-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QpoaPJuCWh4GjYwgG/lAa3JlG3HD7E/x6BpiF1ozhl1O/QJTBX/HsurbU9JcntPw FO4YogqHaC55BW/9w4jgXA== 0000950159-00-000114.txt : 20000411 0000950159-00-000114.hdr.sgml : 20000411 ACCESSION NUMBER: 0000950159-00-000114 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000329 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PMA CAPITAL CORP CENTRAL INDEX KEY: 0001041665 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 232217932 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-22761 FILM NUMBER: 583723 BUSINESS ADDRESS: STREET 1: 1735 MARKET STREET SUITE 2800 STREET 2: 380 SENTRY PKWY CITY: PHILADELPHIA STATE: PA ZIP: 19103-7590 BUSINESS PHONE: 2156655046 MAIL ADDRESS: STREET 1: 1735 MARKET STREET SUITE 2800 STREET 2: 380 SENTRY PARKWAY CITY: PHILADELPHIA STATE: PA ZIP: 19103-7590 FORMER COMPANY: FORMER CONFORMED NAME: PENNSYLVANIA MANUFACTURERS CORP DATE OF NAME CHANGE: 19970702 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K (MARK ONE) /X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999 / / 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 000-22761 PMA Capital Corporation ------------------------------------------------------ (Exact name of registrant as specified in its charter) Pennsylvania 23-2217932 ------------------------------- ------------------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 1735 Market Street, Suite 2800 Philadelphia, Pennsylvania 19103-7590 - ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (215) 665-5046 -------------- Securities to be registered pursuant to Section 12(b): None Securities to be registered pursuant to Section 12(g) of the Act: Class A Common Stock, par value $5.00 per share ----------------------------------------------- (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES /X/ NO / / Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. / / The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of February 29, 2000, was $230,352,954. There were 12,425,268 shares outstanding of the registrant's Common Stock, $5 par value per share, and 9,846,499 shares outstanding of the registrant's Class A Common Stock, $5 par value per share, as of the close of business on February 29, 2000. DOCUMENTS INCORPORATED BY REFERENCE: (1) Parts I, II and IV of this Form 10-K incorporate by reference portions of the Annual Report to Shareholders for the year ended December 31, 1999, as indicated herein. (2) Part III of this Form 10-K incorporates by reference portions of the registrant's proxy statement dated March 23, 2000 for the 2000 Annual Meeting of Shareholders.
INDEX - --------------------------------------------------------------------------------------------- PART I Page Item 1. Business...................................................................... 1 Company Overview............................................................ 1 PMA Re...................................................................... 3 The PMA Insurance Group..................................................... 7 Caliber One................................................................. 13 Reinsurance and Retrocessional Protection................................... 14 Loss Reserves............................................................... 15 Investments................................................................. 20 Competition................................................................. 21 Regulatory Matters.......................................................... 22 Employees................................................................... 25 Glossary of Selected Insurance Terms........................................ 26 Item 2. Properties.................................................................... 30 Item 3. Legal Proceedings............................................................. 30 Item 4. Submission of Matters to a Vote of Security Holders........................... 30 Executive Officers of the Registrant.......................................... 30 PART II Item 5. Market for the Registrant's Common Equity and Related Shareholder Matters..... 31 Item 6. Selected Financial Data....................................................... 31 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..................................................... 31 Item 7A. Quantitative and Qualitative Disclosure About Market Risk..................... 32 Item 8. Financial Statements and Supplementary Data................................... 32 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........................................... 32 PART III Item 10. Directors and Executive Officers of the Registrant............................ 32 Item 11. Executive Compensation........................................................ 32 Item 12. Security Ownership of Certain Beneficial Owners and Management................ 32 Item 13. Certain Relationships and Related Transactions................................ 32 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.............. 33 Signatures.............................................................................. 34 Index to Financial Statement Schedules.................................................. FS-1 Index to Exhibits....................................................................... E-1
PART I The Business Section and other parts of this Form 10-K contain forward-looking statements that involve risks and uncertainties. The Company's actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in the "Cautionary Statements" on page 43 of the Company's Management's Discussion and Analysis ("MD&A") section of its 1999 Annual Report to Shareholders ("Annual Report") that has been incorporated by reference into Part II, Item 7 of this Form 10-K. Item 1. Business COMPANY OVERVIEW PMA Capital Corporation (the "Company" or "PMA Capital"), headquartered in Philadelphia, Pennsylvania, is an insurance holding company with total assets of approximately $3.2 billion and shareholders' equity of $429.1 million at December 31, 1999. The Company was organized under the laws of the Commonwealth of Pennsylvania as Pennsylvania Manufacturers Corporation in 1982, and changed its name to PMA Capital Corporation in 1998. The Company's operating subsidiaries conduct business in the property and casualty insurance industry. The Company has three operating segments: (i) PMA Re, which provides property and casualty reinsurance products and services; (ii) The PMA Insurance Group, which writes workers' compensation, integrated disability and, to a lesser extent, other standard lines of commercial property and casualty insurance; and (iii) Caliber One, which writes specialty insurance focusing on excess and surplus lines. In addition, the Company's Corporate and Other segment includes unallocated investment income and expenses, including debt service, as well as the results of certain of the Company's real estate properties. Financial information in the tables that follow is presented in conformity with generally accepted accounting principles ("GAAP"), unless otherwise indicated. Certain reclassifications have been made to prior periods' financial information to conform to the 1999 presentation. Revenues, pre-tax operating income and assets attributable to each of the Company's operating segments and its Corporate and Other segment for the last three years are set forth in Note 16 to the Company's consolidated financial statements for the year ended December 31, 1999 ("Financial Statements") included in its Annual Report. The Company's net premiums written by operating segment were as follows: (dollar amounts in thousands)
1999 as 1999 1998 1997 % of total ---- ---- ---- ---------- PMA Re $ 278,998 $ 234,010 $ 177,934 49% The PMA Insurance Group: Excluding Run-off Operations 233,713 244,237 254,970 42% Run-off Operations - (9,400) (51,622) - ------------------------------------------------------------- Total 233,713 234,837 203,348 42% ------------------------------------------------------------- Caliber One 51,237 6,436 - 9% Corporate and Other (438) (522) - - ------------------------------------------------------------- Total $ 563,510 $ 474,761 $ 381,282 100% =============================================================
1 Property and casualty insurance and reinsurance companies provide loss protection to insureds in exchange for premiums. If earned premiums exceed the sum of losses and loss adjustment expenses ("LAE"), commissions to agents or brokers, premium taxes, other operating expenses and policyholders' dividends, then underwriting profits are realized. When earned premiums do not exceed the sum of these items, the result is an underwriting loss. Because time normally elapses between the receipt of premiums and the payment of claims and certain related expenses, the Company invests the available premiums. Underwriting results do not reflect investment income from these funds, investment gains and losses, results of non-insurance business or federal income taxes. These items, when added to underwriting profits or losses, produce net income or loss. For information concerning investment income, see pages 40 and 41 of the MD&A in the Annual Report. The "combined ratio" is a frequently used measure of property and casualty underwriting performance. The combined ratio computed on a GAAP basis is equal to losses and LAE, plus acquisition expenses, operating expenses and policyholders' dividends, where applicable, all divided by net premiums earned. Thus, a combined ratio of under 100% reflects an underwriting profit. The combined ratios of the Company's operating segments were as follows:
1999 1998 1997 ---- ---- ---- PMA Re 102.5% 103.7% 103.8% The PMA Insurance Group: Excluding Run-off Operations 113.3% 116.4% 122.2% Including Run-off Operations 115.4% 122.6% 140.8% Caliber One 109.6% - -
(1) The results of operations of Caliber One for 1998 and 1997 are not material to the underwriting ratios of the Company; accordingly, the ratios for Caliber One are not presented for those years. 2 PMA Re Background PMA Re writes a broad range of property and casualty reinsurance products within the broker market, with an emphasis on risk-exposed casualty excess of loss reinsurance. PMA Re competes on the basis of its ability to offer specialized products to its clients, its long-term relationships with brokers and insurance companies, and its prompt and responsive service. According to data provided by the Reinsurance Association of America (the "RAA"), as of December 31, 1999, PMA Reinsurance Corporation was the 17th largest broker market reinsurer in the United States in terms of statutory capital and surplus and 13th largest in terms of net premiums written. In the broker reinsurance market, the products (reinsurance coverages) are distributed to the ultimate customer (ceding companies) through reinsurance intermediaries, known as brokers. In exchange for providing such distribution services, the brokers are paid commissions, known as brokerage, which are typically based upon a percentage of the premiums ceded under a particular contract. The broker reinsurance market differs from the direct reinsurance market in that direct reinsurers maintain their own sales forces and distribute their products directly to their ceding company clients. Products Reinsurance is an arrangement in which an insurance company, the reinsurer, agrees to indemnify another insurance company, the ceding company, against all or a portion of the insurance risks underwritten by the ceding company under one or more insurance contracts. Reinsurance provides ceding companies with several benefits: reducing exposure on individual risks, protecting against catastrophic losses, and stabilizing underwriting results and maintaining acceptable capital ratios. PMA Re provides reinsurance coverage primarily under two arrangements: treaty and facultative. Typically, in treaty reinsurance, the primary insurer or ceding company is obligated to cede and the reinsurer is obligated to accept a specified portion of all agreed upon types or categories of risks originally written by the primary insurer or ceding company. Facultative reinsurance is a form of reinsurance coverage that is placed on a risk-by-risk basis, and the reinsurer retains the right to accept or reject each individual risk submitted by the ceding company. Of PMA Re's total net premiums written in 1999, 99% were treaty, and 1% was facultative. To better serve its brokers and ceding companies, PMA Re has established four distinct underwriting units, organized by class of business, which provide more specialized expertise in each area. The Traditional, Specialty, and Finite Risk and Financial Products units provide treaty reinsurance coverage. The fourth unit, Facultative, provides reinsurance on a facultative basis. o Traditional-Treaty: This underwriting unit writes general property and casualty business and emphasizes risk-exposed programs where PMA Re can leverage its actuarial and underwriting expertise. Included in the client base for the Traditional unit are standard lines companies, some excess and surplus lines companies, and, to a lesser extent, non-traditional sources of business. The Traditional casualty portfolio includes umbrella, commercial automobile and workers' compensation. In addition, there are more excess of loss contracts than pro rata contracts. o Specialty-Treaty: This unit's underwriters write business that falls outside the confines of traditional property and casualty risks. These risks include environmental impairment, directors and officers liability, and medical malpractice, as well as all other forms of professional liability. Doctors and lawyers constitute the two largest groups of insureds in the Specialty unit's portfolio. o Finite Risk and Financial Products: This unit was introduced in late 1998 as an additional product line to provide PMA Re opportunity for growth. This underwriting unit is charged with providing PMA Re's clients with creative solutions to their complex financial and risk management needs. Many insurance companies have some form of finite protection as a permanent part of their reinsurance program. Examples of finite risk and financial risk products are aggregate stop loss covers, spread loss mechanisms, funded catastrophe coverages, financial quota shares and loss portfolio transfers. While those are the general categories, virtually every contract is individually structured, and PMA Re's approach to product design reflects the complicated nature of this line of business. Although most of the Finite Risk and Financial Products unit's business is related to domestic insurers, approximately 5% of the unit's premiums were generated from international business. 3 o Facultative: This unit writes property and casualty reinsurance on an individual risk basis, and on a program/semi-automatic basis. In addition to serving the facultative brokerage community, this unit strengthens PMA Re's reputation as a full service reinsurer. The facultative property book has grown as this unit leverages its capacity and emphasizes program/semi-automatic business. The facultative casualty focus is on general liability, umbrella and commercial automobile lines. Facultative's emphasis in commercial automobile continues to be on manufacturing, contracting and service fleets. This unit continues to underwrite a broad range of professional liability business, with an emphasis in directors and officers liability, and medical malpractice/hospital professional liability. PMA Re's gross and net premiums written by business unit and major category of business are as follows: (dollar amounts in thousands)
1999 1998 1997 ---- ---- ---- Gross Net Gross Net Gross Net ----- --- ----- --- ----- --- Traditional - Treaty Casualty $ 106,756 $ 80,762 $ 115,483 $ 95,900 $ 110,723 $ 84,208 Property 72,209 56,098 74,222 62,725 70,197 56,577 Other 1,510 1,488 1,044 1,061 795 788 ------------ ------------ ------------ ------------ ----------- ------------ Total Traditional 180,475 138,348 190,749 159,686 181,715 141,573 ------------ ------------ ------------ ------------ ----------- ------------ Specialty - Treaty Casualty 88,433 68,818 79,711 64,625 37,838 33,846 ------------ ------------ ------------ ------------ ----------- ------------ Total Specialty 88,433 68,818 79,711 64,625 37,838 33,846 ------------ ------------ ------------ ------------ ----------- ------------ Finite Risk and Financial Products Casualty 49,881 49,154 7,300 6,971 - - Property 19,854 19,486 - - - - Other 254 249 - - - - ------------ ------------ ------------ ------------ ----------- ------------ Total Finite Risk and Financial Products 69,989 68,889 7,300 6,971 - - ------------ ------------ ------------ ------------ ----------- ------------ Facultative Casualty 1,590 380 3,823 956 3,339 835 Property 3,120 2,563 2,753 1,772 2,429 1,680 ------------ ------------ ------------ ------------ ----------- ------------ Total Facultative 4,710 2,943 6,576 2,728 5,768 2,515 ------------ ------------ ------------ ------------ ----------- ------------ Total Casualty 246,660 199,114 206,317 168,452 151,900 118,889 Total Property 95,183 78,147 76,975 64,497 72,626 58,257 Total Other 1,764 1,737 1,044 1,061 795 788 ------------ ------------ ------------ ------------ ----------- ------------ Total Premiums Written $ 343,607 $ 278,998 $ 284,336 $ 234,010 $ 225,321 $ 177,934 ============ ============ ============ ============ =========== ============
In the three years ended December 31, 1999, PMA Re reported premium growth that exceeded that of the overall reinsurance industry. During such period, PMA Re's compound annual growth rate for net premiums written was 19%, while the reinsurance industry's compound annual growth rate was 4% for the same period based upon information published by the RAA. The increase in gross and net premiums written in 1999 primarily reflects the expansion of the Finite Risk and Financial Products unit, which was formed in late 1998. In 1999, PMA Re wrote $122 million of new business with more than 70% of such new business generated from existing ceding company relationships, and the balance attributable to business written with new ceding company clients. PMA Re formed relationships with 27 new ceding companies during 1999. In 1998 and 1997, PMA Re achieved its premium growth through its Traditional and Specialty units, primarily reflecting increased participation levels on ceding company clients' existing programs and writing additional layers and programs for current ceding company clients. PMA Re has pursued additional or new business from certain existing accounts and new accounts as part of a targeted marketing program. PMA Re targets selected ceding companies, primarily small- to medium-sized insurers (those with surplus of up to $500 million), where PMA Re's level of service and experience will add value to their operations. PMA Re then embarks on a broker visitation plan to give PMA Re the opportunity to lead the reinsurance programs of the targeted ceding companies. 4 PMA Re's efforts to increase premium writings have more than offset the effects of highly competitive conditions in the U.S. reinsurance market and certain situations where ceding companies retain more of their business, and therefore require less reinsurance. PMA Re has sought to maintain its underwriting and pricing discipline, which has prompted PMA Re to decline to participate on business rather than write it at inadequate rates or with terms and conditions that do not meet PMA Re's underwriting standards. As a result, PMA Re did not renew $51 million, $47 million and $40 million of existing business during 1999, 1998 and 1997, respectively. Casualty business has contributed significantly to PMA Re's premium growth since 1997. Casualty business has increased at a compound annual growth rate of 18% in the three-year period ended December 31, 1999, and casualty premiums accounted for approximately 72%, 72% and 67% of net premiums written in 1999, 1998 and 1997, respectively. PMA Re has generally focused on umbrella, commercial automobile, medical malpractice, professional liability and other more specialized liability coverages. Property business accounted for approximately 28%, 28% and 33% of net premiums written for 1999, 1998 and 1997, respectively. In the three-year period ended December 31, 1999, property business has increased at a compound annual growth rate of 24%. Substantially all of the growth in the property business since 1997 has been derived from the recently formed Finite Risk and Financial Products unit. PMA Re has generally de-emphasized property catastrophe excess of loss coverages. As of December 31, 1999, catastrophe business accounted for 3% of net property premiums written. The property programs written by PMA Re generally contain per occurrence limits or are not considered to be significantly exposed to catastrophes, either because of the locations of the insured values or the nature of the underlying properties insured. However, as is common in property reinsurance, PMA Re is exposed to the possibility of loss from catastrophes due to the aggregation of losses with per occurrence limits. PMA Re actively manages this exposure through zonal management, minimizing writings of catastrophe business, and the purchase of retrocessional protection. As of December 31, 1999, PMA Re maintained catastrophe retrocessional protection of $48 million excess of $2 million per occurrence. Although the Company believes that it has adequate reinsurance to protect against the estimated probable maximum gross loss from a catastrophe, an especially severe catastrophe or series of catastrophes could exceed the Company's reinsurance and/or retrocessional protection and may have a material adverse impact on the Company's financial condition, results of operations and liquidity. Distribution PMA Re operates primarily through the domestic broker reinsurance market in which it has developed relationships with the major reinsurance brokers enabling it to gain access to a wide range of ceding companies with varying reinsurance and related service needs. PMA Re's brokers that accounted for more than 10% of the gross premiums written in 1999 were as follows: (dollar amounts in thousands)
Broker Gross premiums written % of total - ------ ---------------------- ---------- AON Reinsurance $99,680 29% Guy Carpenter & Company 86,003 25% E.W. Blanch 66,351 19%
As of December 31, 1999, PMA Re had approximately 200 unaffiliated clients, with no individual client accounting for more than 10% of gross premiums written in 1999, except for one ceding company that accounts for 14% of gross premiums written. Approximately 68% of PMA Re's gross premiums written in 1999 were from small- to medium-sized insurers (those with surplus of up to $500 million). 5 Underwriting In reinsurance, underwriting involves the selection of risks and determining an adequate price given expected losses and estimated volatility of such losses. Maintaining underwriting and pricing discipline is critical to the maintenance of acceptable operating results. PMA Re's underwriting process has two principal aspects - underwriting the specific program/risk submission and underwriting the ceding company. Underwriting the specific program/risk to be reinsured involves, in addition to pricing, a review of the type of account, the total risk and the ceding company's policy forms. Underwriting the ceding company involves an evaluation of the expected future performance of the ceding company through an examination of that company's management, financial strength, claims handling and underwriting abilities. PMA Re may conduct underwriting and claim reviews at the offices of prospective ceding companies before entering into a major treaty, as well as throughout the life of the reinsurance contract. PMA Re's underwriters and actuaries work closely together to evaluate the particular reinsurance program. Using the information provided by the broker, the actuaries employ pricing models to estimate the ultimate exposure to the treaty. The pricing models that are utilized employ various experience-rating and exposure-rating techniques and are tailored in each case to the risk exposures underlying each treaty. The underwriters then analyze the results of the pricing models with the terms and conditions being offered to determine PMA Re's selected price. In underwriting excess-of-loss business, PMA Re has typically sought to write treaties that are risk exposed within the original policy limits of the ceding company. Management believes these layers generally lend themselves more effectively to actuarial pricing techniques. Claims Administration PMA Re's claims department analyzes reported claims, establishes individual claim reserves, pays claims, provides claims-related services to clients, audits the claims activities of selected current clients and assists in the underwriting process by evaluating the claims departments of selected prospective clients. The claims department's evaluation of claims activity includes reviewing loss reports received from ceding companies to confirm that claims are covered under the terms of the relevant reinsurance contract, establishing reserves on an individual case basis and monitoring the adequacy of those reserves. The claims department monitors the progress and ultimate outcome of the claims to determine that subrogation, salvage and other cost recovery opportunities have been adequately explored. The claims department performs these functions in coordination with the actuarial and underwriting departments. In addition to evaluating and adjusting claims, the claims department conducts claims audits at the offices of selected prospective ceding companies. Satisfactory audit results are required in order for reinsurance coverage to be written or continued by PMA Re. Also, the claims department conducts annual claims audits for many current and former client ceding companies. PMA Re's service initiatives in the area of claims administration, including electronic data interchange, have improved the timeliness of claims remittances and increased processing efficiency. Electronic data interchange involves the electronic transmission of data associated with transactions between PMA Re and the client. 6 THE PMA INSURANCE GROUP Background The PMA Insurance Group provides workers' compensation and integrated disability insurance coverages and related services in its ten-state marketing territory concentrated in the Mid-Atlantic and Southern regions of the United States. In addition, The PMA Insurance Group provides other commercial property and casualty insurance coverages, including commercial general liability, commercial automobile and commercial multi-peril, and related services. The domestic insurance subsidiaries through which The PMA Insurance Group writes its insurance products and who share results through an intercompany pooling agreement are referred to herein as the "Pooled Companies." The PMA Insurance Group emphasizes its traditional core business, workers' compensation. The Company believes that it can attract additional business based upon its expertise in workers' compensation and integrated disability, and its reputation as a high quality service provider to middle market and risk management clients. In addition, The PMA Insurance Group has aligned itself with network health care providers to offer medical cost containment services to its insureds. The PMA Insurance Group is one of the leading providers of integrated disability with $23 million in combined workers' compensation and integrated disability premium in 1999, and 88 accounts as of December 31, 1999. The PMA Insurance Group has also enhanced its ability to handle multi-state clients based in its operating territory through its initiative to license several of its insurance companies in 50 states to write workers' compensation, integrated disability and other commercial lines. As of February 29, 2000, The PMA Insurance Group was operational in 39 states for workers' compensation, general liability and commercial automobile. The PMA Insurance Group intends to continue writing other lines of property and casualty insurance, but generally only if such writings are supported by its core workers' compensation business. Products The PMA Insurance Group's premiums written were as follows: (dollar amounts in thousands)
1999 1998 1997 ---- ---- ---- Gross premiums written: Workers' Compensation $208,159 $198,099 $201,104 Commercial Multi-Peril 38,483 42,668 61,141 Commercial Automobile 33,372 36,568 43,703 Other 15,427 16,760 20,053 Run-off Operations - (9,400) (51,622) ------------ ------------ ------------ Total $295,441 $284,695 $274,379 ============ ============ ============ Net premiums written: Workers' Compensation $179,096 $187,033 $175,301 Commercial Multi-Peril 26,322 28,043 41,713 Commercial Automobile 21,610 23,288 28,938 Other 6,685 5,873 9,018 Run-off Operations - (9,400) (51,622) ------------ ------------ ------------ Total $233,713 $234,837 $203,348 ============ ============ ============
Workers' Compensation Insurance All states require employers to provide workers' compensation benefits to their employees for injuries and occupational diseases arising out of employment, regardless of whether such injuries result from the employer's or the employee's negligence. Employers may insure their workers' compensation obligations or, subject to regulatory approval, self-insure such liabilities. State workers' compensation statutes require that a policy cover three types of benefits: medical expenses, disability (indemnity) benefits and death benefits. The amounts of disability and death 7 benefits payable for various types of claims are set and limited by statute, but no maximum dollar limitation exists for medical benefits. Workers' compensation benefits vary among states, and insurance rates are subject to differing forms of state regulation. Statutory direct workers' compensation business written by jurisdiction was as follows: (dollar amounts in thousands)
1999 1998 1997 ---- ---- ---- Pennsylvania $ 108,692 $ 85,923 $ 91,126 New Jersey 29,177 29,098 26,327 Virginia 17,382 19,958 19,552 New York 15,185 7,796 3,143 Maryland 11,787 16,108 16,538 North Carolina 10,711 8,988 9,501 Delaware 7,501 8,372 7,041 Georgia 4,174 353 - Other 10,962 10,317 8,327 ------------- ------------- ------------- Total $ 215,571 $ 186,913 $ 181,555 ============= ============= =============
Based upon direct written premium information published by A.M. Best for the most recently available year (1998), The PMA Insurance Group is the 2nd largest writer of workers' compensation insurance in Pennsylvania and ranks among the 12 largest writers of workers' compensation insurance in Delaware, Maryland, Virginia, New Jersey and the District of Columbia. The PMA Insurance Group has focused on these jurisdictions based upon its knowledge of their workers' compensation systems and The PMA Insurance Group's assessment of each state's respective business, economic and regulatory climates. Rate adequacy, regulatory climate, economic conditions and other factors in each state are closely monitored and taken into consideration in the underwriting process. The PMA Insurance Group intends to employ similar analyses in determining whether and to what extent The PMA Insurance Group will offer its products in additional jurisdictions. The PMA Insurance Group seeks to expand and retain more of its premium base in territories that meet The PMA Insurance Group's underwriting and actuarial criteria. Regulatory reforms in Pennsylvania have made workers' compensation business more attractive from an underwriting perspective than it had been in the early 1990's. To date, these reforms have had a favorable impact on medical loss costs and indemnity loss costs in Pennsylvania. Accordingly, The PMA Insurance Group has expanded its writings of workers' compensation in Pennsylvania. The workers' compensation systems in certain other states in which The PMA Insurance Group does business (specifically New Jersey, North Carolina and Virginia) have also improved in recent years. As a result, The PMA Insurance Group is attempting to recapture a portion of the workers' compensation market share in those states where it has relinquished market share since the early 1990's. Further, in 1999, The PMA Insurance Group achieved profitable business growth in its most recent expansion states, New York and Georgia. The PMA Insurance Group continues to evaluate expansion into other states. The PMA Insurance Group has continued to balance its workers' compensation portfolio by increasing writings in lower hazard classes of business and reducing writings in higher hazard classes of business. For example, lower hazard classes of business such as health care, educational institutions and retail represented 33%, 26% and 21% of total direct workers' compensation premiums written in 1999, 1998 and 1997, respectively, compared to higher hazard classes of business such as construction, which represented 15%, 21% and 26% of total direct workers' compensation premiums written in 1999, 1998 and 1997, respectively. The PMA Insurance Group believes that conditions in the workers' compensation market have been improving in the last several years with respect to the ability to manage and control loss costs, although pricing for workers' compensation products continues to be competitive. Workers' compensation insurers doing business in certain states are required to provide insurance for risks that are 8 not otherwise written on a voluntary basis by the private market ("residual market business"). This system exists in all of the states in which The PMA Insurance Group does business, except Pennsylvania and Maryland. In these two states, separate governmental entities write all of the workers' compensation residual market business. In 1999, The PMA Insurance Group wrote $2.6 million of residual market business, which constituted approximately 1.2% of its direct workers' compensation premiums written. Based upon data for policy year 1998 reported by the National Council on Compensation Insurance, the percentage of residual market business for the industry as a whole, in all states, was 5.5% of direct workers' compensation premiums written. The PMA Insurance Group offers a variety of workers' compensation products to its customers. Certain of these products are based on manual rates filed and approved by state insurance departments ("rate-sensitive products"), while others are priced to a certain extent on the basis of the insured's own loss experience ("loss-sensitive products"). In the last five years, The PMA Insurance Group has also developed and sold alternative market products, such as large deductible products and other programs and services to customers who agree to assume even greater exposure to loss than under more traditional loss-sensitive products. The PMA Insurance Group decides which type of product to offer a customer based upon the customer's needs and an underwriting review. The PMA Insurance Group's voluntary workers' compensation direct premiums written by product type were as follows:
1999 1998 1997 ---- ---- ---- Rate-sensitive products 59% 63% 62% Loss-sensitive products 34% 28% 27% Alternative market products 7% 9% 11% ------------- ------------- ------------- Total 100% 100% 100% ============= ============= =============
o Rate-sensitive products include fixed-cost policies and dividend paying policies. The premium charged on a fixed-cost policy is based upon the manual rates filed with and approved by the state insurance department and does not increase or decrease based upon the losses incurred during the policy period. Under policies that are subject to dividend plans, the customer may receive a dividend based upon loss experience during the policy period. With the enactment of regulatory reform in several states in which The PMA Insurance Group does business, The PMA Insurance Group believes that it is better able to evaluate the expected losses on this type of business. o The PMA Insurance Group's loss-sensitive products adjust the amount of the insured's premiums after the policy period expires based upon the insured's actual losses incurred during the policy period. These loss-sensitive products are generally subject to less price regulation than rate-sensitive products and reduce, but do not eliminate, risk to the insurer. Under these types of policies, claims professionals and actuaries periodically evaluate the reserves on losses after the policy period expires to determine whether additional premiums or refunds are owed under the policy. These policies are typically subject to adjustment for an average of five years after policy expiration. The PMA Insurance Group generally restricts loss-sensitive products to accounts developing minimum annual premiums in excess of $100,000. o The PMA Insurance Group offers a variety of alternative market products for larger accounts, including large deductible policies and off-shore captive programs. Typically, The PMA Insurance Group receives a lower up-front premium for these types of alternative market product plans. However, under this type of business, the insured retains a greater share of the underwriting risk than under rate-sensitive or loss-sensitive products, which reduces the potential for unfavorable claim activity on the accounts and encourages loss control on the part of the insured. For example, under a large deductible policy, the customer is responsible for paying its own losses up to the amount of the deductible for each occurrence. The deductibles under these policies generally range from $250,000 to $1.0 million. In addition to these products, The PMA Insurance Group offers its clients certain workers' compensation services such as claims, risk management and other services. See "PMA Management Corp." below for an additional discussion of such products. The PMA Insurance Group has developed a product for group integrated occupational and non-occupational disability coverages, named PMA One(R), which it began marketing in 1998. PMA One leverages one of The PMA Insurance Group's most important core competencies: managing employee disabilities. PMA One offers employers the benefits of coordinated workers' compensation and disability administration, reduced costs, faster return to work and heightened employee productivity. In 1999, The PMA Insurance Group wrote 41 new PMA One clients, 9 bringing the total of PMA One accounts to 88, and generated $23 million of combined workers' compensation and integrated disability written premiums. PMA One clients include health care systems, educational institutions, manufacturers and financial institutions. Through The PMA Insurance Group's workers' compensation product offerings, the Company offers a comprehensive array of managed care services to control loss costs. These include: o Disability Management Coordinators, who are all registered nurses, employing an early intervention model to proactively manage medical treatment and length of disability in concert with the claims professional and employer. There are also case management nurses who manage more serious claims via on-site visits with injured workers and medical providers. o Access to First Health Corp's workers' compensation preferred provider network. The First Health(R) Network includes doctors, hospitals, physical therapists, outpatient clinics and imaging centers. The PMA Insurance Group's customers that utilize the network generally recognize lower costs than those that do not utilize the network. o Utilization of an automated medical bill review system to detect duplicate billings, unrelated charges and coding discrepancies. Complex bills are forwarded to The PMA Insurance Group's cost containment unit, which is staffed by registered nurses and other medical professionals, to resolve questions of causal relationship and overutilization. o Use of Paradigm Corporation for the medical management of certain catastrophic injuries. Paradigm adds a team of catastrophic case management experts to assist in achieving enhanced clinical and financial outcomes on these catastrophic injuries. PMA Management Corp. PMA Management Corp. offers claims, risk management and related services primarily to self-insureds on an unbundled basis. In addition, PMA Management Corp. offers "rent-a-captive" products for certain insureds and associations. The purpose of a rent-a-captive program is to offer a customer an alternative method of managing its loss exposures by obtaining many of the benefits of a captive insurer without establishing and capitalizing its own captive; in effect, the insured is "renting" a captive facility that the Company has already established. Under this arrangement, the client purchases an insurance policy from the Pooled Companies and chooses a participation level. The Pooled Companies then cede this portion of the premium and loss exposures to a Bermuda or Cayman based subsidiary of the Company. The client participates in the loss and investment experience of the portion ceded to the Bermuda or Cayman based subsidiary through a dividend mechanism. The client is responsible for any loss that may arise within its participation level, and such potential obligation is typically secured through a letter of credit or similar arrangement. The Company's principal sources of income from its rent-a-captive program are the premium income on the risk retained by the Pooled Companies and captive management fees earned by PMA Management Corp. Commercial Lines The PMA Insurance Group writes property and liability coverages for larger and middle market accounts that satisfy its underwriting standards. See "Underwriting" below. These coverages feature commercial multi-peril, general liability and umbrella, and commercial automobile business. The PMA Insurance Group offers these products, but generally only if they complement the core workers' compensation business. In the present market, prices for commercial coverages have been particularly competitive. As a result, The PMA Insurance Group has been selectively non-renewing accounts that do not meet its underwriting standards. 10 Distribution The PMA Insurance Group distributes its products through multiple channels, including national, regional and local brokers and agents, as well as direct sales representatives. The PMA Insurance Group employs 14 direct sales representatives and uses approximately 250 independent brokers and agents. The direct sales representatives are generally responsible for certain business located in Pennsylvania and Delaware. For the year ended December 31, 1999, these employees produced approximately $39.1 million in direct premiums written, constituting 13% of The PMA Insurance Group's direct written premiums. The brokers and agents write business throughout the marketing territory. The current distribution network generally consists of large regional agents and brokers, local agents and national brokers that specialize in larger to middle market accounts that require the variety of workers' compensation, commercial lines and alternative market products offered by The PMA Insurance Group. In 1999, brokers and agents accounted for 87% of The PMA Insurance Group's direct written premiums. The top ten brokers and agents accounted for 26% of The PMA Insurance Group's direct written premiums, the largest of which accounted for approximately 7.5% of its direct written premiums. The PMA Insurance Group's underwriters review all business from brokers and agents before it is accepted. The PMA Insurance Group monitors several statistics with respect to its brokers and agents, including a complete profile of the broker/agent, the number of years the broker/agent has been associated with The PMA Insurance Group, the percentage of the broker/agent's business that is underwritten by The PMA Insurance Group, the ranking of The PMA Insurance Group within the broker/agent's business and the profitability of the broker/agent's business. The field organization currently consists of 16 branch and satellite offices throughout the ten-state marketing territory. These offices deliver a full range of services directly to customers located in their service territory, and smaller satellite offices primarily offer underwriting and claim adjustment services. Underwriting The PMA Insurance Group's underwriters, in consultation with actuaries, determine the general type of business to be written using a number of criteria, including past performance, relative exposure to hazard, premium size, type of business and other indicators of potential loss. Specific types of business are referred to underwriting specialists and actuaries for individual pricing. The underwriting team also establishes classes of business that The PMA Insurance Group generally will not write, such as certain property exposures, certain hazardous products and activities, and certain environmental coverages. Underwriters and risk-control professionals in the field report functionally to the Chief Underwriting Officer and locally to branch vice presidents that are accountable for territorial operating results. Underwriters also work with the field marketing force to identify business that meets prescribed underwriting standards and to develop specific strategies to write the desired business. In performing this assessment, the field office professionals also consult with actuaries who have been assigned to the specific field office regarding loss trends and pricing and utilize actuarial loss rating models to assess the projected underwriting results of accounts. The PMA Insurance Group also employs credit analysts. These employees review the financial strength and stability of customers whose business is written on loss-sensitive and alternative market products and specify the type and amount of collateral that customers must provide under these arrangements. Claims Administration Claims services are delivered to customers primarily through employees in the field offices. The PMA Insurance Group maintains a centralized call center for loss reporting and has automated and centralized the processing of claims payments, which allows the claims adjusters to substantially reduce the time that they spend with clerical and repetitive functions. The PMA Insurance Group also employs in-house attorneys who represent customers in workers' compensation cases and other insurance matters. The PMA Insurance Group has a separate, anti-fraud unit that investigates suspected false claims and other irregularities. Certain specialized matters, such as asbestos and environmental claims, are referred to a special claims unit in the home office. 11 Run-off Operations As a part of The PMA Insurance Group's 1996 restructuring plan, the Run-off Operations were established principally to manage the capital supporting workers' compensation loss reserves for accident years 1992 and prior. The reserves primarily relate to the period of time from 1987 to 1991 when The PMA Insurance Group wrote a much higher volume of business and experienced poor underwriting results. The reserves are mainly indemnity related and are relatively mature. At December 31, 1999, the Run-off Operations had $79.0 million of total assets and $70.8 million in total reserves. See page 35 of the MD&A and Notes 16 and 18 to the Financial Statements in the Annual Report. 12 CALIBER ONE Background In January 1998, the Company's specialty insurance unit, Caliber One, commenced writing business. Caliber One's gross and net premiums written for 1999 were $93.4 million and $51.2 million, respectively. Caliber One writes business through surplus lines brokers and managing general agents on a national basis. Caliber One Indemnity Company, Caliber One's statutory insurance affiliate, is a licensed carrier in Delaware, its state of domicile, and is presently eligible as an excess and surplus lines carrier in 41 states, the District of Columbia and Puerto Rico, with applications pending in two other states. Products, Distribution and Underwriting Caliber One currently focuses on excess and surplus lines of insurance for difficult risks that are typically declined by the standard market. Caliber One offers liability coverages for low frequency/high severity classes, including pharmaceuticals, chemicals, auto parts, machinery manufacturers, toy makers, medical product manufacturers and other difficult-to-insure product liability risks, as well as property coverages for risks declined by admitted insurers. In addition, Caliber One has written environmental impairment liability coverages, clinical trials coverage for emerging biotechnology products, intellectual property rights liability coverages, intermediate and skilled long-term care coverages. Caliber One's policy forms contain various endorsements and exclusions, and in some cases, include defense costs within the policy limits rather than offering such coverage on an unlimited basis. Caliber One also evaluates the diversity of its product offerings in an effort to obtain a balance in coverages being offered. For 1999, casualty business represented $68.9 million, or 74%, of Caliber One's gross premiums written, while property business represented $24.5 million, or 26% of gross premiums written. For 1998, the mix of business on a percentage basis was the same as that for 1999, with $8.7 million of gross premiums written represented by casualty business and $3.1 million by property business. For 1999, casualty business represented $48.2 million, or 94%, of Caliber One's net premiums written, while property business represented $3.0 million, or 6% of net premiums written. For 1998, casualty business represented $5.9 million, or 92%, of net premiums written and property business represented $0.5 million, or 8%, of net premiums written. Caliber One currently operates through three internal underwriting units based on classes of business and distribution channels: casualty brokerage, property brokerage and programs. Gross premiums written by the casualty brokerage unit represented $57.1 million, or 61%, of total gross premiums written in 1999, compared to $8.6 million, or 73%, of gross premiums written in 1998. Gross premiums written by the property brokerage unit represented $16.7 million, or 18% of total gross premiums written in 1999 compared to $2.5 million, or 21%, of gross premiums written in 1998. The programs unit represented $19.6 million, or 21%, of gross premiums written in 1999 compared to $0.7 million, or 6%, for the programs unit in 1998. The underwriting of excess and surplus lines involves a significant amount of judgment. The underwriting process involves reviewing the claims experience of an account, if any, and the claims experience of the particular class or similar classes. The underwriters respond to any special risks of an account through the use of policy features that can be changed in light of the circumstances, such as different levels of retentions, exclusions and endorsements. Caliber One distributes its excess and surplus lines products on a nationwide basis through approximately 45 appointed surplus lines brokers, and, to a lesser extent, through managing general agents for program business. For most product offerings, Caliber One does not grant underwriting or binding authority to its brokers. For its program business, Caliber One currently operates through approximately six managing general agents. Managing general agents are selected based on their specialized areas of expertise and typically have quoting, underwriting and binding authority within pre-approved guidelines. Examples of business written by Caliber One through managing general agents include mobile homeowners, hazardous materials hauling, medical malpractice, excess habitational, crane rental liability and loggers equipment. 13 Acquisition of Caliber One Indemnity Company PMA Reinsurance Corporation acquired 100% of the outstanding common stock of Caliber One Indemnity Company, domiciled in Delaware and formerly known as Lincoln Insurance Company, for approximately $16.0 million in late 1997 and made a capital contribution of approximately $11.3 million to Caliber One Indemnity Company. All of Caliber One Indemnity Company's acquired loss reserves were reinsured with an affiliate of its former parent for adverse development and uncollectible reinsurance (the "Reserve Guarantee") in the amount of the recorded reserves plus $68.5 million. Management believes that the Reserve Guarantee will be adequate to cover any future adverse reserve development or uncollectible reinsurance on the acquired reserves. PMA Reinsurance Corporation intends to maintain Caliber One Indemnity Company's surplus at not less than $25.0 million. REINSURANCE AND RETROCESSIONAL PROTECTION The Company follows the customary insurance practice of reinsuring with other insurance companies a portion of the risks under the policies written by its insurance subsidiaries. This reinsurance is maintained to protect the insurance subsidiaries against the severity of losses on individual claims and unusually serious occurrences in which a number of claims produce an aggregate extraordinary loss. Although reinsurance does not discharge the insurance subsidiaries from their primary liabilities to their policyholders for losses insured under the insurance policies, it does make the assuming reinsurer liable to the insurance subsidiaries for the reinsured portion of the risk. The ceded reinsurance agreements of the Company's insurance subsidiaries generally may be terminated at their annual anniversary by either party upon 30 to 90 days notice. In general, the reinsurance agreements are of the treaty variety, which cover all underwritten risks of the types specified in the treaties. At December 31, 1999, the Company's reinsurance and retrocessional protections were as follows:
Retention Limits(1) --------- --------- PMA Re Per Occurrence: Casualty lines $ 2.8 million $ 17.5 million Workers' compensation $ 2.0 million $ 98.0 million Property lines $ 2.0 million $ 48.0 million Per Risk: Property lines $ 750,000 $ 4.3 million Casualty lines $ 1.5 million $ 6.0 million The PMA Insurance Group Per Occurrence: Workers' compensation $ 150,000 $ 103.5 million Per Risk: Property lines $ 500,000 $ 19.5 million(2) Auto physical damage $ 500,000 $ 2.0 million Other casualty lines $ 175,000 $ 4.8 million(3) Caliber One Per Occurrence and Per Risk: Property lines $ 500,000 $ 4.5 million Casualty lines $ 500,000 $ 5.5 million
(1) Represents the amount of loss protection above the Company's level of loss retention. (2) This coverage also provides protection of $48.5 million per occurrence over the combined net retention of $500,000. (3) This coverage also provides protection of $49.8 million per occurrence over the combined net retention of $175,000. 14 As of December 31, 1999, the maximum gross limits that PMA Re will write are $7.5 million for casualty covers, $5.0 million for property covers and $1.0 million for property catastrophe covers. The Company actively manages its exposure to catastrophes through its underwriting process, where the Company generally monitors the accumulation of insurable values in catastrophe prone regions. Also, in writing property reinsurance coverages, PMA Re typically requires per occurrence loss limitations for contracts that could have catastrophe exposure. Through per risk reinsurance, the Company also manages its net retention in each exposure. As a result, the Company's loss and LAE ratios have not been significantly impacted by catastrophes in the past three years. Although the Company believes it has adequate reinsurance to protect against the estimated probable maximum gross loss from a catastrophe, an especially severe catastrophe or series of catastrophes could exceed the Company's reinsurance and/or retrocessional protection and may have a material adverse impact on the Company's financial condition, results of operations and liquidity. The collectibility of reinsurance is largely a function of the solvency of reinsurers. At December 31, 1999, the Company had reinsurance recoverables due from the following unaffiliated reinsurers in excess of 5% of shareholders' equity:
(dollar amounts in thousands) Reinsurance A.M. Best Reinsurer Recoverables Rating (1) - --------- ---------------- ---------- London Life & Casualty Reinsurance Corp. $ 240,753 A United States Fidelity and Guaranty Company 98,940 A American Re-Insurance Company 29,599 A++ Essex Insurance Company 26,554 A SCOR Reinsurance Company 22,724 A+ Houston Casualty Company 22,574 A+
(1) Ratings are as of March 21, 2000, at which time the rating for Essex Insurance Company was under review. A.M. Best ratings are as follows: A++, Superior, 1st of 15; A+, Superior, 2nd of 15; and A, Excellent, 3rd of 15. The Company performs extensive credit reviews on its reinsurers, focusing on, among other things, financial capacity, stability, trends and commitment to the reinsurance business. Prospective and existing reinsurers failing to meet the Company's standards are excluded from the Company's reinsurance programs. In addition, the Company requires letters of credit or other acceptable collateral to support balances due from reinsurers not authorized to transact business in the applicable jurisdictions. As of December 31, 1999, approximately 98% of the Company's reinsurance receivables related to unpaid reported claims and incurred but not reported claims, and the remaining 2% related to paid losses. The timing and collectibility of reinsurance receivables have not had, and are not expected to have, a material adverse effect on the Company's liquidity. See pages 36-38 of the MD&A and Note 5 to the Financial Statements included in the Annual Report for additional information on reinsurance. LOSS RESERVES Insurers establish reserves representing estimates of future amounts needed to pay claims with respect to insured events that have occurred, including events that have not been reported to the insurer. Reserves are also established for LAE representing the estimated expenses of settling claims, including legal and other fees, and general expenses of administering the claims adjustment process. After a claim is reported, claims personnel establish a "case reserve" for the estimated amount of the ultimate payment. The estimate reflects the informed judgment of management based on reserving practices and management's experience and knowledge regarding the nature and value of the specific type of claim. Claims personnel review and update their estimates as additional information becomes available and claims proceed towards resolution. In addition, "bulk reserves" are also established on an aggregate basis (i) to provide for losses incurred but not yet reported to the insurer; (ii) to provide for the estimated expenses of settling claims, including legal and other fees and general expenses of administering the claims adjustment process; and (iii) to adjust for the 15 fact that, in the aggregate, case reserves may not accurately estimate the ultimate liability for reported claims. Reserves are estimated using various generally accepted actuarial techniques. As part of the reserving process, historical data is reviewed and consideration is given to the anticipated impact of various factors such as legal developments, changes in social attitudes and economic conditions, including the effects of inflation. This process relies on the basic assumption that past experience, adjusted for the effect of current developments and likely trends, is an appropriate basis for predicting future events. The reserving process provides implicit recognition of the impact of inflation and other factors affecting claims payments by taking into account changes in historic payment patterns and perceived probable trends. There is generally no precise method, however, for subsequently evaluating the adequacy of the consideration given to inflation or to any other specific factor, since the eventual deficiency or redundancy of reserves is affected by many factors, some of which are interdependent. In many cases significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured loss, the reporting of the loss to the insurer and the insurer's payment of that loss. Liabilities for reinsurers generally become known more slowly than for primary insurers and are generally subject to more unforeseen development. Estimating the Company's ultimate claims liability is necessarily a complex and judgmental process as the amounts are based on management's informed estimates and judgments using data currently available. As additional experience and data become available regarding claims payment and reporting patterns, legislative developments, regulatory trends on benefit levels for both medical and indemnity payments, and economic conditions, the estimates are revised accordingly. If the Company's ultimate net losses prove to be substantially greater than the amounts recorded in the financial statements, the related adjustments could have a material adverse impact on the Company's financial condition and results of operations. The table on the next page presents the subsequent development of the estimated year-end property and casualty reserves, net of reinsurance ("net reserves"), for the ten years prior to 1999. The first section of the table shows the estimated net reserves that were recorded at the end of each respective year for all current and prior year unpaid losses and LAE. The second section shows the cumulative amounts of such previously recorded net reserves paid in succeeding years. The third section shows the re-estimates of the net reserves made in each succeeding year. The cumulative deficiency (redundancy) as shown in the table represents the aggregate change in the reserve estimates from the original balance sheet dates through December 31, 1999; an increase in a loss estimate that related to a prior year occurrence generates a deficiency in each intervening year. For example, a deficiency first recognized in 1997 relating to losses incurred in 1990 would be included in the cumulative deficiency amount for each of the years 1990 through 1996. However, the deficiency would be reflected in operating results in 1997 only. Conditions and trends that have affected the reserve development reflected in the table may change, and care should be exercised in extrapolating future reserve redundancies or deficiencies from such development. 16
