-----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, S5XWiOr02wlfFkpYICMxMmXeaWWvdkWoSM9bIBmdOLycXoR8Dwq/+Tv/IS6s9KDO BRVF8UKXehderaBRQXOJGw== 0001036050-98-001832.txt : 19981109 0001036050-98-001832.hdr.sgml : 19981109 ACCESSION NUMBER: 0001036050-98-001832 CONFORMED SUBMISSION TYPE: S-3/A PUBLIC DOCUMENT COUNT: 10 FILED AS OF DATE: 19981105 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PENNSYLVANIA MANUFACTURERS 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: S-3/A SEC ACT: SEC FILE NUMBER: 333-63469 FILM NUMBER: 98738855 BUSINESS ADDRESS: STREET 1: THE PMA BLDG STREET 2: 380 SENTRY PKWY CITY: BLUE BELL STATE: PA ZIP: 19422-2328 BUSINESS PHONE: 2156655046 MAIL ADDRESS: STREET 1: THE PMA BLDG STREET 2: 380 SENTRY PARKWAY CITY: BLUE BELL STATE: PA ZIP: 19422-2328 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PMC CAPITAL I CENTRAL INDEX KEY: 0001070406 STANDARD INDUSTRIAL CLASSIFICATION: [] STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-3/A SEC ACT: SEC FILE NUMBER: 333-63469-01 FILM NUMBER: 98738856 BUSINESS ADDRESS: STREET 1: 380 SENTRY PKWY CITY: BLUE BELL STATE: PA ZIP: 19422 BUSINESS PHONE: 2156655046 MAIL ADDRESS: STREET 1: 380 SENTRY PKWY CITY: BLUE BELL STATE: PA ZIP: 19422 S-3/A 1 FORM S-3/A - AMENDMENT NO. 1 As filed with the Securities and Exchange Commission on November 5, 1998 Registration No. 333-63469 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------ AMENDMENT NO. 1 TO FORM S-3 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------ PMC Capital I Pennsylvania Manufacturers Corporation - -------------------------------------- ------------------------------------------ (Exact name of registrant as specified (Exact name of registrant as specified in its charter) in its charter) Delaware Pennsylvania - --------------------------------- ------------------------------- (State or other jurisdiction of (State or other jurisdiction of incorporation or organization) incorporation or organization) Applied For 23-2217932 - -------------------------------------- ---------------------------------------- (I.R.S. Employer Identification No.) (I.R.S. Employer Identification No.) The PMA Building The PMA Building 380 Sentry Parkway 380 Sentry Parkway Blue Bell, Pennsylvania 19422-2328 Blue Bell, Pennsylvania 19422-2328 (215) 665-5046 (215) 665-5046 - -------------------------------------- ---------------------------------------- (address, including zip code, and (address, including zip code, and telephone number, including area telephone number, including area code, of registrant's principal code, of registrant's principal executive offices) executive offices)
-------------------- Francis W. McDonnell Senior Vice President and Chief Financial Officer Pennsylvania Manufacturers Corporation 1735 Market Street Philadelphia, Pennsylvania 19103-7590 (215) 665-5070 ------------------------------------------- (Name, address, including zip code, and telephone number, including area code, of agent for service) -------------------- Copies to: Robert L. Pratter, Esquire William D. Torchiana, Esquire Duane, Morris & Heckscher LLP Sullivan & Cromwell 4200 One Liberty Place 125 Broad Street Philadelphia, PA 19103-7396 New York, New York 10004 (215) 979-1000 (212) 558-4000 -------------------- Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement becomes effective. If the only securities being registered on this Form are to be offered pursuant to dividend or interest reinvestment plans, please check the following box. [_] If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 of the Securities Act of 1933 other than securities offered only in connection with dividend or interest reinvestment plans, check the following box. [_] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration number of the earlier effective registration statement for the same offering. [_] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act of 1933, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If delivery of the prospectus is expected to be made pursuant to Rule 434 under the Securities Act of 1933, please check the following box. [_] ____________________ THE REGISTRANTS HEREBY AMEND THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANTS SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. =========================================== SUBJECT TO COMPLETION PRELIMINARY PROSPECTUS DATED NOVEMBER ___, 1998 $100,000,000 PMC CAPITAL I ___ % CAPITAL SECURITIES, SERIES A (Liquidation Amount $1,000 Per Capital Security) Fully and Unconditionally Guaranteed, As Described Herein, By PENNSYLVANIA MANUFACTURERS CORPORATION ------------------------ The ___% Capital Securities, Series A (the "Capital Securities") offered hereby (the "Offering") represent undivided beneficial interests in the assets of PMC Capital I, a statutory business trust formed under the laws of the State of Delaware (the "Issuer" or the "Trust"). Pennsylvania Manufacturers Corporation ("PMC"), a Pennsylvania corporation, will be the owner of all of the beneficial interests represented by common securities (the "Common Securities") of the Issuer. The Bank of New York is the Property Trustee of the Issuer. The Issuer exists for the sole purpose of issuing the Capital Securities and the Common Securities and investing the proceeds thereof in ___% Junior Subordinated Debentures, Series A (the "Junior Subordinated Debentures") to be issued by PMC. The Junior Subordinated Debentures will mature on _________, 2028 (the "Stated Maturity"). The Capital Securities will have a preference under certain circumstances with respect to cash distributions and amounts payable on liquidation, redemption or otherwise over the Common Securities. See "Description of the Capital Securities -- Subordination of Common Securities." PMC and the Issuer do not intend to list the Capital Securities on any securities exchange. See "Risk Factors -- Liquidity of Trading; Trading Price of the Capital Securities May Not Fully Reflect Value of Unpaid Interest." Holders of the Capital Securities will be entitled to receive preferential cumulative cash distributions accruing from the date of original issuance and payable semi-annually in arrears on and of each year, commencing , 1999, at the annual rate of ___% of the liquidation amount of $1,000 per Capital Security ("distributions"). PMC has the right to defer payments of interest on the Junior Subordinated Debentures, so long as no Debenture Event of Default (as defined herein) has occurred and is continuing, at any time (continued on next page) See "Risk Factors" beginning on Page 19 hereof for certain information Relevant to an investment in the Capital Securities. ----------------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
- ------------------------------------------------------------------------------------------------------------------------ Initial Public Offering Underwriting Proceeds to the Price(1) Commissions(2) Issuer(3)(4) ----------------------- --------------------- --------------------- - ------------------------------------------------------------------------------------------------------------------------ Per Capital Security....... $1,000 (3) - ------------------------------------------------------------------------------------------------------------------------ Total ..................... $100,000,000 (3) - ------------------------------------------------------------------------------------------------------------------------
(1) Plus accrued distributions, if any, from the date of original issuance. (2) The Issuer, PMC and PMA Reinsurance Corporation have agreed to indemnify the several Underwriters against certain liabilities, including liabilities under the Securities Act of 1933, as amended. See "Underwriting." (3) In view of the fact that the proceeds of the sale of the Capital Securities will be used to purchase the Junior Subordinated Debentures, PMC has agreed to pay to the Underwriters as compensation ("Underwriters' Compensation") for their arranging the investment therein of such proceeds, $____ per Capital Security (or $_____ in the aggregate). See "Underwriting." (4) Other expenses of issuance and distribution, which are payable by PMC, are estimated to be $500,000. The Capital Securities offered hereby are offered severally by the Underwriters, as specified herein, subject to receipt and acceptance by them and subject to their right to reject any order in whole or in part. It is expected that the Capital Securities will be ready for delivery in book-entry form only through the facilities of DTC, on or about ____________, 1998, against payment therefor in immediately available funds. Goldman, Sachs & Co. Merrill Lynch & Co. First Union Capital Markets ---------------- The date of this Prospectus is _____________, 1998 [Red Herring Legend] INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. - 2 - CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE CAPITAL SECURITIES, INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT COVERING TRANSACTIONS IN SUCH SECURITIES, AND THE IMPOSITION OF A PENALTY BID, DURING AND AFTER THE OFFERING. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING." (Continued from Cover Page) and from time to time for a period not exceeding 10 consecutive semi-annual periods with respect to each deferral period (each an "Extension Period"), provided that no Extension Period may extend beyond the Stated Maturity of the Junior Subordinated Debentures. Upon the termination of any such Extension Period and the payment of all interest then accrued and unpaid (together with interest thereon at the rate of ___% per annum, compounded semi-annually, to the extent permitted by applicable law), PMC may elect to begin a new Extension Period subject to the requirements set forth herein. If interest payments are so deferred, distributions on the Capital Securities will also be deferred and PMC will not be permitted to declare or pay any distributions with respect to PMC's capital stock or make any payment on any debt securities of PMC that rank pari passu with or junior to the Junior Subordinated Debentures or make any guarantee payments with respect to any guarantee by PMC of the debt securities of any subsidiary of PMC that rank pari passu with or junior to the Junior Subordinated Debentures subject to certain exceptions described herein. During an Extension Period, interest on the Junior Subordinated Debentures will continue to accrue (and the amount of distributions to which holders of the Capital Securities are entitled will accumulate) at the rate of ___% per annum, compounded semi-annually from the relevant payment date for such interest and holders of Capital Securities will be required to accrue interest income for United States federal income tax purposes. See "Description of the Junior Subordinated Debentures--Option to Extend Interest Payment Period" and "United States Federal Income Taxation--Original Issue Discount." PMC has, through the Guarantee, the Trust Agreement, the Capital Securities, the Indenture and the Expense Agreement (each as defined herein), taken together, fully, irrevocably and unconditionally guaranteed all of the Issuer's obligations under the Capital Securities. See "Relationship Among the Capital Securities, the Junior Subordinated Debentures and the Guarantee--Full and Unconditional Guarantee." The Guarantee of PMC guarantees the payment of distributions and payments on liquidation or redemption of the Capital Securities, but only in each case to the extent of funds held by the Issuer, as described herein (the "Guarantee"). See "Description of the Guarantee." If PMC does not make interest payments on the Junior Subordinated Debentures held by the Issuer, the Issuer will have insufficient funds to pay distributions on the Capital Securities. The Guarantee does not cover payment of distributions when the Issuer does not have sufficient funds to pay such distributions. In such event, a holder of Capital Securities may institute a legal proceeding directly against PMC pursuant to the terms of the Indenture to enforce payment of amounts equal to such distributions to such holder. See "Description of the Junior Subordinated Debentures--Debenture Events of Default and Consequent Rights of Certain Holders--Rights of Holders of Capital Securities to Direct Action." PMC's obligations under the Guarantee and the Junior Subordinated Debentures are subordinate and junior in right of payment to all Senior Debt (as defined herein) of PMC. - 3 - The Capital Securities are subject to mandatory redemption, in whole or in part, upon repayment of the Junior Subordinated Debentures at maturity or their earlier redemption. See "Description of the Capital Securities--Redemption." The Junior Subordinated Debentures are redeemable prior to their Stated Maturity at the option of PMC (i) on or after ______________, 2008, in whole at any time or in part from time to time or (ii) prior to , 2008, in whole (but not in part), within 90 days following the occurrence of a Special Event (as defined herein). For a description of redemption prices for the Capital Securities pursuant to clause (i) or (ii) above, see "Description of the Capital Securities--Redemption" and "Description of the Junior Subordinated Debentures-- Optional Redemption." The Junior Subordinated Debentures are unsecured and subordinated and junior in right of payment to all Senior Debt of PMC. After the completion of this Offering and the repayment of debt with the proceeds thereof, PMC will have approximately $104.5 million principal amount of indebtedness for borrowed money constituting Senior Debt. The terms of the Junior Subordinated Debentures do not limit PMC's ability to incur additional Senior Debt. PMC is an insurance holding company and substantially all of the operating assets of PMC are owned by its subsidiaries. PMC relies primarily on the receipt of sufficient funds from its subsidiaries in the form of dividends, net payments under a tax-sharing agreement between PMC and its subsidiaries and loans to meet its obligations for payment of principal and interest on its outstanding debt obligations and corporate expenses. Accordingly, the Junior Subordinated Debentures will be effectively subordinated to all existing and future liabilities of PMC's subsidiaries, which debt totalled approximately $2.4 billion at June 30, 1998, and holders of Junior Subordinated Debentures should look only to the assets of PMC for payments on the Junior Subordinated Debentures. The payment of dividends by PMC's insurance subsidiaries is limited under the insurance laws of their states of domicile (primarily Pennsylvania). PMC's insurance subsidiaries have the ability to loan funds to PMC subject to certain regulatory restrictions. See "Description of the Junior Subordinated Debentures--Subordination." PMC will have the right at any time to terminate the Issuer and cause the Junior Subordinated Debentures to be distributed to the holders of the Capital Securities in liquidation of the Issuer. In the event of the termination of the Issuer, after satisfaction of liabilities to creditors of the Issuer as required by applicable law, the holders of the Capital Securities will be entitled to receive for each Capital Security a Liquidation Amount of $1,000 per Capital Security, plus accumulated and unpaid distributions thereon to the date of payment, or a distribution of such Liquidation Amount in Junior Subordinated Debentures, subject to certain limitations. See "Description of the Capital Securities--Liquidation Distribution Upon Termination." The Capital Securities will be represented by global certificates registered in the name of The Depository Trust Company ("DTC") or its nominee. Beneficial interests in the Capital Securities will be shown on, and transfers thereof will be effected only through, records maintained by participants in DTC. Except as described herein, Capital Securities in certificated form will not be issued in exchange for the global certificates. See "Description of the Capital Securities--Book-Entry-Only Issuance--The Depository Trust Company." FOR NORTH CAROLINA RESIDENTS: THE COMMISSIONER OF INSURANCE OF THE STATE OF NORTH CAROLINA HAS NOT APPROVED OR DISAPPROVED THIS OFFERING NOR - 4 - HAS THE COMMISSIONER PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. AVAILABLE INFORMATION The Trust and PMC have filed with the Securities and Exchange Commission (the "Commission") a Registration Statement on Form S-3 (together with all amendments and exhibits thereto, the "Registration Statement") under the Securities Act of 1933, as amended (the "Securities Act"), with respect to the Capital Securities, the Junior Subordinated Debentures and the Guarantee. This Prospectus, which forms a part of the Registration Statement, does not contain all the information set forth in the Registration Statement, certain parts of which have been omitted in accordance with the Rules and Regulations of the Commission. Statements made in this Prospectus as to the contents of any contract, agreement or other document referred to are not necessarily complete. With respect to each such contract, agreement or other document filed as an exhibit to the Registration Statement, reference is made to the exhibit for a more complete description of the matter involved, and each such statement shall be deemed qualified in its entirety by such reference. PMC is subject to the informational requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance therewith, files reports and other information with the Commission. In addition, the Trust and PMC intend to furnish to holders of Capital Securities annual reports containing consolidated financial statements of PMC certified by an independent public accounting firm. Such reports and other information and the Registration Statement, including the exhibits and schedules filed therewith, may be examined without charge at the public reference facilities maintained by the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street N.W., Washington, D.C. 20549, and at the Commission's regional offices at Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and 7 World Trade Center, 13th Floor, New York, New York 10048. Copies of all or any part of the Registration Statement may be obtained from the Public Reference Section of the Commission at Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. The Commission maintains a Web Site (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding registrants who file electronically with the Commission. The public may obtain information on the operation of the Public Reference Room by calling the Commission at 1-800-SEC-0330. No separate financial statements of the Trust have been included herein. PMC and the Trust do not consider such financial statements material to holders of the Capital Securities because the Trust is a newly formed special purpose entity, has no operating history or independent operations and is not engaged in, and does not propose to engage in, any activity other than its holding as trust assets the Junior Subordinated Debentures of PMC and its issuance of the Capital Securities and the Common Securities. See "The Issuer," "Description of the Capital Securities," "Description of the Guarantee" and "Description of the Junior Subordinated Debentures." In addition, PMC does not expect that the Trust will be filing reports under the Exchange Act with the Commission. The Trust is a statutory business trust formed under the laws of the State of Delaware. PMC, as of the date hereof, beneficially owns all of the beneficial interests in the Trust. PMC's and the Trust's principal executive offices are located at 380 Sentry Parkway, Blue Bell, Pennsylvania 19422-2328, telephone number (215) 665-5046. - 5 - FORWARD-LOOKING STATEMENTS Certain statements made throughout this Prospectus contain forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those expected by the Company. The factors that could cause actual results to vary materially, some of which are described in 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 effect of changes in workers' compensation statutes and the administration thereof; the Company's ability to predict and effectively manage claims related to insurance and reinsurance policies; reliance on key management; adequacy of reserves for claims liabilities; adequacy and collectibility of reinsurance purchased by the Company; frequency and severity of natural disasters and other catastrophes; and other factors disclosed from time to time in reports filed by the Company with the Commission. Investors should not place undue reliance on any such forward- looking statements. - 6 - PROSPECTUS SUMMARY The following summary is qualified in its entirety by reference to the detailed information and consolidated financial statements appearing elsewhere in this Prospectus. Certain insurance terms and other capitalized terms used herein are defined in "Glossary of Certain Insurance and Other Defined Terms." Unless the context otherwise requires, all references in this Prospectus to: (i) "PMC" or the "Company" refers to Pennsylvania Manufacturers Corporation and, depending on the context, its subsidiaries on a consolidated basis; (ii) "PMA Re" refers to the Company's property and casualty reinsurance operations, including PMA Reinsurance Corporation, a Pennsylvania insurance subsidiary of the Company; (iii) "Property and Casualty Group" refers to the Company's workers' compensation and standard commercial lines of property and casualty insurance operations, which are written through the "Pooled Companies" consisting of three Pennsylvania insurance subsidiaries of the Company, including Pennsylvania Manufacturers Association Insurance Company ("PMAIC"), which share underwriting results through an intercompany pooling arrangement; (iv) "Caliber One" refers to the Company's specialty insurance operation, including Caliber One Indemnity Company, a Delaware insurance subsidiary of the Company; (v) "PMA Cayman" refers to PMA Insurance, Cayman Ltd., a Cayman Islands run-off insurance subsidiary of the Company and (vi) "MASCCO" refers to Mid- Atlantic States Casualty Company, a Pennsylvania run-off insurance subsidiary of the Company. Unless otherwise specified, all financial information is presented in accordance with United States generally accepted accounting principles ("GAAP"). Statutory data included herein have been derived from the annual and quarterly statements of PMC's insurance subsidiaries as filed with insurance regulatory authorities and prepared in accordance with statutory accounting principles ("SAP") prescribed or permitted by such regulatory authorities. Unless otherwise specified herein, the information contained herein assumes no exercise of the Underwriters' over-allotment option. The Company General The Company is an insurance holding company, whose subsidiaries operate in three distinct segments of the property and casualty insurance industry: (i) reinsurance, through PMA Re, which commenced business in 1980; (ii) standard commercial lines of insurance, with an emphasis on workers' compensation, through the Property and Casualty Group, which has been in business since 1915 and (iii) specialty insurance products, focusing on excess and surplus lines, through the Company's recently-formed operation, Caliber One. PMA Re writes a broad range of property and casualty reinsurance products with an emphasis on risk-exposed casualty excess of loss reinsurance and operates in the United States domestic brokered market. The Property and Casualty Group offers a broad range of standard commercial lines including commercial general liability, commercial automobile and commercial multi-peril, with an emphasis on underwriting of workers' compensation products and services primarily in nine contiguous jurisdictions in the Mid-Atlantic and Southern regions of the United States, utilizing the PMA Group trade name. In 1998, Caliber One commenced writing excess and surplus lines of insurance, including commercial general liability, automobile and certain - 7 - property exposures on a non-admitted basis. For the six months ended June 30, 1998, the Company's net premiums written of $257.0 million were derived 45.9% from PMA Re, 53.8% from the Property and Casualty Group and 0.3% from Caliber One. Net income for the Company for six months ended June 30, 1998 and the year ended December 31, 1997 was $21.4 million and $15.0 million, respectively. As of June 30, 1998, the Company had total assets of $3,075.4 million and shareholders' equity of $496.4 million. According to data provided by the Reinsurance Association of America ("RAA"), as of June 30, 1998, PMA Reinsurance Corporation was the 24th largest reinsurer in the United States in terms of statutory surplus and 17th largest in terms of net premiums written. Management believes that PMA Re competes on the basis of its ability to offer prompt and responsive service and products designed to meet clients needs and its excellent long-term relationships in the broker and ceding company communities. PMA Re's net premiums written grew at a compound annual rate of 13.2% between 1992 and 1997. As of June 30, 1998, statutory surplus of PMA Reinsurance Corporation was $279.1 million, and for the six months ended June 30, 1998, PMA Re's net premiums written were $117.9 million. PMA Re reported pre-tax operating income of $23.0 million and $23.2 million for the six-month periods ended June 30, 1998 and 1997, respectively, and $46.0 million, $44.8 million and $39.8 million for the years ended December 31, 1997, 1996 and 1995, respectively. The Property and Casualty Group markets a full range of workers' compensation products and services, as well as other standard commercial lines of property and casualty insurance, primarily to middle market accounts (premiums ranging from $40,000 to $300,000) and smaller accounts (premiums less than $40,000). The Property and Casualty Group distributes its products primarily through approximately 240 regional brokers and agents throughout its marketing territories and also utilizes an internal sales force in Pennsylvania and Delaware, which accounted for approximately 13% of direct premiums written in 1997. In 1997, workers' compensation insurance accounted for 60% of the Property and Casualty Group's direct premiums written, and Pennsylvania workers' compensation insurance accounted for 50% of the Property and Casualty Group's workers' compensation direct premiums written. The Property and Casualty Group offers a variety of workers' compensation products, such as third-party claims administration services, rent-a-captives and high-deductible plans in addition to traditional fixed-cost and loss-sensitive workers' compensation products, and management believes that the Property and Casualty Group competes in workers' compensation on the basis of its ability to provide prompt and responsive service. In 1996, the Company restructured the Property and Casualty Group with the goal of restoring its profitability after three years of operating losses. The operating losses resulted primarily from unfavorable underwriting experience and adverse reserve development related to accident years 1987 through 1991, when the Property and Casualty Group wrote a much higher volume of business than its current volume. The principal components of the restructuring were: (i) strengthening loss reserves; (ii) initiating a commutation program to settle a significant number of open claims from the 1987 to 1991 period; (iii) designating PMA Cayman and MASCCO as separate run-off companies to alleviate the SAP impact on the - 8 - Pooled Companies of the loss reserve strengthening and to manage the capital deployed in running off pre-1992 workers' compensation claims; (iv) initiating an expense reduction program and (v) implementing management changes, including the appointment of a new Chief Operating Officer and the creation of a new position of Chief Underwriting Officer. In June 1998, the Company entered into a letter of intent to sell PMA Cayman. Largely as a result of the restructuring, the Property and Casualty Group recorded pre-tax operating income of $5.4 million for the six months ended June 30, 1998, compared to pre-tax operating losses of $5.9 million for the six months ended June 30, 1997 and $3.7 million, $215.7 million (including restructuring and other special charges of $223.1 million) and $3.9 million for the years ended December 31, 1997, 1996 and 1995, respectively. At June 30, 1998, the Pooled Companies' statutory surplus was $263.1 million, and for the six months ended June 30, 1998, the Property and Casualty Group's net premiums written were $138.4 million. See "Business--The Property and Casualty Group." In December 1997, the Company acquired an insurance company, which was renamed Caliber One Indemnity Company, to enter the excess and surplus lines insurance business. Within the last year, the Company hired several experienced specialty insurance executives to manage Caliber One, who have substantial relationships within the wholesale brokerage community, which management believes will have a favorable impact on Caliber One's ability to obtain market acceptance. Caliber One distributes its products primarily through national wholesale brokers, and Caliber One Indemnity Company is approved as a surplus lines carrier in 38 states, Puerto Rico and the District of Columbia. As of June 30, 1998, Caliber One Indemnity Company's statutory surplus was $25.5 million, and for the six months ended June 30, 1998, Caliber One's net premiums written were $917,000. The Company's insurance subsidiaries have the following ratings from A.M. Best: PMA Reinsurance Corporation, A+ ("Superior"); the Pooled Companies, A- ("Excellent") and Caliber One Indemnity Company, A ("Excellent"). Management believes that ratings from A.M. Best are material to its operations and that a downgrade from the present rating classifications could have an adverse effect on the Company's ability to market its products. A.M. Best's ratings are based upon an assessment of an insurance company's perceived financial strength regarding its ability to pay obligations to its policyholders and are not directed toward the protection of investors. The Company maintains its executive offices at 380 Sentry Parkway, Blue Bell, PA 19422, and its telephone number is (215) 665-5046. Business Strategy Management believes that PMC's three insurance businesses are characterized by the need for specialized expertise and a requirement for strong underwriting skills. Management also believes that each of the operations targets sophisticated customers who desire products designed for specific client needs that require a high level of service. The following discussion sets forth the main components of the Company's overall operating strategies and the implementation thereof by the Company's operating units. Underwriting Discipline Management believes that risk selection and pricing is critical to the Company's success. Maintenance of underwriting discipline has become more difficult and more critical to the achievement of an acceptable level of profitability for the Company given the present competitive conditions in - 9 - the property and casualty insurance and reinsurance industries. The Company's three operations have rejected and non-renewed certain accounts because market rates and contract terms for such risks did not provide the opportunity to achieve a rate of return that management considers acceptable. The Company relies on experienced underwriting management in order to maintain underwriting discipline. The underwriting management at PMA Re, the Property and Casualty Group and Caliber One averages 21, 22 and 16 years of experience, respectively, in the property and casualty insurance industry. In addition, in 1997 the Property and Casualty Group strengthened its underwriting management by creating the new position of and appointing a Chief Underwriting Officer, who has over 22 years of experience in the industry. Also, the Property and Casualty Group reorganized the reporting structure so that field underwriting management now reports functionally to the Chief Underwriting Officer rather than to branch managers with primarily marketing responsibilities. For all of the Company's insurance operations, underwriting management is evaluated and compensated with the emphasis on profit objectives. Marketing The Company markets its products on the basis of price, service, product design and financial security. The Company attempts to price its products in such a way that the prices charged to its clients are commensurate with the overall marketplace. The current soft pricing environment has made competition and marketing solely on the basis of price increasingly difficult. Therefore, the Company has focused its marketing efforts on providing excellent service and products designed for specific client needs, as well as maintaining stable and solid relationships with the Company's distribution system. Beginning in 1996, PMA Re undertook a target marketing program designed to increase its business with certain existing accounts and obtain new ceding company clients from a pre-screened list developed by the Company. Management believes that PMA Re has been able to write certain business that has been displaced as a result of the recent consolidation of the United States reinsurance industry. As a result of these factors and PMA Re's other competitive attributes, including management's relationships with broker and ceding company communities, PMA Re's net premiums written grew 8.5% in 1997 compared to 1996 and increased 22.5% for the six months ended June 30, 1998 compared to the six months ended June 30, 1997, notwithstanding the non-renewal or cancellation of a total of $68.2 million of business since January 1, 1997 primarily for underwriting reasons. The Property and Casualty Group's marketing strategy is focused on: (i) reestablishing a portion of its historical market share in its traditional marketing territories on a profitable basis; (ii) implementing planned geographic expansion into selected territories bordering its present marketing territories; (iii) increasing its business with national brokerages and (iv) increasing its business with smaller accounts (less than $40,000 in annual premium) in certain jurisdictions in response to workers' compensation reforms which have made such business more attractive. Caliber One's marketing strategy is based upon management's relationships within the wholesale brokerage community and responsiveness to marketplace needs through product design. - 10 - Products and Services Management believes that the Company's results depend on its ability to offer products designed to meet client needs and services that distinguish the Company from its competitors. The Company's service standards have been designed to emphasize prompt turn-around time for underwriting submissions, access to information and claims handling. PMA Re offers a full range of reinsurance products, including traditional treaty reinsurance, facultative reinsurance, finite risk and other specialized products. In addition, PMA Re has been at the forefront of service initiatives within the brokered reinsurance market, including fastrack claims, electronic data interchange and electronic funds transfer. Fastrack claims is a process whereby certain claims are pre-approved for payment as long as the request for payment falls within certain parameters, thereby accelerating remittance to the client. The Property and Casualty Group has developed products and services to serve the various segments of its market. It offers its workers' compensation insureds the enhanced ability to control medical costs, through its affiliation with First Health Group, Inc., a third party preferred provider organization. The Property and Casualty Group has also utilized aggressive claims settlement processes, including commutations, as part of its strategy to assist clients in reducing the overall cost of their workers' compensation benefits. The Property and Casualty Group offers alternative market products, such as large deductible plans, rent-a-captive services and third party administration of claims to self-insured clients. In addition, in 1998, the Property and Casualty Group began marketing an integrated disability product, PMA One, which combines occupational and non-occupational disability coverages. Caliber One develops products for specialized segments of the market, including coverages for clinical trials, environmental risks, special events, toy manufacturers and retroactive liability. - 11 - PMC Capital I PMC Capital I is a statutory business trust formed under Delaware law. The Issuer exists for the exclusive purposes of (i) issuing the Capital Securities and the Common Securities representing undivided beneficial interests in the assets of the Issuer, (ii) investing the gross proceeds of the sale of the Capital Securities and the Common Securities in the Junior Subordinated Debentures and (iii) engaging in only those other activities necessary or incidental thereto. All of the Common Securities, having an aggregate liquidation amount equal to 3% of the total capital of the Issuer, will be owned by PMC. The Common Securities will rank pari passu, and payments will be made thereon pro rata, with the Capital Securities, except that upon the occurrence and continuance of an event of default under the Amended and Restated Trust Agreement (the "Trust Agreement"), among PMC as Depositor, The Bank of New York as Property Trustee and The Bank of New York (Delaware) as Delaware Trustee, and the Administrative Trustees named therein, resulting from an event of default by PMC on the Junior Subordinated Debentures, the rights of the holders of the Common Securities to payment in respect of distributions and payments upon liquidation, redemption and otherwise will be subordinated to the rights of the holders of the Capital Securities. The Property Trustee and the Administrative Trustees are referred to herein, collectively, as the "Trustees." Subject to the right of holders of a majority in Liquidation Amount of the outstanding Capital Securities to appoint a substitute Property Trustee upon the occurrence of certain events described herein, PMC, as the owner of all of the Common Securities, has the exclusive right (subject to the provisions of the Trust Agreement) to appoint, remove or replace the Property Trustee, the duties and obligations of which will be governed by the Trust Agreement. PMC will pay all fees and expenses related to the Issuer and the offering of the Capital Securities. The Offering Issuer PMC Capital I Securities Offered $100,000,000 of ___% Capital Securities Ownership The ownership interests in the Trust will be evidenced by (i) a class of Capital Securities representing approximately 97% of the ownership interests in the Trust and (ii) a class of Common Securities (together with the Capital Securities, the "Trust Securities") representing approximately 3% of the ownership interest in the Trust. Maturity of the Junior ________, 2028 (the "Stated Maturity"). The Capital Subordinated Debentures Securities are mandatorily redeemable upon the maturity or earlier redemption of the Junior Subordinated Debentures. Distribution Payment Dates ___________ 1 and __________ 1, commencing _______, 1999. Extension of Interest PMC will have the right to extend the interest Payment Period payment period on the Junior Subordinated Debentures, so long as no Event of Default has occurred and is continuing, for a period not exceeding ten consecutive semi-annual periods (each, an "Extension Period"), and, as a consequence, during an Extension Period, semi- annual distributions on the Capital Securities would be deferred (and the amount of distributions which holders of the Capital Securities are entitled to will accumulate additional distributions thereon at the rate of _____% thereof, compounded semi-annually from the relevant payment date for such - 12 - distributions). During an Extension Period, neither PMC nor any of its subsidiaries shall (i) declare or pay any dividends or distributions on, or redeem, purchase, acquire or make a liquidation payment with respect to, any of PMC's outstanding capital stock or (ii) make any payment of principal, interest or premium, if any, on or repay, repurchase or redeem any debt securities of PMC that rank pari passu with or junior to the Junior Subordinated Debentures or make any guarantee payments with respect to any guarantee by PMC of the debt securities of any subsidiaries of PMC that rank pari passu with or junior to the Junior Subordinated Debentures (other than (a) dividends or distributions in Common Stock or Class A Common Stock of PMC, (b) payments under the Guarantee and (c) purchases of Common Stock or Class A Common Stock of PMC related to the issuance of Common Stock or Class A Common Stock of PMC under any of PMC's benefit plan for directors, officers or employees). This deferral feature cannot be used to extend the maturity of the Junior Subordinated Debentures. Guarantee Taken together, PMC's obligations under the Junior Subordinated Debentures, the Indenture, the Trust Agreement, the Expense Agreement and the Guarantee provide, in the aggregate, a full, irrevocable and unconditional guarantee of payments of distributions and other amounts due on the Capital Securities. No single document standing alone or operating in conjunction with fewer than all the other documents constitutes such guarantee. Mandatory Redemption The Capital Securities are subject to mandatory redemption upon repayment of the Junior Subordinated Debentures at maturity or their earlier redemption. PMC will have the option at any time on or after, _________________, 2008, to redeem, in whole or in part, the Junior Subordinated Debentures, at par, plus accrued and unpaid interest, if any, through the redemption date. PMC will also have the right at any time, upon the occurrence of a Special Event (as defined herein), to redeem, in whole but not in part, the Junior Subordinated Debentures. Liquidation Amount $1,000.00 per Capital Security (the "Liquidation Amount"). Subordination of Common Income distributions, payments of redemption prices Securities and amounts distributed in connection with the liquidation of the Trust will be made pari passu among holders of Capital Securities and PMC, as holder of the common Securities, except that, in the event of a default by PMC on the Junior Subordinated Debentures, (i) full income distributions and payments of redemption prices will be made on the Capital Securities before further income distributions or payments of redemption prices are made on the Common Securities and (ii) the full liquidation preference will be paid on the Capital Securities in the event of a liquidation of the Trust before any liquidating distribution is made on the Common Securities. Use of Proceeds All of the proceeds from the sale of Capital Securities will be invested by the Trust in the Junior Subordinated Debentures. PMC will use the proceeds from issuance of the Junior Subordinated Debentures to repay debt that is outstanding under the Revolving Credit Facility. See "Use of Proceeds." The Company has elected not to provide pro forma financial statements to give effect to the issuance of the Capital Securities because the issuance is not expected to result in a change in the Company's overall level of capitalization (only the components thereof will change), and the issuance of the Capital Securities is not expected to result in a change in the Company's ratio of earnings to fixed charges of more than 10%. See "Capitalization" and "Ratio of Earnings to Fixed Charges." - 13 - SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA The summary consolidated financial and operating data set forth below as of December 31, 1997, 1996 and 1995 and for each of the three years in the period ended December 31, 1997 were derived from the audited consolidated financial statements of the Company. The summary consolidated financial and operating data as of June 30, 1998 and 1997 and for the six-month periods ended June 30, 1998 and 1997 were derived from the Company's unaudited consolidated financial statements. The unaudited consolidated financial statements have been prepared on the same basis as the Company's audited consolidated financial statements, and, in the opinion of management, include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the Company's financial position and results of operations for these periods. The results of operations for the six months ended June 30, 1998 may not be indicative of results of operations for the full year. All summary consolidated financial and operating data set forth below should be read in conjunction with the consolidated financial statements of the Company, together with the notes thereto, and Management's Discussion and Analysis of Financial Condition and Results of Operations, both appearing elsewhere in this Prospectus.
(dollar amounts in thousands) Six Months Ended June 30, Year Ended December 31, ----------------------- ------------------------------------ 1998 1997 1997(1) 1996(1) 1995(1) ---- ---- ------- -------- ------- Net premiums written(2) $248,481 $248,285 $381,282 $432,975 $485,876 ======== ======== ======== ======== ======== Consolidated Revenues: Net premiums earned $221,576 $222,401 $375,951 $420,575 $484,952 Net investment income 65,200 68,459 136,698 133,936 139,355 Net realized investment gains (losses) 11,263 (1,931) 8,598 2,984 31,923 Service revenues 5,090 5,038 10,311 9,189 5,106 -------- -------- -------- -------- -------- Total consolidated revenues $303,129 $293,967 $531,558 $566,684 $661,336 ======== ======== ======== ======== ======== Income (loss) before extraordinary item 21,445 5,277 19,753 (135,334) 24,130 Extraordinary loss from early extinguishment of debt, net of related tax effect(3) --- (4,734) (4,734) --- --- -------- -------- -------- -------- -------- Net income (loss) $ 21,445 $ 543 $ 15,019 ($135,334) $ 24,130 ======== ======== ======== ======== ======== At June 30, At December 31, ----------------------- ------------------------------------ 1998 1997 1997 1996 1995 ---- ---- ---- ---- ---- Consolidated Financial Position: Total investments $2,159,303 $2,067,828 $2,194,738 $2,261,353 $2,455,949 Total assets 3,075,413 3,085,640 3,057,258 3,117,516 3,258,572 Reserves for unpaid losses and LAE 1,939,568 2,052,791 2,003,187 2,091,072 2,069,986 Long-term debt 203,000 203,049 203,000 204,699 203,848 Shareholders' equity 496,383 415,120 478,347 425,828 609,668 Six Months Ended June 30, Year Ended December 31, ----------------------- ------------------------------------ 1998 1997 1997(1) 1996(1) 1995(1) ---- ---- ------- -------- ------- Pre-tax operating income (loss)(4): PMA Re $ 22,952 $ 23,187 $ 45,957 $ 44,807 $ 39,793 -------- -------- -------- -------- -------- The Property and Casualty Group(5): Excluding Run-off Operations 4,954 (4,781) (3,607) (215,669) (3,885) Run-off Operations 428 (1,107) (73) --- --- -------- -------- -------- -------- -------- Total Property and Casualty Group 5,382 (5,888) (3,680) (215,669) (3,885) Caliber One (1,070) --- --- --- --- Corporate operations (5,548) (4,526) (9,954) (6,464) (14,184) -------- -------- -------- -------- -------- Total pre-tax operating income (loss) before interest expense 21,716 12,773 32,323 (177,326) 21,724 Interest expense 7,463 8,222 15,768 17,052 18,734 -------- -------- -------- -------- -------- Pre-tax operating income (loss) 14,253 4,551 16,555 (194,378) 2,990 Net realized investment gains (losses) 11,263 (1,931) 8,598 2,984 31,923 -------- -------- -------- -------- -------- Income (loss) before income taxes and extraordinary item 25,516 2,620 25,153 (191,394) 34,913 Provision (benefit) for income taxes 4,071 (2,657) 5,400 (56,060) 10,783 -------- -------- -------- -------- -------- Income (loss) before extraordinary item 21,445 5,277 19,753 (135,334) 24,130 Extraordinary loss from early extinguishment of debt, net of related tax effect(3) --- (4,734) (4,734) --- --- -------- -------- -------- -------- -------- Net income (loss) $ 21,445 $ 543 $ 15,019 $135,334 $ 24,130 ======== ======== ======== ======== ========
- 14 - Ratio of earnings to fixed charges (6) 4.0x 1.3x 2.4x --- 2.7x GAAP Ratios for Insurance Subsidiaries (7): PMA Re: Loss ratio 69.0% 73.1% 69.6% 73.7% 74.6% Expense ratio 35.2% 29.3% 34.2% 28.9% 29.3% ----- ----- ----- ----- ----- Combined ratio (8) 104.2% 102.4% 103.8% 102.6% 103.9% ===== ===== ===== ===== ===== The Property and Casualty Group, including Run-off Operations (5): Loss ratio 85.5% 95.4% 91.1% 158.2% 92.5% Expense ratio (9) 34.0% 35.0% 42.8% 47.1% 30.4% Policyholders' dividend ratio 6.7% 4.8% 6.9% 6.1% 4.8% ----- ----- ----- ----- ----- Combined ratio (8) 126.2% 135.2% 140.8% 211.4% 127.7% ===== ===== ===== ===== ===== The Property and Casualty Group, excluding Run-off Operations (5): Loss ratio 77.7% 84.9% 83.7% --- --- Expense ratio (9) 32.8% 33.9% 32.9% --- --- Policyholders' dividend ratio 6.7% 4.8% 5.6% --- --- ----- ----- ----- ----- ----- Combined ratio (8) 117.2% 123.6% 122.2% --- --- ===== ===== ===== ===== =====
__________________________ (1) Operating results in 1997, 1996 and 1995 were impacted by approximately $12,100, $223,100 and $8,400, respectively, of restructuring and other special charges. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" for further information. (2) Net premiums written were reduced by $2,072 for the six months ended June 30, 1998 and reduced by $37,000, $10,500, and 4,000 for the years ended December 31, 1997, 1996 and 1995, respectively, representing estimated retrospective policy adjustments related to the current accident year and retrospective policy adjustments paid. The corresponding adjustment for the six months ended June 30, 1997 was not material. These adjustments to net premiums written were made for presentation purposes only and had previously been reflected in the Company's reported revenues, financial position and results of operations. (3) In 1997, the Company refinanced substantially all of its long-term debt, resulting in a $4,734 extraordinary loss, net of tax effect. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." - 15 - (4) 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 the Company's interim financial statements and notes thereto as of June 30, 1998 and 1997 included elsewhere in this Prospectus. The Company has excluded net realized investment gains (losses) from the profit and loss measurement it utilizes to assess the performance of its operating segments because (i) net realized investment gains (losses) are unpredictable and not necessarily indicative of future performance and (ii) in many instances, decisions to buy and sell securities are made at the parent holding company level, and such decisions result in net realized gains (losses) that do not relate to the operations of the individual segments. (5) Run-off operations ("Run-off Operations") of the Property and Casualty Group are comprised of MASCCO, PMA Cayman and PMA Life Insurance Company ("PMA Life"), which were established in December 1996 to reinsure certain obligations primarily associated with workers' compensation claims written by the Pooled Companies for the 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. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." (6) For the purposes of determining this ratio, earnings (loss) consist of income (loss) before income taxes and extraordinary loss, plus fixed charges. Fixed charges consist of interest expense on debt, amortization of debt issuance costs and the portion of operating leases that management believes is representative of the interest factor. In 1996, earnings were insufficient to cover fixed charges by $191,394. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." (7) The results of operations of Caliber One are not material to the underwriting ratios of the Company; accordingly, the ratios for Caliber One have not been presented. (8) The combined ratio computed on a GAAP basis is equal to losses and loss adjustment expenses ("LAE") plus amortization of deferred acquisition costs, operating expenses and policyholders' dividends (where applicable), all divided by net premiums earned. (9) The GAAP operating expense ratios exclude $4,718 and $4,506 for the six months ended June 30, 1998 and 1997, respectively, and $9,316, $8,227 and $5,300 for the years ended December 31, 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." - 16 - RISK FACTORS Potential investors should carefully consider the following risk factors and other information in this prospectus prior to making an investment decision regarding the Capital Securities. In addition, because holders of Capital Securities may receive Junior Subordinated Debentures in exchange therefor upon liquidation of the Trust, prospective purchasers of Capital Securities are also making an investment decision with regard to the Junior Subordinated Debentures and should carefully review all the information regarding the Junior Subordinated Debentures and PMC herein. Risk Factors Relating To the Capital Securities Subordination of the Guarantee and the Junior Subordinated Debentures PMC's obligations under the Guarantee and under the Junior Subordinated Debentures are unsecured and rank subordinate and junior in right of payment to all present and future Senior Debt of PMC and pari passu with obligations to or rights of PMC's other general unsecured creditors. Substantially all of PMC's debt constitutes senior debt. PMC is an insurance holding company and substantially all of the operating assets of PMC are owned by its consolidated subsidiaries. PMC relies primarily on the receipt of sufficient funds from its subsidiaries in the form of dividends, net tax sharing payments and loans to meet its obligations for payment of principal and interest on its outstanding debt obligations and corporate expenses. Accordingly, the Junior Subordinated Debentures will be effectively subordinated to all existing and future liabilities of PMC's subsidiaries, and holders of the Junior Subordinated Debentures should look only to the assets of PMC for payments on the Junior Subordinated Debentures. The payment of dividends by PMC's insurance subsidiaries is limited under the insurance laws of their states of domicile (primarily Pennsylvania). At December 31, 1997, PMA Reinsurance Corporation and the Pooled Companies could pay dividends of approximately $48.7 million to PMC without regulatory permission. Through September 1, 1998, $18.0 million in dividends has been declared, of which $10.0 million has been paid. See "Supervision and Regulation." In addition, the ability of PMC's subsidiaries to pay dividends is effectively restricted by certain minimum surplus and risk- based capital requirements contained in the Company's revolving credit agreement. See "Risk Factors Associated With the Company--Restrictions on Subsidiary Dividends." None of the Capital Securities, the Junior Subordinated Debentures or the Guarantee limit PMC's ability to incur additional indebtedness, including Senior Debt. After the completion of this Offering and the repayment of debt with the proceeds thereof, PMC will have outstanding approximately $104.5 million of principal amount of indebtedness constituting Senior Debt. PMC expects from time to time to incur additional indebtedness constituting Senior Debt. See "Description of the Guarantee--Status of the Guarantee" and "Description of the Junior Subordinated Debentures-- Subordination." The ability of the Issuer to pay amounts due on the Capital Securities is solely dependent upon PMC making payments on the Junior Subordinated Debentures as and when required. - 18 - Limited Rights Under the Guarantee The Guarantee will be qualified as an indenture under the Trust Indenture Act of 1939, as amended (the "Trust Indenture Act"). The Property Trustee (herein sometimes called the "Trustee") will act as indenture trustee under the Guarantee for the purposes of compliance with the Trust Indenture Act and to hold the Guarantee for the benefit of the holders of the Capital Securities. The Guarantee guarantees to the holders of the Capital Securities the following payments, to the extent not paid by or on behalf of the Issuer: (i) any accumulated and unpaid distributions that are required to be paid on the Capital Securities, to the extent the Trust has funds available therefor at such time, (ii) the redemption price with respect to the Capital Securities called for redemption by the Trust, to the extent the Trust has funds available therefor at such time and (iii) upon a voluntary or involuntary dissolution, winding-up or termination of the Trust (other than in connection with the distribution of Junior Subordinated Debentures to the holders of the Capital Securities), the lesser of (a) the aggregate of the Liquidation Amount and all accumulated and unpaid distributions on the Capital Securities to the date of the payment to the extent the Trust has funds available therefor at such time and (b) the amount of assets of the Trust remaining available for distribution to holders of the Capital Securities in liquidation of the Trust. The holders of not less than a majority in aggregate Liquidation Amount of the outstanding Capital Securities have the right to direct the time, method and place of conducting any proceeding for any remedy available to the Trustee or exercising any trust or power conferred upon the Trustee under the Guarantee. Any holder of the Capital Securities may institute a legal proceeding directly against PMC to enforce the holder's rights under the Guarantee without first instituting a legal proceeding against the Issuer, the Guarantee Trustee or any other person or entity. If PMC were to default on its obligation to pay amounts payable under the Junior Subordinated Debentures, the Issuer would lack funds for the payment of distributions or amounts payable on redemption of the Capital Securities or otherwise, and, in such event, holders of the Capital Securities would not be able to rely upon the Guarantee for payment of such amounts. Instead, in the event a Debenture Event of Default shall have occurred and be continuing and such event is attributable to the failure of PMC for 30 days to pay interest on the Junior Subordinated Debentures when due and payable or the failure of PMC to pay principal on the Junior Subordinated Debentures when due and payable, then a holder of Capital Securities may, pursuant to the terms of the Indenture and in addition to its rights under the Guarantee, institute a legal proceeding directly against PMC for enforcement of payment to such holder of the principal of and interest on such Junior Subordinated Debentures having a principal amount equal to the aggregate Liquidation Amount of the Capital Securities of such holder (a "Direct Action"). In connection with such a Direct Action, PMC shall have a right of set-off under the Indenture to the extent of any payment made by PMC to such holder of Capital Securities in the Direct Action. See "Description of Junior Subordinated Debentures--Set-Off." Except as set forth herein, holders of Capital Securities will not be able to exercise directly any other remedy available to the holders of the Junior Subordinated Debentures or assert directly any other rights in respect of the Junior Subordinated Debentures. See "Description of the Junior Subordinated Debentures--Debenture Events of Default and Consequent Rights of Certain Holders--Rights of Holders of Capital Securities to Direct Action" and "Description of the Guarantee." The Trust Agreement provides that each holder of Capital Securities by acceptance thereof agrees to the provisions of the Guarantee and the Indenture. - 19 - Limited Voting Rights Holders of Capital Securities will have generally limited voting rights relating only to the conduct of proceedings for remedies available to the Debenture Trustee, waiver of certain defaults, rescission of any declaration of acceleration and certain modifications of the Capital Securities. Holders of Capital Securities will not be entitled to vote to appoint, remove or replace the Property Trustee, which voting rights are vested exclusively in the holder of the Common Securities, except upon the occurrence of certain events described herein. The Property Trustee, the Administrative Trustees and PMC may amend the Trust Agreement without the consent of the holders of Capital Securities to ensure that the Issuer will be classified for United States federal income tax purposes as a grantor trust or as other than an association taxable as a corporation to ensure that the Junior Subordinated Debentures will be treated as indebtedness of PMC or to ensure that the Issuer will not be required to register as an "investment company" under the Investment Company Act unless such action adversely and materially affects the interests of such holders. See "Description of the Capital Securities--Voting Rights." Option to Defer Interest Payments; Tax Consequences and Market Price So long as no Debenture Event of Default (as defined herein) has occurred and is continuing, PMC has the right under the Indenture to defer payments of interest on the Junior Subordinated Debentures at any time, and from time to time for a period not exceeding 10 consecutive semi-annual periods with respect to each deferral period (each, an "Extension Period"), provided that no Extension Period may extend beyond the Stated Maturity of the Junior Subordinated Debentures. As a consequence of such a deferral, semi-annual distributions on the Capital Securities will be deferred by the Trust during any such Extension Period (and the amount of the distributions to which holders of the Capital Securities are entitled will accumulate additional distributions thereon at a rate of ___% per annum, compounded semi-annually from the relevant payment date for such distributions). During any such Extension Period, PMC shall not, and shall cause any subsidiary of PMC not to, (a) declare or pay dividends or distributions on, or redeem, purchase, acquire or make a liquidation payment with respect to, any of PMC's capital stock or (b) make any payment of interest, principal or premium, if any, on or repay, repurchase or redeem any debt securities of PMC that rank pari passu with or junior to the Junior Subordinated Debentures (other than (a) dividends or distributions in Common Stock or Class A Common Stock of PMC, (b) payments under the Guarantee and (c) purchases of Common Stock or Class A Common Stock of PMC related to the issuance of Common Stock or Class A Common Stock of PMC under any of PMC's benefit plans for its directors, officers or employees). Prior to the termination of any such Extension Period, PMC may further defer the payment of interest, provided that no Extension Period shall exceed 10 consecutive semi- annual periods or extend beyond the Stated Maturity of the Junior Subordinated Debentures. Upon the termination of any Extension Period and the payment of all interest then accrued and unpaid (together with interest thereon at the rate of ___% per annum, compounded semi-annually, to the extent permitted by applicable law), PMC may commence a new Extension Period, subject to the above requirements. There is no limitation on the number of times that PMC may elect to begin an Extension Period. See "Description of the Capital Securities-- Distributions" and "Description of the Junior Subordinated Debentures--Option to Extend Interest Payment Period." - 20 - If interest payments are so deferred, each holder of Capital Securities may be required to recognize income (in the form of original issue discount) in respect of its pro rata share of the Junior Subordinated Debentures held by the Issuer for United States federal income tax purposes. As a result, a holder of Capital Securities may be required to include such income in gross income for United States federal income tax purposes in advance of the receipt of cash attributable to such income and will not receive the cash from the Trust related to such income if such holder disposes of its Capital Securities prior to the record date for distributions of such amounts. See "United States Federal Income Taxation -- Interest Income and Original Issue Discount." PMC has no present intention of exercising its right to defer payments of interest by extending the interest payment period on the Junior Subordinated Debentures. However, if PMC determines to exercise such right in the future, the market price of the Capital Securities is likely to be affected. A holder that disposes of its Capital Securities during an Extension Period, therefore, might not receive the same return on its investment as a holder that continues to hold its Capital Securities. In addition, as a result of the existence of PMC's right to defer interest payments, the market price of the Capital Securities (which represent an undivided beneficial interest in the Junior Subordinated Debentures) may be more volatile than other securities on which original issue discount accrues that are not subject to such deferrals. Special Event Redemption or Exchange Upon the occurrence and continuance of a Special Event (as defined herein), prior to ___ 1, 2008, PMC shall have the right to redeem the Junior Subordinated Debentures, in whole but not in part within 90 days following the occurrence of such Special Event and therefore cause a mandatory redemption of the Capital Securities. Any such redemption shall be at a price equal to the Make-Whole Amount (as defined in "Description of the Capital Securities--Redemption") together with accrued interest to but excluding the date fixed for redemption. If a Special Event were to occur, there can be no assurance that PMC would have sufficient funds to effectuate an optional redemption of the Junior Subordinated Debentures and pay the redemption price. PMC's ability to exercise its option to redeem the Junior Subordinated Debentures may be limited by the terms of its then-existing borrowing and other agreements. "Special Event" means either an Investment Company Event or a Tax Event. An "Investment Company Event" means the receipt by the Issuer of an opinion of counsel experienced in such matters to the effect that, as a result of the occurrence of a change in law or regulation or change in interpretation or application of law or regulation by any legislative body, court, governmental agency or regulatory authority (a "Change in 1940 Act Law"), the Issuer is or will be considered an investment company that is required to be registered under the Investment Company Act of 1940, as amended, which Change in 1940 Act Law becomes effective on or after the date of original issuance of the Capital Securities. A "Tax Event" means the receipt by the Issuer of an opinion of counsel experienced in such matters to the effect that, as a result of (a) any amendment to, or change (including any announced prospective change) in, the laws (or any regulations thereunder) of the United States or any political subdivision or taxing authority thereof or therein affecting taxation or (b) any official administrative pronouncement or judicial decision interpreting or applying such laws and regulations, which amendment or change is effective or such pronouncement or decision is announced on or after the date of issuance of the Capital Securities under the Trust Agreement, there is more than an insubstantial risk that (i) the Issuer is, or will be within 90 days of the date of such opinion, subject to United States federal income tax with respect to - 21 - income received or accrued on the Junior Subordinated Debentures, (ii) interest payable by PMC on the Junior Subordinated Debentures is not, or within 90 days of the date of such opinion, will not be, deductible by PMC, in whole or in part, for United States federal income tax purposes or (iii) the Issuer is, or will be within 90 days of the date of such opinion, subject to more than a de minimis amount of other taxes, duties or other governmental charges. See "Description of the Capital Securities--Redemption--Special Event Redemption or Distribution of Junior Subordinated Debentures." At any time, PMC has the right to terminate the Issuer and, after satisfaction of the liabilities of creditors of the Issuer as provided by applicable law, cause the Junior Subordinated Debentures to be distributed to the holders of the Capital Securities in liquidation of the Trust. See "Description of the Capital Securities--Liquidation Distribution upon Termination." Tax Consequences The receipt of cash by the holders of the Capital Securities upon a termination of the Trust would be a taxable event to such holders. Under current United States federal income tax law, a distribution of Junior Subordinated Debentures upon the termination of the Trust generally would not be a taxable event to holders of the Capital Securities. See "United States Federal Income Taxation--Receipt of Junior Subordinated Debentures or Cash Upon Liquidation of the Trust." Effect on Market Prices There can be no assurance as to the market prices for the Capital Securities or the Junior Subordinated Debentures that may be distributed in exchange for the Capital Securities if a termination or liquidation of the Trust were to occur. Accordingly, the Capital Securities that an investor may purchase, whether pursuant to the offer made hereby or in the secondary market, or the Junior Subordinated Debentures that a holder of Capital Securities may receive on termination and liquidation of the Trust, may trade at a discount to the price that the investor paid to purchase the Capital Securities offered hereby. Corresponding Investment Decision in Junior Subordinated Debentures Because holders of Capital Securities may receive Junior Subordinated Debentures in connection with a liquidation of the Trust, prospective purchasers of the Capital Securities are also making an investment decision with regard to the Junior Subordinated Debentures and should carefully review all the information regarding the Junior Subordinated Debentures contained herein. See "Description of the Capital Securities--Liquidation Distribution upon Termination" and "Description of the Junior Subordinated Debentures." Possible Tax Law Changes Prospective investors should be aware that Enron Corporation has filed a petition in the United States Tax Court challenging the proposed disallowance by the Internal Revenue Service (the "IRS") of the deduction of interest expense on securities issued by Enron Corporation in 1993 and 1994 that are similar to, although different in a number of respects from, the Junior Subordinated Debentures. It is - 22 - possible that a decision in that case could give rise to a Tax Event, which would permit PMC to cause a redemption of the Capital Securities, as described more fully under "Description of Capital Securities--Redemption--Special Event Redemption or Distribution of Junior Subordinated Debentures." Prospective investors also should be aware that legislation has been proposed by the Clinton Administration in the past that, if enacted, would have denied an interest deduction to issuers of instruments such as the Junior Subordinated Debentures. No such legislation is currently pending. There can be no assurance, however, that similar legislation will not ultimately be enacted into law, or that other developments will not occur on or after the date hereof that would adversely affect that tax treatment of the Junior Subordinated Debentures or the Issuer. Such changes also could give rise to a Tax Event. Liquidity of Trading; Trading Price of the Capital Securities May Not Fully Reflect Value of Unpaid Interest PMC and the Issuer do not intend to have the Capital Securities listed on any securities exchange. If the Underwriters do not make a market for the Capital Securities, the liquidity of the Capital Securities could be adversely affected. The Capital Securities may trade at a price that does not fully reflect the value of accrued but unpaid interest with respect to the underlying Junior Subordinated Debentures. A holder who disposes of his Capital Securities between record dates for payments of distributions thereon (and consequently does not receive a distribution from the Issuer for the period prior to such disposition) will nevertheless be required to include accrued but unpaid interest on the Junior Subordinated Debentures through the date of disposition in income as ordinary income, and to add such amount to his adjusted tax basis in the Capital Securities disposed of. To the extent that the selling price (which may not fully reflect the value of accrued but unpaid interest) is less than the holder's adjusted tax basis (which will include accrued but unpaid interest), the holder may recognize a capital loss. Subject to certain limited exceptions, capital losses cannot be applied to offset ordinary income for United States federal income tax purposes. See "United States Federal Income Taxation-- Interest Income and Original Issue Discount" and "--Sales of Capital Securities." Risk Factors Associated with the Company Holding Company Structure PMC is an insurance holding company and the right of PMC to participate in any distribution of assets of any subsidiary upon such subsidiary's liquidation or reorganization or otherwise (and thus the ability of holders of the Junior Subordinated Debentures and the Capital Securities to benefit indirectly from such distribution) is subject to the prior claims of creditors of that subsidiary, except to the extent that the Company may itself be recognized as a creditor of that subsidiary. Accordingly, the Junior Subordinated Debentures will be effectively subordinated to all existing and future liabilities of the subsidiaries of PMC, and the holders of Junior Subordinated Debentures should look only to the assets of PMC for payments on the Junior Subordinated Debentures. At June 30, 1998, the subsidiaries of PMC had total liabilities, excluding liabilities owed to PMC and intercompany transactions, of approximately $2.4 billion. - 23 - Restrictions on Subsidiary Dividends and Other Payments PMC is an insurance holding company whose assets consist principally of all of the outstanding common stock of its insurance subsidiaries. PMC's ongoing ability to pay dividends to its shareholders and meet its other obligations, including operating expenses and any principal and interest on debt (including the Junior Subordinated Debentures), 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 PMC and its subsidiaries and loans. The payment of dividends by PMC's subsidiaries to PMC is regulated under the insurance laws of Pennsylvania and Delaware (such laws are substantially similar). 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 law, PMC's Pennsylvania-domiciled 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 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. Based upon this limitation and the 1997 statutory results of PMA Reinsurance Corporation and the Pooled Companies, PMA Reinsurance Corporation and the Pooled Companies have the legal capacity to pay approximately $48.7 million in dividends in the aggregate to PMC in 1998 without obtaining the approval of the Pennsylvania Insurance Commissioner. Through September 1, 1998, $18.0 million in dividends had been declared, of which $10.0 million has been paid. 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. 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 PMC. As noted above, the Delaware insurance law provisions restricting dividends by insurers are substantially similar to such provisions under Pennsylvania insurance laws. During 1998, Caliber One Indemnity Company may pay up to $2.5 million of dividends to PMA Reinsurance Corporation without prior approval of the Delaware Insurance Commissioner. During 1998, no dividends have been 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 PMC in the future is reduced or eliminated, PMC's ability to pay principal and interest on, and/or redeem, the Junior Subordinated Debentures could be materially and adversely affected, depending upon the extent of such reduction. See "Supervision and Regulation." In March 1997, the Company refinanced substantially all of its existing debt facility with a $235.0 million revolving credit facility (the "Revolving Credit Facility"). In addition to the Revolving Credit Facility, the Company maintains a committed facility of $50.0 million for letters of credit (the "Letter of Credit Facility"). The Revolving Credit Facility and the Letter of Credit Facility are sometimes referred to herein as the "Credit Facilities." In addition to the foregoing regulatory restrictions, the Credit Facilities also impose restrictions on the ability of the Company's subsidiaries to pay dividends. Under these restrictions, the statutory surplus of PMC's insurance subsidiaries (as measured each calendar quarter) must not be less than $450 million and such subsidiaries - 24 - must annually maintain certain minimum ratios of adjusted surplus to risk-based capital (300% for PMA Reinsurance Corporation and 230% for the Pooled Companies in 1998, increasing to 240% thereafter). As of June 30, 1998, the Company's insurance subsidiaries reported combined statutory surplus of $561.1 million, and as of December 31, 1997, PMA Reinsurance Corporation's risk-based capital ratio was 355% and the Pooled Companies' risk-based capital ratios ranged from 293% to 324%. Certain Risks Affecting the Property and Casualty Insurance Industry The Company's operating results may be impacted by several factors that broadly impact the property and casualty insurance industry. Such factors include weather-related and other catastrophic losses, general economic conditions, including interest rate changes and trends in inflation of claims costs, legislative and regulatory initiatives, frequency of litigation and trends in the size of awards, as well as competitive conditions. In writing property and casualty insurance, the Company's insurance subsidiaries are subject to the possibility of losses from catastrophic events. In order to reduce risk and increase its underwriting capacity, the Company actively manages its exposure to such events through the underwriting process and through the purchase of reinsurance coverages; as a result, the Company's historical underwriting results have not been significantly impacted by catastrophes. However, catastrophic events could exceed the Company's reinsurance and/or retrocessional protection, and materially and adversely impact the Company's financial position. See "Business--The Company's Reinsurance Ceded." Overall economic trends, as well as legislative, regulatory and judicial trends may impact the operations of the Company's insurance subsidiaries. In addition, because the Company's earnings are substantially dependent on investment income and capital gains, changes in interest rates or other factors affecting the Company's investment portfolio and the credit quality and performance thereof may reduce the Company's investment results and have a material adverse effect on its results of operations. An economic downturn may reduce the overall demand for the Company's insurance products. Also, management believes that, in times of less favorable economic conditions, workers' compensation claims (particularly indemnity claims) have a tendency to be more severe. Legislative, regulatory and judicial issues that could adversely affect the Company include (i) an environment of more frequent and severe claims, (ii) increases in the overall cost of doing business, through increased capital requirements, higher taxes and assessments, residual market charges or higher overall costs of regulatory compliance, (iii) restrictions on premium rates and policy terms and (iv) reduced demand for the Company's products. The impact of these factors can dramatically impact the demand for the Company's products, insurance capacity, pricing and claims experience and, ultimately, have a material adverse effect on the Company's business, results of operations and financial condition. See "--Certain Concentrations" below, "Business--Regulatory Matters," "Business--The Property and Casualty Group--Workers' Compensation Insurance" and "Supervision and Regulation." Adequacy of Loss Reserves 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. - 25 - In addition, the reserving for workers' compensation insurance is more difficult than many other lines of insurance. The Company has recorded favorable (adverse) development of $86.0 million, ($156.1) million and ($51.5) million in 1997, 1996 and 1995, respectively, of which $44.1 million, ($110.0) million and ($54.7) million in 1997, 1996 and 1995, respectively, were associated with workers' compensation. See "Business--Loss Reserves" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Estimating reserves for workers' compensation claims can be more difficult than for many other lines of property and casualty insurance for several reasons, including (i) the long payment "tail" associated with the business, (ii) the impact of social, political and regulatory trends on benefit levels for both medical and indemnity payments, (iii) the impact of economic trends and (iv) the impact of changes in the mix of business. At various times, one or a combination of such factors can make the interpretation of actuarial data associated with workers' compensation loss development more difficult, and it can take additional time to recognize changes in loss development patterns. Under such circumstances, reserve adjustments will be made as loss patterns develop and new information becomes available, and such adjustments may be material. As is common practice in the property and casualty insurance industry, the Company discounts its workers' compensation unpaid losses; the average discount rate presently utilized is approximately 5.0%. As such, future operating results of the Company will be impacted by accretion of loss reserve discount. For the six-month periods ended June 30, 1998 and 1997, respectively, accretion of discount increased losses incurred by $14.4 million and $23.8 million, and for the years ended December 31, 1997, 1996 and 1995, respectively, accretion of discount increased losses incurred by $51.4 million, $57.5 million and $13.3 million (net of $35.0 million related to the change in discount rate from approximately 4.0% to 5.0%). At June 30, 1998, the Company had loss reserve discount of $437.0 million, comprised as follows: the Pooled Companies, $114.6 million; MASCCO, $55.4 million, PMA Cayman, $226.2 million; other Property and Casualty Group entities, $6.5 million and PMA Re, $34.3 million. See "Business-- Loss Reserves." Estimation of obligations for asbestos and environmental exposures continues to be more difficult than for other loss reserves because of several factors, including (i) evolving methodologies for the estimation of 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. The Company recorded incurred losses for asbestos and environmental exposures of $1.0 million, $60.4 million and $25.3 million in 1997, 1996 and 1995, respectively, and at December 31, 1997, the Company maintained loss reserves of $48.6 million ($76.7 million gross of reinsurance) for asbestos-related losses (of which $41.9 million was IBNR) and loss reserves of $31.7 million ($45.1 million gross of reinsurance) for environmental-related losses (of which, $20.5 million was IBNR). 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 liability and other factors, the ultimate exposure to the Property and Casualty Group for these claims may vary significantly from the reserves currently recorded, resulting in a potential future - 26 - adjustment in the claims reserves recorded. See "Business--Loss Reserves" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Estimating the Company's ultimate claims liability is necessarily a complex and judgmental process as the amounts are based upon 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 and economic conditions, the estimates are revised accordingly. If the Company's ultimate net losses prove to be substantially greater than the reserves recorded, the related adjustments could have a material adverse impact on the Company's financial condition and results of operations. Competitive Conditions The domestic property and casualty insurance and reinsurance industries are very competitive and consist of many companies, with no one company dominating the market. Competitive conditions may vary from state to state and market to market for a variety of reasons, including the regulatory climate, the number of market participants and similar factors. In addition to other insurance companies, the Company's insurance subsidiaries 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 and offer a broader range of products than the Company. Historically, the financial performance of the property and casualty insurance industry has tended to fluctuate in cyclical patterns of very competitive (soft) markets followed by less competitive (hard) markets. Although an individual insurance company's financial performance depends in part upon its own specific business characteristics; the profitability of most property and casualty insurance companies tends to follow this cyclical market pattern. At present, the property and casualty insurance industry is experiencing a prolonged soft market, and the extension of the current market conditions could have an adverse effect on the Company's business, results of operations and financial condition. There can be no assurance that market conditions will improve or, if they do improve that they will have a favorable impact on the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." One of the bases of competition in the insurance industry, particularly in the reinsurance segment, is size of capitalization. While management believes that PMA Re's present level of capitalization is appropriate and has not materially adversely affected its participation in business opportunities or resulted in any significant erosion of its client base, PMA Re could be affected by (i) changes in market perception of appropriate levels of capitalization or (ii) the need to increase capitalization in response to market opportunities. While the purpose of the Offering is to increase the Company's flexibility to respond to such situations, there can be no assurance that PMC will have the ability to increase PMA Re's capitalization to satisfy state insurance regulators or to maintain the current A.M. Best ratings of PMC's insurance subsidiaries. See "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business--Competition" and "Use of Proceeds." The Property and Casualty Group must attract and retain productive agents to sell its insurance products and services. Strong competition exists among insurance companies for agents with demonstrated abilities. Competition among insurance companies for such agents - 27 - is based upon, among other things, the services provided to, and relationships developed with, these agents in addition to compensation and product structure. If the Property and Casualty Group is not able to continue to attract and retain productive agents, there could be a material adverse effect on the Company. The surplus lines of insurance offered by Caliber One are generally placed by wholesale brokers and managing general agents who specialize in particular lines of coverage or classes of insureds. These insureds tend to be sophisticated and price-conscious insurance purchasers. As a result, surplus lines insurers may experience increased premium rate competition in soft markets. This could result in a material adverse effect on the Company. Collectibility of Reinsurance The Company follows the customary insurance practice of reinsuring with other insurance companies a portion of the risks underwritten by its insurance subsidiaries. This reinsurance is maintained to protect the Company against the severity of losses on individual claims and unusually serious occurrences in which a number of claims produces an aggregate extraordinary loss. Reinsurance does not discharge the Company's insurance subsidiaries from their obligations to their policyholders; however, it does make the assuming reinsurers liable to the Company's insurance subsidiaries for the reinsured portion of the risk. At June 30, 1998, the Company had $211.2 million in reinsurance receivables which are not directly secured by letters of credit, trust arrangements, funds held or other collateral. Although management believes that the Company's reinsurance protection is placed with financially sound companies, there can be no assurance that such reinsurers will pay reinsurance claims on a timely basis, if at all. Further, although the Company has reinsurance it believes to be adequate, there can be no assurance that the Company will continue to be able to obtain reinsurance on acceptable terms and that the Company's reinsurance protection will be adequate in the event of a catastrophe. See "Certain Risks Affecting the Property and Casualty Insurance Industry" above and "Business--The Company's Reinsurance Ceded." Certain Concentrations In 1997, the Property and Casualty Group derived 49% of its direct written premiums from Pennsylvania, 61% of which was workers' compensation. Also in 1997, the Property and Casualty Group derived 60% of its direct written premiums from workers' compensation in all of the states in which it conducts business. This concentration exposes the Company to changes affecting the Pennsylvania economy, as well as changes impacting benefit and/or rate levels for workers' compensation in Pennsylvania and the other states in which it conducts business. Since 1993, two major benefit reform laws have been passed in Pennsylvania, which have had a favorable impact on workers' compensation loss costs. In 1993, Act 44 introduced medical cost containment measures and improved the Property and Casualty Group's ability to utilize managed care techniques. Specifically, Act 44 introduced medical cost containment measures to the Pennsylvania workers' compensation benefit system and increased the length of time in which an insurer may require an employee to accept medical treatment from the employer's list of designated health care providers from 14 days to 30 days. In addition, the law reduced the minimum wage replacement benefit to injured workers, introduced a credit for unemployment compensation benefits, restored the right of subrogation against tort - 28 - recoveries in work-related automobile accidents and created new anti-fraud measures. In 1996, Act 57 introduced measures that primarily reduce indemnity loss costs. Among its provisions, Act 57: (i) imposes application of American Medical Association Impairment Guidelines for the assessment of permanent and total claims after the first two years of total disability compensation payments and limits indemnity benefits to an additional 500 weeks for workers who are not at least 50% disabled (as measured by those guidelines); (ii) contains certain Social Security and pension benefits offsets; (iii) further increases the time frame for directed medical treatment; (iv) addresses certain inequities in the average weekly wage calculation; (v) increases the ability of employers to demonstrate that injured workers have earning capacity and (vi) facilitates the use of full and final settlements of employers' workers' compensation obligations on particular claims. As a result of these Acts, as well as reforms in several other states in which the Property and Casualty Group operates, the frequency and severity of workers' compensation claims have been decreasing, which has contributed to the decreased accident year workers' compensation loss ratios of the Property and Casualty Group since 1993. In conjunction with these benefit reforms, manual rate levels in Pennsylvania decreased approximately 10% in 1994, 25% in 1997 and 27% in the first six months of 1998 (although management expects such rate of change to be a 19% decrease for the year ending December 31, 1998) when compared to the respective preceding year. Management believes the projected savings derived from the reforms will offset these manual rate decreases. However, the ultimate cost of workers' compensation claims can be difficult to predict and there can be no assurance that rates will remain adequate. While management believes that the Company has benefited from workers' compensation reform in Pennsylvania and elsewhere, as well as a generally good economic climate in the states in which it conducts business, there can be no assurance that: (i) there will not be initiatives, legislative or otherwise, to reverse the effects of workers' compensation reforms; (ii) workers' compensation rates will remain adequate or (iii) economic conditions will remain favorable. See "Business--The Property and Casualty Group" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." PMA Re distributes its products through reinsurance intermediaries, known as brokers. In 1997, three brokers each accounted for more than 10% of PMA Re's gross premiums in force: Aon Reinsurance (35.7%); Guy Carpenter & Company (23.3%); and E.W. Blanch (13.6%). PMA Re's top five brokers accounted for 90.8% of its gross premiums in force in 1997. While management believes that these relationships with these brokers are generally excellent, if relations with any of its major brokers were to deteriorate, resulting in reduced premium flow, it could have a material adverse effect on PMA Re and the Company. See "Business-- PMA Re--Marketing and Distribution." Importance of Ratings As insurers and reinsurers tend to compete on the basis of financial stability, among other things, management believes that the ratings of the Company's insurance subsidiaries by the major rating agencies are material to its operations. Presently, A.M. Best has rated PMA Reinsurance Corporation, A+ ("Superior"), the Pooled Companies, A- ("Excellent") and Caliber One Indemnity Company, A ("Excellent"). The Company is also presently seeking ratings of its insurance subsidiaries from Standard & Poor's and Moody's. The ratings of the insurance subsidiaries from these rating agencies would be based upon an analysis of the insurance company's perceived financial strength regarding its ability to pay obligations to its - 29 - policyholders and would not be directed toward the protection of investors. Such ratings would be subject to changes and do not constitute recommendations to buy, sell or hold securities. There can be no assurance that such ratings, if obtained, or future changes therein will not affect the Company's competitive position. There can be no assurance that PMA Reinsurance Corporation, the Pooled Companies or Caliber One Indemnity Company will obtain or maintain any ratings, and any downgrade could have a material adverse effect on their respective businesses. In addition, there can be no assurance that any rating received from Standard & Poor's and/or Moody's would not have a detrimental effect on the Company's competitive position. See "Business--Competition." Regulation The Company is subject to regulation under applicable insurance statutes, including the insurance holding company statutes of Pennsylvania. In addition, the Company's insurance subsidiaries are subject to regulation in each of the states in which they transact business. Insurance regulation is intended to protect policyholders rather than to protect investors in insurance companies or their holding companies. 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 for admitted insurers and, for certain lines of insurance, including all of the lines written by the Property and Casualty Group, approval of rates. In supervising and regulating insurance companies, including reinsurers, state insurance departments enjoy broad authority and discretion in applying applicable insurance laws and regulations for the protection of policyholders and the public. Inasmuch as they are subject to regulatory approval, the rates that the Property and Casualty Group can charge for workers' compensation and standard commercial lines of property and casualty insurance might not keep pace with the underlying claim costs. In addition, any changes in these laws and regulations or the failure of the Company to comply with such laws and regulations could materially adversely affect the Company's operations. See "Supervision and Regulation." Workers' compensation insurers doing business in certain states are required to provide insurance for risks which are not otherwise written on a voluntary basis by the private market ("residual market business"). This system exists in all of the Property and Casualty Group's current marketing territories, except Pennsylvania and Maryland, in which separate governmental entities write all of the workers' compensation residual market business. Because residual market business consists of difficult to insure risks and entities and classes with poor experience, the underwriting results of residual market business tend to be worse than those of voluntary business. In 1997, the Property and Casualty Group wrote $5.2 million of residual market business, which constituted approximately 3% of its voluntary market volume. While management believes that the Property and Casualty Group has a lesser exposure to residual market business than many other companies writing workers' compensation business, based upon the volume of residual market business written, the Company is exposed to the possibility that its underwriting results will be adversely affected by increases in the size of the residual market and worsening experience in the residual market. See "Business--the Property and Casualty Group--Workers' Compensation Residual Market Business." - 30 - In recent years, various proposals have been introduced in Congress, which call for the federal government to assume some role in the regulation of insurance. To date, none of these proposals has been enacted, and the Company cannot predict what form such future proposals might take or what effect, if any, such proposals might have on PMC or its subsidiaries if enacted into law. Year 2000 Issue As a consequence of the programming convention which utilized a two-digit date field rather than a four-digit date field, most computers require relatively costly reprogramming to enable them to perform correctly date operations involving year 2000 ("Year 2000") or later (the "Year 2000 Issue"). Many anticipate that the Year 2000 Issue will have substantial repercussions on the business world, since computer operations involving date calculations are pervasive. With the assistance of outside consulting groups, the Company began evaluating and reprogramming its own computer systems to address the Year 2000 Issue in late 1995. Management anticipates that by year-end 1998, it will have substantially completed all necessary programming work. Accordingly, management believes that Year 2000 Issues related to the Company's hardware and internal software programs are not likely to result in any material adverse disruptions in the Company's computer systems or its internal business operations. The cost of this work through June 30, 1998 has been approximately $5.3 million, including approximately $1.5 million incurred during the first six months of 1998. The Company estimates that the total remaining cost will be approximately $175,000, which will be expensed throughout the remainder of 1998. The Company is currently in the process of evaluating its relationships with third parties with which the Company has a direct and material relationship to determine whether they are Year 2000 compliant, such as banks, brokers, reinsurers, third party service providers, software and other service vendors, insureds and agents and other intermediaries. The responses by such third parties to inquiries made by the Company as have been received to date indicate that these third parties either are or expect to be compliant by the Year 2000. Even assuming that all material third parties provide a timely representation affirming such Year 2000 compliance, however, it is not possible to state with certainty that such representations will turn out to have been accurate, or that the operations of such third parties will not be materially impacted in turn by other parties with whom they themselves have a material relationship, and who fail to timely become Year 2000 compliant. Consequently, it is not possible to predict whether or to what extent the Year 2000 Issues may have an adverse material impact on the Company as a result of their impact on the operations of third parties with whom the Company has a material relationship. The failure of one or more third parties with whom the Company has a material relationship to be Year 2000 compliant could cause significant disruptions in the Company's ability to pay claims, receive and deposit funds and make investments, which could have a material adverse effect on the Company's financial condition and results of operations. The Company's contingency plans in the event of failure of such third parties to be Year 2000 compliant include replacing the third party, performing directly the services performed by the third party and maintaining liquidity under the Company's Revolving Credit Facility, which may have a material impact on the Company. Many experts now believe that Year 2000 Issues may have a material adverse effect on the national and global economy generally. In addition, it seems likely that if businesses are materially damaged as a result of Year 2000 Issues, at least some such businesses may attempt to recoup their losses by claiming coverage under various types of insurance policies. Management of the Property and Casualty Group and Caliber One believe that under a fair reading of the various policies issued by them, no coverage for Year 2000 Issues should exist. Management of PMA Re also believes that the policies of its ceding company clients which are reinsured by PMA Re do not provide coverage for Year 2000 issues. However, in the event that claims for Year 2000 Issues are asserted against the Property and Casualty Group, Caliber One or PMA Re, it is not possible to predict whether or to what extent any such coverage could ultimately be found to exist by courts in various jurisdictions, or, if found, the effect thereof on any of such companies or the Company. In addition, to the extent that the Property and Casualty Group, Caliber One or PMA Re contest the assertion of Year 2000 coverage claims, it is likely that the costs of litigation could be material, even if they are able to prevail in their coverage positions as to which no assurance can be given. - 31 - Dependence Upon Key Personnel The Company depends upon its executive management, including the executive management of its insurance subsidiaries, to execute its business strategy. The loss of any of these individuals or a reduction in the time devoted by such persons to the Company's business could have a material adverse effect on the Company's business. The Company's future success will depend, in part, upon its ability to attract and retain highly qualified personnel. The Company faces competition for such personnel from other companies, many of which have significantly greater resources than the Company. There can be no assurance that the Company will be able to attract and retain the necessary personnel on acceptable terms. See "Business" and "Management." - 32 - THE COMPANY The Company is an insurance holding company, whose subsidiaries operate in three distinct segments of the property and casualty insurance industry: (i) reinsurance, through PMA Re, which commenced business in 1980; (ii) standard commercial lines of insurance, with an emphasis on workers' compensation through the Property and Casualty Group, which has been in business since 1915 and (iii) specialty insurance products, focusing on excess and surplus lines, through the Company's recently-formed operation, Caliber One. PMA Re writes a broad range of property and casualty reinsurance products with an emphasis on risk-exposed casualty excess of loss reinsurance and operates in the United States domestic brokered market. The Property and Casualty Group offers a broad range of standard commercial lines products including commercial general liability, commercial automobile and commercial multi-peril, with an emphasis on underwriting of workers' compensation products and services primarily in nine contiguous jurisdictions in the Mid-Atlantic and Southern regions of the United States, utilizing the PMA Group trade name. In 1998, Caliber One commenced writing excess and surplus lines of property and casualty insurance, including commercial general liability, automobile and certain property exposures on a non-admitted basis. For the six months ended June 30, 1998, the Company's net premiums written of $257.0 million were derived 45.9% from PMA Re, 53.8% from the Property and Casualty Group and 0.3% from Caliber One. Net income for the Company for the six months ended June 30, 1998 and the year ended December 31, 1997 was $21.4 million and $15.0 million, respectively. As of June 30, 1998, the Company had total assets of $3,075.4 million and shareholders' equity of $496.4 million. According to data provided by the RAA, as of June 30, 1998, PMA Reinsurance Corporation was the 24th largest reinsurer in the United States in terms of statutory surplus and 17th largest in terms of net premiums written. Management believes that PMA Re competes on the basis of its ability to offer prompt and responsive service and products designed to meet client needs and its excellent long-term relationships in the broker and ceding company communities. PMA Re's net premiums written grew at a compound annual rate of 13.2% between 1992 and 1997. As of June 30, 1998, statutory surplus of PMA Reinsurance Corporation was $279.1 million, and for the six months ended June 30, 1998, PMA Re's net premiums written were $117.9 million. PMA Re reported pre-tax operating income of $23.0 million and $23.2 million for the six-month periods ended June 30, 1998 and 1997, respectively, and $46.0 million, $44.8 million and $39.8 million for the years ended December 31, 1997, 1996 and 1995, respectively. The Property and Casualty Group markets a full range of workers' compensation products and services, as well as other standard commercial lines of property and casualty insurance, primarily to middle market accounts (premiums ranging from $40,000 to $300,000) and smaller accounts (premiums less than $40,000). The Property and Casualty Group distributes its products primarily through approximately 240 regional brokers and agents throughout its marketing territories and also utilizes an internal sales force in Pennsylvania and Delaware, which accounted for approximately 13% of direct premiums written in 1997. In 1997, workers' compensation insurance accounted for 60% of the Property and Casualty Group's direct premiums written, and Pennsylvania workers' compensation insurance accounted for 50% of - 33 - the Property and Casualty Group's workers' compensation direct premiums written. The Property and Casualty Group offers a variety of workers' compensation products, such as third-party claims administration services, rent-a-captives and high-deductible plans in addition to traditional fixed-cost and loss- sensitive workers' compensation products, and management believes that the Property and Casualty Group competes in workers' compensation on the basis of its ability to provide prompt and responsive service. In 1996, the Company restructured the Property and Casualty Group with the goal of restoring its profitability after three years of operating losses. The losses resulted primarily from unfavorable underwriting experience and adverse reserve development related to accident years 1987 through 1991, when the Property and Casualty Group wrote a much higher volume of business than its current volume. The principal components of the restructuring were: (i) strengthening loss reserves; (ii) initiating a commutation program to settle a significant number of open claims from the 1987 to 1991 period; (iii) designating PMA Cayman and MASCCO as separate run-off companies to alleviate the SAP impact on the Pooled Companies of the loss reserve strengthening and to manage the capital deployed in running off pre-1992 workers' compensation claims; (iv) initiating an expense reduction program and (v) implementing management changes, including the appointment of a new Chief Operating Officer and the creation of the position of Chief Underwriting Officer. In June 1998, the Company entered into a letter of intent to sell PMA Cayman. Largely as a result of the restructuring, the Property and Casualty Group recorded pre-tax operating income of $5.4 million for the six months ended June 30, 1998, compared to pre-tax operating losses of $5.9 million for the six months ended June 30, 1997 and $3.7 million, $215.7 million (including restructuring and other special charges of $223.1 million) and $3.9 million for the years ended December 31, 1997, 1996 and 1995, respectively. At June 30, 1998, the Pooled Companies' statutory surplus was $263.1 million, and for the six months ended June 30, 1998, the Property and Casualty Group's net premiums written were $138.4 million. See "Business--The Property and Casualty Group." In December 1997, the Company acquired an insurance company, which was renamed Caliber One Indemnity Company, to enter the excess and surplus lines insurance business. Within the last year, the Company hired several experienced specialty insurance executives to manage Caliber One, who have substantial relationships within the wholesale brokerage community, which management believes will have a favorable impact on Caliber One's ability to obtain market acceptance. Caliber One distributes its products primarily through national wholesale brokers, and Caliber One Indemnity Company is approved as a surplus lines carrier in 38 states, Puerto Rico and the District of Columbia. As of June 30, 1998, Caliber One Indemnity Company's statutory surplus was $25.5 million, and for the six months ended June 30, 1998, Caliber One's net premiums written were $917,000. The Company's insurance subsidiaries have the following ratings from A.M. Best: PMA Reinsurance Corporation, A+ ("Superior"); the Pooled Companies, A- ("Excellent") and Caliber One Indemnity Company, A ("Excellent"). Management believes that ratings from A.M. Best are material to its operations and that a downgrade from the present rating classifications could have an adverse effect on the Company's ability to market its products. A.M. Best's ratings are based upon an assessment of an insurance company's perceived financial strength regarding its ability to pay obligations to its policyholders and are not directed toward the protection of investors. - 34 - The Company maintains its executive offices at 380 Sentry Parkway, Blue Bell, PA 19422, and its telephone number is (215) 665-5046. THE ISSUER The Issuer is a statutory business trust formed under Delaware law pursuant to (i) a trust agreement executed by PMC as Depositor, The Bank of New York, as the Property Trustee of the Issuer, and The Bank of New York (Delaware), as Trustee, and (ii) a certificate of trust filed with the Delaware Secretary of State. The trust agreement will be amended and restated in its entirety (as so amended and restated, the "Trust Agreement") substantially in the form filed as an exhibit to the Registration Statement of which this Prospectus forms a part. The Trust Agreement will be qualified as an indenture under the Trust Indenture Act. The Issuer exists for exclusive purposes of (i) issuing and selling the Capital Securities and the Common Securities, (ii) using the proceeds from the sale of the Capital Securities and the Common Securities to acquire the Junior Subordinated Debentures issued by PMC and (iii) engaging in only those other activities necessary, or incidental thereto. Accordingly, the Junior Subordinated Debentures, the rights of the Property Trustee under the Guarantee and the right to reimbursement of expenses under the Expense Agreement will be the sole assets of the Issuer, and payments under the Junior Subordinated Debentures and the Expense Agreement will be the sole revenue of the Issuer. All of the Common Securities of the Issuer will be owned by PMC. The Common Securities will rank pari passu, and payments will be made thereon pro rata, with the Capital Securities, except that upon the occurrence and continuance of an Event of Default under the Trust Agreement (as defined therein) resulting from a Debenture Event of Default, the rights of PMC as holder of the Common Securities to payment in respect of distributions and payments upon liquidation, redemption or otherwise will be subordinated to the rights of the holders of the Capital Securities. See "Description of the Capital Securities -- Subordination of Common Securities." PMC will acquire Common Securities in an aggregate liquidation amount equal to approximately 3% of the total capital of the Issuer. The Issuer has a term of approximately 55 years, but may terminate earlier as provided in the Trust Agreement. The Issuer's business and affairs are conducted by its trustees, each appointed by PMC as holder of the Common Securities. The trustees for the Issuer will be The Bank of New York, as the Property Trustee, The Bank of New York (Delaware), as Trustee, and three individual Administrative Trustees who are employees or officers of or affiliated with PMC. The Bank of New York, as Property Trustee, will act as sole indenture trustee under the Trust Agreement for purposes of compliance with the Trust Indenture Act. The Bank of New York will also act as Trustee under the Guarantee and the Indenture (each as defined herein). See "Description of the Guarantee" and "Description of the Junior Subordinated Debentures." The holder of the Common Securities of the Issuer, or the holders of a majority in Liquidation Amount of the Capital Securities if a Debenture Event of Default has occurred and is continuing, will be entitled to appoint, remove or replace the Property Trustee. In no event will the holders of the Capital Securities have the right to vote to appoint, remove or replace the Administrative Trustees; such voting rights are vested exclusively in the holder of the Common Securities. The duties and obligations of the Property Trustee are governed by the Trust Agreement. PMC will pay all fees and expenses related to the Issuer and the - 35 - offering of the Capital Securities and will pay, directly or indirectly, all ongoing costs, expenses and liabilities of the Issuer. The principal executive office of the Issuer is located at 380 Sentry Parkway, Blue Bell, Pennsylvania 19422, and its telephone number is (215) 665- 5046. RATIO OF EARNINGS TO FIXED CHARGES The following table sets forth the Company's ratio of earnings to fixed charges for the six months ended June 30, 1998 and 1997 and the years ended December 31, 1997, 1996, 1995, 1994 and 1993.
Six Months Ended Year ended December 31, June 30, ----------- ------------------------------- 1998 1997 1997 1996(2) 1995 1994 1993 ----- ---- ---- ------- ---- ---- ---- Ratio of Earnings to Fixed Charges(1) 4.0x 1.3x 2.4x -- 2.7x 5.5x 7.7x
(1) For the purposes of determining this ratio, earnings (loss) consist of income (loss) before income taxes and extraordinary loss (1997), plus fixed charges. Fixed charges consist of interest expense on debt, amortization of debt issuance costs and the portion of operating leases that management believes is representative of the interest factor. (2) In 1996, earnings were insufficient to cover fixed charges by $191.4 million. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." - 36 - CAPITALIZATION The following table sets forth the unaudited consolidated capitalization of the Company at June 30, 1998 on an actual basis and as adjusted to reflect the issuance of the Junior Subordinated Debentures in connection with the Offering as if the Offering had occurred on June 30, 1998, after deducting the estimated underwriting discount and expenses of the Offering. This table should be read in conjunction with the consolidated financial statements, including the notes thereto, appearing elsewhere in this Prospectus.
(dollar amounts in thousands, except per share data) At June 30, 1998 (Unaudited) Actual As Adjusted ------ ----------- Long-term debt: Revolving Credit Facility(1) $203,000 $104,500 -------- -------- Company-obligated mandatorily redeemable Capital Securities of subsidiary trust holding solely Junior Subordinated Debentures of the Company(2) -- 100,000 -------- -------- Shareholders' equity: Common stock, $5.00 par value, 40,000,000 shares authorized, 14,765,020 shares issued and 14,329,013 shares outstanding 73,825 73,825 Class A common stock, $5.00 par value, 40,000,000 shares authorized, 9,677,925 shares issued and 9,356,995 shares outstanding 48,389 48,389 Additional paid-in capital-Class A common stock 339 339 Retained earnings 359,486 359,486 Accumulated other comprehensive income 26,297 26,297 Notes receivable from officers (198) (198) Treasury stock, at cost (436,007 shares- common stock and 320,930 shares- Class A common stock) (11,755) (11,755) -------- -------- Total shareholders' equity 496,383 496,383 -------- -------- Total capitalization $699,383 $700,883 ======== ========
(1) At June 30, 1998, $32,000 was available for borrowing under the Company's Revolving Credit Facility. As adjusted, at June 30, 1998, available borrowings under the Company's Revolving Credit Facility are $130,500. (2) Represents the issuance of the Capital Securities by the Trust (net of related issuance costs). One hundred percent of the assets of the Trust will consist of approximately $103,093 of Junior Subordinated Debentures of PMC. The financial statements of the Trust will be reflected in the consolidated financial statements of the Company with the Capital Securities reflected as Company-obligated mandatorily redeemable Capital Securities of subsidiary trust holding solely Junior Subordinated Debentures of the Company. See "Accounting Treatment." - 37 - USE OF PROCEEDS PMC currently estimates the net proceeds to be received from the Offering will be $98.5 million, after giving effect to estimated underwriting discounts and estimated offering expenses. All of the net proceeds from the sale of the Capital Securities will be invested in the Junior Subordinated Debentures. PMC intends to use the proceeds from the sale of such Junior Subordinated Debentures to repay indebtedness under the Revolving Credit Facility, which will increase the availability under the Revolving Credit Facility from $32 million to $130.5 million. The final maturity of the Revolving Credit Facility is December 31, 2002, with reductions in availability of $47.5 million on December 31, 1999 and level reductions in availability of $62.5 million each December 31 thereafter, commencing in 2000. The Revolving Credit Facility bears interest at a variable interest rate of LIBOR plus .70% on the drawn amount (with such spread adjustable downward based upon reductions in the Company's ratio of debt to total capitalization), or 6.4% at June 30, 1998, and carries a .275% facility fee on the undrawn portion (also adjustable downward based upon reductions in the Company's ratio of debt to total capitalization). It is the Company's intention to utilize availability under the Revolving Credit Facility, from time to time in the future, to capitalize subsidiaries and make other strategic investments as business opportunities arise, subject to the maintenance of appropriate financial leverage ratios. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." ACCOUNTING TREATMENT For financial reporting purposes, the Issuer will be treated as a subsidiary of the Company, and, accordingly, the accounts of the Issuer will be included in the consolidated financial statements of the Company. The Capital Securities will be presented as a separate line item in the consolidated balance sheets of the Company, entitled "Company-obligated mandatorily redeemable Capital Securities of subsidiary trust holding solely Junior Subordinated Debentures of the Company" and the audited notes to the consolidated financial statements will contain disclosure that (a) the Common Securities of the Trust are wholly owned by PMC, (b) the sole asset of the Trust is the ___% Junior Subordinated Debentures of PMC in the approximate principal amount of $103.093 million, having a stated maturity of ___, 2028, and (c) PMC fully and unconditionally guarantees the Trust's obligations under the Capital Securities. For financial reporting purposes, the Company will record distributions payable on the Capital Securities as an expense in its consolidated statements of operations. - 38 - SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA The selected consolidated financial and operating data set forth below as of December 31, 1997, 1996, 1995, 1994, and 1993 and for each of the five years in the period ended December 31, 1997 were derived from the audited consolidated financial statements of the Company. The selected consolidated financial and operating data as of June 30, 1998 and 1997 and for the six-month periods ended June 30, 1998 and 1997 were derived from the Company's unaudited consolidated financial statements. The unaudited consolidated financial statements have been prepared on the same basis as the Company's audited consolidated financial statements, and, in the opinion of management, include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the Company's financial position and results of operations for these periods. The results of operations for the six months ended June 30, 1998 may not be indicative of results of operations for the full year. All selected consolidated financial and operating data set forth below should be read in conjunction with the consolidated financial statements of the Company, together with the notes thereto, and Management's Discussion and Analysis of Financial Condition and Results of Operations, both appearing elsewhere in this Prospectus.
