||
DILUTED EARNINGS PER SHARE | $ | 1.16 | $ | 0.59 | ||||
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING | 22,018,270 | 21,865,269 | ||||||
WEIGHTED-AVERAGE SHARE EQUIVALENTS OUTSTANDING | 1,082,611 | 562,552 | ||||||
WEIGHTED-AVERAGE SHARES AND SHARE EQUIVALENTS OUTSTANDING | 23,100,881 | 22,427,821 | ||||||
The accompanying notes are an integral part of the consolidated financial statements.
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PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS’ EQUITY
For the Three | ||||||||
Months Ended | For the Year Ended | |||||||
March 31, 2004 | December 31, | |||||||
(Restated) | 2003 | |||||||
(Unaudited) | (Restated) | |||||||
COMMON SHARES: | ||||||||
BALANCE AT BEGINNING OF YEAR | 22,007,552 | 21,868,877 | ||||||
EXERCISE OF EMPLOYEE STOCK OPTIONS | 26,000 | 99,875 | ||||||
ISSUANCES OF SHARES PURSUANT TO STOCK PURCHASE PLANS, NET | 345 | 38,800 | ||||||
BALANCE AT END OF PERIOD | 22,033,897 | 22,007,552 | ||||||
TREASURY SHARES: | ||||||||
BALANCE AT BEGINNING OF YEAR | — | — | ||||||
SHARES REPURCHASED PURSUANT TO AUTHORIZATION | — | 10,000 | ||||||
EXERCISE OF EMPLOYEE STOCK OPTIONS | — | (6,500 | ) | |||||
ISSUANCES OF SHARES PURSUANT TO STOCK PURCHASE PLANS, NET | — | (3,500 | ) | |||||
BALANCE AT END OF PERIOD | — | — | ||||||
COMMON STOCK: | ||||||||
BALANCE AT BEGINNING OF YEAR | $ | 281,088 | $ | 276,945 | ||||
EXERCISE OF EMPLOYEE STOCK OPTIONS | 819 | 2,852 | ||||||
ISSUANCES OF SHARES PURSUANT TO STOCK PURCHASE PLANS | 44 | 1,291 | ||||||
BALANCE AT END OF PERIOD | 281,951 | 281,088 | ||||||
NOTES RECEIVABLE FROM SHAREHOLDERS: | ||||||||
BALANCE AT BEGINNING OF YEAR | (5,444 | ) | (6,407 | ) | ||||
NOTES RECEIVABLE (ISSUED) FORFEITURES PURSUANT TO EMPLOYEE STOCK PURCHASE PLANS | 25 | (1,065 | ) | |||||
COLLECTION OF NOTES RECEIVABLE | 373 | 2,028 | ||||||
BALANCE AT END OF PERIOD | (5,046 | ) | (5,444 | ) | ||||
ACCUMULATED OTHER COMPREHENSIVE INCOME, NET OF DEFERRED INCOME TAXES: | ||||||||
BALANCE AT BEGINNING OF YEAR | 16,715 | 16,185 | ||||||
OTHER COMPREHENSIVE INCOME, NET OF TAXES | 6,412 | 530 | ||||||
BALANCE AT END OF PERIOD | 23,127 | 16,715 | ||||||
RETAINED EARNINGS: | ||||||||
BALANCE AT BEGINNING OF YEAR | 253,287 | 191,100 | ||||||
NET INCOME | 26,761 | 62,187 | ||||||
BALANCE AT END OF PERIOD | 280,048 | 253,287 | ||||||
COMMON STOCK HELD IN TREASURY: | ||||||||
BALANCE AT BEGINNING OF YEAR | — | — | ||||||
EXERCISE OF EMPLOYEE STOCK OPTIONS | — | 94 | ||||||
COMMON SHARES REPURCHASED | — | (300 | ) | |||||
ISSUANCES OF SHARES PURSUANT TO STOCK PURCHASE PLANS | — | 206 | ||||||
BALANCE AT END OF PERIOD | — | — | ||||||
TOTAL SHAREHOLDERS’ EQUITY | $ | 580,080 | $ | 545,646 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
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PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the Three Months Ended March 31, | ||||||||
2004 | 2003 | |||||||
(Restated) | | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||
NET INCOME | $ | 26,761 | $ | 13,233 | ||||
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: | ||||||||
NET REALIZED INVESTMENT (GAIN) LOSS | (1,778 | ) | 1,133 | |||||
DEPRECIATION AND AMORTIZATION EXPENSE | 3,131 | 1,724 | ||||||
DEFERRED INCOME TAX EXPENSE, (BENEFIT) | 1,478 | (1,756 | ) | |||||
CHANGE IN PREMIUMS RECEIVABLE | 14,228 | (290 | ) | |||||
CHANGE IN OTHER RECEIVABLES | 3,761 | (779 | ) | |||||
CHANGE IN DEFERRED ACQUISITION COSTS | (13,069 | ) | (1,774 | ) | ||||
CHANGE IN INCOME TAXES PAYABLE | 8,612 | 5,450 | ||||||
CHANGE IN OTHER ASSETS | (895 | ) | (4,256 | ) | ||||
CHANGE IN UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES | 46,449 | 41,647 | ||||||
CHANGE IN UNEARNED PREMIUMS | 11,220 | 20,297 | ||||||
CHANGE IN FUNDS HELD PAYABLE TO REINSURER | 5,342 | — | ||||||
CHANGE IN OTHER LIABILITIES | 1,753 | 7,347 | ||||||
TAX BENEFIT FROM EXERCISE OF EMPLOYEE STOCK OPTIONS | 387 | — | ||||||
NET CASH PROVIDED BY OPERATING ACTIVITIES | 107,380 | 81,976 | ||||||
CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||
PROCEEDS FROM SALES OF INVESTMENTS IN FIXED MATURITIES | 17,051 | 6,504 | ||||||
PROCEEDS FROM MATURITY OF INVESTMENTS IN FIXED MATURITIES | 33,972 | 47,509 | ||||||
PROCEEDS FROM SALES OF INVESTMENTS IN EQUITY SECURITIES | 8,853 | 3,053 | ||||||
COST OF FIXED MATURITIES ACQUIRED | (146,682 | ) | (150,325 | ) | ||||
COST OF EQUITY SECURITIES ACQUIRED | (26,889 | ) | (1,850 | ) | ||||
PURCHASE OF PROPERTY AND EQUIPMENT, NET | (2,338 | ) | (1,104 | ) | ||||
NET CASH USED FOR INVESTING ACTIVITIES | (116,033 | ) | (96,213 | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||
PROCEEDS FROM LOANS PAYABLE | 20,084 | 15,161 | ||||||
REPAYMENTS ON LOANS PAYABLE | (21,504 | ) | (4,957 | ) | ||||
PROCEEDS FROM EXERCISE OF EMPLOYEE STOCK OPTIONS | 432 | — | ||||||
PROCEEDS FROM SHARES ISSUED PURSUANT TO STOCK PURCHASE PLANS | 69 | 19 | ||||||
PROCEEDS FROM COLLECTION OF NOTES RECEIVABLE | 373 | 396 | ||||||
COST OF COMMON STOCK REPURCHASED | — | (300 | ) | |||||
NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES | (546 | ) | 10,319 | |||||
NET DECREASE IN CASH AND CASH EQUIVALENTS | (9,199 | ) | (3,918 | ) | ||||
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR | 73,942 | 42,002 | ||||||
CASH AND CASH EQUIVALENTS AT END OF PERIOD | $ | 64,743 | $ | 38,084 | ||||
CASH PAID DURING THE PERIOD FOR: | ||||||||
INCOME TAXES | $ | 2,650 | $ | 1,930 | ||||
INTEREST | $ | 145 | $ | 134 | ||||
NON-CASH TRANSACTIONS: | ||||||||
ISSUANCE (FORFEITURES) OF SHARES PURSUANT TO EMPLOYEE STOCK PURCHASE PLAN IN EXCHANGE FOR NOTES RECEIVABLE | $ | (25 | ) | $ | (59 | ) |
The accompanying notes are an integral part of the consolidated financial statements.