Consolidated Loss and Loss Adjustment Expense Development December 31, (dollar amounts in millions) 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Initial estimated liability for unpaid losses and LAE, net of reinsurance $1,632.2 $1,734.6 $1,824.3 $1,941.0 $1,932.0 $1,855.9 $1,808.5 $1,834.5 $1,670.9 $1,347.2 $1,284.4 ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== Amount of reserve paid, net of reinsurance, through: - - one year later $ 444.6 $ 470.8 $ 490.5 $ 442.4 $ 407.8 $ 398.9 $ 437.6 $ 398.8 $ 360.7 $ 351.5 -- - - two years later 771.5 842.0 848.8 779.1 746.1 763.7 780.0 669.6 646.0 - - three years later 1,042.6 1,133.8 1,127.0 1,066.8 1,055.9 1,072.9 999.0 894.8 - - four years later 1,258.0 1,353.1 1,364.9 1,329.2 1,330.6 1,252.2 1,183.5 - - five years later 1,421.4 1,539.4 1,585.4 1,573.8 1,472.7 1,405.9 - - six years later 1,553.1 1,715.1 1,788.9 1,688.7 1,605.4 - - seven years later 1,684.6 1,882.1 1,882.2 1,805.4 - - eight years later 1,817.3 1,962.6 1,986.5 - - nine years later 1,887.4 2,048.9 - - ten years later 1,956.4 Re-estimated liability, net of reinsurance, as of: - - one year later $1,696.0 $1,795.3 $1,966.8 $1,998.1 $1,932.3 $1,907.4 $1,964.6 $1,748.5 $1,624.3 $1,314.7 - - two years later 1,742.5 1,949.9 2,067.5 2,006.5 1,982.5 2,073.4 1,866.8 1,700.5 1,557.6 - - three years later 1,876.0 2,034.1 2,081.5 2,060.6 2,163.9 1,986.7 1,819.2 1,611.1 - - four years later 1,938.2 2,040.8 2,134.8 2,258.2 2,078.3 1,942.0 1,742.1 - - five years later 1,935.1 2,123.0 2,302.0 2,170.3 2,030.5 1,880.3 - - six years later 1,985.3 2,273.3 2,209.3 2,126.6 1,973.2 - - seven years later 2,098.2 2,205.4 2,169.5 2,079.9 - - eight years later 2,052.2 2,168.4 2,133.7 - - nine years later 2,020.1 2,138.6 - - ten years later 1,999.8 Indicated deficiency (redundancy) $ 367.6 $ 404.0 $ 309.4 $ 138.9 $ 41.2 $ 24.4 $(66.4) $(223.4) $(113.3) $ (32.5) ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== Net liability $1,932.0 $1,855.9 $1,808.5 $1,834.5 $1,670.9 $1,347.2 $1,284.4 Reinsurance recoverables 218.7 247.9 261.5 256.6 332.3 593.7 648.2 -------- -------- -------- -------- -------- -------- -------- Gross liability $2,150.7 $2,103.8 $2,070.0 $2,091.1 $2,003.2 $1,940.9 $1,932.6 ======== ======== ======== ======== ======== ======== ======== Re-estimated net liability $1,973.2 $1,880.3 $1,742.1 $1,611.1 $1,557.6 $1,314.7 Re-estimated reinsurance recoverables 197.6 241.9 274.5 271.3 353.0 606.6 -------- -------- -------- -------- -------- -------- Re-estimated gross liability $2,170.8 $2,122.2 $2,016.6 $1,882.4 $1,910.6 $1,921.3 ======== ======== ======== ======== ======== ========
17 Unpaid losses and LAE on a GAAP basis were $1,932.6 million and $1,940.1 million at December 31, 1999 and 1998, respectively. Unpaid losses and LAE on a statutory basis were $1,282.0 million and $1,347.2 million at December 31, 1999 and 1998, respectively. Substantially all of the difference between GAAP and statutory loss reserves is due to reinsurance recoverables on unpaid losses and LAE, which are recorded as assets for GAAP but netted against statutory loss reserves. At December 31, 1999 and 1998, the Company's GAAP loss reserves were stated net of discount of $180.4 million and $194.6 million, respectively, primarily related to workers' compensation business. Pre-tax income is negatively impacted by accretion of discount on prior year reserves and favorably impacted by setting up discount for current year reserves. The net of these amounts is referred to as net discount accretion. Net discount accretion decreased pre-tax income by $2.7 million and $14.5 million in 1999 and 1998, respectively. The components of the Company's (favorable) unfavorable development of reserves for losses and LAE for prior accident years, excluding accretion of discount, are as follows: (dollar amounts in millions)
1999 1998 1997 ---- ---- ---- PMA Re $ (23.5) $ (31.5) $ (32.1) The PMA Insurance Group: Workers' compensation (7.1) (17.3) (44.1) Other (1.9) 2.3 (9.8) ------------ ------------ ------------- Total PMA Insurance Group (9.0) (15.0) (53.9) ------------ ------------ ------------- Total $ (32.5) $ (46.5) $ (86.0) ============ ============ =============
During 1999, 1998 and 1997, PMA Re recorded favorable reserve development on prior accident years ("prior year development") of $23.5 million, $31.5 million and $32.1 million, respectively. The favorable reserve development reflects development on prior accident years due to re-estimated loss trends for such years that were lower than previous expectations. During 1999, 1998 and 1997, The PMA Insurance Group recorded favorable prior year development of $9.0 million, $15.0 million and $53.9 million. The favorable reserve development in 1999 reflects better than expected loss experience from loss-sensitive and rent-a-captive workers' compensation business. This favorable development has been substantially offset by premium adjustments for loss-sensitive business and policyholders' dividends for rent-a-captive business. Rent-a-captives are used by customers as an alternative method to manage their loss exposure without establishing and capitalizing their own captive insurance company. The favorable reserve development during 1998 primarily relates to the formal commutation programs, which resulted in early liability settlements made during 1998 to reduce future claim payments. Favorable loss development in 1997 is attributable to the following: favorable reserve development of approximately $37.0 million related to retrospectively rated policies for Run-off Operations; the cession of prior year reserves of $14.8 million from Run-off Operations to a third party reinsurer; and favorable reserve development of $7.1 million on guaranteed cost workers' compensation reserves, partially offset by reserve strengthening of $5.0 million in commercial multi-peril business. The PMA Insurance Group has been executing programs under which it commuted, or settled, a large number of workers' compensation claims. Commutations are agreements whereby the claimants, in exchange for a lump sum payment, release their rights to future indemnity payments from The PMA Insurance Group. The PMA Insurance Group paid approximately $38 million, $65 million and $113 million in 1999, 1998 and 1997, respectively, to commute workers' compensation claims. The commutation programs resulted in payments that were less than the corresponding carried reserves. Savings associated with these claims were consistent with management's expectations. At December 31, 1999, the Company's loss reserves were stated net of $43.8 million of salvage and subrogation. The Company's policy with respect to estimating the amounts and realizability of salvage and subrogation is to develop accident year schedules of historic paid salvage and subrogation by line of business, which are then 18 projected to an ultimate basis using actuarial projection techniques. The anticipated salvage and subrogation is the estimated ultimate salvage and subrogation less any amounts received by the Company. The realizability of anticipated salvage and subrogation is reflected in the historical data that is used to complete the projection, as historical paid data implicitly considers realization and collectibility. Asbestos and Environmental Reserves The Company's asbestos-related losses were as follows: (dollar amounts in thousands)
1999 1998 1997 ---- ---- ---- Gross of reinsurance: Beginning reserves $ 67,857 $ 76,726 $ 80,055 Incurred losses and LAE 1,910 (1,976) 2,435 Paid losses and LAE (8,490) (6,893) (5,764) ------------- ------------ ------------ Ending reserves $ 61,277 $ 67,857 $ 76,726 ============= ============ ============ Net of reinsurance: Beginning reserves $ 43,556 $ 48,578 $ 53,300 Incurred losses and LAE (341) (2,754) (36) Paid losses and LAE (4,364) (2,268) (4,686) ------------- ------------ ------------ Ending reserves $ 38,851 $ 43,556 $ 48,578 ============= ============ ============
The Company's environmental-related losses were as follows: (dollar amounts in thousands)
1999 1998 1997 ---- ---- ---- Gross of reinsurance: Beginning reserves $ 47,036 $ 45,108 $ 35,626 Incurred losses and LAE 5,081 11,895 1,130 Reserves acquired through purchase of Caliber One Indemnity Company(1) - - 13,060 Paid losses and LAE (10,758) (9,967) (4,708) ------------ ------------ ------------- Ending reserves $ 41,359 $ 47,036 $ 45,108 ============ ============ ============= Net of reinsurance: Beginning reserves $ 29,356 $ 31,695 $ 34,592 Incurred losses and LAE 82 3,644 1,068 Paid losses and LAE (4,916) (5,983) (3,965) ------------ ------------ ------------- Ending reserves $ 24,522 $ 29,356 $ 31,695 ============ ============ =============
(1) Such acquired reserves have been reinsured by an affiliate of the former parent (see "Caliber One" for further discussion). Of the total net asbestos reserves, approximately $32.0 million, $34.2 million and $41.9 million related to IBNR losses at December 31, 1999, 1998 and 1997, respectively. Of the total net environmental reserves, approximately $18.0 million, $20.3 million and $20.5 million related to IBNR losses at December 31, 1999, 1998 and 1997, respectively. All incurred asbestos and environmental losses were for accident years 1986 and prior. Estimating reserves for asbestos and environmental exposures continues to be difficult because of several factors, including: (i) evolving methodologies for the estimation of the liabilities; (ii) lack of reliable historical claim data; (iii) uncertainties with respect to insurance and reinsurance coverage related to these obligations; (iv) changing judicial interpretations; and (v) changing government standards. To reserve for environmental claims, the Company currently utilizes a calendar year development technique known as aggregate loss development. This technique 19 focuses on the aggregate losses paid as of a particular date and aggregate payment patterns associated with such claims. Several elements including remediation studies, remediation, defense, declaratory judgment and third party bodily injury claims were considered in estimating the costs and payment patterns of the environmental and toxic tort losses. Prior to the development of these techniques, there was a substantial range in the nature of reserving for environmental and toxic tort liabilities. Management believes that its reserves for asbestos and environmental claims are appropriately established based upon known facts, existing case law and generally accepted actuarial methodologies. However, due to changing interpretations by courts involving coverage issues, the potential for changes in federal and state standards for clean-up and liability, as well as issues involving policy provisions, allocation of liability among participating insurers, proof of coverage and other factors, the Company's ultimate exposure for these claims may vary significantly from the amounts currently recorded, resulting in a potential future adjustment that could be material to the Company's financial condition and results of operations. INVESTMENTS An important component of the financial results of the Company is the return on invested assets. The Company's investment objectives are to (i) seek competitive after-tax income and total return, (ii) maintain medium to high investment grade asset quality and high marketability, (iii) maintain maturity distribution commensurate with the Company's business objectives, (iv) provide portfolio flexibility for changing business and investment climates and (v) provide liquidity to meet operating objectives. The Company's investment strategy includes guidelines for asset quality standards, asset allocations and other relevant criteria for its portfolio. In addition, maturities are structured after projecting liability cash flows with actuarial models of loss reserve payouts. Property and casualty claim demands are somewhat unpredictable in nature and require liquidity from the underlying invested assets, which are structured to emphasize current investment income to the extent consistent with maintaining appropriate portfolio quality and diversity. The liquidity requirements are met primarily through publicly traded fixed maturities as well as operating cash flows and short-term investments. The Executive and Finance Committees of the Company's Board of Directors are responsible for the Company's investment objectives. The Company retains outside investment advisers to provide investment advice and guidance, supervise the Company's portfolio and arrange securities transactions through brokers and dealers. The Executive and Finance Committees of the Company's Board of Directors meet periodically with the investment advisers to review the performance of the investment portfolio and to determine what actions should be taken with respect to the Company's investments. Investments by the Pooled Companies, MASCCO and PMA Reinsurance Corporation must comply with the insurance laws and regulations of the Commonwealth of Pennsylvania and investments for Caliber One Indemnity Company must comply with the insurance laws and regulations of Delaware. The Company currently has only one derivative financial instrument outstanding, an interest rate swap on its Credit Facility, which is used as a hedge in accordance with the Company's investment strategy. Derivatives are not used for speculative purposes. The Company's portfolio does not contain any significant concentrations in single issuers (other than U.S. Treasury and agency obligations), industry segments or geographic regions. For additional information on the Company's investments, including carrying values by category, quality ratings and net investment income, see pages 40-41 of the MD&A as well as Notes 2(B) and 3 to the Financial Statements in the Annual Report. 20 COMPETITION The domestic property and casualty insurance and reinsurance industries are very competitive and consist of many companies, with no one company dominating the market. In addition, the degree and nature of competition varies from state to state for a variety of reasons, including the regulatory climate and other market participants in each state. PMA Re competes with other reinsurers in the broker market as well as reinsurers that underwrite reinsurance business on a direct basis. In addition to competition from other insurance companies, The PMA Insurance Group and Caliber One compete with certain alternative market arrangements, such as captive insurers, risk-sharing pools and associations, risk retention groups, and self-insurance programs. Many of the Company's competitors are larger and have greater financial resources than the Company. The main factors upon which entities in the Company's markets compete are price, service, product capabilities and financial security. PMA Re, The PMA Insurance Group and Caliber One attempt to price their products in such a way that the prices charged to their clients are commensurate with the overall marketplace while still meeting the Company's rate of return targets. The present soft pricing environment has made competing solely on the basis of price increasingly difficult. PMA Re, The PMA Insurance Group and Caliber One have rejected and/or non-renewed certain accounts in recent years, as the market rates for such risks did not provide the opportunity to achieve an acceptable rate of return. In terms of service, the Company maintains service standards concerning turn-around time for underwriting submissions, information flow, claims handling and the quality of other services. These standards help ensure that clients are satisfied with the Company's products and services. The Company periodically participates in surveys of intermediaries and clients to gain an understanding of the perceptions of its service as compared to its competitors. The Company attempts to design products that meet the needs of clients in its markets. PMA Re has expanded its product line in recent years to satisfy the needs of its client base. Products introduced by PMA Re in the last four years include finite risk and financial products reinsurance and facultative reinsurance. See "PMA Re--Products" for additional discussion. In recent years, The PMA Insurance Group has developed products that reflect the evolving nature of the workers' compensation market. Specifically, it has developed PMA One, a product that provides for group integrated occupational and non-occupational disability coverages. The PMA Insurance Group has also increased its focus on rehabilitation and managed care to control workers' compensation costs for the employers. In addition, The PMA Insurance Group has introduced and refined alternative market products, as well as unbundled risk management and claims administration services. See "The PMA Insurance Group--Products" for additional discussion. Caliber One intends to design products that meet the needs of new classes of business and that cover emerging risks. The Company continually evaluates new product opportunities for PMA Re, The PMA Insurance Group and Caliber One. For many intermediaries and clients, financial security is measured by the ratings assigned by independent rating agencies. Certain of the Company's insurance subsidiaries are rated by independent rating agencies. The ratings represent the opinions of the rating agencies on the insurance company's financial strength and its ability to pay obligations to its policyholders. Management believes that the ratings assigned by nationally recognized, independent rating agencies, particularly A.M. Best, are material to the Company's operations. The rating scales of the principal agencies that rate the Company's insurance subsidiaries are characterized as follows: o A.M. Best Company, Inc. ("A.M. Best"), A++ to F ("Superior" to "In Liquidation") o Moody's Investors Service ("Moody's"), Aaa to C ("Exceptional" to "Lowest") As of March 15, 2000, A.M. Best had assigned an A+ ("Superior," 2nd of 15) rating to PMA Reinsurance Corporation, an A- ("Excellent," 4th of 15) rating to the Pooled Companies and an A ("Excellent," 3rd of 15) rating to Caliber One Indemnity Company. In addition, Moody's had rated PMA Reinsurance Corporation A3 ("Good," 7th of 21) and the Pooled Companies Baa2 ("Adequate," 9th of 21). These ratings are subject to revision or withdrawal at any time by the rating agencies, and therefore, no assurance can be given that PMA Reinsurance 21 Corporation, the Pooled Companies and/or Caliber One Indemnity Company can maintain these ratings. Each rating should be evaluated independently of any other rating. REGULATORY MATTERS General PMA Reinsurance Corporation is licensed or accredited to transact its reinsurance business in, and is subject to regulation and supervision by, 50 states and the District of Columbia. The Pooled Companies are licensed to transact insurance business in, and are subject to regulation and supervision by, 44 states and the District of Columbia. Caliber One Indemnity Company is licensed in one state and is an eligible excess and surplus lines carrier in 41 states, the District of Columbia and Puerto Rico. The Company's insurance subsidiaries are authorized and regulated in all jurisdictions where they conduct insurance business. In supervising and regulating insurance and reinsurance companies, state insurance departments, charged primarily with protecting policyholders and the public rather than investors, enjoy broad authority and discretion in applying applicable insurance laws and regulations for that purpose. PMA Reinsurance Corporation and the Pooled Companies are domiciled in Pennsylvania, and the Pennsylvania Insurance Department exercises principal regulatory jurisdiction over them. Caliber One Indemnity Company is domiciled in Delaware, and the Delaware Insurance Department exercises principal jurisdiction over Caliber One Indemnity Company. The extent of regulation by the states varies, but in general, most jurisdictions have laws and regulations governing standards of solvency, adequacy of reserves, reinsurance, capital adequacy and standards of business conduct. In addition, statutes and regulations usually require the licensing of insurers and their agents, the approval of policy forms and related material and, for certain lines of insurance, including rate-sensitive workers' compensation, the approval of rates. Property and casualty reinsurers, and excess and surplus lines carriers are generally not subject to filing or other regulatory requirements applicable to primary standard lines insurers with respect to rates, policy forms or contract wording. The form and content of statutory financial statements are regulated. The U.S. federal government does not directly regulate the insurance industry; however, federal initiatives from time to time can impact the insurance industry. On November 12, 1999, the President of the United States signed into law the "Gramm-Leach-Bliley Financial Modernization Act," which removed many of the restrictions on affiliations among firms in different financial services businesses, notably banking, securities and insurance. The Act also contains provisions to protect the privacy of certain information on individuals held by insurance companies and financial institutions. Several governmental agencies are expected to propose standards to implement these privacy provisions. Although it is too early to assess the effects of this legislation on the Company, the Act could result in additional costs to the Company and additional competition in one or more of the markets in which the Company sells its products and services. Further, although the Company does not write health insurance, federal and state rules and regulations affecting health care services can affect the workers' compensation and integrated disability services the Company provides. Pending initiatives to increase health care regulation at the federal level include managed care reform and a patient's bill of rights. The Company cannot predict what health care reform legislation will be adopted by Congress or by state legislatures where the Company does business or the effect, if any, that the adoption of health care legislation or regulations at the federal or state level will have on the Company's results of operations. State insurance departments in jurisdictions in which the Company's insurance subsidiaries do business also conduct periodic examinations of their respective operations and accounts and require the filing of annual and other reports relating to their financial condition. The Pennsylvania Department of Insurance last conducted examinations of the Pooled Companies as of December 31, 1997. No material adjustments to previously filed statutory financial statements were required as a result of such examinations. In addition, there were no material qualitative matters indicated in the examination reports that had or are expected to have a material adverse effect on the operations of the Pooled Companies. The Pennsylvania Department of Insurance recently completed examinations of PMA Reinsurance Corporation and MASCCO as of December 31, 1997. Although the Company has not received the final reports of examination, the Company does not expect the results of the examinations to have a material adverse effect on results of operations of PMA Reinsurance Corporation or MASCCO. Caliber One Indemnity Company 22 has not been subjected to an Insurance Department examination in the two years that the company has been writing business as Caliber One Indemnity Company. Insurance Holding Company Regulation The Company and its insurance subsidiaries are subject to regulation pursuant to the insurance holding company laws of Pennsylvania and Delaware. These state insurance holding company laws generally require an insurance holding company and insurers and reinsurers that are members of such insurance holding company's system to register with the state regulatory authorities, to file with those authorities certain reports disclosing information including their capital structure, ownership, management, financial condition, certain intercompany transactions including material transfers of assets and intercompany business agreements and to report material changes in such information. These laws also require that intercompany transactions be fair and reasonable and that an insurer's policyholders' surplus following any dividends or distributions to shareholder affiliates be reasonable in relation to the insurer's outstanding liabilities and adequate for its financial needs. Under Pennsylvania and Delaware law, no person may acquire, directly or indirectly, a controlling interest in the capital stock of the Company unless such person, corporation or other entity has obtained prior approval from the respective Commissioner for such acquisition of control. Pursuant to the Pennsylvania and Delaware law, any person acquiring, controlling or holding the power to vote, directly or indirectly, ten percent or more of the voting securities of an insurance company, is presumed to have "control" of such company. This presumption may be rebutted by a showing that control does not exist in fact. The respective Commissioner, however, may find that "control" exists in circumstances in which a person owns or controls a smaller amount of voting securities. To obtain approval from the Commissioner of any acquisition of control of an insurance company, the proposed acquirer must file with the Commissioner an application containing information regarding: the identity and background of the acquirer and its affiliates; the nature, source and amount of funds to be used to carry out the acquisition; the financial statements of the acquirer and its affiliates; any potential plans for disposition of the securities or business of the insurer; the number and type of securities to be acquired; any contracts with respect to the securities to be acquired; any agreements with broker-dealers; and other matters. Other jurisdictions in which the Company's insurance subsidiaries are licensed to transact business may have requirements for prior approval of any acquisition of control of an insurance or reinsurance company licensed or authorized to transact business in those jurisdictions. Additional requirements in those jurisdictions may include re-licensing or subsequent approval for renewal of existing licenses upon an acquisition of control. As further described below, laws that govern the holding company structure also govern payment of dividends by the Company's insurance subsidiaries to the Company. Restrictions on Subsidiaries' Dividends and Other Payments PMA Capital is an insurance holding company whose assets consist principally of all of the outstanding common stock of its insurance subsidiaries. PMA Capital's ongoing ability to pay dividends to its shareholders and meet its other obligations, including operating expenses and any principal and interest on debt, is primarily dependent on the receipt of sufficient funds from its insurance subsidiaries in the form of dividends, net payments under a tax-sharing agreement between PMA Capital and its subsidiaries, and borrowings. The Company's domestic insurance subsidiaries' ability to pay dividends to PMA Capital is regulated under the insurance laws and regulations of Pennsylvania and Delaware (the laws of which are substantially similar with respect to dividends). In addition, to the extent tax-sharing payments and loans exceed certain threshold amounts, notice to and non-disapproval by the Pennsylvania Insurance Commissioner would be required. Under Pennsylvania laws and regulations, PMA Capital's significant Pennsylvania-domiciled insurance subsidiaries (PMA Reinsurance Corporation and the Pooled Companies) may pay dividends only from unassigned surplus and future earnings arising from their businesses and must receive prior approval of the Pennsylvania Insurance Commissioner to pay a dividend if such dividend would exceed the statutory limitation. The current statutory limitation is the greater of (i) 10% of the insurer's policyholders' surplus, as shown on its last annual statement on file with the Pennsylvania Insurance Commissioner or (ii) the insurer's statutory net income for the previous calendar year. Pennsylvania law gives the Pennsylvania Insurance Commissioner broad discretion to disapprove requests for dividends in excess of these limits. 23 Based upon this limitation, these companies have the legal capacity to pay approximately $55 million in dividends to PMA Capital in 2000 without obtaining the prior approval of the Pennsylvania Insurance Commissioner. Pennsylvania law also provides that following the payment of any dividend, the insurer's policyholders' surplus must be reasonable in relation to its outstanding liabilities and adequate for its financial needs, and permits the Pennsylvania Insurance Commissioner to bring an action to rescind a dividend which violates these standards. During 1999, $41.9 million of dividends were paid by PMA Reinsurance Corporation and the Pooled Companies to PMA Capital Corporation. Caliber One Indemnity Company is a Delaware-domiciled insurance subsidiary of PMA Reinsurance Corporation. As a subsidiary of PMA Reinsurance Corporation, Caliber One Indemnity Company's dividends are not directly available to PMA Capital. As noted above, the Delaware insurance law provisions restricting dividends by insurers are substantially similar to such provisions under Pennsylvania insurance laws. During 2000, Caliber One Indemnity Company may pay up to $3.3 million of dividends to PMA Reinsurance Corporation without the prior approval of the Delaware Insurance Commissioner. During 1999, no dividends were declared or paid by Caliber One Indemnity Company. In the event that the ability of either the Pooled Companies or PMA Reinsurance Corporation to pay dividends or make other payments to PMA Capital in the future is reduced or eliminated, PMA Capital's ability to pay dividends to its shareholders and meet its other obligations, including operating expenses and any principal and interest on debt, could be materially and adversely affected, depending upon the extent of such reduction. The Pennsylvania Insurance Commissioner could use his or her broad discretionary authority to seek to require PMA Capital to apply payments received from one insurance subsidiary for the benefit of another insurance subsidiary of PMA Capital. In addition to regulatory restrictions on dividends, the Company's Revolving Credit Facility and Letter of Credit Facility also impose restrictions on the ability of the Company's insurance subsidiaries to pay dividends. Under these restrictions, the statutory surplus of PMA Capital's insurance subsidiaries (as measured each calendar quarter) must not be less than $450 million and such subsidiaries must annually maintain certain minimum ratios of adjusted surplus to risk-based capital (300% for PMA Reinsurance Corporation and 240% for the Pooled Companies in 1999). As of December 31, 1999, the Company's insurance subsidiaries reported combined statutory surplus of $552.8 million, and, as of December 31, 1999, PMA Reinsurance Corporation's risk-based capital ratio was 323% and the Pooled Companies' ratios ranged from 380% to 521%. Under the most restrictive debt covenant of the Facilities, PMA Capital would be able to pay approximately $10 million in dividends in 2000. Risk-Based Capital The National Association of Insurance Commissioners (the "NAIC") has adopted risk-based capital ("RBC") requirements for property/casualty insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, asset and liability matching, loss reserve adequacy and other business factors. Under RBC requirements, regulatory compliance is determined by the ratio of a company's total adjusted capital, as defined by the NAIC, to its authorized control level of RBC("RBC ratio"), also as defined by the NAIC. Four levels of regulatory attention may be triggered if the RBC ratio is insufficient: o "Company action level" - If the RBC ratio is between 150% and 200%, then the company must submit a plan to the regulator detailing corrective action it proposes to undertake. o "Regulatory action level" - If the RBC ratio is between 100% and 150%, then the company must also submit a plan, but a regulator may also issue a corrective order requiring the insurer to comply within a specified period. o "Authorized control level" - If the RBC ratio is between 70% and 100%, then the regulatory response is the same as at the "Regulatory action level," but in addition, the regulator may take action to rehabilitate or liquidate the insurer. o "Mandatory control level" - If the RBC ratio is less than 70%, then the regulator must rehabilitate or liquidate the insurer. 24 At December 31, 1999, the RBC ratios of the Pooled Companies ranged from 380% to 521%, and the RBC ratio of MASCCO, The PMA Insurance Group's domestic run-off subsidiary was 275%. PMA Reinsurance Corporation's RBC ratio was 323% and Caliber One Indemnity Company's RBC ratio was 732%. The Company believes that it will be able to maintain the RBC ratios of its insurance subsidiaries in excess of the "Company action level" through prudent underwriting, claims handling, investing and capital management. However, no assurances can be given that developments affecting the insurance subsidiaries, many of which could be outside of management's control, including but not limited to changes in the regulatory environment, economic conditions and competitive conditions in the jurisdictions in which the insurance subsidiaries write business, will not cause the RBC ratios to fall below required levels resulting in a corresponding regulatory response. The NAIC has also developed a series of twelve ratios (the "IRIS ratios") designed to further assist regulators in assessing the financial condition of insurers. These ratio results are computed annually and reported to the NAIC and the insurer's state of domicile. In 1999, PMA Reinsurance Corporation reported an unusual value in one ratio, relating to reserve development due to the change in mix of business and growth in earned premiums. In 1999, two of the Pooled Companies reported an unusual value in one ratio, relating to reserve development due to the paydown of loss reserves. In 1999, Caliber One Indemnity Company reported three unusual values, relating to the change in net premiums written, agent's balances to surplus, and surplus aid (i.e., reinsurance) to surplus. The unusual value relating to the change in net premiums written was attributable to the continued growth of Caliber One during its first full year of operations. The unusual value relating to agent's balances to surplus was also attributable to the continued growth of Caliber One. The third unusual value for Caliber One, relating to surplus aid to surplus, is the result of management's intentional strategy to purchase certain types and amounts of reinsurance during the initial growth period of Caliber One to protect its surplus. EMPLOYEES As of February 29, 2000, the Company had approximately 1000 full-time employees. None of the employees of the Company is represented by a labor union and the Company is not a party to any collective bargaining agreements. The Company considers its employee relations to be good. 25 GLOSSARY OF SELECTED INSURANCE TERMS Aggregate stop loss .................A form of excess of loss treaty reinsurance whereby the reinsurer responds when a ceding insurer incurs losses on a particular line of business during a specific period in excess of a stated dollar amount. Broker ..............................One who negotiates contracts of reinsurance between a primary insurer or other reinsured and a reinsurer on behalf of the primary insurer or other reinsured. The broker receives from the reinsurer a commission for placement and other services rendered. Bulk reserves .......................Reserves established on an aggregate basis to provide for losses incurred but not yet reported to the insurer; to provide for the estimated expenses of settling claims, including legal and other fees and general expenses of administering the claims adjustment process; and to adjust for the fact that, in the aggregate, case reserves may not accurately estimate the ultimate liability for reported claims. Case reserves........................Loss reserves established with respect to individual reported claims. Casualty insurance and/or reinsurance ........................Insurance and/or reinsurance that is concerned primarily with the losses caused by injuries to third persons (in other words, persons other than the policyholder) and the legal liability imposed on the insured resulting therefrom. Catastrophe reinsurance .............A form of excess of loss property reinsurance that, subject to a specified limit, indemnifies the ceding company for the amount of loss in excess of a specified retention with respect to an accumulation of losses resulting from a catastrophic event. The actual reinsurance document is called a "catastrophe cover." Cede; ceding company; cedent .............................When a company reinsures its risk with another, it "cedes" business and is referred to as the "ceding company" or the "cedent." Combined ratio (GAAP)................The sum of losses and LAE, acquisition expenses, operating expenses and policyholders' dividends, where applicable, all divided by net premiums earned. Direct reinsurer, direct underwriter, direct writer......... A reinsurer that markets and sells reinsurance directly to its reinsureds without the assistance of brokers. Excess and surplus lines ............Surplus lines risks are those risks not fitting normal underwriting patterns, involving a degree of risk that is not commensurate with standard rates and/or policy forms, or that will not be written by standard carriers because of general market conditions. Excess insurance refers to coverage that attaches for an insured over the limits of a primary policy or a stipulated self-insured retention. Policies are bound or accepted by carriers not licensed in the jurisdiction where the risk is located, and generally are not subject to regulations governing premium rates or policy language. Excess of loss reinsurance ..........The generic term describing reinsurance that indemnifies the reinsured against all or a specified portion of losses on underlying insurance policies in excess of a specified dollar amount, called a "layer" or "retention." Also known as nonproportional reinsurance or stop loss coverage. Facultative reinsurance..............The reinsurance of all or a portion of the insurance provided by a single policy. Each policy reinsured is separately negotiated. 26 Financial quota share reinsurance.........................A form of finite risk reinsurance wherein the cedent transfers some of its premiums to a finite risk provider and achieves, by virtue of an individual arrangement for reinsurance commission, the required financial effects, such as a stabilization of net claims costs. Finite risk reinsurance..............The reinsurance of potential losses in a transaction in which the primary element of risk is financial rather than underwriting. Gross premiums written...............Total premiums for direct insurance and reinsurance assumed during a given period. Incurred but not reported ("IBNR") reserves...................Loss reserves for estimated losses that have been incurred but not yet reported to the insurer or reinsurer. Incurred losses......................The total losses sustained by an insurance company under a policy or policies, whether paid or unpaid. Incurred losses include a provision for claims that have occurred but have not yet been reported to the insurer ("IBNR"). IRIS ratios..........................Financial ratios annually calculated by the NAIC to assist state insurance departments in monitoring the financial condition of insurance companies. Layers...............................The division of a particular reinsurance program delineated by an attachment point and a maximum limit. Often, a reinsurance program will be divided into several layers, with the lower layers typically having higher premiums and higher claim frequency and the higher layers typically having lower premiums and claim frequency. Loss adjustment expenses ("LAE").............................The expenses of settling claims, including legal and other fees and the portion of general expenses allocated to claim settlement costs. Loss and LAE ratio (GAAP) ...........Loss and LAE ratio is equal to losses and LAE divided by earned premiums. Loss reserves........................Liabilities established by insurers and reinsurers to reflect the estimated cost of claims payments that the insurer or reinsurer ultimately will be required to pay in respect of insurance or reinsurance it has written. Reserves are established for losses and for LAE and consist of case reserves, bulk reserves and IBNR reserves. Manual rates.........................Insurance rates for lines and classes of business that are approved and published by state insurance departments. Net premiums earned..................The portion of net premiums written that is earned during a period and recognized for accounting purposes as revenue. Net premiums written.................Gross premiums written for a given period less premiums ceded to reinsurers during such period. Operating ratio .....................The combined ratio, reduced by the net investment income ratio. The ratio measures a company's operating profitability, exclusive of realized gains and federal income taxes. Per occurrence ......................A form of insurance or reinsurance under which the date of the loss event is deemed to be the date of the occurrence, regardless of when reported and permits all losses arising out of one event to be aggregated instead of being handled on a risk-by-risk basis. 27 Policyholders' dividend ratio .......The ratio of policyholders' dividends to earned premiums. Primary insurer .....................An insurance company that issues insurance policies to the general public or to certain non-insurance entities. Pro rata reinsurance ................Forms of reinsurance in which the reinsurer shares a proportional part of the original premiums and losses of the reinsured. Pro rata reinsurance also is known as proportional reinsurance, quota share reinsurance and participating reinsurance. Property insurance and/or reinsurance ................Insurance and/or reinsurance that indemnifies a person with an insurable interest in tangible property for his property loss, damage or loss of use. Reinsurance .........................The practice whereby one party, called the reinsurer, in consideration of a premium paid to it, agrees to indemnify another party, called the reinsured, for part or all of the liability assumed by the reinsured under a policy or policies of insurance that it has issued. The reinsured may be referred to as the original or primary insurer, the direct writing company or the ceding company. Retention, retention layer ..........The amount or portion of risk that an insurer or reinsurer retains for its own account. Losses in excess of the retention layer are paid by the reinsurer or retrocessionaire. In proportional treaties, the retention may be a percentage of the original policy's limit. In excess of loss business, the retention is a dollar amount of loss, a loss ratio or a percentage. Retrocession; retrocessionaire....................A transaction whereby a reinsurer cedes to another reinsurer (the "retrocessionaire") all or part of the reinsurance it has assumed. Retrocession does not legally discharge the ceding reinsurer from its liability with respect to its obligations to the reinsured. Statutory accounting principles ("SAP")..................Recording transactions and preparing financial statements in accordance with the rules and procedures prescribed or permitted by state insurance regulatory authorities including the NAIC. Statutory or policyholders' surplus; statutory capital & surplus ..........................The excess of admitted assets over total liabilities (including loss reserves), determined in accordance with SAP. Stop loss ...........................See "Excess of loss reinsurance." Treaty reinsurance ..................The reinsurance of a specified type or category of risks defined in a reinsurance agreement (a "treaty") between a primary insurer or other reinsured and a reinsurer. Typically, in treaty reinsurance, the primary insurer or reinsured is obligated to offer and the reinsurer is obligated to accept a specified portion of all agreed upon types or categories of risks originally written by the primary insurer or reinsured. Underwriting ........................The reinsurer's process of reviewing applications submitted for insurance coverage, deciding whether to accept all or part of the coverage requested and determining the applicable premiums. Underwriting expenses ...............The aggregate of policy acquisition costs, including commissions, and the portion of administrative, general and other expenses attributable to underwriting operations. 28 Unearned premiums ...................The portion of a premium representing the unexpired portion of the exposure period as of a certain date. Unearned premium reserve ............Liabilities established by insurers and reinsurers to reflect unearned premiums which are refundable to policyholders if an insurance or reinsurance contract is canceled prior to expiration of the contract term. 29 Item 2. Properties The Company's and PMA Re's headquarters are located in 78,000 square feet of leased space in center city Philadelphia, Pennsylvania. The PMA Insurance Group's headquarters are located in a four story, 110,000 square foot building in Blue Bell, Pennsylvania. Caliber One's headquarters are located in 20,000 square feet of leased office space in Yardley, Pennsylvania. Through various wholly owned subsidiaries, the Company also owns and occupies additional office facilities in three other locations and rents additional office space for its insurance operations in 15 other locations. The Company believes that such owned properties are suitable and adequate for its current business operations. Item 3. Legal Proceedings The Company is continuously involved in numerous lawsuits arising, for the most part, in the ordinary course of business, either as a liability insurer defending third-party claims brought against its insureds, or as an insurer defending coverage claims brought against it by its policyholders or other insurers. While the outcome of all litigation involving the Company, including insurance-related litigation, cannot be determined, litigation is not expected to result in losses that differ from recorded reserves by amounts that would be material to financial condition, results of operations or liquidity. In addition, reinsurance recoveries related to claims in litigation, net of the allowance for uncollectible reinsurance, are not expected to result in recoveries that differ from recorded recoverables by amounts that would be material to the Company's financial condition, results of operations or liquidity. Item 4. Submission of Matters to a Vote of Security Holders There were no matters submitted to a vote of security holders during the fourth quarter of 1999. Executive Officers of the Registrant The executive officers of the Company are as follows: Name Age Position ---- --- -------- John W. Smithson .........54 President and Chief Executive Officer Frederick W. Anton III....66 Chairman of the Board Ronald S. Austin .........42 President and Chief Operating Officer - Caliber One Management Company Vincent T. Donnelly ......47 President and Chief Operating Officer - The PMA Insurance Group Francis W. McDonnell .....43 Senior Vice President, Chief Financial Officer and Treasurer Robert L. Pratter.........55 Senior Vice President, General Counsel and Secretary Stephen G. Tirney ........46 President and Chief Operating Officer - PMA Reinsurance Corporation John W. Smithson has served as President and Chief Executive Officer of the Company since May 1997, and as a director of the Company since 1987. Mr. Smithson served as President and Chief Operating Officer of the Company from 1995 to May 1997, as Chairman and Chief Executive Officer of PMA Reinsurance Corporation since 1984, as Chairman and Chief Executive Officer of The PMA Insurance Group since April 1995, and as Chairman and Chief Executive Officer of Caliber One Management Company since April 1997. Frederick W. Anton III has served as Chairman of the Board since 1995 and as a director of the Company since 1972. Mr. Anton served as Chairman of the Board and Chief Executive Officer from 1995 to May 1997, and as President and Chief Executive Officer from 1981 to 1995. 30 Ronald S. Austin has served as the President and Chief Operating Officer of Caliber One Management Company since 1997. From 1988 to 1997, Mr. Austin served as an officer and director of General Star Management Company, a member of the General Re Group. Vincent T. Donnelly has served as President and Chief Operating Officer of The PMA Insurance Group since February 1997. Mr. Donnelly served as Senior Vice President - Finance and Chief Actuary of The PMA Insurance Group from 1995 to 1997. Francis W. McDonnell has served as Senior Vice President and Chief Financial Officer of the Company since 1995 and as Treasurer since 1997, and has served as Senior Vice President and Chief Financial Officer of PMA Reinsurance Corporation since 1995. Robert L. Pratter has served as Senior Vice President, General Counsel and Secretary since 1999. From 1969 to 1999, Mr. Pratter was an attorney and partner in the law firm of Duane, Morris & Heckscher LLP. Stephen G. Tirney has served as President and Chief Operating Officer of PMA Reinsurance Corporation since 1997. Mr. Tirney served as Executive Vice President of PMA Reinsurance Corporation from 1993 to 1997. PART II Item 5. Market for the Registrant's Common Equity and Related Shareholder Matters The "Class A Common Stock Prices" under the caption "Quarterly Financial Information" and the last paragraph on page 69 of the Annual Report, as well as the information under the captions "Securities Listing" and "Dividends" on page 72 of the Annual Report are incorporated herein by reference. Further, the information in Note 14 to the Financial Statements in the Annual Report and under the caption "Regulation--Restrictions on Subsidiaries' Dividends and Other Payments" in Item 1 of this Form 10-K is incorporated herein by reference. Recent Sales of Unregistered Securities During the year ended December 31, 1997, the Company sold shares of Class A Common Stock in connection with the exercise of employee stock options pursuant to the terms of the Company's stock option plans. In 1997, an aggregate of 162,248 shares were sold to fourteen officers and employees of the Company pursuant to such options at exercise prices ranging from $8.00 to $15.00 per share for an aggregate price of $1,424,349. Additionally, in 1997, the Company sold 1,000 shares to employees at $18.00 per share. The Company believes that these sales were made pursuant to the exemption afforded by Section 4(2) of the Securities Act inasmuch as the sales were made to a limited number of sophisticated investors in transactions not involving a public offering. No unregistered sales of Company securities were made in 1999 or 1998. Item 6. Selected Financial Data The information under the caption "Selected Financial Data" on pages 26 and 27 of the Annual Report is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 28 through 43 of the Annual Report is incorporated herein by reference. 31 Item 7A. Quantitative and Qualitative Disclosure About Market Risk The information under the caption "Market Risk of Financial Instruments" on page 41 of the Annual Report is incorporated herein by reference. Item 8. Financial Statements and Supplementary Data The Company's Consolidated Financial Statements and Notes to Consolidated Financial Statements on pages 44 through 67 and the Report of Independent Accountants on page 68 of the Annual Report are incorporated herein by reference, as is the unaudited "Income Statement Data" and "Per Share Data" under the caption "Quarterly Financial Information" on page 69 of the Annual Report. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. PART III Item 10. Directors and Executive Officers of the Registrant See "Executive Officers of the Registrant" under Item 4 above. The information under the captions "Nominees For Election" and "Directors Continuing in Office" on pages 5 and 6 of the Company's 2000 Proxy Statement dated March 23, 2000 ("Proxy Statement") is incorporated herein by reference, as is the information under the caption "Section 16(a) Beneficial Reporting Compliance" on page 33 of the Proxy Statement. Item 11. Executive Compensation The information under the caption "Compensation of Executive Officers" on pages 8 through 11 and under the caption "Director Compensation" on page 7 of the Proxy Statement is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management The information under the caption "Beneficial Ownership of Common Stock and Class A Common Stock" on pages 2 through 4 of the Proxy Statement is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions The information under the captions "Certain Transactions" on pages 15 and 16 as well as "Compensation Committee Interlocks and Insider Participation" on page 11 of the Proxy Statement is incorporated herein by reference. 32 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K FINANCIAL STATEMENTS AND SCHEDULES (a) (1) The following consolidated financial statements of PMA Capital and its subsidiary companies and Report of Independent Accountants, included on pages 44 through 68 of the Annual Report are incorporated herein by reference: o Consolidated Balance Sheets at December 31, 1999 and 1998 o Consolidated Statements of Operations for the years ended December 31, 1999, 1998 and 1997 o Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997 o Consolidated Statements of Shareholders' Equity for the years ended December 31, 1999, 1998 and 1997 o Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 1999, 1998 and 1997 o Notes to Consolidated Financial Statements o Report of Independent Accountants (a) (2) The Financial Statement Schedules are listed in the Index to Financial Statement Schedules on page FS-1 All other schedules specified by Article 7 of Regulation S-X are not required pursuant to the related instructions or are inapplicable and, therefore, have been omitted. (a) (3) The Exhibits are listed in the Index to Exhibits on pages E-1 through E-4. (b) Reports on Form 8-K filed during the quarter ended December 31, 1999: During the quarterly period ended December 31, 1999, the Company filed the following report on Form 8-K: - dated November 3, 1999, Item 5 - containing a news release regarding its third quarter 1999 results 33 Signatures Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf, and in the capacities indicated, by the undersigned, thereunto duly authorized. PMA CAPITAL CORPORATION Date: March 29, 2000 By: /s/ Francis W. McDonnell ----------------- ------------------------- Francis W. McDonnell Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 29, 2000. Signature* Title - ---------- ----- John W. Smithson President and Chief Executive Officer and a Director (Principal Executive Officer) Frederick W. Anton III Chairman of the Board and a Director Paul I. Detwiler, Jr. Director Joseph H. Foster Director Anne S. Genter Director James F. Malone III Director A. John May Director Louis N. McCarter III Director John W. Miller, Jr. Director Edward H. Owlett Director Louis I. Pollock Director Roderic H. Ross Director L. J. Rowell, Jr. Director * By: /s/ Charles A. Brawley, III ---------------------------- Charles A. Brawley, III Attorney-in-Fact 34 PMA Capital Corporation Index to Financial Statement Schedules Schedule No. Description Page II Condensed Financial Information of FS-2 to FS-4 Registrant as of December 31, 1999 and 1998 and for the years ended December 31, 1999, 1998 and 1997 III Supplementary Insurance Information for the FS-5 years ended December 31, 1999, 1998 and 1997 IV Reinsurance for the years ended December 31, FS-6 1999, 1998 and 1997 V Valuation and Qualifying Accounts for the FS-7 years ended December 31, 1999, 1998 and 1997 VI Supplemental Information Concerning FS-8 Property and Casualty Insurance Operations for the years ended December 31, 1999, 1998 and 1997 Report of Independent Accountants on Financial FS-9 Statement Schedules Certain financial statement schedules have been omitted because they are either not applicable or the required financial information is contained in the Company's 1999 consolidated financial statements and notes thereto. FS-1 PMA Capital Corporation Schedule II - Registrant Only Financial Statements Balance Sheets (Parent Company Only)
December 31, (dollar amounts in thousands) 1999 1998 - ----------------------------------------------------------------------------------------------------------------------------- Assets Cash $ 605 $ -- Investment in subsidiaries 620,788 700,772 Deferred income taxes, net 2,527 8,078 Other assets 316 420 ------------------------ Total assets $ 624,236 $ 709,270 ======================== Liabilities Long-term debt $ 163,000 $ 163,000 Related party payables 15,294 14,354 Other liabilities 16,799 20,436 ------------------------ Total liabilities 195,093 197,790 Stockholders' Equity Common stock, $5 par value (40,000,000 shares authorized; 1999 - 13,084,665 shares issued and 12,648,658 outstanding 1998 - 13,956,268 shares issued and 13,520,261 outstanding) 65,423 69,781 Class A Common stock, $5 par value (40,000,000 shares authorized; 1999 - 11,358,280 shares issued and 9,692,854 outstanding 1998 - 10,486,677 shares issued and 9,837,963 outstanding) 56,791 52,433 Additional paid-in capital - Class A Common stock 339 339 Retained earnings 391,981 377,601 Accumulated other comprehensive income (loss) (46,844) 30,016 Notes receivable from officers (56) (498) Treasury stock, at cost: Common stock (1999 - 436,007 shares; 1998 - 436,007 shares) (5,582) (5,582) Class A Common stock (1999 - 1,665,426 shares; 1998 - 648,714 shares) (32,909) (12,610) ------------------------ Total shareholders' equity 429,143 511,480 ------------------------ Total liabilities and shareholders' equity $ 624,236 $ 709,270 ========================
These financial statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto. FS-2
PMA Capital Corporation Schedule II - Registrant Only Financial Statements Statements of Operations (Parent Company Only) Years ended December 31, (dollar amounts in thousands) 1999 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------ Revenues: Net investment income (expense) $ (14) $ (18) $ 70 Net realized investment loss - (1,740) - Other revenues 98 1,089 193 -------------------------------------------------------- Total revenues 84 (669) 263 -------------------------------------------------------- Expenses: General expenses 8,012 10,834 6,911 Interest expense 12,434 15,221 15,764 -------------------------------------------------------- Total expenses 20,446 26,055 22,675 -------------------------------------------------------- Loss before income taxes, equity in earnings of subsidiaries and extraordinary loss (20,362) (26,724) (22,412) Income tax expense (benefit) (6,426) 1,256 (14,271) -------------------------------------------------------- Loss before equity in earnings of subsidiaries and extraordinary loss (13,936) (27,980) (8,141) Equity in earnings of subsidiaries 39,530 72,714 27,894 -------------------------------------------------------- Income before extraordinary loss 25,594 44,734 19,753 Extraordinary loss from early extinguishment of debt (net of income tax benefit of $2,549) - - (4,734) -------------------------------------------------------- Net income $ 25,594 $ 44,734 $ 15,019 ======================================================== These financial statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto.
