UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended MARCH 31, 2003
or ______
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ______ to ______.
Commission file number 0-16533
ProAssurance Corporation
- -------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 63-1261433
- ------------------------------- ----------------------
(State or other jurisdiction of (IRS Employer
incorporation of organization) Identification ID No.)
100 Brookwood Place, Birmingham, AL 35209
- --------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(205) 877-4400
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (l) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
As of March 31, 2003 there were 28,921,444 shares of the registrant's common
stock outstanding.
Page 1 of 33
ProAssurance Corporation
Form 10Q
Table of Contents
Part I - Financial Information
Item l. Condensed Consolidated Financial Statements (Unaudited)
of ProAssurance Corporation and Subsidiaries
Condensed Consolidated Balance Sheets ....................... 4
Condensed Consolidated Statements of Changes in Capital ..... 5
Condensed Consolidated Statements of Income ................. 6
Condensed Consolidated Statements of Comprehensive Income ... 7
Condensed Consolidated Statements of Cash Flows ............. 8
Notes to Condensed Consolidated Financial Statements ........ 9
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ................................... 17
Item 3. Quantitative and Qualitative Disclosures about Market Risk ........ 29
Item 4. Controls and Procedures ........................................... 30
Part II - Other Information
Item 1. Legal Proceedings ................................................. 31
Item 6. Exhibits and Reports on Form 8-K .................................. 31
Signatures ................................................................ 31
Certifications ............................................................ 32
PART 1 - FINANCIAL INFORMATION
3
PROASSURANCE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
MARCH 31 December 31
2003 2002
----------- -----------
ASSETS
Investments:
Fixed maturities available for sale, at fair value $ 1,552,023 $ 1,328,897
Equity securities available for sale, at fair value 77,845 80,197
Real estate, net 17,530 17,549
Short-term investments 172,433 252,854
----------- -----------
Total investments 1,819,831 1,679,497
Cash and cash equivalents 46,429 143,306
Premiums receivable 132,528 111,028
Receivable from reinsurers on unpaid losses
and loss adjustment expenses 469,693 462,012
Prepaid reinsurance premiums 22,058 21,294
Deferred taxes 72,200 73,091
Other assets 108,531 96,422
----------- -----------
$ 2,671,270 $ 2,586,650
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Policy liabilities and accruals:
Reserve for losses and loss adjustment expenses $ 1,675,467 $ 1,622,468
Unearned premiums 289,879 248,371
Reinsurance premiums payable 61,474 62,549
----------- -----------
Total policy liabilities 2,026,820 1,933,388
Other liabilities 61,272 49,198
Long-term debt 70,000 72,500
----------- -----------
Total liabilities 2,158,092 2,055,086
Minority interest -- 26,370
Commitments and contingencies -- --
Stockholders' Equity:
Common stock, par value $0.01 per share
100,000,000 shares authorized; 29,043,209
and 28,998,917 shares issued, respectively 290 290
Additional paid-in capital 309,443 308,501
Accumulated other comprehensive gain, net of deferred tax
expense of $19,515 and $19,612, respectively 36,238 35,545
Retained earnings 167,263 160,914
----------- -----------
513,234 505,250
Less treasury stock, at cost, 121,765 shares (56) (56)
----------- -----------
Total stockholders' equity 513,178 505,194
----------- -----------
$ 2,671,270 $ 2,586,650
=========== ===========
4
PROASSURANCE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN CAPITAL (UNAUDITED)
(IN THOUSANDS)
ACCUMULATED
OTHER
COMPREHENSIVE RETAINED OTHER CAPITAL
TOTAL INCOME (LOSS) EARNINGS ACCOUNTS
--------- ------------- --------- -------------
Balance at December 31, 2002 $ 505,194 $ 35,545 $160,914 $308,735
Net income 6,349 -- 6,349 --
Change in fair value of securities available for sale, net of
reclassification adjustments and deferred taxes (193) (193) -- --
Acquisition of minority interest 886 886 -- --
Common stock issued for compensation 942 -- -- 942
--------- -------- -------- --------
Balance at March 31, 2003 $ 513,178 $ 36,238 $167,263 $309,677
========= ======== ======== ========
Accumulated
Other
Comprehensive Retained Other Capital
Total Income (Loss) Earnings Accounts
--------- ------------- --------- -------------
Balance at December 31, 2001 $ 413,231 $ 3,533 $148,707 $260,991
Net income 3,672 -- 3,672 --
Change in fair value of securities available for sale, net of
reclassification adjustments, deferred taxes and minority
interest (7,760) (7,760) -- --
Common stock issued for compensation 962 -- -- 962
Stock options exercised 3 -- -- 3
--------- ------- -------- --------
Balance at March 31, 2002 $ 410,108 $(4,227) $152,379 $261,956
========= ======= ======== ========
5
PROASSURANCE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Three Months Ended
March 31
---------------------------
2003 2002
--------- ---------
Revenues:
Gross premiums written $ 202,660 $ 181,113
========= =========
Net premiums written $ 178,936 $ 151,800
========= =========
Premiums earned $ 161,153 $ 132,466
Premiums ceded 22,957 21,977
--------- ---------
Net premiums earned 138,196 110,489
Net investment income 17,248 19,202
Net realized investment gains (losses) 1,007 (1,119)
Other income 1,659 1,601
--------- ---------
Total revenues 158,110 130,173
Expenses:
Losses and loss adjustment expenses 145,646 130,297
Reinsurance recoveries 20,598 23,098
--------- ---------
Net losses and loss adjustment expenses 125,048 107,199
Underwriting, acquisition and insurance expenses 24,422 20,982
Interest expense 578 769
--------- ---------
Total expenses 150,048 128,950
--------- ---------
Income (loss) before income taxes, minority interest and cumulative effect of
accounting change 8,062 1,223
Provision for income taxes:
Current expense (benefit) 558 1,001
Deferred expense (benefit) 974 (2,160)
--------- ---------
1,532 (1,159)
--------- ---------
Income (loss) before minority interest and cumulative effect of accounting 6,530 2,382
change
Minority interest 181 404
--------- ---------
Income (loss) before cumulative effect of accounting change 6,349 1,978
Cumulative effect of accounting change, net of tax -- 1,694
--------- ---------
Net income (loss) $ 6,349 $ 3,672
========= =========
Earnings per share (basic and diluted):
Income (loss) before cumulative effect of accounting change $ 0.22 $ 0.08
Cumulative effect of accounting change, net of tax -- 0.06
--------- ---------
Net income (loss) $ 0.22 $ 0.14
========= =========
Weighted average number of common shares outstanding:
Basic 28,893 25,851
========= =========
Diluted 29,003 25,865
========= =========
6
PROASSURANCE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(IN THOUSANDS)
Three Months Ended
March 31
---------------------------
2003 2002
------- -------
Comprehensive income:
Net income (loss) $ 6,349 $ 3,672
Change in fair value of securities available for sale,
net of deferred taxes and minority interest 462 (8,487)
Reclassification adjustment for realized (gains) losses
included in income, net of deferred taxes (655) 727
------- -------
Comprehensive income (loss) $ 6,156 $(4,088)
======= =======
7
PROASSURANCE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
Three Months Ended
March 31
-------------------------------
2003 2002
--------- ---------
OPERATING ACTIVITIES
Net cash provided (used) by operating activities $ 72,522 $ 55,079
INVESTING ACTIVITIES
Purchases of fixed maturities available for sale (352,899) (234,996)
Purchases of equity securities available for sale (404) (4,041)
Proceeds from sale or maturities of fixed maturities available for sale 129,116 163,961
Proceeds from sale of equity securities available for sale 1,895 2,906
Net decrease in short-term investments 80,422 37,549
Other 8,219 408
--------- ---------
Net cash provided (used) by investing activities (133,651) (34,213)
FINANCING ACTIVITIES
Repayment of debt (2,500) (2,500)
Purchase of minority interest (33,248) --
--------- ---------
Net cash provided (used) by financing activities (35,748) (2,500)
Increase (decrease) in cash and cash equivalents (96,877) 18,366
Cash and cash equivalents at beginning of period 143,306 53,163
--------- ---------
Cash and cash equivalents at end of period $ 46,429 $ 71,529
========= =========
8
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2003
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
include the accounts of ProAssurance Corporation and its subsidiaries
(collectively "ProAssurance"). The financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
for interim financial information and with instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and notes required by accounting principles generally accepted in
the United States for complete financial statements. In the opinion of
management, all adjustments, consisting of normal recurring adjustments,
considered necessary for a fair presentation have been included. Operating
results for the three month period ended March 31, 2003 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2003.