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PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
1. | Basis of Presentation | |||
The consolidated financial statements as of and for the three months ended March 31, 2004 and 2003 are unaudited, but in the opinion of management have been prepared on the same basis as the annual audited consolidated financial statements and reflect all adjustments, (consisting of normal recurring adjustments and accruals and adjustments necessary to reflect the restatement discussed in Note 2), necessary for a fair statement of the information set forth therein. The results of operations for the three months ended March 31, 2004 are not necessarily indicative of the operating results to be expected for the full year or any other period. Certain prior years’ amounts have been reclassified for comparative purposes. | ||||
The consolidated financial statements for the period ended March 31, 2004 have been restated as further described in Note 2. | ||||
These financial statements should be read in conjunction with the financial statements and notes included in the Company’s Annual Reports on Form 10-K and Form 10-K/A, Amendment No. 1 as of and for the year ended December 31, 2003. | ||||
2. | Restatement of Financial Statements | |||
The Company’s previously issued consolidated balance sheets as of March 31, 2004 and December 31, 2003 and consolidated statements of operations and comprehensive income for the three months ended March 31, 2004, changes in shareholders’ equity for the three months ended March 31, 2004 and the year ended December 31, 2003 and cash flows for the period ended March 31, 2004 have been restated to record a portion of the revenue and net income arising from profit commissions under two reinsurance contracts. The revenue and net income of one of the contracts had originally been fully recorded in the fourth quarter 2003 although portions of such revenue and net income should have been recorded in the quarters ended June 30, 2003, September 30, 2003 and March 31, 2004. Portions of the revenue and net income for the other contract should have been recorded in the quarters ended June 30, 2003, September 30, 2003, December 31, 2003 and March 31, 2004. These profit commissions were due to the Company from reinsurers under a quota share reinsurance contract effective during the period April 1, 2003 through December 31, 2003 and an excess catastrophe reinsurance contract effective during the period June 1, 2003 through May 31, 2004. | ||||
The decision to restate resulted from an analysis of the accounting effect at the expiration of one of these reinsurance contracts. Based upon the provisions of Emerging Issues Task Force No. 93-6, “Accounting for Multiple – Year Retrospectively Rated Contracts by Ceding and Assuming Enterprises,” the Company determined that under generally acceptable accounting principles there was an error in the prior period financial statements and it should have been accruing a profit commission for each period since the inception of the contracts based on the actual experience of the underlying business. As a result, the Company has restated its aforementioned previously issued financial statements to include a portion of the revenue and net income arising from the profit commissions in each of the prior quarters that the contracts were in effect. |
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The effect of this restatement on the consolidated statement of operations and comprehensive income for the three months ended March 31, 2004 and on the consolidated balance sheet as of March 31, 2004 is shown in the tables below (in thousands, except per share amounts): | ||||
Consolidated Statement of Operations and Comprehensive Income Data |
Three Months Ended March 31, 2004 | ||||||||||||
As | ||||||||||||
Previously | Restatement | As | ||||||||||
Reported | Adjustment | Restated | ||||||||||
Net earned premiums | $ | 168,784 | $ | 2,638 | $ | 171,422 | ||||||
Total revenue | $ | 181,917 | $ | 2,638 | $ | 184,555 | ||||||
Income before income taxes | $ | 36,551 | $ | 2,638 | $ | 39,189 | ||||||
Income tax expense: deferred | $ | 555 | $ | 923 | $ | 1,478 | ||||||
Total income tax expense | $ | 11,505 | $ | 923 | $ | 12,428 | ||||||
Net income | $ | 25,046 | $ | 1,715 | $ | 26,761 | ||||||
Basic earnings per share | $ | 1.14 | $ | 0.08 | $ | 1.22 | ||||||
Diluted earnings per share | $ | 1.08 | $ | 0.08 | $ | 1.16 |
Consolidated Balance Sheet Data |
As of March 31, 2004 | ||||||||||||
As | ||||||||||||
Previously | Restatement | As | ||||||||||
Reported | Adjustment | Restated | ||||||||||
Deferred income taxes | $ | 15,169 | $ | (1,951 | ) | $ | 13,218 | |||||
Other assets | $ | 19,314 | $ | 5,576 | $ | 24,890 | ||||||
Total assets | $ | 1,975,077 | $ | 3,625 | $ | 1,978,702 | ||||||
Retained earnings | $ | 276,423 | $ | 3,625 | $ | 280,048 | ||||||
Total shareholders’ equity | $ | 576,455 | $ | 3,625 | $ | 580,080 | ||||||
Total liabilities and shareholders’ equity | $ | 1,975,077 | $ | 3,625 | $ | 1,978,702 |
3. | Investments | |||
The carrying amounts for the Company’s investments approximates their estimated fair value. The Company measures the fair value of investments based upon quoted market prices or by obtaining quotes from dealers. At March 31, 2004, the Company held no derivative financial instruments or embedded financial derivatives. | ||||
The Company performs various analytical procedures with respect to its investments, including identifying any security whose fair value is below its cost. Upon identification of such securities, a detailed review is performed for such securities, except interests in securitized assets, meeting predetermined thresholds to determine whether a decline in fair value below a security’s cost basis is other than temporary. If the Company determines a decline in value to be other than temporary, the cost basis of the security is written down to its fair value with the amount of the write down included in earnings as a realized loss in the period the impairment arose. Non-cash realized investment losses recorded for the three months ended March 31, 2004 and 2003 were $0 million and $0.9 million, respectively, as a result of the Company’s other than temporary impairment evaluation. | ||||
The Company’s impairment evaluation and recognition for interests in securitized assets is conducted in accordance with the guidance provided by the Emerging Issues Task Force of the Financial Accounting Standards Board. Under this guidance, impairment losses on securities must be recognized if both the fair value of the security is less than its book value and the net present value of expected future cash flows is less than the net present value of expected future cash flows at the most recent (prior) estimation date. If these criteria are met, an impairment charge, calculated as the difference between the current book value of the security and its fair value, is included in earnings as a realized loss in the period the impairment arose. Non-cash realized |
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investment losses recorded for the three months ended March 31, 2004 and 2003 were $1.0 million and $0.6 million, respectively, as a result of the Company’s impairment evaluation for investments in securitized assets. | ||||
The following table (in thousands) identifies the period of time securities with an unrealized loss at March 31, 2004 have continuously been in an unrealized loss position. Included in the amounts displayed in the table are $4.8 million of unrealized losses due to non-investment grade fixed maturity securities having a fair value of $20.6 million. No issuer of securities or industry represents more than 5.8% and 18.2%, respectively, of the total estimated fair value, or 18.6% and 46.9%, respectively, of the total gross unrealized loss included in the table below. As previously discussed, there are certain risks and uncertainties inherent in the Company’s impairment methodology, such as the financial condition of specific industry sectors and the resultant effect on underlying security collateral values. Should the Company subsequently determine a decline in the fair value below the cost basis to be other than temporary, the security would be written down to its fair value and the difference would be included in earnings as a realized loss for the period such determination was made. |
Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
Fixed Maturities: | Unrealized | Unrealized | Unrealized | |||||||||||||||||||||