FS-3
PMA Capital Corporation Schedule II - Registrant Only Financial Statements Statements of Cash Flows (Parent Company Only) Years ended December 31, (dollar amounts in thousands) 1999 1998 1997 - ----------------------------------------------------------------------------------------------------------------------------- Cash Flows From Operating Activities: Net income $ 25,594 $ 44,734 $ 15,019 Adjustments to reconcile net income to net cash flows provided by operating activities: Equity in earnings of subsidiaries (39,530) (72,714) (27,894) Dividends received from subsidiaries 43,206 35,502 22,500 Net tax sharing payments received from subsidiaries 21,798 29,728 19,950 Net realized investment losses - 1,740 - Deferred income tax expense 5,926 21,085 9,614 Extraordinary loss from early extinguishment of debt - - 4,734 Other, net (5,173) 17,771 (3,426) ---------------------------------------- Net cash flows provided by operating activities 51,821 77,846 40,497 Cash Flows From Investing Activities: Cash contributions to subsidiaries (7,100) (480) (11,000) ---------------------------------------- Net cash flows used by investing activities (7,100) (480) (11,000) ---------------------------------------- Cash Flows From Financing Activities: Dividends paid to shareholders (7,795) (7,939) (7,965) Purchase of treasury stock (30,241) (18,850) (597) Proceeds from exercised stock options and issuance of Class A Common stock 6,035 4,283 1,442 Change in related party receivables and payables (12,557) (14,813) (21,389) Repayments of long-term debt - (40,000) (211,699) Proceeds from issuance of long-term debt - - 210,000 Net repayments (issuance) of notes receivable from officers 442 (300) 964 ---------------------------------------- Net cash flows used by financing activities (44,116) (77,619) (29,244) ---------------------------------------- Net increase (decrease) in cash 605 (253) 253 Cash - beginning of year - 253 - ---------------------------------------- Cash - end of year $ 605 $ - $ 253 ======================================== Supplementary cash flow information: Income taxes paid (refunded) $ 12,352 $ (15,170) $ (19,112) Interest paid $ 12,263 $ 15,107 $ 19,776 These financial statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto.
FS-4
PMA Capital Corporation Schedule III Supplementary Insurance Information Unpaid Deferred losses Losses policy and loss Net Net and loss Net (dollar amounts acquisition adjustment Unearned premiums investment adjustment Acquisition Operating premiums in thousands) costs expenses premiums earned income(1) expenses expenses expenses written Year ended December 31, 1999: The PMA Insurance Group $20,558 $1,144,087 $120,928 $221,934 $50,282 $166,674 $39,378 $38,909 $233,713 PMA Re 23,446 743,528 88,183 293,862 57,686 206,891 80,749 13,589 278,998 Caliber One 4,945 54,809 51,241 24,729 2,459 18,908 4,241 3,956 51,237 Corporate and Other -- (9,823) -- (438) (370) -- -- 10,368 (438) ----------------------------------------------------------------------------------------------------------- Total $48,949 $1,932,601 $260,352 $540,087 $110,057 $392,473 $124,368 $66,822 $563,510 =========================================================================================================== Year ended December 31, 1998: The PMA Insurance Group $18,660 $1,250,694 $109,766 $241,928 $64,580 $197,525 $45,190 $45,309 $234,837 PMA Re 30,446 668,604 109,675 223,559 54,734 154,062 64,689 13,134 234,010 Caliber One 2,009 33,147 8,504 1,750 1,453 1,402 958 2,449 6,436 Corporate and Other -- (11,550) -- (522) (642) (318) -- 11,267 (522) ----------------------------------------------------------------------------------------------------------- Total $51,115 $1,940,895 $227,945 $466,715 $120,125 $352,671 $110,837 $72,159 $474,761 =========================================================================================================== Year ended December 31, 1997: The PMA Insurance Group $20,010 $1,353,917 $115,998 $212,348 $81,927 $193,530 $48,343 $51,848 $203,348 PMA Re 25,278 622,484 95,457 163,603 52,270 113,931 45,158 10,827 177,934 Corporate and Other -- 26,786 -- -- (805) (180) -- 12,464 -- ----------------------------------------------------------------------------------------------------------- Total $45,288 $2,003,187 $211,455 $375,951 $133,392 $307,281 $93,501 $75,139 $381,282 ===========================================================================================================
(1) Net investment income is based on each segment's invested assets. FS-5 PMA Capital Corporation Schedule IV Reinsurance
Assumed Ceded to from Percentage of Direct other other amount assumed (dollar amounts in thousands) amount companies companies Net amount to net - -------------------------------------------------------------------------------------------------------------- Year Ended December 31, 1999: Property and liability insurance premiums $328,590 $154,532 $366,029 $540,087 68% ======== ======== ======== ======== ======== Year Ended December 31, 1998: Property and liability insurance premiums $286,987 $ 96,961 $276,689 $466,715 59% ======== ======== ======== ======== ======== Year Ended December 31, 1997: Property and liability insurance premiums $277,871 $118,277 $216,357 $375,951 58% ======== ======== ======== ======== ========
FS-6 PMA Capital Corporation Schedule V Valuation and Qualifying Accounts
Deductions - Balance at Charged to write-offs of Balance at (dollar amounts in thousands) beginning of costs and uncollectible end of Description period expenses accounts period Year ended December 31, 1999: Allowance for uncollectible accounts: Premiums receivable $19,874 $275 $2,061 $18,088 Reinsurance receivables 2,178 3,350 -- 5,528 Year ended December 31, 1998: Allowance for uncollectible accounts: Premiums receivable $18,406 $1,488 $20 $19,874 Reinsurance receivables 2,096 108 26 2,178 Year ended December 31, 1997: Allowance for uncollectible accounts: Premiums receivable $18,877 -- $471 $18,406 Reinsurance receivables 2,603 -- 507 2,096
FS-7
PMA Capital Corporation Schedule VI Supplemental Information Concerning Property and Casualty Insurance Operations Discount on reserves for Deferred Reserves for unpaid unpaid claims (dollar amounts in thousands) policy claims and claim and claim acquisition adjustment adjustment Unearned Earned Affiliation with registrant costs expenses expenses (1) premiums premiums Consolidated property-casualty subsidiaries: Year Ended December 31, 1999 $48,949 $1,932,601 $180,379 $260,352 $540,087 Year Ended December 31, 1998 51,115 1,940,895 194,624 227,945 466,715 Year Ended December 31, 1997 45,288 2,003,187 460,230 211,455 375,951 Claims and claim adjustment expenses incurred related to (dollar amounts in thousands) Net ------------------------- Paid claims Net investment Current Prior Acquisition and adjustment premiums Affiliation with registrant income year years (2) expenses expenses written Consolidated property-casualty subsidiaries: Year Ended December 31, 1999 $110,057 $409,554 $(32,514) $124,368 $455,293 $563,510 Year Ended December 31, 1998 120,125 373,098 (46,515) 110,837 458,844 474,761 Year Ended December 31, 1997 133,392 341,880 (86,006) 93,501 470,874 381,282
(1) Workers' compensation reserves discounted at approximately 5%. (2) Excludes accretion of loss reserve discount of $15,433, $26,088 and $51,407 in 1999, 1998 and 1997, respectively. FS-8 PricewaterhouseCoopers LLP [Letterhead] Report of Independent Accountants on Financial Statement Schedules To the Board of Directors and Shareholders of PMA Capital Corporation: Our audits of the consolidated financial statements referred to in our report dated February 2, 2000 appearing in the 1999 Annual Report to Shareholders of PMA Capital Corporations (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedules listed in Item 14(a)(2) of this Form 10-K. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. /s/ PricewaterhouseCoopers LLP February 2, 2000 FS-9
INDEX TO EXHIBITS Exhibit No. Description of Exhibit Method of Filing - ----------------------------------------------------- ---------------- (3) Articles of incorporation and bylaws: 3.1 Amended and Restated Articles of Filed herewith. Incorporation of the Company as last amended December 7, 1998. 3.2 Amended and Restated Bylaws of the Company. Filed herewith. (10) Material Contracts: Exhibits 10.1 through 10.21 are management contracts or compensatory plans. 10.1 Deferred Compensation Plan for Non-Employee Filed herewith. Directors of the Company. 10.2 Amended and Restated Employment Agreement, Filed as Exhibit 10.6 to the Company's Quarterly Report on dated May 1, 1999, between PMA Capital Form 10-Q/A, No. 1 for the quarter ended June 30, 1999 and Corporation and Frederick W. Anton III. incorporated herein by reference. 10.3 Amended and Restated Split-Dollar Insurance Filed as Exhibit 10.7 to the Company's Quarterly Report on Agreement, dated May 12, 1999, among PMA Form 10-Q/A, No. 1 for the quarter ended June 30, 1999 and Capital Corporation, Frederick W. Anton III incorporated herein by reference. and Irrevocable Deed and Trust of Frederick W. Anton III. 10.4 Split-Dollar Insurance Agreement, dated May Filed as Exhibit 10.8 to the Company's Quarterly Report on 12, 1999, among PMA Capital Corporation, Form 10-Q/A, No. 1 for the quarter ended June 30, 1999 and Frederick W. Anton III and Irrevocable Deed incorporated herein by reference. of Trust of Frederick W. Anton III. 10.5 Split-Dollar Insurance Agreement, dated May Filed as Exhibit 10.9 to the Company's Quarterly Report on 12, 1999, among PMA Capital Corporation, Form 10-Q/A, No. 1 for the quarter ended June 30, 1999 and Frederick W. Anton III and Irrevocable Deed incorporated herein by reference. of Trust of Frederick W. Anton III. 10.6 Employment Agreement dated May 1, 1995 Filed as Exhibit 10.2 to the Company's Registration between the Company and John W. Smithson. Statement on Form 10 dated June 26, 1997 and incorporated herein by reference. 10.7 Company's EDC Plan Trust Agreement dated as Filed as Exhibit 10.3 to the Company's Registration of 1994. Statement on Form 10 dated June 26, 1997 and incorporated herein by reference. 10.8 Company's Amended and Restated Executive Filed as Exhibit 10.4 to the Company's Annual Report on Form Deferred Compensation Plan. 10-K for the year ended December 31, 1998 and incorporated herein by reference. E-1 10.9 Company's Supplemental Executive Retirement Filed as Exhibit 10.4 to the Company's Registration Plan (SERP) dated July 1995. Statement on Form 10 dated June 26, 1997 and incorporated herein by reference. 10.10 Company's Amended and Restated 1987 Filed as Exhibit 10.5 to the Company's Registration Incentive Stock Option Plan. Statement on Form 10 dated June 26, 1997 and incorporated herein by reference. 10.11 Company's Amended and Restated 1991 Equity Filed as Exhibit 10.6 to the Company's Registration Incentive Plan. Statement on Form 10 dated June 26, 1997 and incorporated herein by reference. 10.12 Amendment No. 1 to the Amended and Restated Filed as Exhibit 10.1 to the Company's Quarterly Report on 1991 Equity Incentive Plan dated May 5, Form 10-Q for the quarter ended June 30, 1999 and 1999. incorporated herein by reference. 10.13 Company's Amended and Restated 1993 Equity Filed as Exhibit 10.7 to the Company's Registration Incentive Plan. Statement on Form 10 dated June 26, 1997 and incorporated herein by reference. 10.14 Amendment No. 1 to the Amended and Restated Filed as Exhibit 10.2 to the Company's Quarterly Report on 1993 Equity Incentive Plan dated May 5, Form 10-Q for the quarter ended June 30, 1999 and 1999. incorporated herein by reference. 10.15 Company's Amended and Restated 1994 Equity Filed as Exhibit 10.8 to the Company's Registration Incentive Plan. Statement on Form 10 dated June 26, 1997 and incorporated herein by reference. 10.16 Amendment No. 1 to the Amended and Restated Filed as Exhibit 10.3 to the Company's Quarterly Report on 1994 Equity Incentive Plan dated May 5, Form 10-Q for the quarter ended June 30, 1999 and 1999. incorporated herein by reference. 10.17 Company's 1995 Equity Incentive Plan. Filed as Exhibit 10.9 to the Company's Registration Statement on Form 10 dated June 26, 1997 and incorporated herein by reference. 10.18 Amendment No. 1 to the 1995 Equity Incentive Filed as Exhibit 10.4 to the Company's Quarterly Report on Plan dated May 5, 1999. Form 10-Q for the quarter ended June 30, 1999 and incorporated herein by reference. 10.19 Company's 1996 Equity Incentive Plan. Filed as Exhibit 10.10 to the Company's Registration Statement on Form 10 dated June 26, 1997 and incorporated herein by reference. 10.20 Amendment No. 1 to the 1996 Equity Incentive Filed as Exhibit 10.5 to the Company's Quarterly Report on Plan dated May 5, 1999. Form 10-Q for the quarter ended June 30, 1999 and incorporated herein by reference. 10.21 Company's 1999 Equity Incentive Plan. Filed as Annex A to the Company's Definitive Proxy Statement on Schedule 14A dated March 26, 1999 and incorporated herein by reference. E-2 10.22 Credit Agreement dated as of March 14, 1997 Filed as Exhibit 10.13 to the Company's Registration by and among the Company, The Bank of New Statement on Form 10 dated June 26, 1997 and incorporated York, First Union National Bank of North herein by reference. Carolina, Fleet National Bank, PNC Bank, National Association, Mellon Bank, N.A., CoreStates Bank, N.A. and Dresdener Bank AG, New York Branch and Grand Cayman Branch. 10.23 Master Agreement dated as of February 7, Filed as Exhibit 10.14 to the Company's Registration 1997 between the Company and First Union Statement on Form 10 dated June 26, 1997 and incorporated National Bank of North Carolina. herein by reference. 10.24 First Amended and Restated Letter of Credit Filed as Exhibit 10.15 to the Company's Registration Agreement, dated March 14, 1997, by and Statement on Form 10 dated June 26, 1997 and incorporated among the Company, the Bank of New York, herein by reference. Mellon Bank, N.A., Fleet Bank, National Association, PNC Bank, National Association and First Union Bank of North Carolina. 10.25 Amendment No. 1 and Restatement, dated Filed as Exhibit 10.15 to the Company's Annual Report on September 29, 1997, to the First Amended and Form 10-K for the year ended December 31, 1998 and Restated Letter of Credit Agreement, dated incorporated herein by reference. March 14, 1997. 10.26 Amendment No. 2, dated September 28, 1998, Filed as Exhibit 10.16 to the Company's Annual Report on to the First Amended and Restated Letter of Form 10-K for the year ended December 31, 1998 and Credit Agreement, dated March 14, 1997. incorporated herein by reference. 10.27 Amendment No. 3, dated October 2, 1998, to Filed as Exhibit 10.17 to the Company's Annual Report on the First Amended and Restated Letter of Form 10-K for the year ended December 31, 1998 and Credit Agreement, dated March 14, 1997. incorporated herein by reference. 10.28 Amended No. 4, dated as of September 27, Filed as Exhibit 10 to the Company's Quarterly Report on 1999, to First Amendment and Restated Letter Form 10-Q for the quarter ended September 30, 1999 and of Credit Agreement, dated March 14, 1997. incorporated herein by reference. 10.29 Caliber One Indemnity Company Purchase Filed as Exhibit 10.17 to the Company's Annual Report on Agreement dated December 15, 1997. Form 10-K for the year ended December 31, 1997 and incorporated herein by reference. (12) Computation of Ratio of Earnings to Fixed Filed herewith. Charges. (13) Portions of the Company's 1999 Annual Report Filed herewith. to Shareholders, which are expressly incorporated by reference in this Form 10-K, are "filed" as part of this Form 10-K. (21) Subsidiaries of the Company. Filed herewith. (23) Consent of independent accountant. Filed herewith. E-3 (24) Power of attorney. 24.1 Powers of attorney. Filed herewith. 24.2 Certified resolutions. Filed herewith. (27) Financial Data Schedule. Filed herewith (EDGAR version only).
Shareholders may obtain copies of exhibits by writing to the Company at PMA Capital Corporation, 1735 Market Street, Suite 2800, Philadelphia, PA. 19103-7590, Attn: Secretary E-4 EX-3.1 2 Commonwealth of Pennsylvania Department of State To All to Whom These Presents Shall Come, Greeting: Whereas, In and by Article VIII of the Business Corporation Law, approved the fifth day of May, Anno Domini one thousand nine hundred and thirty-three, P.L. 364, as amended, the Department of State is authorized and required to issue a CERTIFICATE OF AMENDMENT evidencing the amendment and restatement of the Articles of Incorporation in their entirety of a business corporation organized under or subject to the provisions of that Law; and Whereas, The stipulations and conditions of that Law pertaining to the amendment of Articles of Incorporation have been fully complied with by PENNSYLVANIA MANUFACTURERS CORPORATION Henceforth The "Articles," as defined in Article I of the Business Corporation Law, shall not include any prior documents; Therefore, Know Ye, That subject to the Constitution of this Commonwealth and under authority of the Business Corporation Law, I do by these presents, which I have caused to be Sealed with the Great Seal of the Commonwealth, extend the rights and powers of the corporation named above, in accordance with the terms and provisions of the Articles of Amendment presented by it to the Department of State, with full power and authority to use and enjoy such rights and powers, subject to all the provisions and restrictions of the Business Corporation Law and all other applicable laws of this Commonwealth. Given under my Hand and the Great Seal of the Commonwealth, at the City of Harrisburg, this 7th day of May in the year of our Lord one thousand nine hundred and eighty seven and of the Commonwealth the two hundred eleventh, /s/ James J. Hagerty - - ----------------------------- Secretary of the Commonwealth COMMONWEALTH OF PENNSYLVANIA DEPARTMENT OF STATE CORPORATION BUREAU APPLICANT'S ACCT. NO. Filed this day of May 07 1987 DSCB: BCL-806 (REV. 8-72) Commonwealth of Pennsylvania Department of State /s/ James J. Hagerty Secretary of the Commonwealth (Box for Certification) Articles of Amendment-- Domestic Business Corporation In compliance with the requirements of section 806 of the Business Corporation Law, act of May 5, 1933 (P.L.364) (15 P.S. SS.1806), the undersigned corporation, desiring to amend its Articles, does hereby certify that: 1. The name of the corporation is: Pennsylvania Manufacturers Corporation 2. The location of its registered office in this Commonwealth is (the Department of State is hereby authorized to correct the following statement to conform to the records of the Department): 1021 West Eighth Avenue ----------------------- (NUMBER) (STREET) King of Prussia Pennsylvania 19406 -------------------------------------------------------------------- (CITY) (ZIP CODE) 3. The statute by or under which it was incorporated is: Act of May 5, 1933, P.L. 364, as amended 4. The date of its incorporation is: February 23, 1982 5. (Check, and if appropriate, complete one of the following): /X/ The meeting of the shareholders of the corporation at which the amendment was adopted was held at the time and place and pursuant to the kind and period of notice herein stated. Time: The 27th day of April, 1987 Place: 925 Chestnut Street, Philadelphia, PA Kind and period of notice Written notice (Proxy Statement); 30 days / / The amendment was adopted by a consent in writing, setting forth the action so taken, signed by all of the shareholders entitled to vote thereon and filed with the Secretary of the corporation. 6. At the time of the action of shareholders: (a) The total number of shares outstanding was: 797,476 shares (b) The number of shares entitled to vote was: 797,476 shares 7. In the action taken by the shareholders: (a) The number of shares voted in favor of the amendment was: 699,557 shares (b) The number of shares voted against the amendment was: -0 against; 10,000 abstained 8. The amendment adopted by the shareholders, set forth in full, is as follows: See Exhibit A attached and incorporated by reference herein for the text of the Amended and Restated Articles of Incorporation of the Corporation. IN TESTIMONY WHEREOF, the undersigned corporation has caused these Articles of Amendment to be signed by a duly authorized officer and its corporate seal, duly attested by another such officer, to be hereunto affixed this 27th day of April, 1987. PENNSYLVANIA MANUFACTURERS CORPORATION -------------------------------------- (NAME OF CORPORATION) Attest: By: /s/ David L. Johnson By: /s/ Frederick W. Anton ------------------------------- --------------------------------- (SIGNATURE) (SIGNATURE) David L. Johnson, Secretary Frederick W. Anton, III, President - - ----------------------------------- ---------------------------------- (TITLE; SECRETARY, (TITLE; PRESIDENT, ASSISTANT SECRETARY, ETC.) VICE PRESIDENT, ETC.) (CORPORATE SEAL) INSTRUCTIONS FOR COMPLETION OF FORM A. Any necessary copies of Form DSCB:17.2 (Consent to Appropriation of Name) or Form DSCB: 17.3 (Consent to Use of Similar Name) shall accompany Articles of Amendment effecting a change of name. B. Any necessary governmental approvals shall accompany this form. C. Where action is taken by partial written consent pursuant to the Articles, the second alternate of Paragraph 5 should be modified accordingly. D. If the shares of any class were entitled to vote as a class, the number of shares of each class so entitled and the number of shares of all other classes entitled to vote should be set forth in Paragraph 6(b). E. If the shares of any class were entitled to vote as a class, the number of shares of such class and the number of shares of all other classes voted for and against such amendment respectively should be set forth in Paragraphs 7(a) and 7(b). F. BCL Section 807 (15 P.S. Section 1807) requires that the corporation shall advertise its intention to file or the filing of Articles of Amendment. Proof of publication of such advertising should not be delivered to the Department, but should be filed with the minutes of the corporation. EXHIBIT A RESOLVED that, the Articles of Incorporation of Pennsylvania Manufacturers Corporation shall be amended and restated in their entirety as follows: AMENDED AND RESTATED ARTICLES OF INCORPORATION 1. The name of the Corporation is Pennsylvania Manufacturers Corporation. 2. The location and post office address of the registered office of the Corporation in this Commonwealth is 1021 West Eighth Avenue, King of Prussia, Pennsylvania 19406. 3. The Corporation is incorporated under the Business Corporation Law of the Commonwealth of Pennsylvania for the following purpose or purposes: The Corporation shall have unlimited power to engage in and to do any or all lawful business for which corporations may be incorporated under the Act of Assembly approved May 5, 1933, P.S. 364, as amended, under which Act the Corporation is incorporated, including, without limitation of the foregoing, the power to manufacture, buy, sell, trade and generally deal in products, merchandise, goods and articles of any kind and description whatsoever. 4. The term for which the Corporation is to exist is perpetual. 5. The aggregate number of shares which the Corporation shall have the authority to issue is: Two Million (2,000,000) shares of Common Stock, $5.00 par value per share (the "Common Stock"), and Two Million (2,000,000) shares of Class A Common Stock, $5.00 par value per share (the "Class A Common Stock"). A. Voting Rights and Powers. Except as otherwise required by the Pennsylvania Business Corporation Law or as otherwise provided in these Articles of Incorporation or the By-laws of the Corporation, with respect to all matters upon which shareholders are entitled to vote or to which shareholders are entitled to give consent, the holders of the outstanding shares of the Common Stock and the holders of any outstanding shares of the Class A Common Stock shall vote together without regard to class, and every holder of the outstanding shares of the Common Stock shall be entitled to cast thereon ten (10) votes in person or by proxy for each share of the Common Stock standing in his name, and every holder of any outstanding shares of the Class A Common Stock shall be entitled to cast thereon one (1) vote in person or by proxy for each share of the Class A Common Stock standing in his name. In all elections for directors, each shareholder is entitled to cumulate his votes. With respect to any proposed amendment to these Articles of Incorporation which would increase or decrease the number of authorized shares of either the Common Stock or the Class A Common Stock, increase or decrease the par value of the shares of the Common Stock or the Class A Common Stock, or alter or change the powers, preferences, relative voting power or special rights of the shares of the Common Stock or the Class A Common Stock so as to affect it adversely, the approval of a majority of the votes entitled to be cast by the holders of the class affected by the proposed amendment, voting separately as a class, shall be obtained in addition to the approval of a majority of the votes entitled to be cast by the holders of the Common Stock and the Class A Common Stock voting together without regard to class as hereinbefore provided. B. Dividends and Distributions. (a) Cash Dividends. At any time shares of the Class A Common Stock are outstanding, as and when cash dividends may be declared by the Board of Directors, the cash dividend payable on shares of the Class A Common Stock shall in all cases be at least ten percent (10%) higher on a per share basis than the cash dividend payable on shares of the Common Stock. (b) Other Dividends and Distributions. Each share of the Common Stock and each share of the Class A Common Stock shall be equal in respect of rights to dividends (other than cash) and distributions, when and as declared, in the form of stock or other property of the Corporation, except that in the case of dividends or other distributions payable in stock of the Corporation, including distributions pursuant to stock split-ups or divisions, which occur after the date shares of the Class A Common Stock are first issued by the Corporation, only shares of the Common Stock shall be distributed with respect to the Common Stock and only shares of Class A Common Stock shall be distributed with respect to Class A Common Stock. C. Other Rights. Except as otherwise required by the Pennsylvania Business Corporation Law or as otherwise provided in these Articles of Incorporation, each share of the Common Stock and each share of Class A Common Stock shall have identical powers, preferences and rights, including rights in liquidation. D. Conversion of the Common Stock. Each share of Common Stock may at any time be converted at the election of the holder thereof into one fully paid and nonassessable share of Class A Common Stock. Any holder of shares of Common Stock may elect to convert any or all of such shares at one time or at various times in such holder's discretion. Such right shall be exercised by the surrender of the certificate representing each share of Common Stock to be converted to the agent for the registration for transfer of shares of Common Stock at its office, or to the Corporation at its principal executive offices, accompanied by a written notice of the election by the holder thereof to convert and (if so required by the transfer agent or by the Corporation) by instruments of transfer, in form satisfactory to the transfer agent and to the Corporation, duly executed by such holder of his duly authorized attorney. The issuance of a certificate or certificates for shares of Class A Common Stock upon conversion of shares of Common Stock shall be made without charge for any stamp or other similar tax in respect of such issuance. However, if any such certificate or certificates is or are to be issued in a name other than that of the holder of the share or shares of Common Stock converted, the person or persons requesting the issuance thereof shall pay to the transfer agent or to the Corporation the amount of any tax which may be payable in respect of any such transfer, or shall establish to the satisfaction of the transfer agent or of the Corporation that such tax has been paid. As promptly as practicable after the surrender for conversion of a certificate or certificates representing shares of Common Stock and the payment of any tax as hereinbefore provided, the Corporation will deliver or cause to be delivered at the office of the transfer agent to, or upon the written order of, the holder of such certificate or certificates, a certificate or certificates representing the number of shares of Class A Common Stock issuable upon such conversion, issued in such name or names as such holder may direct. Such conversion shall be irrevocable and shall be deemed to have been made immediately prior to the close of business on the date of the surrender of the certificate or certificates representing shares of Common Stock (if on such date the transfer books of the Corporation shall be closed, then immediately prior to the close of business on the first date thereafter that said books shall be open), and all rights of A-2 such holder arising from ownership of such shares of Common Stock shall cease at such time, and the person or persons in whose name or names the certificate or certificates representing shares of Class A Common Stock are to be issued shall be treated for all purposes as having become the record holder or holders of such shares of Class A Common Stock at such time and shall have and may exercise all the rights and powers appertaining thereto. No adjustments in respect of past cash dividends shall be made upon the conversion of any share of Common Stock; provided, however, that if any shares of Common Stock shall be converted subsequent to the record date for the payment of a cash or stock dividend or other distribution on shares of Common Stock but prior to such payment, the registered holder of such shares at the close of business on such record date shall be entitled to receive the cash or stock dividend or the distribution payable to holders of the Common Stock. The Corporation shall at all times reserve and keep available, solely for the purpose of issue upon conversion of outstanding shares of Common Stock, such number of shares of Class A Common Stock as may be issuable upon the conversion of all such outstanding shares of Common Stock, provided, the Corporation may deliver shares of Class A Common Stock which are held in the treasury of the Corporation for shares of Common Stock to be converted. If any shares of Class A Common Stock require registration with or approval of any governmental authority under any federal or state law before such shares of Class A Common Stock may be issued upon conversion, the Corporation will cause such shares to be duly registered or approved, as the case may be. All shares of Class A Common Stock which may be issued upon conversion of shares of Common Stock will, upon issue, be fully paid and nonassessable. 6. Except with respect to shares, rights, options and other securities of the Corporation that are issued or granted in connection with any stock purchase plan, stock option plan or other similar benefit plan that has been approved by the holders of a majority of the Corporation's outstanding Common Stock, the holders of Common Stock of the Corporation shall be entitled, as such, as a matter of right, to subscribe for and to purchase any part of any new or additional issue of Common Stock, any rights or options to purchase Common Stock, or any securities convertible into, exchangeable for or carrying rights or options to purchase Common Stock, whether now or hereafter authorized, but only in those instances in which such shares of Common Stock, rights or options to purchase Common Stock are issued for a consideration consisting solely of money. In the event of the issuance of such shares or other securities solely for money, the preemptive right herein granted shall only be an opportunity to acquire such shares or other securities under such terms and conditions as the Board of Directors shall fix. The preemptive right herein granted shall not apply in any respect to the Corporation's Class A Common Stock, and holders of such Class A Common Stock, as such, shall have no preemptive rights. A-3 Commonwealth of Pennsylvania Department of State To All to Whom These Presents Shall Come, Greeting: Whereas, In and by Article VIII of the Business Corporation Law, approved the fifth day of May, Anno Domini one thousand nine hundred and thirty-three, P.L. 364, as amended, the Department of State is authorized and required to issue a CERTIFICATE OF AMENDMENT evidencing the amendment of the Articles of Incorporation of a business corporation organized under or subject to the provisions of that Law; and Whereas, The stipulations and conditions of that Law pertaining to the amendment of Articles of Incorporation have been fully complied with by PENNSYLVANIA MANUFACTURERS CORPORATION Therefore, Know Ye, That subject to the Constitution of this Commonwealth and under the authority of the Business Corporation Law, I do by these presents, which I have caused to be sealed with the Great Seal of the Commonwealth, extend the rights and powers of the corporation named above, in accordance with the terms and provisions of the Articles of Amendment presented by it to the Department of State, with full power and authority to use and enjoy such rights and powers, subject to all the provisions and restrictions of the Business Corporation Law and all other applicable laws of this Commonwealth. Given under my Hand and the Great Seal of the Commonwealth, at the City of Harrisburg, this 27th day of April in the year of our Lord one thousand nine hundred and eighty eight and of the Commonwealth the two hundred twelfth. /s/ James J. Hagerty - - ----------------------------- Secretary of the Commonwealth pjd DSCB-21 (7-73) COMMONWEALTH OF PENNSYLVANIA DEPARTMENT OF STATE CORPORATION BUREAU Filed this day of April 27 1988 Commonwealth of Pennsylvania Department of State /s/ James J. Hagerty Secretary of the Commonwealth (Box for Certification) Articles of Amendment-- Domestic Business Corporation In compliance with the requirements of section 806 of the Business Corporation Law, act of May 5, 1933 (P.L.364) (15 P.S. SS.1806), the undersigned corporation, desiring to amend its Articles, does hereby certify that: 1. The name of the corporation is: Pennsylvania Manufacturers Corporation 2. The location of its registered office in this Commonwealth is (the Department of State is hereby authorized to correct the following statement to conform to the records of the Department): 1021 West Eighth Avenue ----------------------- (NUMBER) (STREET) King of Prussia Pennsylvania 19406 -------------------------------------------------------------------- (CITY) (ZIP CODE) 3. The statute by or under which it was incorporated is: Act of May 5, 1933, P.L. 364, as amended 4. The date of its incorporation is: February 23, 1982 5. (Check, and if appropriate, complete one of the following): /X/ The meeting of the shareholders of the corporation at which the amendment was adopted was held at the time and place and pursuant to the kind and period of notice herein stated. Time: The 25th day of April, 1988 Place: 925 Chestnut Street, Philadelphia, PA Kind and period of notice Written notice (proxy statement); 30 days / / The amendment was adopted by a consent in writing, setting forth the action so taken, signed by all of the shareholders entitled to vote thereon and filed with the Secretary of the corporation. 6. At the time of the action of shareholders: (a) The total number of shares outstanding was: 749,605 shares of Common Stock and 206,511 shares of Class A Common Stock. (b) The number of shares entitled to vote was: 749,605 shares of Common Stock (entitled to cast ten votes per share) and 206,511 shares of Class A Common Stock (entitled to cast one vote per share). 7. In the action taken by the shareholders: (a) The number of shares voted in favor of the amendment was: 652,403 shares of Common Stock and 184,675 shares of Class A Common Stock. (b) The number of shares voted against the amendment was: 11,680 shares of Common Stock and 2,336 shares of Class A Common Stock. 8. The amendment adopted by the shareholders, set forth in full, is as follows: RESOLVED, that the first full paragraph of Article 5 of the Articles of Incorporation of Pennsylvania Manufacturers Corporation shall be amended and restated in its entirety as follows: 5. The aggregate number of shares which the Corporation shall have authority to issue is: Ten Million (10,000,000) shares of Common Stock, $5.00 par value per share (the "Common Stock"), and Ten Million (10,000,000) shares of Class A Common Stock, $5.00 par value per share (the "Class A Common Stock"). IN TESTIMONY WHEREOF, the undersigned corporation has caused these Articles of Amendment to be signed by a duly authorized officer and its corporate seal, duly attested by another such officer, to be hereunto affixed this 25th day of April, 1988. PENNSYLVANIA MANUFACTURERS CORPORATION -------------------------------------- (NAME OF CORPORATION) Attest: By: /s/ David L. Johnson By: /s/ Frederick W. Anton ------------------------------- --------------------------------- (SIGNATURE) (SIGNATURE) David L. Johnson, Secretary Frederick W. Anton, III, President - - ----------------------------------- -------------------------------- (TITLE; SECRETARY, (TITLE; PRESIDENT, ASSISTANT SECRETARY, ETC.) VICE PRESIDENT, ETC.) (CORPORATE SEAL) INSTRUCTIONS FOR COMPLETION OF FORM A. Any necessary copies of Form DSCB:17.2 (Consent to Appropriation of Name) or Form DSCB: 17.3 (Consent to Use of Similar Name) shall accompany Articles of Amendment effecting a change of name. B. Any necessary governmental approvals shall accompany this form. C. Where action is taken by partial written consent pursuant to the Articles, the second alternate of Paragraph 5 should be modified accordingly. D. If the shares of any class were entitled to vote as a class, the number of shares of each class so entitled and the number of shares of all other classes entitled to vote should be set forth in Paragraph 6(b). E. If the shares of any class were entitled to vote as a class, the number of shares of such class and the number of shares of all other classes voted for and against such amendment respectively should be set forth in Paragraphs 7(a) and 7(b). F. BCL Section 807 (15 P.S. Section 1807) requires that the corporation shall advertise its intention to file or the filing of Articles of Amendment. Proofs of publication of such advertising should not be delivered to the Department, but should be filed with the minutes of the corporation. Commonwealth of Pennsylvania Department of State To All to Whom These Presents Shall Come, Greeting: Whereas, In and by Article VIII of the Business Corporation Law, approved the fifth day of May, Anno Domini one thousand nine hundred and thirty-three, P.L. 364, as amended, the Department of State is authorized and required to issue a CERTIFICATE OF AMENDMENT evidencing the amendment of the Articles of Incorporation of a business corporation organized under or subject to the provisions of that Law; and Whereas, The stipulations and conditions of that Law pertaining to the amendment of Articles of Incorporation have been fully complied with by PENNSYLVANIA MANUFACTURERS CORPORATION Therefore, Know Ye, That subject to the Constitution of this Commonwealth and under the authority of the Business Corporation Law, I do by these presents, which I have caused to be sealed with the Great Seal of the Commonwealth, extend the rights and powers of the corporation named above, in accordance with the terms and provisions of the Articles of Amendment presented by it to the Department of State, with full power and authority to use and enjoy such rights and powers, subject to all the provisions and restrictions of the Business Corporation Law and all other applicable laws of this Commonwealth. Given under my Hand and the Great Seal of the Commonwealth, at the City of Harrisburg, this 24th day of April in the year of our Lord one thousand nine hundred and eighty-nine and of the Commonwealth the two hundred thirteenth. /s/ James J. Hagerty - ------------------------------ Secretary of the Commonwealth cas DSCB-21 (7-73) COMMONWEALTH OF PENNSYLVANIA DEPARTMENT OF STATE CORPORATION BUREAU Filed this day of April 24 1989 Commonwealth of Pennsylvania Department of State /s/ James J. Hagerty Secretary of the Commonwealth (Box for Certification) Articles of Amendment-- Domestic Business Corporation In compliance with the requirements of section 806 of the Business Corporation Law, act of May 5, 1933 (P.L.364) (15 P.S. SS.1806), the undersigned corporation, desiring to amend its Articles, does hereby certify that: 1. The name of the corporation is: Pennsylvania Manufacturers Corporation 2. The location of its registered office in this Commonwealth is (the Department of State is hereby authorized to correct the following statement to conform to the records of the Department): 1021 West Eighth Avenue ----------------------- (NUMBER) (STREET) King of Prussia Pennsylvania 19406 -------------------------------------------------------------------- (CITY) (ZIP CODE) 3. The statute by or under which it was incorporated is: Act of May 5, 1933, P.L. 364, as amended 4. The date of its incorporation is: February 23, 1982 5. (Check, and if appropriate, complete one of the following): /X/ The meeting of the shareholders of the corporation at which the amendment was adopted was held at the time and place and pursuant to the kind and period of notice herein stated. Time: The 17th day of April, 1989 Place: 925 Chestnut Street, Philadelphia, PA Kind and period of notice Written notice (proxy statement); 31 days / / The amendment was adopted by a consent in writing, setting forth the action so taken, signed by all of the shareholders entitled to vote thereon and filed with the Secretary of the corporation. 6. At the time of the action of shareholders: (a) The total number of shares outstanding was: 805,275 shares of Common Stock and 220,725 shares of Class A common Stock. (b) The number of shares entitled to vote was: 805,275 shares of Common Stock (entitled to cast ten votes per share) and 220,725 shares of Class A Common Stock (entitled to cast one vote per share). 7. In the action taken by the shareholders: (a) The number of shares voted in favor of the amendment was: 720,853 shares of Common Stock and 196,822 shares of Class A Common Stock. (b) The number of shares voted against the amendment was: 10,000 shares of Common Stock and 2,000 shares of Class A Common Stock. 8. The amendment adopted by the shareholders, set forth in full, is as follows: RESOLVED, that the first full paragraph of Article 5 of the Articles of Incorporation of Pennsylvania Manufacturers Corporation shall be amended and restated in its entirety as follows: 5. The aggregate number of shares which the Corporation shall have authority to issue is: Twenty Million (20,000,000) shares of Common Stock, $5.00 par value per share (the "Common Stock"), and Twenty Million (20,000,000) shares of Class A Common Stock, $5.00 par value per share (the "Class A Common Stock"). IN TESTIMONY WHEREOF, the undersigned corporation has caused these Articles of Amendment to be signed by a duly authorized officer and its corporate seal, duly attested by another such officer, to be hereunto affixed this 17th day of April, 1989. PENNSYLVANIA MANUFACTURERS CORPORATION -------------------------------------- (NAME OF CORPORATION) Attest: By: /s/ David L. Johnson By: /s/ Frederick W. Anton ------------------------------- --------------------------------- (SIGNATURE) (SIGNATURE) David L. Johnson, Secretary Frederick W. Anton, III, President - ------------------------------------ ---------------------------------- (TITLE; SECRETARY, (TITLE; PRESIDENT, ASSISTANT SECRETARY, ETC.) VICE PRESIDENT, ETC.) (CORPORATE SEAL) INSTRUCTIONS FOR COMPLETION OF FORM A. Any necessary copies of Form DSCB:17.2 (Consent to Appropriation of Name) or Form DSCB: 17.3 (Consent to Use of Similar Name) shall accompany Articles of Amendment effecting a change of name. B. Any necessary governmental approvals shall accompany this form. C. Where action is taken by partial written consent pursuant to the Articles, the second alternate of Paragraph 5 should be modified accordingly. D. If the shares of any class were entitled to vote as a class, the number of shares of each class so entitled and the number of shares of all other classes entitled to vote should be set forth in Paragraph 6(b). E. If the shares of any class were entitled to vote as a class, the number of shares of such class and the number of shares of all other classes voted for and against such amendment respectively should be set forth in Paragraphs 7(a) and 7(b). F. BCL Section 807 (15 P.S. Section 1807) requires that the corporation shall advertise its intention to file or the filing of Articles of Amendment. Proofs of publication of such advertising should not be delivered to the Department, but should be filed with the minutes of the corporation. ARTICLES OF AMENDMENT-DOMESTIC BUSINESS CORPORATION In compliance with the requirements of 15 Pa. C.S. ss. 1915 (relating to articles of amendment), the undersigned business corporation, desiring to amend its Articles, hereby states that: 1. The name of the corporation is Pennsylvania Manufacturers Corporation 2. The (a) address of this corporation's current registered office in this Commonwealth or (b) name of its commercial registered office provider and the county of venue is (the Department is hereby authorized to correct the following information to conform to the records of the Department): (a) 1021 West Eighth Avenue King of Prussia Pennsylvania 19046 Montgomery ---------------------------------------------------------------------------- Number and Street City State Zip County (b) c/o: --------------------------------------------------------------------------- Name of Commercial Registered Office Provider County For a corporation represented by a commercial registered office provider, the county in (b) shall be deemed the county in which the corporation is located for venue and official publication purposes. 3. The statute by or under which it was incorporated is: Act of Assembly approved May 5, 1933, P.S. 364 4. The date of its incorporation is: February 23, 1982 5. (Check, and if appropriate complete, one of the following): X The amendment shall be effective upon filing these Articles of Amendment in the Department of State. __ The amendment shall be effective on _________________ at _______________ Date Hour 6. (Check one of the following): X The amendment was adopted by the shareholders (or members) pursuant to 15 Pa.C.S. ss. 1914(a) and (b). __ The amendment was adopted by the board of directors pursuant to 15 Pa. C.S. ss. 1914(c). 7. (Check, and if appropriate complete, one of the following): __ The amendment adopted by the corporation, set forth in full, as follows: X The amendment adopted by the corporation as set forth in full in Exhibit A attached hereto and made a part hereof. 8. (Check if the amendment restates the Articles): __ The restated Articles of Incorporation supersede the original Articles and all amendments thereto. IN TESTIMONY WHEREOF, the undersigned corporation has caused these Articles of Amendment to be signed by a duly authorized officer thereof this 22nd day of April 1991. PENNSYLVANIA MANUFACTURERS CORPORATION --------------------------------------- (Name of Corporation) BY: /s/ Frederick W. Anton, III ------------------------------- Frederick W. Anton, III TITLE: President ----------------- EXHIBIT A TO ARTICLES OF AMENDMENT OF PENNSYLVANIA MANUFACTURERS CORPORATION The first full paragraph of Article 5 of the Articles of Incorporation of Pennsylvania Manufacturers Corporation is amended and restated to read in its entirety as follows: "5. The aggregate number of shares which the Corporation shall have authority to issue is: Forty Million (40,000,000) shares of Common Stock, $5.00 par value per share (the "Common Stock"), and Forty Million (40,000,000) shares of Class A Common Stock, $5.00 par value per share (the "Class A Common Stock")." STATEMENT OF CHANGE OF REGISTERED OFFICE Indicate type of entity (check one) X Domestic Business Corporation (15 PA.C.S. ss. 1507) - --- Foreign Business Corporation (15 PA.C.S. ss. 4144) - --- Domestic Nonprofit Corporation (15 PA.C.S. ss. 5507) - --- Foreign Nonprofit Corporation (15 PA.C.S. ss. 6144) - --- Domestic Limited Partnership (15 PA.C.S. ss. 8506) - --- In compliance with the requirements of the applicable provisions of 15 Pa.C.S. (relating to corporations and unincorporated associations) the undersigned corporation or limited partnership, desiring to effect a change of registered office, hereby states that: 1. The name of the corporation or limited partnership is: Pennsylvania Manufacturers Corporation ---------------------------------------------------------------------------- 2. The (a) address of this corporation's or limited partnership's current registered office in this Commonwealth or (b) name of its commercial registered office provider and the county of venue is: (the Department is hereby authorized to correct the following information to conform to the records of the Department): (a) 1021 W. Eighth Avenue, King of Prussia PA 19406 Montgomery ------------------------------------------------------------------------ Number and Street City State Zip County (b) c/o: -------------------------------------------------------------------- Name of Commercial Registered Office Provider County For a corporation or a limited partnership represented by a commercial registered office provider, the county in (b) shall be deemed the county in which the corporation or limited partnership is located for venue and official publication purposes. 3. (Complete part (a) or (b)): (a) The address to which the registered office of the corporation or limited partnership in this Commonwealth is to be changed is: 380 Sentry Parkway Blue Bell PA 19422-0754 Montgomery ------------------------------------------------------------------------ Number and Street City State Zip County (b) The registered office of the corporation or limited partnership shall be provided by: c/o: -------------------------------------------------------------------- Name of Commercial Registered Office Provider County For a corporation or a limited partnership represented by a commercial registered office provider, the count in (b) shall be deemed the county in which the corporation or limited partnership is located for venue and official publication purposes. 4. (Strike out if a limited partnership): Such change was authorized by the Board of Directors of the corporation. IN TESTIMONY WHEREOF, the undersigned corporation or limited partnership has caused this statement to be signed by a duly authorized officer thereof this 14 day of September, 1974. --- --------- ---- Pennsylvania Manufacturers Corporation ---------------------------------------- (Name of Corporation/Limited Partnership) BY: /s/ Robert Gaffney ------------------------------------ (Signature) TITLE: Secretary --------------------------------- ARTICLES OF AMENDMENT-DOMESTIC BUSINESS CORPORATION In compliance with the requirements of 15 Pa.C.S. (section) 1915 (relating to articles of amendment), the undersigned business corporation, desiring to amend its Articles, hereby states that: 1. The name of the corporation is: Pennsylvania Manufacturers Corporation ------------------------------------------ - -------------------------------------------------------------------------------- 2. The (a) address of this corporation's current registered office in this Commonwealth or (b) name of its commercial registered office provider and the county of venue is (the Department is hereby authorized to correct the following information to conform to the records of the Department): (a) The PMA Building, 380 Sentry Parkway Blue Bell PA 19422 Montgomery ----------------------------------------------------------------------- Number and Street City State Zip County (b) c/o N/A ----------------------------------------------------------------------- Name of Commercial Registered Office Provider County For a corporation represented by a commercial registered office provider, the county in (b) shall be deemed the county in which the corporation is located for venue and official publication purposes. 