ProAssurance grants stock options to key employees under its Incentive
Compensation Stock Plan ("the ProAssurance Plan") and accounts for such stock
options under the recognition and measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related Interpretations ("APB
25"). In compliance with APB 25, ProAssurance has not recognized compensation
expense in 2003 or 2002 related to options granted under the ProAssurance Plan,
as all options have been granted with an exercise price equal to the market
value of the underlying common stock on the date of grant. The following table
illustrates the effect on net income (in thousands) and earnings per share as if
ProAssurance had applied the fair value recognition provisions of Statement of
Financial Accounting Standard (SFAS) No. 123, Accounting for Stock-Based
Compensation, to options granted under the ProAssurance Plan.
THREE MONTHS ENDED MARCH 31
-------------------------------
2003 2002
---------- ---------
Net income, as reported $ 6,349 $ 3,672
Deduct: Total stock-based employee compensation expense determined
under fair value based method for all awards, net of related
tax effects (150) (188)
---------- ---------
Pro forma net income $ 6,199 $ 3,484
========== =========
Earnings per share:
Basic--as reported $ 0.22 $ 0.14
========== =========
Basic--pro forma $ 0.21 $ 0.13
========== =========
Diluted--as reported $ 0.22 $ 0.14
========== =========
Diluted--pro forma $ 0.21 $ 0.13
========== =========
In 2003, ProAssurance granted 305,000 options under the plan. The
options granted during 2003 have an exercise price of $22 per share. The
estimated fair value of each option is $8.46, using the Black-Scholes option
pricing model and the following model assumptions: risk-free interest rate of
3.1%; volatility of 0.34; expected life of 6 years; and dividend yield of 0%.
9
2. SEGMENT INFORMATION
ProAssurance operates in the United States of America in two
reportable industry segments: the professional liability insurance segment and
the personal lines segment.
The professional liability insurance segment principally provides
professional liability insurance and reinsurance for providers of health care
services, and to a limited extent, providers of legal services. The
professional liability segment includes the operating results of four
significant insurance companies: The Medical Assurance Company, Inc., Medical
Assurance of West Virginia Inc., ProNational Insurance Company (ProNational),
and Red Mountain Casualty Insurance Company, Inc.
The personal lines segment provides personal auto, homeowners, boat
and umbrella coverages primarily to educational employees and their families
through a single insurance company, MEEMIC Insurance Company, Inc. ("MEEMIC").
The accounting policies of each segment are consistent with those
described in Note 1. Other than cash and marketable securities owned directly
by the parent company, the identifiable assets of ProAssurance are allocated to
the reportable operating segments. Except for investment income earned directly
by the parent company and interest expense related to long-term debt held by
the parent company, all revenues and expenses of ProAssurance are allocated to
the operating segments for purposes of SFAS No. 131, Disclosures about Segments
of an Enterprise and Related Information. Revenue is primarily from
unaffiliated customers and the effects of transactions between segments have
been eliminated.
10
2. SEGMENT INFORMATION (CONTINUED)
The table below provides a reconciliation of segment information to
total consolidated information (in thousands).
THREE MONTHS ENDED MARCH 31
-------------------------------
2003 2002
--------- ---------
Revenues:
Professional liability lines $ 114,874 $ 92,603
Personal lines 43,174 37,570
Corporate investment income 62 --
--------- ---------
Total revenues $ 158,110 $ 130,173
========= =========
Income (loss) before cumulative effect of accounting change:
Professional liability lines $ 1,805 $ 327
Personal lines 4,879 2,151
Corporate (335) (500)
--------- ---------
Total $ 6,349 $ 1,978
========= =========
Net income (loss):
Professional liability lines $ 1,805 $ 2,021
Personal lines 4,879 2,151
Corporate (335) (500)
--------- ---------
Total net income (loss) $ 6,349 $ 3,672
========= =========
MARCH 31 2003 DECEMBER 31 2002
------------- ----------------
Identifiable Assets:
Professional liability lines $2,308,662 $2,184,551
Personal lines 361,913 372,086
Corporate 695 30,013
---------- ----------
Total assets $2,671,270 $2,586,650
========== ==========
11
3. INVESTMENTS
The amortized cost of fixed maturities and equity securities available
for sale was $1.574 billion and $1.353 billion at March 31, 2003 and December
31, 2002, respectively. Operating results for the three months ended March 31,
2003 and 2002 included the following (in thousands):
THREE MONTHS ENDED MARCH 31
------------------------------
2003 2002
-------- ---------
Proceeds from sales excluding maturities
and paydowns $ 79,384 $ 114,214
Gross realized gains 1,827 1,946
Gross realized (losses) (531) (1,065)
Other than temporary impairment losses (289) (2,000)
-------- ---------
Net realized investment gains (losses) $ 1,007 $ (1,119)
======== =========
4. RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
ProAssurance establishes reserves for losses and loss adjustment
expenses based on its estimates of the future amounts necessary to pay claims
and expenses associated with investigation and settlement of claims.