Available for Sale | Fair Value | Losses | Fair Value | Losses | Fair Value | Losses | ||||||||||||||||||
U.S. Treasury Securities and Obligations of U.S. Government Corporations and Agencies | $ | 604 | $ | 5 | $ | — | $ | — | $ | 604 | $ | 5 | ||||||||||||
Obligations of States and Political Subdivisions | 71,993 | 884 | — | — | 71,993 | 884 | ||||||||||||||||||
Corporate and Bank Debt Securities | 17,557 | 185 | — | — | 17,557 | 185 | ||||||||||||||||||
Asset Backed Securities | 10,647 | 401 | 15,377 | 5,049 | 26,024 | 5,450 | ||||||||||||||||||
Mortgage Pass-Through Securities | 7,584 | 147 | — | — | 7,584 | 147 | ||||||||||||||||||
Collateralized Mortgage Obligations | 11,418 | 113 | 693 | 145 | 12,111 | 258 | ||||||||||||||||||
Total Fixed Maturities Available for Sale | 119,803 | 1,735 | 16,070 | 5,194 | 135,873 | 6,929 | ||||||||||||||||||
Equity Securities | 18,752 | 1,928 | — | — | 18,752 | 1,928 | ||||||||||||||||||
Total Investments | $ | 138,555 | $ | 3,663 | $ | 16,070 | $ | 5,194 | $ | 154,625 | $ | 8,857 | ||||||||||||
Based upon the Company’s impairment evaluation as of March 31, 2004, it was concluded that the remaining unrealized losses in the table above are not other than temporary. | ||||
4. | Restricted Assets | |||
The Insurance Subsidiaries have investments, principally U.S. Treasury securities, on deposit with the various states in which they are licensed insurers. At March 31, 2004 and December 31, 2003, the carrying value of the securities on deposit totaled $15.3 million and $15.5 million, respectively. | ||||
Additionally, the Insurance Subsidiaries have investments, principally asset backed securities, which collateralize the borrowings from the Federal Home Loan Bank of Pittsburgh, see Note 7. The carrying value of these investments was $56.7 million and $59.1 million as of March 31, 2004 and December 31, 2003, respectively. | ||||
5. | Goodwill | |||
The carrying amount of goodwill is subject to an annual impairment test to identify potential goodwill impairment and measure the amount of a goodwill impairment loss to be recognized (if any). As a result of the impairment analysis, no change in the carrying amount of goodwill was recorded by the Company for the year ended December 31, 2003. No events have occurred or circumstances have arisen subsequent to December 31, 2003 that would necessitate the Company to perform an interim impairment test. Consequently no change in the carrying amount of goodwill has been recorded for the three months ended March 31, 2004. |
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6. | Liability for Unpaid Loss and Loss Adjustment Expenses | |||
The liability for unpaid loss and loss adjustment expenses reflects the Company’s best estimate for future amounts needed to pay losses and related settlement expenses with respect to insured events which have occurred. The process of establishing the ultimate claims liability is necessarily a complex imprecise process, requiring the use of informed estimates and judgments using data currently available. The liability includes an amount determined on the basis of claim adjusters’ evaluations with respect to insured events that have occurred and an amount for losses incurred that have not been reported to the Company. In some cases significant periods of time, up to several years or more, may elapse between the occurrence of an insured loss and the reporting of such to the Company. The method for determining the Company’s liability for unpaid loss and loss adjustment expenses includes, but is not limited to, reviewing past loss experience and, industry data and considering other factors such as legal, social, and economic developments. The methods of making such estimates and establishing the resulting liabilities are regularly reviewed and updated and any adjustments there from are made in the accounting period in which the adjustment arose. If the Company’s ultimate losses, net of reinsurance, prove to differ substantially from the amounts recorded at March 31, 2004, the related adjustments could have a material adverse impact on the Company’s financial condition, and results of operations. | ||||
7. | Funds Held Payable To Reinsurer | |||
Effective April 1, 2003, the Company entered into a quota share reinsurance agreement. Under this agreement, the Company ceded 22% of its net written premiums and loss and loss adjustment expenses for substantially all of the Company’s lines of business on policies effective April 1, 2003 through December 31, 2003, and 10% of its commercial and specialty lines net written premiums and loss and loss adjustment expenses for policies effective January 1, 2004 and thereafter. The Company receives a provisional commission of 33.0% adjusted pro-rata based upon the ratio of losses incurred to premiums earned. Pursuant to this reinsurance agreement the Company withholds the reinsurance premium due the reinsurers reduced by the reinsurers’ expense allowance, and the Company’s ceding commission allowance in a Funds Held Payable to Reinsurer account. This Funds Held Payable to Reinsurer account is also reduced by ceded paid losses and loss adjustment expenses under this agreement, and increased by an interest credit. In addition, the agreement provides that a profit commission will be paid to the Company upon commutation equal to the positive balance in the Funds Held Payable to Reinsurer account. | ||||
Pursuant to the quota share reinsurance agreement, the Company ceded $18.3 million of net written premiums, $38.9 million of net earned premiums, $22.8 million in net loss and loss adjustment expenses, and earned $15.3 million in ceding commissions, for the three months ended March 31, 2004, respectively. In addition, the interest credit (expense), which is included in net investment income, for the three months ended March 31, 2004 was $1.1 million. The Company has also accrued a profit commission based upon the experience of the underlying business ceded to this reinsurance agreement, in the amount of $4.1 million for the three months ended March 31, 2004. The profit commission reduces ceded written and earned premiums. | ||||
8. | Loans Payable | |||
As of March 31, 2004, the Company had aggregate borrowings of $47.1 million from the Federal Home Loan Bank. These borrowings bear interest at adjusted LIBOR and mature twelve months from inception. The proceeds from these borrowings are invested in collateralized mortgage obligation and asset backed securities to achieve a positive spread between the rate of interest on these securities and the borrowing rates. |
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9. | Earnings Per Share | |||
Earnings per common share has been calculated by dividing net income for the period by the weighted average number of common shares and common share equivalents outstanding during the period. Following is the computation of earnings per share for the three months ended March 31, 2004 and 2003, respectively (in thousands, except per share data): |
For the Three Months | ||||||||
Ended March 31, | ||||||||
2004 | 2003 | |||||||
(Restated) | | |||||||
Weighted-Average Common Shares Outstanding | 22,018 | 21,865 | ||||||
Weighted-Average Share Equivalents Outstanding | 1,083 | 563 | ||||||
Weighted-Average Shares and Share Equivalents Outstanding | 23,101 | 22,428 | ||||||
Net Income | $ | 26,761 | $ | 13,233 | ||||
Basic Earnings per Share | $ | 1.22 | $ | 0.61 | ||||
Diluted Earnings per Share | $ | 1.16 | $ | 0.59 | ||||
10. | Income Taxes | |||
The effective tax rate differs from the 35% marginal tax rate principally as a result of tax-exempt interest income, the dividend received deduction and other differences in the recognition of revenues and expenses for tax and financial reporting purposes. | ||||
11. | Stock-Based Compensation | |||
Stock-based compensation plans are accounted for under the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, no compensation expense is recognized for fixed stock option grants and the Company’s stock purchase plans. The following table illustrates the effect on net income and earnings per share as if the provisions of statement of Financial Accounting Standards (SFAS) No. 123 (as amended by SFAS No. 148), “Accounting for Stock-Based Compensation,” had been applied for the three months ended March 31, 2004 and 2003, respectively: |
Three Months Ended March 31, | ||||||||
2004 | 2003 | |||||||
(In thousands, except per share data) | (Restated) | | ||||||
Net Income As Reported | $ | 26,761 | $ | 13,233 | ||||