3. The statute by or under which it was incorporated is: Act of May 5, 1934, P.L. 364, as amended -------------------- 4. The date of its incorporation is: February 23, 1982 --------------------------------------- 5. (Check, and if appropriate complete, one of the following): X The amendment shall be effective upon filing these Articles of --- Amendment in the Department of State. --- The amendment shall be effective on: at -------------- --------------- Date Hour 6. (Check one of the following): X The amendment was adopted by the shareholders (or members) pursuant to --- 15 Pa.C.S. (section) 1914(a) and (b). --- The amendment was adopted by the board of directors pursuant to 15 Pa.C.S. (section) 1914(c). 7. (Check, and if appropriate, complete one of the following): X The amendment adopted by the corporation, set forth in full, --- as follows: Article 7, the full text of which is set forth in its entirety below, is hereby added to the Amended and Restated Articles of Incorporation of the Corporation: "7. Subchapters E, F, G, H, I and J of Chapter 25 and Sections 2538 and 2539 of Subchapter D of Chapter 25 of the Pennsylvania Business Corporation Law of 1988, as amended, shall not be applicable to the Corporation." --- The amendment adopted by the corporation is set forth in full in Exhibit A attached hereto and made a part hereof. 8. (Check if the amendment restates the Articles): The restated articles of Incorporation supercede the original --- Articles and all amendments thereto. IN TESTIMONY WHEREOF, the undersigned corporation has caused these Articles of Amendment to be signed by a duly authorized officer thereof this 25th day of June , 1997. ---------- ----------- ---- Pennsylvania Manufacturers Corporation -------------------------------------- (Name of Corporation) BY: /s/ Francis W. McDonnell ----------------------------------- (Signature) Francis W. McDonnell, Senior Vice President, TITLE: Chief Financial Officer and Treasurer ---------------------------------------------- ARTICLES OF AMENDMENT-DOMESTIC BUSINESS CORPORATION DSCB:15-1915 (Rev 91) In compliance with the requirements of 15 Pa.C.S. (S) 1915 (relating to articles of amendment), the undersigned business corporation, desiring to amend its Articles, hereby states that: 1. The name of the corporation is: PENNSYLVANIA MANUFACTURERS CORPORATION -------------------------------------- 2. The (a) address of this corporation's current registered office in this Commonwealth or (b) name of its commercial registered office provider and the county of venue is (the Department is hereby authorized to correct the following information to conform to the records of the Department): (a) The PMA Building, 380 Sentry Parkway, Blue Bell, Pennsylvania 19422-2328 Montgomery ------------------------------------------------------------------------- Number and Street City State Zip County (b) c/o: N/A ------------------------------------------------------------------------- Name of Commercial Registered Office Provider County For a corporation represented by a commercial registered office provider, the county in (b) shall be deemed the county in which the corporation is located for venue and official publication purposes. 3. The statute by or under which it was incorporated is: Act of May 5, 1933, P.L. 364, as amended ---------------------------------------- 4. The date of its incorporation is: February 23, 1982 ----------------- 5. (Check, and if appropriate complete, one of the following): The amendment shall be effective upon filing these Articles of Amendment in the Department of State. X The amendment shall be effective on: December 7, 1998 at 12:01 a.m. ---------------- --------- Date Hour 6. (Check one of the following): The amendment was adopted by the shareholders (or members) pursuant to 15 Pa.C.S. (S) 1914(a) and (b). X The amendment was adopted by the board of directors pursuant to 15 Pa.C.S. (S) 1914(c). 7. (Check, and if appropriate complete, one of the following): X The amendment adopted by the corporation, set forth in full, is as follows: Resolved, that Article I of the Articles of Incorporation of the Corporation is hereby amended in its entirety, to read as follows: "I. The name of the Corporation is: PMA Capital Corporation." The amendment adopted by the corporation is set forth in full in Exhibit A attached hereto and made a part hereof. DSCB:15-1915 (Rev 91)-2 8. (Check if the amendment restates the Articles): The restated Articles of Incorporation supersede the original Articles and all amendments thereto. IN TESTIMONY WHEREOF, the undersigned corporation has caused these Articles of Amendment to be signed by a duly authorized officer thereof this 1st day of December, 1998. - ------------------------- Pennsylvania Manufacturers Corporation -------------------------------------- (Name of Corporation) BY: /s/ Francis W. McDonnell ---------------------------------- (Signature) Francis W. McDonnell, TITLE: Senior Vice President, Chief Financial Officer and Treasurer ------------------------------- EX-3.2 3 AMENDED AND RESTATED BY-LAWS OF THE COMPANY Exhibit 3.2 AMENDED AND RESTATED BYLAWS OF PMA CAPITAL CORPORATION ARTICLE 1 Corporate Office ---------------- Section 1.1 The Corporation shall have and continuously maintain in the Commonwealth of Pennsylvania a registered office at an address to be designated from time to time by the Board of Directors which may, but need not, be the same as its place of business. Section 1.2 The Corporation may also have offices at such other places as the Board of Directors may from time to time designate or the business of the Corporation may require. ARTICLE 2 Shareholders; Share Certificates -------------------------------- Section 2.1 No person, firm, association, corporation or other entity is qualified to own any shares of Common Stock, $5.00 par value, ("Common Stock") of the Corporation except: (1) PMA Foundation. (2) A member of PMA Foundation. (3) A former member of PMA Foundation who resigned in good standing, but only in respect to Common Stock of the Corporation owned by such former member of PMA Foundation on the date of resignation. (4) The Corporation or Pennsylvania Manufacturers' Association Insurance Company. (5) An officer, proprietor or partner of a member of PMA Foundation or a retired officer, proprietor or partner of a member or former member of PMA Foundation but only in respect to Common Stock of the Corporation owned by such retired officer, proprietor or partner on the date of retirement. (6) A director or officer of the Corporation, Pennsylvania Manufacturers' Association Insurance Company or PMA Foundation. (7) A retired director or officer of the Corporation, Pennsylvania Manufacturers' Association Insurance Company or PMA Foundation but only in respect to Common Stock of the Corporation owned by such retired director or officer on the date of retirement. (8) The surviving spouse of a deceased person who, at the time of his or her death, was qualified to own Common Stock of the Corporation, but not a surviving spouse of a person who became qualified to own Common Stock of the Corporation solely by reason of the provisions of this Subsection (8). (9) A person, firm, association, corporation or other entity who was a shareholder of record of Pennsylvania Manufacturers' Association Insurance Company on April 1, 1982. (10) Any child or grandchild of a shareholder of Pennsylvania Manufacturers' Association Insurance Company of record on April 1, 1982. (11) A trustee under a written trust solely for the benefit of a person qualified under these Bylaws to own Common Stock of the Corporation or a spouse, child or grandchild of such qualified person. (12) Employees of the Corporation or any of its affiliates who are not officers of any of these entities, but whose duties require the exercise of executive and administrative responsibilities, shall be deemed qualified to own Common Stock of the Corporation. By resolution of the Board of Directors dated May 19, 1983 as amended by resolution of the Board of Directors dated February 27, 1996. (13) A spouse of a person who owned Common Stock of record on December 8, 1990 is qualified to own shares of the Corporation's Common Stock. By resolution of the Board of Directors dated December 8, 1990. (14) Such other classes of persons as are from time to time approved by the Board of Directors of the Corporation. Nothing set forth in this Section 2.1 shall prohibit any person from owning any shares of Class A Common Stock, $5.00 par value, ("Class A Common Stock") of the Corporation. Section 2.2 All shares issued by the Corporation shall be represented by certificates. The share certificates of the Corporation shall be numbered and registered in a share register as they are issued; shall state that the Corporation is incorporated under the laws of the Commonwealth of Pennsylvania; shall bear the name of the registered holder, the number and class of shares and the designation of the series, if any, represented thereby, the par value, if any, of each share or a statement that the shares are without par value, as the case may be; shall be signed by the President or a Vice President, and the Secretary or the Treasurer or any other person properly authorized by the Board of Directors, and shall bear the corporate seal, which seal may be facsimile engraved or printed. Where the certificate is signed by a transfer agent or a registrar, the signature of any corporate officer on such certificate may be a facsimile engraved or printed. In case any officer who has signed, or whose facsimile signature has been placed upon, any share certificate shall have ceased to be such officer because of death, resignation or otherwise before the certificate is issued, such share certificate may be issued by the Corporation with the same effect as if the officer had not ceased to be such at the date of its issue. Section 2.3 Duplicate certificates may be issued for those lost or destroyed, under such terms as may be prescribed by the Board of Directors. Section 2.4 No person, firm, association, corporation or other entity, except PMA Foundation shall at any time hold more than seven percent of the outstanding Common Stock of the Corporation. Nothing set forth in this Section 2.4 shall limit in any respect any person's ownership of shares of Class A Common Stock of the Corporation. - 2 - Section 2.5 Upon surrender to the Corporation of a share certificate duly endorsed by the person named in the certificate or by attorney duly appointed in writing and accompanied where necessary by the proper evidence of succession, assignment or authority to transfer, a new certificate shall be issued to the person entitled thereto and the old certificate canceled and the transfer recorded on the share register of the Corporation. A transferee of shares of the Corporation shall not be a record holder of such shares entitled to the rights and benefits associated therewith unless and until the share transfer has been recorded on the share transfer books of the Corporation. No transfer shall be made if it would be inconsistent with the provisions of (i) Article 8 of the Pennsylvania Uniform Commercial Code or (ii) Article 2 of these Bylaws. Section 2.6 The Common Stock of the Corporation shall be owned by and shall be transferable only to a person, firm, association, corporation or other entity qualified to own Common Stock under these Bylaws. If any shareholders of the Corporation shall cease to be qualified to own Common Stock under these Bylaws or if the executor or administrator of any shareholder, or the grantee or assignee of any Common Stock sold on execution, or for debt, or as the result of bankruptcy or insolvency proceedings, or if any other person, firm, association, corporation or other entity who is not qualified to own Common Stock under these Bylaws shall become the holder of Common Stock, then in any such case, unless a transfer of such Common Stock shall be made within six months to a person qualified, such holder shall be required to offer to sell such Common Stock to PMA Foundation at a price to be agreed upon by the holder and PMA Foundation. If the holder and PMA Foundation are unable to agree upon a price, a committee of arbitrators shall be appointed to appraise the fair market value of the Common Stock. The number of arbitrators shall be three, and shall be appointed as follows: one member of the committee shall be appointed by the Executive Committee of PMA Foundation, and one member by the holder of the Common Stock. The two members so appointed shall appoint a third member of the committee. The committee shall then, by a majority agreement appraise the fair market value of the Common Stock. Thereafter, PMA Foundation shall have the option to purchase such Common Stock at the fair market value as appraised by the majority of the three appointees. If within 30 days after the appraisal of the fair market value of the Common Stock and the presentment thereof to PMA Foundation, PMA Foundation does not exercise its option to purchase, then the Corporation shall have the option to purchase such Common Stock at the appraised fair market value, and if within 30 days after the presentment of such Common Stock to the Corporation for purchase, the Corporation does not exercise its option to purchase, then the holder of such Common Stock shall be deemed the qualified owner thereof until such time as the holder transfers such Common Stock to a person, firm, association, corporation or other entity who is qualified to own Common Stock under these Bylaws. It shall be the duty of any unqualified holder of Common Stock to comply with the provisions of this Section 2.6, and no dividends shall be paid on account of such Common - 3 - Stock held by any unqualified holder after a holding period of six months in the absence of compliance with the provisions of this Section 2.6. No transfer of any interest in Common Stock of the Corporation shall be effective for any purpose unless such transfer is made in accordance with the provisions of this Section 2.6. Nothing set forth in this Section 2.6 shall limit the transfer of any shares of Class A Common Stock of the Corporation. Section 2.7 Upon issuance of each certificate of Common Stock a receipt shall be taken as follows: "Received Certificate No. , subject to the conditions and restrictions therein referred to and to the Bylaws of this Corporation to which the undersigned agrees to conform. This agreement shall be binding upon the heirs, executors, administrators and assigns of the undersigned." Section 2.8. All certificates of Common Stock, in addition to the usual and necessary matters, shall contain the following printed thereon: "The ownership and transfer of Common Stock in this Corporation is limited by the Bylaws printed on the back of this certificate." Upon the back of each certificate of Common Stock shall be printed Sections 2.1, 2.4 and 2.6 of Article 2 of these Bylaws. ARTICLE 3 Shareholders Meetings --------------------- Section 3.1 All meetings of the shareholders shall be held at such time and place, within or without the Commonwealth of Pennsylvania, as may be determined from time to time by the Board of Directors and need not be held at the registered office of the Corporation. Section 3.2 An annual meeting of the shareholders for the election of directors and the transaction of such other business as may properly be brought before the meeting shall be held in each calendar year at such time and place as may be determined by the Board of Directors. - 4 - Section 3.3 Special meetings of the shareholders may be called at any time by (i) the Chairman or President (ii) the Board of Directors or (iii) shareholders entitled to cast at least one-fifth of the votes that all shareholders are entitled to cast at the particular meeting. The request of any person who has called a special meeting of shareholders shall be addressed to the Secretary of the Corporation, shall be signed by the persons making the request and shall state the purpose or purposes of the meeting. Upon receipt of any such request it shall be the duty of the Secretary to fix the time and provide written notice of the special meeting of shareholders, which shall be held not more than 60 days after the receipt of the request. If the Secretary shall neglect or refuse to fix the time or provide written notice of the special meeting, the person or persons making the request may fix the time and provide written notice of the special meeting. Section 3.4 Written notice of each meeting other than an adjourned meeting of shareholders, stating the place and time, and, in the case of a special meeting of shareholders, the general nature of the business to be transacted, shall be provided to each shareholder of record entitled to vote at the meeting at such address as appears on the books of the Corporation. Except as otherwise required by Article 22 hereof, such notice shall be given, in accordance with the provisions of Article 21 of these Bylaws, at least (i) ten days prior to the day named for a meeting to consider a fundamental change under Chapter 19 of the Pennsylvania Business Corporation Law of 1988 (the "BCL") or (ii) five days prior to the day named for the meeting in any other case. Section 3.5 Whenever the Corporation has been unable to communicate with a shareholder for more than 24 consecutive months because communications to the shareholder are returned unclaimed or the shareholder has otherwise failed to provide the Corporation with a current address, the giving of notice to such shareholder pursuant to Section 3.4 of these Bylaws shall not be required. Any action or meeting that is taken or held without notice or communication to that shareholder shall have the same validity as if the notice or communication had been duly given. Whenever a shareholder provides the Corporation with a current address this Section 3.5 shall cease to be applicable to such shareholder. The Corporation shall not be required to give notice to any shareholder pursuant to Section 3.4 hereof if and for as long as communication with such shareholder is unlawful. Section 3.6 The Board of Directors may provide by resolution with respect to a specific meeting or with respect to a class of meetings that one or more shareholders may participate in such meeting or meetings of shareholders by means of conference telephone or other communications equipment by means of which all persons participating in the meeting can hear one another. Participation in the meeting by such means shall constitute presence in person at the meeting. Any notice otherwise required to be given in - 5 - connection with any meeting at which participation by conference telephone or other communications equipment is permitted shall so specify. ARTICLE 4 Quorum of Shareholders ---------------------- Section 4.1 A meeting of shareholders duly called shall not be organized for the transaction of business unless a quorum is present. Section 4.2 The holders of a majority of the outstanding voting power of the shares of stock of the Corporation, appearing either in person or by proxy, shall constitute a quorum for the transaction of business at any annual or special meeting of the shareholders. Section 4.3 The shareholders present at a duly organized meeting can continue to do business until adjournment notwithstanding the withdrawal of enough shareholders to leave less than a quorum. Section 4.4 If a meeting of shareholders cannot be organized because a quorum is not present those present in person or by proxy, may, except as otherwise provided by statute, adjourn the meeting to such time and place as they may determine, without notice other than an announcement at the meeting, until the requisite number of shareholders for a quorum shall be present in person or by proxy. Section 4.5 Notwithstanding the provisions of Sections 4.1, 4.2, 4.3 and 4.4 of these Bylaws: (1) Any meeting at which directors are to be elected may be adjourned only from day to day, or for such longer periods not exceeding 15 days each as the shareholders present and entitled to vote shall direct. (2) Those shareholders entitled to vote who attend a meeting called for election of directors that has been previously adjourned for lack of a quorum, although less than a quorum as fixed in these Bylaws, shall nevertheless constitute a quorum for the purpose of electing directors. (3) Those shareholders entitled to vote who attend a meeting that has been previously adjourned for one or more periods aggregating at least 15 days because of an absence of a quorum, although less than a quorum is fixed in these Bylaws, - 6 - shall nevertheless constitute a quorum for the purpose of acting upon any matter set forth in the notice of the meeting if the notice states that those shareholders who attend the adjourned meeting shall nevertheless constitute a quorum for the purpose of acting upon the matter. Section 4.6 Except as otherwise provided by statute, the Articles of Incorporation or these Bylaws, at any duly organized meeting of shareholders the vote of the holders of a majority of the votes cast shall decide any question brought before such meeting. ARTICLE 5 Proxies ------- Section 5.1 Every shareholder entitled to vote at a meeting of shareholders, or to express consent or dissent to corporate action in writing without a meeting, may authorize another person or persons to act for him by proxy. Every proxy shall be executed in writing by the shareholder or his duly authorized attorney-in-fact and filed with the Secretary of the Corporation. A proxy, unless coupled with an interest shall be revocable at will, notwithstanding any other agreement or any provision in the proxy to the contrary, but the revocation of a proxy shall not be effective until written notice thereof has been given to the Secretary of the Corporation. An unrevoked proxy shall not be valid after three years from the date of its execution unless a longer time is expressly provided therein. A proxy shall not be revoked by the death or incapacity of the maker, unless before the vote is counted or the authority is exercised, written notice of such death or incapacity is given to the Secretary of the Corporation. Section 5.2 Where two or more proxies of a shareholder are present, the Corporation shall, unless otherwise expressly provided in the proxy, accept as the vote of all shares represented thereby the vote cast by a majority of them and, if a majority of the proxies cannot agree whether the shares represented shall be voted or upon the manner of voting the shares, the voting of the shares shall be divided equally among those persons. ARTICLE 6 Record Date ----------- Section 6.1 The Board of Directors may fix a time prior to the date of any meeting of shareholders as a record date for the determination of the shareholders entitled to notice of, or to vote at, the meeting, which time, except in the case of an adjourned - 7 - meeting, shall not be more than 90 days prior to the date of the meeting of shareholders. Only shareholders of record on the date so fixed shall be entitled to notice of, or to vote at, such meeting, notwithstanding any transfer of shares on the books of the Corporation after any record date fixed as aforesaid. The Board of Directors may similarly fix a record date for the determination of shareholders of record for any other purpose, such as the payment of a distribution or conversion or exchange of shares. ARTICLE 7 Record of Shareholders ---------------------- Section 7.1 The Treasurer shall have charge of the share transfer books of the Corporation and shall maintain an alphabetical record of the shareholders with their addresses and the number of shares held by each. ARTICLE 8 Judges of Election ------------------ Section 8.1 Prior to any meeting of shareholders, the Board of Directors may appoint judges of election, who may but need not be shareholders, to act at such meeting or any adjournment thereof. If judges of election are not so appointed, the presiding officer of any such meeting may, and on the request of any shareholder or his proxy shall, make such appointment at the meeting. The number of judges shall be one or three. No person who is a candidate for an office to be filled at the meeting shall act as a judge of election. Section 8.2 In case any person appointed as a judge of election fails to appear or fails or refuses to act, the vacancy so created may be filled by appointment made by the Board of Directors in advance of the convening of the meeting or at the meeting by the presiding officer thereof. Section 8.3 The judges of election shall determine the number of shares outstanding and the voting power of each, the shares represented at the meeting, the existence of a quorum and the authenticity, validity and effect of proxies. The judges of election shall also receive votes or ballots, hear and determine all challenges and questions in any way arising in connection with the right to vote, count and tabulate all votes, determine the result and do such other acts as may be proper to conduct the election or vote with fairness to all shareholders. The judges of election shall perform their duties impartially, in good faith, to the best of their ability and as expeditiously as - 8 - practicable. If there are three judges of election, the decision, act or certificate of a majority shall be the decision, act or certificate of all. Section 8.4 On request of the presiding officer of the meeting or of any shareholder, the judges of election shall make a report in writing of any challenge, question or matter determined by them and execute a certificate of any fact found by them. Any report or certificate made by them shall be prima facie evidence of the facts found by them. ARTICLE 9 Consent of Shareholders in Lieu of Meeting ------------------------------------------ Section 9.1 Any action required or permitted to be taken at a meeting of the shareholders may be taken without a meeting if, prior or subsequent to the action, a written consent or consents thereto signed by all of the shareholders who would be entitled to vote at a meeting for such purpose shall be filed with the Secretary of the Corporation. Section 9.2 Any action required or permitted to be taken at a meeting of the shareholders or of a class of shareholders may be taken without a meeting upon the written consent of shareholders who would have been entitled to cast the minimum number of votes that would be necessary to authorize the action at a meeting at which all the shareholders entitled to vote thereon were present and voting. The consents shall be filed with the Secretary of the Corporation. If a written consent or consents are signed by fewer than all of the shareholders who would be entitled to vote at a meeting for such purpose, the action shall not become effective until ten days after written notice of the action has been given to each shareholder entitled to vote thereon who has not consented thereto. ARTICLE 10 Directors --------- Section 10.1 The business and affairs of the Corporation shall be managed under the direction of a Board of Directors of not less than 12 or more than 24 directors. The Board of Directors shall be divided into three classes, and directors of each class shall be elected for a term of three years and until their successors are elected and qualified or until their earlier death, resignation or removal. A decrease in the number of directors - 9 - shall not have the effect of shortening the term of any incumbent director. Prior to each election of a class of directors, the Board of Directors shall fix the size of that class of directors at a minimum of four and a maximum of eight directors. The Board of Directors may exercise all such powers of the Corporation and do all such lawful acts and things as are required or permitted to be exercised and done by statute, the Articles of Incorporation or these Bylaws. Section 10.2 In all elections of directors, each shareholder, or his proxy, shall be entitled to the number of votes to which the shares of stock owned by him are entitled to cast under the Articles of Incorporation of the Corporation and may cumulate his votes as provided in the Articles of Incorporation. All elections shall be by ballot. Section 10.3 Every director shall be a shareholder in the Corporation. When first elected to the Board of Directors, each director shall be regularly engaged in a business, trade, or profession and shall be a resident of a jurisdiction in which the Corporation is transacting business. No person shall be elected a director who is or becomes 70 years of age prior to or during his first term in office as a director. No person shall be considered as a candidate, nor shall any votes be counted for any person, unless written notice of the nomination of the candidacy shall have been filed with the Secretary of the Corporation for the information of the shareholders not less than 60 days prior to the election; provided, however, that nominees selected by the then existing Board of Directors, or by a Nominating Committee appointed by the Board of Directors and consisting of four directors continuing in office, may be candidates and voted for without such notice. Section 10.4 A meeting of the Board of Directors may be held immediately following the annual meeting of shareholders at which directors have been elected without the necessity of notice to the directors. At the first regular meeting of the Board of Directors after each annual meeting of shareholders, the Board of Directors shall elect a Chairman of the Board of Directors, a President, a Secretary, a Treasurer and such other officers as the Board of Directors shall determine. The President and Secretary shall be natural persons of full age. The Treasurer may be a corporation, but if a natural person shall be of full age. The Chairman of the Board of Directors and the President shall be, and each other officer may be, a director of the Corporation. The offices of Secretary and Treasurer may be filled by one person. Section 10.5 Regular meetings of the Board of Directors shall be held at least four times each year at times and places within or without the Commonwealth of Pennsylvania designated by the Board of Directors. One or more directors may participate in any meeting of the Board of Directors, or of any committee thereof, by means of a conference telephone or similar communications equipment by means of which all persons - 10 - participating in the meeting can hear one another. Participation in a meeting by such means shall constitute presence in person at the meeting. Section 10.6 A special meeting of the Board of Directors may be called at any time by the Chairman of the Board on 24 hours' notice to each director, either by telephone, or if in writing, in accordance with Article 21 of these Bylaws and shall be called by him or, in his absence, by the Secretary, upon the written request of three members of the Board of Directors. Such special meeting of the Board of Directors shall be held at a time and place designated by the Chairman of the Board, or, in his absence, the Secretary. Section 10.7 A majority of the directors then in office shall constitute a quorum at any regular or special meeting of the Board of Directors, and the acts of a majority of the directors present and voting at a meeting at which a quorum is present shall be the acts of the Board of Directors, except as may be otherwise specifically provided by statute or by the Articles of Incorporation or by these Bylaws. ARTICLE 11 Removal of Directors -------------------- Section 11.1 Unless otherwise provided in the Articles of Incorporation, or in Article 11, Section 11. 3 of these Bylaws the entire Board of Directors, or any class of the Board of Directors or any individual director, may be removed from office by vote of the shareholders entitled to vote thereon only for cause. Notwithstanding the foregoing, an individual director shall not be removed (unless the entire Board of Directors or class of Directors is removed) from the Board of Directors if sufficient votes are cast against the resolution for such director's removal which, if cumulatively voted at an annual or other regular election of directors, would be sufficient to elect one or more directors to the Board of Directors or a class thereof. If any directors are so removed, new directors may be elected at the same meeting. Section 11.2 The Board of Directors may declare vacant the office of a director who has been judicially declared of unsound mind or who has been convicted of an offense punishable by imprisonment for a term of more than one year. Section 11.3 The Board of Directors may be removed at any time with or without cause by the unanimous consent of shareholders entitled to vote thereon. - 11 - ARTICLE 12 Vacancies in the Board of Directors ----------------------------------- Section 12.1 Vacancies in the Board of Directors occurring for any reason, including vacancies resulting from an increase in the number of directors, shall be filled by a majority vote of the remaining members of the Board of Directors, though less than a quorum, or by a sole remaining director, and each person so elected shall be a director to serve for the balance of the unexpired term and until his successor has been elected and qualified or until his earlier death, resignation or removal. Section 12.2 When one or more directors resign from the Board of Directors effective at a future date, the directors then in office, including those who have so resigned, shall have the power by a majority vote to fill the vacancies, the vote thereon to take effect when the resignations become effective. ARTICLE 13 Action by Written Consent ------------------------- Section 13.1 Any action required or permitted to be taken at a meeting of the Board of Directors may be taken without a meeting if, prior or subsequent to the action, a consent or consents thereto signed by all of the directors is filed with the Secretary of the Corporation. ARTICLE 14 Compensation of Directors ------------------------- Section 14.1 Directors, as such, may receive a stated salary for their services or a fixed sum and expenses for attendance at regular and special meetings, or any combination of the foregoing as may be determined from time to time by resolution of the Board of Directors, and nothing contained herein shall be construed to preclude any director from receiving compensation for services rendered to the Corporation in any other capacity. - 12 - ARTICLE 15 Committees ---------- Section 15.1 The Board of Directors may, by resolution adopted by a majority of the directors in office, establish one or more committees consisting of one or more directors as may be deemed appropriate or desirable by the Board of Directors to serve at the pleasure of the Board. Any committee, to the extent provided in the resolution of the Board of Directors pursuant to which it was created, shall have and may exercise all of the powers and authority of the Board of Directors, except that no committee shall have any power or authority as to the following: (1) The submission to shareholders of any action requiring approval of shareholders; (2) The creation or filling of vacancies in the Board of Directors; (3) The adoption, amendment or repeal of these Bylaws; (4) The amendment or repeal of any resolution of the Board of Directors that by its terms is amendable or repealable only by the Board of Directors; and (5) Action on matters committed by the Bylaws or resolution of the Board of Directors to another committee of the Board of Directors. Section 15.2 At the first meeting following each annual meeting of shareholders, the Board of Directors shall elect an Executive Committee of not more than four (4) directors and not more than six (6) directors, a Finance Committee of not less than four (4) directors and not more than six (6) directors, an Audit Committee of a maximum of three (3) directors and a Compensation and Stock Option Committee of a maximum of three (3) directors. These committees shall meet at the call of the Chairman of each such committee. A majority of the elected and, to the extent applicable ex officio, members of the committees shall constitute a quorum. At least one third of the total number of the members of each committee so appointed shall be persons who are not officers or employees of the Corporation or any entity controlling, controlled by or under common control with the Corporation and who are not the beneficial owners of a controlling interest in the voting stock of the Corporation or any such entity. Section 15.3 The Executive Committee shall have supervision of all business of the Corporation and shall have the authority in between the time of regular meetings of the Board of Directors as specified in Article 10, Section 10.5 hereof, to exercise all powers of the Corporation and do all such lawful acts and things as are required or permitted to be exercised and done by statute, the Articles of Incorporation or these Bylaws. The Executive Committee shall have the power to create offices and titles as deemed desirable or advisable. The holders of such offices need not be directors of the Corporation. - 13 - Section 15.4 The Finance Committee shall review the investment results of the Corporation's assets and perform such other duties as the Board of Directors or the Executive Committee may prescribe. Section 15.5 The Audit Committee shall consist of a maximum of three (3) members of the Board of Directors, none of whom shall be an officer or employee of the Corporation or of any entity controlling, controlled by or under common control with the Corporation and who are not beneficial owners of a controlling interest in the voting stock of the Corporation or any such entity. The Audit Committee shall recommend the selection of independent certified public accountants and review the scope and results of the independent audit and the management recommendations made by the independent certified public accountants. Section 15.6 The Nominating Committee shall consist of no fewer than four (4) members of the Board of Directors continuing in office, none of whom shall be an officer or employee of the Corporation or of any entity controlling, controlled by or under common control with the Corporation and who are not beneficial owners of a controlling interest in the voting stock of the Corporation or any such entity. The Nominating Committee shall nominate persons for election for director by the shareholders and shall review and report on the qualifications of candidates otherwise nominated for director. Section 15.7 The Compensation and Stock Option Committee shall consist of a maximum of three (3) members of the Board of Directors, none of whom shall be an officer or employee of the Corporation or of any entity controlling, controlled by or under common control with the Corporation and who are not beneficial owners of a controlling interest in the voting stock of the Company or any such entity. The Compensation and Stock Option Committee shall evaluate the performance of officers deemed to be executive officers of the Corporation and recommend to the Board of Directors compensation of the executive officers. The Compensation and Stock Option Committee may invite the Chairman of the Board and the President of the Corporation to attend its meetings and provide relevant information for the Committee's review, provided however, that the Chairman of the Board and the President may not vote on matters coming before the Committee. ARTICLE 16 Liability of Directors ---------------------- Section 16.1 A director of the Corporation shall stand in a fiduciary relation to the Corporation and shall perform his duties as a director, including his duties as a member of - 14 - any committee of the Board of Directors upon which he may serve, in good faith, in a manner he reasonably believes to be in the best interests of the Corporation, and with such care, including reasonable inquiry, skill and diligence, as a person of ordinary prudence would use under similar circumstances. In performing his duties, a director shall be entitled to rely in good faith on information, opinions, reports or statements, including financial statements and other financial data, in each case prepared or presented by any of the following: (i) one or more officers or employees of the Corporation whom the director reasonably believes to be reliable and competent in the matters presented; (ii) legal counsel, public accountants or other persons as to matters which the director reasonably believes to be within the professional or expert competence of such persons; or (iii) a committee of the Board of Directors upon which he does not serve, duly designated in accordance with law, as to matters within its designated authority, which committee the director reasonably believes to merit confidence. A director shall not be considered to be acting in good faith if he has knowledge concerning the matter in question that would cause his reliance to be unwarranted. Section 16.2 In discharging the duties of their respective positions, the Board of Directors, committees of the Board of Directors and individual directors may, in considering the best interests of the Corporation, consider the effects of any action upon employees, upon suppliers and customers of the Corporation and upon communities in which offices or other establishments of the Corporation are located, and all other pertinent factors. The consideration of these factors shall not constitute a violation of Section 16. 1 of this Article 16. Section 16.3 Absent breach of fiduciary duty, lack of good faith or self- dealing, actions taken as a director or any failure to take any action shall be presumed to be in the best interests of the Corporation. Section 16.4 A director of the Corporation shall not be personally liable for monetary damages as such for any action taken, or any failure to take any action, unless: (i) the director has breached or failed to perform the duties of his office under Sections 16.1 through 16.3 of this Article 16; and (ii) the breach or failure to perform constitutes self-dealing, willful misconduct or recklessness. Section 16.5 The provisions of Section 16.4 of this Article 16 shall not apply to: (i) the responsibility or liability of a director pursuant to any criminal statute; or (ii) the liability of a director for the payment of taxes pursuant to local, state or federal law. Section 16.6 Notwithstanding any other provisions of these Bylaws, the approval by the affirmative vote of the holders of a majority of the outstanding voting power of the shares of stock of the Corporation shall be required to amend, repeal or adopt any - 15 - provision as part of these Bylaws that is inconsistent with the purpose or intent of Sections 16.1, 16.2, 16.3, 16.4, 16.5 or 16.6 of this Article 16, and, if any such action shall be taken, it shall become effective only on a prospective basis from and after the date of such shareholder approval. The provisions of Section 16.1, 16.2, 16.3, 16.4 and 16.5 were originally adopted by the shareholders of the Corporation on April 27, 1987. ARTICLE 17 Officers -------- Section 17.1 The Corporation shall have a Chairman of the Board, a President, a Secretary and a Treasurer or persons who shall act as such, regardless of the name or title by which they may be designated, elected or appointed and may have such other officers and assistant officers as the Board of Directors may authorize from time to time. The Chairman of the Board or the President shall be the chief executive officer of the Corporation, as the Board of Directors may determine from time to time. Each officer shall hold office at the pleasure of the Board of Directors and until his successor has been elected and qualified or until his earlier death, resignation or removal. Any officer may resign at any time upon written notice to the Corporation. The resignation shall be effective upon receipt thereof by the Corporation or at such subsequent time as may be specified in the notice of resignation. Section 17.2 Except as otherwise provided in the Articles of Incorporation, an officer shall perform his duties as an officer in good faith, in a manner he reasonably believes to be in the best interests of the Corporation and with such care, including reasonable inquiry, skill and diligence, as a person of ordinary prudence would use under similar circumstances. A person who so performs his duties shall not be liable by reason of having been an officer of the Corporation. Section 17.3 Any officer or agent of the Corporation may be removed by the Board of Directors with or without cause by a vote of not less than two- thirds of the whole Board. The removal shall be without prejudice to the contract rights, if any, of any person so removed. Election or appointment of an officer or agent shall not of itself create contract rights. If the office of any officer becomes vacant for any reason, the vacancy may be filled by the Board of Directors. - 16 - ARTICLE 18 Duties of Officers ------------------ Section 18.1 The Chairman of the Board shall preside at all meetings of the Board of Directors and at all meetings of the shareholders, appoint all committees not otherwise provided for in the Bylaws and shall be ex officio a member of all committees other than the Audit Committee, the Nominating Committee, and the Compensation and Stock Option Committee. Section 18.2 In the absence of the Chairman of the Board, the President shall preside at all meetings of the Board of Directors and at all meetings of the shareholders. Except as otherwise provided herein, the President shall have general supervision and control of all the employees of the Corporation; shall be responsible for the general and active management of the business of the Corporation; shall see that all orders and resolutions of the Board of Directors are put into effect, subject, however, to the right of the Board of Directors to delegate any specific powers, except such as may be by statute exclusively conferred on the President or on any other officer or officers of the Corporation; shall have the authority to execute bonds, mortgages and other contracts requiring a seal, under the seal of the Corporation, except where required or permitted by law to be otherwise signed and executed and except where the signing and execution thereof shall be expressly delegated by the Board of Directors to some other office or agent of the Corporation; and shall be ex officio a member of all committees other than the Audit Committee, the Nominating Committee, and the Compensation and Stock Option Committee. Section 18.3 In the absence of the President, the Executive Vice President, if any, shall assume the duties of the President. The Executive Vice President, if any, shall perform such duties as may be assigned to him by the Corporation's chief executive officer, the Board of Directors or the Executive Committee of the Board of Directors. Section 18.4 The Vice Presidents shall perform such duties as may be designated from time to time by the Corporation's chief executive officer, the Board of Directors or the Executive Committee of the Board of Directors. Section 18.5 The Secretary shall act under the direction and superintendence of the Corporation chief executive officer; attend all the meetings of shareholders, directors and committees, and keep in suitable books the minutes thereof; superintend the keeping and have charge of the seal, books, papers and records pertaining to his office, sign such documents as shall require his attention, issue notices for all meetings; make or superintend the making of monthly and annual statements to the Board of Directors, - 17 - which shall fully show the current business and condition of the Corporation and perform generally all the duties incident to the office of Secretary. Section 18.6 The Treasurer or his designee shall receive and take care of all moneys, securities and evidences of indebtedness belonging to the Corporation; maintain day by day records of his transactions and deposit the daily receipts in a General Account in the name of the Corporation in such bank or banks or such depositories as the Board of Directors or the Executive Committee may direct. All checks or other orders on such banks or depositories for the payment or transfer of money shall be signed by the Treasurer or his designee and by another officer of the Corporation. In addition to the aforesaid General Account the Treasurer or his designee shall maintain Special Accounts as the Board of Directors or the Executive Committee may from time to time create in banks for current payments; such deposits shall be made in the name of the Corporation and shall be replenished from the General Account as may be necessary to maintain working balances in such Special Accounts. All checks or drafts drawn against such Special Accounts shall be signed by such officer or officers or employees as may from time to time be authorized by the Board of Directors or the Executive Committee of the Board of Directors. Section 18.7 The Assistant Secretary shall, in the absence of the Secretary, perform the duties of the Secretary and such other duties as may be assigned to him by the Secretary. Section 18.8 The Assistant Treasurer shall, in the absence of the Treasurer, perform the duties of the Treasurer and such other duties as may be assigned to him by the Treasurer. Section 18.9 All officers and employees shall give bond for the faithful performance of their duties in such amount as is required by the Board of Directors or the Executive Committee of the Board of Directors. ARTICLE 19 Indemnification of Officers, Directors, Employees, and Agents ------------------------------------------------------------- Section 19.1 The Corporation shall indemnify any director or officer, and may indemnify any other employee or agent who was or is a party to, or is threatened to be made a party to or who is called as a witness in connection with, any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or - 18 - investigative, including an action by or in the right of the Corporation by reason of the fact that he is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses, including attorneys' fees, judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such action, suit or proceeding unless the act or failure to act giving rise to the claim for indemnification is determined by a court to have constituted willful misconduct or recklessness. Section 19.2 The indemnification and advancement of expenses provided by, or granted pursuant to, this Article 19 shall not be deemed exclusive of any other rights to which those seeking indemnification or advancement of expenses may be entitled under any Bylaw, agreement, contract, vote of shareholders or disinterested directors or pursuant to the direction, howsoever embodied, of any court of competent jurisdiction or otherwise, both as to action in their official capacity and as to action in another capacity while holding such office. It is the policy of the Corporation that indemnification of, and advancement of expenses to, directors and officers of the Corporation shall be made to the fullest extent permitted by law. To this end, the provisions of this Article 19 shall be deemed to have been amended for the benefit of directors and officers of the Corporation effective immediately upon any modification of the BCL or the Directors' Liability Act of the Commonwealth of Pennsylvania (the "DLA") which expands or enlarges the power or obligation of corporations organized under the BCL or subject to the DLA to indemnify, or advance expenses to, directors and officers of corporations. Section 19.3 The Corporation shall pay expenses incurred by an officer or director, and may pay expenses incurred by any other employee or agent in defending a civil or criminal action, suit or proceeding in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of such person to repay such amount if it shall ultimately be determined that he is not entitled to be indemnified by the Corporation. Section 19.4 The indemnification and advancement of expenses provided