ProAssurance considers expected outcomes for individual claims and actuarially
determined estimates of future losses based on ProAssurance's past loss
experience, available industry data and projections as to future claims
frequency, severity, inflationary trends and settlement patterns. ProAssurance
believes that the methods it uses to establish reserves are reasonable and
appropriate. However, estimating reserves, especially professional liability
reserves, is a complex process which is heavily dependent on judgment and
involves many uncertainties. As a result, reserve estimates may vary
significantly from the eventual outcome. The assumptions used in establishing
ProAssurance's reserves are regularly reviewed and updated by management as new
data becomes available. Any adjustments necessary are reflected in current
operations.
ProAssurance's management believes the unearned premiums under
contracts together with the related anticipated investment income to be earned,
are adequate to discharge the related contract liabilities.
5. DEFERRED POLICY ACQUISITION COSTS
Costs that vary with and are directly related to the production of new
and renewal premiums (primarily premium taxes, commissions and underwriting
salaries) are deferred to the extent they are recoverable against unearned
premiums and are amortized as related premiums are earned. Amortization of
deferred acquisition costs, net of ceding commissions earned, amounted to
approximately $12.0 million and $8.9 million for the three months ended March
31, 2003 and 2002, respectively.
12
6. INCOME TAXES
The provision for income taxes is different from that which would be
obtained by applying the statutory Federal income tax rate to income before
taxes because a portion of ProAssurance's investment income is tax-exempt.
7. LONG-TERM DEBT
On June 27, 2001, ProAssurance borrowed $110 million under a term loan
facility in order to fund the consolidation. At March 31, 2003 the remaining
outstanding balance under the loan was $70 million.
The debt requires quarterly principal repayments of $2.5 million.
ProAssurance must also repay an additional annual installment equal to 50% of
the adjusted parent-only annual cash flow for the preceding annual period, up
to a maximum of $15 million. No cash flow repayment is required in 2003 because
the adjusted 2002 parent-only cash flow was a negative amount. ProAssurance has
made all required quarterly repayments on the loan.
Excluding any required annual cash flow repayments, the aggregate
remaining amounts of maturities of long-term debt for the next five years are
as follows: $7.5 million for 2003, $10 million each year in 2004 and 2005, and
in 2006 the remaining balance becomes due on May 31.
The debt bears interest at a variable rate based on the London
Interbank Offered Rate (LIBOR) or the bank's base rate as elected from time to
time by ProAssurance. At March 31, 2003 the interest rate was 2.8%.
The term loan is part of a credit facility provided to ProAssurance by
a bank syndicate under the terms of a credit agreement that also provides for a
revolving line of credit in the amount of $40 million. ProAssurance has not
borrowed any funds under the revolving line of credit. Should ProAssurance
choose to do so, the borrowed funds are repayable when the line expires in May
2003. ProAssurance currently expects to renew the line at its expiration date.
13
7. LONG-TERM DEBT (CONTINUED)
The credit agreement, as is customary for credit agreements of this
size and nature, requires that ProAssurance maintain certain financial
standards, otherwise known as loan covenants, including:
- a consolidated debt coverage ratio of 3.0 to 1;
- minimum consolidated tangible net worth equal to the sum of
(i) 90% of the consolidated net worth of ProAssurance as of
June 30, 2001, and (ii) 75% of cumulative consolidated net
income after June 30, 2001;
- a consolidated fixed charge coverage ratio of 1.5 to 1;
- a funded debt to adjusted statutory capital ratio of 0.35 to
1; and
- maintenance of statutory Risk-Based Capital ratios (as
defined by the National Association of Insurance
Commissioners and measured annually on December 31) of 3.5 to
1 by two of its insurance companies, The Medical Assurance
Company, Inc. and ProNational Insurance Company.
As of March 31, 2003, ProAssurance was in compliance with the
aforementioned loan covenants.
8. STOCKHOLDERS' EQUITY
At March 31, 2003 ProAssurance had 100 million shares of authorized
common stock and 50 million shares of authorized preferred stock. The Board of
Directors has the authorization to determine the provisions for the issuance of
shares of the preferred stock, including the number of shares to be issued and
the designations, powers, preferences and rights and the qualifications,
limitations or restrictions of such shares. At March 31, 2003, the Board of
Directors had not authorized the issuance of any preferred stock nor determined
any provisions for the preferred stock.
9. COMMITMENTS AND CONTINGENCIES
ProAssurance is involved in various legal actions arising primarily
from claims related to insurance policies. At other times legal actions may
arise from claims asserted by policyholders. The legal actions arising from
these claims have been considered by ProAssurance in establishing its reserves.
While the outcome of all legal actions is not presently determinable,
ProAssurance's management is of the opinion, based on consultation with legal
counsel, that the settlement of these actions will not have a material adverse
effect on ProAssurance's financial position but could have an unfavorable impact
on quarterly results of operation.
14
10. CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE AND NEW ACCOUNTING
PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued
SFAS No. 141 "Business Combinations". SFAS No. 141 requires that the purchase
method of accounting be used for all business combinations with a closing date
after June 30, 2001. SFAS No. 141 includes guidance on the initial recognition
and measurement of goodwill and other intangible assets in a business
combination. The FASB has also issued SFAS No. 142 "Goodwill and Other
Intangible Assets" effective for fiscal years beginning after December 15, 2001.
SFAS No. 142 addresses how goodwill and other intangible assets should be
accounted for in financial statements upon acquisition and how these items
should be accounted for subsequent to acquisition. SFAS No. 142 does not presume
that goodwill and all other intangible assets are wasting assets requiring
amortization. Instead, goodwill and intangible assets that have indefinite
useful lives are tested at least annually for impairment. ProAssurance does not
believe that any of its recorded goodwill or intangible assets has suffered
impairment.
ProAssurance adopted SFAS Nos. 141 and 142 effective January 1, 2002.
Upon adoption, ProAssurance discontinued amortizing its recorded goodwill and
deferred credits and wrote-off unamortized deferred credits of $1.7 million
that existed at December 31, 2001 related to business combinations completed
prior to July 1, 2001. The write-off was recognized as the cumulative
effect of a change in accounting principle. There was no tax effect related to
the write-off because the deferred credits were not amortizable for tax
purposes.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure," which amends the
disclosure provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation." SFAS No. 148 became effective for financial statements for fiscal
years ending after December 15, 2002. ProAssurance has adopted the provisions of
SFAS No. 148.
11. MINORITY INTEREST
On January 29, 2003 ProAssurance's indirect subsidiary, MEEMIC
Holdings, Inc. (MEEMIC Holdings) repurchased all of the outstanding shares of
its common stock that were not owned by ProAssurance's subsidiary, ProNational.