(dollar amounts in thousands, except per share data) Six Months Ended June 30, Year Ended December 31, ------------------------ -------------------------------------------------------------------- 1998 1997 1997(1) 1996(1) 1995(1) 1994(1) 1993 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Net premiums written (2) $ 248,481 $ 248,285 $ 381,282 $ 432,975 $ 485,876 $ 465,502 $ 533,487 =========== =========== =========== =========== =========== =========== =========== Consolidated Revenues: Net premiums earned $ 221,576 $ 222,401 $ 375,951 $ 420,575 $ 484,952 $ 466,534 $ 547,407 Net investment income 65,200 68,459 136,698 133,936 139,355 138,719 153,842 Net realized investment gains (losses) 11,263 (1,931) 8,598 2,984 31,923 47,521 69,798 Service revenues 5,090 5,038 10,311 9,189 5,106 3,380 1,321 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Total consolidated revenues $ 303,129 $ 293,967 $ 531,558 $ 566,684 $ 661,336 $ 656,154 $ 772,368 =========== =========== =========== =========== =========== =========== =========== Income (loss) before cumulative effect of accounting changes and extraordinary item 21,445 5,277 19,753 (135,334) 24,130 57,250 68,297 Cumulative effect of accounting changes, net of related tax effects (3) --- --- --- --- --- --- 14,119 Extraordinary loss from early extinguishment of debt, net of related tax effect (4) --- (4,734) (4,734) --- --- --- --- ----------- ----------- ----------- ----------- ----------- ----------- ----------- Net income (loss) $ 21,445 $ 543 $ 15,019 $ (135,334) $ 24,130 $ 57,250 $ 82,416 =========== =========== =========== =========== =========== =========== =========== Per Share Data: Weighted average shares: Basic (5) 23,770,912 23,832,562 23,855,031 23,800,791 23,816,088 23,897,263 24,231,071 Diluted (5), (6) 24,658,911 24,504,892 24,567,378 23,800,791 24,781,949 24,650,741 24,470,024 Income (loss) before cumulative effect of accounting changes and extraordinary item per share: Basic (5) $ .90 $ .22 $ .83 $ (5.68) $ 1.01 $ 2.40 2.82 Diluted (5), (6) .87 .21 .80 (5.68) .97 2.32 2.79 Net income (loss) per share: Basic (5) .90 .02 .63 (5.68) 1.01 2.40 3.40 Diluted (5), (6) .87 .02 .61 (5.68) .97 2.32 3.37 Dividends paid per common share .16 .16 .32 .32 .32 .32 .28 Dividends paid per Class A common share .18 .18 .36 .36 .36 .36 32 Shareholders' equity per share 20.96 17.40 19.96 17.86 25.53 22.10 22.23 At June 30, At December 31, ----------------- ------------------------------------------------------------- 1998 1997 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- ---- ---- Consolidated Financial Position: Total investments $ 2,159,303 $ 2,067,828 $ 2,194,738 $ 2,261,353 $ 2,455,949 $ 2,313,261 $ 2,374,208 Total assets 3,075,413 3,085,640 3,057,258 3,117,516 3,258,572 3,181,979 3,197,909 Reserves for unpaid losses and LAE 1,939,568 2,052,791 2,003,187 2,091,072 2,069,986 2,103,714 2,150,665 Long-term debt 203,000 203,049 203,000 204,699 203,848 203,975 194,836 Shareholders' equity (7) 496,383 415,120 478,347 425,828 609,668 524,862 534,383 - ---------------------------
- 39 -
(dollar amounts in thousands, except per share data) Six Months Ended June 30, Year Ended December 31, ------------------------ -------------------------------------------------------------------- 1998 1997 1997(1) 1996(1) 1995(1) 1994(1) 1993 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Pre-tax operating income (loss)(8): PMA Re $ 22,952 $ 23,187 $ 45,957 $ 44,807 $ 39,793 $ 33,703 $ 33,511 ----------- ----------- ----------- ----------- ----------- ----------- ----------- The Property and Casualty Group (9): Excluding Run-off Operations 4,954 (4,781) (3,607) (215,669) (3,885) 3,893 (1,153) Run-off Operations 428 (1,107) (73) --- --- --- --- ----------- ----------- ----------- ----------- ----------- ----------- ----------- Total Property and Casualty Group 5,382 (5,888) (3,680) (215,669) (3,885) 3,893 (1,153) Caliber One (1,070) --- --- --- --- --- --- Corporate operations (5,548) (4,526) (9,954) (6,464) (14,184) (6,686) (885) ----------- ----------- ----------- ----------- ----------- ----------- ----------- Total pre-tax operating income (loss) before interest expense 21,716 12,773 32,323 (177,326) 21,724 30,910 31,473 Interest expense 7,463 8,222 15,768 17,052 18,734 13,051 11,650 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Pre-tax operating income (loss) 14,253 4,551 16,555 (194,378) 2,990 17,859 19,823 Net realized investment gains (losses) 11,263 (1,931) 8,598 2,984 31,923 47,521 69,798 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Income (loss) before income taxes and extraordinary item 25,516 2,620 25,153 (191,394) 34,913 65,380 89,621 Provision (benefit) for income taxes 4,071 (2,657) 5,400 (56,060) 10,783 8,130 21,324 ----------- ----------- ----------- ----------- ----------- ----------- ----------- Income (loss) before cumulative effect of accounting changes and extraordinary item 21,445 5,277 19,753 (135,334) 24,130 57,250 68,297 Ratio of earnings to fixed charges (10) 4.0x 1.3x 2.4x -- 2.7x 5.5x 7.7x GAAP Ratios for Insurance Subsidiaries (11): PMA Re: Loss ratio 69.0% 73.1% 69.6% 73.7% 74.6% 74.7% 80.6% Expense ratio 35.2% 29.3% 34.2% 28.9% 29.3% 33.3% 29.4% ----------- ----------- ----------- ----------- ----------- ----------- ----------- Combined ratio (12) 104.2% 102.4% 103.8% 102.6% 103.9% 108.0% 110.0% =========== =========== =========== =========== =========== =========== =========== The Property and Casualty Group, including Run-off Operations (9): Loss ratio 85.5% 95.4% 91.1% 158.2% 92.5% 90.1% 96.3% Expense ratio (13) 34.0% 35.0% 42.8% 47.1% 30.4% 31.4% 25.0% Policyholders' dividend ratio 6.7% 4.8% 6.9% 6.1% 4.8% 4.6% 3.5% ----------- ----------- ----------- ----------- ----------- ----------- ----------- Combined ratio (12) 126.2% 135.2% 140.8% 211.4% 127.7% 126.1% 124.8% =========== =========== =========== =========== =========== =========== =========== The Property and Casualty Group, excluding Run-off Operations (9): Loss ratio 77.7% 84.9% 83.7% -- -- -- -- Expense ratio (13) 32.8% 33.9% 32.9% -- -- -- -- Policyholders' dividend ratio 6.7% 4.8% 5.6% -- -- -- -- ----------- ----------- ----------- ----------- ----------- ----------- ----------- Combined ratio (12) 117.2% 123.6% 122.2% -- -- -- -- =========== =========== =========== =========== =========== =========== ===========
___________________________ (1) Operating results in 1997, 1996 and 1995 were impacted by approximately $12,100, $223,100 and $8,400, respectively, of restructuring and other special charges. See "Management's Discussion and Analysis of Financial Condition and Results of - 40 - Operations" for further information. In addition, 1994 operating results included a charge of approximately $4,908 to write down the value of the Company's former headquarters building. (2) Net premiums written were reduced by $2,072 for the six months ended June 30, 1998 and reduced by $37,000, $10,500, $4,000, $1,000, and $3,500 for the years ended December 31, 1997, 1996, 1995, 1994 and 1993, respectively, representing estimated retrospective policy adjustments related to the current accident year and retrospective policy adjustments paid. The corresponding adjustment for the six months ended June 30, 1997 was not material. These adjustments to net premiums written were made for presentation purposes only and had previously been reflected in the Company's reported revenues, financial position and results of operations. (3) In 1993, the Company recognized an after-tax net benefit of $14,119 resulting from the adoption of SFAS No. 109, "Accounting for Income Taxes," ($21,500 benefit), and SFAS No. 106, "Employers' Accounting for Post- retirement Benefits Other Than Pensions," ($7,381 after-tax charge). (4) In 1997, the Company refinanced substantially all of its long-term debt that resulted in a $4,734 extraordinary loss, net of tax effect. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." (5) In 1997, the Company adopted SFAS No. 128, "Earnings Per Share," which requires the presentation of basic and diluted earnings per share (see Notes 1-I and 16 to the audited consolidated financial statements appearing elsewhere in this Prospectus). All prior periods' presentation of earnings per share data has been restated to conform to SFAS No. 128. (6) 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. (7) In 1994, shareholders' equity increased $45,343 related to the adoption of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." (8) 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 the Company's interim financial statements and notes thereto as of June 30, 1998 and 1997 included elsewhere in this Prospectus. The Company has excluded net realized investment gains (losses) from the profit and loss measurement it utilizes to assess the performance of its operating segments because (i) net realized investment gains (losses) are unpredictable and not necessarily indicative of future performance and (ii) in many instances, decisions to buy and sell securities are made at the parent holding company level, and such decisions result in net realized gains (losses) that do not relate to the operations of the individual segments. (9) Run-off Operations of the Property and Casualty Group consist of MASCCO, PMA Cayman and PMA Life, each of which was established in December 1996 to reinsure certain obligations primarily associated with workers' compensation claims written by the Pooled Companies for the 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. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." - 41 - (10) For the purposes of determining this ratio, earnings (loss) consist of income (loss) before income taxes and extraordinary loss, plus fixed charges. Fixed charges consist of interest expense on debt, amortization of debt issuance costs and the portion of operating leases that management believes is representative of the interest factor. In 1996, earnings were insufficient to cover fixed charges by $191,394. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." (11) The results of operations of Caliber One are not material to the underwriting ratios of the Company; accordingly, the ratios for Caliber One have not been presented. (12) The combined ratio computed on a GAAP basis is equal to losses and LAE, plus amortization of deferred acquisition costs, operating expenses and policyholders' dividends (where applicable), all divided by net premiums earned. (13) The GAAP operating expense ratios exclude $4,718 and $4,506 for the six months ended June 30, 1998 and 1997, respectively, and $9,316, $8,227 and $5,300, for the years ended December 31, 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." - 42 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of the Company's results of operations and its liquidity and capital resources should be read in connection with the Selected Consolidated Financial and Operating Data of the Company and the consolidated financial statements of the Company and notes thereto, and the unaudited financial statements and notes thereto included elsewhere in this Prospectus. Results of Operations for the Three and Six Months Ended June 30, 1998 Compared to the Three and Six Months Ended June 30, 1997 The table below presents the major components of net income for the Company for the three and six months ended June 30, 1998 and 1997: (dollar amounts in thousands, except per share data)
Three Months Ended Six Months Ended June 30, June 30, ------------------ ----------------- 1998 1997 1998 1997 ---- ---- ---- ---- Pre-tax operating income (loss)(1) $ 7,026 $(4,018) $14,253 $ 4,551 Net realized investment gains (losses) 3,749 (680) 11,263 (1,931) ------- ------- ------- ------- Income before income taxes and extraordinary loss 10,775 (4,698) 25,516 2,620 Provision (benefit) for income taxes 1,418 (5,218) 4,071 (2,657) ------- ------- ------- ------- Income before extraordinary loss 9,357 520 21,445 5,277 Extraordinary loss, net of related taxes -- -- -- (4,734) ------- ------- ------- ------- Net income $ 9,357 $ 520 $21,445 $ 543 ======= ======= ======= ======= Per Basic Share: Income before extraordinary loss $ 0.39 $ 0.02 $ 0.90 $ 0.22 Extraordinary loss -- -- -- (0.20) ------- ------- ------- ------- Net income $ 0.38 $ 0.02 $ 0.90 $ 0.02 ======= ======= ======= =======
- 43 -
Per Diluted Share: Income before extraordinary loss $ 0.38 $ 0.02 $ 0.87 $ 0.21 Extraordinary loss -- $ -- -- $ (0.19) ------- ------- ------- ------- Net income $ 0.38 $ 0.02 $ 0.87 $ 0.02 ======= ======= ======= =======
- ------------------------- (1) Pre-tax operating income (loss) is defined as income from continuing operations before income taxes, but excluding net realized investment gains (losses). The Company has excluded net realized investment gains (losses) from the profit and loss measurement it utilizes to assess the performance of its operating segments because (i) net realized investment gains (losses) are unpredictable and not necessarily indicative of future performance and (ii) in many instances, decisions to buy and sell securities are made at the parent holding company level, and such decisions result in net realized gains (losses) that do not relate to the operations of the individual segments. The following table indicates the Company's pre-tax operating income (loss) by business segment for the three and six months ended June 30, 1998 and 1997:
(dollar amounts in thousands) Three Months Ended Six Months Ended June 30, June 30, --------------------- --------------------- 1998 1997(1) 1998 1997(1) ---- ------- PMA Re $11,580 $ 9,829 $22,952 $23,187 ------- ------- ------- ------- The Property and Casualty Group: Excluding Run-off Operations 2,353 (6,777) 4,954 (4,781) Run-off Operations 293 (533) 428 (1,107) ------- ------- ------- ------- Total 2,646 (7,310) 5,382 (5,888) ------- ------- ------- ------- Caliber One (681) -- (1,070) -- Corporate and Other (2,757) (2,649) (5,548) (4,526) ------- ------- ------- ------- Pre-tax operating income (loss) before interest expense 10,788 (130) 21,716 12,773 Interest expense 3,762 3,888 7,463 8,222 ------- ------- ------- ------- Pre-tax operating income (loss) $ 7,026 $(4,018) $14,253 $ 4,551 ======= ======= ======= =======
(1) Pre-tax operating income (loss) by business segment has been reclassified for 1997 to reflect the changes related to the implementation of SFAS No. 131 (See Note 3 to the interim consolidated financial statements included elsewhere in this Prospectus for further discussion). At June 30, 1998, the Company's total assets by business segment were as follows: (dollar amounts in thousands) PMA Re $1,188,852 The Property and Casualty Group: Excluding Run-Off Operations 1,469,795 Run-Off Operations 352,965 ---------- Total 1,822,760 ---------- Caliber One 62,465 Corporate and Other 1,336 ---------- Total assets $3,075,413 ========== - ---------------------- On a consolidated basis, the Company reported pre-tax operating income of $7.0 million and $14.3 million for the three and six months ended June 30, 1998, respectively, compared to a pre-tax loss of $4.0 million for the second quarter of 1997 and pre-tax operating income of $4.6 million for the six months ended June 30, 1997. The increases in pre-tax operating income were primarily due to increased - 44 - operating income at PMA Re for the second quarter of 1998 and at the Property and Casualty Group for both the first and second quarters of 1998 partially offset by the Caliber One pre-tax operating loss of $1.1 million related to the commencement of its operations. The increase in operating income for PMA Re for the second quarter of 1998 was primarily related to higher premium volume, lower loss ratios and higher investment income. Pre-tax operating income for PMA Re for the first half of 1998 was flat relative to the first half of 1997, as higher premium volumes, lower loss ratios and higher investment income were offset by increases in acquisition costs as well as timing issues related to certain operating expenses in the first six months of 1998. The increase in pre- tax operating income for the Property and Casualty Group was due to lower losses and expenses recorded in the first half of 1998 compared to 1997 as a result of the restructuring efforts initiated during 1997. The pre-tax operating loss at Corporate and Other for the second quarter of 1998 was comparable to the second quarter of 1997, while the operating loss for the first half of 1998 was $1.0 million higher than the comparable 1997 period, related to certain compensation programs, which were not adopted until the second half of 1997, partially offset by costs incurred in the first six months of 1997 related to certain corporate properties that were disposed of in the third quarter of 1997. Interest expense for the second quarter of 1998 was comparable to the second quarter of 1997 and decreased $759,000 for the six months ended June 30, 1998 compared to the same period in 1997 due to the March 1997 refinancing of the Company's debt facility. Net realized investment gains were $3.7 million and $11.3 million in the three and six months ended June 30, 1998, respectively, compared to net realized investment losses of $0.7 million and $1.9 million in the comparable 1997 periods due primarily to lower interest rates in the 1998 periods. For the three months ended June 30, 1998, net income amounted to $9.4 million, or $0.39 per basic share and $0.38 per diluted share, as compared to net income of $0.5 million, or $0.02 per basic and diluted share, for the three months ended June 30, 1997. Net income on a consolidated basis before extraordinary item was $21.4 million, or $0.90 per basic share and $0.87 per diluted share, for the six months ended June 30, 1998 compared to $5.3 million, or $0.22 per basic share and $0.21 per diluted share, for the six months ended June 30, 1997. On March 14, 1997, the Company refinanced substantially all of its outstanding credit agreements not already maturing in 1997. In connection with this refinancing, the Company recognized an extraordinary loss in the first six months of 1997 from the early extinguishment of debt of $4.7 million, or $0.20 per basic share and $0.19 per diluted share, net of tax. PMA Re Results of Operations Summarized financial results of PMA Re for the three and six months ended June 30, 1998 and 1997 are as follows: (dollar amounts in thousands) Three Months Ended Six Months Ended June 30, June 30, ------------------- ------------------- 1998 1997 1998 1997 ---- ---- ---- ---- Net premiums written $ 47,089 $ 36,789 $117,908 $ 96,279 ======== ======== ======== ======== Net premiums earned $ 54,869 $ 45,791 $100,967 $ 85,087 Net investment income 13,671 12,134 27,171 25,288 -------- -------- -------- -------- Operating revenues 68,540 57,925 128,138 110,375 -------- -------- -------- -------- Losses and LAE incurred 36,864 32,386 69,678 62,231 - 45 - Acquisition and operating expenses 20,096 15,710 35,508 24,957 -------- -------- -------- -------- Total losses and expenses 56,960 48,096 105,186 87,188 -------- -------- -------- -------- Pre-tax operating income $ 11,580 $ 9,829 $ 22,952 $ 23,187 ======== ======== ======== ======== GAAP loss ratio 67.2% 70.7% 69.0% 73.1% GAAP combined ratio 103.8% 105.0% 104.2% 102.4% SAP loss ratio 66.2% 70.7% 68.4% 73.1% SAP combined ratio 108.9% 105.1% 104.5% 103.5% Premium Revenues The following table indicates PMA Re's gross and net premiums written by major category of business for the three and six months ended June 30, 1998 and 1997:
(dollar amounts in thousands) Three Months Ended Six Months Ended June 30, June 30, --------------------- --------------------- 1998 1997 1998 1997 ---- ---- ---- ---- Gross premiums written: Casualty lines $ 41,804 $32,861 $102,608 $83,289 Property lines 15,402 13,150 41,313 36,916 Other lines 107 48 501 501 -------- -------- -------- -------- Total $ 57,313 $ 46,059 $144,422 $120,706 ======== ======== ======== ======== Net premiums written: Casualty lines $ 35,122 $ 25,536 $ 83,535 $ 68,286 Property lines 11,845 11,214 33,849 27,501 Other lines 122 39 524 492 -------- -------- -------- -------- Total $ 47,089 $ 36,789 $117,908 $ 96,279 ======== ======== ======== ========
Gross premiums written increased $11.3 million, or 24.4% and $23.7 million, or 19.6%, for the three and six months ended June 30, 1998, respectively, compared to the same periods in 1997. For the three and six months ended June 30, 1998, gross premiums written increased 27.3% and 23.2% for casualty lines and 17.1% and 11.9% for property lines compared to the same periods in 1997. The main reasons for these increases in gross premiums written were increased participations on reinsurance treaties and new programs with existing clients, as well as contracts with new clients. During the first six months of 1998, PMA Re added new programs with 30 existing clients and added contracts with 10 new clients, which resulted in an 11% increase in premiums compared to the first six months of 1997. The remaining increase in premiums relates to increased participations with existing clients which was partially offset by the trend toward large ceding companies increasing their retentions, which decreases PMA Re's subject premium. In addition, highly competitive conditions in the United States reinsurance market caused PMA Re to non-renew certain accounts due to inadequate rates and/or other underwriting concerns; during the first six months of 1998, primarily as a result of these underwriting issues, PMA Re non-renewed contracts amounting to approximately $27.5 million of premiums. Net premiums written increased $21.6 million, or 22.5%, for the six months ended June 30, 1998 compared to the same period in 1997. PMA Re made changes to its retrocessional program in the second half of 1997 and in 1998, which reduced the percentage of premiums ceded to retrocessionaires in 1998. Net premiums earned for PMA Re also increased $15.9 million, or 18.7%, for the six months ended June 30, 1998, respectively, compared to the same period in 1997. Net premiums earned generally follow growth patterns similar to net premiums written after giving effect to a lag in premium earnings. - 46 - Losses and Expenses The following table reflects the components of PMA Re's combined ratios, computed in accordance with GAAP for the three and six months ended June 30, 1998 and 1997:
Three Months Ended Six Months Ended June 30, June 30, ------------------ ------------------ 1998 1997 1998 1997 ---- ---- ---- ---- Loss ratio 67.2% 70.7% 69.0% 73.1% ---- ---- ---- ---- Expense ratio: Amortization of deferred acquisition costs 30.5% 27.9% 28.5% 23.8% Operating expenses 6.1% 6.4% 6.7% 5.5% ---- ---- ---- ---- Total expense ratio 36.6% 34.3% 35.2% 29.3% ---- ---- ---- ---- Combined ratio - GAAP (1) 103.8% 105.0% 104.2% 102.4% ===== ===== ===== =====
- --------------------- (1) The combined ratio computed on a GAAP basis is equal to losses and LAE, plus amortization of deferred acquisition costs, operating expenses and policyholders' dividends (where applicable), all divided by net premiums earned. For both the three and six-month periods ended June 30, 1998, PMA Re posted lower loss ratios, reflecting higher levels of favorable loss reserve development and the effects of more treaties written with ceding commissions, which increased the proportion of the subject premium assumed by PMA Re. The quarter ended June 30, 1998 and six-month period ended June 30, 1998 were also impacted by higher acquisition costs, which reflected the aforementioned increase in the number of treaties written with ceding commissions, as well as competitive conditions. The ratio of operating expenses to net premiums earned (the "Operating Expense Ratio") for the quarter ended June 30, 1998 was comparable to the quarter ended June 30, 1997. The Operating Expense Ratio increased 1.2 points for the six months ended June 30, 1998 compared to the same period in 1997. The increase in the Operating Expense Ratio relates to increases in staff relating to higher activity levels, as well as the timing of certain expenses in 1997, such as costs relating to the restructuring of PMA Re's compensation plans. PMA Re increased staff by approximately 11% from June 30, 1997 to June 30, 1998 in reponse to the higher activity levels from year to year. Also, during the third quarter of 1997, the compenstion plans at PMA Re were restructured to provide incentive compensation for management, which resulted in an accrual of approximately $500,000 in the second half of 1997. In addition, the increase is partially due to the Year 2000 compliance program, for which the majority of expenses incurred began in the second half of 1997. PMA Re has incurred costs of approximately $425,000 during 1998 related to the Year 2000 compliance program. Management expects that PMA Re will incur approximately $175,000 of additional expenses in 1998 related to the Year 2000 compliance program and that such project will be completed in 1998. See "Liquidity and Capital Resources" for further discussion. Net Investment Income Higher levels of investment income, which reflected higher levels of invested assets, also impacted PMA Re's operating income. For the quarter ended June 30, 1998, PMA Re's net investment income increased $1.5 million versus the quarter ended June 30, 1997 and for the six months ended June 30, 1998, net investment income increased $1.9 million versus the comparable 1997 period. - 47 - The Property and Casualty Group Results of Operations Net premiums written for the Property and Casualty Group were reduced by $2.2 million and $2.1 million for the three and six months ended June 30, 1998, respectively, representing estimated retrospective policy adjustments related to the current and prior accident years and retrospective policy adjustments paid. The corresponding adjustments for the 1997 periods were not material. These adjustments were made for presentation purposes only and do not impact the Property and Casualty Group's reported revenues, financial position or results of operations because these adjustments have no effect on net premiums earned. Summarized financial results of the Property and Casualty Group for the three and six months ended June 30, 1998 and 1997 are as follows:
(dollar amounts in thousands) Three Months Ended Six Months Ended June 30, June 30, ------------------ ---------------- 1998 1997 1998 1997 ---- ---- ---- ---- Net premiums written: Workers' compensation $ 33,507 $ 38,024 $ 98,395 $ 99,624 Commercial lines 13,778 23,545 31,432 52,382 ------- -------- ------- -------- Total $ 47,285 $ 61,569 $129,827 $152,006 ======== ======== ======== ======== Net premiums earned: Workers' compensation $ 42,698 $ 45,897 $ 87,011 $ 95,616 Commercial lines 17,093 22,763 33,578 41,698 -------- -------- -------- -------- Total 59,791 68,660 120,589 137,314 -------- -------- -------- -------- Net investment income: Excluding Run-off Operations 12,657 12,315 25,367 26,930 Run-off Operations 5,464 7,459 11,303 14,972 -------- -------- -------- -------- Total 18,121 19,774 36,670 41,902 -------- -------- -------- -------- Service revenues 2,655 2,490 5,090 5,038 -------- -------- -------- -------- Operating revenues 80,567 90,924 162,349 184,254 -------- -------- -------- -------- Losses and LAE incurred: Excluding Run-off Operations 46,478 58,890 93,684 115,873 Run-off Operations 4,505 6,989 9,401 15,097 -------- -------- -------- -------- Total 50,983 65,879 103,085 130,970 -------- -------- -------- -------- Acquisition and operating expenses: Excluding Run-off Operations 22,059 27,992 44,278 50,759 Run-off Operations 666 1,003 1,474 1,796 -------- -------- -------- -------- Total 22,725 28,995 45,752 52,555 -------- -------- -------- -------- Policyholders' dividends 4,213 3,360 8,130 6,617 -------- -------- -------- -------- Total losses and expenses 77,921 98,234 156,967 190,142 -------- -------- -------- -------- Pre-tax operating income (loss) $ 2,646 $ (7,310) $ 5,382 $ (5,888) ======== ======== ======== ======== GAAP loss ratio 85.3% 95.9% 85.5% 95.4% GAAP combined ratio 126.3% 139.8% 126.2% 135.2% SAP loss ratio(1) 78.4% 85.1% 77.9% 85.3% SAP combined ratio(1) 119.0% 123.1% 113.4% 118.9%
- -------------------------- (1) The SAP loss and combined ratios above relate to the Pooled Companies only. - 48 - The Property and Casualty Group Excluding Run-off Operations Premium Revenues Direct premiums written for the Property and Casualty Group decreased $11.7 million and $19.9 million for three and six months ended June 30, 1998, respectively, compared to the same periods in 1997. Direct premiums written for 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 $8.0 million and $19.6 million for the three and six months ended June 30, 1998, respectively, compared to the same periods in 1997. Direct premiums written for workers' compensation decreased $3.7 million and $298,000 for the three and six months ended June 30, 1998, respectively, compared to the same periods in 1997. For the three months ended June 30, 1998 reinsurance premiums assumed increased $570,000 compared to the same period in 1997 and decreased $73,000 for the six months ended June 30, 1998 compared to the same period in 1997. Reinsurance premiums ceded increased $717,000 and decreased $1.5 million for the three and six months ended June 30, 1998, respectively, compared to the same periods in 1997. The percentage of net workers' compensation premiums written to total net premiums written increased to 70% and 76% for the three and six months ended June 30, 1998, respectively, from 62% and 65% during the three and six months ended June 30, 1997, respectively. This increase was primarily due to a planned reduction in Commercial Lines business, as described below, and continued competitive conditions. For three and six months ended June 30, 1998, net premiums written decreased $14.3 million and $21.4 million compared to the same periods in 1997. Earned premiums decreased by $8.9 million and $16.7 million for the three and six months ended June 30, 1998, respectively, compared to the same periods in 1997. Net premiums earned generally follow growth patterns similar to net premiums written after giving effect to a lag in premium earnings, absent any significant adjustments to accrued retrospective premiums. Such adjustments did not fluctuate materially between periods. The decrease in direct premiums written for workers' compensation was primarily due to continued intense price competition in the workers' compensation market as well as the impact of rate changes associated with workers' compensation benefit reforms in Pennsylvania. Workers' compensation reform laws adopted in Pennsylvania ("Act 57") resulted in a reduction in manual workers' compensation rates in excess of 25%, effective February 1997 for new and renewal business. Management does not expect manual rate decreases to be as significant for the 1998 policy year as compared to the 1997 policy year, although manual rate levels in all of the Group's principal marketing states continue to decrease. The Property and Casualty Group has continued its marketing of alternative market workers' compensation products for larger accounts, including large- deductible policies and providing excess coverage to self-insured groups. Typically, the Property and Casualty 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 claims activity on the accounts and encourages loss control on the part of the insured. A substantial portion of related revenues are recorded as service revenues. Such service revenues increased $165,000 and $52,000 for the three and six months ended June 30, 1998, respectively, compared to the same periods in 1997. - 49 - Direct workers' compensation premiums written were also impacted by changes in the level of premium adjustments, primarily related to audit premiums. For the three and six months ended June 30, 1998, respectively, such adjustments increased premiums written by $3.6 million and $8.1 million compared to increases of $4.0 million and $8.3 million in the comparable 1997 periods. The decreases in Commercial Lines direct writings for the three and six months ended June 30, 1998 compared to the comparable 1997 periods were primarily due to a planned reduction in net Commercial Lines business as well as continued competitive conditions in Commercial Lines pricing in 1998. Rather than lower prices to what it believes are unacceptable levels, the Property and Casualty Group has chosen not to renew some of its Commercial Lines business. In addition, the Property and Casualty Group has reduced its writings of new Commercial Lines accounts in the first six months of 1998 compared to the same period in 1997 because management believes that market rates and contract terms for many of these accounts did not provide the opportunity to achieve what management considers to be an acceptable return. Losses and Expenses The following table reflects the components of the Property and Casualty Group's combined ratios, computed in accordance with GAAP for the three and six months ended June 30, 1998 and 1997:
Three Months Ended Six Months Ended June 30, June 30, ------------------ ----------------- 1998 1997 1998 1997 ---- ---- ---- ---- Loss ratio 77.7% 85.8% 77.7% 84.9% ----- ----- ----- ----- Expense ratio: Amortization of deferred acquisition costs 20.7% 22.4% 19.2% 19.2% Operating expenses(1) 12.1% 15.1% 13.6% 14.7% ----- ----- ----- ----- Total expense ratio 32.8% 37.5% 32.8% 33.9% ----- ----- ----- ----- Policyholders' dividend ratio 7.0% 4.9% 6.7% 4.8% ----- ----- ----- ----- Combined - GAAP(2) 117.5% 128.2% 117.2% 123.6% ===== ===== ===== =====
- ------------------------------ (1) The GAAP Operating Expense Ratio excludes $2.4 million and $2.2 million for the three and six months ended June 30, 1998 and 1997, respectively, and $4.7 million and $4.5 million for the six months ended June 30, 1998 and 1997, respectively, of PMA Management Corp. direct expenses related to service revenues, which are not included in premiums earned. (2) The GAAP combined ratios for the Property and Casualty Group including the Run-off Operations were 126.3% and 126.2% for the three and six months ended June 30, 1998, respectively, compared to 139.8% and 135.2% for the three and six months ended June 30, 1997, respectively. See "Run-off Operations." For the three and six months ended June 30, 1998, respectively, the GAAP loss ratio improved by 8.1 points and 7.2 points compared to the same periods in 1997. This improvement was primarily due to an improved loss and LAE ratio in Commercial Lines and an improvement in medical costs and in LAE in the workers' compensation line and a lower amount of discount accretion on workers' compensation loss reserves. - 50 - The improvement in the loss and LAE ratio in Commercial Lines favorably impacted the overall loss ratio by 1.7 points and 1.4 points for three and six months ended June 30, 1998, respectively, compared to the same periods in 1997. This improvement in the Commercial Lines loss and LAE ratio was primarily due to a reduction in exposures underwritten by the Property and Casualty Group in 1998 compared to the same period in 1997. The Property and Casualty Group believes that reduced exposures, which have occurred primarily as a result of price competition and more stringent underwriting, have improved the overall loss ratio on its remaining Commercial Lines business. Measures to control medical costs and LAE in workers' compensation improved the overall loss and LAE ratio by 3.0 points and 2.5 points in the three and six months ended June 30, 1998, respectively, compared to the same periods in 1997. Medical costs improved primarily due to the Property and Casualty Group's affiliation with a national preferred provider organization, which became effective January 1998. This affiliation enabled the Property and Casualty Group to lower its cost in providing medical benefits to injured workers. LAE decreased primarily due to continued use of certain claims resolution practices. By using techniques such as managed care and commutations, the Property and Casualty Group has reduced the amount and number of outstanding claims and the amount of time that a claim remains open. These techniques have lowered costs associated with managing open claims. In July 1997, the Property and Casualty Group completed a formal program under which it commuted a large number of workers' compensation claims from accident years 1991 and prior. The commutation program resulted in current payments, which were less than the carried reserves. As substantially all of these reserves were carried on a discounted basis, the ultimate level of discount on the Property and Casualty Group's carried reserves decreased as well. As the level of discount has decreased, the loss ratio has benefited from lower amounts of discount accretion. During the past five years, direct premiums written for workers' compensation have declined significantly and the Property and Casualty Group has underwritten less exposures in more recent years. As a result, loss reserve levels have declined and the level of discount has declined as well. These reductions have decreased the amount of discount accretion related to the established loss reserves. As a result, this lower amount of discount accretion improved the overall loss and LAE ratio by 2.6 points in the first six months of 1998 compared to the same period in 1997. The Property and Casualty Group has initiated another commutation program, which is currently underway and expected to continue through 1998. This program is expected to focus on claims from accident years 1992 to 1996. The increase in the percentage of net workers' compensation premiums written and earned to total net premiums written and earned had a favorable impact on the loss and LAE ratio, as workers' compensation business has had better loss experience than other Commercial Lines in the Property and Casualty Group's marketing territory. This mix of business caused a 0.8 point and 0.7 point reduction in the loss and LAE ratio for the three and six months ended June 30, 1998, respectively, compared to the same periods in 1997. The GAAP expense ratio decreased by 4.7 points and 1.1 points for the three and six months ended June 30, 1998, respectively, compared to the same periods in 1997 related to a corresponding reduction in the operating expense ratio. Such reduction was due to decreases in operating expenses of $3.3 million and $3.7 - 51 - million during the three and six months ended June 30, 1998, respectively, compared to the same periods in 1997 as a result of the continuation of cost reduction measures initiated during 1997. The Property and Casualty Group incurred severance and other restructuring costs of approximately $80,000 and $498,000, respectively, for the three and six months ended June 30, 1998, compared with $1.7 million for the same periods in 1997. In addition, approximately $875,000 and $1.0 million of costs related to addressing the Year 2000 Issue were incurred during the three and six months ended June 30, 1998, respectively, compared with $145,000 and $438,000 for the same periods in 1997. The remaining Year 2000 costs are not expected to be material and management anticipates that such project will be completed in 1998. See "Liquidity and Capital Resources" for further discussion. The policyholders' dividend ratio was 7.0% and 6.7%, respectively, for the three and six months ended June 30, 1998 compared to 4.9% and 4.8% for the same periods in 1997. The increase in the dividend ratio is primarily due to improved loss experience in the workers' compensation line of business and increased writings of participating business. Net Investment Income Net investment income was $12.7 million and $25.4 million, respectively, for the three and six months ended June 30, 1998 compared to $12.3 million and $26.9 million for the same periods in 1997. Net investment income decreased for the first six months of 1998 compared to the same period in 1997, primarily as a result of lower fixed income yields, partially offset by slightly higher average invested assets. The Run-off Operations ---------------------- As a part of the Property and Casualty Group's 1996 restructuring plan, the Property and Casualty Group established the Run-off Operations principally to manage the capital supporting workers' compensation loss reserves from accident years 1992 and prior. Such reserves primarily relate to the period of time from 1987 to 1991 when the Property and Casualty Group wrote a much higher volume of business and experienced poor underwriting results. The reserves are mainly indemnity related and relate to the pre-1992 periods. The Run-off Operations consist of PMA Cayman, MASCCO and PMA Life. PMA Cayman was incorporated in Grand Cayman, and had no material operations until 1996. In 1996, the Pooled Companies ceded to PMA Cayman substantially all of the Pooled Companies' remaining liability for workers' compensation claims for accident years 1991 and prior other than the policies ceded to MASCCO. In 1997, the Pooled Companies also ceded to PMA Cayman a portion of the Pooled Companies' workers compensation reserves from accident years 1992 to 1996. At June 30, 1998, PMA Cayman had $233.0 million in total assets and $215.5 million in total reserves. Substantially all of PMA Cayman's assets are held in trust for the benefit of the Pooled Companies. The Company entered into a letter of intent dated June 26, 1998, to sell PMA Cayman. The transaction is subject to customary closing conditions, including regulatory approvals, and is expected to be completed in the third quarter of 1998. In connection with the proposed sale, the Company recorded a $2.4 million pre-tax loss in the second quarter of 1998, which is included in "Net Realized Investment Gains." -52- MASCCO is a Pennsylvania insurance company and a wholly owned subsidiary of the Company. Prior to December 31, 1996, MASCCO was a party to a pooling agreement with the Pooled Companies. Effective December 31, 1996, and with the approval of the Pennsylvania Commissioner, MASCCO withdrew from the pooling agreement and ceased writing any new business. The Pooled Companies also ceded to MASCCO the indemnity portion of Pennsylvania workers' compensation claims for accident years 1991 and prior. At June 30, 1998, MASCCO had $97.0 million in total assets and $80.1 million in total reserves. Substantially all of MASCCO's assets are held in trust for the benefit of the Pooled Companies. PMA Life is a Pennsylvania life insurance company that derives all of its insurance revenues from intercompany transactions with the Pooled Companies. In 1997, the Property and Casualty Group reinsured substantially all of PMA Life's insurance liabilities with a third party reinsurer and no longer places insurance business with PMA Life. At June 30, 1998, PMA Life had assets of $22.9 million and $17.7 million in total reserves. The following table reflects the components of the Property and Casualty Group - Run-off Operations' operating results for the three and six months ended June 30, 1998 and 1997:
(dollar amounts in thousands) Three Months Ended Six Months Ended June 30, June 30, -------------------- -------------------- 1998 1997 1998 1997 ------- ------- ------- ------- Net investment income $ 5,464 $ 7,459 $11,303 $14,972 Net premiums earned(1) -- -- -- 814 ------- ------- ------- ------- Total operating revenues 5,464 7,459 11,303 15,786 ------- ------- ------- ------- Losses and LAE incurred 4,505 6,989 9,401 15,097 Operating expenses 666 1,003 1,474 1,796 ------- ------- ------- ------- Total expenses 5,171 7,992 10,875 16,893 ------- ------- ------- ------- Pre-tax operating income (loss) $ 293 $ (533) $ 428 $(1,107) ======= ======= ======= =======
- ----------------------- (1) Amount represents net premiums earned during the first six months of 1997 for PMA Life prior to the reinsurance transaction mentioned above, after which PMA Life was placed into run-off. Investment income for the Run-off Operations decreased by $2.0 million and $3.6 million in the three and six months ended June 30, 1998, respectively, compared to the same periods in 1997 primarily due to lower average invested balances as the Run-off Operations paid claims aggregating $160.7 million in 1997 and $58.4 million in the first six months of 1998. The aforementioned commutation program initiated by the Property and Casualty Group in late 1996 and completed in July 1997 accelerated payments to claimants, and a portion of such payments were funded by the Run-off Operations. -53- Losses and LAE of the Run-off Operations are comprised of discount accretion on established loss reserves of the Run-off Operations. The decrease in loss reserve discount accretion was primarily due to the payments made for the underlying claims in 1997. Caliber One Results of Operations Summarized financial results of Caliber One for the three and six months ended June 30, 1998 are as follows:
(dollar amounts in thousands) Three Months Ended Six Months Ended June 30, 1998 June 30, 1998 ------------------ ---------------- Net premiums written $ 705 $ 917 ====== ====== Net premiums earned $ 165 $ 191 Net investment income 371 714 ------ ------ Operating revenues 536 905 ------ ------ Losses and LAE incurred 133 153 Acquisition and operating expenses 1,084 1,822 ------ ------ Total losses and expenses 1,217 1,975 ------ ------ Pre-tax operating loss $ (681) $(1,070) ======== ========
Due to the start-up nature of the business, the financial ratios for Caliber One do not provide meaningful representation of its operating results and, therefore, have been excluded from the table above. Gross premiums written and net premiums written for Caliber One in the second quarter of 1998 were $1.3 million and $705,000, respectively, representing a 345% increase in gross premiums written and a 233% increase in net premiums written compared to the first quarter of 1998. The loss ratio for the second quarter of 1998 was 80.6% and for the first six months of 1998 was 80.1%. As expected, operating expenses, which include start-up costs, in the first half of 1998 were high relative to the premium volume, which distorts the expense ratio. Management expects operating expenses to be more commensurate with premium volume over time as premium volume continues to grow. Net investment income was $317,000 and $714,000 for the second quarter and first half of 1998, respectively. Corporate and Other Results of Operations Corporate and Other is primarily comprised of corporate overhead and the operations of the Company's properties. For the three and six months ended June 30, 1998, respectively, Corporate and Other recorded pre-tax operating losses before interest expense of $2.8 million and $5.5 million compared to $ 2.6 million and $4.5 million for the three and six months ended June 30, 1997, respectively. The higher operating loss in 1998 compared to the same period in 1997 relates to increased corporate operating costs, primarily related to compensation as the Company implemented a new management incentive compensation plan in the second quarter of 1997 that increased expenses for 1998 relative to the first half of 1997, partially offset by operating costs associated with certain corporate properties disposed of in the third quarter of 1997. -54- Net Realized Investment Gains The Company recorded net realized investment gains of $3.7 million and $11.3 million for the three and six months ended June 30, 1998, respectively, compared to net realized investment losses of $680,000 and $1.9 million for the comparable 1997 periods. 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 future results. In addition, the $2.4 million pre-tax loss related to the pending sale of PMA Cayman was included in net realized investment gains for the six months ended June 30, 1998. Interest Expense and Income Taxes Interest expense decreased $126,000 and $759,000 for the three and six months ended June 30, 1998, respectively, compared to the similar 1997 periods due to the refinancing of the Company's debt in March 1997. The Company's effective tax rate was 13.2% and 16.0% for the three and six months ended June 30, 1998, respectively, compared to 111.1% and a benefit of 101.4% for the three and six months ended June 30, 1997, respectively. The Company recorded a net deferred tax asset of $63.0 million as of June 30, 1998 compared to $70.4 million as of December 31, 1997. Liquidity and Capital Resources Liquidity 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, the Company requires cash to pay debt obligations and dividends to shareholders, pay taxes to the federal government and capitalize subsidiaries from time to time. The Company's primary sources of liquidity are dividends from subsidiaries, net tax payments received from subsidiaries, and borrowings. The Company paid interest of $7.5 million for the six months ended June 30, 1998 compared to $12.2 million for the six months ended June 30, 1997. The decrease in interest paid for the first half of 1998 relates to the fact that the March 1997 refinancing of PMC's debt obligations accelerated certain interest payments to the first quarter of 1997. The Company paid $4.1 million of dividends to shareholders in the six-month period ended June 30, 1998 compared to $4.0 million for the comparable period in 1997. Dividends received from subsidiaries were $10.0 million for the six months ended June 30, 1998 compared to $8.0 million for the comparable 1997 period. Net tax cash flows from subsidiaries were $14.7 million for the six months ended June 30, 1998 compared to $8.4 million for the comparable 1997 period. 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 also by the Credit Facilities. Under such laws and regulations, dividends may not be paid without prior approval of the Pennsylvania Insurance Commissioner in excess of the greater of (i) 10% of surplus as regards to policyholders as of the end of the preceding year or (ii) statutory net income for the preceding year, but in no event to exceed unassigned - 55 - funds. Under this standard, the Pooled Companies and PMA Reinsurance Corporation can pay an aggregate of $48.7 million of dividends, without the prior approval of the Pennsylvania Insurance Commissioner, during 1998. Caliber One Indemnity Company is a direct subsidiary of PMA Reinsurance Corporation, and as such, its dividends may not be paid directly to PMC. As noted above, the Delaware insurance law provisions restricting dividends by insurers are substantially similar to such provisions under Pennsylvania insurance laws. During 1998, $2.5 million of dividends are available to be paid to PMA Reinsurance Corporation by Caliber One Indemnity Company without the prior approval of the Delaware Insurance Commissioner, none of which have been declared or paid during 1998. PMC's dividends to shareholders are restricted by its debt agreements. Based upon the terms of the Company's Credit Facilities, under the most restrictive debt covenant, PMC would be able to pay dividends to shareholders of approximately $14.5 million in 1998. Management believes that the Company's sources of funds will provide sufficient liquidity to meet its short-term and long-term obligations. Capital Resources The Company's total assets increased $18.1 million to $3,075.4 million at June 30, 1998 compared to $3,057.3 million at December 31, 1997. Total investments decreased $35.4 million to $2,159.3 million at June 30, 1998. This decrease was primarily attributable to the Property and Casualty Group's pay- down of loss reserves from prior accident years. All other assets increased $53.6 million, primarily due to increases in uncollected premiums of $40.9 million and reinsurance receivables of $15.4 million in comparison to December 31, 1997. The increase in uncollected premiums compared to December 31, 1997 was primarily related to the cyclical nature of the premium volume and collection patterns throughout the year. The uncollected premiums are more comparable to the balances at June 30, 1997. The increase in reinsurance receivables compared to December 31, 1997 primarily relates to the Property and Casualty Group's new reinsurance treaty for Commercial Lines entered into during 1997. Additional increases in other assets and deferred acquisition costs of $24.9 million and $8.1 million, respectively, were offset by a decrease in cash of $24.6 million related to settlement timing of investment transactions at December 31, 1997. The increase in other assets at June 30, 1998 compared to December 31, 1997 primarily relates to timing differences in prepaid expenses and miscellaneous assets at the operating companies. The increase in deferred acquisition costs at June 30, 1998 compared to December 31, 1997 is primarily due to the higher acquisition costs at PMA Re (see "PMA Re Results of Operations") as well as the cyclical nature of the premium writings which increases acquisition costs in the beginning of the year. Consolidated shareholders' equity at June 30, 1998 totaled $496.4 million, or $20.96 per share, compared to $478.3 million, or $19.96 per share, at December 31, 1997. As a result of changes in market interest rates, the unrealized appreciation of investments, net of tax, was $26.3 million at June 30, 1998 compared to $18.8 million at December 31, 1997, resulting in an increase in shareholders' equity of $7.5 million, or $0.32 per share. At June 30, 1998, the Company had $203.0 million outstanding under its existing credit facility, with $32.0 million available for additional borrowings. Management also entered into an interest rate swap agreement which is intended to manage the impact of the potential volatility of the interest rate associated with the floating rates on the credit facility. The interest rate swap covers a notional principal amount of $150.0 million and effectively converts the floating rate on such portion of the credit facility to a fixed rate of 7.24%. At June 30, 1998, the Company had $47.0 million of outstanding letters of credit under the Letter of Credit Facility. See "Liquidity and Capital Resources December 31, 1997 and 1996." - 56 - The Company's interest rate swap agreement 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 agreement, 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 significant. Year 2000 Issue With the assistance of outside consulting groups, the Company began evaluating and reprogramming its own computer systems to address the Year 2000 Issue in late 1995. Management anticipates that by year-end 1998, it will have substantially completed all necessary programming work. Accordingly, management believes that Year 2000 Issues related to the Company's hardware and internal software programs are not likely to result in any material adverse disruptions in the Company's computer systems or its internal business operations. The cost of this work through June 30, 1998 has been approximately $5.3 million, including approximately $1.5 million incurred during the first six months of 1998. The Company estimates that the total remaining cost will be approximately $175,000, which will be expensed throughout the remainder of 1998. The Company is currently in the process of evaluating its relationships with third parties with which the Company has a direct and material relationship to determine whether they are Year 2000 compliant, such as banks, brokers, reinsurers, third party service providers, software and other service vendors, insureds and agents and other intermediaries. The responses by such third parties to inquiries made by the Company as have been received to date indicate that these third parties either are or expect to be compliant by the Year 2000. Even assuming that all material third parties provide a timely representation affirming such Year 2000 compliance, however, it is not possible to state with certainty that such representations will turn out to have been accurate, or that the operations of such third parties will not be materially impacted in turn by other parties with whom they themselves have a material relationship, and who fail to timely become Year 2000 compliant. Consequently, it is not possible to predict whether or to what extent the Year 2000 Issues may have an adverse material impact on the Company as a result of their impact on the operations of third parties with whom the Company has a material relationship. The failure of one or more third parties with whom the Company has a material relationship to be Year 2000 compliant could cause significant disruptions in the Company's ability to pay claims, receive and deposit funds and make investments, which could have a material adverse effect on the Company's financial condition and results of operations. The Company's contingency plans in the event of failure of such third parties to be Year 2000 compliant include replacing the third party, performing directly the services performed by the third party and maintaining liquidity under the Company's Revolving Credit Facility, which may have a material impact on the Company. Many experts now believe that Year 2000 Issues may have a material adverse effect on the national and global economy generally. In addition, it seems likely that if businesses are materially damaged as a result of Year 2000 Issues, at least some such businesses may attempt to recoup their losses by claiming coverage under various types of insurance policies. Management of the Property and Casualty Group and Caliber One believe that under a fair reading of the various policies issued by them, no coverage for Year 2000 Issues should exist. Management of PMA Re also believes that the policies of its ceding company clients which are reinsured by PMA Re do not provide coverage for Year 2000 Issues. However, in the event that claims for Year 2000 Issues are asserted against the Property and Casualty Group, Caliber One or PMA Re, it is not possible to predict whether or to what extent any such coverage could ultimately be found to exist by courts in various jurisdictions, or, if found, the effect thereof on any of such companies or the Company. In addition, to the extent that the Property and Casualty Group, Caliber One or PMA Re contest the assertion of Year 2000 coverage claims, it is likely that the costs of litigation could be material, even if they are able to prevail in their coverage positions as to which no assurance can be given. - 57 - New Accounting Pronouncements As of January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Comprehensive Income" ("SFAS No. 130"), 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. Comprehensive income includes a reclassification adjustment for net realized investment gains included in net income of $8.9 million (after income taxes of $4.8 million) for the six months ended June 30, 1998 and net realized investment losses of $950,000 (after income taxes of $512,000) for the six months ended June 30, 1997. The new standard requires only additional disclosures in the consolidated financial statements; it does not affect the Company's financial position or results of operations. As of January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS No. 131"), which establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and interim financial reports issued to shareholders. 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 reinsurance products and services; (ii) the Property and Casualty Group, which writes workers' compensation and other standard lines of commercial insurance and includes run-off operations; (iii) Caliber One, which writes specialty insurance focusing on excess and surplus lines and (iv) Corporate and Other, which is primarily comprised of corporate overhead and the operations of the Company's properties. The Company has excluded net realized investment gains (losses) from the profit and loss measurement it utilizes to assess the performance of its operating segments because (1) net realized investment gains (losses) are unpredictable and not necessarily indicative of future performance and (ii) in many instances, decisions to buy and sell securities are made at the parent holding company level, and such decisions result in net realized gains (losses) that do not relate to the operations of the individual segments. Pursuant to the adoption of SFAS No. 131, the Company has restated the information for the six-month period ended June 30, 1997 for comparability, primarily related to certain corporate expenses that were previously allocated to the operating segments. SFAS No. 131 requires only additional disclosures in the consolidated financial statements; it does not affect the Company's financial position or results of operations. Supplemental financial information for annual periods prior to the date of adoption of SFAS No. 131 are as follows: - 58 - (dollar amounts in thousands) Year ended December 31, -------------------------------- 1997 1996 1995 ---- ---- ---- Pre-tax operating income (loss): PMA Re $45,957 $ 44,807 $ 39,793 The Property and Casualty Group: Excluding Run-off Operations (3,607) (215,669) (3,885) Run-off Operations (73) -- -- ------- --------- -------- Total (3,680) (215,669) (3,885) Corporate and Other (9,954) (6,464) (14,184) ------- --------- -------- Total pre-tax operating income (loss) $32,323 ($177,326) $ 21,724 ======= ========= ======== The difference between this supplemental information and the information in the Company's audited financial statements and year end Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Prospectus is primarily related to certain corporate expenses that were previously allocated to the operating segments. The amount of this adjustment was $6.5 million ($1.2 million allocated to PMA Re and $5.3 million to the Property and Casualty Group), $6.0 million ($2.0 million allocated to PMA Re and $4.0 million to the Property and Casualty Group) and $770,000 ($350,000 allocated to PMA Re and $420,000 to the Property and Casualty Group) for the years ended December 31, 1997, 1996 and 1995, respectively. Amounts for previous years were not material; accordingly no adjustment has been made. The following table indicates the Company's pre-tax operating income (loss) by principal business segment for the three and six months ended June 30, 1998 and 1997:
Three Months Ended Six Months Ended June 30, June 30, 1998 1997(1) 1998 1997(1) - ----------------------------------------------------------------------------------------------------------------------------------- PMA Re $11,580 $ 9,829 $22,952 $23,187 -------- ------- ------- ------- The Property and Casualty Group: Excluding Run-off Operations 2,353 (6,777) 4,954 (4,781) Run-off Operations 293 (533) 428 (1,107) -------- ------- ------- ------- Total 2,646 (7,310) 5,382 (5,888) -------- ------- ------- ------- Caliber One (681) -- (1,070) -- Corporate and Other (2,757) (2,649) (5,548) (4,526) -------- ------- ------- ------- Pre-tax operating income (loss) before interest expense 10,788 (130) 21,716 12,773 Interest expense 3,762 3,888 7,463 8,222 -------- ------- ------- ------- Pre-tax operating income (loss) $ 7,026 $(4,018) $14,253 $ 4,551 ======== ======= ======= =======
(1) Pre-tax operating income (loss) by business segment has been reclassified for 1997 to reflect the changes related to the implementation of SFAS No. 131 (See Note 3 to the interim consolidated financial statements for further discussion). The following table indicates the Company's total assets by principal business segment at June 30, 1998:
- -------------------------------------------------------- PMA Re $1,188,852 The Property and Casualty Group: Excluding Run-off Operations 1,469,795 Run-off Operations 352,965 ---------- Total 1,822,760 Caliber One 62,465 Corporate and Other 1,336 ---------- Total assets $3,075,413 ==========
- 59 - In January 1998, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments" ("SOP 97-3"). SOP 97-3, which is effective for fiscal years beginning after December 31, 1998, and 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. While the Company is presently evaluating the impact of SOP 97-3, the adoption of SOP 97-3 is likely to result in an increase in the Company's liabilities for such assessments, although such increase is not expected to exceed $5.0 million. The impact of adopting SOP 97-3 will be reflected as a cumulative effect of an accounting change in the first quarter of 1999. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"), 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 that entities recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (i) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (ii) a hedge of the exposure to variable cash flows of a forecasted transaction or (iii) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security or a foreign-currency-denominated forecasted transaction. 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. SFAS No. 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. 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 or results of operations. - 60 - Results of Operations for the Years Ended December 31, 1997, 1996 and 1995 The table below presents the major components of net income (loss) for the years ended December 31, 1997, 1996 and 1995: (dollar amounts in thousands, except per share data) 1997 1996 1995 -------- ---------- ------- Pre-tax operating income (loss) (1)........ $16,555 $(194,378) $ 2,990 Net realized investment gains.............. 8,598 2,984 31,923 ------- --------- ------- Income (loss) before income taxes.......... 25,153 (191,394) 34,913 Provision (benefit) for income taxes....... 5,400 (56,060) 10,783 ------- --------- ------- Income (loss) before extraordinary loss.... 19,753 (135,334) 24,130 Extraordinary loss, net of related taxes... (4,734) --- --- ------- --------- ------- Net income (loss).......................... $15,019 $(135,334) $24,130 ======= ========= ======= Per basic share: Income (loss) before extraordinary loss.. $ .83 $ (5.68) $ 1.01 Extraordinary loss....................... (.20) -- -- ------- --------- ------- Net income (loss)........................ $ .63 $ (5.68) $ 1.01 ======= ========= ======= Per diluted share: Income (loss) before extraordinary loss.. $ .80 $ (5.68) $ .97 Extraordinary loss....................... (.19) -- -- ------- --------- ------- Net income (loss)........................ $ .61 $ (5.68) $ .97 ======= ========= ======= - -------------- (1) Pre-tax operating income (loss) is defined as income (loss) from continuing operations before income taxes, but excluding net realized investment gains. The following table indicates the Company's pre-tax operating income (loss) by principal business segment for the years ended December 31, 1997, 1996 and 1995: (dollar amounts in thousands) 1997 1996 1995 -------- ---------- --------- PMA Re.................................. $44,802 $ 42,783 $ 39,443 The Property and Casualty Group......... (9,038) (219,619) (4,305) Corporate and Other..................... (3,441) (490) (13,414) ------- --------- -------- Pre-tax operating income (loss) before interest expense...................... 32,323 (177,326) 21,724 Interest expense........................ 15,768 17,052 18,734 ------- --------- -------- Pre-tax operating income (loss)......... $16,555 $(194,378) $ 2,990 ======= ========= ======== In 1997, the Company reported consolidated pre-tax operating income of $16.6 million, or $0.69 and $0.67 per basic and diluted share, respectively, compared to a pre-tax operating loss of $194.4 million, or $8.17 per basic and diluted share, in 1996. After-tax operating income for 1997 was $14.2 million, or $0.59 and $0.58 per basic and diluted share, respectively, compared to an after-tax operating loss of $137.3 million, or $5.77 per basic and diluted share, - 61 - in 1996. The improvement in the 1997 results was due primarily to special charges recorded in 1996, increased pre-tax operating income generated by PMA Re and improved underwriting results by the Property and Casualty Group. The increase in PMA Re's pre-tax operating income to $44.8 million in 1997 compared to $42.8 million in 1996, was due to higher premium volume, improved underwriting results and higher investment income. The pre-tax operating loss of the Property and Casualty Group decreased in 1997 to $9.0 million compared to $219.6 million in 1996, due primarily to special charges recorded in 1996, as well as the impact of cost savings initiatives implemented in late 1996 and in 1997. Corporate and Other operations reported a pre-tax operating loss of $3.4 million in 1997 compared to a pre-tax operating loss of $500,000 in 1996. The higher operating loss for Corporate and Other operations was due primarily to increased operating costs related to certain corporate properties disposed of during the third quarter of 1997. Interest expense decreased in 1997 by $1.3 million due to the refinancing of the Company's debt with the Revolving Credit Facility. See "Liquidity and Capital Resources" herein for further discussion. On a consolidated basis, the Company reported pre-tax operating income of $3.0 million, or $0.13 and $0.12 per basic and diluted share, respectively, in 1995 compared to the $194.4 million pre-tax operating loss discussed above for 1996. After-tax operating income was $3.4 million, or $0.14 per basic and diluted share, in 1995 compared to the $137.3 million after-tax operating loss in 1996 mentioned above. The decrease from 1995 to 1996 was due primarily to special charges recorded in 1996 at the Property and Casualty Group. In 1995, PMA Re reported pre-tax operating income of $39.4 million, the Property and Casualty Group had a pre-tax operating loss of $4.3 million and Corporate and Other operations recorded a pre-tax operating loss of $13.4 million. The improvement in the operating results of Corporate and Other from 1995 to 1996 was due primarily to an $8.4 million write-down in 1995 of certain real estate properties owned by the Company as well as higher overhead expenses. Interest expense decreased in 1996 by approximately $1.7 million as compared to 1995, primarily reflecting lower average debt balances and the pay-down of higher coupon debt. Net income on a consolidated basis, before extraordinary items, was $19.8 million, or $0.83 per basic share and $0.80 per diluted share, respectively, in 1997 compared to a net loss of $135.3 million, or $5.68 per basic and diluted share, in 1996. On March 14, 1997, the Company refinanced substantially all of its outstanding credit agreements not already maturing in 1997 with the Revolving Credit Facility. In connection with this refinancing, the Company recognized an extraordinary loss from the early extinguishment of debt of $4.7 million, or $0.20 and $0.19 per basic and diluted share, respectively, net of tax. Over the past three years, restructuring charges and other special items have impacted the Company's operating results. During 1997, the Company recorded $7.0 million of severance and other restructuring charges, primarily related to the Property and Casualty Group and Corporate and Other operations. In addition, the Company recorded $2.2 million of operating costs for certain corporate properties which were disposed of during 1997 (see "Corporate and Other") and $2.0 million of Year 2000 expenses. See "Liquidity and Capital Resources" for further discussion. In 1996, the Company's operating results included a pre-tax charge of $221.3 million ($143.8 million after tax) recorded by the Property and Casualty Group in order to strengthen its loss and LAE reserves, to recognize restructuring costs in connection with staff reductions and to write off certain accounts receivable. In addition, pre-tax Year 2000 costs in 1996 were $1.8 million. In 1995, the Company recorded a charge of $8.4 - 62 - million to write down the Company's former headquarters building and certain adjacent properties to their fair market values less costs to carry and sell the properties. The charges over the three-year period consisted of the following: (dollar amounts in millions) 1997 1996 1995 ----- ------ ----- Severance and other restructuring charges.. $ 7.0 $ 7.6 $ -- Year 2000 costs............................ 2.0 1.8 -- Costs related to corporate properties...... 2.2 -- -- Write-down of corporate properties......... -- -- 8.4 Caliber One pre-opening costs.............. 0.9 -- -- Loss reserve strengthening................. -- 191.4 -- Receivables write-down..................... -- 17.5 -- Equipment write-down....................... -- 4.8 -- ----- ------ ---- Total pre-tax charge....................... $12.1 $223.1 $8.4 ===== ====== ==== The $7.6 million of severance and restructuring charges recorded in the fourth quarter of 1996 related to the Voluntary Early Retirement Program ("VERIP") initiated in 1996. These amounts are expected to be paid out over time in accordance with existing retirement and post-employment obligations. As discussed further in Note 9 of the Consolidated Financial Statements, 50 employees opted to participate in the VERIP resulting in the following charges being recorded as of December 31, 1996: (dollar amounts in thousands) - -------------------------------------------------------------------------------- Pension costs $ 4,300 Postemployment costs 2,360 Postretirement costs 975 Total $ 7,635 During 1997, the Property and Casualty Group recorded $5.2 million and Corporate and Other recorded $1.8 million for severance and cost reduction initiatives. The charges consisted primarily of costs associated with nonvoluntary terminations of approximately 60 employees in various operational and management positions. The cash outlays associated with these charges will continue through 1998, and funding the cash outlays will not have a material adverse effect on the Company's liquidity. As of December 31, 1997, approximately $3.5 million of such charges remained in Other Liabilities on the balance sheet. PMA Re Results of Operations Summarized financial results of PMA Re for the years ended December 31, 1997, 1996 and 1995 are as follows: (dollar amounts in thousands) 1997 1996 1995 -------- -------- -------- Net premiums written................ $177,934 $164,053 $152,760 ======== ======== ======== Net premiums earned................. $163,603 $151,974 $139,345 Net investment income............... 52,270 48,676 45,166 -------- -------- -------- Operating revenues.................. 215,873 200,650 184,511 -------- -------- -------- Losses and LAE incurred............. 113,931 111,937 103,947 Acquisition and operating expenses.. 57,140 45,930 41,121 -------- -------- -------- Total losses and expenses........... 171,071 157,867 145,068 -------- -------- -------- Pre-tax operating income............ $ 44,802 $ 42,783 $ 39,443 ======== ======== ======== GAAP loss ratio..................... 69.6% 73.7% 74.6% GAAP combined ratio................. 104.5% 103.9% 104.1% SAP loss ratio...................... 69.5% 73.7% 74.6% SAP combined ratio.................. 103.8% 104.4% 105.5% Premium Revenues In 1997 and 1996, net premiums written increased 8.5% and 7.4%, respectively. The increases in 1997 and 1996 were primarily the result of increased participation in reinsurance treaties and the writing of additional layers and programs with existing clients. An increased number of programs added for property lines during the second half of 1996 and during 1997 also contributed to the aforementioned increases in net premiums written. These increases were partially offset by the trend toward large ceding companies increasing their retentions, which decreased PMA Re's subject premium. In addition, highly competitive pricing - 63 - conditions in the United States reinsurance market caused PMA Re to non-renew certain existing business and to decline certain new business opportunities. The following table indicates PMA Re's gross and net premiums written by major category of business for the years ended December 31, 1997, 1996 and 1995: (dollar amounts in thousands) % Change % Change 1997 1996 to to 1997 1996 1995 1996 1995 -------- -------- --------- -------- -------- Gross premiums written: Casualty lines.......... $151,901 $143,991 $128,736 5.5 % 11.9 % Property lines.......... 72,625 63,325 63,693 14.7 % (0.6)% Other lines............. 795 842 (63) (5.6)% -- -------- -------- -------- ----- ----- Total.................... $225,321 $208,158 $192,366 8.2 % 8.2 % ======== ======== ======== ===== ===== Net premiums written: Casualty lines.......... $118,889 $122,008 $107,383 (2.6)% 13.6 % Property lines.......... 58,257 41,240 45,440 41.3 % (9.2)% Other lines............. 788 805 (63) (2.1)% -- -------- -------- -------- ----- ----- Total.................... $177,934 $164,053 $152,760 8.5 % 7.4 % ======== ======== ======== ===== ===== PMA Re's net casualty premiums written decreased 2.6% in 1997 and increased 13.6% in 1996. The decrease in 1997 was primarily attributable to the purchase of increased retrocessional protection, which offset increases in gross casualty premiums relating to new business with existing clients and larger lines taken on existing programs. The growth in 1996 was attributable to the expansion of several programs covering specialty business, which included professional liability, directors' and officers' liability and other coverages written on a surplus lines basis. PMA Re's net property business increased 41.3% during 1997 and decreased 9.2% during 1996. The increase in net property premiums written in 1997 was primarily the result of additional property underwriting expertise that PMA Re added to its underwriting staff in late 1996 to broaden its product offerings. Such expertise enabled PMA Re to increase cross-selling opportunities with its existing treaty reinsurance clients by offering additional and expanded property coverages. In addition, property premiums ceded decreased primarily related to changes in PMA Re's property retrocessional coverages in terms of premiums and ceding commissions. The decrease in net premiums written in 1996 was primarily attributable to higher ceding company retentions, competitive pricing conditions and higher ceded property premiums. The property programs written by PMA Re generally contain per occurrence limits or are not considered significantly catastrophe exposed, 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 catastrophic events due to the aggregation of per occurrence limits and similar issues. PMA Re actively manages this exposure through aggregate management, minimizing the writing of catastrophe business and retrocessional protection. See "Liquidity and Capital Resources -- Capital Resources." - 64 - In 1997, PMA Re recorded $2.5 million of net facultative reinsurance premiums, which represented 1.4% of total net premiums written for the year, compared to $1.0 million, or 0.6%, in 1996. PMA Re commenced writing facultative reinsurance in November 1995. Net premiums earned increased 7.7% and 9.1% in 1997 and 1996, respectively. These increases both correspond to the increases in net premiums written, as net premiums earned generally follow growth patterns similar to net premiums written adjusted for the customary lag related to the timing of premium writings within the year. Losses and Expenses PMA Re's combined ratios have remained relatively stable from 1995 through 1997, ranging from 103.9% to 104.5% during the three-year period. This relative stability is attributable to (i) consistently favorable development of unpaid losses and LAE; (ii) prudent management of catastrophe exposures and (iii) lower loss ratios offsetting generally increased acquisition costs related to writing more business with ceding commissions. The following table indicates the components of PMA Re's combined ratios computed in accordance with GAAP for the years ended December 31, 1997, 1996 and 1995(1): 1997 1996 1995 ------ ------ ------ Loss ratio................................... 69.6% 73.7% 74.6% ----- ----- ----- Expense ratio: Amortization of deferred acquisition costs.. 27.6% 24.7% 24.2% Operating expenses.......................... 7.3% 5.5% 5.3% ----- ----- ----- Total expense ratio.......................... 34.9% 30.2% 29.5% ----- ----- ----- Combined ratio-GAAP.......................... 104.5% 103.9% 104.1% ===== ===== ===== - ------------ (1) The combined ratio computed in accordance with GAAP is equal to the sum of losses and LAE, amortization of deferred acquisition costs, operating expenses and policyholders' dividends (where applicable), all divided by net premiums earned. For the three years ended December 31, 1997, PMA Re's loss ratios have declined primarily as a result of increased ceding commissions and favorable loss reserve development. PMA Re's loss ratio decreased to 69.6% in 1997 from 73.7% and 74.6% in 1996 and 1995, respectively. For contracts written on a pro rata basis and other contracts containing ceding commissions, premiums tend to be higher relative to the losses when compared to contracts that do not contain ceding commissions. In the three years ended December 31, 1997, PMA Re has written more contracts containing ceding commissions which has contributed to the decreases in loss ratios. For such contracts, PMA Re pays the ceding company a commission, but in return, PMA Re receives a higher proportion of the subject premium. In addition, net favorable development on prior years' unpaid losses and LAE was $23.3 million, $28.6 million and $15.0 million in 1997, 1996 and 1995, respectively, primarily for accident years 1993 and prior. Such favorable development is attributable to losses emerging at a lower rate than was anticipated (based upon historical loss development patterns) when the initial accident year reserves were established. While loss emergence patterns have been trending downward for the pre-1993 accident years, resulting in favorable loss reserve development, there can be no assurance that such trend will continue in the future. The ratio of amortization of deferred acquisition costs to net premiums earned ("Acquisition Expense Ratio") increased 2.9 points to 27.6% in 1997 compared to 1996 and 0.5 points in 1996 compared to 1995. These increases predominantly relate to the fact that PMA - 65 - Re continues to write more contracts with ceding commissions. In addition, the ceding commissions that PMA Re received related to its retrocessional catastrophe cover were higher in 1996 than in 1997, which contributed to the lower Acquisition Expense Ratio in 1996. The ratio of operating expenses to net premiums earned (the "Operating Expense Ratio") increased 1.8 points to 7.3% in 1997 compared to 5.5% in 1996. This increase was attributable to increases in certain expenses, such as salary and facility expenses, in connection with the addition of staff and expansion of office facilities during 1997. During the three-year period ended December 31, 1997, PMA Re has continued to add staff in response to increased premium volume and to increase the level of specialized services provided to customers. Accordingly, the Operating Expense Ratio increased from 5.3% in 1995 to 7.3% in 1997. The Company is presently undertaking a project to upgrade all of its computer systems to be able to process records with dates beyond December 31, 1999. During 1997, PMA Re incurred costs amounting to approximately $400,000 related to the Year 2000 compliance program. Management expects that PMA Re will incur approximately $600,000 in 1998 related to the Year 2000 compliance program. Management expects that such project will be completed in 1998. See "Liquidity and Capital Resources." Net Investment Income Net investment income increased 7.4% to $52.3 million in 1997 from $48.7 million in 1996, which represented a 7.8% increase from $45.2 million in 1995. Such increases were primarily attributable to the overall increase in PMA Re's invested assets, as well as changes in portfolio holdings. During 1997, PMA Re shifted some of its holdings from government securities to high-quality corporate securities, which generally yield higher levels of investment income. In addition, the 1996 increase was due to a decrease in holdings of tax-exempt securities for which pre-tax yields tend to be lower than other investment vehicles. At amortized cost, PMA Re's cash and invested assets increased $49.0 million, or 5.9%, and $34.9 million, or 4.4%, during 1997 and 1996, respectively. Comparison of SAP and GAAP Results The difference between the combined ratios presented in accordance with GAAP compared to SAP is primarily attributable to the different accounting treatment of acquisition costs. As PMA Re's premium volume has grown during 1997 and 1996, PMA Re has incurred additional acquisition costs, which are deferred for GAAP. For SAP purposes, PMA Re is required to expense such costs as incurred, resulting in an incremental expense recorded on a SAP basis compared to GAAP. The Property and Casualty Group Results of Operations Summarized financial results of the Property and Casualty Group for the years ended December 31, 1997, 1996 and 1995 are as follows: - 66 - (dollar amounts in thousands) 1997 1996 1995 -------- --------- -------- Net premiums written: Workers' compensation............. $175,301 $ 189,338 $233,145 Commercial Lines.................. 65,047 90,084 103,971 -------- --------- -------- Total............................. $240,348 $ 279,422 $337,116 ======== ========= ======== Net premiums earned: Workers' compensation............. $152,773 $ 176,380 $243,175 Commercial Lines.................. 59,575 92,221 102,432 -------- --------- -------- Total............................. 212,348 268,601 345,607 Net investment income............... 82,098 82,455 92,275 Service revenues.................... 10,311 9,189 5,106 -------- --------- -------- Operating revenues.................. 304,757 360,245 442,988 -------- --------- -------- Losses and LAE incurred............. 193,530 424,900 319,644 Acquisition and operating expenses.. 105,549 138,709 110,906 Policyholder dividends.............. 14,716 16,255 16,743 -------- --------- -------- Total losses and expenses........... 313,795 579,864 447,293 -------- --------- -------- Pre-tax operating loss.............. $ (9,038) $(219,619) $ (4,305) ======== ========= ======== GAAP loss ratio..................... 91.1% 158.2% 92.5% GAAP combined ratio................. 143.3% 212.9% 127.9% SAP loss ratio(1)................... 84.0% 125.7% 77.3% SAP combined ratio(1)............... 119.0% 175.6% 115.1% - ---------------- (1) The SAP loss and combined ratios above relate to the operations of the Pooled Companies only and do not include the results of other statutory entities within the Property and Casualty Group. Premium Revenues Premiums for the Property and Casualty Group have decreased in the three- year period ended December 31, 1997. Between 1997 and 1996, net premiums written decreased 14.0%, and between 1996 and 1995, net premiums written decreased 17.1%. Direct premiums written for workers' compensation decreased $20.6 million and $36.5 million in 1997 and 1996, respectively. Direct premiums written for Commercial Lines increased $11.7 million in 1997 compared to 1996, and decreased $11.6 million in 1996 compared to 1995. Reinsurance premiums assumed decreased $4.4 million between 1997 and 1996 and increased $0.8 million between 1996 and 1995. Reinsurance premiums ceded increased $25.8 million in 1997 compared to 1996 and $10.4 million in 1996 compared to 1995. Net premiums earned decreased $56.3 million between 1997 and 1996 and $77.0 million between 1996 and 1995. The decline in premiums from 1995 to 1997 is due to a number of factors discussed below, including the Property and Casualty Group's underwriting decisions, competition and the impact of workers' compensation benefit reform laws. During the three years ended December 31, 1997, competition and manual rate levels affected workers' compensation premium volume. During this period, the Property and Casualty Group did not renew certain accounts due to inadequate profit potential. Intense competition caused rates for certain accounts to be unattractive relative to the risks assumed. - 67 - Rather than match the price merely to retain the volume, the Property and Casualty Group declined to write the accounts. Average manual rate levels declined 25.0%, 7.0% and 3.0% in 1997, 1996, and 1995, respectively. The rate decreases had a substantially lower proportional impact on premiums written during 1996 and 1995, because the Property and Casualty Group had reduced its dependence on rate-sensitive business. The Property and Casualty Group increased its focus on rate sensitive small account business in 1997 because it believes that the impact of recently passed legislation in its principal marketing states, including Act 57 in Pennsylvania, may make loss experience on such business more predictable than it has been in recent years. Workers' compensation premiums also declined during the three-year period ended December 31, 1997 as a result of the enactment of workers' compensation benefit reform laws. The decline in workers' compensation premiums has been concentrated primarily in Pennsylvania. Direct workers' compensation premiums for all other jurisdictions increased in 1997 compared to 1996, including an increase of $3.8 million from new jurisdictions in 1997. The number of workers' compensation policies increased to 3,184 in 1997 compared to 2,757 in 1996. However, the increase in policies was offset by the rate decreases related to the benefit reform laws. These benefit reform laws also have had a favorable impact on loss and LAE reserves for business written on policies subject to such reform laws. See "Losses and Expenses" below. The changes in workers' compensation benefits that were promulgated under Act 57 in Pennsylvania were accompanied by a change in the basic premium rate structure for workers' compensation insurance, which lowered the rates charged to insureds by approximately 25% effective February 1997. This change in rate structure was reviewed by an independent actuarial firm on behalf of the Commonwealth of Pennsylvania in connection with the approval of rates under Act 57. In addition, the Company's actuaries reviewed the effect that the reforms would have on workers' compensation benefits paid in relation to the changes in premiums charged. It was the opinion of both groups of actuaries that the rate changes mandated by Act 57 were consistent with the changes in benefits allowed under Act 57, and the effect of the rate changes would be minimal with respect to the profitability of the business. 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. Since the late 1980's, the Property and Casualty Group has reduced its proportion of rate-sensitive products from over 70% to approximately 62%. As a result of the enactment of regulatory reform in several jurisdictions in the Property and Casualty Group's marketing territory, the Property and Casualty Group may write more rate-sensitive accounts in such jurisdictions in the future. Direct workers' compensation premiums were also impacted by changes in the level of premium adjustments, primarily related to audit premiums and retrospective policies. In 1997, such adjustments decreased premiums written by $4.4 million ($15.8 million in audit premiums billed and $20.2 million in retrospective premiums returned), while in 1996, such adjustments reduced premiums written by $6.1 million ($17.1 million in audit premiums billed and $23.2 million in retrospective premiums returned) and in 1995, such adjustments increased premiums written by $13.1 million ($26.9 million in audit premiums billed and $13.8 million in retrospective premiums returned). The slightly lower impact of premium adjustments in 1997 compared to 1996 was due primarily to a decrease in retrospectively rated premiums - 68 - returned to insureds, resulting from a lower volume of workers' compensation business written during the three years ended December 31, 1997. The decrease in 1996 compared to 1995 was due primarily to two factors: the lower amount of billed audit premiums, which is attributable to better estimating of the ultimate exposure base (generally, payroll) on such risks by the Property and Casualty Group's underwriters and the increase in retrospectively rated premiums returned to insureds, resulting from the favorable loss experience in more recent accident years in workers' compensation. As the Property and Casualty Group has expanded retrospectively rated business since 1989, proportionately more policies had mature loss data, resulting in more premium adjustments. Changes in actuarial estimates of future premium adjustments on retrospective policies are recorded directly in net premiums earned (see below for further discussion), and, therefore, such retrospective adjustments returned to insureds do not impact net premiums earned. Under retrospectively rated policies, the Property and Casualty Group receives an up-front provisional premium that is adjusted based upon loss experience of the insured. If losses are lower than expected, the insured receives a refund, subject to a minimum premium and, if losses are higher than expected, the insured owes additional premium, subject to a maximum premium. Between the minimum and maximum premiums, the net impact on the Company's operating results is negligible, because changes in loss estimates pertaining to retrospectively rated contracts are offset by changes in premium estimates, net of changes in estimates for accrued premium taxes and other loss-based costs. While the premium is adjusted based upon loss experience, the Company's profit load (or margin) portion of the premium is fixed at the policy's inception and is not adjusted based upon loss experience, although the margin would be impaired in the event losses exceed the maximum premium amount. Approximately $50.1 million, $59.0 million and $85.0 million of the Property and Casualty Group's workers' compensation premiums were derived from loss-sensitive products in 1997, 1996 and 1995, respectively. The audit premiums referred to above were derived from the Company's workers' compensation insurance policies. An insured's workers' compensation premiums are determined by two factors: aggregate payroll and employer business classification. The Company determines its initial estimate of annual premium based on payroll records and business classification data submitted to it by the insured. An audit of this data is performed after the policy year ends, and an adjustment to the premium is then made and billed to the insured. Also reducing net premiums written is the fact that, since 1992, the Property and Casualty Group has been increasing its focus on alternative market workers' compensation products. These products include large-deductible policies, offshore rent-a-captive programs and individual self-insurance programs. Typically, the Property and Casualty Group receives a lower net premium for these types of 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. A substantial portion of related revenues are recorded as service revenues rather than premiums. Such service revenues increased $1.1 million in 1997 compared to 1996 and $4.1 million in 1996 compared to 1995. Companies writing workers' compensation in certain states generally must share in the risk of insuring entities that cannot obtain insurance in the voluntary market. Typically, an insurer's share of this residual market is dependent upon its market share of direct premiums - 69 - in the voluntary market, and the assignments are accomplished either by direct assignment or by assumption from pools. In 1997, the Property and Casualty Group's direct assignments, which are included in direct written premiums, decreased $3.1 million compared to 1996 and decreased $15.3 million in 1996 compared to 1995. These decreases reflect generally lower premium volume in workers' compensation for the Property and Casualty Group, as well as increasingly competitive conditions in the voluntary workers' compensation market which has led to lower amounts of residual market business. During 1997 compared to 1996, direct writings of Commercial Lines increased $11.7 million assumed Commercial Lines premiums decreased $8.5 million and ceded Commercial Lines premiums increased $28.2 million. The growth in direct writings for Commercial Lines in 1997 was due primarily to rate increases on existing business as well as additional companion commercial business associated with new workers' compensation customers. The Property and Casualty Group is continuing to review the profitability of these lines, and the net growth in such lines has been limited as a result of this review and the new reinsurance treaty discussed below. Also, market conditions have been extremely competitive in these lines, and management has refused to compromise underwriting standards merely to increase volume. During 1996 compared to 1995, direct writings of Commercial Lines decreased $11.6 million assumed Commercial Lines premiums increased $0.8 million and ceded Commercial Lines premiums increased $3.1 million. In 1997, the Property and Casualty Group entered into a new reinsurance treaty that covers substantially all of the Commercial Lines casualty business at a $175,000 per risk attachment point, compared to a $500,000 per risk attachment point in 1996 which accounted for the increase in ceded Commercial Lines premiums. Ceded premiums increased $25.8 million in 1997 compared to 1996, and increased $10.4 million in 1996 compared to 1995. The increase in 1997 compared to 1996 was due primarily to a reinsurance treaty effected at December 31, 1997, ceding $15.4 million of annuity reserves held by PMA Life to a third party (the "PMA Life transaction"). Ceded premiums also increased approximately $6.6 million due to the aforementioned lower attachment point of the Commercial Lines casualty reinsurance treaty the Property and Casualty Group entered into effective January 1, 1997. Finally, ceded reinsurance premiums increased an additional $6.2 million, due to the increased direct writings of Commercial Lines business in 1997 compared to 1996. In 1996 compared to 1995, ceded premiums decreased, although the rate of decrease was less than the rate of decrease in direct premiums due to the increased use of facultative reinsurance for specific risks in Commercial Lines. Fluctuations in net premiums earned were primarily attributable to changes in net premiums written. In addition to the impact of fluctuations in premiums written, premiums earned were also impacted by the change in accrued retrospective premiums. Accrued retrospective premiums, which are a component of uncollected premiums, 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 policy year based upon estimated loss experience on the underlying policies and adjusted in subsequent periods in conjunction with revisions of the estimated underlying losses on such policies. In addition, accrued retrospective premiums are increased or decreased based upon retrospective policy - 70 - adjustments paid or billed. Such adjustments actually billed or paid do not impact premium revenues because the Company records an offsetting amount through net premiums written. The following table sets forth the components of the change in accrued retrospective premiums for each of the three years in the period ended December 31, 1997: (dollar amounts in thousands) 1997 1996 1995 --------- --------- --------- Estimated retrospective policy adjustments related to the current accident year........................ ($12,460) ($18,767) ($12,941) Revision of estimate of retrospective policy adjustments related to prior accident years................. (44,719) (9,888) (4,845) Retrospective policy adjustments paid.. 20,179 23,155 13,786 Uncollectible write-off................ --- (5,000) --- -------- -------- -------- Total.................................. ($37,000) ($10,500) ($4,000) ======== ======== ======== In 1997, 1996 and 1995, the Property and Casualty Group reduced accrued retrospective premiums by $37.0 million, $10.5 million and $4.0 million, respectively. The primary reason for the additional reduction in 1997 compared to 1996 was a $44.7 million revision of estimate of accrued retrospective premiums, primarily due to the favorable development of claims liabilities for more recent accident years ($35.7 million) and the commutation of claims for accident years 1991 and prior in 1997 ($9.0 million). The reduction for policy years 1991 and prior primarily relates to the commutation program for such years initiated in late 1996. In July 1997, the Property and Casualty Group completed a formal program under which it commuted a large number of claims associated with workers' compensation claims from accident years 1991 and prior, including loss reserves associated with retrospective policies. The commutation program resulted in current payments to claimants that were less than the carried reserves. As a result of the differences between the current commutation payments to claimants and carried reserves on such claims, management reduced its estimate of amounts recoverable under retrospectively rated policies and the Property and Casualty Group also recognized a reduction in losses and LAE associated with such policies. See "Losses and Expenses." The reduction for the 1992 through 1996 policy years was related primarily to a corresponding amount of favorable development on underlying loss reserves for such years. The effects of the commutations on these prior loss reserves, as well as the intent of the Property and Casualty Group to continue utilizing early intervention techniques such as commutations on claims from more recent accident years, have led to a re-estimation of policy liabilities for these more recent accident years, and a re-estimation of amounts due under retrospectively rated policies for these more recent accident years. The reduction in amounts due under retrospectively rated policies and the corresponding reduction in loss reserves resulting from commutation of the carried loss reserves and re-estimation of more recent accident years resulted in a reduction of the GAAP loss ratio for 1997 compared to 1996 and 1995. See "Losses and Expenses." In addition, the reduction of earned premiums caused both the GAAP expense ratio and the policyholder dividend ratio to increase for 1997 compared to 1996 and 1995. However, the impact of the reduction of the accrued - 71 - retrospective premiums (net of the adjustment to underlying loss reserves) on the Company's results of operations was negligible. The increased adjustment to prior accident years recorded in 1996 compared to 1995 reflects additional favorable loss reserve development in the prior three accident years. Management believes that it has made a reasonable estimate of the Company's accrued retrospective premiums. While the eventual ultimate receivable may differ from the current estimates, management does not believe that the difference will have a material effect, either adversely or favorably, on the Company's financial position or results of operations. Losses and Expenses The following table reflects the components of the Property and Casualty Group's combined ratios, computed in accordance with GAAP for the years ended December 31, 1997, 1996 and 1995: 1997 1996 1995 ------ ------ ------ Loss ratio................................... 91.1% 158.2% 92.5% ----- ----- ----- Expense ratio: Amortization of deferred acquisition costs.. 22.7% 19.7% 15.5% Operating expenses(1)....................... 22.6% 28.9% 15.1% ----- ----- ----- Total expense ratio.......................... 45.3% 48.6% 30.6% ----- ----- ----- Policyholders' dividend ratio................ 6.9% 6.1% 4.8% ----- ----- ----- Combined ratio-GAAP.......................... 143.3% 212.9% 127.9% ===== ===== ===== - ---------- (1) The GAAP Operating Expense Ratio excludes $9.3 million, $8.2 million and $5.3 million in 1997, 1996 and 1995, respectively, of PMA Management Corp. direct expenses related to service revenues which are not included in premiums earned. The components of the loss and LAE ratio for the Property and Casualty Group for the years ended December 31, 1997, 1996 and 1995 are as follows: 1997 1996 1995 ------ ------ ------ Current accident year - undiscounted............ 81.3% 81.4% 83.8% Accretion of discount for prior accident years and discounting of current accident year....... 12.0% 5.5% (0.7%) Adjustments to retrospectively rated business and net effect of PMA Life transaction......... (1.5%) -- -- Change in discount rate......................... -- -- (9.8%) Reserve (release) strengthening................. (0.7%) 71.3% 19.2% ---- ----- ---- Loss and LAE ratio.............................. 91.1% 158.2% 92.5% ==== ===== ==== In 1997, the calendar year loss ratio was impacted by a $31.7 million net charge, which represented the accretion of discount on workers' compensation loss reserves for prior accident years, partially offset by discounting of current accident year reserves, while the 1996 calendar year loss ratio was impacted by a $15.0 million net charge for accretion of discount - 72 - on prior accident year workers' compensation loss reserves and discounting of current accident year reserves. The increase in the net charge for discount accretion is due primarily to higher overall reserve levels in 1997 and lower levels of current accident year reserves being discounted in 1997 compared to 1996. The Property and Casualty Group expects lower levels of discount associated with current accident year reserves to continue due to benefit reforms which have been enacted in many of the states in which it does business that reduce claims duration. Management also expects that the net charge associated with accretion of discount of prior years' reserves will decrease in 1998 and forward because the accelerated payment of claims due to commutations is expected to lower the level of discount in the Property and Casualty Group's loss reserves. The increase in the loss ratio in 1996 compared to 1995 from the accretion of discount was due primarily to higher overall reserves in 1996 and to lower levels of earned premium in 1996 compared to 1995. Discounting of reserves for workers' compensation claims is established in accordance with applicable state laws, which permit discounting the estimated claim payments on certain claims at various rates. The Property and Casualty Group uses a discount rate of approximately 5% per year, which is within the range of permitted rates in the states in which it does business. Loss reserves on other lines of business as well as loss adjustment expense reserves for all lines of business are not discounted. In 1996 and 1995, the loss ratio included $191.4 million and $66.5 million, respectively, of strengthening of unpaid losses and LAE of prior accident years. For the years ended December 31, 1997, 1996 and 1995, the loss reserve (release) strengthening, net of retrospectively rated policies and the PMA Life Insurance Company transaction, was associated with the following lines of business: (dollar amounts in millions) 1997 1996 1995 ------ ------ ------- Pre-1992 workers' compensation......... $(7.1) $110.0 $ 54.7 Asbestos and environmental............. -- 60.4 23.4 Other lines of business................ 5.0 21.0 (11.6) ----- ------ ------ Total reserve (release) strengthening.. $(2.1) $191.4 $ 66.5 ===== ====== ====== In 1997, the Property and Casualty Group recorded a reserve release of $53.9 million on prior year losses and LAE, excluding the accretion of discount. The release primarily relates to favorable reserve development of $9.0 million for workers' compensation retrospectively rated policies for accident years 1991 and prior resulting from unanticipated additional savings from the Company's 1997 commutation program and favorable development of workers' compensation reserves for accident years 1992 through 1996 of $35.1 million ($28.0 million related to retrospectively rated policies), primarily resulting from greater than expected savings associated with benefit reforms in Pennsylvania. Furthermore, incurred losses on prior accident years were also affected by the cession of prior year loss reserves included in the PMA Life transaction of $14.8 million. See "-Premium Revenues" above. The reserve release pertaining to the retrospectively rated policies and the PMA Life transaction were offset in the consolidated statements of operations by a corresponding reduction in earned premiums. The aforementioned reserve releases were partially offset by reserve strengthening of $5.0 million in commercial multi-peril business for accident year 1996. It is the opinion of management that these reserve adjustments are not indicative of any future trend. The 1996 aggregate workers' compensation adverse development was allocated $102.0 million to Pennsylvania and $8.0 million to all other states in which the Property and Casualty Group does business. Of the $102.0 million, the allocation by year is as follows: prior to 1987: $16.0 million; 1987 to 1991: $101.0 million and 1992 and subsequent years: ($15.0 million). In 1995, substantially all of the workers compensation adverse development related to accident years 1987 to 1991 in Pennsylvania. For accident years prior to 1992, the traditional paid loss development schedules for workers' compensation had begun to exhibit an increasing trend - 73 - in loss development factors by 1993. This trend was initially attributed to an increase in commutation activity. In 1995, management began to question whether loss data was developing in a manner that was consistent with the conclusion that the loss development trends were impacted solely by commutation activity. As a result, management began to accumulate additional data in order to determine whether there were additional causes for the increase in the paid loss development data and management obtained claim count data that was far more detailed than had been historically utilized in the reserve setting process. This data indicated that the paid loss development factors were not only impacted by commutation activity, but also by a decline in the claims closure rate in Pennsylvania. Management believes that the decline in the closure rates was due to several interrelated factors. One factor related to the fact that efforts to rehabilitate claimants and return them to work were not as successful as anticipated. For accident years 1987 to 1991, in particular, extensive efforts were made by the Company to rehabilitate claimants and return them to work at either full or modified duty. By late 1995 and into 1996, it was recognized, by a review of a slow down in the claims closure pattern, that these rehabilitation efforts were not impacting the closure rates as expected. Another factor negatively impacting claims closure rates related to the economic conditions in Pennsylvania in the early 1990's. During the period from 1990 to 1994, economic conditions in Pennsylvania were considered to be depressed in the Company's major industry niches for workers' compensation insurance (construction and heavy manufacturing). Payrolls in these industries were stagnant, and in many cases, employment was flat or declining. The Company believes that in periods of declining employment opportunities, there is a tendency for indemnity periods to increase, which occurred for workers who suffered injuries in these industries. The above factors, when considered with the fact that the benefits period in Pennsylvania was unlimited, caused the Company to believe that a substantial portion of claimants from the pre-1992 period, who had already been out of work five to nine years, would not return to work in any capacity. In late 1995 and during 1996, management undertook an effort to quantify the impact of the declining closure rates compared to the increase in commutation activity. During the fourth quarter of 1995, the Property and Casualty Group strengthened its workers' compensation reserves by $54.7 million; however, the quantification of the effect of the claims closure rate was an extremely complex process, and as such, the data was not fully understood at that time. As the data under analysis was more mature and refined in 1996, management determined that the workers' compensation loss reserves for Pennsylvania for pre-1992 accident years needed to be increased substantially; therefore, the Property and Casualty Group increased its workers' compensation reserves by $110.0 million. Benefit reforms enacted by states in which the Property and Casualty Group transacts business, most significantly Pennsylvania, have had a beneficial impact on more recent accident year loss ratios. Prior to 1996, the principal revisions to the Pennsylvania system included medical cost containment measures and an expansion of the period of time during which the insurer may require an employee to accept medical treatment from the employer's list of designated healthcare providers. In July 1996, Pennsylvania enacted Act 57, a workers' compensation reform bill that is expected to reduce substantially indemnity benefit periods in Pennsylvania. In addition to regulatory reforms, the loss ratios have been favorably impacted by the conversion to loss sensitive and alternative market products. Such a trend is evidenced by the fact that accident year loss ratios (losses recorded for the year in which - 74 - the event occurred expressed as a percentage of the earned premiums for that year) for workers' compensation have been generally lower in more recent accident years, as the following chart indicates: Property and Casualty Group Workers' Compensation Undiscounted -------------------------------------------------------------- Accident Year Pure Loss Ratios at December 31, 1997 --------------------------------------------------- Accident Year Loss Ratio ------------- ---------- 1990 100% 1991 86% 1992 80% 1993 64% 1994 64% 1995 63% 1996 63% 1997 66% In addition, management took several steps to reduce the outstanding claims associated with the Pennsylvania workers' compensation business written through 1991. A formal commutation program was initiated in the fourth quarter 1996 and continued into late 1997. Commutations are agreements with claimants whereby the claimants, in exchange for a lump sum payment, will forego their rights to future indemnity payments from the Property and Casualty Group. Under Pennsylvania workers' compensation laws, the claimant and the Pennsylvania Workers' Compensation Board must approve all such commutation arrangements. The Property and Casualty Group paid $101.1 million and $17.8 million in 1997 and the fourth quarter of 1996, respectively, to commute workers' compensation indemnity claims. Savings associated with these claims were consistent with management's expectations. The number of open claims for accident years 1991 and prior was substantially reduced as a result of the commutation program. This reduction in open claims is expected to reduce the possibility of further adverse development on such reserves, although there can be no assurance that the level of commutations will have a significant impact on the future development of such reserves. Estimating reserves for workers' compensation claims can be more difficult than for many other lines of property and casualty insurance for several reasons, including (i) the long payment "tail" associated with the business; (ii) the impact of social, political and regulatory trends on benefit levels for both medical and indemnity payments; (iii) the impact of economic trends and (iv) the impact of changes in the mix of business. At various times, one or a combination of such factors can make the interpretation of actuarial data associated with workers' compensation loss development more difficult, and it can take additional time to recognize changes in loss development patterns. Under such circumstances, adjustments will be made to such reserves as loss patterns develop and new information becomes available and such adjustments may be material. The adverse development in reserves associated with asbestos and environmental claims is the result of a detailed analysis completed in 1996 of loss and LAE reserves associated with asbestos and environmental liability claims. The reserving for asbestos and environmental claims has undergone change at both the Company and in the insurance - 75 - industry in general. For environmental and asbestos liability claims, reserving methodology has been evolving in the recent past into accepted industry practice. The Company has applied these methods to its asbestos and environmental loss reserves in 1997 and 1996. 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 estimating reserves for environmental and toxic tort liabilities. The methods employed by the Company prior to the review completed in 1996 included a review of aggregate loss and LAE paid and case incurred data along with resulting "survival ratios" to establish IBNR for environmental and toxic tort claims. For asbestos claims, the Company had previously reserved costs to defend, and any indemnification payments anticipated on, claims for which it had received notice that it was a responsible party, plus a bulk factor applied to the estimated case reserves to provide for potential development of indemnification and defense cost related to such claims. In 1996, the Company performed a ground up analysis of asbestos loss reserves using an actuarially accepted modeling technique. Using historical information as a base and information obtained from a review of open claims files, assumptions were made about future claims activity in order to estimate ultimate losses. For each individual major account, projections were made regarding new plaintiffs per year, the number of years new claims will be reported, the average loss severity per plaintiff and the ratio of LAE to loss. In many cases involving larger asbestos claims, the Company reserved up to the policy limits for the applicable loss coverage parts for the affected accounts. Policy terms and reinsurance treaties were applied in the modeling of future losses. Estimation of obligations for asbestos and environmental exposures continues to be more difficult than for other loss reserves 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. The Company's asbestos-related loss reserves as of December 31, 1997, 1996 and 1995 which include reserves for PMA Re of $0.3 million, $0.3 million and $0.6 million, gross and net, at December 31, 1997, 1996 and 1995, respectively: (dollar amounts in thousands) 1997 1996 1995 -------- --------- -------- Gross of reinsurance: Beginning reserves......................... $80,055 $ 27,611 $13,969 Incurred losses and LAE.................... 2,435 62,854 22,482 Calendar year payments for losses and LAE.. (5,764) (10,410) (8,840) ------- -------- ------- Ending reserves............................ $76,726 $ 80,055 $27,611 ======= ======== ======= Net of reinsurance: Beginning reserves......................... $53,300 $ 23,443 $ 8,168 Incurred losses and LAE.................... (36) 39,427 21,826 Calendar year payments for losses and LAE.................................. (4,686) (9,570) (6,551) ------- -------- ------- Ending reserves............................ $48,578 $ 53,300 $23,443 ======= ======== ======= - 76 - The Company's environmental-related loss reserves as of December 31, 1997, 1996 and 1995, which include reserves for PMA Re of $3.8 million, $2.9 million and $2.6 million, gross and net, at December 31, 1997, 1996 and 1995, respectively, and $13.1 million gross and zero net for Caliber One Indemnity Company at December 31, 1997 were as follows: (dollar amounts in thousands) 1997 1996 1995 -------- -------- -------- Gross of reinsurance: Beginning reserves..................... $35,626 $20,134 $20,952 Incurred losses and LAE................ 1,130 22,143 3,516 Reserves acquired through purchase of Caliber One Indemnity Company(1)..... 13,060 --- --- Calendar year payments for losses and LAE.............................. (4,708) (6,651) (4,334) ------- ------- ------- Ending reserves........................ $45,108 $35,626 $20,134 ======= ======= ======= Net of reinsurance: Beginning reserves..................... $34,592 $20,134 $20,952 Incurred losses and LAE................ 1,068 21,109 3,516 Calendar year payments for losses and LAE.............................. (3,965) (6,651) (4,334) ------- ------- ------- Ending reserves........................ $31,695 $34,592 $20,134 ======= ======= ======= - --------------- (1) Such acquired reserves have been reinsured by an affiliate of the former parent. See "Liquidity and Capital Resources." Of the total net asbestos reserves, $6.7 million, $6.8 million and $6.7 million related to established claims reserves at December 31, 1997, 1996 and 1995, respectively, and $41.9 million, $46.5 million and $16.7 million related to IBNR at December 31, 1997, 1996 and 1995, respectively. Of the total net environmental reserves, $11.2 million, $12.5 million and $10.3 million related to established claims reserves at December 31, 1997, 1996 and 1995, respectively, and $20.5 million, $22.1 million and $9.8 million related to incurred but not reported losses at December 31, 1997, 1996 and 1995, respectively. All incurred asbestos and environmental losses were for accident years 1986 and prior. Management believes that the Property and Casualty Group's 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 and other factors, the ultimate exposure to the Property and Casualty Group for these claims may vary significantly from the amounts currently recorded, resulting in a potential future adjustment in the claims reserves recorded. In addition, issues involving policy provisions, allocation of liability among participating insurers, proof of coverage and other factors make quantification of liabilities exceptionally difficult and subject to adjustment based upon newly available data. In 1996, Commercial Lines experienced reserve strengthening of $21.0 million compared to a reserve release of $11.6 million in 1995. The reserve strengthening in 1996 was principally - 77 - due to a re-estimation of loss adjustment costs associated with general liability claims. Through 1991, the Property and Casualty Group's mix of general liability insurance policies was weighted towards the manufacturing classes of business. Subsequent to 1991, the Property and Casualty Group's mix of business became more heavily weighted towards the construction and contracting classes of business. These particular classes of business have experienced losses due to alleged construction defects and similar matters that have taken longer to emerge than the classes of business previously written by the Property and Casualty Group. Defense costs associated with these claims have also exceeded the original estimate of the Property and Casualty Group's management, which was based on the patterns of indemnification payments associated with the earlier classes of business written. When this issue was discovered, the Property and Casualty Group factored the increased defense costs and the emergence pattern in determining a more appropriate reserve amount for loss handling costs. The release of reserves in 1995 was due primarily to favorable loss experience in commercial automobile business. The 1997 expense ratio declined by 3.3 points compared to the 1996 expense ratio. The 1997 Acquisition Expense Ratio increased by 3.0 points compared to 1996, primarily due to a 4.2 point increase related to the aforementioned adjustment to accrued retrospective premiums in 1997 ($37.0 million) and by the 1997 cession of premiums associated with the PMA Life transaction ($15.4 million), offset by the write-off in 1996 of $5.0 million in retrospectively rated premiums. These actions reduced earned premiums without a commensurate decrease in acquisition expenses. Such increase was partially offset by ceding commissions received by the Property and Casualty Group on its reinsurance arrangement for Commercial Lines casualty losses. Such commissions are recorded as a reduction of acquisition expenses. In 1996, the Acquisition Expense Ratio increased 4.2 points compared to 1995 primarily due to a change in the mix of business to a greater proportion of alternative market products and self-insured services, which have much lower, if any, net premium which caused acquisition expenses to represent a larger proportion of net premiums earned. The 1997 Operating Expense Ratio was 22.6%, a decrease of 6.3 points as compared to 28.9% in 1996. After adjusting for the reduction in accrued retrospective premiums and the PMA Life transaction, the adjusted Operating Expense Ratio would have been 18.1% in 1997. The lower adjusted Operating Expense Ratio is primarily attributable to expense containment programs begun at the Property and Casualty Group, and the higher levels of restructuring charges and valuation adjustments in 1996. Operating expenses in 1997 decreased by $31.0 million compared to 1996, despite an increase of $1.1 million in expenses associated with the Property and Casualty Group's service revenues. The 1996 Operating Expense Ratio was adversely impacted by several factors, including an accrual of $7.6 million for a voluntary early retirement program ("VERIP"), a $4.8 million charge associated with a change in depreciable lives of computer equipment and a $10.1 million increase in premium balances written off. In 1997, the Property and Casualty Group recorded $5.2 million for severance and related costs associated with the continued restructuring and cost reduction initiatives. These initiatives lowered payroll and related expenses in 1997 by $4.9 million. The 1996 Operating Expense Ratio increased 13.8 points in comparison to 1995 primarily related to the aforementioned factors that adversely impacted the 1996 ratio. In 1997 and 1996, respectively, the Property and Casualty Group incurred approximately $1.6 million and $1.8 million associated with the Year 2000 Issue. Management - 78 - anticipates that the Property and Casualty Group will incur approximately $700,000 in 1998 as a result of this conversion; it is expected that this conversion will be completed by the end of 1998. See "Liquidity and Capital Resources." The policyholders' dividend ratios were 6.9%, 6.1% and 4.8% for the years ended December 31, 1997, 1996 and 1995, respectively. The policyholders' dividend ratio increased by 1.3 points in 1997 as a result of the adjustment to retrospectively rated premiums and the PMA Life transaction. The ratios have generally increased over the three-year period ended December 31, 1997 primarily because of sliding-scale dividend plans. Under such plans, the insured receives a dividend based upon the collective loss experience of the plan. As the loss experience for the three underwriting years ended December 31, 1997 has improved relative to the years prior to this period, the Property and Casualty Group has incurred higher policyholders' dividends. Net Investment Income Net investment income was relatively flat in 1997 compared to 1996, as lower average investment balances resulting from the pay-down of loss reserves from prior accident years primarily related to the commutation program and decreasing premium volume were offset by higher yields associated with the purchase of high grade corporate bonds and asset-backed securities. Net investment income decreased 10.6% in 1996 compared to 1995, primarily due to lower average investment balances. Comparison of SAP and GAAP Results The results presented under SAP are those of the Pooled Companies. Prior to December 31, 1996, the Pooled Companies were comprised of four domestic insurance companies: PMAIC, Manufacturers Alliance Insurance Company, Pennsylvania Manufacturers Indemnity Company and MASCCO. As part of a plan to reduce the amount of indemnity reserves from accident years 1991 and prior in the Pooled Companies, MASCCO was removed from the pooling arrangement effective December 31, 1996, and indemnity reserves from accident years 1991 and prior were transferred to MASCCO. The other significant difference relates to various reinsurance agreements between the Pooled Companies and certain foreign insurance subsidiaries. Prior to December 31, 1996, Chestnut Insurance Company, Ltd. was the reinsurer under these agreements. At December 31, 1996, these reinsurance arrangements were novated, and the assets and liabilities associated with such contracts were sold to PMA Cayman, a foreign affiliate. At December 31, 1997, the Pooled Companies had reinsurance recoverables from MASCCO and PMA Cayman of $96.2 million and $284.9 million, respectively. In addition to the above and the different accounting treatment of acquisition costs (see "PMA Re Results of Operations" for further discussion of SAP to GAAP differences related to acquisition costs), the GAAP results for the Property and Casualty Group include the results of other entities within the Property and Casualty Group, but excluded from the aforementioned pooling agreement, including PMA Life and other affiliated reinsurers and non-insurance companies utilized in providing certain products and services to the Property and Casualty Group's clients. The exclusion of such entities tends to decrease the SAP combined ratio relative to the GAAP combined ratio. - 79 - Corporate and Other The Corporate and Other segment is primarily comprised of corporate overhead and the operations of the Company's properties. Corporate and Other operations reported a pre-tax operating loss of $3.4 million in 1997 compared to a pre-tax operating loss of $500,000 in 1996. The decline in the operating results of Corporate and Other was due primarily to a $2.2 million increase in operating costs related to certain corporate properties disposed of during the third quarter of 1997. No material gain or loss was recorded in connection with the disposal of such properties. In 1995, management determined that the fair market values of the Company's former headquarters building, which was disposed of in 1997, and certain adjacent properties were less than the carrying values plus the costs to carry and sell the properties. The Company recorded a charge of $8.4 million in 1995 to write down these properties to their fair market values less costs to carry and sell the properties. No such charge was recorded during 1996. During 1997, the Company incurred pre-operating charges of approximately $900,000 in establishing Caliber One. The Corporate and Other segment also incurred $1.8 million of severance and related restructuring costs in 1997. Net Realized Investment Gains Net realized investment gains amounted to $8.6 million, $3.0 million and $31.9 million in 1997, 1996 and 1995, respectively. During the three-year period ended December 31, 1997, the Company realized gains from investment sales related to the following: (i) transactions to move holdings between taxable and tax-exempt fixed-maturity investments in order to maximize after-tax yields; (ii) 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; (iii) transactions based upon an assessment of the interest rate environment and the shape of the yield curve and (iv) sales of equity securities, as the Company has substantially reduced its holdings of this asset class over the last three years. 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 future results. 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. As interest rates declined in the latter part of the year, these transactions resulted in a net $8.6 million gain for 1997. During 1996 and 1995, most of the investment sales activity resulted from reducing the Company's holdings of tax-advantaged securities. Based upon an assessment of the Company's position with respect to the alternative minimum tax ("AMT"), the Company reduced its tax-advantaged securities positions beginning in late 1995 and throughout 1996. In 1996, these sales resulted in a net loss of $900,000, compared to 1995 when such transactions resulted in a net gain of $12.1 million. In addition to gains and losses arising from the sales of fixed maturity investments, sales of equity securities generated net realized gains of $3.9 million and $900,000 in 1996 and 1995, respectively. - 80 - Interest Expense and Income Taxes Interest expense decreased $1.3 million in 1997 to $15.8 million from $17.1 million in 1996 due to the refinancing of the Company's debt with the Revolving Credit Facility. See "Liquidity and Capital Resources" below. In 1996, interest expense decreased to $17.1 million from $18.7 million in 1995. Such reduction related to slightly lower average debt balances in 1996. In addition, principal payments on the Company's higher coupon senior notes for which average coupon rate of amounts paid was 9.49% were funded with drawdowns on the Company's Revolving Credit Facility which had an average interest rate of 6.08% in 1996. The Company's effective tax rates were 21.5%, (29.3)% and 30.9% in 1997, 1996 and 1995, respectively. The Company recorded a net deferred tax asset of $70.4 million and $101.6 million in 1997 and 1996, respectively. See "Liquidity and Capital Resources -- Capital Resources." In the normal course of business the Company is examined by various taxing authorities, including the Internal Revenue Service. Federal tax return examinations have been completed for the years 1992 and 1993. The examinations for years 1994 and 1995 are currently in progress. In management's opinion, the ultimate resolution of these matters will not have an adverse impact on the Company's financial position or results of operations . Liquidity and Capital Resources Liquidity 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, the Company requires cash to pay debt obligations, dividends to shareholders and taxes to the federal government, as well as to capitalize subsidiaries from time to time. PMC's primary sources of liquidity are dividends from subsidiaries, net tax payments received from subsidiaries and borrowings. The Company paid interest of $19.8 million, $16.6 million and $15.1 million in 1997, 1996 and 1995, respectively. The Company made scheduled debt repayments in 1997, 1996 and 1995 of $7.3 million, $25.1 million and $125.1 million, respectively, and paid dividends to shareholders of $8.0 million in 1997 and $7.9 million in 1996 and 1995. PMC also made cash capital contributions to its subsidiaries totaling $11.0 million, $50.0 million and $61.0 million in 1997, 1996 and 1995, respectively. In 1995, PMC also utilized cash to settle intercompany balances with its domestic insurance subsidiaries. Dividends from subsidiaries were $22.5 million, $53.6 million and $103.2 million in 1997, 1996 and 1995, respectively. Net tax cash flows were $20.0 million, $12.0 million and $11.4 million in 1997, 1996 and 1995, respectively. In addition to dividends and tax payments from subsidiaries, the Company utilized the following sources to generate liquidity for the above needs. During the first quarter of 1997, the Company made debt repayments of $8.0 million on the revolving credit agreement before refinancing all of its credit agreements not already maturing in 1997 with the Revolving Credit Facility. See "Capital Resources." During 1996, the Company financed scheduled repayments on its senior note facilities of $25.0 million through drawdowns on its revolving credit agreement. - 81 - In 1995, the Company repaid its expiring revolving credit agreement by issuing $107.0 million of 7.62% privately placed senior notes. In addition, in 1995, the Company funded the scheduled debt repayments on its existing senior notes by drawing down $18.0 million on a new $50.0 million revolving credit agreement with a banking syndicate. At December 31, 1997, the Company had $32.0 million available on the Revolving Credit Facility. In addition to the Revolving Credit Facility, the Company maintains a committed facility of $50 million for letters of credit. The Letter of Credit Facility is utilized primarily for securing reinsurance obligations of the Company's insurance subsidiaries. As of December 31, 1997, the Company had $46.9 million outstanding in letters of credit under the Letter of Credit Facility. The Company's domestic insurance subsidiaries' ability to pay dividends to the Company is limited by the insurance laws and regulations of Pennsylvania. Under such laws and regulations, dividends may not be paid without prior approval of the Pennsylvania Insurance Commissioner in excess of the greater of (i) 10% of surplus as regards policyholders as of the end of the preceding year or (ii) SAP net income for the preceding year, but in no event to exceed unassigned funds. Under this standard, the Pooled Companies and PMA Reinsurance Corporation can pay an aggregate of $48.7 million of dividends during 1998 without the prior approval of the Pennsylvania Insurance Commissioner. Caliber One Indemnity Company had an unassigned deficit of $6.4 million as of December 31, 1997, and, therefore, cannot pay non-extraordinary dividends; also, PMA Reinsurance Corporation owns Caliber One Indemnity Company, and, as such, its dividends may not be paid directly to PMC. Under its plan of operation filed with the Pennsylvania Insurance Department, MASCCO must maintain a ratio of unpaid losses and LAE to surplus of no more than eight to one; as of December 31, 1997, MASCCO was in compliance with such requirement. The Credit Facilities also contain limitations on the ability of the Company's insurance subsidiaries to pay dividends. The Credit Facilities require the Company's insurance subsidiaries to maintain combined statutory capital and surplus of $450.0 million. At December 31, 1997, the Company's insurance subsidiaries had combined statutory capital and surplus of $552.2 million. In addition, the Credit Facilities require that the Pooled Companies maintain an adjusted surplus to authorized control level ratio, as calculated under risk-based capital rules, of not less than 220% as of December 31, 1997, 230% as of December 31, 1998 and 240% as of December 31, 1999 and thereafter, and requires that PMA Reinsurance Corporation maintain such ratio at 300%. At December 31, 1997, the ratios of the Pooled Companies ranged from 293% to 324%, PMA Reinsurance Corporation's ratio was 355% and Caliber One Indemnity Company's ratio was 1,922%. In December 1997, PMA Reinsurance Corporation acquired 100% of the outstanding common stock of Caliber One Indemnity Company (formerly known as Lincoln Insurance Company) for approximately $16.0 million and made a capital contribution of $11.3 million to Caliber One Indemnity Company. Immediately prior to and in conjunction with this purchase, all of Caliber One Indemnity Company's acquired loss reserves were reinsured by an affiliate of Caliber One Indemnity Company's former parent for adverse development and uncollectible reinsurance in the amount of the stated reserves plus $68.5 million. See Note 1 to the Consolidated Financial Statements and "Business--Loss Reserves." Management believes that the reinsurance obtained as part of the purchase will be adequate to cover any future adverse reserve development or uncollectible reinsurance on the acquired - 82 - reserves. PMA Re intends to maintain Caliber One Indemnity Company's surplus at not less than $25.0 million, the minimum capital and surplus required by many states in order to be an eligible surplus lines carrier. PMC's dividends to shareholders are restricted by its debt agreements. Based upon the terms of the Revolving Credit Facility, on a pro forma basis, under the most restrictive debt covenant, PMC would be able to pay dividends of approximately $14.5 million in 1998. See "Liquidity and Capital Resources -- Capital Resources." Management believes that the Company's sources of funds will provide sufficient liquidity to meet short-term and long-term obligations. Capital Resources The Company's total assets decreased to $3,057.3 million at December 31, 1997 from $3,117.5 million at December 31, 1996. Total investments decreased $66.6 million to $2,194.7 million at December 31, 1997. The decrease in investments is primarily attributable to the Property and Casualty Group's pay- down of loss reserves from prior accident years as part of the formal commutation program that was initiated in the fourth quarter of 1996 and continued into late 1997. All other assets increased $6.4 million in 1997, mainly due to increases in reinsurance recoverables of $74.4 million and cash of $25.0 million. The reinsurance recoverables increase primarily relates to the purchase of Caliber One Indemnity Company during 1997 and the PMA Life transaction, which included approximately $32.7 million and $15.4 million, respectively, of ceded loss reserves. The increase in cash relates to investment security purchases that did not settle until January 1, 1998, causing a large cash balance at year-end. The above asset increases were partially offset by a $33.6 million decrease in uncollected premiums primarily related to the reduction in accrued retrospective premiums by the Property and Casualty Group, a $31.2 million decrease in deferred income taxes and a $12.2 million decrease in fixed assets primarily related to the disposal of certain corporate properties during the third quarter of 1997. No material gain or loss was recorded in connection with the disposal of such properties. The Company's deferred income tax asset decreased to $70.4 million at December 31, 1997 from $101.6 million at December 31, 1996. The $31.2 million decrease from 1996 to 1997 resulted primarily from the $23.5 million charge related to the fair value of Company's investments that is recorded as a component of the deferred tax asset. The net deferred tax asset of $70.4 million reflects management's estimate of the amounts that the Company expects to recover in future years primarily through the utilization of net operating losses and AMT credit carryforwards. Under SFAS No. 109, a valuation allowance should be provided to offset the effects of a deferred tax asset if management believes that it is more likely than not that the benefit of a deferred tax item will not be realized. Management believes that the benefit of its deferred tax asset will be fully realized, and therefore has not provided for a valuation allowance. At December 31, 1997, the Company had approximately $109.6 million of net operating carryforwards (expiring in 2011), approximately $7.5 million of AMT credit carryforwards (which do not expire) and approximately $188,000 of general business credit carryforwards (expiring in 2010 and 2011). - 83 - Unpaid losses and LAE decreased $87.9 million to $2,003.2 million at December 31, 1997. This decrease reflects the Property and Casualty Group's pay-down of loss reserves from prior accident years as part of the formal commutation program which was initiated in the fourth quarter of 1996 and continued into late 1997, partially offset by loss reserves acquired in connection with the purchase of Caliber One Indemnity Company. Estimating future claims costs is necessarily a complex and judgmental process inasmuch as reserve amounts are based on management's informed estimates and judgments using data currently available. As such, management reviews a variety of information, and uses a number of actuarial methods applied to historical claims data, which often produces a range of possible results. As additional experience and other data are reviewed, these estimates and judgments are revised, at which point reserves may be increased or decreased accordingly. Such increases or decreases are reflected in operating results for the time period in which the adjustments are made. While the estimate for unpaid losses and LAE is subject to many uncertainties, management believes that it has made adequate provision for the Company's claims liabilities. However, if actual losses exceed the amounts recorded in the Company's financial statements, the Company's financial condition and results of operations could be adversely affected. At December 31, 1997, the Company's loss reserves were stated net of $59.9 million of salvage and subrogation. $50.8 million of salvage and subrogation related to the Property and Casualty Group, $46.0 million of which related to workers' compensation and $4.8 million related to Commercial Lines. The anticipated salvage and subrogation was $9.1 million for PMA Re. Incurred salvage and subrogation (increased) reduced losses and LAE by ($18.5) million, ($0.6) million and $9.5 million in 1997, 1996 and 1995, respectively. 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 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 historic paid data implicitly considers realization and collectibility. The Company actively manages its exposure to catastrophic events. In the underwriting process, the Company generally minimizes the writing 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 $46.0 million excess of $2.0 million per occurrence, and the Property and Casualty Group maintains catastrophe reinsurance protection of $27.7 million excess of $850,000. As a result, the Company's loss ratios have not been significantly impacted by catastrophes, and management believes that the Company has adequate reinsurance to protect against the estimated probable maximum gross loss from a catastrophic event; however, although management believes it is unlikely, an especially severe catastrophic event could exceed the Company's reinsurance and retrocessional protection, and materially adversely impact the Company's financial position. - 84 - The Company also maintains reinsurance and retrocessional protection for other lines of business at December 31, 1997 as follows: Retention Limits ---------------- -------------- The Property and Casualty Group: Per Occurrence: Workers' compensation......... $ 1.5 million $ 103.5 million Per Risk: Property lines................ $ 0.5 million(1) $ 19.5 million Auto physical damage.......... $ 0.5 million $ 2.0 million Other casualty lines.......... $ 0.2 million(2) $ 4.8 million PMA Re:........................... Per Occurrence: Casualty lines................ $ 2.8 million $ 12.5 million Workers' compensation......... $ 2.0 million $ 53.0 million Property lines................ $ 2.0 million $ 48.0 million Per Risk: Property lines................ $ 0.8 million $ 4.2 million Casualty lines................ $ 1.5 million $ 6.0 million - ---------------- (1) This coverage also provides protection of $48.5 million per occurrence over its combined net retention of $0.5 million. (2) This coverage also provides protection of $49.8 million per occurrence over its combined net retention of $0.2 million. PMA Re also maintains aggregate protection up to $22.3 million in excess of $178.0 million for the current accident year. Effective January 1, 1998, PMA Re added a new workers' compensation program which includes coverage of $98.0 million excess of $2.0 million per occurrence, $98.5 million excess of $1.5 million per program per occurrence and $18.5 million excess of $1.5 million per person per occurrence. 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 to support balances due from reinsurers not authorized to transact business in the applicable jurisdictions. At December 31, 1997, the Company had reinsurance recoverables due from the following unaffiliated single reinsurers in excess of 3% of shareholders' equity: (dollar amounts in thousands) Gross amount A.M. Best due to the Company Rating ------------------- --------- Reinsurer - --------- United States Fidelity and Guaranty Company..... $74,041 A Essex Insurance Company......................... $36,807 A American Re-Insurance Corporation............... $35,411 A+ - 85 - Kemper Reinsurance Corporation.................. $21,853 A London Life International Reinsurance Corporation.................................... $16,212 A+ Continental Casualty Company.................... $15,209 A The Company maintained funds held to collateralize the above balances in the amount of $66.2 million at December 31, 1997. The Company believes that it would have the right to offset the funds withheld from a reinsurer against the balances due from such reinsurer in the event of insolvency. Funds held under reinsurance treaties decreased $17.3 million in 1997, primarily due to the commutation of a prior underwriting year for one of the reinsurance covers at the Property and Casualty Group as well as one of the retrocessional covers at PMA Re, partially offset by retrocessional activity at PMA Re for the current underwriting year. Long-term debt remained essentially constant between 1997 and 1996. As noted previously, management refinanced the Company's existing credit agreements on March 14, 1997 under the Revolving Credit Facility, replacing the following debt that was outstanding at that time: (dollar amounts in thousands) Senior notes 9.60%, due 2001.................. $ 46,428 Senior notes 7.62%, due 2001, Series A........ 71,000 Senior notes 7.62%, due 2000, Series B........ 36,000 Revolving credit agreement, expiring in 1998.. 36,000 -------- Total......................................... $189,428 ======== The early extinguishment of the senior note agreements resulted in an extraordinary loss of $4.7 million ($7.3 million pre-tax) which was recorded in the first quarter of 1997. The Revolving Credit Facility bears interest at LIBOR plus 0.70% on the utilized portion and carries a 0.275% facility fee on the unutilized portion. The margin over LIBOR is adjustable downward based upon future reductions in the Company's debt to capitalization ratio. As of December 31, 1997, the interest rate on the Revolving Credit Facility was 6.61% on the utilized portion. The final expiration of the Revolving Credit Facility will be December 31, 2002, maturing in an installment of $15.5 million in 1999 and annual installments of $62.5 million commencing in 2000 through 2002. Management also entered into an interest rate swap agreement that manages the impact of the potential volatility of the interest rate associated with the floating rates on the Revolving Credit Facility. The interest rate swap covers a notional principal amount of $150.0 million and effectively converts the floating rate on such portion of the Revolving Credit Facility to a fixed 7.24%. Other liabilities, including taxes, licenses and fees, decreased $9.1 million in 1997 to $81.5 million compared to 1996 primarily due to lower operating expenses at the Property and Casualty Group during 1997. Consolidated shareholders' equity at December 31, 1997 totaled $478.3 million, or $19.96 per share, compared to $425.8 million, or $17.86 per share, at December 31, 1996. As a result of changes in market interest rates, the unrealized appreciation of investments, net of tax, was $18.8 million at December 31, 1997 compared to an unrealized depreciation of investments, net of tax, of $24.9 million at December 31, 1996, resulting in an increase in shareholders' - 86 - equity of $43.7 million, or $1.82 per share. Consolidated shareholders' equity decreased to $425.8 million, or $17.86 per share, at December 31, 1996, from $609.7 million, or $25.53 per share, at December 31, 1995. This decrease was due primarily to the net loss of $135.3 million in 1996, a decrease in shareholders' equity of $42.4 million, net of tax, or $1.78 per share, related to unrealized depreciation of investments and dividends declared of $7.9 million. At December 31, 1997, the Company's capital structure consisted of $203.0 million of long-term debt and $478.3 million of shareholders' equity. The Company utilizes long-term debt in its capital structure to fund internal expansion through capital contributions to subsidiaries, to pursue investment opportunities and to refinance existing debt. Due to the inherent risks associated with the insurance industry, management strives to maintain a relatively conservative capital structure. Management believes that a certain amount of debt is necessary in order to enhance returns on shareholders' equity; however, the level of debt must be appropriate in terms of the availability of dividends from subsidiaries, operating income and the overall capital structure. In determining the appropriate level of long-term debt, management focuses on the following statistics: statutory dividends to interest expense, earnings (loss) before interest and taxes to interest expense, pre-tax operating income (loss) before interest to interest expenses and debt to capitalization ratio. The following table indicates the Company's status with respect to these statistics: 1997 1996 1995 ----- ------ ----- Statutory dividends to interest expense (times)........ 1.4 3.1 3.8 Earnings (loss) before interest and taxes to interest expense (times)...................................... 2.6 (10.2)(1) 2.9 Pre-tax operating income (loss) before interest to interest expense (times)............................. 2.0 (10.4)(1) 1.2 Debt to total capitalization (excluding SFAS No. 115 adjustment).......................................... 30.6% 31.2% 25.6% (1) Relates to the loss before interest and taxes and the pre-tax operating loss of $191.4 million and $194.4 million, respectively, in 1996. Investments The Company's investment policy objectives are to (i) seek competitive after-tax income and total return, (ii) maintain very high-grade asset quality and 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 has established strategies, asset quality standards, asset allocations and other relevant criteria for its fixed maturity and equity portfolios. In addition, maturities are structured after projecting liability cash flows with actuarial models. The Company also does not invest in various types of investments, including speculative derivatives. 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's Board of Directors is responsible for the Company's investment policy 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 - 87 - 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 Re 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 the State of Delaware. The Company's capital not allocated to the Pooled Companies, MASCCO, PMA Re and Caliber One Indemnity Company may be invested in securities and other investments that are not subject to such insurance laws, but nonetheless conform to the Company's investment policy. The following table summarizes the Company's investments by carrying value as of June 30, 1998 and as of December 31, 1997 and 1996: (dollar amounts in millions)
June 30, December 31, ------------------ --------------------------------------- 1998 1997 1996 ------------------ ------------------ ------------------ Carrying Carrying Carrying Value(1) Percent Value(1) Percent Value(1) Percent -------- ------- -------- ------- -------- ------- Investment - ---------- U.S. Treasury securities and obligations of U.S. Government agencies........................... $1,007.4 46.7% $1,119.5 51.0% $1,602.8 70.8% Obligations of states and political subdivisions....................... 16.5 0.8% --- -- 76.5 3.4% Corporate debt securities............ 805.4 37.3% 687.7 31.3% 372.8 16.5% Mortgage backed securities........... 166.4 7.7% 122.3 5.6% 74.0 3.3% Equity securities.................... --- -- --- -- 0.3 -- Short-term investments............... 163.6 7.5% 265.2 12.1% 135.0 6.0% -------- ----- -------- ----- -------- ----- Total................................ $2,159.3 100.0% $2,194.7 100.0% $2,261.4 100.0% ======== ===== ======== ===== ======== ===== - ------------
(1) Carrying value is equal to market value for all periods presented. The Company has no investments which are not dollar denominated as of June 30, 1998. The following table indicates the composition of the Company's fixed maturities portfolio at carrying value, excluding short-term investments, by rating as of June 30, 1998 and as of December 31, 1997 and 1996: - 88 - (dollar amounts in millions)
June 30, December 31, ------------------ ---------------------------------------- 1998 1997 1996 ------------------ ------------------- ------------------- Carrying Carrying Carrying Value(2) Percent Value(2) Percent Value(2) Percent -------- -------- -------- -------- ------- ---------- Ratings(1) - ---------- U.S. Treasury securities and AAA.. $1,480.6 74.2% $1,449.0 75.1 $1,882.4 88.5% AA................................ 147.5 7.4% 150.0 7.8% 95.8 4.5% A................................. 224.7 11.2% 282.2 14.6% 147.9 7.0% BBB............................... 142.9 7.2% 48.3 2.5% --- -- -------- ----- -------- ----- -------- ----- Total............................. $1,995.7 100.0% $1,929.5 100.0% $2,126.1 100.0% ======== ===== ======== ===== ======== ===== - -----------