by, or granted pursuant to, this Article 19 shall, unless otherwise provided when authorized or ratified, continue as to a person who has ceased to be a director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such person. Section 19.5 The Corporation shall have the authority to create a fund of any nature, which may, but need not, be under the control of an independent trustee, or otherwise secure or insure in any manner, its indemnification obligations, whether arising under these Bylaws or otherwise. The authority shall include, without limitation, the - 19 - authority to: (i) deposit funds in trust or in escrow, (ii) establish any form of self-insurance, (iii) secure its indemnity obligation by grant of a security interest, mortgage or other lien on the assets of the Corporation or (iv) establish a letter of credit, guaranty or surety arrangement for the benefit of such persons in connection with the anticipated indemnification or advancement of expenses contemplated by this Article 19. The provisions of this Article 19 shall not be deemed to preclude the indemnification of, or advancement of expenses to, any person who is not specified in Section 19.1 of this Article 19 but whom the Corporation has the power or obligation to indemnify, or to advance expenses for, under the provisions of the BCL or the DLA or otherwise. The authority granted by this Section 19.5 shall be exercised by the Board of Directors of the Corporation. Section 19.6 The Corporation shall have the authority to enter into a separate indemnification agreement with any officer, director, employee or agent of the Corporation or any subsidiary providing for such indemnification of such person as the Board of Directors shall determine up to the fullest extent permitted by law. Section 19.7 As soon as practicable after receipt by any person specified in Section 19.1 of this Article 19 of notice of the commencement of any action, suit or proceeding specified in Section 19.1 of this Article 19, such person shall, if a claim with respect thereto may be made against the Corporation under Article 19 of these Bylaws, notify the Corporation in writing of the commencement or threat thereof; however, the omission so to notify the Corporation shall not relieve the Corporation for any liability under Article 19 of the Bylaws unless the Corporation shall have been prejudiced thereby or from any other liability which it may have to such person other than under Article 19 of these Bylaws. With respect to any such action as to which such person notifies the Corporation of the commencement or threat thereof, the Corporation may participate therein at its own expense, and except as otherwise provided below, to the extent that it desires, the Corporation jointly with any other indemnifying party similarly notified, shall be entitled to assume the defense thereof, with counsel selected by the Corporation to the reasonable satisfaction of such person. After notice from the Corporation to such person of its election to assume the defense thereof, the Corporation shall not be liable to such person under Article 19 of these Bylaws for any legal or other expenses subsequently incurred by such person in connection with the defense thereof other than as otherwise provided below. Such person shall have the right to employ his own legal counsel in such action, but the fees and expenses of such legal counsel incurred after notice from the Corporation of its assumption of the defense thereof shall be at the expense of such person unless: (i) the employment of legal counsel by such person shall have been authorized by the Corporation; (ii) such person shall have reasonably concluded that there may be a conflict of interest between the Corporation and such person in the conduct of the defense of such proceeding; or (iii) the Corporation shall not in fact have employed - 20 - legal counsel to assume the defense of such action. The Corporation shall not be entitled to assume the defense of any proceeding brought by or on behalf of the Corporation or as to which such person shall have reasonably concluded that there may be a conflict of interest. If indemnification under Article 19 of these Bylaws or advancement of expenses are not paid or made by the Corporation, or on its behalf, within 90 days after a written claim for indemnification or a request for an advancement of expenses has been received by the Corporation, such person may, at any time thereafter, bring suit against the Corporation to recover the unpaid amount of the claim or the advancement of expenses. The right to indemnification and advancement of expenses provided hereunder shall be enforceable by such person in any court of competent jurisdiction. The burden of proving that indemnification is not appropriate shall be on the Corporation. Expenses reasonably incurred by such person in connection with successfully establishing the right to indemnification or advancement of expenses, in whole or in part, shall also be indemnified by the Corporation. Section 19.8 The Corporation shall have power to purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the Corporation would have the power to indemnify him against such liability under the provisions of this Article 19. Section 19.9 Notwithstanding any other provisions of these Bylaws, the approval by (i) the affirmative vote of the holders of a majority of the outstanding voting power of the shares of stock of the Corporation or (ii) a majority vote of the members of the Board of Directors shall be required to amend, repeal or adopt any provision as part of these Bylaws which is inconsistent with the purpose or intent of this Article 19, and, if any such action shall be taken, it shall become effective only on a prospective basis from and after the date of such approval. The provisions of Sections 19.1, 19.2, 19.3, 19.4, 19.5, 19.6, 19.7 and 19.8 were originally adopted by the shareholders of the Corporation on April 27, 1987. ARTICLE 20 Fiscal Year ----------- Section 20.1 The fiscal year of the Corporation shall be determined by the Board of Directors. - 21 - ARTICLE 21 Manner of Giving Written Notice; Waivers of Notice -------------------------------------------------- Section 21.1 Whenever written notice is required to be given to any person under the provisions of these Bylaws, it may be given to the person either personally or by sending a copy thereof by first class or express mail, postage prepaid, or by telegram (with messenger service specified), telex or TWX (with answer back received) or courier service, charges prepaid, or by telecopier, to his address (or to his telex, TWX, telecopier or telephone number) appearing on the books of the Corporation or, in the case of written notice to directors, supplied by each director to the Corporation for the purpose of the notice. If the notice is sent by mail, telegraph or courier service, it shall be deemed to have been given to the person entitled thereto when deposited in the United States mail or with a telegraph office or courier service for delivery to that person or, in the case of telex or TWX, when dispatched. Section 21.2 Any written notice required to be given to any person under the provisions of statute, the Corporation's Articles of Incorporation or these Bylaws may be waived in a writing signed by the person entitled to such notice whether before or after the time stated therein. Except as otherwise required by statute, and except in the case of a special meeting, neither the business to be transacted at, nor the purpose of, a meeting need be specified in the waiver of notice. In the case of a special meeting of shareholders, the waiver of notice shall specify the general nature of the business to be transacted. Attendance of any person, whether in person or by proxy, at any meeting shall constitute a waiver of notice of such meeting, except where a person attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting was not lawfully called or convened. ARTICLE 22 Amendments ---------- Section 22.1 Neither this Section 22.1 nor Article 2 of these Bylaws may be altered, amended or repealed unless approved by the affirmative vote of the holders of two-thirds of the outstanding Common Stock of the Corporation, voting as a separate class, at any annual meeting of shareholders or at a special meeting of shareholders called for that purpose, provided that 30 days' notice of the proposed amendments shall have been mailed to the last recorded address of each shareholder as furnished to the Corporation, and that the same shall have been submitted to the Board of Directors at least 30 days prior to such meeting. - 22 - Section 22.2 Neither this Section 22.2 nor Article 16 of these Bylaws may be altered, amended or repealed unless approved by the affirmative vote of the holders of a majority of the outstanding voting power of the shares of stock of the Corporation at a duly organized meeting of shareholders called for that purpose, provided that 30 days' notice of the proposed amendments shall have been mailed to the last recorded address of each shareholder as furnished to the Corporation, and that the same shall have been submitted to the Board of Directors at least 30 days prior to such meeting. Section 22.3 Neither this Section 22.3 nor Article 19 of these Bylaws may be altered, amended or repealed unless approved by: (i) the affirmative vote of the holders of a majority of the outstanding voting power of the shares of stock of the Corporation at a duly organized meeting called for that purpose, provided that 30 days' notice of the proposed amendments shall have been mailed to the last recorded address of each shareholder as furnished to the Corporation, and that the same shall have been submitted to the Board of Directors at least 30 days prior to such meeting, or (ii) a majority vote of the members of the Board of Directors at any regular meeting or any special meeting duly convened after notice to the directors of that purpose, subject to the power of the shareholders to change such action by the affirmative vote of the holders of a majority of the outstanding voting power of the shares of stock of the Corporation at any duly organized meeting called for that purpose. Section 22.4 All provisions of these Bylaws other than Articles 2, 16 and 19 and Sections 22.1, 22.2 and 22.3 may be altered, amended or repealed: (i) by the affirmative vote of the holders of a majority of the outstanding voting power of the shares of stock of the Corporation at a duly organized meeting called for that purpose, or (ii) by a majority vote of the members of the Board of Directors at any regular meeting or any special meeting duly convened after notice to the directors of that purpose, subject to the power of the shareholders to change such action by the affirmative vote of the holders of a majority of the outstanding voting power of the shares of stock of the Corporation at any duly organized meeting called for that purpose. - 23 - EX-10.1 4 Exhibit 10.1 DEFERRED COMPENSATION PLAN FOR NON-EMPLOYEE DIRECTORS OF PMA CAPITAL CORPORATION ARTICLE I. DEFINITIONS --------- ----------- The following are defined terms wherever they appear in the Plan. 1.1 "Administrator" shall mean the person, or committee, appointed by the President and Chief Executive Officer of PMA Capital, and charged with responsibility for administration of the Plan. 1.2 "Board of Directors" or "Board" shall mean the Board of Directors of PMA Capital. 1.3 "Business Day" shall mean any day during which trades occur on the Nasdaq Stock Market. 1.4 "Change of Control" shall mean a change of control of PMA Capital of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act") whether or not PMA Capital is then subject to such reporting requirements; provided that, without limitation, such a Change of Control shall be deemed to occur if, (a) Any "person" (as such term is used in Section 13(d) and 14(d) of the Exchange Act) is or first becomes the "beneficial owner" (as determined for purposes of Regulation 13D-G under the Exchange Act as currently in effect), directly or indirectly, in a transaction or series of transaction, of securities of PMA Capital representing more than 50% of the combined voting power of PMA Capital's Common Stock and Class A Common Stock (collectively, the "Voting Capital Stock"), or (b) The consummation of a merger, or other business combination after which the holders of the Voting Capital Stock do not collectively own 50% or more of the voting capital stock of the entity surviving such merger or other business combination, or the sale, lease, exchange or other transfer in a transaction or series of transactions of all or substantially all of the assets of PMA Capital, or (c) As a result or in connection with any cash tender offer or exchange offer, merger or other business combination, sale of assets or contested election of directors or any combination of the foregoing transactions (a "Transaction"), the persons who constituted a majority of the members of the Board of Directors of PMA Capital effective before the event that constitutes a Change of Control, no longer constitutes such a majority of the members of the Board of Directors of PMA Capital then in office. A Transaction constituting a Change in Control shall only be deemed to have occurred upon the closing of the Transaction. 1.5 "PMA Capital Common Stock" or "Common Stock" or "Stock" shall mean the Class A Common Stock of PMA Capital, par value of five dollars ($5.00) per share. 1 1.6 "Committee" shall mean the Compensation Committee of the Board of Directors of PMA Capital, or the successor to such committee. 1.7 "Deferral Election" shall mean the instrument executed by a Participant which specifies amounts and items of compensation to be deferred into the Deferred Compensation Account. 1.8 "Deferred Compensation Account" shall mean the separate bookkeeping account established under the Plan for each Participant, as described in Section 3.1. 1.9 "Director" shall mean any individual serving on the Board who is not an employee of PMA Capital or any of its subsidiaries or affiliates. 1.10 "Participant" shall mean each individual who as a Director of PMA Capital participates in the Plan in accordance with the terms and conditions of the Plan. 1.11 "Payment Election" shall mean the instrument executed by a Participant which specifies the method of payment of deferred compensation. 1.12 "PMA Capital" shall mean PMA Capital Corporation. 1.13 "Plan" shall mean the Deferred Compensation Plan for Non-Employee Directors of PMA Capital, as it may be amended or restated from time to time by the Board of Directors. 1.14 "Termination of Service" shall mean termination of services as a Director of PMA Capital, including but not limited to termination by retirement, death or disability. 1.15 "Unforeseeable Emergency" shall mean a severe financial hardship to the Participant resulting from a sudden and unexpected illness or accident of the Participant or of a dependent (as defined in section 152(a) of the Internal Revenue Code of 1986, as amended) of the Participant, loss of the Participant's property due to casualty, or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the Participant. 1.16 "Valuation Date" shall mean the close of business on the last business day of each month. 2 ARTICLE II. PARTICIPATION 2.1 Eligibility to Participate in the Plan. -------------------------------------- The individuals who are eligible to participate in the Plan are those persons who serve as Directors of PMA Capital and who are not also employees of PMA Capital. 2.2 Participation in the Plan. ------------------------- (a) A Participant may elect to defer receipt of all or a portion of the annual Board retainer fee and Board and Board committee attendance fees, and such other compensation for services as a Director as are specified by the Administrator. (b) The election to defer is made by delivering a properly executed Deferral Election to the Administrator. The Deferral Election shall specify the item or items of compensation to be deferred, and the amount of such compensation to be deferred. The election for payment of compensation deferred is made by delivering a properly executed Payment Election to the Administrator. The Payment Election shall specify the method by which such deferred compensation is to be paid, and the date or dates for payment of such deferred compensation. (c) An election to defer compensation must be filed by the Participant prior to the commencement of a calendar year during which such compensation will be paid. (d) Notwithstanding Section 2.2(c), an election to defer compensation made by an individual who subsequently begins active service as a Director of PMA Capital that is filed prior to the date upon which such active service begins, shall be effective according to Section 2.2(e)(2), below. (e) An election to defer compensation is effective: (1) for the calendar year beginning after the election, and for subsequent calendar years, unless modified or revoked; or, (2) if Section 2.2(d) applies, for the remainder of the first year of active service, as of the first day of active service, and for subsequent calendar years, unless modified or revoked. 2.3 Elections Pertaining to Payments. -------------------------------- (a) No payments may be made or commence under the Plan until the later of (1) at least six (6) months elapses after a Termination of Service occurs or (2) the first day of the first calendar year following the date the Payment Election is filed with the Administrator, except as provided in Sections 4.2, 4.3 and 4.4 below. (b) In executing a Payment Election, the Participant shall elect among the following methods of payment: (1) Lump sum payment, or 3 (2) Periodic Payments - the payments shall be made at least annually, (but no more frequently than monthly) over a period not to exceed fifteen (15) years. (c) The balance of a Participant's Deferred Compensation Account shall be paid, in all events, no later than January of the fifteenth year following Termination of Service. (d) If there is not in effect as of Participant's Termination of Service a valid Payment Election, the Participant's Deferred Compensation Account shall be paid in a lump sum. All payments under the Plan shall be in cash only and no Participant shall have any right to obtain payment in any other form. 2.4 Modification of Elections Pertaining to Payments. ------------------------------------------------- A Participant may request modification of his existing Payment Election at any time before a Termination of Service. The Board shall consider any such modification request and may grant or deny the request, in its discretion, which decision shall be final and binding on the Participant. In determining whether the request should be allowed, the Board may consider the Participant's financial needs, including any changed circumstances, as well as the projected financial needs of PMA Capital. If the Board determines that the request should be allowed, the requested modifications shall be made. The Participant shall effect the modifications through execution of a new Payment Election, which shall constitute the only Payment Election which is outstanding and effective. 2.5 Reduction or Termination of Future Deferral. -------------------------------------------- (a) A Participant may elect to reduce or to revoke his deferral of compensation into his Deferred Compensation Account, but such election shall have effect only prospectively. A Participant shall effect an election to reduce his deferral of compensation by execution of a new Deferral Election, which shall constitute the only Deferral Election which is outstanding and effective on a prospective basis. A Participant shall effect an election to revoke his deferral of compensation into his Deferred Compensation Account by informing the Administrator in writing. Only one election to reduce and one election to revoke may be made under this Section 2.5 by each Participant in a calendar year. (b) An election to reduce or to revoke deferral of compensation under Section 2.5(a) above shall become effective on the later of (1) the first day of the first calendar year following the date on which the election to reduce or revoke is made or (2) on the first day of the calendar month following receipt of such election by the Administrator except in the case of an Unforeseeable Emergency under the circumstances described below in Section 4.2. 4 ARTICLE III. COMPENSATION DEFERRED ----------- --------------------- 3.1 Deferred Compensation Account. ----------------------------- A Deferred Compensation Account shall be established as a bookkeeping account for each Director when the Director becomes a Participant. Compensation deferred by a Participant under the Plan shall be credited to the Deferred Compensation Account on the date such compensation would otherwise have been paid to the Participant. Hypothetical income on deferred compensation shall be credited to the Deferred Compensation Account as provided in Section 3.3, below. 3.2 Balance of Deferred Compensation Account. ---------------------------------------- The balance credited to each Participant's Deferred Compensation Account shall include compensation deferred by the Participant, plus hypothetical income, dividends and gains credited with respect to hypothetical investments. Losses from hypothetical investments shall reduce the amount credited to the Participant's Deferred Compensation Account balance. The balance credited to each Participant's Deferred Compensation Account shall be determined as of each Valuation Date. 3.3 Hypothetical Investment. ----------------------- (a) Compensation deferred under the Plan which would have been paid in cash shall be assumed to be invested, without charge, in one or more hypothetical investment vehicles. The hypothetical investment vehicles shall be specified from time to time by the Administrator, except that a hypothetical Common Stock investment vehicle shall be available. With respect to such hypothetical investments other than the hypothetical Common Stock investment vehicle, which is discussed in Section 3.3(b) below: (1) Cash compensation deferred shall be deemed to earn investment returns under the hypothetical investment vehicle. The Administrator shall credit such income to the Participant's Deferred Compensation Account, pursuant to Section 3.4 below. (2) The Committee, in its sole discretion, may provide Plan Participants with options for one or more additional hypothetical investment vehicles for investment of cash compensation deferred under the Plan, with respect to which: (A) A Participant may modify his election of hypothetical investment and may make any transfers between and among hypothetical investments, through a written request to the Administrator, provided that, (B) Only one such modification or transfer shall be allowed during any calendar quarter; (C) Any such modification or transfer shall be effective in the second calendar month following receipt of the request by the Administrator; and 5 (D) Such modifications and transfers will be in accordance with rules and procedures adopted by the Administrator. (b) Compensation deferred under the Plan and credited as a bookkeeping entry to the Participant's Deferred Compensation Account may be deemed to be invested, hypothetically and without charge, in shares of hypothetical Common Stock. Shares of hypothetical Common Stock shall be subject to adjustment in order to reflect Common Stock dividends, splits, and reclassifications. Except in the event of a Change of Control, amounts credited to the Participant's Deferred Compensation Account and deemed invested in hypothetical Common Stock must remain so invested, and no other hypothetical investment vehicle available hereunder may be substituted therefor until the January following the Participant's Termination of Service. Thereafter, changes to the deemed hypothetical investment in Common Stock may be made only in accordance with Section 3.3(a) above; provided that all such changes occurring within six months after the Participant's Termination of Service shall be subject to approval by the Administrator to ensure compliance with Section 16 of the Securities Exchange Act of 1934. (c) Amounts equal to cash dividends which would have been paid on shares of Common Stock shall be deemed paid on whole shares of hypothetical Common Stock in the Participant's Deferred Compensation Account. Such amounts shall be deemed reinvested in shares of hypothetical Common Stock in the Participant's Deferred Compensation Account. (d) In the event of a Change of Control, the Committee shall provide Participants with the option for investment in at least one hypothetical investment vehicle, the annual income earned on which must be not less than 50 basis points over the Ten-Year Constant Treasury Maturity Yield as reported by the Federal Reserve Board, based upon the November averages for the preceding year. 3.4 Time of Hypothetical Investment. ------------------------------- (a) The balance of each Participant's Deferred Compensation Account shall be deemed hypothetically invested on each Valuation Date, and income shall accrue on such balance upon such date, from the previous Valuation Date. (b) Compensation which would have been paid in cash shall be deemed invested in the Participant's Deferred Compensation Account on the Valuation Date next following such hypothetical investment or credit. (c) Compensation hypothetically invested in Common Stock shall be deemed invested in shares of Common Stock as of the date such compensation otherwise would have been payable to the Participant. The number of shares of Common Stock in which compensation is deemed hypothetically invested in the Deferred Compensation Account shall be determined by reference to the average of the high and low price as reported on the Nasdaq Stock Market for the day that the said compensation otherwise would have been payable to the Participant (or the next Business Day, if such day is not a Business Day) provided, that in absence of such information, the Common Stock value shall be determined by the Committee. 6 3.5 Statement of Account. -------------------- The Administrator shall provide each Participant a statement of his Deferred Compensation Account at least annually. ARTICLE IV. PAYMENT OF DEFERRED COMPENSATION ----------- -------------------------------- 4.1 Payment of Deferred Compensation. -------------------------------- (a) The Administrator shall make payments measured by the hypothetical amounts credited to the Participant's Deferred Compensation Account in accordance with the Participant's Payment Election. (b) Compensation deferred under the Plan shall be paid to the Participant in cash pursuant to Section 4.1(a). 4.2. Unforeseeable Emergency Payment. ------------------------------- Notwithstanding any other provision of the Plan, if the Board, after consideration of a Participant's application, determines that the Participant has an Unforeseeable Emergency of such a substantial nature that immediate payment of compensation deferred under the Plan is warranted, the Board in its sole and absolute discretion may direct that a payment equal to all or a portion of the balance of the Participant's Deferred Compensation Account be paid to the Participant in cash. The amount of any such distribution shall be limited to the amount deemed necessary by the Board to alleviate or remedy the Unforeseeable Emergency. The payment shall be made in a manner and at the time specified by the Board. A Participant receiving an Unforeseeable Emergency payment is deemed to have revoked his election for deferral of compensation under the Plan, as of the time of Unforeseeable Emergency payment. Any subsequent deferral of compensation under the Plan shall require that the Participant execute a new Deferral Election, subject to terms of Section 2.2(e)(1) hereof. The circumstances that will constitute an Unforeseeable Emergency will depend upon the facts of each case, but, in any case, payment may not be made to the extent that such hardship is or may be relieved: (a) Through reimbursement or compensation by insurance or otherwise; (b) By liquidation of the Participant's assets, to the extent the liquidation of such assets would not itself cause severe financial hardship; or (c) By cessation of deferrals under the Plan. Examples of what are not considered to be Unforeseeable Emergencies include the need to send a Participant's child to college or the desire to purchase a home. 4.3 Certain Accelerated Payments. ---------------------------- (a) If a Participant terminates service as a Director under circumstances which are such that the Board deems it in the best interest of PMA Capital that payment of the Participant's Deferred Compensation Account be accelerated, then the Board, upon its own motion and in its sole discretion, 7 may direct that the Participant's Deferred Compensation Account be paid to him immediately in a lump sum. (b) If, as a result of substantial and unforeseen changes affecting (1) the business of PMA Capital, or (2) the operation or administration of the Plan, the Board, upon its own motion and sole discretion, determines that the interests of the Participant and of PMA Capital are best served through accelerated payment of the Participant's Deferred Compensation Account, the Board on its own motion and in its sole discretion may direct that the Participant's Deferred Compensation Account balances be paid to him immediately in a lump sum. (c) A Participant who is not entitled to payment of his Deferred Compensation Account under any other provision of Article IV may make a written request to the Board for an accelerated payment of his entire Deferred Compensation Account balance. If the Board receives such a request, it shall make a final valuation of the Participant's Deferred Compensation Account and pay ninety percent (90%) of the Deferred Compensation Account balance to the Participant. The Participant shall forfeit the remaining ten percent (10%) of his Deferred Compensation Account balance to PMA Capital. 4.4 Payments of a Deceased Participant's Account -------------------------------------------- (a) If a Participant dies before his entire Deferred Compensation Account has been paid to him, the Administrator shall pay an amount equal to the amount credited to the Deferred Compensation Account in a single lump sum payment to the person(s) or trust(s) designated in writing by the Participant as his beneficiary(ies) under the Plan. The Administrator is authorized to establish rules and procedures for designations of beneficiaries and shall have the sole discretion to make determinations regarding the existence and identity of beneficiaries and the validity of beneficiary designations. (b) Notwithstanding Section 4.4(a), the Administrator shall make payment pursuant to Section 4.4(a), as soon as administratively feasible, in a single lump sum payment to the Participant's estate if: (1) The Participant dies without having a valid beneficiary designation in effect; (2) The Participant's designated beneficiary has predeceased him; (3) The Participant's designated beneficiary cannot be found after what the Administrator determines, in his sole discretion, has been a reasonably diligent search; or (4) The Administrator determines, in his sole discretion, that a payment in such form is in the best interest of PMA Capital. 8 ARTICLE V. GENERAL PROVISIONS - --------- ------------------ 5.1 Participant Requests -------------------- A Participant shall take no part in any decision pertaining to a request by such Participant under Sections 2.4, 4.2, and 4.3 hereof. 5.2 Participant's Rights Unsecured. ------------------------------- This Plan is intended to be an unfunded plan for the benefit of Participants. No Participant shall have any property interest whatsoever in any specific assets of PMA Capital. No action taken pursuant to the provisions of this Plan shall create or be construed to create a trust of any kind or a fiduciary relationship between PMA Capital and the Participant, the Participant's designated beneficiaries, or any other person. To the extent that any person acquires a right to receive payments from PMA Capital under this Plan, such right shall be no greater than the right of any unsecured general creditor of PMA Capital or of any successor company which assumes the liabilities of PMA Capital. The Board may, however, in the event of a Change of Control of PMA Capital or for administrative reasons, fully fund the Plan by means of a contribution to a "rabbi" trust selected by the Administrator. 5.3 Assignability. -------------- (a) No right to receive payments hereunder shall be transferable or assignable by a Participant. Any attempted assignment or alienation of payments hereunder shall be void and of no force or effect. No such payment, prior to receipt thereof pursuant to the provisions of the Plan, shall be in any manner liable for, or subject to, the debts, contracts, liabilities, engagements or torts of the Participant. (b) Notwithstanding Section 5.3(a), if a Participant is indebted to PMA Capital at any time when payments are to be made by PMA Capital to the Participant under the provisions of the Plan, PMA Capital shall have the right to reduce the amount of payment to be made to the Participant (or the Participant's beneficiary) to the extent of such indebtedness. Any election by PMA Capital not to reduce such payment shall not constitute a waiver of its claim for such indebtedness. 5.4 Administration. --------------- Except as otherwise provided herein, the Plan shall be administered by the Administrator who shall have the authority to adopt rules and regulations for carrying out the Plan, and who shall interpret, construe and implement the provisions of the Plan. 5.5 Amendment. ---------- The Plan may be amended, restated, modified, or terminated by the Board of Directors, except that Section 3.3(d) of the Plan may not be amended or modified following a Change of Control without the consent of the Participant. No amendment, restatement, modification, or termination shall reduce the dollar value of a Participant's Deferred Compensation Account balance as of the Valuation Date immediately preceding such action. 9 5.6 Correction of Errors and Inconsistencies. ----------------------------------------- The Committee upon its own motion, or at the request of the Administrator or of a Participant, shall have the authority to effect consistency among deferral elections, payment elections, or hypothetical investment with respect to amounts deferred by a Participant under the Plan, so as to avoid or rectify difficulties in Plan administration. In no event shall such action by the Committee reduce the dollar value of a Participant's Deferred Compensation Account balance as of the Valuation Date immediately preceding such action, nor shall the Committee take any action inconsistent with Section 3.3(b) hereof. The Committee may take such action with respect to a Participant's Deferred Compensation Account, regardless of whether such Participant may continue as a Director of PMA Capital, or whether he may have terminated service as a Director of PMA Capital. 5.7 Compliance with Section 16. --------------------------- If the Administrator determines that, in order to comply with Section 16 of the Securities Exchange Act of 1934, as amended, it is necessary for the Board rather than the Committee to take any action which the Plan authorizes the Committee to take, the Administrator shall request the Board to do so. 5.8 Withholding/Employment Taxes. ----------------------------- As required by applicable tax law, PMA Capital may withhold, deduct and adjust a Participant's Deferred Compensation Account for all amounts necessary to satisfy any federal, state or other governmental withholding taxes arising directly or indirectly in connection with the Plan or any deferral hereunder whether under current or future tax laws. 5.9 No Liability for Interpretation and Administration of Plan. ----------------------------------------------------------- No officer, director, or member of PMA Capital shall be liable to any person for any action taken or omitted in connection with the interpretation and administration of this Plan unless attributable to willful misconduct or fraud. To the extent coverage is not provided by any applicable insurance policy, PMA Capital hereby agrees to indemnify the Administrator and to hold him harmless against any and all liability for his acts, omissions and conduct and for the acts, omissions and conduct of his duly appointed agents made in good faith pursuant to the provisions of the Plan, including, without limitation, any out-of-pocket expenses reasonably incurred in the defense of any claim relating thereto; provided, however, that he shall not voluntarily assume or admit any liability, nor, except at his own cost, shall he make any payment, assume any obligations or incur any expense without the prior written consent of PMA Capital. 5.10 Incapacity of Recipient. ----------------------- If PMA Capital finds that any person to whom any payment is payable under this Plan is unable to take care of his or her affairs because of illness or accident, any payment due (unless a prior claim therefor has been made by a duly appointed guardian, committee or other legal representative) may be paid to the intended recipient's spouse, child, parent, brother or sister, or any other person deemed by PMA Capital to have incurred expense for the person otherwise entitled to payment, in such manner and proportions as PMA Capital may determine. Any such payments, to the extent thereof, shall be a complete discharge of PMA Capital's obligation under this Plan. 10 5.11 Construction. ------------- The masculine gender where appearing in the Plan shall be deemed to include the feminine gender. The singular shall be deemed to include the plural and the plural the singular. 5.12 Successors and Heirs. -------------------- The Plan and any properly executed elections hereunder shall be binding upon PMA Capital and the Participants, and upon any assignee or successor in interest to PMA Capital and upon the heirs, legal representatives and beneficiaries of any Participant 5.13 Governing Law. ------------- This Plan shall be governed by the laws of the Commonwealth of Pennsylvania and by applicable Federal law. Adopted by Board of Directors: November 3, 1999 11 EX-12 5
EXHIBIT 12 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES(1) ($ In Thousands) 1999 1998 1997 1996 1995 ------------ ------------ ----------- -------------- ------------ EARNINGS Pre-tax income (loss) $40,092 $55,069 $25,153 $(191,394) $34,913 Fixed charges 13,109 15,865 16,683 17,913 19,594 ------------ ------------ ----------- -------------- ------------ Total (a) $53,201 $70,934 $41,836 $(173,481) $54,507 ============ ============ =========== ============== ============ FIXED CHARGES Interest expense and amortization of debt discount and premium on all indebtedness $12,221 $15,009 $15,768 $ 17,052 $18,734 Interest portion of rental expense 888 856 915 861 860 ------------ ------------ ----------- -------------- ------------ Total fixed charges (b) $13,109 $15,865 $16,683 $ 17,913 $19,594 ============ ============ =========== ============== ============ Ratio of earnings to fixed charges (a)/(b) 4.1x 4.5x 2.5x (2) 2.8x (1) For purposes of determining this ratio, pre-tax income (loss) consists of income before income taxes, cumulative effect of accounting change (1999) and extraordinary loss (1997), plus fixed charges. Fixed charges consist of interest expense and the portion of operating leases that management believes are representive of the interest factor. (2) Earnings were insufficient to cover fixed charges by $191.4 million in 1996.
EX-13 6 Selected Financial Data
For the year ended December 31, (dollar amounts in thousands, except share and per share data) 1999 1998 1997 (1) 1996 (1) 1995 (1) - ------------------------------------------------------------------------------------------------------------------- Net premiums written $ 563,510 $ 474,761 $ 381,282 $ 432,975 $ 485,876 ===================================================================== Consolidated Results of Operations: Net premiums earned $ 540,087 $ 466,715 $ 375,951 $ 420,575 $ 484,952 Net investment income 110,057 120,125 133,392 130,837 138,111 Net realized investment gains (losses) (7,745) 21,745 8,598 2,984 31,923 Other revenues 12,718 14,896 13,617 12,288 6,350 --------------------------------------------------------------------- Total consolidated revenues $ 655,117 $ 623,481 $ 531,558 $ 566,684 $ 661,336 ===================================================================== Income (loss) before extraordinary loss and cumulative effect of accounting change $ 28,353 $ 44,734 $ 19,753 $(135,334) $ 24,130 Extraordinary loss from early extinguishment of debt, net of related tax effect(2) -- -- (4,734) -- -- Cumulative effect of accounting change, net of related tax effect (3) (2,759) -- -- -- -- --------------------------------------------------------------------- Net income (loss) $ 25,594 $ 44,734 $ 15,019 $(135,334) $ 24,130 ===================================================================== Per Share Data: Weighted average shares: Basic(4) 22,976,326 23,608,618 23,855,031 23,800,791 23,816,088 Diluted(4), (5) 23,785,916 24,524,888 24,567,378 23,800,791 24,781,949 Income (loss) before extraordinary loss and cumulative effect of accounting change Basic(4) $ 1.23 $ 1.89 $ 0.83 $ (5.68) $ 1.01 Diluted(4), (5) 1.19 1.82 0.80 (5.68) 0.97 Net income (loss) per share: Basic(4) 1.11 1.89 0.63 (5.68) 1.01 Diluted(4), (5) 1.08 1.82 0.61 (5.68) 0.97 Dividends paid per Common share 0.32 0.32 0.32 0.32 0.32 Dividends paid per Class A Common share 0.36 0.36 0.36 0.36 0.36 Shareholders' equity per share 19.21 21.90 19.96 17.86 25.53 Consolidated Financial Position: Total investments $1,918,035 $2,325,409 $2,194,738 $2,261,353 $2,455,949 Total assets 3,245,087 3,460,718 3,057,258 3,117,516 3,258,572 Reserves for unpaid losses and LAE 1,932,601 1,940,895 2,003,187 2,091,072 2,069,986 Long-term debt 163,000 163,000 203,000 204,699 203,848 Shareholders' equity(5) 429,143 511,480 478,347 425,828 609,668
(1) Operating results in 1997, 1996 and 1995 were impacted by approximately $12.1 million, $223.1 million and $8.4 million, respectively, of restructuring, reserve strengthening and other special charges. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." (2) In 1997, the Company refinanced substantially all of its long-term debt resulting in a $4.7 million extraordinary loss, net of tax effect. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." (3) In 1999, the Company adopted SOP 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments." As a result of adopting SOP 97-3, the Company recorded a liability of $4.3 million pre-tax and a resulting charge to earnings of $2.8 million, net of tax effect. (4) In 1997, the Company adopted SFAS No. 128, "Earnings Per Share," which requires the presentation of basic and diluted earnings per share. See Note 15 to the Company's Consolidated Financial Statements for additional information. All prior periods' presentation of earnings per share data has been restated to conform to SFAS No. 128. (5) For the year ended December 31, 1996 common stock equivalents were not taken into consideration in the computation of weighted-average diluted shares as these common stock equivalents would have an anti-dilutive effect on the net loss per share. (6) Pre-tax operating income (loss) excludes net realized investment gains (losses). Pre-tax operating income by business segment for all periods is unaudited and has been presented in accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which the Company adopted on January 1, 1998. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 16 to the Company's Consolidated Financial Statements. The Company excludes net realized investment gains (losses) from the profit and loss measure it utilizes to assess the performance of its operating segments because (i) net realized investment gains (losses) are unpredictable and not necessarily indicative of current operating fundamentals or future performance and (ii) in many instances, decisions to buy and sell securities are made at the holding company level, and such decisions result in net realized gains (losses) that do not relate to the operations of the individual segments. (7) Run-off Operations of The PMA Insurance Group were established in December 1996 to reinsure certain obligations primarily associated with workers' compensation claims written by the Pooled Companies for accident years 1991 and prior. The Run-off Operations are separate legal entities and substantially all of the assets of the Run-off Operations are held in trust for the benefit of the Pooled Companies. Effective July 1, 1998 the Company sold PMA Cayman. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." (8) The combined ratio computed on a GAAP basis is equal to losses and loss adjustment expenses plus acquisition expenses, operating expenses and policyholders' dividends (where applicable), all divided by net premiums earned. 26
For the year ended December 31, (dollar amounts in thousands, except share and per share data) 1999 1998 1997 (1) 1996 (1) 1995 (1) - ------------------------------------------------------------------------------------------------------------------- Pre-tax operating income (loss)(6): PMA Re $ 50,319 $ 46,408 $ 45,957 $ 44,807 $ 39,793 --------------------------------------------------------------------- The PMA Insurance Group(7): Excluding Run-off Operations 18,389 10,018 (3,607) (215,669) (3,885) Run-off Operations (189) 452 (73) -- -- --------------------------------------------------------------------- Total PMA Insurance Group 18,200 10,470 (3,680) (215,669) (3,885) Caliber One 83 (1,606) -- -- -- Corporate and Other (8,544) (6,939) (9,954) (6,464) (14,184) --------------------------------------------------------------------- Total pre-tax operating income (loss) before interest expense 60,058 48,333 32,323 (177,326) 21,724 Interest expense 12,221 15,009 15,768 17,052 18,734 --------------------------------------------------------------------- Pre-tax operating income (loss) 47,837 33,324 16,555 (194,378) 2,990 Net realized investment gains (losses) (7,745) 21,745 8,598 2,984 31,923 --------------------------------------------------------------------- Income (loss) before income taxes, extraordinary loss and cumulative effect of accounting change 40,092 55,069 25,153 (191,394) 34,913 Income tax expense (benefit) 11,739 10,335 5,400 (56,060) 10,783 --------------------------------------------------------------------- Income (loss) before extraordinary loss and cumulative effect of accounting change 28,353 44,734 19,753 (135,334) 24,130 Extraordinary loss from early extinguishment of debt, net of related tax effect(2) -- -- (4,734) -- -- Cumulative effect of accounting change, net of related tax effect (3) (2,759) -- -- -- -- --------------------------------------------------------------------- Net income (loss) $ 25,594 $ 44,734 $ 15,019 $(135,334) $ 24,130 ===================================================================== GAAP Ratios for Insurance Subsidiaries: PMA Re: Loss and LAE ratio 70.4% 68.9% 69.6% 73.7% 74.6% Expense ratio 32.1% 34.8% 34.2% 28.9% 29.3% --------------------------------------------------------------------- Combined ratio(8) 102.5% 103.7% 103.8% 102.6% 103.9% ===================================================================== The PMA Insurance Group, including Run-off Operations(7): Loss and LAE ratio 75.1% 81.6% 91.1% 158.2% 92.5% Expense ratio(9) 31.7% 33.7% 42.8% 47.1% 30.4% Policyholders' dividend ratio 8.6% 7.3% 6.9% 6.1% 4.8% --------------------------------------------------------------------- Combined ratio(8) 115.4% 122.6% 140.8% 211.4% 127.7% ===================================================================== The PMA Insurance Group, excluding Run-off Operations(7): Loss and LAE ratio 73.6% 78.0% 83.7% -- -- Expense ratio(9) 31.1% 31.3% 32.9% -- -- Policyholders' dividend ratio 8.6% 7.1% 5.6% -- -- --------------------------------------------------------------------- Combined ratio(8) 113.3% 116.4% 122.2% -- -- ===================================================================== Caliber One (10): Loss and LAE ratio 76.5% -- -- -- -- Expense ratio 33.1% -- -- -- -- --------------------------------------------------------------------- Combined ratio(8) 109.6% -- -- -- -- =====================================================================
(9) The GAAP operating expense ratios exclude $7.9 million, $9.0 million, $9.3 million, $8.2 million and $5.3 million for the years ended December 31, 1999, 1998, 1997, 1996 and 1995, respectively, of PMA Management Corp. direct expenses related to service revenues, which are not included in premiums earned. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." (10) The results of operations of Caliber One for the years ended 1998 and 1997 are not material to the underwriting ratios of the Company; accordingly, the ratios for Caliber One have not been presented for those years. 27 Management's Discussion and Analysis of Financial Condition and Results of Operations The following is a discussion of the financial condition of PMA Capital Corporation and its consolidated subsidiaries ("PMA Capital" or the "Company") as of December 31, 1999, compared with December 31, 1998, and the results of operations of PMA Capital for 1999 and 1998, compared with the immediately preceding year. The balance sheet information presented below is as of December 31 for each respective year. The statement of operations information is for the year ended December 31 for each respective year. The term "SAP" refers to the statutory accounting practices prescribed or permitted by applicable state insurance departments, and the term "GAAP" refers to generally accepted accounting principles. CONSOLIDATED RESULTS The major components of operating revenues, pre-tax operating income and net income are as follows:
(dollar amounts in thousands) 1999 1998 1997 - ------------------------------------------------------------------------------------------------------------------- Net premiums written $ 563,510 $ 474,761 $ 381,282 ============================================== Net premiums earned $ 540,087 $ 466,715 $ 375,951 Net investment income 110,057 120,125 133,392 Other revenues 12,718 14,896 13,617 ---------------------------------------------- Total operating revenues $ 662,862 $ 601,736 $ 522,960 ============================================== Components of pre-tax operating income(1) and net income: PMA Re $ 50,319 $ 46,408 $ 45,957 The PMA Insurance Group: Excluding Run-off Operations 18,389 10,018 (3,607) Run-off Operations (189) 452 (73) ---------------------------------------------- Total 18,200 10,470 (3,680) Caliber One 83 (1,606) -- Corporate and Other (20,765) (21,948) (25,722) ---------------------------------------------- Pre-tax operating income 47,837 33,324 16,555 Net realized investment gains (losses) (7,745) 21,745 8,598 ---------------------------------------------- Income before income taxes, extraordinary loss and cumulative effect of accounting change 40,092 55,069 25,153 Income tax expense 11,739 10,335 5,400 ---------------------------------------------- Income before extraordinary loss and cumulative effect of accounting change 28,353 44,734 19,753 Extraordinary loss, net of tax -- -- (4,734) Cumulative effect of accounting change, net of tax (2,759) -- -- ---------------------------------------------- Net income $ 25,594 $ 44,734 $ 15,019 ============================================== (1)Pre-tax operating income is defined as income from continuing operations before income taxes, excluding net realized investment gains (losses). The Company excludes net realized investment gains (losses) from the profit and loss measure it utilizes to assess the performance of its operating segments because (i) net realized investment gains (losses) are unpredictable and not necessarily indicative of current operating fundamentals or future performance and (ii) in many instances, decisions to buy and sell securities are made at the holding company level, and such decisions result in net realized gains (losses) that do not relate to the operations of the individual segments.
