-----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, HtEYs0vEUwO6ZE9fA7f9mj949Shbi5jz69AvPsA8i4h12ZZ/HpSqhMIXlAT9tilF q1d2QGq8qAqBX5rBNdpBTg== 0001036050-99-000695.txt : 19990402 0001036050-99-000695.hdr.sgml : 19990402 ACCESSION NUMBER: 0001036050-99-000695 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 14 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PMA CAPITAL CORP CENTRAL INDEX KEY: 0001041665 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 232217932 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-22761 FILM NUMBER: 99582680 BUSINESS ADDRESS: STREET 1: 1735 MARKET STREET SUITE 2800 CITY: PHILADELPHIA STATE: PA ZIP: 19103-7590 BUSINESS PHONE: 2156655046 MAIL ADDRESS: STREET 1: 1735 MARKET STREET SUITE 2800 CITY: PHILADELPHIA STATE: PA ZIP: 19103-7590 FORMER COMPANY: FORMER CONFORMED NAME: PENNSYLVANIA MANUFACTURERS CORP DATE OF NAME CHANGE: 19970702 10-K 1 FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K (MARK ONE) /X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO __________ Commission File Number 000-22761 PMA Capital Corporation ----------------------- (Exact name of registrant as specified in its charter) Pennsylvania 23-2217932 - ---------------------------------------- ---------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 1735 MARKET STREET, SUITE 2800 Philadelphia, Pennsylvania 19103-7590 - ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (215) 665-5046 -------------- Securities to be registered pursuant to Section 12(b): None Securities to be registered pursuant to Section 12(g) of the Act: CLASS A COMMON STOCK, PAR VALUE $5.00 PER SHARE ----------------------------------------------- (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES /X/ NO / / Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. / / The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of February 28, 1999, was $263,158,213. There were 13,504,816 shares outstanding of the registrant's Common Stock, $5 par value per share, and 9,895,360 shares outstanding of the registrant's Class A Common Stock, $5 par value per share, as of the close of business on February 28, 1999. DOCUMENTS INCORPORATED BY REFERENCE: (1) Parts I and II of this Form 10-K incorporate by reference portions of the Annual Report to Shareholders for the year ended December 31, 1998, as indicated herein. (2) Part III of this Form 10-K incorporates portions of the registrant's proxy statement dated March 26, 1999 for the 1999 Annual Meeting of Shareholders. INDEX - --------------------------------------------------------------------------------
PART I PAGE Item 1. Business....................................................................... 1 Company Overview............................................................ 1 PMA Re...................................................................... 2 The PMA Insurance Group..................................................... 6 Caliber One................................................................. 12 Reinsurance and Retrocessional Protection................................... 12 Loss Reserves............................................................... 14 Investments................................................................. 20 Competition................................................................. 21 Regulatory Matters.......................................................... 22 Employees................................................................... 25 Glossary of Selected Insurance Terms........................................ 26 Item 2. Properties..................................................................... 30 Item 3. Legal Proceedings.............................................................. 30 Item 4. Submission of Matters to a Vote of Security Holders............................ 30 Executive Officers of the Registrant........................................... 30 PART II Item 5. Market for the Registrant's Common Equity and Related Shareholder Matters...... 31 Item 6. Selected Financial Data........................................................ 31 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...................................................... 31 Item 7A. Quantitative and Qualitative Disclosures About Market Risk..................... 32 Item 8. Financial Statements and Supplementary Data.................................... 32 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............................................ 32 PART III Item 10. Directors and Executive Officers of the Registrant............................. 32 Item 11. Executive Compensation......................................................... 32 Item 12. Security Ownership of Certain Beneficial Owners and Management................. 32 Item 13. Certain Relationships and Related Transactions................................. 32 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............... 33 Signatures.............................................................................. 34 Index to Financial Statement Schedules.................................................. FS-1 Index to Exhibits....................................................................... E-1
PART I The Business Section and other parts of this Form 10-K contain forward-looking statements that involve risks and uncertainties. The Company's actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in the "Cautionary Statements" on page 49 of the Company's Management's Discussion and Analysis ("MD&A") section of its 1998 Annual Report to Shareholders ("Annual Report") that has been incorporated by reference into Part II, Item 7 of this Form 10-K. ITEM 1. Business COMPANY OVERVIEW PMA Capital Corporation (the "Company" or "PMA Capital"), headquartered in Philadelphia, Pennsylvania, is an insurance holding company with total assets of approximately $3.5 billion and shareholders' equity of $511.5 million at December 31, 1998. In 1998, the Company changed its name to PMA Capital Corporation from Pennsylvania Manufacturers Corporation. The new name is more representative of the full breadth of the Company's insurance operations and underscores the diversity of its risk management services. The Company's operating subsidiaries conduct business in the property and casualty insurance industry. The Company has three operating segments: (i) PMA Re, which provides property and casualty reinsurance products and services; (ii) The PMA Insurance Group, which writes workers' compensation and other standard lines of commercial insurance; and (iii) Caliber One, which writes specialty insurance focusing on excess and surplus lines. In addition, the Company's Corporate and Other segment includes unallocated investment income; expenses, including debt service; and taxes, as well as the results of certain of the Company's real estate properties. Financial information in the tables that follow is presented in conformity with generally accepted accounting principles ("GAAP"), unless otherwise indicated. Certain reclassifications have been made to prior periods' financial information to conform with the 1998 presentation. Revenues, income (loss) before income taxes and net realized investment gains, and assets attributable to each of the Company's operating segments and its Corporate and Other segment for the last three fiscal years are set forth in Note 17 to the Company's consolidated financial statements for the year ended December 31, 1998 ("Financial Statements") included in its Annual Report. The composition of the Company's net premiums written for the year ended December 31, 1998 was as follows: (dollar amounts in thousands)
Net premiums written % of total -------------------- ------------------ PMA Re................................... $234,010 49.2 % -------- ----- The PMA Insurance Group: Workers' compensation.................. 187,033 39.4 % Other commercial lines................. 57,204 12.0 % Run-off Operations..................... (9,400) (2.0)% -------- ----- Total.................................. 234,837 49.4 % -------- ----- Caliber One............................. 6,436 1.4 % Corporate and Other...................... (522) -- -------- ----- Total.................................... $474,761 100.0 % ======== =====
1 PMA RE Background 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 brokered market. PMA Re competes on the basis of its ability to offer specialized products to its clients, its long-term relationships in the broker and ceding company communities, and its prompt and responsive service. According to data provided by the Reinsurance Association of America (the "RAA"), as of December 31, 1998, PMA Reinsurance Corporation was the 22nd largest reinsurer in the United States in terms of statutory capital and surplus and 17th largest in terms of net premiums written. In the broker reinsurance market, the products (reinsurance coverages) are distributed to the ultimate customer (ceding companies) through reinsurance intermediaries, known as brokers. In exchange for providing such distribution services, the brokers are paid commissions, known as brokerage, which are typically based upon a percentage of the premiums ceded under a particular contract. The broker reinsurance market differs from the direct reinsurance market in which direct reinsurers maintain their own sales forces and distribute their products directly to their ceding company clients. From 1993 to 1998, 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 18.0%, while the reinsurance industry's compound annual growth rate was 4.1% 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 ceding company clients' existing programs, as well as the writing of additional layers and programs for current ceding company clients. To a lesser extent, volume growth has been attributable to business written with new ceding company clients. 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. In addition, PMA Re has benefited from the greater selectivity of ceding companies that have restricted the number of reinsurers with which they will transact business. Finally, PMA Re has been able to write business for customers that was formerly written by reinsurers that have been acquired by other reinsurers. These factors have more than offset the recent trends beginning in 1996 of ceding companies retaining more of their business and highly competitive conditions in the U.S. reinsurance market. The competitive conditions have caused PMA Re to non-renew certain accounts amounting to $46.8 million of in- force premium in the twelve months ended December 31, 1998 and to not accept certain new business opportunities largely due to inadequate rates and/or other underwriting concerns. In addition, PMA Re has attempted to offset these competitive conditions through a target marketing program commenced in 1996, 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. Products PMA Re provides reinsurance coverage primarily under two arrangements: treaty and facultative. Typically, in treaty reinsurance, the primary insurer or ceding company is obligated to offer and the reinsurer is obligated to accept a specified portion of all agreed upon types or categories of risks originally written by the primary insurer or ceding company. Facultative reinsurance is a form of reinsurance coverage that is placed on a risk-by-risk basis, and the reinsurer retains the right to accept or reject each individual risk submitted by the ceding company. Of PMA Re's total net premiums written in 1998, 98.8% were treaty and 1.2% were facultative. During 1998, PMA Re created four internal underwriting units to serve its principal classes of business. Treaty reinsurance is provided through two of these units: (1) Traditional, which consists of pro-rata and excess-of-loss reinsurance treaties and (2) Specialty, which underwrites specialty risks such as environmental, employment 2 practices and professional liability writings. PMA Re also offers products through two other units, Finite and Financial Products, which was formed in 1998 to provide reinsurance solutions to the more complex risk management issues; and Facultative, which provides coverage on a risk-by-risk basis. The following table indicates PMA Re's gross and net premiums written by major category of business for the years ended December 31: (dollar amounts in thousands)