Assumed Stock Compensation Cost | (794 | ) | (688 | ) | ||||
Pro Forma Net Income | $ | 25,967 | $ | 12,545 | ||||
Basic Earnings Per Share: | ||||||||
As Reported | $ | 1.22 | $ | 0.61 | ||||
Pro Forma | $ | 1.18 | $ | 0.57 | ||||
Diluted Earnings Per Share: | ||||||||
As Reported | $ | 1.16 | $ | 0.59 | ||||
Pro Forma | $ | 1.12 | $ | 0.56 | ||||
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12. | Reinsurance | |||
In the normal course of business, the Company has entered into various reinsurance contracts with unrelated reinsurers. The Company participates in such agreements for the purpose of limited loss exposure and diversifying business. Reinsurance contracts do not relieve the Company from its obligations to policyholders. The effect of reinsurance on premiums written and earned is as follows (See Note 7): |
(In thousands) For the Three Months Ended March 31, 2004 (Restated) |
Written | Earned | |||||||
Direct Business | $ | 250,861 | $ | 239,087 | ||||
Reinsurance Assumed | 1,576 | 2,130 | ||||||
Reinsurance Ceded | 49,857 | 69,795 | ||||||
Net Premiums | $ | 202,580 | $ | 171,422 | ||||
For the Three Months Ended March 31, 2003 |
Written | Earned | |||||||
Direct Business | $ | 192,312 | $ | 172,311 | ||||
Reinsurance Assumed | 970 | 675 | ||||||
Reinsurance Ceded | 21,634 | 24,624 | ||||||
Net Premiums | $ | 171,648 | $ | 148,362 | ||||
Certain of the Company’s reinsurance contracts have provisions whereby the Company is entitled to a return profit commission based on the ultimate experience of the underlying business ceded to the contracts. Under the terms of these contracts, the Company accrued profit commissions of $4.1 million for the three months ended March 31, 2004. The profit commissions reduce ceded written and earned premiums. | ||||
13. | Commitments and Contingencies | |||
The Company is subject to routine legal proceedings in connection with its property and casualty insurance business. The Company is not involved in any other pending or threatened legal or administrative proceedings which management believes can reasonably be expected to have a material adverse effect on the Company’s financial condition or results of operations. | ||||
14. | Comprehensive Income | |||
Components of comprehensive income, as detailed in the Consolidated Statements of Operations and Comprehensive Income, are net of tax. The related tax effect of Holding Gains (Losses) arising during the three months ended March 31, 2004 and 2003 was ($4.1) million and $2.1 million, respectively. The related tax effect of Reclassification Adjustments for the three months ended March 31, 2004 and 2003 was $0.6 million and ($0.4) million, respectively. | ||||
15. | Segment Information | |||
The Company’s operations are classified into three reportable business segments which are organized around its three underwriting divisions: The Commercial Lines Underwriting Group, which has underwriting responsibility for the Commercial Automobile and Commercial Property and Commercial multi-peril package insurance products; The Specialty Lines Underwriting Group, which has underwriting responsibility for the professional liability insurance products; and The Personal Lines Group, which designs, markets and underwrites personal property and casualty insurance products for the Manufactured Housing and Homeowners markets. Each business segment’s responsibilities include: pricing, managing the risk selection process and |
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monitoring the loss ratios by product and insured. The reportable segments operate solely within the United States and have not been aggregated. | ||||
The segments follow the same accounting policies used for the Company’s consolidated financial statements as described in the summary of significant accounting policies. Management evaluates a segment’s performance based upon premium production and the associated loss experience which includes paid losses, an amount determined on the basis of claim adjusters’ evaluation with respect to insured events that have occurred and an amount for losses incurred that have not been reported. Investments and investment performance including investment income and net realized investment gain (loss), acquisition costs and other underwriting expenses including commissions, premium taxes and other acquisition costs, and other operating expenses are managed at a corporate level by the corporate accounting function in conjunction with other corporate departments, and are included in “Corporate”. |
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Following is a tabulation of business segment information for the three months ended March 31, 2004 and 2003. Corporate information is included to reconcile segment data to the consolidated financial statements (in thousands): |
Commercial | Specialty | Personal | ||||||||||||||||||
Lines | Lines | Lines | Corporate | Total | ||||||||||||||||
March 31, 2004 (Restated): | ||||||||||||||||||||
Gross Written Premiums | $ | 175,072 | $ | 47,393 | $ | 29,972 | $ | — | $ | 252,437 | ||||||||||
Net Written Premiums | $ | 144,742 | $ | 40,050 | $ | 17,788 | $ | — | $ | 202,580 | ||||||||||
Revenue: | ||||||||||||||||||||
Net Earned Premiums | $ | 133,521 | $ | 29,413 | $ | 8,488 | $ | — | $ | 171,422 | ||||||||||
Net Investment Income | — | — | — | 9,973 | 9,973 | |||||||||||||||
Net Realized Investment Gain | — | — | — | 1,778 | 1,778 | |||||||||||||||
Other Income | — | — | 1,143 | 239 | 1,382 | |||||||||||||||
Total Revenue | 133,521 | 29,413 | 9,631 | 11,990 | 184,555 | |||||||||||||||
Losses and Expenses: | ||||||||||||||||||||
Net Loss and Loss Adjustment Expenses | 73,909 | 18,055 | 4,279 | — | 96,243 | |||||||||||||||
Acquisition Costs and Other Underwriting Expenses | — | — | — | 47,354 | 47,354 | |||||||||||||||
Other Operating Expenses | — | — | 245 | 1,524 | 1,769 | |||||||||||||||
Total Losses and Expenses | 73,909 | 18,055 | 4,524 | 48,878 | 145,366 | |||||||||||||||
Income Before Income Taxes | 59,612 | 11,358 | 5,107 | (36,888 | ) | 39,189 | ||||||||||||||
Total Income Tax Expense | — | — | — | 12,428 | 12,428 | |||||||||||||||
Net Income | $ | 59,612 | $ | 11,358 | $ | 5,107 | $ | (49,316 | ) | $ | 26,761 | |||||||||
Total Assets | $ | — | $ | — | $ | 291,431 | $ | 1,687,271 | $ | 1,978,702 | ||||||||||
March 31, 2003: | ||||||||||||||||||||
Gross Written Premiums | $ | 127,897 | $ | 40,387 | $ | 24,998 | $ | — | $ | 193,282 | ||||||||||
Net Written Premiums | $ | 120,353 | $ | 37,317 | $ | 13,978 | $ | — | $ | 171,648 | ||||||||||
Revenue: | ||||||||||||||||||||
Net Earned Premiums | $ | 109,258 | $ | 29,118 | $ | 9,986 | $ | — | $ | 148,362 | ||||||||||
Net Investment Income | — | — | — | 9,805 | 9,805 | |||||||||||||||
Net Realized Investment Loss | — | — | — | (1,133 | ) | (1,133 | ) | |||||||||||||
Other Income | — | — | 580 | 81 | 661 | |||||||||||||||
Total Revenue | 109,258 | 29,118 | 10,566 | 8,753 | 157,695 | |||||||||||||||
Losses and Expenses: | ||||||||||||||||||||
Net Loss and Loss Adjustment Expenses | 65,938 | 18,641 | 5,781 | — | 90,360 | |||||||||||||||
Acquisition Costs and Other Underwriting Expenses | — | — | — | 46,420 | 46,420 | |||||||||||||||
Other Operating Expenses | — | — | 325 | 1,349 | 1,674 | |||||||||||||||
Total Losses and Expenses | 65,938 | 18,641 | 6,106 | 47,769 | 138,454 | |||||||||||||||
Income Before Income Taxes | 43,320 | 10,477 | 4,460 | (39,016 | ) | 19,241 | ||||||||||||||
Total Income Tax Expense | — | — | — | 6,008 | 6,008 | |||||||||||||||
Net Income | $ | 43,320 | $ | 10,477 | $ | 4,460 | $ | (45,024 | ) | $ | 13,233 | |||||||||
Total Assets | $ | — | $ | — | $ | 232,292 | $ | 1,226,511 | $ | 1,458,803 | ||||||||||
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PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Restatement of Financial Statements
The Company’s previously issued financial statements for the quarterly period ended March 31, 2004 have been restated to record a portion of the revenue and net income arising from profit commissions under two reinsurance contracts, one of which had originally been recorded in the fourth quarter 2003 and the other of which should have been recorded in previous periods. These profit commissions were due to the Company from reinsurers under a quota share reinsurance contract effective during the period April 1, 2003 through December 31, 2003 and an excess catastrophe reinsurance contract effective during the period June 1, 2003 through May 31, 2004. See Note 2 of Notes to Consolidated Financial Statements for more information.