(1) Ratings as assigned by Standard & Poor's. Such ratings are generally assigned at the issuance of the securities, subject to revision on the basis of ongoing evaluations. Ratings in the table are as of December 31 of the years indicated. (2) Carrying value is equal to market value. The following table sets forth scheduled maturities for the Company's investments in fixed maturities, excluding short-term investments, based on stated maturity dates as of June 30, 1998. Expected maturities will differ from contractual maturities because the issuers may have the right to call or prepay obligations with or without call or prepayment penalties: (dollar amounts in millions) Carrying Value(1) Percent -------------- -------- 1 year or less $ 140.9 7.0% Over 1 year through 5 years 659.6 33.1% Over 5 years through 10 years 323.1 16.2% Over 10 years through 20 years 209.5 10.5% Over 20 years 496.1 24.9% Mortgage backed securities 166.5 8.3% -------- ----- Total $1,995.7 100.0% ======== ===== ______________ (1) Carrying value is equal to market value. The following table reflects the Company's investment results for the six months ended June 30, 1998 and for each year in the three-year period ended December 31, 1997: (dollar amounts in millions) Six Months Ended Year Ended December 31, June 30, ------------------------------------- 1998 1997 1996 1995 ---------- ---------- ------------ ----------- Average invested assets(1).. $2,177.0 $2,247.7 $2,366.8 $2,395.8 Net investment income(2).... $ 65.2 $ 136.7 $ 133.9 $ 139.4 Net effective yield(3)...... 5.99% 6.09% 5.66% 5.82% Net realized investment gains(4)................... $ 13.7 $ 8.6 $ 3.0 $ 31.9 - ------------- - 89 - (1) Average of beginning and ending amounts of cash and investments for the period at carrying value (market value). (2) After investment expenses, excluding net realized investment gains. (3) Net investment income for the period divided by average invested assets for the same period. The net effective yield for the six months ended June 30, 1998 has been annualized. (4) Excludes loss on sale of PMA Cayman of $2.4 million. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." As of June 30, 1998 and December 31, 1997, respectively, the effective duration of the Company's investments was approximately 5.4 years and 5.3 years and the effective duration of its liabilities was approximately 4.9 years and 5.1 years. During 1997, the Company established a securities lending program through which securities are loaned 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 loaned 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. In addition, the Company limits securities lending to 40% of statutory admitted assets of its insurance subsidiaries, with a 2% limit on statutory 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. In the six-month period ended June 30, 1998 and the year ended December 31, 1997, respectively, the Company recognized income from securities lending transactions of approximately $406,000 and $524,000, net of lending fees, which was included in investment income. The Company had approximately $632.9 million and $175.0 million, respectively, of securities on loan as of June 30, 1998 and December 31, 1997. - 90 - BUSINESS Company Overview The Company is an insurance holding company, whose subsidiaries operate in three distinct segments of the property and casualty insurance industry: (i) reinsurance, through PMA Re, which commenced business in 1980; (ii) standard commercial lines of insurance, with an emphasis on workers' compensation through the Property and Casualty Group, which has been in business since 1915 and (iii) specialty insurance products, focusing on excess and surplus lines, through the Company's recently-formed operation, Caliber One. PMA Re writes a broad range of property and casualty reinsurance products with an emphasis on risk-exposed casualty excess of loss reinsurance and operates in the United States domestic brokered market. The Property and Casualty Group offers a broad range of standard commercial lines, including commercial general liability, commercial automobile and commercial multi-peril, with an emphasis on workers' compensation products and services primarily in nine contiguous jurisdictions in the Mid- Atlantic and Southern regions of the United States, utilizing the PMA Group trade name. In 1998, Caliber One commenced writing excess and surplus lines of property and casualty insurance, including commercial general liability, automobile and certain property exposures on a non-admitted basis. For the six months ended June 30, 1998, the Company's net premiums written of $257.0 million were derived 45.9% from PMA Re, 53.8% from the Property and Casualty Group and 0.3% from Caliber One. Net income for the Company for the six months ended June 30, 1998 and the year ended December 31, 1997 was $21.4 million and $15.0 million, respectively. As of June 30, 1998, the Company had total assets of $3,075.4 million and shareholders' equity of $496.4 million. The Company's insurance subsidiaries have the following ratings from A.M. Best: PMA Reinsurance Corporation, A+ ("Superior"); the Pooled Companies, A- ("Excellent") and Caliber One Indemnity Company, A ("Excellent"). Management believes that ratings from A.M. Best are material to its operations and that a downgrade from the present rating classifications could have an adverse effect on the Company's ability to market its products. A.M. Best's ratings are based upon an assessment of an insurance company's perceived financial strength regarding its ability to pay obligations to its policyholders and are not directed toward the protection of investors. After a period of rapid growth in the late 1980's, the Company's consolidated total net premiums written declined from $552.0 million in 1992 to $418.3 million in 1997. Since 1993, PMA Re's premium volume expanded as a result of the increased demand for reinsurance in the markets in which PMA Re participates as well as trends towards ceding companies restricting the number of reinsurers with which they will do business. PMA Re has also obtained additional business as a result of a target marketing program commenced in 1996 as well as from business displaced in the recent consolidation of the United States reinsurance industry. Those trends have facilitated PMA Re's increased participation on reinsurance treaties with its existing clients, the writing of additional layers and programs with existing clients, and to a lesser extent, the addition of business from new ceding companies. During this period, the market for the products written by the Property and Casualty Group was very competitive. The Property and Casualty Group restricted its premium volume, rather than write business at rates that were not commensurate with the risks assumed, and introduced loss-sensitive coverages and large-deductible programs, under which insureds pay less - 91 - premium but bear a greater portion of loss exposure. Beginning in 1992, premiums written were also reduced as a result of the Property and Casualty Group's re- underwriting of its book of business and, commencing in 1993, rate reductions associated with workers' compensation benefit reform laws. Management believes that recent initiatives undertaken and workers' compensation reforms enacted in recent years, including the restructuring and the loss reserve strengthening of $257.9 million in 1995 and 1996, afford the Property and Casualty Group an opportunity to increase its core business, workers' compensation insurance, on terms acceptable to it. See "The Property and Casualty Group--Background and Recent Developments" below. In 1996, the Company restructured the Property and Casualty Group with the goal of restoring its profitability after three years of operating losses. The losses resulted primarily from unfavorable underwriting experience and adverse reserve development related to accident years 1987 through 1991, when the Property and Casualty Group wrote a much higher volume of business than its current volume. The principal components of the restructuring were: (i) strengthening loss reserves; (ii) initiating a commutation program to settle a significant number of open claims from the 1987 to 1991 period; (iii) designating PMA Cayman and MASCCO as separate run-off companies to alleviate the SAP impact on the Pooled Companies of the loss reserve strengthening and to manage the capital deployed in running off pre-1992 workers' compensation claims; (iv) initiating an expense reduction program and (v) implementing management changes, including the appointment of a new Chief Operating Officer and the creation of the position of Chief Underwriting Officer. In June 1998, the Company entered into a letter of intent to sell PMA Cayman. Largely as a result of the restructuring, the Property and Casualty Group recorded pre-tax operating income of $5.4 million for the six months ended June 30, 1998, compared to pre-tax operating losses of $5.9 million for the six months ended June 30, 1997 and $3.7 million, $215.7 million (including restructuring and other special charges of $223.1 million) and $3.9 million for the years ended December 31, 1997, 1996 and 1995, respectively. The composition of the Company's net premiums written for the six months ended June 30, 1998 and the year ended December 31, 1997 was as follows: (dollar amounts in thousands) Six Months Ended Year Ended June 30, 1998 December 31, 1997 ----------------------- ------------------------- Net Net premiums % of premiums % of written total written total ------- ----- ------- ----- PMA Re..................... $117,908 45.9% $177,934 42.5% The Property and Casualty Group: Workers' compensation.... 106,952 41.6% 175,301 41.9% Other commercial lines... 31,432 12.2% 65,047 15.6% -------- ----- -------- ----- Total.................... 138,384 53.8% 240,348 57.5% -------- ----- -------- ----- Caliber One................ 917 0.3% -- -- Eliminations............... (171) -- -- -- -------- ----- -------- ----- Total...................... $257,038 100.0% $418,282 100.0% ======== ===== ======== ===== - 92 - PMA Re Background According to data provided by the RAA, as of June 30, 1998, PMA Reinsurance Corporation was the 24th largest reinsurer in the United States in terms of statutory capital and surplus and 17th largest in terms of net premiums written. PMA Re writes a broad range of property and casualty reinsurance products with an emphasis on risk-exposed casualty excess of loss reinsurance within the United States domestic brokered market. Management believes that PMA Re competes on the basis of its ability to offer prompt and responsive service and specialized products to its clients and its excellent long-term relationships in the broker and ceding company communities. In the brokered 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 is typically based upon a percentage of the premiums ceded under a particular contract. The brokered reinsurance market differs from the direct reinsurance market in which reinsurers maintain their own sales forces and distribute their products directly to their ceding company clients. During the five-year period ended December 31, 1997, PMA Re has expanded its premium base without changing its underwriting standards. From 1992 to 1997, PMA Re reported premium volume growth that exceeded that of the overall reinsurance industry. During such period, PMA Re's compound annual growth rate for net premiums written was 13.2%, while it is estimated that the reinsurance industry's compound annual growth rate was 8.2% for the same period based upon information published by the RAA. PMA Re's premium volume increases have largely taken the form of increased participation levels on clients' existing programs, as well as writing of additional layers and programs with current clients. To a lesser extent, volume growth has been attributable to business written with new ceding company clients. Management believes that the expansion of PMA Re's premium base has been attributable to several factors. First, PMA Re's volume was impacted by industry trends between 1992 and 1995 that tended to increase the demand for reinsurance. Specifically, much of the growth that occurred in the primary insurance market in those years was attributable to regional and niche companies. Typically, these companies demand more reinsurance than their larger counterparts. Second, management believes that PMA Re has benefited from the greater selectivity of ceding companies that have restricted the number of reinsurers with which they will transact business. In addition, commencing in 1996, PMA Re initiated a target marketing program, under which certain existing accounts and new accounts identified as having certain desirable characteristics (such as quality management and underwriting) were pursued for additional or new business. Finally, PMA Re has been able to write business for customers that was formerly written by reinsurers in the brokered market that have been acquired by other reinsurers. These factors have more than offset the recent trends in 1996 and 1997 of ceding companies retaining more of their business and highly competitive conditions, which caused PMA Re to non-renew certain accounts amounting to $68.2 million of in- - 93 - force premium in the 18 months ended June 30, 1998 and not accept certain new business opportunities for underwriting or pricing reasons. Reinsurance Products The following table indicates PMA Re's gross and net premiums written by major category of business:
(dollar amounts in thousands) Six Months Ended June 30, Year Ended December 31, ------------------ ---------------------------------------------- 1998 1997 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- ---- ---- Gross premiums written(1) Casualty................. $102,608 $ 83,289 $151,901 $143,991 $128,736 $107,001 $ 94,482 Property................. 41,313 36,916 72,625 63,325 63,693 36,592 28,217 Other.................... 501 501 795 842 (63) 837 1,854 -------- -------- -------- -------- -------- -------- -------- Total.................... $144,422 $120,706 $225,321 $208,158 $192,366 $144,430 $124,553 ======== ======== ======== ======== ======== ======== ======== Net premiums written(2) Casualty................. $ 83,535 $ 68,286 $118,889 $122,008 $107,383 $ 88,585 $ 82,016 Property................. 33,849 27,501 58,257 41,240 45,440 23,929 18,407 Other.................... 524 492 788 805 (63) 837 1,854 -------- -------- -------- -------- -------- -------- -------- Total...................... $117,908 $ 96,279 $177,934 $164,053 $152,760 $113,351 $102,277 ======== ======== ======== ======== ======== ======== ======== - --------------------
(1) For the six months ended June 30, 1998, gross premiums written include $3.4 million of facultative reinsurance comprised of $1.5 million of property and $1.9 million of casualty. For the six months ended June 30, 1997, gross premiums written include $2.7 million of facultative reinsurance comprised of $1.1 million of property and $1.6 million of casualty. For the years ended December 31, 1997 and 1996, gross premiums written include $5.8 million and $3.5 million of facultative reinsurance, respectively, comprised of the following: property, $2.4 million and $1.1 million, respectively; casualty, $3.4 million and $2.3 million, respectively, and other lines, $100,000 in 1996. (2) For the six months ended June 30, 1998, net premiums written include $1.2 million of facultative reinsurance comprised of $700,000 of property and $500,000 of casualty. For the six months ended June 30, 1997, net premiums written include $700,000 of facultative reinsurance comprised of $300,000 of property and $400,000 of casualty. In 1997 and 1996, net premiums written include $2.5 million and $1.0 million of facultative reinsurance, respectively, comprised of the following: property, $1.7 million and $500,000, respectively; casualty, $800,000 and $500,000, respectively, and other lines, less than $0.1 million in 1996. Casualty Business Casualty business accounted for 70.8% and 66.8% of net premiums written for the six months ended June 30, 1998 and the year ended December 31, 1997, respectively. In the five-year period ended December 31, 1997, casualty business has increased at a compound - 94 - annual growth rate of 7.2%. The following table indicates the mix of casualty business by class on the basis of net premiums written: (dollar amounts in thousands)
Six Months Ended June 30, Year Ended December 31, ---------------- ----------------------------------------------- 1998 1997 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- ---- ---- Umbrella.................. $13,777 $21,692 $ 30,967 $ 40,307 $ 51,558 $38,743 $34,189 Errors and Omissions...... 11,781 10,557 13,813 19,866 7,149 7,281 4,033 General Liability......... 12,072 5,597 15,174 11,702 7,460 8,936 8,665 Medical Malpractice....... 6,369 3,899 7,373 7,411 6,835 6,355 6,657 Directors' and Officers'.. 3,385 3,363 5,897 6,210 4,586 4,156 1,815 Miscellaneous Liability... 15,441 7,019 16,431 12,811 10,350 6,006 3,690 Auto Liability............ 16,992 11,313 22,268 17,056 13,032 10,134 12,616 Workers' Compensation..... 3,718 4,846 6,966 6,645 6,412 6,974 10,351 ------- ------- -------- -------- -------- ------- ------- Total..................... $83,535 $68,286 $118,889 $122,008 $107,382 $88,585 $82,016 ======= ======= ======== ======== ======== ======= =======
Due to the competitive conditions in the casualty market, management has maintained a relatively conservative growth posture for casualty business in the five-year period. PMA Re has generally focused on other liability coverages (which include general liability, products liability, professional liability and other more specialized liability coverages), while maintaining a relatively stable level of auto liability premiums and de-emphasizing workers' compensation coverages. In 1998, casualty premiums increased primarily as a result of the addition of certain large general liability and auto liability programs. The decrease in 1997 casualty net premiums was primarily attributable to increased retrocessional protection purchased which offset increases in gross casualty premiums relating to new business with existing clients and larger lines taken on existing programs. In 1998, 1997, 1996 and 1995, PMA Re decreased the amount of its excess and umbrella business as rates and terms for this type of business were no longer as attractive as they had been. Much of the growth in 1995 and 1996 related to the expansion and addition of several programs covering specialty business (which includes professional liability, directors' and officers' liability, environmental impairment liability, employment practices liability and other miscellaneous specialized coverages). Such specialty business now accounts for approximately 53.1% of in-force casualty treaty business. In 1994, the growth in other liability was primarily attributable to excess and umbrella business as PMA Re added several significant programs. Property Business Property business accounted for 28.7% and 32.7% of net premiums written for the six months ended June 30, 1998 and the year ended December 31, 1997, respectively. In the five-year period ended December 31, 1997, property business has increased at a compound annual growth rate of 40.4%. The increases in net property premiums written have been primarily the result of additional property underwriting expertise that PMA Re added to its underwriting staff in late 1996 to broaden its product offerings. Such expertise enabled PMA Re to increase cross-selling opportunities with its existing treaty reinsurance clients by offering additional and expanded property coverages. In addition, property premiums ceded decreased primarily related to changes in PMA Re's property retrocessional coverages in terms of premiums and ceding commissions. The decrease in net premiums written in 1996 was primarily attributable to higher ceding company retentions, competitive - 95 - pricing conditions and higher ceded property premiums. The growth in net property business in 1995 and 1994, of 89.9% and 30.0%, respectively, was attributable to the expansion of several programs covering auto physical damage, inland marine risks and certain specialty property coverages written on a surplus lines basis. PMA Re has generally de-emphasized catastrophe coverages. As of June 30, 1998 and December 31, 1997, catastrophe business accounted for approximately 4.7% and 4.0%, respectively, of property premiums in force. The property programs written by PMA Re generally contain per occurrence limits or are not considered significantly catastrophe exposed, 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 catastrophic events due to the aggregation of per occurrence limits and similar issues. PMA Re actively manages this exposure through aggregate management, minimizing writings of catastrophe business and retrocessional protection. As of June 30, 1998, PMA Re maintained catastrophe retrocessional protection of $48 million excess of $2 million. Management believes that PMA Re's catastrophe retrocessional coverage is adequate to protect PMA Re against its probable maximum loss from a significant catastrophe; however, an especially severe catastrophic event could exceed PMA Re's retrocessional protection and materially and adversely affect the Company's financial position and results of operations. See "Risk Factors--Certain Risks Affecting the Property and Casualty Industry," "Underwriting" and "The Company's Reinsurance Ceded." Facultative Reinsurance 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. Facultative reinsurance differs from treaty reinsurance in that treaty reinsurance typically covers multiple risks within a particular classification, the reinsurer does not retain the right to accept or reject individual risks as long as such risks conform to the contract stipulations, and the ceding company is obligated to cede the risks to the reinsurer. Companies typically purchase facultative reinsurance for several reasons, including to (i) cover unusual risks; (ii) cover high hazard risks; (iii) protect a ceding company's net retention and treaty reinsurers; (iv) obtain additional capacity beyond that provided by a company's treaty reinsurers; (v) cover risks excluded under a company's treaties and (vi) cover risks under a company's new line of business. There are some facultative products that are variations of the above general concept, such as automatic and semi-automatic facultative contracts. Under automatic facultative arrangements (sometimes known as facultative obligatory treaties), the cession is not obligatory from the ceding company's point of view, but the acceptance of the risk is automatic from the reinsurer's standpoint. For semi-automatic facultative contracts, the cession is not obligatory, but the acceptance of the risk is obligatory, unless the risk falls outside certain stipulated criteria. If the risk falls outside such criteria, the reinsurer has the option of either: (i) accepting the risk, (ii) declining the risk or (iii) repricing the risk. - 96 - For the six months ended June 30, 1998, PMA Re recorded $1.2 million of net facultative reinsurance premiums that represented 1.0% of total net premiums written. For the year ended December 31, 1997, PMA Re recorded $2.5 million of net facultative reinsurance premiums which represented 1.4% of total net premiums written for the year, compared to $1.0 million, or 0.6%, for the year ended December 31, 1996. PMA Re offers facultative products as a complement to existing treaty business, as well as offering such products to companies with whom PMA Re does not presently have a relationship. The products offered include traditional facultative certificates and automatic or semi-automatic programs for both property and casualty exposures. Marketing and Distribution PMA Re operates primarily through the domestic brokered reinsurance market in which it has developed relationships with major reinsurance brokers enabling it to gain access to a wide range of ceding companies with varying reinsurance and related service needs. Brokers that accounted for more than 7% of PMA Re's gross premiums in force were as follows: (dollar amounts in thousands) June 30, 1998 December 31, 1997 --------------------- -------------------- Gross Gross Premiums Percentage Premiums Percentage in Force of Total in Force of Total -------- -------- -------- -------- Aon Reinsurance.......... $107,855 38.6% $99,151 35.7% Guy Carpenter & Company.. 62,660 22.4% 64,803 23.3% E. W. Blanch............. 38,121 13.6% 38,267 13.8% Sedgwick Payne Company... 29,285 10.5% 27,322 9.8% Towers Perrin Re......... 20,029 7.2% 22,669 8.2% The above brokers are among the largest brokers in the reinsurance industry. Beginning in 1996, PMA Re began a target marketing program designed to identify companies in the smaller and medium company segments with whom PMA Re presently has either no or an insignificant relationship, but meet desired risk profiles. After such identification, marketing and underwriting personnel work with the ceding company's broker to enable PMA Re to have an opportunity to participate in the reinsurance coverage. As of June 30, 1998, PMA Re had approximately 212 clients, with no individual client accounting for more than 6.5% of gross premiums in force . Underwriting In reinsurance, underwriting involves the selection of risks and determining whether the market pricing is adequate given expected losses and estimated volatility of such losses. Given the present soft-pricing environment, maintaining underwriting discipline is more difficult and more critical to the maintenance of acceptable results of operations. PMA Re's underwriting management averages 21 years in the property and casualty industry. - 97 - PMA Re's underwriting process has two principal aspects: underwriting the specific program to be reinsured and underwriting the ceding company. Underwriting the specific program to be reinsured involves, in addition to pricing, a review of the type of program, 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 generally conducts 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. In underwriting excess-of-loss business, PMA Re has typically sought to write treaties that are exposed to loss on a per occurrence basis within the original policy limits of the ceding company. Management believes these layers in general lend themselves more effectively to actuarial pricing techniques. 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 weigh the results of the pricing models with the terms and conditions being offered to determine PMA Re's selected price. As noted above, PMA Re typically requires per occurrence limits for property coverages and requires that the underlying insured values not be catastrophe exposed. Also, PMA Re minimizes catastrophe reinsurance coverages and has historically maintained sufficient retrocessional protection. Recent natural catastrophes did not have a significant adverse impact on PMA Re's combined ratio and earnings inasmuch as PMA Re has minimized assuming catastrophe reinsurance business or catastrophe-exposed coverages and it has had sufficient retrocessional arrangements. The following table indicates PMA Re's gross, ceded and net losses from recent catastrophes as of December 31, 1997: (dollar amounts in thousands)
Industry Incurred PMA Re PMA Re PMA Re Catastrophe Year Loss(1) Gross Loss Ceded Loss Net Loss - ----------- ---- -------- ---------- ---------- -------- Hurricane Hugo............. 1989 $ 4,200,000 $13,200 $11,400 $1,800 San Francisco Earthquake... 1989 1,000,000 2,300 1,000 1,300 Oakland Fires.............. 1991 1,700,000 2,700 1,400 1,300 Hurricane Andrew........... 1992 15,500,000 22,800 20,700 2,100 Hurricane Iniki............ 1992 1,600,000 4,100 2,900 1,200 Northridge, CA Earthquake.. 1994 12,500,000 17,600 11,700 5,900 Hurricane Fran............. 1996 1,500,000 1,300 900 400 - --------------------
(1) Source: Property Claims Services. - 98 - PMA Re has no significant obligations to its reinsurers as a result of the above catastrophes. Claims Administration PMA Re's claims department evaluates loss exposures, establishes individual claim reserves, pays claims, provides claims-related services to PMA Re's clients, audits the claims activities of current clients and assists in the underwriting process by evaluating the claims departments of prospective clients. PMA Re's claims department's evaluation of loss exposure 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 PMA Re's actuarial and underwriting departments. In addition to evaluating and adjusting claims, the claims department conducts claims audits at the offices of prospective ceding companies. Satisfactory audit results are required in order for reinsurance coverage to be written by PMA Re. Also, the claims department conducts annual claims audits for many current and former client ceding companies. Management believes that PMA Re has been at the forefront of several service initiatives in the brokered reinsurance market, involving improved timeliness of claims remittances, including fastrack claims and electronic data interchange. Fastrack claims involve the pre-approval of payment of certain claims provided the claims meet predetermined criteria and electronically disbursing funds to the clients. Electronic data interchange involves the electronic transmission of data associated with transactions between PMA Re and the client. The Property and Casualty Group Background The Property and Casualty Group provides workers' compensation insurance, other commercial property and casualty insurance coverages and related services to entities located primarily in nine contiguous jurisdictions in the Mid- Atlantic and Southern regions of the United States, utilizing the PMA Group trade name. As a result primarily of the Property and Casualty Group's underwriting decisions, the introduction of loss-sensitive coverages and large deductible programs, competition and the impact of workers' compensation benefit reform laws, the Property and Casualty Group's statutory net premiums written declined from $434.7 million in 1993 to $240.3 million in 1997. For the six months ended June 30, 1998, net written premiums were $138.4 million compared to $156.8 million for the six months ended June 30, 1997. The operating results of the Property and Casualty Group improved in 1997 compared to 1996, primarily as a result of reserve strengthening that the Property and Casualty Group effectuated in 1996 and expense initiatives instituted by the Property and Casualty Group in 1997. This improvement has continued through the first six months of 1998. In 1996, the Property and Casualty Group strengthened its loss reserves by $191.4 million. Of this amount, $110.0 million related to workers' compensation, $60.4 million related to asbestos and environmental claims and $21.0 million related to other lines and LAE. The adverse development arising from workers' compensation had reduced the Property and Casualty Group's earnings by a cumulative $251.6 million between 1992 and 1995. The reform legislation enacted in Pennsylvania, the Property and Casualty Group's principal marketing territory, in 1993 and 1996 has introduced various controls and limitations on disability and medical benefits. Management believes that the reforms and more stringent underwriting standards adopted by the Property and Casualty Group since 1991 have had and continue to have a beneficial effect on the Property and Casualty Group's accident year loss ratios. The strengthening recorded for asbestos and environmental claims was based upon a detailed loss analysis that examined data on an account-by-account and site-by-site basis for asbestos, and an actuarial calendar year aggregate loss development technique for environmental claims. The Property and Casualty Group's net survival ratio was 7.4 years at December 31, 1997 (8.2 years at December 31, 1996). At June 30, 1998, the Property and Casualty Group's net survival ratio was 8.2 years. In 1997 and through the first six months of 1998, the Property and Casualty Group did not record any adverse loss reserve development (see "Loss Reserves"), and, in addition, the impact of a lower expense base has contributed to improved operating results for the Property and Casualty Group. See "Loss Reserves." In 1997, the Property and Casualty Group completed a formal commutation program in which it paid approximately $118.9 million, of which $17.8 million was paid in the fourth quarter of 1996, to injured workers in exchange for a release from any future indemnity - 99 - payments. Commutations are agreements with claimants whereby the claimants, in exchange for a lump sum payment, release their rights to future indemnity payments from the Property and Casualty Group. Under Pennsylvania workers' compensation law, the claimant, who is generally represented by legal counsel and the Pennsylvania Workers' Compensation Board, must approve all such commutation agreements. Savings associated with these claims were consistent with management's expectations. The number of open claims for accident years 1991 and prior was substantially reduced as a result of the commutation program. This reduction in open claims is expected to reduce the possibility of further adverse development on such reserves, although there can be no assurance that the level of commutations will have a significant impact on the future development of such reserves. As a result of the success of this formal commutation program, the Property and Casualty Group has continued its efforts to commute additional claims from accident years 1991 and prior and also has started to commute claims for accident years 1992 through 1996. During the six months ended June 30, 1998, the Property and Casualty Group paid approximately $60.1 million to injured workers in exchange for a release from any future indemnity payments. The Property and Casualty Group continues to emphasize its traditional core business, workers' compensation. Management believes that it can capitalize on the recent regulatory reforms, attract additional business based upon the Property and Casualty Group's expertise in workers' compensation and reduce acquisition expenses, because acquisition costs are lower for workers' compensation than for other lines of commercial insurance. In addition, the Property and Casualty Group has aligned itself with network health care providers in order to offer medical cost containment practices to its insureds. - 100 - In Pennsylvania, the Property and Casualty Group will seek to expand and retain more of its premium base in territories that meet the Property and Casualty Group's underwriting and actuarial criteria. Recent regulatory reforms in Pennsylvania (Acts 44 and 57) have made workers' compensation business more attractive from an underwriting perspective than it had been in the early 1990's. The workers' compensation system in certain other states in which the Property and Casualty Group does business (specifically, New Jersey, North Carolina and Virginia) has also improved in recent years. It is management's intention to seek to recapture a portion of the workers' compensation market share in those states where the Property and Casualty Group has lost market share since the early 1990's. In addition, the Property and Casualty Group intends to expand into certain new territories. In 1997, the Property and Casualty Group began writing business in Georgia, and, in 1996, in New York and South Carolina. In all new territories, the Property and Casualty Group will undertake a target marketing effort by identifying profiles of entities that it desires to insure. These profiles will be communicated to the key producers in these states. It is also contemplated that the Property and Casualty Group will seek to expand its relationships with larger national and regional brokerage operations in both its existing and new states. However, no assurance can be given that the Property and Casualty Group will be able to accomplish these marketing objectives. The Property and Casualty 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. Effective January 1, 1997, the Property and Casualty Group reduced its retention on commercial casualty lines of business to $175,000 per risk from $500,000 per risk. Business Written The following table sets forth net premiums written for the Property and Casualty Group for the periods indicated:
(dollar amounts in thousands) Six Months ended June 30, Year Ended December 31, ------------------- ----------------------------------------------------- 1998 1997 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- ---- ---- Workers' Compensation........... $ 98,395 $ 99,624 $138,301 $187,698 $232,742 $266,033 $338,684 Commercial Auto................. 13,002 16,918 28,938 35,224 39,834 38,984 48,108 Commercial Multi-Peril.......... 15,420 25,438 41,713 35,108 40,659 31,123 27,306 General Liability and Umbrella.. 1,903 6,550 8,751 8,204 11,370 12,691 16,788 Other........................... 1,107 3,476 (14,355) 6,245 8,511 3,320 324 -------- -------- -------- -------- -------- -------- -------- Total........................... $129,827 $152,006 $203,348 $272,479 $333,116 $352,151 $431,210 ======== ======== ======== ======== ======== ======== ========
Workers' Compensation Insurance Workers' compensation is a statutory system that requires employers to provide workers' compensation benefits to their employees and their employees' dependents for - 101 - 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 benefits payable for various types of claims are established 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. Based upon direct written premium information published by A.M. Best for the most recently available year (1998), the Property and Casualty Group is the fourth largest private writer of workers' compensation insurance in Pennsylvania and between the 2nd and 12th largest writer of workers' compensation insurance in the other jurisdictions listed in the table below (except for North Carolina). The Property and Casualty Group has focused on these jurisdictions based upon its knowledge of their workers' compensation systems and the Property and Casualty Group's assessment of their 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. Management intends to employ similar analyses in determining whether and to what extent the Property and Casualty Group will sell its products in additional jurisdictions. See "Underwriting." The following table sets forth statutory direct workers' compensation business written by jurisdiction for the five years ended December 31, 1997 and for the six months ended June 30, 1998 and 1997. (dollar amounts in thousands)
Six Months Ended June 30, Year Ended December 31, -------------------- --------------------------------------------------------- 1998 1997 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- ---- ---- Pennsylvania $ 43,820 $ 53,348 $ 91,126 $134,171 $142,234 $169,448 $224,067 New Jersey 21,857 15,486 26,327 17,995 24,388 31,287 47,745 Virginia 12,538 13,077 19,552 17,449 26,395 29,938 31,545 Maryland 7,726 7,750 16,538 11,406 17,993 14,391 15,318 North Carolina 4,966 5,420 9,501 8,195 14,035 11,649 21,216 Delaware 4,024 3,463 7,041 7,545 5,763 4,831 4,274 Other 8,630 6,946 11,470 5,403 7,889 4,864 7,165 -------- -------- -------- -------- -------- -------- -------- Total $103,561 $105,490 $181,555 $202,164 $238,697 $266,408 $351,330 ======== ======== ======== ======== ======== ======== ========
Management of the Property and Casualty Group believes that conditions in the workers' compensation market have been improving in the last several years. In addition, several states, including Pennsylvania, have enacted reforms to the workers' compensation benefit system. In 1993, Pennsylvania enacted Act 44, which introduced medical cost containment measures to the workers' compensation benefit system and expanded the period of time during which the insurer may require an employee to accept medical treatment from the employer's list of designated health care providers from 14 to 30 days. Act 44 also reduced the minimum wage replacement benefit to injured workers, introduced a credit for unemployment compensation - 102 - benefits, restored the right of subrogation against tort recoveries in work- related automobile accidents and created new anti-fraud measures. In June 1996, Pennsylvania enacted Act 57, which further reformed the workers' compensation system in the state. Among other provisions, Act 57: (i) imposes application of American Medical Association Impairment Guidelines for the assessment of permanent and total claims after the first two years of total disability compensation payments and limits indemnity benefits to an additional 500 weeks for workers who are not at least 50% disabled (as measured by those guidelines); (ii) contains certain Social Security and pension benefit offsets; (iii) further increases the time frame for directed medical treatment; (iv) addresses certain inequities in the average weekly wage calculation; (v) increases the ability of employers to demonstrate that injured workers have earning capacity and (vi) facilitates the use of full and final settlements of employers' workers' compensation obligations on particular claims. To date, Act 44 has had a favorable impact on medical loss costs in Pennsylvania and Act 57 has had a favorable impact on indemnity loss costs. In recognition of these developments, in the respective first years following the enactments of Act 44 and Act 57, the average manual rate level in Pennsylvania decreased approximately 10% in 1994 and approximately 25% in 1997. The benefit reforms, management's re-underwriting of the Property and Casualty Group's book of business and the use of loss-sensitive and alternative market products have had a favorable impact on the Property and Casualty Group's accident year loss ratios, as evidenced by the table below: Property and Casualty Group's Workers' Compensation Undiscounted Accident Year ------------------------------------------------------------------------------ Pure Loss Ratios as of December 31, 1997 ---------------------------------------- Accident Year Loss Ratio ---- ---------- 1990 100% 1991 86% 1992 80% 1993 64% 1994 64% 1995 63% 1996 63% 1997 66% Workers' Compensation Products The Property and Casualty Group offers a variety of workers' compensation products to its customers. Certain of these products are based on 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 Property and Casualty Group has also developed and sold large deductible products and other programs and services to customers who agree to assume an even greater exposure to loss than under more traditional loss-sensitive products ("alternative market products"). The Property and Casualty Group decides which type of product to offer a customer based upon the customer's needs and the underwriting review. See "Underwriting." Set forth below is percentage information on the voluntary workers' compensation direct premiums written by product type for the policy years indicated: - 103 -
1998(1) 1997 1996 1995 1994 1993 1992 1991 1990 ------- ----- ----- ----- ----- ----- ----- ----- ----- Rate-sensitive products 64% 62% 57% 52% 50% 54% 53% 54% 60% Loss-sensitive products 28% 27% 30% 34% 39% 40% 46% 46% 40% Alternative market products 8% 11% 13% 14% 11% 6% 1% 0% 0% ---- ---- ---- ---- ---- ---- ---- ---- ---- Total 100% 100% 100% 100% 100% 100% 100% 100% 100% ==== ==== ==== ==== ==== ==== ==== ==== ====
- ------------------------------------ (1) 1998 data is through June 30, 1998. Rate-Sensitive Workers' Compensation Products 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 Property and Casualty Group does business, the Property and Casualty Group has become more interested in this type of business and increased its writings of rate-sensitive accounts in such jurisdictions in 1997 and 1998. Loss-Sensitive Workers' Compensation Products The Property and Casualty 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. Such policies are typically open for adjustments for an average of five years after policy expiration. The Property and Casualty Group generally restricts such loss- sensitive products to accounts developing annual minimum premiums in excess of $100,000. Alternative Market Workers' Compensation Products Since 1992, the Property and Casualty Group has developed a variety of alternative market products for larger accounts, including large deductible policies and offshore captive programs. Typically, the Property and Casualty 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 such policies generally range from $250,000 to $1.0 million. In addition to these products, the Property and Casualty Group - 104 - offers certain workers' compensation services to its clients unbundled from the insurance products. See "PMA Management Corp." PMA One In 1997, the Property and Casualty Group developed PMA One, a new product that provides for group integrated occupational and non-occupational disability coverages. The Property and Casualty Group believes that it can be successful in this product line as it will utilize its expertise in managed care to reduce disability periods. The Property and Casualty Group recorded premiums of $1.1 million for the six months ended June 30, 1998 for PMA One. Workers' Compensation Residual Market Business Workers' compensation insurers doing business in certain states are required to provide insurance for risks which are 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 Property and Casualty Group does business, except Pennsylvania and Maryland. In these two states, separate governmental entities write all of the workers' compensation residual market business. In 1997, the Property and Casualty Group wrote $5.2 million of residual market business, which constituted approximately 3% of its voluntary net workers' compensation premiums written. The Property and Casualty Group wrote $1.6 million of residual market business for the six months ended June 30, 1998 compared to $2.5 million for the six months ended June 30, 1997. Based upon data for policy year 1997 reported by the National Council on Compensation Insurance, the percentage for the industry as a whole, in all states, was 9.7%. Commercial Lines The Property and Casualty Group writes property and liability coverages for larger and middle market accounts that satisfy its underwriting standards. See "Underwriting" below. These coverages feature package, umbrella and commercial automobile business. During the present soft market, prices for commercial coverages have been particularly competitive. The Property and Casualty Group intends to continue offering these products, but generally only if they support the core workers' compensation business. As a result, the Property and Casualty Group has been selectively non-renewing accounts that do not meet its underwriting standards. In addition, effective January 1, 1997, the Property and Casualty Group has reduced its retention on commercial casualty lines of business to $175,000 per risk from $500,000 per risk. See "The Company's Reinsurance Ceded" below. Home Office and Field Operations As of June 30, 1998, approximately 230 employees worked in the home office located in Blue Bell, Pennsylvania, and approximately 660 employees were assigned to field offices located throughout the states in which the Property and Casualty Group does business. Senior executives, financial operations, management information systems, human resources, actuarial services and legal services are headquartered in the home office. The - 105 - definition of overall underwriting standards and major account and alternative market underwriting support also take place in the home office. The home office works in conjunction with senior managers from the field to establish the Property and Casualty Group's business plan and underwriting standards, which are then implemented by the field organization. The field organization currently consists of three regional offices in Valley Forge, Pennsylvania, Harrisburg, Pennsylvania and Richmond, Virginia, as well as branch offices in each of Georgia, Maryland, New Jersey, Pennsylvania, Virginia and North Carolina. In addition, the Property and Casualty Group operates smaller satellite offices in Ohio and New York. The branch offices deliver a full range of services directly to customers located in their service territory, and the satellite offices offer primarily underwriting and claim adjustment services. Distribution The Property and Casualty Group distributes its products through approximately 20 direct sales employees and approximately 240 independent brokers and agents. The direct sales employees are generally responsible for certain business located in Pennsylvania. For the year ended December 31, 1997, these employees produced $39.2 million in direct premiums written, constituting 13% of the Property and Casualty Group's direct written business. For the six months ended June 30, 1998, these employees produced $16.9 million in direct premiums written, constituting 12% of the Property and Casualty Group's direct written business. The brokers and agents write business throughout the marketing territory. In 1997, the top ten brokers and agents accounted for 28% of the Property and Casualty Group's business, the largest of which accounted for not more than 8% of its business. All brokers and agents are required to submit business to the Property and Casualty Group's underwriting process before business may be accepted. The Property and Casualty Group monitors several statistics relating to its producer force, including the number of years the producer has been associated with the Property and Casualty Group, the percentage of the producer's business that is underwritten by the Property and Casualty Group, the ranking of the Property and Casualty Group within the producer's business, and the profitability of the producer's business. The 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 Property and Casualty Group. Underwriting Home office underwriters, in consultation with casualty actuaries, determine the general types 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. The home office underwriting team also establishes classes of business that the Property and Casualty Group generally will not write, such as most coastal property exposures, certain hazardous products and activities and certain environmental coverages. The home office establishes the overall business goals and the underwriting authority for each regional and - 106 - branch office. It also identifies specific types of business that must be referred to home office underwriting specialists and actuaries for individual pricing; including large accounts over a specified dollar limit and alternative market workers' compensation products. In 1997, the Property and Casualty Group changed the reporting structure so that underwriters and risk-control professionals in the field report functionally to the Chief Underwriting Officer rather than to branch managers with marketing responsibilities; however, underwriters also work as a team 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 Property and Casualty Group's underwriting management averages 22 years of experience in the property and casualty industry. The Property and Casualty 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. Rehabilitation and Managed Care The Property and Casualty Group uses a variety of managed care techniques to reduce costs and losses. Disability management coordinators and point-of- service case managers, all of whom are registered nurses, work together with claims professionals to provide expeditious medical and disability management to injured workers and to investigate injuries. The case managers and professionals also help employers identify opportunities that allow injured employees to make a gradual transition to full-time, full-duty jobs. The Property and Casualty Group also has contracts with First Health Group, Inc. for most of its marketing territory and with other preferred provider networks consisting of medical practitioners and hospitals selected for their expertise in treating injured workers. Specialties include occupational medicine, physical medicine, orthopedics and neurology. There are also preferred pharmacy networks to reduce the cost of medication. In addition, the Property and Casualty Group uses an outside network to check medical bills for accuracy, duplication, unrelated charges and overcharges. Questionable bills are forwarded to the Cost Containment Unit, which is staffed by registered nurses and resolves disputed or suspect charges. Claims Administration Claims services are delivered to customers primarily through employees in the field offices. Certain specialized matters, such as asbestos and environmental claims, are referred to a special unit in the home office. The Property and Casualty Group maintains a centralized call center for loss reporting and has automated and centralized the processing of claims payments in its Allentown, Pennsylvania facility. This centralization allows the claims adjusters to reduce substantially the time that they spend with clerical and repetitive functions. The Property and Casualty Group also employs in-house attorneys who represent customers in workers' compensation cases and other insurance matters. The Property and Casualty Group has a separate, anti-fraud unit that investigates suspected false claims and other irregularities and cooperates with regulatory and law enforcement officials in prosecuting violators. - 107 - 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 subsidiary of PMC. The client participates in the loss and investment experience of the portion ceded to the Bermuda 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 excess risk retained by the Pooled Companies and captive management fees earned by PMA Management Corp. Run-off Operations As a part of the Property and Casualty Group's 1996 restructuring plan, the Property and Casualty Group established the Run-off Operations principally to manage the capital supporting workers' compensation loss reserves from accident years 1992 and prior. Such reserves primarily relate to the period of time from 1987 to 1991 when the Property and Casualty Group wrote a much higher volume of business and experienced poor underwriting results. The reserves are mainly indemnity related and are relatively mature. The Run-off Operations consist of PMA Cayman, MASCCO and PMA Life. MASCCO is a Pennsylvania insurance company and a wholly owned subsidiary of the Company. Prior to December 31, 1996, MASCCO was a party to a pooling agreement with the Pooled Companies. Effective December 31, 1996, and with the approval of the Pennsylvania Insurance Commissioner MASCCO withdrew from the pooling agreement and ceased writing any new business. The Pooled Companies also ceded to MASCCO the indemnity portion of Pennsylvania workers' compensation claims for accident years 1991 and prior. Pursuant to a surplus maintenance agreement between PMC and the Pennsylvania Insurance Commissioner, MASCCO is required to discount its reserves utilizing a rate of not more than 5%, maintain a reserve to surplus ratio not in excess of 8 to 1 and continue to invest its assets only in investment grade securities. At June 30, 1998, MASCCO had $97.0 million in total assets and $80.1 million in total reserves and its reserve to surplus ratio was 5 to 1. Substantially all of MASCCO's assets are held in trust for the benefit of the Pooled Companies. PMA Cayman was incorporated in Grand Cayman, and had no material operations until 1996. In 1996, the Pooled Companies ceded to PMA Cayman substantially all of their remaining liability for workers' compensation claims for accident years 1991 and prior. In 1997, the Pooled Companies also ceded to PMA Cayman a portion of their workers' compensation reserves from accident years 1992 to 1996. At June 30, 1998, PMA Cayman had $233.0 million in total assets and $215.5 million in total reserves. Substantially all of PMA - 108 - Cayman's assets are held in trust for the benefit of the Pooled Companies. The Company entered into a letter of intent to sell PMA Cayman. The transaction is subject to the customary closing conditions, including regulatory approvals, and is expected to be completed in the third quarter of 1998. In connection with the announced sale, the Company recorded a $2.4 million pre-tax loss in the second quarter, which is included in "Net Realized Investment Gains." PMA Life is a Pennsylvania life insurance company that derived all of its insurance revenues from intercompany structured settlement annuity transactions with the Pooled Companies. In 1997, the Property and Casualty Group reinsured substantially all of PMA Life's insurance liabilities with a third party reinsurer and the Property and Casualty Group no longer places insurance business with PMA Life. At June 30, 1998, PMA Life had assets of $22.9 million and $17.7 million in total reserves. The following table reflects the components of the Property and Casualty Group -- Run-off Operations' operating results for the six months ended June 30, 1998 and 1997 and for the year ended December 31, 1997: (dollar amounts in thousands) Year Six Months Ended Ended June 30, December 31, -------------- ------------ 1998 1997 1997 ---- ---- ---- Net investment income.................. $11,303 $14,972 $28,131 Net premiums earned(1)................. -- 814 (51,622) ------- ------- -------- Total operating revenues............... $11,303 15,786 (23,491) ------- ------- -------- Losses and LAE incurred................ 9,401 15,097 (27,460) Operating expenses..................... 1,474 1,796 4,042 ------- ------- -------- Total expenses......................... $10,875 $16,893 $(23,418) ------- ------- -------- Pre-tax operating income (loss)........ $428 $(1,107) $(73) ======= ======= ======== - ---------------------------- (1) Amount represents net premiums earned during the first six months of 1997 for PMA Life prior to the reinsurance transaction mentioned above, after which PMA Life was placed into run-off. Caliber One In 1997, the Company established a specialty insurance operation, Caliber One. In starting Caliber One, the Company's intention was to expand PMC's access to the insurance market by offering products and marketing to classes of business in which neither PMA Re nor the Property and Casualty Group were involved. The Company has hired an experienced senior underwriting professional to be the Chief Operating Officer of this unit as well as other individuals with experience in underwriting and claims management for specialty insurance. See "Management." - 109 - Products, Underwriting and Distribution Caliber One's present focus is 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, machinery manufacturers, toy makers, medical product manufacturers and other difficult-to-insure product liability risks. In addition, Caliber One markets environmental impairment liability coverages, clinical trials coverage for emerging biotechnology products and intellectual property rights liability coverages as well as property coverages for unprotected and vacant buildings. Caliber One's policy forms contain appropriate and flexible manuscript endorsements and exclusions, and in some cases, will contain defense costs within the policy limits rather than offering such coverage on an unlimited basis. Through June 30, 1998, Caliber One had $1.6 million and $917,000 in gross premiums and net premiums written, respectively. The underwriting of these specialty products involves a significant amount of judgment. The senior underwriters that Caliber One has hired have a significant amount of experience in dealing with esoteric high severity risks, and average 16 years of specialty insurance experience. The underwriting process involves reviewing the claim experience of an account, if any, the claim experience of the particular class or similar classes and responding to special risks that an account has through the use of policy features that can be changed for the circumstances, such as retentions, exclusions and endorsements. Caliber One's underwriting teams for casualty products have been divided into three regions within the United States, each led by a regional underwriting vice president who reports to the Chief Operating Officer. For property products, one underwriting team supports the activities of the three regions. Caliber One distributes its excess and surplus lines products on a nationwide basis through approximately 45 appointed surplus lines brokers. For most product offerings, Caliber One does not grant underwriting or binding authority to its brokers. Acquisition of Caliber One Indemnity Company In December 1997, PMA Re acquired 100% of the common stock of a Delaware domiciled insurance company which it renamed Caliber One Indemnity Company. PMA Re paid $16.0 million to acquire the company and made an $11.3 million capital contribution to bring Caliber One Indemnity Company's statutory surplus to $25.0 million, the minimum surplus level required by several states to be an authorized excess and surplus lines carrier. Caliber One Indemnity Company was essentially a shell company, as affiliates of the former parent had taken over the business that had been previously written. In addition, an affiliate of the former parent entered into a reinsurance transaction immediately prior to the acquisition whereby such company assumed all of the Company's existing loss reserves and is providing protection against adverse loss reserve development and uncollectible reinsurance of up to $68.5 million. See "Loss Reserves" below. Also, PMA Re has entered into a surplus maintenance agreement with Caliber One Indemnity Company whereby PMA Re will maintain Caliber One Indemnity Company's statutory surplus such that the amount is not less than $25.0 million and so that the net premiums written to surplus ratio does not exceed 1.0 to 1.0. - 110 - Caliber One Indemnity Company is presently authorized as an excess and surplus lines carrier in 38 states, and it is management's intention to be authorized in 49 states so that products can be offered on a national basis. Caliber One Indemnity Company has obtained an "A" (Excellent) rating from A.M. Best. The Company's Reinsurance Ceded The Company follows the customary insurance practice of reinsuring with other insurance companies a portion of the risks under the policies written by the 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 maximum liabilities to their policyholders for the full amount of the 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 Insurance Subsidiaries' reinsurance ceded agreements 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. Presently, the maximum gross lines that PMA Re will write are $5.0 million for property covers, $1.0 million for property catastrophe covers and $7.5 million for casualty covers. Net retentions on any one claim are $750,000 for property covers and $1.5 million for casualty covers. PMA Re maintains property catastrophe retrocession programs in an aggregate amount of $48.0 million in excess of $2.0 million for multiple claims arising from two or more risks in a single occurrence or event. PMA Re also maintains casualty retrocession programs. PMA Re has a casualty retrocession contract, written on a funds withheld basis, which covers individual casualty losses and provides low-layer clash protection. For individual losses, the contract covers $6.0 million in excess of $1.5 million on a per occurrence basis. The contract has clash limits for losses arising from two or more risks of $1.3 million in excess of $1.5 million. The term of the contract is three years, and the term aggregate limit is $25.0 million plus the amount of funds withheld. In addition to the above programs, PMA Re maintains casualty clash protection of $17.5 million in excess of $2.8 million per occurrence. Effective January 1, 1998, PMA Re's workers' compensation program was modified to include coverage of $98.0 million excess of $2.0 million per occurrence, $98.5 million excess of $1.5 million per program per occurrence and $18.5 million excess of $1.5 million per person per occurrence. The Property and Casualty Group has its own ceded reinsurance program, and carries excess-of-loss per occurrence reinsurance for $103.5 million over a net retention of $1.5 million on workers' compensation. The Property and Casualty Group also carries excess-of-loss per risk reinsurance for $4.8 million ($49.8 million per occurrence) over a net retention of $175,000 - 111 - on other casualty lines; $2.0 million on automobile physical damage and $19.5 million ($48.5 million per occurrence) on property claims over its combined net retention of $500,000. A property catastrophe program with a per occurrence limit of $27.7 million in excess of an $850,000 retention is maintained to provide protection for multiple property losses involved in one occurrence. The Property and Casualty Group also maintains reinsurance protection for its umbrella risks at $9.0 million over a net retention of $1.0 and purchases facultative reinsurance for certain other risks. Effective January 1, 1998, Caliber One maintains reinsurance protection of $4.5 million excess of $500,000 per policy. For primary coverages, the reinsurance is written on an excess of loss basis, and for excess coverages, the reinsurance is written on a surplus share basis. Caliber One Indemnity Company is also reinsured by an affiliate of its former parent relating to all business written prior to its acquisition by PMA Re in December 1997. The Company actively manages its exposure to catastrophic events. In the underwriting process, the Company generally minimizes 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 ratios have not been significantly impacted by catastrophes, and management believes that the Company has adequate reinsurance to protect against the estimated probable maximum gross loss from a catastrophic event; however, an especially severe catastrophic event could exceed the Company's reinsurance and retrocessional protection and materially adversely impact the Company's financial position. 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 to support balances due from reinsurers not authorized to transact business in the applicable jurisdictions. Loss Reserves 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. To recognize liabilities for unpaid losses, insurers establish reserves, which are balance sheet liabilities representing estimates of future amounts needed to pay claims with respect to insured events which 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. - 112 - When 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 such personnel, based on general corporate reserving practices and the experience and knowledge of such personnel regarding the nature and value of the specific type of claim. Reserves are also established on an aggregate basis to provide for losses incurred but not yet reported to the insurer, for the overall adequacy of case reserves and the estimated expenses of settling claims. Such 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. 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 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 components of the Company's incurred losses and LAE for prior accident years as of December 31, 1997, 1996 and 1995 excluding accretion of discount, are as follows (favorable loss reserve development is denoted by the bracketed figures): (dollar amounts in millions) Year Ended December 31, ------------------------------- 1997 1996 1995 --------- --------- --------- PMA Re............................ $(32.1) $(35.3) $(15.0) The Property and Casualty Group: Workers' compensation........... (44.1) 110.0 54.7 Asbestos and environmental...... -- 60.4 23.4 PMA Life........................ (14.8) -- -- Other losses and LAE............ 5.0 21.0 (11.6) ------ ------ ------ Total........................... (53.9) 191.4 66.5 ------ ------ ------ Total............................. $(86.0) $156.1 $ 51.5 ====== ====== ====== - 113 - The following table shows the composition of changes in the reserves for losses and LAE for each of the three years ended December 31, 1997: (dollar amounts in thousands) Year Ended December 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Balance at beginning of period.......... $2,091,072 $2,069,986 $2,103,714 Less: Reinsurance recoverable on unpaid losses and LAE......................... 256,576 261,492 247,856 ---------- ---------- ---------- Net balance at beginning of period.... 1,834,496 1,808,494 1,855,858 ---------- ---------- ---------- Losses and LAE incurred, net: Current period........................ 341,880 323,069 357,787 Prior periods......................... (86,006) 156,074 51,491 Accretion of discount (includes ($35,000) effect of the change in the discount rate for the Property and Casualty Group's workers' compensation unpaid losses from 4% to 5% in 1995).......................... 51,407 57,480 13,300 ---------- ---------- ---------- Total losses and LAE incurred, net...... 307,281 536,623 422,578 ---------- ---------- ---------- Losses and LAE paid, net: Current period........................ (72,399) (72,194) (71,126) Prior periods......................... (398,475) (438,427) (398,816) ---------- ---------- ---------- Total losses and LAE paid, net:......... (470,874) (510,621) (469,942) ---------- ---------- ---------- Net balance at end of period............ 1,670,903 1,834,496 1,808,494 Reinsurance recoverable on unpaid losses and LAE......................... 332,284 256,576 261,492 ---------- ---------- ---------- - 114 - Balance at end of period................ $2,003,187 $2,091,072 $2,069,986 ========== ========== ========== The following table shows how the Company's losses have been paid and reserves re-estimated over time compared to the liability initially estimated: Consolidated Loss and Loss Adjustment Expense Development
(dollar amounts in millions) 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------- ------ Initial estimated liability for unpaid losses and LAE net of reinsurance recoverables................... $1,246 $1,457 $1,632 $1,735 $1,824 $1,941 $1,932 $1,856 $1,809 $1,835 $1,671 Amount of reserve paid, net of reinsurance through: - - one year later............... 305 322 445 471 491 442 408 399 438 399 --- - - two years later.............. 504 601 772 842 849 779 746 764 780 - - three years later............ 692 826 1,043 1,134 1,127 1,067 1,056 1,073 - - four years later............. 834 1,011 1,258 1,353 1,365 1,329 1,331 - - five years later............. 956 1,166 1,421 1,539 1,585 1,574 - - six years later.............. 1,063 1,284 1,553 1,715 1,789 - - seven years later............ 1,143 1,380 1,685 1,882 - - eight years later............ 1,214 1,479 1,817 - - nine years later............. 1,288 1,584 - - ten years later.............. 1,367 Reestimated liability, net of reinsurance as of: - - one year later............... 1,280 1,468 1,696 1,795 1,967 1,998 1,932 1,907 1,965 1,749 --- - - two years later.............. 1,304 1,512 1,743 1,950 2,068 2,007 1,983 2,073 1,867 - - three years later............ 1,339 1,553 1,876 2,034 2,082 2,061 2,164 1,987 - - four years later............. 1,359 1,607 1,938 2,041 2,135 2,258 2,078 - - five years later............. 1,368 1,652 1,935 2,123 2,302 2,170 - - six years later.............. 1,391 1,649 1,985 2,273 2,209 - - seven years later............ 1,393 1,684 2,098 2,205 - - eight years later............ 1,425 1,784 2,052 - - nine years later............. 1,504 1,752 - - ten years later.............. 1,485 Indicated deficiency (redundancy)................... $ 239 $ 294 $ 420 $ 471 $ 385 $ 229 $ 146 $ 131 $ 58 $ (86) $ -- Net liability - December 31.... $1,932 $1,856 $1,809 $1,835 $1,671 Reinsurance recoverables....... 219 248 262 257 332 Gross liability - December 31.. $2,151 $2,104 $2,070 $2,091 $2,003 Reestimated net liability...... $2,078 $1,987 $1,867 $1,749 $1,671 Reestimated reinsurance recoverables.................. 178 221 254 251 332 Reestimated gross liability.... $2,256 $2,208 $2,120 $1,999 $2,003
The columns in the above exhibit are not mutually exclusive. For example, if a reserve established in 1987 for a claim incurred during that year had been re-estimated during 1989, the re-estimate would be reflected in the table for each of the statement years from 1987 and 1988 during calendar years 1989 through 1997. Conditions and trends that have affected the reserve development reflected in the table may change and care should be exercised in making conclusions about the relative adequacy of reserves from such development. - 115 - For PMA Re, gross favorable loss reserve development on prior years' unpaid losses and LAE was $32.1 million, $35.3 million and $15.0 million in 1997, 1996 and 1995, respectively, primarily for accident years 1993 and prior. Such favorable loss reserve development is attributable to losses emerging at a lower rate than was anticipated (based upon historical loss development patterns) when the initial accident year reserves were established. While loss emergence patterns have been trending downward for the pre-1993 accident years, resulting in favorable loss reserve development, there can be no assurance that such trend will continue in the future. In 1997, the Property and Casualty Group recorded a release of $53.9 million on prior year losses and LAE, excluding the accretion of discount. The release primarily relates to favorable reserve development of $9.0 million for workers' compensation retrospectively rated policies for accident years 1991 and prior, resulting from unanticipated additional savings from the Company's 1997 commutation program and favorable development of workers' compensation reserves for accident years 1992 through 1996 of $35.1 million ($28.0 million related to retrospectively related policies), primarily resulting from greater than expected savings associated with benefit reforms in Pennsylvania. Furthermore, incurred losses on prior accident years were also affected by the cession of prior year loss reserves included in the PMA Life transaction of $14.8 million. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." The reserve release pertaining to the retrospectively rated policies and the PMA Life transaction were offset in the consolidated statements of operations by a corresponding reduction in earned premiums. The aforementioned reserve releases were partially offset by reserve strengthening of $5.0 million in commercial multi-peril business for accident year 1996. It is the opinion of management that these reserve adjustments are not indicative of any future trend. The 1996 aggregate workers' compensation adverse development was allocated $102.0 million to Pennsylvania and $8.0 million to all other states in which the Company does business. Of the $102.0 million, the allocation by year is as follows: prior to 1987: $16.0 million; 1987 to 1991: $101.0 million and 1992 and subsequent years: ($15.0 million). In 1995, substantially all of the workers' compensation adverse development related to accident years 1987 to 1991 in Pennsylvania. For accident years prior to 1992, the traditional paid loss development schedules for workers' compensation had begun to exhibit an increasing trend in loss development factors by 1993. This trend was initially attributed to an increase in commutation activity. In 1995, management began to question whether loss data was developing in a manner that was consistent with the conclusion that the loss development trends were impacted solely by commutation activity. As a result, management began to accumulate additional data in order to determine whether there were additional causes of the increase in the paid loss development data, and management obtained claim count data that was far more detailed than had been historically utilized in the reserve setting process. This data indicated that the paid loss development factors were not only impacted by commutation activity, but also by a decline in the claims closure rate in Pennsylvania. Management believes that the decline of the closure rates was due to several interrelated factors. One factor related to the fact that efforts to rehabilitate claimants and return them to work were not as successful as anticipated. For accident years 1987 to 1991, in particular, extensive efforts were made by the Company to rehabilitate claimants and return them to work at either full or modified duty. By late 1995 and into 1996, it was recognized by a review of a slow down in the claims closure pattern that these rehabilitation efforts were not impacting the closure rates as expected. Another factor negatively impacting claims closure rates related to the economic conditions in Pennsylvania in the early 1990's. During the period from 1990 to 1994, economic conditions in Pennsylvania were considered to be depressed in the Company's major industry niches for workers' compensation insurance (construction and heavy manufacturing). Payrolls in these industries were stagnant, and in many cases, employment was flat or declining. The Company believes that in periods of declining employment opportunities, there is a tendency for indemnity periods to increase, which occurred for workers who suffered injuries in these industries. The above factors, when considered with the fact that the benefits period in Pennsylvania was unlimited, caused the Company to believe that a substantial portion of claimants from the pre-1992 period, who had already been out of work five to nine years, would not return to work in any capacity. In late 1995 and during 1996, management undertook an effort to quantify the impact of the declining closure rates versus the increase in commutation activity. During the fourth quarter of 1995, management strengthened the Property and Casualty Group's workers' compensation reserves by $54.7 million; however, the quantification of the effect of the claims closure rate was an extremely complex process and as such, the data was not fully understood at that time. As the data under analysis was more mature and refined in 1996, management determined that the workers' compensation loss reserves for Pennsylvania in the pre-1992 accident years needed to be increased substantially; therefore, the Property and Casualty Group increased its workers' compensation reserves by $110.0 million. Benefit reforms enacted by states in which the Property and Casualty Group transacts business, most significantly Pennsylvania, have had a beneficial impact on more recent accident year loss ratios. Prior to 1996, the principal revisions of the Pennsylvania system - 116 - included medical cost containment measures and an expansion of the period of time during which the insurer may require an employee to accept medical treatment from the employer's list of designated health care providers. In July 1996, Pennsylvania enacted Act 57, a workers' compensation reform bill which is expected to reduce substantially indemnity benefit periods in Pennsylvania. In addition to regulatory reforms, the loss ratios have been favorably impacted by the conversion to loss-sensitive and alternative market products. Such a trend is evidenced by the fact that accident year pure loss ratios (losses recorded for the year in which the event occurred expressed as a percentage of the earned premiums for that year) for workers' compensation have been generally lower in more recent accident years, as the following chart indicates: Property and Casualty Group's Workers' Compensation Undiscounted Accident Year ------------------------------------------------------------------------------ Pure Loss Ratios as of December 31, 1997 ---------------------------------------- Accident Years Loss Ratios -------------- ----------- 1990 100% 1991 86% 1992 80% 1993 64% 1994 64% 1995 63% 1996 63% 1997 66% In addition, management took several steps to reduce the outstanding claims associated with the Pennsylvania workers' compensation business written through 1991. A formal commutation program was initiated in the fourth quarter of 1996 and continued into late 1997. Commutations are agreements with claimants whereby the claimants, in exchange for a lump sum payment, release their rights to future indemnity payments from the Property and Casualty Group. Under Pennsylvania workers' compensation laws, the claimant and the Pennsylvania Workers' Compensation Board must approve all such commutation arrangements. The Property and Casualty Group paid $101.1 million and $17.8 million in 1997 and the fourth quarter of 1996, respectively, to commute workers' compensation indemnity claims. Savings associated with these claims were consistent with management's expectations. The number of open claims for accident years 1991 and prior was substantially reduced as a result of the commutation program. This reduction in open claims is expected to reduce the possibility of any further adverse development on such reserves, although there can be no assurance that the level of commutations will have a significant impact on the future development of such reserves. Estimating reserves for workers' compensation claims can be more difficult than many other lines of property and casualty insurance for several reasons, including (i) the long payment "tail" associated with the business; (ii) the impact of social, political and regulatory trends on benefit levels for both medical and indemnity payments; (iii) the impact of economic trends and (iv) the impact of changes in the mix of business. At various times, one or a combination of such factors can make the interpretation of actuarial data associated with workers' compensation loss development more difficult, and it can take additional time to recognize changes in loss development patterns. Under such circumstances, adjustments will - 117 - be made to such reserves as loss patterns develop and new information becomes available and such adjustments may be material. The adverse development in reserves associated with asbestos and environmental claims is the result of a detailed analysis completed in 1996 of loss and LAE reserves associated with asbestos and environmental liability claims. The reserving for asbestos and environmental claims has undergone change at both the Company and in the insurance industry in general. For environmental and asbestos liability claims, reserving methodology has been evolving into accepted industry practice in the recent past. The Company's actuaries were able to apply these methods to the Company's loss reserves in 1997 and 1996. 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 method of reserving for environmental and toxic tort liabilities. The methods employed by the Company prior to the review performed in 1996 included a review of aggregate loss and loss adjustment paid and case incurred data along with resulting "survival ratios" to establish IBNR for environmental and toxic tort claims. For asbestos claims, the Company had previously reserved costs to defend, and any indemnification payments anticipated on, claims for which it had received notice that it was a responsible party, plus a bulk factor applied to the estimated case reserves to provide for potential development of indemnification and defense cost related to such claims. In 1996, the Company performed a ground up analysis of asbestos loss reserves using an actuarially accepted modeling technique. Using historical information as a base and information obtained from a review of open claims files, assumptions were made about future claims activity in order to estimate ultimate losses. For each individual major account, projections were made regarding new plaintiffs per year, the number of years new claims will be reported, the average loss severity per plaintiff and the ratio of loss adjustment expense to loss. In many cases involving larger asbestos claims, the Company reserved up to the policy limits for the applicable loss coverage parts for the affected accounts. Policy terms and reinsurance treaties were applied in the modeling of future losses. Estimation of obligations for asbestos and environmental exposures continues to be more difficult than for other loss reserves 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. The Company's asbestos-related loss reserves for the years ended December 31, 1997, 1996 and 1995 were as follows: (dollar amounts in thousands) 1997 1996 1995 -------- --------- -------- Gross of reinsurance: Beginning reserves......................... $80,055 $ 27,611 $13,969 Incurred losses and LAE.................... 2,435 62,854 22,482 Calendar year payments for losses and LAE.. (5,764) (10,410) (8,840) ------- -------- ------- Ending reserves............................ $76,726 $ 80,055 $27,611 ======= ======== ======= - 118 - Net of reinsurance: Beginning reserves......................... $53,300 $ 23,443 $ 8,168 Incurred losses and LAE.................... (36) 39,427 21,826 Calendar year payments for losses and LAE.. (4,686) (9,570) (6,551) ------- -------- ------- Ending reserves............................ $48,578 $ 53,300 $23,443 ======= ======== ======= The Company's environmental-related loss reserves for the years ended December 31, 1997, 1996 and 1995 were as follows: (dollar amounts in thousands) 1997 1996 1995 -------- -------- -------- Gross of reinsurance: Beginning reserves............................. $35,626 $20,134 $20,952 Incurred losses and LAE........................ 1,130 22,143 3,516 Reserves acquired through purchase of Caliber One Indemnity Company(1).................... 13,060 -- -- Calendar year payments for losses and LAE...... (4,708) (6,651) (4,334) ------- ------- ------- Ending reserves................................ $45,108 $35,626 $20,134 ======= ======= ======= Net of reinsurance: Beginning reserves............................. $34,592 $20,134 $20,952 Incurred losses and LAE........................ 1,068 21,109 3,516 Calendar year payments for losses and LAE...... (3,965) (6,651) (4,334) ------- ------- ------- Ending reserves................................ $31,695 $34,592 $20,134 ======= ======= ======= - ---------------------- (1) Such acquired reserves have been reinsured by an affiliate of the former parent. See "Caliber One." Of the total net asbestos reserves, $6.7 million, $6.8 million and $6.7 million related to established claims reserves at December 31, 1997, 1996 and 1995, respectively, and $41.9 million, $46.5 million and $16.7 million related to IBNR at December 31, 1997, 1996 and 1995, respectively. Of the total net environmental reserves, $11.2 million, $12.5 million and $10.3 million related to established claims reserves at December 31, 1997, 1996 and 1995, respectively, and $20.5 million, $22.1 million and $9.8 million related to IBNR at December 31, 1997, 1996 and 1995, respectively. All incurred asbestos and environmental losses were for accident years 1986 and prior. Management believes that the Property and Casualty Group's 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 and other factors, the ultimate exposure to the Property and Casualty Group for these claims may vary significantly from the amounts currently recorded, resulting in a potential future adjustment in the claims reserves recorded. In addition, issues involving policy provisions, allocation of liability among participating insurers, proof of coverage and other factors make quantification of liabilities exceptionally difficult and subject to adjustment based upon newly available data. - 119 - In 1996, Commercial Lines experienced reserve strengthening of $21.0 million compared to a reserve release of $11.6 million in 1995. The reserve strengthening in 1996 was principally due to a re-estimation of loss adjustment costs associated with general liability claims. Through 1991, the Property and Casualty Group's mix of general liability insurance policies were weighted towards the manufacturing classes of business. Subsequent to 1991, the Property and Casualty Group's mix of business became more heavily weighted towards the construction and contracting classes of business. These particular classes of business have experienced losses due to construction defects and similar matters that have taken longer to emerge than the classes of business previously written by the Property and Casualty Group. Defense costs associated with these claims have also exceeded the original estimate of the Property and Casualty Group's management, which was based on the patterns of indemnification payments associated with the earlier classes of business written. When this issue was discovered, the Property and Casualty Group factored the increased defense costs and the emergence pattern in determining a more appropriate reserve amount for loss handling costs. The release of reserves in 1995 was primarily due to favorable loss experience in commercial automobile business. Unpaid losses on workers' compensation claims for the Company were approximately $816.0 million and $1,012.0 million, net of discount of $460.2 million and $514.2 million, at December 31, 1997 and 1996, respectively. The approximate discount rate utilized was 5.0% at December 31, 1997 and 1996. In 1995, the Property and Casualty Group's domestic insurance subsidiaries changed the discount rate with respect to their workers' compensation unpaid losses from approximately 4% to 5% for SAP and GAAP purposes. This change was approved and is permitted by the Pennsylvania Insurance Department. The effect on losses incurred in 1995 was a reduction of $35.0 million. Loss reserves on other lines of business as well as reserves for LAE for all lines of business are not discounted. For the six-month period ended June 30, 1998 and 1997, respectively, accretion of discount amounted to $14.4 million and $23.8 million. As of June 30, 1998, the total discount was approximately $437.0 million, comprised as follows: the Pooled Companies, $114.6 million; MASCCO, $55.4 million, PMA Cayman, $226.2 million; other Property and Casualty Group entities, $6.5 million and PMA Re, $34.3 million. PMA Re has reported net favorable development of unpaid losses and LAE of $23.3 million in 1997, $28.6 million in 1996 and $15.0 million in 1995 primarily for accident years 1993 and prior. Such favorable development is attributable to losses emerging at a lower rate than was anticipated (based upon historical loss development patterns) when the initial accident year reserves were established. While loss emergence patterns have been trending downward for the pre-1993 accident years, resulting in favorable loss reserve development, there can be no assurance that such trend will continue in the future. Immediately prior to and in conjunction with the acquisition of Caliber One Indemnity Company (see "Caliber One"), all of Caliber One Indemnity Company's acquired loss reserves were reinsured by an insurance affiliate of its former parent (the "Reserve Guarantee"). The Reserve Guarantee covers adverse development and uncollectible reinsurance in an amount equal to the stated amount of the reserves acquired, plus an additional $68.5 million. Upon the purchase of Caliber One Indemnity Company, management of the Company valued the amount of the Reserve Guarantee at approximately $5.0 million in excess of the stated acquired reserves . Management of the Company believes that the Reserve Guarantee will be adequate to cover any future adverse reserve development or uncollectible reinsurance on the acquired reserves. At December 31, 1997, $36.8 million was recoverable under the Reserve Guarantee, which is included in reinsurance receivables as of that date. The Compnay is accounting for the Reserve Guarantee in conformity with EITF Topic D-54, "Accounting by the Purchaser for a Seller's Guarantee of the Adequacy of Liabilities for Losses and Loss Adjustment Expenses of an Insurance Enterprise Acquired in a Purchase Business Combination," and accordingly, any future revisions to the estimates of the amount of underlying loss reserves and the amount recoverable under the Reserve Guarantee will be recognized in losses and loss adjustment expenses in the period in which the estimates are changed. At December 31, 1997, the Company's loss reserves were stated net of $59.9 million of salvage and subrogation, of which $50.8 million related to the Property and Casualty Group, which was comprised of $46.0 million related to workers' compensation and $4.8 million related to Commercial Lines. The anticipated salvage and subrogation was $9.1 million for PMA Re. Incurred salvage and subrogation (increased) reduced losses and LAE by ($18.5) million, ($0.6) million and $9.5 million in 1997, 1996 and 1995, respectively. 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 projected to an ultimate basis using actuarial projection techniques. - 120 - 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 historic paid data implicitly considers realization and collectibility. Recent Developments PMA Re and the Property and Casualty Group posted favorable loss reserve development during the six-month period ended June 30, 1998 of $8.3 million and $1.7 million ($1.5 million excluding Run-off Operations), respectively. PMA Re's favorable loss reserve development is attributable to losses emerging at a lesser rate than was expected when the reserves for the applicable accident years were established, resulting in downward revisions of loss reserve estimates. The favorable development of the Property and Casualty Group's loss reserves is primarily attributable to recently established programs to control medical costs further and reductions in LAE for workers' compensation. Medical costs have improved primarily due to the Property and Casualty Group's affiliation with a national preferred provider organization, which became effective January 1998. This affiliation has enabled the Property and Casualty Group to lower its cost in providing medical benefits to injured workers. Loss adjustment expenses have decreased primarily due to continued use of certain claims resolution practices. By using techniques such as managed care and commutations, the Property and Casualty Group has reduced the amount and number of outstanding claims and the amount of time that a claim remains open, which in turn has lowered costs associated with managing open claims. - 121 - 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. In addition to competition from other insurance companies, the Property and Casualty 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. PMA Re competes with other reinsurers in the brokered market as well as reinsurers that directly underwrite reinsurance business. 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. The Property and Casualty Group, PMA Re 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 return targets. Given the present soft pricing environment, competing solely on the basis of price has become increasingly difficult for the Property and Casualty Group and PMA Re, and both have had to reject risks submitted and non-renew certain accounts in recent years, as the market rates for such risks did not provide the opportunity to achieve what management considers to be an acceptable return. In terms of service, management maintains service standards to ensure that clients are satisfied with the products and services provided by the Company. Such standards have been designed to emphasize prompt turn-around time for underwriting submissions, access to information, claims handling and the quality of other services. Management periodically participates in surveys of intermediaries and clients to gain an understanding of the perceptions of the Company's service compared to its competitors. Management attempts to design products that meet the needs of clients in the Company's markets. In recent years, the Property and Casualty Group has developed products that reflect the evolving nature of the workers' compensation market. Specifically, - 124 - management has increased its focus on rehabilitation and managed care to keep workers' compensation costs lower for the employers. In addition, the Property and Casualty Group has introduced and refined alternative market products, as well as unbundled risk management and claims administration services. See "The Property and Casualty Group." PMA Re has also expanded its product line in recent years to satisfy the needs of its client base. Products introduced by PMA Re in the last two years include facultative reinsurance, finite risk reinsurance and integrated capital management (which involves providing reinsurance as well as some type of direct investment in a ceding company). See "PMA Re." For Caliber One, it is management's intention to design products that meet the needs of new classes of business and that cover emerging risks. See "Caliber One." Management continues to review new product opportunities for the Property and Casualty Group, PMA Re and Caliber One. For many intermediaries and clients, financial security is measured by the ratings assigned by independent rating agencies. Therefore, management believes that the ratings assigned by independent rating agencies, particularly A.M. Best, are material to the Company's operations. A.M. Best has currently assigned an "A+" (Superior) rating to PMA Reinsurance Corporation, an "A-" (Excellent) rating to the Pooled Companies and an "A" (Excellent) to Caliber One Indemnity Company. A.M. Best's ratings are based on an analysis of an insurance company's perceived financial strength and its ability to pay obligations to its policyholders and are not directed toward the protection of investors. No assurance can be given that PMA Reinsurance Corporation, the Pooled Companies and Caliber One Indemnity Company can maintain these ratings. The Company is also presently seeking ratings of its insurance subsidiaries from Standard & Poor's and Moody's. In addition, there can be no assurance that ratings to be received from Standard & Poor's and Moody's will not have a detrimental effect on the Company's competitive position. Employees As of June 30, 1998, the Company had 986 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. Properties The Company's headquarters are located in a four story, 110,000 square foot building in Blue Bell, Pennsylvania. PMA Re's headquarters are located in 78,000 square feet of leased space in Mellon Bank Center, Philadelphia, 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 properties are suitable and adequate for its current business operations. - 125 - Legal Proceedings The Company's insurance subsidiaries are defendants in actions arising out of their insurance business and from time to time are involved in various governmental and administrative proceedings. These actions include lawsuits seeking coverage for alleged damages relating to exposure to asbestos and other toxic substances and environmental clean-up actions under federal and state law. In the opinion of management, the resolution of these matters will not have a material adverse effect on the Company's financial condition, results of operations or cash flows. See "Business-Loss Reserves" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." - 126 - SUPERVISION AND REGULATION 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 45 states and the District of Columbia. Caliber One Indemnity Company is licensed in one state and is approved as a surplus lines carrier in 38 states, Puerto Rico and the District of Columbia. The Company's insurance subsidiaries are authorized and regulated in all jurisdictions where they conduct insurance business. Inasmuch as PMA Reinsurance Corporation and the Pooled Companies are domiciled in Pennsylvania, however, the Pennsylvania Insurance Department exercises principal regulatory jurisdiction over them, 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 all lines of business written by the Pooled Companies, 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. 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. Approximately once every three to five years as part of their routine regulatory oversight process, state insurance departments conduct detailed examinations of the books, records and accounts of insurance companies domiciled in their states. Such examinations are generally conducted in cooperation with the departments of two or three other states under guidelines promulgated by the NAIC. The Pennsylvania Insurance Department last issued examinations reports for PMA Reinsurance Corporation and the Pooled Companies as of December 31, 1992, and the Delaware Department of Insurance last conducted an examination of Caliber One Indemnity Company as of December 31, 1996. No adjustments to previously filed statutory financial statements were required as a result of such examinations. In addition, there were no substantive qualitative matters indicated in the examination reports that had or are expected to have a material adverse impact on the operations of PMA Reinsurance Corporation, the Pooled Companies or Caliber One Indemnity Company. The Pennsylvania Insurance Department is currently conducting examinations of PMA Reinsurance Corporation and the Pooled Companies as of December 31, 1997. The Pennsylvania Insurance Department has raised no material issues in connection with the pending examination. In supervising and regulating insurance companies, including reinsurers, 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 the protection of policyholders and the public. Every state in which the Company's insurance subsidiaries are licensed administers a guaranty fund, which provides for assessments of licensed insurers for the protection of policyholders of insolvent insurance companies. There has been an increase in the number of insurance companies that are under supervision that has resulted in an increase in the - 127 - amount of assessments to cover losses to policyholders of such companies. The Company's insurance subsidiaries have made accruals for their portion of assessments related to such insolvencies based upon the most current information furnished by the guaranty associations. During the five years ended December 31, 1997 and the six months ended June 30, 1998, the amount of such insolvency assessments paid by the Company's insurance subsidiaries has not been material. Management cannot reasonably predict the amount of future assessments, if any. Recently, the insurance regulatory framework has been placed under increased scrutiny by various states, the federal government and the NAIC. Various states have considered or enacted legislation which changes, and in many cases increases, the state's authority to regulate insurance companies. Although legislation has been under consideration for several years in Congress, which, if enacted, would result in the federal government assuming some role in the regulation of insurance companies, management does not expect the current Congress to enact federal insurance regulation. The NAIC, in conjunction with the state regulators, has been reviewing existing insurance laws and regulations. The NAIC recently approved and recommended to the states for adoption and implementation several regulatory initiatives designed to reduce the risk of insurance company insolvencies. Through the NAIC accreditation program, these recommendations for state legislation have taken an increased significance. Two such initiatives that have been adopted by the NAIC are risk- based capital standards ("RBC") and a model investment law. 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. Such laws also require that intercompany transactions be fair and reasonable and that an insurer's surplus as regards policyholders 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 Commissioner(s) for such acquisition of control. Pursuant to Pennsylvania and Delaware law, any person acquiring, controlling or holding with 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(s), 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(s) of any acquisition of control of an insurance company, the proposed acquirer - 128 - must file with the Commissioner(s) 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 effect 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 such jurisdictions. Additional requirements in such jurisdictions may include re-licensing or subsequent approval for renewal of existing licenses upon an acquisition of control. As further described below, laws also govern the holding company structure payment of dividends by the Company's insurance subsidiaries to the Company. Restrictions on Subsidiaries' Dividends and Other Payments PMC is an insurance holding company whose assets consist principally of all of the outstanding common stock of its insurance subsidiaries. PMC's ongoing ability to pay dividends to its shareholders and meet its other obligations, including operating expenses and any principal and interest on debt (including the Junior Subordinated Debentures), 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 PMC and its subsidiaries and loans. The payment of dividends by PMC's subsidiaries to PMC is regulated under the insurance laws of Pennsylvania and Delaware (such laws are substantially similar). 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 law, PMC's Pennsylvania-domiciled 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 certain statutory limitations. The current statutory limitation is the greater of (i) of 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. Based upon this limitation and the 1997 statutory results of PMA Reinsurance Corporation and the Pooled Companies, PMA Reinsurance Corporation and the Pooled Companies have the legal capacity to pay $48.7 million in dividends in the aggregate to PMC in 1998 without obtaining the approval of the Pennsylvania Insurance Commissioner. Through September 1, 1998, $18.0 million of dividends had been declared, of which $10.0 million has been paid. 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. 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 PMC. As noted above, the Delaware insurance law provisions restricting dividends by insurers are substantially similar to such provisions under Pennsylvania insurance laws. During 1998, Caliber One Indemnity Company may pay up to $2.5 million of dividends to PMA Reinsurance Corporation without the prior approval of the Delaware Insurance Commissioner. During 1998, no dividends have been 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 PMC in the future is reduced or eliminated, PMC's ability to pay - 129 - principal and interest on and redeem the Junior Subordinated Debentures 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 PMC to apply payments received from one insurance subsidiary for the benefit of another insurance subsidiary of PMC. In addition to regulatory restrictions on dividends, the Company's Credit Facilities also impose restrictions on the ability of the Company's insurance subsidiaries to pay dividends. Under these restrictions, the statutory surplus of PMC'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 230% for the Pooled Companies in 1998, increasing to 240% thereafter). As of June 30, 1998, the Company's insurance subsidiaries reported combined statutory surplus of $561.1 million, and, as of December 31, 1997, PMA Reinsurance Corporation's risk-based capital ratio was 355% and the Pooled Companies' ratios ranged from 293% to 324%. Risk-Based Capital The NAIC has adopted risk-based capital 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, also as defined by the NAIC. Companies below prescribed trigger points in terms of such ratio are classified as follows: Company action level............. 200% Regulatory action level.......... 150% Authorized control level......... 100% Mandatory control level.......... 70% At December 31, 1997, the ratios of the Pooled Companies ranged from 293% to 324%, PMA Reinsurance Corporation's ratio was 355% and Caliber One Indemnity Company's ratio was 1,922%. As a result, the RBC requirements are not expected to have an adverse impact on the operations, financial condition or operating results of the Company's insurance subsidiaries. RBC requirements for property and casualty insurance companies allow a discount for workers' compensation reserves to be included in the adjusted surplus calculation. However, the calculation for RBC requires the phase-out of non-tabular reserve discount previously taken for workers' compensation reserves by 1998. As a result, this phase-out negatively impacts the RBC ratios of companies that write workers' compensation insurance and discount such reserves on a non-tabular basis to companies that write other types of property and casualty insurance. Management believes that the Pooled Companies will be able to maintain their RBC in excess of regulatory requirements through prudent underwriting and claims - 130 - handling, investing and capital management. However, no assurances can be given that developments affecting the Property and Casualty Group, 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 Property and Casualty Group writes business, will cause the Pooled Companies' RBC to fall below required levels resulting in a corresponding regulatory response. IRIS Ratios One method utilized by state insurance regulators to monitor the solvency of insurers are twelve financial ratios (the "IRIS ratios") developed by the NAIC. The IRIS ratios were developed by insurance regulators, in conjunction with other regulatory and financial monitoring systems (such as risk-based capital), to provide an early warning system for determining whether an insurer is experiencing financial difficulties. The general categories of IRIS ratios are operating leverage and growth, liquidity, surplus/surplus quality, historical profitability and loss reserves. The ratios are formula-driven based upon line items in an insurer's annual statement provided to state insurance regulators, and each ratio has a guideline which stipulates the range of reported values considered to be normal. Such guideline ranges are the same for all companies. Generally, if a company reports four of more ratios outside of the normal ranges (i.e., "unusual values"), it prompts additional inquiries from state insurance regulators. In 1997 and 1996, the Pooled Companies and MASCCO reported unusual values in certain IRIS ratios primarily resulting from the reserve strengthening and restructuring charges recorded during 1996 and the establishment of the Run-off Operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." In 1997, the Pooled Companies reported unusual values for three of the twelve IRIS ratios: the Two-year Overall Operating Ratio, its Two-year Reserve Development to Surplus Ratio and Estimated Current Reserve Deficiency to Surplus Ratio. During 1996, the Pooled Companies reported unusual values in five IRIS ratios, which included the One-year Reserve Development to Surplus Ratio and Change in Surplus Ratio in addition to the IRIS ratios for which the Pooled Companies reported unusual values in 1997. The Two-year Overall Operating Ratio is the sum of a company's two-year loss ratio and two-year expense ratio (underwriting expenses divided by net premiums written) offset by its two-year investment income ratio (net investment income divided by net premiums earned). The Pooled Companies' results for the Two-year Overall Operating Ratio ranged from 123% to 130% at December 31, 1997, compared to the guideline ratio of 100%. These unusual values resulted from the reserve strengthening and restructuring charges recorded during 1996. The Two-year Reserve Development to Surplus Ratio, which is the average of the prior two years' development of loss reserves divided by surplus, ranged from 20% to 21% for the Pooled Companies at December 31, 1997 or slightly in excess of the guideline ratio of 20%. These unusual values resulted from the aforementioned reserve strengthening which occurred during 1996. The Estimated Current Reserve Deficiency to Surplus Ratio is the difference between a formula driven estimate of loss reserves (which is based on paid losses compared to earned premiums and is not an actuarial calculation) and the reserves carried on the financial statements, divided by surplus. The Pooled Companies' ratios ranged from 50% to 64% at December 31, 1997 compared to a guideline ratio range of 25%. These unusual values resulted from the commutation program initiated by the Pooled Companies in 1997, which accelerated loss payments in 1997 compared to earned premiums in prior years. In 1996, in addition to reporting unusual values for the above three IRIS ratios, the Pooled Companies had unusual values for two additional IRIS ratios, Change in Surplus Ratio (the difference in surplus between the current and prior year divided by the prior year's surplus) and One-year Reserve Development to Surplus Ratio (one-year loss reserve development divided by surplus), due to the reserve strengthening and restructuring charges recorded in 1996. In 1997 and 1996, MASCCO reported unusual values for three of the twelve IRIS ratios. The Two-year Overall Operating Ratio and Change in Surplus Ratio reflected unusual values for both years. MASCCO's Two-year Overall Operating Ratio was 159% and 117% for 1997 and 1996, respectively, compared to a guideline ratio of 100%, and MASCCO's Change in Surplus Ratio was -13% and 132% for 1997 and 1996, respectively, compared to a guideline range of -10% to 50%. These unusual values were the result of an intercompany reinsurance agreement which was consummated at the end of 1996 relating to the establishment of the Run-off Operations. During 1997, the ratio for Change in Net Writings was -99% compared to a guideline ratio of -33% resulting from the discontinuance of premium writings in MASCCO at December 31, 1996. During 1996, Investment Yield for MASCCO was lower than the guideline range due to a large increase in investments in December of 1996 that resulted from an intercompany transfer of investments and loss reserves related to the aforementioned intercompany reinsurance agreement. The reporting of the above unusual values did not result in any significant unresolved issues with insurance regulators. MANAGEMENT The executive officers and directors of the Company are as follows: Name Age Position - --------------------------- --- ---------------------------------------------- Frederick W. Anton III..... 64 Chairman of the Board John W. Smithson........... 52 President and Chief Executive Officer Francis W. McDonnell....... 42 Senior Vice President, Chief Financial Officer and Treasurer Vincent T. Donnelly........ 45 President and Chief Operating Officer - The Property and Casualty Group Stephen G. Tirney.......... 45 President and Chief Operating Officer - PMA Re Ronald S. Austin........... 41 President and Chief Operating Officer - Caliber One Paul I. Detwiler, Jr....... 65 Director Joseph H. Foster........... 70 Director Anne S. Genter............. 63 Director James F. Malone III........ 55 Director A. John May................ 70 Director Louis N. McCarter III...... 69 Director John W. Miller, Jr., M.D... 64 Director Edward H. Owlett........... 71 Director Louis I. Pollock........... 68 Director Roderic H. Ross............ 68 Director L.J. Rowell, Jr............ 66 Director Frederick W. Anton III has served as Chairman of the Board since 1995 and as a director of the Company since 1972. Mr. Anton's current term as a director of the Company expires in 2000. Mr. Anton served as Chairman of the Board and Chief Executive Officer from 1995 to May 1997, as President and Chief Executive Officer from 1981 to 1995, as President - 131 - of The Property and Casualty Group from 1972 to 1989 and as Secretary and General Counsel of PMAIC from 1962 to 1972. 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's current term as a director of the Company expires in 1999. Mr. Smithson has served as President and Chief Operating Officer of the Company from 1995 to May 1997, as Chairman, President and Chief Executive Officer of PMA Re from 1984 to 1997 and as Chairman, President and Chief Executive Officer of the Property and Casualty Group from April 1995 to 1997, and was employed by PMAIC from 1972 to 1984. Mr. Smithson is a designated Chartered Property-Casualty Underwriter. 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 Re since 1995. From 1993 to 1995, Mr. McDonnell served as Vice President Finance of PMA Re. Prior to joining PMA Re in 1993, Mr. McDonnell served in various controllership positions with Reliance Insurance Company from 1985 to 1993. Mr. McDonnell is a certified public accountant and a designated Chartered Property- Casualty Underwriter. Vincent T. Donnelly has served as President and Chief Operating Officer of the Property and Casualty Group since February 1997. Mr. Donnelly served as Senior Vice President - Finance and Chief Actuary of the Property and Casualty Group from 1992 to 1997. Prior to joining the Property and Casualty Group, Mr. Donnelly served as Vice President and Actuary of Continental Insurance Company from 1987 to 1992 and as Actuary of American International Group, a property and casualty insurance company, from 1978 to 1987. Mr. Donnelly is a Fellow of the Casualty Actuarial Society and a member of the American Academy of Actuaries. Stephen G. Tirney has served as President and Chief Operating Officer of PMA Re since 1997. Mr. Tirney served as Executive Vice President of PMA Re from 1993 to 1997, as Senior Vice President of PMA Re from 1989 to 1993 and has been an employee of PMA Re since 1976. Ronald S. Austin was hired in 1997 as the President and Chief Operating Officer of Caliber One. From 1988 to 1997, Mr. Austin served as an officer and director of General Star Management Company, a member of the General Reinsurance Group. Paul I. Detwiler, Jr., a director since 1984, has served as Chairman of the Board of New Enterprise Stone & Lime Co., a quarrying and construction company, since 1990. Mr. Detwiler's current term as a director of the Company expires in 1999. Mr. Detwiler is also a director of Keystone Financial, Inc. Joseph H. Foster, a director since 1982, has been a partner of White & Williams, a law firm, since 1958. Mr. Foster's current term as a director of the Company expires in 2000. - 132 - Anne S. Genter, a director since 1991, has served as President of Anne S. Genter Interior Design, an interior design company, since 1975. Ms. Genter's current term as a director of the Company expires in 1999. James F. Malone III, a director since 1974, has been a partner of Malone, Larchuk & Middleman, P.C., a law firm, since 1997 and from 1980 to 1997 was a partner of Dickie, McCamey & Chilcote, P.C., a law firm. Mr. Malone's current term as a director of the Company expires in 2000. A. John May, a director since 1977, has been a partner of Duane, Morris & Heckscher LLP, a law firm, since 1963. Mr. May's current term as a director of the Company expires in 1999. Louis N. McCarter III a director since 1975, has been President of the McCarter Corp., a manufacturer of specialized mixing machinery, since 1954. Mr. McCarter's current term as a director of the Company expires in 2001. John W. Miller, Jr., M.D., a director since 1988, has been a physician and has served as President of Ear, Nose and Throat Associates of Lancaster since 1970. Dr. Miller's current term as a director of the Company expires in 2001. Edward H. Owlett, a director since 1964, has been a partner of Owlett, Lewis & Ginn, P.C., a law firm, since 1981. From 1960 to 1981, Mr. Owlett served as a partner of Cox, Wilcox, Owlett & Lewis, a law firm. Mr. Owlett's current term as a director of the Company expires in 2001. Mr. Owlett is also a director of Citizens and Northern Corporation. Louis I. Pollock, a director since 1984, has served as President and Chief Executive Officer of Morris Coupling Company, a manufacturer of pipe and tubing, since 1957. Mr. Pollock's current term as a director of the Company expires in 2001. Roderic H. Ross, a director since 1981, has served as Chairman of the Board and Chief Executive Officer of Keystone State Life Insurance Company since 1985. Prior to 1985, Mr. Ross held various positions at Philadelphia Life Insurance Company and was an employee of Philadelphia Life Insurance Company from 1970 to 1984. Mr. Ross' current term as a director of the Company expires in 1999. Mr. Ross is also a director of Hunt Manufacturing Co. and PNC Bank Corp. L. J. Rowell, Jr., a director since 1992, was Chairman, President and Chief Executive Officer of Provident Mutual Life Insurance Company from 1992 until his retirement in July 1996. Prior to 1992, Mr. Rowell held various positions at Provident Mutual and was an employee of Provident Mutual from 1980 until July 1996. Mr. Rowell's current term as a director of the Company expires in 2000. The Board of Directors of the Company is divided into three classes, and the directors of each class are elected for a term of three years and until their successors are elected and qualified or until their earlier death, resignation or removal. Prior to each election of a class of directors, the Board of Directors must fix the size of that class of directors at a minimum of four and a maximum of eight directors. Every director must be a shareholder of the - 133 - Company. No person may be considered as a candidate, and no votes may be counted for any person, unless written notice of such person's nomination or candidacy has been filed with the Secretary of the Company not less than 60 days prior to the date of election; provided, however, that nominees selected by the then existing Board of Directors or nominating committee appointed by the Board of Directors may be candidates and voted for without such notice. DESCRIPTION OF THE CAPITAL SECURITIES The trust agreement between PMC as Depositor and The Bank of New York (Delaware), as Delaware Trustee, authorized and created the Issuer. The Amended and Restated Trust Agreement among PMC as Depositor, The Bank of New York (Delaware) as Delaware Trustee and The Bank of New York as Property Trustee and the Administrative Trustees named therein is referred to herein as the "Trust Agreement". The Trust Agreement will be qualified under the Trust Indenture Act. The Property Trustee, The Bank of New York, will act as the indenture trustee for purposes of compliance with the provisions of the Trust Indenture Act. The Capital Securities and the Common Securities (together, the "Trust Securities") will be issued by the Administrative Trustees on behalf of the Issuer pursuant to the terms of the Trust Agreement. The Capital Securities represent undivided beneficial interests in the Issuer and entitle the holders thereof to a preference in certain circumstances with respect to distributions and amounts payable on redemption or liquidation over the Common Securities, as well as other benefits as described in the Trust Agreement. The following statements relating to the provisions of the Trust Agreement summarize the material provisions of the Trust Agreement. Reference is made to the provisions of the Trust Agreement, the form of which is filed as an exhibit to the Registration Statement of which this Prospectus forms a part, and the Trust Indenture Act for a more complete description of the provisions summarized herein, and each such statement shall be deemed qualified in its entirety by such reference. Wherever particular sections of the Trust Agreement are referred to, such sections are incorporated herein by reference. Section references used herein are references to provisions of the Trust Agreement, unless otherwise noted. General The Issuer is a Delaware statutory business trust. PMC, the Depositor, will own, directly or indirectly, all of the outstanding Common Securities of the Trust. The Common Securities rank pari passu, and payments will be made thereon pro rata, with the Capital Securities except as described under "--Subordination of Common Securities." (Section 4.03.) The Junior Subordinated Debentures will be owned by the Property Trustee and held in trust for the benefit of the Trust and the holders of the Trust Securities. (Section 2.09.) Pursuant to the Guarantee, PMC fully and unconditionally guarantees the payment of distributions (as defined below) and amounts payable on redemption of the Capital Securities or liquidation of the Issuer, but does not guarantee such payments when the Issuer does not have funds available to pay such amounts. The Trustees Pursuant to the Trust Agreement, the number of the Issuer's trustees (the "Trustees") initially will be four. (Section 8.17.) In addition to the Property Trustee, the Issuer initially will have three Administrative Trustees who will be officers or employees of, or otherwise affiliated - 134 - with PMC. The Administrative Trustees are authorized and directed to conduct the affairs of the Issuer and to operate the Issuer such that the Issuer will not be deemed to be an "investment company" required to be registered under the Investment Company Act or fail or cease to qualify as a grantor trust for United States federal income tax purposes and so that the Junior Subordinated Debentures will be treated as indebtedness of PMC for United States federal income tax purposes. In this connection, PMC and the Administrative Trustees are authorized to take any action, not inconsistent with applicable law, the certificate of trust of the Issuer or the Trust Agreement, that each of PMC and the Administrative Trustees determines in its discretion to be necessary or desirable for such purposes, as long as such action does not adversely affect, in any material respect, the interests of the holders of the Capital Securities. (Section 2.07(d).) Subject to the specific authority and duties of the Property Trustee, the Trust Agreement provides the Administrative Trustees with exclusive and complete authority to operate and carry out the purposes of the Issuer. As among the Trustees, the Administrative Trustees have the power, duty and authority to act on behalf of the Issuer with respect to (A) the issuance and sale of the Trust Securities, (B) to cause the Issuer to enter into, and to execute, deliver and perform on behalf of the Issuer, certain agreements necessary or desirable in connection with the purposes and function of the Trust, (C) assisting in any registration of the Capital Securities under the Securities Act and under state securities or blue sky laws, and the qualification of the Trust Agreement under the Trust Indenture Act, (D) assisting in any quotation or listing of the Capital Securities upon the Nasdaq National Market or such securities exchange or exchanges as determined by PMC and the registration of the Capital Securities under the Securities Exchange Act, and the preparation and filing of all periodic and other reports and other documents pursuant to the foregoing, (E) the sending of notices (other than notices of default) and other information regarding the Trust Securities and the Junior Subordinated Debentures to the holders of Trust Securities, (F) the consent to the appointment of certain agents in accordance with the Trust Agreement and (G) certain other functions relating to the registration of stock transfers, the winding up and liquidation of the Issuer and the execution of documents and actions incidental to the foregoing. As set forth in greater detail below, the Property Trustee has the power, duty and authority to act on behalf of the Issuer with respect to (A) establishment of a payment account, (B) the receipt of the Junior Subordinated Debentures, (C) the collection and distribution of amounts due under the Junior Subordinated Debentures, (D) the exercise of all of the rights, powers and privileges of a holder of the Junior Subordinated Debentures, (E) the sending of notices of default and other information regarding the Trust Securities and the Junior Subordinated Debentures to the holders of the Trust Securities, (F) the distribution of the Trust Property in accordance with the Trust Agreement and certain other functions relating to the winding up and liquidation of the Issuer and the protection and conservation of the Trust Property after an Event of Default (as defined below). (Section 2.07(a).) The Property Trustee, other than during the occurrence and continuance of an Event of Default, undertakes to perform only such duties as are specifically set forth in the Trust Agreement and pursuant to the Trust Indenture Act and, after such Event of Default, must exercise the same degree of care and skill as a prudent person would exercise or use in the conduct of his or her own affairs. Subject to this provision, the Property Trustee is under no obligation to exercise any of the powers vested in it by the Trust Agreement at the request of any holder of Capital Securities unless it is offered reasonable indemnity against the costs, expenses and liabilities that might be - 135 - incurred thereby. (Section 8.01(a) and (c).) If no Event of Default has occurred and is continuing and the Property Trustee is required to decide between alternative causes of action, construe ambiguous provisions in the Trust Agreement or is unsure of the application of any provision of the Trust Agreement, and the matter is not one on which holders of Capital Securities are entitled under the Trust Agreement to vote, then the Property Trustee shall take such action as is directed by PMC and if not so directed, shall take such action as it deems advisable and in the best interests of the holders of the Trust Securities and will have no liability except for its own bad faith, negligence or willful misconduct. (Section 8.03.) Distributions The Capital Securities represent undivided beneficial interests in the assets of the Issuer, and the distributions on each Capital Security will be payable at a rate per annum of __% of the stated amount of $1,000 per Capital Security (the "Liquidation Amount"). The amount of distributions payable for any period will be computed on the basis of a 360-day year of twelve 30-day months. (Section 4.01(a).) See "Description of the Junior Subordinated Debentures-- Interest" and "Description of the Junior Subordinated Debentures--Option to Extend Interest Payment Period." Distributions on the Capital Securities will be cumulative, will accumulate from the date of original issuance and will be payable semi-annual in arrears, on ____ and ____ of each year, commencing ________, 1999 (each a "Distribution Date"). In the event that any date on which distributions are otherwise payable on the Capital Securities is not a Business Day, payment of the distribution payable on such date will be made on the next succeeding day that is a Business Day (and without any additional distribution or other payment in respect of any such delay) except that, if such Business Day is in the next succeeding calendar year, payment of such distribution shall be made on the immediately preceding Business Day, in each case with the same force and effect as if made on the date such payment was originally payable. "Business Day" means any day other than a Saturday or Sunday, or a day on which banking institutions in The City of New York are authorized or required by law or executive order to remain closed or a day on which the principal office of the Property Trustee or Debenture Trustee (as defined below) is closed for business. (Section 4.01(a).) PMC has the right under the Indenture pursuant to which it will issue the Junior Subordinated Debentures, so long as no Event of Default under the Indenture (also referred to herein as a "Debenture Event of Default" and defined below, see "Description of the Junior Subordinated Debentures--Debenture Events of Default and Consequent Rights of Certain Holders") has occurred and is continuing, to defer the payment of interest at any time and from time to time on the Junior Subordinated Debentures for a period not exceeding 10 consecutive semi-annual periods with respect to each deferral period (each, an "Extension Period"), provided that no Extension Period may extend beyond 2028, the Stated Maturity of the Junior Subordinated Debentures. As a consequence of any such election, the Issuer will defer semi-annual distributions on the Capital Securities during any such Extension Period. Distributions to which holders of the Capital Securities are entitled will accumulate additional distributions thereon at a rate per annum of ___% thereof, compounded semi-annually from the relevant payment date for such distributions. The term, "distributions" as used herein shall include any such additional distributions. In the event that PMC exercises this right, during such Extension Period PMC may not, and shall cause any subsidiary of PMC not to, -136- (i) declare or pay any dividends or distributions on, or redeem, purchase, acquire or make a liquidation payment with respect to, any of PMC's capital stock or (ii) make any payment of principal, interest or premium, if any, on or repay, repurchase or redeem any debt securities of PMC that rank pari passu with or junior in interest to the Junior Subordinated Debentures or make any guarantee payments with respect to any guarantee by PMC of the debt securities of any subsidiary of PMC that by their terms rank pari passu or junior in interest to the Junior Subordinated Debentures (other than (a) dividends or distributions in Common Stock or Class A Common Stock of PMC, (b) payments under the Guarantee, and (c) purchases of Common Stock or Class A Common Stock of PMC related to the issuance of Common Stock or Class A Common Stock of PMC under any of PMC's benefit plans for its directors, officers or employees). Prior to the termination of any such Extension Period, PMC may further extend the interest payment period, provided that no Extension Period together may exceed 10 consecutive semi-annual periods or extend beyond the Stated Maturity of the Junior Subordinated Debentures. Upon the termination of any Extension Period and the payment of all amounts then accrued and unpaid (together with interest thereon at the rate of ___% per annum compounded semi-annually to the extent permitted by applicable law), PMC may elect to begin a new Extension Period. There is no limitation on the number of times that PMC may elect to begin an Extension Period. See "Description of the Junior Subordinated Debentures-- Interest" and "Description of the Junior Subordinated Debentures--Option to Extend Interest Payment Period." It is anticipated that the income of the Issuer available for distribution to the holders of the Capital Securities will be limited to payments under the Junior Subordinated Debentures in which the Issuer will invest the proceeds from the issuance and sale of the Capital Securities and the Common Securities. See "Description of the Junior Subordinated Debentures." If PMC does not make interest payments on the Junior Subordinated Debentures, the Property Trustee will not have funds available to pay distributions on the Capital Securities. The payment of distributions (if and to the extent the Issuer has funds legally available for the payment of such distributions and cash sufficient to make such payment therefor at such time) is guaranteed by PMC as set forth herein under "Description of the Guarantee." Distributions on the Capital Securities will be payable to the holders thereof as they appear on the register of the Issuer on the relevant record dates, which, as long as the Capital Securities remain in book-entry-only form, will be one Business Day prior to the relevant Distribution Date. Subject to any applicable laws and regulations and the provisions of the Trust Agreement, each such payment will be made as described under "--Book-Entry-Only Issuance--The Depository Trust Company" below. In the event the Capital Securities do not remain in book-entry-only form, the relevant record date shall be the date 15 days prior to the relevant Distribution Date. (Section 4.01(b).) Redemption Mandatory Redemption Upon the repayment or redemption, in whole or in part, of the Junior Subordinated Debentures at Stated Maturity or upon earlier redemption as provided in the Indenture (each, a "Redemption Date"), the proceeds from such repayment or redemption shall be applied by -137- the Trustee to redeem a Like Amount of Capital Securities, upon not less than 30 nor more than 60 days' notice. See "Description of the Junior Subordinated Debentures-- Optional Redemption." "Like Amount" means (i) with respect to a redemption of Trust Securities, Trust Securities having a Liquidation Amount equal to the principal amount of Junior Subordinated Debentures to be contemporaneously redeemed in accordance with the Indenture and the proceeds of which will be used to pay the Redemption Price of such Trust Securities, and (ii) with respect to a distribution of Junior Subordinated Debentures to holders of Trust Securities in connection with a dissolution or liquidation of the Issuer, Junior Subordinated Debentures having a principal amount equal to the Liquidation Amount of the Trust Securities of the holder to whom such Junior Subordinated Debentures are distributed. If less than all of the Junior Subordinated Debentures are to be repaid or redeemed on a redemption date then the proceeds from such repayment or redemption shall be allocated to the redemption pro-rata of the Capital Securities and the Common Securities. The amount of the premium, if any, paid by PMC upon the redemption of all or any part of the Junior Subordinated Debentures to be repaid or redeemed on a Redemption Date shall be allocated to the redemption pro rata of the Capital Securities and the Common Securities (Section 4.02). PMC has the right to redeem the Junior Subordinated Debentures (i) on or after ____, 2008, in whole at any time or in part from time to time, subject to the conditions described under "Description of Junior Subordinated Debentures-- Optional Redemption", or (ii) at any time prior to ____, 2008, in whole but not in part, within 90 days following the occurrence of a Tax Event or an Investment Company Event (each, as defined below, a "Special Event") and subject to the further conditions described under "Description of the Junior Subordinated Debentures--Optional Redemption." The Redemption Price, in the case of a redemption under (i) above (which includes redemption at Stated Maturity), shall equal the following prices expressed in percentages of the Liquidation Amount together with accrued distributions to but excluding the Redemption Date. If redeemed during the 12- month period beginning __________ 1: Year Redemption Price ---- ---------------- 2008 ................. 10x.xxxx% 2009 ................. 10x.xxxx% 2010 ................. 10x.xxxx% 2011 ................. 10x.xxxx% 2012 ................. 10x.xxxx% 2013 ................. 10x.xxxx% 2014 ................. 10x.xxxx% 2015 ................. 10x.xxxx% 2016 ................. 10x.xxxx% 2017 ................. 10x.xxxx% and 100% on and after _________ 1, 2018. Special Event Redemption or Distribution of Junior Subordinated Debentures -138- If prior to __________, 2008 a Special Event shall occur and be continuing, PMC has the right within 90 days following the occurrence of such Special Event to redeem the Junior Subordinated Debentures in whole (but not in part) and thereby cause a mandatory redemption of the Capital Securities and Common Securities in whole (but not in part) at the Redemption Price set forth below. If a Special Event were to occur, there can be no assurance that PMC would have sufficient funds to effectuate an optional redemption of the Junior Subordinated Debentures and pay the Redemption Price. PMC's ability to exercise its option to redeem the Junior Subordinated Debentures may be limited by the terms of its then-existing borrowing and other agreements. At any time, PMC has the right to terminate the Issuer and, after satisfaction of the liabilities of creditors of the Issuer as provided by applicable law, cause a Like Amount (defined above) of the Junior Subordinated Debentures to be distributed to the holders of the Capital Securities and Common Securities in liquidation of the Issuer (after which such Capital Securities and Common Securities will no longer be deemed to be outstanding). If PMC does not elect either option described above, the Capital Securities will remain outstanding and, in the event a Tax Event has occurred and is continuing, Additional Sums (as defined below) may be payable on the Junior Subordinated Debentures. "Additional Sums" means the additional amounts as may be necessary in order that the amount of distributions then due and payable by the Issuer on the outstanding Capital Securities and Common Securities shall not be reduced as a result of any additional taxes, duties and other governmental charges to which the Issuer has become subject as a result of a Tax Event. "Investment Company Event" means the receipt by the Issuer of an opinion of counsel experienced in such matters to the effect that, as a result of the occurrence of a change in law or regulation or a change in interpretation or application of law or regulation by any legislative body, court, governmental agency or regulatory authority (a "Change in 1940 Act Law"), the Issuer is or will be considered an "investment company" that is required to be registered under the Investment Company Act of 1940, as amended (the "Investment Company Act"), which Change in 1940 Act Law becomes effective on or after the date of original issuance of the Junior Subordinated Debentures. PMC has the right, within 90 days following the occurrence of an Investment Company Event, to redeem the Junior Subordinated Debentures in whole (but not in part). "Tax Event" means the receipt by the Issuer of an opinion of counsel experienced in such matters to the effect that, as a result of (a) any amendment to, clarification of, or change (including any announced prospective change) in, the laws (or any regulations thereunder) of the United States or any political subdivision or taxing authority thereof or therein, or (b) any official administrative pronouncement (including any private letter ruling, technical advice memorandum or field service advice) or regulatory procedure ("an Administrative Action") or judicial determination, regardless of whether such judicial decision or Administrative Action is issued to or in connection with a proceeding involving PMC or the Issuer and whether or not subject to review or appeal, which amendment, clarification, change, Administrative Action or decision is enacted, promulgated or announced, in each case, on or after the date of issuance of the Junior Subordinated Debentures, there is more than an insubstantial risk that (i) the Issuer is, or will be within 90 days of the date of such opinion, subject to United States federal income tax with respect to interest income received or accrued on the Junior Subordinated Debentures, (ii) interest payable by PMC on the Junior Subordinated Debentures is not, or within 90 days of the date of such opinion, will not be, deductible by PMC, in whole or in part, for United States federal income tax purposes or (iii) the Issuer is, or will be within 90 days of the date of such opinion, subject to more than a de minimis amount of other taxes, duties or other governmental charges. PMC has the right, within 90 days following the occurrence of a Tax Event, to redeem the Junior Subordinated Debentures in whole (but not in part). -139- The Redemption Price, in the case of a redemption following a Special Event prior to _____ 1, 2008 (as described above) shall equal for each Capital Security, the Make-Whole Amount for a corresponding $1,000 principal amount of Junior Subordinated Debentures together with accrued distributions to but excluding the Redemption Date. The "Make-Whole Amount" shall be equal to the greater of (i) 100% of the principal amount of such Junior Subordinated Debentures or (ii) as determined by a Quotation Agent (as defined below), the sum of the present values of the principal amount and premium payable as part of the Redemption Price with respect to an optional redemption of such Junior Subordinated Debentures on _____ 1, 2008, together with scheduled payments of interest from the Redemption Date to ____ 1, 2008 (the "Remaining Life"), in each case discounted to the Redemption Date on a semi-annual basis (assuming a 360-day year consisting of 30-day months) at the Adjusted Treasury Rate (as defined below). "Adjusted Treasury Rate" means, with respect to any Redemption Date, the Treasury Rate (as defined below) plus (i) _____% if such Redemption Date occurs on or before _______ 1, 1999 or (ii) ______% if such Redemption Date occurs after _________ 1, 1999. "Treasury Rate" means (i) the yield, under the heading which represents the average for the immediately prior week, appearing in the most recently published statistical release designated "H.15(519)" or any successor publication which is published weekly by the Federal Reserve and which establishes yields on actively traded United States Treasury securities adjusted to constant maturity under the caption "Treasury Constant Maturities," for the maturity corresponding to the Remaining Life (if no maturity is within three months before or after the Remaining Life, yields for the two published maturities most closely corresponding to the Remaining Life shall be determined and the Treasury Rate shall be interpolated or extrapolated from such yields on a straight-line basis, rounding to the nearest month) or (ii) if such release (or any successor release) is not published during the week preceding the calculation date or does not contain such yields, the rate per annum equal to the semi-annual equivalent yield to maturity of the Comparable Treasury Issue, calculated using a price for the Comparable Treasury Issue (expressed as a percentage of its principal amount) equal to the Comparable Treasury Price for such Redemption Date. The Treasury Rate shall be calculated on the third Business Day preceding the Redemption Date. "Comparable Treasury Issue" means, with respect to any Redemption Date, the United States Treasury security selected by the Quotation Agent as having a maturity comparable to the Remaining Life that would be utilized, at the time of selection and in accordance with customary financial practice, in pricing new issues of corporate debt securities of comparable maturity to the Remaining Life. If no United States Treasury security has a maturity which is within a period from three months before to three months after ____ 1, 2008, the two most closely corresponding United States Treasury securities shall be used as the Comparable Treasury Issue, and the Treasury Rate shall be interpolated or extrapolated on a straight-line basis, rounding to the nearest month using such securities. "Quotation Agent" means Goldman, Sachs & Co. and their successors; provided, however, that if the foregoing shall cease to be a primary United States Government securities dealer in New York City (a "Primary Treasury Dealer"), PMC shall substitute therefor another Primary Treasury Dealer. -140- "Reference Treasury Dealer" means (i) the Quotation Agent and (ii) any other Primary Treasury Dealer selected by the Debenture Trustee after consultation with PMC. "Comparable Treasury Price" means (A) the average of five Reference Treasury Dealer Quotations for such Redemption Date, after excluding the highest and lowest such Reference Treasury Dealer Quotations or (B) if the Debenture Trustee obtains fewer than three such Reference Treasury Dealer Quotations, the average of all such Quotations. "Reference Treasury Dealer Quotations" means, with respect to each Reference Treasury Dealer and any Redemption Date, the average, as determined by the Debenture Trustee, of the bid and asked prices for the Comparable Treasury Issue (expressed in each case, as a percentage of its principal amount) quoted in writing to the Debenture Trustee by such Reference Treasury Dealer at 5:00 p.m., New York City time, on the third Business Day preceding such Redemption Date. With certain limited exceptions, after the liquidation date fixed for any distribution of Junior Subordinated Debentures to holders of Capital Securities (the "Liquidation Date") (i) the Capital Securities will no longer be deemed to be outstanding, (ii) The Depository Trust Company ("DTC") or its nominee, as the record holder of the Capital Securities, will receive a registered global certificate or certificates representing the Junior Subordinated Debentures to be delivered upon such distribution, (iii) any certificates representing Capital Securities not held by DTC or its nominee will be deemed to represent Junior Subordinated Debentures having a principal amount equal to the stated Liquidation Amount of the Capital Securities, and bearing accrued and unpaid interest in an amount equal to the accumulated and unpaid distributions on such Capital Securities until such certificates are surrendered and (iv) all rights of the holders of Capital Securities will cease, except the right of such holders to receive Junior Subordinated Debentures upon surrender of the certificates representing Capital Securities. (Section 9.04(c).) There can be no assurance as to the market prices for the Capital Securities or the Junior Subordinated Debentures that may be distributed in exchange for Capital Securities if a termination and liquidation of the Issuer were to occur. Accordingly, the Capital Securities that an investor may purchase, or the Junior Subordinated Debentures that the investor may receive upon termination and liquidation of the Issuer, may trade at a discount to the price that the investor paid to purchase the Capital Securities offered hereby. Redemption Procedures Capital Securities redeemed on each Redemption Date shall be redeemed at the Redemption Price stated above with the proceeds from the contemporaneous redemption of Junior Subordinated Debentures. Redemptions of the Capital Securities shall be made and the Redemption Price shall be payable on each Redemption Date only to the extent that the Issuer has funds available for the payment of such Redemption Price. (Section 4.02(c).) See also "--Subordination of Common Securities." If the Property Trustee gives a notice of redemption in respect of Capital Securities, then, by 12:00 noon, New York time, on the Redemption Date, to the extent that funds are available, the Property Trustee will, so long as the Capital Securities are in book-entry-only -141- form, irrevocably deposit with DTC funds sufficient to pay the applicable Redemption Price and will give DTC irrevocable instructions and authority to pay the Redemption Price to the holders of the Capital Securities. See "--Book-Entry- Only Issuance--The Depository Trust Company." If the Capital Securities are no longer in book-entry-only form, the Property Trustee, to the extent funds are available, will irrevocably deposit with the paying agent for the Capital Securities funds sufficient to pay the applicable Redemption Price and will give such paying agent irrevocable instructions and authority to pay the Redemption Price to the holders thereof upon surrender of their certificates representing Capital Securities. Notwithstanding the foregoing, distributions payable on or prior to the Redemption Date for any Capital Securities called for redemption shall be payable to the holders of such Capital Securities on the relevant record dates for the related Distribution Dates. If notice of redemption shall have been given and funds deposited as required, then upon the Redemption Date, all rights of holders of such Capital Securities so called for redemption will cease, except the right of the holders of such Capital Securities to receive the Redemption Price, including any distributions payable in respect of the Capital Securities on or prior to the Redemption Date but without interest on such Redemption Price, and such Capital Securities will cease to be outstanding. In the event that any date fixed for redemption of Capital Securities is not a Business Day, then payment of the Redemption Price payable on such date will be made on the next succeeding day that is a Business Day (and without any interest or other payment in respect of any such delay), except that, if such Business Day falls in the next calendar year, such payment shall be made on the immediately preceding Business Day in each case, with the same force and effect as if made on such date. In the event that payment of the Redemption Price in respect of any Capital Securities called for redemption is improperly withheld or refused and not paid either by the Issuer or by PMC pursuant to the Guarantee described under "Description of the Guarantee," distributions on such Capital Securities will continue to accumulate, at the then applicable rate, from the original Redemption Date to the date of payment, in which case the actual payment date will be the date fixed for redemption for purposes of calculating the Redemption Price. (Section 4.02(d).) Payment of the Redemption Price on the Capital Securities and distribution of Junior Subordinated Debentures to holders of Capital Securities shall be made to the record holders thereof as they appear on the register for the Capital Securities on the relevant record date, which shall be one Business Day prior to the relevant Redemption Date or Liquidation Date, as applicable; provided, however, that in the event that the Capital Securities do not remain in book- entry-only form, the relevant record date shall be the date 15 days prior to the Redemption Date or Liquidation Date, as applicable. (Section 4.02(e).) If less than all the outstanding Trust Securities are to be redeemed on a Redemption Date, then the aggregate Liquidation Amount of Trust Securities to be redeemed shall be allocated pro rata among the Common Securities and the Capital Securities according to their relative aggregate Liquidation Amounts. The particular Capital Securities to be redeemed shall be selected on a pro rata basis (based upon Liquidation Amounts) not more than 60 days prior to the Redemption Date by the Property Trustee from the outstanding Capital Securities not previously called for redemption, by such method (including, without limitation, by lot) as the Property Trustee shall deem fair and appropriate and which may provide for the selection for redemption of portions (equal to $1,000 or an integral multiple of $1,000 in excess thereof) of the Liquidation Amount of Capital Securities of a denomination larger than $1,000. See "--Book-Entry Only Issuance--The Depository Trust Company." The Property Trustee shall -142- promptly notify the Securities Registrar in writing of the Capital Securities selected for redemption and, in the case of any Capital Securities selected for partial redemption, the Liquidation Amount thereof to be redeemed. For all purposes of the Trust Agreement, unless the context otherwise requires, all provisions relating to the redemption of Capital Securities shall relate, in the case of any Capital Securities redeemed or to be redeemed only in part, to the portion of the Liquidation Amount of Capital Securities which has been or is to be redeemed. The Bank of New York is the initial Securities Registrar. (Sections 4.02(f) and 5.04.) Subject to applicable law (including, without limitation, United States federal securities law), PMC or its subsidiaries may at any time and from time to time purchase outstanding Capital Securities by tender, in the open market or by private agreement. Subordination of Common Securities Payment of distributions on, and the Redemption Price of, the Trust Securities, as applicable, shall be made pro rata based on the Liquidation Amount of the Trust Securities; provided, however, that if on any Distribution Date, Redemption Date or Liquidation Date any Event of Default (as defined below, see "--Events of Default; Notice") under the Trust Agreement resulting from a Debenture Event of Default (as defined below) shall have occurred and be continuing, no payment of any distribution on, or Redemption Price of, or Liquidation Distribution (as defined below) in respect of any Common Security, and no other payment on account of the redemption, liquidation or other acquisition of Common Securities, shall be made unless payment in full in cash of all accumulated and unpaid distributions on all outstanding Capital Securities for all distribution periods terminating on or prior thereto, or in the case of payment of the Redemption Price the full amount of such Redemption Price on all outstanding Capital Securities, or in the case of payment of the Liquidation Distribution the full amount of such Liquidation Distribution on all outstanding Capital Securities, shall have been made or provided for, and all funds available to the Property Trustee shall first be applied to the payment in full in cash of all distributions on, or the Redemption Price of, Capital Securities then due and payable. (Section 4.03(a).) In the case of the occurrence of any Event of Default under the Trust Agreement resulting from a Debenture Event of Default, the holder of the Common Securities will be deemed to have waived any right to act with respect to any such Event of Default under the Trust Agreement with respect to the Common Securities until the effect of all such Events of Default have been cured, waived or otherwise eliminated. Until any such Events of Default under the Trust Agreement with respect to the Capital Securities have been cured, waived or otherwise eliminated, the Property Trustee shall act solely on behalf of the holders of the Capital Securities and not the holder of the Common Securities, and only the holders of the Capital Securities will have the right to direct the Property Trustee to act on their behalf. (Section 4.03(b).) Liquidation Distribution upon Termination Pursuant to the Trust Agreement, the Issuer shall be terminated by the Trustees on the first to occur of: (i) the expiration of the term of the Issuer; (ii) the occurrence of certain events of bankruptcy or insolvency in respect of, or the dissolution or liquidation of, PMC; (iii) the distribution of the Junior Subordinated Debentures to the holders of Capital Securities and -143- Common Securities if PMC, as Depositor, has given written direction to the Property Trustee to terminate the Issuer (which direction is optional and wholly within the discretion of PMC, as Depositor); (iv) the redemption of all of the Trust Securities and (v) the entry of an order for dissolution of the Issuer by a court of competent jurisdiction. (Sections 9.01 and 9.02.) If a termination event specified in clause (ii), (iii) or (v) above occurs, the Issuer shall be liquidated by the Trustees as expeditiously as the Trustees determine to be possible by distributing, after satisfaction of liabilities to creditors of the Trust as provided by applicable law, to each holder of Capital Securities and Common Securities a Like Amount of Junior Subordinated Debentures, unless such distribution is determined by the Property Trustee not to be practical, in which event such holders will be entitled to receive out of the assets of the Issuer available for distribution to holders after satisfaction of liabilities to creditors, an amount equal to, in the case of the Capital Securities, the aggregate of the Liquidation Amount plus accumulated and unpaid distributions thereon to the date of payment (such amount being the "Liquidation Distribution"). If such Liquidation Distribution can be paid only in part because the Issuer has insufficient assets available to pay in full the aggregate Liquidation Distribution, then, subject to the next succeeding sentence, the amounts payable by the Issuer on the Capital Securities shall be paid on a pro rata basis (based on Liquidation Amounts). The holder of the Common Securities will be entitled to receive Liquidation Distributions upon any such liquidation pro rata with the holders of the Capital Securities, except that if a Debenture Event of Default has occurred and is continuing, the Capital Securities shall have a priority over the Common Securities. (Sections 9.04(a)and 9.04(d).) Events of Default; Notice Any one of the following events constitutes an "Event of Default" under the Trust Agreement with respect to the Capital Securities issued thereunder (whatever the reason for such Event of Default and whether it shall be voluntary or involuntary or be effected by operation of law or pursuant to any judgment, decree or order of any court or any order, rule or regulation of any administrative or governmental body): (i) the occurrence of a Debenture Event of Default under the Indenture (as defined in "Description of Junior Subordinated Debentures-- Debenture Events of Default and Consequent Rights of Certain Holders"); or (ii) default by the Property Trustee in the payment of any distribution, other than payment of principal, when it becomes due and payable, and continuation of such default for a period of 30 days; or (iii) default by the Property Trustee in the payment of any Redemption Price of any Trust Security when it becomes due and payable; or (iv) default in the performance, or breach, in any material respect, of any covenant or warranty of the Trustees in the Trust Agreement (other than a covenant or warranty a default in the performance of which or the breach of which is dealt with in clause (ii) or (iii) above), and continuation of such default or breach for a period of 60 days after there has been given, by registered or certified mail, to the defaulting Trustee or Trustees by the holders of at least 25% in aggregate Liquidation Amount of the outstanding Capital -144- Securities a written notice specifying such default or breach and requiring it to be remedied and stating that such notice is a "Notice of Default" under the Trust Agreement; or (v) The occurrence of certain events of bankruptcy or insolvency with respect to the Property Trustee and the failure by PMC to appoint a successor Property Trustee within 60 days thereof. (Section 1.01.) Within five Business Days after the occurrence of any Event of Default, the Property Trustee shall transmit notice of any Event of Default actually known to the Property Trustee to the holders of Trust Securities, the Administrative Trustees and PMC, as Depositor, unless such Event of Default shall have been cured or waived. (Section 8.02.) Each of PMC, as Depositor, and the Administrative Trustees on behalf of the Trust is required to provide annually to the Property Trustee a certificate as to whether or not they are in compliance with all of the conditions and covenants applicable to them under the Trust Agreement. (Section 8.15.) If a Debenture Event of Default has occurred and is continuing, the Capital Securities shall have a preference over the Common Securities as described above. See "--Liquidation Distribution Upon Termination." The existence of an Event of Default does not entitle the holders of Capital Securities to accelerate the maturity thereof. Removal of Trustees Unless a Debenture Event of Default shall have occurred and be continuing the holder of the Common Securities may remove any Trustee at any time. The holders of at least a majority in aggregate Liquidation Amount of the outstanding Capital Securities may remove the Property Trustee or if a Debenture Event of Default has occurred and is continuing, the Property Trustee, may be removed at such time by the holders of a majority in aggregate Liquidation Amount of the outstanding Capital Securities with or without cause. In no event will the holders of the Capital Securities have the right to vote to appoint, remove or replace the Administrative Trustees, which voting rights are vested exclusively in PMC as the holder of the Common Securities. No resignation or removal of any Trustee and no appointment of a successor Trustee shall be effective until the acceptance of appointment by the successor Trustee in accordance with the applicable provisions of the Trust Agreement. (Section 8.10.) Merger or Consolidation of Trustees Any entity into which the Property Trustee, the Delaware Trustee or any Administrative Trustee that is not a natural person may be merged or converted or with which it may be consolidated, or any entity resulting from any merger, conversion or consolidation to which any such Trustee shall be a party, or any entity succeeding to all or substantially all of the corporate trust business of any such Trustee, shall be the successor of such Trustee under the Trust Agreement, provided such entity shall be otherwise qualified and eligible. (Section 8.12.) Merger, Consolidation, Amalgamation or Replacement of the Issuer -145- The Issuer may not merge consolidate amalgamate with or into, or be replaced by, or convey, transfer or lease its properties and assets substantially as an entirety to any corporation or other entity, except as described below. The Issuer may, at the request of PMC, with the consent of the Administrative Trustees and with the consent of the holders of at least a majority in aggregate Liquidation Amount of the Capital Securities or the Property Trustee, merge, consolidate, or amalgamate with or into, or be replaced by or convey, transfer or lease its properties and assets substantially as an entirety to a trust organized as such under the laws of any state; provided, that (i) such successor entity either (a) expressly assumes all of the obligations of the Issuer with respect to the Capital Securities or (b) substitutes for the Capital Securities other securities having substantially the same terms as the Capital Securities (the "Successor Securities") so long as the Successor Securities rank the same as the Capital Securities rank in priority with respect to distributions and payments upon liquidation, redemption and otherwise, (ii) PMC expressly appoints a trustee of such successor entity possessing the same powers and duties as the Property Trustee as the holder of the Junior Subordinated Debentures, (iii) the Successor Securities are listed or quoted, or any Successor Securities will be listed or quoted upon notification of issuance, on any national securities exchange, the Nasdaq National Market or other organization on which the Capital Securities are then listed or quoted, if any, (iv) such merger, consolidation, amalgamation, replacement, conveyance, transfer or lease does not cause the Capital Securities (including any Successor Securities) to be downgraded by any nationally recognized statistical rating organization, (v) such merger, consolidation, amalgamation, replacement, conveyance, transfer or lease does not adversely affect the rights, preferences and privileges of the holders of the Capital Securities (including any Successor Securities) in any material respect, (vi) such successor entity has a purpose identical to that of the Issuer, (vii) prior to such merger, consolidation, amalgamation, replacement, conveyance, transfer or lease, PMC has received an opinion from independent counsel to the Issuer experienced in such matters to the effect that (a) such merger, consolidation, amalgamation, replacement, conveyance, transfer or lease does not adversely affect the rights, preferences and privileges of the holders of the Capital Securities (including any Successor Securities) in any material respect and (b) following such merger, consolidation, amalgamation, replacement, conveyance, transfer or lease, neither the Issuer nor such successor entity will be required to register as an investment company under the Investment Company Act and (viii) PMC or any permitted successor or assignee owns all of the Common Securities of such successor entity and guarantees the obligations of such successor entity under the Successor Securities at least to the extent provided by the Guarantee. Notwithstanding the foregoing, the Issuer shall not, except with the consent of holders of 100% in Liquidation Amount of the Capital Securities, consolidate, amalgamate, or merge with or into or be replaced by or convey, transfer or lease its properties and assets substantially as an entirety to any other entity or permit any other entity to consolidate, amalgamate merge with or into, or replace it if such consolidation, amalgamation, merger, replacement, conveyance, transfer or lease would cause the Issuer or the successor entity to be classified as other than a grantor trust for United States federal income tax purposes. (Section 9.05.) Voting Rights Except as provided below and under "Description of the Guarantee-- Amendments and Assignment" and "Description of the Junior Subordinated Debentures--Modification of the -146- Indenture" and as otherwise required by law and the Trust Agreement, the holders of the Capital Securities will have no voting rights. (Section 6.01(a).) The Trust Agreement may be amended from time to time by PMC, the Property Trustee and the Administrative Trustees, without the consent of the holders of the Capital Securities (i) to cure any ambiguity, correct or supplement any provision in the Trust Agreement that may be inconsistent with any other provision or to make any other provisions with respect to matters or questions arising under the Trust Agreement, which shall not be inconsistent with the other provisions of the Trust Agreement or (ii) to modify, eliminate or add to any provisions of the Trust Agreement to such extent as shall be necessary to ensure that the Issuer will be classified for United States federal income tax purposes as a grantor trust at all times that any Trust Securities are outstanding or to ensure that the Issuer will not be required to register as an "investment company" under the Investment Company Act; provided, however, that in the case of either clause (i) or clause (ii), such action shall not adversely affect in any material respect the interests of