28 In 1999, pre-tax operating income and after-tax operating income were $47.8 million and $33.4 million, respectively, compared to $33.3 million and $30.6 million in 1998. The increase in pre-tax and after-tax operating income was primarily due to higher pre-tax operating income for The PMA Insurance Group and PMA Re and lower interest expense. The increase in after-tax operating income in 1999 was partially offset by a higher effective tax rate in 1999. In 1998, pre-tax operating income and after-tax operating income were $33.3 million and $30.6 million, respectively, compared to $16.6 million and $14.2 million in 1997. The improvement in the 1998 results was due primarily to increased pre-tax operating income generated by The PMA Insurance Group and PMA Re, as well as the absence of $9.2 million in charges related to The PMA Insurance Group's restructuring and cost reduction initiatives in 1997. The Company currently expects operating income to continue to improve in 2000 primarily reflecting higher pre-tax operating income from PMA Re and The PMA Insurance Group. This expectation may differ materially from actual results because of the risk factors noted in the "Cautionary Statements" on page 43. Net income was $25.6 million, $44.7 million and $15.0 million in 1999, 1998 and 1997, respectively. Net income for 1999 includes an after-tax charge of $2.8 million for the effect of adopting Statement of Position 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments." See "Recent Accounting Pronouncements" for additional information. Net income for 1997 includes an extraordinary loss of $4.7 million, net of tax, reflecting the early extinguishment of debt in March 1997 when the Company refinanced substantially all of its outstanding credit agreements not already maturing in 1997 with a new revolving credit facility (the "Credit Facility"). Net income also includes after-tax gains and losses on the sale of investments. The timing and recognition of such gains and losses are unpredictable and are not indicative of future operating performance. After-tax net realized investment losses were $5.0 million for 1999, compared to after-tax net realized investment gains of $14.1 million in 1998 and $5.6 million for 1997. The realized losses for 1999 reflect sales of investments in a rising interest rate environment in order to invest in yield enhancing investment opportunities. This is in contrast to the realized gains in 1998 and 1997, which reflect sales of investments in a declining interest rate environment. Net realized investment gains for 1998 also include a $2.4 million pre-tax loss related to the sale of PMA Insurance, Cayman Ltd. ("PMA Cayman"). See Note 18 to the Company's Consolidated Financial Statements for additional information. In connection with the adoption of SFAS No. 131 in 1998, the Company identified four reportable segments: (i) PMA Re, which provides property and casualty reinsurance products and services; (ii) The PMA Insurance Group, which writes managed care workers' compensation, integrated disability and to a lesser extent, other standard lines of commercial insurance; (iii) Caliber One, which writes specialty insurance focusing on excess and surplus lines; and (iv) Corporate and Other, which includes unallocated investment income, expenses, including debt service, as well as the results of certain of the Company's real estate properties. Because Caliber One's operating results were not significant in 1997, Caliber One's financial information was included within the Corporate and Other segment in 1997. PMA RE Summarized financial results of PMA Re are as follows: (dollar amounts in thousands) 1999 1998 1997 - -------------------------------------------------------- Net premiums written $278,998 $234,010 $177,934 ============================== Net premiums earned $293,862 $223,559 $163,603 Net investment income 57,686 54,734 52,270 ------------------------------ Operating revenues 351,548 278,293 215,873 ------------------------------ Losses and loss adjustment expenses incurred 206,891 154,062 113,931 Acquisition and operating expenses 94,338 77,823 55,985 ------------------------------ Total losses and expenses 301,229 231,885 169,916 ------------------------------ Pre-tax operating income $50,319 $46,408 $45,957 ============================== GAAP loss and LAE ratio 70.4% 68.9% 69.6% GAAP combined ratio 102.5% 103.7% 103.8% ------------------------------ PMA Re's pre-tax operating income increased to $50.3 million in 1999, compared to $46.4 million in 1998. The increase in operating results reflects an increase in net investment income, and to a lesser extent, slower growth in operating expenses relative to premium growth, partially offset by increased losses and loss adjustment expenses ("LAE"). The increase in PMA Re's pre-tax operating income to $46.4 million in 1998, compared to $46.0 million in 1997, was primarily due to higher investment income, as well as higher premium volume, which was partially offset by increased losses and LAE and acquisition costs. 29 Premium Revenues PMA Re's gross premiums written by business unit and major category of business are as follows:
(dollar amounts 1999 1998 in thousands) 1999 1998 1997 Change % Change % - -------------------------------------------------------------------------------------------------------- Business Unit: Traditional - Treaty $ 180,475 $ 190,749 $ 181,715 (5)% 5% Specialty - Treaty 88,433 79,711 37,838 11% 111% Finite Risk and Financial Products 69,989 7,300 -- 859% N/A Facultative 4,710 6,576 5,768 (28)% 14% ---------------------------------------------------------------- Total $ 343,607 $ 284,336 $ 225,321 21% 26% ================================================================ Major Category of Business: Casualty lines $ 246,660 $ 206,317 $ 151,901 20% 36% Property lines 95,183 76,975 72,625 24% 6% Other lines 1,764 1,044 795 69% 31% ---------------------------------------------------------------- Total $ 343,607 $ 284,336 $ 225,321 21% 26% ================================================================
NA - Not applicable PMA Re's net premiums written by business unit and major category of business are as follows:
1999 1998 (dollar amounts in thousands) 1999 1998 1997 Change % Change % - --------------------------------------------------------------------------------------------------------- Business Unit: Traditional - Treaty $ 137,686 $ 159,686 $ 141,573 (14)% 13% Specialty - Treaty 68,818 64,625 33,846 6% 91% Finite Risk and Financial Products 69,551 6,971 -- 898% N/A Facultative 2,943 2,728 2,515 8% 8% ---------------------------------------------------------------- Total $ 278,998 $ 234,010 $ 177,934 19% 32% ================================================================ Major Category of Business: Casualty lines $ 199,113 $ 168,452 $ 118,889 18% 42% Property lines 78,148 64,497 58,257 21% 11% Other lines 1,737 1,061 788 64% 35% ---------------------------------------------------------------- Total $ 278,998 $ 234,010 $ 177,934 19% 32% ================================================================
NA - Not applicable In 1999, net premiums written increased 19%, primarily reflecting the successful expansion of finite risk and financial product offerings, which resulted in $49.2 million of casualty writings and $20.1 million of property writings. In 1998, net premiums written increased 32%, primarily reflecting the expansion of relationships with PMA Re's existing clients, which accounted for approximately $33 million of the growth in casualty premiums in 1998, and contracts with new clients, which accounted for approximately $17 million of the growth in casualty premiums in 1998. In addition, as a result of the increased business flow generated by these activities, estimated net premiums written and not received increased by $16.6 million in 1998. Partially offsetting these factors were the effects of highly competitive conditions in the U.S. reinsurance market, particularly in 30 the traditional market during 1999, which has caused PMA Re to non-renew certain accounts largely due to inadequate rates and/or other underwriting issues. Net premiums earned increased 31% in 1999, compared to 1998, and 37% in 1998, compared to 1997. Generally, trends in net premiums earned follow patterns similar to net premiums written, with premiums being earned principally on a pro rata basis over the terms of the contracts. In 1999, PMA Re's earned premiums include approximately $32 million related to a revision in the methodology used in estimating unearned premiums on in-force contracts. Losses and Expenses The components of PMA Re's GAAP combined ratios are as follows: 1999 1998 1997 - -------------------------------------------------------- Loss and LAE ratio 70.4% 68.9% 69.6% ---------------------------- Expense ratio: Acquisition expenses 27.5% 28.9% 27.6% Operating expenses 4.6% 5.9% 6.6% ---------------------------- Total expense ratio 32.1% 34.8% 34.2% ---------------------------- GAAP combined ratio(1) 102.5% 103.7% 103.8% ============================ (1)The combined ratio computed on a GAAP basis is equal to losses and LAE, plus acquisition expenses and operating expenses, all divided by net premiums earned. In 1999, PMA Re's combined ratio decreased slightly to 102.5%, compared with a combined ratio of 103.7% in 1998 and 103.8% in 1997. Since 1997, the 1.3 point decline in the combined ratio is primarily attributable to a 2.0 point improvement in the operating expense ratio. The operating expense ratio decreased 1.3 points in 1999, compared to 1998 and 0.7 points in 1998, compared to 1997. These improvements in the operating expense ratio primarily reflect faster growth in earned premiums than in operating expenses. Net Investment Income Net investment income was $57.7 million, $54.7 million and $52.3 million in 1999, 1998 and 1997, respectively. These improvements primarily reflect an increase in investment yield and, to a lesser extent, higher average invested assets. During 1999 and 1998, PMA Re shifted some of its investment holdings out of U.S. Government securities and into corporate and asset-backed securities, which generally yield higher levels of investment income. At amortized cost, PMA Re's cash and invested assets increased approximately $35 million, or 4%, and approximately $55 million, or 6%, during 1999 and 1998, respectively. THE PMA INSURANCE GROUP The PMA Insurance Group is comprised of Pennsylvania Manufacturers' Association Insurance Company, Manufacturers Alliance Insurance Company and Pennsylvania Manufacturers Indemnity Company (collectively, the "Pooled Companies"), as well as PMA Management Corp., Pennsylvania Manufacturers International Insurance, Limited, PMA Insurance SPC, Cayman and Run-off Operations. Run-off operations ("Run-off Operations") of The PMA Insurance Group were classified by management and segregated from ongoing operations effective December 31, 1996. The Run-off Operations have been established to reinsure certain obligations primarily associated with workers' compensation claims written by the Pooled Companies for the years 1991 and prior. The Run-off Operations have been segregated into separate legal entities and substantially all of the assets of the Run-off Operations are held in trust for the benefit of the Pooled Companies. 31 Summarized financial results of The PMA Insurance Group are as follows:
(dollar amounts in thousands) 1999 1998 1997 - ------------------------------------------------------------------------------------- The PMA Insurance Group Net premiums written $ 233,713 $ 234,837 $ 203,348 =========================================== Net premiums earned $ 221,934 $ 241,928 $ 212,348 Net investment income 50,282 64,580 81,927 Other revenues 10,086 9,722 10,482 ------------------------------------------- Operating revenues 282,302 316,230 304,757 ------------------------------------------- Losses and LAE 166,674 197,525 193,530 Acquisition and operating expenses 78,287 90,499 100,191 Dividends to policyholders 19,141 17,736 14,716 ------------------------------------------- Total losses and expenses 264,102 305,760 308,437 ------------------------------------------- Pre-tax operating income (loss) $ 18,200 $ 10,470 $ (3,680) =========================================== The PMA Insurance Group Excluding Run-off Operations Net premiums written $ 233,713 $ 244,237 $ 254,970 =========================================== Net premiums earned $ 221,934 $ 251,328 $ 263,970 Net investment income 45,870 50,419 53,796 Other revenues 10,086 9,722 10,482 ------------------------------------------- Operating revenues 277,890 311,469 328,248 ------------------------------------------- Losses and LAE 163,375 196,018 220,990 Acquisition and operating expenses 76,985 87,697 96,149 Dividends to policyholders 19,141 17,736 14,716 ------------------------------------------- Total losses and expenses 259,501 301,451 331,855 ------------------------------------------- Pre-tax operating income (loss) $ 18,389 $ 10,018 $ (3,607) =========================================== Run-off Operations Net premiums written $ -- $ (9,400) $ (51,622) =========================================== Net premiums earned $ -- $ (9,400) $ (51,622) Net investment income 4,412 14,161 28,131 ------------------------------------------- Operating revenues 4,412 4,761 (23,491) ------------------------------------------- Losses and LAE 3,299 1,507 (27,460) Acquisition and operating expenses 1,302 2,802 4,042 ------------------------------------------- Total losses and expenses 4,601 4,309 (23,418) ------------------------------------------- Pre-tax operating income (loss) $ (189) $ 452 $ (73) ===========================================
Pre-tax operating income for The PMA Insurance Group increased in 1999 to $18.2 million, compared with pre-tax operating income of $10.5 million in 1998, and a pre-tax operating loss of $3.7 million in 1997. The increases in operating income since 1997 were primarily due to improved loss experience and lower operating expenses resulting from ongoing cost reduction initiatives. In addition, the improvements in operating income reflect a reduction in the level of net exposures underwritten due to disciplined and focused under-writing as well as an increase in the use of reinsurance. The PMA Insurance Group Excluding Run-off Operations - ---------------------------------------------------- Premiums (dollar amounts in thousands) 1999 1998 1997 - ----------------------------------------------------------------------- Workers' compensation: Direct premiums written $203,571 $183,913 $181,556 Premiums assumed 4,588 4,786 4,112 Premiums ceded 29,063 1,666 10,367 -------------------------------------- Net premiums written 179,096 187,033 175,301 -------------------------------------- Commercial Lines: Direct premiums written 85,500 93,628 122,003 Premiums assumed 1,782 2,368 2,894 Premiums ceded 32,665 38,792 45,228 -------------------------------------- Net premiums written 54,617 57,204 79,669 -------------------------------------- Total: Direct premiums written 289,071 277,541 303,559 Premiums assumed 6,370 7,154 7,006 Premiums ceded 61,728 40,458 55,595 -------------------------------------- Net premiums written $233,713 $244,237 $254,970 ====================================== Direct workers' compensation premiums written increased in the three-year period ended December 31, 1999, due to an increase in the volume of risks underwritten. However, manual rate reductions in The PMA Insurance Group's principal marketing territories have constrained the growth in direct workers' compensation premiums written in 1998 and 1997, and to a much lesser extent in 1999. In addition, continued intense price competition and selected non-renewal of non-profitable accounts tempered increases in direct premiums written. In recent years, the PMA Insurance Group increased its writings of workers' compensation premiums through focused marketing efforts and has continued to balance its workers' compensation portfolio by increasing writings in relatively lower hazard classes of business and reducing writings in higher hazard classes of business. 32 For example, lower hazard classes of business such as healthcare, educational institutions and retail represented 33%, 26% and 21% of total direct workers' compensation premiums written in 1999, 1998 and 1997, respectively, whereas higher hazard classes of business, such as construction, represented 15%, 21% and 26% of total direct workers' compensation premiums written in 1999, 1998 and 1997, respectively. The enactment of workers' compensation benefit reform laws in The PMA Insurance Group's principal marketing territories has caused manual rates for workers' compensation to decline in the past three years. These benefit reform laws also have had a favorable impact on losses and LAE for business written on policies subject to such reform laws. Because manual rate reductions directly affect the prices that The PMA Insurance Group can charge for its rate sensitive workers' compensation products, which include fixed cost and dividend policies, such declines in manual rate levels have had a significant effect on workers' compensation premium volume. The premium charged on a fixed-cost policy is based upon the manual rates filed with the state insurance department. In 1999, 1998 and 1997, manual rate levels have declined on average approximately 3%, 13% and 25%, respectively. As a result, the impact of decreasing manual rate levels has declined over the last three years. During 1999, direct writings of commercial lines of business other than workers' compensation, such as commercial auto, general liability, umbrella, multi-peril and commercial property lines (collectively, "Commercial Lines") decreased $8.1 million, compared to 1998. During 1998, direct writings of Commercial Lines decreased $28.4 million, compared to 1997. These decreases are primarily due to planned reductions in such lines and continued competitive conditions. Rather than lower prices to what it believes are unacceptable levels, The PMA Insurance Group has chosen not to renew some of its business in the Commercial Lines. The increase in premiums ceded for 1999, compared to 1998, primarily reflects a new reinsurance treaty that reduced the net retention level on workers' compensation exposures from $1.5 million to $150,000 per occurrence, beginning in 1999. Partially offsetting such increase in premiums ceded was a decrease of $6.1 million in ceded premiums for Commercial Lines, which is primarily due to the reduction in direct Commercial Lines business written and negotiated rate reductions for various treaties reinsuring certain Commercial Lines business. Premiums ceded for 1998 decreased $15.1 million, compared to 1997, reflecting lower ceded premiums for workers' compensation business of $8.7 million due primarily to the effect of a $9.4 million profit commission between the Pooled Companies and the Run-off Operations. In addition, ceded premiums on Commercial Lines for 1998 decreased $6.4 million, compared to 1997, due to the reduction in direct Commercial Lines business written. Net premiums earned decreased 12% in 1999, compared to 1998, and 5% in 1998, compared to 1997. Each year's decrease corresponds to the decrease in net premiums written. Generally, trends in net premiums earned follow patterns similar to net premiums written adjusted for the customary lag related to the timing of premium writings within the year. Direct premiums are earned principally on a pro rata basis over the terms of the policies. Losses and Expenses The components of The PMA Insurance Group's GAAP combined ratios, excluding Run-off Operations are as follows: 1999 1998 1997 - ------------------------------------------------------------- Loss and LAE ratio 73.6% 78.0% 83.7% --------------------------- Expense ratio: Acquisition expenses 17.7% 18.0% 18.3% Operating expenses(1) (2) 13.4% 13.3% 14.6% --------------------------- Total expense ratio 31.1% 31.3% 32.9% Policyholders' dividend ratio 8.6% 7.1% 5.6% --------------------------- GAAP combined ratio- (1) (2) (3) (4) 113.3% 116.4% 122.2% =========================== (1)The expense ratio and the combined ratio for 1999 exclude the impact of the cumulative effect of accounting change of $4.3 million ($2.8 million after-tax) for insurance-related assessments. (2)The expense ratio and the combined ratio exclude $7.9 million, $9.0 million and $9.3 million in 1999, 1998 and 1997, respectively, for direct expenses related to service revenues, which are not included in premiums earned. (3)The combined ratio computed on a GAAP basis is equal to losses and LAE, plus acquisition expenses, operating expenses and policyholders' dividends, all divided by net premiums earned. (4)The GAAP combined ratios for The PMA Insurance Group including the Run-off Operations were 115.4%, 122.6% and 140.8% for 1999, 1998 and 1997, respectively. 33 The components of the loss and LAE ratio are as follows: 1999 1998 1997 - ------------------------------------------------------------------------- Current accident year - undiscounted(1) 76.8% 80.0% 81.0% Prior year reserve development(2) (4.2)% (1.8)% (0.4)% Net discount accretion 1.0% (0.2)% 3.1% ----------------------------- Loss and LAE ratio 73.6% 78.0% 83.7% ============================= (1)Returned premiums of $5.7 million, $3.0 million and $0 associated with older years reduced reported premiums in 1999, 1998 and 1997, respectively. The current accident year undiscounted loss and LAE ratios excluding such adjustments were 74.8%, 79.0% and 81.0% in 1999, 1998 and 1997, respectively. (2)The prior year reserve development excluding the aforementioned premium adjustments and amounts returned to the policyholders for rent-a-captive business were 0.4%, 0% and 0.3% in 1999, 1998 and 1997, respectively. The loss and LAE ratio improved 4.4 points in 1999, compared to 1998, primarily due to an improved current accident year loss and LAE ratio, and more favorable prior accident year reserve development, partially offset by a decline in the level of reserve discount. The loss and LAE ratio improved 5.7 points for 1998, compared to 1997, primarily due to a more favorable impact on the loss and LAE ratio from the lower level of reserve discount and more favorable prior accident year reserve development. In 1999, The PMA Insurance Group experienced $9.2 million of favorable development of prior accident year reserves, excluding the accretion of discount ("prior year development"). The favorable prior year development primarily reflects better than expected loss experience from loss-sensitive and rent-a-captive workers' compensation business. Premium adjustments for loss-sensitive business and policyholders' dividends for rent-a-captive business have substantially offset this favorable development. Rent-a-captives are used by customers as an alternative method to manage their loss exposure without establishing and capitalizing their own captive insurance company. In 1998, favorable prior year development was $4.6 million, comprised of $6.9 million of favorable prior year development for workers' compensation, partially offset by $2.3 million of adverse prior year development in Commercial Lines. In 1997, favorable prior year development was $1.0 million, reflecting favorable prior year development of $6.0 million on workers' compensation, partially offset by reserve strengthening of $5.0 million in commercial multi-peril business (see Note 4 to the Company's Consolidated Financial Statements for additional information). The loss and LAE ratio is negatively impacted by accretion of discount on prior year reserves and favorably impacted by setting up discount for current year reserves. The net of these amounts is referred to as net discount accretion. Accretion of prior year discounted reserves exceeded the setting up of discount for 1999 and 1997, whereas the setting up of discount exceeded the accretion of prior year discounted reserves in 1998. Net discount accretion in 1999 reflects a reduction in the amount of discount recorded on current year's reserves as a result of higher ceded loss reserves due to the new reinsurance treaty for workers' compensation. In 1999, 1998 and 1997, the impact on the loss and LAE ratio from the effects of discounting loss reserves has generally declined due mainly to the effect of commutations and lower business writings. The PMA Insurance Group has been executing programs under which it commuted, or settled, a large number of workers' compensation claims. Commutations are agreements whereby the claimants, in exchange for a lump sum payment, release their rights to future payments. The PMA Insurance Group paid approximately $38 million, $65 million and $113 million in 1999, 1998 and 1997, respectively, to commute workers' compensation claims. The commutation programs resulted in payments that were less than the corresponding carried reserves. Savings associated with these claims were consistent with management's expectations. Because substantially all of these reserves were carried on a discounted basis, the ultimate level of discount on The PMA Insurance Group's carried reserves decreased. Measures to control medical costs and LAE on workers' compensation claims have also improved the overall loss and LAE ratio. Medical costs have improved primarily due to The PMA Insurance Group's affiliation with a national preferred provider organization, which became effective late in 1997. This affiliation has enabled The PMA Insurance Group to control its cost of providing medical benefits to injured workers. In addition to this improvement in loss costs, LAE costs have decreased as well, primarily due to continued use of certain claims resolution practices. By using techniques such as managed care and commutations, The PMA Insurance Group has reduced the amount and number of outstanding claims and the amount of time that a claim remains open. This in turn has lowered costs associated with managing open claims. 34 The loss and LAE ratio for Commercial Lines has improved due to stricter underwriting standards and measures to control LAE. As mentioned above, The PMA Insurance Group has chosen not to renew some of its Commercial Lines business rather than lower prices to what it believes are unacceptable levels. In addition, LAE costs have been reduced due to improved efficiency in claims resolution and use of in-house legal services. In 1999, the expense ratio decreased by 0.2 points, compared to 1998, due to a decrease in the acquisition expense ratio of 0.3 points, partially offset by an increase in the operating expense ratio of 0.1 points. The decrease in the acquisition expense ratio for 1999 is a result of higher ceded commissions received as a result of the new reinsurance treaty in 1999 and a reduction in certain state assessments, compared to 1998. The 1998 operating expense ratio declined 1.6 points, compared to 1997, due to decreases of 0.3 points in the acquisition expense ratio and 1.3 points in the operating expense ratio, compared to 1997. The 1998 acquisition expense ratio decreased slightly, compared to 1997, primarily due to a change in the mix of business to workers' compensation business, which has a lower acquisition rate than Commercial Lines. The 1998 operating expense ratio decreased 1.3 points, compared to 1997, due to continued cost cutting measures. The policyholders' dividend ratio was 8.6%, 7.1% and 5.6% in 1999, 1998 and 1997, respectively. Under policies that are subject to dividend plans, the customer may receive a dividend based upon loss experience during the policy period. The increases in the policyholders' dividend ratios are primarily due to improved loss experience related to rent-a-captive business and selling more business under dividend plans, which resulted in higher dividend payout to policyholders. Net Investment Income Net investment income was $4.5 million lower in 1999, compared to 1998, and $3.4 million lower in 1998, compared to 1997. The decrease in net investment income over the three years is primarily due to a lower asset base resulting from the paydown of loss reserves from prior accident years. The paydown of loss reserves in 1998 reflects payments under the commutation programs. The decrease was partially offset by higher investment yields associated with a shift in invested assets towards higher yielding invested assets, such as asset-backed securities. Run-off Operations - ------------------ Net investment income for the Run-off Operations decreased $9.7 million in 1999, compared to 1998, primarily due to the sale of PMA Cayman in mid-1998, which decreased invested assets. To a lesser extent, the decline in net investment income also reflects lower invested assets due to the paydown of losses by the remaining run-off entities. Net investment income for 1998 decreased $14.0 million, compared with 1997, due to the sale of PMA Cayman in mid-1998. Effective July 1, 1998, the Company sold PMA Cayman for a purchase price of $1.8 million and recorded an after-tax loss of $1.6 million. This transaction included the transfer of $231.5 million in cash and invested assets to the buyer. At December 31, 1999, the Company had recorded $240.8 million in reinsurance receivables from the buyer related to this transaction, all of which are secured by assets in a trust and by letters of credit (see Note 18 to the Company's Consolidated Financial Statements for additional discussion). Losses and LAE of the Run-off Operations consist of discount accretion on established loss reserves within the Run-off Operations. In 1998, favorable loss development was $10.3 million, and included $9.4 million that was returned to the Pooled Companies as a profit commission. Accordingly, Run-off Operations recorded a $9.4 million premium adjustment in 1998. In 1997, favorable loss development was $51.8 million, which included $37.0 million related to retrospectively rated policies. Losses and LAE of the Run-off Operations for 1997 were favorably impacted by the cession of prior year reserves of $14.8 million to a third party reinsurer in 1997. The favorable loss development in 1997 was offset by reductions in earned premiums for the Run-off Operations. 35 CALIBER ONE Summarized financial results of Caliber One are as follows: (dollar amounts in thousands) 1999 1998 - ------------------------------------------------------------- Net premiums written $51,237 $ 6,436 ================== Net premiums earned $24,729 $ 1,750 Net investment income 2,459 1,453 ------------------ Operating revenues 27,188 3,203 ------------------ Losses and LAE 18,908 1,402 Acquisition and operating expenses 8,197 3,407 ------------------ Total losses and expenses 27,105 4,809 ------------------ Pre-tax operating income (loss) $ 83 $(1,606) ================== Caliber One recorded pre-tax operating income of $83,000 in 1999, compared to a pre-tax operating loss of $1.6 million in 1998. The improvement in operating results reflects the significant growth in premiums and stabilization of Caliber One's expenses relative to their premiums, along with a commensurate increase in net investment income. Gross and net premiums written for Caliber One for 1999 were $93.4 million and $51.2 million, respectively, compared to $11.8 million and $6.4 million, respectively, for 1998. Earned premiums also increased significantly in 1999, compared to 1998. The growth in premiums written and earned in 1999, compared to the prior year, reflects Caliber One's rising market acceptance and penetration, and expanded product offerings and distribution network. The increase in losses and LAE, and acquisition expenses, comparing 1999 to 1998, results from the increase in business written from year to year. Operating expenses increased in 1999, compared to 1998, primarily due to the increasing employee base and the expected, continued investment into the infrastructure of Caliber One. Caliber One's combined ratio in 1999 was 109.6%, consisting of a loss and LAE ratio of 76.5% and an expense ratio of 33.1%. Net investment income increased 69.2% to $2.5 million in 1999, compared to $1.5 million in 1998. This increase primarily reflects a larger average invested asset base, due primarily to premium collections in excess of paid losses and expenses in 1999. In December 1997, PMA Reinsurance Corporation acquired 100% of the outstanding Common stock of Caliber One Indemnity Company, domiciled in Delaware and formerly known as Lincoln Insurance Company, for approximately $16.0 million and made a capital contribution of approximately $11.3 million to Caliber One Indemnity Company. All of Caliber One Indemnity Company's acquired loss reserves were reinsured with an affiliate of its former parent for adverse development and uncollectible reinsurance (the "Reserve Guarantee") in the amount of the recorded reserves plus $68.5 million. Management believes that the Reserve Guarantee will be adequate to cover any future adverse reserve development or uncollectible reinsurance on the acquired reserves. Management believes that the reinsurance obtained as part of the purchase will be adequate to cover any future reserve development or uncollectible reinsurance on the acquired reserves. PMA Reinsurance Corporation intends to maintain Caliber One Indemnity Company's surplus at not less than $25.0 million. LOSS RESERVES AND REINSURANCE The Company's consolidated unpaid losses and LAE, net of reinsurance, at December 31, 1999 and 1998 were $1,284.4 million and $1,347.2 million, net of discount of $180.4 million and $194.6 million, respectively. Unpaid losses and LAE reflect management's best estimate of future amounts needed to pay claims and related settlement costs with respect to insured events that have occurred, including events that have not been reported to the Company. In many cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured loss, the reporting of the loss to the Company and the Company's payment of that loss. In general, liabilities for reinsurers become known more slowly than for primary insurers and are subject to more unforeseen development and uncertainty. As part of the process for determining these amounts, historical data is reviewed and consideration is given to the impact of various factors, such as legal developments, changes in social attitudes and economic conditions. Unpaid losses for the Company's workers' compensation claims, net of reinsurance, at December 31, 1999 and 1998 were $527.9 million and $628.5 million, net of discount of $173.1 million and $194.3 million, respectively. The approximate discount rate used was 5% at December 31, 1999 and 1998. Management believes that its unpaid losses and LAE are fairly stated at December 31, 1999. However, estimating the ultimate claims liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management's informed estimates and judgments using data currently available. As additional experience and data become available regarding claims payment and reporting patterns, legislative developments, regulatory trends on benefit levels for both medical and indemnity payments, and economic conditions, the estimates are revised accordingly. If the Company's ultimate net losses prove to differ substantially from the amounts 36 recorded at December 31, 1999, the related adjustments could have a material adverse effect on the Company's financial condition, results of operations and liquidity. At December 31, 1999, 1998 and 1997, the Company's gross reserves for asbestos-related losses were $61.3 million, $67.9 million and $76.7 million, respectively ($38.9 million, $43.6 million and $48.6 million, net of reinsurance, respectively). At December 31, 1999, 1998 and 1997, the Company's gross reserves for environmental-related losses were $41.4 million, $47.0 million and $45.1 million, respectively ($24.5 million, $29.4 million and $31.7 million, net of reinsurance, respectively). Estimating reserves for asbestos and environmental exposures continues to be difficult because of several factors, including: (i) evolving methodologies for the estimation of the liabilities; (ii) lack of reliable historical claim data; (iii) uncertainties with respect to insurance and reinsurance coverage related to these obligations; (iv) changing judicial interpretations; and (v) changing government standards. To reserve for environmental claims, the Company currently utilizes a calendar year development technique known as aggregate loss development. This technique focuses on the aggregate losses paid as of a particular date and aggregate payment patterns associated with such claims. Several elements including remediation studies, remediation, defense, declaratory judgment and third party bodily injury claims were considered in estimating the costs and payment patterns of the environmental and toxic tort losses. Prior to the development of these techniques, there was a substantial range in the nature of reserving for environmental and toxic tort liabilities. Management believes that its reserves for asbestos and environmental claims are appropriately established based upon known facts, existing case law and generally accepted actuarial methodologies. However, due to changing interpretations by courts involving coverage issues, the potential for changes in federal and state standards for clean-up and liability, as well as issues involving policy provisions, allocation of liability among participating insurers and proof of coverage, the Company's ultimate exposure for these claims may vary significantly from the amounts currently recorded, resulting in a potential future adjustment that could be material to the Company's financial condition and results of operations (see "Loss Reserves" in the Company's 1999 Form 10-K and Note 4 to the Company's Consolidated Financial Statements for additional discussion). At December 31, 1999, the Company's reinsurance and retrocessional protection was as follows: Retention Limits (1) - --------------------------------------------------------------- PMA Re Per Occurrence: Casualty lines $2.8 million $17.5 million Workers' compensation $2.0 million $98.0 million Property lines $2.0 million $48.0 million Per Risk: Property lines $ 750,000 $4.3 million Casualty lines $1.5 million $6.0 million The PMA Insurance Group Per Occurrence: Workers' compensation $ 150,000 $103.5 million Per Risk: Property lines $ 500,000(2) $19.5 million Auto physical damage $ 500,000 $2.0 million Other casualty lines $ 175,000(3) $4.8 million Caliber One Per Occurrence and Per Risk: Property lines $ 500,000 $4.5 million Casualty lines $ 500,000 $5.5 million ------------------------------ (1) Represents the amount of loss protection above the Company's level of loss retention. (2) This coverage also provides protection of $48.5 million per occurrence over its combined net retention of $500,000. (3) This coverage also provides protection of $49.8 million per occurrence over its combined net retention of $175,000. The Company actively manages its exposure to catastrophes through its underwriting process, where the Company generally monitors the accumulation of insurable values in catastrophe prone regions. Also, in writing property reinsurance coverages, PMA Re typically requires per occurrence loss limitations for contracts that could have catastrophe exposure. Through per risk reinsurance, the Company also manages its net retention in each exposure. In addition, PMA Re maintains retrocessional protection of $48.0 million in excess of $2.0 million per occurrence. The PMA Insurance Group maintains catastrophe reinsurance protection of $27.7 million in excess of $850,000 and Caliber One maintains catastrophe reinsurance protection of $19.3 million in excess of $750,000. As a result, the Company's loss and LAE ratios have not been significantly impacted by catastrophes in 1999, 1998 or 1997. Although the Company believes that it has adequate reinsurance to protect against the estimated probable maximum gross loss from a catastrophe, an especially severe catastrophe or series of catastrophes could exceed the Company's 37 reinsurance and/or retrocessional protection and may have a material adverse impact on the Company's financial condition, results of operations and liquidity. The Company performs extensive credit reviews on its reinsurers, focusing on, among other things, financial capacity, stability, trends and commitment to the reinsurance business. Prospective and existing reinsurers failing to meet the Company's standards are excluded from the Company's reinsurance programs. In addition, the Company requires letters of credit or other acceptable collateral to support balances due from reinsurers not authorized to transact business in the applicable jurisdictions. The timing and collectibility of reinsurance recoverables have not had, and are not expected to have, a material adverse effect on the Company's liquidity (see Note 5 to the Company's Consolidated Financial Statements for additional discussion). CORPORATE AND OTHER The Corporate and Other segment includes unallocated investment income, expenses, including debt service, as well as the results of certain of the Company's real estate properties. For 1999, Corporate and Other recorded a pre-tax operating loss of $20.8 million, compared to $21.9 million in 1998. The decrease in pre-tax operating loss was due to lower interest expense of $2.8 million for 1999, compared to 1998, reflecting a $40.0 million paydown in outstanding debt in the fourth quarter of 1998 (see "Liquidity and Capital Resources" below for further discussion), partially offset by higher net revenues from non-core real estate properties in 1998. In 1998, Corporate and Other recorded a pre-tax operating loss of $21.9 million, compared to $25.7 million in 1997. The decrease in the operating loss in 1998, compared to 1997, was primarily due to higher net revenues from non-core real estate properties in 1998. Additionally, during 1997, the Company incurred $1.8 million of severance and related restructuring costs and pre-operating charges of approximately $900,000 in establishing Caliber One. NET REALIZED INVESTMENT GAINS/LOSSES The Company recorded net pre-tax realized investment losses of $7.7 million in 1999, compared with net pre-tax realized investment gains of $21.7 million in 1998 and $8.6 million in 1997. Gains and losses on the sale of investments are recognized as a component of net income, but the timing and recognition of such gains and losses are unpredictable and are not indicative of current or future results. Accordingly, such gains and losses are not included as a component of operating income. During the three-year period ended December 31, 1999, the Company realized gains and losses from investment sales related to the following: (i) transactions to expand the asset classes in which the Company invests to capitalize on favorable yield spreads between such instruments and U.S. Treasury securities and (ii) transactions based upon an assessment of the interest rate environment. The realized losses for 1999 primarily reflect sales of investments in a rising interest rate environment in order to invest in yield enhancing investment opportunities. This is in contrast to the realized gains in 1998 and 1997, which reflect sales of investments in a declining interest rate environment. In 1999 and 1998, the Company diversified its investment portfolio by increasing its holdings of corporate bonds, mortgage-backed and other asset-backed securities, while reducing holdings in government securities. In 1997, the Company repositioned its investment portfolio to improve its pre-tax investment yield, while maintaining the maturity matching structure between investments and liability cash flow projections. LIQUIDITY AND CAPITAL RESOURCES Liquidity is a measure of an entity's ability to secure enough cash to meet its contractual obligations and operating needs. At the holding company level, cash is needed to pay debt obligations, dividends to shareholders and taxes to the Federal government, as well as to capitalize subsidiaries from time to time. PMA Capital's primary sources of liquidity are dividends from subsidiaries, net tax payments received from subsidiaries and borrowings. At December 31, 1999 and 1998, the Company had $163.0 million outstanding under its existing Credit Facility. Throughout much of 1998, the Company had $203.0 million outstanding under the Credit Facility. In late 1998, the Company made an unscheduled debt repayment of $40.0 million to reduce the outstanding debt to $163.0 million. At December 31, 1999, $24.5 million is available under the Credit Facility. In 1997, the Company made scheduled debt payments of $7.3 million as well as an additional debt repayment of $8.0 million before refinancing all of its credit agreements not already maturing in 1997. The final expiration of the Credit Facility is December 31, 2002, and the Credit Facility matures in an installment of $38.0 million in 2000 and installments of $62.5 million in 2001 and 2002. 38 In addition to the Credit Facility, the Company maintains a committed facility of $50.0 million for letters of credit (the "Letter of Credit Facility"). The Letter of Credit Facility is utilized primarily for securing reinsurance obligations of the Company's insurance subsidiaries. As of December 31, 1999, the Company had $45.9 million outstanding in letters of credit under the Letter of Credit Facility. The Company's domestic insurance subsidiaries' ability to pay dividends to the holding company is limited by the insurance laws and regulations of Pennsylvania and Delaware (the laws of which are substantially similar with respect to dividends). Under Pennsylvania laws and regulations, dividends may not be paid without prior approval of the Pennsylvania Insurance Commissioner (the "Commissioner") in excess of the greater of (i) 10% of policyholders' surplus as of the end of the preceding year or (ii) SAP net income for the preceding year, but in no event to exceed SAP unassigned surplus. Under this standard, the Pooled Companies and PMA Reinsurance Corporation can pay an aggregate of approximately $55 million of dividends without the prior approval of the Commissioner during 2000. Caliber One Indemnity Company, a Delaware-domiciled company, is directly owned by PMA Reinsurance Corporation and, as such, its dividends may not be paid directly to PMA Capital. As stated above, Delaware's insurance laws as they apply to restricting the payment of dividends are substantially similar to Pennsylvania's insurance laws. Under Delaware insurance laws, Caliber One Indemnity Company can pay $3.3 million in dividends during 2000. Dividends received from subsidiaries were $43.2 million, $35.5 million and $22.5 million in 1999, 1998 and 1997, respectively. Net tax payments received from subsidiaries were $21.8 million, $29.7 million and $20.0 million in 1999, 1998 and 1997, respectively. In December 1998, the Company received a refund from the Internal Revenue Service ("IRS") of approximately $15 million relating to Federal income taxes paid by the Company. The refund relates to a claim for refund filed by the Company with regard to its 1992 U.S. Federal income tax return. In 1997, the Company received a refund from the IRS of approximately $16.8 million as a result of a net operating loss, which was generated in 1996 and carried back to 1993, 1994 and 1995 (see Note 8 to the Company's Consolidated Financial Statements for additional discussion of income taxes). PMA Capital's dividends to shareholders are restricted by its debt agreements. Based upon the terms of the Credit Facility and the Letter of Credit Facility, under the most restrictive debt covenant, PMA Capital would be able to pay dividends of approximately $10 million in 2000. The Company paid dividends to shareholders of $7.8 million, $7.9 million and $8.0 million in 1999, 1998 and 1997, respectively. In December 1997, PMA Reinsurance Corporation acquired 100% of the outstanding Common stock of Caliber One Indemnity Company for approximately $16.0 million and made a capital contribution of approximately $11.3 million to Caliber One Indemnity Company (see "Caliber One" herein for additional discussion). PMA Capital also made cash capital contributions to its subsidiaries totaling $7.1 million, $480,000 and $11.0 million in 1999, 1998 and 1997, respectively. In 1998, the Company's Board of Directors authorized a plan to repurchase shares of Common stock and Class A Common stock in an amount not to exceed $25.0 million. In 1999, an additional $50.0 million of share repurchase authority was approved by the Company's Board of Directors. During 1999, the Company repurchased a total of approximately 1.5 million Class A shares at a total cost of $30.2 million (average per share price was $19.81). During 1998, the Company repurchased a total of approximately 1.0 million shares at a total cost of $18.9 million (average per share price was $18.92). Since the inception of its share repurchase program in February 1998, PMA Capital has repurchased a total of approximately 2.5 million Class A shares at a total cost of $49.1 million (average per share price was $19.46), leaving $25.9 million of share repurchase authorization. Decisions regarding share repurchases are subject to the costs and benefits associated with alternative uses of capital and prevailing market conditions. The Company's total assets decreased to $3,245.1 million at December 31, 1999 from $3,460.7 million at December 31, 1998. Total investments decreased $407.4 million to $1,918.0 million at December 31, 1999. The decrease in investments is primarily attributable to declines in market values of $118.2 million due to rising interest rates as well as a decrease of $178.8 million in securities on loan under the Company's securities lending program. Management believes that the Company's sources of funds will provide sufficient liquidity to meet short-term and long-term obligations. In addition, management believes that the existing capital structure is appropriate. However, management continually monitors the capital structure in light of developments in the business, and the present assessment could change as management becomes aware of new opportunities and challenges in the Company's business. 39 INVESTMENTS The Company's investment objectives are to (i) seek competitive after-tax income and total return, (ii) maintain medium to high investment grade asset quality and high marketability, (iii) maintain maturity distribution commensurate with the Company's business objectives, (iv) provide portfolio flexibility for changing business and investment climates and (v) provide liquidity to meet operating objectives. The Company's investment strategy includes guidelines for asset quality standards, asset allocations and other relevant criteria for its portfolio. In addition, maturities are structured after projecting liability cash flows with actuarial models of loss reserve payouts. The Company's portfolio does not contain any significant concentrations in single issuers (other than U.S. Treasury and agency obligations), industry segments or geographic regions. The Company has no investments that are not dollar denominated as of December 31, 1999. The Company's investments at fair value were as follows at December 31:
1999 1998 - ------------------------------------------------------------------------------------------------------------- (dollar amounts in millions) Fair Value Percent Fair Value Percent - ------------------------------------------------------------------------------------------------------------- U.S. Treasury securities and obligations of U.S. Government agencies $ 419.4 22% $ 827.2 36% Obligations of states, political subdivisions and foreign governments 30.6 1% 24.9 1% Corporate debt securities 555.1 29% 420.3 18% Mortgage-backed and other asset-backed securities 574.5 30% 555.0 24% Equity securities 35.0 2% -- -- Short-term investments 303.4 16% 498.0 21% ------------------------------------------------ Total $1,918.0 100% $2,325.4 100% ================================================
Mortgage-backed and other asset-backed securities include collateralized mortgage obligations ("CMOs") of $168.2 million and $100.0 million carried at fair value as of December 31, 1999 and 1998, respectively. CMO holdings are concentrated in securities with limited prepayment, extension and default risk, such as planned amortization class bonds. The composition of the Company's fixed maturities at fair value, excluding short-term investments, by rating was as follows at December 31:
1999 1998 - ------------------------------------------------------------------------------------------------ (dollar amounts in millions) Fair Value Percent Fair Value Percent - ------------------------------------------------------------------------------------------------ U.S. Treasury securities and AAA $1,018.1 64% $1,355.2 74% AA 86.7 5% 100.5 5% A 325.9 21% 266.4 15% BBB 124.0 8% 105.3 6% BB 21.9 1% -- -- B 3.0 1% -- -- -------------------------------------------------- Total $1,579.6 100% $1,827.4 100% ==================================================