MEEMIC Holdings used its internal funds in the approximate amount of $34.1
million to acquire 1,062,298 shares of its common stock, to pay for outstanding
options representing 120,000 shares, and to pay the expenses of the transaction.
The funds were derived from MEEMIC Holdings' cash and investment resources. As a
result of the transaction MEEMIC Holdings is now a wholly owned indirect
subsidiary of ProAssurance. ProAssurance recognized goodwill of $7.6 million
related to the transaction. Income for the three months ended March 31, 2003 was
reduced by the income attributable (16%) to the MEEMIC Holdings minority
interest for the period from January 1, 2003 to January 29, 2003. MEEMIC
Holdings is the 100% owner of MEEMIC.
15
12. EARNINGS PER SHARE
The following represents a reconciliation from the basic to the
diluted numerator and denominator used in calculating the diluted earnings per
share (amounts are in thousands, except per share data):
THREE MONTHS ENDED
MARCH 31
---------------------------
2003 2002
------- --------
BASIC EARNINGS PER SHARE CALCULATION:
Numerator:
Income before cumulative effect of accounting change $ 6,349 $ 1,978
Cumulative effect of accounting change -- 1,694
------- --------
Net income $ 6,349 $ 3,672
======= ========
Denominator:
Weighted average number of common shares outstanding 28,893 25,851
======= ========
Basic earnings per share:
Income before cumulative effect of accounting change $ 0.22 $ 0.08
Cumulative effect of accounting change -- 0.06
------- --------
Net income $ 0.22 $ 0.14
======= ========
DILUTED EARNINGS PER SHARE CALCULATION:
Numerator:
Income before cumulative effect of accounting change $ 6,349 $ 1,978
Dilutive effect of stock options held by minority shareholders -- (27)
------- --------
Income before cumulative effect of accounting change--diluted computation
6,349 1,951
Cumulative effect of accounting change -- 1,694
------- --------
Net income--diluted computation $ 6,349 $ 3,645
======= ========
Denominator:
Weighted average number of common shares outstanding 28,893 25,851
Assumed conversion of dilutive stock options and awards 110 14
------- --------
Diluted weighted average number of common shares outstanding 29,003 25,865
======= ========
Diluted earnings per share
Income before cumulative effect of accounting change $ 0.22 $ 0.08
Cumulative effect of accounting change -- 0.06
------- --------
Net income $ 0.22 $ 0.14
======= ========
Approximately 328,000 and 663,000 employee stock options were
excluded from the computation of diluted earnings per share for the period
ending March 31, 2003 and 2002. The effect of including the options would have
been antidilutive to earnings per share because the exercise price of the
options was more than the average stock price during the quarter.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
We are required to make estimates and assumptions in certain
circumstances that affect amounts reported in our consolidated financial
statements and related footnotes. We evaluate these estimates and assumptions
on an on-going basis based on historical developments, market conditions,
industry trends and other information that we believe to be reasonable under
the circumstances. There can be no assurance that actual results will conform
to our estimates and assumptions, and that reported results of operations will
not be materially adversely affected from time to time by the need to make
accounting adjustments reflecting changes in these estimates and assumptions.
We believe the following policies are the most sensitive to estimates and
judgments.
Premium Income: We recognize insurance premium income on a monthly pro
rata basis over the respective terms of the policies in force. Unearned
premiums represent the portion of premiums written applicable to the unexpired
terms of the policies in force.
Reserve for Losses and Loss Adjustment Expenses ("losses and LAE"):
Our reserve for losses and LAE represents our estimate of the future amounts
necessary to pay claims and expenses associated with investigation and
settlement of claims. These estimates consist of case reserves and bulk
reserves. Case reserves are estimates of future losses and LAE for reported
claims and are established by our claims departments. Bulk reserves, which
include a provision for losses that have occurred but have not been reported to
us as well as development on reported claims, are the difference between (i)
the sum of case reserves and paid losses and (ii) an actuarially determined
estimate of the total losses and LAE necessary for the ultimate settlement of
all reported claims and incurred but not reported claims, including amounts
already paid. The estimates take into consideration our past loss experience,
available industry data and projections as to future claims frequency,
severity, inflationary trends and settlement patterns. Independent actuaries
review our reserves for losses and LAE each year and prepare reports that
include recommendations as to the level of reserves. We consider these
recommendations as well as other factors, such as known, anticipated or
estimated changes in frequency and severity of claims and loss retention levels
and premium rates, in establishing the amount of our reserves for losses and
LAE. Estimating professional liability reserves is a particularly complex
process because such estimates reflect multiple judgments involving many
uncertainties made over an extended period of time, often exceeding five years,
during which these claims are resolved. Our reserve estimates may vary
significantly from the eventual outcome. The assumptions used in establishing
our reserves are regularly reviewed and updated by management as new data
becomes available. Any adjustments necessary are reflected in current
operations. Due to the size of our reserves, even a small percentage adjustment
to the assumptions can have a material effect on our results of operations for
the period in which the change is made.
Reinsurance: Loss recoveries and receivables from reinsurers are
estimates of the ultimate amount of our losses and LAE that will be reimbursed
by reinsurers. We also estimate premiums ceded under reinsurance agreements
wherein the premium, subject to certain maximums and minimums, due to the
reinsurer is a percentage of the losses paid under the agreement. These
estimates are based upon our estimates of the ultimate losses and LAE that we
expect to incur and the portion of those losses that we expect to be allocable
to reinsurers based upon the terms of our reinsurance agreements. Given the
uncertainty of the ultimate amounts of our losses and LAE, these estimates may
vary significantly from the eventual outcome. Our estimates of the amounts
receivable from and due to reinsurers are regularly reviewed and updated by
management as new data becomes available, including data regarding the
collectibility of the recorded amounts receivable from reinsurers. Any
adjustments necessary are reflected in then current operations. At March 31,
2003, all receivables from reinsurers are considered collectible.
Investments: We consider our fixed maturity and equity securities as
available-for-sale, which means they are available to be sold in response to
our liquidity needs, changes in market interest rates and investment management
strategies, among others. Available-for-sale securities are recorded at fair
value, with unrealized gains and losses, net of the related income tax effect,
excluded from income and reported as a separate component of shareholders'
equity.
17
We evaluate the securities in our investment portfolio on at least a
quarterly basis for declines in market value below cost for the purpose of
determining whether these declines represent other than temporary declines. The
evaluation involves judgment by management. Some of the factors we consider in
the evaluation of our investments are:
- the extent to which the market value of the security is less
than its cost basis
- the length of time for which the market value of the security
has been less than its cost basis
- the financial condition and near-term prospects of the
security's issuer, taking into consideration the economic
prospects of the issuers' industry and geographical region,
to the extent that information is publicly available
- ProAssurance's ability and intent to hold the investment for
a period of time sufficient to allow for any anticipated
recovery in market value
A decline in the fair value of an available-for-sale security below
cost that we judge to be other than temporary is realized as a loss in the
current period and reduces the cost basis of the security. In subsequent
periods, we base any measurement of gain or loss or decline in value upon the
adjusted cost basis of the security.