1998 1997 1996 1995 1994 ------------- ------------- ------------- -------------- ------------- Gross premiums written (1) Casualty........................... $206,317 $151,901 $143,991 $128,736 $107,001 Property........................... 76,975 72,625 63,325 63,693 36,592 Other.............................. 1,044 795 842 (63) 837 -------- -------- -------- -------- -------- Total.............................. $284,336 $225,321 $208,158 $192,366 $144,430 ======== ======== ======== ======== ======== Net premiums written (2) Casualty........................... $168,452 $118,889 $122,008 $107,383 $ 88,585 Property........................... 64,497 58,257 41,240 45,440 23,929 Other.............................. 1,061 788 805 (63) 837 -------- -------- -------- -------- -------- Total.............................. $234,010 $177,934 $164,053 $152,760 $113,351 ======== ======== ======== ======== ========
(1) In 1998 and 1997, gross premiums written included $6.6 million and $5.8 million of facultative reinsurance, respectively, consisting of the following: property, $2.8 million and $2.4 million, respectively, and casualty, $3.8 million and $3.4 million, respectively. (2) In 1998 and 1997, net premiums written included $2.7 million and $2.5 million of facultative reinsurance, respectively, consisting of the following: property, $1.8 million and $1.7 million, respectively, and casualty, $0.9 million and $0.8 million, respectively. Casualty Business In terms of net premiums written, casualty business has increased at a compound annual growth rate of 15.5% in the five-year period ended December 31, 1998, and accounted for 72.0% of net premiums written in 1998. PMA Re has generally focused on general liability, professional liability and other more specialized liability coverages. The following table indicates the mix of casualty business by class on the basis of net premiums written: (dollar amounts in thousands)
1998 1997 1996 1995 1994 --------------- --------------- --------------- --------------- --------------- Auto Liability................. $ 30,720 $ 22,268 $ 17,056 $ 13,032 $10,134 Miscellaneous Liability........ 28,422 16,431 12,811 10,350 6,006 Errors and Omissions........... 27,889 13,813 19,866 7,149 7,281 Umbrella (1)................... 25,056 30,967 40,307 51,559 38,743 General Liability.............. 23,234 15,174 11,702 7,460 8,936 Medical Malpractice............ 15,645 7,373 7,411 6,835 6,355 Other.......................... 17,486 12,863 12,855 10,998 11,130 -------- -------- -------- -------- ------- Total.......................... $168,452 $118,889 $122,008 $107,383 $88,585 ======== ======== ======== ======== =======
(1) Umbrella casualty business includes coverage above a specific dollar amount set forth in the original policies issued by the ceding companies. 3 Property Business Property business accounted for 27.6% of net premiums written for the year ended December 31, 1998. In the five-year period ended December 31, 1998, property business has increased at a compound annual growth rate of 28.5%. The increases in net property premiums written primarily reflect 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. No single line of property business has contributed 10% or more of the Company's consolidated net premiums written within the last three fiscal years. PMA Re has generally de-emphasized catastrophe coverages. As of December 31, 1998, catastrophe business accounted for 3.9% of net property premiums written. 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 catastrophes due to the aggregation of per occurrence limits and similar issues. PMA Re actively manages this exposure through zonal management, minimizing writings of catastrophe business, and the purchase of retrocessional protection. As of December 31, 1998, PMA Re maintained catastrophe retrocessional protection of $48 million excess of $2 million per occurrence. Although the Company believes that it has adequate reinsurance to protect against the estimated probable maximum gross loss from a catastrophe, an especially severe catastrophe or series of catastrophes could exceed the Company's reinsurance and/or retrocessional protection and may have a material adverse impact on the Company's results of operations and financial condition. Distribution PMA Re operates primarily through the domestic broker reinsurance market in which it has developed relationships with the major reinsurance brokers enabling it to gain access to a wide range of ceding companies with varying reinsurance and related service needs. PMA Re's brokers that accounted for more than 10% of the gross premiums written in 1998 were as follows: (dollar amounts in thousands)
Broker Gross premiums written % of total - ------------------------------------- ------------------------------- ------------------------- Aon Reinsurance...................... $89,742 31.6% Guy Carpenter & Company.............. 86,338 30.4% E. W. Blanch......................... 39,052 13.7%
In 1996, PMA Re reemphasized its marketing program and identified target companies in the smaller and medium company segments with whom PMA Re had either no or an insignificant relationship, but met desired risk profiles. After such identification, marketing and underwriting, personnel worked with the ceding company's broker to enable PMA Re to have an opportunity to participate in the reinsurance coverage. As of December 31, 1998, PMA Re had 225 unaffiliated clients, with no individual client accounting for more than 6.1% of gross premiums written in 1998. 4 Underwriting In reinsurance, underwriting involves the selection of risks and determining an adequate price given expected losses and estimated volatility of such losses. Given the present soft-pricing environment, maintaining underwriting discipline is critical to the maintenance of acceptable results of operations. 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 may conduct underwriting and claim reviews at the offices of prospective ceding companies before entering into a major treaty, as well as throughout the life of the reinsurance contract. PMA Re's underwriters and actuaries work closely together to evaluate the particular reinsurance program. Using the information provided by the broker, the actuaries employ pricing models to estimate the ultimate exposure to the treaty. The pricing models that are utilized employ various experience rating and exposure rating techniques and are tailored in each case to the risk exposures underlying each treaty. The underwriters then analyze the results of the pricing models with the terms and conditions being offered to determine PMA Re's selected price. In underwriting excess-of-loss business, PMA Re has typically sought to write treaties that are risk exposed within the original policy limits of the ceding company. Management believes these layers generally lend themselves more effectively to actuarial pricing techniques. As noted above, PMA Re typically requires per occurrence limits for property coverage. Also, PMA Re minimizes catastrophe reinsurance coverages and has historically maintained sufficient retrocessional protection. Because of these factors, recent catastrophes did not have a significant adverse impact on PMA Re's combined ratio or results of operations. PMA Re has no significant obligations to its reinsureds as a result of catastrophes reinsured within the last five years. Claims Administration PMA Re's claims department analyzes reported claims, establishes individual claim reserves, pays claims, provides claims-related services to clients, audits the claims activities of selected current clients and assists in the underwriting process by evaluating the claims departments of selected prospective clients. The claims department's evaluation of claims activity includes reviewing loss reports received from ceding companies to confirm that claims are covered under the terms of the relevant reinsurance contract, establishing reserves on an individual case basis and monitoring the adequacy of those reserves. The claims department monitors the progress and ultimate outcome of the claims to determine that subrogation, salvage and other cost recovery opportunities have been adequately explored. The claims department performs these functions in coordination with the actuarial and underwriting departments. In addition to evaluating and adjusting claims, the claims department conducts claims audits at the offices of selected prospective ceding companies. Satisfactory audit results are required in order for reinsurance coverage to be written or continued by PMA Re. Also, the claims department conducts annual claims audits for many current and former client ceding companies. In the area of claims administration, PMA Re has been among the first companies to implement several claims service initiatives in the broker 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. 5 THE PMA INSURANCE GROUP Background The PMA Insurance Group provides workers' compensation insurance, other commercial property and casualty insurance coverages, including commercial general liability, commercial automobile and commercial multi-peril, and related services to entities located in its ten-state marketing territory concentrated in the Mid-Atlantic and Southern regions of the United States. The domestic insurance subsidiaries through which The PMA Insurance Group writes its insurance products and who share results through an intercompany pooling agreement are referred to herein as the "Pooled Companies." The PMA Insurance Group's net premiums written declined from $352.2 million in 1994 to $234.8 million in 1998, primarily reflecting The PMA Insurance Group's underwriting decisions, competition and the impact of workers' compensation rate reductions and related benefit reform laws. The PMA Insurance 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 premium but bear a greater portion of loss exposure. The PMA Insurance Group intends to continue writing other lines of property and casualty insurance, but generally only if such writings are supported by its core workers' compensation business. The PMA Insurance Group continues to emphasize its traditional core business, workers' compensation. The Company believes that it can capitalize on the recent workers' compensation regulatory reforms, attract additional business based upon its 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 PMA Insurance Group has aligned itself with network health care providers in order to offer medical cost containment practices to its insureds. In Pennsylvania, The PMA Insurance Group seeks to expand and retain more of its premium base in territories that meet The PMA Insurance Group's underwriting and actuarial criteria. Regulatory reforms in Pennsylvania (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 systems in certain other states in which The PMA Insurance Group does business (specifically, New Jersey, North Carolina and Virginia) have also improved in recent years. The PMA Insurance Group is attempting to recapture a portion of the workers' compensation market share in those states where it has relinquished market share since the early 1990's. In addition, The PMA Insurance Group has shifted its workers' compensation premiums towards lower hazard lines of business such as health care, schools/colleges and retail which comprised 25.8%, 20.6% and 12.9% of total workers' compensation premiums written in 1998,1997 and 1996, respectively, while de-emphasizing its participation in higher hazard lines of business, including construction and manufacturing which comprised 43.1%, 46.4% and 52.0% of total workers' compensation premiums written in 1998, 1997 and 1996, respectively. Further, The PMA Insurance Group intends to expand into certain new territories. In 1997, The PMA Insurance Group began writing business in Georgia, and, in 1996, in New York and South Carolina. In these territories, The PMA Insurance Group has identified profiles of entities that it desired to insure. These profiles were communicated to the key producers in these states. The PMA Insurance Group is contemplating expanding its relationships with larger national and regional brokerage operations in both its existing and new states. However, no assurance can be given that The PMA Insurance Group will be able to accomplish these marketing objectives. In 1996, the Company restructured The PMA Insurance Group with the goal of restoring its profitability after three previous 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 PMA Insurance 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 workers' compensation claims from the 1987 to 1991 period; (iii) designating PMA Insurance, Cayman Ltd. ("PMA Cayman"), and Mid-Atlantic States Casualty Company ("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, and appointment of, a Chief Underwriting Officer. Effective July 1, 1998, the Company sold PMA Cayman. See "Run-off Operations" below for additional discussion. 6 Products The following table sets forth certain information on The PMA Insurance Group's net premiums written for the years ended December 31: (dollar amounts in thousands)