any holder of Capital Securities, and any amendments of such Trust Agreement shall become effective when notice thereof is given to the holders of Trust Securities. The Trust Agreement may be amended by PMC, the Property Trustee and the Administrative Trustees with (i) the consent of holders representing not less than a majority (based upon Liquidation Amounts) of the outstanding Trust Securities and (ii) receipt by the Trustees of an opinion of counsel to the effect that such amendment or the exercise of any power granted to the Trustees in accordance with such amendment will not affect the Issuer's status as a grantor trust for United States federal income tax purposes or the Issuer's exemption from status as an "investment company" under the Investment Company Act, provided that without the consent of each affected holder of Trust Securities, such Trust Agreement may not be amended to (i) change the amount or timing of any distribution on the Trust Securities or otherwise adversely affect the amount of any distribution required to be made in respect of the Trust Securities as of a specified date or (ii) restrict the right of a holder of Trust Securities to institute suit for the enforcement of any such payment on or after such date. (Section 10.03.) So long as any Junior Subordinated Debentures are held by the Property Trustee, the Trustees shall not (i) direct the time, method and place of conducting any proceeding for any remedy available to the Debenture Trustee, or executing any trust or power conferred on the Debenture Trustee with respect to the Junior Subordinated Debentures, (ii) waive any past default that is waivable under Section 513 of the Indenture, (iii) exercise any right to rescind or annul a declaration that the principal of all the Junior Subordinated Debentures shall be due and payable or (iv) consent to any amendment, modification or termination of the Indenture or the Junior Subordinated Debentures, where such consent shall be required, without, in each case, obtaining the prior approval of the holders of at least a majority in Liquidation Amount of the outstanding Capital Securities; provided, however, that where a consent under the Indenture would require the consent of each holder of Junior Subordinated Debentures affected thereby, no such consent shall be given by the Property Trustee without the prior consent of each holder of Capital Securities. The Trustees shall not revoke any action previously authorized or approved by a vote of the holders of Capital Securities except by subsequent vote of the holders of Capital Securities. The Property Trustee shall notify all holders of the Capital Securities of any notice of default received from the Debenture Trustee. In addition to obtaining the foregoing approvals of the holders of the Capital Securities, prior to taking any of the foregoing actions, the Trustees shall, at the expense of PMC, obtain an -147- opinion of counsel experienced in such matters to the effect that the Issuer will not fail to be classified as a grantor trust for United States federal income tax purposes on account of such action. (Section 6.01(b).) Any required approval of holders of Capital Securities may be given at a separate meeting of holders of Capital Securities convened for such purpose or pursuant to written consent. The Administrative Trustees will cause a notice of any meeting at which holders of Capital Securities are entitled to vote, or of any matter upon which action by written consent of such holders is to be taken, to be given to each holder of record of the outstanding Capital Securities in the manner set forth in the Trust Agreement. (Sections 6.02 and 6.06.) No vote or consent of the holders of Capital Securities will be required for the Issuer to redeem and cancel Capital Securities in accordance with the Trust Agreement. Notwithstanding that holders of Capital Securities are entitled to vote or consent under any of the circumstances described above, any of the Capital Securities that are owned by PMC, any Trustee or any affiliate of PMC or any Trustee, shall, for purposes of such vote or consent, be treated as if they were not outstanding. (Section 1.01.) Co-Trustees and Separate Trustee Unless an Event of Default under the Trust Agreement shall have occurred and be continuing, at any time or times, for the purpose of meeting the legal requirements of the Trust Indenture Act or of any jurisdiction in which any part of the Trust Property may at the time be located, the Administrative Trustees and PMC shall have power to appoint, and upon the written request of the Administrative Trustees, PMC, as Depositor, shall for such purpose join with the Administrative Trustees in the execution, delivery, and performance of all instruments and agreements necessary or proper to appoint one or more persons or entities approved by the Property Trustee either to act as co-trustee, jointly with the Property Trustee, of all or any part of such Trust Property, or to act as separate trustee of any such property, in either case with such powers as may be provided in the instrument of appointment, and to vest in such person(s) or entity(s) in such capacity, any property, title, right or power deemed necessary or desirable, subject to the provisions of the Trust Agreement. If the Depositor does not join in such appointment within 15 days after the receipt by it of a request so to do, or in case a Debenture Event of Default has occurred and is continuing, the Property Trustee alone shall have power to make such appointment. (Section 8.09.) "Trust Property" means (a) the Junior Subordinated Debentures, (b) any cash on deposit in, or owing to, the payment account maintained by the Property Trustee, (c) all proceeds and rights in respect of the foregoing and any other property and assets for the time being held or deemed to be held by the Property Trustee pursuant to the trusts of the Trust Agreement and (d) the rights of the Property Trustee under the Guarantee. (Section 1.01.) Book-Entry Only Issuance--The Depository Trust Company DTC will act as securities depositary for the Capital Securities. The Capital Securities will be issued only as fully registered securities registered in the name of Cede & Co. (DTC's nominee). One or more fully registered global Capital Security certificates will be issued, representing in the aggregate the total number of Capital Securities, and will be deposited with DTC. (Section 5.11.) - 148 - DTC is a limited purpose trust company organized under the New York Banking Law, a "banking organization" within the meaning of the New York Banking Law, a member of the Federal Reserve System, a "clearing corporation" within the meaning of the New York Uniform Commercial Code, and a "clearing agency" registered pursuant to the provisions of Section 17A of the Exchange Act. DTC holds securities that its participants ("Participants") deposit with DTC. DTC also facilitates the settlement among Participants through electronic computerized book-entry changes in Participants' accounts, thereby eliminating the need for physical movement of securities certificates. Direct Participants include securities brokers and dealers, banks, trust companies, clearing corporations, and certain other organizations ("Direct Participants"). DTC is owned by a number of its Direct Participants and by the New York Stock Exchange Inc. (the "New York Stock Exchange"), the American Stock Exchange, Inc. and the National Association of Securities Dealers, Inc. Access to the DTC system is also available to others such as securities brokers and dealers, banks and trust companies that clear through or maintain custodial relationships with Direct Participants, either directly or indirectly ("Indirect Participants"). The rules applicable to DTC and its Participants are on file with the Commission. Purchases of Capital Securities within the DTC system must be made by or through Direct Participants, which will receive a credit for the Capital Securities on DTC's records. The ownership interest of each actual purchaser of each Capital Security ("Beneficial Owner") is in turn to be recorded on the Direct and Indirect Participants' records. Beneficial Owners will not receive written confirmation from DTC of their purchases, but Beneficial Owners are expected to receive written confirmations providing details of the transactions, as well as periodic statements of their holdings, from the Direct or Indirect Participants through which the Beneficial Owners purchased Capital Securities. Transfers of ownership interests in the Capital Securities are to be accomplished by entries made on the books of Participants acting on behalf of Beneficial Owners. Beneficial Owners will not receive certificates representing their ownership interests in Capital Securities, unless use of the book-entry system for the Capital Securities is discontinued. DTC has no knowledge of the actual Beneficial Owners of the Capital Securities; DTC's records reflect only the identity of the Direct Participants to whose accounts such Capital Securities are credited, which may or may not be the Beneficial Owners. The Participants will remain responsible for keeping account of their holdings on behalf of their customers. Conveyance of notices and other communications by DTC to Direct Participants, by Direct Participants to Indirect Participants, and by Direct Participants and Indirect Participants to Beneficial Owners and the voting rights of Direct Participants, Indirect Participants and Beneficial Owners will be governed by arrangements among them, subject to any statutory or regulatory requirements as may be in effect from time to time. Redemption notices shall be sent to Cede & Co. If less than all of the Capital Securities are being redeemed, DTC will reduce the amount of the interest of each Direct Participant in such Capital Securities in accordance with its procedures. DTC's current practice is to determine by lot the amount of the interest of each Direct Participant to be redeemed. Although voting with respect to the Capital Securities is limited to the holders of record of the Capital Securities, in those cases where a vote is required, neither DTC nor Cede & Co. - 149 - will itself consent or vote with respect to Capital Securities. Under its usual procedures, DTC would mail an omnibus proxy to the Property Trustee as soon as possible after the record date. The omnibus proxy assigns Cede & Co.'s consenting or voting rights to those Direct Participants to whose accounts the Capital Securities are credited on the record date (identified in a listing attached to the omnibus proxy). The Issuer will make distribution payments on the Capital Securities to DTC. DTC's practice is to credit Direct Participants' accounts on the relevant payment date in accordance with their respective holdings shown on DTC's records unless DTC has reason to believe that it will not receive payments on such payment date. Payments by Participants to Beneficial Owners will be governed by standing instructions and customary practices and will be the responsibility of such Participant and not of DTC, the Issuer or PMC, subject to any statutory or regulatory requirements as may be in effect from time to time. Payment of distributions to DTC is the responsibility of the Issuer, disbursement of such payments to Direct Participants is the responsibility of DTC, and disbursements of such payments to the Beneficial Owners is the responsibility of Direct and Indirect Participants. A global security shall be exchangeable for Capital Securities registered in the names of persons other than DTC or its nominee only if (i) DTC properly notifies PMC, the Trustees, and the Registrar and Transfer Agent that it is unwilling or unable to continue as a depositary for such global security and no successor depositary shall have been appointed, or if at any time, DTC ceases to be a clearing agency registered under the Exchange Act, at a time when DTC is required to be so registered to act as such depositary, (ii) the Issuer in its sole discretion determines that such global security shall be so exchangeable or (iii) there shall have occurred and be continuing a Debenture Event of Default. Any global security that is exchangeable pursuant to the preceding sentence shall be exchangeable for definitive certificates registered in such names, as DTC shall direct. It is expected that such instructions will be based upon directions received by DTC from its Participants with respect to ownership of beneficial interests in such global security. In the event that Capital Securities are issued in definitive form, such Capital Securities will be in denominations of $1,000 and integral multiples thereof and may be transferred or exchanged at the offices described below. In the event Capital Securities are issued in certificated form, the Liquidation Amount and distributions will be payable, the transfer of the Capital Securities will be registrable and Capital Securities will be exchangeable for Capital Securities of other denominations of a like aggregate Liquidation Amount, at the corporate office of the Property Trustee, or at the offices of any paying agent or transfer agent; provided that payment of any distribution may be made at the option of the Administrative Trustees by check mailed to the address of the persons entitled thereto or by wire transfer. In addition, if the Capital Securities are issued in certificated form, the record dates for payment of distributions will be the date 15 days prior to the relevant Distribution Date (whether or not a Business Day). The information in this section concerning DTC and DTC's book-entry system has been obtained from sources that the Issuer and PMC believe to be reliable. Neither the Issuer nor PMC has any responsibility for the performance by DTC or its Participants of their respective obligations as described hereunder or under the rules and procedures governing their respective operations. - 150 - Registrar and Transfer Agent The Bank of New York will act as Securities Registrar and Transfer Agent for the Capital Securities. (Section 5.04.) Registration of transfers and exchanges of Capital Securities will be effected without charge by or on behalf of the Issuer, but the Securities Registrar may require payment (with the giving of such indemnity as the Issuer or PMC may require) of a sum sufficient to cover any tax or other governmental charge that may be imposed in connection with any transfer or exchange. The Securities Registrar will not be required to register the transfer of any Capital Securities that have been called for redemption. (Section 5.04.) Miscellaneous Payment And Paying Agency Payments in respect of the Capital Securities shall be made to DTC (so long as the Capital Securities are held by DTC), which shall credit the relevant participants' accounts at DTC on the applicable Distribution Dates or, if the Capital Securities are not held by DTC, such payments shall be made at the corporate office of the Property Trustee, or at the offices of any paying agent or transfer agent; provided that payment of any distribution may be made at the option of the Administrative Trustees by check mailed to the address of the person entitled thereto as such address shall appear on the Security Register or by wire transfer. The Paying Agent shall initially be The Bank of New York, and any co-paying agent chosen by The Bank of New York and acceptable to the Administrative Trustees and PMC. The Paying Agent shall be permitted to resign as Paying Agent upon 30 days' written notice to the Administrative Trustees, the Property Trustee and PMC. In the event that The Bank of New York shall no longer be the Paying Agent or a successor Paying Agent shall resign or its authority to act be revoked, the Administrative Trustees shall appoint a successor to act as Paying Agent (which shall be a bank or trust company acceptable to the Property Trustee and PMC). (Sections 4.04 and 5.09.) Holders of the Capital Securities have no preemptive or similar rights. (Section 5.14(a).) The Issuer may not borrow money or issue debt (other than the Capital Securities and the Common Securities) or mortgage or pledge any of its assets. (Section 2.07(b).) DESCRIPTION OF THE GUARANTEE Set forth below is a summary of the material provisions of the Guarantee that will be executed and delivered by PMC for the benefit of the holders from time to time of the Capital Securities. The Guarantee will be qualified under the Trust Indenture Act, and The Bank of New York will act as indenture trustee (the "Guarantee Trustee") under the Guarantee for purposes of compliance with the Trust Indenture Act. The terms of the Guarantee will be those set forth in such Guarantee and those made part of such Guarantee by the Trust Indenture Act. Reference is made to the provisions of the Guarantee, the form of which is filed as an - 151 - exhibit to the Registration Statement of which this Prospectus forms a part, and the Trust Indenture Act for a more complete description of the provisions summarized herein, and each statement set forth below shall be deemed qualified in its entirety by such reference. Whenever particular provisions in the Guarantee are referred to herein, such provisions are incorporated by reference herein. Section references used herein are references to provisions of the Guarantee unless otherwise noted. The Guarantee Trustee will hold the Guarantee for the benefit of the holders of the Capital Securities. General PMC will irrevocably and unconditionally agree, to the extent set forth herein, to pay the Guarantee Payments (as defined below) in full to the holders of the Capital Securities (without duplication of amounts theretofore paid by or on behalf of the Issuer), as and when due, regardless of any defense, right of set-off or counterclaim which the Issuer may have or assert other than the defense of payment. The following payments with respect to Capital Securities, to the extent not paid by or on behalf of the Issuer (the "Guarantee Payments"), will be subject to the Guarantee: (i) any accumulated and unpaid distributions required to be paid on the Capital Securities, to the extent the Issuer shall have funds available therefor at such time, (ii) the Redemption Price with respect to any Capital Securities called for redemption by the Issuer, to the extent the Issuer shall have funds available therefor at such time and (iii) upon a voluntary or involuntary dissolution, winding-up or termination of the Issuer (other than in connection with a redemption of all of the outstanding Capital Securities or the distribution of Junior Subordinated Debentures to the holders of Capital Securities as provided in the Trust Agreement), the lesser of (a) the aggregate of the Liquidation Amount and all accumulated and unpaid distributions on the Capital Securities to the date of payment to the extent the Issuer shall have funds available therefor at such time and (b) the amount of assets of the Issuer remaining available for distribution to holders of Capital Securities after satisfaction of liabilities to creditors of the Issuer as required by applicable law. PMC's obligation to make a Guarantee Payment may be satisfied by direct payment of the required amounts by PMC to the holders of Capital Securities or by causing the Issuer to pay such amounts to such holders. (Section 5.01.) The Guarantee will be a full and unconditional guarantee on a subordinated basis with respect to the Capital Securities issued by the Issuer from the time of issuance of the Capital Securities, but will apply only to the extent that the Issuer has sufficient funds to make such payments, and is not a guarantee of collection of payment. (Sections 5.01 and 5.05.) If PMC does not make interest payments on the Junior Subordinated Debentures held by the Issuer, it is expected that the Issuer will not pay distributions on the Capital Securities and will not have funds available therefor. The Guarantee will rank subordinate and junior in right of payment to all Senior Debt of PMC. "Senior Debt" means the principal of (and premium, if any) and interest, if any (including interest accruing on or after the filing of any petition in bankruptcy or for reorganization relating to PMC whether or not such claim for post-petition interest is allowed in such proceeding), on Debt, whether incurred on or prior to the date of the Guarantee or thereafter incurred, unless, in the instrument creating or evidencing the same or pursuant to which the same is outstanding, it is provided that such obligations are not superior in right of payment to the Guarantee or to other Debt which is pari passu with, or subordinated to, the Guarantee; provided, however, that Senior Debt shall not be deemed to include (i) any Debt of PMC which, when incurred and without respect to any election under Section 1111(b) - 152 - of the Bankruptcy Code, was without recourse to PMC, (ii) any Debt of PMC to any of its subsidiaries, (iii) Debt to any employee of PMC, (iv) trade accounts payable of PMC, (v) accrued liabilities of PMC or any of its subsidiaries arising in the ordinary course of business of PMC, (vi) the Junior Subordinated Debentures, and (vii) the Guarantee. (Section 1.01.) "Debt" for purposes of the Guarantee, has the same meaning as that specified under "Description of the Junior Subordinated Debentures--Subordination" below. PMC's obligations under the Trust Agreement, the Guarantee, the Indenture, the Junior Subordinated Debentures and the Expense Agreement taken together provide a full, irrevocable, and unconditional guarantee on a subordinated basis by PMC of all of the Issuer's obligations under the Capital Securities. See "-- Status of the Guarantee." PMC is an insurance holding company and substantially all of the operating assets of PMC are owned by its consolidated subsidiaries, principally PMA Reinsurance Corporation and the Pooled Companies. PMC relies primarily on the receipt of sufficient funds from PMA Re and the Pooled Companies in the form of dividends, net payments under tax-sharing agreements or loans to meet its obligations for payment of principal and interest on outstanding debt obligations (including the Junior Subordinated Debentures) and corporate expenses. Accordingly, PMC's obligations under the Guarantee will be effectively subordinated to all existing and future liabilities of PMC's subsidiaries, and claimants should look only to the assets of PMC for payments thereunder. Pennsylvania law limits the payment of dividends by PMA Reinsurance Corporation and the Pooled Companies. PMA Reinsurance Corporation and the Pooled Companies have the ability to loan funds to PMC subject to certain regulatory restrictions. See "Risk Factors--Subordination of the Guarantee and the Junior Subordinated Debentures," "--Holding Company Structure and Restrictions on Subsidiary Dividends" and "Supervision and Regulation". Certain Covenants of PMC In the Guarantee, PMC will covenant that, so long as any Capital Securities remain outstanding, PMC will not, and will cause its subsidiaries not to, (a) declare or pay any dividends or distributions on (other than dividends or distributions in Common Stock or Class A Common Stock of PMC), or redeem, purchase, acquire or make a liquidation payment with respect to, any of PMC's outstanding capital stock or (b) make any payment of principal, interest or premium, if any, on or repay, repurchase or redeem any debt securities that rank pari passu with or junior to the Junior Subordinated Debentures or make any guarantee payments with respect to the foregoing if at such time (i) PMC shall be in default with respect to its Guarantee Payments under the Guarantee, (ii) there shall have occurred and be continuing any Debenture Event of Default or (iii) PMC shall have given notice of its selection of an Extension Period and such period, or any extension thereof, is continuing. (Section 6.01.) Amendments And Assignment Except with respect to any changes that do not materially adversely affect the rights of holders of Capital Securities (in which case no consent of holders of Capital Securities will be required), the terms of the Guarantee may be amended only with the prior approval of the holders of not less than a majority of the Liquidation Amount of the outstanding Capital Securities. (Section 8.02.) All guarantees and agreements contained in the Guarantee shall bind - 153 - the successors, assigns, receivers, trustees and representatives of PMC and shall inure to the benefit of the holders of the Capital Securities then outstanding. (Section 8.01.) Events of Default An event of default under the Guarantee (a "Guarantee Event of Default") will occur upon the failure of PMC to perform any of its payment obligations thereunder or the failure to perform any non-payment obligations thereunder if any such non-payment obligation remains unremedied for 30 days. (Section 1.01.) The holders of a majority in Liquidation Amount of the Capital Securities have the right to direct the time, method and place of conducting any proceeding for any remedy available to the Guarantee Trustee in respect of the Guarantee or exercising any trust or power conferred upon the Guarantee Trustee under the Guarantee. (Section 5.04.) Any holder of Capital Securities may institute a legal proceeding directly against PMC to enforce the holder's rights under such Guarantee without first instituting a legal proceeding against the Issuer, the Guarantee Trustee or any other person or entity. (Section 5.04.) PMC will be required to provide annually to the Guarantee Trustee an officer's certificate as to PMC's compliance with all conditions and covenants under the Guarantee. PMC will also be required to provide annually to the Guarantee Trustee an officer's certificate as to PMC's compliance with all conditions precedent, if any, provided for in the Guarantee that relate to any action to be taken by the Guarantee Trustee at PMC's request. (Sections 2.04 and 2.05.) Information Concerning the Guarantee Trustee The Guarantee Trustee, other than during the occurrence and continuance of a Guarantee Event of Default, undertakes to perform only such duties as are specifically set forth in the Guarantee and, in case a Guarantee Event of Default has occurred (that has not been cured or waived), the Guarantee Trustee must exercise such of the rights and powers vested in it by the Guarantee, and use the same degree of care and skill in its exercise thereof, as a prudent individual would exercise or use under the circumstances in the conduct of his or her own affairs. (Section 3.01(c).) Subject to this provision, the Guarantee Trustee is under no obligation to exercise any of the powers vested in it by the Guarantee at the request of any holder of Capital Securities unless it is provided with reasonable indemnity against the costs, expenses and liabilities that might be incurred thereby. (Section 3.02. (a)(v).) Termination of the Guarantee The Guarantee will terminate and be of no further force and effect upon (i) full payment of the Redemption Price of all Capital Securities, (ii) the distribution of Junior Subordinated Debentures to holders of Capital Securities in exchange for all of the Capital Securities or (iii) payment in full of the amounts payable in accordance with the Trust Agreement upon liquidation of the Issuer. Notwithstanding the foregoing, the Guarantee will continue to be effective or will be reinstated, as the case may be, if at any time any holder of Capital Securities must restore payment of any sums paid with respect to the Capital Securities or the Guarantee. (Section 7.01.) - 154 - Status of the Guarantee The Guarantee will constitute an unsecured obligation of PMC and will rank (i) subordinate and junior in right of payment to all Senior Debt of PMC in the same manner as the Junior Subordinated Debentures, (ii) pari passu with any similar guarantee agreements issued by PMC on behalf of the holders of capital securities issued by a business trust or similar entity whose common securities are owned, directly or indirectly, by PMC and (iii) senior to PMC's Common Stock and the Class A Common Stock. The Trust Agreement provides that each holder of Trust Securities by acceptance thereof accepts the subordination provisions and other terms of the Guarantee. (Sections 6.02 and 6.03.) The Guarantee will constitute a guarantee of payment and not of collection (i.e., the guaranteed party may institute a legal proceeding directly against PMC to enforce its rights under the Guarantee without first instituting a legal proceeding against any other person or entity). (Section 5.05.) The Guarantee will be held for the benefit of the holders of the Capital Securities. The Guarantee will not be discharged except by payment of the Guarantee Payments in full to the extent not paid by the Issuer or upon distribution to the holders of the Capital Securities of the Junior Subordinated Debentures. The Guarantee does not place a limitation on the amount of additional Senior Debt that may be incurred by PMC. PMC expects from time to time to incur additional indebtedness constituting Senior Debt. (Sections 3.01(a) and 5.05.) Governing Law The Guarantee Agreement will be governed by, and construed in accordance with, the laws of the State of New York. (Section 8.06.) The Expense Agreement Pursuant to the Expense Agreement entered into by PMC under the Trust Agreement (the "Expense Agreement"), PMC will irrevocably and unconditionally guarantee to each person or entity to whom the Issuer is or becomes indebted or liable, the full payment of any and all indebtedness, expenses or liabilities of the Issuer including, without limitation, the fees, expenses and indemnities of the Trustees, other than obligations of the Issuer to pay to the holders of any Capital Securities or other similar interests in the Issuer of the amounts due such holders pursuant to the terms of the Capital Securities or such other similar interests, as the case may be. The Expense Agreement will be enforceable by third parties. DESCRIPTION OF THE JUNIOR SUBORDINATED DEBENTURES Set forth below is a summary of the material terms of the Junior Subordinated Debentures in which the Issuer will invest the proceeds of the issuance and sale of the Trust Securities. The Junior Subordinated Debentures will be qualified under the Trust Indenture Act. Reference is made to the provisions in the Indenture, (the "Indenture"), between PMC and The Bank of New York, as trustee with respect to the Junior Subordinated Debentures (the "Debenture Trustee"), the form of which is filed as an exhibit to the Registration Statement of which this Prospectus forms a part, and the Trust Indenture Act for a more complete description of the provisions summarized herein, and each such statement shall be deemed qualified in its entirety by such reference. Whenever particular provisions in the - 155 - Indenture are referred to herein, such provisions are incorporated by reference herein. Section references used herein are references to provisions of the Indenture unless otherwise noted. Under certain circumstances involving the termination of the Issuer, after satisfaction of liabilities to creditors of the Issuer as required under applicable law, Junior Subordinated Debentures may be distributed to the holders of the Capital Securities in exchange for the Capital Securities in liquidation of the Issuer. See "Description of the Capital Securities--Redemption--Special Event Redemption or Distribution of Junior Subordinated Debentures" and "Description of the Capital Securities--Liquidation Distribution upon Termination." General The Junior Subordinated Debentures will be limited in aggregate principal amount to a sum equal to the aggregate stated Liquidation Amount of the Capital Securities plus PMC's concurrent investment in the Common Securities. The Junior Subordinated Debentures will be unsecured subordinated obligations of PMC which rank junior to all PMC's Senior Debt (as defined below). The Junior Subordinated Debentures will initially mature on ____, 2028 (the "Stated Maturity"). PMC is an insurance holding company and substantially all of the operating assets of PMC are owned by its consolidated subsidiaries, principally PMA Reinsurance Corporation and the Pooled Companies. PMC relies primarily on the receipt of sufficient funds from PMA Reinsurance Corporation and the Pooled Companies in the form of dividends, net payments under tax-sharing agreements or loans to meet its obligations for payment of principal and interest on its outstanding debt obligations (including the Junior Subordinated Debentures) and corporate expenses. Accordingly, PMC's obligations under the Junior Subordinated Debentures will be effectively subordinated to all existing and future liabilities of PMC's subsidiaries, and claimants should look only to the assets of PMC for payments thereunder. Pennsylvania law limits the payment of dividends by PMA Reinsurance Corporation and the Pooled Companies. PMA Reinsurance Corporation and the Pooled Companies have the ability to loan funds to PMC subject to certain regulatory restrictions. See "Risk Factors--Subordination of the Guarantee and the Junior Subordinated Debentures", "--Restrictions on Subsidiary Dividends and Other Payments" and "Supervision and Regulation." Optional Redemption The Junior Subordinated Debentures are redeemable prior to maturity at the option of PMC (i) on or after ____, 2008, in whole at any time or in part from time to time, or (ii) prior to ____, 2008, in whole (but not in part) and within 90 days following the occurrence of a Special Event, in each case at the Redemption Price described below. The Redemption Price in the case of a redemption under (i) above shall equal the following prices, expressed in percentages of the principal amount, together with accrued interest to but excluding the Redemption Date. If redeemed during the 12-month period beginning _________ 1: - 156 - Year Redemption Price ---- ---------------- 2008................... 10x.xxxx% 2009................... 10x.xxxx% 2010................... 10x.xxxx% 2011................... 10x.xxxx% 2012................... 10x.xxxx% 2013................... 10x.xxxx% 2014................... 10x.xxxx% 2015................... 10x.xxxx% 2016................... 10x.xxxx% 2017................... 10x.xxxx% and 100% on and after __________ 1, 2018. (Section 1207.) The Redemption Price, in the case of a redemption following a Special Event as described under (ii) above, shall equal the Make-Whole Amount (as defined under "Description of the Capital Securities--Redemption"), together with accrued interest to but excluding the Redemption Date. (Section 1207.) Junior Subordinated Debentures in denominations larger than $1,000.00 may be redeemed in part but only in integral multiples of $1,000. (Section 1203.) Unless PMC defaults in payment of the Redemption Price, on and after the Redemption Date, interest ceases to accrue on such Junior Subordinated Debentures or portions thereof called for redemption. (Section 1206.) For so long as the Issuer is the holder of all the outstanding Junior Subordinated Debentures, the proceeds of any such redemption described above will be used by the Issuer to redeem Capital Securities in accordance with their terms. PMC may not redeem the Junior Subordinated Debentures in part unless all accrued and unpaid interest has been paid in full on all outstanding Junior Subordinated Debentures for all semi-annual interest periods terminating on or prior to the Redemption Date. (Section 1207.) Notice of any redemption will be mailed at least 45 days but not more than 75 days before the Redemption Date to each holder of Junior Subordinated Debentures to be redeemed at its registered address. (Section 1204.) Distribution of Junior Subordinated Debentures Under certain circumstances involving the termination of the Issuer, Junior Subordinated Debentures may be distributed to the holders of the Capital Securities in liquidation of the Issuer after the satisfaction of liabilities to creditors of the Issuer as provided by applicable law. If distributed to holders of Capital Securities in liquidation, the Junior Subordinated Debentures will initially be issued in the form of one or more global securities and DTC, or any successor depositary for the Capital Securities will act as depositary for the Junior Subordinated Debentures. (Section 904.) It is anticipated that the depositary arrangements for the Junior Subordinated Debentures would be substantially identical to those in effect for the - 157 - Capital Securities. There can be no assurance as to the market price of any Junior Subordinated Debentures that may be distributed to the holders of the Capital Securities. See "Description of the Capital Securities--Redemption-- Special Event Redemption or Distribution of Junior Subordinated Debentures" and "Description of the Capital Securities--Liquidation Distribution upon Termination." For a description of DTC and the terms of the depositary matters, see "Description of the Capital Securities--Book-Entry-Only Issuance--The Depositary Trust Company." Interest The Junior Subordinated Debentures shall bear interest at the rate of ___% per annum. Such interest is payable semi-annual in arrears on ___ 1 and ____ 1 of each year (each, an "Interest Payment Date"), commencing ______ 1, 1999, to the person in whose name each Junior Subordinated Debenture is registered at the close of business on the Business Day next preceding such Interest Payment Date. (Sections 301 and 307.) It is anticipated that, until the liquidation, if any, of the Issuer, each Junior Subordinated Debenture will be held in the name of the Property Trustee in trust for the benefit of the Issuer and the holders of the Capital Securities. The amount of interest payable for any period will be computed on the basis of a 360-day year of twelve 30-day months. (Section 310). In the event that any date on which interest is payable on the Junior Subordinated Debentures is not a Business Day (as defined above), then payment of the interest payable on such date will be made on the next succeeding day that is a Business Day (and without any interest or other payment in respect of any such delay), except that, if such Business Day is in the next succeeding calendar year, such payment shall be made on the immediately preceding Business Day, in each case with the same force and effect as if made on the date the payment was originally payable. Accrued interest that is not paid on the applicable Interest Payment Date will bear additional interest on the amount thereof (to the extent permitted by law) at the rate per annum of ___% thereof, compounded semi-annually. The term "interest" as used herein shall include semi-annual interest payments, interest on semi-annual interest payments not paid on the applicable Interest Payment Date and Additional Sums (as described below), as applicable. (Section 301.) Option To Extend Interest Payment Period So long as no Event of Default under the Indenture has occurred and is continuing, PMC shall have the right at any time during the term of the Junior Subordinated Debentures to defer the payment of interest on such Junior Subordinated Debentures from time to time for a period not exceeding 10 consecutive semi-annual periods (each, an "Extension Period"), provided that no Extension Period may extend beyond the Stated Maturity of the Junior Subordinated Debentures. PMC shall have the right to make partial payments of interest on any Interest Payment Date. At the end of any such Extension Period, PMC must pay all interest then accrued and unpaid (together with interest thereon at the rate of ___% per annum, compounded semi-annually, to the extent permitted by applicable law). During an Extension Period, interest will continue to accrue and holders of Junior Subordinated Debentures (or holders of Capital Securities while outstanding) will be required to accrue interest income for United States federal income tax purposes. See "United States Federal Income Taxation--Original Issue Discount." However, during any such Extension Period, PMC - 158 - shall not, and shall cause any subsidiary of PMC not to, (a) declare or pay any dividends or distributions on, or redeem, purchase, acquire or make a liquidation payment with respect to, any of PMC's capital stock or (b) make any payment of principal, interest or premium, if any, on or repay, repurchase or redeem any debt securities of PMC that rank pari passu with or junior in interest to the Junior Subordinated Debentures or make any guarantee payments with respect to any guarantee by PMC of the debt securities of any subsidiary of PMC that by their terms rank pari passu or junior in interest to the Junior Subordinated Debentures (other than (a) dividends or distributions in Common Stock or Class A Common Stock of PMC, (b) payments under the Guarantee and (c) purchases of Common Stock or Class A Common Stock of PMC related to the issuance of Common Stock or Class A Common Stock of PMC under any of PMC's benefit plans for its directors, officers or employees). Prior to the termination of any such Extension Period, PMC may further extend the interest payment period, provided that such Extension Period, together with all such previous and further extensions thereof, shall not exceed 10 consecutive semi-annual periods or extend beyond the Stated Maturity of the Junior Subordinated Debentures. Upon the termination of any Extension Period and the payment of all interest then accrued and unpaid (together with interest thereon at the rate of ____% per annum, compounded semi-annually, to the extent permitted by applicable law), PMC may elect to begin a new Extension Period, subject to the above requirements. No interest shall be due and payable during an Extension Period, except at the end thereof. PMC must give the Debenture Trustee and the Administrative Trustees notice of its election to begin any Extension Period at least one Business Day prior to the earliest of (i) the date interest on the Junior Subordinated Debentures would have been payable except for the election to begin such Extension Period or (ii) the date the distributions on the Capital Securities are payable or (iii) the date the Administrative Trustees are required to give notice to the New York Stock Exchange, the Nasdaq National Market or other applicable self-regulatory organization or to holders of the Capital Securities of the record date or the date such distributions are payable, but in any event not less than one Business Day prior to such record date. The Debenture Trustee shall give notice of PMC's election to begin any Extension Period to the holders of the outstanding Capital Securities. There is no limitation on the number of times that PMC may elect to begin an Extension Period. (Section 301.) Set-Off Notwithstanding anything to the contrary in the Indenture, PMC shall have the right to set-off any payment it is otherwise required to make thereunder with respect to any Junior Subordinated Debenture and to the extent PMC has theretofore made, or is concurrently on the date of such payment making, a payment under the Guarantee or under the provisions of the Indenture which permit any holder of the Capital Securities, upon the occurrence of a Debenture Event of Default (as defined below) relating to nonpayment of interest or principal on the Junior Subordinated Debentures to institute suit for the enforcement of the payment of interest or principal. (Section 311.) This provision prevents double collection from PMC of identical amounts due under the various provisions of the Indenture and the Guarantee. To the extent PMC makes a payment of unpaid distributions to holders of Capital Securities under the Guarantee, PMC is not then also required to make a like payment of interest on the Junior Subordinated Debentures (since such interest payment would be paid out to such holders as the same unpaid distribution). Likewise, if holders of Capital Securities bring an action directly against PMC under the Indenture and collect unpaid distributions in such - 159 - action, PMC may deduct the amounts so paid from any aggregate amount it owes on the Junior Subordinated Debentures. Therefore, to the extent PMC makes payments directly to holders of Capital Securities under the Guarantee or the Indenture, the Property Trustee may not also collect such amounts under the Junior Subordinated Debentures. Subordination The Junior Subordinated Debentures are subordinate and junior in right of payment to all Senior Debt (as defined below) of PMC as provided in the Indenture. No payment or distribution on account of principal of (or premium, if any) or interest, if any, on, the Junior Subordinated Debentures or on account of the purchase or other acquisition of Junior Subordinated Debentures by PMC or any subsidiary may be made (a) in the event and during the continuation of any default in the payment of principal of (or premium, if any) or interest on any Senior Debt, or if the maturity of any Senior Debt has been accelerated because of a default until such event of default shall have been cured or waived or shall have ceased to exist and such acceleration shall have been rescinded or annulled or (b) in the event of any judicial proceeding with respect to any such default in payment or such event of default. (Section 1104.) In the case of the pendency of any liquidation, reorganization, bankruptcy, insolvency, receivership, arrangement, adjustment, composition or other judicial proceeding relative to PMC, all principal of, and premium, if any, and interest, if any, on all Senior Debt must be paid in full or provision must be made for such payment in cash or cash equivalents or otherwise in a manner satisfactory to the holders of Senior Debt, before the holders of the Junior Subordinated Debentures are entitled to receive or retain any payment or distribution thereon. (Section 1102.) In the event that, notwithstanding the foregoing, any payment or distribution of cash, property or securities shall be received or collected by a holder of the Junior Subordinated Debentures in contravention of the foregoing provisions, such payment or distribution shall be held for the benefit of and shall be paid over to the holders of Senior Debt or their representative or representatives or to the trustee or trustees under any indenture under which any instrument evidencing Senior Debt may have been issued, as their respective interests may appear, to the extent necessary to pay in full all Senior Debt then due, after giving effect to any concurrent payment to the holders of Senior Debt, but only to the extent that the holders of the Senior Debt (or their representative or representatives) notify the Trustees in writing, within 90 days of such payment, of the amounts then due and owing on such Senior Debt and only the amounts specified in such notice to the Trustees shall be paid to the holders of such Senior Debt. (Section 1104.) Subject to the prior payment of all Senior Debt, the rights of the holders of the Junior Subordinated Debentures will be subrogated to the rights of the holders of Senior Debt to the extent of the payments or distributions made to the holders of such Senior Debt until all amounts owing on the Junior Subordinated Debentures are paid in full. (Section 1106.) "Debt" means with respect to any entity, whether recourse is to all or a portion of the assets of such entity and whether or not contingent, (i) every obligation of such entity for money borrowed; (ii) every obligation of such entity evidenced by bonds, debentures, notes or other similar instruments, including obligations incurred in connection with the acquisition of property, assets or businesses; (iii) every reimbursement obligation of such entity with respect to letters of credit, bankers' acceptances or similar facilities issued for the account of such entity; (iv) every obligation of such entity issued or assumed as the deferred purchase price of property or services (but excluding trade accounts payable or accrued liabilities arising in the ordinary course of business); (v) every capital lease obligation of such entity; and (vi) every obligation of the type referred to in clauses (i) through (v) of another entity and all dividends of another entity the payment of which, in either case, such entity has guaranteed or is responsible or liable for, directly or indirectly, as obligor or otherwise. (Section 101.) "Senior Debt" means the principal of (and premium, if any) and interest, if any (including interest accruing on or after the filing of any petition in bankruptcy or for reorganization relating to PMC whether or not such claim for post-petition interest is allowed in such proceeding), on Debt, whether incurred on or prior to the date of the Indenture or thereafter incurred, unless, in the instrument creating or evidencing the same or pursuant to - 160 - which the same is outstanding, it is provided that such obligations are not superior in right of payment to the Junior Subordinated Debentures or to other Debt which is pari passu with, or subordinated to, the Junior Subordinated Debentures; provided, however, that Senior Debt shall not be deemed to include (i) any Debt of PMC which, when incurred and without respect to any election under Section 1111(b)of the Bankruptcy Code, was without recourse to PMC, (ii) any Debt of PMC to any of its subsidiaries, (iii) Debt to any employee of PMC, (iv) trade accounts payable of PMC, (v) accrued liabilities arising in the ordinary course of business of PMC, (vi) the Junior Subordinated Debentures, and (vii) the Guarantee. PMC is an insurance holding company and substantially all of the operating assets of PMC are owned by its consolidated subsidiaries, principally PMA Reinsurance Corporation and the Pooled Companies. PMC relies primarily on the receipt of sufficient funds from PMA Reinsurance Corporation and the Pooled Companies in the form of dividends, net payments under tax-sharing agreements or loans to meet its obligations for payment of principal and interest on outstanding debt obligations (including to Junior Subordinated Debentures) and corporate expenses. Accordingly, PMC's obligations under the Junior Subordinated Debentures will be effectively subordinated to all existing and future liabilities of PMC's subsidiaries, and claimants should look only to the assets of PMC for payments thereunder. Pennsylvania insurance law limits the payment of dividends by PMA Reinsurance Corporation and the Pooled Companies. PMA Reinsurance Corporation and the Pooled Companies have the ability to loan funds to PMC subject to certain regulatory restrictions. See "Risk Factors-- Subordination of the Guarantee and the Junior Subordinated Debentures," and "--Holding Company Structure--Restrictions on Subsidiary Dividends and Other Payments" and "Supervision and Regulation". The Indenture does not limit the aggregate amount of Senior Debt that may be issued. After the completion of this Offering and the repayment of debt with the proceeds thereof, PMC will have approximately $104.5 million of principal amount of indebtedness for borrowed money constituting Senior Debt. PMC expects from time to time to incur additional indebtedness constituting Senior Debt. Certain Covenants of PMC PMC will covenant in the Indenture that if and so long as (i) the Issuer is the holder of all of the outstanding Junior Subordinated Debentures, (ii) a Tax Event (as defined above) has occurred and is continuing and (iii) PMC has not redeemed the Junior Subordinated Debentures pursuant to the Indenture or terminated the Issuer pursuant to the Trust Agreement, PMC will pay to the Issuer, for so long as the Issuer is the registered holder of any Junior Subordinated Debentures, such additional amounts as may be necessary in order that the amount of distributions then due and payable by the Issuer on the outstanding Capital Securities and Common Securities of the Issuer shall not be reduced as a result of any additional taxes, duties and other governmental charges to which the Issuer has become subject from time to time as a result of a Tax Event (the "Additional Sums"). (Section 1005). PMC will also covenant that it will not, and it will not permit any subsidiary to, (a) declare or pay any dividends or distributions on, or redeem, purchase, acquire or make a liquidation payment with respect to, any of PMC's outstanding capital stock or (b) make any payment of principal, interest or premium, if any, on or repay, repurchase or redeem any debt securities that rank pari passu with or junior to the Junior Subordinated Debentures or make any guarantee payments with respect to any guarantee by PMC of the debt securities of any subsidiary of PMC that by their terms rank pari passu or junior in interest to the Junior - 161 - Subordinated Debentures, (other than (a) dividends or distributions in Common Stock or Class A Common Stock of PMC, (b) payments under the Guarantee, and (c) purchases of Common Stock or Class A Common Stock of PMC related to the issuance of Common Stock or Class A Common Stock of PMC under any of PMC's benefit plans for its directors, officers or employees) if at such time (i) there shall have occurred and be continuing any event that, with the giving of notice or the lapse of time, or both, would constitute a Debenture Event of Default and in respect of which PMC shall not have taken reasonable steps to cure, (ii) PMC shall be in default with respect to its payment of any obligations under the Guarantee or (iii) PMC shall have given notice of its selection of an Extension Period as provided in the Indenture and shall not have rescinded such notice and such Extension Period, or any extension thereof, shall be continuing (Section 1006.) PMC will also covenant (i) to maintain directly or indirectly 100% ownership of the Common Securities of the Issuer (provided, however, that any permitted successor of PMC may succeed to such ownership), (ii) not to voluntarily dissolve, wind-up or terminate the Issuer, except in connection with a distribution of the Junior Subordinated Debentures to the holders of the Capital Securities in exchange for the Capital Securities and in liquidation of the Issuer or in connection with certain mergers, consolidations or amalgamations permitted by the Trust Agreement and (iii) to use its reasonable efforts, consistent with the terms and provisions of the Trust Agreement, to cause the Issuer to remain a business trust and to be classified as a grantor trust for United States federal income tax purposes, except in connection with a distribution of the Junior Subordinated Debentures to the holders of the Capital Securities in liquidation of the Issuer. (Section 1006.) Debenture Events of Default And Consequent Rights of Certain Holders The Indenture provides that any one or more of the following described events, that has occurred and is continuing constitutes an "Event of Default" (also referred to herein as a "Debenture Event of Default") with respect to the Junior Subordinated Debentures: (a) failure for 30 days to pay interest on the Junior Subordinated Debentures when due (subject to the deferral of any due date in the case of an Extension Period); or (b) failure to pay principal (or premium, if any) on the Junior Subordinated Debentures when due whether at Stated Maturity, upon redemption, by declaration or otherwise; or (c) failure to observe or perform in any material respect any other covenant contained in the Indenture for 90 days after written notice to PMC from the Debenture Trustee or the holders of at least 25% in aggregate principal amount of the outstanding Junior Subordinated Debentures; or (d) Certain events in bankruptcy, insolvency or reorganization of PMC. (Section 501.) Each of the above events is a Debenture Event of Default regardless of the reason for such Event of Default and whether it shall be voluntary or involuntary or be effected by operation of law or pursuant to any judgment, decree or order of any court or any order, rule or regulation of any administrative or governmental body. (Section 501.) There is no - 162 - requirement that any such event must be declared by anyone to be a Debenture Event of Default. The holders of a majority in principal amount of the outstanding Junior Subordinated Debentures have the right to direct the time, method and place of conducting any proceeding for any remedy available to the Debenture Trustee, under certain conditions. (Section 512.) Acceleration of Maturity; Rescission and Annulment The Debenture Trustee or the holders of not less than 25% in principal amount of the outstanding Junior Subordinated Debentures may declare the principal of all the Junior Subordinated Debentures due and payable immediately upon the occurrence and continuation of a Debenture Event of Default, and should the Debenture Trustee or such holders of Junior Subordinated Debentures fail to make such declaration, the holders of at least 25% in aggregate Liquidation Amount of Capital Securities then outstanding shall have such right. The holders of a majority in principal amount of the outstanding Junior Subordinated Debentures may rescind and annul such declaration. If the holders of a majority in principal amount of the outstanding Junior Subordinated Debentures fail to annul such declaration and its consequences, the holders of a majority in aggregate Liquidation Amount of the Capital Securities may rescind and annul such declaration and its consequences. (Section 502.) Waiver of Defaults Subject to certain limitations, the holders of not less than a majority in aggregate principal amount of the outstanding Junior Subordinated Debentures affected thereby may, on behalf of the holders of all the Junior Subordinated Debentures, waive any past default under the Indenture and its consequences, except a default in the payment of principal of or interest on any Junior Subordinated Debentures (unless such default has been cured and a sum sufficient to pay all matured installments of interest and principal due otherwise than by acceleration has been deposited with the Debenture Trustee) or a default in respect of a covenant or provision of the Indenture which under the Indenture cannot be modified or amended without the consent of the holder of each outstanding Junior Subordinated Debenture affected. If the holders of such Junior Subordinated Debentures fail to waive such default, the holders of a majority in aggregate Liquidation Amount of the Capital Securities shall have such right. (Section 513.) PMC is required to deliver annually to the Debenture Trustee a certificate stating whether or not to the best knowledge of the signers thereof PMC is in default in the performance, observance or fulfillment of or compliance with any of the material terms, provisions, covenants and conditions of the Indenture (without regard to any period of grace or requirement of notice provided under the Indenture) and, if PMC shall be in default, specifying all such defaults and the nature and status thereof of which they may have knowledge. (Section 1004.) Creditor's Rights of The Debenture Trustee In case a Debenture Event of Default shall occur and be continuing, the Debenture Trustee will have the right to declare the principal (or specific portions thereof) of and the interest on the Junior Subordinated Debentures, and any other amount payable under the Indenture, to be forthwith due and payable and to enforce its other rights as a creditor with - 163 - respect to the Junior Subordinated Debentures. (Sections 502 and 503.) If the Debenture Trustee obtains a judgment against PMC following the occurrence of a Debenture Event of Default, the provisions of Pennsylvania law regulating insurance holding companies would limit the ability of the Debenture Trustee to realize upon the assets of PMC by conveying or transferring the capital stock of PMA Reinsurance Corporation or the Pooled Companies owned by PMC. Any conveyance, transfer, assignment, or alienation of a ten percent or greater interest in the voting shares of PMA Reinsurance Corporation or any of the Pooled Companies would require the prior approval of the Pennsylvania Commissioner. See "Supervision and Regulation." Rights of Holders of Capital Securities to Direct Action As explained more fully above (see "--Debenture Events of Default and Consequent Rights of Certain Holders" and--Waiver of Defaults"), holders of less than all of the outstanding Junior Subordinated Debentures or holders of less than all of the Capital Securities may waive any past default (with certain limited exceptions identified above). If so waived, any such Debenture Event of Default shall cease to be "continuing" for purposes of the Indenture. However, such holders may not waive any default in the payment of principal of or interest on any Junior Subordinated Debentures unless such default has been cured and a sum sufficient to pay all matured installments of interest and principal due otherwise than by acceleration has been deposited with the Debenture Trustee. If a Debenture Event of Default has occurred and is continuing and such event is attributable to the failure of PMC for 30 days to pay interest on or the failure of PMC to pay principal of the Junior Subordinated Debentures on the date such interest or principal is otherwise payable, any holder of Capital Securities may institute a suit directly against PMC for enforcement of payment to such holder of the principal of and interest on such Junior Subordinated Debentures having a principal amount equal to the aggregate Liquidation Amount of the Capital Securities of such holder (a "Direct Action") (Section 508). PMC may not amend the Indenture to remove the foregoing right to bring a Direct Action without the prior written consent of the holders of all of the outstanding Capital Securities. (Section 902). If the right to bring a Direct Action is removed, the Issuer may become subject to the regulatory obligations under the Exchange Act. The holders of the Capital Securities would not be able to exercise directly any remedies other than those set forth in the preceding paragraph available to the holders of the Junior Subordinated Debentures unless there shall have been a Debenture Event of Default and the holders of the Junior Subordinated Debentures fail to exercise such remedies. See "--Debenture Events of Default and Consequent Rights of Certain Holders" "--Acceleration of Maturity; Rescission and Annulment" and "Debenture Events of Default and Consequent Rights of Certain Holders", and --"Waiver of Defaults". Form, Exchange and Transfer The Junior Subordinated Debentures will be issuable only in registered form, without coupons, and only in denominations of $1,000 and integral multiples thereof. (Section 302.) Subject to the terms of the Indenture, Junior Subordinated Debentures may be presented for registration of transfer (duly endorsed or with the form of transfer endorsed thereon duly executed) at the office of the Security Registrar or at an office or agency of PMC designated by PMC for such purpose. No service charge will be made to a holder of Junior - 164 - Subordinated Debentures for any registration of transfer or exchange of Junior Subordinated Debentures, but PMC or the Security Registrar may require payment of a sum sufficient to cover any tax or other governmental charge that may be imposed in connection therewith. Such transfer or exchange will be effected upon the Securities Registrar or PMC, as the case may be, being satisfied with the documents of title and identity of the person making the request. PMC has appointed the Debenture Trustee as Securities Registrar. (Section 305.) PMC may at any time designate additional transfer agents or rescind the designation of any transfer agent or approve a change in the office through which any transfer agent acts. (Section 1002.) Neither PMC nor the Securities Registrar will be required (i) to issue, transfer or exchange any Junior Subordinated Debenture during a period beginning at the opening of business 15 days before the day of selection for redemption of any such Junior Subordinated Debentures pursuant to the Indenture and ending at the close of business on the day of mailing of notice of redemption or (ii) to transfer or exchange any Junior Subordinated Debentures so selected for redemption, in whole or in part, except the unredeemed portion of any such Junior Subordinated Debentures being redeemed in part. (Section 305.) Payment And Paying Agents Payment of interest on a Junior Subordinated Debenture on any Interest Payment Date will be made to the person in whose name such Junior Subordinated Debenture (or predecessor security) is registered at the close of business on the Business Day next preceding such Interest Payment Date except in the case of interest which is payable but is not paid or provided for on such Interest Payment Date. (Section 307.) Principal of and any interest on the Junior Subordinated Debentures will be payable at the office of such Paying Agent or Paying Agents as PMC may designate for such purpose from time to time, provided, however, that at the option of PMC, payment of any interest may be made (i) by check mailed to the address of the person entitled thereto as such address shall appear in the Securities Register or (ii) by wire transfer in immediately available funds at such place and to such account as may be designated by the person entitled thereto as specified in the Securities Register. The Bank of New York will act as Paying Agent with respect to the Junior Subordinated Debentures. PMC may at any time designate additional Paying Agents or rescind the designation of any Paying Agent or approve a change in the office through which any Paying Agent acts. (Section 301.) Modification of The Indenture From time to time, PMC and the Debenture Trustee may, without the consent of the holders of Junior Subordinated Debentures, amends waive or supplement the Indenture for specified purpose, including, among other things, curing ambiguities, defects or inconsistencies (provided that any such action does not materially adversely affect the interest of the holders of any Junior Subordinated Debentures or the holders of Capital Securities so long as they remain outstanding) and qualifying, or maintaining the qualification of, the Indenture under the Trust Indenture Act. The Indenture contains provisions permitting PMC and the Debenture Trustee, with the consent of the holders of not less than a majority in principal amount of the outstanding Junior Subordinated Debentures, to modify the Indenture in a manner adversely affecting the rights of the holders of the Junior Subordinated - 165 - Debentures; provided that no such modification may, without the consent of the holder of each outstanding Junior Subordinated Debenture affected thereby, (i) except as set forth in "--Option to Extend Interest Payment Period" above, change the Stated Maturity of, the principal of, or any installment of interest on, any Junior Subordinated Debenture or reduce the principal amount thereof, or the rate of interest thereon or reduce any premium payable upon the redemption thereof or change the place of payment where, or the coin or currency in which, any Junior Subordinated Debenture or interest thereon is payable, or impair the right to institute suit for the enforcement of any such payment on or after the Stated Maturity thereof (or in the case of redemption, on or after the Redemption Date), or modify the provisions of the Indenture with respect to the subordination of the Junior Subordinated Debentures in a manner adverse to the holders thereof (except such change or extension as is contemplated thereby, (ii) reduce the percentage in principal amount of the outstanding Junior Subordinated Debentures, the consent of the holders of which is required for any waiver provided for in the Indenture or (iii) modify certain provisions of the Indenture providing for waiver of defaults, waiver of covenants and modification of the Indenture, except to increase the percentage or to provide that certain other provisions of the Indenture cannot be modified or waived without the consent of the holder of each outstanding Junior Subordinated Debenture affected thereby; provided, that, so long as any of the Capital Securities remains outstanding, (a) no such modification may be made that adversely affects the holders of the Capital Securities in any material respect, and no termination of the Indenture may occur, and no waiver of any Debenture Event of Default or compliance with any covenant under the Indenture shall be effective, without the prior consent of the holders of at least a majority of the aggregate Liquidation Amount of the outstanding Capital Securities unless and until the principal of and any premium on the Junior Subordinated Debentures and all accrued and unpaid interest thereon have been paid in full and (b) where a consent under the Indenture would require the consent of each holder of Junior Subordinated Debentures, no such consent will be given by the Property Trustee without the prior consent of each holder of the Capital Securities. (Section 902.) Consolidation, Merger And Sale PMC, without the consent of the holders of any outstanding Junior Subordinated Debentures, may consolidate with or merge into, or convey, transfer or lease its properties and assets substantially as an entirety to any person, and may permit any person to consolidate with or merge into, or convey, transfer or lease its properties and assets substantially as an entirety to PMC, provided (i) that any successor person must be a corporation, partnership, trust or other entity organized and validly existing under the laws of any domestic jurisdiction and must expressly assume PMC's obligations on the Junior Subordinated Debentures and under the Indenture, (ii) that immediately after giving effect to the transaction no Debenture Event of Default, and no event which, after notice or lapse of time or both, would become a Debenture Event of Default, shall have occurred and be continuing, (iii) that such transaction is permitted under the Trust Agreement and the Guarantee and does not give rise to any breach or violation of, the Trust Agreement or the Guarantee and (iv) that certain other conditions as prescribed by the Indenture are met. (Section 801). The general provisions of the Indenture do not afford holders of Junior Subordinated Debentures protection in the event of a highly leveraged or other transaction involving PMC that may adversely affect holders of the Junior Subordinated Debentures. Since the Indenture - 166 - does not limit the aggregate amount of Senior Debt that may be issued and the Junior Subordinated Debentures are subordinate to all Senior Debt, including such Debt incurred after the date of the Indenture (see "--Subordination" above), if the PMC chooses to engage in a highly leveraged transaction whereby it would incur a substantial amount of Debt, the obligations under the Junior Subordinated Debentures would become more deeply subordinated and the holders of the Junior Subordinated Debentures would not be able to avoid this consequence provided that the conditions set forth in the immediately preceding paragraph are met. Similarly, PMC could be involved in a reorganization, restructuring, merger or similar transaction that could adversely affect the holders of the Junior Subordinated Debentures but, provided that the conditions set forth in the immediately preceding paragraph are met, such holders could not avoid such adverse affects. Satisfaction and Discharge Under the terms of the Indenture, the Indenture will cease to be of further effect and PMC will be deemed to have satisfied and discharged the Indenture (except as to PMC's obligations to pay all other sums due pursuant to the Indenture and to provide the officers' certificates and opinions of counsel described therein), if all Junior Subordinated Debentures not previously delivered to the Debenture Trustee for cancellation have become due and payable, or will become due and payable at their Stated Maturity within one year of the date of deposit, and PMC deposits with the Debenture Trustee, in trust, cash, or cash equivalents in an amount sufficient to pay all the principal of, premium, if any, and interest on the Junior Subordinated Debentures to the date of such deposit or to the Stated Maturity, as the case may be. (Section 401.) Governing Law The Indenture and the Junior Subordinated Debentures will be governed by, and construed in accordance with, the laws of the State of New York. (Section 112.) Miscellaneous PMC will have the right of all times to assign any of its rights or obligations under the Indenture to a direct or indirect wholly-owned subsidiary of PMC, provided that, in the event of any such assignment, PMC will remain liable for all such obligations. The Issuer may not assign any of its rights under the Indenture without the prior written consent of PMC. The Indenture is not otherwise assignable by the parties thereto. Subject to the foregoing, the Indenture will be binding upon and inure to the benefit of the parties thereto and their respective successors and assigns. (Section 109.) - 167 - RELATIONSHIP AMONG THE CAPITAL SECURITIES, THE JUNIOR SUBORDINATED DEBENTURES AND THE GUARANTEE Full and Unconditional Guarantee Payments of distributions and other amounts due on the Capital Securities (to the extent the Issuer has funds available for the payment of such distributions) are irrevocably guaranteed by PMC as and to the extent set forth under "Description of the Guarantee." Taken together, PMC's obligations under the Junior Subordinated Debentures, the Indenture, the Trust Agreement, the Expense Agreement, and the Guarantee provide, in the aggregate, a full, irrevocable and unconditional guarantee of payments of distributions and other amounts due on the Capital Securities. No single document standing alone or operating in conjunction with fewer than all of the other documents constitutes such guarantee. It is only the combined operation of these documents that has the effect of providing a full, irrevocable and unconditional guarantee of the Issuer's obligations under the Capital Securities. If and to the extent that PMC does not make payments on the Junior Subordinated Debentures, the Issuer will not pay distributions or other amounts due on its Capital Securities. The Guarantee does not cover payment of distributions when the Issuer does not have sufficient funds to pay such distributions. In such event, the remedy of a holder of Capital Securities is to institute a legal proceeding directly against PMC under the terms of the Indenture for enforcement of payment of such distributions to such holder. The Indenture likewise provides for such a direct action by holders of the Junior Subordinated Debentures. The obligations of PMC under the Guarantee are subordinate and junior in right of payment to all Senior Debt of PMC. Sufficiency of Payments As long as payments of interest and other payments are made when due on the Junior Subordinated Debentures, such payments will be sufficient to cover distributions and other payments due on the Capital Securities, primarily because (i) the aggregate principal amount of the Junior Subordinated Debentures will be equal to the sum of the aggregate stated Liquidation Amount of the Capital Securities and the Common Securities; (ii) the interest rate and interest and other payment dates on the Junior Subordinated Debentures will match the distribution rate and distribution and other payment dates for the Capital Securities; (iii) PMC shall pay for all and any costs, expenses and liabilities of the Issuer except the Issuer's obligations to holders of its Capital Securities under the Capital Securities and (iv) the Trust Agreement further provides that the Issuer will not engage in any activity that is not consistent with its limited purposes. Notwithstanding anything to the contrary in the Indenture, PMC has the right to set-off any payment it is otherwise required to make thereunder with and to the extent PMC has theretofore made, or is concurrently on the date of such payment making, a payment under the Guarantee. See "Description of the Junior Subordinated Debentures--Set-Off." Enforcement Rights of Holders of Capital Securities A holder of any Capital Security may, to the extent permissible under applicable law, institute a legal proceeding directly against PMC to enforce its rights under the Guarantee - 168 - without first instituting a legal proceeding against the Guarantee Trustee, the Issuer or any other person or entity. A default or event of default under any Senior Debt of PMC would not constitute a default or Debenture Event of Default under the Indenture. However, in the event of payment defaults under, or acceleration of Senior Debt of PMC, the subordination provisions of the Indenture provide that no payments may be made in respect of the Junior Subordinated Debentures until such Senior Debt has been paid in full or any payment default thereunder has been cured or waived. Failure to make required payments on Junior Subordinated Debentures would constitute a Debenture Event of Default. Limited Purpose of Issuer The Issuer's Capital Securities evidence a beneficial interest in the Issuer, and the Issuer exists for the sole purpose of issuing its Capital Securities and Common Securities and investing the proceeds thereof in the Junior Subordinated Debentures. A principal difference between the rights of a holder of a Capital Security and a holder of a Junior Subordinated Debenture is that a holder of a Junior Subordinated Debenture is entitled to receive from PMC the principal amount of and interest accrued on the Junior Subordinated Debentures held, while a holder of Capital Securities is entitled to receive distributions from the Issuer (or, to the extent such distributions are not made by or on behalf of the Issuer, from PMC under the Guarantee) if and to the extent the Issuer has funds available for payment of such distributions. Rights Upon Termination Upon any voluntary or involuntary dissolution, winding-up or termination of the Issuer, after satisfaction of the liabilities of the Issuer to creditors as required by applicable law, the holders of Capital Securities will be entitled to receive, out of assets available for distribution to holders, the Liquidation Distribution in cash or Junior Subordinated Debentures. See "Description of the Capital Securities--Liquidation Distribution upon Termination." Upon any voluntary or involuntary liquidation or bankruptcy of PMC, the Property Trustee, as holder of the Junior Subordinated Debentures, would be a subordinated creditor of PMC, subordinated in right of payment to all Senior Debt, but entitled to receive payment in full of principal, premium, if any, and interest, before any shareholders of PMC receive payments or distributions. Since PMC is Guarantor under the Guarantee and has agreed, under the Expense Agreement, to pay for all indebtedness, expenses and liabilities of the Issuer (other than the Issuer's obligations to Capital Security holders under the Capital Securities), the positions of a holder of Capital Securities and a holder of Junior Subordinated Debentures relative to other creditors and to shareholders of PMC in the event of liquidation or bankruptcy of PMC would be substantially the same. - 169 - UNITED STATES FEDERAL INCOME TAXATION General The following is a summary of the principal United States federal income tax consequences of the purchase, ownership and disposition of Capital Securities, based upon the opinion of Duane, Morris & Heckscher LLP, counsel to PMC. Unless otherwise stated, this summary deals only with Capital Securities held as capital assets by a holder that purchases the Capital Securities upon original issuance at their original issue price and that is (i) a citizen or resident of the United States, (ii) a domestic corporation, (iii) an estate the income of which is subject to the United States federal income tax without regard to its source or (iv) a trust if a United States court is able to exercise primary supervision over administration of the trust and one or more United States persons have authority to control all substantial decisions of the trust (a "United States Holder"). This summary does not address all the tax consequences that may be relevant to holders that may be subject to special tax treatment such as, for example, banks, real estate investment trusts, regulated investment companies, insurance companies, dealers in securities or currencies, traders that elect to mark to market, tax-exempt investors, persons whose functional currency is other than the United States dollar, persons who hold Capital Securities as part of a straddle, hedging or conversion transaction or, except as specifically described herein, foreign taxpayers. In addition, this summary does not address any aspects of state, local or foreign laws. This summary is based on the Internal Revenue Code of 1986, as amended (the "Code"), Treasury regulations promulgated thereunder and administrative and judicial interpretations thereof, as of the date hereof, all of which are subject to change, possibly on a retroactive basis. Each holder should also consult its tax advisor as to its particular tax consequences of acquiring, holding, and disposing of the Capital Securities, including the tax consequences under state, local and foreign laws. Classification of the Junior Subordinated Debentures It is a condition to the issuance of the Capital Securities that Duane, Morris & Heckscher LLP, counsel to PMC, render its opinion to the effect that, under current United States federal income tax law, the Junior Subordinated Debentures held by the Trust will be classified for United States federal income tax purposes as indebtedness of PMC. Accordingly, corporate United States Holders of Capital Securities will not be entitled to a dividends-received deduction with respect to any income recognized with respect to the Capital Securities. Classification of the Trust Duane, Morris & Heckscher LLP, counsel to PMC and the Trust, has rendered its opinion to the effect that, under current United States federal income tax law, the Trust will be classified for United States federal income tax purposes as a grantor trust and not as an association taxable as a corporation. Accordingly, for United States federal income tax purposes, each United States Holder of Capital Securities will generally be considered the owner of an undivided interest in the Junior Subordinated Debentures, and each United States Holder will be required to include in its gross income any interest paid or accrued or any original issue discount ("OID") accrued with respect to its allocable share of those Junior Subordinated Debentures. Investors - 170 - should be aware that the foregoing opinions of Duane, Morris & Heckscher LLP will not be confirmed by the IRS by private ruling or otherwise, and will not be binding on the Service or the courts. By its acceptance of a Capital Security, a holder agrees to treat the Capital Security and the Junior Subordinated Debentures consistently with the foregoing opinions. Interest Income and Original Issue Discount PMC has the option, under the terms of the Junior Subordinated Debentures, to defer payments of interest by extending interest payments for up to 10 semi- annual periods. See "Description of the Junior Subordinated Debentures--Option to Extend Interest Payment Period." Under applicable Treasury regulations (the "Regulations"), a contingency that stated interest will not be timely paid that is "remote", because of the terms of the relevant debt instrument, will be ignored in determining whether such debt instrument is issued with OID. As a result of the terms and conditions of the Junior Subordinated Debentures that prohibit certain payments with respect to PMC's capital stock and indebtedness if PMC elects to extend interest payment periods, PMC believes that the likelihood of its exercising its option to defer payments is remote. See "Description of the Junior Subordinated Debentures--Option to Defer Interest Payment Period." Based on the foregoing, PMC believes that the Junior Subordinated Debentures will not be considered to be issued with OID at the time of their original issuance and, accordingly, a United States Holder should include in gross income such holder's allocable share of interest on the Junior Subordinated Debentures in accordance with such holder's normal method of accounting for tax purposes. If the option to defer any payment of interest was determined not to be "remote" or if PMC exercises its option to defer any payment of interest, the Junior Subordinated Debentures would be treated as issued with OID at the time of issuance or at the time of such exercise, as the case may be, and all stated interest on the Junior Subordinated Debentures would thereafter be treated as OID as long as the Junior Subordinated Debentures remained outstanding. In such event, all of a United States Holder's taxable interest income with respect to the Junior Subordinated Debentures would be accounted for as OID on a constant yield method regardless of such holder's method of tax accounting, and actual distributions of stated interest would not be reported as taxable income. Consequently, a United States Holder would be required to include OID in gross income even though PMC would not make any actual cash payments during an Extension Period. The IRS has not addressed the Regulations in any rulings or other interpretations, and it is possible that the IRS could take a position contrary to the interpretation herein. Because income on the Capital Securities will constitute interest or OID, corporate United States Holders of the Capital Securities will not be entitled to a dividends received deduction with respect to any income recognized with respect to the Capital Securities. Market Discount and Premium United States Holders of Capital Securities other than holders that purchased the Capital Securities upon original issuance at their original issue price may be considered to - 171 - have acquired their undivided interest in the Junior Subordinated Debentures with market discount, amortizable bond premium or acquisition premium as such terms are defined for United States federal income tax purposes. Such holders are urged to consult their tax advisors as to the income tax consequences of the acquisition, ownership and disposition of the Capital Securities. Receipt of Junior Subordinated Debentures or Cash Upon Liquidation of the Trust Under certain circumstances, as described under the caption "Description of the Capital Securities--Redemption--Special Event Redemption or Distribution of Junior Subordinated Debentures" and "Description of the Capital Securities-- Liquidation Distribution upon Termination," Junior Subordinated Debentures may be distributed to holders in exchange for the Capital Securities and in liquidation of the Trust. Such a distribution would generally be a non-taxable event to each United States Holder, and each United States Holder would have an aggregate tax basis in the Junior Subordinated Debentures equal to such holder's aggregate tax basis in its Capital Securities. A United States Holder's holding period in the Junior Subordinated Debentures so received in liquidation of the Trust would include the period during which such holder held the Capital Securities. If, however, the liquidation of the Trust were to occur because the Trust is subject to United States federal income tax with respect to income accrued or received on the Junior Subordinated Debentures, as would be the case if, for example, the Trust were treated as an association taxable as a corporation, the distribution of Junior Subordinated Debentures to a United States Holder by the Trust would be a taxable event to the Trust and each United States Holder, and each United States Holder would recognize a gain or loss as if the United States Holder had exchanged its Capital Securities for the Junior Subordinated Debentures it received upon liquidation of the Trust. A United States Holder will include interest in income in respect of Junior Subordinated Debentures received from the Trust in the manner described above under "--Interest Income and Original Issue Discount." Under certain circumstances described herein (see "Description of the Capital Securities"), the Junior Subordinated Debentures may be redeemed for cash and the proceeds of such redemption distributed to holders in redemption of their Capital Securities. Such a redemption would be a taxable event to each United States Holder, and a United States Holder would recognize gain or loss as if it sold such redeemed Capital Securities for cash. See "-- Sales of Capital Securities." Sales of Capital Securities A United States Holder that sells Capital Securities will recognize gain or loss equal to the difference between such holder's adjusted tax basis in the Capital Securities and the amount realized on the sale of such Capital Securities. Assuming that PMC does not exercise its option to defer payment of interest on the Junior Subordinated Debentures, and the Junior Subordinated Debentures are not considered issued with OID, a holder's adjusted tax basis in the Capital Securities generally will be its initial purchase price. If the Junior Subordinated Debentures are deemed to be issued with OID, a holder's adjusted tax basis in the Capital Securities generally will be its initial purchase price, increased by OID previously includible in such holder's gross income to the date of disposition and decreased by distributions or other payments received on the Capital Securities since and including the date the Junior Subordinated Debentures were treated as issued with OID. Such gain or loss will generally be capital gain or loss and will generally be long-term capital gain or loss if the Capital Securities have been held for more than one year. Long-term capital gain of a non-corporate United States Holder is generally subject to a maximum tax rate of 20%. - 172 - The Capital Securities may trade at prices that do not accurately reflect the value of accrued but unpaid interest with respect to the underlying Junior Subordinated Debentures. A United States Holder that disposes of Capital Securities between record dates for payments of distributions thereon will be required to include accrued but unpaid interest on the Junior Subordinated Debentures through the date of disposition in income as ordinary income, and to add such amount to such holder's adjusted tax basis in the pro rata share of the underlying Junior Subordinated Debentures deemed disposed of. To the extent that the selling price is less than such holder's adjusted tax basis (so determined) a United States Holder will recognize a capital loss. Subject to certain limited exceptions, capital losses cannot be applied to offset ordinary income for United States federal income tax purposes. United States Alien Holders For purposes of this discussion, a "United States Alien Holder" is any corporation, individual, partnership, estate or trust that is, for United States federal income tax purposes, a foreign corporation, a nonresident alien individual, a foreign partnership, or a nonresident fiduciary of a foreign estate or trust. The discussion assumes that income with respect to the Capital Securities is not effectively connected with a trade or business in the United States in which the United States Alien Holder is engaged. Under current United States federal income tax law, and subject to the discussion of backup withholding in the following section: (1) payments with respect to principal and interest (including OID) by the Trust or any of its paying agents to any holder of Capital Securities that is a United States Alien Holder will not be subject to withholding of United States federal income tax; provided that, in the case of interest, (a) the beneficial owner of the Capital Securities does not actually or constructively own 10% or more of the total combined voting power of all classes of stock of PMC entitled to vote, (b) the beneficial owner of the Capital Securities is not a controlled foreign corporation that is related, directly or indirectly, to PMC through stock ownership and (c) either (A) the beneficial owner of the Capital Securities certifies to the Trust or its agent, under penalties of perjury, that it is a United States Alien Holder and provides its name and address or (B) a securities clearing organization, bank or other financial institution that holds customers' securities in the ordinary course of its trade or business (a "Financial Institution"), and holds the Capital Securities in such capacity, certifies to the Trust or its agent, under penalties of perjury, that such statement has been received from the beneficial owner by it or by a Financial Institution between it and the beneficial owner and furnishes the Trust or its agent with a copy thereof and (2) a United States Alien Holder of Capital Securities will generally not be subject to withholding of United States federal income tax on any gain realized upon the sale or other disposition of a Capital Securities (however, gains recognized by an individual United States Alien Holder that holds the Capital Securities as a capital asset and is in the United States for 183 or more days in the taxable year of sale may be subject to United States federal income tax). Backup Withholding Tax And Information Reporting Under current United States federal income tax law, information reporting requirements apply to interest (including OID) and principal payments made to, and to the proceeds of sales before maturity by, certain non-corporate persons. In addition, a 31% backup - 173 - withholding tax applies if a non-corporate person (i) fails to furnish such person's Taxpayer Identification Number ("TIN") (which, for an individual, would be his or her Social Security Number) to the payor in the manner required, (ii) furnishes an incorrect TIN and the payor is so notified by the Service, (iii) is notified by the Service that such person has failed properly to report payments of interest and dividends or (iv) in certain circumstances, fails to certify, under penalties of perjury, that such person has not been notified by the Service that such person is subject to backup withholding for failure properly to report interest and dividend payments. Backup withholding does not apply with respect to payments made to certain exempt recipients, such as corporations and tax-exempt organizations. In the case of a United States Alien Holder, backup withholding and information reporting do not apply to payments of principal and interest with respect to a Capital Security with respect to which such Holder has provided the required certification under penalties of perjury that such Holder is a United States Alien Holder or has otherwise established an exemption, provided that certain conditions are satisfied. In general, (i) principal or interest payments with respect to a Capital Security collected outside the United States by a foreign office of a custodian, nominee or other agent acting on behalf of a beneficial owner of a Capital Security and (ii) payments on the sale, exchange or retirement of a Capital Security to or through a foreign office of a broker are not subject to backup withholding or information reporting. However, if such custodian, nominee, agent or broker is (i) a United States person, (ii) a controlled foreign corporation for United States federal income tax purposes, (iii) a foreign person 50% or more of whose gross income is effectively connected with the conduct of a United States trade or business for a specified three-year period or (iv) with respect to payments made after December 31, 1999, a foreign partnership, if at any time during its tax year, one or more of its partners are United States persons (as defined in United States Treasury regulations) who in the aggregate hold more than 50% of the income or capital interest in the partnership or if at any time during its tax year, such foreign partnership is engaged in a United States trade or business, such custodian, nominee, agent or broker may be subject to certain information reporting (but not backup withholding) requirements with respect to such payments. Backup withholding tax is not an additional tax. Rather, any amounts withheld from a payment to a person under the backup withholding rules are allowed as a refund or a credit against such person's United States federal income tax, provided that the required information is furnished to the Service. Possible Tax Law Changes Prospective investors should be aware that Enron Corporation has filed a petition in the United States Tax Court challenging the proposed disallowance by the IRS of the deduction of interest expense on securities issued by Enron Corporation in 1993 and 1994 that are similar to, although different in a number of respects from, the Junior Subordinated Debentures. It is possible that a decision in that case could give rise to a Tax Event, which would permit PMC to cause a redemption of the Capital Securities, as described more fully under "Description of the Capital Securities--Redemption--Special Event Redemption or Distribution of Junior Subordinated Debentures." Prospective investors should also be aware that legislation has been proposed by the Clinton Administration in the past that, if enacted, - 174 - would have denied an interest deduction to issuers of instruments such as the Junior Subordinated Debentures. No such legislation is currently pending. There can be no assurance, however, that similar legislation will not ultimately be enacted into law, or that other developments will not occur on or after the date hereof that would adversely affect the tax treatment of the Junior Subordinated Debentures or the Trust. Such changes also could give rise to a Tax Event. CERTAIN ERISA CONSIDERATIONS Each fiduciary of a pension, profit-sharing or other employee benefit plan subject to the Employee Retirement Income Security Act of 1974, as amended ("ERISA") (a "Plan"), should consider the fiduciary standards of ERISA in the context of the Plan's particular circumstances before authorizing an investment in the Capital Securities. Accordingly, among other factors, the fiduciary should consider whether the investment would satisfy the prudence and diversification requirements of ERISA and would be consistent with the documents and instruments governing the Plan. Section 406 of ERISA and Section 4975 of the Code prohibit Plans, as well as individual retirement accounts and Keogh plans subject to Section 4975 of the Code (also "Plans"), from engaging in certain transactions involving "plan assets" with persons who are "parties in interest" under ERISA or "disqualified persons" under the Code ("Parties in Interest") with respect to such Plan. A violation of these "prohibited transaction" rules may result in an excise tax or other liabilities under ERISA and/or Section 4975 of the Code for such persons, unless exemptive relief is available under an applicable statutory or administrative exemption. Employee benefit plans that are governmental plans (as defined in Section 3(32) of ERISA), certain church plans (as defined in Section 3(33) of ERISA) and foreign plans (as described in Section (4)(b)(5) of ERISA are not subject to the requirements of ERISA or Section 4975 of the Code; governmental plans may be subject to similar provisions under applicable state laws. Under a regulation (the "Plan Assets Regulation") issued by the U.S. Department of Labor (the "DOL"), the assets of the Issuer would be deemed to be "plan assets" of a Plan for purposes of ERISA and Section 4975 of the Code if "plan assets" of the Plan were used to acquire an equity interest in the Issuer and no exception were applicable under the Plan Assets Regulation. An "equity interest" is defined under the Plan Assets Regulation as any interest in an entity other than an instrument which is treated as indebtedness under applicable local law and which has no substantial equity features and specifically includes a beneficial interest in a trust. Pursuant to an exception contained in the Plan Assets Regulation, the assets of the Issuer would not be deemed to be "plan assets" of investing Plans if, immediately after the most recent acquisition of any equity interest in the Issuer, less than 25% of the value of each class of equity interests in the Issuer were held by Plans, other employee benefit plans not subject to ERISA or Section 4975 of the Code (such as governmental, church and foreign plans), and entities holding assets deemed to be "plan assets" of any Plan (collectively, "Benefit Plan Investors"), or if the Capital Securities were "publicly-offered securities" for purposes of the Plan Assets Regulation. No assurance can be given that the value of the Capital Securities held by Benefit Plan Investors will be less than 25% of the total value of such Capital - 175 - Securities at the completion of the initial offering or thereafter, and no monitoring or other measures will be taken with respect to the satisfaction of the conditions to this exception. In addition, no assurance can be given that the Capital Securities would be considered to be "publicly-offered securities" under the Plan Assets Regulation. All of the Common Securities will be purchased and initially held by PMC. Certain transactions involving the Issuer could be deemed to constitute direct or indirect prohibited transactions under ERISA and Section 4975 of the Code with respect to a Plan if the Capital Securities were acquired with "plan assets" of such Plan and the assets of the Issuer were deemed to be "plan assets" of such Plan and the assets were deemed to be "plan assets" of Plans investing in the Issuer. For example, if PMC is a Party in Interest with respect to an investing Plan (either directly or by reason of its ownership of its subsidiaries), extensions of credit between PMC and the Issuer (as represented by the Junior Subordinated Debentures and the Guarantee) would likely be prohibited by Section 406(a)(1)(B) of ERISA and Section 4975(c)(1)(B) of the Code unless exemptive relief were available under an applicable administrative exemption (see below). In addition, if PMC were considered to be a fiduciary with respect to the Issuer as a result of certain powers it holds (such as the powers o remove and replace the Property Trustee and the Administrative Trustee), the optional redemption or acceleration of the Junior Subordinated Debentures could be considered to be prohibited transactions under Section 406(b) of ERISA and Section 4975(c)(1)(E) of the Code. In order to avoid such prohibited transactions, each investing Plan by purchasing the Capital Securities will be deemed to have directed the Issuer to invest in the Junior Subordinated Debentures and to have appointed the Property Trustee. The DOL has issued five prohibited transaction class exemptions ("PTCEs") that may provide exemptive relief if required for direct or indirect prohibited transactions that may arise from the purchase or holding of the Capital Securities if assets of the Issuer were deemed to be "plan assets" of Plans investing in the Issuer as described above. Those class exemptions are PTCE 96- 23 (for certain transactions determined by in-house asset managers), PTCE 95-60 (for certain transactions involving insurance company general accounts), PTCE 91-38 (for certain transactions involving bank collective investment funds), PTCE 90-1 (for certain transactions involving insurance company separate accounts), and PTCE 84-14 (for certain transactions determined by independent qualified professional asset managers). Because the Capital Securities may be deemed to be equity interests in the Issuer for purposes of applying ERISA and Section 4975 of the Code, the Capital Securities may not be purchased or held by any Plan, any entity whose underlying assets include "plan assets" by reasons of any Plan's investment in the entity (a "Plan Asset Entity") or any person investing "plan assets" of any Plan, unless such purchaser or holder is eligible for the exemptive relief available under PTCE 96-23, 95-60, 91-38, 90-1 or 84-14 or another applicable exemption. Any purchaser or holder of the Capital Securities or any interest therein will be deemed to have represented by its purchase and holding thereof that it either (a) is not a Plan or a Plan Asset Entity and is not purchasing such securities on behalf of or with "plan assets" of any Plan or (b) is eligible for the exemptive relief available under PTCE 96-23, 95-60, 91-38, 90-1 or 84-14 or another applicable exemption with respect to such purchase or holding. If a purchaser or holder of the Capital Securities that is a Plan or a Plan Asset Entity elects to rely on an exemption other than PTCE 96-23, 95-60, 91-38, 90-1 or 84-14, PMC and the Issuer may require - 176 - a satisfactory opinion of counsel or other evidence with respect to the availability of such exemption for such purchase and holding. Due to the complexity of these rules and the penalties that may be imposed upon persons involved in non-exempt prohibited transactions, it is particularly important that fiduciaries or other persons considering purchasing the Capital Securities on behalf of or with "plan assets" of any Plan consult with their counsel regarding the potential consequences if the assets of the issuer were deemed to be "plan assets" and the availability of exemptive relief under PTCE 96-23, 95-60, 91-38, 90-1 or 84-14 or any other applicable exemption. VALIDITY OF SECURITIES Certain matters of Delaware law relating to the validity of the Capital Securities, the enforceability of the Trust Agreement and the formation of the Issuer will be passed upon by Duane, Morris & Heckscher LLP, counsel to PMC and the Issuer. The validity of the Guarantee and the Junior Subordinated Debentures will be passed upon for PMC by Duane, Morris & Heckscher LLP and for the Underwriters by Sullivan & Cromwell, New York, New York. Sullivan & Cromwell will rely on the opinions of Duane, Morris & Heckscher LLP as to matters of Delaware and Pennsylvania law. Certain matters relating to the United States federal income tax considerations will be passed upon for PMC by Duane, Morris & Heckscher LLP. A John May, a director of the Company, is a member of Duane, Morris & Heckscher LLP. Mr. May beneficially owns an aggregate of 257,200 shares of the Company's Common Stock and 66,200 shares of the Company's Class A Common Stock. Of these shares, 11,250 shares of Common Stock and 2,650 shares of Class A Common Stock are owned jointly by Mr. May and his wife; 1,550 shares of Class A Common Stock are owned by Mr. May's wife as custodian for their minor grandchildren and 17,250 shares of Class A Common Stock are held by a partnership of which Mr. May is a general partner. Members of Duane, Morris & Heckscher LLP, including Mr. May, hold an aggregate of 259,700 shares of Common Stock and 67,270 shares of Class A Common Stock of the Company. UNDERWRITING Subject to the terms and conditions of an underwriting agreement (the "Underwriting Agreement"), PMC and the Issuer have agreed that the Issuer will sell to each of the Underwriters named below, and each of such Underwriters, for whom Goldman, Sachs & Co., Merrill Lynch, Pierce, Fenner & Smith Incorporated and First Union Capital Markets, a division of Wheat First Securities, Inc. are acting as representatives, has severally agreed to purchase from the Issuer, the respective number of Capital Securities set forth opposite its name below: Underwriter Number of Capital Securities Purchased -------------------- -------------------------------------- Goldman, Sachs & Co. Merrill Lynch, Pierce, Fenner & Smith Incorporated First Union Capital Markets Under the terms and conditions of the Underwriting Agreement, the Underwriters are committed to take and pay for all the Capital Securities offered hereby, if any are taken. The Underwriters propose to offer the Capital Securities in part directly to the public at the initial public offering price set forth on the cover page of this Prospectus and in part to certain securities dealers at such price less a concession of $___ per Capital Security. The Underwriters may allow, and such dealers may reallow, a concession not in excess of $______ per Capital Security to certain brokers and dealers. After the Capital Securities are released - 177 - for sale to the public, the offering price and other selling terms may from time to time be varied by the representatives. In view of the fact that the proceeds from the sale of the Capital Securities will be used to purchase the Junior Subordinated Debentures issued by PMC, the Underwriting Agreement provides that PMC will pay as Underwriters' Compensation for the Underwriters' arranging the investment therein of such proceeds an amount of $___ per Capital Security for the accounts of the several Underwriters. In connection with the Offering, the Underwriters may purchase and sell the Capital Securities in the open market. These transactions may include over- allotment and stabilizing transactions and purchases to cover short positions created by the Underwriters in connection with the Offering. Stabilizing transactions consist of certain bids or purchases for the purpose of preventing or retarding a decline in the market price of the Capital Securities, and short positions created by the Underwriters involve the sale by the Underwriters of a greater number of the Capital Securities than they are required to purchase from PMC in the Offering. The Underwriters may also impose a penalty bid, whereby selling concessions allowed to broker-dealers in respect of the Capital Securities sold in the offering may be reclaimed by the Underwriters if such Capital Securities are repurchased by the Underwriters in stabilizing or covering transactions. These activities may stabilize, maintain or otherwise affect the market price of the Capital Securities, which may be higher than the price that might otherwise prevail in the open market, and these activities, if commenced, may be discontinued at any time. These transactions may be effected in the over-the-counter market or otherwise. Because the National Association of Securities Dealers, Inc. ("NASD") is expected to view the Capital Securities offered hereby as interests in a direct participation program, the Offering is being made in compliance with Rule 2810 of the NASD's Conduct Rules. Offers and sales of Capital Securities will be made only to (i) "qualified institutional buyers", as defined in Rule 144A under the Securities Act of 1933, as amended (the Act") or (ii) institutional "accredited investors", as defined in Rule 501(a)(1)-(3) of Regulation D under the Act. Sales to discretionary accounts may not be made without the prior written approval of the customer. PMC and the Issuer have agreed that, during the period beginning from the date of this Prospectus and continuing to and including the earlier of (i) the termination of trading restrictions on the Capital Securities, as determined by the Underwriters, or (ii) 30 days after the closing date, they will not offer, sell, contract to sell, or otherwise dispose of any Capital Securities, any other interests of the Issuer, or any capital stock or any other securities of the Issuer or PMC which are substantially similar to the Capital Securities, including but not limited to any guarantee of such security, or any securities convertible into or exchangeable for or representing the right to receive, Capital Securities, preferred stock or such substantially similar securities of either the Issuer or PMC, without the prior written consent of Goldman, Sachs & Co., except for the Capital Securities offered in connection with this Offering, the Common Securities and the Guarantee. - 178 - There is no established public trading market for the Capital Securities. The Underwriters have advised PMC that they intend to make a market in the Capital Securities, but are not obligated to do so and may discontinue market making at any time without notice. No assurance can be given as the liquidity of the trading market for the Capital Securities. The Issuer, PMC and PMA Reinsurance Corporation have agreed to indemnify the several Underwriters against certain liabilities, including liabilities under the Act. Certain of the Underwriters or their affiliates have provided from time to time, and expect to provide in the future, investment or commercial banking services to PMC and its affiliates, for which such Underwriters or their affiliates have received or will receive customary fees and commissions. EXPERTS The consolidated financial statements and schedules of the Company as of December 31, 1997 and 1996 and for each of the years in the three-year period ended December 31, 1997, have been included herein and in the Registration Statement in reliance upon the reports of PricewaterhouseCoopers LLP, independent accountants, appearing elsewhere herein, and upon the authority of said firm as experts in accounting and auditing. - 179 - INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE The following documents have been previously filed by the Company with the Commission and are hereby incorporated by reference in this Prospectus as of their respective dates: (i) The Company's Annual Report on Form 10-K for the year ended December 31, 1997 (filed March 23, 1998); (ii) The Company's Quarterly Reports on Form 10-Q for the quarters ended March 31, 1998 (filed May 15, 1998) and June 30, 1998 (filed August 13, 1998); (iii) information included under the captions "Beneficial Ownership of Common Stock," "Section 16(a) Beneficial Reporting Compliance," "Election of Directors," "Information Regarding Management" (except for information under "Report of Compensation Committee on the Compensation of Executive Officers of the Company for the Year Ended December 31, 1997" and "Comparison of Total Return on the Company's Class A Common Stock with Certain Indices" which shall not be deemed incorporated by reference in this Prospectus) and "Certain Transactions" of the Company's definitive proxy statement (filed March 26, 1998); and (iv) The Company's Current Reports on Form 8-K dated February 5, 1998 and February 9, 1998. In addition, all documents filed by the Company with the Commission pursuant to Section 13(a), 13(c), 14 or 15(d) of the Exchange Act subsequent to the date of this Prospectus and prior to the termination of the Offering shall be deemed to be incorporated by reference in this Prospectus and to be a part hereof from the date of filing of such documents. Any statement or information contained herein or in a document incorporated by reference herein shall be deemed to be modified or superseded for purposes of this Prospectus to the extent that a statement or information contained herein or in any other subsequently filed document that is also incorporated by reference herein modifies or replaces such a statement or such information. Any such statement or information so modified or replaced shall not be deemed, except as so modified or replaced, to be a part of this Prospectus. The Company will furnish without charge, including any beneficial owner, to each person to whom this Prospectus is delivered, upon written or oral request, a copy of any and all of the documents that have been incorporated by reference in this Prospectus, other than exhibits to such documents, unless such exhibits are specifically incorporated by reference into the documents that this Prospectus incorporates. Requests should be submitted by telephone to (215) 665-5046 or in writing to Pennsylvania Manufacturers Corporation, 1735 Market Street, Philadelphia, Pennsylvania, 19103-7590, Attention: Investor Relations. - 180 - GLOSSARY OF CERTAIN INSURANCE AND OTHER DEFINED TERMS Actuarial analysis..... Evaluation of risks in order to attempt to assure that premiums and loss reserves adequately reflect expected future loss experience and claims payments; in evaluating risks, mathematical models are used to predict future loss experience and claims payments based on past loss ratios and loss development patterns and other relevant data and assumptions. Affiliate..... With respect to any Person, any other person which directly or indirectly controls, is controlled by or is under common control with such Person. Adverse....... loss development Increases in losses and ALAE exceeding anticipated loss and ALAE experience over a given period of time. Aggregate excess reinsurance arrangements. Reinsurance arrangements under which a reinsurer assumes the risks and/or loss reserves of certain business of a ceding company in their entirety. Allocated loss adjustment expenses ("ALAE")..... Allocated loss adjustment expenses include all legal expenses and other expenses incurred by a company in connection with the investigation, adjustment, settlement or litigation of claims or losses under business covered. ALAE does not include costs of "in house" counsel, claims staff or other overhead or general expense of the reinsured. A.M. Best..... A.M. Best Company, Inc. A.M. Best financial condition ratings are opinions of an insurance company's financial strength, operating performance and ability to meet its obligations to policyowners. Such ratings are based upon a comprehensive review of a company's financial performance, which is supplemented by certain data, including responses to A.M. Best's questionnaires, quarterly NAIC filings, state insurance department examination reports, loss reserve reports, annual reports and reports filed with state insurance departments. A.M. Best undertakes a quantitative evaluation based on profitability, leverage and liquidity and a qualitative evaluation based upon a company's book of business or spread of risk, the amount, appropriateness and soundness of reinsurance, the quality, diversification and estimated market value of its assets, the adequacy of its loss reserves and policyowners' surplus and the experience and - 181 - competence of its management. A.M. Best Company, Inc. uses the following rating scale: A++ and A+ Superior A and A- Excellent B++ and B+ Very Good B and B- Adequate C++ and C+ Fair C and C- Marginal D Very Vulnerable E Under State Supervision F In Liquidation Annualized premium...... The expected premium payment for a 12-month period for each policy, excluding single premium policies. Actual premium payments may be higher or lower than annualized premiums. Attachment point........ The amount of losses above which excess of loss reinsurance becomes operative. Automatic facultative arrangements. Facultative insurance contracts whereby the ceding company has the right, but not the obligation, to cede risks to a reinsurer and the reinsurer is obligated to accept such risks pursuant to the contract terms. Broker; intermediary. One who negotiates contracts of reinsurance between a primary insurer or other reinsured and a reinsurer on behalf of the primary insurer or reinsured. The broker receives from the reinsurer a commission for placement and other services rendered. Broker reinsurer.... A reinsurer that markets and sells reinsurance through brokers rather than through its own employees. 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 - 182 - 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". Claim closure rate......... The number of closed lost time workers' compensation claims divided by total reported lost time workers' compensation claims by accident year as of a given evaluation date. Clash cover... A form of excess of loss casualty reinsurance policy covering losses arising from a single set of circumstances covered by more than one primary policy. For example, if an insurer covers both motorists involved in an accident, a clash cover would protect the insurer from suffering a net loss in the full amount of both parties. The clash cover would pay to the insurer a portion of the loss in excess of the coverage of one of the two parties. Combined ratio........ A combination of the underwriting expense ratio, the loss and LAE ratio, and the policyholder dividend ratio. The loss and LAE ratio measures the ratio of net incurred losses and LAE to net earned premiums. The underwriting expense ratio measures the ratio of underwriting expenses to net premiums written. The policyholder dividend ratio measures policyholder dividends as a percent of net premiums earned. Generally, companies that write predominately long-tailed liability risks will have a higher combined ratio than those companies writing predominately property risks. Commutation... An agreement with a claimant whereby the claimant, in exchange for a lump sum payment, releases his or her rights to future indemnity payments. Direct reinsurer, direct underwriter, direct writer A reinsurer that markets and sells reinsurance directly to its reinsureds without the assistance of brokers. - 183 - Excess and surplus lines Surplus lines risks are those risks not fitting normal under- writing 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. GAAP.......... United States generally accepted accounting principles for property and casualty insurance companies Gross premiums written...... Total premiums for direct insurance and reinsurance assumed during a given period. Incurred but not reported - 184 - ("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 estimated losses that have been incurred 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 (See "Low or working layer excess of loss reinsurance") 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 ratio/ pure loss ratio........ Loss ratio is equal to losses and LAE divided by earned premiums. The pure loss ratio refers to losses divided by earned premiums. Undiscounted loss ratios refer to loss ratios that do not consider the net effect of discounting of loss reserves; the Company's current practice is to discount loss reserves for workers' compensation insurance. 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 and IBNR reserves. Low or working layer excess of loss reinsurance.. Reinsurance that absorbs the losses immediately above the reinsured's retention layer. A low layer excess of loss reinsurer will pay up to a certain dollar amount at which point a higher layer reinsurer (or the ceding company) will be liable for additional losses. - 185 - Manual rates.. Refers to insurance rates for lines and classes of business approved and published by state insurance departments. Manual rate level or average manual rate level... Refers to the manual rates for lines and classes of business relative to a benchmark; within this document, the term refers to the manual rates, as compared to other periods, such as a prior policy year. Moody's....... Moody's Investors Service, Inc. Moody's financial strength ratings are opinions of an operating insurance company's ability to discharge senior policyowner claims and obligations pursuant to its insurance policies. Moody's financial strength ratings are based on information provided by the company and federal and state regulators. Moody's Investors Service, Inc. uses the following rating scale: Aaa Exceptional Aa1, Aa2 and Aa3 Excellent A1, A2 and A3 Good Baa1, Baa2 and Baa3 Adequate Ba1, Ba2 and Ba3 Questionable B1, B2 and B3 Poor Caa Very Poor Ca Extremely Poor C Lowest NAIC.......... The National Association of Insurance Commissioners, an association of the chief insurance supervisory officials of each state, territory and insular possession of the United States. Net leverage.. Sum of net premiums written and liabilities divided by surplus. Net premiums earned....... The portion of net premiums written that is recognized for accounting purposes as income during a period. Net premiums written...... Gross premiums written for a given period less premiums ceded to reinsurers during such period. Non-admitted basis........ Refers to the fact that a company marketing excess and surplus lines of insurance in a particular jurisdiction is not required to be fully licensed in such jurisdiction buy may write insurance on an excess and surplus lines basis in that jurisdiction. In addition, unlike standard lines of insurance, premium rates and policy forms for coverages written on a non-admitted basis do not require the approval of the insurance department of the jurisdiction. Operating ratio........ The combined ratio reduced by the net investment income ratio. The net investment income ratio is the ratio of net investment income to net premiums earned. The ratio measures a company's operating profitability, exclusive of realized gains and federal income taxes. - 186 - 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. Premium....... Payments received on insurance policies issued or reinsured by an insurance company. Primary insurer...... An insurance company that issues insurance policies to the general public or to certain noninsurance entities. Pro rata reinsurance.. A generic term describing all 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. Pure loss ratio........ See "Loss ratio/pure loss ratio" above. Reinsurance... The practice whereby one party, called the reinsurer or assuming company, in consideration of a premium paid to such party, 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. Reinsurance provides a primary insurer with three major benefits: it reduces net liability on individual risks; it helps to protect against catastrophic losses and it helps to maintain acceptable surplus and reserve ratios. Reinsurance provides a primary insurer with additional underwriting capacity in that the primary insurer can accept larger risks and can expand the volume of business it writes without increasing its capital base. The ceding company remains liable on its obligations under the policies reinsured if the reinsurer fails to pay claims on a reinsured policy. Rent-a -captive..... Refers to an arrangement pursuant to which an insurer's client purchases a policy from the insurer and chooses a participation level. The insurer, in turn, cedes the portion of the premium and loss exposure representative of the participation level to an affiliate, typically located in an offshore jurisdiction, such as Bermuda. The client then participates in the loss and investment experience within the participation level, generally through a dividend mechanism. The client is responsible for any losses that may arise within its participation level, and such potential obligation is typically secured through a letter of credit or similar collateral. Reserves...... Liabilities established by insurers to reflect the estimated discounted present value of costs of claims, payments or contract liabilities and the related expenses that the insurer - 187 - will ultimately be required to pay in respect of insurance it has written. 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; retrocession- aire......... 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. Risk-based capital requirements or RBC....... Regulatory and rating agency targeted surplus based on the relationship of statutory surplus, with certain adjustments, to the sum of stated percentages of each element of a specified list of company risk exposures. Risk-exposed.. Reinsurance coverages that attach within the underlying policy limits of the ceding company, which differs from catastrophe reinsurance and clash coverages. Semiautomatic facultative arrangements. Facultative reinsurance contracts where the ceding company has the right, but not the obligation to cede risks to a reinsurer and the reinsurer is obligated to accept such risks as long as they are within stated criteria. If a risk falls outside such criteria, the reinsurer has the option of either: (i) accepting the risk, (ii) declining the risk, or (iii) repricing the risk. SFAS.......... Statement of Financial Accounting Standards. Standard & Poor's..... Standard & Poor's Ratings Group. Standard & Poor's claims-paying ability ratings are opinions of an operating insurance company's financial ability to meet its obligations under its insurance policies. Standard & Poor's claims-paying ability ratings are based on current information provided by the subject insurance company and other reliable sources. Standard & Poor's Rating Group uses the following rating scale: - 188 - AAA Superior AA+, AA and AA- Excellent financial security A+, A and A- Good financial security BBB+, BBB and BBB- Adequate BB+, BB and BB- Financial security may be adequate B+, B and B- Vulnerable CCC Extremely Vulnerable R Regulatory actions A\\pi\\, BBB\\pi\\, BB\\pi\\ and B\\pi\\ Qualified solvency ratings 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, which in general reflect a liquidating, rather than going concern, concept of accounting. Statutory reserves..... Monetary amounts established by state insurance law that an insurer must have available to provide for future obligations with respect to all policies. Statutory reserves are liabilities on the balance sheet of financial statements prepared in conformity with SAP. Statutory or policy- holder's surplus; statutory capital and surplus...... The excess of statutory admitted assets over statutory liabilities (including loss reserves) as shown on an insurer's statutory financial statements. Stop loss..... See "Excess of loss reinsurance". Survival ratio For asbestos and environmental (A&E) claims, the survival ratio is equal to the average normalized loss and LAE payments for A&E over three years divided by loss reserves established for A&E. Treaty reinsurance.. The reinsurance of a specified type or category of risks defined in a reinsurance agreement (a "treaty") between a primary insurer or other reinsured and a reinsurer. Typically, in treaty reinsurance, the primary insurer or reinsured is obligated to offer and the reinsurer is obligated to accept a specified portion of all such type or category of risks originally written by the primary insurer or reinsured. Underwriting.. The insurer's process of reviewing applications submitted for insurance coverage, deciding whether to accept all or - 189 - part of the coverage requested and determining the applicable premiums. Underwriting cycle........ An historical pattern in which property and casualty insurance and reinsurance premiums, profits and availability of coverage rise and fall with some regularity over time. Underwriting expenses..... The aggregate of policy acquisition costs, including commissions, and the portion of administrative, general and other expenses attributable to underwriting operations. Unearned premium...... 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 that are refundable to policyholders if an insurance or reinsurance contract is canceled prior to expiration of the contract term. - 190 - PENNSYLVANIA MANUFACTURERS CORPORATION INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
Consolidated Financial Statements (Unaudited) Consolidated Balance Sheet at June 30, 1998 F-2 Consolidated Statements of Operations for the three and six months ended June 30, 1998 and 1997 F-3 Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 1998 and 1997 F-4 Consolidated Statements of Cash Flows for the six months ended June 30, 1998 and 1997 F-5 Notes to Consolidated Financial Statements F-6 Audited Consolidated Financial Statements Consolidated Financial Statements: Report of Independent Accountants F-9 Consolidated Balance Sheets at December 31, 1997 and 1996 F-10 Consolidated Statements of Operations for each of the three years in the period ended December 31, 1997 F-11 Consolidated Statements of Changes in Shareholders' Equity for each of the three years in the period ended December 31, 1997 F-12 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1997 F-14 Notes to Consolidated Financial Statements F-15
F-1 PENNSYLVANIA MANUFACTURERS CORPORATION CONSOLIDATED BALANCE SHEET
(Unaudited) (in thousands, except share data) June 30, 1998 ------------------- Assets Investments: Fixed maturities available for sale, at fair value (amortized cost of $1,955,206) $ 1,995,653 Equity securities, at fair value (cost of $5) 15 Short-term investments, at amortized cost which approximates fair value 163,635 ----------- Total investments 2,159,303 Cash 7,585 Investment income due and accrued 20,808 Uncollected premiums (net of allowance for uncollectible accounts of $18,495) 293,303 Reinsurance receivables (net of allowance for uncollectible reinsurance of $2,085) 347,821 Property and equipment (net of accumulated depreciation of $49,822) 37,901 Deferred income taxes, net 62,978 Deferred acquisition costs 53,363 Other assets 92,351 ----------- Total assets $ 3,075,413 =========== Liabilities Unpaid losses and loss adjustment expenses $ 1,939,568 Unearned premiums 243,012 Long-term debt 203,000 Dividends to policyholders 10,779 Funds held under reinsurance treaties 75,806 Taxes, licenses and fees, and other expenses 52,543 Other liabilities 54,322 ----------- Total liabilities 2,579,030 ----------- Shareholders' Equity Common stock, $5 par value (40,000,000 shares authorized; 14,765,020 shares issued and 14,329,013 outstanding) 73,825 Class A common stock, $5 par value (40,000,000 shares authorized; 9,677,925 shares issued and 9,356,995 outstanding) 48,389 Additional paid-in capital - Class A common stock 339 Retained earnings 359,486 Accumulated other comprehensive income 26,297 Notes receivable from officers (198) Treasury stock, at cost: Common stock (436,007 shares) (5,582) Class A common stock (320,930 shares) (6,173) ----------- Total shareholders' equity 496,383 ----------- Total liabilities and shareholders' equity $ 3,075,413 ===========
See accompanying notes to the consolidated financial statements. F-2 PENNSYLVANIA MANUFACTURERS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three months ended June 30, Six months ended June 30, --------------------------- ------------------------- (in thousands, except per share data) 1998 1997 1998 1997 - -------------------------------------------------------------------------------------------------------------------------------- Revenues: Net premiums written $ 94,908 $ 98,358 $ 248,481 $ 248,285 Change in net unearned premiums 19,746 16,093 (26,905) (25,884) --------- --------- --------- --------- Net premiums earned 114,654 114,451 221,576 222,401 Net investment income 32,685 32,612 65,200 68,459 Net realized investment gains (losses) 3,749 (680) 11,263 (1,931) Service revenues 2,655 2,490 5,090 5,038 --------- --------- --------- --------- Total revenues 153,743 148,873 303,129 293,967 --------- --------- --------- --------- Losses and expenses: Losses and loss adjustment expenses 87,900 98,230 172,757 193,134 Acquisition expenses 29,060 28,130 51,763 46,469 Operating expenses 18,033 19,963 37,500 36,905 Dividends to policyholders 4,213 3,360 8,130 6,617 Interest expense 3,762 3,888 7,463 8,222 --------- --------- --------- -------- Total losses and expenses 142,968 153,571 277,613 291,347 --------- --------- --------- -------- Income before income taxes and extraordinary item 10,775 (4,698) 25,516 2,620 Provision (benefit) for income taxes: Current 481 -- 691 (353) Deferred 937 (5,218) 3,380 (2,304) --------- --------- --------- -------- Total 1,418 (5,218) 4,071 (2,657) --------- --------- --------- -------- Income before extraordinary item 9,357 520 21,445 5,277 Extraordinary loss from early extinguishment of debt (net of income tax benefit of $2,549) -- -- -- (4,734) --------- --------- --------- -------- Net income $ 9,357 $ 520 $ 21,445 $ 543 ========= ========= ========= ======== Earnings per common and equivalent share: Basic: Earnings before extraordinary loss $ 0.39 $ 0.02 $ 0.90 $ 0.22 Extraordinary item -- -- -- (0.20) --------- --------- --------- -------- Net income $ 0.39 $ 0.02 $ 0.90 $ 0.02 ========= ========= ========= ======== Diluted: Earnings before extraordinary loss $ 0.38 $ 0.02 $ 0.87 $ 0.21 Extraordinary item -- -- -- (0.19) --------- --------- --------- -------- Net income $ 0.38 $ 0.02 $ 0.87 $ 0.02 ========= ========= ========= ========
See accompanying notes to the consolidated financial statements. F-3 PENNSYLVANIA MANUFACTURERS CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
Three months ended June 30, Six months ended June 30, --------------------------- ------------------------- (in thousands) 1998 1997 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------- Net income $ 9,357 $ 520 $21,445 $ 543 ------- ------- ------- ------- Other comprehensive income (loss), net of tax: Unrealized losses on securities: Holding gains (losses) arising during the period 15,433 30,637 16,399 (8,230) Less: reclassification adjustment for (gains) losses included in net income (4,024) 137 (8,908) 950 ------- ------- ------ ------- Other comprehensive income (loss) 11,409 30,774 7,491 (7,280) ------- ------- ------- ------- Comprehensive income (loss) $20,766 $31,294 $28,936 $(6,737) ======= ======= ======= =======
See accompanying notes to the consolidated financial statements. F-4 PENNSYLVANIA MANUFACTURERS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Six months ended June 30, ------------------------------- (in thousands) 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income $ 21,445 $ 543 Adjustments to reconcile net income to net cash flows used by operating activities: Depreciation 2,773 3,945 (Accretion) amortization (1,307) 3,160 Provision (benefit) for deferred income taxes 3,380 (2,304) Extraordinary loss from early extinguishment of debt -- (4,734) Net realized investment (gains) losses (11,263) 1,931 Change in uncollected premiums and unearned premiums, net (9,321) (16,998) Change in dividends to policyholders 579 883 Change in reinsurance receivables (15,415) (26,482) Change in unpaid losses and loss adjustment expenses (63,619) (38,281) Change in investment income due and accrued 3,010 4,333 Other, net (3,801) (15,789) --------- --------- Net cash flows used in operating activities (73,539) (89,793) --------- --------- Cash flows from investing activities: Fixed maturity investments available for sale: Purchases (927,342) (771,135) Maturities or calls 84,915 75,400 Sales 802,825 790,994 Net sales of short-term investments 101,572 81,974 Net purchases of property and equipment (2,053) (2,239) --------- --------- Net cash flows provided by investing activities 59,917 174,994 --------- --------- Cash flows from financing activities: Dividends paid to shareholders (4,059) (3,982) Proceeds from long-term debt -- 210,000 Repayments of long-term debt -- (211,650) Repayments of notes receivable from officers -- 507 Treasury stock transactions, net (6,882) 486 --------- --------- Net cash flows used in financing activities (10,941) (4,639) --------- --------- Net (decrease) increase in cash (24,563) 80,562 Cash January 1 32,148 7,176 --------- --------- Cash June 30 $ 7,585 $ 87,738 ========= ========= Supplementary cash flow information: Cash received for income taxes $ -- $ (2,900) Cash paid for interest $ 7,467 $ 12,161
See accompanying notes to the consolidated financial statements. F-5 PENNSYLVANIA MANUFACTURERS CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 (dollar amounts in thousands, except per share data) 1. General The accompanying consolidated financial statements include the accounts of Pennsylvania Manufacturers Corporation (PMC) and its wholly and majority owned subsidiaries (the Company). PMC is an insurance holding company that sells property and casualty reinsurance and insurance through its insurance subsidiaries. PMC's insurance subsidiaries are domiciled in Pennsylvania, except for its excess and surplus lines affiliate which is domiciled in Delaware, and certain foreign subsidiaries. Reinsurance -- PMC's reinsurance subsidiary, PMA Reinsurance Corporation (PMA Re), emphasizes risk-exposed, excess of loss reinsurance and operates in the brokered market. PMA Re's business is predominantly in casualty lines of reinsurance. Workers' Compensation and Primary Standard Insurance -- PMC's property and casualty insurance subsidiaries (the Property and Casualty Group) write workers' compensation and other standard lines of commercial insurance primarily in the Mid-Atlantic and Southern regions of the U.S. Specialty Property and Casualty -- In January of 1998, the Company's specialty insurance unit, Caliber One, commenced writing business. It is management's intention that Caliber One will write primarily casualty business through surplus lines brokers on a nationwide basis. Caliber One's excess and surplus lines insurance affiliate, Caliber One Indemnity Company, is presently authorized as a surplus lines carrier in 37 states, Washington, DC, and Puerto Rico, with applications either pending or being prepared for the remaining states. The consolidated financial statements have been prepared in accordance with generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. It is management's opinion that all adjustments, including normal recurring accruals, considered necessary for a fair presentation have been included. Certain reclassifications of prior year amounts have been made to conform with the 1998 presentation. Additionally, net premiums written were reduced by ($2,239) and ($2,072) for the three and six months ended June 30, 1998, respectively, and ($31) for the three months ended June 30, 1997, and increased $14 for the six months ended June 30, 1998, representing estimated retrospective policy adjustments related to the current accident year and retrospective policy adjustments paid. These adjustments were made for presentation purposes only and do not impact the Company's reported revenues, financial position or results of operations as these adjustments have no effect on net premiums earned. Operating results for the three and six months ended June 30, 1998, are not necessarily indicative of the results to be expected for the full year. For further information, refer to the December 31, 1997 audited consolidated financial statements and footnotes thereto included elsewhere in this Prospectus. F-6 2. Per Share Data In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS No. 128"), which supersedes Accounting Principles Board Opinion No. 15, "Earnings Per Share," and Related Interpretations. The Company adopted SFAS No. 128 during 1997. In accordance with SFAS No. 128, all prior period data presented has been restated to conform with the provisions of this statement. SFAS No. 128 replaces the presentation of primary earnings per share with a presentation of basic earnings per share and requires the presentation of both basic and diluted earnings per share on the face of the income statement. SFAS No. 128 also requires a reconciliation of the numerators and denominators used in the basic earnings per share calculation to the numerators and denominators used in the diluted earnings per share calculation. Such reconciliation is provided below:
Three months ended June 30, Six months ended June 30, --------------------------- ------------------------- 1998 1997 1998 1997 ---- ---- ---- ---- Numerator: Control number - income before extraordinary loss........... $ 9,357 $ 520 $ 21,445 $ 5,277 Denominator: Basic shares - weighted average Common and Class A common shares outstanding.................. 23,692,071 23,828,248 23,770,912 23,832,562 Dilutive stock options................ 1,002,385 613,862 887,999 672,330 ----------- ----------- ----------- ----------- Total diluted shares.................. 24,694,456 24,442,110 24,658,911 24,504,892 =========== =========== =========== ===========
Basic earnings per share: For the three and six months ended June 30, 1998 and 1997, basic earnings per share calculations were based upon the weighted average number of common and Class A common shares outstanding for the period. Diluted earnings per share: For the three and six months ended June 30, 1998 and 1997, diluted earnings per share calculations were based upon the weighted average number of common and Class A common shares outstanding during the periods and the assumed exercise price of dilutive stock options, less the number of treasury shares assumed to be purchased from the proceeds using the average market price of the Company's Class A common stock. 3. Accounting Pronouncements As of January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Comprehensive Income" ("SFAS No. 130"), 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. Comprehensive income includes a reclassification adjustment for net realized investment gains included in net income of $4,024 (after income taxes of $2,167) and $8,908 (after income taxes of $4,797) for the three and six months ended June 30, 1998, respectively, and net realized investment losses of $137 (after income taxes of $74) and $950 (after income taxes of $512) for the three and six months ended June 30, 1997, respectively. The new standard requires only additional disclosures in the consolidated financial statements; it does not affect the Company's financial position or results of operations. F-7 As of January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS No. 131"), which establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and interim financial reports issued to shareholders. 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 reinsurance products and services; (ii) the Property and Casualty Group, which writes workers' compensation and other standard lines of commercial insurance and includes run-off operations; (iii) Caliber One, which writes specialty insurance focusing on excess and surplus lines; and (iv) Corporate and Other, which is primarily comprised of corporate overhead and the operations of the Company's properties. Management has excluded net realized investment gains (losses) from the profit and loss measurement it utilizes to assess the performance of its operating segments because (i) net realized investment gains (losses) are unpredictable and not necessarily indicative of future performance and (ii) in many instances, decisions to buy and sell securities are made at the parent holding company level, and such decisions result in net realized gains (losses) that do not relate to the operations of the individual segments. Pursuant to the adoption of SFAS No. 131, the Company has restated the information for the three and six-month periods ended June 30,1997 for comparability, primarily related to certain corporate expenses that were previously allocated to the operating segments. SFAS No. 131 requires only additional disclosures in the consolidated financial statements; it does not affect the Company's financial position or results of operations. Supplemental financial information for the annual periods prior to the date of adoption of SFAS No. 131 are as follows:
Year ended December 31, ------------------------------------------------------- 1997 1996 1995 ---------------- ---------------- ----------------- Pre-tax operating income (loss): PMA Re $45,957 $ 44,807 $ 39,793 The Property and Casualty Group: Excluding Run-off Operations (3,607) (215,669) (3,885) Run-off Operations (73) - - --------------------------------------------------------- Total (3,680) (215,669) (3,885) Corporate and Other (9,954) (6,464) (14,184) --------------------------------------------------------- Total pre-tax operating income (loss) $32,323 $(177,326) $ 21,724 =========================================================
The difference between this supplemental financial information and the information in the Company's audited financial statements included elsewhere in this Prospectus is primarily related to certain corporate expenses that were previously allocated to the operating segments. The amount of this adjustment was $6,513 ($1,155 allocated to PMA Re and $5,358 to the Property and Casualty Group), $5,974 ($2,024 allocated to PMA Re and $3,950 to the Property and Casualty Group) and $770 ($350 allocated to PMA Re and $420 to the Property and Casualty Group) for the years ended December 31, 1997, 1996, and 1995, respectively. Amounts for previous years were not material; accordingly, no adjustments have been made. The following table indicates the Company's pre-tax operating income (loss) by principal business segment for the three and six months ended June 30, 1998 and 1997:
Three Months Ended Six Months Ended June 30, June 30, --------------------- --------------------- 1998 1997(1) 1998 1997(1) - ---------------------------------------------------------------------------------------------------------- PMA Re $11,580 $ 9,829 $22,952 $23,187 The Property and Casualty Group: Excluding Run-off Operations 2,353 (6,777) 4,954 (4,781) Run-off Operations 293 (533) 428 (1,107) ------- -------- ------- ------- Total 2,646 (7,310) 5,382 (5,888) Caliber One (681) -- (1,070) -- Corporate and Other (2,757) (2,649) (5,548) (4,526) ------- -------- ------- ------- Pre-tax operating income (loss) before interest expense 10,788 (130) 21,716 12,773 Interest expense 3,762 3,888 7,463 8,222 ------- -------- ------- ------- Pre-tax operating income (loss) 7,026 (4,018) 14,253 4,551 ------- -------- ------- ------- Net realized investment gains (losses) 3,749 (680) 11,263 (1,931) ------- -------- ------- ------- Income (loss) before income taxes and extraordinary items $10,775 $ (4,698) $25,516 $ 2,620 ======= ======== ======= =======
The following table indicates the Company's total assets by principal business segment at June 30, 1998:
1998 - ----------------------------------------------------- PMA Re $1,188,852 The Property and Casualty Group: Excluding Run-off Operations 1,469,795 Run-off Operations 352,965 ---------- Total 1,822,760 Caliber One 62,465 Corporate and Other 1,336 ---------- Total assets $3,075,413 ==========
(1) Pre-tax operating income (loss) by business segment has been reclassified for 1997 to reflect the changes related to the implementation of SFAS No. 131 (see Note 3 to the Consolidated Financial Statements for further discussion). In January 1998, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments" ("SOP 97-3"). SOP 97-3, which is effective for fiscal years beginning after December 15, 1998, 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. While the Company is presently evaluating the impact of SOP 97-3, the adoption of SOP 97-3 is likely to result in an increase in the Company's liabilities for such assessments, although such increase is not expected to exceed $5,000. The impact of adopting SOP 97-3 will be reflected as a cumulative effect of an accounting change in the first quarter of 1999. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"), 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 that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (i) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (ii) a hedge of the exposure to variable cash flows of a forecasted transaction, or (iii) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. 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. SFAS No. 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. 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 or results of operations. 4. Sale of Subsidiary The Company entered into a definitive letter of intent, dated June 26, 1998, to sell PMA Insurance, Cayman Ltd., one of the run-off entities included in the Property and Casualty Group's Run-off Operations. The transaction is subject to customary closing conditions, including regulatory approvals, and is expected to be completed in the third quarter of 1998. In connection with the announced sale, the Company recorded a pre-tax loss of $2,442 in the second quarter of 1998, which is included in "Net Realized Investment Gains." 5. Cost Reduction Initiatives During 1997, the Company recorded a $7,000 charge to operating expenses for costs associated with nonvoluntary terminations of approximately 60 employees in various operational and management positions. During the first six months of 1998, the Company recorded an additional charge of approximately $500 to operating expenses for such terminations. As of June 30, 1998, approximately $2,400 of such charges remained in Other Liabilities on the balance sheet. F-8 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders Pennsylvania Manufacturers Corporation: We have audited the accompanying consolidated balance sheets of Pennsylvania Manufacturers Corporation and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Pennsylvania Manufacturers Corporation and subsidiaries as of December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/ PricewaterhouseCoopers LLP One South Market Square Harrisburg, Pennsylvania February 6, 1998 F-9 PENNSYLVANIA MANUFACTURERS CORPORATION CONSOLIDATED BALANCE SHEETS
DECEMBER 31, December 31, (in thousands, except share data) 1997 1996 - --------------------------------------------------------------------------------------------------------------------------- ASSETS Investments: Fixed maturities available for sale, at fair value (amortized cost: 1997-$1,900,594; 1996-$2,164,391) $1,929,518 $2,126,120 Equity securities, at fair value (cost: 1997-$5; 1996-$259) 13 262 Short-term investments, at amortized cost which approximates fair value 265,207 134,971 ------------------------------- Total investments 2,194,738 2,261,353 Cash 32,148 7,176 Investment income due and accrued 23,818 30,268 Uncollected premiums (net of allowance for uncollectible accounts: 1997-$18,406; 1996-$18,877) 252,425 285,982 Reinsurance receivables (net of allowance for uncollectible reinsurance: 1997-$2,096; 1996-$3,901) 332,406 257,983 Property and equipment (net of accumulated depreciation: 1997-$42,771; 1996-$41,219) 38,621 50,861 Deferred income taxes, net 70,391 101,642 Deferred acquisition costs 45,288 44,006 Other assets 67,423 78,245 ------------------------------- Total assets $3,057,258 $3,117,516 ------------------------------- LIABILITIES Unpaid losses and loss adjustment expenses $2,003,187 $2,091,072 Unearned premiums 211,455 205,982 Long-term debt 203,000 204,699 Dividends to policyholders 10,200 12,524 Funds held under reinsurance treaties 69,545 86,804 Taxes, licenses and fees, and other expenses 49,410 39,226 Other liabilities 32,114 51,381 ------------------------------- Total liabilities 2,578,911 2,691,688 ------------------------------- Commitments and contingencies (Note 13) SHAREHOLDERS' EQUITY Common stock, $5 par value (40,000,000 shares authorized; 15,286,263 shares issued and 14,850,789 outstanding - 1997; 16,095,416 shares issued and 15,670,052 outstanding - 1996) 76,431 80,477 Class A common stock, $5 par value (40,000,000 shares authorized; 9,156,682 shares issued and 9,117,735 outstanding - 1997; 8,247,804 shares issued and 8,173,023 outstanding - 1996) 45,783 41,239 Additional paid-in capital - Class A common stock 339 - Retained earnings 343,368 336,921 Unrealized gain (loss) on investments (net of deferred income taxes: 1997-$(10,126); 1996-$13,394) 18,806 (24,874) Notes receivable from officers (198) (1,162) Treasury stock, at cost: Common stock (1997-435,474 shares; 1996-425,364 shares) (5,572) (5,408) Class A common stock (1997-38,947 shares; 1996-74,781 shares) (610) (1,365) ------------------------------- Total shareholders' equity 478,347 425,828 ------------------------------- Total liabilities and shareholders' equity $3,057,258 $3,117,516 -------------------------------
See accompanying notes to the consolidated financial statements. F-10 PENNSYLVANIA MANUFACTURERS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS
for the years ended December 31, (in thousands, except per share data) 1997 1996 1995 - ---------------------------------------------------------------------------------------------------------------------------------- REVENUES: Net premiums written $418,282 $ 443,475 $489,876 Change in net unearned premiums (5,331) (12,400) (924) Change in accrued retrospective premiums (37,000) (10,500) (4,000) ----------------------------------------- Net premiums earned 375,951 420,575 484,952 Net investment income 136,698 133,936 139,355 Net realized investment gains 8,598 2,984 31,923 Service revenues 10,311 9,189 5,106 ----------------------------------------- Total revenues 531,558 566,684 661,336 ----------------------------------------- LOSSES AND EXPENSES: Losses and loss adjustment expenses (includes $(35,000) effect of the change in discount rate on the Property and Casualty Group's workers' compensation unpaid losses from 4% to 5% in 1995) 307,281 536,623 422,578 Amortization of deferred acquisition costs 93,501 90,292 87,207 Operating expenses 75,139 97,856 81,161 Dividends to policyholders 14,716 16,255 16,743 Interest expense 15,768 17,052 18,734 ----------------------------------------- Total losses and expenses 506,405 758,078 626,423 ----------------------------------------- Income (loss) before income taxes and extraordinary item 25,153 (191,394) 34,913 ----------------------------------------- Provision (benefit) for income taxes: Current (4,506) (44,572) (4,570) Deferred 9,906 (11,488) 15,353 ----------------------------------------- Total 5,400 (56,060) 10,783 ----------------------------------------- Income (loss) before extraordinary item 19,753 (135,334) 24,130 Extraordinary loss from early extinguishment of debt (net of income tax benefit of $2,549) (4,734) - - ----------------------------------------- Net income (loss) $ 15,019 $(135,334) $ 24,130 ----------------------------------------- EARNINGS (LOSS) PER COMMON AND EQUIVALENT SHARE Basic: Earnings (loss) before extraordinary item $ 0.83 $ (5.68) $ 1.01 Extraordinary item (0.20) - - ----------------------------------------- Net earnings (loss) $ 0.63 $ (5.68) $ 1.01 ----------------------------------------- Diluted: Earnings (loss) before extraordinary item $ 0.80 $ (5.68) $ 0.97 Extraordinary item (0.19) - - ----------------------------------------- Net earnings (loss) $ 0.61 $ (5.68) $ 0.97 -----------------------------------------
See accompanying notes to the consolidated financial statements. F-11
COMMON STOCK CLASS A COMMON STOCK ---------------------------------------------------- (in thousands, except share and per share data) SHARES AMOUNTS SHARES AMOUNTS - ----------------------------------------------------------------------------------------------------------- Balance-January 1, 1995 17,606,850 $88,034 6,736,370 $33,682 Net income Common stock dividends declared ($.32 per share) Class A common stock dividends declared ($.36 per share) Conversion of common stock into Class A common stock (562,270) (2,811) 562,270 2,811 Unrealized gain on investments available for sale (net of tax effect of $(36,063)) Repayment of notes Purchase of treasury shares, net Effect of other treasury stock transactions - ----------------------------------------------------------------------------------------------------------- Balance-December 31, 1995 17,044,580 85,223 7,298,640 36,493 Net loss Common stock dividends declared ($.32 per share) Class A common stock dividends declared ($.36 per share) Conversion of common into Class A common stock (949,164) (4,746) 949,164 4,746 Unrealized loss on investments available for sale (net of tax effect of $22,823) Repayment of notes Purchase of treasury shares, net - ----------------------------------------------------------------------------------------------------------- Balance-December 31, 1996 16,095,416 80,477 8,247,804 41,239 Net income Common stock dividends declared ($.32 per share) Class A common stock dividends declared ($.36 per share) Conversion of common stock into Class A common stock (809,153) (4,046) 809,153 4,046 Class A common stock issued under stock option plans and other issuances of Class A common stock 99,725 498 Unrealized gain on investments available for sale (net of tax effect of $(23,520)) Repayment of notes (Purchase) reissuance of treasury shares, net - ----------------------------------------------------------------------------------------------------------- Balance-December 31, 1997 15,286,263 $76,431 9,156,682 $45,783 - -----------------------------------------------------------------------------------------------------------
See accompanying notes to the consolidated financial statements. F-12
ADDITIONAL PAID IN CAPITAL- UNREALIZED NOTES CLASS A GAIN (LOSS) RECEIVABLE COMMON REATINED ON FROM STOCK EARNINGS INVESTMENTS OFFICERS - -------------------------------------------------------------------------------------------------------------------- Balance-January 1, 1995 $ - $ 463,952 $(49,465) $(4,374) Net income 24,130 Common stock dividends declared ($.32 per share) (5,396) Class A common stock dividends declared ($.36 per share) (2,505) Conversion of common stock into Class A common stock 66,976 Unrealized gain on investments available for sale (net of tax effect of $(36,063)) Repayment of notes 478 Purchase of treasury shares, net Effect of other treasury stock transactions - ----------------------------------------------------------------------------------------------------------------- Balance-December 31, 1995 - 480,181 17,511 (3,896) Net loss (135,334) Common stock dividends declared ($.32 per share) (5,138) Class A common stock dividends declared ($.36 per share) (2,788) Conversion of common into Class A common stock Unrealized loss on investments available for sale (net of tax effect of $22,823) (42,385) Repayment of notes 2,734 Purchase of treasury shares, net - ----------------------------------------------------------------------------------------------------------------- Balance-December 31, 1996 - 336,921 (24,874) (1,162) Net income 15,019 Common stock dividends declared ($.32 per share) (4,842) Class A common stock dividends declared ($.36 per share) (3,147) Conversion of common stock into Class A common stock 339 Class A common stock issued under stock option plans and other issuances of Class A common stock 43,680 Unrealized gain on investments available for sale (net of tax effect of $(23,520)) Repayment of notes (Purchase) reissuance of treasury shares, net (583) 964 - ------------------------------------------------------------------------------------------------------------------ $339 $ 343,368 $ 18,806 $ (198) - ------------------------------------------------------------------------------------------------------------------ TREASURY STOCK, AT COST ------------------------------------------------------- COMMON STOCK CLASS A COMMON STOCK ----------------------------------------------------- SHARES AMOUNTS SHARES AMOUNTS TOTAL Balance-January 1, 1995 388,514 $(4,706) 200,498 $(2,261) $ 524,862 Net income 24,130 Common stock dividends declared ($.32 per share) (5,396) Class A common stock dividends declared ($.36 per share) (2,505) Conversion of common stock into Class A common stock - Unrealized gain on investments available for sale (net of tax effect of $(36,063)) 66,976 Repayment of notes 478 Purchase of treasury shares, net 4,050 (63) 150,442 (2,355) (2,418) Effect of other treasury stock transactions (277,532) 3,541 3,541 - ---------------------------------------------------------------------------------------------------------------------------- Balance-December 31, 1995 392,564 (4,769) 73,408 (1,075) 609,668 Net loss (135,334) Common stock dividends declared ($.32 per share) (5,138) Class A common stock dividends declared ($.36 per share) (2,788) Conversion of common into Class A common stock - Unrealized loss on investments available for sale (net of tax effect of $22,823) (42,385) Repayment of notes 2,734 Purchase of treasury shares, net 32,800 (639) 1,373 (290) (929) - ---------------------------------------------------------------------------------------------------------------------------- Balance-December 31, 1996 425,364 (5,408) 74,781 (1,365) 425,828 Net income 15,019 Common stock dividends declared ($.32 per share) (4,842) Class A common stock dividends declared ($.36 per share) (3,147) Conversion of common stock into Class A common stock - Class A common stock issued under stock option plans and other issuances of Class A common stock 837 Unrealized gain on investments available for sale (net of tax effect of $(23,520)) 43,680 Repayment of notes 964 (Purchase) reissuance of treasury shares, net 10,110 (164) (35,834) 755 8 - ---------------------------------------------------------------------------------------------------------------------------- 435,474 $(5,572) 38,947 $ (610) $ 478,347 - ----------------------------------------------------------------------------------------------------------------------------