Ratings as assigned by Standard and Poor's Corp. Such ratings are generally assigned at the time of the issuance of the securities, subject to revision on the basis of ongoing evaluations. 40 The following table reflects the Company's investment results: (dollar amounts in millions) 1999 1998 1997 - -------------------------------------------------------------------------- Average invested assets(1) $ 1,818.0 $ 2,038.0 $ 2,207.0 Net investment income(2) $ 108.7 $ 119.1 $ 132.8 Net effective yield(3) 5.98% 5.84% 6.02% --------------------------------------- (1)Average invested assets throughout the year, at amortized cost, excluding amounts related to securities lending activities. (2)Gross investment income less investment expenses. Excludes net realized investment gains and amounts related to securities lending activities. (3)Net investment income for the period divided by average invested assets for the same period. As of December 31, 1999, the duration of the Company's investments that support the insurance reserves was approximately 4 years, which generally approximates the duration of the insurance reserves. See "Business - Investments" in the Company's 1999 Form 10-K and Notes 2-B and 3 to the Company's Consolidated Financial Statements for additional discussion. MARKET RISK OF FINANCIAL INSTRUMENTS A significant portion of PMA Capital's assets and liabilities are financial instruments, which are subject to the market risk of potential losses from adverse changes in market rates and prices. The Company's primary market risk exposures relate to interest rate risk on fixed rate domestic medium-term instruments and, to a lesser extent, domestic short- and long-term instruments. The Company has established strategies, asset quality standards, asset allocations and other relevant criteria for its portfolio to manage its exposure to market risk. In addition, maturities are structured after projecting liability cash flows with actuarial models. The Company currently has only one derivative instrument outstanding, an interest rate swap on its Credit Facility, which is used as a hedge. All of the Company's financial instruments are held for purposes other than trading. The Company's portfolio does not contain any significant concentrations in single issuers (other than U.S. Treasury and agency obligations), industry segments or geographic regions. See Notes 3, 6 and 10 to the Company's Consolidated Financial Statements for additional information about financial instruments. Caution should be used in evaluating PMA Capital's overall market risk from the information below, since actual results could differ materially because the information was developed using estimates and assumptions as described below, and because insurance liabilities and reinsurance receivables are excluded in the hypothetical effects (insurance liabilities represent 78% of total liabilities and reinsurance receivables on unpaid losses represent 20% of total assets). The hypothetical effects of changes in market rates or prices on the fair values of financial instruments as of December 31, 1999, excluding insurance liabilities and reinsurance receivables on unpaid losses because such insurance related assets and liabilities are not carried at fair value, would have been as follows: o If interest rates had increased by 100 basis points, there would have been no significant change in the fair value of the Company's long-term debt or the related swap agreement. The change in fair values was determined by estimating the present value of future cash flows using models that measure the change in net present values arising from selected hypothetical changes in market interest rates. o If interest rates had increased by 100 basis points, there would have been a net decrease of approximately $75 million in the fair value of the Company's investment portfolio. The change in fair values was determined by estimating the present value of future cash flows using various models, primarily duration modeling. OTHER MATTERS The Company's businesses are subject to a changing social, economic, legal, legislative and regulatory environment that could affect them. Some of the changes include initiatives to restrict insurance pricing and the application of underwriting standards and reinterpretations of insurance contracts long after the policies were written in an effort to provide coverage unanticipated by the Company. The eventual effect on the Company of the changing environment in which it operates remains uncertain (see Notes 4, 8 and 12 to the Company's Consolidated Financial Statements for additional discussion). Year 2000 Issue - --------------- As a consequence of the programming convention which utilized a two-digit field rather than a four-digit field, certain information technology ("IT") systems and non-IT systems, such as equipment with embedded chips or microprocessors, required reprogramming or replacement to enable them to perform correctly date operations involving year 2000 or later ("Year 2000 Issue"). 41 With the assistance of outside consulting groups, the Company began evaluating and reprogramming its IT systems to address the Year 2000 Issue in late 1995. The Company's Year 2000 systems' program consisted of four phases: (i) identifying systems requiring remediation; (ii) assessing the requirements to remediate those systems; (iii) remediating those systems to make them Year 2000 ready by either modifying or replacing them; and (iv) testing the systems for Year 2000 readiness, including, where applicable, that they properly interface with third parties. Prior to the end of 1999, the Company remediated and tested its IT systems that the Company determined were critical to maintaining operations or the failure of which would result in significant costs or disruption of operations ("mission critical systems") and its non-IT systems. As of February 29, 2000, the Company has not experienced any material disruptions to its business due to Year 2000 Issues with its mission critical systems or non-IT systems. The cost of the Company's Year 2000 readiness work through December 31, 1999 was approximately $5.4 million. As of February 29, 2000, the Company was not aware of any Year 2000 problems with third parties with which the Company has a direct and material relationship. It is possible that the Company's computerized systems could be affected in the future by the Year 2000 Issue. The Company has numerous computerized interfaces with third parties that are possibly vulnerable to failure if those third parties have not adequately addressed their Year 2000 Issues. Systems failures resulting from these issues could cause significant disruptions to the Company's operations. As of February 29, 2000, there do not appear to have been any such failures. Although there have been no apparent Year 2000 problems related to internal systems and third parties, the Company may have underwriting exposure related to the Year 2000 Issue. Businesses materially damaged as a result of the Year 2000 Issue may attempt to recoup their losses by claiming coverage under various types of insurance policies underwritten by the Company and by ceding companies to whom the Company provides reinsurance. The Company has attempted, whenever possible, to avoid or otherwise limit its potential Year 2000 exposure through its underwriting process. In the event that claims for Year 2000 Issues are asserted against the Company, it is not possible to predict whether or to what extent coverage could ultimately be found to exist by courts in various jurisdictions, or, if found, the effect thereof on the Company. In addition, even if such coverage were found not to exist, which cannot be predicted, the costs of litigation could be material. In the absence of any claims experience at this time, such losses and costs are not currently reasonably estimable. As of February 29, 2000, the Company has not received notice of any material claims from insureds based on the Year 2000 Issue. Comparison of SAP and GAAP Results Results presented in accordance with GAAP vary in certain respects from statutory accounting practices prescribed or permitted by the Pennsylvania Insurance Department and the Delaware Insurance Department, (collectively "SAP"). Prescribed SAP includes state laws, regulations and general administrative rules, as well as a variety of National Association of Insurance Commissioners ("NAIC") publications. Permitted SAP encompasses all accounting practices that are not prescribed. In 1998, the NAIC adopted the Codification of Statutory Accounting Principles ("Codification") guidance, which will replace the current Accounting Practices and Procedures manual as the NAIC's primary guidance on statutory accounting. Codification provides guidance for areas where statutory accounting has been silent and changes current statutory accounting in some areas, such as deferred income taxes. The Company's insurance subsidiaries will implement the Codification guidelines effective January 1, 2001. The Company is in the process of assessing the impact that Codification will have on its statutory surplus and currently expects that the impact of adopting Codification will not be material to statutory surplus. Recent Accounting Pronouncements - -------------------------------- Effective January 1, 1999, the Company adopted Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments." SOP 97-3 provides guidance for determining when an insurance company should recognize a liability for guaranty fund and other insurance related assessments and how to measure that liability. As a result of adopting SOP 97-3, the Company recorded a liability of $4.3 million pre-tax and a resulting charge to earnings of $2.8 million, net of income tax benefit of $1.5 million, which has been reported as a cumulative effect of accounting change in 1999. This accounting change impacts The PMA Insurance Group segment. 42 In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as "derivatives") and for hedging activities. SFAS No. 133 requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities-Deferral of the Effective Date of FASB Statement No. 133," which defers the effective date of SFAS No. 133 to fiscal years beginning after June 15, 2000. While the Company is presently evaluating the impact of SFAS No. 133, the adoption of SFAS No. 133 is not expected to have a material impact on the Company's financial condition, results of operations or liquidity. In October 1998, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued SOP 98-7, "Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." This statement identifies several methods of deposit accounting and provides guidance on the application of each method. This statement classifies insurance and reinsurance contracts for which the deposit method is appropriate as contracts that (i) transfer only significant timing risk, (ii) transfer only significant underwriting risk, (iii) transfer neither significant timing nor underwriting risk and (iv) have an indeterminate risk. SOP 98-7 is effective for financial statements for fiscal years beginning after June 15, 1999. The adoption of SOP 98-7 is not expected to have a material impact on the Company's financial condition, results of operations or liquidity. See Note 2-J to the Company's Consolidated Financial Statements for additional discussion. CAUTIONARY STATEMENTS Except for historical information provided in this Management's Discussion and Analysis and otherwise in this report, statements made throughout this report are forward-looking and contain information about financial results, economic conditions, trends and known uncertainties. These forward-looking statements are based on currently available financial, competitive and economic data and the Company's current operating plans based on assumptions regarding future events. The Company's actual results could differ materially from those expected by the Company's management. The factors that could cause actual results to vary materially, some of which are described with the forward-looking statements, include, but are not limited to, changes in general economic conditions, including the performance of financial markets and interest rates; regulatory or tax changes, including changes in risk-based capital or other regulatory standards that affect the ability of the Company to conduct its business; competitive or regulatory changes that affect the cost of or demand for the Company's products; the Company's ability to meet its marketing objectives; the effect of changes in workers' compensation statutes and their administration; the Company's ability to predict and effectively manage claims related to insurance and reinsurance policies; reliance on key management; adequacy of reserves for claim liabilities; adverse property and casualty loss development for events the Company insured in prior years; adequacy and collectibility of reinsurance purchased by the Company; severity of natural disasters and other catastrophes; and other factors disclosed from time to time in reports filed by the Company with the Securities and Exchange Commission. Investors should not place undue reliance on any such forward-looking statements. The Company disclaims any obligation to update forward-looking statements. 43 Consolidated Balance Sheets
December 31, (in thousands, except share data) 1999 1998 - ------------------------------------------------------------------------------------------------------------------- Assets: Investments: Fixed maturities available for sale, at fair value (amortized cost: 1999 - $1,648,894; 1998 - $1,781,188) $1,579,640 $ 1,827,354 Equity securities, at fair value (cost: 1999 - $37,779; 1998 - $5) 34,966 17 Short-term investments, at cost which approximates fair value 303,429 498,038 ---------------------------- Total investments 1,918,035 2,325,409 Cash 84,261 2,562 Accrued investment income 20,480 19,900 Premiums receivable (net of valuation allowance: 1999 -$18,088; 1998 - $19,874) 271,833 279,633 Reinsurance receivables (net of valuation allowance: 1999 -$5,528; 1998 - $2,178) 658,164 610,291 Deferred income taxes, net 105,363 63,929 Deferred acquisition costs 48,949 51,115 Other assets 138,002 107,879 ---------------------------- Total assets $3,245,087 $ 3,460,718 ============================ Liabilities: Unpaid losses and loss adjustment expenses $1,932,601 $ 1,940,895 Unearned premiums 260,352 227,945 Long-term debt 163,000 163,000 Accounts payable and accrued expenses 109,447 107,952 Funds held under reinsurance treaties 94,445 77,674 Dividends to policyholders 13,782 10,700 Payable under securities loan agreements 242,317 421,072 ---------------------------- Total liabilities 2,815,944 2,949,238 ---------------------------- Commitments and contingencies (Note 12) Shareholders' Equity: Common stock, $5 par value (40,000,000 shares authorized; 1999 - 13,084,665 shares issued and 12,648,658 outstanding; 1998 - 13,956,268 shares issued and 13,520,261 outstanding) 65,423 69,781 Class A common stock, $5 par value (40,000,000 shares authorized; 1999 - 11,358,280 shares issued and 9,692,854 outstanding; 1998 - 10,486,677 shares issued and 9,837,963 outstanding) 56,791 52,433 Additional paid-in capital - Class A common stock 339 339 Retained earnings 391,981 377,601 Accumulated other comprehensive income (loss) (46,844) 30,016 Notes receivable from officers (56) (498) Treasury stock, at cost: Common stock (1999 - 436,007 shares; 1998 - 436,007 shares) (5,582) (5,582) Class A common stock (1999-1,665,426 shares; 1998 - 648,714 shares) (32,909) (12,610) ---------------------------- Total shareholders' equity 429,143 511,480 ---------------------------- Total liabilities and shareholders' equity $3,245,087 $ 3,460,718 ============================
See accompanying notes to the consolidated financial statements. 44 Consolidated Statements of Operations
For the years ended December 31, (in thousands, except per share data) 1999 1998 1997 - --------------------------------------------------------------------------------------------------------------------------- Revenues: Net premiums written $ 563,510 $ 474,761 $ 381,282 Change in net unearned premiums (23,423) (8,046) (5,331) ---------------------------------------------- Net premiums earned 540,087 466,715 375,951 Net investment income 110,057 120,125 133,392 Net realized investment gains (losses) (7,745) 21,745 8,598 Other revenues 12,718 14,896 13,617 ---------------------------------------------- Total revenues 655,117 623,481 531,558 ---------------------------------------------- Losses and Expenses: Losses and loss adjustment expenses 392,473 352,671 307,281 Acquisition expenses 124,368 110,837 93,501 Operating expenses 66,822 72,159 75,139 Dividends to policyholders 19,141 17,736 14,716 Interest expense 12,221 15,009 15,768 ---------------------------------------------- Total losses and expenses 615,025 568,412 506,405 ---------------------------------------------- Income before income taxes, extraordinary loss and cumulative effect of accounting change 40,092 55,069 25,153 Income tax expense 11,739 10,335 5,400 ---------------------------------------------- Income before extraordinary loss and cumulative effect of accounting change 28,353 44,734 19,753 Extraordinary loss from early extinguishment of debt (net of income tax benefit of $2,549) -- -- (4,734) Cumulative effect of accounting change (net of income tax benefit of $1,485) (2,759) -- -- ---------------------------------------------- Net income $ 25,594 $ 44,734 $ 15,019 ============================================== Income (loss) per share: Basic: Income before extraordinary loss and cumulative effect of accounting change $ 1.23 $ 1.89 $ 0.83 Extraordinary loss -- -- (0.20) Cumulative effect of accounting change (0.12) -- -- ---------------------------------------------- Net income $ 1.11 $ 1.89 $ 0.63 ============================================== Diluted: Income before extraordinary loss and cumulative effect of accounting change $ 1.19 $ 1.82 $ 0.80 Extraordinary loss -- -- (0.19) Cumulative effect of accounting change (0.11) -- -- ---------------------------------------------- Net income $ 1.08 $ 1.82 $ 0.61 ==============================================
See accompanying notes to the consolidated financial statements. 45 Consolidated Statements of Cash Flows
For the years ended December 31, (in thousands) 1999 1998 1997 - --------------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income $ 25,594 $ 44,734 $ 15,019 Adjustments to reconcile net income to net cash flows provided by (used in) operating activities: Depreciation and amortization 7,403 7,109 12,744 Provision for deferred income taxes 1,813 425 9,906 Extraordinary loss from early extinguishment of debt -- -- 4,734 Cumulative effect of accounting change 2,759 -- -- Net realized investment (gains) losses 7,745 (21,745) (8,598) Change in: Premiums receivable and unearned premiums, net 40,207 (10,718) 39,030 Dividends to policyholders 3,082 500 (2,324) Reinsurance receivables (47,873) (60,348) (74,423) Unpaid losses and loss adjustment expenses (8,294) (62,292) (87,885) Accrued investment income (580) 3,918 6,577 Deferred acquisition costs 2,166 (5,827) (1,282) Other, net (16,625) 24,592 (20,275) ---------------------------------------------- Net cash flows provided by (used in) operating activities 17,397 (79,652) (106,777) ---------------------------------------------- Cash flows from investing activities: Fixed maturities available for sale: Purchases (1,198,557) (1,741,790) (1,963,492) Maturities or calls 171,091 207,285 168,304 Sales 1,149,951 1,468,231 2,072,842 Equity securities: Purchases (37,779) -- -- Sales 6 -- 254 Net (purchases) sales of short-term investments 15,887 176,658 (130,391) Proceeds from sale of PMA Insurance, Cayman Ltd. -- 2,902 -- Purchase of Caliber One Indemnity Company, net of acquired cash -- -- (11,481) Other, net (4,738) (414) 3,568 ---------------------------------------------- Net cash flows provided by investing activities 95,861 112,872 139,604 ---------------------------------------------- Cash flows from financing activities: Dividends paid to shareholders (7,795) (7,939) (7,965) Proceeds from exercised stock options and issuance of Class A Common stock 6,035 4,283 1,442 Purchase of treasury stock (30,241) (18,850) (597) Repayments of long-term debt -- (40,000) (211,699) Proceeds from issuance of long-term debt -- -- 210,000 Net repayments (issuance) of notes receivable from officers 442 (300) 964 ---------------------------------------------- Net cash flows used in financing activities (31,559) (62,806) (7,855) ---------------------------------------------- Net increase (decrease) in cash 81,699 (29,586) 24,972 Cash - beginning of year 2,562 32,148 7,176 ---------------------------------------------- Cash - end of year $ 84,261 $ 2,562 $ 32,148 ============================================== Supplementary cash flow information: Income tax paid (refunded) $ 12,352 $ (15,170) $ (19,112) Interest paid $ 12,050 $ 14,895 $ 19,776
See accompanying notes to the consolidated financial statements. 46 Consolidated Statements of Shareholders' Equity
For the years ended December 31, (in thousands) 1999 1998 1997 - ------------------------------------------------------------------------------------------------------------------- Common stock: Balance at beginning of year $ 69,781 $ 76,431 $ 80,477 Conversion of Common stock into Class A Common stock (4,358) (6,650) (4,046) --------------------------------------------- Balance at end of year 65,423 69,781 76,431 --------------------------------------------- Class A Common stock: Balance at beginning of year 52,433 45,783 41,239 Conversion of Common stock into Class A Common stock 4,358 6,650 4,046 Issuance of shares -- -- 498 --------------------------------------------- Balance at end of year 56,791 52,433 45,783 --------------------------------------------- Additional paid-in capital - Class A Common stock: Balance at beginning of year 339 339 -- Issuance of shares -- -- 339 --------------------------------------------- Balance at end of year 339 339 339 --------------------------------------------- Retained earnings: Balance at beginning of year 377,601 343,368 336,921 Net income 25,594 44,734 15,019 Common stock dividends declared (4,139) (4,527) (4,842) Class A Common stock dividends declared (3,543) (3,417) (3,147) Reissuance of treasury shares under employee benefit plans (3,532) (2,557) (583) --------------------------------------------- Balance at end of year 391,981 377,601 343,368 --------------------------------------------- Accumulated other comprehensive income (loss): Balance at beginning of year 30,016 18,806 (24,874) Other comprehensive income (loss), net of tax (expense) benefit: 1999 - $41,386; 1998 - ($6,036); 1997 - ($23,520) (76,860) 11,210 43,680 --------------------------------------------- Balance at end of year (46,844) 30,016 18,806 --------------------------------------------- Notes receivable from officers: Balance at beginning of year (498) (198) (1,162) Repayment (issuance) of notes receivable from officers 442 (300) 964 --------------------------------------------- Balance at end of year (56) (498) (198) --------------------------------------------- Treasury stock - Common: Balance at beginning of year (5,582) (5,572) (5,408) Purchase of treasury shares -- (10) (164) --------------------------------------------- Balance at end of year (5,582) (5,582) (5,572) --------------------------------------------- Treasury stock - Class A Common: Balance at beginning of year (12,610) (610) (1,365) Purchase of treasury shares (30,241) (18,840) (433) Reissuance of treasury shares under employee benefit plans 9,942 6,840 1,188 --------------------------------------------- Balance at end of year (32,909) (12,610) (610) --------------------------------------------- Total shareholders' equity: Balance at beginning of year 511,480 478,347 425,828 Net income 25,594 44,734 15,019 Common stock dividends declared (4,139) (4,527) (4,842) Class A Common stock dividends declared (3,543) (3,417) (3,147) Purchase of treasury shares (30,241) (18,850) (597) Reissuance of treasury shares under employee benefit plans 6,410 4,283 605 Other comprehensive income (loss) (76,860) 11,210 43,680 Repayment (issuance) of notes receivable from officers 442 (300) 964 Issuance of shares -- -- 837 --------------------------------------------- Balance at end of year $ 429,143 $511,480 $ 478,347 =============================================
See accompanying notes to the consolidated financial statements. 47 Consolidated Statements of Comprehensive Income (Loss)
For the years ended December 31, (in thousands) 1999 1998 1997 - ------------------------------------------------------------------------------------------------------------------- Net income $ 25,594 $ 44,734 $ 15,019 -------------------------------------------- Other comprehensive income (loss), net of tax: Unrealized gain (loss) on securities: Holding gain (loss) arising during the period (81,894) 25,344 49,269 Less: reclassification adjustment for (gains) losses included in net income, net of tax expense (benefit): 1999 - ($2,711); 1998 - $7,611; 1997 - $3,009 5,034 (14,134) (5,589) -------------------------------------------- Other comprehensive income (loss), net of tax (76,860) 11,210 43,680 -------------------------------------------- Comprehensive income (loss) $(51,266) $ 55,944 $ 58,699 ============================================
See accompanying notes to the consolidated financial statements. 48 Notes to Consolidated Financial Statements 1. Business Description The accompanying consolidated financial statements include the accounts of PMA Capital Corporation and its wholly and majority owned subsidiaries (collectively referred to as "PMA Capital" or the "Company"). PMA Capital is an insurance holding company that operates three specialty risk management businesses, which are more fully described below. Reinsurance -- PMA Capital's reinsurance operations ("PMA Re") consist mainly of PMA Reinsurance Corporation, a Pennsylvania domiciled insurance company, and emphasize risk-exposed, excess of loss reinsurance and operate in the brokered market. PMA Re's business is predominantly in casualty lines of reinsurance. Workers' Compensation and Primary Standard Insurance -- PMA Capital's property and casualty insurance subsidiaries ("The PMA Insurance Group") include Pennsylvania domiciled insurance companies as well as certain foreign subsidiaries. The PMA Insurance Group primarily writes managed care workers' compensation, integrated disability and to a lesser extent, other standard lines of commercial insurance, primarily in the Mid-Atlantic and Southern regions of the U.S. The majority of The PMA Insurance Group's business is produced by independent agents and brokers. Specialty Property and Casualty -- The Company established a separate specialty insurance operation focusing on excess and surplus lines ("Caliber One") in 1997, and Caliber One commenced writing business in 1998. Caliber One writes business through surplus lines brokers on a national basis. Caliber One's excess and surplus lines insurance affiliate, Caliber One Indemnity Company, is an eligible surplus lines insurer in 41 states, the District of Columbia and Puerto Rico, with applications pending in two other states. Because Caliber One's results were not significant in 1997, its financial information was included within the Corporate and Other segment in 1997, including pre-opening costs of approximately $900,000, which were expensed as incurred. PMA Reinsurance Corporation acquired 100% of the outstanding Common stock of Caliber One Indemnity Company, domiciled in Delaware and formerly known as Lincoln Insurance Company, for approximately $16.0 million in late 1997 and made a capital contribution of approximately $11.3 million to Caliber One Indemnity Company. All of Caliber One Indemnity Company's acquired loss reserves were reinsured with an affiliate of its former parent for adverse development and uncollectible reinsurance (the "Reserve Guarantee") in the amount of the recorded reserves plus $68.5 million. Management believes that the Reserve Guarantee will be adequate to cover any future adverse reserve development or uncollectible reinsurance on the acquired reserves. PMA Reinsurance Corporation intends to maintain Caliber One Indemnity Company's surplus at not less than $25.0 million. 2. Summary of Significant Accounting Policies A. Basis of Presentation -- The consolidated financial statements have been prepared in accordance with generally accepted accounting principles ("GAAP"). All significant intercompany accounts and transactions have been eliminated in consolidation. The preparation of consolidated financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. In addition, certain prior year amounts have been restated to conform to the current year classification. B. Investments -- Fixed maturity investments include U.S. Treasury securities and obligations of U.S. Government agencies; obligations of states, political subdivisions and foreign governments; corporate debt securities; and mortgage-backed and other asset-backed securities. All fixed maturity investments are classified as available-for-sale and, accordingly, are carried at fair value with changes in fair value, net of income tax effects, reflected in accumulated other comprehensive income (loss). Equity securities for all periods are stated at fair value with changes in fair value, net of income tax effects, reflected in accumulated other comprehensive income (loss). Short-term investments, which have an original maturity of one year or less, are carried at cost, which approximates fair value. Realized gains and losses, determined by specific identification where possible and the first-in, first-out method in other instances, are reflected in income in the period in which the sale transaction occurs. 49 C. Premiums -- Premiums, including estimates of additional premiums resulting from audits of insureds' records, and premiums from ceding companies which are typically reported on a delayed basis, are earned principally on a pro rata basis over the terms of the policies. Premiums applicable to the unexpired terms of policies in force are reported as unearned premiums. The estimated premiums receivable on retrospectively rated policies are reported as a component of premiums receivable (see Note 2-K). D. Unpaid Losses and Loss Adjustment Expenses -- Unpaid losses and loss adjustment expenses, which are stated net of estimated salvage and subrogation, are estimates of losses and loss adjustment expenses on known claims, and estimates of losses and loss adjustment expenses incurred but not reported ("IBNR"). IBNR reserves are calculated utilizing various actuarial methods. Unpaid losses on certain workers' compensation claims are discounted to present value using the Company's payment experience and mortality and interest assumptions in accordance with statutory accounting practices prescribed or permitted by the Pennsylvania Insurance Department (collectively "SAP"). The methods of making such estimates and establishing the resulting reserves are continually reviewed and updated and any adjustments resulting therefrom are reflected in earnings currently (see Note 4). E. Deferred Acquisition Costs -- Costs that directly relate to and vary with acquisition of new and renewal business are deferred and amortized over the period during which the related premiums are earned. Such direct costs include commissions, brokerage and premium taxes, as well as other policy issuance costs and underwriting expenses. The Company determines whether deferred acquisition costs are recoverable considering future losses and loss adjustment expenses, maintenance costs and anticipated investment income. To the extent that deferred acquisition costs are not recoverable, the deficiency is charged to income currently. F. Dividends to Policyholders -- The PMA Insurance Group issues certain workers' compensation insurance policies with dividend payment features. These policyholders share in the operating results of their respective policies in the form of dividends declared at the discretion of the Board of Directors of The PMA Insurance Group's operating companies. Dividends to policyholders are accrued during the period in which the related premiums are earned and are determined based on the terms of the individual policies. G. Income Taxes -- The Company records deferred tax assets and liabilities in accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." Under SFAS No. 109 the Company records deferred income taxes, which reflect the net tax effect of the temporary difference between the carrying amounts of the assets and liabilities for financial reporting purposes and their respective tax bases. A valuation allowance is recorded for deferred tax assets where it appears more likely than not that the Company will not be able to recover the deferred tax asset. H. Stock-Based Compensation -- The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's Class A Common stock at grant date or other measurement date over the amount an employee must pay to acquire the Class A Common stock. I. Other Revenues -- Other revenues include service revenues related to unbundled claims, risk management and related services provided by The PMA Insurance Group, which are earned over the term of the related contracts in proportion to the actual services rendered, and other miscellaneous revenues. J. Recent Accounting Pronouncements -- Effective January 1, 1999, the Company adopted Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments." SOP 97-3 provides guidance for determining when an insurance company should recognize a liability for guaranty fund and other insurance-related assessments and how to measure that liability. As a result of adopting SOP 97-3, the Company recorded a liability of $4.3 million pre-tax and a resulting charge to earnings of $2.8 million, net of income tax benefit of $1.5 million, which has been reported as a cumulative effect of accounting change. This accounting change impacts The PMA Insurance Group segment. As of January 1, 1998, the Company adopted SFAS No. 130, "Comprehensive Income," which establishes standards for the reporting and disclosure of comprehensive income and its components (revenues, expenses, gains and losses). SFAS No. 130 requires that all items required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS No. 130 requires only additional disclosures and does not affect the Company's financial condition or results of operations. 50 As of January 1, 1998, the Company adopted SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information," which establishes standards for the reporting of information about operating segments. SFAS No. 131 also establishes standards for related disclosures about products and services, geographic areas and major customers. In connection with the adoption of SFAS No. 131, the Company has identified four reportable segments: (i) PMA Re, which provides property and casualty reinsurance products and services; (ii) The PMA Insurance Group, which writes managed care workers' compensation, integrated disability, and to a lesser extent, other standard lines of commercial insurance; (iii) Caliber One, which writes specialty insurance focusing on excess and surplus lines; and (iv) Corporate and Other, which includes unallocated investment income and expenses, including debt service, as well as the results of certain of the Company's real estate properties. SFAS No. 131 requires only additional disclosures (see Note 16) and does not affect the Company's financial condition, results of operations or liquidity. In February 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," which revises employers' disclosures about pensions and other postretirement benefit plans. SFAS No. 132 does not change the measurement or recognition of those plans and was effective for fiscal years beginning after December 15, 1997. The Company has applied the guidelines of SFAS No. 132 in its pension and other postretirement-related disclosures (see Note 9). In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as "derivatives") and for hedging activities. SFAS No. 133 requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities-Deferral of the Effective Date of FASB Statement No. 133," which defers the effective date of SFAS No. 133 to fiscal years beginning after June 15, 2000. While the Company is presently evaluating the impact of SFAS No. 133, the adoption of SFAS No. 133 is not expected to have a material impact on the Company's financial condition, results of operations or liquidity. In October 1998, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued SOP 98-7, "Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." This statement identifies several methods of deposit accounting and provides guidance on the application of each method. This statement classifies insurance and reinsurance contracts for which the deposit method is appropriate as contracts that (i) transfer only significant timing risk, (ii) transfer only significant underwriting risk, (iii) transfer neither significant timing nor underwriting risk and (iv) have an indeterminate risk. SOP 98-7 is effective for financial statements for fiscal years beginning after June 15, 1999. The adoption of SOP 98-7 is not expected to have a material impact on the Company's financial condition, results of operations or liquidity. K. Accrued Retrospective Premiums -- Accrued retrospective premiums, which are a component of premiums receivable, are based upon actuarial estimates of expected ultimate losses and resulting estimated premium adjustments relating to retrospectively rated policies. The estimated ultimate premium adjustments under retrospectively rated policies are recorded in the initial accident year based upon estimated loss experience on the underlying policies and adjusted in subsequent periods in conjunction with revisions of the underlying estimated losses on such policies. In addition, accrued retrospective premiums are increased based upon retrospective policy adjustments paid and decreased based on billings. The change in accrued retrospective premiums is a component of net premiums written and net premiums earned. The components of the change in accrued retrospective premiums are as follows: For the years ended December 31, (dollar amounts in thousands) 1999 1998 1997 - --------------------------------------------------------------------------- Estimated retrospective policy adjustments related to current accident year $(20,061) $ (9,204) $(12,460) Revision of estimate of retrospective policy adjustments related to prior accident years (10,743) (11,684) (44,719) Retrospective policy adjustments paid 13,804 17,888 20,179 Write-off of uncollectible amounts (4,000) -- -- -------- -------- -------- Net decrease in accrued retrospective premiums $(21,000) $ (3,000) $(37,000) ======== ======== ======== 51 For 1999 and 1998, the net decrease in accrued retrospective premiums of $21 million and $3 million respectively, primarily reflects favorable development of claims liabilities at The PMA Insurance Group. The net decrease in accrued retrospective premiums of $37 million for 1997 is due primarily to the $44.7 million revision of the estimate of retrospective policy adjustments related to prior years. This revision related to the favorable development of claims liabilities for accident years 1992 through 1996, and the commutation of claims for accident years 1991 and prior. As a result, management recognized a reduction in losses and loss adjustment expenses under retrospectively rated policies and also reduced its estimate of amounts recoverable associated with such policies. Management believes that it has made a reasonable estimate of the Company's accrued retrospective premiums. While the ultimate amount receivable may differ from the current estimates, management does not believe that the difference will have a material effect on the Company's financial condition, results of operations or liquidity. 3. Investments The Company's investment portfolio is diversified and contains no significant concentrations in any specific industry, business segment or individual issuer. The amortized cost and fair value of the Company's investment portfolio are as follows:
Gross Gross Amortized Unrealized Unrealized Fair (dollar amounts in thousands) Cost Gains Losses Value - -------------------------------------------------------------------------------------------------------------------- December 31, 1999 Fixed maturities available for sale: U.S. Treasury securities and obligations of U.S. Government agencies $ 438,412 $ 841 $ 19,797 $ 419,456 States, political subdivisions and foreign government securities 32,164 18 1,602 30,580 Corporate debt securities 580,710 380 25,964 555,126 Mortgage-backed and other asset-backed securities 597,608 204 23,334 574,478 ------------------------------------------------------- Total fixed maturities available for sale 1,648,894 1,443 70,697 1,579,640 ------------------------------------------------------- Equity securities 37,779 614 3,427 34,966 Short-term investments 303,429 -- -- 303,429 ------------------------------------------------------- Total investments $1,990,102 $ 2,057 $ 74,124 $1,918,035 ======================================================= December 31, 1998 Fixed maturities available for sale: U.S. Treasury securities and obligations of U.S. Government agencies $ 801,174 $ 27,112 $ 1,097 $ 827,189 States, political subdivisions and foreign government securities 24,634 236 9 24,861 Corporate debt securities 406,707 14,267 632 420,342 Mortgage-backed and other asset-backed securities 548,673 7,263 974 554,962 ------------------------------------------------------- Total fixed maturities available for sale 1,781,188 48,878 2,712 1,827,354 Equity securities 5 12 -- 17 Short-term investments 498,038 -- -- 498,038 ------------------------------------------------------- Total investments $2,279,231 $ 48,890 $ 2,712 $2,325,409 =======================================================
52 The amortized cost and fair value of fixed maturities at December 31, 1999, by contractual maturity, are as follows: Amortized Fair (dollar amounts in thousands) Cost Value - ---------------------------------------------------------------------- 2000 $ 69,240 $69,159 2001-2004 445,238 435,980 2005-2009 205,228 195,166 2010 and thereafter 331,580 304,857 Mortgage-backed and other asset-backed securities 597,608 574,478 ---------------------------------- $1,648,894 $1,579,640 ================================== Net investment income consists of the following: For the years ended December 31, (dollar amounts in thousands) 1999 1998 1997 - ------------------------------------------------------------------------- Fixed maturities $106,058 $115,414 $128,400 Equity securities 131 -- -- Short-term investments 5,126 7,959 7,282 Other 2,887 1,590 1,116 ----------------------------------- Total investment income 114,202 124,963 136,798 Investment expenses 4,145 4,838 3,406 ----------------------------------- Net investment income $110,057 $120,125 $133,392 =================================== Net realized investment gains (losses) consist of the following:
For the years ended December 31, (dollar amounts in thousands) 1999 1998 1997 - -------------------------------------------------------------------------------------- Realized gains: Fixed maturities $ 6,839 $ 28,140 $ 20,899 Equity securities 2 -- -- ------------------------------------- 6,841 28,140 20,899 Realized losses: Fixed maturities (14,585) (6,070) (12,203) Equity securities (1) -- -- ------------------------------------- (14,586) (6,070) (12,203) Other realized losses, net -- (325) (98) ------------------------------------- Total net realized investment gains (losses) $ (7,745) $ 21,745 $ 8,598 =====================================
The change in unrealized appreciation (depreciation) of investments for 1999, 1998 and 1997 was ($118.2) million, $17.2 million and $67.2 million, respectively, primarily attributable to fixed maturities. On December 31, 1999, the Company had securities with a total amortized cost of $31.5 million and fair value of $30.1 million on deposit with various governmental authorities, as required by law. In addition, at December 31, 1999, securities with a total amortized cost of $13.2 million and fair value of $12.7 million, were pledged as collateral for letters of credit issued on behalf of the Company. During 1997, the Company established a securities lending program through which securities are lent from the Company's portfolio to qualifying third parties, subject to certain limits, via a lending agent for short periods of time. Borrowers of these securities must provide collateral equal to a minimum of 102% of the market value and accrued interest of the lent securities. Acceptable collateral may be in the form of either cash or securities. Cash received as collateral is invested in short-term investments, and all securities received as collateral are of similar quality to those securities lent by the Company. The Company is not permitted by contract to sell or repledge the securities received as collateral. Additionally, the Company limits securities lending to 40% of SAP admitted assets of its insurance subsidiaries, with a 2% limit on SAP admitted assets to any individual borrower. The Company receives either a fee from the borrower or retains a portion of the income earned on the collateral. Under the terms of the securities lending program, the Company is indemnified against borrower default, with the lending agent responsible to the Company for any deficiency between the cost of replacing a security that was not returned and the amount of collateral held by the Company. The Company recognized income from securities lending transactions of $1.3 million, $1.0 million and $524,000 in 1999, 1998 and 1997, respectively, net of lending fees, which was included in net investment income. At December 31, 1999, the Company had approximately $248.5 million of collateral related to securities on loan of which $242.3 million was cash received and subsequently reinvested in short-term investments. 53 4. Unpaid Losses and Loss Adjustment Expenses Activity in the liability for unpaid losses and loss adjustment expenses ("LAE") is summarized as follows:
For the years ended December 31, (dollar amounts in thousands) 1999 1998 1997 - ----------------------------------------------------------------------------------------------- Balance at January 1 $ 1,940,895 $ 2,003,187 $ 2,091,072 Less: reinsurance recoverable on unpaid losses and LAE 593,701 332,284 256,576 ---------------------------------------------- Net balance at January 1 1,347,194 1,670,903 1,834,496 ---------------------------------------------- Losses and LAE incurred, net: Current year, net of discount 409,554 373,098 341,880 Prior years (32,514) (46,515) (86,006) Accretion of prior years' discount 15,433 26,088 51,407 ---------------------------------------------- Total losses and LAE incurred, net 392,473 352,671 307,281 ---------------------------------------------- Losses and LAE paid, net: Current year (103,798) (96,658) (72,399) Prior years (351,495) (362,186) (398,475) ---------------------------------------------- Total losses and LAE paid, net (455,293) (458,844) (470,874) ---------------------------------------------- Reserves transferred upon sale of subsidiary -- (217,536) -- ---------------------------------------------- Net balance at December 31 1,284,374 1,347,194 1,670,903 Reinsurance recoverable on unpaid losses and LAE 648,227 593,701 332,284 ---------------------------------------------- Balance at December 31 $ 1,932,601 $ 1,940,895 $ 2,003,187 ==============================================
The Company's results of operations benefited from a decrease in estimated incurred losses and LAE related to prior accident years of $32.5 million, $46.5 million and $86.0 million in 1999, 1998 and 1997, respectively, which was partially offset by adjustments to premiums for retrospectively rated business and by dividends on captive workers' compensation business of $13.4 million, $4.5 million and $51.8 million in 1999, 1998 and 1997, respectively. During 1999, 1998 and 1997, PMA Re recorded favorable reserve development on prior accident years ("prior year development") of $23.5 million, $31.5 million and $32.1 million, respectively. The favorable reserve development reflects development on prior accident years due to re-estimated loss trends for such years that were lower than previous expectations. This is largely due to favorable development on casualty excess of loss business. During 1999, 1998 and 1997, The PMA Insurance Group recorded favorable prior year development of $9.0 million, $15.0 million and $53.9 million, respectively. The favorable reserve development in 1999 reflects better than expected loss experience from loss-sensitive and rent-a-captive workers' compensation business. This favorable development has been substantially offset by premium adjustments for loss-sensitive business and policyholders' dividends for rent-a-captive business. Rent-a-captives are used by customers as an alternative method to manage their loss exposure without establishing and capitalizing their own captive insurance company. The favorable reserve development during 1998 primarily relates to the formal commutation programs, which resulted in early liability settlements made during 1998 to reduce future claim payments. Favorable loss development in 1997 is attributable to the following: favorable reserve development of approximately $37.0 million related to retrospectively rated policies for Run-off Operations; the cession of prior year reserves of $14.8 million from Run-off Operations to a third party reinsurer; and favorable reserve development of $7.1 million on guaranteed cost workers' compensation reserves, partially offset by reserve strengthening of $5.0 million in commercial multi-peril business. Unpaid losses and LAE reflect management's best estimate of future amounts needed to pay claims and related settlement costs with respect to insured events which have occurred, including events that have not been reported to the Company. In many cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured loss, the reporting of the loss to the Company and the Company's payment of that loss. In general, liabilities for reinsurers become known more slowly than for primary insurers and are subject to more unforeseen development and uncertainty. As part of the process in determining these amounts, historical data is reviewed and consideration is given to the impact of various factors, such as legal developments, changes in social attitudes and economic conditions. Unpaid losses for the Company's workers' compensation claims, net of reinsurance, at December 31, 1999 and 1998 were $527.9 million and $628.5 million, net of discount of $173.1 million and $194.3 million, respectively. The approximate discount rate used was 5% at December 31, 1999 and 1998. 54 Since 1996, the impact on losses from the effects of discounting loss reserves at The PMA Insurance Group has generally declined due mainly to the effect of commutations and lower business writings. The PMA Insurance Group has been executing programs under which it commuted, or settled, a large number of workers' compensation claims. Commutations are agreements whereby the claimants, in exchange for a lump sum payment, release their rights to future payments from The PMA Insurance Group. The PMA Insurance Group paid approximately $38 million, $65 million and $113 million in 1999, 1998 and 1997, respectively, to commute workers' compensation claims. The commutation programs resulted in payments which were less than the corresponding carried reserves. Savings associated with these claims were consistent with management's expectations. As substantially all of these reserves were carried on a discounted basis, the ultimate level of discount on The PMA Insurance Group's carried reserves decreased. Management believes that its unpaid losses and LAE are fairly stated at December 31, 1999. However, estimating the ultimate claims liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management's informed estimates and judgments using data currently available. As additional experience and data become available regarding claims payment and reporting patterns, legislative developments, regulatory trends on benefit levels for both medical and indemnity payments, and economic conditions, the estimates are revised accordingly. If the Company's ultimate net losses prove to differ substantially from the amounts recorded at December 31, 1999, the related adjustments could have a material adverse impact on the Company's financial condition, results of operations and liquidity. The Company's asbestos-related losses were as follows: For the years ended December 31, (dollar amounts in thousands) 1999 1998 1997 - -------------------------------------------------------------------- Gross of reinsurance: Beginning reserves $ 67,857 $ 76,726 $ 80,055 Incurred losses and LAE 1,910 (1,976) 2,435 Paid losses and LAE (8,490) (6,893) (5,764) -------------------------------------- Ending reserves $ 61,277 $ 67,857 $ 76,726 ====================================== Net of reinsurance: Beginning reserves $ 43,556 $ 48,578 $ 53,300 Incurred losses and LAE (341) (2,754) (36) Paid losses and LAE (4,364) (2,268) (4,686) -------------------------------------- Ending reserves $ 38,851 $ 43,556 $ 48,578 ====================================== The Company's environmental-related losses were as follows: For the years ended December 31, (dollar amounts in thousands) 1999 1998 1997 - --------------------------------------------------------------------- Gross of reinsurance: Beginning reserves $ 47,036 $ 45,108 $ 35,626 Incurred losses and LAE 5,081 11,895 1,130 Reserves acquired through purchase of Caliber One Indemnity Company(1) -- -- 13,060 Paid losses and LAE (10,758) (9,967) (4,708) ------------------------------------ Ending reserves $ 41,359 $ 47,036 $ 45,108 ==================================== Net of reinsurance: Beginning reserves $ 29,356 $ 31,695 $ 34,592 Incurred losses and LAE 82 3,644 1,068 Paid losses and LAE (4,916) (5,983) (3,965) ------------------------------------ Ending reserves $ 24,522 $ 29,356 $ 31,695 ==================================== (1) Such acquired reserves have been reinsured by an affiliate of the former parent (see Note 1). Of the total net asbestos reserves, approximately $32.0 million, $34.2 million and $41.9 million related to IBNR losses at December 31, 1999, 1998 and 1997, respectively. Of the total net environmental reserves, approximately $18.0 million, $20.3 million and $20.5 million related to IBNR losses at December 31, 1999, 1998 and 1997, respectively. All incurred asbestos and environmental losses were for accident years 1986 and prior. Estimating reserves for asbestos and environmental exposures continues to be difficult because of several factors, including: (i) evolving methodologies for the estimation of the liabilities; (ii) lack of reliable historical claim data; (iii) uncertainties with respect to insurance and reinsurance coverage related to these obligations; (iv) changing judicial interpretations; and (v) changing government standards. To reserve for environmental claims, the Company currently utilizes a calendar year development technique known as aggregate loss development. This technique focuses on the aggregate losses paid as of a particular date and aggregate payment patterns associated with such claims. Several elements including remediation studies, remediation, defense, declaratory judgment and third party bodily injury claims were considered in estimating the costs and payment patterns of the environmental and toxic tort losses. Prior to the development of these techniques, there was a substantial range in the nature of reserving for environmental and toxic tort liabilities. 55 Management believes that its reserves for asbestos and environmental claims are appropriately established based upon known facts, existing case law and generally accepted actuarial methodologies. However, due to changing interpretations by courts involving coverage issues, the potential for changes in federal and state standards for clean-up and liability, as well as issues involving policy provisions, allocation of liability among participating insurers and proof of coverage, the Company's ultimate exposure for these claims may vary significantly from the amounts currently recorded, resulting in a potential future adjustment that could be material to the Company's financial condition and results of operations. The Company's loss reserves were stated net of salvage and subrogation of approximately $43.8 million and $60.4 million at December 31, 1999 and 1998, respectively. 5. Reinsurance In the ordinary course of business, PMA Capital's reinsurance and insurance subsidiaries assume and cede premiums with other insurance companies and are members of various pools and associations. The reinsurance and insurance subsidiaries cede business, primarily on an excess of loss basis, in order to limit the maximum net loss from large risks and limit the accumulation of many smaller losses from a catastrophic event. The reinsurance and insurance subsidiaries remain primarily liable to their clients in the event their reinsurers are unable to meet their financial obligations. The components of net premiums earned and losses and LAE incurred are as follows: For the years ended December 31, (dollar amounts in thousands) 1999 1998 1997 - ----------------------------------------------------------------------- Earned premiums: Direct $ 328,590 $ 286,987 $ 277,871 Assumed 366,029 276,689 216,357 Ceded (154,532) (96,961) (118,277) ----------------------------------------- Net $ 540,087 $ 466,715 $ 375,951 ========================================= Losses and LAE incurred: Direct $ 262,340 $ 250,641 $ 244,429 Assumed 243,200 184,309 166,202 Ceded (113,067) (82,279) (103,350) ----------------------------------------- Net $ 392,473 $ 352,671 $ 307,281 ========================================= At December 31, 1999, the Company had reinsurance receivables due from the following unaffiliated single reinsurers in excess of 3% of shareholders' equity: (dollar amounts in thousands) Gross amount due - ----------------------------------------------------------------- London Life Reinsurance Group $ 240,753 United States Fidelity and Guaranty Company 98,940 American Reinsurance Corporation 29,599 Essex Insurance Company 26,554 SCOR Reinsurance Company 22,724 Houston Casualty Company 22,574 GE Reinsurance Corporation 20,051 Continental Casualty Company 16,062 Odyssey Reinsurance Corporation 15,279 Signet Star Reinsurance Company 14,132 FolksAmerica Reinsurance Company 14,003 The Company performs extensive credit reviews of its reinsurers focusing on, among other things, financial capacity, stability, trends and commitment to the reinsurance business. Prospective and existing reinsurers failing to meet the Company's standards are excluded from the Company's reinsurance programs. In addition, the Company requires letters of credit or other acceptable collateral to support balances due from reinsurers not authorized to transact business in the applicable jurisdictions. The Company maintained funds held to collateralize the above balances in the amount of $91.1 million at December 31, 1999. In addition, the entire receivable from the London Life Reinsurance Group is secured by assets in trust and letters of credit. 6. Long-Term Debt Long-term debt consisted of $163.0 million outstanding under the Company's revolving credit facility (the "Credit Facility") as of December 31, 1999 and 1998. The Credit Facility matures as follows: $38.0 million in 2000, $62.5 million in 2001 and $62.5 million in 2002. The Credit Facility bears interest at the London InterBank Offered Rate ("LIBOR") plus 0.375% on the utilized portion and carries a 0.225% facility fee on the unutilized portion. The spread over LIBOR and the facility fee are adjustable downward in the future based upon the Company's debt-to-capitalization ratios. As of December 31, 1999, the interest rate on the utilized portion of the Credit Facility was 6.56%. The Company has entered into an interest rate swap agreement in its management of its existing interest rate exposures with a notional principal balance of $150.0 million at December 31, 1999. The rate on the swap 56 resets every three months such that it effectively converts the Company's interest rate exposure on $150.0 million of the Credit Facility, which has a floating rate, to a fixed obligation (7.14% at December 31, 1999). The swap involves the exchange of interest payment obligations without the exchange of underlying principal. The differential to be paid or received is recognized as an adjustment of interest expense. In the event that a counterparty fails to meet the terms of the swap, the Company's exposure is limited to the interest rate differential on the notional principal amount ($150.0 million). Management believes such credit risk is minimal and any loss would not be material to financial condition, results of operations and liquidity. On March 14, 1997, the Company refinanced substantially all of its existing credit agreements not already maturing in 1997 through the completion of the Credit Facility. The early extinguishment of the senior note agreements resulted in an extraordinary loss of $4.7 million ($7.3 million pre-tax). Effective March 14, 1997, the Company modified its letter of credit agreement with a group of banks (the "Letter of Credit Agreement") to reduce its aggregate outstanding face amount to $50.0 million. The agreement requires the Company to pay a commitment fee, which is adjustable downward in the future based upon the Company's debt-to-capitalization ratios. At December 31, 1999, the commitment fee was 0.225% per annum. At December 31, 1999 and 1998, the aggregate outstanding face amount of letters of credit issued was $45.9 million and $46.9 million, respectively. The Letter of Credit Agreement primarily secures reinsurance liabilities of the insurance subsidiaries of the Company. The debt covenants supporting the Credit Facility and the Letter of Credit Agreement contain provisions that, among other matters, limit the Company's ability to incur additional indebtedness, merge, consolidate and acquire or sell assets. The debt covenants also require the Company to satisfy certain ratios related to net worth, debt-to-capitalization and interest coverage. Additionally, the debt covenants place restrictions on dividends to shareholders (see Note 14). 7. Stock Options The Company currently has seven stock option plans in place for stock options granted to officers and other key employees for the purchase of the Company's Class A Common stock, under which 3,787,897 Class A Common shares were reserved for issuance at December 31, 1999. The stock options are granted under terms and conditions determined by the Stock Option Committee of the Board of Directors. Stock options granted have a maximum term of ten years, generally vest over periods ranging between zero and five years, and are typically granted with an exercise price at least equal to the fair market value of the Class A Common stock on the date the options are granted. Information regarding these option plans is as follows:
1999 1998 1997 - --------------------------------------------------------------------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Shares Price Shares Price Shares Price - --------------------------------------------------------------------------------------------------------------------------- Options outstanding, beginning of year 3,446,170 $ 14.39 3,117,612 $ 13.18 3,242,160 $ 12.43 Options granted 427,000 19.53 826,500 17.12 324,500 17.00 Options exercised (515,864) 11.94 (386,142) 11.07 (162,248) 8.78 Options forfeited or expired (36,750) 16.53 (111,800) 12.26 (286,800) 11.53 ----------------------------------------------------------------------- Options outstanding, end of year(1) 3,320,556 $ 15.40 3,446,170 $ 14.39 3,117,612 $ 13.18 ======================================================================= Options exercisable, end of year 2,160,486 $ 14.03 2,468,233 $ 13.32 2,556,087 $ 12.42 ======================================================================= Option price range at end of year $8.00 to $20.44 $8.00 to $19.00 $8.00 to $17.00 Option price range for exercised shares $8.00 to $17.00 $8.00 to $17.00 $8.00 to $15.00 Options available for grant at end of year 467,341 7,591 747,291
(1) Included in the options outstanding at the end of 1999 and 1998 are 420,000 options ("Target Price Options") with an exercise price of $17.00, which become exercisable based on the Company's Class A Common stock achieving certain target prices, with one-half of those options becoming exercisable at $28.00 and the remaining one-half becoming exercisable at $32.00. In 1998, the Company recorded approximately $1 million in compensation expense related to such options. 57 In 1999, all options were granted with an exercise price that exceeded the market value on the grant date ("out-of-the-money"), and such options had a weighted average exercise price of $19.53 per share and a fair value of $9.61 per share. Of the total options granted in 1998, 96% were granted out-of-the-money at an exercise price of $17.03 per share and a weighted average fair value of $3.65 per share. The remaining 4% were granted with an exercise price that was lower than the market value on the grant date ("in-the-money"), and such options had a weighted average exercise price of $19.00 per share and a weighted average fair value of $7.59 per share. In 1997, all options were granted out-of-the-money at an exercise price of $17.00 per share and a fair value of $5.79 per share. Stock options outstanding at December 31, 1999 and related exercise price and weighted average remaining life information is as follows: Weighted Average Options Options Remaining Life Exercise Prices Outstanding Exercisable (in years) - ---------------------------------------------------------------------- $ 8.00 to $11.00 290,916 290,916 2.21 $11.01 to $14.00 684,200 684,200 3.81 $14.01 to $17.00 1,868,440 1,157,120 5.95 $17.01 to $21.00 477,000 28,250 9.05 --------------------------- 3,320,556 2,160,486 5.63 =========================== The fair value of options at date of grant was estimated using a binomial option-pricing model with the following weighted average assumptions: 1999 1998 1997 - ---------------------------------------------------------- Expected life (years) 10 7.5 10 Risk-free interest rate 4.9% 5.5% 6.3% Expected volatility 17% 26% 18% Expected dividend yield 2.0% 1.9% 2.3% The Company has adopted the disclosure-only provision of SFAS No. 123, "Accounting for Stock-Based Compensation." Accordingly, compensation cost that was recognized in 1999, 1998 and 1997 for stock options, other than Target Price Options, was not significant. Had compensation costs for the Company's stock option plans been determined based on the fair value at the grant date for awards granted during the year, pre-tax income would have been reduced by $4.1 million, $3.2 million and $1.9 million in 1999, 1998 and 1997, respectively. After-tax income would have been reduced by $2.7 million, $2.1 million and $1.2 million or $0.12, $0.09 and $0.05 per basic share and $0.11, $0.08 and $0.05 per diluted share in 1999, 1998 and 1997, respectively. 8. Income Taxes The components of the Federal income tax expense from continuing operations are as follows: (dollar amounts For the years ended December 31, in thousands) 1999 1998 1997 - --------------------------------------------------------- Current $ 9,926 $9,910 $(4,506) Deferred 1,813 425 9,906 ------------------------------ Income tax expense $11,739 $10,335 $ 5,400 ============================== In addition, the Company recognized a deferred Federal income tax benefit of $1.5 million related to the cumulative effect of accounting change recorded in 1999. The Company also recognized current and deferred Federal income tax benefits of $374,000 and $2.2 million, respectively, related to the extraordinary loss recorded in 1997. A reconciliation between the total income tax expense and the amounts computed at the Statutory Federal income tax rate of 35% is as follows: For the years ended December 31, (dollar amounts in thousands) 1999 1998 1997 - ---------------------------------------------------------------------- Computed at the Statutory Federal income tax rate $ 14,032 $ 19,274 $ 8,804 Increase (decrease) in taxes resulting from: Reversal of income tax accruals (2,672) (12,637) (3,703) Tax-exempt interest -- -- (61) Other 379 3,698 360 -------------------------------------- Income tax expense $ 11,739 $ 10,335 $ 5,400 ====================================== 58 The tax effects of significant temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that represent the net deferred tax asset are as follows: December 31, (dollar amounts in thousands) 1999 1998 - -------------------------------------------------------------------- Discounting of unpaid losses and LAE $ 56,817 $ 55,945 Unrealized depreciation of investments 25,223 -- Tax credit carryforwards 21,705 29,039 Unearned premiums 15,612 14,305 Allowance for uncollectible accounts 6,188 6,822 Postretirement benefit obligation 5,179 5,160 Other 14,489 12,823 ------------------------- Gross deferred tax asset 145,213 124,094 ------------------------- Deferred acquisition costs (17,021) (17,377) Unrealized appreciation of investments -- (16,163) Losses of foreign reinsurance affiliate (21,130) (24,542) Other (1,699) (2,083) ------------------------- Gross deferred tax liability (39,850) (60,165) ------------------------- Net deferred tax asset $ 105,363 $ 63,929 ========================= At December 31, 1999, the Company had approximately $21.3 million of alternative minimum tax credit carryforwards, which do not expire. Management believes that it is more likely than not that the benefit of its deferred tax asset will be fully realized, and therefore has not recorded a valuation allowance. The Company's Federal income tax returns are subject to audit by the Internal Revenue Service ("IRS"), and provisions are made in the financial statements in anticipation of the results of these audits. The Company's 1996 Federal income tax return is currently under examination by the IRS. In 1998, the IRS completed their examination of the 1994 and 1995 U.S. Federal tax returns. In 1997, the IRS completed their examinations of the 1992 and 1993 U.S. Federal tax returns. In management's opinion, adequate liabilities have been established for all years. In December 1998, the Company received a refund from the IRS of approximately $15.0 million. The refund relates to a claim for refund filed by the Company with regard to its 1992 income tax return. In 1997, the Company received a refund from the IRS of approximately $16.8 million as a result of a net operating loss, which was generated in 1996 and carried back to 1993, 1994 and 1995. 9. Employee Retirement, Postretirement and Postemployment Benefits A. Pension and Other Postretirement Benefits: Pension Benefits -- The Company sponsors a qualified non-contributory defined benefit pension plan (the "Qualified Pension Plan") covering substantially all employees. After meeting certain qualifications, an employee acquires a vested right to future benefits. The benefits payable under the plan are generally determined on the basis of an employee's length of employment and modified career average salary. The Company's policy is to fund pension costs in accordance with the Employee Retirement Income Security Act of 1974. The Company also maintains non-qualified unfunded supplemental defined benefit pension plans (the "Non-qualified Pension Plans") for the benefit of certain key employees. The projected benefit obligation and accumulated benefit obligation for the Non-qualified Pension Plans were $3.9 million and $3.6 million, respectively, as of December 31, 1999. Other Postretirement Benefits -- In addition to providing pension benefits, the Company provides certain health care benefits for retired employees and their spouses. Substantially all of the Company's employees may become eligible for those benefits if they meet the requirements for early retirement under the Pension Plan and have a minimum of 10 years employment with the Company. For employees who retired on or subsequent to January 1, 1993, the Company will pay a fixed portion of medical insurance premiums. Retirees will absorb future increases in medical premiums. The Company also provides Medicare Part B reimbursement for certain retirees as well as retiree life insurance. 59 The following tables set forth the amounts recognized in the Company's financial statements with respect to Pension Benefits and Other Postretirement Benefits:
Pension Benefits Other Postretirement Benefits December 31, December 31, (dollar amounts in thousands) 1999 1998 1999 1998 - --------------------------------------------------------------------------------------------------------------------------- Change in benefit obligation: Benefit obligation at beginning of year $ 50,280 $ 47,125 $ 9,169 $ 9,673 Service cost 1,597 1,780 286 271 Interest cost 3,372 3,201 622 594 Plan amendments 1,177 310 -- -- Actuarial (gain) loss (7,335) 168 (975) (870) Benefits paid (2,209) (2,304) (411) (499) ------------------------------------------------------------- Benefit obligation at end of year $ 46,882 $ 50,280 $ 8,691 $ 9,169 ------------------------------------------------------------- Change in plan assets: Fair value of plan assets at beginning of year $ 42,816 $ 40,600 $ -- $ -- Actual return on plan assets 6,931 2,660 -- -- Employer contributions 1,689 1,860 -- -- Benefits paid (2,209) (2,304) -- -- ------------------------------------------------------------- Fair value of plan assets at end of year $ 49,227 $ 42,816 $ -- $ -- ------------------------------------------------------------- Benefit obligation (greater) less than the fair value of plan assets $ 2,345 $ (7,464) $ (8,691) $ (9,169) Unrecognized actuarial (gain) loss (4,722) 5,894 (4,957) (4,137) Unrecognized prior service (cost) benefit 507 (700) (1,079) (1,198) Unrecognized net transition obligation 321 316 -- -- ------------------------------------------------------------- Accrued benefit at end of year $ (1,549) $ (1,954) $(14,727) $(14,504) =============================================================
Pension Benefits Other Postretirement Benefits For the years ended December 31, For the years ended December 31, (dollar amounts in thousands) 1999 1998 1997 1999 1998 1997 - --------------------------------------------------------------------------------------------------------------------------- Components of net periodic benefit cost: Service cost $ 1,597 $ 1,780 $ 1,468 $ 286 $ 271 $ 237 Interest cost 3,372 3,201 3,200 622 594 655 Expected return on plan assets (3,619) (3,496) (3,159) -- -- -- Amortization of transition obligation (5) (3) (23) -- -- -- Amortization of prior service cost (30) (91) (99) (119) (119) (119) Recognized actuarial (gain) loss 4 (11) -- (155) (188) (123) Settlement charge -- -- 115 -- -- -- ------------------------------------------------------------------- Net periodic benefit cost $ 1,319 $ 1,380 $ 1,502 $ 634 $ 558 $ 650 =================================================================== Weighted average assumptions: Discount rate 7.75% 6.75% 7.00% 7.75% 6.75% 7.00% Expected return on plan assets 9.00% 9.00% 9.00% -- -- -- Rate of compensation increase 5.00% 4.50% 4.50% -- -- --
60 For the measurement of Other Postretirement Benefits, a 6.50% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1999. The rate was assumed to decrease gradually to 5.50% for 2002 and remain at that level thereafter. A one percentage point change in assumed health care cost trend rates would have an immaterial impact on the total service and interest cost components of the net periodic benefit cost and the postretirement benefit obligation. Qualified Pension Plan assets consist of equity securities, fixed maturity securities and fixed income contracts. The Pension Plan owned approximately 249,000 shares of the Company's common stock at December 31, 1998. All 249,000 shares were sold during 1999. During 1997, an annuity contract with a third party was terminated, resulting in a one-time settlement charge of approximately $115,000. B. Defined Contribution Savings Plan -- The Company also maintains a voluntary defined contribution savings plan covering substantially all employees. The Company matches employee contributions up to 5% of compensation. Contributions under such plans charged to income were $2.3 million, $2.0 million and $1.7 million in 1999, 1998 and 1997, respectively. C. Postemployment Benefits -- The Company provides certain benefits to employees subsequent to their employment, but prior to retirement including severance, long-term and short-term disability payments, salary continuation, postemployment health benefits, supplemental unemployment benefits and other related payments. Postemployment benefits attributable to prior service and/or that relate to benefits that vest or accumulate are accrued presently if the payments are probable and reasonably estimable. Postemployment benefits that do not meet such criteria are accrued when payments are probable and reasonably estimable. 10. Fair Value of Financial Instruments As of December 31, 1999 and 1998, the carrying amounts for the Company's financial instruments approximated their estimated fair value, except for interest rate swaps which had a carrying value of zero and a fair value of $305,000 and ($5.8) million at December 31, 1999 and 1998, respectively. The Company measures the fair value of fixed maturities and interest rate swaps based upon quoted market prices or by obtaining quotes from dealers. The fair value of long-term debt is estimated using discounted cash flow calculations based upon the Company's current incremental borrowing rate for similar types of borrowing facilities or the rate utilized to prepay obligations, where applicable. For other financial instruments, the carrying values approximate their fair values. Certain financial instruments, specifically amounts relating to insurance contracts, are excluded from this disclosure. 11. Transactions with Related Parties The Company's largest shareholder is PMA Foundation (the "Foundation"), a not-for-profit corporation qualified under Section 501(c)(6) of the Internal Revenue Code, whose purposes include the promotion of the common business interests of its members and the economic prosperity of the Commonwealth of Pennsylvania. As of December 31, 1999, the Foundation owned 4,561,225 shares of Common stock (36.1% of the class) and 912,225 shares of Class A Common stock (9.4% of the class), which constitutes 34.2% of the total number of votes available to be cast in matters brought before the Company's shareholders. All of the members of the Company's Board of Directors currently serve as members of the Foundation's Board of Trustees. Also, Frederick W. Anton III, Chairman of the Company, serves as President and Chief Executive Officer of the Foundation. The Company and certain of its subsidiaries provide certain administrative services to the Foundation for which the Company and its subsidiaries receive reimbursement. Total reimbursements amounted to $13,000, $14,000 and $34,000 for the years ended December 31, 1999, 1998 and 1997, respectively. The Foundation also leases its Harrisburg, Pennsylvania headquarters facility from a subsidiary of the Company under an operating lease presently requiring rent payments of $25,000 per month, and reimburses a subsidiary of the Company for its use of office space in the Blue Bell, Pennsylvania facility. Rent and related reimbursements paid to the Company's affiliates by the Foundation amounted to $304,000, $262,000 and $250,000 for the years ended December 31, 1999, 1998 and 1997, respectively. 61 The Company incurred legal and consulting fees aggregating approximately $5.3 million, $6.5 million and $6.5 million in 1999, 1998 and 1997, respectively, from firms in which directors of the Company are partners or principals. The Company has notes receivable from officers that are accounted for as a reduction of shareholders' equity in the accompanying balance sheets. Such notes receivable had balances of $56,000 and $498,000 as of December 31, 1999 and 1998, respectively. The interest rates on the notes range between 6% and 8%. The Company has arranged an executive loan program with a financial institution. The institution provides personal demand loans to officers of the Company at a floating interest rate equal to the financial institution's prime rate minus 1/2%. Such loans are collateralized by Common Stock and Class A Common Stock beneficially owned by the officer and a Company treasury security. The Company has agreed to purchase any loan made to an officer (including accrued interest and related expenses) from the financial institution in the event that the borrower defaults on the loan. The amount of loans outstanding to current employees as of December 31,1999 under this program was $729,847. 12. Commitments and Contingencies For the years ended December 31, 1999, 1998 and 1997, total rent expense was $2.7 million, $2.6 million and $2.8 million, respectively. At December 31, 1999, the Company was obligated under noncancelable operating leases for office space with aggregate minimum annual rentals of $3.8 million in 2000, $4.1 million in 2001, $3.9 million in 2002, $3.6 million in 2003, $3.2 million in 2004 and $4.3 million thereafter. In the event a property and casualty insurer operating in a jurisdiction where the Company's insurance subsidiaries also operate becomes or is declared insolvent, state insurance regulations provide for the assessment of other insurers to fund any capital deficiency of the insolvent insurer. Generally, this assessment is based upon the ratio of an insurer's voluntary premiums written to the total premiums written for all insurers in that particular jurisdiction (see Note 2-J regarding SOP 97-3). The Company has provided guarantees of approximately $7.7 million, primarily related to loans on properties in which the Company has an interest. The Company is continuously involved in numerous lawsuits arising, for the most part, in the ordinary course of business, either as a liability insurer defending third party claims brought against its insureds, or as an insurer defending coverage claims brought against it by its policyholders or other insurers. While the outcome of all litigation involving the Company, including insurance-related litigation, cannot be determined, litigation is not expected to result in losses that differ from recorded reserves by amounts that would be material to the Company's financial condition, results of operations or liquidity. In addition, reinsurance recoveries related to claims in litigation, net of the allowance for uncollectible reinsurance, are not expected to result in recoveries that differ from recorded recoverables by amounts that would be material to the Company's financial condition, results of operations or liquidity. 13. Cost Reduction Initiatives During 1997, the Company recorded a $7.0 million pre-tax charge ($4.6 million after-tax) in operating expenses for costs associated with nonvoluntary terminations of approximately 60 employees in various operational and management positions. As of December 31, 1999, approximately $1.5 million of such charges remained in accounts payable and accrued expenses on the balance sheet. 14. Shareholders' Equity The Company has two classes of Common stock, Class A Common stock and Common stock. The Company's bylaws limit the classes of persons who may own the Common stock. Holders of Common stock may elect to convert any or all such shares into Class A Common stock on a share-for-share basis. The Company's Class A Common stock and Common stock generally vote without regard to class on matters submitted to shareholders, with the Class A Common stock having one vote per share and the Common stock having ten votes per share. With respect to dividend rights, the Class A Common stock is entitled to cash dividends at least 10% higher than those declared and paid on the Common stock. The Company declared dividends on its Common stock and Class A Common stock of $0.32 per share and $0.36 per share, respectively, in 1999, 1998 and 1997. 62 Changes in Common stock and Class A Common stock shares were as follows:
For the years ended December 31, 1999 1998 1997 - ----------------------------------------------------------------------------------------------------------------- Common stock: Balance at beginning of year 13,956,268 15,286,263 16,095,416 Conversion of Common stock into Class A Common stock (871,603) (1,329,995) (809,153) ----------------------------------------------- Balance at end of year 13,084,665 13,956,268 15,286,263 =============================================== Class A Common stock: Balance at beginning of year 10,486,677 9,156,682 8,247,804 Conversion of Common stock into Class A Common stock 871,603 1,329,995 809,153 Issuance of shares -- -- 99,725 ----------------------------------------------- Balance at end of year 11,358,280 10,486,677 9,156,682 =============================================== Treasury stock - Common stock: Balance at beginning of year 436,007 435,474 425,364 Purchase of treasury shares -- 533 10,110 ----------------------------------------------- Balance at end of year 436,007 436,007 435,474 =============================================== Treasury stock - Class A Common stock: Balance at beginning of year 648,714 38,947 74,781 Purchase of treasury shares 1,526,500 995,909 27,689 Reissuance of treasury shares under employee benefit plans (509,788) (386,142) (63,523) ----------------------------------------------- Balance at end of year 1,665,426 648,714 38,947 ===============================================
In 1998, the Company's Board of Directors authorized a plan to repurchase shares of Common stock and Class A Common stock in an amount not to exceed $25.0 million. In 1999, an additional $50.0 million of share repurchase authority was approved by the Company's Board of Directors. During 1999, the Company repurchased a total of approximately 1.5 million Class A shares at a total cost of $30.2 million (average per share price was $19.81). During 1998, the Company repurchased a total of approximately 1.0 million shares at a total cost of $18.9 million (average per share price was $18.92). Since the inception of its share repurchase program in February 1998, PMA Capital has repurchased a total of approximately 2.5 million Class A shares at a total cost of $49.1 million (average per share price was $19.46), leaving $25.9 million of share repurchase authorization. Decisions regarding share repurchases are subject to the costs and benefits associated with alternative uses of capital and prevailing market conditions. The Company's domestic insurance subsidiaries' ability to pay dividends to the holding company is limited by the insurance laws and regulations of Pennsylvania and Delaware (the laws of which are substantially similar with respect to dividends). Under Pennsylvania laws and regulations, without prior approval of the Pennsylvania Insurance Commissioner (the "Commissioner"), dividends may not be paid in excess of the greater of (i) 10% of policyholders' surplus as of the end of the preceding year or (ii) SAP net income for the preceding year, but in no event to exceed SAP unassigned surplus. At December 31, 1999, the maximum amount available to be paid as dividends from the Company's insurance subsidiaries to PMA Capital, without the prior consent of the Pennsylvania Insurance Department, was approximately $55 million. PMA Capital's dividends to shareholders are restricted by its debt agreements. Under the terms of the Credit Facility and the Letter of Credit Agreement, under the most restrictive debt covenant, the Company could pay dividends of approximately $10 million in 2000. 63 15. Earnings Per Share A reconciliation of the shares used as the denominator of the basic and diluted earnings per share computations is presented below. 1999 1998 1997 - -------------------------------------------------------------------- Basic shares - weighted average Common and Class A Common shares outstanding 22,976,326 23,608,618 23,855,031 Effect of dilutive stock options 809,590 916,270 712,347 ----------------------------------------- Total diluted shares 23,785,916 24,524,888 24,567,378 ========================================= For all years presented, there were no differences in the numerator (income before extraordinary item and cumulative effect of accounting change) for the basic and diluted earnings per share calculation. Options to purchase shares of Class A Common stock are excluded from the computation of diluted earnings per share if they would have been anti-dilutive, and for 1999, 1998 and 1997, such anti-dilutive options were 12,500, 42,000 and 646,000, respectively. 16. Business Segments The Company's pre-tax operating income by principal business segment were as follows:
For the years ended December 31, (dollar amounts in thousands) 1999 1998 1997 - ----------------------------------------------------------------------------------------------------------------------- Components of pre-tax operating income and net income(1): PMA Re $ 50,319 $ 46,408 $ 45,957 The PMA Insurance Group: Excluding Run-off Operations 18,389 10,018 (3,607) Run-off Operations (189) 452 (73) ---------------------------------------- Total 18,200 10,470 (3,680) Caliber One 83 (1,606) -- Corporate and Other (20,765) (21,948) (25,722) ---------------------------------------- Pre-tax operating income 47,837 33,324 16,555 Net realized investment gains (losses) (7,745) 21,745 8,598 ---------------------------------------- Income before income taxes, extraordinary loss and cumulative effect of accounting change 40,092 55,069 25,153 Income tax expense 11,739 10,335 5,400 ---------------------------------------- Income before extraordinary loss and cumulative effect of accounting change 28,353 44,734 19,753 Extraordinary loss, net of tax -- -- (4,734) Cumulative effect of accounting change, net of tax (2,759) -- -- ---------------------------------------- Net income $ 25,594 $ 44,734 $ 15,019 ========================================
(1) Pre-tax operating income is defined as income from continuing operations before income taxes, excluding net realized investment gains (losses). The Company excludes net realized investment gains (losses) from the profit and loss measure it utilizes to assess the performance of its operating segments because: (i) net realized investment gains (losses) are unpredictable and not necessarily indicative of current operating fundamentals or future performance, and (ii) in many instances, decisions to buy and sell securities are made at the holding company level, and such decisions result in net realized gains (losses) that do not relate to the operations of the individual segments. 64 The Company's revenues, all of which are generated within the U.S., by principal business segment were as follows:
For the years ended December 31, (dollar amounts in thousands) 1999 1998 1997 Revenues: PMA Re $ 351,548 $ 278,293 $ 215,873 The PMA Insurance Group: Excluding Run-off Operations 277,890 311,469 328,248 Run-off Operations 4,412 4,761 (23,491) --------------------------------------- Total 282,302 316,230 304,757 Caliber One 27,188 3,203 -- Corporate and Other 1,824 4,010 2,330 Net realized investment gains (losses) (7,745) 21,745 8,598 --------------------------------------- Total revenues $ 655,117 $ 623,481 $ 531,558 =======================================
The Company recorded amortization and depreciation expense of $7.4 million, $7.1 million and $12.7 million in 1999, 1998 and 1997, respectively. PMA Re and The PMA Insurance Group recorded amortization and depreciation expense of $2.8 million and $3.0 million, respectively, in 1999; $2.0 million and $4.2 million, respectively, in 1998; and $2.5 million and $7.6 million, respectively, in 1997. The Company's total assets by principal business segment were as follows:
December 31, (dollar amounts in thousands) 1999 1998 1997 - -------------------------------------------------------------------------------- Assets(1): PMA Re $ 1,351,962 $ 1,417,901 $ 1,102,242 The PMA Insurance Group: Excluding Run-off Operations 1,667,673 1,883,575 1,452,469 Run-off Operations 79,003 95,110 398,959 ---------------------------------------------- Total 1,746,676 1,978,685 1,851,428 Caliber One 160,194 69,083 64,302 Corporate and Other (13,745) (4,951) 39,286 ---------------------------------------------- Total assets $ 3,245,087 $ 3,460,718 $ 3,057,258 ==============================================
(1) Equity investments in subsidiaries, which eliminate in consolidation, are excluded from total assets for each segment. PMA Re distributes its products through major reinsurance brokers, and PMA Re's top four such brokers accounted for approximately 83% of PMA Re's gross premiums in force at December 31, 1999. During 1999, 1998 and 1997, total revenues amounting to $158.8 million, $70.6 million and $54.8 million, respectively, were placed through brokers which individually exceeded 10% of the Company's total revenue. In 1999, 1998 and 1997, casualty reinsurance lines at PMA Re represented 35.3%, 35.5% and 31.2%, respectively, of the Company's total net premiums written. The PMA Insurance Group's operations are concentrated in seven contiguous states in the Mid-Atlantic and Southern regions of the U.S. As such, economic trends in individual states may not be independent of one another. Also, The PMA Insurance Group's products are highly regulated by each of these states. For many of The PMA Insurance Group's products, the insurance departments of the states in which it conducts business must approve rates and policy forms. In addition, workers' compensation benefits are determined by statutes and regulations in each of these states. While The PMA Insurance Group considers factors such as rate adequacy, regulatory climate and economic factors in its underwriting process, unfavorable developments in these factors could have an adverse impact on the Company's financial condition 65 and results of operations. In 1999, 1998 and 1997, workers' compensation net premiums at The PMA Insurance Group represented 31.8%, 39.4% and 46.0%, respectively, of the Company's total net premiums written. The Company actively manages its exposure to catastrophes through its underwriting process, where the Company generally monitors the accumulation of insurable values in catastrophe prone regions. Also, in writing property reinsurance coverages, PMA Re typically requires per occurrence loss limitations for contracts that could have catastrophe exposure. Through per risk reinsurance, the Company also manages its net retention in each exposure. In addition, PMA Re maintains retrocessional protection of $48.0 million in excess of $2.0 million per occurrence, The PMA Insurance Group maintains catastrophe reinsurance protection of $27.7 million in excess of $850,000 and Caliber One maintains catastrophe reinsurance protection of $19.3 million in excess of $750,000. As a result, the Company's loss and LAE ratios have not been significantly impacted by catastrophes in 1999, 1998 or 1997. Although the Company believes that it has adequate reinsurance to protect against the estimated probable maximum gross loss from a catastrophe, an especially severe catastrophe or series of catastrophes could exceed the Company's reinsurance and/or retrocessional protection, and may have a material adverse impact on the Company's financial condition, results of operations and liquidity. 17. Statutory Financial Information These consolidated financial statements vary in certain respects from those prepared using statutory accounting practices prescribed or permitted by the Pennsylvania Insurance Department and the Delaware Insurance Department, (collectively "SAP"). Prescribed SAP includes state laws, regulations and general administrative rules, as well as a variety of National Association of Insurance Commissioners ("NAIC") publications. Permitted SAP encompasses all accounting practices that are not prescribed. In 1998, the NAIC adopted the Codification of Statutory Accounting Principles ("Codification") guidance, which will replace the current Accounting Practices and Procedures manual as the NAIC's primary guidance on statutory accounting beginning in 2001. Codification provides guidance for areas where statutory accounting has been silent and changes current statutory accounting in some areas, such as deferred income taxes, which will be recorded under Codification. Effective January 1, 2001 the Company's insurance subsidiaries will implement the Codification guidelines. The Company is in the process of assessing the impact that Codification will have on its statutory surplus and currently expects that the impact of adopting Codification will not be material. SAP net income (loss) and capital and surplus for PMA Capital's domestic insurance subsidiaries are as follows: (dollar amounts in thousands) 1999 1998 1997 - ------------------------------------------------------------------------------- SAP net income (loss): PMA Reinsurance Corporation $ 34,412 $ 29,746 $ 25,752 The PMA Insurance Group (domestic insurance subsidiaries) 6,963 23,034 10,785 Caliber One Indemnity Company (5,453) (90) -- ---------------------------------------- Total $ 35,922 $ 52,690 $ 36,537 ======================================== SAP capital and surplus: PMA Reinsurance Corporation(1) $ 287,635 $ 287,466 $ 271,154 The PMA Insurance Group (domestic insurance subsidiaries) 265,162 281,947 281,071 ---------------------------------------- Total $ 552,797 $ 569,413 $ 552,225 ======================================== (1)The SAP capital and surplus of PMA Reinsurance Corporation includes PMA Reinsurance Corporation's investment in Caliber One Indemnity Company of $32.8 million in 1999 and $25.0 million in 1998 and 1997. 66 A reconciliation of PMA Capital's domestic insurance subsidiaries' SAP net income to the Company's GAAP net income is as follows:
For the years ended December 31, (dollar amounts in thousands) 1999 1998 1997 - ------------------------------------------------------------------------------------------ SAP net income - domestic insurance subsidiaries $ 35,922 $ 52,690 $ 36,537 GAAP adjustments: Change in deferred acquisition costs (1,159) 4,504 1,282 Benefit for deferred income taxes 3,937 14,012 4,725 Cumulative effect of accounting change (2,759) -- -- Allowance for doubtful accounts 1,750 -- -- Guaranty fund and loss based assessments 1,306 -- -- Other 4,700 4,366 1,131 -------------------------------------- GAAP net income - domestic insurance subsidiaries 43,697 75,572 43,675 Other entities and eliminations (18,103) (30,838) (23,922) Extraordinary loss -- -- (4,734) -------------------------------------- GAAP net income $ 25,594 $ 44,734 $ 15,019 ======================================
A reconciliation of PMA Capital's domestic insurance subsidiaries' SAP capital and surplus to the Company's GAAP shareholders' equity is as follows:
December 31, (dollar amounts in thousands) 1999 1998 1997 - --------------------------------------------------------------------------------------------------------------------------- SAP capital and surplus - domestic insurance subsidiaries $ 552,797 $ 569,413 $ 552,225 GAAP adjustments: Deferred acquisition costs 47,946 49,118 45,288 Deferred income taxes 78,371 71,443 52,571 Allowance for doubtful accounts (21,550) (19,650) (19,700) Retirement accruals (9,965) (10,244) (10,653) Reversal of non-admitted assets 21,136 22,711 21,330 Unrealized gain (loss) on fixed maturities available for sale (40,654) 27,506 19,380 Other 15,000 13,569 3,254 ---------------------------------------- GAAP shareholders' equity - domestic insurance subsidiaries 643,081 723,866 663,695 Other entities and eliminations (213,938) (212,386) (185,348) ---------------------------------------- GAAP shareholders' equity $ 429,143 $ 511,480 $ 478,347 ========================================
18. Dispositions Effective July 1, 1998, the Company sold PMA Insurance, Cayman Ltd. ("PMA Cayman"), one of the entities included in The PMA Insurance Group's Run-off Operations, which reinsures claims for certain policies written by other members of The PMA Insurance Group, to a third party for a purchase price of $1.8 million and recorded an after-tax loss of $1.6 million. This transaction included the transfer of $231.5 million in cash and invested assets to the buyer. At December 31, 1999, the Company has recorded $240.8 million in reinsurance receivables related to this transaction, all of which are secured by assets in trust or by letters of credit. If the actual claim payments in the aggregate exceed the estimated payments upon which the loss reserves have been established, the Company has agreed to indemnify the buyer, up to a maximum of $15.0 million. If the actual claim payments in the aggregate are less than the estimated payments upon which the loss reserves have been established, the Company will participate in such favorable loss reserve development. 67 [PricewaterhouseCoopers LLP LOGO] Report of Independent Accountants To the Board of Directors and Shareholders of PMA Capital Corporation In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, shareholders' equity, cash flows and comprehensive income (loss) present fairly, in all material respects, the financial position of PMA Capital Corporation and its subsidiaries at December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999 in conformity with accounting principles generally accepted in the United States. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ PricewaterhouseCoopers LLP 1177 Avenue of the Americas New York, New York February 2, 2000 68 Quarterly Financial Information (Unaudited) The following unaudited quarterly financial data are presented on a consolidated basis for each of the years ended December 31, 1999 and 1998. Quarterly financial results necessarily rely on estimates and caution is required in drawing specific conclusions from quarterly consolidated results.
First Second Third Fourth Quarter Quarter Quarter Quarter - ------------------------------------------------------------------------------------------------------------------ 1999 Income Statement Data: Total revenues $140,446 $157,168 $156,034 $201,469 Income before income taxes 13,147 6,381 10,369 10,195 Income before cumulative effect of accounting change 8,468 6,746 6,512 6,627 Net income 5,709 6,746 6,512 6,627 Per Share Data: Basic: Income before cumulative effect of accounting change $ 0.37 $ 0.29 $ 0.28 $ 0.29 Net income 0.25 0.29 0.28 0.29 Diluted: Income before cumulative effect of accounting change 0.35 0.28 0.27 0.28 Net income 0.24 0.28 0.27 0.28 Class A Common Stock Prices: High $ 20.31 $ 21.00 $ 21.00 $ 20.38 Low 17.63 19.00 19.38 19.38 Close 20.13 20.56 20.00 19.88 1998 Income Statement Data: Total revenues $149,386 $153,743 $149,471 $170,881 Income before income taxes 14,741 10,775 12,584 16,969 Net income 12,088 9,357 10,552 12,737 Per Share Data: Net income (Basic) $ 0.51 $ 0.39 $ 0.45 $ 0.54 Net income (Diluted) 0.49 0.38 0.43 0.52 Class A Common Stock Prices: High $ 19.38 $ 23.00 $ 22.69 $ 19.63 Low 15.75 17.63 17.25 16.75 Close 18.00 23.00 19.50 19.56
The Company had 326 recordholders of Class A Common stock and 142 recordholders of Common stock at January 31, 2000. For each of the quarters in the two years ended December 31, 1999, the Company declared a quarterly dividend of $0.08 and $0.09 per share for its Common stock and Class A Common stock, respectively. 69 Securities Listing The Corporation's Class A Common stock is listed on The Nasdaq Stock Market(R). It trades under the stock symbol: PMACA [PMACA LOGO] Dividends PMA Capital Corporation's quarterly dividends on Common stock and Class A Common stock are paid on or about the first day of January, April, July and October. Each share of Class A Common stock is entitled to a cash dividend at least 10% higher than any cash dividend paid on the Common stock. 72 EX-21 7 EXHIBIT 21 PMA Capital Corporation Significant Subsidiaries of Registrant As of December 31, 1999 PMA Capital Corporation (Pennsylvania) PMA Reinsurance Corporation (Pennsylvania) Caliber One Indemnity Company (Delaware) Pennsylvania Manufacturers' Association Insurance Company (Pennsylvania) PMA Management Corporation (Pennsylvania) PMA Services Incorporated (Pennsylvania) Presque Enterprises Incorporated (Pennsylvania) Pennsylvania Manufacturers Indemnity Company (Pennsylvania) Manufacturers Alliance Insurance Company (Pennsylvania) Mid-Atlantic States Investment Company (Delaware) Mid-Atlantic States Casualty Company (Pennsylvania) PMA Holdings Cayman, Ltd. (Cayman) PMA International Insurance Cayman, Ltd. (Cayman) High Mountain Reinsurance, Ltd. (Cayman) PMA Insurance SPC (Cayman) Caliber One Management Company, Inc. (Delaware) PMA Holdings Limited (Bermuda) Pennsylvania Manufacturers International Insurance, Ltd. (Bermuda) PMA Life Insurance Company (Pennsylvania) EX-23 8 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (File No. 333-45949, File No. 333-68855 and File No. 333-77111) of PMA Capital Corporation of our report dated February 2, 2000 relating to the financial statements, which appears in the 1999 Annual Report to Shareholders, which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report dated February 2, 2000 relating to the financial statement schedules, which appears in this Form 10-K. /s/ PricewaterhouseCoopers LLP New York, New York March 29, 2000 EX-24.1 9 Exhibit 24.1 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director and officer of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Robert L. Pratter, Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1999 and all amendments thereto; (ii)any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-77111, 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2001. IN WITNESS WHEREOF, the undersigned has executed this document as of the 2nd day of February 2000. /s/ Frederick W. Anton III ---------------------------------- Frederick W. Anton III POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Robert L. Pratter, Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1999 and all amendments thereto; (ii)any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-77111, 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2001. IN WITNESS WHEREOF, the undersigned has executed this document as of the 2nd day of February 2000. /s/ Paul I. Detwiler, Jr. ---------------------------------- Paul I. Detwiler, Jr. POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Robert L. Pratter, Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1999 and all amendments thereto; (ii)any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-77111, 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2001. IN WITNESS WHEREOF, the undersigned has executed this document as of the 2nd day of February 2000. /s/ Joseph H. Foster ---------------------------------- Joseph H. Foster POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Robert L. Pratter, Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1999 and all amendments thereto; (ii)any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-77111, 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2001. IN WITNESS WHEREOF, the undersigned has executed this document as of the 2nd day of February 2000. /s/ Anne S. Genter ---------------------------------- Anne S. Genter POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Robert L. Pratter, Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1999 and all amendments thereto; (ii)any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-77111, 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2001. IN WITNESS WHEREOF, the undersigned has executed this document as of the 2nd day of February 2000. /s/ James F. Malone, III ---------------------------------- James F. Malone, III POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Robert L. Pratter, Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1999 and all amendments thereto; (ii)any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-77111, 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2001. IN WITNESS WHEREOF, the undersigned has executed this document as of the 2nd day of February 2000. /s/ A. John May ---------------------------------- A. John May POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Robert L. Pratter, Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1999 and all amendments thereto; (ii)any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-77111, 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2001. IN WITNESS WHEREOF, the undersigned has executed this document as of the 2nd day of February 2000. /s/ Louis N. McCarter, III ---------------------------------- Louis N. McCarter, III POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Robert L. Pratter, Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1999 and all amendments thereto; (ii)any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-77111, 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2001. IN WITNESS WHEREOF, the undersigned has executed this document as of the 2nd day of February 2000. /s/ John W. Miller, Jr. ---------------------------------- John W. Miller, Jr. POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Robert L. Pratter, Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1999 and all amendments thereto; (ii) any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-77111, 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2001. IN WITNESS WHEREOF, the undersigned has executed this document as of the 2nd day of February 2000. /s/ Edward H. Owlett ---------------------------------- Edward H. Owlett POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Robert L. Pratter, Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1999 and all amendments thereto; (ii)any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-77111, 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2001. IN WITNESS WHEREOF, the undersigned has executed this document as of the 2nd day of February 2000. /s/ Louis I. Pollock ---------------------------------- Louis I. Pollock POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Robert L. Pratter, Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1999 and all amendments thereto; (ii)any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-77111, 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2001. IN WITNESS WHEREOF, the undersigned has executed this document as of the 2nd day of February 2000. /s/ Roderic H. Ross ---------------------------------- Roderic H. Ross POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Robert L. Pratter, Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1999 and all amendments thereto; (ii)any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-77111, 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2001. IN WITNESS WHEREOF, the undersigned has executed this document as of the 2nd day of February 2000. /s/ L.J. Rowell, Jr. ---------------------------------- L.J. Rowell, Jr. POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director and officer of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Robert L. Pratter, Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1999 and all amendments thereto; (ii) any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-77111, 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2001. IN WITNESS WHEREOF, the undersigned has executed this document as of the 2nd day of February 2000. /s/ John W. Smithson ---------------------------------- John W. Smithson EX-24.2 10 Exhibit 24.2 SECRETARY'S CERTIFICATE I, Robert L. Pratter, Senior Vice President, General Counsel and Secretary of PMA Capital Corporation, a corporation organized and existing under the laws of the Commonwealth of Pennsylvania, hereby certify that the following resolutions were adopted at the February 2, 2000 meeting of the Board of Directors: RESOLVED, that the Officers of the Corporation, and each of them, are hereby authorized to sign the Corporation's Annual Report on Form 10-K for the year ended December 31, 1999, and any amendments thereto, (the "Form 10-K") in the name and on behalf the Corporation and as attorneys for each of its Directors and Officers. RESOLVED, that each Officer and Director of the Corporation who may be required to execute (whether on behalf of the Corporation or as an Officer or Director thereof) the Form 10-K, is hereby authorized to execute and deliver a power of attorney appointing such person or persons named therein as true and lawful attorneys and agents to execute in the name, place and stead (in any such capacity) of any such Officer or Director the Form 10-K and to file any such power of attorney together with the Form 10-K with the Securities and Exchange Commission. IN WITNESS WHEREOF, I have hereunto set my hand and affixed the seal of the Corporation, this 10th day of March, 2000. /s/ Robert L. Pratter ---------------------------------- Senior Vice President, General Counsel and Secretary (SEAL) EX-27 11
7 This schedule contains summary financial information extracted from the financial statements contained in Form 10-K for the year ended December 31, 1999 for PMA Capital Corporation and is qualified in its entirety by reference to such statements. 1,000 Year DEC-31-1999 JAN-01-1999 DEC-31-1999 1,579,640 0 0 34,966 0 0 1,918,035 84,261 658,164 48,949 3,245,087 1,932,601 260,352 0 13,782 163,000 0 0 122,214 306,929 3,245,087 540,087 110,057 (7,745) 12,718 392,473 124,368 85,963 40,092 11,739 0 0 0 (2,759) 25,594 1.11 1.08 1,347,194 409,554 (32,514) 103,798 351,495 1,284,374 (32,514) Represents reinsurance recoverable on paid and unpaid losses. Reserve balance is shown net of reinsurance receivables on unpaid losses and LAE. Excludes impact of accretion of prior years' discount of $15,433.
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