1998 1997 1996 1995 1994 --------------- ---------------- --------------- --------------- --------------- Workers' Compensation............. $187,033 $175,301 $187,698 $232,742 $266,033 Commercial Multi-Peril............ 28,043 41,713 35,108 40,659 31,123 Commercial Auto................... 23,288 28,938 35,224 39,834 38,984 Other............................. 5,873 9,018 14,449 19,881 16,011 Run-off Operations(1)............. (9,400) (51,622) -- -- -- -------- -------- -------- -------- -------- Total............................. $234,837 $203,348 $272,479 $333,116 $352,151 ======== ======== ======== ======== ======== - --------------
(1) Run-off Operations were classified by management and segregated from ongoing operations effective December 31, 1996. Workers' Compensation Insurance All states require employers to provide workers' compensation benefits to their employees and their employees' dependents for injuries and occupational diseases arising out of employment, regardless of whether such injuries result from the employer's or the employee's negligence. Employers may insure their workers' compensation obligations or, subject to regulatory approval, self-insure such liabilities. State workers' compensation statutes require that a policy cover three types of benefits: medical expenses, disability (indemnity) benefits and death benefits. The amounts of disability and death 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 (1997), The PMA Insurance Group is the 4th largest writer of workers' compensation insurance in Pennsylvania and ranks between the 2nd and 12th largest writer of workers' compensation insurance in the other jurisdictions in which it does business, except for New York and North Carolina. The PMA Insurance Group has focused on these jurisdictions based upon its knowledge of their workers' compensation systems and The PMA Insurance Group's assessment of 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. The PMA Insurance Group intends to employ similar analyses in determining whether and to what extent The PMA Insurance Group will offer its products in additional jurisdictions. See "Underwriting." The following table sets forth statutory direct workers' compensation business written by jurisdiction for the five years ended December 31: (dollar amounts in thousands)
1998 1997 1996 1995 1994 --------------- --------------- --------------- --------------- --------------- Pennsylvania.................. $ 85,923 $ 91,126 $134,171 $142,234 $169,448 New Jersey.................... 29,098 26,327 17,995 24,388 31,287 Virginia...................... 19,958 19,552 17,449 26,395 29,938 Maryland...................... 16,108 16,538 11,406 17,993 14,391 North Carolina................ 8,988 9,501 8,195 14,035 11,649 Delaware...................... 8,372 7,041 7,545 5,763 4,831 New York...................... 7,796 3,143 583 983 439 Other......................... 10,670 8,327 4,820 6,906 4,425 --------------- --------------- --------------- --------------- --------------- Total......................... $186,913 $181,555 $202,164 $238,697 $266,408 =============== =============== =============== =============== ===============
7 The PMA Insurance Group believes that conditions in the workers' compensation market have been improving in the last several years with respect to the ability to manage and control loss costs, although pricing for workers' compensation products continues to be competitive. In addition over the last five years, 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 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, which are uniform and stringent 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) further increases the time frame for directed medical treatment; and (iii) increases the ability of employers to demonstrate that injured workers have earnings capacity. 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 1994 and 1997, the first years following the enactments of Act 44 and Act 57, the average manual rate level in Pennsylvania decreased approximately 10% and approximately 25%, respectively. Workers' compensation insurers doing business in certain states are required to provide insurance for risks that 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 PMA Insurance Group does business, except Pennsylvania and Maryland. In these two states, separate governmental entities write all of the workers' compensation residual market business. In 1998, The PMA Insurance Group wrote $3.7 million of residual market business, which constituted approximately 2% of its net workers' compensation premiums written. 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 6.3%. The PMA Insurance Group offers a variety of workers' compensation products to its customers. Certain of these products are based on manual rates filed and approved by state insurance departments ("rate-sensitive products"), while others are priced to a certain extent on the basis of the insured's own loss experience ("loss-sensitive products"). In the last five years, The PMA Insurance Group has also developed and sold alternative market products, such as large deductible products and other programs and services to customers who agree to assume even greater exposure to loss than under more traditional loss- sensitive products. The PMA Insurance Group decides which type of product to offer a customer based upon the customer's needs and an underwriting review. In 1997, The PMA Insurance Group developed PMA One, a new product that provides for group intergated occupational and non-occupational disability coverages, and began marketing PMA One in 1998. This product line utilizes The PMA Insurance Group's expertise in managed care to reduce disability periods. Set forth below is percentage information on the voluntary workers' compensation direct premiums written by product type for the policy years indicated:
1998 1997 1996 1995 1994 ---------------- ---------------- ---------------- ---------------- ---------------- Rate-sensitive products....... 63% 62% 57% 52% 50% Loss-sensitive products....... 28% 27% 30% 34% 39% Alternative market products... 9% 11% 13% 14% 11% ---------------- ---------------- ---------------- ---------------- ---------------- Total......................... 100% 100% 100% 100% 100% ================ ================ ================ ================ ================
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 8 enactment of regulatory reform in several states in which The PMA Insurance Group does business, The PMA Insurance Group believes that it is better able to evaluate the expected losses on this type of business. Loss-Sensitive Workers' Compensation Products - ---------------------------------------------- The PMA Insurance Group's loss-sensitive products adjust the amount of the insured's premiums after the policy period expires based upon the insured's actual losses incurred during the policy period. These loss-sensitive products are generally subject to less price regulation than rate-sensitive products and reduce, but do not eliminate, risk to the insurer. Under these types of policies, claims professionals and actuaries periodically evaluate the reserves on losses after the policy period expires to determine whether additional premiums or refunds are owed under the policy. Such policies are typically open for adjustments for an average of five years after policy expiration. The PMA Insurance Group generally restricts such loss-sensitive products to accounts developing minimum annual premiums in excess of $100,000. Alternative Market Workers' Compensation Products - -------------------------------------------------- The PMA Insurance Group offers a variety of alternative market products for larger accounts, including large deductible policies and off-shore captive programs. Typically, The PMA Insurance Group receives a lower up-front premium for these types of alternative market product plans. However, under this type of business, the insured retains a greater share of the underwriting risk than under rate-sensitive or loss-sensitive products, which reduces the potential for unfavorable claim activity on the accounts and encourages loss control on the part of the insured. For example, under a large deductible policy, the customer is responsible for paying its own losses up to the amount of the deductible for each occurrence. The deductibles under such policies generally range from $250,000 to $1.0 million. In addition to these products, The PMA Insurance Group offers certain workers' compensation services to its clients unbundled from the insurance products. See "PMA Management Corp." for additional discussion of such products. The PMA Insurance Group offers a comprehensive array of workers' compensation managed care services to reduce loss costs. Disability Management Coordinators, who are all registered nurses, utilize an early intervention model to proactively manage medical treatment and length of disability in concert with the claim professional and employer. There are also case management nurses who manage more serious claims via on-site visits with injured workers and medical providers. In addition, The PMA Insurance Group utilizes the services of Paradigm Corporation for certain catastrophic injuries. Paradigm adds a team of catastrophic case management experts to assist in achieving enhanced clinical and financial outcomes on these claims. The PMA Insurance Group also established a partnership with First Health Corp. for access to their workers' compensation preferred provider network. The First Health/R/ Network includes doctors, hospitals, physical therapists, outpatient clinics and imaging centers. The PMA Insurance Group's customers that utilize the network generally recognize lower costs than those that do not utilize the network. Finally, an automated medical bill review system is used to detect duplicate billings, unrelated charges and coding discrepancies. Complex bills are forwarded to The PMA Insurance Group's cost containment unit, which is staffed by registered nurses and other medical professionals, to resolve questions of causal relationship and over-utilization. Commercial Lines The PMA Insurance Group writes property and liability coverages for larger and middle market accounts that satisfy its underwriting standards. See "Underwriting" below. These coverages feature multi-peril, general liability and umbrella and commercial automobile business. The PMA Insurance Group intends to continue offering these products, but generally only if they complement the core workers' compensation business. In the present market, prices for commercial coverages have been particularly competitive. As a result, The PMA Insurance Group has been selectively non-renewing accounts that do not meet its underwriting standards. 9 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 the Company. 