F-13 PENNSYLVANIA MANUFACTURERS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, (in thousands) 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 15,019 $ (135,334) $ 24,130 Adjustments to reconcile net income (loss) to net cash flows (used) provided by operating activities: Depreciation 8,672 12,511 7,652 Amortization 4,054 7,243 35 Provision (benefit) for deferred income taxes 9,906 (11,488) 15,353 Extraordinary loss from early extinguishment of debt (4,734) - - Net realized investment gains (8,598) (2,984) (31,923) Change inuncollected premiums and unearned premiums, net 39,030 17,983 22,381 Change in dividends to policyholders (2,324) (632) 910 Change in unpaid losses and loss adjustment expenses (87,885) 21,086 (33,728) Change in investment income due and accrued 6,577 5,188 4,961 Change in deferred acquisition costs (1,282) (6,105) (5,665) Other, net (85,795) (23,413) 11,807 ------------------------------------------------ Net cash flows (used) provided by operating activities (107,360) (115,945) 15,913 ------------------------------------------------ CASH FLOWS FROM INVESTING ACTIVITIES: Fixed maturity investments held to maturity: Maturities or calls - - 3,809 Fixed maturity investments available for sale: Purchases (1,963,492) (1,227,173) (2,147,600) Maturities or calls 168,304 52,280 75,861 Sales 2,072,842 1,210,114 2,085,864 Equity securities: Purchases - (5,196) (18,104) Sales 254 16,984 28,793 Net (purchases) sales of short-term investments (130,391) 78,935 (35,445) Sale of corporate properties 7,145 - - Net purchases of property and equipment (3,577) (6,723) (6,017) Purchase of Caliber One Indemnity Company (15,990) - - Cash acquired in purchase of Caliber One Indemnity Company 4,509 - - ------------------------------------------------ Net cash flows provided (used) by investing activities 139,604 119,221 (12,839) ------------------------------------------------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from long-term debt 210,000 26,000 125,000 Repayments of long-term debt (211,699) (25,149) (125,127) Dividends paid to shareholders (7,965) (7,926) (7,885) Proceeds from exercised stock options and issuance of Class A common stock 837 - - Treasury stock transactions, net 591 (929) 480 Repayments of notes receivable from officers 964 2,734 478 ------------------------------------------------- Net cash flows used by financing activities (7,272) (5,270) (7,054) ------------------------------------------------ Net increase (decrease) in cash 24,972 (1,994) (3,980) Cash January 1 7,176 9,170 13,150 ------------------------------------------------ Cash December 31 $ 32,148 $ 7,176 $ 9,170 ------------------------------------------------ SUPPLEMENTARY CASH FLOW INFORMATION: Amounts (received) paid for income taxes $ (19,112) $ 5,525 $ (951) Amounts paid for interest $ 19,776 $ 16,622 $ 15,062 Fair value of securities transferred from held to maturity classification to available for sale classification $ - $ - $ 1,238,077
See accompanying notes to the consolidated financial statements. F-14 PENNSYLVANIA MANUFACTURERS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 (Dollar amounts in thousands, except share and per share data) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accompanying consolidated financial statements include the accounts of Pennsylvania Manufacturers Corporation (PMC) and its wholly and majority owned subsidiaries (the Company). PMC is an insurance holding company that sells property and casualty reinsurance and insurance through its insurance subsidiaries. PMC's insurance subsidiaries are domiciled in Pennsylvania, except for its newly established excess and surplus lines writer, discussed below, which is domiciled in Delaware, and certain foreign subsidiaries. Reinsurance -- PMC's reinsurance subsidiary, PMA Reinsurance Corporation (PMA Re), emphasizes risk-exposed, excess of loss reinsurance and operates in the brokered market. PMA Re's business is predominantly in casualty lines of reinsurance. Workers' Compensation and Primary Standard Insurance -- PMC's property and casualty insurance subsidiaries (the Property and Casualty Group) write workers' compensation and other standard lines of commercial insurance primarily in the Mid-Atlantic and Southern regions of the U.S. Specialty Property and Casualty -- During 1997, the Company established a separate specialty insurance operation focusing on excess and surplus lines, Caliber One Management Company (Caliber One). In December 1997, PMA Re acquired 100% of the outstanding common stock of Caliber One Indemnity Company (formerly known as Lincoln Insurance Company) for approximately $16,000 and made a capital contribution of approximately $11,300 to Caliber One Indemnity Company. All of Caliber One Indemnity Company's acquired loss reserves were reinsured by an insurance affiliate of Caliber One Indemnity Company's former parent immediately prior to and in conjunction with the purchase (the "Reserve Guarantee"). The Reserve Guarantee covers adverse development and uncollectible reinsurance in an amount equal to the stated amount of the reserves acquired, plus an additional $68,500. Upon the purchase of Caliber One Indemnity Company, management valued the amount of the Reserve Guarantee at approximately $5,000 in excess of the stated acquired reserves. Management believes that the Reserve Guarantee will be adequate to cover any future adverse reserve development or uncollectible reinsurance on the acquired reserves. At December 31, 1997, $36,807 was recoverable under the Reserve Guarantee, which is included in reinsurance receivables. Management is accounting for the Reserve Guarantee in conformity with EITF Topic D-54, "Accounting by the Purchaser for a Seller's Guarantee of the Adequacy of Liabilities for Losses and Loss Adjustment Expenses of an Insurance Enterprise Acquired in a Purchase Business Combination", and, accordingly, any future revisions to the estimates of the amount of underlying loss reserves and the amount recoverable under the Reserve Guarantee will be recognized in losses and loss adjustment expenses in the period in which the estimates are changed. Management believes that the reinsurance obtained as part of the purchase will be adequate to cover any future adverse reserve development or uncollectible insurance on the acquired reserves. PMA Re intends to maintain Caliber One Indemnity Company's surplus at not less than $25,000, the minimum capital and surplus required for many states in order to be an eligible excess and surplus lines carrier. Management anticipates that Caliber One will primarily write multi-line business consisting of primary and excess commercial general liability, professional liability, excess automobile and certain property exposures. Because Caliber One's results were not significant in 1997, Caliber One's financial information has been included within the Corporate and Other segment, including pre-opening costs of approximately $900, which have been expensed as incurred. The Company's significant accounting policies and practices are as follows: 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 amounts reported in its consolidated financial statements and accompanying notes. Actual results may differ from those estimates. These consolidated financial statements 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 NAIC publications. Permitted SAP encompasses all accounting practices that are not prescribed. The NAIC has a project to codify SAP, the result of which is expected to constitute the only source of prescribed SAP. The project, when completed, will change the definitions of what comprises prescribed versus permitted SAP and may result in changes to the accounting policies that insurance companies use to prepare SAP financial statements. See Note 18 for additional SAP information and a reconciliation of SAP net income and surplus to GAAP net income and shareholders' equity. F-15 B. INVESTMENTS -- Fixed maturity investments include U.S. Treasury securities and obligations of U.S. Government agencies, obligations of states and political subdivisions, where applicable, corporate debt securities and mortgage-backed securities. Under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," fixed maturities which the Company may hold for an indefinite period of time 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 shareholders' equity. Fixed maturities which the Company has the positive intent and ability to hold to maturity are carried at amortized cost. In 1995, the Company re-evaluated the classifications of its fixed maturity investments. As a result, effective June 30, 1995, the Company reclassified its entire held-to-maturity portfolio, which had an amortized cost of $1,241,774, to the available-for-sale designation in order to match more closely the Company's investment strategy. This reclassification resulted in a $1,238,077 increase in available-for-sale securities and a $2,403 unrealized loss (net of deferred taxes), with no impact on net income. As of December 31, 1997, the Company's entire fixed income portfolio remains designated as available for sale. Equity securities for all periods are stated at fair value with changes in fair value, net of income tax effects, reflected in shareholders' equity. Realized gains and losses, determined by specific identification, are reflected in income in the period in which the sale transaction occurs. C. PREMIUMS -- Premiums, including estimates of additional premiums resulting from audits of insureds' records, 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. Estimated premiums receivable on retrospectively rated policies are reported as a component of uncollected premiums (See Note 1-P). The Company follows Emerging Issues Task Force Consensus Position No. 93-6, "Accounting for Multiple Year Retrospectively Rated Contracts by Ceding and Assuming Enterprises" (EITF 93-6). EITF 93-6 requires that the Company reflect adjustments to future premiums, as the result of past experience under multiple year reinsurance contracts, in earnings currently. The impact of EITF 93-6 has been immaterial. D. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES -- Unpaid losses and loss adjustment expenses are stated net of estimated salvage and subrogation and are determined using claims adjusters' evaluations, 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 SAP mortality and interest assumptions (See Note 3). 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. E. DEFERRED ACQUISITION COSTS -- The costs of acquiring new and renewal business are deferred and amortized over the period during which the related premiums are earned. Such costs include direct acquisition costs, including commissions, brokerage, and premium taxes as well as other policy issuance costs and underwriting expenses that directly relate to and vary with the production of business. 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 Property and Casualty Group issues certain workers' compensation insurance policies with dividend payment features. These policyholders share in the operating results in the form of dividends declared at the discretion of the Company's board of directors. 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 accounts for income taxes under SFAS No. 109, "Accounting for Income Taxes." SFAS No. 109 is an asset and liability approach, whereby deferred tax assets and liabilities are recorded to the extent of the tax effect of differences between the financial statement carrying values and tax bases of assets and liabilities. 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. In addition, PMC and a majority of its subsidiaries have a written tax-sharing agreement which allocates to F-16 each entity subject to the agreement its Federal income taxes on a separate return basis. The benefit of any net operating losses is retained by PMC. H. PROPERTY AND EQUIPMENT -- Property and equipment are stated at cost, less accumulated depreciation. Depreciation is calculated on the straight-line method utilizing useful lives ranging from 3 to 40 years. During 1996, the Property and Casualty Group changed the depreciable lives for its mainframe computer equipment from five years to three years. The effect of this adjustment was to increase 1996 depreciation expense by approximately $4,800. I. PER SHARE INFORMATION -- In February 1997, the Financial Accounting Standards Board issued SFAS No. 128, "Earnings Per Share", which supersedes Accounting Principles Board Opinion No. 15, "Earnings Per Share," and Related Interpretations, and which the Company adopted during 1997. In accordance with SFAS No. 128, all prior period data presented has been restated to conform with the provisions of this statement. SFAS No. 128 replaces the presentation of primary earnings per share with a presentation of basic earnings per share and requires the presentation of both basic and diluted earnings per share on the face of the income statement. SFAS No. 128 also requires a reconciliation of the numerators and denominators used in the basic earnings per share calculation to the numerators and denominators used in the diluted earnings per share calculation. Such reconciliation is provided in Note 16. Basic earnings per share: For years 1997, 1996 and 1995, basic earnings per share was based upon the weighted average number of common and Class A common shares outstanding for the period. Diluted earnings per share: For years 1997 and 1995, diluted earnings per share was based upon the weighted average number of common and Class A common shares outstanding during the year and the assumed exercise price of dilutive stock options, less the number of treasury shares assumed to be purchased from the proceeds using the average market price of the Company's Class A common stock. In 1996, diluted earnings per share was based upon the weighted average common and Class A common shares outstanding during the year; the assumed exercise price of stock options using the average market price of the Company's Class A common stock was not taken into consideration as these stock options would have had an anti-dilutive effect on the net loss per share (See Note 16). J. STOCK-BASED COMPENSATION -- The Company has chosen to continue to account 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 the date of the grants over the amount an employee must pay to acquire the Class A common stock. K. COMPUTER SOFTWARE COSTS RELATED TO THE YEAR 2000 -- In 1996, the Company adopted Emerging Issues Task Force Consensus Position No. 96-14, "Accounting for the Costs Associated with Modifying Computer Software for the Year 2000" (EITF 96-14). EITF 96-14 states that external and internal costs specifically associated with modifying internal-use software for the Year 2000 should be charged to expense as incurred. In accordance with EITF 96-14, the Company charged approximately $2,000 and $1,800 to operating expenses during the years ended December 31, 1997 and 1996, respectively, for costs associated with modifying internal-use software. L. SERVICE REVENUES -- Service revenues are earned over the term of the related contracts in proportion to the actual services rendered. M. RECLASSIFICATIONS -- Certain prior year amounts have been reclassified to conform to the current year presentation. Additionally, in 1995, the Company elected to change its method of reporting cash flows from the direct method to the indirect method. N. RECENTLY ISSUED ACCOUNTING STANDARDS -- In June 1996, the Financial Accounting Standards Board issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." SFAS No. 125, which is effective for transfers and extinguishments occurring after December 31, 1996, provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. The Property and Casualty Group's domestic insurance subsidiaries participated in a transfer arrangement of certain accounts receivable. This arrangement has been terminated F-17 as a result of SFAS No. 125. The termination did not have a material impact on the Company's financial condition or results of operations. During 1997, the FASB issued 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 that are 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. In addition, the FASB issued SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information," which establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and interim financial reports issued to shareholders. SFAS No. 131 also establishes standards for related disclosures about products and services, geographic areas and major customers. The Company will adopt the provisions of these pronouncements in 1998. The adoption of these pronouncements will not have an impact on the Company's financial position and results of operations, but may change the presentation of certain of the Company's financial statements and related notes and data thereto. O. LONG-LIVED ASSETS -- It is management's policy to review long-lived assets, such as the Company's properties, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Such changes in circumstances include such things as significant decline in market value or change in use of the asset. Periodically, management reviews appraisals and/or cash flow projections from properties and other long- lived assets and compares such amounts to the carrying values to determine whether or not there has been an impairment. If such an impairment exists, it is management's policy to write down the carrying value of the asset to fair value less costs to carry and dispose of the asset, where applicable. P. ACCRUED RETROSPECTIVE PREMIUMS -- Accrued retrospective premiums, which are a component of uncollected premiums, are based upon actuarial estimates of expected ultimate losses and resulting estimated premium adjustments relating to retrospectively rated policies. The change in accrued retrospective premiums is a component of net premiums earned. 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 estimated underlying losses on such policies. In addition, accrued retrospective premiums are increased (decreased) based upon retrospective policy adjustments paid (billed); such adjustments actually billed or paid do not impact premium revenues as the Company records an offsetting amount through net premiums written. The following sets forth the components of the change in accrued retrospective premiums for each of the past three years:
For the years ended December 31, 1997 1996 1995 ---- ---- ---- Estimated retrospective policy adjustments related to current accident year.......................... $(12,460) $(18,767) $(12,941) Revision of estimate of retrospective policy adjustments related to prior accident years................... (44,719) (9,888) (4,845) Retrospective policy adjustments paid.... 20,179 23,155 13,786 Uncollectible write-off.................. -- (5,000) -- -------- -------- -------- Total.................................... $(37,000) $(10,500) $ (4,000) ======== ======== ========
In 1997, 1996 and 1995, the Property and Casualty Group reduced accrued retrospective premiums by $37,000, $10,500 and $4,000, respectively. The primary reason for the additional reduction in 1997 relative to 1996 was a $44,719 revision of estimate of accrued retrospective premiums, primarily due to the favorable development of claims liabilities for more recent accident years ($35,719) and the commutation of claims for accident years 1991 and prior in 1997 ($9,000). The reduction for policy years 1991 and prior primarily relates to the commutation program for such years initiated in late 1996. In July 1997, the Property and Casualty Group completed a formal program where it commuted a large number of claims associated with workers' compensation claims from accident years 1991 and prior, including loss reserves associated with retrospective policies (See Note 3). The commutation program resulted in current F-18 payments to claimants which were less than the carried reserves. As a result of the differences between the current commutation payments to claimants and carried reserves on such claims, management reduced its estimate of amounts recoverable under retrospectively rated policies and also recognized a reduction in losses and LAE associated with such policies. The reduction related to 1992 through 1996 policy years was primarily related to a corresponding amount of favorable development on underlying loss reserves for such years (See Note 3). The effects of the commutations on these prior loss reserves, as well as the intent of the Property and Casualty Group to continue utilizing early intervention techniques such as commutations on claims from more recent accident years, have led to a re-estimation of policy liabilities for these more recent accident years, and a re-estimation of amounts due under retrospectively rated policies for these more recent accident years. Management believes that it has made a reasonable estimate of the Company's accrued retrospective premiums. While the eventual ultimate receivable may differ from the current estimates, management does not believe that the difference will have a material effect, either adversely or favorably, on the Company's financial position or results of operations. 2. INVESTMENTS The Company's investment portfolio is well diversified and contains no significant concentrations in any specific industry, business segment, or individual issuer. The Company principally invests in U.S. Treasury securities and obligations of U.S. Government agencies, high-quality obligations of states and political subdivisions and corporations, and mortgage backed securities. Equity securities consist entirely of common stocks of financial institutions, public utilities, and industrial and service entities. F-19 The amortized cost and fair value of the Company's investment portfolio are as follows:
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---- ----- ------ ----- DECEMBER 31, 1997 Fixed maturities available for sale: U.S. Treasury securities and obligations of U.S. Government agencies....................... $1,105,689 $17,267 $ 3,390 $1,119,566 Corporate debt securities....................... 675,218 12,845 392 687,671 Mortgage backed securities...................... 119,687 2,657 63 122,281 ---------- ------- ------- ---------- Total fixed maturities available for sale......... 1,900,594 32,769 3,845 1,929,518 Equity securities................................. 5 8 -- 13 Short-term investments............................ 265,207 -- -- 265,207 ---------- ------- ------- ---------- Total investments................................. $2,165,806 $32,777 $ 3,845 $2,194,738 ========== ======= ======= ========== DECEMBER 31, 1996 Fixed maturities available for sale: U.S. Treasury securities and obligations of U.S. Government agencies....................... $1,640,881 $ 4,045 $42,182 $1,602,744 Obligations of states and political subdivisions 77,562 194 1,229 76,527 Corporate debt securities....................... 372,620 3,203 2,977 372,846 Mortgage backed securities...................... 73,328 728 53 74,003 ---------- ------- ------- ---------- Total fixed maturities available for sale......... 2,164,391 8,170 46,441 2,126,120 Equity securities................................. 259 3 -- 262 Short-term investments............................ 134,971 -- -- 134,971 ---------- ------- ------- ---------- Total investments................................. $2,299,621 $ 8,173 $46,441 $2,261,353 ========== ======= ======= ==========
The amortized cost and estimated fair value of fixed maturities at December 31, 1997, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because the issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
Amortized Fair Cost Value ---- ----- 1998.......................................... $ 129,047 $ 128,919 1999-2002..................................... 634,888 633,643 2003-2007..................................... 394,704 396,459 2008 and thereafter........................... 622,268 648,216 Mortgage backed securities.................... 119,687 122,281 ---------- ---------- $1,900,594 $1,929,518 ========== ==========
Net investment income consists of the following:
For the years ended December 31, 1997 1996 1995 ---- ---- ---- Fixed maturities......................... $128,400 $131,530 $129,883 Equity securities........................ -- 148 503 Short-term investments................... 7,282 7,711 11,764 Other.................................... 4,422 3,251 4,303 -------- -------- -------- Total investment income................ 140,104 142,640 146,453 Investment expenses...................... 3,406 8,704 7,098 -------- -------- -------- Net investment income.................. $136,698 $133,936 $139,355 ======== ======== ========
F-20 Net realized investment gains consist of the following:
For the years ended December 31, 1997 1996 1995 ---- ---- ---- Realized gains: Fixed maturities......................... $20,899 $12,762 $37,900 Equity securities........................ -- 4,351 3,117 Other.................................... -- 4 -- ------- ------- ------- 20,899 17,117 41,017 ------- ------- ------- Realized losses: Fixed maturities......................... 12,203 12,861 5,956 Equity securities........................ -- 436 2,200 Other.................................... 98 836 938 ------- ------- ------- 12,301 14,133 9,094 ------- ------- ------- Total net realized investment gains........ $ 8,598 $ 2,984 $31,923 ======= ======= =======
On December 31, 1997, the Company had securities with a total amortized cost and fair value of $30,925 and $31,105, respectively, on deposit with various governmental authorities, as required by law. In addition, at December 31, 1997, securities with a total amortized cost and fair value of $11,603 and $11,547, respectively, were pledged as collateral for letters of credit issued on behalf of the Company. Change in unrealized appreciation (depreciation) of investments consists of the following:
For the years ended December 31, 1997 1996 1995 ---- ---- ---- Fixed maturities available for sale........ $67,195 $(62,457) $ 99,874 Equity securities.......................... 5 (2,751) 3,165 ------- -------- -------- Change in unrealized appreciation (depreciation) of investments....... $67,200 $(65,208) $103,039 ======= ======== ========
During 1997, the Company established a securities lending program through which securities are loaned 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 loaned 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. Additionally, the Company limits securities lending to 40% of statutory admitted assets of its insurance subsidiaries, with a 2% limit on statutory 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. In 1997, the Company recognized income from securities lending transactions of $524, net of lending fees, which was included in investment income. The Company had approximately $175,000 of securities on loan as of December 31, 1997. F-21 3. 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, 1997 1996 1995 --------------- --------------- --------------- Balance at January 1......................................... $2,091,072 $2,069,986 $2,103,714 Less: reinsurance recoverable on unpaid losses and LAE....... 256,576 261,492 247,856 ---------- ---------- ---------- Net balance at January 1..................................... 1,834,496 1,808,494 1,855,858 ---------- ---------- ---------- Losses and LAE incurred, net: Current year............................................... 341,880 323,069 357,787 Prior years................................................ (86,006) 156,074 51,491 Accretion of discount (includes ($35,000) effect of the change in the discount rate for the Property and Casualty Group's workers' compensation unpaid losses from 4% to 5% in 1995).................................................. 51,407 57,480 13,300 ---------- ---------- ---------- Total losses and LAE incurred, net........................... 307,281 536,623 422,578 ---------- ---------- ---------- Losses and LAE paid, net: Current year............................................... (72,399) (72,194) (71,126) Prior years................................................ (398,475) (438,427) (398,816) ---------- ---------- ---------- Total losses and LAE paid, net............................... (470,874) (510,621) ( 469,942) ---------- ---------- ---------- Net balance at December 31................................... 1,670,903 1,834,496 1,808,494 Reinsurance recoverable on unpaid losses and LAE............. 332,284 256,576 261,492 ---------- ---------- ---------- Balance at December 31....................................... $2,003,187 $2,091,072 $2,069,986 ========== ========== ==========
The Company's results of operations included a decrease in estimated incurred losses and LAE related to prior accident years of $86,006 in 1997, and an increase of $156,074 and $51,491 in 1996 and 1995, respectively. During 1997, PMA Re recorded favorable reserve development on prior accident years of approximately $32,100. PMA Re has consistently recorded favorable reserve development on prior accident years for the past several years. The remaining decrease in estimated losses and LAE on prior accident years during calendar year 1997 can be attributed primarily to the following: the cession of prior year reserves by PMA Life Insurance Company to a third party reinsurer of approximately $14,800 (See Note 5); favorable reserve development at the Property and Casualty Group in conjunction with the formal commutation program, discussed below, of approximately $9,000 pertaining to retrospectively rated policies for accident years 1991 and prior; favorable reserve development at the Property and Casualty Group of approximately $28,000 related to retrospectively rated policies pertaining to accident years 1992 through 1996; and favorable development on pre-1992 workers' compensation reserves of $7,100, partially offset by reserve strengthening in commercial multi-peril business for accident year 1996 of $5,000. The increase in estimated incurred losses and LAE during 1996 is primarily due to a loss reserve strengthening charge of $191,400. This loss reserve strengthening was associated with the following lines of business:
1996 ------------ Workers' compensation..................... $110,000 Asbestos and environmental................ 60,400 Other lines of business................... 21,000 -------- $191,400 ========
The 1996 aggregate workers' compensation adverse development was allocated $102,000 to Pennsylvania and $8,000 to all other states in the Company's marketing territory. Of the $102,000, the allocation by accident year is as follows: prior to 1987: $16,000; 1987 to 1991: $101,000; and 1992 and subsequent years: $(15,000). In 1995, substantially all of the workers' compensation adverse development related to accident years 1987 to 1991 in Pennsylvania. For accident years prior to 1992, the traditional paid loss development schedules for workers' compensation had begun to exhibit an increasing trend in loss development factors by 1993. This trend was initially attributed to an increase in commutation activity. In 1995, management began to question whether loss data was developing in a manner that was consistent F-22 with the conclusion that the loss development trends were impacted solely by commutation activity. As a result, management began to accumulate additional data in order to determine whether there were additional causes of the increase in the paid loss development data; management obtained claim count data that was far more detailed than had been historically utilized in the reserve setting process. This data indicated that the paid loss development factors were not only impacted by commutation activity, but also by a decline in the claims closure rate in Pennsylvania. Management believes that the decline of the closure rates was due to several interrelated factors. One factor related to the fact that efforts to rehabilitate claimants and return them to work were not as successful as anticipated. For accident years 1987 to 1991, in particular, extensive efforts were made by the Company to rehabilitate claimants and return them to work at either full or modified duty. By late 1995 and into 1996, it was recognized, by a review of a slow down in the claims closure pattern that these rehabilitation efforts were not impacting the closure rates as expected. Another factor negatively impacting claims closure rates related to the economic conditions in Pennsylvania in the early 1990's. During the period from 1990 to 1994, economic conditions in Pennsylvania were considered to be depressed in the Company's major industry niches for workers' compensation insurance (construction, heavy manufacturing). Payrolls in these industries were stagnant, and in many cases, employment was flat or declining. The Company believes that in periods of declining employment opportunities, there is a tendency for indemnity periods to increase, which occurred for workers who suffered injuries in these industries. The above factors, when considered with the fact that the benefits period in Pennsylvania was unlimited, caused the Company to believe that a substantial portion of claimants from the pre-1992 period, who had already been out of work five to nine years, would not return to work in any capacity. In late 1995 and during 1996, management undertook an effort to quantify the impact of the declining closure rates versus the increase in commutation activity. During the fourth quarter of 1995, management strengthened the Property and Casualty Group's workers' compensation reserves by $54,700; however, the quantification of the effect of the claims closure rate was an extremely complex process, and as such, the data was not fully understood at that time. As the data under analysis was more mature and refined in 1996, management determined that the workers' compensation loss reserves for Pennsylvania in the pre-1992 accident years needed to be increased substantially; therefore, the Property and Casualty Group increased its workers' compensation reserves by $110,000 in 1996. Workers' compensation reform legislation enacted in Pennsylvania in 1993 and 1996 introduced various controls and limitations on medical and disability benefits. Management believes that these reforms have had and will continue to have a favorable impact on workers' compensation loss ratios for accident years 1993 and subsequent. In addition, management took several steps to reduce the outstanding claims associated with the Pennsylvania workers' compensation business written through 1991. A formal commutation program was initiated in the fourth quarter 1996 and continued into late 1997. Commutations are agreements with claimants whereby the claimants, in exchange for a lump sum payment, will forego their rights to future indemnity payments from the Property and Casualty Group. Under Pennsylvania workers' compensation laws, all such commutation arrangements must be approved by the claimant and the Pennsylvania Workers' Compensation Board. The Property and Casualty Group paid approximately $101,100 and $17,800 in 1997 and the fourth quarter of 1996, respectively, to commute workers' compensation indemnity claims. Savings associated with these claims were consistent with management's expectations. The number of open claims for accident years 1991 and prior was substantially reduced as a result of the commutation program. This reduction in open claims is expected to reduce the possibility of any further adverse development on such reserves, although there can be no assurances that the level of commutations will have a significant impact on the future development of such reserves. Estimating reserves for workers' compensation claims can be more difficult than many other lines of property and casualty insurance for several reasons, including (i) the long payment `tail' associated with the business; (ii) the impact of social, political and regulatory trends on benefit levels; (iii) the impact of economic trends; and (iv) the impact of changes in the mix of business. At various times, one or a combination of such factors can make the interpretation of actuarial data associated with workers' compensation loss development more difficult, and it can take additional time to recognize changes in loss development patterns. Under such circumstances, adjustments will be made to such reserves as loss patterns develop and new information becomes available and such adjustments may be material. The adverse development in reserves associated with asbestos and environmental claims during 1996 was due to the completion of a detailed analysis of loss and LAE reserves associated with asbestos and environmental liability claims in 1996. The reserving for asbestos and environmental claims has undergone F-23 change at both the Company and in the insurance industry in general. For environmental and asbestos liability claims, reserving methodology has been evolving into accepted industry practice in the recent past; the Company's actuaries were able to apply these methods to its loss reserves in 1997 and 1996. 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. The methods employed by the Company prior to the review performed in 1996 included a review of aggregate loss and loss adjustment paid and case incurred data along with resulting "survival ratios" to establish IBNR for environmental and toxic tort claims. For asbestos claims, the Company had previously reserved costs to defend, and any indemnification payments anticipated on, claims for which it had received notice that it was a responsible party, plus a bulk factor applied to the estimated case reserves to provide for potential development of indemnification and defense costs related to such claims. In 1996, the Company performed a ground up analysis of asbestos loss reserves using an actuarially accepted modeling technique. Using historical information as a base and information obtained from a review of open claims files, assumptions were made about future claims activity in order to estimate ultimate losses. For each individual major account, projections were made regarding new plaintiffs per year, the number of years new claims will be reported, the average loss severity per plaintiff, and the ratio of loss adjustment expense to loss. In many cases involving larger asbestos claims, the Company reserved up to the policy limits for the applicable loss coverage parts for the affected accounts. Policy terms and reinsurance treaties were applied in the modeling of future losses. Estimation of obligations for asbestos and environmental exposures continues to be more difficult than other loss reserves 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. The Company's asbestos-related losses were as follows:
For the years ended December 31, 1997 1996 1995 -------------- -------------- -------------- Gross of reinsurance: Beginning reserves............................... $80,055 $ 27,611 $13,969 Incurred losses and LAE.......................... 2,435 62,854 22,482 Calendar year payments for losses and LAE........ (5,764) (10,410) (8,840) ------- -------- ------- Ending reserves.................................. $76,726 $ 80,055 $27,611 ======= ======== ======= 1997 1996 1995 -------------- -------------- -------------- Net of reinsurance: Beginning reserves............................... $53,300 $23,443 $ 8,168 Incurred losses and LAE.......................... (36) 39,427 21,826 Calendar year payments for losses and LAE....... (4,686) (9,570) (6,551) ------- ------- ------- Ending reserves.................................. $48,578 $53,300 $23,443 ======= ======= =======
F-24 The Company's environmental-related losses were as follows:
For the years ended December 31, 1997 1996 1995 -------------- -------------- -------------- Gross of reinsurance: Beginning reserves............................... $35,626 $20,134 $20,952 Incurred losses and LAE.......................... 1,130 22,143 3,516 Reserves acquired through purchase of Caliber One Indemnity Company(1).................. 13,060 -- -- Calendar year payments for losses and LAE........ (4,708) (6,651) (4,334) ------- ------- ------- Ending reserves.................................. $45,108 $35,626 $20,134 ======= ======= ======= Net of reinsurance: Beginning reserves............................... $34,592 $20,134 $20,952 Incurred losses and LAE.......................... 1,068 21,109 3,516 Calendar year payments for losses and LAE....... (3,965) (6,651) (4,334) ------- ------- ------- Ending reserves.................................. $31,695 $34,592 $20,134 ======= ======= =======
(1) Such acquired reserves have been reinsured by an affiliate of the former parent (See Note 1). Of the total net asbestos reserves, approximately $6,700, $6,800, and $6,700 related to established claims reserves at December 31, 1997, 1996, and 1995, respectively, and $41,900, $46,500, and $16,700 related to incurred but not reported losses at December 31, 1997, 1996, and 1995, respectively. Of the total net environmental reserves, approximately $11,200, $12,500, and $10,300 related to established claims reserves at December 31, 1997, 1996, and 1995, respectively, and $20,500, $22,100, and $9,800 related to incurred but not reported losses at December 31, 1997, 1996, and 1995, respectively. All incurred asbestos and environmental losses were for accident years 1986 and prior. 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 and other factors, the ultimate exposure to the Company for these claims may vary significantly from the amounts currently recorded, resulting in a potential adjustment in the claims reserves recorded. Additionally, issues involving policy provisions, allocation of liability among participating insurers, proof of coverage, and other factors make quantification of liabilities exceptionally difficult and subject to adjustment based upon newly available data. In 1996, other commercial lines for the Property and Casualty Group experienced reserve strengthening of $21,000, as compared to a reserve release of $11,600 in 1995. The reserve strengthening was principally due to a re-estimation of loss adjustment costs associated with general liability claims. Through 1991, the Property and Casualty Group's mix of general liability insurance policies were weighted towards the manufacturing classes of business. Subsequent to 1991, the Property and Casualty Group's mix of business became more heavily weighted towards the construction and contracting classes of business. These particular classes of business have experienced losses due to construction defects and similar matters, that have taken longer to emerge than the classes of business previously written by the Property and Casualty Group. Defense costs associated with these claims have also exceeded the original estimate of the Property and Casualty Group's management, which was based on the patterns of indemnification payments associated with the earlier classes of business written. When this issue was discovered, the Property and Casualty Group factored the increased defense costs and the emergence pattern in determining a more appropriate reserve amount for loss handling costs. The release of reserves in 1995 was primarily due to favorable loss experience in commercial automobile business. Unpaid losses on workers' compensation claims for the Company include approximately $816,000 and $1,012,000, net of discount of $460,230 and $514,248, at December 31, 1997 and 1996, respectively. The approximate discount rate used was 5% at December 31, 1997 and 1996. In 1995, the Property and Casualty Group changed its discount rate with respect to its workers' compensation unpaid losses from approximately 4% to 5% for SAP and GAAP purposes. This change was approved and is permitted by the Pennsylvania Insurance Department. The effect on net income (net of tax effect of $12,250) in 1995 was $22,750 ($0.96 per basic share and $0.92 per diluted share). F-25 The Company's loss reserves were stated net of salvage and subrogation of approximately $59,900 and $75,000 at December 31, 1997 and 1996, respectively. The following table presents the salvage and subrogation by segment and product line:
December 31, 1997 1996 ---------- ---------- Property and Casualty Group: Workers' compensation $46,000 $61,900 Other Commercial Lines 4,800 3,900 ------- ------- Total Property and Casualty Group 50,800 65,800 PMA Re 9,100 9,200 ------- ------- Total salvage and subrogation $59,900 $75,000 ======= =======
The Company's policy with respect to estimating the amounts and realizability of salvage and subrogation is to develop historical accident year schedules of paid salvage and subrogation by line of business, which are then 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. 4. DEFERRED ACQUISITION COSTS The following represents the components of deferred acquisition costs and the amounts that were charged to expense:
For the years ended December 31, 1997 1996 1995 ----------- ----------- ---------- Balance at January 1........................... $ 44,006 $ 37,901 $ 32,236 Deferral of acquisition costs.................. 94,783 96,397 92,872 Amortization of deferred acquisition costs..... (93,501) (90,292) (87,207) -------- -------- -------- Balance at December 31......................... $ 45,288 $ 44,006 $ 37,901 ======== ======== ========
5. REINSURANCE In the ordinary course of business, PMC's reinsurance and insurance subsidiaries assume and cede reinsurance 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. Amounts receivable from reinsurers related to paid and unpaid losses are displayed separately on the consolidated balance sheets, net of an allowance for uncollectible accounts. F-26 The components of net premiums earned and losses and LAE incurred are as follows:
For the years ended December 31, 1997 1996 1995 ---- ---- ---- Earned Premiums: Direct.......................... $ 277,871 $299,386 $370,590 Assumed......................... 216,357 209,688 149,838 Ceded........................... (118,277) (88,499) (35,476) --------- -------- -------- Net............................... $ 375,951 $420,575 $484,952 ========= ======== ======== Losses and LAE Incurred: Direct.......................... $ 244,429 $420,157 $317,552 Assumed......................... 166,202 163,799 127,910 Ceded........................... (103,350) (47,333) (22,884) --------- -------- -------- Net............................... $ 307,281 $536,623 $422,578 ========= ======== ========
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 to support balances due from reinsurers not authorized to transact business in the applicable jurisdictions. At December 31, 1997, the Company had reinsurance recoverables due from the following unaffiliated single reinsurers in excess of 3% of shareholders' equity:
Gross amount due Reinsurer to the Company A.M. Best Rating - --------- -------------- ---------------- United States Fidelity and Guaranty Company......... $74,041 A Essex Insurance Company............................. 36,807 A American Re-Insurance Corporation................... 35,411 A+ Kemper Reinsurance Corporation...................... 21,853 A London Life International Reinsurance Corporation 16,212 A+ Continental Casualty Company........................ 15,209 A
The Company maintained funds held to collateralize the above balances in the amount of $66,891 at December 31, 1997. The Company believes that it would have the right to offset the funds withheld from a reinsurer against the balances due from such reinsurer in the event of insolvency. During 1997, PMA Life Insurance Company reinsured the majority of its in force annuity business with a third party reinsurer via a quota-share reinsurance agreement for approximately $15,400. The transaction effectively makes PMA Life Insurance Company a dormant company. All of Caliber One Indemnity Company's acquired loss reserves were reinsured with an affiliate of its former parent in conjunction with its purchase by PMA Re, as discussed in Note 1. Management believes that such reinsurance is adequate to cover any future reserve development or uncollectible reinsurance on the acquired reserves. F-27 6. LONG-TERM DEBT Long-term debt consists of the following:
December 31, 1997 1996 ---- ---- Senior notes 9.53%, due 1997......................... $ -- $ 7,143 Senior notes 9.60%, due 2001......................... -- 46,428 Senior notes 7.62%, due 2001, Series A............... -- 71,000 Senior notes 7.62%, due 2000, Series B............... -- 36,000 Revolving credit agreement, expiring in 1998......... -- 44,000 Revolving credit facility, expiring in 2002(1)....... 203,000 -- Mortgage notes....................................... -- 128 -------- -------- Long-term debt....................................... $203,000 $204,699 ======== ========
(1) Maturing in an installment of $15,500 in 1999 and annual installments of $62,500 commencing in 2000 through 2002. On March 14, 1997, the Company refinanced substantially all of its existing credit agreements not already maturing in 1997 through the completion of a new $235,000 revolving credit facility (New Credit Facility). Utilizing the New Credit Facility, the Company refinanced the following obligations: Senior notes 9.60%, due 2001......................... $ 46,428 Senior notes 7.62%, due 2001, Series A............... 71,000 Senior notes 7.62%, due 2000, Series B............... 36,000 Revolving credit agreement, expiring in 1998(1)...... 36,000 -------- Total................................................ $189,428 ========
(1) The Company repaid $8,000 of the revolving credit agreement prior to March 14, 1997. The early extinguishment of the senior note agreements resulted in an extraordinary loss of $4,734 ($7,283 pre-tax). The New Credit Facility bears interest at LIBOR plus 0.70% on the utilized portion and carries a 0.275% facility fee on the unutilized portion. The spread over LIBOR and the facility fee are adjustable downward based upon the Company's debt to capitalization ratios in the future. As of December 31, 1997, the interest rate on the utilized portion of the New Credit Facility was 6.61%. In November of 1996, the Company entered into a letter of credit agreement with a group of banks, which currently extends through November of 1998. The original agreement allowed the issuing bank to issue letters of credit having an aggregate outstanding face amount up to $75,000. Effective March 14, 1997, this facility was reduced to an aggregate outstanding face amount not to exceed $50,000. The agreement requires the Company to pay a commitment fee during the existence of the agreement equal to 0.1875% per annum on the average daily available amount. At December 31, 1997 and 1996, the aggregate outstanding face amount of letters of credit issued was $46,881 and $47,461, respectively. This agreement primarily secures reinsurance liabilities of the insurance subsidiaries of the Company. The debt covenants supporting the revolving credit facility and the letter of credit agreement contain provisions which, 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 15). F-28 The Company has entered into an interest rate swap agreement in its management of its existing interest rate exposures. This transaction effectively changed the Company's interest rate exposure on a portion of the New Credit Facility, which has a floating rate, to a fixed obligation as follows:
Notional Principal Balance at Debt Agreement December 31, 1997 Fixed Rate Floating Rate - -------------- ----------------- ---------- ------------- Revolving Credit Facility, 2002 $150,000 7.24% 6.61%
The variable rate resets every three months. This agreement involves the exchange of interest payment obligation 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 agreement, the Company's exposure is limited to the interest rate differential on the notional principal amount ($150,000). Management believes such credit risk is minimal and any loss would not be significant. 7. STOCK OPTIONS The Company currently has six stock option plans in place for options granted to officers and other key employees for the purchase of the Company's Class A common stock, under which 3,864,903 Class A common shares are reserved for issuance. The stock options are granted under terms and conditions determined by a committee appointed by the Company's board of directors. Granted stock options have a maximum term of ten years, vest over periods ranging between zero and five years, and are typically granted with an exercise price equal to the fair market value of the stock. Information regarding these option plans for 1997, 1996, and 1995 are as follows:
1997 1996 1995 ----------------------------------------------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Shares Price Shares Price Shares Price ------ ----- ------ ----- ------ ----- Options outstanding, beginning of year...... 3,242,160 $ 12.43 3,087,260 $ 11.80 2,926,000 $ 10.41 Options granted.......... 324,500 17.00 325,000 17.00 775,000 15.59 Options exercised........ (162,248) (8.78) (99,150) (8.33) (205,199) (8.66) Options canceled......... (286,800) (11.53) (70,950) (11.55) (408,541) (10.65) --------- ------- --------- ------- --------- ------- Options outstanding, end of year............ 3,117,612 $ 13.18 3,242,160 $ 12.43 3,087,260 $ 11.80 ========= ======= ========= ======= ========= =======
Option price range at end of year............ $8.00 to $17.00 $8.00 to $17.00 $6.60 to $16.00 Option price range for exercised shares....... $8.00 to $15.00 $6.60 to $10.00 $6.60 to $11.50 Options available for grant at end of year... 747,291 921,566 425,616
F-29 Stock options outstanding at December 31, 1997 and related exercise price and weighted average remaining life information is as follows:
Weighted Options Options Average Outstanding at Exercisable at Remaining Life Exercise Prices December 31, 1997 December 31, 1997 (in years) - --------------- ----------------- ----------------- ---------- $8.00............................. 254,357 246,857 3.49 10.00............................. 438,690 438,690 4.46 11.50............................. 799,000 799,000 5.65 12.75............................. 271,500 271,500 6.17 15.00............................. 296,580 287,580 7.45 16.00............................. 411,485 283,735 7.43 17.00............................. 646,000 228,725 9.15 --------- --------- 3,117,612 2,556,087 ========= =========
The fair value of options at date of grant was estimated using a binomial model with the following weighted average assumptions:
1997(1) 1996(2) 1995(3) 1995(4) ------- ------- ------- ------- Expected life (years)............. 10 10 10 10 Interest rate..................... 6.3% 6.3% 6.1% 6.2% Volatility........................ 18% 18% 18% 18% Dividend yield.................... 2.3% 2.3% 2.3% 2.3%
(1) Options granted on September 3, 1997 (2) Options granted on July 23, 1996 (3) Options granted on June 5, 1995 (4) Options granted on September 1, 1995 The Company has adopted the disclosure-only provision of SFAS No. 123, "Accounting for Stock-Based Compensation". Accordingly, no compensation cost has been recognized for the stock option plans. 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, pretax income would have been reduced by $1,878 ($1,221 after tax, or $0.05 per basic share), $2,079 ($1,352 after tax, or $0.06 per basic share), and $4,308 ($2,800 after tax, or $0.12 per basic share) in 1997, 1996, and 1995, respectively. 8. INCOME TAXES The components of income tax provision (benefit) from continuing operations are:
For the years ended December 31, 1997 1996 1995 ---- ---- ---- Current: Federal.................................... $(4,506) $(44,572) $(4,570) ------- -------- ------- (4,506) (44,572) (4,570) ------- -------- ------- Deferred: Federal.................................... 9,906 (11,488) 15,353 ------- -------- ------- 9,906 (11,488) 15,353 ------- -------- ------- Income tax provision (benefit) from continuing operations....................... $ 5,400 $(56,060) $10,783 ======= ======== =======
F-30 The components of income tax benefit from extraordinary item are:
For the years ended December 31, 1997 1996 1995 --------- ---------- ---------- Current: Federal.................................... $ (374) $ -- $ -- ------- ---------- ---------- (374) -- -- ------- ---------- ---------- Deferred: Federal.................................... (2,175) -- -- ------- ---------- ---------- (2,175) -- -- ------- ---------- ---------- Income tax benefit from extraordinary item.......................... $(2,549) $ -- $ -- ======= ========== ==========
A reconciliation between the total provision (benefit) for income taxes and the amounts computed at the Statutory Federal income tax rate of 35% for the years 1997, 1996 and 1995 is as follows:
For the years ended December 31, 1997 1996 1995 ---------- ---------- ---------- Computed at the Statutory tax rate............. $ 8,804 $(66,988) $ 12,220 (Decrease) increase in taxes resulting from: Excludable dividends......................... -- (36) (107) Tax-exempt interest.......................... (61) (4,547) (12,917) Losses of foreign reinsurance affiliate...... -- 16,060 8,469 Reversal of income tax accruals.............. (3,703) -- -- Other........................................ 360 (549) 3,118 ------- -------- -------- Provision (benefit) for income taxes........... $ 5,400 $(56,060) $ 10,783 ======= ======== ========
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, 1997 1996 ----------- ----------- Allowance for uncollectible accounts.......... $ 6,839 $ 9,037 Unearned premiums............................. 13,756 13,386 Discounting of unpaid losses and LAE.......... 63,743 51,086 Unrealized depreciation of investments........ -- 13,394 Depreciation.................................. -- 5,646 Postretirement benefit obligation............. 5,139 5,111 Tax carryforwards............................. 46,088 67,014 Other......................................... 18,919 9,458 -------- -------- Gross deferred tax asset...................... 154,484 174,132 -------- -------- Deferred acquisition costs.................... (15,723) (15,352) Pension asset................................. (371) (1,348) Depreciation.................................. (574) -- Unrealized appreciation of investments........ (10,126) -- Losses of foreign reinsurance affiliate....... (55,087) (55,790) Other......................................... (2,212) -- -------- -------- Gross deferred tax liability.................. (84,093) (72,490) -------- -------- Net deferred tax asset........................ $ 70,391 $101,642 ======== ========
At December 31, 1997, the Company had approximately $109,622 of net operating loss carryforwards (expiring in 2011), approximately $7,532 of alternative minimum tax credit carryforwards (which do not expire) and approximately $188 of general business credit carryforwards (expiring in 2010 and 2011). Under SFAS 109, a valuation allowance should be provided to offset the effects of a deferred tax asset if management believes that it is more likely than not that the benefit of a deferred tax item will not be F-31 realized. Management believes that the benefit of its deferred tax asset will be fully realized, and therefore has not provided for a valuation allowance. U.S. Federal tax return examinations have been completed for the years 1992 and 1993. The examinations for years 1994 and 1995 are currently in progress. In management's opinion, the ultimate resolution of these matters will not have an adverse impact on the Company's financial position or results of operations. 9. EMPLOYEE RETIREMENT, POSTRETIREMENT, AND POSTEMPLOYMENT BENEFITS During 1996, the Property and Casualty Group initiated a Voluntary Early Retirement Program ("VERIP"). Eligibility to participate in the VERIP was contingent upon an employee's age and years of service with the Company. Of the approximately 85 employees eligible to participate in the VERIP, approximately 50 employees opted to participate. At December 31, 1996, the Company accrued $7,635 in connection with the VERIP. The components of this accrual are as follows: Pension costs..................................................... $4,300 Postemployment costs.............................................. 2,360 Postretirement costs.............................................. 975 ------ $7,635 ======
The Company did not offer a VERIP in 1997, and as such, did not incur any VERIP expenses. The Company did, however, incur certain restructuring and other charges during 1997 (See Note 20). A. PENSION AND RETIREMENT PLANS -- The Company sponsors a qualified non- contributory defined benefit pension plan (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 career average salary. The Company's policy is to fund pension cost accrued in accordance with the Employee Retirement Income Security Act of 1974. The Company also maintains a non-qualified unfunded supplemental defined benefit pension plan (Non-qualified Pension Plan) for the benefit of certain key employees. The following tables set forth the amounts recognized in the Company's financial statements with respect to the Qualified and Non-qualified pension plans:
For the year ended December 31, 1997 For the year ended December 31, 1996 Non- Non- Qualified Qualified Qualified Qualified Plan Plan Total Plan Plan Total ------------ ----------- --------- ---------- --------- -------- Service cost-benefits earned during the period......... $ 1,375 $ 93 $ 1,468 $ 1,665 $ 98 $ 1,763 Interest cost on projected benefit obligation........ 3,034 166 3,200 2,948 150 3,098 Actual return on plan assets . (2,490) -- (2,490) (2,830) -- (2,830) Net amortization and deferral.................. (884) 93 (791) (842) 94 (748) VERIP......................... -- -- -- 4,300 -- 4,300 ------- ---- ------- ------- ---- ------- Net pension cost.............. $ 1,035 $352 $ 1,387 $ 5,241 $342 $ 5,583 ======= ==== ======= ======= ==== ======= For the year ended December 31, 1995 Non- Qualified Qualified Plan Plan Total ---------- --------- -------- Service cost-benefits earned during the period......... $ 1,132 $ 108 $ 1,240 Interest cost on projected 2,770 158 2,928 benefit obligation........ (8,712) -- (8,712) Actual return on plan assets . Net amortization and 5,803 94 5,897 deferral.................. -- -- -- VERIP......................... ------- ------ ------- $ 993 $ 360 $ 1,353 Net pension cost.............. ======= ====== =======
F-32
December 31, 1997 December 31, 1996 Non- Non- Qualified Qualified Qualified Qualified Plan Plan Total Plan Total ---------- ---------- --------- ---------- --------- -------- Actuarial present value of: Vested benefit obligation......... $36,405 $ 1,238 $37,643 $41,932 $ 1,069 $43,001 Non-vested benefit obligation..... 3,919 79 3,998 3,487 68 3,555 ------- ------- ------- ------- ------- ------- Accumulated benefit obligation........ $40,324 $ 1,317 $41,641 $45,419 $ 1,137 $46,556 ======= ======= ======= ======= ======= ======= Projected benefit obligation.......... $44,653 $ 2,472 $47,125 $49,331 $ 2,133 $51,464 Fair value of Pension Plan assets..... 40,600 -- 40,600 46,739 -- 46,739 ------- ------- ------- ------- ------- ------- Excess of projected benefit obligation over Pension Plan assets........ (4,053) (2,472) (6,525) (2,592) (2,133) (4,725) Unrecognized net loss (gain).......... 4,830 29 4,859 588 (63) 525 Unrecognized transition asset......... (810) 1,123 313 (1,081) 1,216 135 Unrecognized prior service benefit.... (1,101) -- (1,101) (1,199) -- (1,199) ------- ------- ------- ------- ------- ------- Pension liability..................... $(1,134) $(1,320) $(2,454) $(4,284) $ (980) $(5,264) ======= ======= ======= ======= ======= =======
Qualified Pension Plan assets consist of equity securities, fixed maturity securities, fixed income contracts, and the Company's common stock. Actuarial assumptions utilized by the Qualified and Non-qualified Pension Plan are as follows:
For the years ended December 31, 1997 1996 1995 --------- --------- -------- Discount rate..................................... 7.0% 7.5% 7.0% Rate of compensation increase..................... 4.5% 5.0% 5.0% Expected long-term rate of return on plan assets.. 8.0% 8.0% 8.0%
The Company also maintains a voluntary defined contribution savings plan covering all employees who work a minimum of 20 hours per week. The Company matches employee contributions up to 5% of compensation. Contributions under such plans charged to income were $1,735, $2,153 and $1,726 in 1997, 1996 and 1995, respectively. B. POSTRETIREMENT BENEFITS -- In addition to providing pension benefits, the Company provides certain health care benefits for retired employees. Substantially all of the Company's employees may become eligible for those benefits if they have worked fifteen or more years with the Company and have attained the age of fifty while in the service of the Company. For employees who retire 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 funded status of this liability is as follows:
December 31, 1997 1996 -------- --------- Accumulated postretirement benefit obligation: Retirees and dependents.......................... $ 6,076 $ 6,931 Fully eligible active employees.................. 1,214 952 Active employees not fully eligible.............. 2,383 1,871 ------- ------- Total............................................ 9,673 9,754 Unrecognized prior service cost.................. 1,317 1,436 Unrecognized net gain............................ 3,455 4,031 ------- ------- Accrued postretirement benefit liability......... $14,445 $15,221 ======= =======
F-33 The components of postretirement benefit cost include the following:
For the years ended December 31, 1997 1996 1995 --------- --------- ---------- Service cost.......................... $ 237 $ 248 $ 330 Interest cost......................... 655 561 658 Amortization.......................... (242) (251) (209) VERIP................................. -- 975 -- ----- ------ ----- Postretirement benefit cost........... $ 650 $1,533 $ 779 ===== ====== =====
Assumptions used in the computation of the funded status and postretirement benefit cost are as follows:
For the years ended December 31, 1997 1996 1995 --------- --------- ---------- Discount rate......................... 7.5% 7.0% 7.0% Health care inflation rate: Next year........................... 7.5% 8.0% 8.5% Ultimate............................ 5.5% 5.5% 5.5%
The assumed health care cost trend rate used to measure the expected cost of benefits covered by the plan has been established at 7.5% for 1998 and is expected to decline gradually to 5.5% in 2002 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. A 1% increase in the trend rate for health care costs would have increased the accumulated postretirement benefit obligation by $405 and the annual service and interest cost by $27. C. POSTEMPLOYMENT BENEFITS -- SFAS No. 112, "Employers' Accounting for Postemployment Benefits," establishes the accounting standards for employers who provide benefits to employees subsequent to their employment, but prior to retirement. These benefits include severance, long-term and short-term disability payments, salary continuation, postemployment health benefits, supplemental unemployment benefits, and other related payments. SFAS No. 112 requires that benefit obligations attributable to prior service and/or that relate to benefits that vest or accumulate must be 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. In connection with the VERIP described above, the Company recorded $2,360 of postemployment costs in 1996. While a VERIP was not offered in 1997, the Company incurred approximately $7,000 of severance and other restructuring charges during 1997 (See Note 20). 10. FAIR VALUE OF FINANCIAL INSTRUMENTS The following table represents the carrying amounts and estimated fair values of the Company's financial instruments. Estimated fair value is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties. Certain financial instruments, specifically amounts relating to insurance contracts, are excluded from this disclosure. F-34
December 31, 1997 December 31, 1996 Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value --------------- --------------- --------------- --------------- Financial assets: Fixed maturities available for sale...... $1,929,518 $1,929,518 $2,126,120 $2,126,120 Equity securities........................ 13 13 262 262 Financial liabilities: Long-term debt........................... 203,000 203,000 204,699 218,101 Interest rate swap agreements............ -- 3,388 -- 52
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate values:
Fixed maturities: The fair values are estimated based upon quoted market prices. Equity securities: The fair values are estimated based upon quoted market prices. Long-term debt: The fair value 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. Interest rate swaps: The fair values are estimated by obtaining quotes from dealers. Guarantees: The fair values are determined based upon the likelihood of the Company being required to satisfy the underlying obligations. Management believes that it is a remote possibility that the Company would have to act upon any guarantees. Therefore, the fair value of the guarantees is zero. Other financial instruments (excluded from the above table): The carrying values approximate the fair values.
11. DISCLOSURE OF CERTAIN RISKS AND UNCERTAINTIES A. BUSINESS SEGMENTS AND CONCENTRATIONS -- As stated in Note 1, PMC is an insurance holding company that sells property and casualty reinsurance and insurance through its insurance subsidiaries. The following summarizes the relative importance of the segments and lines of insurance in terms of net premiums written:
Percent of the Company's Net Premiums Written 1997 1996 1995 ---------- ---------- ---------- PMA Re-total................................... 42.5% 37.0% 31.2% PMA Re-casualty reinsurance lines.............. 28.4 27.5 21.9 The Property and Casualty Group-total.......... 57.5 63.0 68.8 The Property and Casualty Group-workers' compensation................................. 43.2 45.6 42.8
PMA Re distributes its products through major reinsurance brokers. PMA Re's top five such brokers accounted for 90.8% of PMA Re's gross premiums in force at December 31, 1997. The Property and Casualty Group's operations are concentrated in six 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 Property and Casualty Group's products are highly regulated by each of these states. For many of the Property and Casualty 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 Property and Casualty Group considers factors such as rate adequacy, regulatory climate, and economic factors in its underwriting F-35 process, unfavorable developments in these factors could have an adverse impact on the Company's financial condition and results of operations. The Company actively manages its exposure to catastrophic events. In the underwriting process, the Company generally avoids 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 $46,000 excess of $2,000 per occurrence, and the Property and Casualty Group maintains catastrophe reinsurance protection of $27,700 excess of $850. As a result, the Company's loss ratios have not been significantly impacted by catastrophes, and management believes that the Company has adequate reinsurance to protect against the estimated probable maximum gross loss from a catastrophic event; however, though management believes it is unlikely, an especially severe catastrophic event could exceed the Company's reinsurance and/or retrocessional protection, and adversely impact the Company's financial position, perhaps materially. B. USE OF ESTIMATES IN THE PREPARATION OF THE FINANCIAL STATEMENTS -- The preparation of financial statements in conformity with GAAP requires management to make 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. Unpaid Losses and Loss Adjustment Expenses -- At December 31, 1997, the Company carried $2,003,187 of unpaid losses and loss adjustment expenses. Unpaid losses and loss adjustment expenses 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. 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. In addition, estimating reserves for workers' compensation claims can be more difficult than many other lines of property and casualty insurance for several reasons, including (i) the long payment `tail' associated with the business; (ii) the impact of social, political and regulatory trends on benefit levels for both medical and indemnity payments; (iii) the impact of economic trends; and (iv) the impact of changes in the mix of business. At various times, one or a combination of such factors can make the interpretation of actuarial data associated with workers' compensation loss development more difficult, and it can take additional time to recognize changes in loss development patterns. Under such circumstances, adjustments will be made to such reserves as loss patterns develop and new information becomes available and such adjustments may be material. Management believes that its unpaid losses and loss adjustment expenses are fairly stated at December 31, 1997, in accordance with GAAP. 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, and economic conditions, the estimates are revised accordingly. If the Company's ultimate net losses prove to be substantially greater than the amounts recorded at December 31, 1997, the related adjustments could have a material adverse impact on the Company's financial condition and results of operations (See also Note 3). C. YEAR 2000 ISSUE -- The unprecedented advances in computer technology over the past several decades have resulted in dramatic changes in the way companies do business. Most of these developments have been tremendously beneficial, but some have proven costly, as businesses have struggled to adapt to various features of the new technological landscape. One such well-publicized problem has arisen out of the worldwide use of the so-called "Year 2000" programming convention, in which two digit numbers were generally used instead of four digit numbers to identify the years used in dates. As a consequence, most computers require relatively costly reprogramming to enable them to correctly perform date operations involving years 2000 or later, a problem anticipated to have substantial repercussions on the business world, since computer operations involving date calculations are pervasive. F-36 With the assistance of outside consulting groups, the Company began evaluating and reprogramming its own computer systems to address the Year 2000 problem in late 1995. Management anticipates that by no later than year end 1998, it will have completed substantially all necessary programming work so that Year 2000 issues are not likely to result in any material adverse disruption in the Company's computer systems or its internal business operations. The cost of this work through year-end 1997 has been approximately $3,800. The Company estimates that the total remaining cost will be approximately $1,300, and will be expensed in 1998. Many experts now believe that Year 2000 problem may have a material adverse impact on the national and global economy generally. In addition, it seems likely that if businesses are materially damaged as a result of Year 2000 problems, at least some such businesses may attempt to recoup their losses by claiming coverage under various types of insurance policies. And, although management has concluded that under a fair reading of the various policies of insurance issued by it no coverage for Year 2000 problems should be considered to exist, it is not possible to predict whether or to what extent any such coverage could ultimately be found to exist by courts in the various jurisdictions. Accordingly, important factors which could cause actual results to differ materially from those expressed in the forward looking statements include but are not limited to the inability of the Company to accurately estimate the impact of the Year 2000 problem on the insurance, or other business operations, of the Company. 12. TRANSACTIONS WITH RELATED PARTIES The Company's largest shareholder is PMA Foundation (the "Foundation"), formerly known as Pennsylvania Manufacturers' Association, which is 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, 1997, the Foundation owned 4,561,225 shares of common stock (30.7% of the class) and 912,225 shares of Class A common stock (10.0% of the class), which constitutes 29.5% 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 $34, $82, and $269 for the years ended December 31, 1997, 1996, and 1995, respectively. The Foundation also leases its Harrisburg, Pennsylvania headquarters facility from a subsidiary of the Company under a monthly operating lease presently requiring rent payments of $20 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 $250, $247, and $294, for the years ended December 31, 1997, 1996, and 1995, respectively. In addition, the Company has arranged an executive loan program with a financial institution whereby such institution will provide prime rate personal loans to officers of the Company and its subsidiaries collateralized by common stock and Class A common stock at a maximum 50% loan to value ratio. The Company has agreed to purchase any loan made under this program from the financial institution in the event that the borrower defaults on such loan. The amount of loans outstanding at December 31, 1997 under this program was $4,642. The Company incurred legal and consulting fees aggregating approximately $6,506, $7,917, and $6,279 in 1997, 1996 and 1995, respectively, from firms in which directors of the Company are partners or principals. The Company has notes receivable from officers which are accounted for as a reduction of shareholders' equity in the accompanying balance sheets. Such notes receivable had balances of $198 and $1,162 as of December 31, 1997 and December 31, 1996, respectively. The interest rate on the notes range between 6.0% and 8.0%. F-37 13. COMMITMENTS AND CONTINGENCIES For the years ended December 31, 1997, 1996 and 1995, total rent expense was $5,745, $6,114 and $4,536 respectively. At December 31, 1997, the Company was obligated under noncancelable operating leases for office space with aggregate minimum annual rentals as follows:
For the years ended December 31, 1998.................................. $ 3,972 1999.................................. 2,940 2000.................................. 1,811 2001.................................. 1,820 2002.................................. 1,566 Thereafter............................ 2,133 ------- Total................................. $14,242 =======
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. The Company is not aware of any material potential assessments at December 31, 1997. The Company has provided guarantees of approximately $11,048 related to loans on properties in which the Company has an interest. The Company is named in various legal proceedings arising in the normal course of business. In the opinion of management, the resolution of these matters will not have a material adverse effect on the Company's financial condition, results of operations, or cash flows. 14. SALE OF UNCOLLECTED PREMIUMS Insurance subsidiaries of PMC, from time to time, engage in the practice of selling uncollected premiums to a third-party financial institution. No such sales were transacted during 1997. The proceeds received from such sales were $10,628 and $19,509 in 1996 and 1995, respectively. These receivables were excluded from uncollected premiums in the accompanying balance sheets. However, the Company had recorded an allowance for doubtful accounts related to the estimated uncollectible accounts since the Company had retained risk under the recourse provisions. At December 31, 1997, the Company had no contingent obligations outstanding related to the sale of uncollected premiums. 15. SHAREHOLDERS' EQUITY The Company has two classes of common stock, Class A common stock and common stock. The Company's common stock and Class A common stock generally vote without regard to class on matters submitted to shareholders, with the common stock having ten votes per share and the Class A common stock having one vote 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'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. Under the insurance laws and regulations of Pennsylvania, PMC's insurance subsidiaries may not pay dividends to PMC without prior regulatory approval, over a twelve-month period in excess of the greater of (a) 10% of the preceding year-end's policyholders surplus or (b) the preceding year's SAP net income, but in no event to exceed unassigned funds. At December 31, 1997, the maximum amount available to be paid as dividends from the Company's insurance subsidiaries to PMC, without the prior consent of the Pennsylvania Insurance Department, was $51,220. F-38 PMC's dividends to shareholders are restricted by its debt agreements. On March 14, 1997, the Company refinanced certain debt agreements through the completion of the New Credit Facility (See Note 6). Under the terms of the New Credit Facility under the most restrictive debt covenant, the Company could pay dividends of approximately $14,500 in 1998. PMA Re intends to maintain Caliber One Indemnity Company's surplus at not less than $25,000, the minimum capital and surplus required for many states in order to be an eligible surplus lines carrier (See Note 1). 16. EARNINGS PER SHARE In accordance with SFAS No. 128 discussed in Note 1-I, the Company is required to present a reconciliation of the numerators and denominators used in the basic earnings per share calculation to the numerators and denominators used in the diluted earnings per share calculation. The computation of diluted earnings per share is similar to the computation of basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if all dilutive potential common shares, such as outstanding stock options with exercise prices below the average market price, had been issued. For all years presented, there were no differences in the numerator for the basic and diluted earnings per share calculation. For entities that report an extraordinary item, as the Company did in 1997, SFAS No. 128 requires that income before extraordinary item be used as the control number in determining whether or not potential common shares are dilutive. The Company's income (loss) before extraordinary item, which was equal to net income in 1996 and 1995, and a reconciliation of the denominator of the basic and diluted earnings per share computations are presented below.
1997 1996 1995 ------------------ ------------------- ------------------ NUMERATOR: Control number - income (loss) before extraordinary item........... $ 19,753 $ (135,334) $ 24,130 DENOMINATOR: Basic shares - weighted average common and Class A common shares outstanding... 23,855,031 23,800,791 23,816,088 Dilutive stock options................ 712,347 -- 965,861 ----------- ----------- ----------- Total diluted shares.................. 24,567,378 23,800,791 24,781,949 =========== =========== ===========
Options to purchase 646,000 shares of Class A common stock at $17.00 per share were outstanding at December 31, 1997, but were not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of the Class A common shares. Options to purchase 3,242,160 shares of Class A common stock at prices ranging between $8.00 and $17.00 were outstanding during at December 31, 1996, but were excluded from the computation of diluted earnings per share as they would have been anti-dilutive. F-39 17. BUSINESS SEGMENTS Operating revenues, income (loss) before income taxes, and identifiable assets of the Company's business segments were as follows:
For the year ending December 31, 1997 1996 1995 ---------------- ---------------- --------------- OPERATING REVENUES (1) PMA Re Net premiums earned................................... $163,603 $ 151,974 $139,345 Net investment income................................. 52,270 48,676 45,166 -------- --------- -------- 215,873 200,650 184,511 -------- --------- -------- The Property and Casualty Group Net premiums earned - workers' compensation.... 152,773 176,380 243,175 Net premiums earned - commercial lines......... 59,575 92,221 102,432 -------- --------- -------- Net premiums earned - total.................... 212,348 268,601 345,607 Net investment income................................. 82,098 82,455 92,275 Service revenues...................................... 10,311 9,189 5,106 -------- --------- -------- 304,757 360,245 442,988 -------- --------- -------- Corporate, Other and Consolidating Eliminations Net investment income................................. 2,330 2,805 1,914 -------- --------- -------- 2,330 2,805 1,914 -------- --------- -------- Total operating revenues.................................. $522,960 $ 563,700 $629,413 ======== ========= ======== (1) Operating revenues exclude net realized investment gains. For the year ending December 31, 1997 1996 1995 ---------------- ---------------- --------------- INCOME (LOSS) BEFORE INCOME TAXES PMA Re.................................................... $ 44,802 $ 42,783 $ 39,443 The Property and Casualty Group........................... (9,038) (219,619) (4,305) Corporate, Other and Consolidating Eliminations........... (3,441) (490) (13,414) -------- --------- -------- Pre-tax operating income (loss) before interest expense... 32,323 (177,326) 21,724 Net realized investment gains............................. 8,598 2,984 31,923 Interest expense.......................................... (15,768) (17,052) (18,734) -------- --------- -------- Total income (loss) before income taxes................... $ 25,153 $(191,394) $ 34,913 ======== ========= ======== December 31, 1997 1996 --------------- -------------- IDENTIFIABLE ASSETS PMA Re................................................... $1,126,176 $1,031,149 The Property and Casualty Group.......................... 1,863,975 2,050,648 Corporate, Other and Consolidating Eliminations.......... 67,107 35,719 ---------- ---------- Total identifiable assets................................ $3,057,258 $3,117,516 ========== ==========
F-40 18. SAP INFORMATION SAP net income (loss) and capital and surplus for PMC's domestic insurance subsidiaries as reported to the Insurance Departments of Pennsylvania and Delaware are as follows:
For the years ended December 31, 1997 1996 1995 --------------- ---------------- --------------- SAP NET INCOME (LOSS) PMA Re................................................... $ 25,752 $ 26,338 $ 36,854 The Property and Casualty Group.......................... 10,785 (191,640) 30,925 -------- --------- -------- Total(1)................................................. $ 36,537 $(165,302) $ 67,779 ======== ========= ======== (1) Caliber One Indemnity Company had no SAP net income or loss during 1997. December 31, 1997 1996 1995 -------- --------- -------- SAP CAPITAL AND SURPLUS PMA Re(1)................................................ $271,154 $ 260,853 $254,088 The Property and Casualty Group.......................... 281,071 279,764 402,968 -------- --------- -------- Total.................................................... $552,225 $ 540,617 $657,056 ======== ========= ========
(1) The SAP capital and surplus of PMA Re includes PMA Re's investment in Caliber One Indemnity Company, equal to Caliber One Indemnity Company's SAP capital and surplus of $25,039 at December 31, 1997. A reconciliation of PMC's domestic insurance subsidiaries' SAP net income (loss) and capital and surplus to the Company's GAAP net income (loss) and shareholders' equity is as follows:
For the years ended December 31, 1997 1996 1995 ---------------- ---------------- --------------- NET INCOME (LOSS) SAP net income (loss): Domestic insurance subsidiaries......................... $ 36,537 $(165,302) $ 67,779 GAAP adjustments: Change in deferred acquisition costs.................... 1,282 6,105 5,665 Benefit (provision) for deferred income taxes........... 4,725 11,488 (15,353) Allowance for doubtful accounts......................... 307 (5,317) 4,105 Retirement accruals..................................... 275 (76) (3,613) Other................................................... 549 (938) (306) -------- --------- -------- GAAP net income (loss) - domestic insurance subsidiaries.. 43,675 (154,040) 58,277 Other entities and eliminations........................... (23,922) 18,706 (34,147) Extraordinary loss (4,734) -- -- -------- --------- -------- GAAP net income (loss)................................... $ 15,019 $(135,334) $ 24,130 ======== ========= ========
F-41
December 31, 1997 1996 1995 --------------- --------------- --------------- SHAREHOLDERS' EQUITY SAP capital and surplus: Domestic insurance subsidiaries............................ $ 552,225 $ 540,617 $ 657,056 GAAP adjustments: Deferred acquisition costs................................. 45,288 44,006 37,901 Deferred income taxes...................................... 52,571 101,642 67,331 Allowance for doubtful accounts............................ (19,700) (26,214) (20,897) Retirement accruals........................................ (10,653) (14,571) (14,495) Reversal of non-admitted assets............................ 21,330 25,599 32,841 Unrealized gain (loss) on fixed maturity investments available for sale..................................... 19,380 (38,271) 24,186 Other...................................................... 3,254 (338) 958 --------- --------- --------- GAAP shareholders' equity - domestic insurance subsidiaries. 663,695 632,470 784,881 Other entities and eliminations.............................. (185,348) (206,642) (175,213) --------- --------- --------- GAAP shareholders' equity.................................... $ 478,347 $ 425,828 $ 609,668 ========= ========= =========
19. SUBSEQUENT EVENTS In February of 1998, the Company's Board of Directors authorized a plan to repurchase, over the next two years, up to a maximum of 1,500,000 shares of common stock and Class A common stock, in an amount not to exceed $25,000. Repurchases may be made, from time to time, at the discretion of the Company in the open market or directly from shareholders at prevailing market prices. The 1.5 million share limit equated to approximately 6.25% of the total common and Class A common stock outstanding at December 31, 1997. Effective February 5, 1998, the Company's Class A common stock began trading on the Nasdaq National Market under the ticker symbol, "PMFRA". Previously, the Company's Class A common stock traded on the OTC Bulletin Board under the same ticker symbol. 20. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) As noted in Note 19, the Company's Class A common stock began trading on the Nasdaq National Market during 1998. As of December 31, 1997 and 1996, neither class of common equity was traded on an established exchange. Transactions in the common stock were conducted privately among persons qualified to own the common stock. No price information was available for such transactions. Throughout 1997 and 1996, Class A common stock traded under the symbol, "PMFRA", on the OTC Bulletin Board through approximately ten broker/dealers who voluntarily made a market in the Class A common stock. The stock price data presented below for 1997 and 1996 for the Class A common stock are based upon over-the-counter market bid quotations, which reflect interdealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions. As of February 28, 1998, the Company had 186 and 404 record holders of common stock and Class A common stock, respectively. Over the past two years, the Company's operating results have been impacted by restructuring charges and other related items. During 1997, the Company incurred restructuring and other charges of approximately $775, $3,500, $2,660 and $5,165 for the first, second, third and fourth quarters, respectively. The components of the charges for 1997, which were included in operating expenses, were as follows: $7,000, for costs associated with nonvoluntary terminations of approximately 60 employees in various operational and management positions; $2,000, for converting internal computer programs to address the Year 2000 problem, as further discussed in Note 11 to the Consolidated Financial Statements: $2,200, for operating costs associated with certain corporate properties which were disposed of during 1997; and $900, for costs to establish the new specialty insurance operation in 1997. As of December 31, 1997, approximately $3.5 million of such charges remained in Other Liabilities on the balance sheet. During 1996, the Company incurred approximately $31,700 of restructuring and other charges, excluding loss reserve strengthening, during the fourth quarter. The components of the charges for 1996, which were included in operating expenses, were as follows: $7,600, for costs associated with the VERIP which is discussed further in Note 9 to the Consolidated Financial Statements; $2,000, for converting internal computer programs to address the Year 2000 problem, as further discussed in Note 11 to the Consolidated Financial Statements; $17,500, for a valuation adjustment related to premium balances; and $4,800, associated with a change in depreciable lives of computer equipment. Excluding the Year 2000 issue, these initiatives were completed in 1996 with no material difference from original estimates. The Company recorded $10,000 and $181,400 of loss reserve strengthening in the third and fourth quarters of 1996, respectively (See Note 3). F-42 The following tables provide a summary of quarterly financial information:
1997 - ------------------------------------------------------------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter - ------------------------------------------------------------------------------------------- INCOME STATEMENT DATA: Net premiums written $149,882 $ 98,389 $104,487 $ 65,524 ======== ======== ======== ======== Net premiums earned $107,950 $114,451 $ 62,970 $ 90,580 Net investment income 35,847 32,612 34,353 33,886 Net realized investment (losses) gains (1,251) (680) 5,531 4,998 Service revenues 2,548 2,490 2,674 2,599 -------- -------- -------- -------- Total revenues 145,094 148,873 105,528 132,063 -------- -------- -------- -------- Losses and loss adjustment expenses 94,904 98,230 47,785 66,362 Operating expenses 35,281 48,093 38,858 46,408 Dividends to policyholders 3,257 3,360 3,566 4,533 Interest expense 4,334 3,888 3,803 3,743 -------- -------- -------- -------- Total losses and expenses 137,776 153,571 94,012 121,046 -------- -------- -------- -------- Income before income taxes and extraordinary item 7,318 (4,698) 11,516 11,017 Provision (benefit) for income tax 2,561 (5,218) 4,172 3,885 -------- -------- -------- -------- Income before extraordinary item 4,757 520 7,344 7,132 Extraordinary item, net of tax (4,734) - -- -- -------- -------- -------- -------- Net income $ 23 $ 520 $ 7,344 $ 7,132 ======== ======== ======== ======== - ------------------------------------------------------------------------------------------- PER SHARE DATA: Basic: Income before extraordinary item $ 0.20 $ 0.02 $ 0.31 $ 0.30 Extraordinary item (0.20) -- -- -- -------- -------- -------- -------- Net income $ -- $ 0.02 $ 0.31 $ 0.30 ======== ======== ======== ======== Diluted: Income before extraordinary item $ 0.19 $ 0.02 $ 0.30 $ 0.29 Extraordinary item ( 0.19) -- -- -- -------- -------- -------- -------- Net income $ -- $ 0.02 $ 0.30 $ 0.29 ======== ======== ======== ======== - ------------------------------------------------------------------------------------------- CLASS A COMMON STOCK PRICES: High $ 16.125 $ 16.000 $ 16.750 $ 18.000 Low $ 15.625 $ 14.000 $ 15.000 $ 16.000 Close $ 16.000 $ 15.000 $ 16.750 $ 16.000
F-43
1996 - ----------------------------------------------------------------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter - ----------------------------------------------------------------------------------------------- INCOME STATEMENT DATA: Net premiums written $147,444 $ 96,336 $116,745 $ 82,950 ======== ======== ======== ========= Net premiums earned $117,937 $102,226 $106,034 $ 94,378 Net investment income 33,420 32,511 32,732 35,273 Net realized investment gains (losses) 943 (1,412) 5,972 (2,519) Service revenues 1,748 2,264 2,642 2,535 -------- -------- -------- --------- Total revenues 154,048 135,589 147,380 129,667 -------- -------- -------- --------- Losses and loss adjustment expenses 99,943 85,512 97,013 254,155 Operating expenses 38,310 42,012 40,748 67,078 Dividends to policyholders 3,122 2,730 3,566 6,837 Interest expense 4,472 4,358 4,331 3,891 -------- -------- -------- --------- Total losses and expenses 145,847 134,612 145,658 331,961 -------- -------- -------- --------- Income before income taxes and extraordinary item 8,201 977 1,722 (202,294) Provision (benefit) for income tax 2,572 (139) (734) (57,759) -------- -------- -------- --------- Net income (loss) $ 5,629 $ 1,116 $ 2,456 $(144,535) ======== ======== ======== ========= - ----------------------------------------------------------------------------------------------- PER SHARE DATA: Basic: Net income (loss) $ 0.23 $ 0.05 $ 0.11 $ (6.07) ======== ======== ======== ========= Diluted: Net income (loss) $ 0.22 $ 0.05 $ 0.10 $ (6.07) ======== ======== ======== ========= - ----------------------------------------------------------------------------------------------- CLASS A COMMON STOCK PRICES: High $ 20.500 $ 18.500 $ 17.500 $ 17.500 Low $ 18.250 $ 16.500 $ 17.000 $ 15.625 Close $ 18.875 $ 17.000 $ 17.500 $ 15.750
F-44 No person has been authorized to give any information or to make any representations other than those contained in this prospectus, and, if given or made, such information or representations must not be relied upon as having been authorized. This prospectus does not constitute an offer to sell or the solicitation of an offer to buy any securities other than the securities to which it relates or an offer to sell or the solicitation of an offer to buy such securities in any circumstances in which such offer or solicitation is unlawful. Neither the delivery of this prospectus nor any sale made hereunder shall, under any circumstances, create any implication that there has been no change in the affairs of PMC since the date hereof or that the information contained herein is correct as of any time subsequent to its date. TABLE OF CONTENTS ----------------- Page Available Information........................................ Prospectus Summary........................................... Risk Factors................................................. The Company.................................................. The Issuer................................................... Ratio of Earnings to Fixed Charges........................... Capitalization............................................... Use of Proceeds.............................................. Accounting Treatment......................................... Selected Consolidated Financial and Operating Data........... Management's Discussion and Analysis of Financial Condition and Results of Operations.................................. Business..................................................... Supervision and Regulation................................... Management................................................... Description of the Capital Securities........................ Description of the Guarantee................................. Description of the Junior Subordinated Debentures............ Relationship Among the Capital Securities, the Junior Subordinated Debentures and the Guarantee.................. United States Federal Income Taxation........................ Certain ERISA Considerations................................. Validity of Securities....................................... Underwriting................................................. Experts...................................................... Incorporation of Certain Documents by Reference.............. Glossary of Certain Insurance and Other Defined Terms........ Index to Consolidated Financial Statements................... F-1 $ 100,000,000 PMC Capital I ___% Capital Securities, Series A Fully and unconditionally guaranteed, as described herein, by Pennsylvania Manufacturers Corporation -------------------- PROSPECTUS -------------------- Goldman, Sachs & Co. Merrill Lynch & Co. First Union Capital Markets PART II INFORMATION NOT REQUIRED IN THE PROSPECTUS Item 14. Other Expenses of Issuance and Distribution. - ------- ------------------------------------------- The following table sets forth an itemized statement of all estimated expenses to be paid by Pennsylvania Manufacturers Corporation (the "Company") in connection with the issuance and distribution of the Capital Securities being registered other than underwriting discounts and commissions: Securities and Exchange Commission registration fee......... $ 29,500 NASD filing fee............................................. 10,500 Trustees' fees and expenses................................. * Legal fees and expenses..................................... * Accountants fees and expenses............................... * Printing and engraving expenses............................. * Rating agencies' fees....................................... * Blue sky fees and expenses.................................. * Miscellaneous............................................... * ____________ Total............. $ 500,000 =========== * TO BE FILED BY AMENDMENT Except for the Securities and Exchange Commission registration fee, all fees and expenses are estimated and subject to future contingencies. II-1 Item 16. Exhibits. - ------- -------- Exhibit No. Description of Exhibit ----------- -------------------------------------------------------- * 1.1 Form of Underwriting Agreement among the Issuer, the Company and Goldman, Sachs & Co., Merrill Lynch, Pierce, Fenner & Smith Incorporated and First Union Capital Markets as representatives of the Underwriters ** 3.1 Amended and Restated Articles of Incorporation of the Company *** 3.2 Amended and Restated By-laws of the Company *** 3.3 Certificate of Trust of the Issuer *** 3.4 Trust Agreement 3.5 Form of Amended and Restated Trust Agreement (filed herewith) 4.1 Form of Indenture between the Company and The Bank of New York as Indenture Trustee 4.2 Form of Capital Security (included in Exhibit 3.5) 4.3 Form of Junior Subordinated Debenture (included in Exhibit 3.5) 4.4 Form of Guarantee Agreement between the Company and Bank of New York * 5.1 Opinion of Duane, Morris & Heckscher LLP re legality of securities offered hereby * 5.2 Opinion of Duane, Morris & Heckscher LLP re certain matters of Delaware and Pennsylvania Law 8.1 Form of Opinion of Duane, Morris & Heckscher LLP re certain tax matters ** 10.1 Employment Agreement dated April 1, 1995 between the Company and Frederick W. Anton III II-2 ** 10.2 Employment Agreement dated May 1, 1995 between the Company and John W. Smithson ** 10.3 The PMC EDC Plan Trust Agreement dated as of 1994 ** 10.4 The PMC Supplemental Executive Retirement Plan (SERP) dated July 1995 ** 10.5 The Company's Amended and Restated 1987 Incentive Stock Option Plan ** 10.6 The Company's Amended and Restated 1991 Equity Incentive Plan ** 10.7 The Company's Amended and Restated 1993 Equity Incentive Plan ** 10.8 The Company's Amended and Restated 1994 Equity Incentive Plan ** 10.9 The Company's 1995 Equity Incentive Plan ** 10.10 The Company's 1996 Equity Incentive Plan ** 10.11 Federal Tax Allocation Agreement ** 10.12 Office lease between Nine Penn Center Associates, L.P., as Landlord, and Lorjo Corp., as Tenant, covering premises located at Mellon Bank Center, 1735 Market Street, Philadelphia, Pennsylvania, dated May 26, 1994 ** 10.13 Credit Agreement dated as of March 14, 1997 by and among the Company, The Bank of New York, First Union National Bank of North 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 ** 10.14 Master Agreement dated as of February 7, 1997 between the Company and First Union National Bank of North Carolina ** 10.15 First Amended and Restated Letter of Credit Agreement by and among the Company, the Bank of New York, Mellon Bank, N.A., Fleet Bank, National Association, PNC Bank, National Association and First Union Bank of North Carolina **** 10.16 Amendment No. 1 to Tax Allocation Agreement dated January 7, 1998 II-3 **** 10.17 Caliber One Indemnity Company Purchase Agreement dated December 15, 1997 **** 11.1 Statement regarding computation of per share earnings 12.1 Statement regarding computation of earnings to fixed charges **** 21.1 Subsidiaries of the Company 23.1 Consent of PricewaterhouseCoopers LLP (filed herewith) * 23.2 Consent of Duane, Morris & Heckscher LLP (included in Exhibits 5.1, 5.2 and 8.1) *** 24.1 Powers of Attorney (included as part of signature pages to initial filing of this Registration Statement on September 16, 1998) 25.1 Statement of Eligibility of The Bank of New York as to the Guarantee (Form T-1) 25.2 Statement of Eligibility of The Bank of New York as to the Capital Securities (Form T-1) 25.3 Statement of Eligibility of The Bank of New York as to the Junior Subordinated Debentures (Form T-1) **** 27 Financial Data Schedule ______________ * to be filed by Amendment. ** incorporated by reference to like-numbered exhibit in the Company's Form 10 Registration Statement as filed with the Commission on June 26, 1997. *** previously filed as part of this registration statement on September 16, 1998. **** incorporated by reference to like-numbered exhibit in the Company's Annual Report on Form 10-K for the year ended December 31, 1997 and the Company's Report on Form 10-Q for the quarter ended June 30, 1998. The following financial statement schedules are included:
Consolidated Financial Statement Schedules: Report of Independent Accountants S-1 Schedule I- Summary of Investments Other Than Investments in Related Parties S-2 Schedule II- Condensed Financial Information of Registrant as of December 31, 1997 and 1996 and for the years ended December 31, 1997, 1996, and 1995 S-3 Schedule III- Supplementary Insurance Information for the years ended December 31, 1997, 1996, and 1995 S-6 Schedule IV- Reinsurance for the years ended December 31, 1997, 1996, and 1995 S-7 Schedule V- Valuation and Qualifying Accounts for the years ended December 31, 1997, 1996, and 1995 S-8 Schedule VI- Supplementary Information Concerning Property & Casualty Insurance Operations for the years ended December 31, 1997, 1996, and 1995 S-9
II-4 REPORT OF INDEPENDENT ACCOUNTANTS Our report on the consolidated financial statements of Pennsylvania Manufacturers Corporation and subsidiaries has been included in this Registration Statement on page F-9. In connection with our audit of such financial statements, we have also audited the financial statement schedules listed in the index in Item 16 of this Registration Statement. In our opinion, these financial statement schedules referred to above, when considered in relation to the basic financial statements taken as whole, present fairly, in all material respects, the information required to be included therein. /s/ PricewaterhouseCoopers LLP One South Market Square Harrisburg, Pennsylvania February 6, 1998 S-1 Pennsylvania Manufacturers Corporation Schedule I Summary of Investments-Other Than Investments in Related Parties December 31, 1997
Amount at which shown in Type of investment Cost Value the balance sheet - --------------------------------------------------------------------------------------------------------------------------- (Dollar amounts in thousands) Fixed maturities: Bonds: U.S. Treasury Securities and obligations of U.S. Government agencies $ 1,105,689 $ 1,119,566 $ 1,119,566 Corporate debt securities 675,218 687,671 687,671 Mortgage-backed securities 119,687 122,281 122,281 ----------- ----------- ----------- Total fixed maturities 1,900,594 1,929,518 1,929,518 ----------- ----------- ----------- Equity securities: Common Stocks: Industrial, miscellaneous and all other 5 13 13 ----------- ----------- ----------- Total equity securities 5 13 13 ----------- ----------- ----------- Short-term investments 265,207 265,207 265,207 ----------- ----------- ----------- Total investments $ 2,165,806 $ 2,194,738 $ 2,194,738 =========== =========== ===========
S-2 Pennsylvania Manufacturers Corporation Schedule II Balance Sheets (Parent Company Only)
as of December 31 (in thousands, except share data) 1997 1996 - --------------------------------------------------------------------------------------------------------- ASSETS Cash $ 253 $ - Investments in subsidiaries 632,680 584,608 Deferred tax asset, net 29,163 36,602 Related party receivables 7,074 727 Other assets 22,545 21,096 ---------------------- Total assets $ 691,715 $ 643,033 ====================== LIABILITIES Long term debt $ 203,000 $ 204,571 Related party payables - 1,605 Dividends payable to shareholders 2,008 1,983 Other liabilities 8,360 9,046 ---------------------- Total liabilities 213,368 217,205 ---------------------- SHAREHOLDERS' EQUITY Common stock, $5 par value (40,000,000 shares authorized; 15,286,263 shares issued and 14,850,789 outstanding - 1997 16,095,416 shares issued and 15,670,052 outstanding - 1996) 76,431 80,477 Class A common stock, $5 par value (40,000,000 shares authorized; 9,156,682 shares issued and 9,117,735 outstanding - 1997 8,247,804 shares issued and 8,173,023 outstanding - 1996) 45,783 41,239 Additional paid-in capital - Class A common stock 339 - Retained earnings 343,368 336,921 Unrealized gain (loss) on investments of subsidiaries (net of deferred income taxes: 1997 - $(10,126); 1996 - $13,394) 18,806 (24,874) Notes receivable from officers (198) (1,162) Treasury stock, at cost: Common stock (1997 - 435,474 shares; 1996 - 425,364 shares (5,572) (5,408) Class A common stock (1997 - 38,947 shares; 1996 - 74,781 shares) (610) (1,365) ---------------------- Total shareholders' equity 478,347 425,828 ---------------------- Total liabilities and shareholders' equity $ 691,715 $ 643,033 ======================
These financial statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto. S-3 Pennsylvania Manufacturers Corporation Schedule II Statements of Operations (Parent Company Only)
for the years ended December 31, (in thousands) 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------- Revenues: Net investment income $ 263 $ 354 $ 217 Net realized investment gains - 35 4 Management fees 8,977 5,974 350 Other related party income - 263 1,642 ----------------------------------- Total revenues 9,240 6,626 2,213 ----------------------------------- Expenses: General expenses 9,375 7,082 6,982 Interest expense 15,764 17,039 18,712 ----------------------------------- Total expenses 25,139 24,121 25,694 ----------------------------------- Loss before income taxes and equity in earnings (losses) of subsidiaries (15,899) (17,495) (23,481) Benefit for income taxes (14,271) (60,345) (13,210) ----------------------------------- (Loss) income before equity in earnings (losses) of subsidiaries and extraordinary item (1,628) 42,850 (10,271) Equity in earnings (losses) of subsidiaries 21,381 (178,184) 34,401 ----------------------------------- Income (loss) before extraordinary item 19,753 (135,334) 24,130 Extraordinary loss from early extinguishment of debt (net of income tax benefit of $2,549) (4,734) - - ----------------------------------- Net income (loss) $ 15,019 $ (135,334) $ 24,130 ===================================
These financial statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto. S-4 Pennsylvania Manufacturers Corporation Schedule II Statements of Cash Flows (Parent Company Only)
for the years ended December 31, (in thousands) 1997 1996 1995 - ------------------------------------------------------------------------------------------------------ Cash Flows From Operating Activities: Net income (loss) $ 15,019 $(135,334) $ 24,130 Adjustments to reconcile net income to net cash flows provided by operating activities: Equity in (earnings) losses of subsidiaries (21,381) 178,184 (34,401) Net realized investment gains - (35) (4) Provision (benefit) for deferred income taxes 9,614 (19,822) 7,000 Extraordinary loss from early extingusihment of debt (4,734) - - Dividends received from subsidiaries 22,500 53,634 103,213 Other, net 5,331 (33,283) (20,384) ----------------------------------- Net cash flows provided by operating activities 26,349 43,344 79,554 ----------------------------------- Cash Flows From Investing Activities: Cash contributions to subsidiaries (11,000) (50,000) (61,000) Sales of fixed maturity investments, net - 45 2,122 Sales (purchases) of equity investments, net - 70 (16) ----------------------------------- Net cash flows used by investing activities (11,000) (49,885) (58,894) ----------------------------------- Cash Flows From Financing Activities: Change in related party receivables and payables (7,952) 10,863 (12,939) Proceeds from issuance of long-term debt 210,000 26,000 125,000 Repayments of long-term debt (211,571) (25,000) (125,000) Dividends paid to shareholders (7,965) (7,926) (7,885) Proceeds from exercised stock options and issuance of Class A common stock 837 - - Treasury stock transactions, net 591 (929) 480 Repayments of notes receivable from officers 964 2,734 478 ----------------------------------- Net cash flows (used) provided by financing activities (15,096) 5,742 (19,866) ----------------------------------- Net increase (decrease) in cash 253 (799) 794 Cash January 1 - 799 5 ----------------------------------- Cash December 31 $ 253 $ - $ 799 ===================================
These financial statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto. S-5 Pennsylvania Manufacturers Corporation Schedule III Supplementary Insurance Information
Future policy benefits, losses, Net Deferred policy claims, and loss Unearned Premium investment (in thousands) acquisition costs expenses premiums revenue income(1) - ----------------------------------------------------------------------------------------------------------------------------------- Year ended December 31, 1997: The Property and Casualty Group $20,010 $1,353,917 $115,998 $212,348 $ 82,098 PMA Re 25,278 622,484 95,457 163,603 52,270 Corporate and Other - 26,786 - - 2,330 - ----------------------------------------------------------------------------------------------------------------------------------- Total $45,288 $2,003,187 $211,455 $375,951 $136,698 =================================================================================================================================== Year ended December 31, 1996: The Property and Casualty Group $23,488 $1,501,897 $127,986 $268,601 $ 82,455 PMA Re 20,518 589,175 77,996 151,974 48,676 Corporate and Other - - - - 2,805 - ----------------------------------------------------------------------------------------------------------------------------------- Total $44,006 $2,091,072 $205,982 $420,575 $133,936 =================================================================================================================================== Year ended December 31, 1995: The Property and Casualty Group $20,747 $1,518,163 $124,988 $345,607 $ 92,275 PMA Re 17,154 551,823 67,734 139,345 45,166 Corporate and Other - - - - 1,914 - ----------------------------------------------------------------------------------------------------------------------------------- Total $37,901 $2,069,986 $192,722 $484,952 $139,355 ===================================================================================================================================
Benefits, claims, Amortization of Other losses and settlement deferred policy operating Net premiums (in thousands) expenses acquisition costs expenses(2) written - ----------------------------------------------------------------------------------------------------------------------------------- Year ended December 31, 1997: The Property and Casualty Group $ 193,530 $48,343 $57,206 $240,348 PMA Re 113,931 45,158 11,982 177,934 Corporate and Other (180) - 5,951 - - ---------------------------------------------------------------------------------------------------------------------------------- Total $ 307,281 $93,501 $75,139 $418,282 ================================================================================================================================== Year ended December 31, 1996: The Property and Casualty Group $ 424,900 $52,706 $86,003 $279,422 PMA Re 111,937 37,586 8,344 164,053 Corporate and Other (214) - 3,509 - - ----------------------------------------------------------------------------------------------------------------------------------- Total $ 536,623 $90,292 $97,856 $443,475 =================================================================================================================================== Year ended December 31, 1995: The Property and Casualty Group $ 319,644 $53,420 $57,486 $337,116 PMA Re 103,947 33,787 7,334 152,760 Corporate and Other (1,013) - 16,341 - - ---------------------------------------------------------------------------------------------------------------------------------- Total $ 422,578 $87,207 $81,161 $489,876 ==================================================================================================================================
(1) Net investment income is based on each segment's invested assets. (2) Other operating expenses are allocated primarily on the specific identification basis. When indirect expenses cannot be directly related to a segment, these expenses are allocated depending on the nature of the expense. S-6 Pennsylvania Manufacturers Corporation Schedule IV Reinsurance
Ceded to Percentage of Direct other Assumed from amount assumed to (dollar amounts in thousands) Amount companies other companies Net amount net - -------------------------------------------------------------------------------------------------------------------- Year Ended December 31, 1997: Premiums: Property and liability insurance $ 277,871 $ 118,277 $ 216,357 $ 375,951 58% ========= ========= ========= ========= ========= Year Ended December 31, 1996: Premiums: Property and liability insurance $ 299,386 $ 88,499 $ 209,688 $ 420,575 50% ========= ========= ========= ========= ========= Year Ended December 31, 1995: Premiums: Property and liability insurance $ 370,590 $ 35,476 $ 149,838 $ 484,952 31% ========= ========= ========= ========= =========
S-7
Pennsylvania Manufacturers Corporation Schedule V Valuation and Qualifying Accounts Description Balance at beginning of Charged to cost and Deductions - write-offs period expenses uncollectible accounts Year ended December 31, 1997: Allowance for uncollectible accounts: Uncollected premiums $18,877 - 471 Year ended December 31, 1996: Allowance for uncollectible accounts: Uncollected premiums $16,330 19,532 16,985 Year ended December 31, 1995: Allowance for uncollectible accounts: Uncollected premiums $22,402 - 6,072
Description Balance at end of period Year ended December 31, 1997: Allowance for uncollectible accounts: Uncollected premiums $18,406 Year ended December 31, 1996: Allowance for uncollectible accounts: Uncollected premiums $18,877 Year ended December 31, 1995: Allowance for uncollectible accounts: Uncollected premiums $16,330
S-8 Pennsylvania Manufacturers Corporation Schedule VI Supplemental Information Concerning Property and Casualty Insurance Operations
- ---------------------------------------------------------------------------------------------------------------------------------- Discount on Reserves for Reserves for Unpaid Unpaid Claims and Deferred policy Claims and Claim Claim Adjustment Affiliation with Registrant acquisition costs Adjustment Expenses Expenses(1) Unearned Premiums Earned Premiums - ---------------------------------------------------------------------------------------------------------------------------------- Consolidated property-casualty subsidiaries: Year Ended December 31, 1997 $45,288 $2,003,187 $ 460,230 $ 211,455 $375,951 Year Ended December 31, 1996 $44,006 $2,091,072 $ 514,248 $ 205,982 $420,575 Year Ended December 31, 1995 $37,901 $2,069,986 $ 587,025 $ 192,722 $484,952 - ----------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------- Claims and claim adjustment expenses incurred related to ---------------------------- Amortization of Net Investment Prior deferred policy Paid claims and Net Premiums Affiliation with Registrant Income Current Year Years(2) acquisition costs adjustment expenses Written - ---------------------------------------------------------------------------------------------------------------------------------- Consolidated property-casualty subsidiaries: Year Ended December 31, 1997 $134,368 $ 341,880 $(86,006) $93,501 $470,874 $ 418,282 Year Ended December 31, 1996 $131,133 $ 323,069 $156,074 $90,292 $510,621 $ 443,475 Year Ended December 31, 1995 $137,441 $ 357,787 $ 51,491 $87,207 $469,942 $ 489,876 - ----------------------------------------------------------------------------------------------------------------------------------
(1) - Workers' compensation reserves discounted at approximately 5%. (2) - Excludes accretion of loss reserve discount of $51,407, $57,480 and $13,300 in 1997, 1996 and 1995, respectively. S-9 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, Pennsylvania Manufacturers Corporation certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form S-3 and that it has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the city of Philadelphia, Pennsylvania on November 4, 1998. PENNSYLVANIA MANUFACTURERS CORPORATION By:/s/ John W. Smithson -------------------------------------- John W. Smithson, President and Chief Executive Officer Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed below by the following persons in the capacities and on the dates indicated. Signature Title Date - -------------------------- ---------------------------- ------------------ * Chairman of the Board and November 4, 1998 - --------------------------- a Director Frederick W. Anton, III * President, Chief Executive November 4, 1998 - --------------------------- Officer and a Director John W. Smithson (principal executive officer) /s/ Francis W. McDonnell Senior Vice President, Chief November 4, 1998 - --------------------------- Financial Officer and Francis W. McDonnell Treasurer (principal financial and accounting officer) II-5 * Director November 4, 1998 - -------------------------- Paul I. Detwiler, Jr. * Director November 4, 1998 - -------------------------- Joseph H. Foster * Director November 4, 1998 - -------------------------- Anne S. Genter * Director November 4, 1998 - -------------------------- James F. Malone, III * Director November 4, 1998 - -------------------------- A. John May * Director November 4, 1998 - -------------------------- Louis N. McCarter, III * Director November 4, 1998 - -------------------------- John W. Miller, Jr. * Director November 4, 1998 - -------------------------- Edward H. Owlett * Director November 4, 1998 - -------------------------- Louis I. Pollock * Director November 4, 1998 - -------------------------- Roderic H. Ross * Director November 4, 1998 - -------------------------- L.J. Rowell, Jr. *By: Francis W. McDonnell --------------------- Attorney-in-Fact II-6 Pursuant to the requirements of the Securities Act of 1933, PMC Capital I certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form S-3 and that it has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the city of Philadelphia, Pennsylvania on November 4, 1998. PMC CAPITAL I By Pennsylvania Manufacturers Corporation, as Depositor By: /s/ Francis W. McDonnell --------------------------------------- Francis W. McDonnell, Senior Vice President, Chief Financial Officer and Treasurer II-7 EXHIBIT INDEX ------------- Exhibit No. Description of Exhibit ----------- -------------------------------------------------------- * 1.1 Form of Underwriting Agreement among the Issuer, the Company and Goldman, Sachs & Co., Merrill Lynch, Pierce, Fenner & Smith Incorporated and First Union Capital Markets as representatives of the Underwriters ** 3.1 Amended and Restated Articles of Incorporation of the Company *** 3.2 Amended and Restated By-laws of the Company *** 3.3 Certificate of Trust of the Issuer (filed herewith) *** 3.4 Trust Agreement (filed herewith) 3.5 Form of Amended and Restated Trust Agreement 4.1 Form of Indenture between the Company and Bank of New York as Indenture Trustee 4.2 Form of Capital Security (included in Exhibit 3.5) 4.3 Form of Junior Subordinated Debenture (included in Exhibit 3.5) 4.4 Form of Guarantee Agreement between the Company and Bank of New York * 5.1 Opinion of Duane, Morris & Heckscher LLP re legality of securities offered hereby * 5.2 Opinion of Duane, Morris & Heckscher LLP re certain matters of Delaware and Pennsylvania Law 8.1 Form of Opinion of Duane, Morris & Heckscher LLP re certain tax matters ** 10.1 Employment Agreement dated April 1, 1995 between the Company and Frederick W. Anton III ** 10.2 Employment Agreement dated May 1, 1995 between the Company and John W. Smithson ** 10.3 The PMC EDC Plan Trust Agreement dated as of 1994 ** 10.4 The PMC Supplemental Executive Retirement Plan (SERP) dated July 1995 ** 10.5 The Company's Amended and Restated 1987 Incentive Stock Option Plan ** 10.6 The Company's Amended and Restated 1991 Equity Incentive Plan ** 10.7 The Company's Amended and Restated 1993 Equity Incentive Plan ** 10.8 The Company's Amended and Restated 1994 Equity Incentive Plan ** 10.9 The Company's 1995 Equity Incentive Plan ** 10.10 The Company's 1996 Equity Incentive Plan ** 10.11 Federal Tax Allocation Agreement ** 10.12 Office lease between Nine Penn Center Associates, L.P., as Landlord, and Lorjo Corp., as Tenant, covering premises located at Mellon Bank Center, 1735 Market Street, Philadelphia, Pennsylvania, dated May 26, 1994 ** 10.13 Credit Agreement dated as of March 14, 1997 by and among the Company, The Bank of New York, First Union National Bank of North 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 ** 10.14 Master Agreement dated as of February 7, 1997 between the Company and First Union National Bank of North Carolina ** 10.15 First Amended and Restated Letter of Credit Agreement by and among the Company, the Bank of New York, Mellon Bank, N.A., Fleet Bank, National Association, PNC Bank, National Association and First Union Bank of North Carolina **** 10.16 Amendment No. 1 to Tax Allocation Agreement dated January 7, 1998 **** 10.17 Caliber One Indemnity Company Purchase Agreement dated December 15, 1997 **** 11.1 Statement regarding computation of per share earnings 12.1 Statement regarding computation of earnings to fixed charges (filed herewith) **** 21.1 Subsidiaries of the Company 23.1 Consent of PricewaterhouseCoopers LLP (filed herewith) * 23.2 Consent of Duane, Morris & Heckscher LLP (included in Exhibits 5.1, 5.2 and 8.1) *** 24.1 Powers of Attorney (included as part of signature pages hereto) 25.1 Statement of Eligibility of Bank of New York as to the Guarantee (Form T-1) (Filed herewith) 25.2 Statement of Eligibility of Bank of New York as to the Capital Securities (Form T-1) (Filed herewith) 25.3 Statement of Eligibility of Bank of New York as to the Junior Subordinated Debentures (Form T-1) (Filed herewith) *** 27 Financial Data Schedule ______________ * to be filed by Amendment. ** incorporated by reference to like-numbered exhibit in the Company's Form 10 Registration Statement as filed with the Commission on June 26, 1997. *** previously filed as part of this registration statement on September 16, 1998. **** incorporated by reference to like-numbered exhibit in the Company's Annual Report on Form 10-K for the year ended December 31, 1997 and the Company's Report on Form 10-Q for the quarter ended June 30, 1998. EX-3.5 2 AMENDED AND RESTATED TRUST AGREEMENT Exhibit 3.5 ================================================================================ AMENDED AND RESTATED TRUST AGREEMENT among PENNSYLVANIA MANUFACTURERS CORPORATION, as Depositor, THE BANK OF NEW YORK (DELAWARE), as Trustee, THE BANK OF NEW YORK, as Property Trustee, and THE ADMINISTRATIVE TRUSTEES NAMED HEREIN Dated as of ______________________________, 1998 PMC CAPITAL I ================================================================================ PMC Capital I Certain Sections of this Trust Agreement relating to Sections 310 through 318 of the Trust Indenture Act of 1939: Trust Indenture Trust Agreement Act Section Section - --------------------- ------------------ (S) 310(a)(1).................................... 8.07 (a)(2)................................. 8.07 (a)(3)................................. 8.09 (a)(4)................................. Not Applicable (b).................................... 8.08 (S) 311(a)....................................... 8.13 (b).................................... 8.13 (S) 312(a)....................................... 5.07 (b).................................... 5.07 (c).................................... 5.07 (S) 313(a)....................................... 8.14(a) (a)(4)................................. 8.14(b) (b).................................... 8.14(b) (c).................................... 8.14(a) (d).................................... 8.14(a), 8.14(b) (S) 314(a)....................................... 8.15 (b).................................... Not Applicable (c)(1)................................. 8.16 (c)(2)................................. 8.16 (c)(3)................................. 8.16 (d).................................... Not Applicable (e).................................... 1.01 (S) 315(a)....................................... 8.01 (b).................................... 8.02, 8.14(b) (c).................................... 8.01(a) (d).................................... 8.01, 8.03 (e).................................... Not Applicable (S) 316(a)....................................... Not Applicable (a)(1)(A).............................. Not Applicable (a)(1)(B).............................. Not Applicable (a)(2)................................. Not Applicable (b).................................... Not Applicable (c).................................... Not Applicable (S) 317(a)(1).................................... Not Applicable (a)(2)................................. Not Applicable (b).................................... 5.09 (S) 318(a)....................................... 10.10 TABLE OF CONTENTS
ARTICLE I Defined Terms Section 1.01. Definitions................................................................. 1 ARTICLE II Establishment of the Trust Section 2.01. Name........................................................................ 9 Section 2.02. Office of the Trustee; Office of the Property Trustee; Principal Place of Business.................................................................... 9 Section 2.03. Initial Contribution of Trust Property; Organizational Expenses............. 9 Section 2.04. Issuance of the Capital Securities.......................................... 9 Section 2.05. Purchase of Debentures; Issuance of the Common Securities................... 10 Section 2.06. Declaration of Trust........................................................ 10 Section 2.07. Authorization to Enter into Certain Transactions............................ 10 Section 2.08. Assets of Trust............................................................. 14 Section 2.09. Title to Trust Property..................................................... 14 ARTICLE III Payment Account Section 3.01. Payment Account............................................................. 14 ARTICLE IV Distributions; Redemption Section 4.01. Distributions............................................................... 14 Section 4.02. Redemption.................................................................. 15 Section 4.03. Subordination of Common Securities.......................................... 17 Section 4.04. Payment Procedures.......................................................... 18 Section 4.05. Withholding Tax............................................................. 18 Section 4.06. Tax Returns and Reports..................................................... 19 Section 4.07. Payment of Taxes, Duties, Etc. of the Trust................................. 20 Section 4.08. Payments under Indenture.................................................... 20 ARTICLE V Trust Securities Certificates Section 5.01. Initial Ownership........................................................... 19 Section 5.02. The Trust Securities Certificates........................................... 19 Section 5.03. Delivery of Trust Securities Certificates................................... 20 Section 5.04. Registration of Transfer and Exchange of Capital Securities Certificates.... 20 Section 5.05. Mutilated, Destroyed, Lost or Stolen Trust Securities Certificates.......... 21 Section 5.06. Persons Deemed Securityholders.............................................. 21
Section 5.07. Access to List of Securityholders' Names and Addresses...................... 21 Section 5.08. Maintenance of Office or Agency............................................. 21 Section 5.09. Appointment of Paying Agent................................................. 22 Section 5.10. Ownership of Common Securities by Depositor................................. 22 Section 5.11. Book-Entry Capital Securities Certificates; Common Securities Certificate................................................................. 22 Section 5.12. Notices to Clearing Agency.................................................. 23 Section 5.13. Definitive Capital Securities Certificates.................................. 24 Section 5.14. Rights of Securityholders................................................... 25 ARTICLE VI Acts of Securityholders; Meetings; Voting Section 6.01. Limitations on Voting Rights................................................ 27 Section 6.02. Notice of Meetings.......................................................... 28 Section 6.03. Meetings of Capital Securityholders......................................... 28 Section 6.04. Voting Rights............................................................... 28 Section 6.05. Proxies, etc................................................................ 28 Section 6.06. Securityholder Action by Written Consent.................................... 29 Section 6.07. Record Date for Voting and Other Purposes................................... 29 Section 6.08. Acts of Securityholders..................................................... 29 Section 6.09. Inspection of Records....................................................... 30 ARTICLE VII Representations and Warranties Section 7.01. Representations and Warranties of the Bank and the Property Trustee..................................................................... 30 Section 7.02. Representations and Warranties of Parent.................................... 31 ARTICLE VIII The Trustees Section 8.01. Certain Duties and Responsibilities......................................... 32 Section 8.02. Certain Notices............................................................. 34 Section 8.03. Certain Rights of Property Trustee.......................................... 34 Section 8.04. Not Responsible for Recitals or Issuance of Securities...................... 36 Section 8.05. May Hold Securities......................................................... 36 Section 8.06. Compensation; Indemnity; Fees............................................... 36 Section 8.07. Corporate Property Trustee Required; Eligibility of Trustees................ 37 Section 8.08. Conflicting Interests....................................................... 37 Section 8.09. Co-Trustees and Separate Trustee............................................ 37 Section 8.10. Resignation and Removal; Appointment of Successor........................... 39 Section 8.11. Acceptance of Appointment by Successor...................................... 40 Section 8.12. Merger, Conversion, Consolidation or Succession to Business of a Trustee................................................................ 41 Section 8.13. Preferential Collection of Claims Against Depositor or Trust................ 41 Section 8.14. Reports by Property Trustee................................................. 42
-ii- Section 8.15. Reports to the Property Trustee............................................. 43 Section 8.16. Evidence of Compliance with Conditions Precedent............................ 43 Section 8.17. Number of Trustees.......................................................... 43 Section 8.18. Delegation of Power......................................................... 43 ARTICLE IX Termination and Liquidation Section 9.01. Termination Upon Expiration Date............................................ 44 Section 9.02. Early Termination........................................................... 44 Section 9.03. Termination................................................................. 44 Section 9.04. Liquidation................................................................. 44 Section 9.05. Merger, Consolidation, Amalgamation or Replacement of the Trust............. 46 ARTICLE X Miscellaneous Provisions Section 10.01. Expense Agreement.......................................................... 47 Section 10.02. Limitation of Rights of Securityholders.................................... 47 Section 10.03. Amendment.................................................................. 47 Section 10.04. Separability............................................................... 49 Section 10.05. Governing Law.............................................................. 49 Section 10.06. Payments Due on Non-Business Day........................................... 49 Section 10.07. Successors................................................................. 49 Section 10.08. Headings................................................................... 49 Section 10.09. Reports, Notices and Demands............................................... 49 Section 10.10. Agreement Not to Petition.................................................. 50 Section 10.11. Trust Indenture Act; Conflict with Trust Indenture Act..................... 50 Section 10.12. Rights Under Indenture..................................................... 50 Section 10.13. Effectiveness.............................................................. 51 Section 10.14. Intention of the Parties................................................... 51 EXHIBITS -------- Exhibit A Certificate of Trust Exhibit B Form of Certificate Depository Agreement Exhibit C Form of Common Securities Certificate Exhibit D Form of Capital Securities Certificate