LIQUIDITY AND CAPITAL RESOURCES
We need liquid funds to pay losses and loss adjustment expenses
(losses and LAE) and operating expenses in the ordinary course of business and
to meet our debt service requirements. Cash provided by our operating
activities was sufficient to meet those needs during the three months ended
March 31, 2003. We believe that our operating activities will provide
sufficient cash to meet our liquidity needs during the next twelve months.
Our reserves for net losses and LAE (net of amounts receivable from
reinsurers) at March 31, 2003 increased approximately $45.3 million over those
at December 31, 2002. Substantially all of this increase is in our professional
liability segment, a "long tailed" business. A characteristic of a "long
tailed" business is that there is a long length of time between the occurrence
of an insured event and significant payment on that event. Because of this
characteristic, it is not unusual for reserves to increase.
Our positive cash flow from operations for the three months ended
March 31, 2003 of $72.5 million primarily results from timing delays that exists
between the collection of premiums and the payment of losses and from growth in
our premiums written, which is discussed in more detail in the following
section, "Results of Operations".
Investments and cash and cash equivalents increased by approximately
$43.5 million during the first quarter of 2003. The increase primarily resulted
from the cash flow from operations offset by the funds that were expended to
purchase the MEEMIC Holdings, Inc. (MEEMIC Holdings) minority interest as
discussed below.
On January 29, 2003 ProAssurance's subsidiary, MEEMIC Holdings
repurchased all of the outstanding shares of its common stock that were not
owned by ProAssurance's subsidiary, ProNational Insurance Company
(ProNational). MEEMIC Holdings used its internal funds in the approximate
amount of $34.1 million to acquire 1,062,298 shares of its common stock, to pay
for outstanding options representing 120,000 shares, and to pay the expenses of
the transactions. The funds were derived from MEEMIC Holdings' cash and
investment resources. As a result of the transaction MEEMIC Holdings is
18
now a wholly owned indirect subsidiary of ProAssurance. Goodwill of
approximately $7.6 million was recorded related to the transaction.
At March 31, 2003 we have a term loan balance of $70.0 million
remaining from the $110 million that we borrowed in order to fund the cash
requirements of the consolidation with Professionals Group. We are required to
pay quarterly principal repayments of $2.5 million and an additional principal
payment is determined annually based on a formula related to parent-only cash
flow. The formula does not require an additional principal payment in 2003. We
have made all quarterly payments on the loan. The term loan bears interest at a
variable rate based on the London Interbank Offered Rate (LIBOR) or the bank's
base rate at our election. At March 31, 2003 the interest rate was 2.8%.
The credit agreement also provides for a revolving line of credit in
the amount of $40 million that is available for our operating and working
capital requirements. We have not borrowed any funds under the line and
currently expect to renew the line at the same or similar terms when the line
expires on May 31, 2003.
The borrowings under the credit agreement are secured by a pledge of
the outstanding stock of all of our significant subsidiaries other than MEEMIC
Holdings and its subsidiaries. The credit agreement for the term loan, as is
customary for credit agreements of this size and nature, requires that
ProAssurance maintain certain financial standards, otherwise known as loan
covenants. As of March 31, 2003 we were in compliance with all loan covenants.
See Note 7 to our Condensed Consolidated Financial Statements for more
information regarding the terms of the credit agreement, including the
financial covenants.
Our board has authorized stock repurchases of up to approximately one
million shares. We have not repurchased any shares of our common stock against
this authorization in 2003.
RESULTS OF OPERATIONS - THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THREE
MONTHS ENDED MARCH 31, 2002
OVERVIEW
We operate in two industry segments: professional liability insurance
and personal lines insurance.
Our professional liability insurance segment principally provides
liability insurance and reinsurance for providers of health care services, and,
to a limited extent, providers of legal services. The principal operating
insurance subsidiaries of this segment are: The Medical Assurance Company,
Inc., Medical Assurance of West Virginia, Inc., ProNational Insurance Company
and Red Mountain Casualty Insurance Company, Inc.
Our personal lines insurance segment provides personal property and
casualty insurance to individuals. Our personal lines segment includes the
operations of a single insurance company, MEEMIC Insurance Company, Inc.
All of our revenues and expenses are allocated to the operating
segments, other than investment income earned directly by the parent holding
company and interest expense related to long-term debt held by the parent.
Our consolidated net income is $6.3 million, or $0.22 per share, for
the three months ended March 31, 2003. The operating results of each of our
reportable industry segments are discussed separately in the following
sections.
19
Interest expense of $578,000 in 2003 and $769,000 in 2002 relates
entirely to the bank loan that provided financing for the consolidation with
Professionals Group. The debt bears interest at a variable rate based on the
London Interbank Offered Rate (LIBOR), or at our election, the bank's base
rate. The interest rate is 2.8% on March 31, 2003.
Interest expense decreased during 2003 as compared to 2002 both because
the average outstanding balance on the loan was $10 million lower in 2003 and
because interest rates were lower in 2003.
Our effective tax rate for both periods is significantly lower than
the expected 35% statutory tax rate because of investment income earned from
tax-exempt sources. After adjustment for tax-exempt income, we have net taxable
income for the three months ended March 31, 2003 as compared to a net taxable
loss for the three months ended March 31, 2002.
We have available approximately $10.1 million in Federal tax loss
carryforwards available for use against our 2003 or later tax liability. These
carryforwards expire in 2021.
Minority interest in both 2003 and 2002 relates entirely to the
minority interest in the income of MEEMIC Holdings. As discussed under
"Liquidity and Capital Resources" this minority interest was purchased on
January 29, 2003. In 2003, earnings were allocable to the minority interest
only for the period from January 1 to January 29 while in 2002, earnings were
allocable to the minority interest for the entire period.
20
PROFESSIONAL LIABILITY INSURANCE SEGMENT
Operating results for our professional liability insurance segment for
the three months ended March 31, 2003 and 2002 are summarized in the table
below (dollars in thousands).