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 risk retained by the Pooled Companies and captive management fees earned by PMA Management Corp. Distribution The PMA Insurance Group distributes its products through approximately 15 direct sales employees and approximately 235 independent brokers and agents. The direct sales employees are generally responsible for certain business located in Pennsylvania. For the year ended December 31, 1998, these employees produced approximately $35 million in direct premiums written, constituting 12% of The PMA Insurance Group's direct written business. The brokers and agents write business throughout the marketing territory. In 1998, the top ten brokers and agents accounted for 25.5% of The PMA Insurance Group's business, the largest of which accounted for approximately 7.4% of its business. All business from brokers and agents is reviewed by The PMA Insurance Group's underwriters before it is accepted. The PMA Insurance Group monitors several statistics with respect to its producer force, including the number of years the producer has been associated with The PMA Insurance Group, the percentage of the producer's business that is underwritten by The PMA Insurance Group, the ranking of The PMA Insurance Group within the producer's business, and the profitability of the producer's business. The current distribution network generally consists of large regional agents and brokers, local agents and national brokers that specialize in larger to middle market accounts that require the variety of workers' compensation, commercial lines and alternative market products offered by The PMA Insurance Group. The field organization currently consists of 17 regional or branch offices throughout the ten-state marketing territory. These offices deliver a full range of services directly to customers located in their service territory, and smaller satellite offices primarily offer underwriting and claim adjustment services. Underwriting The PMA Insurance Group's underwriters, in consultation with 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. Specific types of business are referred to underwriting specialists and actuaries for individual pricing. The underwriting team also establishes classes of business that The PMA Insurance Group generally will not write, such as certain property exposures, certain hazardous products and activities and certain environmental coverages. Underwriters and risk-control professionals in the field report functionally to the Chief Underwriting Officer rather than to branch managers with marketing responsibilities. Underwriters also work with the field marketing force to identify business that meets prescribed underwriting standards and to develop specific strategies to write the desired business. In performing this assessment, the field office professionals also consult with actuaries who have been assigned to the specific field office regarding loss trends and pricing and utilize actuarial loss rating models to assess the projected underwriting results of accounts. The PMA Insurance Group also employs credit analysts. These employees review the financial strength and stability of customers whose business is written on loss- sensitive and alternative market products and specify the type and amount of collateral that customers must provide under these arrangements. 10 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 claims unit in the home office. The PMA Insurance Group maintains a centralized call center for loss reporting and has automated and centralized the processing of claims payments, which allows the claims adjusters to substantially reduce the time that they spend with clerical and repetitive functions. The PMA Insurance Group also employs in-house attorneys who represent customers in workers' compensation cases and other insurance matters. The PMA Insurance Group has a separate, anti-fraud unit that investigates suspected false claims and other irregularities. Run-off Operations As a part of The PMA Insurance Group's 1996 restructuring plan, the Run-off Operations were established principally to manage the capital supporting workers' compensation loss reserves for accident years 1992 and prior. Such reserves primarily relate to the period of time from 1987 to 1991 when The PMA Insurance Group wrote a much higher volume of business and experienced poor underwriting results. The reserves are mainly indemnity related and are relatively mature. At December 31, 1998, the Run-off Operations had $95.1 million of total assets and $81.1 million in total reserves. See pages 37-38 of the MD&A and Notes 17 and 19 to the Financial Statements in the Annual Report. 11 CALIBER ONE In January 1998, the Company's specialty insurance unit, Caliber One, commenced writing business. Caliber One's gross and net premiums written for 1998 were $11.8 million and $6.4 million, respectively. Caliber One writes business through surplus lines brokers on a national basis. Caliber One Indemnity Company, Caliber One's statutory insurance subsidiary, is presently authorized as an excess and surplus lines carrier in 40 states, the District of Columbia and Puerto Rico, with applications pending in the remaining states. Products, Distribution and Underwriting 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 risks declined by admitted insurers. Caliber One's policy forms contain appropriate and flexible endorsements and exclusions, and in some cases, include defense costs within the policy limits rather than offering such coverage on an unlimited basis. The underwriting of these specialty products involves a significant amount of judgment. 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 distributes its excess and surplus lines products on a nationwide basis through 37 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 Reinsurance Corporation acquired 100% of the outstanding common stock of Caliber One Indemnity Company, domiciled in Delaware and formerly known as Lincoln Insurance Company, for approximately $16.0 million and made a capital contribution of approximately $11.3 million to Caliber One Indemnity Company. All of Caliber One Indemnity Company's acquired loss reserves were reinsured with an affiliate of its former parent for adverse development and uncollectible reinsurance (the "Reserve Guarantee") in the amount of the recorded reserves plus $68.5 million. Upon the purchase of Caliber One Indemnity Company, management valued the amount of the Reserve Guarantee at approximately $5.0 million 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. PMA Reinsurance Corporation 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. REINSURANCE AND RETROCESSIONAL PROTECTION The Company follows the customary insurance practice of reinsuring with other insurance companies a portion of the risks under the policies written by its insurance subsidiaries. This reinsurance is maintained to protect the insurance subsidiaries against the severity of losses on individual claims and unusually serious occurrences in which a number of claims produce an aggregate extraordinary loss. Although reinsurance does not discharge the insurance subsidiaries from their primary liabilities to their policyholders for losses insured under the insurance policies, it does make the assuming reinsurer liable to the insurance subsidiaries for the reinsured portion of the risk. The reinsurance ceded agreements of the Company's insurance subsidiaries generally may be terminated at their 12 annual anniversary by either party upon 30 to 90 days' notice. In general, the reinsurance agreements are of the treaty variety, which cover all underwritten risks of the types specified in the treaties. At December 31, 1998, the Company's reinsurance and retrocessional protection was as follows:
Retention Limits(1) ---------------------------- ------------------------- PMA Re Per Occurrence: Casualty lines $ 2.8 million $ 17.5 million Workers' compensation $ 2.0 million(2) $ 98.0 million Property lines $ 2.0 million $ 48.0 million Per Risk: Property lines $ 800,000 $ 4.3 million Casualty lines $ 1.5 million(3) $ 6.0 million THE PMA INSURANCE GROUP(4) Per Occurrence: Workers' compensation $ 1.5 million(5) $ 103.5 million Property lines $ 2.0 million $ 28.0 million(6) Per Risk: Property lines $ 500,000 $ 19.5 million(7) Auto physical damage $ 500,000 $ 2.0 million Other casualty lines $ 175,000 $ 4.8 million(8) CALIBER ONE(9) Per Occurrence and Per Risk: Property lines $ 200,000 $ 4.8 million Casualty lines $ 500,000 $ 4.5 million
(1) Represents the amount of loss protection above the Company's level of loss retention. (2) This coverage also provides protection of $98.5 million in excess of $1.5 million per program per occurrence and $18.5 million in excess of $1.5 million per person per occurrence. (3) This 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, expiring in 2000, and the term aggregate limit is $25.0 million plus the amount of funds withheld. (4) The PMA Insurance Group also maintains reinsurance protection for its umbrella risks at $9.0 million over a net retention of $1.0 million and purchases facultative reinsurance for certain other risks. (5) Effective January 1, 1999, The PMA Insurance Group's net retention on workers' compensation has been reduced to $150,000. (6) This coverage also includes coinsurance of 5% (7) This coverage also provides a per occurrence limit of $48.5 million. (8) This coverage also provides protection of $49.8 million per occurrence over its net retention of $175,000. (9) Caliber One Indemnity Company is 100% reinsured by an affiliate of its former parent for all business written prior to its acquisition by PMA Reinsurance Corporation in December, 1997. Caliber One Indemnity Company has also entered into a surplus maintenance reinsurance agreement with its parent, PMA Reinsurance Corporation, whereby PMA Reinsurance Corporation will provide reinsurance if Caliber One Indemnity Company's statutory combined ratio exceeds 105.0% or if its statutory net written premium to surplus ratio exceeds 1:1. See "Caliber One - Acquisition of Caliber One Indemnity Company" above for additional discussion. 13 As of December 31, 1998, 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. The Company actively manages its exposure to catastrophes through its underwriting process, where the Company monitors the accumulation of insurable values in catastrophe prone regions. Also, in writing property reinsurance coverages, PMA Re typically requires per occurrence loss limitations for contracts that could have catastrophe exposure. Through per risk reinsurance, the Company also manages its net retention in each exposure. As a result, the Company's loss and LAE ratios have not been significantly impacted by catastrophes in the past three years. Although the Company believes it has adequate reinsurance to protect against the estimated probable maximum gross loss from a catastrophe, an especially severe catastrophe or series of catastrophes could exceed the Company's reinsurance and/or retrocessional protection and may have a material adverse impact on the Company's results of operations and financial position. The collectibility of reinsurance is largely a function of the solvency of reinsurers. The Company performs extensive credit reviews on its reinsurers, focusing on, among other things, financial capacity, stability, trends and commitment to the reinsurance business. Prospective and existing reinsurers failing to meet the Company's standards are excluded from the Company's reinsurance programs. In addition, the Company requires letters of credit or other acceptable collateral to support balances due from reinsurers not authorized to transact business in the applicable jurisdictions. As of December 31, 1998, approximately 97.3% of the Company's reinsurance receivables related to unpaid reported claims and incurred but not reported claims, and the remaining 2.7% related to paid losses. The timing and collectibility of reinsurance receivables have not had, and are not expected to have, a material adverse effect on the Company's liquidity. See pages 43-44 of the MD&A and Note 5 to the Financial Statements included in the Annual Report for additional information on reinsurance. LOSS RESERVES Insurers establish reserves representing estimates of future amounts needed to pay claims with respect to insured events which have occurred, including events that have not been reported to the insurer. Reserves are also established for loss adjustment expenses ("LAE") representing the estimated expenses of settling claims, including legal and other fees, and general expenses of administering the claims adjustment process. After a claim is reported, claims personnel establish a "case reserve" for the estimated amount of the ultimate payment. The estimate reflects the informed judgment of management, based on reserving practices and management's experience and knowledge regarding the nature and value of the specific type of claim. Claims personnel review and update their estimates as additional information becomes available and claims proceed towards resolution. In addition, "bulk reserves" are also established on an aggregate basis (i) to provide for losses incurred but not yet reported to the insurer; (ii) to provide for the estimated expenses of settling claims, including legal and other fees and general expenses of administering the claims adjustment process; and (iii) to adjust for the fact that, in the aggregate, case