-iii- AMENDED AND RESTATED TRUST AGREEMENT, dated as of ______________, 1998, among (i) Pennsylvania Manufacturers Corporation, a Pennsylvania corporation (the "Depositor" or "Parent"), (ii) The Bank of New York (Delaware), a banking corporation duly organized and existing under the laws of the State of Delaware, as Delaware trustee (the "Trustee"), (iii) The Bank of New York, a banking corporation duly organized and existing under the laws of the State of New York, as Property Trustee (the "Property Trustee" and, in its separate corporate capacity and not in its capacity as Property Trustee, the "Bank"), (iv) John W. Smithson, an individual, Francis W. McDonnell, an individual, and Edward S. Hochberg, an individual, each of whose address is Pennsylvania Manufacturers Corporation, 1735 Market Street, Philadelphia, Pennsylvania 19103-7590 (each an "Administrative Trustee" and collectively the "Administrative Trustees") (the Trustee, the Property Trustee and the Administrative Trustees being referred to collectively as the "Trustees") and (v) of the several Holders, as hereinafter defined. WITNESSETH: ---------- WHEREAS, the Depositor and the Trustee have heretofore duly declared and established a business trust pursuant to the Delaware Business Trust Act by the entering into of that certain Trust Agreement, dated as of September 15, 1998 (the "Original Trust Agreement"), and by the execution and filing by the Trustee with the Secretary of State of the State of Delaware of the Certificate of Trust, filed on September 15, 1998, attached as Exhibit A; and WHEREAS, the Depositor, the Trustee and the Property Trustee desire to amend and restate the Original Trust Agreement in its entirety as set forth herein to provide for, among other things, (a) the acquisition by the Trust from the Depositor of all of the right, title and interest in the Debentures, (b) the issuance of the Common Securities by the Trust to the Depositor, (c) the issuance and sale of the Capital Securities by the Trust pursuant to the Underwriting Agreement and (d) the appointment of the Administrative Trustees; NOW THEREFORE, in consideration of the agreements and obligations set forth herein and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, each party, for the benefit of the other parties and for the benefit of the Securityholders, hereby amends and restates the Original Trust Agreement in its entirety and agrees as follows: ARTICLE I Defined Terms Section 1.01. Definitions. For all purposes of this Trust Agreement, ----------- except as otherwise expressly provided or unless the context otherwise requires: (a) the terms defined in this Article have the meanings assigned to them in this Article and include the plural as well as the singular; (b) all other terms used herein that are defined in the Trust Indenture Act, either directly or by reference therein, have the meanings assigned to them therein; -1- (c) unless the context otherwise requires, any reference to an "Article" or a "Section" refers to an Article or a Section, as the case may be, of this Trust Agreement; and (d) the words "herein", "hereof" and "hereunder" and other words of similar import refer to this Trust Agreement as a whole and not to any particular Article, Section or other subdivision. "Act" has the meaning specified in Section 6.08. --- "Additional Amount" means, with respect to Trust Securities of a given ----------------- Liquidation Amount and/or a given period, the amount of Additional Interest (as defined in the Indenture) paid by the Depositor on a Like Amount of Debentures for such period. "Additional Sums" has the meaning specified in Section 1005 of the --------------- Indenture. "Administrative Trustee" means each of the individuals identified as an ---------------------- "Administrative Trustee" in the preamble to this Trust Agreement, solely in his capacity as Administrative Trustee of the Trust formed and continued hereunder and not in his individual capacity, or such Administrative Trustee's successor in interest in such capacity, or any successor Administrative Trustee appointed as herein provided. "Affiliate" of any specified Person means any other Person directly or --------- indirectly controlling or controlled by or under direct or indirect common control with such specified Person. For the purposes of this definition, "control" when used with respect to any specified Person means the power to direct the management and policies of such Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise; and the terms "controlling" and "controlled" have meanings correlative to the foregoing. "Applicable Procedures" means, with respect to any transfer or transaction ---------------------- involving a Book-Entry Capital Security, the rules and procedures of the Clearing Agency for such Book-Entry Capital Security, in each case to the extent applicable to such transaction and as in effect from time to time. "Bank" has the meaning specified in the preamble to this Trust Agreement. ---- "Bankruptcy Event" means, with respect to any Person: ---------------- (a) the entry of a decree or order by a court having jurisdiction in the premises judging such Person a bankrupt or insolvent, or approving as properly filed a petition seeking reorganization, arrangement, adjudication or composition of or in respect of such Person under any applicable Federal or State bankruptcy, insolvency, reorganization or other similar law, or appointing a receiver, liquidator, assignee, trustee, sequestrator or other similar official of such Person or of any substantial part of its property, or ordering the winding up or liquidation of its affairs, and the continuance of any such decree or order unstayed and in effect for a period of 60 consecutive days; or (b) the institution by such Person of proceedings to be adjudicated a bankrupt or insolvent, or of the consent by it to the institution of bankruptcy or insolvency proceedings -2- against it, or the filing by it of a petition or answer or consent seeking reorganization or relief under any applicable Federal or State bankruptcy, insolvency, reorganization or other similar law, or the consent by it to the filing of such petition or to the appointment of a receiver, liquidator, assignee, trustee, sequestrator or similar official of such Person or of any substantial part of its property or the admission by it in writing of its inability to pay its debts generally as they become due and its willingness to be adjudicated as a bankrupt, or the making by it of an assignment for the benefit of creditors, or the taking of action by such Person in furtherance of any such action. "Bankruptcy Laws" has the meaning specified in Section 10.10. --------------- "Board Resolution" means a copy of a resolution certified by the Secretary ---------------- or an Assistant Secretary of the Depositor to have been duly adopted by the Depositor's Board of Directors or a duly authorized committee thereof or officers of the Depositor to which authority to act on behalf of the Board of Directors has been delegated and to be in full force and effect on the date of such certification, and delivered to the Property Trustee. "Book-Entry Capital Securities Certificate" means a Capital Securities ----------------------------------------- Certificate evidencing ownership of Book-Entry Capital Securities. "Book-Entry Capital Security" means a Capital Security, the ownership and --------------------------- transfers of which shall be made through book entries by a Clearing Agency as described in Section 5.11. "Business Day" means a day other than (a) a Saturday or Sunday, (b) a day on ------------ which banking institutions in The City of New York are authorized or obligated by law or executive order to remain closed or (c) a day on which the Property Trustee's Corporate Trust Office or the Debenture Trustee's Corporate Trust Office is closed for business. "Capital Securities Certificate" means a certificate evidencing ownership of ------------------------------ Capital Securities, substantially in the form attached as Exhibit D. "Capital Security" means an undivided beneficial interest in the assets of ---------------- the Trust, having a Liquidation Amount of $1,000 and having rights provided therefor in this Trust Agreement, including the right to receive Distributions and a Liquidation Distribution as provided herein. "Certificate Depository Agreement" means the agreement among the Trust, the -------------------------------- Depositor and The Depository Trust Company, as the initial Clearing Agency, dated as of the Closing Date, relating to the Capital Securities Certificates, substantially in the form attached as Exhibit B, as the same may be amended and supplemented from time to time. "Clearing Agency" means an organization registered as a "clearing agency" --------------- pursuant to Section 17A of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The Depository Trust Company will be the initial Clearing Agency. "Clearing Agency Participant" means a broker, dealer, bank, other financial --------------------------- institution or other Person for whom from time to time a Clearing Agency effects book-entry transfers and pledges of securities deposited with the Clearing Agency. -3- "Closing Date" means the First Time of Delivery as defined in the ------------ Underwriting Agreement, which date is also the date of execution and delivery of this Trust Agreement. "Code" means the Internal Revenue Code of 1986, as amended. ---- "Commission" means the Securities and Exchange Commission, as from time to ---------- time constituted, created under the Exchange Act or, if at any time after the execution of this instrument such Commission is not existing and performing the duties now assigned to it under the Trust Indenture Act, then the body performing such duties at such time. "Common Securities Certificate" means a certificate evidencing ownership of ----------------------------- Common Securities, substantially in the form attached as Exhibit C. "Common Security" means an undivided beneficial interest in the assets of --------------- the Trust, having a Liquidation Amount of $1,000 and having the rights provided therefor in this Trust Agreement, including the right to receive Distributions and a Liquidation Distribution as provided herein. "Corporate Trust Office" means the principal office of either the Property ---------------------- Trustee or the Trustee named in the Indenture. So long as The Bank of New York serves in both capacities, such principal office is located in ________________. "Debenture Event of Default" means an "Event of Default" as defined in the -------------------------- Indenture. "Debenture Redemption Date" means "Redemption Date" as defined in the ------------------------- Indenture. "Debenture Trustee" means The Bank of New York, a banking corporation duly ----------------- organized and existing under the laws of the State of New York. "Debentures" means the $103,093,000 aggregate principal amount of the ---------- Parent's ____% Junior Subordinated Debentures, Series A issued pursuant to the Indenture. "Definitive Capital Securities Certificates" means either or both (as the ------------------------------------------ context requires) of (a) Capital Securities Certificates issued as Book-Entry Capital Securities Certificates as provided in Section 5.11(a) and (b) Capital Securities Certificates issued in certificated, fully registered form as provided in Section 5.13. "Delaware Business Trust Act" means Chapter 38 of Title 12 of the Delaware --------------------------- Code, 12 Del. C. (S) 3801, et seq., as it may be amended from time to time. "Depositor" has the meaning specified in the preamble to this Trust --------- Agreement and includes Pennsylvania Manufacturers Corporation in its capacity as Holder of the Common Securities. "Direct Action" has the meaning specified in Section 5.14(c). ------------- "Distribution Date" has the meaning specified in Section 4.01(a). ----------------- -4- "Distributions" means amounts payable in respect of the Trust Securities as ------------- provided in Section 4.01. "Event of Default" means any one of the following events (whatever the ---------------- reason for such Event of Default and whether it shall be voluntary or involuntary or be effected by operation of law or pursuant to any judgment, decree or order of any court or any order, rule or regulation of any administrative or governmental body): (a) the occurrence of a Debenture Event of Default; or (b) default by the Property Trustee in the payment of any Distribution when it becomes due and payable, and continuation of such default for a period of 30 days; or (c) default by the Property Trustee in the payment of any Redemption Price of any Trust Security when it becomes due and payable; or (d) default in the performance, or breach, in any material respect, of any covenant or warranty of the Trustees in this Trust Agreement (other than a covenant or warranty a default in the performance of which or the breach of which is dealt with in clause (b) or (c), above) and continuation of such default or breach for a period of 60 days after there has been given, by registered or certified mail, to the defaulting Trustee or Trustees by the Holders of at least 25% in aggregate Liquidation Amount of the Outstanding Capital Securities a written notice specifying such default or breach and requiring it to be remedied and stating that such notice is a "Notice of Default" hereunder; or (e) the occurrence of a Bankruptcy Event with respect to the Property Trustee and the failure by the Depositor to appoint a successor Property Trustee within 60 days thereof. "Expense Agreement" means the Agreement as to Expenses and Liabilities ----------------- between the Parent and the Trust, substantially in the form attached as Exhibit A to the Indenture, as amended from time to time. "Guarantee" means the Guarantee Agreement executed and delivered by the --------- Parent and The Bank of New York, a banking corporation, as trustee, contemporaneously with the execution and delivery of this Trust Agreement, for the benefit of the Holders of the Capital Securities, as amended from time to time. "Indenture" means the Junior Subordinated Indenture, dated as of --------- _____________________, 1998, between the Parent and the Debenture Trustee, as trustee, as amended or supplemented from time to time. "Lien" means any lien, pledge, charge, encumbrance, mortgage, deed of trust, ---- adverse ownership interest, hypothecation, assignment, security interest or preference, priority or other security agreement or preferential arrangement of any kind or nature whatsoever. "Like Amount" means (a) with respect to a redemption of Trust Securities, ----------- Trust Securities having a Liquidation Amount equal to the principal amount of Debentures to be -5- contemporaneously redeemed in accordance with the Indenture and the proceeds of which will be used to pay the Redemption Price of such Trust Securities, (b) with respect to a distribution of Debentures to Holders of Trust Securities in connection with a dissolution or liquidation of the Trust, Debentures having a principal amount equal to the Liquidation Amount of the Trust Securities of the Holder to whom such Debentures are distributed and (c) with respect to any distribution of Additional Amounts to Holders of Trust Securities, Debentures having a principal amount equal to the Liquidation Amount of the Trust Securities in respect of which such distribution is made. "Liquidation Amount" means the stated amount of $1,000 per Trust Security. ------------------ "Liquidation Date" means the date of dissolution, winding-up or termination ---------------- and liquidation of the Trust pursuant to Section 9.04(a). "Liquidation Distribution" has the meaning specified in Section 9.04(d). ------------------------ "Majority in Liquidation Amount of the Capital Securities" or "Majority in -------------------------------------------------------- ------------ Liquidation Amount of the Common Securities" means, except as provided by the - ------------------------------------------- Trust Indenture Act, Capital Securities or Common Securities, as the case may be, representing more than 50% of the aggregate Liquidation Amount of all then Outstanding Capital Securities or Common Securities, as the case may be. "Officers' Certificate" means a certificate signed by the Chairman of the --------------------- Board, the President or a Senior Vice President and by the Treasurer, Chief Financial Officer or the Vice President of Finance of the Depositor, and delivered to the appropriate Trustee. One of the officers signing an Officers' Certificate given pursuant to Section 8.16 shall be the principal executive, financial or accounting officer of the Depositor. Any Officers' Certificate delivered with respect to compliance with a condition or covenant provided for in this Trust Agreement shall include: (a) a statement that each officer signing the Officers' Certificate has read the covenant or condition and the definitions relating thereto; (b) a brief statement of the nature and scope of the examination or investigation undertaken by each officer in rendering the Officers' Certificate; (c) a statement that each such officer has made such examination or investigation as, in such officer's opinion, is necessary to enable such officer to express an informed opinion as to whether or not such covenant or condition has been complied with; and (d) a statement as to whether, in the opinion of each such officer, such condition or covenant has been complied with. "Opinion of Counsel" means a written opinion of counsel, who may be counsel ------------------ for the Trust, the Property Trustee or the Depositor, and may be an employee of any thereof, and who shall be acceptable to the Property Trustee. "Original Trust Agreement" has the meaning specified in the recitals to this ------------------------ Trust Agreement. -6- "Outstanding", when used with respect to Trust Securities, means, as of the ----------- date of determination, all Trust Securities theretofore executed, authenticated and delivered under this Trust Agreement, except: (a) Trust Securities theretofore canceled by the Administrative Trustees or delivered to the Administrative Trustees for cancellation; (b) Trust Securities for whose payment or redemption money in the necessary amount has been theretofore deposited with the Property Trustee or any Paying Agent; provided that, if such Trust Securities are to be redeemed, notice of such redemption has been duly given pursuant to this Trust Agreement; and (c) Trust Securities that have been paid or in exchange for or in lieu of which other Capital Securities have been executed, authenticated and delivered pursuant to this Trust Agreement; provided, however, that in determining whether the Holders of the requisite Liquidation Amount of the Outstanding Capital Securities have given any request, demand, authorization, direction, notice, consent or waiver hereunder, Capital Securities owned by the Depositor, any Trustee or any Affiliate of the Depositor or any Trustee shall be disregarded and deemed not to be Outstanding, except that (a) in determining whether any Trustee shall be protected in relying upon any such request, demand, authorization, direction, notice, consent or waiver, only Capital Securities which such Trustee knows to be so owned shall be so disregarded and (b) the foregoing shall not apply at any time when all of the Outstanding Capital Securities are owned by the Depositor, one or more of the Trustees and/or any such Affiliate. Capital Securities so owned which have been pledged in good faith may be regarded as Outstanding if the pledgee establishes to the satisfaction of the Administrative Trustees the pledgee's right so to act with respect to such Capital Securities and that the pledgee is not the Depositor or any Affiliate of the Depositor. "Owner" means each Person who is the beneficial owner of a Book-Entry ----- Capital Securities Certificate as reflected in the records of the Clearing Agency or, if a Clearing Agency Participant is not the Owner, then as reflected in the records of a Person maintaining an account with such Clearing Agency (directly or indirectly, in accordance with the rules of such Clearing Agency). "Parent" has the meaning specified in the preamble to this Trust Agreement. ------ "Paying Agent" means any paying agent or co-paying agent appointed pursuant ------------ to Section 5.09 and shall initially be the Bank. "Payment Account" means a segregated non-interest-bearing corporate trust --------------- account maintained by the Property Trustee with the Bank in its corporate trust department for the benefit of the Securityholders in which all amounts paid in respect of the Debentures will be held and from which the Property Trustee shall make payments to the Securityholders in accordance with Section 4.01. "Person" means any individual, corporation, partnership, joint venture, ------ trust, limited liability company or corporation, unincorporated organization or government or any agency or political subdivision thereof. -7- "Property Trustee" means the commercial bank or trust company identified as ---------------- the "Property Trustee" in the preamble to this Trust Agreement solely in its capacity as Property Trustee of the Trust heretofore formed and continued hereunder and not in its individual capacity, or its successor in interest in such capacity, or any successor Property Trustee appointed as herein provided. "Redemption Date" means, with respect to any Trust Security to be redeemed, --------------- the date fixed for such redemption by or pursuant to this Trust Agreement; provided that each Debenture Redemption Date and the stated maturity of the Debentures shall be a Redemption Date for a Like Amount of Trust Securities. "Redemption Price" means, with respect to any date fixed for redemption of ---------------- any Trust Security, the Liquidation Amount of such Trust Security, plus accumulated and unpaid Distributions to such date, plus the amount of the premium, if any, paid by the Depositor upon the concurrent redemption of a Like Amount of Debentures allocated on a pro rata basis (based on Liquidation Amounts) among the Trust Securities. "Relevant Trustee" shall have the meaning specified in Section 8.10. ---------------- "Securities Register" and "Securities Registrar" have the respective ------------------- -------------------- meanings specified in Section 5.04. "Securityholder" or "Holder" means a Person in whose name a Trust Security -------------- ------ or Securities is registered in the Securities Register; any such Person shall be deemed to be a beneficial owner within the meaning of the Delaware Business Trust Act; provided, however, that in determining whether the Holders of the requisite amount of Capital Securities have voted on any matter provided for in this Trust Agreement, then for the purpose of any such determination, so long as Definitive Capital Securities Certificates have not been issued, the term Securityholders or Holders as used herein shall refer to Owners. "Transfer Agent" shall be the person specified in or pursuant to Section -------------- 5.04. "Trust" means the Delaware business trust created and continued hereby and ----- identified on the cover page to this Trust Agreement. "Trust Agreement" means this Amended and Restated Trust Agreement, as the --------------- same may be modified, amended or supplemented in accordance with the applicable provisions hereof, including all exhibits hereto, including, for all purposes of this Trust Agreement and any such modification, amendment or supplement, the provisions of the Trust Indenture Act that are deemed to be a part of and govern this Trust Agreement and any such modification, amendment or supplement, respectively. "Trust Indenture Act" means the Trust Indenture Act of 1939 as in force at ------------------- the date as of which this instrument was executed; provided, however, that in the event the Trust Indenture Act of 1939 is amended after such date, "Trust Indenture Act" means, to the extent required by any such amendment, the Trust Indenture Act of 1939 as so amended. -8- "Trust Property" means (a) the Debentures, (b) any cash on deposit in, or -------------- owing to, the Payment Account, (c) all proceeds and rights in respect of the foregoing and any other property and assets for the time being held or deemed to be held by the Property Trustee pursuant to the trusts of this Trust Agreement and (d) the rights of the Property Trustee under the Guarantee. "Trust Security" means any one of the Common Securities or the Capital -------------- Securities. "Trust Securities Certificate" means any one of the Common Securities ---------------------------- Certificates or the Capital Securities Certificates. "Trustee" means the commercial bank or trust company identified as the ------- "Trustee" in the preamble to this Trust Agreement solely in its capacity as Trustee of the Trust heretofore formed and continued hereunder and not in its individual capacity, or its successor in interest in such capacity, or any successor Trustee appointed as herein provided. "Trustees" has the meaning specified in the preamble to this Trust -------- Agreement. "Underwriting Agreement" means the Underwriting Agreement, dated as of ---------------------- _________________________, 1998, among the Trust, the Parent, PMA Reinsurance Corporation and the several underwriters named therein. ARTICLE II Establishment of the Trust Section 2.01. Name. The Trust created and continued hereby shall be known ---- as "PMC Capital I," as such name may be modified from time to time by the Administrative Trustees following written notice to the Holders of Trust Securities and the other Trustees, in which name the Trustees may conduct the business of the Trust, make and execute contracts and other instruments on behalf of the Trust and sue and be sued. Section 2.02. Office of the Trustee; Office of the Property Trustee; ------------------------------------------------------ Principal Place of Business. The office of the Trustee in the State of Delaware - --------------------------- is _____________________________, Attention: Corporate Trust Administration, or such other address in the State of Delaware as the Trustee may designate by written notice to the Securityholders and the Depositor. The office of the Property Trustee is _______________________________, New York, New York, or such other address as the Property Trustee may designate by written notice to the Securityholders and the Depositor. The principal place of business of the Trust is c/o Pennsylvania Manufacturers Corporation, The PMA Building, 380 Sentry Parkway, Blue Bell, Pennsylvania 19422-2328. Section 2.03. Initial Contribution of Trust Property; Organizational ------------------------------------------------------ Expenses. The Trustee acknowledges receipt in trust from the Depositor in - -------- connection with the Original Trust Agreement of the sum of $10, which constituted the initial Trust Property. The Depositor shall pay organizational expenses of the Trust as they arise or shall, upon request of any Trustee, promptly reimburse such Trustee for any such expenses paid by -9- such Trustee. The Depositor shall make no claim upon the Trust Property for the payment of such expenses. Section 2.04. Issuance of the Capital Securities. On ---------------------------------- _______________________, 1998 the Depositor, both on its own behalf and on behalf of the Trust and pursuant to the Original Trust Agreement, executed and delivered the Underwriting Agreement. Contemporaneously with the execution and delivery of this Trust Agreement, an Administrative Trustee, on behalf of the Trust, shall execute and deliver to the underwriters named in the Underwriting Agreement Capital Securities Certificates, registered in the name of the nominee of the initial Clearing Agency, in an aggregate amount of 100,000 Capital Securities having an aggregate Liquidation Amount of $100,000,000, against receipt of the aggregate purchase price of such Capital Securities of $100,000,000, which amount the Administrative Trustee shall promptly deliver to the Property Trustee. Section 2.05. Purchase of Debentures; Issuance of the Common Securities. --------------------------------------------------------- Contemporaneously with the execution and delivery of this Trust Agreement, an Administrative Trustee, on behalf of the Trust, shall purchase from the Depositor Debentures, registered in the name of the Trust and having an aggregate principal amount equal to $100,000,000, and, in satisfaction of the purchase price for such Debentures, (w) the Property Trustee, on behalf of the Trust, shall deliver to the Depositor the sum of $100,000,000, and (x) contemporaneously therewith, an Administrative Trustee, on behalf of the Trust, shall execute and deliver to the Depositor Common Securities Certificates, registered in the name of the Depositor, in an aggregate amount of 3,093 Common Securi ties having an aggregate Liquidation Amount of $3,093,000. Section 2.06. Declaration of Trust. The exclusive purposes and functions -------------------- of the Trust are (a) to issue and sell the Trust Securities and use the proceeds from such sale to acquire the Debentures and (b) to engage in those activities necessary, convenient or incidental thereto. The Depositor hereby appoints the Trustees as trustees of the Trust, to have all the rights, powers and duties set forth herein and the Trustees hereby accept such appointment. The Property Trustee hereby declares that it will hold the Trust Property in trust upon and subject to the conditions set forth herein for the benefit of the Trust and the Securityholders. The Administrative Trustees shall have all rights, powers and duties set forth herein and in accordance with applicable law with respect to accomplishing the purposes of the Trust. Section 2.07. Authorization to Enter into Certain Transactions. ------------------------------------------------ (a) The Trustee, the Property Trustee and the Administrative Trustees shall conduct the affairs of the Trust in accordance with the terms of this Trust Agreement. Subject to the limitations set forth in paragraph (b) of this Section, and in accordance with the following provisions (i) and (ii), the Property Trustee and the Administrative Trustees shall have the authority to enter into all transactions and agreements determined by the Trustees to be appropriate in exercising the authority, express or implied, otherwise granted to the Trustees under this Trust Agreement, and to perform all acts in furtherance thereof, including without limitation, the following: -10- (i) As among the Trustees, the Administrative Trustees shall have the power, duty and authority to act on behalf of the Trust with respect to the following matters: (A) the issuance and sale of the Trust Securities; (B) to cause the Trust to enter into, and to execute, deliver and perform on behalf of the Trust, the Expense Agreement and the Certificate Depository Agreement and such other agreements as may be necessary or desirable in connection with the purposes and function of the Trust; (C) assisting in any registration of the Capital Securities under the Securities Act of 1933, as amended, and under state securities or blue sky laws, and the qualification of this Trust Agreement under the Trust Indenture Act; (D) assisting in any quotation or listing of the Capital Securities upon the Nasdaq National Market System ("Nasdaq") or such securities exchange or exchanges as shall be determined by the Depositor and the registration of the Capital Securities under the Exchange Act and the preparation and filing of all periodic and other reports and other documents pursuant to the foregoing; (E) the sending of notices (other than notices of default) and other information regarding the Trust Securities and the Debentures to the Securityholders in accordance with this Trust Agreement; (F) the consent to the appointment of a Paying Agent, authenticating agent, Securities Registrar and Transfer Agent in accordance with this Trust Agreement (which consent shall not be unreasonably withheld); (G) registering transfers of the Trust Securities in accordance with this Trust Agreement; (H) to the extent provided in this Trust Agreement, the winding up of the affairs of and liquidation of the Trust and the preparation, execution and filing of the certificate of cancellation with the Secretary of State of the State of Delaware; (I) unless otherwise determined by the Property Trustee or the Holders of at least a majority in Liquidation Amount of the Capital Securities, or as otherwise required by the Delaware Business Trust Act or the Trust Indenture Act, to execute on behalf of the Trust (either acting alone or together with any or all of the Administrative Trustees) any documents that the Administrative Trustees have the power to execute pursuant to this Trust Agreement; and (J) the taking of any action incidental to the foregoing as the Trustees may from time to time determine is necessary or advisable to give effect to the terms of this Trust Agreement and protect and conserve the Trust Property for the benefit of the Securityholders (without consideration of the effect of any such action on any particular Securityholder). -11- (ii) As among the Trustees, the Property Trustee shall have the power, duty and authority to act on behalf of the Trust with respect to the following matters: (A) the establishment of the Payment Account; (B) the receipt of the Debentures; (C) the collection of interest, principal and any other payments made in respect of the Debentures in the Payment Account; (D) the distribution through the Paying Agent of amounts distributable to the Securityholders in respect of the Trust Securities; (E) the exercise of all of the rights, powers and privileges of a holder of the Debentures; (F) the sending of notices of default and other information regarding the Trust Securities and the Debentures to the Securityholders in accordance with this Trust Agreement; (G) the distribution of the Trust Property in accordance with the terms of this Trust Agreement; (H) to the extent provided in this Trust Agreement, the winding up of the affairs of and liquidation of the Trust and the preparation, execution and filing of the certificate of cancellation with the Secretary of State of the State of Delaware; (I) after an Event of Default (other than under paragraph (b), (c), (d) or (e) of the definition of such term if such Event of Default is by or with respect to the Property Trustee) the taking of any action incidental to the foregoing as the Property Trustee may from time to time determine is necessary or advisable to give effect to the terms of this Trust Agreement and protect and conserve the Trust Property for the benefit of the Securityholders (without consideration of the effect of any such action on any particular Securityholder); and (J) any of the duties, liabilities, powers or the authority of the Administrative Trustees set forth in Section 2.07(a)(i)(E) and (I) herein; and in the event of a conflict between the action of the Administrative Trustees and the action of the Property Trustee, the action of the Property Trustee shall prevail. (b) So long as this Trust Agreement remains in effect, the Trust (or the Trustees acting on behalf of the Trust) shall not undertake any business, activities or transaction except as expressly provided herein or contemplated hereby. In particular, neither the Trustees nor the Trust shall (i) acquire any investments or engage in any activities not authorized by this Trust Agreement, (ii) sell, assign, transfer, exchange, mortgage, pledge, set-off or otherwise dispose of any of the Trust Property or interests therein, including to the Securityholders, except as expressly provided herein, (iii) take any action that would result in more than an insubstantial risk that the Trust would be taxable as a corporation or would fail or cease to qualify as a "grantor trust" for United States federal income tax -12- purposes, (iv) incur any indebtedness for borrowed money or issue any other debt or (v) take or consent to any action that would result in the placement of a Lien on any of the Trust Property. The Administrative Trustees shall defend all claims and demands of all Persons at any time claiming any Lien on any of the Trust Property adverse to the interest of the Trust or the Securityholders in their capacity as Securityholders. (c) In connection with the issue and sale of the Capital Securities, the Depositor shall have the right and responsibility to assist the Trust with respect to, or effect on behalf of the Trust, the following (and any actions taken by the Depositor in furtherance of the following prior to the date of this Trust Agreement are hereby ratified and confirmed in all respects as actions of the Trust): (i) to prepare for filing by the Trust with the Commission and to execute on behalf of the Trust a registration statement on Form S-3 in relation to the Capital Securities, including any amendments thereto, and to take any action necessary or desirable to sell the Capital Securities in a transaction; (ii) to determine the States in which to take appropriate action to qualify or register for sale all or part of the Capital Securities and to do any and all such acts, other than actions which must be taken by or on behalf of the Trust, and advise the Trustees of actions they must take on behalf of the Trust, and prepare for execution and filing any documents to be executed and filed by the Trust or on behalf of the Trust, as the Depositor deems necessary or advisable in order to comply with the applicable laws of any such States and in connection with the sale of the Capital Securities; (iii) to prepare for filing by the Trust and to execute any application to Nasdaq or any national stock exchange for quotation or listing upon notice of issuance, as applicable, of any Capital Securities; (iv) to prepare for filing by the Trust with the Commission and to execute a registration statement on Form 8-A relating to the registration of the Capital Securities under Section 12(b) or 12(g) of the Exchange Act, including any amendments thereto; (v) to negotiate the terms of, and execute and deliver, the Underwriting Agreement providing for the sale of the Capital Securities; and (vi) to take any other actions necessary or desirable to carry out any of the foregoing activities. (d) Notwithstanding anything herein to the contrary, the Administrative Trustees are authorized and directed to conduct the affairs of the Trust and to operate the Trust so that the Trust will not (i) be deemed to be an "investment company" required to be registered under the Investment Company Act of 1940, as amended, or (ii) fail or cease to qualify as a grantor trust for United States federal income tax purposes and so that the Debentures will be treated as indebtedness of the Depositor for United States federal income tax purposes. In this connection, the Depositor and the Administrative Trustees are authorized to take any action, not inconsistent with applicable law, the Certificate of Trust or this Trust Agreement, that each of the Depositor and the Administrative Trustees determines in its discretion to be necessary or desirable for such purposes as long as such -13- action does not adversely affect in any material respect the interests of the Holders of the Capital Securities. In no event shall the Trustees be liable to the Trust or the Holders for any failure to comply with this Section that results from a change in law or regulation or in the interpretation thereof. (e) All prior actions taken by John W. Smithson, Francis W. McDonnell and Edward S. Hochberg on behalf of the Parent in furtherance of the Parent's powers, duties and obligations under the Original Trust Agreement are hereby ratified and affirmed as actions of the Trust. Section 2.08. Assets of Trust. The assets of the Trust shall consist of --------------- the Trust Property. Section 2.09. Title to Trust Property. Legal title to all Trust Property ----------------------- shall be vested at all times in the Property Trustee (in its capacity as such) and shall be held and administered by the Property Trustee for the benefit of the Trust and the Securityholders in accordance with this Trust Agreement. ARTICLE III Payment Account Section 3.01. Payment Account. --------------- (a) On or prior to the Closing Date, the Property Trustee shall establish the Payment Account. The Property Trustee and any agent of the Property Trustee shall have exclusive control and sole right of withdrawal with respect to the Payment Account for the purpose of making deposits in and withdrawals from the Payment Account in accordance with this Trust Agreement. All monies and other property deposited or held from time to time in the Payment Account shall be held by the Property Trustee in the Payment Account for the exclusive benefit of the Securityholders and for distribution as herein provided, including (and subject to) any priority of payments provided for herein. (b) The Property Trustee shall deposit in the Payment Account, promptly upon receipt, all payments of principal of or interest on, and any other payments or proceeds with respect to, the Debentures. Amounts held in the Payment Account shall not be invested by the Property Trustee pending distribution thereof. ARTICLE IV Distributions; Redemption Section 4.01. Distributions. ------------- (a) The Trust Securities represent undivided beneficial interests in the Trust Property, and Distributions (including of Additional Amounts) will be made on the Trust Securities at the rate and on the dates that payments of interest (including of Additional Interest, as defined in the Indenture) are made on the Debentures. Accordingly: -14- (i) Distributions on the Trust Securities shall be cumulative, and will accumulate whether or not there are funds of the Trust available for the payment of Distributions. Distributions shall accumulate from ____________________, 1998, and, except in the event (and to the extent) that the Parent exercises its right to defer interest payments on the Debentures pursuant to Section 301 of the Indenture, shall be payable semi-annually in arrears on ________________________ 1 and ___________________ 1 of each year, commencing on ____________________, 1999. If any date on which Distributions are otherwise payable on the Trust Securities is not a Business Day, then the payment of such Distribution shall be made on the next succeeding day which is a Business Day (and without any additional distribution or other payment in respect of any such delay) except that, if such Business Day is in the next succeeding calendar year, payment of such Distribution shall be made on the immediately preceding Business Day, in each case with the same force and effect as if made on the date on which such payment was originally payable (each date on which distributions are payable in accordance with this Section 4.01(a), a "Distribution Date"). (ii) Subject to Section 4.03 hereof, all Distributions will be made pro rata on each of the Trust Securities. Distributions payable on the Capital Securities shall be fixed at a rate of ________% per annum of the Liquidation Amount of the Capital Securities. Distributions payable on the Common Securities shall be fixed at a rate of ________% per annum of the Liquidation Amount of the Common Securities. The amount of Distributions payable for any full semi-annual period shall be computed on the basis of twelve 30-day months and a 360-day year and, for any period shorter than a full monthly period, shall be computed on the basis of the actual number of days elapsed in such period. Distributions payable for each full Distribution period shall be computed by dividing the rate per annum by two. The amount of Distributions payable for any period shall include the Additional Amounts, if any. (iii) Distributions on the Trust Securities shall be made by the Property Trustee from the Payment Account and shall be deemed payable on each Distribution Date only to the extent that the Trust has funds available in the Payment Account for the payment of such Distributions. (b) Distributions on the Trust Securities with respect to a Distribution Date shall be payable to the Holders thereof as they appear on the Securities Register for the Trust Securities at the close of business on the relevant record date, which shall be one Business Day prior to such Distribution Date; provided, however, that in the event that the Capital Securities do not remain in book-entry-only form, the relevant record date shall be the date 15 days prior to the relevant Distribution Date. Section 4.02. Redemption. ---------- (a) On each Debenture Redemption Date and on the maturity of the Debentures, the Trust will be required to redeem a Like Amount of Trust Securities at the Redemption Price. (b) Notice of redemption shall be given by the Property Trustee by first- class mail, postage prepaid, mailed not less than 30 nor more than 60 days prior to the Redemption Date to each Holder of Trust Securities to be redeemed, at such Holder's address appearing in the Security Register. All notices of redemption or liquidation shall state: -15- (i) the Redemption Date; (ii) the Redemption Price; (iii) the CUSIP number or numbers of the Capital Securities affected; (iv) if less than all the Outstanding Trust Securities are to be redeemed, the identification and the aggregate Liquidation Amount of the particular Trust Securities to be redeemed; (v) that on the Redemption Date the Redemption Price will become due and payable upon each such Trust Security to be redeemed and that Distributions thereon will cease to accrue on and after said date, except as provided in Section 4.2(d) below; and (vi) the place or places where the Trust Securities are to be surrendered for the payment of the Redemption Price. (c) The Trust Securities redeemed on each Redemption Date shall be redeemed at the Redemption Price with the proceeds from the contemporaneous redemption of Debentures. Redemptions of the Trust Securities shall be made and the Redemption Price shall be payable on each Redemption Date only to the extent that the Trust has funds available in the Payment Account for the payment of such Redemption Price. (d) If the Property Trustee gives a notice of redemption in respect of any Capital Securities, then, by 12:00 noon, New York time, on the Redemption Date, subject to Sec tion 4.02(c), the Property Trustee will, so long as the Capital Securities are in book-entry-only form, irrevocably deposit with the Clearing Agency for the Capital Securities, funds sufficient to pay the applicable Redemption Price and will give such Clearing Agency irrevocable instructions and authority to pay the Redemption Price to the Holders thereof. If the Capital Securities are no longer in book-entry-only form, the Property Trustee, subject to Section 4.02(c), will irrevocably deposit with the Paying Agent funds sufficient to pay the applicable Redemption Price and will give the Paying Agent irrevocable instruc tions and authority to pay the Redemption Price to the Holders thereof upon surrender of their Capital Securities Certificates. Notwithstanding the foregoing, Distributions payable on or prior to the Redemption Date for any Trust Securities called for redemption shall be payable to the Holders of such Trust Securities as they appear on the Securities Register for the Trust Securities on the relevant record dates for the related Distribution Dates. If notice of redemption shall have been given and funds deposited as required, then upon the date of such deposit, all rights of Securityholders holding Trust Securities so called for redemption will cease, except the right of such Securityholders to receive the Redemption Price, and any Distribution payable in respect of the Trust Securities on or prior to the Redemption Date, but without interest on such Redemption Price, and such Trust Securities will cease to be outstanding. In the event that any date fixed for redemption of the Trust Securities is not a Business Day, then payment of the Redemption Price payable on such date will be made on the next succeeding day which is a Business Day (and without any interest or other payment in respect of any such delay), except that, if such Business Day falls in the next calendar year, such payment will be made on the immediately preceding Business Day, in each case, with the same force and effect as if made on such date. In the event that payment of the Redemption Price in respect of any -16- Trust Securities called for redemption is improperly withheld or refused and not paid either by the Trust or by the Depositor pursuant to the Guarantee, Distributions on such Trust Securities will continue to accumulate, as set forth in Section 4.01, from the Redemption Date originally established by the Trust for such Trust Securities to the date such Redemption Price is actually paid, in which case the actual payment date will be the date fixed for redemption for purposes of calculating the Redemption Price. (e) Payment of the Redemption Price on the Trust Securities and distribution of the Debentures to holders of Capital Securities shall be made to the recordholders thereof as they appear on the Securities Register for the Trust Securities on the relevant record date, which shall be one Business Day prior to the relevant Redemption Date or Liquidation Date, as applicable; provided, however, that in the event that the Capital Securities do not remain in book-entry-only form, the relevant record date shall be the date 15 days prior to the Redemption Date or Liquidation Date, as applicable. (f) Subject to Section 4.03(a), if less than all the Outstanding Trust Securities are to be redeemed on a Redemption Date, then the aggregate Liquidation Amount of the Trust Securities to be redeemed shall be allocated proportionally between the Common Securities and the Capital Securities according to their aggregate Liquidation Amounts. The particular Capital Securities to be redeemed shall be selected on a pro rata basis (based upon Liquidation Amounts) not more than 60 days prior to the Redemption Date by the Property Trustee from the Outstanding Capital Securities not previously called for redemption, by such method (including, without limitation, by lot) as the Property Trustee shall deem fair and appropriate and which may provide for the selection for redemption of portions (equal to $1,000 or an integral multiple of $1,000 in excess thereof) of the Liquidation Amount of the Capital Securities of a denomination larger than $1,000; provided that so long as the Capital Securities are in book-entry-only form, such selection shall be made in accordance with the customary procedures for the Clearing Agency for the Capital Securities. The Property Trustee shall promptly notify the Security Registrar in writing of the Capital Securities selected for redemption and, in the case of any Capital Securities selected for partial redemption, the Liquidation Amount thereof to be redeemed. For all purposes of this Trust Agreement, unless the context otherwise requires, all provisions relating to the redemption of the Capital Securities shall relate, in the case of any aggregate Capital Securities redeemed or to be redeemed only in part, to the portion of the aggregate Liquidation Amount of the Capital Securities which has been or is to be redeemed. Section 4.03. Subordination of Common Securities. ---------------------------------- (a) Payment of Distributions (including Additional Amounts, if applicable) on, the Redemption Price of and the Liquidation Distribution in respect of the Trust Securities, as applicable, shall be made, subject to Section 4.02(f), pro rata among the Capital Securities and the Common Securities based on the Liquidation Amount of the Trust Securities; provided, however, that if on any Distribution Date, Redemption Date or Liquidation Date any Event of Default resulting from a Debenture Event of Default specified in Section 501(a) or 501(b) of the Indenture shall have occurred and be continuing, no payment of any Distribution (including Additional Amounts, if applicable) on, or Redemption Price of, or Liquidation Distribution in respect of, any Common Security, and no other payment on account of the redemption, liquidation or other acquisition of the Common Securities, shall -17- be made unless payment in full in cash of all accumulated and unpaid Distributions (including Additional Amounts, if applicable) on all Outstanding Capital Securities for all distribution periods terminating on or prior thereto, or in the case of payment of the Redemption Price the full amount of such Redemption Price on all Outstanding Capital Securities then called for redemption, or in the case of payment of the Liquidation Distribution the full amount of such Liquidation Distribution on all Outstanding Capital Securities, shall have been made or provided for, and all funds available to the Property Trustee shall first be applied to the payment in full in cash of all Distributions (including Additional Amounts, if applicable) on, or the Redemption Price of, the Capital Securities then due and payable. (b) In the case of the occurrence of any Event of Default resulting from any Debenture Event of Default, the Holder of the Common Securities will be deemed to have waived any right to act with respect to any such Event of Default under this Trust Agreement until the effect of all such Events of Default with respect to the Capital Securities have been cured, waived or otherwise eliminated. Until all such Events of Default under this Trust Agreement with respect to the Capital Securities have been so cured, waived or otherwise eliminated, the Property Trustee shall act solely on behalf of the Holders of the Capital Securities and not on behalf of the Holder of the Common Securities, and only the Holders of the Capital Securities will have the right to direct the Property Trustee to act on their behalf. Section 4.04. Payment Procedures. Payments of Distributions (including ------------------ Additional Amounts if applicable) in respect of the Capital Securities shall be made at (a) the Corporate Trust Office of the Property Trustee, (b) the principal office of any Paying Agent or (c) the principal office of the Securities Registrar and Transfer Agent; provided that payment of any Distribution may be made, at the option of the Administrative Trustees, by check mailed to the address of the Person entitled thereto as such address shall appear on the Securities Register or by wire transfer in immediately available funds at such place and to such account as may be designated by the Person entitled thereto as specified in the Securities Register; if the Capital Securities are held by a Clearing Agency, such payments shall be made either by check or by wire transfer, at the option of the Paying Agent, to the Clearing Agency in immediately available funds, which shall credit the relevant Persons' accounts at such Clearing Agency on the applicable Distribution Dates. Payments in respect of the Common Securities shall be made in such manner as shall be mutually agreed between the Property Trustee and the Holder of the Common Securities. Section 4.05. Withholding Tax. --------------- The Trust and the Administrative Trustees shall comply with all withholding and backup withholding tax requirements under United States federal, state and local law. The Trust shall request, and the Holders shall provide to the Trust, such forms or certificates as are necessary to establish an exemption from withholding and backup withholding tax with respect to each Holder, and any representations and forms as shall reasonably be requested by the Trust to assist it in determining the extend of, and in fulfilling, its withholding and backup withholding tax obligations. The Administrative Trustees shall file required forms with applicable jurisdictions and, unless an exemption from withholding and backup withholding tax is properly established by a Holder, shall remit amounts withheld with respect to the Holder applicable jurisdictions. To the extent that -18- the Trust is required to withhold and pay over any amounts to any authority with respect to Distributions or allocations to any Holder, the amount withheld shall be deemed to be a Distribution in the amount of the withholding to the Holder. In the event of any claimed overwithholding, Holders shall be limited to an action against the applicable jurisdiction. If the amount required to be withheld was not withheld from actual Distributions made, the Trust may reduce subsequent Distributions by the amount of such required withholding. Section 4.06. Tax Returns and Reports. ----------------------- (a) The Administrative Trustees shall prepare (or cause to be prepared), at the Depositor's expense, and file by January 31 following each calendar year all federal, state and local tax and information returns and reports required to be filed by or in respect of the Trust. In this regard, by January 31 following each calendar year the Administrative Trustees shall (i) prepare and file (or cause to be prepared or filed) the Internal Revenue Service Form 1041 (or any successor form) required to be filed in respect of the Trust in each taxable year of the Trust and (ii) prepare and furnish (or cause to be prepared and furnished) to each Securityholder the related Internal Revenue Service Form 1099 (or any successor form). The Administrative Trustees shall provide the Depositor and the Property Trustee with a copy of all such returns, reports and schedules promptly after such filing or furnishing. (b) In the event that any withholding tax is imposed on the Trust's payment to a Securityholder, such tax shall reduce the amount otherwise distributable to the Securityholder in accordance with this Section. Any Securityholder who is a nonresident alien individual or which is organized under the laws of a jurisdiction outside the United States shall, on or prior to the date such Securityholder becomes a Securityholder, (i) so notify the Trust and the Trustees, and (ii) either (A) provide the Trust and the Trustees with Internal Revenue Service Form 1001, 4224, 8709 or W-8, as appropriate, or (b) notify the Trust and the Trustees that it is not entitled to an exemption from United States withholding tax or a reduction in the rate thereof on payments of interest. Any such Securityholder agrees by its acceptance of a Capital Security, on an ongoing basis, to provide like certification for each taxable year for which it is necessary to provide such information and to notify the Trust and the Trustees should subsequent circumstances arise affecting the information provided the Trustees in clauses (i) and (ii) above. The Trustees shall be fully protected in relying upon, and each Securityholder by its acceptance of a Capital Security hereunder agrees to indemnify and hold the Trustees harmless against all claims or liability of any kind arising in connection with or related to the Trustees' reliance upon any documents, forms or information provided by any Securityholder to the Trustees. In addition, if the Trustees have not withheld taxes on any payment made to any Securityholder, and the Trustees are subsequently required to remit to any taxing authority any such amount not withheld, such Securityholder shall return such amount to the Trustees upon written demand by the Trustees. The Trustees shall be liable only for direct (but not consequential) damages to any Securityholder due to the Trustees' violation of the Code and only to the extent such liability is caused by the Trustees' failure to act in accordance with its standard of care under this Agreement. The Trustees shall comply with United States federal withholding and backup withholding tax -19- laws and information reporting requirements with respect to any payments to Securityholders under the Trust Securities. Section 4.07. Payment of Taxes, Duties, Etc. of the Trust. Upon receipt ------------------------------------------- under the Debentures of Additional Sums (as defined in the Indenture), the Property Trustee shall promptly pay any taxes, duties or governmental charges of whatsoever nature (other than withholding taxes) imposed on the Trust by the United States or any other taxing authority. Section 4.08. Payments under Indenture. Any amount payable hereunder to ------------------------ any Holder of Capital Securities (and any Owner with respect thereto) shall be reduced by the amount of any corresponding payment such Holder (and Owner with respect to a Holder's Capital Securities) has directly received pursuant to Section 508 of the Indenture or Section 5.14 of this Trust Agreement. ARTICLE V Trust Securities Certificates Section 5.01. Initial Ownership. Upon the formation of the Trust and the ----------------- contribution by the Depositor pursuant to Section 2.03 and until the issuance of the Trust Securities, and at any time during which no Trust Securities are outstanding, the Depositor shall be the sole beneficial owner of the Trust. Section 5.02. The Trust Securities Certificates. The Capital Securities --------------------------------- Certificates shall be issued in minimum denominations of $1,000 Liquidation Amount and integral multiples of $1,000 in excess thereof, and the Common Securities Certificates shall be issued in denominations of $1,000 Liquidation Amount and integral multiples thereof. The Trust Securities Certificates shall be executed on behalf of the Trust by manual signature of at least one Administrative Trustee. Trust Securities Certificates bearing the manual signatures of individuals who were, at the time when such signatures shall have been affixed, authorized to sign on behalf of the Trust, shall be validly issued and entitled to the benefits of this Trust Agreement, notwithstanding that such individuals or any of them shall have ceased to be so authorized prior to the delivery of such Trust Securities Certificates or did not hold such offices at the date of delivery of such Trust Securities Certificates. A transferee of a Trust Securities Certificate shall become a Securityholder, and shall be entitled to the rights and subject to the obligations of a Securityholder hereunder, upon due registration of such Trust Securities Certificate in such transferee's name pursuant to Section 5.04. Section 5.03. Delivery of Trust Securities Certificates. On the Closing ----------------------------------------- Date, the Administrative Trustees shall cause Trust Securities Certificates, in an aggregate Liquidation Amount as provided in Sections 2.04 and 2.05, to be executed on behalf of the Trust and delivered to or upon the written order of the Depositor, executed by one authorized officer thereof, without further corporate action by the Depositor, in authorized denominations. -20- Section 5.04. Registration of Transfer and Exchange of Capital Securities ----------------------------------------------------------- Certificates. The Property Trustee shall keep or cause to be kept, at the office - ------------ or agency maintained pursuant to Section 5.08, a register or registers for the purpose of registering Trust Securities Certificates and transfers and exchanges of Trust Securities Certificates (the "Securities Register") in which, subject to such reasonable regulations as it may prescribe, the Securities Registrar shall provide for the registration of Capital Securities Certificates and Common Securities Certificates (subject to Section 5.10 in the case of Common Securities Certificates) and registration of transfers and exchanges of Capital Securities Certificates as herein provided. The Bank shall be the initial Securities Registrar and Transfer Agent. The provisions of Sections 8.01, 8.03 and 8.06 shall apply to the Bank also in its role as Securities Registrar and Transfer Agent, for so long as the Bank shall act as Securities Registrar and Transfer Agent. Upon surrender for registration of transfer of any Capital Securities Certificate at the office or agency maintained pursuant to Section 5.08, the Administrative Trustees or any one of them shall execute and shall cause to be delivered to the Property Trustee, and the Property Trustee shall deliver, in the name of the designated transferee or transferees, one or more new Capital Securities Certificates in authorized denominations of a like aggregate Liquidation Amount dated the date of execution by such Administrative Trustee or Trustees. The Securities Registrar shall not be required to register the transfer of any Capital Securities that have been called for redemption. At the option of a Holder, Capital Securities Certificates may be exchanged for other Capital Securities Certificates in autho rized denominations and of a like aggregate Liquidation Amount upon surrender of the Capital Securities Certificates to be exchanged at the office or agency maintained pursuant to Section 5.08. Every Capital Securities Certificate presented or surrendered for registration of transfer or exchange shall be accompanied by a written instrument of transfer in form satisfactory to an Administrative Trustee and the Securities Registrar duly executed by the Holder or his attorney duly authorized in writing. Each Capital Securities Certificate surrendered for registration of transfer or exchange shall be canceled and subsequently disposed of by the Securities Registrar, in accordance with its customary practice. No service charge shall be made for any registration of transfer or exchange of Capital Securities Certificates, but the Securities Registrar may require payment (with the giving of such indemnity as the Trust or the Parent may require) of a sum sufficient to cover any tax or governmental charge that may be imposed in connection with any transfer or exchange of Capital Securities Certificates. Section 5.05. Mutilated, Destroyed, Lost or Stolen Trust Securities ----------------------------------------------------- Certificates. If (a) any mutilated Trust Securities Certificate shall be - ------------ surrendered to the Securities Regis trar, or if the Securities Registrar shall receive evidence to its satisfaction of the destruction, loss or theft of any Trust Securities Certificate and (b) there shall be delivered to the Securities Registrar and the Administrative Trustees such security or indemnity as may be required by them to save each of them harmless, then in the absence of notice that such Trust Securities Certificate shall have been acquired by a bona fide purchaser, the Administrative Trustees, or any one of them, on behalf of the Trust shall execute and cause to be made available for delivery, in exchange for or in lieu of any such mutilated, destroyed, lost or stolen Trust Securities Certificate, a new Trust Securities Certificate of -21- like class, tenor and denomination. In connection with the issuance of any new Trust Securities Certificate under this Section, the Administrative Trustees or the Securities Registrar may require the payment of a sum sufficient to cover any tax or other governmental charge that may be imposed in connection therewith. Any duplicate Trust Securities Certificate issued pursuant to this Section shall constitute conclusive evidence of an undivided beneficial interest in the assets of the Trust, as if originally issued, whether or not the lost, stolen or destroyed Trust Securities Certificate shall be found at any time. Section 5.06. Persons Deemed Securityholders. Prior to due presentation of ------------------------------ a Trust Securities Certificate for registration of transfer, the Administrative Trustees or the Securities Registrar shall treat the Person in whose name any Trust Securities Certificate shall be registered in the Securities Register as the owner of such Trust Securities Certificate for the purpose of receiving distributions and for all other purposes whatsoever, and neither the Trustees nor the Securities Registrar shall be bound by any notice to the contrary. Section 5.07. Access to List of Securityholders' Names and Addresses. The ------------------------------------------------------ duties and responsibilities of the Depositor and any other party to provide any list of Securityholders shall be as set forth in the Trust Indenture Act, including Section 312 of such Trust Indenture Act. Each Holder, by receiving and holding a Trust Securities Certificate, and each Owner shall be deemed to have agreed not to hold either the Depositor, the Property Trustee, the Trustee or the Administrative Trustees accountable by reason of the disclosure of its name and address, regardless of the source from which such information was derived. Section 5.08. Maintenance of Office or Agency. The Property Trustee shall ------------------------------- maintain, with the consent of the Administrative Trustees, an office or offices or agency or agencies where Capital Securities Certificates may be surrendered for registration of transfer or exchange and where notices and demands to or upon the Trustees in respect of the Trust Securities Certificates may be served. Such offices or agencies shall consist of (a) the Corporate Trust Office of the Property Trustee which address is, c/o The Bank of New York (Delaware), __________________________________________________, Attention: Corporate Trust Administration, (b) the principal office of any Paying Agent or (c) the principal office of the Securities Registrar and Transfer Agent. The Administrative Trustees shall give prompt written notice to the Depositor and to the Securityholders of any change in the location of the Securities Register or any such office or agency. Section 5.09. Appointment of Paying Agent. The Paying Agent shall make --------------------------- distributions to Securityholders from the Payment Account and shall report the amounts of such distributions to the Property Trustee and the Administrative Trustees. Any Paying Agent shall have the revocable power to withdraw funds from the Payment Account for the purpose of making the distributions referred to above. The Administrative Trustees may revoke such power and remove the Paying Agent in their sole discretion. The Paying Agent shall initially be the Bank, and any co-paying agent chosen by the Bank, and acceptable to the Administrative Trustees and the Depositor. Any Person acting as Paying Agent shall be permitted to resign as Paying Agent upon 30 days' written notice to the Administrative Trustees, the Property Trustee and the Depositor. In the event that the Bank shall no longer be the Paying Agent or a successor Paying Agent shall resign or its authority to act be revoked, the Administrative Trustees shall appoint a successor that is -22- acceptable to the Property Trustee and the Depositor to act as Paying Agent (which shall be a bank or trust company). The Administrative Trustees shall cause such successor Paying Agent or any additional Paying Agent appointed by the Administrative Trustees to execute and deliver to the Trustees an instrument in which such successor Paying Agent or additional Paying Agent shall agree with the Trustees that as Paying Agent, such successor Paying Agent or additional Paying Agent will hold all sums, if any, held by it for payment to the Securityholders in trust for the benefit of the Securityholders entitled thereto until such sums shall be paid to such Securityholders. The Paying Agent shall return all unclaimed funds to the Property Trustee and upon removal of a Paying Agent such Paying Agent shall also return all funds in its possession to the Property Trustee. The provisions of Sections 8.01, 8.03 and 8.06 shall apply to the Bank also in its role as Paying Agent, for so long as the Bank shall act as Paying Agent and, to the extent applicable, to any other paying agent appointed hereunder. Any reference in this Agreement to the Paying Agent shall include any co-paying agent unless the context requires otherwise. Section 5.10. Ownership of Common Securities by Depositor. On the Closing ------------------------------------------- Date the Depositor shall acquire and thereafter shall retain beneficial and record ownership of the Common Securities. Any attempted transfer of the Common Securities other than as set forth in the preceding sentence shall be void; provided that any permitted successor of the Depositor under the Indenture may succeed to the Depositor's ownership of the Common Securities. The Administrative Trustees shall cause each Common Securities Certificate issued to the Depositor to contain a legend stating substantially "THIS CERTIFICATE IS NOT TRANSFERABLE". Section 5.11. Book-Entry Capital Securities Certificates; Common -------------------------------------------------- Securities Certificate. - ---------------------- (a) The Capital Securities Certificates, upon original issuance, will be issued in the form of a typewritten Capital Securities Certificate or Certificates representing Book-Entry Capital Securities Certificates, to be delivered to The Depository Trust Company, the initial Clearing Agency, by, or on behalf of, the Trust. Such Capital Securities Certificate or Certificates shall initially be registered on the Securities Register in the name of Cede & Co., the nominee of the initial Clearing Agency, and no Book-Entry Capital Securities Certificate may be exchanged in whole or in part for Capital Securities Certificates registered, and no transfer of a Book-Entry Capital Securities Certificate in whole or in part may be registered, in the name of any Person other than the Clearing Agency for such Book-Entry Capital Securities Certificates of a nominee thereof, except as provided in Section 5.13. Unless and until Definitive Capital Securities Certificates have been issued to Owners pursuant to Section 5.13: (i) the provisions of this Section 5.11(a) shall be in full force and effect; (ii) the Clearing Agency or its nominee, as registered owner of a Book- Entry Capital Securities Certificate, shall be the Holder of such Book-Entry Capital Securities Certificate for all purposes under this Trust Agreement and the Book-Entry Capital Securities Certificate, and Owners with respect to a Book-Entry Capital Securities Certificate shall hold such interests pursuant to the Applicable Procedures; the Securities Registrar and the Trustees shall be entitled to deal with the Clearing Agency for all purposes of this Trust Agreement relating to the Book-Entry Capital Securities Certificates -23- (including the payment of the Liquidation Amount of and Distributions on the Book-Entry Capital Securities and the giving of instructions or directions to Owners of Book-Entry Capital Securities) as the sole Holder of the Book-Entry Capital Securities and shall have no obligations to the Owners thereof; (iii) to the extent that the provisions of this Section 5.11 conflict with any other provisions of this Trust Agreement, the provisions of this Section 5.11 shall control; (iv) the rights of the Owners of the Book-Entry Capital Securities Certificates shall be exercised only through the Clearing Agency and shall be limited to those established by law, the Applicable Procedures and agreements between such Owners and the Clearing Agency and/or the Clearing Agency Participants. Pursuant to the Certificate Depository Agreement, unless and until Definitive Capital Securities Certificates are issued pursuant to Section 5.13, the initial Clearing Agency will make book-entry transfers among the Clearing Agency Participants and receive and transmit payments on the Capital Securities to such Clearing Agency Participants; and (v) whenever this Trust Agreement requires or permits actions to be taken based upon instructions or directions of Holders of Trust Certificates evidencing a specified percentage of the aggregate Liquidation Amount, the Clearing Agency shall be deemed to represent such percentage only to the extent that it has received instructions to such effect from Owners and/or Clearing Agency Participants owning or representing, respectively, such required percentage of the beneficial interest in the applicable class of Trust Certificates and has delivered such instructions to the Administrative Trustees. (b) A single Common Securities Certificate representing the Common Securities shall be issued to the Depositor in the form of a definitive Common Securities Certificate. Section 5.12. Notices to Clearing Agency. To the extent that a notice or -------------------------- other communication to the Owners is required under this Trust Agreement, unless and until Definitive Capital Securities Certificates shall have been issued to Owners pursuant to Section 5.13, the Trustees shall give all such notices and communications specified herein to be given to the Clearing Agency, and shall have no obligations to the Owners. Section 5.13. Definitive Capital Securities Certificates. If (a) the ------------------------------------------ Clearing Agency advises the Trustees, the Securities Registrar and Transfer Agent and Parent by giving ninety (90) days' prior written notice (provided, however, that if the Clearing Agency is required to discontinue its services as depositary with respect to the Capital Securities pursuant to any governmental, judicial or regulatory order or decree, and such discontinuation is required in less than 90 days from the date of such order or decree, then the Clearing Agency may discontinue such services by giving notice to Parent, the Trustees and the Securities Registrar and Transfer Agent as soon as reasonably possible), that it is no longer willing or able to properly discharge its responsibilities with respect to the Capital Securities Certificates, and the Depositor is unable to locate a qualified successor, (b) the Clearing Agency ceases to be a clearing agency registered under the Exchange Act, at a time when the Clearing Agency is required to be so registered to act as such clearing agency, (c) the Trust at its option advises the Depositary in writing that it elects to terminate the book-entry system through the Clearing Agency or (d) a Debenture Event of Default has occurred and is continuing, then the Administrative Trustees shall notify the -24- Clearing Agency and the Clearing Agency shall notify all Owners of Capital Securities Certificates and the Trustees of the occurrence of any such event and of the availability of the Definitive Capital Securities Certificates to Owners of such class or classes, as applicable, requesting the same. If any Book-Entry Capital Securities Certificate is to be exchanged for other Capital Securities Certificates or canceled in part, or if any other Capital Securities Certificate is to be exchanged in whole or in part for Book- Entry Capital Securities represented by a Book-Entry Capital Securities Certificate, then either (a) such Book-Entry Capital Securities Certificate shall be so surrendered for exchange or cancellation as provided in this Article V or (b) the aggregate Liquidation Amount represented by such Book-Entry Capital Securities Certificate shall be reduced, subject to Section 5.02, or increased by an amount equal to the Liquidation Amount represented by that portion of the Book-Entry Capital Securities Certificate to be so exchanged or canceled, or equal to the Liquidation Amount represented by such other Capital Securities Certificates to be so exchanged for Book-Entry Capital Securities represented thereby, as the case may be, by means of an appropriate adjustment made on the records of the Securities Registrar, whereupon the Property Trustee, in accordance with the Applicable Procedures, shall instruct the Clearing Agency or its authorized representative to make a corresponding adjustment to its records. Upon surrender to the Administrative Trustees of the typewritten Capital Securities Certificate or Certificates representing the Book-Entry Capital Securities Certificates by the Clearing Agency, accompanied by registration instructions, the Administrative Trustees, or any one of them, shall execute the Definitive Capital Securities Certificates in accordance with the instructions of the Clearing Agency. In the event that Capital Securities are issued in definitive form, such Capital Securities will be in denominations of $1,000 and integral multiples thereof. Neither the Securities Registrar nor the Trustees shall be liable for any delay in delivery of such instructions and may conclusively rely on, and shall be protected in relying on, such instructions. Upon the issuance of Definitive Capital Securities Certificates, the Trustees shall recognize the Holders of the Definitive Capital Securities Certificates as Securityholders. The Definitive Capital Securities Certificates shall be printed, lithographed or engraved or may be produced in any other manner as is reasonably acceptable to the Administrative Trustees, as evidenced by the execution thereof by the Administrative Trustees or any one of them and may have such letters, numbers or other marks of identification or designation and such legends or endorsements as the Administrative Trustees may deem appropriate, or as may be required to comply with any law or rule or regulation made pursuant thereto or with any rule or regulation of any stock exchange on which Capital Securities may be listed, or to conform to usage. Section 5.14. Rights of Securityholders. ------------------------- (a) The legal title to the Trust Property is vested exclusively in the Property Trustee (in its capacity as such) in accordance with Section 2.09, and the Securityholders shall not have any right or title therein other than the undivided beneficial interest in the assets of the Trust conferred by their Trust Securities and they shall have no right to call for any partition or division of property, profits or rights of the Trust except as described below. The Trust Securities shall be personal property giving only the rights specifically set forth therein and in this Trust Agreement. The Trust Securities shall have no preemptive or similar rights and when issued and delivered to the Securityholders against payment of the purchase price therefor and upon such payment will be fully paid and nonassessable -25- by the Trust. The Holders of the Trust Securities, in their capacities as such, shall be entitled to the same limitation of personal liability extended to stockholders of private corporations for profit organized under the General Corporation Law of the State of Delaware. (b) For so long as any Capital Securities remain Outstanding, if, upon a Debenture Event of Default, the Debenture Trustee fails or the holders of not less than 25% in aggregate principal amount of the outstanding Debentures fail to declare the principal of all of the Debentures to be immediately due and payable, the Holders of at least 25% in Liquidation Amount of the Capital Securities then Outstanding shall have such right by a notice in writing to the Depositor and the Debenture Trustee; and upon any such declaration such principal amount of and the accrued interest on all of the Debentures shall become immediately due and payable, provided that the payment of principal and interest on such Debentures remains subordinated to the extent provided in the Indenture. At any time after such a declaration of acceleration with respect to the Debentures has been made and before a judgment or decree for payment of the money due has been obtained by the Debenture Trustee as in the Indenture provided, if the holders of a majority in aggregate principal amount of the outstanding Debentures fail to annul any such declaration and waive such default, the Holders of a majority in Liquidation Amount of the Capital Securities, by written notice to the Depositor and the Debenture Trustee, may rescind and annul such declaration and its consequences if: (i) the Depositor has paid or deposited with the Debenture Trustee a sum sufficient to pay: (A) all overdue installments of interest (including any Additional Interest as defined in the Indenture) on all of the Debentures, (B) the principal of (and premium, if any, on) any Debenture which have become due otherwise than by such declaration of acceleration and interest thereon at the rate borne by the Debentures, and (C) all sums paid or advanced by the Debenture Trustee under the Indenture and the reasonable compensation, expenses, disbursements and advances of the Debenture Trustee and the Property Trustee, their agents and counsel; and (ii) all Debenture Events of Default, other than the non-payment of the principal of the Debentures which has become due solely by such acceleration, have been cured or waived as provided in Section 513 of the Indenture. The holders of a majority in aggregate Liquidation Amount of the Capital Securities may, on behalf of the Holders of all the Capital Securities, waive any past default under the Indenture, except a default in the payment of principal of (or premium, if any) or interest (including any Additional Interest, as defined in the Indenture) on any Debenture (unless such default has been cured and a sum sufficient to pay all matured installments of interest (including any Additional Interest, as defined in the Indenture) and principal due otherwise than by acceleration (and premium, if any) has been deposited with the Debenture Trustee) or a default in respect of a covenant or provision which under the -26- Indenture cannot be modified or amended without the consent of the holder of each outstanding Debenture. No such rescissions shall affect any subsequent default or impair any right consequent thereon. Upon receipt by the Property Trustee of written notice declaring such an acceleration, or rescission and annulment thereof, by Holders of the Capital Securities all or part of which are represented by Book-Entry Capital Securities Certificates, a record date shall be established for determining Holders of Outstanding Capital Securities entitled to join in such notice, which record date shall be at the close of business on the day the Property Trustee receives such notice. The Holders on such record date, or their duly designated proxies, and only such Persons, shall be entitled to join in such notice, whether or not such Holders remain Holders after such record date; provided, that, unless such declaration of acceleration, or rescission and annulment, as the case may be, shall have become effective by virtue of the requisite percentage having joined in such notice prior to the day which is 90 days after such record date, such notice of declaration or acceleration, or rescission and annulment, as the case may be, shall automatically and without further action by any Holder be canceled and of no further effect. Nothing in this paragraph shall prevent a Holder, or a proxy of a Holder, from giving, after expiration of such 90-day period, a new written notice of declaration of acceleration, or rescission and annulment thereof, as the case may be, that is identical to a written notice which has been canceled pursuant to the proviso to the preceding sentence, in which event a new record date shall be established pursuant to the provisions of this Section 5.14(b). (c) For so long as any Capital Securities remain outstanding, to the fullest extent permitted by law and subject to the terms of this Trust Agreement and the Indenture, upon a Debenture Event of Default specified in Section 501(a) or 501(b) of the Indenture, any Holder of Capital Securities shall have the right to institute a proceeding directly against the Depositor, pursuant to Section 508 of the Indenture, for enforcement of payment to such Holder of the principal amount of (and premium, if any) or interest (including any Additional Interest, as defined in the Indenture) on the Debentures having a principal amount equal to the aggregate Liquidation Amount of the Capital Securities of such Holder (a "Direct Action"). Except as set forth in Section 5.14(b) and (c), the Holders of Capital Securities shall have no right to exercise directly any right or remedy available to the holders of, or in respect of, the Debentures. (d) Except as otherwise provided in paragraphs (a), (b) and (c) of this Section 5.14, the Holders of at least a Majority in Liquidation Amount of the Capital Securities may, on behalf of the Holders of all the Capital Securities, waive any past default or Event of Default and its consequences. Upon such waiver, any such default or Event of Default shall cease to exist, and any default or Event of Default arising therefrom shall be deemed to have been cured, for every purpose of this Trust Agreement, but no such waiver shall extend to any subsequent or other default or Event of Default or impair any right consequent thereon. -27- ARTICLE VI Acts of Securityholders; Meetings; Voting Section 6.01. Limitations on Voting Rights. ---------------------------- (a) Except as provided in this Section, in Section 10.03 and in the Indenture and as otherwise required by law, no Holder of Capital Securities shall have any right to vote or in any manner otherwise control the administration, operation and management of the Trust or the obligations of the parties hereto, nor shall anything herein set forth, or contained in the terms of the Trust Securities Certificates, be construed so as to constitute the Securityholders from time to time as partners or members of an association. (b) So long as any Debentures are held by the Property Trustee, the Trustees shall not (i) direct the time, method and place of conducting any proceeding for any remedy available to the Debenture Trustee, or executing any trust or power conferred on the Debenture Trustee with respect to such Debentures, (ii) waive any past default which is waivable under Section 513 of the Indenture, (iii) exercise any right to rescind or annul a declaration that the principal of all the Debentures shall be due and payable or (iv) consent to any amendment, modification or termination of the Indenture or the Debentures, where such consent shall be required, without, in each case, obtaining the prior approval of the Holders of at least a majority in Liquidation Amount of the Outstanding Capital Securities; provided, however, that where a consent under the Indenture would require the consent of each holder of Debentures affected thereby, no such consent shall be given by the Property Trustee without the prior written consent of each Holder of Capital Securities. The Trustees shall not revoke any action previously authorized or approved by a vote of the Holders of Capital Securities, except by a subsequent vote of the Holders of Capital Securities. The Property Trustee shall notify all Holders of the Capital Securities of any notice of default received from the Debenture Trustee. In addition to obtaining the foregoing approvals of the Holders of the Capital Securities, prior to taking any of the foregoing actions, the Trustees shall, at the expense of the Depositor, obtain an Opinion of Counsel experienced in such matters to the effect that such action shall not cause the Trust to be taxable as a corporation or classified as other than a grantor trust for United States federal income tax purposes on account of such action. (c) Except as provided in Section 10.03, if any proposed amendment to the Trust Agreement provides for, or the Trustees otherwise propose to effect, (i) any action that would adversely affect in any material respect the powers, preferences or special rights of the Capital Securities, whether by way of amendment to the Trust Agreement or otherwise, or (ii) the dissolution, winding- up or termination of the Trust, other than pursuant to the terms of this Trust Agreement, then the Holders of Outstanding Capital Securities as a class will be entitled to vote on such amendment or proposal and such amendment or proposal shall not be effective except with the approval of the Holders of at least a majority in Liquidation Amount of the Outstanding Capital Securities. No amendment to this Trust Agreement may be made if, as a result of such amendment, it would cause the trust to be taxable as a corporation or classified as other than a grantor trust for United States federal income tax purposes or would lose its exemption from status as an "investment company" under the Investment Company Act. -28- Section 6.02. Notice of Meetings. Notice of all meetings of the Capital ------------------ Securityholders, stating the time, place and purpose of the meeting, shall be given by the Administrative Trustees pursuant to Section 10.09 to each Capital Securityholder of record, at his registered address, at least 15 days and not more than 90 days before the meeting. At any such meeting, any business properly before the meeting may be so considered whether or not stated in the notice of the meeting. Any adjourned meeting may be held as adjourned without further notice. Any and all notices to which any Capital Securityholder hereunder may be entitled and any and all communications shall be deemed duly served or given if mailed, postage prepaid, addressed to any Capital Securityholder of record at his last known address as recorded on the Securities Register. Section 6.03. Meetings of Capital Securityholders. No annual meeting of ----------------------------------- Securityholders is required to be held. The Administrative Trustees, however, shall call a meeting of Securityholders to vote on any matter upon the written request of the Capital Securityholders of record of at least 25% in aggregate Liquidation Amount of the Outstanding Capital Securities and the Administrative Trustees or the Property Trustee may, at any time in their discretion, call a meeting of Capital Securityholders to vote on any matters as to the which Capital Securityholders are entitled to vote. Capital Securityholders of record of at least 50% in aggregate Liquidation Amount of the Outstanding Capital Securities present in person or by proxy, shall constitute a quorum at any meeting of Securityholders. If a quorum is present at a meeting, an affirmative vote by the Capital Securityholders of record present, in person or by proxy, holding at least a majority in aggregate Liquidation Amount of the Capital Securities held by the Capital Securityholders of record present, either in person or by proxy, at such meeting shall constitute the action of the Securityholders, unless this Trust Agreement requires a greater number of affirmative votes. Section 6.04. Voting Rights. Securityholders shall be entitled to one ------------- vote for each $1,000 of Liquidation Amount represented by their Trust Securities in respect of any matter as to which such Securityholders are entitled to vote. Section 6.05. Proxies, etc. At any meeting of Securityholders, any ------------- Securityholder entitled to vote thereat may vote by proxy, provided that no proxy shall be voted at any meeting unless it shall have been placed on file with the Administrative Trustees, or with such other officer or agent of the Trust as the Administrative Trustees may direct, for verification prior to the time at which such vote shall be taken. Pursuant to a resolution of the Property Trustee, proxies may be solicited in the name of the Property Trustee or one or more officers of the Property Trustee. Only Securityholders of record shall be entitled to vote. When Trust Securities are held jointly by several persons, any one of them may vote at any meeting in person or by proxy in respect of such Trust Securities, but if more than one of them shall be present at such meeting in person or by proxy, and such joint owners or their proxies so present disagree as to any vote to be cast, such vote shall not be received in respect of such Trust Securities. A proxy purporting to be executed by or on behalf of a Securityholder shall be deemed valid unless challenged at or prior to its -29- exercise, and the burden of proving invalidity shall rest on the challenger. No proxy shall be valid more than three years after its date of execution. Section 6.06. Securityholder Action by Written Consent. Any action which ---------------------------------------- may be taken by Securityholders at a meeting may be taken without a meeting if Securityholders holding at least a majority in aggregate Liquidation Amount of all Outstanding Trust Securities entitled to vote in respect of such action (or such larger proportion thereof as shall be required by any express provision of this Trust Agreement) shall consent to the action in writing. The Administrative Trustees shall cause a notice of any matter upon which action by written consent of the Securityholders is to be taken, to be given to each Holder of record of the Outstanding Capital Securities in the same manner as that set forth in Section 6.02 for notice of meetings. Section 6.07. Record Date for Voting and Other Purposes. For the purposes ----------------------------------------- of determining the Securityholders who are entitled to notice of and to vote at any meeting or by written consent, or to participate in any Distribution on the Trust Securities in respect of which a record date is not otherwise provided for in this Trust Agreement, or for the purpose of any other action, the Administrative Trustees or the Property Trustee may from time to time fix a date, not more than 90 days prior to the date of any meeting of Securityholders or the payment of Distribution or other action, as the case may be, as a record date for the determination of the identity of the Securityholders of record for such purposes. Section 6.08. Acts of Securityholders. Any request, demand, ----------------------- authorization, direction, notice, consent, waiver or other action provided or permitted by this Trust Agreement to be given, made or taken by Securityholders or Owners may be embodied in and evidenced by one or more instruments of substantially similar tenor signed by such Securityholders or Owners in person or by an agent duly appointed in writing; and, except as otherwise expressly provided herein, such action shall become effective when such instrument or instruments are delivered to an Administrative Trustee. Such instrument or instruments (and the action embodied therein and evidenced thereby) are herein sometimes referred to as the "Act" of the Securityholders or Owners signing such instrument or instruments. Proof of execution of any such instrument or of a writing appointing any such agent shall be sufficient for any purpose of this Trust Agreement and (subject to Section 8.01) conclusive in favor of the Trustees, if made in the manner provided in this Section. The fact and date of the execution by any Person of any such instrument or writing may be proved by the affidavit of a witness of such execution or by a certificate of a notary public or other officer authorized by law to take acknowledgments of deeds, certifying that the individual signing such instrument or writing acknowledged to him the execution thereof. Where such execution is by a signer acting in a capacity other than his individual capacity, such certificate or affidavit shall also constitute sufficient proof of his authority. The fact and date of the execution of any such instrument or writing, or the authority of the Person executing the same, may also be proved in any other manner which any Trustee receiving the same deems sufficient. The ownership of Trust Securities shall be proved by the Securities Register. -30- Any request, demand, authorization, direction, notice, consent, waiver or other Act of the Securityholder of any Trust Security shall bind every future Securityholder of the same Trust Security and the Securityholder of every Trust Security issued upon the registration of transfer thereof or in exchange therefor or in lieu thereof in respect of anything done, omitted or suffered to be done by the Trustees or the Trust in reliance thereon, whether or not notation of such action is made upon such Trust Security. Without limiting the foregoing, a Securityholder entitled hereunder to take any action hereunder with regard to any particular Trust Security may do so with regard to all or any part of the Liquidation Amount of such Trust Security or by one or more duly appointed agents each of which may do so pursuant to such appointment with regard to all or any part of such Liquidation Amount. If any dispute shall arise between the Securityholders of Trust Securities and the Administrative Trustees or among such Securityholders or Trustees with respect to the authenticity, validity or binding nature of any request, demand, authorization, direction, consent, waiver or other Act of such Securityholder or Trustee under this Article VI, then the determination of such matter by the Property Trustee shall be conclusive with respect to such matter. A Securityholder may institute a legal proceeding directly against the Depositor under the Guarantee to enforce its rights under the Guarantee without first instituting a legal proceeding against the Guarantee Trustee (as defined in the Guarantee), the Trust or any person or entity. Section 6.09. Inspection of Records. Upon reasonable notice to the --------------------- Administrative Trustees and the Property Trustee, the records of the Trust shall be open to inspection by Securityholders during normal business hours for any purpose reasonably related to such Securityholder's interest as a Securityholder. ARTICLE VII Representations and Warranties Section 7.01. Representations and Warranties of the Bank, the Property -------------------------------------------------------- Trustee and the Trustee. The Bank, the Property Trustee and the Trustee, each - ----------------------- severally on behalf of and as to itself, hereby represents and warrants as to itself only and for the benefit of the Depositor and the Securityholders that: (a) the Bank is a banking corporation duly organized, validly existing and in good standing under the laws of the State of New York; (b) the Bank has full corporate power, authority and legal right to execute, deliver and perform its obligations under this Trust Agreement and has taken all necessary action to authorize the execution, delivery and performance by it of this Trust Agreement; (c) the Trustee is a Delaware banking corporation; -31- (d) the Trustee has full corporate power, authority and legal right to execute, deliver and perform its obligations under this Trust Agreement and has taken all necessary action to authorize the execution, delivery and performance by it of this Trust Agreement. (e) this Trust Agreement has been duly authorized, executed and delivered by the Bank and the Trustee and constitutes the valid and legally binding agreement each of the Bank and the Trustee enforceable against each of them in accordance with its terms, subject to bankruptcy, insolvency, fraudulent transfer, reorganization, moratorium and similar laws of general applicability relating to or affecting creditors' rights and to general equity principles; (f) the execution, delivery and performance by the Bank of this Trust Agreement have been duly authorized by all necessary corporate and other action on the part of the Bank, the Trustee and the Property Trustee, and do not require any approval of stockholders of the Bank or the Trustee and such execution, delivery and performance will not (i) violate the Charter or By-laws of the Bank or the Trustee, (ii) violate any provision of, or constitute, with or without notice or lapse of time, a default under, or result in the creation or imposition of, any Lien on any properties included in the Trust Property pursuant to the provisions of, any indenture, mortgage, credit agreement, license or other agreement or instrument to which the Bank, the Property Trustee or the Trustee is a party or by which it is bound or (iii) violate any law, governmental rule or regulation of the State of New York, the State of Delaware or the United States governing the banking or trust powers of the Bank, the Trustee and the Property Trustee or any order, judgment or decree applicable to the Bank, the Property Trustee or the Trustee; (g) neither the authorization, execution or delivery by the Bank or the Trustee of this Trust Agreement nor the consummation of any of the transactions by the Bank, the Trustee or the Property Trustee contemplated herein or therein require the consent or approval of, the giving of notice to, the registration with or the taking of any other action with respect to any governmental authority or agency under any existing federal law governing the banking or trust powers of the Bank or under the laws of the United States, the State of Delaware or the State of New York; (h) there are no proceedings pending or, to the best of each of the Bank's and the Trustee's knowledge, threatened against or affecting the Bank, the Trustee or the Property Trustee in any court or before any governmental authority, agency or arbitration board or tribunal which, individually or in the aggregate, would materially and adversely affect the Trust or would question the right, power and authority of the Bank or the Trustee, as the case may be, to enter into or perform its obligations as one of the Trustees under this Trust Agreement; and (i) the principal place of business of the Trustee is located in the State of Delaware. Section 7.02. Representations and Warranties of Parent. The Parent ---------------------------------------- hereby represents and warrants for the benefit of the Securityholders that: (a) this Trust Agreement has been duly authorized, executed and delivered by Parent and constitutes the valid and legally binding agreement of Parent enforceable against Parent in accordance with its terms, subject to bankruptcy, insolvency, fraudulent -32- transfer, reorganization, moratorium and similar laws of general applicability relating to or affecting creditors' rights and to general equity principles; (b) the Trust Securities Certificates issued on the Closing Date on behalf of the Trust have been duly authorized and will have been, as of each such date, duly and validly executed, issued and delivered by the Trustees pursuant to the terms and provisions of, and in accordance with the requirements of, this Trust Agreement and the Securityholders will be, as of such date, entitled to the benefits of this Trust Agreement; and (c) there are no taxes, fees or other governmental charges payable by the Trust (or the Trustees on behalf of the Trust) under the laws of the State of Delaware or any political subdivision thereof in connection with the execution, delivery and performance by the Bank or the Property Trustee, as the case may be, of this Trust Agreement. ARTICLE VIII The Trustees Section 8.01. Certain Duties and Responsibilities. ----------------------------------- (a) The duties and responsibilities of the Trustees shall be as provided by this Trust Agreement and, in the case of the Property Trustee, by the Trust Indenture Act. Notwithstanding the foregoing, no provision of this Trust Agreement shall require the Trustees to expend or risk their own funds or otherwise incur any financial liability in the performance of any of their duties hereunder, or in the exercise of any of their rights or powers, if it shall have reasonable grounds for believing that repayment of such funds or adequate indemnity against such risk or liability is not reasonably assured to it. Whether or not therein expressly so provided, every provision of this Trust Agreement relating to the conduct or affecting the liability of or affording protection to the Trustees shall be subject to the provisions of this Section. Nothing in this Trust Agreement shall be construed to release an Administrative Trustee from liability for such Person's own negligent action, such Person's own negligent failure to act or such Person's own willful misconduct. To the extent that, at law or in equity, any Trustee has duties and liabilities relating to the Trust or to the Holders, such Trustee shall not be liable to the Trust or to any Holder for such Trustee's good faith reliance on the provisions of this Trust Agreement. The provisions of this Trust Agreement, to the extent that they restrict the duties and liabilities of the Trustees otherwise existing at law or in equity, are agreed by the Depositor and the Holders to replace such other duties and liabilities of the Trustees. (b) All payments made by the Property Trustee or a Paying Agent in respect of the Trust Securities shall be made only from the revenue and proceeds from the Trust Property and only to the extent that there shall be sufficient revenue or proceeds from the Trust Property to enable the Property Trustee or a Paying Agent to make payments in accordance with the terms hereof. Each Securityholder, by its acceptance of a Trust Security, agrees that it will look solely to the revenue and proceeds from the Trust Property to the extent legally available for distribution to it as herein provided and that -33- the Trustees are not personally liable to it for any amount distributable in respect of any Trust Security or for any other liability in respect of any Trust Security. This Section 8.01(b) does not limit the liability of the Trustees expressly set forth elsewhere in this Trust Agreement or, in the case of the Property Trustee, in the Trust Indenture Act. (c) The Property Trustee, before the occurrence of any Event of Default and after the curing of all Events of Default that may have occurred, shall undertake to perform only such duties as are specifically set forth in this Trust Agreement and no implied covenants shall be read into this Trust Agreement against the Property Trustee. In case an Event of Default has occurred (that has not been cured or waived), the Property Trustee shall exercise such of the rights and powers vested in it by this Trust Agreement, and use the same degree of care and skill in their exercise, as a prudent person would exercise or use under the circumstances in the conduct of his own affairs. (d) No provision of this Trust Agreement shall be construed to relieve the Property Trustee from liability for its own negligent action, its own negligent failure to act or its own willful misconduct, except that: (i) the Property Trustee shall not be liable for any error of judgment made in good faith by an authorized officer of the Property Trustee, unless it shall be proved that the Property Trustee was negligent in ascertaining the pertinent facts; (ii) the Property Trustee shall not be liable with respect to any action taken or omitted to be taken by it in good faith in accordance with the direction of the Holders of not less than a majority in Liquidation Amount of the Capital Securities relating to the time, method and place of conducting any proceeding for any remedy available to the Property Trustee, or exercising any trust or power conferred upon the Property Trustee under this Trust Agreement; (iii) the Property Trustee's sole duty with respect to the custody, safe keeping and physical preservation of the Debentures and the Payment Account shall be to deal with such property in a similar manner as the Property Trustee deals with similar property for its own account, subject to the protections and limitations on liability afforded to the Property Trustee under this Trust Agreement and the Trust Indenture Act; (iv) the Property Trustee shall not be liable for any interest on any money received by it except as it may otherwise agree with the Depositor. Money held by the Property Trustee need not be segregated from other funds held by it except in relation to the Payment Account maintained by the Property Trustee pursuant to Section 3.01 and except to the extent otherwise required by law; and (v) the Property Trustee shall not be responsible for monitoring the compliance by the Administrative Trustees or the Depositor with their respective duties under this Trust Agreement, nor shall the Property Trustee be liable for the default or misconduct of the Administrative Trustees or the Depositor. -34- Section 8.02. Certain Notices. --------------- Within five Business Days after the occurrence of any Event of Default, the Property Trustee shall transmit, in the manner and to the extent provided in Section 10.09, notice of any Event of Default actually known to the Property Trustee to the Securityholders, the Administrative Trustees and the Depositor, unless such Event of Default shall have been cured or waived. Within five Business Days after the receipt of notice of the Depositor's exercise of its right to defer the payment of interest on the Debentures pursuant to the Indenture, the Administrative Trustees shall transmit, in the manner and to the extent provided in Section 10.09, notice of such exercise to the Securityholders and the Property Trustee, unless such exercise shall have been revoked. Section 8.03. Certain Rights of Property Trustee. Subject to the ---------------------------------- provisions of Section 8.01 and except as provided by law: (a) the Property Trustee may rely and shall be protected in acting or refraining from acting in good faith upon any resolution, Opinion of Counsel, certificate, written representation of a Holder or transferee, certificate of auditors or any other certificate, statement, instrument, opinion, report, notice, request, consent, order, appraisal, bond, debenture, note, other evidence of indebtedness or other paper or document believed by it to be genuine and to have been signed or presented by the proper party or parties; (b) if (i) in performing its duties under this Trust Agreement the Property Trustee is required to decide between alternative courses of action or (ii) in construing any of the provisions in this Trust Agreement the Property Trustee finds the same ambiguous or inconsistent with any other provisions contained herein or (iii) the Property Trustee is unsure of the application of any provision of this Trust Agreement, then, except as to any matter as to which the Capital Securityholders are entitled to vote under the terms of this Trust Agreement, the Property Trustee shall deliver a notice to the Depositor requesting written instructions of the Depositor as to the course of action to be taken. The Property Trustee shall take such action, or refrain from taking such action, as the Property Trustee shall be instructed in writing to take, or to refrain from taking, by the Depositor; provided, however, that if the Property Trustee does not receive such instructions of the Depositor within ten Business Days after it has delivered such notice, or such reasonably shorter period of time set forth in such notice (which to the extent practicable shall not be less than two Business Days), it may, but shall be under no duty to, take or refrain from taking such action not inconsistent with this Trust Agreement as it shall deem advisable and in the best interests of the Securityholders, in which event the Property Trustee shall have no liability except for its own bad faith, negligence or willful misconduct; (c) any direction or act of the Depositor or the Administrative Trustees contemplated by this Trust Agreement shall be sufficiently evidenced by an Officer's Certificate; (d) whenever in the administration of this Trust Agreement, the Property Trustee shall deem it desirable that a matter be established before undertaking, suffering or -35- omitting any action hereunder, the Property Trustee (unless other evidence is herein specifically prescribed) may, in the absence of bad faith on its part, request and rely upon an Officer's Certificate which, upon receipt of such request, shall be promptly delivered by the Depositor or the Administrative Trustees; (e) the Property Trustee shall have no duty to see to any recording, filing or registration of any instrument (including any financing or continuation statement or any filing under tax or securities laws) or any rerecording, refiling or reregistration thereof; (f) the Property Trustee may (at the expense of the Depositor) consult with counsel (which counsel may be counsel to the Depositor or any of its Affiliates, and may include any of its employees) and the written advice of such counsel shall be full and complete authorization and protection in respect of any action taken, suffered or omitted by it hereunder in good faith and in reliance thereon; the Property Trustee shall have the right at any time to seek instructions concerning the administration of this Trust Agreement from any court of competent jurisdiction; (g) the Property Trustee shall be under no obligation to exercise any of the rights or powers vested in it by this Trust Agreement at the request or direction of any of the Securityholders pursuant to this Trust Agreement, unless such Securityholders shall have offered to the Property Trustee reasonable security or indemnity against the costs, expenses and liabilities which might be incurred by it in compliance with such request or direction; (h) the Property Trustee shall not be bound to make any investigation into the facts or matters stated in any resolution, certificate, statement, instrument, opinion, report, notice, request, consent, order, approval, bond, debenture, note or other evidence of indebtedness or other paper or document, unless requested in writing to do so by one or more Securityholders, but the Property Trustee may make such further inquiry or investigation into such facts or matters as it may see fit; (i) the Property Trustee may execute any of the trusts or powers hereunder or perform any duties hereunder either directly or by or through its agents or attorneys, provided that the Property Trustee shall be responsible for its own negligence or misconduct with respect to selection of any agent or attorney appointed by it hereunder; (j) whenever in the administration of this Trust Agreement the Property Trustee shall deem it desirable to receive instructions with respect to enforcing any remedy or right or taking any other action hereunder, the Property Trustee (i) may request instructions from the Holders of the Trust Securities which instructions may only be given by the Holders of the same proportion in Liquidation Amount of the Trust Securities as would be entitled to direct the Property Trustee under the terms of the Trust Securities in respect of such remedy, right or action, (ii) may refrain from enforcing such remedy or right or taking such other action until such instructions are received and (iii) shall be protected in acting in accordance with such instructions; and (k) except as otherwise expressly provided by this Trust Agreement, the Property Trustee shall not be under any obligation to take any action that is discretionary under the provisions of this Trust Agreement. -36- No provision of this Trust Agreement shall be deemed to impose any duty or obligation on the Property Trustee to perform any act or acts or exercise any right, power, duty or obligation conferred or imposed on it, in any jurisdiction in which it shall be illegal, or in which the Property Trustee shall be unqualified or incompetent in accordance with applicable law, to perform any such act or acts, or to exercise any such right, power, duty or obligation. No permissive power or authority available to the Property Trustee shall be construed to be a duty. Section 8.04. Not Responsible for Recitals or Issuance of Securities. The ------------------------------------------------------ recitals contained herein and in the Trust Securities Certificates shall be taken as the statements of the Trust and the Depositor, and the Trustees do not assume any responsibility for their correctness. The Trustees shall not be accountable for the use or application by the Depositor of the proceeds of the Debentures. Section 8.05. May Hold Securities. Except as provided in the definition ------------------- of the term "Outstanding" in Article I, any Trustee or any other agent of any Trustee or the Trust, in its individual or any other capacity, may become the owner or pledgee of Trust Securities and, subject to Sections 8.8 and 8.13, may otherwise deal with the Trust with the same rights it would have if it were not a Trustee or such other agent. Section 8.06. Compensation; Indemnity; Fees. ----------------------------- The Trust shall: (a) pay to the Trustees from time to time reasonable compensation for all services rendered by them hereunder and in the case of the Property Trustee, such compensation as is separately agreed by the Depositor and the Property Trustee (which compensation shall not be limited by any provision of law in regard to the compensation of a trustee of an express trust); and (b) except as otherwise expressly provided herein, reimburse the Trustees upon request for all reasonable expenses, disbursements and advances incurred or made by the Trustees in accordance with any provision of this Trust Agreement (including the reasonable compensation and the expenses and disbursements of its agents and counsel), except any such expense, disbursement or advance as may be attributable to its negligence or bad faith. The Depositor agrees to indemnify each of the Trustees or any predecessor Trustee for, and to hold the Trustees harmless against, any loss, damage, claims, liability, tax, penalty or expense of any kind and nature whatsoever incurred without negligence or bad faith on its part, arising out of or in connection with the acceptance or administration of this Trust Agreement, including the costs and expenses of defending itself against any claim or liability in connection with the exercise or performance of any of its powers or duties hereunder. The provisions of this Section 8.06 shall survive the termination of this Trust Agreement. No Trustee or Paying Agent may claim any lien on any Trust Property as a result of any amount due pursuant to this Section 8.06. -37- Section 8.07. Corporate Property Trustee Required; Eligibility of --------------------------------------------------- Trustees. (a) There shall at all times be a Property Trustee hereunder with respect to the Trust Securities. The Property Trustee shall be a Person that is a national or state chartered bank and eligible pursuant to the Trust Indenture Act to act as such and has a combined capital and surplus of at least $50,000,000. If any such Person publishes reports of condition at least annually, pursuant to law or to the requirements of its supervising or examining authority, then for the purposes of this Section and to the extent permitted by the Trust Indenture Act, the combined capital and surplus of such Person shall be deemed to be its combined capital and surplus as set forth in its most recent report of condition so published. If at any time the Property Trustee with respect to the Trust Securities shall cease to be eligible in accordance with the provisions of this Section, it shall resign immediately in the manner and with the effect hereinafter specified in this Article. (b) There shall at all times be one or more Administrative Trustees hereunder with respect to the Trust Securities. Each Administrative Trustee shall be either a natural person who is at least 21 years of age or a legal entity that shall act through one or more persons authorized to bind that entity. (c) There shall at all times be a Trustee with respect to the Trust Securities that shall either be (i) a natural person who is at least 21 years of age and a resident of the State of Delaware or (ii) a legal entity with its principal place of business in the State of Delaware and that otherwise meets the requirements of applicable Delaware law that shall act through one or more persons authorized to bind such entity. Section 8.08. Conflicting Interests. --------------------- (a) If the Property Trustee has or shall acquire a conflicting interest within the meaning of the Trust Indenture Act, the Property Trustee shall either eliminate such interest or resign, to the extent and in the manner provided by, and subject to the provisions of, the Trust Indenture Act and this Trust Agreement. (b) The Guarantee Agreement and the Indenture shall be deemed to be specifically described in this Trust Agreement for the purposes of clause (i) of the first proviso contained in Section 310(b) of the Trust Indenture Act. Section 8.09. Co-Trustees and Separate Trustee. Unless an Event of -------------------------------- Default shall have occurred and be continuing, at any time or times, for the purpose of meeting the legal requirements of the Trust Indenture Act or of any jurisdiction in which any part of the Trust Property may at the time be located, the Depositor and the Administrative Trustees, by agreed action of the majority of such Trustees, shall have power to appoint, and upon the written request of the Administrative Trustees, the Depositor shall for such purpose join with the Administrative Trustees in the execution, delivery and performance of all instruments and agreements necessary or proper to appoint one or more Persons approved by the Property Trustee either to act as co-trustee, jointly with the Property Trustee, of all or any part of such Trust Property, or to the extent required by law, to act as separate trustee of any such property, in either case with such powers as may be provided in the instrument of appointment, and to vest in such Person or -38- Persons in the capacity aforesaid, any property, title, right or power deemed necessary or desirable, subject to the other provisions of this Trust Agreement. If the Depositor does not join in such appointment within 15 days after the receipt by it of a request so to do, or in case a Debenture Event of Default has occurred and is continuing, the Property Trustee alone shall also have the power to make such appointment. Any co-trustee or separate trustee appointed pursuant to this Section shall satisfy the requirements of Section 8.07. Should any written instrument from the Depositor be required by any co- trustee or separate trustee so appointed for more fully confirming to such co- trustee or separate trustee such property, title, right or power, any and all such instruments shall, on request, be executed, acknowledged and delivered by the Depositor. Every co-trustee or separate trustee shall, to the extent permitted by law, but to such extent only, be appointed subject to the following terms, namely: (a) The Trust Securities shall be executed by one or more Administrative Trustees, and the Trust Securities shall be delivered by the Property Trustee, and all rights, powers, duties and obligations hereunder in respect of the custody of securities, cash and other personal property held by, or required to be deposited or pledged with, the Trustees specified hereunder, shall be exercised solely by such Trustees and not by such co-trustee or separate trustee. (b) The rights, powers, duties, and obligations hereby conferred or imposed upon the Property Trustee in respect of any property covered by such appointment shall be conferred or imposed upon and exercised or performed by the Property Trustee or by the Property Trustee and such co-trustee or separate trustee jointly, as shall be provided in the instrument appointing such co-trustee or separate trustee, except to the extent that under any law of any jurisdiction in which any particular act is to be performed, the Property Trustee shall be incompetent or unqualified to perform such act, in which event such rights, powers, duties and obligations shall be exercised and performed by such co- trustee or separate trustee. (c) The Property Trustee at any time, by an instrument in writing executed by it, with the written concurrence of the Depositor, may accept the resignation of or remove any co-trustee or separate trustee appointed under this Section, and, in case a Debenture Event of Default has occurred and is continuing, the Property Trustee shall have power to accept the resignation of, or remove, any such co-trustee or separate trustee without the concurrence of the Depositor. Upon the written request of the Property Trustee, the Depositor shall join with the Property Trustee in the execution, delivery and performance of all instruments and agreements necessary or proper to effectuate such resignation or removal. A successor to any co-trustee or separate trustee so resigned or removed may be appointed in the manner provided in this Section. (d) No co-trustee or separate trustee hereunder shall be personally liable by reason of any act or omission of the Property Trustee or any other trustee hereunder. (e) The Property Trustee shall not be liable by reason of any act of a co- trustee or separate trustee. -39- (f) Any Act of Holders delivered to the Property Trustee shall be deemed to have been delivered to each such co-trustee and separate trustee. Section 8.10. Resignation and Removal; Appointment of Successor. No ------------------------------------------------- resignation or removal of any Trustee (the "Relevant Trustee") and no appointment of a successor Relevant Trustee pursuant to this Article shall become effective until the acceptance of appointment by the successor Relevant Trustee in accordance with the applicable requirements of Section 8.11. Subject to the immediately preceding paragraph, the Relevant Trustee may resign at any time with respect to the Trust Securities by giving written notice thereof to the Securityholders. If the instrument of acceptance by a successor Relevant Trustee required by Section 8.11 shall not have been delivered to the Relevant Trustee within 30 days after the giving of such notice of resignation, the resigning Relevant Trustee may petition, at the expense of the Trust, any court of competent jurisdiction for the appointment of a successor Relevant Trustee with respect to the Trust Securities. Subject to the following sentence, any of the Trustees may be removed at any time by Act of the Common Securityholder. The Holders of at least a Majority in Liquidation Amount of the Outstanding Securities may remove the Property Trustee or the Trustee, or both of them, for cause, or if a Debenture Event of Default shall have occurred and be continuing, the Property Trustee or the Trustee, as the case may be, may be removed at such time by Act of the Holders of a Majority in Liquidation Amount of the Outstanding Capital Securities with or without cause, delivered to the Property Trustee (in its individual capacity and on behalf of the Trust). An Administrative Trustee may be removed by the Common Securityholder at any time. If the Relevant Trustee shall resign, be removed or become incapable of continuing to act as Relevant Trustee, or if a vacancy shall occur in the office of any Trustee for any cause, at a time when no Debenture Event of Default shall have occurred and be continuing, the Common Securityholder, by Act of the Common Securityholder delivered to the retiring Relevant Trustee, shall promptly appoint a successor Relevant Trustee or Trustees with respect to the Trust Securities and the Trust, and the retiring Relevant Trustee shall comply with the applicable requirements of Sec tion 8.11. If the Property Trustee shall resign, be removed or become incapable of continuing to act as the Property Trustee at a time when a Debenture Event of Default shall have occurred and be continuing, the Capital Securityholders, by Act of the Securityholders of a majority in Liquidation Amount of the Capital Securities then Out standing delivered to the retiring Relevant Trustee, shall promptly appoint a successor Relevant Trustee or Trustees with respect to the Trust Securities and the Trust, and such successor Trustee shall comply with the applicable requirements of Section 8.11. If an Administrative Trustee shall resign, be removed or become incapable of continuing to act as Administrative Trustee at a time when a Debenture Event of Default shall have occurred and be continuing, the Common Securityholder may appoint a successor Administrative Trustee, which successor Trustee shall comply with the applicable requirements of Section 8.11 or the Common Securityholder may reduce the number of Administrative Trustees pursuant to Section 8.17(a). If no successor Relevant Trustee with respect to the Trust Securities shall have been so appointed by the Common Securityholder or the Capital Securityholders and accepted appointment in the manner -40- required by Section 8.11, any Securityholder who has been a Securityholder of Trust Securities for at least six months may, on behalf of himself and all others similarly situated, petition any court of competent jurisdiction for the appointment of a successor Relevant Trustee with respect to the Trust Securities. The Property Trustee shall give notice of each resignation and each removal of the Property Trustee with respect to the Trust Securities and the Trust and each appointment of a successor Property Trustee with respect to the Trust Securities and the Trust to all Securityholders in the manner provided in Section 10.09 and shall give notice to the Depositor. Each notice shall include the name of the successor Property Trustee with respect to the Trust Securities and the Trust and the address of its Corporate Trust Office. Notwithstanding the foregoing or any other provision of this Trust Agreement, in the event any Administrative Trustee, a Trustee or a Property Trustee who is a natural person dies or becomes incompetent or incapacitated, the vacancy created by such death, incompetence or incapacity may be filled by (a) the unanimous act of the remaining Administrative Trustees if there are at least two of them prior to such vacancy or (b) otherwise by the Depositor (with the successor in each case being an individual who satisfies the eligibility requirement for Administrative Trustees set forth in Section 8.07). Additionally, notwithstanding the foregoing or any other provision of this Trust Agreement, in the event the Depositor believes that any Administrative Trustee or a Property Trustee who is a natural person, as the case may be, has become incompetent or incapacitated, the Depositor, by notice to the remaining Trustees, may terminate the status of such Person as an Administrative Trustee or a Property Trustee, as the case may be (in which case the vacancy so created will be filled in accordance with the preceding sentence). Section 8.11. Acceptance of Appointment by Successor. In case of the -------------------------------------- appointment hereunder of a successor Relevant Trustee with respect to the Trust Securities and the Trust, every such successor Relevant Trustee so appointed shall execute, acknowledge and deliver to the Trust and to the retiring Relevant Trustee an instrument accepting such appointment, and thereupon the resignation or removal of the retiring Relevant Trustee shall become effective and such successor Relevant Trustee, without any further act, deed or conveyance, shall become vested with all the rights, powers, trusts and duties of the retiring Relevant Trustee; but, on the request of the Depositor or the successor Relevant Trustee, such retiring Relevant Trustee shall, upon payment of its charges, execute and deliver an instrument transferring to such successor Relevant Trustee all the rights, powers and trusts of the retiring Relevant Trustee and shall duly assign, transfer and deliver to such successor Relevant Trustee all property and money held by such retiring Relevant Trustee hereunder. In case of the appointment hereunder of a successor Relevant Trustee with respect to the Trust Securities and the Trust, the retiring Relevant Trustee and each successor Relevant Trustee with respect to the Trust Securities shall execute and deliver an amendment hereto wherein each successor Relevant Trustee shall accept such appointment and which (a) shall contain such provisions as shall be necessary or desirable to transfer and confirm to, and to vest in, each successor Relevant Trustee all the rights, powers, trusts and duties of the retiring Relevant Trustee with respect to the -41- Trust Securities and the Trust and (b) shall add to or change any of the provisions of this Trust Agreement as shall be necessary to provide for or facilitate the administration of the trusts hereunder by more than one Relevant Trustee, it being understood that nothing herein or in such amendment shall constitute such Relevant Trustees co-trustees of the same trust and that each such Relevant Trustee shall be trustee of a trust or trusts hereunder separate and apart from any trust or trusts hereunder administered by any other such Relevant Trustee and upon the execution and delivery of such amendment the resignation or removal of the retiring Relevant Trustee shall become effective to the extent provided therein and each such successor Relevant Trustee, without any further act, deed or conveyance, shall become vested with all the rights, powers, trusts and duties of the retiring Relevant Trustee with respect to the Trust Securities and the Trust; but, on request of the Trust or any successor Relevant Trustee, such retiring Relevant Trustee shall duly assign, transfer and deliver to such successor Relevant Trustee all Trust Property, all proceeds thereof and money held by such retiring Relevant Trustee hereunder with respect to the Trust Securities and the Trust. Upon request of any such successor Relevant Trustee, the Trust shall execute any and all instruments for more fully and certainly vesting in and confirming to such successor Relevant Trustee all such rights, powers and trusts referred to in the first or second preceding paragraph, as the case may be. No successor Relevant Trustee shall accept its appointment unless at the time of such acceptance such successor Relevant Trustee shall be qualified and eligible under this Article. Section 8.12. Merger, Conversion, Consolidation or Succession to Business ----------------------------------------------------------- of a Trustee. Any Person into which the Property Trustee, Trustee or any - ------------ Administrative Trustee which is not a natural person may be merged or converted or with which it may be consolidated, or any Person resulting from any merger, conversion or consolidation to which such Relevant Trustee shall be a party, or any Person succeeding to all or substantially all the corporate trust business of any such Relevant Trustee, shall be the successor of such Relevant Trustee hereunder, provided such Person shall be otherwise qualified and eligible under this Article, without the execution or filing of any paper or any further act on the part of any of the parties hereto. Section 8.13. Preferential Collection of Claims Against Depositor or the ---------------------------------------------------------- Trust. If and when the Property Trustee shall be or become a creditor of the - ----- Depositor of the Trust (or any other obligor upon the Capital Securities), the Property Trustee shall be subject to the provisions of the Trust Indenture Act regarding the collection of claims against the Depositor or the Trust ( or any such other obligor). Section 8.14. Reports by Property Trustee. --------------------------- (a) Within 90 days after December 31 of each year commencing with December 31, 1998, the Property Trustee shall transmit by mail to all Securityholders, as their names and addresses appear in the Securities Register, and to the Depositor, a brief report dated as of such December 31 with respect to: -42- (i) its eligibility under Section 8.07 or, in lieu thereof, if to the best of its knowledge it has continued to be eligible under said Section, a written statement to such effect; (ii) a statement that the Property Trustee has complied with all of its obligations under this Trust Agreement during the twelve-month period (or, in the case of the initial report, the period since the Closing Date) ending with such December 31 or, if the Property Trustee has not complied in any material respect with such obliga tions, a description of such non-compliance; and (iii) any change in the property and funds in its possession as Property Trustee since the date of its last report and any action taken by the Property Trustee in the performance of its duties hereunder which it has not previously reported and which in its opinion materially affects the Trust Securities. (b) In addition, the Property Trustee shall transmit to Securityholders such reports concerning the Property Trustee and its actions under this Trust Agreement as may be required pursuant to the Trust Indenture Act at the times and in the manner provided pursuant thereto. (c) A copy of each such report shall, at the time of such transmission to Holders, be filed by the Property Trustee with each stock exchange, the Nasdaq National Market or such other interdealer quotation system or self-regulatory organization upon which the Trust Securities are listed or traded, if any, with the Commission and with the Depositor. Section 8.15. Reports to the Property Trustee. Each of the Depositor and ------------------------------- the Administrative Trustees on behalf of the Trust shall provide to the Property Trustee such documents, reports and information as required by Section 314 of the Trust Indenture Act (if any) and the compliance certificate required by Section 314 of the Trust Indenture Act in the form, in the manner and at the times required by Section 314 of the Trust Indenture Act. The Depositor and the Administrators shall annually file with the Property Trustee a certificate specifying whether such Person is in compliance with all the terms and covenants applicable to such Person thereunder. Section 8.16. Evidence of Compliance with Conditions Precedent. Each of ------------------------------------------------ the Depositor and the Administrative Trustees on behalf of the Trust shall provide to the Property Trustee such evidence of compliance with any conditions precedent, if any, provided for in this Trust Agreement that relate to any of the matters set forth in Section 314(c) of the Trust Indenture Act. Any certificate or opinion required to be given by an officer pursuant to Section 314(c)(1) of the Trust Indenture Act may be given in the form of an Officers' Certificate. Section 8.17. Number of Trustees. ------------------ (a) The number of Trustees shall be four, provided that the Depositor, by written instrument, may increase or decrease the number of Administrative Trustees. -43- (b) If a Trustee ceases to hold office for any reason and the number of Administrative Trustees is not reduced pursuant to Section 8.17(a), or if the number of Trustees is increased pursuant to Section 8.17(a), a vacancy shall occur. The vacancy shall be filled with a Trustee appointed in accordance with Section 8.10. (c) The death, resignation, retirement, removal, bankruptcy, incompetence or incapacity to perform the duties of a Trustee shall not operate to annul, dissolve or terminate the Trust. Whenever a vacancy in the number of Administrative Trustees shall occur, until such vacancy is filled by the appointment of an Administrative Trustee in accordance with Section 8.10, the Administrative Trustees in office, regardless of their number (and notwithstanding any other provision of this Agreement), shall have all the powers granted to the Administrative Trustees and shall discharge all the duties imposed upon the Administrative Trustees by this Trust Agreement. Section 8.18. Delegation of Power. ------------------- (a) Any Administrative Trustee may, by power of attorney consistent with applicable law, delegate to any other natural person over the age of 21 his or her power for the purpose of executing any documents contemplated in Section 2.07(a), including any registration statement or amendment thereto filed with the Commission or making any other governmental filing; and (b) The Administrative Trustees shall have power to delegate from time to time to such of their number or to the Depositor the doing of such things and the execution of such instruments either in the name of the Trust or the names of the Administrative Trustees or otherwise as the Administrative Trustees may deem expedient, to the extent such delegation is not prohibited by applicable law or contrary to the provisions of the Trust, as set forth herein. ARTICLE IX Termination and Liquidation Section 9.01. Termination Upon Expiration Date. The Trust shall -------------------------------- automatically terminate on (_______________________, 2053), (the "Expiration Date") following the distribution of the Trust Property in accordance with Section 9.04. Section 9.02. Early Termination. Upon the first to occur of any of the ----------------- following events (such first occurrence, an "Early Termination Event"): (a) the occurrence of a Bankruptcy Event in respect of, or the dissolution or liquidation of, the Depositor; (b) the written direction to the Property Trustee from the Depositor at any time (which direction is optional and wholly within the discretion of the Depositor) to terminate the Trust and distribute the Debentures to the Securityholders in exchange for the Trust Securities; -44- (c) the redemption of all of the Capital Securities in connection with the redemption of all of the Debentures; and (d) the entry of an order for dissolution of the Trust shall have been entered by a court of competent jurisdiction, then the Trustees shall take such action as is required by Section 4.02 or Section 9.04, as applicable, and as soon as practicable after the occurrence of any event referred to in this Section 9.02, the Trustees shall cause to be filed a certificate of cancellation relating to the Trust with the Secretary of State of the State of Delaware. Section 9.03. Termination. The respective obligations and ----------- responsibilities of the Trustees and the Trust created and continued hereby shall terminate upon the latest to occur of the following: (a) the distribution by the Property Trustee to Securityholders upon the liquidation of the Trust pursuant to Section 9.04, or upon the redemption of all of the Trust Securities pursuant to Section 4.02, of all amounts required to be distributed hereunder upon the final payment of the Trust Securities; (b) the payment of any expenses owed by the Trust and (c) the discharge of all administrative duties of the Administrative Trustees, including the performance of any tax reporting obligations with respect to the Trust or the Securityholders. Section 9.04. Liquidation. ----------- (a) If an Early Termination Event specified in clauses (a), (b) or (d) of Section 9.02 occurs or immediately prior to the Expiration Date specified in Section 9.01, the Trust shall be liquidated by the Trustees as expeditiously as the Trustees determine to be possible by distributing, after satisfaction of liabilities to creditors of the Trust as provided by applicable law, to each Securityholder a Like Amount of the Debentures, subject to Section 9.04(d). Notice of liquidation shall be given by the Administrative Trustees by first- class mail, postage prepaid, mailed not later than 30 nor more than 60 days prior to the Liquidation Date to each Holder of Trust Securities at such Holder's address appearing in the Securities Register. All notices of liquidation shall: (i) state the Liquidation Date; (ii) state that from and after the Liquidation Date, the Trust Securities will no longer be deemed to be Outstanding and any Trust Securities Certificates not surrendered for exchange will be deemed to represent a Like Amount of the Debentures; and (iii) provide such information with respect to the mechanics by which Holders may exchange Trust Securities Certificates for the Debentures, or if Section 9.04(d) applies, receive a Liquidation Distribution, as the Administrative Trustees or the Property Trustee shall deem appropriate. (b) Except where Sections 9.02(c) or 9.04(d) apply, in order to effect the liquidation of the Trust and distribution of the Debentures to Securityholders, the Property Trustee shall establish a record date for such distribution (which shall be not more than 45 days prior to the Liquidation Date) and, either itself acting as exchange -45- agent or through the appointment of a separate exchange agent, shall establish such procedures as it shall deem appropriate to effect the distribution of the Debentures in exchange for the Outstanding Trust Securities Certificates. (c) Except where Sections 9.02 (c) or 9.04(d) apply, after the Liquidation Date, (i) the Trust Securities will no longer be deemed to be Outstanding, (ii) The Depository Trust Company ("DTC") or its nominee, as the record Holder of the Capital Securities, will receive a registered global certificate or certificates representing the Debentures to be delivered upon such distribution, (iii) any Capital Securities Certificates not held by DTC or its nominee will be deemed to represent a Like Amount of the Debentures, bearing accrued and unpaid interest in an amount equal to the accumulated and unpaid Distributions on such Trust Certificates until such certificates are so surrendered (and until such certificates are so surrendered, no payments or interest or principal will be made to Holders of Trust Securities Certificates with respect to such Debentures), (iv) certificates representing a Like Amount of the Debentures will be issued to the Holder of the Common Securities Certificates, upon surrender of such certificates to the Administrative Trustees or their agent for exchange, (v) all rights of Securityholders holding Trust Securities will cease, except the right of such Securityholders to receive the Debentures upon surrender of Trust Securities Certificates and (vi) the Depositor shall use its reasonable efforts to have the Debentures listed on the New York Stock Exchange or on such other exchange, interdealer quotation system or self-regulatory organization as the Capital Securities are then listed, if any. (d) In the event that, notwithstanding the other provisions of this Section 9.04, whether because of an order for dissolution entered by a court of competent jurisdiction or payment at the stated maturity thereof of all principal of and interest on the Debentures or otherwise, distribution of the Debentures in the manner provided herein is determined by the Property Trustee not to be practical, the Trust Property shall be liquidated, and the Trust shall be dissolved, wound-up or terminated, by the Property Trustee in such manner as the Property Trustee determines. In such event, on the date of the dissolution, winding-up or other termination of the Trust, Securityholders will be entitled to receive out of the assets of the Trust available for distribution to Securityholders, after satisfaction of liabilities to creditors, an amount equal to the Liquidation Amount per Trust Security plus accumulated and unpaid Distributions thereon to the date of payment (such amount being the "Liquidation Distribution"). If, upon any such dissolution, winding up or termination, the Liquidation Distribution can be paid only in part because the Trust has insufficient assets available to pay in full the aggregate Liquidation Distribution, then, subject to the next succeeding sentence, the amounts payable by the Trust on the Trust Securities shall be paid on a pro rata basis (based upon Liquidation Amounts). The Holder of the Common Securities will be entitled to receive Liquidation Distributions upon any such dissolution, winding-up or termination pro rata (determined as aforesaid) with Holders of Capital Securities, except that, if an Event of Default specified in Sections 501(a) or 501(b) of the Indenture has occurred and is continuing, the Capital Securities shall have a priority over the Common Securities. In the event the Capital Securities are issued in certificated form, the Liquidation Distribution will be payable at (i) the Corporate Trust Office of the Property Trustee, (ii) the principal office of any Paying Agent or (iii) the principal office of the Securities Registrar and Transfer Agent; provided that payment of any Liquidation Distribution may be made, at the option of the Administrative Trustees, by -46- check mailed to the address of the Person entitled thereto as such address shall appear on the Securities Register or by wire transfer in immediately available funds at such place and to such place and to such account as may be designated by the Person entitled thereto as specified in the Securities Register. Section 9.05. Merger, Consolidation, Amalgamation or Replacement of the --------------------------------------------------------- Trust. - ----- The Trust may not merge, consolidate or amalgamate with or into, or be replaced by, or convey, transfer or lease its properties and assets substantially as an entirety to any corporation or other Person, except pursuant to this Section 9.05. At the request of the Depositor, with the consent of the Administrative Trustees and with the consent of the Holders of at least a Majority in Liquidation Amount of the Capital Securities or the Property Trustee, the Trust may merge, consolidate or amalgamate with or into, or be replaced by or convey, transfer or lease its properties and assets substantially as an entirety to a trust organized as such under the laws of any State; provided, that (a) such successor entity either (i) expressly assumes all of the obligations of the Trust with respect to the Capital Securities or (ii) substitutes for the Capital Securities other securities having substantially the same terms as the Capital Securities (the "Successor Securities") so long as the Successor Securities rank the same as the Capital Securities rank in priority with respect to distributions and payments upon liquidation, redemption and otherwise, (b) the Depositor expressly appoints a trustee of such successor entity possessing the same powers and duties as the Property Trustee as the holder of the Debentures, (c) the Successor Securities are listed or quoted, or any Successor Securities will be listed or quoted upon notification of issuance, on any national securities exchange, Nasdaq or other organization on which the Capital Securities are then quoted or listed, if any, (d) such merger, consolidation, amalgamation, replacement, conveyance, transfer or lease does not cause the Capital Securities (including any Successor Securities) to be downgraded by any nationally recognized statistical rating organization, (e) such merger, consolidation, amalgamation, replacement, conveyance, transfer or lease does not adversely affect the rights, preferences and privileges of the Holders of the Capital Securities (including any Successor Securities) in any material respect, (f) such successor entity has a purpose substantially identical to that of the Trust, (g) prior to such merger, consolidation, amalgamation, replacement, conveyance, transfer or lease, the Depositor has received an opinion from independent counsel to the Trust experienced in such matters to the effect that (i) such merger, consolidation, amalgamation, replacement, conveyance, transfer or lease does not adversely affect the rights, preferences and privileges of the Holders of the Capital Securities (including any Successor Securities) in any material respect and (ii) following such merger, consolidation, amalgamation, replacement, conveyance, transfer or lease, neither the Trust nor such successor entity will be required to register as an investment company under the Investment Company Act of 1940, as amended (the "1940 Act"), and (h) the Depositor or any permitted successor or assignee owns all of the common securities of such successor entity and guarantees the obligations of such successor entity under the Successor Securities at least to the extent provided by the Guarantee. Notwithstanding the foregoing, the Trust shall not, except with the consent of Holders of 100% in Liquidation Amount of the Capital Securities, consolidate, amalgamate or merge with or into, or be replaced by or convey, transfer or lease its properties and assets substantially as an entirety to any other entity or permit any other entity to consolidate, amalgamate, merge with or into, or replace it if such consolidation, -47- amalgamation, merger, replacement, conveyance, transfer or lease would cause the Trust or the successor entity to be taxable as a corporation or classified as other than a grantor trust for United States federal income tax purposes or cause the Junior Subordinated Debentures to be treated as other than indebtedness of the Parent for United States federal income tax purposes. ARTICLE X Miscellaneous Provisions Section 10.01. Expense Agreement. It is the contemplation of the parties ----------------- that the Expense Agreement shall be entered into no later than _________________________,1998. Section 10.02. Limitation of Rights of Securityholders. The death or --------------------------------------- incapacity of any person having an interest, beneficial or otherwise, in the Trust Securities shall not operate to terminate this Trust Agreement, nor entitle the legal representatives or heirs of such person or any Securityholder for such person, to claim an accounting, take any action or bring any proceeding in any court for a partition or winding up of the arrangements contemplated hereby nor otherwise affect the rights, obligations and liabilities of the parties hereto or any of them. Section 10.03. Amendment. --------- (a) This Trust Agreement may be amended from time to time by the Trustees and the Depositor, without the consent of any Securityholders, (i) to cure any ambiguity, correct or supplement any provision herein which may be inconsistent with any other provision herein or to make any other provisions with respect to matters or questions arising under this Trust Agreement, which shall not be inconsistent with the other provisions of this Trust Agreement or (ii) to modify, eliminate or add to any provisions of this Trust Agreement to such extent as shall be necessary to ensure that the Trust will not be taxable as a corporation or will be classified as a grantor trust for United States federal income tax purposes at all times that any Trust Securities are outstanding or to ensure that the Trust will not be required to register as an "investment company" under the 1940 Act; provided, however, that in the case of either clause (i) or clause (ii), such action shall not adversely affect in any material respect the interests of any Securityholder and any amendments of this Trust Agreement shall become effective when notice thereof is given to the Securityholders. (b) Except as provided in Section 10.03(c) hereof, any provision of this Trust Agreement may be amended by the Trustees and the Depositor with (i) the consent of Trust Securityholders representing not less than a majority in Liquidation Amount of the Trust Securities then Outstanding and (ii) the receipt by the Trustees of an Opinion of Counsel to the effect that such amendment or the exercise of any power granted to the Trustees in accordance with such amendment will not affect the Trust's status as a grantor trust or cause the Trust to be taxable as a corporation for United States federal income tax purposes or the Trust's exemption from status as an "investment company" under the Investment Company Act of 1940, as amended. -48- (c) In addition to and notwithstanding any other provision in this Trust Agreement, without the consent of each affected Securityholder (such consent being obtained in accordance with Section 6.03 or 6.06 hereof), this Trust Agreement may not be amended to (i) change the amount or timing of any Distribution on the Trust Securities or otherwise adversely affect the amount of any Distribution required to be made in respect of the Trust Securities as of a specified date or (ii) restrict the right of a Securityholder to institute suit for the enforcement of any such payment on or after such date; notwithstanding any other provision herein without the unanimous consent of the Securityholders (such consent being obtained in accordance with Section 6.03 or 6.06 hereof), paragraph (b) of this Section 10.03 may not be amended. (d) Notwithstanding any other provisions of this Trust Agreement, no Trustee shall enter into or consent to any amendment to this Trust Agreement which would cause the Trust to (i) fail or cease to qualify, as evidenced by an Opinion of Counsel, for an exemption from status of an "investment company" under the Investment Company Act of 1940, as amended, or (ii) be taxable as a corporation or fail or cease to be classified, as evidenced by an Opinion of Counsel, as a grantor trust for United States federal income tax purposes. (e) Notwithstanding anything in this Trust Agreement to the contrary, without the consent of the Depositor and the Administrative Trustees, this Trust Agreement may not be amended in a manner which imposes any additional obligation on the Depositor or the Administrative Trustees. (f) In the event that any amendment to this Trust Agreement is made, the Administrative Trustees shall promptly provide to the Depositor a copy of such amendment. (g) The Property Trustee shall not be required to enter into any amendment to this Trust Agreement which affects its own rights, duties or immunities under this Trust Agreement. The Property Trustee shall be entitled to receive an Opinion of Counsel and an Officer's Certificate stating that any amendment to this Trust Agreement is in compliance with this Trust Agreement. Section 10.04. Separability. In case any provision in this Trust ------------ Agreement or in the Trust Securities Certificates shall be invalid, illegal or unenforceable, the validity, legality and enforceability of the remaining provisions hereof and thereof shall not in any way be affected or impaired thereby. SECTION 10.05. GOVERNING LAW. THIS TRUST AGREEMENT AND THE RIGHTS AND ------------- OBLIGATIONS OF EACH OF THE SECURITYHOLDERS, THE DEPOSITOR, THE TRUST AND THE TRUSTEES WITH RESPECT TO THIS TRUST AGREEMENT AND THE TRUST SECURITIES SHALL BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY THE LAWS OF THE STATE OF DELAWARE WITHOUT REFERENCE TO ITS CONFLICTS OF LAWS PROVISIONS. Section 10.06. Payments Due on Non-Business Day. If the date fixed for -------------------------------- any payment on any Trust Security shall be a day which is not a Business Day, then such payment need not be made on such date but may be made on the next succeeding day -49- which is a Business Day (except as otherwise provided in Section 4.01(a) and 4.02(d)), with the same force and effect as though made on the date fixed for such payment, and no Distribution shall accumulate on such unpaid amount thereon for the period after such date. Section 10.07. Successors. This Trust Agreement shall be binding upon and ---------- shall inure to the benefit of any successor to the Depositor, the Trust or any Relevant Trustee, including any successor by operation of law. Except in connection with a consolidation, merger or sale involving the Depositor that is permitted under Article Eight of the Indenture and pursuant to which the assignee agrees in writing to perform the Depositor's obligations hereunder, the Depositor shall not assign its obligations hereunder. Section 10.08. Headings. The Article and Section headings are for -------- convenience only and shall not affect the construction of this Trust Agreement. Section 10.09. Reports, Notices and Demands. Any report, notice, demand ---------------------------- or other communication which by any provision of this Trust Agreement is required or permitted to be given or served to or upon any Securityholder or the Depositor shall be given or served in writing by deposit thereof, postage prepaid, in the United States mail, hand delivery or facsimile transmission, in each case, addressed, (a) in the case of a Capital Securityholder, to such Capital Securityholder as such Securityholder's name and address may appear on the Securities Register; and (b) in the case of the Common Securityholder or the Depositor, to Pennsylvania Manufacturers Corporation, 1735 Market Street, Philadelphia, Pennsylvania 19103-7590, Attention: President, facsimile no.: (215) 665-5061. Such notice, demand or other communication to or upon a Securityholder shall be deemed to have been sufficiently given or made, for all purposes, upon hand delivery, mailing or transmission. Any notice, demand or other communication which by any provision of this Trust Agreement is required or permitted to be given or served to or upon the Trust, the Property Trustee or the Administrative Trustees shall be given in writing addressed (until another address is published by the Trust) as follows: (a) with respect to the Trustee, to The Bank of New York (Delaware), __________________________________________ Attention: Corporate Trust Administration; (b) with respect to the Property Trustee, The Bank of New York, _______________________________; Attention: Corporate Trust Administration and (c) with respect to the Administrative Trustees, to them at the address above for notices to the Depositor, marked "Attention: Administrative Trustees of PMC Capital I c/o President." Such notice, demand or other communication to or upon the Trust or the Property Trustee shall be deemed to have been sufficiently given or made only upon actual receipt of the writing by the Trust or the Property Trustee. Section 10.10. Agreement Not to Petition. Each of the Trustees and the ------------------------- Depositor agree for the benefit of the Securityholders that, until at least one year and one day after the Trust has been terminated in accordance with Article IX, they shall not file, or join in the filing of, a petition against the Trust under any bankruptcy, reorganization, arrangement, insolvency, liquidation or other similar law (including, without limitation, the United States Bankruptcy Code) (collectively, "Bankruptcy Laws") or otherwise join in the commencement of any proceeding against the Trust under any Bankruptcy Law. -50- In the event the Depositor takes action in violation of this Section 10.10, the Property Trustee agrees, for the benefit of Securityholders, that at the expense of the Depositor, it shall file an answer with the bankruptcy court or otherwise properly contest the filing of such petition by the Depositor against the Trust or the commencement of such action and raise the defense that the Depositor has agreed in writing not to take such action and should be stopped and precluded therefrom and such other defenses, if any, as counsel for the Property Trustee or the Trust may assert. The provisions of this Section 10.10 shall survive the termination of this Trust Agreement. Section 10.11. Trust Indenture Act; Conflict with Trust Indenture Act. ------------------------------------------------------ (a) This Trust Agreement is subject to the provisions of the Trust Indenture Act that are required to be part of this Trust Agreement and shall, to the extent applicable, be governed by such provisions. (b) The Property Trustee shall be the only Trustee which is a Trustee for the purposes of the Trust Indenture Act. (c) If any provision hereof limits, qualifies or conflicts with the duties imposed by Section 310 to 317, inclusive, of the Trust Indenture Act through operation of Section 318(c) thereof, such imposed duty provision shall control. If any provision of this Trust Agreement modifies or excludes any provision of the Trust Indenture Act which may be so modified or excluded, the latter provision shall be deemed to apply to this Trust Agreement as so modified or excluded, as the case may be. (d) The application of the Trust Indenture Act to this Trust Agreement shall not affect the nature of the Securities as equity securities representing undivided beneficial interests in the assets of the Trust. Section 10.12. Rights Under Indenture. The Trust may not assign any of ---------------------- its rights under the Indenture without the prior written consent of the Depositor. Section 10.13. Effectiveness. This Trust Agreement shall become effective ------------- when signed by the Depositor, the Trustee and the Bank. Each Administrative Trustee shall assume the duties of an Administrative Trustee hereunder when he signs the signature page hereof. Section 10.14. Intention of the Parties. It is the intention of the parties ------------------------ hereto that the Trust not be characterized for United States federal income tax purposes as a corporation or a partnership, but rather that the Trust be characterized as a grantor trust or otherwise in a manner that each Owner be treated as owning an undivided beneficial interest in the assets of the Trust. The provisions of this Trust Agreement shall be interpreted to further this intention of the parties. -51- THE RECEIPT AND ACCEPTANCE OF A TRUST SECURITY OR ANY INTEREST THEREIN BY OR ON BEHALF OF A SECURITYHOLDER OR ANY BENEFICIAL OWNER, WITHOUT ANY SIGNATURE OR FURTHER MANIFESTATION OF ASSENT, SHALL CONSTITUTE THE UNCONDITIONAL ACCEPTANCE BY THE SECURITYHOLDER AND ALL OTHERS HAVING A BENEFICIAL INTEREST IN SUCH TRUST SECURITY OF ALL THE TERMS AND PROVISIONS OF THIS TRUST AGREEMENT AND AGREEMENT TO THE SUBORDINATION PROVISIONS AND OTHER TERMS OF THE GUARANTEE AND THE INDENTURE, AND SHALL CONSTITUTE THE AGREEMENT OF THE TRUST, SUCH SECURITYHOLDER AND SUCH OTHERS THAT THOSE TERMS AND PROVISIONS OF THIS TRUST AGREEMENT SHALL BE BINDING, OPERATIVE AND EFFECTIVE AS BETWEEN THE TRUST AND SUCH SECURITYHOLDER AND SUCH OTHERS. PENNSYLVANIA MANUFACTURERS CORPORATION, as Depositor By: ----------------------------------- John W. Smithson, President and Chief Executive Officer THE BANK OF NEW YORK (DELAWARE), as Trustee By: ----------------------------------- Name: Title: THE BANK OF NEW YORK, as Property Trustee By: ----------------------------------- Name: Title: -------------------------------------- John W. Smithson, as Administrative Trustee -------------------------------------- Francis W. McDonnell, as Administrative Trustee -------------------------------------- Edward S. Hochberg, as Administrative Trustee -52- EX-4.1 3 FORM OF INDENTURE Exhibti 4.1 PENNSYLVANIA MANUFACTURERS CORPORATION TO THE BANK OF NEW YORK Trustee ________________ Junior Subordinated Indenture Dated as of ___________________________, 1998 Up to $103,093,000 _________% Junior Subordinated Debentures, Series A Sections 310 through 318 of the Trust Indenture Act of 1939: Trust Indenture Indenture Act Section Section - ----------------- ----------------- (S) 310(a)(1).................................... 609 (a)(2).................................... 609 (a)(3).................................... Not Applicable (a)(4).................................... Not Applicable (b)....................................... 608, 610 (S) 311(a)....................................... 613 (b)....................................... 613 (S) 312(a)....................................... 701 702(a) (b)....................................... 702(b) (c)....................................... 702(c) (S) 313(a)....................................... 703(a) (a)(4).................................... 101, 1004 (b)....................................... 703(a) (c)....................................... 703(a) (d)....................................... 703(b) (S) 314(a)....................................... 704 (b)....................................... Not Applicable (c)(1).................................... 102 (c)(2).................................... 102 (c)(3).................................... Not Applicable (d)....................................... Not Applicable (e)....................................... 102 (S) 315(a)....................................... 601 (b)....................................... 602 (c)....................................... 601 (d)....................................... 601 (e)....................................... 514 (S) 316(a)....................................... 101 (a)(1)(A)................................. 502 512 (a)(1)(B)................................. 513 (a)(2).................................... Not Applicable (b)....................................... 508 (c)....................................... 104(c) (S) 317(a)(1).................................... 503 (a)(2).................................... 504 (b)....................................... 1003 (S) 318(a)....................................... 107 TABLE OF CONTENTS
Page ARTICLE ONE Definitions and Other Provisions of General Application SECTION 101. Definitions..................................................... 2 Act.......................................................................... 2 Additional Interest.......................................................... 2 Additional Sums.............................................................. 3 Additional Taxes............................................................. 3 Administrative Trustees...................................................... 3 Affiliate.................................................................... 3 Authenticating Agent......................................................... 3 Board of Directors........................................................... 3 Board Resolution............................................................. 3 Business Day................................................................. 3 Capital Securities........................................................... 3 Commission................................................................... 3 Common Securities............................................................ 4 Common Stock................................................................. 4 Company...................................................................... 4 Company Request.............................................................. 4 Company Order................................................................ 4 Corporate Trust Office....................................................... 4 Corporation.................................................................. 4 Debt......................................................................... 4 Defaulted Interest........................................................... 4 Depositary................................................................... 4 Event of Default............................................................. 4 Expense Agreement............................................................ 4 Extension Period............................................................. 4 Global Security.............................................................. 5 Government Obligations....................................................... 5 Holder....................................................................... 5 Indenture.................................................................... 5 Interest Payment Date........................................................ 5 Investment Company Event..................................................... 5 Junior Subordinated Payment.................................................. 5 Maturity..................................................................... 5 Officers' Certificate........................................................ 6 Opinion of Counsel........................................................... 6 Outstanding.................................................................. 6 Parent Guarantee............................................................. 6 Paying Agent................................................................. 7 Person....................................................................... 7 PMC Capital I................................................................ 7 Predecessor Security......................................................... 7
-i- Proceeding................................................................... 7 Property Trustee............................................................. 7 Redemption Date.............................................................. 7 Redemption Price............................................................. 7 Regular Record Date.......................................................... 7 Responsible Officer.......................................................... 7 Securities................................................................... 7 Security Register............................................................ 7 Security Registrar........................................................... 7 Senior Debt.................................................................. 7 Special Event................................................................ 8 Special Record Date.......................................................... 8 Stated Maturity.............................................................. 8 Subsidiary................................................................... 8 Tax Event.................................................................... 8 Trust Agreement.............................................................. 8 Trustee...................................................................... 8 Trust Indenture Act.......................................................... 9 Trust Securities............................................................. 9 SECTION 102. Compliance Certificates and Opinions............................ 9 SECTION 103. Form of Documents Delivered to Trustee.......................... 9 SECTION 104. Acts of Holders; Record Dates................................... 10 SECTION 105. Notices, Etc., to Trustee and the Company....................... 12 SECTION 106. Notices to Holders; Waiver...................................... 12 SECTION 107. Conflict with Trust Indenture Act............................... 13 SECTION 108. Effect of Headings and Table of Contents........................ 13 SECTION 109. Successors and Assigns.......................................... 13 SECTION 110. Separability Clause............................................. 13 SECTION 111. Benefits of Indenture........................................... 13 SECTION 112. Governing Law................................................... 14 SECTION 113. Non-Business Days............................................... 14 ARTICLE TWO Security Forms SECTION 201. Forms Generally................................................. 14 SECTION 202. Form of Face of Security........................................ 15 SECTION 203. Form of Reverse of Security..................................... 19 SECTION 204. Additional Provisions Required in Global Security............... 23 SECTION 205. Form of Trustee's Certificate of Authentication................. 24 ARTICLE THREE The Securities SECTION 301. Title and Terms; Paying Agent................................... 24
-ii- SECTION 302. Denominations.....................................................26 SECTION 303. Execution, Authentication, Delivery and Dating....................26 SECTION 304. Temporary Securities..............................................27 SECTION 305. Registration, Registration of Transfer and Exchange...............27 SECTION 306. Mutilated, Destroyed, Lost and Stolen Securities..................28 SECTION 307. Payment of Interest; Interest Rights Preserved....................29 SECTION 308. Persons Deemed Owners.............................................30 SECTION 309. Cancellation......................................................31 SECTION 310. Computation of Interest...........................................31 SECTION 311. Right of Set-Off..................................................31 SECTION 312. Agreed Tax Treatment..............................................31 SECTION 313. CUSIP Numbers.....................................................32 ARTICLE FOUR Satisfaction and Discharge SECTION 401. Satisfaction and Discharge of Indenture...........................32 SECTION 402. Application of Trust Money........................................33 SECTION 403. Satisfaction, Discharge and Defeasance of Securities..............33 ARTICLE FIVE Remedies SECTION 501. Events of Default.................................................34 SECTION 502. Acceleration of Maturity; Rescission and Annulment................35 SECTION 503. Collection of Indebtedness and Suits for Enforcement by Trustee........................................................37 SECTION 504. Trustee May File Proofs of Claim..................................37 SECTION 505. Trustee May Enforce Claims Without Possession of Securities.......38 SECTION 506. Application of Money Collected....................................38 SECTION 507. Limitation on Suits...............................................39 SECTION 508. Unconditional Right of Holders to Receive Principal and Interest......................................................39 SECTION 509. Restoration of Rights and Remedies................................40 SECTION 510. Rights and Remedies Cumulative....................................40 SECTION 511. Delay or Omission Not Waiver......................................40 SECTION 512. Control by Holders................................................40 SECTION 513. Waiver of Past Defaults...........................................41 SECTION 514. Undertaking for Costs.............................................42 SECTION 515. Waiver of Usury, Stay or Extension Laws...........................42 ARTICLE SIX The Trustee SECTION 601. Certain Duties and Responsibilities...............................42 SECTION 602. Notice of Defaults................................................44 SECTION 603. Certain Rights of Trustee.........................................44 SECTION 604. Not Responsible for Recitals or Issuance of Securities............45
-iii- SECTION 605. May Hold Securities.............................................. 45 SECTION 606. Money Held in Trust.............................................. 45 SECTION 607. Compensation; Reimbursement and Indemnity........................ 45 SECTION 608. Disqualification; Conflicting Interests.......................... 46 SECTION 609. Corporate Trustee Required; Eligibility.......................... 46 SECTION 610. Resignation and Removal; Appointment of Successor................ 47 SECTION 611. Acceptance of Appointment by Successor........................... 48 SECTION 612. Merger, Conversion, Consolidation or Succession to Business...... 49 SECTION 613. Preferential Collection of Claims Against Company................ 49 SECTION 614. Appointment of Authenticating Agent.............................. 49 ARTICLE SEVEN Holders' Lists and Reports by Trustee and Company SECTION 701. Company to Furnish Trustee Names and Addresses of Holders........ 51 SECTION 702. Preservation of Information; Communications to Holders........... 51 SECTION 703. Reports by Trustee............................................... 51 SECTION 704. Reports by Company............................................... 52 ARTICLE EIGHT Consolidation, Merger, Conveyance, Transfer or Lease SECTION 801. Company May Consolidate, Etc., Only on Certain Terms............. 52 SECTION 802. Successor Substituted............................................ 53 ARTICLE NINE Supplemental Indentures SECTION 901. Supplemental Indentures Without Consent of Holders............... 54 SECTION 902. Supplemental Indentures with Consent of Holders.................. 54 SECTION 903. Execution of Supplemental Indentures............................. 55 SECTION 904. Effect of Supplemental Indentures................................ 56 SECTION 905. Conformity with Trust Indenture Act.............................. 56 SECTION 906. Reference in Securities to Supplemental Indentures............... 56 ARTICLE TEN Covenants; Representations and Warranties SECTION 1001. Payment of Principal and Interest............................... 56 SECTION 1002. Maintenance of Office or Agency................................. 56 SECTION 1003. Money for Security Payments to Be Held in Trust................. 57 SECTION 1004. Statement by Officers as to Compliance.......................... 58 SECTION 1005. Additional Sums................................................. 58 SECTION 1006. Additional Covenants............................................ 59 SECTION 1007. Waiver of Certain Covenants..................................... 59
-iv- ARTICLE ELEVEN Subordination of Securities SECTION 1101. Securities Subordinate to Senior Debt........................... 60 SECTION 1102. Payment Over of Proceeds Upon Dissolution, Etc.................. 60 SECTION 1103. Prior Payment to Senior Debt Upon Acceleration of Securities.... 62 SECTION 1104. No Payment When Senior Debt in Default.......................... 62 SECTION 1105. Payment Permitted If No Default................................. 63 SECTION 1106. Subrogation to Rights of Holders of Senior Debt................. 63 SECTION 1107. Provisions Solely to Define Relative Rights..................... 63 SECTION 1108. Trustee to Effectuate Subordination............................. 64 SECTION 1109. No Waiver of Subordination Provisions........................... 64 SECTION 1110. Notice to Trustee............................................... 64 SECTION 1111. Reliance on Judicial Order or Certificate of Liquidating Agent.. 65 SECTION 1112. Trustee Not Fiduciary for Holders of Senior Debt................ 65 SECTION 1113. Rights of Trustee as Holder of Senior Debt; Preservation of Trustee's Rights............................................. 66 SECTION 1114. Article Applicable to Paying Agents............................. 66 SECTION 1115. Certain Conversions or Exchanges Deemed Payment................. 66 ARTICLE TWELVE Redemption of Securities SECTION 1201. Applicability of this Article................................... 66 SECTION 1202. Election to Redeem; Notice to Trustee........................... 67 SECTION 1203. Selection by Trustee of Securities to Be Redeemed............... 67 SECTION 1204. Notice of Redemption............................................ 67 SECTION 1205. Deposit of Redemption Price..................................... 68 SECTION 1206. Securities Payable on Redemption Date........................... 68 SECTION 1207. Optional Redemption; Conditions to Optional Redemption.......... 69 ANNEX A: Form of Amended and Restated Trust Agreement among Pennsylvania Manufacturers Corporation, as Depositor, The Bank of New York (Delaware), as Trustee, The Bank of New York, as Property Trustee, and the Administrative Trustees named therein dated as of _____________________, 1998. EXHIBIT A: Agreement as to Expenses and Liabilities between Pennsylvania Manufacturers Corporation and PMC Capital I dated as of _____________, 1998.