THREE MONTHS ENDED
MARCH 31
----------------------------------------------------
INCREASE
2003 2002 (DECREASE)
-------- --------- ---------
Gross premiums written $158,249 $ 141,841 $ 16,408
======== ========= ========
Net premiums written $138,823 $ 114,801 $ 24,022
======== ========= ========
Revenues:
Premiums earned $116,898 $ 95,681 $ 21,217
Premiums ceded 18,661 19,697 (1,036)
-------- --------- --------
Net premiums earned 98,237 75,984 22,253
Net investment income 14,612 16,603 (1,991)
Net realized investment gains (losses) 832 (1,119) 1,951
Other income 1,193 1,135 58
-------- --------- --------
Total revenues 114,874 92,603 22,271
Expenses:
Net losses and loss adjustment expenses 98,054 80,650 17,404
Underwriting, acquisition and insurance expenses
15,495 13,375 2,120
-------- --------- --------
Total expenses 113,549 94,025 19,524
-------- --------- --------
Income (loss) before income taxes $ 1,325 $ (1,422) $ 2,747
======== ========= ========
Net loss and LAE ratio* 99.8% 106.1% (6.3)%
Underwriting expenses ratio* 15.8% 17.6% (1.8)%
-------- --------- --------
Combined ratio 115.6% 123.7% (8.1)%
Less: Investment income ratio* 14.9% 21.9% (7.0)%
-------- --------- --------
Operating ratio 100.7% 101.8% (1.1)%
======== ========= ========
* Ratios shown are expressed as a percentage of net premiums earned.
MARCH 31 DECEMBER 31
2003 2002
---------- ----------
Net reserves for loss and LAE $1,139,598 $1,096,205
========== ==========
PREMIUMS
Premiums written:
Our professional liability insurance segment principally provides
liability insurance for providers of medical and other healthcare services, and
to a limited extent, providers of legal services.
Premiums written for the professional liability segment for the three
months ended March 31, 2003 were $158.2 million, which is an increase of $16.4
million as compared to the same period of 2002.
21
The increase is primarily due to growth in physician premiums and principally
reflects the beneficial effect of rate increases.
We have implemented and we plan to continue to implement rate increases
based on loss trends, however, our ability to implement those rate increases is
subject to regulatory approval. We estimate that, on average, 2003 renewals were
at rates that were more than 25% higher than 2002 rates. However, we do not
expect premium growth to reflect the full amount of the rate increases because
retention of our insureds may be reduced by the higher rates. Additionally, we
are in the process of converting occurrence coverage to claims-made coverage in
certain states. Since first-year claims-made coverage has a significantly lower
premium than occurrence coverage, due to lower loss exposure, the conversion
will depress gross premiums written.
Premiums earned:
Premiums earned for the three months ended March 31, 2003 increased by
$21.2 million as compared to the three months ended March 31, 2002. The
increase primarily reflects the beneficial impact of rate increases. Since
premiums are earned over the entire policy period (usually one year) after the
policy is written, the 2003 increase in earned premiums reflects the effect of
rate increases implemented since January 1, 2002.
Premiums ceded:
Premiums ceded represent the premiums we must ultimately pay to our
reinsurers for their assumption of a portion of our losses. Premiums ceded for
the three months ended March 31, 2003 decreased by $1.0 million as compared to
the three months ended March 31, 2002, primarily because we reduced the portion
of our losses that we cede to our reinsurers. Under reinsurance contracts that
became effective in October 2002, our retention levels became $1.0 million in
all states whereas previously our retention in many states was as low as
$250,000. Premiums ceded have decreased both in total dollars and as a
percentage of premiums earned because we have ceded a smaller portion of our
risk.
LOSSES AND LOSS ADJUSTMENT EXPENSES
Our reserve for losses and LAE represents our estimate of the future
amounts necessary to pay claims and expenses associated with investigation and
settlement of claims. The resulting net losses and loss adjustment expenses
(hereafter referred to as "net losses and LAE") may be summarized into three
components of these estimates: (i) actuarial evaluation of incurred loss levels
for the current accident year; (ii) actuarial re-evaluation of incurred loss
levels for prior accident years and (iii) actuarial re-evaluation of the
reserve for the death, disability and retirement provision.
Accident year refers to the accounting period in which the insured
event becomes a liability of the insurer. For occurrence policies the insured
event becomes a liability when the event takes place; for claims-made policies
the insured event becomes a liability when the event is first reported to the
insurer. We believe that measuring losses on an accident year basis is the most
indicative measure of the underlying profitability of the premiums earned in
that period since it associates policy premiums earned with our estimate of
the losses incurred related to those policy premiums.
Net losses and LAE during each of the three-month periods ended March
31, 2003 and 2002 include net losses and LAE for the current accident year,
only. There are no adjustments to prior year loss estimates in either period.
Net losses and LAE for the three months ended March 31, 2003 increased by $17.4
million as compared to the three months ended March 31, 2002, primarily due to
an increase of loss costs per unit of risk. The current accident year net loss
ratio for the three months ended March 31,
22
2003, as compared to the same period in 2002, has decreased from 106.1% to
99.8%. The improvement in the loss ratio primarily reflects the effects of a
more adequate premium structure as a result of rate increases implemented during
2003 and 2002.
NET INVESTMENT INCOME
Our professional liability segment investment income is primarily
derived from the interest income earned by our fixed maturity securities but
also includes interest income from short-term and cash equivalent investments,
dividend income from equity securities, and rental income earned by our
commercial real estate holdings. Investment fees and expenses and real estate
expenses are deducted from investment income. Our net investment income for the
three months ended March 31, 2003 decreased by $2.0 million as compared to the
same period in 2002.
The decrease is primarily attributable to a decline in the average
yield of our fixed maturity investments. Throughout 2002 and 2003 as funds
matured they were reinvested at lower rates. Also, in the fourth quarter of
2002 we sold a significant portion of our fixed maturity portfolio. We purchase
fixed maturity securities with the initial intent to hold such securities until
their maturity, however, we may dispose of securities prior to their respective
maturities if we believe such disposals are consistent with our overall
investment objectives, including maximizing total yields over time, maximizing
after-tax profits and disposing of securities that no longer meet our risk
management criteria. The securities sold late in 2002 reduced 2003 yields both
because varying portions of the sale proceeds were held in lower yielding
short-term investments during the first two months of 2003 and because the
proceeds were reinvested at lower rates.
The weighted average tax equivalent book yield (tax adjusted gross
earnings divided by the average quarterly ending book value) of our
professional liability segment fixed maturity investments was 5.19% for the
three months ended March 31, 2003 as compared to 6.22% for the same period in
2002. The weighted average tax equivalent book yield of the securities held in
our professional liability fixed maturity portfolio decreased to an average of
5.03% on March 31, 2003 as compared to an average of 5.49% on December 31,
2002.
NET REALIZED INVESTMENT GAINS (LOSSES)
Net realized investment gains (losses) include gains and losses
realized on sales of investment securities and realized losses for other than
temporary impairments in the fair value of investment securities, as shown in
the following table (in thousands).