reserves may not accurately estimate the ultimate liability for reported claims. Reserves are estimated using various generally accepted actuarial techniques. As part of the reserving process, historical data is reviewed and consideration is given to the anticipated impact of various factors such as legal developments, changes in social attitudes and economic conditions, including the effects of inflation. This process relies on the basic assumption that past experience, adjusted for the effect of current developments and likely trends, is an appropriate basis for predicting future events. The reserving process provides implicit recognition of the impact of inflation and other factors affecting claims payments by taking into account changes in historic payment patterns and perceived probable trends. There is generally no precise method, however, for subsequently evaluating the adequacy of the consideration given to inflation or to any other specific factor, since the eventual deficiency or redundancy of reserves is affected by many factors, some of which are interdependent. In many cases significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured loss, the reporting of the loss to the insurer and the insurer's payment of that loss. Liabilities for 14 reinsurers generally become known more slowly than for primary insurers and are generally subject to more unforeseen development. Estimating the Company's ultimate claims liability is necessarily a complex and judgmental process as the amounts are based on management's informed estimates and judgments using data currently available. As additional experience and data become available regarding claims payment and reporting patterns, legislative developments 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. Estimating reserves for workers' compensation claims is difficult for several reasons, including (i) the long payment "tail" associated with the business; (ii) the impact of social, political, case law 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. If necessary, adjustments will be made to such reserves as they are identified if loss patterns develop differently than forecasted or if new information becomes available and such adjustments may be material to results of operations, financial condition and liquidity. The table on the next page presents the subsequent development of the estimated year-end property and casualty reserves, net of reinsurance ("net reserves"), for the 10 years prior to 1998. The first section of the table shows the estimated net reserves that were recorded at the end of each of the indicated years for all current and prior year unpaid losses and loss adjustment expenses. The second section shows the cumulative amounts of such previously recorded net reserves paid in succeeding years. The third section shows the re- estimates of the net reserves made in each succeeding year. The cumulative deficiency (redundancy) as shown in the table represents the aggregate change in the reserve estimates from the original balance sheet dates through 1998; an increase in a loss estimate that related to a prior year occurrence generates a deficiency in each intervening year. For example, a deficiency first recognized in 1997 relating to losses incurred in 1989 would be included in the cumulative deficiency amount for each of the years 1989 through 1996. Yet, the deficiency would be reflected in operating results in 1997 only. Conditions and trends that have affected the reserve development reflected in the table may change, and care should be exercised in extrapolating future reserve redundancies or deficiencies from such development. 15 Consolidated Loss and Loss Adjustment Expense Development December 31, (dollar amounts in millions)
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 -------- -------- -------- -------- -------- -------- -------- -------- --------- --------- -------- Initial estimated liability for unpaid losses and LAE net of $1,457.4 $1,632.2 $1,734.6 $1,824.3 $1,941.0 $1,932.0 $1,855.9 $1,808.5 $1,834.5 $1,670.9 $1,347.2 reinsurance......... ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== Amount of reserve paid, net of reinsurance through - - one year later.... $ 322.3 $ 444.6 $ 470.8 $ 490.5 $ 442.4 $ 407.8 $ 398.9 $ 437.6 $ 398.8 $ 360.7 -- - - two years later... 601.1 771.5 842.0 848.8 779.1 746.1 763.7 780.0 669.6 - - three years later. 825.9 1,042.6 1,133.8 1,127.0 1,066.8 1,055.9 1,072.9 999.0 - - four years later.. 1,011.4 1,258.0 1,353.1 1,364.9 1,329.2 1,330.6 1,252.2 - - five years later.. 1,165.8 1,421.4 1,539.4 1,585.4 1,573.8 1,472.7 - - six years later... 1,283.8 1,553.1 1,715.1 1,788.9 1,688.7 - - seven years later. 1,380.1 1,684.6 1,882.1 1,882.2 - - eight years later. 1,478.9 1,817.3 1,962.6 - - nine years later.. 1,584.2 1,887.4 - - ten years later... 1,642.0 Re-estimated liability, net of reinsurance as of: - - one year later.... $1,468.3 $1,696.0 $1,795.3 $1,966.8 $1,998.1 $1,932.3 $1,907.4 $1,964.6 $1,748.5 $1,624.4 -- - - two years later... 1,511.9 1,742.5 1,949.9 2,067.5 2,006.5 1,982.5 2,073.4 1,866.8 1,700.5 - - three years later. 1,553.3 1,876.0 2,034.1 2,081.5 2,060.6 2,163.9 1,986.7 1,819.2 - - four years later.. 1,607.3 1,938.2 2,040.8 2,134.8 2,258.2 2,078.3 1,942.0 - - five years later.. 1,651.5 1,935.1 2,123.0 2,302.0 2,170.3 2,030.5 - - six years later... 1,648.7 1,985.3 2,273.3 2,209.3 2,126.6 - - seven years later. 1,684.2 2,098.2 2,205.4 2,169.5 - - eight years later. 1,783.6 2,052.2 2,168.4 - - nine years later.. 1,751.8 2,020.1 - - ten years later... 1,729.1 Indicated deficiency (redundancy) $ 271.7 $ 387.9 $ 433.8 $ 345.2 $ 185.6 $ 98.5 $ 86.1 $ 10.7 $ (134.0) $ (46.5) ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== Net liability........... $1,932.0 $1,855.9 $1,808.5 $1,834.5 $1,670.9 $1,347.2 reinsurance recoverables........ 218.7 247.9 261.5 256.6 332.3 593.7 -------- -------- -------- -------- -------- -------- Gross liability........... $2,150.7 $2,103.8 $2,070.0 $2,091.1 $2,003.2 $1,940.9 ======== ======== ======== ======== ======== ======== Re-estimated net liability........... $2,030.5 $1,942.0 $1,819.2 $1,700.5 $1,624.4 Re-estimated reinsurance recoverables........ 209.0 250.1 277.8 271.3 349.8 -------- -------- -------- -------- -------- Re-estimated gross liability........... $2,239.5 $2,192.1 $2,097.0 $1,971.8 $1,974.2 ======== ======== ======== ======== ========
16 The components of the Company's incurred losses and LAE for prior accident years, excluding accretion of discount, are as follows (favorable loss development is denoted by the bracketed figures): (dollar amounts in millions)
1998 1997 1996 ------------------ ------------------ ------------------ PMA Re........................... $(31.5) $(32.1) $(35.3) ------------------ ------------------ ------------------ The PMA Insurance Group: Workers' compensation.......... (17.3) (44.1) 110.0 Asbestos and environmental..... -- -- 60.4 Other losses and LAE........... 2.3 (9.8) 21.0 ------------------ ------------------ ------------------ (15.0) (53.9) 191.4 ------------------ ------------------ ------------------ Total............................ $(46.5) $(86.0) $156.1 ================== ================== ==================
During 1998, PMA Re and The PMA Insurance Group recorded favorable reserve development on prior accident years of $31.5 million and $15.0 million, respectively. PMA Re recorded favorable reserve development on prior accident years due to re-estimated loss trends for such years that are lower than previous expectations. The favorable reserve development at The PMA Insurance Group primarily relates to the formal commutation programs, which resulted in early liability settlements made during 1998 to reduce future claim payments. During 1997, PMA Re and The PMA Insurance Group recorded favorable reserve development of $32.1 million and $53.9 million, respectively. PMA Re recorded favorable reserve development on prior accident years due to re-estimated loss trends for such years that are lower than previous expectations. Favorable loss development at The PMA Insurance Group in 1997 can be attributed to the following: favorable reserve development of approximately $37.0 million related to retrospectively rated policies for Run-off Operations; the cession of prior year reserves of $14.8 million from Run-off Operations to a third party reinsurer; and favorable reserve development of $7.1 million on guaranteed cost workers' compensation reserves, partially offset by reserve strengthening of $5.0 million in commercial multi-peril business. The increase in incurred losses and LAE during 1996 is primarily due to a loss reserve strengthening charge of $191.4 million. The 1996 aggregate workers' compensation adverse development of $110.0 million was allocated $102.0 million to Pennsylvania and $8.0 million to all other states in The PMA Insurance Group's marketing territory. 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. These increases were the result of an analysis of increases in paid loss development data started in 1995. In 1995, The PMA Insurance Group began to accumulate additional data in order to determine whether there were additional causes of the increase in the paid loss development data, including 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. The PMA Insurance Group believes that the decline of the closure rates was due to several interrelated factors, including efforts to rehabilitate claimants and return them to work at either full or modified duty, which were not as successful as anticipated. In addition, the depressed economic conditions in The PMA Insurance Group's major industry niches for worker's compensation insurance (construction, heavy manufacturing) in Pennsylvania caused an increase in indemnity periods for workers who suffered injuries in these industries. The decline in claim closure rates combined with the fact that the benefits period in Pennsylvania was unlimited, caused The PMA Insurance Group 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, The PMA Insurance Group undertook an effort to quantify the impact of the declining closure rates versus the increase in commutation activity. During the fourth quarter of 1995, workers' compensation reserves were strengthened 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 17 mature and refined in 1996, The PMA Insurance Group determined that the workers' compensation loss reserves for Pennsylvania in the pre-1992 accident years needed to be increased by $110.0 million. Benefit reforms enacted by states in which The PMA Insurance Group transacts business, most significantly Pennsylvania, have had a beneficial impact on more recent accident year loss and LAE ratios. Prior to 1996, the principal revisions of 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 health care providers. In July 1996, Pennsylvania enacted Act 57, a workers' compensation reform bill which is expected to substantially reduce indemnity benefit periods in Pennsylvania. In addition to regulatory reforms, the loss and LAE ratios have been favorably impacted by the conversion to loss sensitive and alternative market products. Management believes that the reforms and more stringent underwriting standards adopted since 1991 have had and continue to have a beneficial effect on the Company's accident year loss and LAE ratios. For further discussion of benefit reforms, see "The PMA Insurance Group--Workers' Compensation Insurance" above. 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 whereby the claimants, in exchange for a lump sum payment, release their rights to future indemnity payments from The PMA Insurance Group. The PMA Insurance Group paid approximately $64.9 million, $113.0 million and $17.8 million in 1998, 1997 and 1996, respectively, to commute workers' compensation indemnity claims. The commutation program resulted in payments, which were less than the corresponding carried reserves. 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. As a result of the success of this formal commutation program, The PMA Insurance 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. In 1996, Commercial Lines reserves were strengthened by $21.0 million. The reserve strengthening in 1996 was principally due to a re-estimation of loss adjustment costs associated with general liability claims. Through 1991, The PMA Insurance Group's mix of general liability insurance policies were weighted towards the manufacturing classes of business. Subsequent to 1991, The PMA Insurance Group's mix of general liability 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 PMA Insurance Group. Defense costs associated with these claims have also exceeded the original estimate of The PMA Insurance 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 PMA Insurance Group factored the increased defense costs and the emergence pattern in determining a more appropriate reserve amount for loss handling costs. At December 31, 1998, the Company's loss reserves were stated net of $60.4 million of salvage and subrogation. The Company's policy with respect to estimating the amounts and realizability of salvage and subrogation is to develop accident year schedules of historic paid salvage and subrogation by line of business, which are then 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. 18 Asbestos and Environmental Reserves The Company's asbestos-related loss reserves for the years ended December 31, were as follows: (dollar amounts in thousands)