The impact of this restatement on the previously reported results of operations for the three months ended March 31, 2004 was to increase net income by $1.7 million ($0.08 diluted earnings per share). The restatement also resulted in an increase to net earned premium in the amount of $2.6 million for the three months ended March 31, 2004, and an increase to the previously reported retained earnings balance as of March 31, 2004 in the amount of $3.6 million. References herein to those fiscal periods that have been restated are to the restated amounts.
General
Although the Company’s financial performance is dependent upon its own specific business characteristics, certain risk factors can affect the profitability of the Company. These include, but are not limited to:
• | Industry factors — Historically the financial performance of the property and casualty insurance industry has tended to fluctuate in cyclical patterns of soft markets followed by hard markets. The Company’s strategy is to focus on underwriting profits, and accordingly the Company’s marketing organization is being directed into those niche businesses that exhibit the greatest potential for underwriting profits. |
• | Competition — The Company competes in the property and casualty business with other domestic and international insurers having greater financial and other resources than the Company. |
• | Financial Strength Rating — If A.M. Best Company downgrades the rating of the Company’s insurance subsidiaries the Company may not be able to compete as effectively with its commercial and specialty lines competitors. |
• | Regulation — The Company’s insurance subsidiaries are subject to a substantial degree of regulatory oversight, which generally is designed to protect the interests of policyholders, as opposed to shareholders. |
• | Litigation — Adverse rulings in any material litigation to which the Company is a party could materially affect its financial position and results of operations. |
• | Inflation — Property and casualty insurance premiums are established before the amount of losses and loss adjustment expenses, or the extent to which inflation may affect such amounts is known. |
• | Investment Risk — Substantial future increases in interest rates could result in a decline in the market value of the Company’s investment portfolio and resulting losses and/or reduction in shareholders’ equity. |
• | Claims development and the process of estimating loss reserves – Estimating the Company’s ultimate liability for unpaid loss and loss adjustment expenses is necessarily a complex and judgmental process, inasmuch as the amounts of any ultimate liability of the Company with respect to such claims are based on management’s informed estimates and judgments using data currently available. |
• | Catastrophe Exposure – The Company’s insurance subsidiaries issue insurance policies which provide coverage for commercial and personal property and casualty risks. It is possible that a catastrophic event could |
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PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Continued)
greatly increase claims under the insurance policies the insurance subsidiaries issue. Catastrophes may result from a variety of events or conditions, including hurricanes, windstorms, earthquakes, hail and other severe weather conditions and may include terrorist events. It is possible that a catastrophic event could adversely impact profitability. |
• | Reinsurance – The adequacy of reinsurance coverage which may be obtained by the Company and the ability and willingness of the Company’s reinsurers to pay. |
The above risk factors should be read in conjunction with the Certain Critical Accounting Estimates and Judgments included in the Company’s Annual Report on Form 10-K and Form 10-K/A Amendment No. 1 for the Fiscal Year Ended December 31, 2003.
Investments
The Company’s investment objective is the realization of relatively high levels of investment income while generating competitive after-tax total rates of return within a prudent level of risk and within the constraints of maintaining adequate securities in amount and duration to meet cash requirements of current operations and long-term liabilities, as well as maintaining and improving the Company’s A.M. Best rating. The Company utilizes external independent professional investment managers for its fixed maturity and equity investments. These investments consist of diversified issuers and issues, and as of March 31, 2004, approximately 88.0% and 7.6% of the total invested assets (total investments plus cash equivalents) on a cost basis consisted of investments in fixed maturity and equity securities, respectively, versus 87.8% and 6.6%, respectively, at December 31, 2003.
During 2004 the relative percentage investment in tax-exempt fixed maturity securities versus taxable fixed maturity securities increased, due to the Company taking advantage of the more favorable after-tax yields. As of March 31, 2004, on a cost basis, investment grade tax-exempt fixed maturity securities represented 39.6% of the total invested assets, compared to 39.2% as of the end of 2003.
Asset backed, mortgage pass through, and collateralized mortgage obligation securities, on a cost basis, amounted to $167.1 million, $183.0 million and $47.6 million, respectively, as of March 31, 2004 and $183.0 million, $159.2 million and $53.8 million, respectively, as of December 31, 2003. The asset backed, mortgage pass through, and collateralized mortgage obligation investments are amortizing securities possessing favorable prepayment risk and/or extension profiles.
The Company regularly performs various analytical procedures with respect to its investments, including identifying any security whose fair value is below its cost. Upon identification of such securities, a detailed review is performed for all securities, except interests in securitized assets, meeting predetermined thresholds to determine whether such decline is other than temporary. If the Company determines a decline in value to be other than temporary, based upon its detailed review, or if a decline in value for an equity investment has persisted continuously for nine months, the cost basis of the security is written down to its fair value. The factors considered in reaching the conclusion that a decline below cost is other than temporary include, but are not limited to, whether: the issuer is in financial distress; the investment is secured; a significant credit rating action has occurred; scheduled interest payments have been delayed or missed; or changes in laws and/or regulations have impacted an issuer or industry. The amount of any write down is included in earnings as a realized loss in the period the impairment arose. This evaluation resulted in non-cash realized investment losses of $0 million and $0.9 million for the three months ended March 31, 2004 and 2003, respectively. Such non-cash realized investment losses resulted from other than temporary declines in the fair value of certain holdings in the Company’s common stock portfolio occurring primarily in the fourth quarter of 2002 and the first quarter of 2003. The Company primarily attributes these other than temporary declines in fair value to the uncertain economic climate, the overhang of corporate governance issues, and the high profile bankruptcies occurring during 2002 into early 2003.