THREE MONTHS ENDED
----------------------------
MARCH 31 MARCH 31
2003 2002
------- --------
Net gains from sales $ 1,121 $ 881
Other than temporary impairment losses (289) (2,000)
------- -------
Net realized investment gains (losses) $ 832 $(1,119)
======= =======
UNDERWRITING, ACQUISITION AND INSURANCE EXPENSES
Underwriting, acquisition and insurance expenses increased by $2.1
million for the three months ended March 31, 2003 as compared to the same
period in 2002. This increase results from additional commissions and premium
taxes that we have incurred on our higher earned premiums, as previously
discussed. The underwriting expense ratio is the total of underwriting,
acquisition and insurance expenses divided by net premiums earned. This ratio
for the three months ended March 31, 2003 is
23
15.8% as compared to 17.6% for the same period in 2002. The decrease in the
ratio is primarily due to operating efficiencies realized in 2003 and the
effect of rate increases.
Guaranty fund assessments for the three months ended March 31, 2003
and 2002 were approximately $111,000 and $212,000, respectively. We are
required by most states to be a member of its insolvency or guaranty fund
association and, as such, must make payments to the association when so
assessed by the state. Such assessments can and do vary from period to period.
24
PERSONAL LINES INSURANCE OPERATIONS SEGMENT
Our personal lines segment is comprised of the operations of a single
insurance company, MEEMIC Insurance Company. Selected financial data for our
personal lines insurance segment for the three months ended March 31, 2003 and
2002 is summarized in the table below (dollars in thousands).
THREE MONTHS ENDED
MARCH 31
-------------------------------------------------
INCREASE
2003 2002 (DECREASE)
------- ------- ----------
Gross premiums written $44,411 $39,272 $ 5,139
======= ======= =======
Net premiums written $40,113 $36,999 $ 3,114
======= ======= =======
Revenues:
Premiums earned $44,255 $36,785 $ 7,470
Premiums ceded 4,296 2,280 2,016
------- ------- -------
Net premiums earned 39,959 34,505 5,454
Net investment income 2,574 2,599 (25)
Net realized investment gains (losses) 175 -- 175
Other income 466 466 --
------- ------- -------
Total revenues 43,174 37,570 5,604
Expenses:
Net losses and loss adjustment expenses 26,994 26,549 445
Underwriting, acquisition and insurance expenses
8,927 7,607 1,320
------- ------- -------
Total expenses 35,921 34,156 1,765
------- ------- -------
Income (loss) before income taxes $ 7,253 $ 3,414 $ 3,839
======= ======= =======
Net loss and LAE ratio 67.6% 76.9% (9.3%)
Underwriting expenses ratio 22.3% 22.1% 0.2%
------- ------- -------
Combined ratio 89.9% 99.0% (9.1%)
======= ======= =======
MARCH 31, DECEMBER 31,
2003 2002
--------- -----------
Net reserves for loss and LAE $66,176 $64,251
======= =======
25
PREMIUMS
Premiums written:
Gross premiums written for the three months ended March 31, 2003
increased by $5.1 million as compared to the same period in 2002. Premiums by
line of business for the three months ended March 31, 2003 and 2002 are as
follows (dollars in thousands):
THREE MONTHS ENDED MARCH 31
---------------------------------------------------------------
2003 2002
------------------------- -------------------------
AMOUNT % AMOUNT %
------- ----- ------- -----
Automobile $38,189 86.0% $34,888 88.8%
Homeowners 6,129 13.8% 4,314 11.0%
Boat, umbrella and other 93 0.2% 70 0.2%
------- ----- ------- -----
$44,411 100.0% $39,272 100.0%
======= ===== ======= =====
Automobile premiums increased due to an increase in the number of
autos insured and due to an increase in the value of those autos. The number of
insured vehicles increased from 174,236 at March 31, 2002 to 182,939 at March
31, 2003.
Homeowner premiums increased due to a rate increase of approximately
22% that became effective on July 1, 2002 and due to increases in the number of
homes insured and in the value of those homes. The number of insured homes
increased from 49,863 at March 31, 2002 to 57,008 at March 31, 2003.
Premiums earned:
Premiums earned increased by $7.5 million, for the three months ended
March 31, 2003 as compared to the same period in 2002. As with premiums
written, this increase is primarily due to increases in the number of autos and
homes insured and increases in the values of those autos and homes.
Premiums ceded:
Premiums ceded are the portion of our earned premium due to reinsurers
in return for the transfer of a portion of our risk to them. Premiums ceded
increased by $2.0 million for the three months ended March 31, 2003 as compared
to the same period in 2002. Premiums ceded were reduced by $1.3 million for the
three months ended March 31, 2002 due to downward revisions of our estimates of
the amounts due to our reinsurers related to prior year coverages. After giving
consideration to this reduction, premiums ceded for the three months ended
March 31, 2003 increased $0.7 million as compared to the three months ended
March 31, 2002. The $0.7 million increase is primarily attributable to
increased rates charged by our reinsurers.
26
LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table summarizes personal lines net losses and LAE
and net loss ratios for the three months ended March 31 for 2003 and 2002 by
separating losses between the current accident year and all prior accident
years (dollars in thousands). The net loss ratios shown are calculated by
dividing the applicable net losses and LAE by current calendar year net
premiums earned.
THREE MONTHS ENDED
--------------------------------
2003 2002
--------- ---------
Net losses and LAE:
Current accident year $ 28,382 $ 25,778
Prior accident years (1,388) 771
--------- ---------
Calendar year net losses and LAE $ 26,994 $ 26,549
========= =========
Net loss ratio attributable to:
Current accident year net losses and LAE 71.0% 74.7%
Prior accident year net losses and LAE (3.4%) 2.2%
--------- ---------
Calendar year net loss ratio 67.6% 76.9%
========= =========
Calendar year net losses and LAE increased $445,000, for the three
months ended March 31, 2003 as compared to the same period in 2002. The 2003
current accident year net loss ratio (current accident year net losses and LAE
divided by net premiums earned) is 71.0% as compared to 74.7% for 2002 and
reflects the effect of a rate increase for homeowners combined with decreases
in both the frequency and severity of auto and homeowner claims, largely due to
milder weather conditions.
We reduced net losses and LAE for the three months ended March 31,
2003 by approximately $1.4 million as a result of favorable development in our
estimates of prior year's loss reserves. We increased net losses and LAE for
the three months ended March 31, 2002 by approximately $771,000 as a result of
unfavorable development of our estimates of prior year's loss reserves. The
adjustments recorded in the three-month periods ended March 31, 2003 and 2002
were made in the normal course of business and represented 2.2% and 1.2% of
personal lines net loss and LAE reserves at December 31, 2002 and 2001,
respectively.
27
NET INVESTMENT INCOME
Our net investment income is comprised of the interest and dividend
income from our fixed maturity, short-term, cash equivalents and equity
investments, net of investment expenses. There was no significant change in our
net investment income between the two three month periods ended March 31, 2003
and 2002, primarily because increases in the size of the portfolio were offset
by declines in market interest rates.