1998 1997 1996 ------------- ------------- -------------- Gross of reinsurance: Beginning reserves............................... $76,726 $80,055 $ 27,611 Incurred losses and LAE.......................... (1,976) 2,435 62,854 Calendar year payments for losses and LAE........ (6,893) (5,764) (10,410) ------- ------- -------- Ending reserves.................................. $67,857 $76,726 $ 80,055 ======= ======= ======== Net of reinsurance: Beginning reserves............................... $48,578 $53,300 $ 23,443 Incurred losses and LAE.......................... (2,754) (36) 39,427 Calendar year payments for losses and LAE....... (2,268) (4,686) (9,570) ------- ------- -------- Ending reserves.................................. $43,556 $48,578 $ 53,300 ======= ======= ========
The Company's environmental-related loss reserves for the years ended December 31, were as follows: (dollar amounts in thousands)
1998 1997 1996 -------------- ------------- -------------- Gross of reinsurance: Beginning reserves............................... $45,108 $35,626 $20,134 Incurred losses and LAE.......................... 11,895 1,130 22,143 Reserves acquired through purchase of Caliber One Indemnity Company(1).................. -- 13,060 -- Calendar year payments for losses and LAE........ (9,967) (4,708) (6,651) ------- ------- ------- Ending reserves.................................. $47,036 $45,108 $35,626 ======= ======= ======= Net of reinsurance: Beginning reserves............................... $31,695 $34,592 $20,134 Incurred losses and LAE.......................... 3,644 1,068 21,109 Calendar year payments for losses and LAE....... (5,983) (3,965) (6,651) ------- ------- ------- Ending reserves.................................. $29,356 $31,695 $34,592 ======= ======= =======
(1) Such acquired reserves have been reinsured by an affiliate of the former parent (see "Caliber One" for further discussion). Of the total net asbestos reserves, approximately $34.2 million, $41.9 million and $46.5 million related to incurred but not reported losses at December 31, 1998, 1997 and 1996, respectively. Of the total net environmental reserves, approximately $20.3 million, $20.5 million and $22.1 million related to incurred but not reported losses at December 31, 1998, 1997 and 1996, respectively. All incurred asbestos and environmental losses were for accident years 1986 and prior. Estimating reserves for asbestos and environmental exposures continues to be difficult because of several factors, including: (i) evolving methodologies for the estimation of the liabilities; (ii) lack of reliable historical claim data; (iii) uncertainties with respect to insurance and reinsurance coverage related to these obligations; (iv) changing judicial interpretations; and (v) changing government standards. To reserve for environmental claims, the Company currently utilizes a calendar year development technique known as aggregate loss development. This technique focuses on the aggregate losses paid as of a particular date and aggregate payment patterns associated with such claims. Several elements including remediation studies, remediation, defense, declaratory judgment and third party bodily injury claims were considered in estimating the costs and payment patterns of the environmental and toxic 19 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. In 1996, the Company performed a ground up analysis of loss reserves for direct asbetos exposures 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 in which 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. Management believes that its reserves for asbestos and environmental claims are appropriately established based upon known facts, existing case law and generally accepted actuarial methodologies. However, due to changing interpretations by courts involving coverage issues, the potential for changes in federal and state standards for clean-up and liability, as well as issues involving policy provisions, allocation of liability among participating insurers, proof of coverage and other factors, the Company's ultimate exposure for these claims may vary significantly from the amounts currently recorded, resulting in a potential future adjustment that could be material to the Company's financial condition and results of operations. INVESTMENTS The Company's investment policy objectives are to (i) seek competitive after-tax income and total return, (ii) maintain high investment 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's investment strategy includes guidelines for asset quality standards, asset allocations and other relevant criteria for its portfolio. In addition, maturities are structured after projecting liability cash flows with actuarial models. Property and casualty claim demands are somewhat unpredictable in nature and require liquidity from the underlying invested assets, which are structured to emphasize current investment income to the extent consistent with maintaining appropriate portfolio quality and diversity. The liquidity requirements are met primarily through publicly traded fixed maturities as well as operating cash flows and short-term investments. The 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 Company's Executive and Finance Committee of the Board of Directors meets periodically with the investment advisers to review the performance of the investment portfolio and to determine what actions should be taken with respect to the Company's investments. Investment by the Pooled Companies, MASCCO and PMA Reinsurance Corporation must comply with the insurance laws and regulations of the Commonwealth of Pennsylvania and investments for Caliber One Indemnity Company must comply with the insurance laws and regulations of Delaware. The Company currently has only one derivative financial instrument outstanding, an interest rate swap on its Credit Facility, which is used as a hedge in accordance with the Company's investment strategy. Derivatives are not used for speculative purposes. The Company's portfolio does not contain any significant concentrations in single issuers (other than U.S. treasury and agency obligations), industry segments or geographic regions. For additional information on the Company's investments, including carrying values by category, quality ratings and net investment income, see pages 44-45 of the MD&A as well as Notes 2 and 3 to the Financial Statements in the Annual Report. 20 COMPETITION The domestic property and casualty insurance and reinsurance industries are very competitive and consist of many companies, with no one company dominating the market. In addition, the degree and nature of competition varies from state to state for a variety of reasons, including the regulatory climate and other market participants in each state. In addition to competition from other insurance companies, The PMA Insurance Group and Caliber One compete with certain alternative market arrangements, such as captive insurers, risk-sharing pools and associations, risk retention groups, and self-insurance programs. PMA Re competes with other reinsurers in the broker market as well as reinsurers that underwrite reinsurance business on a direct basis. 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 PMA Insurance 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 rate of return targets. The present soft pricing environment has made competing solely on the basis of price increasingly difficult. The PMA Insurance Group, PMA Re and Caliber One have rejected and/or non-renewed certain accounts in recent years, as the market rates for such risks did not provide the opportunity to achieve an acceptable rate of return. In terms of service, the Company maintains service standards concerning turn- around time for underwriting submissions, information flow, claims handling and the quality of other services. These standards help ensure that clients are satisfied with the Company's products and services. The Company periodically participates in surveys of intermediaries and clients to gain an understanding of the perceptions of its service as compared to its competitors. The Company attempts to design products that meet the needs of clients in its markets. In recent years, The PMA Insurance Group has developed products that reflect the evolving nature of the workers' compensation market. Specifically, it has increased its focus on rehabilitation and managed care to keep workers' compensation costs lower for the employers. In addition, The PMA Insurance Group has introduced and refined alternative market products, as well as unbundled risk management and claims administration services. See "The PMA Insurance Group--Products." 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 and finite risk reinsurance. See "PMA Re--Products" for additional discussion. Caliber One intends to design products that meet the needs of new classes of business and that cover emerging risks. The Company continually evaluates new product opportunities for The PMA Insurance Group, PMA Re and Caliber One. For many intermediaries and clients, financial security is measured by the ratings assigned by independent rating agencies. Certain of the Company's insurance subsidiaries are rated by independent rating agencies. The ratings represent the opinions of the rating agencies on the insurance company's financial strength and its ability to pay obligations to its policyholders. Management believes that the ratings assigned by nationally recognized, independent rating agencies, particularly A.M. Best, are material to the Company's operations. The rating scales of the principal agencies that rate the Company's insurance subsidiaries are characterized as follows: . A.M. Best Company, Inc. ("A.M. Best"), A++ to F ("Superior" to "In Liquidation") . Moody's Investors Service ("Moody's"), Aaa to C ("Exceptional" to "Lowest") As of March 15, 1999, A.M. Best had assigned an A+ ("Superior," 2nd of 16) rating to PMA Reinsurance Corporation, an A- ("Excellent," 4th of 16) rating to the Pooled Companies and an A ("Excellent," 3rd of 16) rating to Caliber One Indemnity Company. In addition, Moody's had rated PMA Reinsurance Corporation A3 ("Good," 7th of 21) and the Pooled Companies Baa2 ("Adequate," 9th of 21). These ratings are subject to revision or withdrawal at any time by the rating agencies, and therefore, no assurance can be given that PMA Reinsurance 21 Corporation, the Pooled Companies and/or Caliber One Indemnity Company can maintain these ratings. Each rating should be evaluated independently of any other rating. REGULATORY MATTERS General PMA Reinsurance Corporation is licensed or accredited to transact its reinsurance business in, and is subject to regulation and supervision by, 50 states and the District of Columbia. The Pooled Companies are licensed to transact insurance business in, and are subject to regulation and supervision by, 43 states and the District of Columbia. Caliber One Indemnity Company is licensed in one state and is an eligible excess and surplus lines carrier in 40 states, the District of Columbia and Puerto Rico. The Company's insurance subsidiaries are authorized and regulated in all jurisdictions where they conduct insurance business. In supervising and regulating insurance and reinsurance companies, state insurance departments, charged primarily with protecting policyholders and the public rather than investors, enjoy broad authority and discretion in applying