Additionally, the Company conducts its impairment evaluation and recognition for interests in securitized assets in accordance with the guidance provided by the Emerging Issues Task Force of the Financial Accounting Standards
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PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Continued)
Board (“EITF”) in EITF 99-20. Under this guidance, impairment losses on securities must be recognized if both the fair value of the security is less than its book value and the net present value of expected future cash flows is less than the net present value of expected future cash flows at the most recent (prior) estimation date. If these criteria are met, an impairment charge, calculated as the difference between the current book value of the security and its fair value, is included in earnings as a realized loss in the period the impairment arose. This evaluation resulted in non-cash realized investment losses of $1.0 million and $0.6 million for the three months ended March 31, 2004 and 2003, respectively. These non-cash realized investment losses were primarily due to investments in collateralized bond obligations as a result of the non investment grade default rates which remain higher than historic averages.
The Company’s fixed maturity portfolio amounted to $1,186.9 million and $1,081.7 million, as of March 31, 2004 and December 31, 2003, respectively, of which 98.3% and 98.6% of the portfolio for as of March 31, 2004 and December 31, 2003, respectively, was comprised of investment grade securities. From the fourth quarter of 2001 into early 2003 following the war in Iraq, U.S. investment grade securities experienced varying price and ratings volatility, having been affected by the uncertain economic climate, corporate governance issues, and the subsequent stream of corporate scandals and high profile bankruptcies. More recently certain sectors of the investment grade security market have continued to lag despite a return to a more favorable economic climate. However, the high quality of the Company’s overall “AA+” rated fixed maturity portfolio, has mitigated potential volatility. The Company had fixed maturity investments with unrealized losses amounting to $6.9 million and $10.6 million as of March 31, 2004 and December 31, 2003, respectively. Of these amounts, interests in securitized assets had unrealized losses amounting to $5.8 million and $9.2 million as of March 31, 2004 and December 31, 2003, respectively. As discussed above, the Company’s impairment evaluation and recognition for interests in securitized assets is conducted in accordance with the guidance provided by the EITF.
The following table identifies the period of time securities with an unrealized loss at March 31, 2004 have continuously been in an unrealized loss position. Included in the amounts displayed in the table are $4.8 million of unrealized losses due to non-investment grade fixed maturity securities having a fair value of $20.6 million. No issuer of securities or industry represents more than 5.8% and 18.2%, respectively, of the total estimated fair value, or 18.6% and 46.9%, respectively, of the total gross unrealized loss included in the table below. As previously discussed, there are certain risks and uncertainties inherent in the Company’s impairment methodology, such as the financial condition of specific industry sectors and the resultant effect on underlying security collateral values. Should the Company subsequently determine a decline in the fair value below the cost basis to be other than temporary, the security would be written down to its fair value and the difference would be included in earnings as a realized loss for the period such determination was made.
Gross Unrealized Losses(1) | ||||||||||||||||||||
(in millions) | ||||||||||||||||||||
Fixed Maturities | ||||||||||||||||||||
Continuous | Available for Sale | Total | ||||||||||||||||||
time in unrealized | Excluding Interests | Interests in | Fixed Maturities | |||||||||||||||||
loss position | in Securitized Assets | Securitized Assets | Available for Sale | Equity Securities | Total Investments | |||||||||||||||
0 – 3 months | $ | 0.8 | $ | 0.3 | $ | 1.1 | $ | 0.3 | $ | 1.4 | ||||||||||
3 – 6 months | 0.1 | — | 0.1 | 1.6 | 1.7 | |||||||||||||||
6 – 9 months | ��� | 0.2 | 0.2 | — | 0.2 | |||||||||||||||
9 – 12 months | 0.2 | 0.1 | 0.3 | — | 0.3 | |||||||||||||||
12 – 18 months | — | — | — | — | — | |||||||||||||||
18 – 24 months | — | 2.8 | 2.8 | — | 2.8 | |||||||||||||||
> 24 months | — | 2.4 | 2.4 | — | 2.4 | |||||||||||||||
Total Gross Unrealized Losses | $ | 1.1 | $ | 5.8 | $ | 6.9 | $ | 1.9 | $ | 8.8 | ||||||||||
Estimated fair value of securities with a gross unrealized loss | $ | 90.2 | $ | 45.7 | $ | 135.9 | $ | 18.7 | $ | 154.6 | ||||||||||
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PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Continued)
The following table presents certain information with respect to individual securities with a significant unrealized loss position as of March 31, 2004.
Significant Unrealized Losses by Security
(in millions)
Issuer | Security Type | Carrying Value | Unrealized Loss(1) | |||||||
Batterson Park CBO I CLC 144A | Equity Security-Equity Tranche of Securitized Asset | $ | 0.0 | $ | 1.2 | |||||
Conseco Fin SEC Corp 2000-4 M1 | Fixed Maturity – Interest in Securitized Assets | 0.5 | 1.6 | |||||||
Conseco Fin SEC Corp SER 2000-4 M2 | Fixed Maturity – Interest in Securitized Assets | 0.1 | 1.0 | |||||||
Greentree Financial Corp. 99-2 B1 | Fixed Maturity – Interest in Securitized Assets | 0.2 | 1.6 | |||||||
$ | 0.8 | $ | 5.4 | |||||||
(1) | Based upon the Company’s impairment evaluation as of March 31, 2004 utilizing cash flow assumptions of the supporting collateral, estimated default and recovery rates it was concluded that the remaining unrealized losses in the Gross Unrealized Losses and Significant Unrealized Losses by Security tables are temporary. |
For the three months ended March 31, 2004 the Company’s gross loss on the sale of fixed maturity and equity securities amounted to $0.2 million and $0.1 million, respectively. The fair value of the fixed maturity and equity securities at the time of sale was $2.8 million and $1.5 million, respectively. For the three months ended March 31, 2003 the Company’s gross loss on the sale of fixed maturity and equity securities amounted to $0 million and $0.5 million, respectively. The fair value of the fixed maturity and equity securities at the time of sale was $0 million and $1.4 million, respectively. The decision to sell these securities was based upon an assessment of economic conditions.