-v- INDENTURE, dated as of _________________, 1998, between Pennsylvania Manufacturers Corporation, a corporation duly organized and existing under the laws of the Commonwealth of Pennsylvania (herein called the "Company"), having its principal office at The PMA Building, 380 Sentry Parkway, Blue Bell, Pennsylvania 19422-2328, and The Bank of New York, a banking corporation duly organized and existing under the laws of New York, as Trustee (herein called the "Trustee"). Unless otherwise defined herein, all capitalized items used herein shall have the meanings ascribed to them in the Amended and Restated Trust Agreement between the Company, as Depositor and The Bank of New York (Delaware), as Trustee ("Delaware Trustee"), The Bank of New York, as Property Trustee, and the Administrative Trustees named therein dated as of _____________________, 1998 (the "Trust Agreement"), as in effect on the date hereof, the form of which is attached as Annex A hereto. RECITALS OF THE COMPANY WHEREAS, PMC Capital I (as defined herein) may pursuant to the Underwriting Agreement dated ______________________, 1998 among the Company, PMC Capital I, PMA Reinsurance Corporation and the several underwriters named therein, issue $100,000,000 aggregate liquidation amount of its ______% Capital Securities, Series A (the "Capital Securities" and, together with the Common Securities, the "Trust Securities") with a liquidation amount of $1,000 per Capital Security; WHEREAS, this Indenture is subject to the provisions of the Trust Indenture Act of 1939, as amended, that are required to be part of this Indenture and shall, to the extent applicable, be governed by such provisions; WHEREAS, the Company is guaranteeing the payment of distributions on the Capital Securities of PMC Capital I and payment of the Redemption Price and payments on liquidation with respect to the Capital Securities, to the extent provided in the Guarantee Agreement dated as of ______________________, 1998, between the Company and The Bank of New York, as guarantee trustee (the "Parent Guarantee") for the benefit of the holders of the Capital Securities; WHEREAS, the Company wishes to sell to PMC Capital I, and PMC Capital I wishes to purchase from the Company, Securities (as defined below) in an aggregate principal amount of $103,093,000 and in satisfaction of the purchase price for such Securities, the trustees of PMC Capital I, on behalf of PMC Capital I, wish to (i) execute and deliver to the Company Common Securities certificates evidencing an ownership interest in PMC Capital I, registered in the name of the Company, in an aggregate amount of 3,093 Common Securities having an aggregate liquidation amount of up to $3,093,000 and (ii) deliver to the Company the sum of $100,000,000; WHEREAS, the Company has duly authorized the creation and issuance of an issue of its unsecured _______% junior subordinated debentures, Series A (the "Securities"), of substantially the tenor and amount hereinafter set forth issued to evidence loans made to the Company of the proceeds from the issuance by PMC Capital I of the Capital Securities and Common Securities, to provide the terms and conditions upon which the Securities are to be authenticated, issued and delivered and to provide therefor the Company has duly authorized the execution and delivery of this Indenture; and WHEREAS, all things necessary to make the Securities, when executed by the Company and authenticated and delivered hereunder and duly issued by the Company, the valid obligations of the Company, and to make this Indenture a valid agreement of the Company, in accordance with their and its terms, have been done. NOW, THEREFORE, THIS INDENTURE WITNESSETH: For and in consideration of the premises and the purchase of the Securities by the Holder thereof, it is mutually agreed, for the equal and proportionate benefit of all Holders of the Securities, as follows: ARTICLE ONE Definitions and Other Provisions of General Application SECTION 101 Definitions. ----------- For all purposes of this Indenture, except as otherwise expressly provided or unless the context otherwise requires: (1) the terms defined in this Article have the meanings assigned to them in this Article and include the plural as well as the singular; (2) all other terms used herein which are defined in the Trust Indenture Act, either directly or by reference therein, have the meanings assigned to them therein; (3) all accounting terms not otherwise defined herein have the meanings assigned to them in accordance with generally accepted accounting principles, and the term "generally accepted accounting principles" with respect to any computation required or permitted hereunder shall mean such accounting principles which are generally accepted at the date or time of such computation; provided, that when two or more principles are so generally accepted, it shall mean that set of principles consistent with those in use by the Company; and (4) the words "herein", "hereof" and "hereunder" and other words of similar import refer to this Indenture as a whole and not to any particular Article, Section or other sub division. "Act", when used with respect to any Holder, has the meaning specified in ---- Section 104. "Additional Interest" means interest, if any, that shall accrue on any -------------------- interest on the Securities the payment of which has not been made on the applicable Interest Payment -2- Date and which shall accrue at the rate of ________% per annum compounded semi- annually (to the extent permitted by law). "Additional Sums" has the meaning specified in Section 1005. ---------------- "Additional Taxes" means the sum of any additional taxes, duties and other ----------------- governmental charges to which PMC Capital I has become subject from time to time as a result of a Tax Event. "Administrative Trustees" means each Person identified as an ----------------------- "Administrative Trustee" in the Trust Agreement, solely in such Person's capacity as Administrative Trustee of PMC Capital I under such Trust Agreement and not in such Person's individual capacity, or any successor administrative trustee appointed as therein provided. "Affiliate" of any specified Person means any other Person directly or ---------- indirectly controlling or controlled by or under direct or indirect common control with such specified Person. For the purposes of this definition, "control" when used with respect to any specified Person means the power to direct the management and policies of such Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise; and the terms "controlling" and "controlled" have meanings correlative to the foregoing. "Authenticating Agent" means any Person authorized by the Trustee pursuant --------------------- to Section 614 to act on behalf of the Trustee to authenticate Securities. "Board of Directors" means either the board of directors of the Company or ------------------- any duly authorized committee of that board. "Board Resolution" means a copy of a resolution certified by the Secretary ----------------- or an Assistant Secretary of the Company to have been duly adopted by the Board of Directors or such committee of the Board of Directors or officers of the Company to which authority to act on behalf of the Board of Directors has been delegated, and to be in full force and effect on the date of such certification, and delivered to the Trustee. "Business Day" means any day other than a Saturday or Sunday or a day on ------------- which banking institutions in the City of New York are authorized or required by law or executive order to remain closed or a day on which the Corporate Trust Office of the Trustee, or the principal office of the Property Trustee or the Delaware Trustee, under the Trust Agreement, is closed for business. "Capital Securities" has the meaning specified in the Recitals to this ------------------- Indenture. "Commission" means the Securities and Exchange Commission, as from time to ----------- time constituted, created under the Securities Exchange Act of 1934, as amended, or, if at any time after the execution of this instrument such Commission is not existing and performing the duties now assigned to it under the Trust Indenture Act, then the body performing such duties at such time. -3- "Common Securities" means undivided beneficial interests in the assets of ----------------- PMC Capital I, having a Liquidation Amount of $1,000 per Common Security and having the rights provided therefor in the Trust Agreement. "Common Stock" means the common stock, without par value, of the Company. ------------ "Company" means the Person named as the "Company" in the first paragraph of -------- this instrument until a successor Person shall have become such pursuant to the applicable provisions of this Indenture, and thereafter "Company" shall mean such successor Person. "Company Request" or "Company Order" means a written request or order ---------------- -------------- signed in the name of the Company by its Chairman of the Board, its Chief Executive Officer, its President or a Senior Vice President, and by its Treasurer and Chief Financial Officer, its Vice President of Finance or its Secretary, and delivered to the Trustee. "Corporate Trust Office" means the principal office of the Trustee in ----------------------- _________________________________________ at which at any particular time its corporate trust business shall be administered and which at the date of this Indenture is ________________________________________________________________________________ ____. "Corporation" includes a corporation, association, company, limited ----------- liability company, joint-stock company or business trust. "Debt" means, with respect to any Person, whether recourse is to all or a ---- portion of the assets of such Person and whether or not contingent, (i) every obligation of such Person for money borrowed; (ii) every obligation of such Person evidenced by bonds, debentures, notes or other similar instruments, including obligations incurred in connection with the acquisition of property, assets or businesses; (iii) every reimbursement obligation of such Person with respect to letters of credit, bankers' acceptances or similar facilities issued for the account of such Person; (iv) every obligation of such Person issued or assumed as the deferred purchase price of property or services (but excluding trade accounts payable or accrued liabilities arising in the ordinary course of business); (v) every capital lease obligation of such Person and (vi) every obligation of the type referred to in clauses (i) through (v) of another Person and all dividends of another Person the payment of which, in either case, such Person has guaranteed or is responsible or liable for, directly or indirectly, as obligor or otherwise. "Defaulted Interest" has the meaning specified in Section 307. ------------------- "Depositary" means, with respect to the Securities issuable or issued in ---------- whole or in part in the form of one or more Global Securities, the Person designated as Depositary by the Company pursuant to this Indenture or any successor thereto. "Event of Default" has the meaning specified in Section 501. ----------------- "Expense Agreement" means the Expense Agreement contemplated by Section ------------------ 607. "Extension Period" has the meaning specified in Section 301. ----------------- -4- "Global Security" means a Security in the form prescribed in Section 204 ---------------- evidencing all or part of the Securities, issued to the Depository or its nominee, and registered in the name of such Depository or its nominee. "Government Obligations" means, with respect to the Securities, securities ----------------------- which are (i) direct obligations of the United States of America or (ii) obligations of a Person controlled or supervised by and acting as an agency or instrumentality of the United States of America the payment of which is unconditionally guaranteed by the United States of America and which, in either case, are full faith and credit obligations of the United States of America and are not callable or redeemable at the option of the issuer thereof and shall also include a depository receipt issued by a bank (as defined in Section 3(a)(2) of the Securities Act of 1933, as amended) as custodian with respect to any such Government Obligation or a specific payment of interest on or principal of any such Government Obligation held by such custodian for the account of the holder of such depository receipt; provided that (except as required by law) such custodian is not authorized to make any deduction from the amount payable to the holder of such depository receipt from any amount received by the custodian in respect of the Government Obligation or the specific payment of interest on or principal of the Government Obligation evidenced by such depository receipt. "Holder" means a Person in whose name a Security is registered in the ------- Security Register. "Indenture" means this instrument as originally executed or as it may from ---------- time to time be supplemented or amended by one or more indentures supplemental hereto entered into pursuant to the applicable provisions hereof, including, for all purposes of this instrument and any such supplemental indenture, the provisions of the Trust Inden ture Act that are deemed to be a part of and govern this instrument and any such supplemental indenture, respectively. "Interest Payment Date", when used with respect to any installment of ---------------------- interest on a Security, means the date specified in such Security as the fixed date on which an installment of interest with respect to the Securities is due and payable. "Investment Company Event" means the receipt by PMC Capital I of an Opinion ------------------------- of Counsel experienced in such matters to the effect that, as a result of the occurrence of a change in law or regulation or a change in interpretation or application of law or regulation by any legislative body, court, governmental agency or regulatory authority (a "Change in 1940 Act Law"), PMC Capital I is or will be considered an "investment company" that is required to be registered under the Investment Company Act of 1940, as amended (the "Investment Company Act"), which Change in 1940 Act Law becomes effective on or after the date of original issuance of the Capital Securities. "Junior Subordinated Payment" has the meaning specified in Section 1102. --------------------------- "Maturity", when used with respect to any Security, means the date on which --------- the principal of such Security becomes due and payable as therein or herein provided, whether at the Stated Maturity or by declaration of acceleration, call for redemption or otherwise. -5- "Officers' Certificate" means a certificate signed by the Chairman of the ---------------------- Board, the Chief Executive Officer, the President or a Senior Vice President, and by the Treasurer, the Chief Financial Officer, the Vice President of Finance of the Company or the Secretary, and delivered to the Trustee. One of the officers signing an Officers' Certificate given pursuant to Section 1004 shall be the principal executive, financial or accounting officer of the Company. "Opinion of Counsel" means a written opinion of counsel, who may be counsel ------------------- for the Company (and who may be an employee of the Company), and who shall be acceptable to the Trustee. "Outstanding," when used with respect to Securities, means, as of the date ------------ of determination, all Securities theretofore authenticated and delivered under this Indenture, except: (a) Securities theretofore canceled by the Trustee or delivered to the Trustee for cancellation; (b) Securities for whose payment or redemption money in the necessary amount has been theretofore deposited with the Trustee or any Paying Agent (other than the Company) in trust or set aside and segregated in trust by the Company (if the Company shall act as its own Paying Agent) for the Holders of such Securities, provided that, if such Securities are to be redeemed, notice of such redemption has been duly given pursuant to this Indenture or provision therefor satisfactory to the Trustee has been made and (c) Securities which have been paid pursuant to Section 306, or in exchange for or in lieu of which other Securities have been authenticated and delivered pursuant to this Indenture, other than any such Securities in respect of which there shall have been presented to the Trustee proof satisfactory to it that such Securities are held by Holders in whose hands such Securities are valid, binding and legal obligations of the Company; provided, however, that in determining whether the Holders of the requisite principal amount of Outstanding Securities have given any request, demand, authorization, direction, notice, consent or waiver hereunder, Securities owned by the Company or any other obligor upon the Securities or any Affiliate of the Company or such other obligor shall be disregarded and deemed not to be Outstanding, except that, in determining whether the Trustee shall be protected in relying upon any such request, demand, authorization, direction, notice, consent or waiver, only Securities which the Trustee knows to be so owned shall be so disregarded. Securities so owned which have been pledged in good faith may be regarded as Outstanding if the pledgee establishes to the satisfaction of the Trustee the pledgee's right so to act with respect to such Securities and that the pledgee is not the Company or any other obligor upon the Securities or any Affiliate of the Company or such other obligor. Upon the written request of the Trustee, the Company shall furnish to the Trustee promptly an Officers' Certificate listing and identifying all Securities, if any, known by the Company to be owned or held by or for the account of the Company, or any other obligor on the Securities or any Affiliate of the Company or such obligor, and, subject to the provisions of Section 601, the Trustee shall be entitled to accept such Officers' Certificate as conclusive evidence of the facts therein set forth and of the fact that all Securities not listed therein are Outstanding for the purpose of any such determination. "Parent Guarantee" has the meaning specified in the Recitals to this ----------------- Indenture. -6- "Paying Agent" means any Person authorized by the Company to pay the ------------- principal (or premium, if any) and interest or other amounts in respect of, any Securities on behalf of the Company. "Person" means any individual, corporation, partnership, joint venture, ------- association, limited liability company, trust, unincorporated organization or government or any agency or political subdivision thereof. "PMC Capital I" means the business trust declared and established pursuant -------------- to the Delaware Business Trust Act (12 Del. Code Section 3801 et seq.) by the Trust Agreement. "Predecessor Security" of any particular Security means every previous --------------------- Security evidencing all or a portion of the same debt as that evidenced by such particular Security; and, for the purposes of this definition, any Security authenticated and delivered under Section 306 in exchange for or in lieu of a mutilated, destroyed, lost or stolen Security shall be deemed to evidence the same debt as the mutilated, destroyed, lost or stolen Security. "Proceeding" has the meaning specified in Section 1102. ----------- "Property Trustee" means the commercial bank or trust company identified as ----------------- the "Property Trustee" in the Trust Agreement, solely in its capacity as Property Trustee under such Trust Agreement and not in its individual capacity, or its successor in interest in such capacity, or any successor property trustee appointed as therein provided. "Redemption Date", when used with respect to any Security to be redeemed, ---------------- means the date fixed for such redemption by or pursuant to this Indenture. "Redemption Price", when used with respect to any Security to be redeemed, ----------------- means the price at which it is to be redeemed pursuant to this Indenture. "Regular Record Date" for the interest payable on any Interest Payment Date -------------------- means the Business Day next preceding such Interest Payment Date. "Responsible Officer", when used with respect to the Trustee, means any -------------------- officer of the Trustee assigned by the Trustee from time to time to administer its corporate trust matters. "Securities" has the meaning specified in the Recitals to this Indenture. ----------- "Security Register" and "Security Registrar" have the respective meanings ------------------ ------------------- specified in Section 305. "Senior Debt" means the principal of (and premium, if any) and interest, if ------------ any (including interest accruing on or after the filing of any petition in bankruptcy or for reorganization relating to the Company whether or not such claim for post-petition interest is allowed in such proceeding), on Debt, whether incurred on or prior to the date of this Indenture or thereafter incurred, unless, in the instrument creating or evidencing the same or pursuant to which the same is outstanding, it is provided that such obligations are not -7- superior in right of payment to the Securities or to other Debt which is pari passu with, or subordinated to, the Securities; provided, however, that Senior Debt shall not be deemed to include (a) any Debt of the Company which, when incurred and without respect to any election under Section 1111(b) of the Bankruptcy Reform Act of 1978, was without recourse to the Company, (b) any Debt of the Company to any of its Subsidiaries, (c) Debt to any employee of the Company, (d) trade accounts payable of the Company, (e) accrued liabilities arising in the ordinary course of business of the Company, (f) the Securities and (g) the Parent Guarantee. "Special Event" means either an Investment Company Event or a Tax Event. -------------- "Special Record Date" for the payment of any Defaulted Interest means a -------------------- date fixed by the Trustee pursuant to Section 307. "Stated Maturity", when used with respect to any Security or any ---------------- installment of principal thereof (or premium, if any) or interest (including any Additional Interest) thereon, means, ______________________________, 2028 the date on which the principal, together with any accrued and unpaid interest (including any Additional Interest), of such Security or such installment of interest is due and payable. "Subsidiary" means a corporation more than 50% of the outstanding voting ----------- stock of which is owned, directly or indirectly, by the Company or by one or more other Subsidi aries, or by the Company and one or more other Subsidiaries. For the purposes of this definition, "voting stock" means stock which ordinarily has voting power for the election of directors, whether at all times or only so long as no senior class of stock has such voting power by reason of any contingency. "Tax Event" means the receipt by PMC Capital I of an Opinion of Counsel ---------- experienced in such matters to the effect that, as a result of any amendment to, or change (including any announced prospective change) in, the laws (or any regulations thereunder) of the United States or any political subdivision or taxing authority thereof or therein or any official administrative pronouncement or judicial decision interpreting or applying such laws or regulations, which amendment or change is effective or which pronouncement or decision is announced on or after the date of issuance of the Securities, there is more than an insubstantial risk that (a) PMC Capital I is, or will be within 90 days of the date of such Opinion of Counsel, subject to United States federal income tax with respect to interest income received or accrued on the Securities, (b) interest payable by the Company on the Securities is not, or within 90 days of the date of such Opinion of Counsel will not be, deductible by the Company, in whole or in part, for United States federal income tax purposes or (c) PMC Capital I is, or will be within 90 days of the date of such Opinion of Counsel, subject to more than a de minimis amount of other taxes, duties or other governmental charges. "Trust Agreement" has the meaning specified in the first paragraph of this ---------------- Indenture. "Trustee" means the Person named as the "Trustee" in the first paragraph of -------- this Indenture until a successor Trustee shall have become such pursuant to the applicable provisions of this Indenture, and thereafter "Trustee" shall mean such successor Trustee. -8- "Trust Indenture Act" means the Trust Indenture Act of 1939, as amended and -------------------- as in force at the date as of which this instrument was executed; provided, however, that in the event the Trust Indenture Act of 1939 is amended after such date, "Trust Indenture Act" means, to the extent required by any such amendment, the Trust Indenture Act of 1939 as so amended. "Trust Securities" has the meaning specified in the Recitals to this ----------------- Indenture. SECTION 102 Compliance Certificates and Opinions. ------------------------------------ Upon any application or request by the Company to the Trustee to take any action under any provision of this Indenture, the Company shall furnish to the Trustee an Officers' Certificate stating that all conditions precedent (including covenants, compliance with which constitutes a condition precedent), if any, provided for in this Indenture relating to the proposed action have been complied with and an Opinion of Counsel stating that in the opinion of such counsel all conditions precedent (including covenants, compliance with which constitutes a condition precedent), if any, have been complied with, except that in the case of any such application or request as to which the furnishing of such documents is specifically required by any provision of this Indenture relating to such particular application or request, no additional certificate or opinion need be furnished. Every certificate or opinion delivered with respect to compliance with a condition or covenant provided for in this Indenture (other than the certificate provided pursuant to Section 1004) shall include: (a) a statement that each officer signing the Officers' Certificate has read the covenant or condition and the definitions herein relating thereto; (b) a brief statement of the nature and scope of the examination or investigation undertaken by each officer in rendering the Officers' Certificate; (c) a statement that each such officer has made such examination or investigation as, in such officer's opinion, is necessary to enable such officer to express an informed opinion as to whether or not such covenant or condition has been complied with; and (d) a statement as to whether, in the opinion of each such officer, such condition or covenant has been complied with. SECTION 103 Form of Documents Delivered to Trustee. -------------------------------------- In any case where several matters are required to be certified by, or covered by an opinion of, any specified Person, it is not necessary that all such matters be certified by, or covered by the opinion of, only one such Person, or that they be so certified or covered by only one document, but one such Person may certify or give an opinion with respect to some matters and one or more other such Persons as to other matters, and any such Person may certify or give an opinion as to such matters in one or several documents. -9- Any certificate or opinion of an officer of the Company may be based, insofar as it relates to legal matters, upon a certificate or opinion of, or representations by, counsel, unless such officer knows, or in the exercise of reasonable care should know, that the certificate or opinion or representations with respect to the matters upon which his certificate or opinion is based are erroneous. Any such certificate or Opinion of Counsel may be based, insofar as it relates to factual matters, upon a certificate or opinion of, or representations by, an officer or officers of the Company stating that the information with respect to such factual matters is in the possession of the Company, unless such counsel knows, or in the exercise of reasonable care should know, that the certificate or opinion or representations with respect to such matters are erroneous. Where any Person is required to make, give or execute two or more applications, requests, consents, certificates, statements, opinions or other instruments under this Indenture, they may, but need not, be consolidated and form one instrument. SECTION 104 Acts of Holders; Record Dates. ----------------------------- (a) Any request, demand, authorization, direction, notice, consent, waiver or other action provided by this Indenture to be given to or taken by Holders may be embodied in and evidenced by one or more instruments of substantially similar tenor signed by such Holders in person or by an agent duly appointed in writing; and, except as herein otherwise expressly provided, such action shall become effective when such instrument or instruments are delivered to the Trustee at the address specified in Section 105 and, where it is hereby expressly required, to the Company. Such instrument or instruments (and the action embodied therein and evidenced thereby) are herein sometimes referred to as the "Act" of the Holders signing such instrument or instruments. Proof of execution of any such instrument or of a writing appointing any such agent shall be sufficient for any purpose of this Indenture and (subject to Section 601) conclusive in favor of the Trustee and the Company, if made in the manner provided in this Section. (b) The fact and date of the execution by any Person of any such instrument or writing may be proved by the affidavit of a witness of such execution or by a certificate of a notary public or other officer authorized by law to take acknowledgments of deeds, certifying that the individual signing such instrument or writing acknowledged to him the execution thereof. Where such execution is by a signer acting in a capacity other than his individual capacity, such certificate or affidavit shall also constitute sufficient proof of his authority. The fact and date of the execution by any Person of any such instrument or writing, or the authority of the Person executing the same, may also be proved in any other manner which the Trustee deems sufficient. (c) The Company may, in the circumstances permitted by the Trust Indenture Act, but shall not be obligated, to fix any day as the record date for the purpose of determining the Holders entitled to give or take any request, demand, authorization, direction, notice, consent, waiver or other action, or to vote on any action, authorized or permitted to be given or taken by Holders. Except as otherwise provided herein, if not set by the Company prior to the first solicitation of a Holder made by any Person in respect of any such action, or, in the case of any such vote, prior to such vote, the record date for any such action or vote shall be the 30th day (or, if later, the date of the most recent list of -10- Holders required to be provided pursuant to Section 701) prior to such first solicitation or vote, as the case may be. With regard to any record date, only the Holders on such date (or their duly designated proxies) shall be entitled to give or take, or vote on, the relevant action, whether or not such Persons continue to be Holders after such record date, provided, however, that unless such vote or consent is obtained from the Holders (or their duly designated proxies) of the requisite principal amount of Outstanding Securities prior to the Expiration Date (as defined below), any such vote or consent previously given shall automatically and without further action by any Holder be canceled and of no further effect and nothing in this paragraph shall be construed to render ineffective any action taken by Holders of the requisite principal amount of Outstanding Securities on the date such action is taken. Promptly after any record date is set pursuant to this paragraph, the Company, at is own expense, shall cause notice of such record date, the proposed action by Holders and the applicable Expiration Date to be given to the Trustee in writing and to each Holder of Securities in the manner set forth in Section 106. The Trustee may set any day as a record date for the purpose of determining the Holders of Outstanding Securities entitled to join in the giving or making of (i) any Notice of Default, (ii) any declaration of acceleration referred to in Section 502, (iii) any request to institute proceedings referred to in Section 507(b) or (iv) any direction referred to in Section 512. If any record date is set pursuant to this paragraph, the Holders of Outstanding Securities on such record date, and no other Holders, shall be entitled to join in such notice, declaration, request or direction, whether or not such Holders remain Holders after such record date, provided that no such action shall be effective hereunder unless taken on or prior to the applicable Expiration Date by Holders of the requisite principal amount of Outstanding Securities on such record date. Nothing in this paragraph shall be construed to prevent the Trustee from setting a new record date for any action for which a record date has previously been set pursuant to this paragraph (whereupon the record date previously set shall automatically and with no action by any Person be canceled and of no effect), and nothing in this paragraph shall be construed to render ineffective any action taken by Holders of the requisite principal amount of Outstanding Securities on the date such action is taken. Promptly after any record date is set pursuant to this paragraph, the Trustee, at the Company's expense, shall cause notice of such record date, the proposed action by Holders and the applicable Expiration Date to be given to the Company in writing and to each Holder of Securities in the manner set forth in Section 106. With respect to any record date set pursuant to this Section, the party hereto that sets such record date may designate any day as the "Expiration Date" and from time to time may change the Expiration Date to any earlier or later day, provided that no such change shall be effective unless notice of the proposed new Expiration Date is given to the other party hereto in writing, and to each Holder of Securities of the relevant series in the manner set forth in Section 106, on or prior to the existing Expiration Date. If an Expiration Date is not designated with respect to any record date set pursuant to this Section, the party hereto that set such record date shall be deemed to have initially designated the 180th day after such record date as the Expiration Date with respect thereto, subject to its right to change the Expiration Date as provided in this paragraph. Notwithstanding the foregoing, no Expiration Date shall be later than the 180th day after the applicable record date. -11- (d) The ownership of Securities shall be proved by the Security Register. (e) Any request, demand, authorization, direction, notice, consent, waiver or other Act of the Holder of any Security shall bind every future Holder of the same Security and the Holder of every Security issued upon the registration of transfer thereof or in exchange therefor or in lieu thereof in respect of anything done, omitted or suffered to be done by the Trustee or the Company in reliance thereon, whether or not notation of such action is made upon such Security. (f) Without limiting the foregoing, a Holder entitled hereunder to take any action hereunder with regard to any particular Security may do so with regard to all or any part of the principal amount of such Security or by one or more duly appointed agents each of which may do so pursuant to such appointment with regard to all or any part of such principal amount. SECTION 105 Notices, Etc., to Trustee and the Company. ----------------------------------------- Any request, demand, authorization, direction, notice, consent, waiver or Act of Holders or other document provided or permitted by this Indenture to be made upon, given or furnished to, or filed with, (a) the Trustee by any Holder or by the Company shall be sufficient for every purpose hereunder if made, given, furnished or filed in writing to or with the Trustee at its Corporate Trust Office, Attention: Corporate Trust Administration; or (b) the Company by the Trustee or by any Holder shall be sufficient for every pur pose hereunder (unless otherwise herein expressly provided) if in writing and mailed, first-class postage prepaid, to the Company addressed to it at the address of its principal office specified in the first paragraph of this instrument or at any other address previously furnished in writing to the Trustee by the Company. SECTION 106 Notices to Holders; Waiver. -------------------------- Where this Indenture provides for notice to Holders of any event, such notice shall be sufficiently given (unless otherwise herein expressly provided) if in writing and mailed, first-class postage prepaid, to each Holder affected by such event, at his address as it appears in the Security Register, not later than the latest date (if any), and not earlier than the earliest date (if any), prescribed for the giving of such notice. In any case where notice to Holders is given by mail, neither the failure to mail such notice, nor any defect in any notice so mailed, to any particular Holder shall affect the sufficiency of such notice with respect to other Holders. Where this Indenture provides for notice in any manner, such notice may be waived in writing by the Person entitled to receive such notice, either before or after the event, and such waiver shall be the equivalent of such notice. Waivers of notice by Holders shall be filed with the Trustee, but such filing shall not be a condition precedent to the validity of any action taken in reliance upon such waiver. In case by reason of the suspension of regular mail service or by reason of any other cause it shall be impracticable to give such notice by mail, then such notification as shall -12- be made with the approval of the Trustee shall constitute a sufficient notification for every purpose hereunder. SECTION 107 Conflict with Trust Indenture Act. --------------------------------- If any provision hereof limits, qualifies or conflicts with a provision of the Trust Indenture Act that is required under such Act to be a part of and govern this Indenture, the latter provision shall control. If any provision of this Indenture modifies or excludes any provision of the Trust Indenture Act that may be so modified or excluded, the latter provision shall be deemed to apply to this Indenture as so modified or to be excluded, as the case may be. SECTION 108 Effect of Headings and Table of Contents. ---------------------------------------- The Article and Section headings herein and the Table of Contents are for convenience only and shall not affect the construction hereof. SECTION 109 Successors and Assigns. ---------------------- The Company will have the right at all times to assign any of its rights or obligations under this Indenture to a direct or indirect wholly owned subsidiary of the Company, provided, that, in the event of any such assignment, the Company will remain liable for all such obligations. PMC Capital I may not assign any of its rights under this Indenture without the prior written consent of the Company. This Indenture is not otherwise assignable by the parties hereto. Subject to the foregoing, this Indenture shall bind and inure to the benefit of the parties hereto and their respective successors and assigns, whether so expressed or not. SECTION 110 Separability Clause. ------------------- In case any provision in this Indenture or in the Securities shall be invalid, illegal or unenforceable, the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired thereby. SECTION 111 Benefits of Indenture. --------------------- Nothing in this Indenture or in the Securities, express or implied, shall give to any Person, other than the parties hereto, any Paying Agent and their successors and assigns hereunder, the holders of Senior Debt, the holders of Capital Securities (to the extent provided herein) and the Holders of Securities, any benefit or any legal or equitable right, remedy or claim under this Indenture. SECTION 112 GOVERNING LAW. ------------- THIS INDENTURE AND THE SECURITIES SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK WITHOUT REFERENCE TO ITS CONFLICTS OF LAWS PROVISIONS. THIS -13- INDENTURE IS SUBJECT TO THE PROVISIONS OF THE TRUST INDENTURE ACT OF 1939, AS AMENDED, THAT ARE REQUIRED TO BE PART OF THIS INDENTURE AND SHALL, TO THE EXTENT APPLICABLE, BE GOVERNED BY SUCH PROVISIONS. SECTION 113 Non-Business Days. ----------------- In any case where any Interest Payment Date, Redemption Date or Stated Maturity of any Security shall not be a Business Day, then (notwithstanding any other provision of this Indenture or of the Securities) payment of interest or principal (and premium, if any) or other amounts in respect of the Securities need not be made on such date, but may be made on the next succeeding Business Day in each case (except that, if such Business Day is in the next succeeding calendar year, payment shall be made on the immediately preceding Business Day) in each case with the same force and effect as if made on the Interest Payment Date or Redemption Date, or at the Stated Maturity, provided that no interest shall accrue in respect of the amounts whose payment is so delayed for the period from and after such Interest Payment Date, Redemption Date or Stated Maturity, as the case may be. ARTICLE TWO Security Forms SECTION 201 Forms Generally. --------------- The Securities and the Trustee's certificates of authentication shall be in substantially the forms set forth in this Article, with such appropriate insertions, omissions, substitutions and other variations as are required or permitted by this Indenture, and may have such letters, numbers or other marks of identification and such legends or endorsements placed thereon as may be required to comply with applicable tax laws or the rules of any securities exchange, the Nasdaq National Market or any other applicable self-regulatory organization as may, consistently herewith, be determined by the officers executing such Securities, as evidenced by their execution of the Securities. The definitive Securities shall be printed, lithographed or engraved or produced by any combination of these or other methods, if required by any securities exchange on which the Securities may be listed, on a steel engraved border or steel engraved borders or may be produced in any other manner permitted by the rules of any securities exchange on which the Securities may be listed, all as determined by the officers executing such Securities, as evidenced by their execution of such Securities. SECTION 202 Form of Face of Security. ------------------------ If the Security is a Global Security, insert: "This Security is a Global Security within the meaning of the Indenture hereinafter referred to and is registered in the name of The Depository Trust Company, a New York -14- corporation ("DTC") or a nominee of DTC. This Security is exchangeable for Securities registered in the name of a person other than DTC or its nominee only in the limited circumstances described in the Indenture and no transfer of this Security (other than a transfer of this Security as a whole by DTC to a nominee of DTC or by a nominee of DTC to DTC or another nominee of DTC) may be registered except in limited circumstances. "Unless this Security is presented by an authorized representative of DTC to Pennsylvania Manufacturers Corporation or its agent for registration of transfer, exchange or payment, and any Security issued is registered in the name of Cede & Co. or in such other name as is requested by an authorized representative of DTC (and any payment hereon is made to Cede & Co. or to such other entity as is requested by an authorized representative of DTC), ANY TRANSFER, PLEDGE OR OTHER USE HEREOF FOR VALUE OR OTHERWISE BY OR TO ANY PERSON IS WRONGFUL inasmuch as the registered owner hereof, Cede & Co. has an interest herein." -15- PENNSYLVANIA MANUFACTURERS CORPORATION ________% Junior Subordinated Debenture, Series A No._________ $__________________________ [CUSIP No. _______________] PENNSYLVANIA MANUFACTURERS CORPORATION, a corporation duly organized and existing under the laws of the Commonwealth of Pennsylvania (herein called "PMC," which term includes any successor Person under the Indenture hereinafter referred to), for value received, hereby promises to pay to ______________________________________, or registered assigns, the principal sum of $_____________________ on __________________________, 2028. PMC further promises to pay interest on said principal sum from__________________________, 2028 or from the most recent interest payment date (each such date, an "Interest Payment Date") to which interest has been paid or duly provided for, semi- annually (subject to deferral as set forth herein) in arrears on ____________________ 1 and ____________________ 1 of each year, com mencing ____________________, 1999, at the rate of _________% per annum together with Additional Sums, if any, until the principal hereof is paid or duly provided for or made available for payment; provided that any overdue principal, premium or Additional Sums and any overdue installment of interest shall bear Additional Interest at the rate of ________% per annum (to the extent that the payment of such interest shall be legally enforceable), compounded semi-annually, from the dates such amounts are due until they are paid or made available for payment. The amount of interest payable for any period less than a full interest period will be computed on the basis of twelve 30-day months and a 360-day year and the actual days elapsed in a partial month in such period. In the event that any date on which interest is payable on this Security is not a Business Day, then a payment of the interest payable on such date will be made on the next succeeding day that is a Business Day (and without any interest or other payment in respect of any such delay), except that, if such Business Day is in the next succeeding calendar year, such payment shall be made on the immediately preceding Business Day, in each case with the same force and effect as if made on the date the payment was originally payable. A "Business Day" shall mean any day other than a Saturday or Sunday or a day on which banking institutions in the City of New York are authorized or required by law or executive order to remain closed or a day on which the Corporate Trust Office of the Trustee, or the principal office of the Property Trustee under the Trust Agreement, is closed for business. The interest installment so payable, and punctually paid or duly provided for, on any Interest Payment Date will, as provided in the Indenture, be paid to the Person in whose name this Security (or one or more Predecessor Securities, as defined in the Indenture) is registered at the close of business on the Regular Record Date for such interest installment, which shall be the close of business on the Business Day next preceding such Interest Payment Date. Any such interest installment not so punctually paid or duly provided for shall forthwith cease to be payable to the Holder on such Regular Record Date and may either be paid to the Person in whose name this Security (or one or more Predecessor Securities) is registered at the close of business on a Special Record Date for the payment of such Defaulted Interest to be fixed by the Trustee, notice whereof shall be given to Holders of Securities not less than 10 days prior to such Special Record Date, or be paid at any time in any other lawful manner not inconsistent with the requirements of any -16- securities exchange on which the Securities may be listed or the Nasdaq National Market if the Securities are quoted thereon, or of any other applicable self- regulatory organization, and upon such notice as may be required by such exchange, the Nasdaq National Market or such other organization all as more fully provided in said Indenture. So long as no Event of Default under the Indenture has occurred and is continuing, PMC shall have the right at any time during the term of this Security, from time to time, to extend the interest payment period of such Security for up to ten consecutive semi-annual periods with respect to each deferral period (each an "Extension Period"), during which period interest will compound semi-annually and PMC shall have the right to make partial payments of interest on any Interest Payment Date, and at the end of which Extension Period PMC shall pay all interest then accrued and unpaid including any Additional Interest; provided, however, that no Extension Period shall extend beyond the Stated Maturity of the principal of this Security as then in effect, and no such Extension Period may end on a date other than an Interest Payment Date; provided, further, that during any such Extension Period, PMC shall not, and shall cause any Subsidiary of PMC not to, (a) declare or pay any dividends or distributions on, or redeem, purchase, acquire or make a liquidation payment with respect to, any of PMC's outstanding capital stock or (b) make any payment of principal, interest or premium, if any, on or repay, repurchase or redeem any debt securities of PMC that rank pari passu with or junior in interest to this Security or make any guarantee payments with respect to any guarantee by PMC of the debt securities of any Subsidiary of PMC that by their terms rank pari passu or junior in interest to the Securities (other than (i) dividends or distributions in Common Stock or Class A Common Stock of PMC, (ii) payments under any Parent Guarantee and (iii) purchases of Common Stock or Class A Common Stock related to the issuance of Common Stock or Class A Common Stock under any of PMC's benefit plans for its directors, officers or employees). Prior to the termination of any such Extension Period, PMC may further defer the interest payments, provided that no Extension Period, together with all such previous and further extensions thereof, shall exceed ten consecutive semi-annual periods or extend beyond the Stated Maturity of this Security or end on a date other than an Interest Payment Date. Upon the termination of any such Extension Period and upon the payment of all accrued and unpaid interest and any Additional Interest then due, PMC may elect to begin a new Extension Period, subject to the above requirements. No interest shall be due and payable during an Extension Period, except at the end thereof but each installment of interest that would otherwise have been due and payable during such Extension Period shall bear Additional Interest (to the extent that the payment of such interest shall be legally enforceable) at the rate of ________% per annum, compounded semi-annually and calculated as set forth in the first paragraph of this Security, from the dates on which amounts would otherwise have been due and payable until paid or made available for payment. PMC shall give the Trustee and the Administrative Trustees notice of its election to begin an Extension Period at least one Business Day prior to the earliest of (a) the date interest on this Security would have been payable except for the election to begin such Extension Period, (b) the date such distributions on the Trust Securities are payable or (c) the date PMC Capital I is required to give notice to any securities exchange or the Nasdaq National Market or other applicable self-regulatory organization or to holders of the Capital Securities of the record date, but in any event not less than one Business Day prior to such record date. -17- Payment of the principal of and premium, if any, and interest (including any Additional Interest) on this Security will be made at the office or agency of PMC maintained for that purpose in the United States, in such coin or currency of the United States of America as at the time of payment is legal tender for payment of public and private debts; provided, however, that at the option of PMC payment of interest may be made (a) by check mailed to the address of the Person entitled thereto as such address shall appear in the Security Register or (b) by wire transfer in immediately available funds at such place and to such account as may be designated by the Person entitled thereto as specified in the Security Register. The indebtedness evidenced by this Security is, to the extent provided in the Indenture, subordinate and junior in right of payment to the prior payment in full of all Senior Debt, and this Security is issued subject to the provisions of the Indenture with respect thereto. Each Holder of this Security, by accepting the same, (a) agrees to and shall be bound by such provisions, (b) authorizes and directs the Trustee on his behalf to take such action as may be necessary or appropriate to effectuate the subordination so provided and (c) appoints the Trustee his attorney-in-fact for any and all such purposes. Each Holder hereof, by his acceptance hereof, waives all notice of the acceptance of the subordination provisions contained herein and in the Indenture by each holder of Senior Debt, whether now outstanding or hereafter incurred, and waives reliance by each such holder upon said provisions. Reference is hereby made to the further provisions of the Indenture summarized on the reverse hereof, which further provisions shall for all purposes have the same effect as if set forth at this place. Unless the certificate of authentication hereon has been executed by the Trustee referred to on the reverse hereof by manual signature, this Security shall not be entitled to any benefit under the Indenture or be valid or obligatory for any purpose. IN WITNESS WHEREOF, Pennsylvania Manufacturers Corporation has caused this instrument to be duly executed under its corporate seal. Dated: PENNSYLVANIA MANUFACTURERS CORPORATION By: ___________________________ Name: Title: Attest: ___________________________ Name: Title: -18- SECTION 203 Form of Reverse of Security. --------------------------- This Security is one of a duly authorized issue of Securities of PMC, designated as its ________% Junior Subordinated Debentures, Series A (herein called the "Securities"), limited in aggregate principal amount to $103,093,000 issued under an Indenture, dated as of ____________________, 1998 (herein called the "Indenture"), between PMC and The Bank of New York, as Trustee (herein called the "Trustee", which term includes any successor trustee under the Indenture), to which Indenture and all indentures supplemental thereto reference is hereby made for a statement of the respective rights, limitations of rights, duties and immunities thereunder of the Trustee, PMC and the Holders of the Securities, and of the terms upon which the Securities are, and are to be, authenticated and delivered. All terms used in this Security which are defined in the Indenture or in the Trust Agreement attached as Annex A thereto shall have the meanings assigned to them in the Indenture or the Trust Agreement, as the case may be. At any time on or after ____________________, 2008, PMC shall have the right, subject to the terms and conditions of Article Twelve of the Indenture, to redeem this Security at the option of PMC, without premium or penalty, in whole at any time or in part from time to time, at a Redemption Price equal to the following prices expressed in percentages of the principal amount to be redeemed, plus accrued but unpaid interest, including any Additional Interest, if any, to the Redemption Date, if redeemed during the 12-month period beginning ____________________ 1: Year Redemption Price ---- ---------------- 2008 10x.xxxx% 2009 10x.xxxx% 2010 10x.xxxx% 2011 10x.xxxx% 2012 10x.xxxx% 2013 10x.xxxx% 2014 10x.xxxx% 2015 10x.xxxx% 2016 10x.xxxx% 2017 10x.xxxx% and at 100% on or after _________________________ 1, 2018. If a Special Event as defined in the Indenture shall occur and be continuing prior to ___________________, 2008, PMC shall have the right, subject to the terms and conditions of Article Twelve of the Indenture, to redeem this Security at the option of PMC, without premium or penalty, in whole but not in part, within 90 days following the occurrence of such Special Event, subject to the provisions of Section 1207 and other provisions of Article Twelve of the Indenture, at a Redemption Price equal to the Make-Whole Amount, plus accrued but unpaid interest, including any Additional Interest, if any, to the Redemption Date. The "Make-Whole Amount" shall be equal to the greater of (a) 100% of the principal -19- amount hereof or (b) as determined by a Quotation Agent (as defined below), the sum of the present values of the principal amount and premium payable as part of the Redemption Price with respect to an optional redemption hereof on _______________________, 2008, together with scheduled payments of interest from the Redemption Date to _____________________, 2008 (the "Remaining Life"), in each case discounted to the Redemption Date on a semi-annual basis (assuming a 360-day year consisting of 30-day months) at the Adjusted Treasury Rate (as defined below). Any redemption pursuant to this paragraph will be made upon not less than 30 nor more than 60 days' notice, provided that, for so long as this Security is held by PMC Capital I, such notice shall be given not less than 45 nor more than 75 days prior to such Redemption Date (unless a shorter notice shall be satisfactory to the Property Trustee). If the Securities are only partially redeemed by PMC, the Securities will be redeemed pro rata. --- ---- "Adjusted Treasury Rate" means, with respect to any Redemption Date, the Treasury Rate (as defined below) plus (a) ________% if such Redemption Date occurs on or before ________________ 1,________ or (b) __________% if such Redemption Date occurs after _______________ 1, ________. "Treasury Rate" means (a) the yield, under the heading which represents the average for the immediately prior week, appearing in the most recently published statistical release designated "H.15(519)" or any successor publication which is published weekly by the Federal Reserve and which establishes yields on actively traded United States Treasury securities adjusted to constant maturity under the caption "Treasury Constant Maturities," for the maturity corresponding to the Remaining Life (if no maturity is within three months before or after the Remaining Life, yields for the two published maturities most closely corresponding to the Remaining Life shall be determined and the Treasury Rate shall be interpolated or extrapolated from such yields on a straight-line basis, rounding to the nearest month) or (b) if such release (or any successor release) is not published during the week preceding the calculation date or does not contain such yields, the rate per annum equal to the semi-annual equivalent yield to maturity of the Comparable Treasury Issue (as defined below), calculated using a price for the Comparable Treasury Issue (expressed as a percentage of its principal amount) equal to the Comparable Treasury Price for such Redemption Date. The Treasury Rate shall be calculated on the third Business Day preceding the Redemption Date. "Comparable Treasury Issue" means, with respect to any Redemption Date, the United States Treasury security selected by the Quotation Agent as having a maturity comparable to the Remaining Life that would be utilized, at the time of selection and in accordance with customary financial practice, in pricing new issues of corporate debt securities of comparable maturity to the Remaining Life. If no United States Treasury security has a maturity which is within a period from three months before to three months after _________________ 1, 2008, the two most closely corresponding United States Treasury securities shall be used as the Comparable Treasury Issue, and the Treasury Rate shall be interpolated or extrapolated on a straight-line basis, rounding to the nearest month using such securities. "Quotation Agent" means Goldman, Sachs & Co. and their successors; provided, however, that if the foregoing shall cease to be a primary U.S. Government securities -20- dealer in New York City (a "Primary Treasury Dealer"), PMC shall substitute therefor another Primary Treasury Dealer. "Reference Treasury Dealer" means (a) the Quotation Agent and (b) any other Primary Treasury Dealer selected by the Trustee after consultation with PMC. "Comparable Treasury Price" means (a) the average of five Reference Treasury Dealer Quotations (as defined below) for such Redemption Date, after excluding the highest and lowest such Reference Treasury Dealer Quotations or (b) if the Trustee obtains fewer than three such Reference Treasury Dealer Quotations, the average of all such Quotations. "Reference Treasury Dealer Quotations" means, with respect to each Reference Treasury Dealer and any Redemption Date, the average, as determined by the Trustee, of the bid and asked prices for the Comparable Treasury Issue (expressed in each case as a percentage of its principal amount) quoted in writing to the Trustee by such Reference Treasury Dealer at 5:00 p.m., New York City time, on the third Business Day preceding such Redemption Date. In the event of redemption of this Security in part only, a new Security or Securities for the unredeemed portion hereof will be issued in the name of the Holder hereof upon the cancellation hereof. If an Event of Default with respect to the Securities shall occur and be continuing, the principal of the Securities may be declared due and payable in the manner, with the effect and subject to the conditions provided in the Indenture. The Indenture contains provisions for satisfaction and discharge and defeasance at any time of the entire indebtedness of this Security upon compliance by PMC with certain conditions set forth in the Indenture. The Indenture contains provisions permitting PMC and the Trustee, with the consent of Holders of not less than a majority in aggregate principal amount of the Outstanding Securities, to modify the Indenture in a manner affecting the rights of the Holders of the Securities; provided that no such modification may, without the consent of the Holder of each Outstanding Security affected thereby, (a) change the fixed maturity of the Securities or reduce the principal amount thereof, or reduce the rate of interest thereon, or (b) reduce the percentage in aggregate principal amount of the Outstanding Securities, the Holders of which are required to consent to any such modification of the Indenture; provided, that, so long as any of the Capital Securities remains outstanding, no such modification may be made that adversely affects the Holders of the Capital Securities in any material respect, and no termination of the Indenture may occur, and no waiver of any Event of Default or compliance with any covenant under the Indenture may be effective, without the prior consent of the Holders of at least a majority of the aggregate Liquidation Amount (as defined in the Trust Agreement) of the outstanding Capital Securities unless and until the principal of and any premium on the Securities and all accrued and unpaid interest (including any Additional Interest) thereon have been paid in full. The Indenture also contains provisions permitting Holders of specified percentages in principal amount of the -21- Securities at the time Outstanding, on behalf of the Holders of all Securities, to waive compliance by PMC with certain provisions of the Indenture and certain past defaults under the Indenture and their consequences. Any such consent or waiver by the Holder of this Security shall be conclusive and binding upon such Holder and upon all future Holders of this Security and of any Security issued upon the registration of transfer hereof or in exchange therefor or in lieu hereof, whether or not notation of such consent or waiver is made upon this Security. As provided in and subject to the provisions of the Indenture, if an Event of Default (other than an Event of Default relating to certain bankruptcy events) with respect to the Securities at the time Outstanding occurs and is continuing, then and in every such case the Trustee or the Holders of not less than 25% in aggregate principal amount of the Outstanding Securities may declare the principal (or a specific portion of) of and the accrued interest on all the Securities, and any other amount payable under the Indenture to be due and payable immediately, by a notice in writing to PMC (and to the Trustee if given by Holders), provided that, if upon an Event of Default the Trustee or such Holders fail to declare the principal of all the Outstanding Securities to be immediately due and payable, the holders of at least 25% in aggregate Liquidation Amount of the Capital Securities then Outstanding shall have the right to make such declaration by a notice in writing to PMC and the Trustee; and upon any such declaration the principal (or a specific portion of) of and the accrued interest (including any Additional Interest) on all the Securities shall become immediately due and payable, provided that the payment of principal and interest (including any Additional Interest) on such Securities shall remain subordinated to the extent provided in Article Eleven of the Indenture. No reference herein to the Indenture and no provision of this Security or of the Indenture shall alter or impair the obligation of PMC, which is absolute and unconditional, to pay the principal of and premium, if any, and interest on this Security at the times, place and rate, and in the coin or currency, herein prescribed. As provided in the Indenture and subject to certain limitations therein set forth, the transfer of this Security is registrable in the Security Register, upon surrender of this Security for registration of transfer at the office or agency of The Bank of New York in ______________________________________________, duly endorsed by, or accompanied by a written instrument of transfer in form satisfactory to The Bank of New York, as the Security Registrar, duly executed by the Holder hereof or his attorney duly authorized in writing, and thereupon one or more new Securities of like tenor, of authorized denominations and for the same aggregate principal amount, will be issued to the designated transferee or transferees. No service charge shall be made for any such registration of transfer or exchange, but PMC or The Bank of New York may require payment of a sum sufficient to cover any tax or other governmental charge payable in connection therewith. Prior to due presentment of this Security for registration of transfer, PMC, the Trustee and any agent of PMC or the Trustee may treat the Person in whose name this Security is registered as the owner hereof for all purposes, whether or not this Security be overdue, and neither PMC, the Trustee nor any such agent shall be affected by notice to the contrary. -22- The Securities are issuable only in registered form without coupons in denominations of $1,000 and any integral multiple thereof. As provided in the Indenture and subject to certain limitations therein set forth, Securities are exchangeable for a like aggregate principal amount of Securities of a different authorized denomination, as requested by the Holder surrendering the same. PMC and, by its acceptance of this Security or a beneficial interest therein, the Holder of, and any Person that acquires a beneficial interest in, this Security agree that for United States federal, state and local tax purposes it is intended that this Security constitute indebtedness. THIS INDENTURE AND THE SECURITIES SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK WITHOUT REGARD TO CONFLICTS OF LAWS PRINCIPLES THEREOF. SECTION 204 Additional Provisions Required in Global Security. ------------------------------------------------- Any Global Security issued hereunder shall, in addition to the provisions contained in Sections 202 and 203, bear a legend in substantially the following form: If the Security is a Global Security, insert: "This Security is a Global Security within the meaning of the Indenture hereinafter referred to and is registered in the name of The Depository Trust Company, a New York corporation ("DTC") or a nominee of DTC. This Security is exchangeable for Securities registered in the name of a person other than DTC or its nominee only in the limited circumstances described in the Indenture and no transfer of this Security (other than a transfer of this Security as a whole by DTC to a nominee of DTC or by a nominee of DTC to DTC or another nominee of DTC) may be registered except in limited circumstances. "Unless this Security is presented by an authorized representative of DTC to Pennsylvania Manufacturers Corporation or its agent for registration of transfer, exchange or payment, and any Security issued is registered in the name of Cede & Co. or in such other name as is requested by an authorized representative of DTC (and any payment hereon is made to Cede & Co. or to such other entity as is requested by an authorized representative of DTC), ANY TRANSFER, PLEDGE OR OTHER USE HEREOF FOR VALUE OR OTHERWISE BY OR TO ANY PERSON IS WRONGFUL inasmuch as the registered owner hereof, Cede & Co. has an interest herein." -23- SECTION 205 Form of Trustee's Certificate of Authentication. ----------------------------------------------- This is one of the Securities referred to in the within-mentioned Indenture. The Bank of New York, as Trustee By: --------------------------------- Authorized Officer ARTICLE THREE The Securities SECTION 301 Title and Terms; Paying Agent. ----------------------------- The aggregate principal amount of Securities which may be authenticated and delivered under this Indenture is limited to $103,093,000 except for Securities authenticated and delivered upon registration of transfer of, or in exchange for, or in lieu of, other Securities pursuant to Sections 304, 305, 306, 906 or 1208. The Securities shall be known and designated as the "________% Junior Subordinated Debentures, Series A" of the Company. Their Stated Maturity shall be __________________ 1, 2028. The Securities shall bear interest at the rate of ________% per annum, from _____________ 1, __________ or from the most recent Interest Payment Date to which interest has been paid or duly provided for, as the case may be, payable semi-annually (subject to deferral as set forth herein), in arrears, on __________________ 1 and__________________ 1 of each year, commencing ______________ 1, 1999 until the principal thereof is paid or made available for payment. Accrued interest that is not paid on the applicable Interest Payment Date (even if unpaid due to an extension of an interest payment period as set forth below in this Section 301) will bear Additional Interest on the amount thereof. In the event that any date on which interest is payable on the Securities is not a Business Day, then a payment of the interest payable on such date will be made on the next succeeding day which is a Business Day (and without any interest or other payment in respect of any such delay), except that, if such Business Day is in the next succeeding calendar year, such payment shall be made on the immediately preceding Business Day, in each case with the same force and effect as if made on the date the payment was originally payable. So long as no Event of Default hereunder has occurred and is continuing, the Company shall have the right at any time during the term of the Securities to defer the payment of interest on such Securities from time to time, for up to ten consecutive semi-annual periods (each, an "Extension Period") during which Extension Periods interest will compound semi-annually and the Company shall have the right to make partial payments of interest on any Interest Payment Date. No Extension Period shall end on a date other -24- than an Interest Payment Date. At the end of any such Extension Period, the Company shall pay all interest then accrued and unpaid on the Securities (together with Additional Interest thereon, if any, at the rate specified for the Securities to the extent permitted by applicable law), provided, however, that during any such Extension Period, the Company shall not, and shall cause any Subsidiary not to, (i) declare or pay any dividends or distributions on, or redeem, purchase, acquire or make a liquidation payment with respect to, any of the Company's capital stock or (ii) make any payment of principal, interest or premium, if any, on or repay, repurchase or redeem any debt securities of the Company that rank pari passu with or junior in interest to the Securities or make any guarantee payments with respect to any guarantee by the Company of the debt securities of any Subsidiary of the Company that by their terms rank pari passu or junior in interest to the Securities (other than (a) dividends or distributions in Common Stock or Class A Common Stock of the Company, (b) payments under the Parent Guarantee and (c) purchases of Common Stock or Class A Common Stock related to the issuance of Common Stock or Class A Common Stock under any of the Company's benefit plans for its directors, officers or employees). Prior to the termination of any such Extension Period, the Company may further extend the interest payment period, provided that no Extension Period shall exceed ten consecutive semi-annual periods or extend beyond the Stated Maturity of the Securities. Upon the termination of any Extension Period and upon the payment of all accrued and unpaid interest and any Additional Interest then due, the Company may elect to begin a new Extension Period, subject to the above requirements. No interest shall be due and payable during an Extension Period, except at the end thereof. The Company shall give the Trustee and the Administrative Trustees notice of its election to begin any such Extension Period at least one Business Day prior to the earliest of (i) the date interest on the Securities would have been payable except for the election to begin such Extension Period, (ii) the date such distributions on the Trust Securities are payable or (iii) the date PMC Capital I is required to give notice to any securities exchange or the Nasdaq National Market or other applicable self-regulatory organization or to holders of the Capital Securities of the record date, but in any event not less than one Business Day prior to such record date. The Trustee shall promptly give notice of the Company's election to begin any such Extension Period to the Holders of the Outstanding Securities. The principal of and premium, if any, and interest (including any Additional Interest) on the Securities shall be payable at the office of such Paying Agent or Paying Agents as the Company may designate for such purpose from time to time, in such coin or currency of the United States of America as at the time of payment is legal tender for payment of public and private debts; provided, however, that at the option of the Company payment of interest may be made (i) by check mailed to the address of the Person entitled thereto as such address shall appear in the Security Register or (ii) by wire transfer in immediately available funds at such place and to such account as may be designated by the Person entitled thereto as specified in the Security Register. The Company designates The Bank of New York as the initial Paying Agent with respect to the Securities. The Company may at any time designate additional Paying Agents or rescind the designation of any Paying Agent or approve a change in the office through which any Paying Agent acts pursuant to Section 1002. -25- The Securities shall be subordinated in right of payment to Senior Debt as provided in Article Eleven. The Securities shall be redeemable as provided in Article Twelve. SECTION 302 Denominations. ------------- The Securities shall be issuable only in registered form, without coupons, and only in denominations of $1,000 and any integral multiple thereof. SECTION 303 Execution, Authentication, Delivery and Dating. ---------------------------------------------- The Securities shall be executed on behalf of the Company by its Chairman of the Board, its President or one of its Senior Vice Presidents, under its corporate seal reproduced thereon attested by its Secretary or one of its Assistant Secretaries. The signature of any of these officers on the Securities may be manual or facsimile. Securities bearing the manual or facsimile signatures of individuals who were at any time the proper officers of the Company shall bind the Company, notwithstanding that such individuals or any of them have ceased to hold such offices prior to the authentication and delivery of such Securities or did not hold such offices at the date of such Securities. At any time and from time to time after the execution and delivery of this Indenture, the Company may deliver Securities executed by the Company to the Trustee for authentication. Securities may be authenticated on original issuance from time to time and delivered pursuant to such procedures acceptable to the Trustee ("Procedures") as may be specified from time to time by Company Order. Procedures may authorize authentication and delivery pursuant to oral instructions of the Company or a duly authorized agent, which instructions shall be promptly confirmed in writing. Prior to the delivery of a Security in any such form to the Trustee for authentication, the Company shall deliver to the Trustee a Company Order requesting the Trustee's authentication and delivery of all or a portion of the Securities, and if less than all, setting forth procedures for such authentication. The Trustee in accordance with such Company Order shall authenticate and deliver such Securities as provided in this Indenture and not otherwise. Each Security shall be dated the date of its authentication. No Security shall be entitled to any benefit under this Indenture or be valid or obligatory for any purpose unless there appears on such Security a certificate of authentication substantially in the form provided for herein executed by the Trustee by manual signature, and such certificate upon any Security shall be conclusive evidence, and the only evidence, that such Security has been duly authenticated and delivered hereunder. -26- SECTION 304 Temporary Securities. -------------------- Pending the preparation of definitive Securities, the Company may execute, and upon Company Order the Trustee shall authenticate and deliver, temporary Securities which are printed, lithographed, typewritten, mimeographed or otherwise produced, in any authorized denomination, substantially of the tenor of the definitive Securities in lieu of which they are issued and with such appropriate insertions, omissions, substitutions and other variations as the officers executing such Securities may determine, as evidenced by their execution of such Securities. If temporary Securities are issued, the Company will cause definitive Securities to be prepared without unreasonable delay. After the preparation of definitive Securities, the temporary Securities shall be exchangeable for definitive Securities upon surrender of the temporary Securities at any office or agency of the Company designated pursuant to Section 1002, without charge to the Holder. Upon surrender for cancellation of any one or more temporary Securities, the Company shall execute and the Trustee shall authenticate and deliver in exchange therefor a like principal amount of definitive Securities having the same date of issuance and Stated Maturity and having the same terms as such temporary Securities. Until so exchanged, the temporary Securities shall in all respects be entitled to the same benefits under this Indenture as definitive Securities. SECTION 305 Registration, Registration of Transfer and Exchange. --------------------------------------------------- The Company shall cause to be kept at the Corporate Trust Office of the Trustee a register (the register maintained in such office and in any other office or agency designated pursuant to Section 1002 being herein sometimes collectively referred to as the "Security Register") in which, subject to such reasonable regulations as it may prescribe, the Company shall provide for the registration of Securities and of transfers of Securities. The Trustee is hereby appointed "Security Registrar" for the purpose of registering Securities and transfers of Securities as herein provided. Upon surrender for registration of transfer of any Security (duly endorsed or with the form of transfer endorsed thereon duly executed) at the office of the Security Registrar or at an office or agency of the Company designated pursuant to Section 1002 for such purpose, the Company shall execute, and the Trustee shall authenticate and deliver, in the name of the designated transferee or transferees, one or more new Securities of any authorized denominations, of a like tenor and aggregate principal amount, having the same date of issuance, Stated Maturity and terms. At the option of the Holder, Securities may be exchanged for other Securities of any authorized denominations, of a like tenor and aggregate principal amount having the same date of issuance, Stated Maturity and terms, upon surrender of the Securities to be exchanged at such office or agency. Whenever any Securities are so surrendered for exchange, the Company shall execute, and the Trustee shall authenticate and deliver, the Securities which the Holder making the exchange is entitled to receive. All Securities issued upon any registration of transfer or exchange of Securities shall be the valid obligations of the Company, evidencing the same debt, and entitled to the -27- same benefits under this Indenture, as the Securities surrendered upon such registration of transfer or exchange. Every Security presented or surrendered for registration of transfer or for exchange shall (if so required by the Company or the Trustee) be duly endorsed, or be accompanied by a written instrument of transfer in form satisfactory to the Company and the Security Registrar duly executed by the Holder thereof or his attorney duly authorized in writing. Such transfer or exchange will be effected upon the Security Registrar or the Company, as the case may be, being satisfied with the documents of title and identity of the Person making the request. No service charge shall be made to a Holder for any registration of transfer or exchange of Securities, but the Company or the Securities Registrar may require payment of a sum sufficient to cover any tax or other governmental charge that may be imposed in connection with any registration of transfer or exchange of Securities, other than exchanges pursuant to Sections 304, 906 or 1206 not involving any transfer. Notwithstanding any of the foregoing, any Global Security shall be exchangeable pursuant to this Section for Securities registered in the name of Persons other than the Depositary for such Security or its nominee only if (a) such Depositary notifies the Company that it is unwilling or unable to continue as Depositary for such Global Security or if at any time such Depositary ceases to be a clearing agency registered under the Securities Exchange Act of 1934, as amended, (b) the Company executes and delivers to the Trustee a Company Order that such Global Security shall be so exchangeable or (c) there shall have occurred and be continuing an Event of Default with respect to the Securities. Any Global Security that is exchangeable pursuant to the preceding sentence shall be exchangeable for Securities registered in such names as such Depositary shall direct. Notwithstanding any other provision in this Indenture, a Global Security may not be transferred except as a whole by the Depositary with respect to such Global Security to a nominee of such Depositary or by a nominee of such Depositary to such Depositary or another nominee of such Depositary. Neither the Company nor the Security Registrar shall be required, pursuant to the provisions of this Section, (a) to issue, register the transfer of or exchange any Security during a period beginning at the opening of business 15 days before the day of selection for redemption of Securities pursuant to Article Twelve and ending at the close of business on the day of mailing of notice of redemption or (b) to register the transfer of or exchange any Security so selected for redemption, in whole or in part, except, in the case of any Security to be redeemed in part, any portion thereof not to be redeemed. SECTION 306 Mutilated, Destroyed, Lost and Stolen Securities. ------------------------------------------------ If any mutilated Security is surrendered to the Trustee together with such security or indemnity as may be required by the Company or the Trustee to save each of them harmless, the Company shall execute, and the Trustee shall authenticate and deliver, in -28- exchange therefor a new Security of like tenor and aggregate principal amount and bearing a number not contemporaneously outstanding. If there shall be delivered to the Company and the Trustee (a) evidence to their satisfaction of the destruction, loss or theft of any Security and (b) such security or indemnity as may be required by them to save each of them and any agent of either of them harmless, then, in the absence of notice to the Company or the Trustee that such Security has been acquired by a bona fide purchaser, the Company shall execute and upon its request the Trustee shall authenticate and deliver, in lieu of any such destroyed, lost or stolen Security, a new Security of like tenor and principal amount and bearing a number not contemporaneously outstanding. In case any such mutilated, destroyed, lost or stolen Security has become or is about to become due and payable, the Company in its discretion may, instead of issuing a new Security, pay such Security. Upon the issuance of any new Security under this Section, the Company may require the payment of a sum sufficient to cover any tax or other governmental charge that may be imposed in relation thereto and any other expenses (including the fees and expenses of the Trustee) connected therewith. Every new Security issued pursuant to this Section in lieu of any destroyed, lost or stolen Security shall constitute an original additional contractual obligation of the Company, whether or not the destroyed, lost or stolen Security shall be at any time enforceable by anyone, and shall be entitled to all the benefits of this Indenture equally and proportionately with any and all other Securities duly issued hereunder. The provisions of this Section are exclusive and shall preclude (to the extent lawful) all other rights and remedies with respect to the replacement or payment of mutilated, destroyed, lost or stolen Securities. SECTION 307 Payment of Interest; Interest Rights Preserved. ---------------------------------------------- Interest and Additional Interest on any Security which is payable, and is punctually paid or duly provided for, on any Interest Payment Date shall be paid to the Person in whose name that Security (or one or more Predecessor Securities) is registered at the close of business on the Regular Record Date for such interest payment except that, unless otherwise provided in the Securities, interest and any Additional Interest payable on the Stated Maturity of the principal of a Security shall be paid to the Person to whom principal is paid. Any interest on any Security which is payable, but is not punctually paid or duly provided for, on any Interest Payment Date (herein called "Defaulted Interest") shall forthwith cease to be payable to the Holder on the relevant Regular Record Date by virtue of having been such Holder, and such Defaulted Interest may be paid by the Company, at its election in each case, as provided in clause (a) or (b) below: -29- (a) The Company may elect to make payment of any Defaulted Interest to the Persons in whose names the Securities (or their respective Predecessor Securities) are regis tered at the close of business on a Special Record Date for the payment of such Defaulted Interest, which shall be fixed in the following manner. The Company shall notify the Trustee in writing of the amount of Defaulted Interest proposed to be paid on each Security and the date of the proposed payment, and at the same time the Company shall deposit with the Trustee an amount of money equal to the aggregate amount proposed to be paid in respect of such Defaulted Interest or shall make arrangements satisfactory to the Trustee for such deposit prior to the date of the proposed payment, such money when deposited to be held in trust for the benefit of the Persons entitled to such Defaulted Interest as in this clause provided. Thereupon the Trustee shall fix a Special Record Date for the payment of such Defaulted Interest which shall be not more than 15 days and not less than 10 days prior to the date of the proposed payment and not less than 10 days after the receipt by the Trustee of the notice of the proposed payment. The Trustee shall promptly notify the Company of such Special Record Date and, in the name and at the expense of the Company, shall cause notice of the proposed payment of such Defaulted Interest and the Special Record Date therefor to be mailed, first-class postage prepaid, to each Holder at his address as it appears in the Security Register, not less than 10 days prior to such Special Record Date. Notice of the proposed payment of such Defaulted Interest and the Special Record Date therefor having been so mailed, such Defaulted Interest shall be paid to the Persons in whose names the Securities (or their respective Predecessor Securities) are registered at the close of business on such Special Record Date and shall no longer be payable pursuant to the following clause (b). (b) The Company may make payment of any Defaulted Interest in any other lawful manner not inconsistent with the requirements of any securities exchange on which the Securities may be listed, and, if so listed, upon such notice as may be required by such exchange, (or by the Trustee if the Securities are not listed) if, after notice given by the Company to the Trustee of the proposed payment pursuant to this clause, such manner of payment shall be deemed practicable by the Trustee. Subject to the foregoing provisions of this Section, each Security delivered under this Indenture upon registration of transfer of or in exchange for or in lieu of any other Security shall carry the rights to interest accrued and unpaid, and to accrue (including in each such case Additional Interest), which were carried by such other Security. SECTION 308 Persons Deemed Owners. --------------------- The Company, the Trustee and any agent of the Company or the Trustee may treat the Person in whose name such Security is registered as the owner of such Security for the purpose of receiving payment of principal of and (subject to Section 307) interest (including Additional Interest) on such Security and for all other purposes whatsoever, whether or not such Security be overdue, and neither the Company, the Trustee nor any agent of the Company or the Trustee shall be affected by notice to the contrary. No holder of any beneficial interest in any Global Security held on its behalf by a Depositary shall have any rights under this Indenture with respect to such Global Security, and such Depositary may be treated by the Company, the Trustee and any agent of the -30- Company or the Trustee as the owner of such Global Security for all purposes whatsoever. Notwithstanding the foregoing, nothing herein shall prevent the Company, the Trustee or any agent of the Company or the Trustee from giving effect to any written certification, proxy or other authorization furnished by a Depositary or impair, as between a Depositary and such holder of beneficial interests, the operation of customary practices governing the exercise of the rights of the Depositary (or its nominee) as Holder of any Security. SECTION 309 Cancellation. ------------ All Securities surrendered for payment, redemption, registration of transfer or exchange shall, if surrendered to any Person other than the Trustee, be delivered to the Trustee and any such Securities and Securities surrendered directly to the Trustee for any such purpose shall be promptly canceled by it. The Company may at any time deliver to the Trustee for cancellation any Securities previously authenticated and delivered hereunder which the Company may have acquired in any manner whatsoever, and all Securities so delivered shall be promptly canceled by the Trustee. No Securities shall be authenticated in lieu of or in exchange for any Securities canceled as provided in this Section, except as expressly permitted by this Indenture. All canceled Securities held by the Trustee shall be disposed of as directed by a Company Order. SECTION 310 Computation of Interest. ----------------------- Interest on the Securities payable for any full semi-annual period shall be computed on the basis of a 360-day year of twelve 30-day months and, for any period shorter than a full monthly period, shall be computed on the basis of the actual number of days elapsed in such period. SECTION 311 Right of Set-Off. ---------------- Notwithstanding anything to the contrary in the Indenture, the Company shall have the right to set-off any payment it is otherwise required to make hereunder with respect to any Security and to the extent the Company has theretofore made, or is concurrently on the date of such payment making, a payment under the Parent Guarantee or under Section 508 hereof. SECTION 312 Agreed Tax Treatment. -------------------- Each Security issued hereunder shall provide that the Company and, by its acceptance of a Security or a beneficial interest therein, the Holder of, and any Person that acquires a beneficial interest in, such Security agree that for United States federal, state and local tax purposes it is intended that such Security constitute indebtedness. -31- SECTION 313 CUSIP Numbers. ------------- The Company in issuing the Securities may use "CUSIP" numbers (if then generally in use), and, if so, the Trustee shall use "CUSIP" numbers in notices of redemption as a convenience to Holders; provided that any such notice may state that no representation is made as to the correctness of such numbers either as printed on the Securities or as contained in any notice of a redemption and that reliance may be placed only on the other identification numbers printed on the Securities, and any such redemption shall not be affected by any defect in or omission of such numbers. ARTICLE FOUR Satisfaction and Discharge SECTION 401 Satisfaction and Discharge of Indenture. --------------------------------------- This Indenture shall, upon Company Request, cease to be of further effect and the Company will be deemed to have satisfied and discharged this Indenture (except as to any surviving rights of registration of transfer or exchange of Securities herein expressly provided for and as otherwise provided in this Section 401) and the Trustee, on written demand of and at the expense of the Company, shall execute instruments supplied by the Company acknowledging satisfaction and discharge of this Indenture, when (a) either (i) all Securities theretofore authenticated and delivered (other than (A) Securities which have been destroyed, lost or stolen and which have been replaced or paid as provided in Section 306 and (B) Securities for whose payment money has theretofore been deposited in trust or segregated and held in trust by the Company and thereafter repaid to the Company or discharged from such trust, as provided in Section 1003) have been delivered to the Trustee for cancellation; or (ii) all such Securities not theretofore delivered to the Trustee for cancellation (A) have become due and payable or (B) will become due and payable at their Stated Maturity within one year of the date of deposit, and the Company, in the case of (A) or (B) above, has deposited or caused to be deposited with the Trustee cash or cash equivalents, as trust funds in trust for the purpose, an amount sufficient to pay and discharge the entire indebtedness on such Securities not theretofore delivered to the Trustee for cancellation, for principal, premium, if any, and interest (including Additional Interest) to the date of such deposit (in the case of Securities which have become due and payable) or to the Stated Maturity or Redemption Date, as the case may be; (b) the Company has paid or caused to be paid all other sums payable hereunder by the Company; and (c) the Company has delivered to the Trustee an Officers' Certificate and an Opinion of Counsel, each stating that all conditions precedent herein provided for relating to the satisfaction and discharge of this Indenture have been complied with. -32- Notwithstanding the satisfaction and discharge of this Indenture, the obligations of the Company to the Trustee under Section 607, the obligations of the Trustee to any Authenticating Agent under Section 614 and, if money shall have been deposited with the Trustee pursuant to subclause (ii) of clause (a) of this Section, the obligations of the Trustee under Section 402 and the last paragraph of Section 1003 shall survive. SECTION 402 Application of Trust Money. -------------------------- Subject to the provisions of the last paragraph of Section 1003, all money deposited with the Trustee pursuant to Section 401 or money or Government Obligations deposited with the Trustee pursuant to Section 403, or received by the Trustee in respect of Government Obligations deposited with the Trustee pursuant to Section 403, shall be held in trust and applied by the Trustee, in accordance with the provisions of the Securities and this Indenture, to the payment, either directly or through any Paying Agent (including the Company acting as its own Paying Agent) as the Trustee may determine, to the Persons entitled thereto, of the principal (and premium, if any) and interest (including any Additional Interest) for the payment of which such money or obligations have been deposited with or received by the Trustee. SECTION 403 Satisfaction, Discharge and Defeasance of Securities. ---------------------------------------------------- The Company shall be deemed to have paid and discharged the entire indebtedness on all the Outstanding Securities and the Trustee, at the expense of the Company, shall execute proper instruments acknowledging satisfaction and discharge of such indebtedness, when (a) with respect to all Outstanding Securities, (i) the Company has irrevocably deposited or caused to be irrevocably deposited with the Trustee as trust funds in trust for such purpose an amount sufficient to pay and discharge the entire indebtedness on all Outstanding Securities for principal (and premium, if any) and interest (including any Additional Interest) to the Stated Maturity or any Redemption Date as contemplated by the penultimate paragraph of this Section, as the case may be; or (ii) the Company has irrevocably deposited or caused to be irrevocably deposited with the Trustee as obligations in trust for such purpose an amount of Government Obligations as will, in the written opinion of independent public accountants delivered to the Trustee, together with predetermined and certain income to accrue thereon, without consideration of any reinvestment thereof, be sufficient to pay and discharge when due the entire indebtedness on all Outstanding Securities for principal (and premium, if any) and interest (including any Additional Interest) to the Stated Maturity or any Redemption Date as contemplated by the penultimate paragraph of this Section, as the case may be; and (b) the Company has paid or caused to be paid all other sums payable with respect to the Outstanding Securities; and -33- (c) the Company has delivered to the Trustee an Officers' Certificate and an Opinion of Counsel, each stating that all conditions precedent herein provided for relating to the satisfaction and discharge of the entire indebtedness on all Outstanding Securities have been complied with. Any deposits with the Trustee referred to in Section 403(a) above shall be irrevocable and shall be made under the terms of an escrow trust agreement in form and substance reasonably satisfactory to the Trustee. If any Outstanding Securities are to be redeemed prior to their Stated Maturity pursuant to any optional redemption provisions, the applicable escrow trust agreement shall provide therefor and the Company shall make such arrangements as are satisfactory to the Trustee for the giving of notice of redemption by the Trustee in the name, and at the expense, of the Company. If the Securities are not to become due and payable at their Stated Maturity or upon call for redemption within one year of the date of deposit, then the Company shall give, not later than the date of such deposit, notice of such deposit to the Holders of Securities. Upon the satisfaction of the conditions set forth in this Section with respect to all the Outstanding Securities, the terms and conditions of the Securities, including the terms and conditions with respect thereto set forth in this Indenture, shall no longer be binding upon, or applicable to, the Company; provided, that the Company shall not be discharged from any payment obligations in respect of Securities which are deemed not to be Outstanding under clause (c) of the definition thereof if such obligations continue to be valid obligations of the Company under applicable law. ARTICLE FIVE Remedies SECTION 501 Events of Default. ----------------- "Event of Default", wherever used herein, means any one of the following ---------------- events that has occurred and is continuing (whatever the reason for such Event of Default and whether it shall be occasioned by the provisions of Article Eleven or be voluntary or involuntary or be effected by operation of law or pursuant to any judgment, decree or order of any court or any order, rule or regulation of any administrative or governmental body): (a) failure for 30 days to pay any interest on the Securities (including Additional Interest, if any) when due (subject to the deferral of any due date in the case of an Extension Period); or (b) failure to pay any principal (or premium, if any) on the Securities when due whether at Stated Maturity, upon redemption, by declaration or otherwise; or (c) failure to observe or perform in any material respect any other covenant herein for 90 days after written notice requiring the Company to remedy the same to the -34- Company from the Trustee or to the Company and the Trustee from the holders of at least 25% in aggregate principal amount of the Outstanding Securities; or (d) entry by a court having jurisdiction in the premises of (i) a decree or order for relief in respect of the Company in an involuntary case or proceeding under any applicable federal or state bankruptcy, insolvency, reorganization or other similar law or (ii) a decree or order adjudging the Company a bankrupt or insolvent, or approving as properly filed a petition seeking reorganization, arrangement, adjustment or composition of or in respect of the Company under any applicable federal or state law, or appointing a custodian, receiver, liquidator, assignee, trustee, sequestrator or other similar official of the Company or of all or substantially all of the property of the Company, or ordering the winding up or liquidation of its affairs, and the continuance of any such decree or order for relief or any such other decree or order unstayed and in effect for a period of 60 consecutive days; or (e) (i) the commencement by the Company of a voluntary case or proceeding under any applicable federal or state bankruptcy, insolvency, reorganization or other similar law or of any other case or proceeding to be adjudicated a bankrupt or insolvent or (ii) the consent by the Company to or the entry of a decree or order for relief in respect of itself in an involuntary case or proceeding under any applicable federal or state bankruptcy, insolvency, reorganization or other similar law or to the commencement of any bankruptcy or insolvency case or proceeding against the Company, or (iii) the filing by the Company of a petition or answer or consent seeking reorganization or relief under any applicable federal or state law, or (iv) the consent by the Company to the filing of such petition or to the appointment of or taking possession by a custodian, receiver, liquidator, assignee, trustee, sequestrator or other similar official of the Company or of all or substantially all of the property of the Company, or (v) the making by the Company of an assignment for the benefit of creditors or (vi) the taking of corporate action by the Company in furtherance of any such action. SECTION 502 Acceleration of Maturity; Rescission and Annulment. -------------------------------------------------- If an Event of Default (other than an Event of Default specified in Sections 501(d) or 501(e)) occurs and is continuing, then and in every such case the Trustee or the Holders of not less than 25% in principal amount of the Outstanding Securities shall have the right to declare the principal (or a specific portion thereof) of and the interest on all the Securities, and any other amount payable under the Indenture, to be due and payable immediately, by a notice in writing to the Company (and to the Trustee if given by Holders) provided, that if upon an Event of Default, the Trustee or the Holders of not less than 25% in aggregate principal amount of the Outstanding Securities fail to declare such amounts to be immediately due and payable, the holders of at least 25% in aggregate Liquidation Amount of Capital Securities then outstanding shall have such right, by a notice in writing to the Company and the Trustee; and upon any such declaration such principal amount (or specified portion thereof) of and the accrued interest (including any Additional Interest) on all the Securities shall become immediately due and payable. If an Event of Default specified in Sections 501(d) or 501(e) occurs, the principal amount of all the Securities shall automatically, and without any declaration or other action on the part of the Trustee or any Holder, become immediately due and payable. Payment of principal and interest -35- (including any Additional Interest) on such Securities shall remain subordinated to the extent provided in Article Eleven. At any time after such a declaration of acceleration has been made and before a judgment or decree for payment of the money due has been obtained by the Trustee as hereinafter provided in this Article, the Holders of a majority in aggregate principal amount of the Outstanding Securities, by written notice to the Company and the Trustee, may rescind and annul such declaration and its consequences if: (a) the Company has paid or deposited with the Trustee a sum sufficient to pay: (i) all overdue installments of interest (including any Additional Interest) on all Securities, (ii) the principal of (and premium, if any, on) any Securities which have become due otherwise than by such declaration of acceleration and interest and Additional Interest, if any, thereon at the rate borne by the Securities and (iii) all sums paid or advanced by the Trustee hereunder and the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel; and (b) all Events of Default, other than the non-payment of the principal of Securities which has become due solely by such declaration of acceleration, have been cured or waived as provided in Section 513. If the Holders of a majority in principal amount of the Outstanding Securities fail to annul such declaration and waive such default, the holders of a majority in aggregate Liquidation Amount of the Capital Securities may rescind and annul such declaration and its consequences, subject to the foregoing conditions. No such rescission shall affect any subsequent default or impair any right consequent thereon. Upon receipt by the Trustee of written notice declaring such an acceleration, or rescission and annulment thereof, with respect to Securities all or part of which are represented by a Global Security, a record date shall be established for determining Holders of Outstanding Securities entitled to join in such notice, which record date shall be at the close of business on the day the Trustee receives such notice. The Holders on such record date, or their duly designated proxies, and only such Persons, shall be entitled to join in such notice, whether or not such Holders remain Holders after such record date; provided, that, unless such declaration of acceleration, or rescission and annulment, as the case may be, shall have become effective by virtue of the requisite percentage having joined in such notice prior to the day which is 90 days after such record date, such notice of declaration of -36- acceleration, or rescission and annulment, as the case may be, shall automatically and without further action by any Holder be canceled and of no further effect. Nothing in this paragraph shall prevent a Holder, or a proxy of a Holder, from giving, after expiration of such 90-day period, a new written notice of declaration of acceleration, or rescission and annulment thereof, as the case may be, that is identical to a written notice which has been canceled pursuant to the proviso to the preceding sentence, in which event a new record date shall be established pursuant to the provisions of this Section 502. SECTION 503 Collection of Indebtedness and Suits for Enforcement by Trustee. --------------------------------------------------------------- The Company covenants that if: (a) default is made in the payment of any installment of interest (including any Additional Interest) on any Security when such interest becomes due and payable and such default continues for a period of 30 days or (b) default is made in the payment of the principal of (and premium, if any, on) any Security at the Maturity thereof, the Company will, upon demand of the Trustee, pay to the Trustee, for the benefit of the Holders of such Securities, the whole amount then due and payable on such Securities for principal (and premium, if any) and interest (including any Additional Interest), and, in addition thereto, all amounts owing the Trustee under Section 607. Payment of principal (and premium, if any) and interest (including any Additional Interest) on such Securities shall remain subordinated to the extent provided in Article Eleven notwithstanding that such amount shall become immediately due and payable as herein provided. If the Company fails to pay such amounts forthwith upon such demand, the Trustee, in its own name and as trustee of an express trust, may institute a judicial proceeding for the collection of the sums so due and unpaid, may prosecute such proceeding to judgment or final decree and may enforce the same against the Company or any other obligor upon the Securities and collect the monies adjudged or decreed to be payable in the manner provided by law out of the property of the Company or any other obligor upon the Securities, wherever situated. If an Event of Default occurs and is continuing, the Trustee may in its discretion proceed to protect and enforce its rights and the rights of the Holders by such appropriate judicial proceedings as the Trustee shall deem most effectual to protect and enforce any such rights, whether for the specific enforcement of any covenant or agreement in this Indenture or in aid of the exercise of any power granted herein or to enforce any other proper remedy. SECTION 504 Trustee May File Proofs of Claim. -------------------------------- In case of the pendency of any receivership, insolvency, liquidation, bankruptcy, reorganization, arrangement, adjustment, composition or other judicial proceeding relative to the Company or any other obligor upon the Securities or the property of the Company or of such other obligor or their creditors, the Trustee (irrespective of whether the principal of the Securities shall then be due and payable as therein expressed or by declaration or otherwise and irrespective of whether the Trustee shall have made any demand on -37- the Company for the payment of overdue principal (and premium, if any) or interest (including Additional Interest)) shall be entitled and empowered, by intervention in such proceeding or otherwise, (a) to file and prove a claim for the whole amount of principal (and premium, if any) and interest (including any Additional Interest) owing and unpaid in respect to the Securities and to file such other papers or documents as may be necessary or advisable and to take any and all actions as are authorized under the Trust Indenture Act in order to have the claims of the Holders and any predecessor to the Trustee under Section 607 allowed in any such judicial proceedings and (b) in particular, the Trustee shall be authorized to collect and receive any monies or other property payable or deliverable on any such claims and to distribute the same in accordance with Section 506; and any custodian, receiver, assignee, trustee, liquidator, sequestrator or other similar official in any such judicial proceeding is hereby authorized by each Holder to make such payments to the Trustee for distribution in accordance with Section 506 and, in the event that the Trustee shall consent to the making of such payments directly to the Holders, to pay to the Trustee any amount due to it and any predecessor Trustee under Section 607. No provision of this Indenture shall be deemed to authorize the Trustee to authorize or consent to or accept or adopt on behalf of any Holder any plan of reorganization, arrangement, adjustment or composition affecting the Securities or the rights of any Holder thereof or to authorize the Trustee to vote in respect of the claim of any Holder in any such proceeding; provided, however, that the Trustee may, on behalf of the Holders, vote for the election of a trustee in bankruptcy or similar official and be a member of a creditors' or other similar committee. SECTION 505 Trustee May Enforce Claims Without Possession of Securities. ----------------------------------------------------------- All rights of action and claims under this Indenture or the Securities may be prosecuted and enforced by the Trustee without the possession of any of the Securities or the production thereof in any proceeding relating thereto, and any such proceeding instituted by the Trustee shall be brought in its own name as trustee of an express trust, and any recovery of judgment shall, subject to Article Eleven and after provision for payment of all the amounts owing the Trustee and any predecessor Trustee under Section 607, its agents and counsel, be for the ratable benefit of the Holders of the Securities in respect of which such judgment has been recovered. SECTION 506 Application of Money Collected. ------------------------------ Subject to Article Eleven, any money or property collected or to be applied by the Trustee pursuant to this Article shall be applied in the following order, at the date or dates fixed by the Trustee and, in case of the distribution of such money or property on account of principal (or premium, if any) or interest (including any Additional Interest), upon presentation of the Securities and the notation thereon of the payment if only partially paid and upon surrender thereof if fully paid: FIRST: To the payment of all amounts due the Trustee and any predecessor Trustee under Section 607; and -38- SECOND: To the payment of the amounts then due and unpaid for principal of (and premium, if any) and interest (including any Additional Interest) on the Securities in respect of which or for the benefit of which such money has been collected, ratably, without preference or priority of any kind, according to the amounts due and payable on such Securities for principal (and premium, if any) and interest (including any Additional Interest), respectively; and THIRD: The balance, if any, to the Person or Persons entitled thereto. SECTION 507 Limitation on Suits. ------------------- No Holder of any Security shall have any right to institute any proceeding, judicial or otherwise, with respect to this Indenture, or for the appointment of a receiver, assignee, trustee, liquidator, sequestrator or other similar official or for any other remedy hereunder, unless: (a) such Holder has previously given written notice to the Trustee of a continuing Event of Default; (b) the Holders of not less than 25% in aggregate principal amount of the Outstanding Securities shall have made written request to the Trustee to institute proceedings in respect of such Event of Default in its own name as Trustee hereunder; (c) such Holder or Holders have offered to the Trustee reasonable indemnity against the costs, expenses and liabilities to be incurred in compliance with such request; (d) the Trustee for 60 days after its receipt of such notice, request and offer of indemnity has failed to institute any such proceeding; and (e) no direction inconsistent with such written request has been given to the Trustee during such 60-day period by the Holders of a majority in aggregate principal amount of the Outstanding Securities; it being understood and intended that no one or more Holders shall have any right in any manner whatever by virtue of, or by availing itself of, any provision of this Indenture to affect, disturb or prejudice the rights of any other Holders, or to obtain or to seek to obtain priority or preference over any other Holders or to enforce any right under this Indenture, except in the manner herein provided and for the equal and ratable benefit of all the Holders. SECTION 508 Unconditional Right of Holders to Receive Principal and Interest. ---------------------------------------------------------------- Notwithstanding any other provision in this Indenture, the Holder of any Security shall have the right, which is absolute and unconditional, to receive payment of the principal of (and premium, if any) and (subject to Section 307) interest (including any Additional Interest) on such Security on the respective Stated Maturities expressed in such Security (or, in the case of redemption, on the Redemption Date) and to institute suit for the enforcement of any such payment, and such right shall not be impaired without the consent of such Holder. Any holder of the Capital Securities shall have the right, upon the occurrence of an Event of Default described in Sections 501(a) or 501(b) hereof, to institute -39- a suit directly against the Company for enforcement of payment to such holder of principal of (and premium, if any) and (subject to Section 307) interest (including any Additional Interest) on the Securities having a principal amount equal to the aggregate Liquidation Amount of the Capital Securities held by such holder. SECTION 509 Restoration of Rights and Remedies. ---------------------------------- If the Trustee or any Holder or any holder of Capital Securities has instituted any proceeding to enforce any right or remedy under this Indenture and such proceeding has been discontinued or abandoned for any reason, or has been determined adversely to the Trustee, such Holder or such holder of Capital Securities, then and in every such case, subject to any determination in such proceeding, the Company, the Trustee, the Holders and the holders of Capital Securities shall be restored severally and respectively to their former positions hereunder, and thereafter all rights and remedies of the Trustee, such Holder and such holders of Capital Securities shall continue as though no such proceeding had been instituted. SECTION 510 Rights and Remedies Cumulative. ------------------------------ Except as otherwise provided with respect to the replacement or payment of mutilated, destroyed, lost or stolen Securities in the last paragraph of Section 306, no right or remedy herein conferred upon or reserved to the Trustee or to the Holders is intended to be exclusive of any other right or remedy, and every right and remedy shall, to the extent permitted by law, be cumulative and in addition to every other right and remedy given hereunder or now or hereafter existing at law or in equity or otherwise. The assertion or employment of any right or remedy hereunder, or otherwise, shall not prevent the concurrent assertion or employment of any other appropriate right or remedy. SECTION 511 Delay or Omission Not Waiver. ---------------------------- Except as otherwise provided with respect to the replacement or payment of mutilated, destroyed, lost or stolen Securities in the last paragraph of Section 306, no delay or omission of the Trustee or of any Holder of any Security or any holder of any Capital Security to exercise any right or remedy accruing upon any Event of Default shall impair any such right or remedy or constitute a waiver of any such Event of Default or an acquiescence therein. Every right and remedy given by this Article or by law to the Trustee or to the Holders and the right and remedy given to the holders of Capital Securities by Section 508 may be exercised from time to time, and as often as may be deemed expedient, by the Trustee or by the Holders or the holders of Capital Securities, as the case may be. SECTION 512 Control by Holders. ------------------ The Holders of a majority in aggregate principal amount of the Outstanding Securities shall have the right to direct the time, method and place of conducting any proceeding for any remedy available to the Trustee or exercising any trust or power conferred on the Trustee, provided that -40- (a) such direction shall not be in conflict with any rule of law or with this Indenture, (b) the Trustee may take any other action deemed proper by the Trustee which is not inconsistent with such direction; and (c) subject to the provisions of Section 601, the Trustee shall have the right to decline to follow such direction if the Trustee in good faith shall, by a Responsible Officer or Officers of the Trustee, determine that the proceeding so directed would be unjustly prejudicial to the Holders not joining in any such direction or would involve the Trustee in personal liability. Upon receipt by the Trustee of any written notice directing the time, method or place of conducting any such proceeding or exercising any such trust or power, with respect to Securities all or part of which are represented by a Global Security, a record date shall be established for determining Holders of Outstanding Securities entitled to join in such notice, which record date shall be at the close of business on the day the Trustee receives such notice. The Holders on such record date, or their duly designated proxies, and only such Persons, shall be entitled to join in such notice, whether or not such Holders remain Holders after such record date; provided, that, unless the Holders of a majority in principal amount of the Outstanding Securities shall have joined in such notice prior to the day which is 90 days after such record date, such notice shall automatically and without further action by any Holder be canceled and of no further effect. Nothing in this paragraph shall prevent a Holder, or a proxy of a Holder, from giving, after expiration of such 90-day period, a new notice identical to a notice which has been canceled pursuant to the proviso to the preceding sentence, in which event a new record date shall be established pursuant to the provisions of this Section. SECTION 513 Waiver of Past Defaults. ----------------------- Subject to Sections 902 and 1007 hereof, the Holders of not less than a majority in aggregate principal amount of the Outstanding Securities affected thereby may waive any past default hereunder and its consequences, except a default: (a) in the payment of the principal of (or premium, if any) or interest (including any Additional Interest) on any Security (unless such default has been cured and a sum sufficient to pay all matured installments of interest (including any Additional Interest) and principal due (and premium, if any) otherwise than by acceleration has been deposited with the Trustee) or (b) in respect of a covenant or provision hereof which under Article Nine cannot be modified or amended without the consent of the Holder of each Outstanding Security affected. If the Holders of such Securities fail to waive such default, the holders of not less than a majority in aggregate Liquidation Amount of the Capital Securities shall have such right. Any such waiver shall be deemed to be on behalf of the Holders of all the Securities or, in the case of a waiver by holders of Capital Securities, by all holders of Capital Securities. -41- Upon any such waiver, such default shall cease to exist, and any Event of Default arising therefrom shall be deemed to have been cured, for every purpose of this Indenture; but no such waiver shall extend to any subsequent or other default or impair any right consequent thereon. SECTION 514 Undertaking for Costs. --------------------- All parties to this Indenture agree, and each Holder of any Security by his acceptance thereof shall be deemed to have agreed that any court may in its discretion require, in any suit for the enforcement of any right or remedy under this Indenture, or in any suit against the Trustee for any action taken or omitted by it as Trustee, the filing by any party litigant in such suit of an undertaking to pay the costs of such suit, and that such court may in its discretion assess reasonable costs against any such party litigant including reasonable attorneys' fees, in the manner and to the extent provided in the Trust Indenture Act having due regard to the merits and good faith of the claims or defenses made by such party litigants; but the provisions of this Section shall not apply to any suit instituted by the Trustee, to any suit instituted by any Holder, or group of Holders, holding in the aggregate more than 10% in aggregate principal amount of the Outstanding Securities, or to any suit instituted by any Holder for the enforcement of the payment of the principal of (or premium, if any) or interest (including any Additional Interest) on any Security on or after the respective Stated Maturities expressed in such Security. SECTION 515 Waiver of Usury, Stay or Extension Laws. --------------------------------------- The Company covenants (to the extent that it may lawfully do so) that it will not at any time insist upon, or plead, or in any manner whatsoever claim or take the benefit or advantage of, any usury, stay or extension law wherever enacted, now or at any time hereafter in force, which may affect the covenants or the performance of this Indenture; and the Company (to the extent that it may lawfully do so) hereby expressly waives all benefit or advantage of any such law and covenants that it will not hinder, delay or impede the execution of any power herein granted to the Trustee, but will suffer and permit the execution of every such power as though no such law had been enacted. ARTICLE SIX The Trustee SECTION 601 Certain Duties and Responsibilities. ----------------------------------- The duties and responsibilities of the Trustee shall be as provided by this Indenture and the Trust Indenture Act. Notwithstanding the foregoing, no provision of this Indenture shall require the Trustee to expend or risk its own funds or otherwise incur any financial liability in the performance of any of its duties hereunder, or in the exercise of any of its rights or powers, if it shall have reasonable grounds for believing that repayment of such funds or adequate indemnity against such risk or liability is not reasonably assured to it. Whether or not therein expressly so provided, every provision of -42- this Indenture relating to the conduct or affecting the liability of or affording protection to the Trustee shall be subject to the provisions of this Section. (a) Except during the continuance of an Event of Default, (i) the Trustee undertakes to perform such duties and only such duties as are specifically set forth in this Indenture, and no implied covenants or obligations shall be read into this Indenture against the Trustee, and (ii) in the absence of bad faith on its part, the Trustee may conclusively rely, as to the truth of the statements and the correctness of the opinions expressed therein, upon certificates or opinions furnished to the Trustee and conforming to the requirements of this Indenture; but in the case of any such certificates or opinions which by any provisions hereof are specifically required to be furnished to the Trustee, the Trustee shall be under a duty to examine the same to determine whether or not they conform to the requirements of this Indenture. (b) In case an Event of Default has occurred and is continuing, the Trustee shall exercise such of the rights and powers vested in it by this Indenture, and use the same degree of care and skill in their exercise, as a prudent person would exercise or use under the circumstances in the conduct of his own affairs. (c) No provision of this Indenture shall be construed to relieve the Trustee from liability for its own negligent action, its own negligent failure to act or its own willful misconduct except that (i) this Subsection shall not be construed to limit the effect of Subsection (a) of this Section; (ii) the Trustee shall not be liable for any error of judgment made in good faith by a Responsible Officer, unless it shall be proved that the Trustee was negligent in ascertaining the pertinent facts; and (iii) the Trustee shall not be liable with respect to any action taken or omitted to be taken by it in good faith in accordance with the direction of Holders pursuant to Section 512 relating to the time, method and place of conducting any proceeding for any remedy available to the Trustee, or exercising any trust or power conferred upon the Trustee under this Indenture with respect to the Securities. (d) No provision of this Indenture shall require the Trustee to expend or risk its own funds or otherwise incur any financial liability in the performance of any of its duties hereunder, or in the exercise of any of its rights or powers, if there shall be reasonable grounds for believing that repayment of such funds or adequate indemnity against such risk or liability is not reasonably assured to it. (e) Whether or not therein expressly so provided, every provision of this Indenture relating to the conduct or affecting the liability of or affording protection to the Trustee shall be subject to the provisions of this Section. -43- SECTION 602 Notice of Defaults. ------------------ Within 90 days after actual knowledge by a Responsible Officer of the Trustee of the occurrence of any default hereunder, the Trustee shall transmit by mail to all Holders of Securities, as their names and addresses appear in the Securities Register, notice of such default hereunder known to the Trustee, unless such default shall have been cured or waived; provided, however, that except in the case of a default in the payment of the principal of (or premium, if any) or interest (including any Additional Interest) on any Security, the Trustee shall be protected in withholding such notice if and so long as the board of directors, the executive committee or a trust committee of directors and/or Responsible Officers of the Trustee in good faith determine that the withholding of such notice is in the interests of the Holders of Securities; provided, further, that in the case of any default of the character specified in Section 501(c), no such notice to Holders shall be given until at least 30 days after the occurrence thereof. For the purpose of this Section, the term "default" means any event which is, or after notice or lapse of time or both would become, an Event of Default. For purposes of this Section, the Trustee shall be deemed to have actual knowledge of a default if it has received written notice of such default in the manner contemplated by Section 105. SECTION 603 Certain Rights of Trustee. ------------------------- Subject to the provisions of Section 601: (a) the Trustee may rely and shall be protected in acting or refraining from acting upon any resolution, certificate, statement, instrument, opinion, report, notice, request, direction, consent, order, bond, debenture, security, note, other evidence of indebtedness or other paper or document believed by it to be genuine and to have been signed or presented by the proper party or parties; (b) any request or direction of the Company mentioned herein shall be sufficiently evidenced by a Company Request or Company Order and any resolution of the Board of Directors may be sufficiently evidenced by a Board Resolution; (c) whenever in the administration of this Indenture the Trustee shall deem it desirable that a matter be proved or established prior to taking, suffering or omitting any action hereunder, the Trustee (unless other evidence be herein specifically prescribed) may, in the absence of bad faith on its part, rely upon an Officers' Certificate; (d) the Trustee may consult with counsel of its choice and the written advice of such counsel or any Opinion of Counsel shall be full and complete authorization and protection in respect of any action taken, suffered or omitted by it hereunder in good faith and in reliance thereon; (e) the Trustee shall be under no obligation to exercise any of the rights or powers vested in it by this Indenture at the request or direction of any of the Holders pursuant to this Indenture, unless such Holders shall have offered to the Trustee reasonable security or -44- indemnity against the costs, expenses and liabilities which might be incurred by it in compliance with such request or direction; (f) the Trustee shall not be bound to make any investigation into the facts or matters stated in any resolution, certificate, statement, instrument, opinion, report, notice, request, direction, consent, order, bond, indenture, Security, note, other evidence of indebtedness or other paper or document, but the Trustee, in its discretion, may make such further inquiry or investigation into such facts or matters as it may see fit, and, if the Trustee shall determine to make such further inquiry or investigation, it shall be entitled to examine the books, records and premises of the Company, personally or by agent or attorney; and (g) the Trustee may execute any of the trusts or powers hereunder or perform any duties hereunder either directly or by or through agents or attorneys and the Trustee shall not be responsible for any misconduct or negligence on the part of any agent or attorney appointed with due care by it hereunder. SECTION 604 Not Responsible for Recitals or Issuance of Securities. ------------------------------------------------------ The recitals contained herein and in the Securities, except the Trustee's certificates of authentication, shall be taken as the statements of the Company, and neither the Trustee nor any Authenticating Agent assumes responsibility for their correctness. The Trustee makes no representations as to the validity or sufficiency of this Indenture or of the Securities. Neither the Trustee nor any Authenticating Agent shall be accountable for the use or application by the Company of the Securities or the proceeds thereof. SECTION 605 May Hold Securities. ------------------- The Trustee, any Authenticating Agent, any Paying Agent, any Security Registrar or any other agent of the Company, in its individual or any other capacity, may become the owner or pledgee of Securities and, subject to Sections 608 and 613, may otherwise deal with the Company with the same rights it would have if it were not Trustee, Authenticating Agent, Paying Agent, Security Registrar or such other agent. SECTION 606 Money Held in Trust. ------------------- Money held by the Trustee in trust hereunder need not be segregated from other funds except to the extent required by law. The Trustee shall be under no liability for interest on any money received by it hereunder except as otherwise agreed in writing with the Company. SECTION 607 Compensation; Reimbursement and Indemnity. ----------------------------------------- The Company agrees (a) to pay to the Trustee from time to time such reasonable compensation as the Company and the Trustee shall from time to time agree in writing for all services rendered by it hereunder (which compensation shall not be limited by any provision of law in regard to the compensation of a trustee of an express trust); -45- (b) except as otherwise expressly provided herein, to reimburse the Trustee upon its request for all reasonable expenses, disbursements and advances incurred or made by the Trustee in accordance with any provision of this Indenture (including the reasonable compensation and the expenses and disbursements of its agents and counsel), except any such expense, disbursement or advance as may be attributable to its negligence or bad faith, and (c) to indemnify the Trustee for, and to hold it harmless against, any and all loss, damage, claim, liability, action, suit, cost or expense (including the reasonable compensation and the expenses and disbursements of its agents and counsel) of any kind and nature whatsoever incurred without negligence or bad faith, arising out of or in connection with the acceptance or administration of this trust or the performance of its duties hereunder, including the costs and expenses of defending itself against any claim or liability in connection with the exercise or performance of any of its powers or duties hereunder. In addition, the Company hereby agrees to pay all amounts owing under Section 8.06 of the Trust Agreement and to enter into and perform an Expense Agreement substantially in the form of Exhibit A to this Indenture. To secure the Company's payment obligations under this Section 607, the Trustee shall have a lien against all money or property held or collected by the Trustee, which lien shall be subordinate to the rights of the Securityholders but prior to the rights of the Company to any such money or property. When the Trustee incurs expenses or renders services after an Event of Default specified in Section 501(d) or (e) occurs, the expenses and the compensation for the services are intended to constitute expenses of administration under the Bankruptcy Reform Act of 1978 or any successor statute. The provisions of this Section shall survive the termination of this Indenture. SECTION 608 Disqualification; Conflicting Interests. --------------------------------------- If the Trustee has or shall acquire a conflicting interest within the meaning of the Trust Indenture Act, the Trustee shall either eliminate such interest or resign, to the extent and in the manner provided by, and subject to the provisions of, Section 310(b) of the Trust Indenture Act and this Indenture. SECTION 609 Corporate Trustee Required; Eligibility. --------------------------------------- There shall at all times be a Trustee hereunder which shall be a Person that is eligible pursuant to the Trust Indenture Act to act as such and has a combined capital and surplus of at least $50,000,000, subject to supervision or examination by federal or state authority. If such Person publishes reports of condition at least annually, pursuant to law or to the requirements of said supervising or examining authority, then for the purposes of this Section and to the extent permitted by the Trust Indenture Act, the combined capital and surplus of such Person shall be deemed to be its combined capital and surplus as set forth in its most recent report of condition so published. If at any time the Trustee shall cease to be eligible in accordance with the provisions of this Section, it shall resign -46- immediately in the manner and with the effect hereinafter specified in this Article. Neither the Company nor any Person directly or indirectly controlling, controlled by or under common control with the Company shall serve as Trustee for the Securities issued hereunder. SECTION 610 Resignation and Removal; Appointment of Successor. ------------------------------------------------- (a) No resignation or removal of the Trustee and no appointment of a successor Trustee pursuant to this Article shall become effective until the acceptance of appointment by the successor Trustee under Section 611. (b) The Trustee may resign at any time by giving written notice thereof to the Company. If an instrument of acceptance by a successor Trustee shall not have been delivered to the Trustee within 30 days after the giving of such notice of resignation, the resigning Trustee may petition any court of competent jurisdiction for the appointment of a successor Trustee. (c) The Trustee may be removed at any time by Act of the Holders of a majority in aggregate principal amount of the Outstanding Securities, delivered to the Trustee and to the Company. (d) If at any time: (i) the Trustee shall fail to comply with Section 608 after written request therefor by the Company or by any Holder who has been a bona fide Holder of a Security for at least six months, or (ii) the Trustee shall cease to be eligible under Section 609 and shall fail to resign after written request therefor by the Company or by any such Holder, or (iii) the Trustee shall become incapable of acting or shall be adjudged a bankrupt or insolvent or a receiver of the Trustee or of its property shall be appointed or any public officer shall take charge or control of the Trustee or of its property or affairs for the purpose of rehabilitation, conservation or liquidation, then, in any such case, (A) the Company by a Board Resolution may remove the Trustee or (B) subject to Section 514, any Holder who has been a bona fide Holder of a Security for at least six months may, on behalf of himself and all others similarly situated, petition any court of competent jurisdiction for the removal of the Trustee and the appointment of a successor Trustee. (e) If the Trustee shall resign, be removed or become incapable of acting, or if a vacancy shall occur in the office of Trustee for any cause, the Company, by a Board Resolution, shall promptly appoint a successor Trustee. If the Company fails to appoint a successor Trustee within 30 days of such resignation, removal or incapability, or the occurrence of such vacancy, the retiring Trustee may, subject to Section 514, petition any court of competent jurisdiction for the appointment of a successor Trustee. If, within one year after such resignation, removal or incapability, or the occurrence of such vacancy, a -47- successor Trustee shall be appointed by Act of the Holders of a majority in aggregate principal amount of the Outstanding Securities delivered to the Company and the retiring Trustee, the successor Trustee so appointed shall, forthwith upon its acceptance of such appointment, become the successor Trustee and supersede the successor Trustee appointed by the Company or any court. If no successor Trustee shall have been so appointed by the Company or the Holders and accepted appointment in the manner hereinafter provided, any Holder who has been a bona fide Holder of a Security for at least six months may, subject to Section 514, on behalf of himself and all others similarly situated, petition any court of competent jurisdiction for the appointment of a successor Trustee. (f) The Company shall give notice of each resignation and each removal of the Trustee and each appointment of a successor Trustee to all Holders in the manner provided in Section 106. Each notice shall include the name of the successor Trustee and the address of its Corporate Trust Office. SECTION 611 Acceptance of Appointment by Successor. -------------------------------------- Every successor Trustee appointed hereunder shall execute, acknowledge and deliver to the Company and to the retiring Trustee an instrument accepting such appointment, and thereupon the resignation or removal of the retiring Trustee shall become effective and such successor Trustee, without any further act, deed or conveyance, shall become vested with all the rights, powers, trusts and duties of the retiring Trustee; provided that, on request of the Company or the successor Trustee, such retiring Trustee shall, upon payment of its charges, execute and deliver an instrument transferring to such successor Trustee all the rights, powers and trusts of the retiring Trustee and shall duly assign, transfer and deliver to such successor Trustee all property and money held by such retiring Trustee hereunder. Upon request of any such successor Trustee, the Company shall execute any and all instruments for more fully and certainly vesting in and confirming to such successor Trustee all such rights, powers and trusts referred to in this Section. In case of the appointment hereunder of a successor Trustee, the Company, the retiring Trustee and each successor Trustee shall execute and deliver an indenture supplemental hereto wherein each successor Trustee shall accept such appointment and which shall contain such provisions as shall be necessary or desirable to transfer and confirm to, and to vest in, each successor Trustee all the rights, powers, trusts and duties of the retiring Trustee; and upon the execution and delivery of such supplemental indenture the resignation or removal of the retiring Trustee shall become effective to the extent provided therein and each such successor Trustee, without any further act, deed or conveyance, shall become vested with all the rights, powers, trusts and duties of the retiring Trustee; but, on request of the Company or any successor Trustee, such retiring Trustee shall duly assign, transfer and deliver to such successor Trustee all property and money hold by such retiring Trustee hereunder. No successor Trustee shall accept its appointment unless at the time of such acceptance such successor Trustee shall be qualified and eligible under this Article. -48- SECTION 612 Merger, Conversion, Consolidation or Succession to Business. ----------------------------------------------------------- Any corporation into which the Trustee may be merged or converted or with which it may be consolidated, or any corporation resulting from any merger, conversion or consolidation to which the Trustee shall be a party, or any corporation succeeding to all or substantially all the corporate trust business of the Trustee, shall be the successor of the Trustee hereunder, provided such corporation shall be otherwise qualified and eligible under this Article, without the execution or filing of any paper or any further act on the part of any of the parties hereto. In case any Securities shall have been authenticated, but not delivered, by the Trustee then in office, any successor by merger, conversion or consolidation to such authenticating Trustee may adopt such authentication and deliver the Securities so authenticated, and in case any Securities shall not have been authenticated, any successor to the Trustee may authenticate such Securities either in the name of any predecessor Trustee or in the name of such successor Trustee, and in all cases the certificate of authentication shall have the full force which it is provided anywhere in the Securities or in this Indenture that the certificate of the Trustee will have. SECTION 613 Preferential Collection of Claims Against Company. ------------------------------------------------- If and when the Trustee shall be or become a creditor of the Company (or any other obligor upon the Securities), the Trustee shall be subject to the provisions of the Trust Indenture Act regarding the collection of claims against the Company (or any such