applicable insurance laws and regulations for the protection of policyholders and the public. PMA Reinsurance Corporation and the Pooled Companies are domiciled in Pennsylvania, therefore the Pennsylvania Insurance Department exercises principal regulatory jurisdiction over them. Caliber One Indemnity Company is domiciled in Delaware, therefore 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, 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. The Pennsylvania Department of Insurance last conducted examinations of 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 material qualitative matters indicated in the examination reports that had or are expected to have a material adverse effect on the operations of PMA Reinsurance Corporation, the Pooled Companies or Caliber One Indemnity Company. The Pennsylvania Department of Insurance is currently conducting examinations of PMA Reinsurance Corporation, the Pooled Companies and MASCCO as of December 31, 1997. Although the Company has not received the final reports of examination, the Company does not expect the results of the examinations to have a material adverse effect on results of operations of PMA Reinsurance Corporation, the Pooled Companies or MASCCO. Insurance Holding Company Regulation The Company and its insurance subsidiaries are subject to regulation pursuant to the insurance holding company laws of Pennsylvania and Delaware. These state insurance holding company laws generally require an insurance holding company and insurers and reinsurers that are members of such insurance holding company's system to register with the state regulatory authorities, to file with those authorities certain reports disclosing information including their capital structure, ownership, management, financial condition, certain intercompany transactions including material transfers of assets and intercompany business agreements, and to report material changes in such information. These laws also require that intercompany transactions be fair and reasonable and that an insurer's policyholders' surplus following any dividends or distributions to shareholder affiliates be reasonable in relation to the insurer's outstanding liabilities and adequate for its financial needs. 22 Under Pennsylvania and Delaware law, no person may acquire, directly or indirectly, a controlling interest in the capital stock of the Company unless such person, corporation or other entity has obtained prior approval from the respective Commissioner for such acquisition of control. Pursuant to the Pennsylvania and Delaware law, any person acquiring, controlling or holding the power to vote, directly or indirectly, ten percent or more of the voting securities of an insurance company, is presumed to have "control" of such company. This presumption may be rebutted by a showing that control does not exist in fact. The respective Commissioner, however, may find that "control" exists in circumstances in which a person owns or controls a smaller amount of voting securities. To obtain approval from the Commissioner of any acquisition of control of an insurance company, the proposed acquirer must file with the Commissioner an application containing information regarding: the identity and background of the acquirer and its affiliates; the nature, source and amount of funds to be used to carry out the acquisition; the financial statements of the acquirer and its affiliates; any potential plans for disposition of the securities or business of the insurer; the number and type of securities to be acquired; any contracts with respect to the securities to be acquired; any agreements with broker-dealers; and other matters. Other jurisdictions in which the Company's insurance subsidiaries are licensed to transact business may have requirements for prior approval of any acquisition of control of an insurance or reinsurance company licensed or authorized to transact business in those jurisdictions. Additional requirements in those jurisdictions may include re-licensing or subsequent approval for renewal of existing licenses upon an acquisition of control. As further described below, laws that govern the holding company structure also govern payment of dividends by the Company's insurance subsidiaries to the Company. Restrictions on Subsidiaries' Dividends and Other Payments PMA Capital is an insurance holding company whose assets consist principally of all of the outstanding common stock of its insurance subsidiaries. PMA Capital's ongoing ability to pay dividends to its shareholders and meet its other obligations, including operating expenses and any principal and interest on debt, is primarily dependent on the receipt of sufficient funds from its insurance subsidiaries in the form of dividends, net payments under a tax- sharing agreement between PMA Capital and its subsidiaries and loans. The payment of dividends by the Company's insurance subsidiaries to PMA Capital 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, PMA Capital's significant Pennsylvania-domiciled insurance subsidiaries (PMA Reinsurance Corporation and the Pooled Companies) may pay dividends only from unassigned surplus and future earnings arising from their businesses and must receive prior approval of the Pennsylvania Insurance Commissioner to pay a dividend if such dividend would exceed the statutory limitation. The current statutory limitation is the greater of (i) 10% of the insurer's policyholders' surplus, as shown on its last annual statement on file with the Pennsylvania Insurance Commissioner or (ii) the insurer's statutory net income for the previous calendar year. Pennsylvania law gives the Pennsylvania Insurance Commissioner broad discretion to disapprove requests for dividends in excess of these limits. Based upon this limitation, these companies have the legal capacity to pay $51.8 million in dividends to PMA Capital in 1999 without obtaining the prior approval of the Pennsylvania Insurance Commissioner. Pennsylvania law also provides that following the payment of any dividend, the insurer's policyholders' surplus must be reasonable in relation to its outstanding liabilities and adequate for its financial needs, and permits the Pennsylvania Insurance Commissioner to bring an action to rescind a dividend which violates these standards. During 1998, $35.5 million of dividends were paid by PMA Reinsurance Corporation and the Pooled Companies to PMA Capital Corporation. Caliber One Indemnity Company is a Delaware-domiciled insurance subsidiary of PMA Reinsurance Corporation. As a subsidiary of PMA Reinsurance Corporation, Caliber One Indemnity Company's dividends are not directly available to PMA Capital. As noted above, the Delaware insurance law provisions restricting dividends by insurers are substantially similar to such provisions under Pennsylvania insurance laws. During 1999, 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 were declared or paid by Caliber One Indemnity Company. 23 In the event that the ability of either the Pooled Companies or PMA Reinsurance Corporation to pay dividends or make other payments to PMA Capital in the future is reduced or eliminated, PMA Capital's ability to pay dividends to its shareholders and meet its other obligations, including operating expenses and any principal and interest on debt could be materially and adversely affected, depending upon the extent of such reduction. The Pennsylvania Insurance Commissioner could use his or her broad discretionary authority to seek to require PMA Capital to apply payments received from one insurance subsidiary for the benefit of another insurance subsidiary of PMA Capital. In addition to regulatory restrictions on dividends, the Company's Revolving Credit Facility and Letter of Credit Facility also impose restrictions on the ability of the Company's insurance subsidiaries to pay dividends. Under these restrictions, the statutory surplus of PMA Capital's insurance subsidiaries (as measured each calendar quarter) must not be less than $450 million and such subsidiaries must annually maintain certain minimum ratios of adjusted surplus to risk-based capital (300% for PMA Reinsurance Corporation and 230% for the Pooled Companies in 1998, increasing to 240% thereafter). As of December 31, 1998, the Company's insurance subsidiaries reported combined statutory surplus of $569.4 million, and, as of December 31, 1998, PMA Reinsurance Corporation's risk-based capital ratio was 348% and the Pooled Companies' ratios ranged from 316% to 368%. Risk-Based Capital The National Association of Insurance Commissioners (the "NAIC") has adopted risk-based capital ("RBC") requirements for property/casualty insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, asset and liability matching, loss reserve adequacy and other business factors. Under RBC requirements, regulatory compliance is determined by the ratio of a Company's total adjusted capital, as defined by the NAIC, to its authorized control level of RBC, also as defined by the NAIC. Four levels of regulatory attention may be triggered if the ratio of total adjusted capital to RBC ("RBC ratio") is insufficient: * If an insurance company's RBC ratio is between 150% and 200%, the "company action level," the company must submit a plan to the regulator detailing corrective action it proposes to undertake. * If a company's RBC ratio is between 100% and 150%, the "regulatory action level," the company must also submit a plan, but a regulator may also issue a corrective order requiring the insurer to comply within a specified period. * If a company's RBC ratio is between 70% and 100%, the "authorized control level," the regulatory response is the same as at the "regulatory action level," but in addition, the regulator may take action to rehabilitate or liquidate the insurer. * If the RBC ratio for a company is less than 70%, the "mandatory control level," the regulator must rehabilitate or liquidate the insurer. At December 31, 1998, the RBC ratios of the Pooled Companies ranged from 316% to 368%, and the ratio of MASCCO, The PMA Insurance Group's run-off subsidiary, was 270%. PMA Reinsurance Corporation's ratio was 348% and Caliber One Indemnity Company's ratio was 1,389%. The Company believes that it will be able to maintain the RBC ratios of its insurance subsidiaries in excess of regulatory requirements through prudent underwriting and claims handling, investing and capital management. However, no assurances can be given that developments affecting the insurance subsidiaries, many of which could be outside of management's control, including but not limited to changes in the regulatory environment, economic conditions and competitive conditions in the jurisdictions in which the insurance subsidiaries write business, will cause the RBC ratios to fall below required levels resulting in a corresponding regulatory response. The NAIC has developed a series of twelve ratios (the "IRIS ratios") designed to further assist regulators in assessing the financial condition of insurers. These ratio results are computed annually and reported to the NAIC 24 and the insurer's state of domicile. In 1998, PMA Reinsurance Corporation reported an unusual value in one ratio, relating to reserve development due to the change in mix of business and growth in earned premiums. In 1998, each of the Pooled Companies reported an unusual value in one ratio, relating to reserve development due to the paydown of loss reserves. In 1998, MASCCO reported unusual values in two ratios due to its reinsurance treaty with PMA International Insurance, Cayman Ltd. and a dividend paid to its parent. In addition, Caliber One Indemnity Company reported one unusual value, relating to the change in net premiums written. EMPLOYEES As of February 28, 1999, the Company had approximately 1,000 full-time employees. None of the employees of the Company is represented by a labor union and the Company is not a party to any collective bargaining agreements. The Company considers its employee relations to be good. 25 Glossary of Selected Insurance Terms 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. Adverse loss development.......Increases in losses and ALAE exceeding anticipated loss and ALAE experience over a given period of time. 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 a company's internal counsel, claims staff or other overhead or general expense of the company. Attachment point...............The amount of losses above which excess of loss reinsurance becomes operative. 