Results of Operations (Three Months ended March 31, 2004 (Restated) vs. March 31, 2003)
Premiums: Premium information for the three months ended March 31, 2004 vs. March 31, 2003 for the Company’s business segments is as follows (in millions):
Commercial Lines | Specialty Lines | Personal Lines | Total | |||||||||||||
2004 Gross Written Premiums | $ | 175.0 | $ | 47.4 | $ | 30.0 | $ | 252.4 | ||||||||
2003 Gross Written Premiums | $ | 127.9 | $ | 40.4 | $ | 25.0 | $ | 193.3 | ||||||||
Percentage Increase | 36.8 | % | 17.3 | % | 20.0 | % | 30.6 | % | ||||||||
2004 Gross Earned Premiums | $ | 178.8 | $ | 39.3 | $ | 23.1 | $ | 241.2 | ||||||||
2003 Gross Earned Premiums | $ | 120.7 | $ | 31.6 | $ | 20.7 | $ | 173.0 | ||||||||
Percentage Increase | 48.1 | % | 24.4 | % | 11.6 | % | 39.4 | % |
The overall growth in gross written premiums is primarily attributable to the following:
• | Further rating downgrades of certain major competitor property and casualty insurance companies have led to their diminished presence in the Company’s commercial and specialty lines business segments and continue to result in additional prospects and increased premium writings, most notably for the Company’s various commercial package and non-profit D&O product lines. |
• | The displacement of certain competitor property and casualty insurance companies and their independent agency relationships continues to result in new agency relationship opportunities for the Company. These relationship opportunities have resulted in additional policyholders and premium writings for the Company’s commercial and specialty lines segments. |
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PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Continued)
• | Continued expansion of marketing efforts relating to commercial lines and specialty lines products through the Company’s field organization and preferred agents. |
• | In-force policy counts as of March 31, 2004 versus March 31, 2003 have increased 10.6% and 33.8% for the commercial and specialty lines segments, respectively, primarily as a result of the factors discussed above. Policy counts were approximately the same for the personal lines segment as a result of restricting new business and not renewing certain business to manage overall property exposures and the related catastrophe loss considerations. However, due to a recent termination of a brokering agreement, Liberty American has recently commenced writing a previously brokered homeowners product on a direct basis. Gross written premiums from this homeowners product approximated $2.4 million for the three months ended March 31, 2004. Firming prices in the property and casualty industry resulted in weighted average rate increases on renewal business approximating 4.3%, 2.8%, and 13.4% for the commercial, specialty and personal lines segments, respectively. |
The respective net written premium changes for commercial lines, specialty lines and personal lines segments for the three months ended March 31, 2004 vs. March 31, 2003 were (in millions):
Commercial Lines | Specialty Lines | Personal Lines | Total | |||||||||||||
2004 Net Written Premiums (Restated) | $ | 144.7 | $ | 40.1 | $ | 17.8 | $ | 202.6 | ||||||||
2003 Net Written Premiums | $ | 120.3 | $ | 37.3 | $ | 14.0 | $ | 171.6 | ||||||||
Percentage Increase | 20.3 | % | 7.5 | % | 27.1 | % | 18.1 | % | ||||||||
2004 Net Earned Premiums (Restated) | $ | 133.5 | $ | 29.4 | $ | 8.5 | $ | 171.4 | ||||||||
2003 Net Earned Premiums | $ | 109.3 | $ | 29.1 | $ | 10.0 | $ | 148.4 | ||||||||
Percentage Increase (Decrease) | 22.1 | % | 1.0 | % | (15.0 | %) | 15.5 | % |
The differing percentage changes in net premiums versus gross premiums for the commercial lines, specialty lines and personal lines segments during the quarter results primarily from the following change in the Company’s reinsurance program:
• | Effective April 1, 2003, the Company entered into a Quota Share reinsurance agreement covering substantially all of the Company’s lines of business. Under this agreement, the Company cedes 22% of its net written premium and loss and loss adjustment expenses for policies effective April 1, 2003 through December 31, 2003 and 10% of its commercial and specialty lines net written premium and loss and loss adjustment expenses for policies effective January 1, 2004 and thereafter. The Company receives a provisional commission of 33.0% adjusted based upon the ratio of losses incurred to premiums earned. Pursuant to this reinsurance agreement the Company withholds the reinsurance premium, reduced by the reinsurers’ expense allowance, and the Company’s ceding commission allowance in a Funds Held Payable to Reinsurer account. This Funds Held Payable to Reinsurer account is also reduced by ceded paid losses and loss adjustment expenses under this agreement, and increased by an interest credit. In addition, the agreement provides that a profit commission will be paid to the Company upon commutation equal to the positive balance in the Funds Held Payable to Reinsurers account During the three months ended March 31, 2004, the Company ceded $17.8 million of net written premiums and $38.4 million of net earned premiums. |
Net Investment IncomeNet investment income approximated $10.0 for the three months ended March 31, 2004 and $9.8 million for the same period of 2003. Total investments grew to $1,298.1 million at March 31, 2004 from $1,002.4 million at March 31, 2003. The growth in investment income is due to investing net cash flows provided from operating activities. The Company’s average duration of its fixed income portfolio increased to approximately 3.9 years at March 31, 2004, compared to 3.2 years at March 31, 2003 as a result of investing in overall “AAA” rated intermediate to longer tax exempt fixed income securities due to their perceived relative value to taxable alternatives. The Company’s taxable equivalent book yield on its fixed income holdings approximated 4.8% at March 31, 2004 and 2003, respectively. Net investment income was reduced by $1.1 million due to the
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Continued)
interest credit on the Funds Held Account balance pursuant to the Company’s quota share reinsurance agreement (see Premiums).
The total return, which includes the effects of both income and price returns on securities, of the Company’s fixed income portfolio was 1.82% and 0.97% for the three months ended March 31, 2004 and 2003, respectively, and was similar to the Lehman Brothers Intermediate Aggregate Bond Index (“the Index”) total return of 2.27% and 1.27% for the same periods, respectively. The Company expects some variation in its portfolio’s total return compared to the index because of the differing sector, security and duration composition of its portfolio compared to the index.
Net Realized Investment Gain (Loss):Net realized investment gains (losses) were $1.8 million for the three months ended March 31, 2004 and ($1.1) million for the same period in 2003. The Company realized net investment gains of $0.5 million and $2.3 million from the sale of fixed maturity and equity securities, respectively, for the three months ended March 31, 2004, and $1.0 million in non-cash realized investment losses for fixed maturity investments as a result of the Company’s impairment evaluations.
The Company realized $0.4 million in net investment gains from the sale of fixed maturity securities for the three months ended March 31, 2003. Additionally, $0.9 million and $0.6 million in non-cash realized investment losses were recorded for common stock and fixed maturity investments, respectively as a result of the Company’s impairment evaluations.
Other Income: Other income approximated $1.4 million for the three months ended March 31, 2004 and $0.7 million for the same period of 2003. Other income primarily consists of commissions earned on brokered personal lines business, and to a lesser extent brokered commercial lines business. The Company seeks to increase brokering activities in its personal lines segment as a means of diversifying its growth and managing property and related catastrophe loss exposures. However, a broker market recently terminated its brokering agreement with the Company. Other income from this brokering agreement amounted to $0.4 million and $2.6 million for the three months ended March 31, 2004 and year ended December 31, 2003, respectively. The Company is currently writing this previously brokered business on a direct basis (See Premiums).
Net Loss and Loss Adjustment Expenses:Net loss and loss adjustment expenses increased $5.8 million (6.4%) to $96.2 million for the three months ended March 31, 2004 from $90.4 million for the same period of 2003 and the loss ratio decreased to 56.1% in 2004 from 60.9% in 2003. This increase in net loss and loss adjustment expenses was due to the 13.8% growth in net earned premiums. The decrease in the loss ratio is primarily attributed to price increases realized on its renewal business and to a lesser extent a reduction in large property losses during the three months ended March 31, 2004 versus March 31, 2003. Additionally, during the three months ended March 31, 2004 the Company ceded $38.9 million of net earned premium and $22.8 million in net loss and loss adjustment expenses pursuant to the quota share reinsurance agreement (see Premiums).
Acquisition Costs and Other Underwriting Expenses:Acquisition costs and other underwriting expenses increased $1.0 million (2.2%) to $47.4 million for the three months ended March 31, 2004 from $46.4 million for the same period of 2003 and the expense ratio decreased to 27.6% in 2004 from 31.3% in 2003. The increase in acquisition costs and other underwriting expenses was due primarily to the 13.8% growth in net earned premiums. This increase was offset in part by and the decrease in the expense ratio is due primarily to ceding commissions earned under the quota share reinsurance agreement (See Premiums). For the three months ended March 31, 2004 the Company ceded $38.9 million of net earned premium and earned $15.3 million in ceding commission.
Other Operating Expenses: Other operating expenses increased $0.1 million to $1.8 million for the three months ended March 31, 2004 from $1.7 million for the same period of 2003 as the Company continues to control its expenses during this period of premium growth.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Continued)
Income Tax Expense:The Company’s effective tax rate for the three months ended March 31, 2004 and 2003 was 31.7% and 31.2%, respectively. The effective rates differed from the 35% statutory rate principally due to investments in tax-exempt securities and the relative proportion of tax exempt income to total income before tax.