The weighted average tax equivalent book yield (tax adjusted gross
earnings divided by the average quarterly ending book value) of the personal
lines segment fixed maturity investments for the three months ended March 31,
2003 was 6.02% as compared to 6.24% for the three months ended March 31, 2002.
The average yield is reduced because market rates available for the investment
of new and matured funds were lower in the first three months of 2003. On March
31, 2003 the weighted average tax equivalent book yield of the securities held
in our personal lines fixed maturity portfolio is 6.15%; the same yield on
December 31, 2002 was 6.20%.
NET REALIZED INVESTMENT GAINS (LOSSES)
Net realized investment gains and losses for the three months ended
March 31, 2003 and 2002 did not include any realized losses for other than
temporary impairments.
UNDERWRITING, ACQUISITION AND INSURANCE EXPENSES
Underwriting, acquisition and insurance expenses consist of normal,
recurring expenses such as commissions, salaries and other expenses. These
expenses for the three months ended March 31, 2003 increased by approximately
$1.3 million as compared to the same period in 2002, primarily due to higher
underwriting and acquisition costs from premium growth. The underwriting
expense ratio is the total of underwriting, acquisition and insurance expenses
divided by net premiums earned. This ratio was 22.3% for the three months ended
March 31, 2003 as compared to 22.1% for the same period in 2002.
28
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We believe that we are principally exposed to three types of market
risk related to our investment operations. These risks are interest rate risk,
credit risk and equity price risk.
The term market risk refers to the risk of loss arising from adverse
changes in market rates and prices, such as interest rates, equity prices and
foreign currency exchange rates.
All market sensitive instruments discussed here relate to our
investment assets that are classified as available for sale.
As of March 31, 2003, our fair value investment in fixed income
securities was $1,552 million. These securities are subject primarily to
interest rate risk and credit risk. At March 31, 2003 we own no equity or fixed
income securities that require treatment as derivatives under generally accepted
accounting principles and we have no plans to acquire securities that would
require such treatment.
INTEREST RATE RISK
Our fixed maturities portfolio is exposed to interest rate risk.
Fluctuations in interest rates have a direct impact on the market valuation of
these securities. As interest rates rise, market values of fixed income
portfolios fall and vice versa. We believe we are in a position to keep our
fixed income investments until maturity, as we do not invest in fixed maturity
securities for trading purposes.
The table below displays the anticipated effect of market interest
rate fluctuations on the value and weighted average modified duration of our
fixed maturity portfolio.
Weighted
Average
Portfolio Change Modified
Interest Value in Value Duration
Rates $ Millions $ Millions Years
- -------- ---------- ---------- --------
200 basis point rise $1,441 $(111) 4.36
100 basis point rise 1,498 (54) 4.08
Current rate* 1,552 -- 3.84
100 basis point decline 1,605 53 3.85
200 basis point decline 1,662 110 3.97
* Current rates are as of March 31, 2003.
Computations of prospective effects of hypothetical interest rate
changes are based on numerous assumptions, including the maintenance of the
existing level and composition of fixed income security assets, and should not
be relied on as indicative of future results.
29
Certain limitations are inherent in the method of analysis presented
in the computation of the fair value of fixed rate instruments. Actual values
may differ from those projections presented should market conditions vary from
assumptions used in the calculation of the fair value of individual securities,
including non-parallel shifts in the term structure of interest rates and
changing individual issuer credit spreads.
At March 31, 2003, the fair value of our investment in preferred
stocks was $33.2 million, including net unrealized gains of $1.4 million.
Preferred stocks are primarily subject to interest rate risk because they bear
a fixed rate of return. The investments in the above table do not include
preferred stocks.
CREDIT RISK
We have exposure to credit risk primarily as a holder of fixed income
securities. We control this exposure by emphasizing investment grade credit
quality in the fixed income securities we purchase.
Our fixed income portfolio primarily consists of securities rated as
investment grade. We believe that this concentration in investment grade
securities reduces our exposure to credit risk on these fixed income
investments to an acceptable level. However, in the current environment even
investment grade securities can rapidly deteriorate and result in significant
losses.
EQUITY PRICE RISK
At March 31, 2003 the fair value of our investment in common stocks,
excluding preferred stocks as discussed in the preceding paragraphs, was $44.6
million, which included net unrealized gains of $0.6 million. These securities
are subject to equity price risk, which is defined as the potential for loss in
market value due to a decline in equity prices. A hypothetical 10% increase in
the market prices as of March 31, 2003 would increase the fair value of these
securities to $49.1 million; a hypothetical 10% decrease in the price of each
of these marketable securities would reduce the fair value to $40.2 million.
The selected hypothetical change does not reflect what could be considered the
best or worst scenarios.
ProAssurance's cash and short-term investment portfolio at March 31,
2003 was on a cost basis which approximates its fair value. This portfolio
lacks significant market rate sensitivity due to its short duration.
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of management,
including the Chief Executive Officer and Chief Financial Officer, the Company
has evaluated the effectiveness of the design and operation of our disclosure
controls and procedures within ninety (90) days of the filing of this Quarterly
Report on Form 10-Q. Based on that evaluation, the Chief Executive Officer and
Chief Financial Officer have concluded that these controls and procedures are
effective. There were no significant changes in the internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation.
Disclosure controls and procedures are the Company's controls and
other procedures that are designed to ensure that information, required to be
disclosed by the Company in the reports that it files or submits under the
Exchange Act, is accumulated and communicated to management, including the
Chief Executive Officer and Chief Financial Officer, as appropriate, to allow
timely decisions regarding required disclosure.
30
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Note 9 to the condensed consolidated financial statements.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
99.1 Certification of Principal Executive Officer
pursuant to 18 U.S.C. Section 1350.
99.2 Certification of Principal Financial Officer
pursuant to 18 U.S.C. Section 1350.
(b) Reports on Form 8-K.
ProAssurance filed a current report on Form 8-K on February
25, 2003 that furnished information regarding operating
results for the quarter and annual periods ended December 31,
2002 that was publicly released on that same day.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PROASSURANCE CORPORATION
May 12, 2003
/s/ Howard H. Friedman
-------------------------------------------
Howard H. Friedman, Chief Financial Officer
(Duly authorized officer and principal
financial officer)
31
CERTIFICATIONS
I, A. Derrill Crowe, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ProAssurance
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data and
have identified for the registrant's auditors any material weaknesses
in internal controls; and
b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 12, 2003
/s/ A. Derrill Crowe, M.D.
----------------------------------
A. Derrill Crowe, M.D.
Chief Executive Officer
32
CERTIFICATIONS
I, Howard H. Friedman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ProAssurance
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data and
have identified for the registrant's auditors any material weaknesses
in internal controls; and
b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 12, 2003
/s/ Howard H. Friedman
-------------------------------------------
Howard H. Friedman
Chief Financial Officer
33