other obligor). SECTION 614. Appointment of Authenticating Agent. ----------------------------------- The Trustee may appoint an Authenticating Agent or Agents which shall be authorized to act on behalf of the Trustee to authenticate Securities issued upon original issue and upon exchange, registration or transfer or partial redemption thereof, and Securities so authenticated shall be entitled to the benefits of this Indenture and shall be valid and obligatory for all purposes as if authenticated by the Trustee hereunder. Wherever reference is made in this Indenture to the authentication and delivery of Securities by the Trustee or the Trustee's certificate of authentication, such reference shall be deemed to include authentication and delivery on behalf of the Trustee by an Authenticating Agent. Each Authenticating Agent shall be acceptable to the Company and shall at all times be a corporation organized and doing business under the laws of the United States of America, or of any State, Territory or the District of Columbia, authorized under such laws to act as Authenticating Agent, having a combined capital and surplus of not less than $50,000,000 and subject to supervision or examination by federal or state authority. If such Authenticating Agent publishes reports of condition at least annually, pursuant to law or to the requirements of said supervising or examining authority, then for the purposes of this Section the combined capital and surplus of such Authenticating Agent shall be deemed to be its combined capital and surplus as set forth in its most recent report of condition so published. If at any time an Authenticating Agent shall cease to be eligible in accordance with the provisions of this Section, such Authenticating Agent shall resign immediately in the manner and with the effect specified in this Section. -49- Any corporation into which an Authenticating Agent may be merged or converted or with which it may be consolidated, or any corporation resulting from any merger, conversion or consolidation to which an Authenticating Agent shall be a party, or any corporation succeeding to all or substantially all of the corporate trust business of an Authenticating Agent shall be the successor Authenticating Agent hereunder, provided such corporation shall be otherwise eligible under this Section, without the execution or filing of any paper or any further act on the part of the Trustee or such Authenticating Agent. An Authenticating Agent may resign at any time by giving written notice thereof to the Trustee and to the Company. The Trustee may at any time terminate the agency of an Authenticating Agent by giving written notice thereof to such Authenticating Agent and to the Company. Upon receiving such a notice of resignation or upon such a termination, or in case at any time such Authenticating Agent shall cease to be eligible in accordance with the provisions of this Section, the Trustee may appoint a successor Authenticating Agent which shall be acceptable to the Company and shall give notice of such appointment in the manner provided in Section 106 to all Holders of Securities. Any successor Authenticating Agent upon acceptance of its appointment hereunder shall become vested with all the rights, powers and duties of its predecessor hereunder, with like effect as if originally named as an Authenticating Agent. No successor Authenticating Agent shall be appointed unless eligible under the provisions of this Section. The Trustee agrees to pay to each Authenticating Agent from time to time reasonable compensation for its services under this Section, and the Trustee shall be entitled to be reimbursed for such payments, subject to the provisions of Section 607. If an appointment is made pursuant to this Section, the Securities may have endorsed thereon, in addition to the Trustee's certificate of authentication, an alternative certificate of authentication in the following form: This is one of the Securities referred to in the within mentioned Indenture. Dated: The Bank of New York, As Trustee By:________________________________ As Authenticating Agent By:________________________________ Authorized Officer -50- ARTICLE SEVEN Holders' Lists and Reports by Trustee and Company SECTION 701 Company to Furnish Trustee Names and Addresses of Holders. --------------------------------------------------------- The Company will furnish or cause to be furnished to the Trustee: (a) semiannually, not later than January 15 and July 15 in each year, a list, in such form as the Trustee may reasonably require, of the names and addresses of the Holders as of a date not more than 15 days prior to the time such list is furnished; and (b) at such other times as the Trustee may request in writing, within 30 days after the receipt by the Company of any such request, a list of similar form and content as of a date not more than 15 days prior to the time such list is furnished; in each case to the extent such information is in the possession or control of the Company and has not otherwise been received by the Trustee in its capacity as Security Registrar. SECTION 702 Preservation of Information; Communications to Holders. ------------------------------------------------------ (a) The Trustee shall preserve, in as current a form as is reasonably practicable, the names and addresses of Holders contained in the most recent list furnished to the Trustee as provided in Section 701 and the names and addresses of Holders received by the Trustee in its capacity as Security Registrar. The Trustee may destroy any list furnished to it as provided in Section 701 upon receipt of a new list so furnished. (b) The rights of Holders to communicate with other Holders with respect to their rights under this Indenture or under the Securities, and the corresponding rights and duties of the Trustee, shall be as provided by the Trust Indenture Act. (c) Every Holder of Securities, by receiving and holding the same, agrees with the Company and the Trustee that neither the Company nor the Trustee nor any agent of either of them shall be held accountable by reason of any disclosure of information as to names and addresses of Holders made pursuant to the Trust Indenture Act. SECTION 703 Reports by Trustee. ------------------ (a) The Trustee shall transmit to Holders such reports concerning the Trustee and its actions under this Indenture as may be required pursuant to the Trust Indenture Act at the times and in the manner provided pursuant thereto. (b) Reports so required to be transmitted at stated intervals of not more than 12 months shall be transmitted no later than July 15 in each calendar year, commencing with the first July 15 after the first issuance of Securities under this Indenture. (c) A copy of each such report shall, at the time of such transmission to Holders, be filed by the Trustee with each stock exchange upon which the Securities are listed and the -51- Nasdaq National Market if the Securities are quoted thereon, with the Commission and with the Company. The Company will notify the Trustee whenever the Securities are listed on any stock exchange. SECTION 704 Reports by Company. ------------------ The Company shall file with the Trustee and the Commission, and transmit to Holders, such information, documents and other reports, and such summaries thereof, as may be required pursuant to the Trust Indenture Act at the times and in the manner provided pursuant to such Act; provided that any such information, documents or reports required to be filed with the Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, shall be filed with the Trustee within 15 days after the same is so required to be filed with the Commission. Notwithstanding that the Company may not be required to remain subject to the reporting requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Company shall continue to file with the Commission and provide the Trustee with the annual reports and the information, documents and other reports which are specified in Sections 13 and 15(d) of the Securities Exchange Act of 1934. The Company also shall comply with the other provisions of Trust Indenture Act Section 314(a). ARTICLE EIGHT Consolidation, Merger, Conveyance, Transfer or Lease SECTION 801 Company May Consolidate, Etc., Only on Certain Terms. ---------------------------------------------------- The Company shall not consolidate with or merge into any other Person or convey, transfer or lease its properties and assets substantially as an entirety to any Person, and the Company shall not permit any Person to consolidate with or merge into the Company or convey, transfer or lease its properties and assets substantially as an entirety to the Company, unless: (a) in case the Company shall consolidate with or merge into another Person or convey, transfer or lease its properties and assets substantially as an entirety to any Person, the Person formed by such consolidation or into which the Company is merged or the Person which acquires by conveyance or transfer, or which leases, the properties and assets of the Company substantially as an entirety shall be a corporation, partnership, trust or other entity, shall be organized and validly existing under the laws of the United States of America, any State thereof or the District of Columbia and shall expressly assume, by an indenture supplemental hereto, executed and delivered to the Trustee, in form satis factory to the Trustee, the due and punctual payment of the principal of (and premium, if any) and interest (including any Additional Interest) on all the Securities and the performance or observance of every covenant of this Indenture and the Securities on the part of the Company to be performed or observed; (b) immediately after giving effect to such transaction, no Event of Default, and no event which, after notice or lapse of time or both, would become an Event of Default, shall have happened and be continuing; -52- (c) such consolidation or merger or conveyance, transfer or lease of properties or assets of the Company is permitted under the Trust Agreement and the Parent Guarantee and does not give rise to any breach or violation of the Trust Agreement or the Parent Guarantee; and (d) the Company has delivered to the Trustee an Officers' Certificate and an Opinion of Counsel, each stating that such consolidation, merger, conveyance, transfer or lease complies with this Article and that all conditions precedent herein provided for relating to such transaction have been complied with; and the Trustee, subject to Section 601, may rely upon such Officers' Certificate and Opinion of Counsel as conclusive evidence that such transaction complies with this Section. SECTION 802 Successor Substituted. --------------------- Upon any consolidation of the Company with, or merger of the Company with or into, any other Person or any conveyance, transfer or lease of the properties and assets of the Company substantially as an entirety in accordance with Section 801, the successor Person formed by such consolidation or into which the Company is merged or to which such conveyance, transfer or lease is made shall succeed to, and be substituted for, and may exercise every right and power of, the Company under this Indenture with the same effect as if such successor Person had been named as the Company herein; and in the event of any such conveyance, transfer or lease, the Company shall be discharged from all obligations and covenants under this Indenture and the Securities and may be dissolved and liquidated. Such successor Person may cause to be signed, and may issue either in its own name or in the name of the Company, any or all of the Securities issuable hereunder which theretofore shall not have been signed by the Company and delivered to the Trustee; and, upon the order of such successor Person instead of the Company and subject to all the terms, conditions and limitations in this Indenture prescribed, the Trustee shall authenticate and shall deliver any Securities which previously shall have been signed and delivered by the officers of the Company to the Trustee for authentication pursuant to such provisions and any Securities which such successor Person thereafter shall cause to be signed and delivered to the Trustee on its behalf for the purpose pursuant to such provisions. All the Securities so issued shall in all respects have the same legal rank and benefit under this Indenture as the Securities theretofore or thereafter issued in accordance with the terms of this Indenture as though all of such Securities has been issued at the date of the execution hereof. In case of any such consolidation, merger, sale, conveyance or lease, such changes in phraseology and form may be made in the Securities thereafter to be issued as may be appropriate. -53- ARTICLE NINE Supplemental Indentures SECTION 901 Supplemental Indentures Without Consent of Holders. -------------------------------------------------- Without the consent of any Holders, the Company, when authorized by a Board Resolution, and the Trustee, at any time and from time to time, may enter into one or more indentures supplemental hereto, in form satisfactory to the Trustee, for any of the following purposes: (a) to evidence the succession of another Person to the Company and the assump tion by any such successor of the covenants of the Company herein and in the Securities; or (b) to convey, transfer, assign, mortgage or pledge any property to or with the Trustee or to surrender any right or power herein conferred upon the Company; or (c) to add to the covenants of the Company for the benefit of the Holders, or to surrender any right or power herein conferred upon the Company; or (d) to add any additional Events of Default; or (e) to cure any ambiguity, to correct or supplement any provision herein which may be defective or inconsistent with any other provision herein, or to make any other provisions with respect to matters or questions arising under this Indenture, provided that such action pursuant to this clause (e) shall not materially adversely affect the interests of the Holders of the Securities or, so long as any of the Capital Securities shall remain outstanding, the holders of the Capital Securities; or (f) to evidence and provide for the acceptance of appointment hereunder by a successor Trustee; or (g) to comply with the requirements of the Commission in order to effect or maintain the qualification of this Indenture under the Trust Indenture Act. SECTION 902 Supplemental Indentures with Consent of Holders. ----------------------------------------------- With the consent of the Holders of not less than a majority in aggregate principal amount of the Outstanding Securities, by Act of said Holders delivered to the Company and the Trustee, the Company, when authorized by a Board Resolution, and the Trustee may enter into an indenture or indentures supplemental hereto for the purpose of adding any provisions to or changing in any manner or eliminating any of the provisions of this Indenture or of modifying in any manner the rights of the Holders under this Indenture; provided, however, that no such supplemental indenture shall, without the consent of the Holder of each Outstanding Security affected thereby, -54- (a) except to the extent permitted and subject to the conditions set forth in Section 301 with respect to the extension of interest payment periods of the Securities, change the Stated Maturity of, the principal of, or any installment of interest (including any Additional Interest) on, any Security, or reduce the principal amount thereof or the rate of interest thereon or reduce any premium payable upon the redemption thereof, or change the place of payment where, or the coin or currency in which, any Security or interest thereon is payable, or impair the right to institute suit for the enforcement of any such payment on or after the Stated Maturity thereof (or, in the case of redemption, on or after the Redemption Date), or modify the provisions of this Indenture with respect to the subordination of the Securities in a manner adverse to the Holders, or (b) reduce the percentage in aggregate principal amount of the Outstanding Securities, the consent of the Holders of which is required for any such supplemental indenture, or the consent of whose Holders is required for any waiver (of compliance with certain provisions of this Indenture or certain defaults hereunder and their consequences) provided for in this Indenture, or (c) modify any of the provisions of this Section, Section 513 or Section 1007, except to increase any such percentage or to provide that certain other provisions of this Indenture cannot be modified or waived without the consent of the Holder of each Outstanding Security affected thereby; provided, that, so long as any of the Capital Securities remains outstanding, no such amendment shall be made that adversely affects the holders of the Capital Securities in any material respect, and no termination of this Indenture shall occur, and no waiver of any Event of Default or compliance with any covenant under this Indenture shall be effective, without the prior consent of the holders of at least a majority of the aggregate Liquidation Amount of the outstanding Capital Securities unless and until the principal of and any premium on the Securities and all accrued and, subject to Section 307, unpaid interest (including any Additional Interest) thereon have been paid in full and where a consent hereunder would require the consent of each holder of the Outstanding Securities, no such consent will be given by the Trustee without the prior consent of each holder of the Capital Securities, provided further, that so long as any of the Capital Securities remains outstanding, no amendment shall be made to Section 508 of this Indenture without the prior consent of the holders of each Capital Security then outstanding unless and until the principal (and premium, if any) of the Securities and all accrued and (subject to Section 301) unpaid interest (including any Additional Interest) thereon have been paid in full. It shall not be necessary for any Act of Holders under this Section to approve the particular form of any proposed supplemental indenture, but it shall be sufficient if such Act shall approve the substance thereof. SECTION 903 Execution of Supplemental Indentures. ------------------------------------ In executing, or accepting the additional trusts created by, any supplemental indenture permitted by this Article or the modifications thereby of the trusts created by this Indenture, the Trustee shall be entitled to receive, and (subject to Section 601) shall be -55- fully protected in relying upon, an Officers' Certificate and an Opinion of Counsel stating that the execution of such supplemental indenture is authorized or permitted by this Indenture, and that all conditions precedent have been complied with. The Trustee may, but shall not be obligated to, enter into any such supplemental indenture which affects the Trustee's own rights, duties or immunities under this Indenture or otherwise. SECTION 904 Effect of Supplemental Indentures. --------------------------------- Upon the execution of any supplemental indenture under this Article, this Indenture shall be modified in accordance therewith, and such supplemental indenture shall form a part of this Indenture for all purposes; and every Holder of Securities theretofore or thereafter authenticated and delivered hereunder shall be bound thereby. SECTION 905 Conformity with Trust Indenture Act. ----------------------------------- Every supplemental indenture executed pursuant to this Article shall conform to the requirements of the Trust Indenture Act as then in effect. SECTION 906 Reference in Securities to Supplemental Indentures. -------------------------------------------------- Securities authenticated and delivered after the execution of any supplemental indenture pursuant to this Article may, and shall if required by the Company, bear a notation in form approved by the Company as to any matter provided for in such supplemental indenture. If the Company shall so determine, new Securities so modified as to conform, in the opinion of the Company, to any such supplemental indenture may be prepared and executed by the Company and authenticated and delivered by the Trustee in exchange for Outstanding Securities. ARTICLE TEN Covenants; Representations and Warranties SECTION 1001 Payment of Principal and Interest. --------------------------------- The Company covenants and agrees for the benefit of the Securities that it will duly and punctually pay the principal of (and premium, if any) and interest (including any Additional Interest) on the Securities in accordance with the terms of the Securities and this Indenture. SECTION 1002 Maintenance of Office or Agency. ------------------------------- The Company will maintain in Wilmington, Delaware, an office or agency where Securities may be presented or surrendered for payment, where Securities may be surrendered for registration of transfer or exchange and where notices and demands to or upon the Company in respect of the Securities and this Indenture may be served. The Company initially appoints the Trustee, acting through its Corporate Trust Office, as its -56- agent for said purposes. The Company will give prompt written notice to the Trustee of any change in the location of any such office or agency. If at any time the Company shall fail to maintain any such required office or agency or shall fail to furnish the Trustee with the address thereof, such presentations, surrenders, notices and demands may be made or served at the Corporate Trust Office of the Trustee, and the Company hereby appoints the Trustee as its agent to receive all such presentations, surrenders, notices and demands. The Company may also from time to time designate one or more other offices or agencies (in the United States) where the Securities may be presented or surrendered for any or all of such purposes, and may from time to time rescind such designations; provided, however, that no such designation or rescission shall in any manner relieve the Company of its obligation to maintain an office or agency in the United States for such purposes. The Company will give prompt written notice to the Trustee of any such designation and any change in the location of any such office or agency. SECTION 1003 Money for Security Payments To Be Held in Trust. ----------------------------------------------- If the Company shall at any time act as its own Paying Agent, it will, on or before each due date of the principal (and premium, if any) of or interest (including any Additional Interest) on any of the Securities, segregate and hold in trust for the benefit of the Persons entitled thereto a sum sufficient to pay the principal (and premium, if any) or interest (including any Additional Interest) so becoming due until such sums shall be paid to such Persons or otherwise disposed of as herein provided, and will promptly notify the Trustee of its failure so to act. Whenever the Company shall have one or more Paying Agents, it will, prior to 10:00 a.m. New York City time on each due date of the principal (or premium, if any) of or interest (including any Additional Interest) on any Securities, deposit with a Paying Agent a sum sufficient to pay the principal (and premium, if any) or interest (including any Additional Interest) so becoming due, such sum to be held in trust for the benefit of the Persons entitled to such principal (and premium, if any) or interest (including any Additional Interest), and (unless such Paying Agent is the Trustee) the Company will promptly notify the Trustee of its failure so to act. The Company will cause each Paying Agent other than the Trustee to execute and deliver to the Trustee an instrument in which such Paying Agent shall agree with the Trustee, subject to the provisions of this Section, that such Paying Agent will (a) comply with the provisions of the Trust Indenture Act applicable to it as a Paying Agent, (b) hold all sums held by it for the payment of the principal of (and premium, if any) or interest (including any Additional Interest) on Securities in trust for the benefit of the Persons entitled thereto until such sums shall be paid to such Persons or otherwise disposed of as herein provided, (c) give the Trustee notice of any default by the Company (or any other obligor upon the Securities) in the making of any payment of principal (and premium, if any) or interest (including any Additional Interest) and (d) at any time during the continuance of any such default by the Company (or any other obligor upon the Securities) in the making of any payment of principal (and premium, if any) or interest (including any Additional Interest), upon written request of the Trustee, forthwith pay to the Trustee all sums held in trust by such Paying Agent. -57- The Company may at any time, for the purpose of obtaining the satisfaction and discharge of this Indenture or for any other purpose, pay, or by Company Order direct any Paying Agent to pay, to the Trustee all sums held in trust by the Company or such Paying Agent, such sums to be held by the Trustee upon the same trusts as those upon which such sums were held by the Company or such Paying Agent; and, upon such payment by the Company or any Paying Agent to the Trustee, such Paying Agent shall be released from all further liability with respect to such money. Any money deposited with the Trustee or any Paying Agent, or then held by the Company, in trust for the payment of the principal of (and premium, if any) or interest (including any Additional Interest) on any Security and remaining unclaimed for two years after such principal (and premium, if any) or interest (including any Additional Interest) has become due and payable shall (unless otherwise required by mandatory provision of applicable escheat or abandoned or unclaimed property law) be paid to the Company on Company Request, or (if then held by the Company) shall (unless otherwise required by mandatory provision of applicable escheat or abandoned or unclaimed property law) be discharged from such trust; and the Holder of such Security shall thereafter, as an unsecured general creditor, look only to the Company for payment thereof, and all liability of the Trustee or such Paying Agent with respect to such trust money, and all liability of the Company as trustee thereof, shall thereupon cease. SECTION 1004 Statement by Officers as to Compliance. -------------------------------------- The Company will deliver to the Trustee, within 120 days after the end of each calendar year of the Company ending after the date hereof, an Officers' Certificate covering the preceding calendar year, stating whether or not to the best knowledge of the signers thereof the Company is in default in the performance, observance or fulfillment of or compliance with any of the terms, provisions, covenants and conditions of this Indenture (without regard to any period of grace or requirement of notice provided hereunder) and, if the Company shall be in default, specifying all such defaults and the nature and status thereof of which they may have knowledge. SECTION 1005 Additional Sums. --------------- In the event that (a) PMC Capital I is the Holder of all of the Outstanding Securities, (b) a Tax Event shall have occurred and be continuing and (c) the Company shall not have redeemed the Securities pursuant to Section 1201 or terminated PMC Capital I pursuant to Section 9.02(b) of the Trust Agreement, so long as no Event of Default has occurred and is continuing, the Company shall pay to PMC Capital I (and its permitted successors or assigns under the Trust Agreement) for so long as PMC Capital I (or its permitted successor or assignee) is the registered holder of any Securities, such additional amounts as may be necessary in order that the amount of distributions (including any Additional Amounts (as defined in the Trust Agreement)) then due and payable by PMC Capital I on the Capital Securities and Common Securities that at any time remain outstanding in accordance with the terms thereof shall not be reduced as a result of any Additional Taxes arising from such Tax Event (the "Additional Sums"). Whenever in this Indenture or the Securities there is a reference in any context to the payment of principal of or interest on -58- the Securities, such mention shall be deemed to include mention of the payments of the Additional Sums provided for in this paragraph to the extent that, in such context, Additional Sums are, were or would be payable in respect thereof pursuant to the provisions of this paragraph and express mention of the payment of Additional Sums (if applicable) in any provisions hereof shall not be construed as excluding Additional Sums in those provisions hereof where such express mention is not made, provided, however, that the deferral of interest payments pursuant to Section 301 or the Securities shall not defer the payment of any Additional Sums that may be due and payable. SECTION 1006 Additional Covenants. -------------------- The Company covenants and agrees with each Holder of Securities that it shall not, and it will not permit any Subsidiary of the Company to, (a) declare or pay any dividends or distributions on, or redeem, purchase, acquire or make a liquidation payment with respect to, any of the Company's outstanding capital stock or (b) make any payment of principal, interest or premium, if any, on or repay, repurchase or redeem any debt securities that rank pari passu with or junior to the Securities or make any guarantee payments with respect to any guarantee by the Company of the debt securities of any Subsidiary of the Company that by their terms rank pari passu or junior in interest to the Securities (other than (i) dividends or distributions in Common Stock or Class A Common Stock of the Company, (ii) payments under the Parent Guarantee and (iii) purchases of Common Stock or Class A Common Stock related to the issuance of Common Stock or Class A Common Stock under any of the Company's benefit plans for its directors, officers or employees), if at such time (A) there shall have occurred and be continuing any event that (1) with the giving of notice or the lapse of time or both, would constitute an Event of Default hereunder and (2) in respect of which the Company shall not have taken reasonable steps to cure, (B) the Company shall be in default with respect to its payment of any obligations under the Parent Guarantee or (C) the Company shall have given notice of its selection of an Extension Period as provided herein and shall not have rescinded such notice and such Extension Period, or any extension thereof, shall be continuing. The Company also covenants (a) to maintain directly or indirectly 100% ownership of the Common Securities of PMC Capital I; provided, however, that any permitted successor of the Company hereunder may succeed to the Company's ownership of such Common Securities, (b) not to voluntarily dissolve, wind-up or liquidate PMC Capital I, except (i) in connection with a distribution of the Securities to the holders of Capital Securities in liquidation of PMC Capital I or (ii) in connection with certain mergers, consolidations or amalgamations permitted by the Trust Agreement and (c) to use its reasonable efforts, consistent with the terms and provisions of the Trust Agreement, to cause PMC Capital I to remain a business trust and to be classified as a grantor trust for United States federal income tax purposes, except in connection with a distribution of the Securities to the holders of Capital Securities in liquidation of PMC Capital I. SECTION 1007 Waiver of Certain Covenants. --------------------------- Except as otherwise specified as contemplated by Section 301 for Securities, the Company may, with respect to the Securities, omit in any particular instance to comply with any term, provision or condition set forth in any covenant provided pursuant to -59- Section 901(b) for the benefit of the Holders if before or after the time for such compliance the Holders of at least a majority in aggregate principal amount of the Outstanding Securities shall, by Act of such Holders, either waive such compliance in such instance or generally waive compliance with such term, provision or condition, but no such waiver shall extend to or affect such term, provision or condition except to the extent so expressly waived, and, until such waiver shall become effective, the obligations of the Company and the duties of the Trustee in respect of any such term, provision or condition shall remain in full force and effect. ARTICLE ELEVEN Subordination of Securities SECTION 1101 Securities Subordinate to Senior Debt. ------------------------------------- The Company covenants and agrees, and each Holder of a Security, by its acceptance thereof, likewise covenants and agrees, that, to the extent and in the manner hereinafter set forth in this Article (subject to Article Four), the payment of the principal of (and premium, if any) and interest (including any Additional Interest) on each and all of the Securities are hereby expressly made subordinate and subject in right of payment to the prior payment in full of all amounts then due and payable in respect of all Senior Debt. The Trustee and the Holders shall take such action (including, without limitation, the delivery of this Indenture to an agent for the holders of Senior Debt or consent to the filing of a financing statement with respect hereto) as may, in the opinion of counsel designated by the holders of a majority in principal amount of the Senior Debt at the time outstanding, be necessary or appropriate to assure the effectiveness of the subordination effected by these provisions. The provisions of Sections 1102, 1103 and 1104 hereof shall not impair any rights, interests, remedies or powers of any secured creditor of the Company in respect of any security interest the creation of which is not prohibited by the provisions of this Indenture. The securing of any obligations of the Company, otherwise ranking on a parity with the Securities or ranking junior to the Securities, shall not be deemed to prevent such obligations from constituting, respectively, obligations ranking on a parity with the Securities or ranking junior to the Securities. SECTION 1102 Payment Over of Proceeds Upon Dissolution, Etc. ----------------------------------------------- In the case of the pendency of (a) any liquidation, reorganization, bankruptcy, insolvency, receivership, arrangement, adjustment, composition or other judicial proceeding relative to the Company, its creditors or its property, (b) any proceeding for the liquidation, dissolution or other winding up of the Company, voluntary or involuntary, whether or not involving insolvency or bankruptcy proceedings, (c) any assignment by the Company for the benefit of creditors or (d) any other marshalling of the assets of the Company (each such event, if any, herein sometimes referred to as a "Proceeding"), then -60- the holders of Senior Debt shall be entitled to receive payment in full of principal of (and premium, if any) and interest, if any, on such Senior Debt (including any interest thereon accruing after the commencement of any such Proceeding), or provision shall be made for such payment in cash or cash equivalents or otherwise in a manner satisfactory to the holders of Senior Debt, before the Holders of the Securities are entitled to receive or retain any payment or distribution of any kind or character, whether in cash, property or securities (including any payment or distribution which may be payable or deliverable by reason of the payment of any other Debt of the Company (including the Securities) subordinated to the payment of the Securities, such payment or distribution being hereinafter referred to as a "Junior Subordinated Payment"), on account of principal of (or premium, if any) or interest (including any Additional Interest) on the Securities or on account of the purchase or other acquisition of Securities by the Company or any Subsidiary and to that end the holders of Senior Debt shall be entitled to receive, for application to the payment thereof, any payment or distribution of any kind or character, whether in cash, property or securities, including any Junior Subordinated Payment, which may be payable or deliverable in respect of the Securities in any such Proceeding. In the event of any Proceeding, after payment in full of all sums owing with respect to Senior Debt, the Holders of the Securities, together with the holders of any obligations of the Company ranking on a parity with the Securities, shall be entitled to be paid from the remaining assets of the Company the amounts at the time due and owing on account of unpaid principal of (and premium, if any) and interest (including any Additional Interest) on the Securities and such other obligations before any payment or other distribution, whether in cash, property or otherwise, shall be made on account of any capital stock or any obligations of the Company ranking junior to the Securities and such other obligations. In the event that, notwithstanding the foregoing provisions of this Section, the Trustee or the Holder of any Security shall have received any payment or distribution of assets of the Company of any kind or character, whether in cash, property or securities, including any Junior Subordinated Payment, before all Senior Debt is paid in full or payment thereof is provided for in cash or cash equivalents or otherwise in a manner satisfactory to the holders of Senior Debt, then and in such event such payment or distribution shall be paid over or delivered forthwith to the trustee in bankruptcy, receiver, liquidating trustee, custodian, assignee, agent or other Person making payment or distribution of assets of the Company for application to the payment of all Senior Debt remaining unpaid, to the extent necessary to pay all Senior Debt in full, after giving effect to any concurrent payment or distribution to or for the holders of Senior Debt. For purposes of this Article only, the words "any payment or distribution of any kind or character, whether in cash, property or securities" shall not be deemed to include shares of stock of the Company as reorganized or readjusted, or securities of the Company or any other corporation provided for by a plan of reorganization or readjustment which securities are subordinated in right of payment to all then outstanding Senior Debt at least to the same extent as the Securities are so subordinated as provided in this Article. The consolidation of the Company with, or the merger of the Company into, another Person or the liquidation or dissolution of the Company following the sale of all or substantially all of its properties and assets as an entirety to another Person upon the terms and conditions -61- set forth in Article Eight shall not be deemed a Proceeding for the purposes of this Section if the Person formed by such consolidation or into which the Company is merged or the Person which acquires by sale such properties and assets as an entirety, as the case may be, shall, as a part of such consolidation, merger, or sale comply with the conditions set forth in Article Eight. SECTION 1103 Prior Payment to Senior Debt Upon Acceleration of Securities. ------------------------------------------------------------ In the event that any Securities are declared due and payable before their Stated Maturity, then and in such event the holders of the Senior Debt outstanding at the time such Securities so become due and payable shall be entitled to receive payment in full of all amounts due on or in respect of such Senior Debt (including any amounts due upon acceleration), or provision shall be made for such payment in cash or cash equivalents or otherwise in a manner satisfactory to the holders of Senior Debt, before the Holders of the Securities are entitled to receive any payment or distribution of any kind or character, whether in cash, properties or securities (including any Junior Subordinated Payment) by the Company on account of the principal of (or premium, if any) or interest (including any Additional Interest) on the Securities or on account of the purchase or other acquisition of Securities by the Company or any Subsidiary. In the event that, notwithstanding the foregoing, the Company shall make any payment to the Trustee or the Holder of any Security prohibited by the foregoing provisions of this Section, then and in such event such payment shall be paid over and delivered forthwith to the Company. The provisions of this Section shall not apply to any payment with respect to which Section 1102 would be applicable. SECTION 1104 No Payment When Senior Debt in Default. -------------------------------------- (a) In the event and during the continuation of any default in the payment of principal of (or premium, if any) or interest on any Senior Debt, when the same becomes due and payable, whether at maturity or at a date fixed for prepayment or by declaration of acceleration or otherwise, then, upon written notice of such default to the Company by the holders of Senior Debt or any trustee therefor, unless and until such event of default shall have been cured or waived or shall have ceased to exist, then no payment or distribution of any kind or character, whether in cash, properties or securities (including any Junior Subordinated Payment) shall be made by the Company on account of principal of (or premium, if any) or interest (including any Additional Interest), if any, on the Securities or on account of the purchase or other acquisition of Securities by the Company or any Subsidiary. In the event that, notwithstanding the foregoing, any payment or distribution of cash, property or securities shall be received or collected by the Trustee or the Holder of any Security in contravention of the foregoing provisions, such payment or distribution shall be held for the benefit of and shall be paid over to the holders of Senior Debt or their representative or representatives or to the trustee or trustees under any indenture under which any instrument evidencing Senior Debt may have been issued, as their respective -62- interests may appear, to the extent necessary to pay in full all Senior Debt then due, after giving effect to any concurrent payment to the holders of Senior Debt, but only to the extent that the holders of the Senior Debt (or their representative or representatives) notify the Trustees in writing, within 90 days of such payment, of the amounts then due and owing on such Senior Debt and only the amounts specified in such notice to the Trustees shall be paid to the holders of such Senior Debt. The provisions of this Section shall not apply to any payment with respect to which Section 1102 would be applicable. SECTION 1105 Payment Permitted If No Default. ------------------------------- Nothing contained in this Article or elsewhere in this Indenture or in any of the Securities shall prevent (a) the Company, at any time except during the pendency of any Proceeding referred to in Section 1102 or under the conditions described in Sections 1103 and 1104, from making payments at any time of principal of (and premium, if any) or interest (including any Additional Interest) on the Securities or (b) the application by the Trustee of any money or Government Obligations deposited with it hereunder to the payment of or on account of the principal of (and premium, if any) or interest (including any Additional Interest) on the Securities or the retention of such payment by the Holders, if, at the time of such application by the Trustee, it did not have knowledge that such payment would have been prohibited by the provisions of this Article. SECTION 1106 Subrogation to Rights of Holders of Senior Debt. ----------------------------------------------- Subject to the payment in full of all amounts due or to become due on all Senior Debt, or the provision for such payment in cash or cash equivalents or otherwise in a manner satisfactory to the holders of the Senior Debt, the Holders of the Securities shall be subrogated to the extent of the payments or distributions made to the holders of such Senior Debt pursuant to the provisions of this Article (equally and ratably with the holders of all indebtedness of the Company which by its express terms is subordinated to Senior Debt of the Company to substantially the same extent as the Securities are subordinated to the Senior Debt and is entitled to like rights of subrogation by reason of any payments or distributions made to holders of such Senior Debt) to the rights of the holders of such Senior Debt to receive payments and distributions of cash, property and securities applicable to the Senior Debt until the principal of (and premium, if any) and interest (including any Additional Interest) on the Securities shall be paid in full. For purposes of such subrogation or assignment, no payments or distributions to the holders of the Senior Debt of any cash, property or securities to which the Holders of the Securities or the Trustee would be entitled except for the provisions of this Article, and no payments over pursuant to the provisions of this Article to the holders of Senior Debt by Holders of the Securities or the Trustee, shall, as among the Company, its creditors other than holders of Senior Debt, and the Holders of the Securities, be deemed to be a payment or distribution by the Company to or on account of the Senior Debt. -63- SECTION 1107 Provisions Solely to Define Relative Rights. ------------------------------------------- The provisions of this Article are and are intended solely for the purpose of defining the relative rights of the Holders of the Securities on the one hand and the holders of Senior Debt on the other hand. Nothing contained in this Article or elsewhere in this Indenture or in the Securities is intended to or shall (a) impair, as between the Company and the Holders of the Securities, the obligations of the Company, which are absolute and unconditional, to pay to the Holders of the Securities the principal of (and premium, if any) and interest (including any Additional Interest) on the Securities as and when the same shall become due and payable in accordance with their terms; (b) affect the relative rights against the Company of the Holders of the Securities and creditors of the Company other than their rights in relation to the holders of Senior Debt or (c) prevent the Trustee or the Holder of any Security (or to the extent expressly provided herein, the holder of any Capital Security) from exercising all remedies otherwise permitted by applicable law upon default under this Indenture including, without limitation, filing and voting claims in any Proceeding, subject to the rights, if any, under this Article of the holders of Senior Debt to receive cash, property and securities otherwise payable or deliverable to the Trustee or such Holder. SECTION 1108 Trustee to Effectuate Subordination. ----------------------------------- Each Holder of a Security by his or her acceptance thereof authorizes and directs the Trustee on his or her behalf to take such action as may be necessary or appropriate to acknowledge or effectuate the subordination provided in this Article and appoints the Trustee his or her attorney-in-fact for any and all such purposes. SECTION 1109 No Waiver of Subordination Provisions. ------------------------------------- No right of any present or future holder of any Senior Debt to enforce subordination as herein provided shall at any time in any way be prejudiced or impaired by any act or failure to act on the part of the Company or by any act or failure to act, in good faith, by any such holder, or by any noncompliance by the Company with the terms, provisions and covenants of this Indenture, regardless of any knowledge thereof that any such holder may have or otherwise be charged with. Without in any way limiting the generality of the immediately preceding paragraph, the holders of Senior Debt may, at any time and from time to time, without the consent of or notice to the Trustee or the Holders of the Securities, without incurring responsibility to such Holders of the Securities and without impairing or releasing the subordination provided in this Article or the obligations hereunder of such Holders of the Securities to the holders of Senior Debt, do any one or more of the following: (a) change the manner, place or terms of payment or extend the time of payment of, or renew or alter, Senior Debt, or otherwise amend or supplement in any manner Senor Debt or any instrument evidencing the same or any agreement under which Senior Debt is outstanding; (b) sell, exchange, release or otherwise deal with any property pledged, mortgaged or otherwise securing Senior Debt; (c) release any Person liable in any manner for the collection of Senior Debt and (d) exercise or refrain from exercising any rights against the Company and any other Person. -64- SECTION 1110 Notice to Trustee. ----------------- The Company shall give prompt written notice to the Trustee of any fact known to the Company that would prohibit the making of any payment to or by the Trustee in respect of the Securities. Notwithstanding the provisions of this Article or any other provision of this Indenture, the Trustee shall not be charged with knowledge of the existence of any facts that would prohibit the making of any payment to or by the Trustee in respect of the Securities, unless and until the Trustee shall have received written notice thereof from the Company or a holder of Senior Debt or from any trustee, agent or representative therefor (whether or not the facts contained in such notice are true); provided, however, that if the Trustee shall not have received the notice provided for in this Section at least two Business Days prior to the date upon which by the terms hereof any monies may become payable for any purpose (including, without limitation, the payment of the principal of (and premium, if any) or interest (including any Additional Interest) on any Security), then, anything herein contained to the contrary notwithstanding, the Trustee shall have full power and authority to receive such monies and to apply the same to the purposes for which they were received, and shall not be affected by any notice to the contrary which may be received by it within two Business Days prior to such date. Subject to the provisions of Section 601, the Trustee shall be entitled to rely on the delivery to it of a written notice by a Person representing such Person to be a holder of Senior Debt (or a trustee or attorney-in-fact therefor) to establish that such notice has been given by a holder of Senior Debt (or a trustee or attorney-in-fact therefor). In the event that the Trustee determines in good faith that further evidence is required with respect to the right of any Person as a holder of Senior Debt to participate in any payment or distribution pursuant to this Article, the Trustee may request such Person to furnish evidence to the reasonable satisfaction of the Trustee as to the amount of Senior Debt held by such Person, the extent to which such Person is entitled to participate in such payment or distribution and any other facts pertinent to the rights of such Person under this Article, and if such evidence is not furnished, the Trustee may defer any payment to such Person pending judicial determination as to the right of such Person to receive such payment. SECTION 1111 Reliance on Judicial Order or Certificate of Liquidating Agent. --------------------------------------------------------------- Upon any payment or distribution of assets of the Company referred to in this Article, the Trustee, subject to the provisions of Article Six, and the Holders of the Securities shall be entitled to rely upon any order or decree entered by any court of competent jurisdiction in which such Proceeding is pending, or a certificate of the trustee in bankruptcy, receiver, liquidating trustee, custodian, assignee for the benefit of creditors, agent or other Person making such payment or distribution, delivered to the Trustee or to the Holders of Securities, for the purpose of ascertaining the Persons entitled to participate in such payment or distribution, the holders of the Senior Debt and other indebtedness of the Company, the amount thereof or payable thereon, the amount or amounts paid or distributed thereon and all other facts pertinent thereto or to this Article. -65- SECTION 1112 Trustee Not Fiduciary for Holders of Senior Debt. ------------------------------------------------- The Trustee, in its capacity as trustee under this Indenture, shall not be deemed to owe any fiduciary duty to the holders of Senior Debt and shall not be liable to any such holders if it shall in good faith mistakenly pay over or distribute to Holders of Securities or to the Company or to any other Person cash, property or securities to which any holders of Senior Debt shall be entitled by virtue of this Article or otherwise. SECTION 1113 Rights of Trustee as Holder of Senior Debt; Preservation of ----------------------------------------------------------- Trustee's Rights. ---------------- The Trustee in its individual capacity shall be entitled to all the rights set forth in this Article in respect of any Senior Debt which may at any time be held by it, to the same extent as any other holder of Senior Debt, and nothing in this Indenture shall deprive the Trustee of any of its rights as such holder. SECTION 1114 Article Applicable to Paying Agents. ------------------------------------ In case at any time any Paying Agent other than the Trustee shall have been appointed by the Company and be then acting hereunder, the term "Trustee" as used in this Article shall in such case (unless the context otherwise requires) be construed as extending to and including such Paying Agent within its meaning as fully for all intents and purposes as if such Paying Agent were named in this Article in addition to or in place of the Trustee. SECTION 1115 Certain Conversions or Exchanges Deemed Payment. ------------------------------------------------ (a) For the purposes of this Article only, (i) the issuance and delivery of junior securities upon exchange of Securities shall not be deemed to constitute a payment or distribution on account of the principal of (or premium, if any) or interest (including any Additional Interest) on Securities or on account of the purchase or other acquisition of Securities and (ii) the payment, issuance or delivery of cash, property or securities (other than junior securities) upon exchange of a Security shall be deemed to constitute payment on account of the principal of such Security. (b) For the purposes of this Section, the term "junior securities" means (i) shares of any stock of any class of the Company and (ii) securities of the Company which are subordinated in right of payment to all Senior Debt which may be outstanding at the time of issuance or delivery of such securities to substantially the same extent as, or to a greater extent than, the Securities are so subordinated as provided in this Article. -66- ARTICLE TWELVE Redemption of Securities SECTION 1201 Applicability of this Article. ----------------------------- Redemption of Securities as permitted or required by any form of Security issued pursuant to this Indenture shall be made in accordance with such form of Security and this Article; provided, however, that if any provision of any such form of Security shall conflict with any provision of this Article, the provision of such form of Security shall govern. Except as otherwise set forth in the form of Security, each Security shall be subject to partial redemption only in the amount of $1,000 or integral multiples thereof. SECTION 1202 Election to Redeem; Notice to Trustee. ------------------------------------- The election of the Company to redeem any Securities shall be evidenced by or pursuant to a Board Resolution. In case of any redemption at the election of the Company, the Company shall at least 45 days prior to the Redemption Date fixed by the Company (unless a shorter notice shall be satisfactory to the Trustee), notify the Trustee of such Redemption Date and of the principal amount of Securities to be redeemed, provided that, for so long as the Securities are held by PMC Capital I, such notice shall be given not less than 45 nor more than 75 days prior to such Redemption Date (unless a shorter notice shall be satisfactory to the Property Trustee). In the case of any redemption of Securities prior to the expiration of any restriction on such redemption provided in the terms of such Securities, the Company shall furnish the Trustee with an Officers' Certificate and an Opinion of Counsel evidencing compliance with such restriction. SECTION 1203 Selection by Trustee of Securities to Be Redeemed. ------------------------------------------------- If less than all the Securities are to be redeemed, the particular Securities to be redeemed shall be selected not more than 75 days prior to the Redemption Date by the Trustee, from the Outstanding Securities not previously called for redemption, by such method as the Trustee shall deem fair and appropriate and which may provide for the selection for redemption of a portion of the principal amount of any Security, provided that the unredeemed portion of the principal amount of any Security shall be in an authorized denomination (which shall not be less than the minimum authorized denomination) for such security. The Trustee shall promptly notify the Company in writing of the Securities selected for partial redemption and the principal amount thereof to be redeemed. For all purposes of this Indenture, unless the context otherwise requires, all provisions relating to the redemption of Securities shall relate, in the case of any Security redeemed or to be redeemed only in part, to the portion of the principal amount of such Security which has been or is to be redeemed. -67- SECTION 1204 Notice of Redemption. -------------------- Notice of redemption shall be given by first-class mail, postage prepaid, mailed not less than 30 nor more than 60 days prior to the Redemption Date, to each Holder of Securities to be redeemed, at the address of such Holder as it appears in the Security Register, provided that, for so long as the Securities are held by PMC Capital I, such notice shall be given not less than 45 nor more than 75 days prior to such Redemption Date (unless a shorter notice shall be satisfactory to the Property Trustee). All notices of redemption shall identify the Securities to be redeemed (including CUSIP number, if any) and shall state: (a) the Redemption Date, (b) the Redemption Price or, if the Redemption Price cannot be calculated prior to the time the notice is required to be sent, the estimate of the Redemption Price together with a statement that it is an estimate and that the actual Redemption Price will be calculated on the third Business Day prior to the Redemption Date (and if an estimate is provided, a further notice shall be sent of the actual Redemption Price on the date that such Redemption Price is calculated); (c) if less than all Outstanding Securities are to be redeemed, the identification (and, in the case of partial redemption, the respective principal amounts) of the particular Securities to be redeemed; (d) that on the Redemption Date the Redemption Price will become due and payable upon each such Security or portion thereof, and that interest thereon, if any, shall cease to accrue on and after said date; and (e) the place or places where such Securities are to be surrendered for payment of the Redemption Price. Notice of redemption of Securities to be redeemed at the election of the Company shall be given by the Company or, at the Company's request, by the Trustee in the name and at the expense of the Company and shall not be irrevocable. The notice if mailed in the manner herein provided shall be conclusively presumed to have been duly given, whether or not the Holder receives such notice. In any case, a failure to give such notice by mail or any defect in the notice to the Holder of any Security designated for redemption as a whole or in part shall not affect the validity of the proceedings for the redemption of any other Security. SECTION 1205 Deposit of Redemption Price. --------------------------- Prior to 10:00 a.m. New York City time on the Redemption Date specified in the notice of redemption, the Company shall deposit with the Trustee or with a Paying Agent (or, if the Company is acting as its own Paying Agent, segregate and hold in trust as provided in Section 1003) an amount of money sufficient to pay the Redemption Price with any interest, of all the Securities (or portions thereof) so called for redemption. -68- SECTION 1206 Securities Payable on Redemption Date. ------------------------------------- If any notice of redemption has been given as provided in Section 1204, the Securities or portion of Securities with respect to which such notice has been given shall become due and payable on the Redemption Date at the place or places stated in such notice and at the Redemption Price therein specified, together with accrued interest to the Redemption Date, and from and after such date (unless the Company shall default in the payment of the Redemption Price and accrued interest) such Securities shall cease to bear interest. On presentation and surrender of such Securities at a place of payment in said notice specified, the said Securities or the specified portions thereof shall be paid and redeemed by the Company at the applicable Redemption Price, together with accrued interest to the Redemption Date; provided, however, that installments of interest (including any Additional Interest) whose corresponding Interest Payment Date is on or prior to the Redemption Date will be payable to the Holders of such Securities, or one or more Predecessor Securities, registered as such at the close of business on the relevant record dates according to their terms and the provisions of Section 307. Upon presentation of any Security redeemed in part only, the Company shall execute and the Trustee shall authenticate and deliver to the Holder thereof, at the expense of the Company, a new Security or Securities, of authorized denominations, in aggregate principal amount equal to the unredeemed portion of the Security so presented and having the same date of issuance, Stated Maturity and terms. If a Global Security is so surrendered, such new Security will also be a Global Security. If any Security called for redemption shall not be so paid upon surrender thereof for redemption, the principal of and premium, if any, on such Security shall, until paid, bear interest from the Redemption Date at the rate prescribed therefor in the Security. SECTION 1207 Optional Redemption; Conditions to Optional Redemption. ------------------------------------------------------ At any time on or after _________________ 1, 2008, the Company shall have the right, subject to the last paragraph of this Section, to redeem the Securities, in whole at any time or in part from time to time, at a Redemption Price equal to the following prices expressed in percentages of the principal amount of Securities to be redeemed, plus any accrued but unpaid interest, including Additional Interest, if any, to the Redemption Date, if redeemed during the 12-month period beginning ____________________ 1: Year Redemption Price ---- ---------------- 2008 10x.xxxx% 2009 10x.xxxx% 2010 10x.xxxx% 2011 10x.xxxx% 2012 10x.xxxx% 2013 10x.xxxx% 2014 10x.xxxx% 2015 10x.xxxx% 2016 10x.xxxx% 2017 10x.xxxx% -69- and at 100% on or after __________________ 1, 2018. The Company shall not redeem the Securities in part unless all accrued and unpaid interest (including any Additional Interest) has been paid in full on all Securities Outstanding for all semi-annual interest periods terminating on or prior to the Redemption Date. If a Special Event shall occur and be continuing prior to __________________ 1, 2008, the Company may, at its option, within 90 days of the occurrence of such Special Event, subject to the last paragraph of this Section and the other provisions of this Article Twelve, redeem the Securities in whole but not in part, at a Redemption Price for each Capital Security equal to the Make-Whole Amount, plus accrued but unpaid interest, including Additional Interest, if any, to but excluding the Redemption Date. The "Make-Whole Amount" shall be equal to the greater of (a) 100% of the principal amount of such Securities or (b) as determined by a Quotation Agent (as defined below), the sum of the present values of the principal amount and premium payable as part of the Redemption Price with respect to an optional redemption of such Securities on _____________________ 1, 2008, together with scheduled payments of interest from the Redemption Date to ____________________ 1, 2008 (the "Remaining Life"), in each case discounted to the Redemption Date on a semi-annual basis (assuming a 360-day year consisting of 30-day months) at the Adjusted Treasury Rate (as defined below). "Adjusted Treasury Rate" means, with respect to any Redemption Date, the Treasury Rate (as defined below) plus (a) __________% if such Redemption Date occurs on or before ___________________________ or (b) _________% if such Redemption Date occurs after __________________________. "Treasury Rate" means (a) the yield, under the heading which represents the average for the immediately prior week, appearing in the most recently published statistical release designated "H.15(519)" or any successor publication which is published weekly by the Federal Reserve and which establishes yields on actively traded United States Treasury securities adjusted to constant maturity under the caption "Treasury Constant Maturities," for the maturity corresponding to the Remaining Life (if no maturity is within three months before or after the Remaining Life, yields for the two published maturities most closely corresponding to the Remaining Life shall be determined and the Treasury Rate shall be interpolated or extrapolated from such yields on a straight-line basis, rounding to the nearest month) or (b) if such release (or any successor release) is not published during the week preceding the calculation date or does not contain such yields, the rate per annum equal to the semi-annual equivalent yield to maturity of the Comparable Treasury Issue (as defined below), calculated using a price for the Comparable Treasury Issue (expressed as a percentage of its principal amount) equal to the Comparable Treasury Price for such Redemption Date. The Treasury Rate shall be calculated on the third Business Day preceding the Redemption Date. "Comparable Treasury Issue" means, with respect to any Redemption Date, the United States Treasury security selected by the Quotation Agent as having a maturity comparable to the Remaining Life that would be utilized, at the time of selection and in accordance with customary financial practice, in pricing new issues of corporate debt securities of comparable maturity to the Remaining Life. If no United States Treasury security has a maturity which is within a period from three months before to three months -70- after __________________ 1, 2008, the two most closely corresponding United States Treasury securities shall be used as the Comparable Treasury Issue, and the Treasury Rate shall be interpolated or extrapolated on a straight-line basis, rounding to the nearest month using such securities. "Quotation Agent" means Goldman, Sachs & Co. and their successors; provided, however, that if the foregoing shall cease to be a primary U.S. Government securities dealer in New York City (a "Primary Treasury Dealer"), the Company shall substitute therefor another Primary Treasury Dealer. "Reference Treasury Dealer" means (a) the Quotation Agent and (b) any other Primary Treasury Dealer selected by the Trustee after consultation with the Company. "Comparable Treasury Price" means (a) the average of five Reference Treasury Dealer Quotations (as defined below) for such Redemption Date, after excluding the highest and lowest such Reference Treasury Dealer Quotations or (b) if the Trustee obtains fewer than three such Reference Treasury Dealer Quotations, the average of all such Quotations. "Reference Treasury Dealer Quotations" means, with respect to each Reference Treasury Dealer and any Redemption Date, the average, as determined by the Trustee, of the bid and asked prices for the Comparable Treasury Issue (expressed in each case as a percentage of its principal amount) quoted in writing to the Trustee by such Reference Treasury Dealer at 5:00 p.m., New York City time, on the third Business Day preceding such Redemption Date. For so long as PMC Capital I is the Holder of all Securities Outstanding, the proceeds of any redemption described in this Section shall be used by PMC Capital I to redeem Trust Securities in accordance with their terms. This instrument may be executed in any number of counterparts, each of which so executed shall be deemed to be an original, but all such counterparts shall together constitute but one and the same instrument. IN WITNESS WHEREOF, the parties hereto have caused this Indenture to be duly executed, and their respective corporate seals to be hereunto affixed and attested, all as of the day and year first above written. PENNSYLVANIA MANUFACTURERS CORPORATION (SEAL) By:____________________________ Name: Attest: Title: ___________________________ Name: Title: -71- THE BANK OF NEW YORK (SEAL) By:____________________________ Name: Title: Attest: ____________________________ Name: Title: -72- COMMONWEALTH OF PENNSYLVANIA ) ss.: COUNTY OF PHILADELPHIA ) On the _____ day of _________________ 1998, before me personally came [________________], to me known, who, being by me duly sworn, did depose and say that he/she is the [____________________] of Pennsylvania Manufacturers Corporation one of the corporations described in and which executed the foregoing instrument; and that he/she signed his/her name thereto by authority of the Board of Directors of such corporation. ______________________________ -73- STATE OF NEW YORK ) ss.: COUNTY OF NEW YORK ) On the _____ day of ________________, 1998, before me personally came ____________________, to me known, who, being by me duly sworn, did depose and say that he/she is a ________________ of The Bank of New York, a New York banking corporation described in and which executed the foregoing instrument; and that he/she signed his/her name thereto by authority of the Board of Directors of such corporation. ______________________________ -74- EX-4.4 4 FORM OF GUARANTEE AGREEMENT Exhibit 4.4 GUARANTEE AGREEMENT Between Pennsylvania Manufacturers Corporation (as Guarantor) and The Bank of New York (as Guarantee Trustee) dated as of _______________, 1998 CROSS-REFERENCE TABLE* Trust Indenture Act Section Guarantee Agreement Section - --------------------------- ---------------------------
310(a) .............................. 4.01(a) 310(b) .............................. 4.01(c), 2.08 310(c) .............................. Inapplicable 311(a) .............................. 2.02(b) 311(b) .............................. 2.02(b) 311(c) .............................. Inapplicable 312(a) .............................. 2.02(a) 312(b) .............................. 2.02(b) 313 .............................. 2.03 314(a) .............................. 2.04 314(b) .............................. Inapplicable 314(c) .............................. 2.05 314(d) .............................. Inapplicable 314(e) .............................. 1.01, 2.05, 3.02 314(f) .............................. 2.01, 3.02 315(a) .............................. 3.01(d) 315(b) .............................. 2.07 315(c) .............................. 3.01 315(d) .............................. 3.01(d) 316(a) .............................. 5.04(a), 2.06 316(b) .............................. 5.03 316(c) .............................. 2.02 317(a) .............................. Inapplicable 317(b) .............................. Inapplicable 318(a) .............................. 2.01(b) 318(b) .............................. 2.01 318(c) .............................. 2.01(a)
_______________ * This Cross-Reference Table does not constitute part of the Guarentee Agreement and shall not affect the interpretation of any of its terms or provisions. TABLE OF CONTENTS ----------------- ARTICLE I DEFINITIONS SECTION 1.01. Definitions ..................................... 1 ARTICLE II TRUST INDENTURE ACT
SECTION 2.01. Trust Indenture Act; Application ................ 4 SECTION 2.02. Lists of Holders ................................ 4 SECTION 2.03. Reports by the Guarantee Trustee ................ 5 SECTION 2.04. Periodic Reports to Guarantee Trustee ........... 5 SECTION 2.05. Evidence of Compliance with Conditions Precedent 5 SECTION 2.06. Events of Default; Waiver ....................... 5 SECTION 2.07. Event of Default; Notice ........................ 5 SECTION 2.08. Conflicting Interests ........................... 6
ARTICLE III POWERS, DUTIES AND RIGHTS OF GUARANTEE TRUSTEE
SECTION 3.01. Powers and Duties of the Guarantee Trustee ...... 6 SECTION 3.02. Certain Rights of Guarantee Trustee ............. 7 SECTION 3.03. Indemnity ....................................... 9
ARTICLE IV GUARANTEE TRUSTEE SECTION 4.01. Guarantee Trustee; Eligibility .................... 9 SECTION 4.02. Appointment, Removal and Resignation of Guarantee Trustee ................................. 10 ARTICLE V GUARANTEE SECTION 5.01. Guarantee ...................................... 10 SECTION 5.02. Waiver of Notice and Demand .................... 10 SECTION 5.03. Obligations Not Affected ....................... 11 SECTION 5.04. Rights of Holders .............................. 11
-i-
SECTION 5.05. Guarantee of Payment ........................... 12 SECTION 5.06. Subrogation .................................... 12 SECTION 5.07. Independent Obligations ........................ 12
ARTICLE VI COVENANTS AND SUBORDINATION
SECTION 6.01. Covenants ...................................... 12 SECTION 6.02. Subordination .................................. 13 SECTION 6.03. Pari Passu Guarantees .......................... 13
ARTICLE VII TERMINATION SECTION 7.01. Termination .................................... 13 ARTICLE VIII MISCELLANEOUS
SECTION 8.01. Successors and Assigns ......................... 13 SECTION 8.02. Amendments ..................................... 14 SECTION 8.03. Notices ........................................ 14 SECTION 8.04. Benefit ........................................ 15 SECTION 8.05. Interpretation ................................. 15 SECTION 8.06. Governing Law .................................. 16
-ii- GUARANTEE AGREEMENT This GUARANTEE AGREEMENT, dated as of _______________, 1998, is executed and delivered by Pennsylvania Manufacturers Corporation, a Pennsylvania corporation (the "Guarantor"), and The Bank of New York, a New York banking corporation, as trustee (the "Guarantee Trustee"), for the benefit of the Holders (as defined herein) from time to time of the Capital Securities (as defined herein) of PMC Capital I, a Delaware statutory business trust (the "Issuer"). WHEREAS, pursuant to an Amended and Restated Trust Agreement (the "Trust Agreement"), dated as of _________________, 1998 among the Guarantor, as Depositor, The Bank of New York (Delaware), as Trustee, The Bank of New York, as Property Trustee, and the Administrative Trustees named therein, the Issuer is issuing up to $100,000,000 aggregate liquidation amount of its ______% Capital Securities, Series A (liquidation amount $1,000 per Capital Security) (the "Capital Securities" and, together with the Common Securities, the "Trust Securities") and up to $3,093,000 aggregate liquidation amount of its Common Securities, each representing ownership interests in the assets of the Issuer and having the terms set forth in the Trust Agreement; WHEREAS, the Trust Securities will be issued by the Issuer and the proceeds thereof will be used to purchase the Debentures (as defined in the Trust Agreement) of the Guarantor which will be deposited with The Bank of New York, as Property Trustee under the Trust Agreement, as trust assets; and WHEREAS, as incentive for the Holders to purchase the Capital Securities the Guarantor desires irrevocably and unconditionally to agree, to the extent set forth herein, to pay to the Holders the Guarantee Payments (as defined herein) and to make certain other payments on the terms and conditions set forth herein; NOW, THEREFORE, in consideration of the purchase by each Holder of the Capital Securities, which purchase the Guarantor hereby agrees shall benefit the Guarantor, the Guarantor executes and delivers this Guarantee Agreement for the benefit of the Holders from time to time of the Capital Securities. ARTICLE I DEFINITIONS SECTION 1.01. Definitions. As used in this Guarantee Agreement, the terms ----------- set forth below shall, unless the context otherwise requires, have the following meanings. Capitalized or otherwise defined terms used but not otherwise defined herein shall have the meanings assigned to such terms in the Trust Agreement as in effect on the date hereof unless otherwise indicated. "Affiliate" of any specified Person means any other Person directly or indirectly controlling or controlled by or under direct or indirect common control with such specified Person; provided, however that an Affiliate of the Guarantor shall not be deemed to include the Issuer. For the purposes of this definition, "control" when used with respect to any specified Person means the power to direct the management and policies of such Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise; and the terms "controlling" and "controlled" have meanings correlative to the foregoing. "Capital Securities" has the meaning specified in the recitals to this Guarantee Agreement. "Common Securities" means the securities representing common undivided beneficial interests in the assets of the Issuer (liquidation amount $1,000 per Common Security). "Debt" means, with respect to any Person, whether recourse is to all or a portion of the assets of such Person and whether or not contingent, (a) every obligation of such Person for money borrowed; (b) every obligation of such Person evidenced by bonds, debentures, notes or other similar instruments, including obligations incurred in connection with the acquisition of property, assets or businesses; (c) every reimbursement obligation of such Person with respect to letters of credit, bankers' acceptances or similar facilities issued for the account of such Person; (d) every obligation of such Person issued or assumed as the deferred purchase price of property or services (but excluding trade accounts payable or accrued liabilities arising in the ordinary course of business); (e) every capital lease obligation of such Person and (f) every obligation of the type referred to in clauses (a) through (e) of another Person and all dividends of another Person the payment of which, in either case, such Person has guaranteed or is responsible or liable for, directly or indirectly, as obligor or otherwise. "Event of Default" shall mean (a) a default by the Guarantor on any of its payment obligations under this Guarantee Agreement or (b) a default by the Guarantor in any other obligation hereunder that remains unremedied for 30 days. "Guarantee" means this Guarantee Agreement, dated as of ____________, 1998, between the Guarantor and the Guarantee Trustee. "Guarantee Payments" shall mean the following payments or distributions, without duplication, with respect to the Capital Securities, to the extent not paid or made by or on behalf of the Issuer: (a) any accumulated and unpaid Distributions (as defined in the Trust Agreement) required to be paid on the Capital Securities, to the extent the Issuer shall have funds available therefor at such time, (b) the Redemption Price (as defined in the Trust Agreement) with respect to the Capital Securities called for redemption by the Issuer, to the extent the Issuer shall have funds available therefor at such time and (c) upon a voluntary or involuntary dissolution, winding-up or termination of the Issuer, unless the Debentures are distributed to the Holders, the lesser of (i) the Liquidation Distribution (as defined in the Trust Agreement) to the extent the Issuer shall have funds available therefor at such time and (ii) the amount of assets of the Issuer remaining available for distribution to Holders, after satisfaction of liabilities to creditors of the Issuer as required by applicable law, in liquidation of the Issuer. -2- "Guarantee Trustee" means The Bank of New York, until a Successor Guarantee Trustee has been appointed and has accepted such appointment pursuant to the terms of this Guarantee Agreement and thereafter means each such Successor Guarantee Trustee. "Holder" shall mean any holder, as registered on the books and records of the Issuer, of any Capital Securities; provided, however, that in determining whether the holders of the requisite percentage of Capital Securities have given any request, notice, consent or waiver hereunder, "Holder" shall not include the Guarantor, the Guarantee Trustee or any Affiliate of the Guarantor or the Guarantee Trustee. "Indenture" means the Junior Subordinated Indenture dated as of ___________________, 1998, among the Guarantor and The Bank of New York, as trustee. "Majority in liquidation amount of the Capital Securities" means, except as provided by the Trust Indenture Act, Capital Securities representing more than 50% of the liquidation amount of all then outstanding Capital Securities. "Officers' Certificate" means, with respect to any Person, a certificate signed by the Chairman of the Board, Chief Executive Officer, the President or a Senior Vice President, and by the Chief Financial Officer, the Treasurer or the Vice President of Finance of such Person, and delivered to the Guarantee Trustee. Any Officers' Certificate delivered with respect to compliance with a condition or covenant provided for in this Guarantee Agreement shall include: (a) a statement that each officer signing the Officers' Certificate has read the covenant or condition and the definitions relating thereto; (b) a brief statement of the nature and scope of the examination or investigation undertaken by each officer in rendering the Officers' Certificate; (c) a statement that each such officer has made such examination or investigation as, in such officer's opinion, is necessary to enable such officer to express an informed opinion as to whether or not such covenant or condition has been complied with; and (d) a statement as to whether, in the opinion of each such officer, such condition or covenant has been complied with. "Person" means a legal person, including any individual, corporation, estate, partnership, joint venture, association, joint stock company, limited liability company, trust, unincorporated association or government or any agency or political subdivision thereof, or any other entity of whatever nature. "Responsible Officer" means, with respect to the Guarantee Trustee, any Vice President, any Assistant Vice President, the Secretary, any Assistant Secretary, the Treasurer, any Assistant Treasurer, any financial services officer or any other officer of the Corporate Trust Administration Department of the Guarantee Trustee customarily performing functions similar to those performed by any of the above designated officers and also means, with respect to a particular corporate trust matter, any other officer to -3- whom such matter is referred because of that officer's knowledge of and familiarity with the particular subject. "Senior Debt" means the principal of (and premium, if any) and interest, if any (including interest accruing on or after the filing of any petition in bankruptcy or for reorganization relating to the Guarantor whether or not such claim for post-petition interest is allowed in such proceeding), on Debt, whether incurred on or prior to the date of this Guarantee or thereafter incurred, unless, in the instrument creating or evidencing the same or pursuant to which the same is outstanding, it is provided that such obligations are not superior in right of payment to the Guarantee or to other Debt which is pari passu with, or subordinated to, the Guarantee; provided, however, that Senior Debt shall not be deemed to include (a) any Debt of the Guarantor which, when incurred and without respect to any election under Section 1111(b) of the Bankruptcy Code, was without recourse to the Guarantor, (b) any Debt of the Guarantor to any of its Subsidiaries (as defined in the Indenture), (c) Debt to any employee of the Guarantor, (d) any trade accounts payable of the Guarantor, (e) accrued liabilities arising in the ordinary course of business of the Guarantor, (f) the Debentures and (g) the Guarantee. "Successor Guarantee Trustee" means a successor Guarantee Trustee possessing the qualifications to act as Guarantee Trustee under Section 4.01. "Trust Indenture Act" means the Trust Indenture Act of 1939, as amended. ARTICLE II TRUST INDENTURE ACT SECTION 2.01. Trust Indenture Act; Application. -------------------------------- (a) This Guarantee Agreement is subject to the provisions of the Trust Indenture Act that are required to be part of this Guarantee Agreement and shall, to the extent applicable, be governed by such provisions. (b) If and to the extent that any provision of this Guarantee Agreement limits, qualifies or conflicts with the duties imposed by Sections 310 to 317, inclusive, of the Trust Indenture Act, through operation of Section 318(c) thereof, such imposed duties shall control. If any provision of this Guarantee Agreement modifies or excludes any provision of the Trust Indenture Act which may be so modified or excluded, the latter provision shall be deemed to apply to this Guarantee Agreement as so modified or excluded, as the case may be. SECTION 2.02. Lists of Holders. ---------------- (a) The Guarantor shall furnish or cause to be furnished to the Guarantee Trustee (i) semi-annually, not later than _________________ 15 and ________________ 15 in each year, a list, in such form as the Guarantee Trustee may reasonably require, of the names and addresses of the Holders of the Capital Securities ("List of Holders") as of a date not more than 15 days prior to the delivery thereof and (ii) at such other times as the Guarantee Trustee -4- may request in writing, within 30 days after the receipt by the Guarantor of any such request, a List of Holders as of a date not more than 15 days prior to the time such list is furnished, in each case to the extent such information is in the possession or control of the Guarantor and has not otherwise been received by the Guarantee Trustee in its capacity as such. The Guarantee Trustee may destroy any List of Holders previously given to it on receipt of a new List of Holders. (b) The Guarantee Trustee shall comply with its obligations under Sections 311(a), 311(b) and Section 312(b) of the Trust Indenture Act. SECTION 2.03. Reports by the Guarantee Trustee. Not later than July 15 of -------------------------------- each year, commencing July 15, 1999, the Guarantee Trustee shall provide to the Holders such reports as are required by Section 313 of the Trust Indenture Act, if any, in the form and in the manner provided by Section 313 of the Trust Indenture Act. The Guarantee Trustee shall also comply with the requirements of Section 313(d) of the Trust Indenture Act. SECTION 2.04. Periodic Reports to Guarantee Trustee. The Guarantor shall ------------------------------------- provide to the Guarantee Trustee, the Securities and Exchange Commission and the Holders such documents, reports and information as are required by Section 314 (if any) and the compliance certificate required by Section 314 of the Trust Indenture Act in the form, in the manner and at the times required by Section 314 of the Trust Indenture Act. SECTION 2.05. Evidence of Compliance with Conditions Precedent. The ------------------------------------------------ Guarantor shall provide to the Guarantee Trustee such evidence of compliance with any conditions precedent, if any, provided for in this Guarantee Agreement that relate to any of the matters set forth in Section 314(c) of the Trust Indenture Act. Any certificate or opinion required to be given by an officer pursuant to Section 314(c)(1) may be given in the form of an Officers' Certificate. SECTION 2.06. Events of Default; Waiver. The Holders of a Majority in ------------------------- liquidation amount of the Capital Securities may, by vote, on behalf of the Holders of all of the Capital Securities, waive any past default or Event of Default and its consequences. Upon such waiver, any such default or Event of Default shall cease to exist, and any Event of Default arising therefrom shall be deemed to have been cured, for every purpose of this Guarantee Agreement, but no such waiver shall extend to any subsequent or other default or Event of Default or impair any right consequent thereon. SECTION 2.07. Event of Default; Notice. ------------------------ (a) The Guarantee Trustee shall, within 90 days after the occurrence of an Event of Default, transmit by mail, first-class postage prepaid, to the Holders of the Capital Securities, notices of all Events of Default known to the Guarantee Trustee, unless such Event of Default has been cured before the giving of such notice; provided that, except in the case of a default in the payment of a Guarantee Payment, the Guarantee Trustee shall be protected in withholding such notice if and so long as the board of directors, the executive committee or a trust committee of directors and/or Responsible Officers of the -5- Guarantee Trustee in good faith determines that the withholding of such notice is in the interests of the Holders of the Capital Securities. (b) The Guarantee Trustee shall not be deemed to have knowledge of any Event of Default unless the Guarantee Trustee shall have received written notice or a Responsible Officer charged with the administration of this Guarantee Agreement shall have obtained actual knowledge of such Event of Default. SECTION 2.08. Conflicting Interests. The Trust Agreement and the --------------------- Indenture shall be deemed to be specifically described in this Guarantee Agreement for the purposes of clause (i) of the first proviso contained in Section 310(b) of the Trust Indenture Act. ARTICLE III POWERS, DUTIES AND RIGHTS OF GUARANTEE TRUSTEE SECTION 3.01. Powers and Duties of the Guarantee Trustee. ------------------------------------------ (a) This Guarantee Agreement shall be held by the Guarantee Trustee for the benefit of the Holders of the Capital Securities, and the Guarantee Trustee shall not transfer this Guarantee Agreement to any Person except a Holder of Capital Securities exercising his or her rights pursuant to Section 5.04(d) or to a Successor Guarantee Trustee on acceptance by such Successor Guarantee Trustee of its appointment to act as Successor Guarantee Trustee. The right, title and interest of the Guarantee Trustee shall auto matically vest in any Successor Guarantee Trustee, upon acceptance by such Successor Guarantee Trustee of its appointment hereunder, and such vesting and cessation of title shall be effective whether or not conveyancing documents have been executed and delivered pursuant to the appointment of such Successor Guarantee Trustee. (b) If an Event of Default has occurred and is continuing, the Guarantee Trustee shall enforce this Guarantee Agreement for the benefit of the Holders of the Capital Securities. (c) The Guarantee Trustee, before the occurrence of any Event of Default and after the curing of all Events of Default that may have occurred, shall undertake to perform only such duties as are specifically set forth in this Guarantee Agreement, and no implied covenants shall be read into this Guarantee Agreement against the Guarantee Trustee. In case an Event of Default has occurred (that has not been cured or waived pursuant to Section 2.06), the Guarantee Trustee shall exercise such of the rights and powers vested in it by this Guarantee Agreement, and use the same degree of care and skill in its exercise thereof as a prudent individual would exercise or use under the circumstances in the conduct of his or her own affairs. (d) No provision of this Guarantee Agreement shall be construed to relieve the Guarantee Trustee from liability for its own negligent action, its own negligent failure to act or its own willful misconduct, except that: -6- (i) prior to the occurrence of any Event of Default and after the curing or waiving of all such Events of Default that may have occurred: (A) the duties and obligations of the Guarantee Trustee shall be determined solely by the express provisions of this Guarantee Agreement, (including pursuant to Section 2.01) and the Guarantee Trustee shall not be liable except for the performance of such duties and obligations as are specifically set forth in this Guarantee Agreement; and (B) in the absence of bad faith on the part of the Guarantee Trustee, the Guarantee Trustee may conclusively rely, as to the truth of the statements and the correctness of the opinions expressed therein, upon any certificates or opinions furnished to the Guarantee Trustee and conforming to the requirements of this Guarantee Agreement; but in the case of any such certificates or opinions that by any provision hereof or of the Trust Indenture Act are specifically required to be furnished to the Guarantee Trustee, the Guarantee Trustee shall be under a duty to examine the same to determine whether or not they conform to the requirements of this Guarantee Agreement; (ii) the Guarantee Trustee shall not be liable for any error of judgment made in good faith by a Responsible Officer of the Guarantee Trustee, unless it shall be proved that the Guarantee Trustee was negligent in ascertaining the pertinent facts upon which such judgment was made; (iii) the Guarantee Trustee shall not be liable with respect to any action taken or omitted to be taken by it in good faith in accordance with the direction of the Holders of not less than a Majority in liquidation amount of the Capital Securities relating to the time, method and place of conducting any proceeding for any remedy available to the Guarantee Trustee or exercising any trust or power conferred upon the Guarantee Trustee under this Guarantee Agreement; and (iv) no provision of this Guarantee Agreement shall require the Guarantee Trustee to expend or risk its own funds or otherwise incur personal financial liability in the performance of any of its duties or in the exercise of any of its rights or powers, if the Guarantee Trustee shall have reasonable grounds for believing that the repayment of such funds or liability is not reasonably assured to it under the terms of this Guarantee Agreement or adequate indemnity against such risk or liability is not reasonably assured to it. SECTION 3.02. Certain Rights of Guarantee Trustee. ----------------------------------- (a) Subject to the provisions of Section 3.01: (i) The Guarantee Trustee may rely and shall be fully protected in acting or refraining from acting upon any resolution, certificate, statement, instrument, opinion, report, notice, request, direction, consent, order, bond, debenture, note, other evidence of indebtedness or other paper or document reasonably believed by it to be genuine and to have been signed, sent or presented by the proper party or parties. -7- (ii) Any direction or act of the Guarantor contemplated by this Guarantee Agreement shall be sufficiently evidenced by an Officers' Certificate unless otherwise prescribed herein. (iii) Whenever, in the administration of this Guarantee Agreement, the Guarantee Trustee shall deem it desirable that a matter be proved or established before taking, suffering or omitting any action hereunder, the Guarantee Trustee (unless other evidence is herein specifically prescribed) may, in the absence of bad faith on its part, request and rely upon an Officers' Certificate which, upon receipt of such request from the Guarantee Trustee, shall be promptly delivered by the Guarantor. (iv) The Guarantee Trustee may (at the expense of the Guarantor) consult with legal counsel, and the written advice or opinion of such legal counsel with respect to legal matters shall be full and complete authorization and protection in respect of any action taken, suffered or omitted by it hereunder in good faith and in accordance with such advice or opinion. Such legal counsel may be legal counsel to the Guarantor or any of its Affiliates and may be one of its employees. The Guarantee Trustee shall have the right at any time to seek instructions concerning the administration of this Guarantee Agreement from any court of competent jurisdiction. (v) The Guarantee Trustee shall be under no obligation to exercise any of the rights or powers vested in it by this Guarantee Agreement at the request or direction of any Holder, unless such Holder shall have provided to the Guarantee Trustee such adequate security and indemnity as would satisfy a reasonable person in the position of the Guarantee Trustee, against the costs, expenses (including attorneys' fees and expenses) and liabilities that might be incurred by it in complying with such request or direction, including such reasonable advances as may be requested by the Guarantee Trustee; provided that nothing contained in this Section 3.02(a)(v) shall be taken to relieve the Guarantee Trustee, upon the occurrence of an Event of Default, of its obligation to exercise the rights and powers vested in it by this Guarantee Agreement. (vi) The Guarantee Trustee shall not be bound to make any investigation into the facts or matters stated in any resolution, certificate, statement, instrument, opinion, report, notice, request, direction, consent, order, bond, debenture, note, other evidence of indebtedness or other paper or document, but the Guarantee Trustee, in its discretion, may make such further inquiry or investigation into such facts or matters as it may see fit. (vii) The Guarantee Trustee may execute any of the trusts or powers hereunder or perform any duties hereunder either directly or by or through agents or attorneys, and the Guarantee Trustee shall not be responsible for any misconduct or negligence on the part of any such agent or attorney appointed with due care by it hereunder. (viii) Whenever in the administration of this Guarantee Agreement the Guarantee Trustee shall deem it desirable to receive instructions with respect to enforcing any remedy or right or taking any other action hereunder, the Guarantee Trustee (A) may request instructions from the Holders of the Capital Securities, (B) may refrain from -8- enforcing such remedy or right or taking such other action until such instructions are received and (C) shall be protected in acting in accordance with such instructions. (b) No provision of this Guarantee Agreement shall be deemed to impose any duty or obligation on the Guarantee Trustee to perform any act or acts or exercise any right, power, duty or obligation conferred or imposed on it in any jurisdiction in which it shall be illegal, or in which the Guarantee Trustee shall be unqualified or incompetent in accordance with applicable law, to perform any such act or acts or to exercise any such right, power, duty or obligation. No permissive power or authority available to the Guarantee Trustee shall be construed to be a duty to act in accordance with such power and authority. SECTION 3.03. Indemnity. The Guarantor agrees to indemnify the Guarantee --------- Trustee for, and to hold it harmless against, any loss, damage, claims, liability, penalty or expense incurred without negligence or bad faith on the part of the Guarantee Trustee, arising out of or in connection with the acceptance or administration of this Guarantee Agreement, including the costs and expenses of defending itself against any claim or liability in connection with the exercise or performance of any of its powers or duties hereunder. The Guarantee Trustee will not claim or exact any lien or charge on any Guarantee Payments as a result of any amount due to it under this Guarantee Agreement. ARTICLE IV GUARANTEE TRUSTEE SECTION 4.01. Guarantee Trustee; Eligibility. ------------------------------ (a) There shall at all times be a Guarantee Trustee which shall: (i) not be an Affiliate of the Guarantor; and (ii) be a Person that is eligible pursuant to the Trust Indenture Act to act as such and has a combined capital and surplus of at least 50 million U.S. dollars ($50,000,000), and shall be a corporation meeting the requirements of Section 310(a) of the Trust Indenture Act. If such corporation publishes reports of condition at least annually, pursuant to law or to the requirements of a supervising or examining authority, then, for the purposes of this Section 4.01(a)(ii) and to the extent permitted by the Trust Indenture Act, the combined capital and surplus of such corporation shall be deemed to be its com bined capital and surplus as set forth in its most recent report of condition so published. (b) If at any time the Guarantee Trustee shall cease to be eligible to so act under Section 4.01(a), the Guarantee Trustee shall immediately resign in the manner and with the effect set out in Section 4.02(c). (c) If the Guarantee Trustee has or shall acquire any "conflicting interest" within the meaning of Section 310(b) of the Trust Indenture Act, the Guarantee Trustee and the -9- Guarantor shall in all respects comply with the provisions of Section 310(b) of the Trust Indenture Act. SECTION 4.02. Appointment, Removal and Resignation of Guarantee Trustee. --------------------------------------------------------- (a) Subject to Section 4.02(b), the Guarantee Trustee may be appointed or removed without cause at any time by the Guarantor. (b) The Guarantee Trustee shall not be removed until a Successor Guarantee Trustee has been appointed and has accepted such appointment by written instrument exe cuted by such Successor Guarantee Trustee and delivered to the Guarantor. (c) The Guarantee Trustee appointed hereunder shall hold office until a Successor Guarantee Trustee shall have been appointed or until its removal or resignation. The Guarantee Trustee may resign from office (without need for prior or subsequent accounting) by an instrument in writing executed by the Guarantee Trustee and delivered to the Guarantor, which resignation shall not take effect until a Successor Guarantee Trustee has been appointed and has accepted such appointment by instrument in writing executed by such Successor Guarantee Trustee and delivered to the Guarantor and the resigning Guarantee Trustee. (d) If no Successor Guarantee Trustee shall have been appointed and accepted appointment as provided in this Section 4.02 within 30 days after delivery to the Guarantor of an instrument of resignation, the resigning Guarantee Trustee may petition, at the expense of the Guarantor, any court of competent jurisdiction for appointment of a Successor Guarantee Trustee. Such court may thereupon, after prescribing such notice, if any, as it may deem proper, appoint a Successor Guarantee Trustee. ARTICLE V GUARANTEE SECTION 5.01. Guarantee. The Guarantor irrevocably and unconditionally --------- agrees to pay in full to the Holders the Guarantee Payments (without duplication of amounts theretofore paid by or on behalf of the Issuer), as and when due, regardless of any defense (other than the defense of payment), right of set-off or counterclaim which the Issuer may have or assert. The Guarantor's obligation to make a Guarantee Payment may be satisfied by direct payment of the required amounts by the Guarantor to the Holders or by causing the Issuer to pay such amounts to the Holders. SECTION 5.02. Waiver of Notice and Demand. The Guarantor hereby waives --------------------------- notice of acceptance of the Guarantee Agreement and of any liability to which it applies or may apply, presentment, demand for payment, any right to require a proceeding first against the Guarantee Trustee, the Issuer or any other Person before proceeding against the Guarantor, protest, notice of nonpayment, notice of dishonor, notice of redemption and all other notices and demands. -10- SECTION 5.03. Obligations Not Affected. The obligations, covenants, ------------------------ agreements and duties of the Guarantor under this Guarantee Agreement shall in no way be affected or impaired by reason of the happening from time to time of any of the following: (a) the release or waiver, by operation of law or otherwise, of the performance or observance by the Issuer of any express or implied agreement, covenant, term or condition relating to the Capital Securities to be performed or observed by the Issuer; (b) the extension of time for the payment by the Issuer of all or any portion of the Distributions (other than an extension of time for payment of Distributions that results from the extension of any interest payment period on the Debentures as so provided in the Indenture), Redemption Price, Liquidation Distribution or any other sums payable under the terms of the Capital Securities or the extension of time for the performance of any other obligation under, arising out of or in connection with the Capital Securities; (c) any failure, omission, delay or lack of diligence on the part of the Holders to enforce, assert or exercise any right, privilege, power or remedy conferred on the Holders pursuant to the terms of the Capital Securities or any action on the part of the Issuer granting indulgence or extension of any kind; (d) the voluntary or involuntary liquidation, dissolution, sale of any collateral, receivership, insolvency, bankruptcy, assignment for the benefit of creditors, reorgani zation, arrangement, composition or readjustment of debt of, or other similar proceedings affecting, the Issuer or any of the assets of the Issuer; (e) any invalidity of, or defect or deficiency in, the Capital Securities; (f) the settlement or compromise of any obligation guaranteed hereby or hereby incurred; or (g) any other circumstance whatsoever that might otherwise constitute a legal or equitable discharge or defense of a guarantor (other than payment of the underlying obligation), it being the intent of this Section 5.03 that the obligations of the Guarantor hereunder shall be absolute and unconditional under any and all circumstances. There shall be no obligation of the Holders to give notice to, or obtain consent of, the Guarantor with respect to the happening of any of the foregoing. SECTION 5.04. Rights of Holders. The Guarantor expressly acknowledges ----------------- that: (a) this Guarantee Agreement will be deposited with the Guarantee Trustee to be held for the benefit of the Holders; (b) the Guarantee Trustee has the right to enforce this Guarantee Agreement on behalf of the Holders; (c) the Holders of a Majority in liquidation amount of the Capital Securities have the right to direct the time, method and place of conducting any proceeding for any remedy available to the Guarantee Trustee in respect of this Guarantee Agreement or exercising any trust or power conferred upon the Guarantee Trustee under this Guarantee Agreement and (d) any Holder of Capital Securities may institute, to the extent permissible under applicable law, a legal proceeding directly against -11- the Guarantor to enforce its rights under this Guarantee Agreement without first instituting a legal proceeding against the Guarantee Trustee, the Issuer or any other Person. SECTION 5.05. Guarantee of Payment. This Guarantee Agreement creates a -------------------- guarantee of payment and not a guarantee of collection. This Guarantee Agreement will not be discharged except by payment of the Guarantee Payments in full (without duplication of amounts theretofore paid by the Issuer) or upon distribution of the Debentures to the Holders as provided in the Trust Agreement. SECTION 5.06. Subrogation. The Guarantor shall be subrogated to all (if ----------- any) rights of the Holders against the Issuer in respect of any amounts paid to the Holders by the Guarantor under this Guarantee Agreement and shall have the right to waive payment by the Issuer pursuant to Section 5.01; provided, however, that the Guarantor shall not (except to the extent required by mandatory provisions of law) be entitled to enforce or exercise any rights which it may acquire by way of subrogation or any indemnity, reimbursement or other agreement, in all cases as a result of payment under this Guarantee Agreement, if, at the time of any such payment, any amounts are due and unpaid under this Guarantee Agreement. If any amount shall be paid to the Guarantor in violation of the preceding sentence, the Guarantor agrees to hold such amount in trust for the Holders and to pay over such amount to the Holders. SECTION 5.07. Independent Obligations. The Guarantor acknowledges that ----------------------- its obligations hereunder are independent of the obligations of the Issuer with respect to the Capital Securities and that the Guarantor shall be liable as principal and as debtor hereunder to make Guarantee Payments pursuant to the terms of this Guarantee Agreement notwithstanding the occurrence of any event referred to in subsections (a) through (g), inclusive, of Section 5.03 hereof. ARTICLE VI COVENANTS AND SUBORDINATION SECTION 6.01. Covenants. So long as any Capital Securities remain --------- outstanding, the Guarantor shall not, and shall cause its Subsidiaries (as defined in the Indenture) not to, (a) declare or pay any dividends or distributions on (other than dividends or distributions in Common Stock or Class A Common Stock of the Guarantor), or redeem, purchase, acquire or make a liquidation payment with respect to, any of the Guarantor's outstanding capital stock or (b) make any payment of principal, interest or premium, if any, on or repay, repurchase or redeem any debt securities that rank pari passu with or junior to the Debentures or make any guarantee payments with respect to the foregoing, if at such time (i) the Guarantor shall be in default with respect to its Guarantee Payments hereunder, (ii) there shall have occurred and be continuing any Event of Default under the Indenture or (iii) the Guarantor shall have given notice of its selection of an Extension Period (as defined in the Indenture) and such period, or any extension thereof, is continuing. -12- SECTION 6.02. Subordination. The obligations of the Guarantor under this ------------- Guarantee Agreement will constitute unsecured obligations of the Guarantor and will rank subordinate and junior in right of payment to all Senior Debt of the Guarantor to the extent and in the manner set forth in the Indenture with respect to the Debentures, and the provisions of Article Eleven of the Indenture will apply, mutatis mutandis, to the obligations of the Guarantor hereunder. The obligations of the Guarantor hereunder do not constitute Senior Debt (as defined in the Indenture) of the Guarantor. SECTION 6.03. Pari Passu Guarantees. The obligations of the Guarantor --------------------- under this Guarantee Agreement shall rank pari passu with the obligations of the Guarantor under (a) any similar guarantee agreements issued by the Guarantor on behalf of the holders of preferred or capital securities issued by a business trust or similar entity whose common securities are owned, directly or indirectly, by the Guarantor, (b) the Indenture and the Debentures issued thereunder, (c) the Expense Agreement (as defined in the Trust Agreement) and any similar expense agreements entered into by the Guarantor in connection with the offering of the Capital Securities by the Trust and (d) any other security, guarantee or other agreement or obligation that is expressly stated to rank pari passu with the obligations of the Guarantor under this Guarantee Agreement or with any obligation that ranks pari passu with the obligations of the Guarantor under this Guarantee Agreement. ARTICLE VII TERMINATION SECTION 7.01. Termination. This Guarantee Agreement shall terminate and ----------- be of no further force and effect upon (a) full payment of the Redemption Price of all Capital Securities, (b) the distribution of the Debentures to the Holders of the Capital Securities in exchange for all of the Capital Securities or (c) payment in full of the amounts payable in accordance with the Trust Agreement upon liquidation of the Issuer. Notwithstanding the foregoing, this Guarantee Agreement will continue to be effective or will be reinstated, as the case may be, if at any time any Holder must restore payment of any sums paid with respect to the Capital Securities or this Guarantee Agreement. The Guarantor will indemnify each Holder and hold it harmless from and against any loss it may suffer in such circumstance. ARTICLE VIII MISCELLANEOUS SECTION 8.01. Successors and Assigns. All guarantees and agreements ---------------------- contained in this Guarantee Agreement shall bind the successors, assigns, receivers, trustees and representatives of the Guarantor and shall inure to the benefit of the Holders of the Capital Securities then outstanding. Except in connection with a consolidation, merger or sale involving the Guarantor or a conveyance, transfer or lease of the Guarantor's properties that is permitted under Article Eight of the Indenture and pursuant -13- to which the successor or assignee agrees in writing to perform the Guarantor's obligations hereunder, the Guarantor shall not assign its obligations hereunder, and any purported assignment other than in accordance with this provision shall be void. SECTION 8.02. Amendments. Except with respect to any changes that do not ---------- adversely affect the rights of the Holders in any material respect (in which case no consent of the Holders will be required), this Guarantee Agreement may be amended only with the prior approval of the Holders of not less than a Majority in liquidation amount of the outstanding Capital Securities. The provisions of Article VI of the Trust Agreement concerning meetings of the Holders shall apply to the giving of such approval. SECTION 8.03. Notices. Any notice, request or other communication ------- required or permitted to be given hereunder shall be in writing, duly signed by the party giving such notice, and delivered, telecopied or mailed by first class mail as follows: (a) if given to the Guarantor, to the address or telecopy number set forth below or such other address as the Guarantor may give notice of to the Guarantee Trustee: Pennsylvania Manufacturers Corporation 1735 Market Street Philadelphia, Pennsylvania 19103-7590 Facsimile No.: (215) 665-5061 Attention: President (b) if given to the Issuer, at the address or telecopy number set forth below or such other address as the Issuer may give notice of to the Guarantee Trustee: PMC Capital I c/o Pennsylvania Manufacturers Corporation 1735 Market Street Philadelphia, Pennsylvania 19103-7590 Facsimile No.: (215) 665-5061 Attention: Administrative Trustee with copy to: The Bank of New York .................... .................... .................... Facsimile No:............ Attention:............... -14- (c) if given to the Guarantee Trustee, at the Guarantee Trustee's address or telecopy number set forth below: The Bank of New York .................... .................... .................... Facsimile No:............. Attention:................ (d) if given to any Holder of the Capital Securities, at the address set forth on the books and records of the Issuer. All notices hereunder shall be deemed to have been given when received in person, telecopied with receipt confirmed, or mailed by first class mail, postage prepaid except that if a notice or other document is refused delivery or cannot be delivered because of a changed address of which no notice was given, such notice or other document shall be deemed to have been delivered on the date of such refusal or inability to deliver. SECTION 8.04. Benefit. This Guarantee Agreement is solely for the ------- benefit of the Holders, and is not separately transferable from the Capital Securities. SECTION 8.05. Interpretation. In this Guarantee Agreement, unless the -------------- context otherwise requires: (a) Capitalized terms used in this Guarantee Agreement but not defined in the preamble hereto have the respective meanings assigned to them in Section 1.01 unless otherwise indicated; (b) a term defined anywhere in this Guarantee Agreement has the same meaning throughout; (c) all references to "the Guarantee Agreement" or "this Guarantee Agreement" are to this Guarantee Agreement as modified, supplemented or amended from time to time; (d) all references in this Guarantee Agreement to Articles and Sections are to Articles and Sections of this Guarantee Agreement unless otherwise specified; (e) a term defined in the Trust Indenture Act has the same meaning when used in this Guarantee Agreement unless otherwise defined in this Guarantee Agreement or unless the context otherwise requires; (f) a reference to the singular includes the plural and vice versa; and -15- (g) the masculine, feminine or neuter genders used herein shall include the masculine, feminine and neuter genders. SECTION 8.06. GOVERNING LAW. THIS GUARANTEE AGREEMENT SHALL BE GOVERNED ------------- BY AND CONSTRUED AND INTERPRETED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK WITHOUT REFERENCE TO ITS CONFLICTS OF LAWS PROVISIONS. This instrument may be executed in any number of counterparts, each of which when so executed shall be deemed to be an original, but all such counterparts shall together constitute but one and the same instrument. THIS GUARANTEE AGREEMENT is executed as of the day and year first above written. PENNSYLVANIA MANUFACTURERS CORPORATION By:.............................. Name: John W. Smithson Title:President and Chief Executive Officer THE BANK OF NEW YORK, as Guarantee Trustee By:.............................. Name: Title: -16- EX-8.1 5 OPINION OF DUANE, MORRIS & HECKSCHER [AN OPINION SUBSTANTIALLY IN THE FORM BELOW WILL BE DELIVERED AT CLOSING OF THE TRANSACTION DESCRIBED HEREIN, ASSUMING NO MATERIAL CHANGE IN THE FACTS OR LAW UPON WHICH SUCH OPINION IS BASED] [Letterhead of Duane, Morris & Heckscher LLP] [Date] Pennsylvania Manufacturers Corporation The PMA Building 380 Sentry Parkway Blue Bell, Pennsylvania 19422-2328 Dear Ladies and Gentlemen: We have acted as counsel to Pennsylvania Manufacturers Corporation, a Pennsylvania corporation ("PMC"), and PMC Capital I, a Delaware statutory business trust (the "Trust"), in connection with the proposed offering by the Trust of its Capital Securities, Series A (the "Capital Securities") as described in the Registration Statement on Form S-1 (the "Registration Statement"), filed by PMC and the Trust with the Securities and Exchange Commission pursuant to the Securities Act of 1933, as amended. The Registration Statement includes the Preliminary Prospectus (the "Prospectus") of PMC and the Trust. Capitalized terms not defined herein have the meanings specified in the Prospectus. In rendering the opinions expressed below, we have examined the Prospectus and such other documents as we have deemed relevant and necessary, including, without limitation, the Form of Amended and Restated Trust Agreement, the Form of Indenture and the Form of Guarantee Agreement, attached as Exhibits to the Registration Statement. Such opinions are conditioned, among other things, upon the accuracy and completeness of the facts, information and representations contained in the Prospectus as of the date hereof and the continuing accuracy and completeness thereof as of the date of the issuance of the Capital Securities. We have assumed that the transactions contemplated by the Prospectus and such other documents will occur as provided therein and that there will be no material change to the Prospectus or any of such other documents between the date hereof and the date of the issuance of the Capital Securities. Pennsylvania Manufacturers Corporation [Date] Page 2 We have assumed the authenticity of all documents submitted to us as originals, the genuineness of all signatures, the legal capacity of all natural persons and the conformity with original documents of all copies submitted to us for our examination. We have also assumed that all obligations imposed by such documents on the parties thereto are or will be enforceable, and have been or will be performed or satisfied in accordance with their terms. In rendering the opinions expressed below, we have considered the applicable provisions of the Internal Revenue Code of 1986, as amended (the "Code"), Regulations promulgated thereunder by the United States Treasury Department (the "Regulations"), pertinent judicial authorities, rulings of the Internal Revenue Service and such other authorities as we have considered relevant. It should be noted that the Code, the Regulations and such judicial decisions, administrative interpretations and other authorities are subject to change at any time and, in some circumstances, with retroactive effect; and any such change could affect the opinions stated herein. Based upon and subject to the foregoing, we are of the opinion that: (1) Under current law, the Junior Subordinated Debentures held by the Trust will be classified for United States federal income tax purposes as indebtedness of PMC; (2) Under current law, the Trust will be classified for United States federal income tax purposes as a grantor trust and not as an association taxable as a corporation; and (3) The discussion set forth in the Prospectus under the caption "UNITED STATES FEDERAL INCOME TAX CONSEQUENCES" is a fair and accurate summary of the matters addressed therein, based upon current law and the assumptions stated or referred to therein. We assume no obligation to update or supplement this letter to reflect any facts or circumstance which may hereafter come to our attention with respect to the opinions expressed above, including any changes in applicable law which may hereafter occur. We hereby consent to the filing of this letter as an Exhibit to the Registration Statement and to all references to our Firm included in or made a part of the Registration Statement and to all references to our Firm included in or made a part of the Registration Statement. Very truly yours, DUANE, MORRIS & HECKSCHER LLP EX-12.1 6 STATEMENT REGARDING COMPUTATION OF EARNINGS Exhibit 12.1 STATEMENT REGARDING COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (1) (dollar amounts in thousands)
SIX MONTHS ENDED JUNE 30, YEAR ENDED DECEMBER 31, 1998 1997 1997 1996 1995 1994 1993 ----------- ----------- ------- ---------- ------- ------- -------- EARNINGS Pre-tax income $25,516 $ 2,620 $25,153 $(191,394) $34,913 $65,380 $ 89,621 Fixed charges 8,411 9,199 17,664 19,070 20,231 14,550 13,356 --------------------------------------------------------------------------- Earnings (a) $33,927 $11,819 $42,817 $(172,324) $55,144 $79,930 $102,977 =========================================================================== FIXED CHARGES Interest expense and amortization of debt discount and premium on all indebtedness $ 7,463 $ 8,222 $15,768 $ 17,052 $18,734 $13,051 $ 11,650 Interest portion of rental expense 948 977 1,896 2,018 1,497 1,499 1,706 --------------------------------------------------------------------------- Fixed charges (c) $ 8,411 $ 9,199 $17,664 $ 19,070 $20,231 $14,550 $ 13,356 =========================================================================== Ratio of earnings to fixed charges including net realized investment gains (a)/(c) 4.0x 1.3x 2.4x (2) 2.7x 5.5x 7.7x
(1) For purposes of determining this ratio, earnings (loss) consist of income (loss) before income taxes and extraordinary loss (1997), plus fixed charges. Fixed charges consist of interest expense and the portion of operating leases that management believes is representative of the interest factor. (2) Earnings were insufficient to cover fixed charges by $191.4 million in 1996. EX-23.1 7 CONSENT OF PRICEWATERHOUSECOOPERS LLP EXHIBIT 23.1 [LETTERHEAD OF PRICEWATERHOUSECOOPERS] CONSENT OF INDEPENDENT ACCOUNTANTS ---------------------------------- November 2, 1998 We consent to the inclusion in this Registration Statement on Form S-3 of our reports dated February 6, 1998, on our audits of the consolidated financial statements and financial statement schedules of Pennsylvania Manufacturers Corporation and subsidiaries as of December 31, 1997 and 1996, and for each of the three years in the period ended December 31, 1997. We also consent to the reference to our firm under the captions "Experts." /s/ PricewaterhouseCoopers LLP EX-25.1 8 STATEMENT OF ELIGIBILITY - GUARANTEE Exhibit 25.1 ================================================================================ FORM T-1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 STATEMENT OF ELIGIBILITY UNDER THE TRUST INDENTURE ACT OF 1939 OF A CORPORATION DESIGNATED TO ACT AS TRUSTEE CHECK IF AN APPLICATION TO DETERMINE ELIGIBILITY OF A TRUSTEE PURSUANT TO SECTION 305(b)(2) |__| ---------------------- THE BANK OF NEW YORK (Exact name of trustee as specified in its charter) New York 13-5160382 (State of incorporation (I.R.S. employer if not a U.S. national bank) identification no.) One Wall Street, New York, N.Y. 10286 (Address of principal executive offices) (Zip code) ---------------------- Pennsylvania Manufacturers Corporation (Exact name of obligor as specified in its charter) Pennsylvania 23-2217932 (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification no.) The PMA Building 380 Sentry Parkway Blue Bell, Pennsylvania 19422 (Address of principal executive offices) (Zip code) ______________________ Junior Subordinated Debentures (Title of the indenture securities) ================================================================================ 1. GENERAL INFORMATION. FURNISH THE FOLLOWING INFORMATION AS TO THE TRUSTEE: (A) NAME AND ADDRESS OF EACH EXAMINING OR SUPERVISING AUTHORITY TO WHICH IT IS SUBJECT.
- --------------------------------------------------------------------------------- Name Address - --------------------------------------------------------------------------------- Superintendent of Banks of the State of 2 Rector Street, New York, New York N.Y. 10006, and Albany, N.Y. 12203 Federal Reserve Bank of New York 33 Liberty Plaza, New York, N.Y. 10045 Federal Deposit Insurance Corporation Washington, D.C. 20429 New York Clearing House Association New York, New York 10005
(B) WHETHER IT IS AUTHORIZED TO EXERCISE CORPORATE TRUST POWERS. Yes. 2. AFFILIATIONS WITH OBLIGOR. IF THE OBLIGOR IS AN AFFILIATE OF THE TRUSTEE, DESCRIBE EACH SUCH AFFILIATION. None. 16. LIST OF EXHIBITS. EXHIBITS IDENTIFIED IN PARENTHESES BELOW, ON FILE WITH THE COMMISSION, ARE INCORPORATED HEREIN BY REFERENCE AS AN EXHIBIT HERETO, PURSUANT TO RULE 7A-29 UNDER THE TRUST INDENTURE ACT OF 1939 (THE "ACT") AND 17 C.F.R. 229.10(D). 1. A copy of the Organization Certificate of The Bank of New York (formerly Irving Trust Company) as now in effect, which contains the authority to commence business and a grant of powers to exercise corporate trust powers. (Exhibit 1 to Amendment No. 1 to Form T-1 filed with Registration Statement No. 33-6215, Exhibits 1a and 1b to Form T-1 filed with Registration Statement No. 33-21672 and Exhibit 1 to Form T-1 filed with Registration Statement No. 33-29637.) 4. A copy of the existing By-laws of the Trustee. (Exhibit 4 to Form T-1 filed with Registration Statement No. 33-31019.) 6. The consent of the Trustee required by Section 321(b) of the Act. (Exhibit 6 to Form T-1 filed with Registration Statement No. 33-44051.) 7. A copy of the latest report of condition of the Trustee published pursuant to law or to the requirements of its supervising or examining authority. 2 SIGNATURE Pursuant to the requirements of the Act, the Trustee, The Bank of New York, a corporation organized and existing under the laws of the State of New York, has duly caused this statement of eligibility to be signed on its behalf by the undersigned, thereunto duly authorized, all in The City of New York, and State of New York, on the 27th day of October, 1998. THE BANK OF NEW YORK By: /s/ Marie E. Trimboli -------------------------- Name: Marie E. Trimboli Title: Assistant Treasurer 3 Exhibit 7 - -------------------------------------------------------------------------------- Consolidated Report of Condition of THE BANK OF NEW YORK of 48 Wall Street, New York, N.Y. 10286 And Foreign and Domestic Subsidiaries, a member of the Federal Reserve System, at the close of business June 30, 1998, published in accordance with a call made by the Federal Reserve Bank of this District pursuant to the provisions of the Federal Reserve Act.
Dollar Amounts ASSETS in Thousands Cash and balances due from depos- itory institutions: Noninterest-bearing balances and currency and coin.................... $ 7,301,241 Interest-bearing balances............. 1,385,944 Securities: Held-to-maturity securities........... 1,000,737 Available-for-sale securities......... 4,240,655 Federal funds sold and Securities pur- chased under agreements to resell..... 971,453 Loans and lease financing receivables: Loans and leases, net of unearned income .................38,788,269 LESS: Allowance for loan and lease losses ..............632,875 LESS: Allocated transfer risk reserve..........................0 Loans and leases, net of unearned income, allowance, and reserve 38,155,394 Assets held in trading accounts......... 1,307,562 Premises and fixed assets (including capitalized leases)................... 670,445 Other real estate owned................. 13,598 Investments in unconsolidated subsidiaries and associated companies............................. 215,024 Customers' liability to this bank on acceptances outstanding............... 974,237 Intangible assets....................... 1,102,625 Other assets............................ 1,944,777 ----------- Total assets............................ $59,283,692 =========== LIABILITIES Deposits: In domestic offices................... $26,930,258 Noninterest-bearing ......11,579,390 Interest-bearing .........15,350,868 In foreign offices, Edge and Agreement subsidiaries, and IBFs...... 16,117,854 Noninterest-bearing .........187,464 Interest-bearing .........15,930,390 Federal funds purchased and Securities sold under agreements to repurchase... 2,170,238 Demand notes issued to the U.S. Treasury.............................. 300,000 Trading liabilities..................... 1,310,867 Other borrowed money: With remaining maturity of one year or less............................. 2,549,479 With remaining maturity of more than one year through three years........ 0 With remaining maturity of more than three years......................... 46,654 Bank's liability on acceptances exe- cuted and outstanding................. 983,398 Subordinated notes and debentures....... 1,314,000 Other liabilities....................... 2,295,520 ----------- Total liabilities....................... 54,018,268 ----------- EQUITY CAPITAL Common stock............................ 1,135,284 Surplus................................. 731,319 Undivided profits and capital reserves.............................. 3,385,227 Net unrealized holding gains (losses) on available-for-sale securities............................ 51,233 Cumulative foreign currency transla- tion adjustments...................... ( 37,639) ----------- Total equity capital.................... 5,265,424 ----------- Total liabilities and equity capital ... $59,283,692 ===========
I, Robert E. Keilman, Senior Vice President and Comptroller of the above- named bank do hereby declare that this Report of Condition has been prepared in conformance with the instructions issued by the Board of Governors of the Federal Reserve System and is true to the best of my knowledge and belief. Robert E. Keilman We, the undersigned directors, attest to the correctness of this Report of Condition and declare that it has been examined by us and to the best of our knowledge and belief has been prepared in conformance with the instructions issued by the Board of Governors of the Federal Reserve System and is true and correct. J. Carter Bacot | Thomas A. Renyi | Directors Alan R. Griffith | - -------------------------------------------------------------------------------- EX-25.2 9 STATEMENT OF ELIGIBILITY - CAPITAL SECURITIES Exhibit 25.2 ================================================================================ FORM T-1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 STATEMENT OF ELIGIBILITY UNDER THE TRUST INDENTURE ACT OF 1939 OF A CORPORATION DESIGNATED TO ACT AS TRUSTEE CHECK IF AN APPLICATION TO DETERMINE ELIGIBILITY OF A TRUSTEE PURSUANT TO SECTION 305(b)(2) |__| ---------------------- THE BANK OF NEW YORK (Exact name of trustee as specified in its charter) New York 13-5160382 (State of incorporation (I.R.S. employer if not a U.S. national bank) identification no.) One Wall Street, New York, N.Y. 10286 (Address of principal executive offices) (Zip code) ---------------------- PMC Capital I (Exact name of obligor as specified in its charter) Delaware Applied For (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification no.) The PMA Building 380 Sentry Parkway Blue Bell, Pennsylvania 19422 (Address of principal executive offices) (Zip code) ______________________ Capital Securities (Title of the indenture securities) ================================================================================ 1. GENERAL INFORMATION. FURNISH THE FOLLOWING INFORMATION AS TO THE TRUSTEE: (A) NAME AND ADDRESS OF EACH EXAMINING OR SUPERVISING AUTHORITY TO WHICH IT IS SUBJECT.
- --------------------------------------------------------------------------------- Name Address - --------------------------------------------------------------------------------- Superintendent of Banks of the State of 2 Rector Street, New York, New York N.Y. 10006, and Albany, N.Y. 12203 Federal Reserve Bank of New York 33 Liberty Plaza, New York, N.Y. 10045 Federal Deposit Insurance Corporation Washington, D.C. 20429 New York Clearing House Association New York, New York 10005
(B) WHETHER IT IS AUTHORIZED TO EXERCISE CORPORATE TRUST POWERS. Yes. 2. AFFILIATIONS WITH OBLIGOR. IF THE OBLIGOR IS AN AFFILIATE OF THE TRUSTEE, DESCRIBE EACH SUCH AFFILIATION. None. 16. LIST OF EXHIBITS. EXHIBITS IDENTIFIED IN PARENTHESES BELOW, ON FILE WITH THE COMMISSION, ARE INCORPORATED HEREIN BY REFERENCE AS AN EXHIBIT HERETO, PURSUANT TO RULE 7A-29 UNDER THE TRUST INDENTURE ACT OF 1939 (THE "ACT") AND 17 C.F.R. 229.10(D). 1. A copy of the Organization Certificate of The Bank of New York (formerly Irving Trust Company) as now in effect, which contains the authority to commence business and a grant of powers to exercise corporate trust powers. (Exhibit 1 to Amendment No. 1 to Form T-1 filed with Registration Statement No. 33-6215, Exhibits 1a and 1b to Form T-1 filed with Registration Statement No. 33-21672 and Exhibit 1 to Form T-1 filed with Registration Statement No. 33-29637.) 4. A copy of the existing By-laws of the Trustee. (Exhibit 4 to Form T-1 filed with Registration Statement No. 33-31019.) 6. The consent of the Trustee required by Section 321(b) of the Act. (Exhibit 6 to Form T-1 filed with Registration Statement No. 33-44051.) 7. A copy of the latest report of condition of the Trustee published pursuant to law or to the requirements of its supervising or examining authority. 2 SIGNATURE Pursuant to the requirements of the Act, the Trustee, The Bank of New York, a corporation organized and existing under the laws of the State of New York, has duly caused this statement of eligibility to be signed on its behalf by the undersigned, thereunto duly authorized, all in The City of New York, and State of New York, on the 27th day of October, 1998. THE BANK OF NEW YORK By: /s/ Marie E. Trimboli -------------------------- Name: Marie E. Trimboli Title: Assistant Treasurer 3 Exhibit 7 - -------------------------------------------------------------------------------- Consolidated Report of Condition of THE BANK OF NEW YORK of 48 Wall Street, New York, N.Y. 10286 And Foreign and Domestic Subsidiaries, a member of the Federal Reserve System, at the close of business June 30, 1998, published in accordance with a call made by the Federal Reserve Bank of this District pursuant to the provisions of the Federal Reserve Act.
Dollar Amounts ASSETS in Thousands Cash and balances due from depos- itory institutions: Noninterest-bearing balances and currency and coin.................... $ 7,301,241 Interest-bearing balances............. 1,385,944 Securities: Held-to-maturity securities........... 1,000,737 Available-for-sale securities......... 4,240,655 Federal funds sold and Securities pur- chased under agreements to resell..... 971,453 Loans and lease financing receivables: Loans and leases, net of unearned income .................38,788,269 LESS: Allowance for loan and lease losses ..............632,875 LESS: Allocated transfer risk reserve..........................0 Loans and leases, net of unearned income, allowance, and reserve 38,155,394 Assets held in trading accounts......... 1,307,562 Premises and fixed assets (including capitalized leases)................... 670,445 Other real estate owned................. 13,598 Investments in unconsolidated subsidiaries and associated companies............................. 215,024 Customers' liability to this bank on acceptances outstanding............... 974,237 Intangible assets....................... 1,102,625 Other assets............................ 1,944,777 ----------- Total assets............................ $59,283,692 =========== LIABILITIES Deposits: In domestic offices................... $26,930,258 Noninterest-bearing ......11,579,390 Interest-bearing .........15,350,868 In foreign offices, Edge and Agreement subsidiaries, and IBFs...... 16,117,854 Noninterest-bearing .........187,464 Interest-bearing .........15,930,390 Federal funds purchased and Securities sold under agreements to repurchase... 2,170,238 Demand notes issued to the U.S. Treasury.............................. 300,000 Trading liabilities..................... 1,310,867 Other borrowed money: With remaining maturity of one year or less............................. 2,549,479 With remaining maturity of more than one year through three years........ 0 With remaining maturity of more than three years......................... 46,654 Bank's liability on acceptances exe- cuted and outstanding................. 983,398 Subordinated notes and debentures....... 1,314,000 Other liabilities....................... 2,295,520 ----------- Total liabilities....................... 54,018,268 ----------- EQUITY CAPITAL Common stock............................ 1,135,284 Surplus................................. 731,319 Undivided profits and capital reserves.............................. 3,385,227 Net unrealized holding gains (losses) on available-for-sale securities............................ 51,233 Cumulative foreign currency transla- tion adjustments...................... ( 37,639) ----------- Total equity capital.................... 5,265,424 ----------- Total liabilities and equity capital ... $59,283,692 ===========
I, Robert E. Keilman, Senior Vice President and Comptroller of the above- named bank do hereby declare that this Report of Condition has been prepared in conformance with the instructions issued by the Board of Governors of the Federal Reserve System and is true to the best of my knowledge and belief. Robert E. Keilman We, the undersigned directors, attest to the correctness of this Report of Condition and declare that it has been examined by us and to the best of our knowledge and belief has been prepared in conformance with the instructions issued by the Board of Governors of the Federal Reserve System and is true and correct. J. Carter Bacot | Thomas A. Renyi | Directors Alan R. Griffith | - -------------------------------------------------------------------------------- EX-25.3 10 STATEMENT OF ELIGIBILITY - JR. SUBORD. DEBS. Exhibit 25.3 ================================================================================ FORM T-1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 STATEMENT OF ELIGIBILITY UNDER THE TRUST INDENTURE ACT OF 1939 OF A CORPORATION DESIGNATED TO ACT AS TRUSTEE CHECK IF AN APPLICATION TO DETERMINE ELIGIBILITY OF A TRUSTEE PURSUANT TO SECTION 305(b)(2) |__| ---------------------- THE BANK OF NEW YORK (Exact name of trustee as specified in its charter) New York 13-5160382 (State of incorporation (I.R.S. employer if not a U.S. national bank) identification no.) One Wall Street, New York, N.Y. 10286 (Address of principal executive offices) (Zip code) ---------------------- Pennsylvania Manufacturers Corporation (Exact name of obligor as specified in its charter) Pennsylvania 23-2217932 (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification no.) The PMA Building 380 Sentry Parkway Blue Bell, Pennsylvania 19422 (Address of principal executive offices) (Zip code) ______________________ Guarantee of Capital Securities of PMC Capital I (Title of the indenture securities) ================================================================================ 1. GENERAL INFORMATION. FURNISH THE FOLLOWING INFORMATION AS TO THE TRUSTEE: (A) NAME AND ADDRESS OF EACH EXAMINING OR SUPERVISING AUTHORITY TO WHICH IT IS SUBJECT.
- --------------------------------------------------------------------------------- Name Address - --------------------------------------------------------------------------------- Superintendent of Banks of the State of 2 Rector Street, New York, New York N.Y. 10006, and Albany, N.Y. 12203 Federal Reserve Bank of New York 33 Liberty Plaza, New York, N.Y. 10045 Federal Deposit Insurance Corporation Washington, D.C. 20429 New York Clearing House Association New York, New York 10005
(B) WHETHER IT IS AUTHORIZED TO EXERCISE CORPORATE TRUST POWERS. Yes. 2. AFFILIATIONS WITH OBLIGOR. IF THE OBLIGOR IS AN AFFILIATE OF THE TRUSTEE, DESCRIBE EACH SUCH AFFILIATION. None. 16. LIST OF EXHIBITS. EXHIBITS IDENTIFIED IN PARENTHESES BELOW, ON FILE WITH THE COMMISSION, ARE INCORPORATED HEREIN BY REFERENCE AS AN EXHIBIT HERETO, PURSUANT TO RULE 7A-29 UNDER THE TRUST INDENTURE ACT OF 1939 (THE "ACT") AND 17 C.F.R. 229.10(D). 1. A copy of the Organization Certificate of The Bank of New York (formerly Irving Trust Company) as now in effect, which contains the authority to commence business and a grant of powers to exercise corporate trust powers. (Exhibit 1 to Amendment No. 1 to Form T-1 filed with Registration Statement No. 33-6215, Exhibits 1a and 1b to Form T-1 filed with Registration Statement No. 33-21672 and Exhibit 1 to Form T-1 filed with Registration Statement No. 33-29637.) 4. A copy of the existing By-laws of the Trustee. (Exhibit 4 to Form T-1 filed with Registration Statement No. 33-31019.) 6. The consent of the Trustee required by Section 321(b) of the Act. (Exhibit 6 to Form T-1 filed with Registration Statement No. 33-44051.) 7. A copy of the latest report of condition of the Trustee published pursuant to law or to the requirements of its supervising or examining authority. 2 SIGNATURE Pursuant to the requirements of the Act, the Trustee, The Bank of New York, a corporation organized and existing under the laws of the State of New York, has duly caused this statement of eligibility to be signed on its behalf by the undersigned, thereunto duly authorized, all in The City of New York, and State of New York, on the 27th day of October, 1998. THE BANK OF NEW YORK By: /s/ Marie E. Trimboli ------------------------------ Name: Marie E. Trimboli Title: Assistant Treasurer 3 Exhibit 7 - -------------------------------------------------------------------------------- Consolidated Report of Condition of THE BANK OF NEW YORK of 48 Wall Street, New York, N.Y. 10286 And Foreign and Domestic Subsidiaries, a member of the Federal Reserve System, at the close of business June 30, 1998, published in accordance with a call made by the Federal Reserve Bank of this District pursuant to the provisions of the Federal Reserve Act.
Dollar Amounts ASSETS in Thousands Cash and balances due from depos- itory institutions: Noninterest-bearing balances and currency and coin.................... $ 7,301,241 Interest-bearing balances............. 1,385,944 Securities: Held-to-maturity securities........... 1,000,737 Available-for-sale securities......... 4,240,655 Federal funds sold and Securities pur- chased under agreements to resell..... 971,453 Loans and lease financing receivables: Loans and leases, net of unearned income .................38,788,269 LESS: Allowance for loan and lease losses ..............632,875 LESS: Allocated transfer risk reserve..........................0 Loans and leases, net of unearned income, allowance, and reserve 38,155,394 Assets held in trading accounts......... 1,307,562 Premises and fixed assets (including capitalized leases)................... 670,445 Other real estate owned................. 13,598 Investments in unconsolidated subsidiaries and associated companies............................. 215,024 Customers' liability to this bank on acceptances outstanding............... 974,237 Intangible assets....................... 1,102,625 Other assets............................ 1,944,777 ----------- Total assets............................ $59,283,692 =========== LIABILITIES Deposits: In domestic offices................... $26,930,258 Noninterest-bearing ......11,579,390 Interest-bearing .........15,350,868 In foreign offices, Edge and Agreement subsidiaries, and IBFs...... 16,117,854 Noninterest-bearing .........187,464 Interest-bearing .........15,930,390 Federal funds purchased and Securities sold under agreements to repurchase... 2,170,238 Demand notes issued to the U.S. Treasury.............................. 300,000 Trading liabilities..................... 1,310,867 Other borrowed money: With remaining maturity of one year or less............................. 2,549,479 With remaining maturity of more than one year through three years........ 0 With remaining maturity of more than three years......................... 46,654 Bank's liability on acceptances exe- cuted and outstanding................. 983,398 Subordinated notes and debentures....... 1,314,000 Other liabilities....................... 2,295,520 ----------- Total liabilities....................... 54,018,268 ----------- EQUITY CAPITAL Common stock............................ 1,135,284 Surplus................................. 731,319 Undivided profits and capital reserves.............................. 3,385,227 Net unrealized holding gains (losses) on available-for-sale securities............................ 51,233 Cumulative foreign currency transla- tion adjustments...................... ( 37,639) ----------- Total equity capital.................... 5,265,424 ----------- Total liabilities and equity capital ... $59,283,692 ===========
I, Robert E. Keilman, Senior Vice President and Comptroller of the above- named bank do hereby declare that this Report of Condition has been prepared in conformance with the instructions issued by the Board of Governors of the Federal Reserve System and is true to the best of my knowledge and belief. Robert E. Keilman We, the undersigned directors, attest to the correctness of this Report of Condition and declare that it has been examined by us and to the best of our knowledge and belief has been prepared in conformance with the instructions issued by the Board of Governors of the Federal Reserve System and is true and correct. J. Carter Bacot | Thomas A. Renyi | Directors Alan R. Griffith | - -------------------------------------------------------------------------------- -----END PRIVACY-ENHANCED MESSAGE-----