Liquidity and Capital Resources
For the three months ended March 31, 2004, the Company’s investments experienced unrealized investment appreciation of $6.4 million, net of the related deferred tax expense of $3.5 million. At March 31, 2004, the Company had total investments with a carrying value of $1,298.1 million, of which 91.4% consisted of investments in fixed maturity securities, including U.S. treasury securities and obligations of U.S. government corporations and agencies, obligations of states and political subdivisions, corporate debt securities, collateralized mortgage securities and asset backed securities. The collateralized mortgage securities and asset backed securities consist of amortizing securities possessing favorable pre-payment and/or extension risk profiles. The remaining 8.6% of the Company’s total investments consisted primarily of publicly traded common stock securities.
The Company produced net cash from operations of $107.4 million and $82.0 million, respectively, for the three months ended March 31, 2004 and 2003. Sources of operating funds consist primarily of net premiums collected and investment income. Funds are used primarily to pay claims and operating expenses and for the purchase of investments. The source of cash from operations for the three months ended March 31, 2004 was primarily generated from strong premium growth during the current year due to increases in the number of policies written and price increases realized on renewal business. Net loss and loss expense payments were $64.4 million and $48.5 million, respectively, for the three months ended March 31, 2004 and 2003. Management believes that the Company has adequate liquidity to pay all claims and meet all other cash needs.
Two of the Company’s insurance subsidiaries are members of the Federal Home Loan Bank of Pittsburgh (“FHLB”). A primary advantage of FHLB membership is the ability of members to access credit products from a reliable capital markets provider. The availability of any one member’s access to credit is based upon its FHLB eligible collateral. At March 31, 2004 the insurance subsidiaries’ borrowing capacity was $139.8 million. The insurance subsidiaries have utilized a portion of their borrowing capacity to purchase a diversified portfolio in investment grade floating rate securities. These purchases were funded by floating rate FHLB borrowings to achieve a positive spread between the rate of interest on these securities and borrowing rates. The remaining borrowing capacity will provide an immediately available line of credit. Borrowings aggregated $47.1 million at March 31, 2004, bear interest at adjusted LIBOR, mature twelve months from inception and are collateralized by $56.7 million of the Company’s fixed maturity securities. The weighted-average interest rate on borrowings outstanding as of March 31, 2004 was 1.2%.
Risk-based capital is a method developed by the NAIC designed to measure the acceptable amount of capital and surplus an insurer should have based on the inherent specific risks of each insurer. The adequacy of a company’s actual capital and surplus is evaluated by a comparison to the risk-based capital results. Insurers failing to meet minimum risk-based capital requirements may be subject to scrutiny by the insurer’s domiciliary insurance department and ultimately rehabilitation or liquidation. Based on the standards currently adopted, the Company’s insurance subsidiaries capital and surplus is in excess of the prescribed risk-based capital requirements.
Forward-Looking Information
Certain information included in this report and other statements or materials published or to be published by the Company are not historical facts but are forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new and existing products, expectations for market segment and growth, and similar matters. In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, the Company provides the following cautionary remarks regarding important factors which, among others, could cause the Company’s actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company’s forward-looking statements. The risks and uncertainties that may affect the operations, performance, development, results of the Company’s business, and
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Continued)
the other matters referred to above include, but are not limited to: (i) changes in the business environment in which the Company operates, including inflation and interest rates; (ii) changes in taxes, governmental laws, and regulations; (iii) competitive product and pricing activity; (iv) difficulties of managing growth profitably; (v) claims development and the adequacy of our liability for unpaid loss and loss adjustment; (vi) severity of natural disasters and other catastrophe losses; (vii) adequacy of reinsurance coverage which may be obtained by the Company; (viii) ability and willingness of our reinsurers to pay; and (ix) future terrorist attacks.
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(a) Evaluation of Disclosure Controls and Procedures. The Company’s disclosure controls and procedures, as that term is defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are designed with the objective of providing reasonable assurance that information required to be disclosed in the Company’s reports filed or submitted under the Exchange Act, such as this report, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (the “SEC”). In designing and evaluating the Company’s disclosure controls and procedures, management recognizes that any disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable, rather than absolute, assurance of achieving the desired control objectives.
An evaluation was performed in April 2004 by management, with the participation of the Company’s chief executive officer (“CEO”) and chief financial officer (“CFO”), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by the Company’s previously filed Quarterly Report on Form 10-Q for the Quarterly Period Ended March 31, 2004. Based on this evaluation, the CEO and CFO had concluded that, as of the end of the period covered by such Quarterly Report on Form 10-Q, the Company’s disclosure controls and procedures were effective to ensure that material information relating to the Company and its consolidated subsidiaries would be made known to them by others within such entities, particularly during the period in which such Quarterly Report on Form 10-Q was being prepared.
In connection with the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004, an evaluation was performed by management, with the participation of the Company’s chief executive officer (“CEO”) and chief financial officer (“CFO”), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by such Quarterly Report. Based on this evaluation, the CEO and CFO have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, subject to the matters set forth in the following paragraph.
As a result of the Company’s restatement of certain of its financial statements, as referred to in Item 2 — Restatement of Financial Statements of this report, to include a portion of its revenue and net income in prior periods arising from profit commissions under two reinsurance contracts, the Company has determined that it should enhance its documentation and research as to its understanding of appropriate accounting for reinsurance transactions. In connection therewith, the Company:
1. | Formed a new reinsurance contract subcommittee with senior members from appropriate departments within the Company to review, discuss and make appropriate conclusions with respect to the documentation requirements and the accounting for the Company’s reinsurance contracts; | |||
2. | Will, as promptly as practicable, add an additional accounting professional to its staff whose responsibility will be to spend substantially all of his or her working time researching and documenting technical accounting matters (including reinsurance matters), as well as supporting other members of the Company’s accounting staff and the reinsurance contract subcommittee. |
The Company’s independent auditors, PricewaterhouseCoopers LLP, have advised the Company that there is a material weakness in the Company’s internal controls over the accounting and reporting for reinsurance contracts. The Company anticipates that its implementation of the matters set forth in the immediately preceding paragraph will correct the material weakness.
(b) Changes in Internal Controls. There has been no change in the Company’s internal control over financial reporting during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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Item 6. Exhibits and Reports on Form 8-K
a. | Exhibits: |
Exhibit No. | Description | |
31.1* | Certification of the Company’s chief executive officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated August 19, 2004 | |
31.2* | Certification of the Company’s chief financial officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated August 19, 2004 | |
32.1* | Certification of the Company’s chief executive officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated August 19, 2004 | |
32.2* | Certification of the Company’s chief financial officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated August 19, 2004 |
* Filed herewith.
b. | The Company did not file any reports on Form 8-K during the quarterly period ended March 31, 2004 but did furnish the following reports: |
Date of Report | Item Reported | |
February 12, 2004 | Fourth Quarter Results December 31, 2003 and Regulation FD Disclosure | |
February 24, 2004 | February 24, 2004 Investor Presentation |
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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 by the undersigned thereunto duly authorized.
PHILADELPHIA CONSOLIDATED HOLDING CORP. | ||||
Registrant | ||||
Date August 19, 2004 | Craig P. Keller | |||
Craig P. Keller | ||||
Executive Vice President, Secretary, Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer) |
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