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 other 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. Bulk reserves..................Reserves established on an aggregate basis to provide for losses incurred but not yet reported to the insurer; to provide for the estimated expenses of settling claims, including legal and other fees and general expenses of administering the claims adjustment process; and to adjust for the fact that, in the aggregate, case reserves may not accurately estimate the ultimate liability for reported claims. Case reserves..................Loss reserves established with respect to individual reported claims. Casualty insurance and/or reinsurance....................Insurance and/or reinsurance that is concerned primarily with the losses caused by injuries to third persons (in other words, persons other than the policyholder) and the legal liability imposed on the insured resulting therefrom. Catastrophe reinsurance........A form of excess of loss property reinsurance that, subject to a specified limit, indemnifies the ceding company for the amount of loss in excess of a specified retention with respect to an accumulation of losses resulting from a catastrophic event. The actual reinsurance document is called a "catastrophe cover." Cede; ceding company; cedent.........................When a company reinsures its risk with another, it "cedes" business and is referred to as the "ceding company" or the "cedent". 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. 26 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.................The sum of the loss and LAE ratio, the underwriting expense ratio, and the policyholders' dividend ratio. Direct reinsurer, direct underwriter, direct writer.....A reinsurer that markets and sells reinsurance directly to its reinsureds without the assistance of brokers. Excess and surplus lines.......Surplus lines risks are those risks not fitting normal underwriting patterns, involving a degree of risk that is not commensurate with standard rates and/or policy forms, or that will not be written by standard carriers because of general market conditions. Excess insurance refers to coverage that attaches for an insured over the limits of a primary policy or a stipulated self- insured retention. Policies are bound or accepted by carriers not licensed in the jurisdiction where the risk is located, and generally are not subject to regulations governing premium rates or policy language. Excess of loss reinsurance.....The generic term describing reinsurance that indemnifies the reinsured against all or a specified portion of losses on underlying insurance policies in excess of a specified dollar amount, called a "layer" or "retention." Also known as nonproportional reinsurance or stop loss coverage. Facultative reinsurance........The reinsurance of all or a portion of the insurance provided by a single policy. Each policy reinsured is separately negotiated. Finite risk reinsurance........The reinsurance of potential losses in a transaction in which the primary element of risk is financial rather than underwriting. Gross premiums written.........Total premiums for direct insurance and reinsurance assumed during a given period. Incurred but not reported ("IBNR") reserves..............Loss reserves for estimated losses that have been incurred but not yet reported to the insurer or reinsurer. Incurred losses................The total losses sustained by an insurance company under a policy or policies, whether paid or unpaid. Incurred losses include a provision for claims that have occurred but have not yet been reported to the insurer ("IBNR"). IRIS ratios....................Financial ratios annually calculated by the NAIC to assist state insurance departments in monitoring the financial condition of insurance companies. Layers.........................The division of a particular reinsurance program delineated by an attachment point and a maximum limit. Often, a reinsurance program will be divided into several layers, with the lower layers (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. 27 Loss and LAE ratio (GAAP)......Loss and LAE ratio is equal to losses and LAE divided by earned premiums. Undiscounted loss and LAE ratios refer to loss and LAE ratios that do not consider the net effect of discounting of loss reserves. Loss reserves..................Liabilities established by insurers and reinsurers to reflect the estimated cost of claims payments that the insurer or reinsurer ultimately will be required to pay in respect of insurance or reinsurance it has written. Reserves are established for losses and for LAE and consist of case reserves, bulk reserves and IBNR reserves. 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. Manual rates...................Insurance rates for lines and classes of business that are approved and published by state insurance departments. Manual rate level or average manual rate level..............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. Net investment income ratio....The ratio of net investment income to net premiums earned. Net premiums earned............The portion of net premiums written that is earned during a period and recognized for accounting purposes as revenue. Net premiums written...........Gross premiums written for a given period less premiums ceded to reinsurers during such period. Operating ratio................The combined ratio, reduced by the net investment income ratio. The ratio measures a company's operating profitability, exclusive of realized gains and federal income taxes. Per occurrence.................A form of insurance or reinsurance under which the date of the loss event is deemed to be the date of the occurrence, regardless of when reported and permits all losses arising out of one event to be aggregated instead of being handled on a risk-by-risk basis. Policyholders' dividend ratio..The ratio of policyholders' dividends to earned premiums Primary insurer................An insurance company that issues insurance policies to the general public or to certain non- insurance entities. Pro rata reinsurance...........Forms of reinsurance in which the reinsurer shares a proportional part of the original premiums and losses of the reinsured. Pro rata reinsurance also is known as proportional reinsurance, quota share reinsurance and participating reinsurance. Property insurance and/or reinsurance.............Insurance and/or reinsurance that indemnifies a person with an insurable interest in tangible property for his property loss, damage or loss of use. Reinsurance....................The practice whereby one party, called the reinsurer, in consideration of a premium paid to it, agrees to indemnify another party, called the reinsured, for part or all of the liability assumed by the reinsured under a policy or policies of 28 insurance that it has issued. The reinsured may be referred to as the original or primary insurer, the direct writing company or the ceding company. Retention, retention layer.....The amount or portion of risk that an insurer or reinsurer retains for its own account. Losses in excess of the retention layer are paid by the reinsurer or retrocessionaire. In proportional treaties, the retention may be a percentage of the original policy's limit. In excess of loss business, the retention is a dollar amount of loss, a loss ratio or a percentage. Retrocession; retrocessionaire...............A transaction whereby a reinsurer cedes to another reinsurer (the "retrocessionaire") all or part of the reinsurance it has assumed. Retrocession does not legally discharge the ceding reinsurer from its liability with respect to its obligations to the reinsured. Statutory accounting principles ("SAP").............Recording transactions and preparing financial statements in accordance with the rules and procedures prescribed or permitted by state insurance regulatory authorities including the NAIC. Statutory or policyholder's surplus; statutory capital & surplus......................The excess of admitted assets over total liabilities (including loss reserves), determined in accordance with SAP. Stop loss......................See "Excess of loss reinsurance". Treaty reinsurance.............The reinsurance of a specified type or category of risks defined in a reinsurance agreement (a "treaty") between a primary insurer or other reinsured and a reinsurer. Typically, in treaty reinsurance, the primary insurer or reinsured is obligated to offer and the reinsurer is obligated to accept a specified portion of all agreed upon types or categories of risks originally written by the primary insurer or reinsured. Underwriting...................The reinsurer's process of reviewing applications submitted for insurance coverage, deciding whether to accept all or part of the coverage requested and determining the applicable premiums. Underwriting cycle.............An historical pattern in which property and casualty insurance and reinsurance premiums, profits and availability of coverage rise and fall 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. Underwriting expense ratio.....The ratio of underwriting expenses to earned premiums. Unearned premiums..............The portion of a premium representing the unexpired portion of the exposure period as of a certain date. Unearned premium reserve.......Liabilities established by insurers and reinsurers to reflect unearned premiums which are refundable to policyholders if an insurance or reinsurance contract is canceled prior to expiration of the contract term. 29 Item 2. Properties The Company's and PMA Re's headquarters are located in 78,000 square feet of leased space in center city Philadelphia, Pennsylvania. The PMA Insurance Group's headquarters are located in a four story, 110,000 square foot building in Blue Bell, Pennsylvania. Caliber One's headquarters are located in 10,000 square feet of leased office space in Langhorne, Pennsylvania. Through various wholly owned subsidiaries, the Company also owns and occupies additional office facilities in three other locations and rents additional office space for its insurance operations in 15 other locations. The Company believes that such owned properties are suitable and adequate for its current business operations. Item 3. Legal Proceedings The Company is continuously involved in numerous lawsuits arising, for the most part, in the ordinary course of business, either as a liability insurer defending third-party claims brought against its insureds, or as an insurer defending coverage claims brought against it by its policyholders or other insurers. While the outcome of all litigation involving the Company, including insurance-related litigation, cannot be determined, litigation is not expected to result in losses that differ from recorded reserves by amounts that would be material to results of operations, liquidity or financial condition. In addition, reinsurance recoveries related to claims in litigation, net of the allowance for uncollectible reinsurance, are not expected to result in recoveries that differ from recorded recoverables by amounts that would be material to the results of operations, liquidity or financial condition. Item 4. Submission of Matters to a Vote of Security Holders There were no matters submitted to a vote of security holders during the fourth quarter of 1998. Executive Officers of the Registrant The executive officers of the Company are as follows:
Name Age Position - --------------------------- --- ----------------------------------------------------- John W. Smithson........... 53 President and Chief Executive Officer Frederick W. Anton III..... 65 Chairman of the Board Ronald S. Austin........... 41 President and Chief Operating Officer - Caliber One Indemnity Company Vincent T. Donnelly........ 46 President and Chief Operating Officer - The PMA Insurance Group Stephen G. Tirney.......... 45 President and Chief Operating Officer - PMA Reinsurance Corporation Francis W. McDonnell....... 42 Senior Vice President, Chief Financial Officer and Treasurer
John W. Smithson has served as President and Chief Executive Officer of the Company since May 1997, and as a director of the Company since 1987. Mr. Smithson served as President and Chief Operating Officer of the Company from 1995 to May 1997, as Chairman and Chief Executive Officer of PMA Reinsurance Corporation since 1984 and as Chairman and Chief Executive Officer of The PMA Insurance Group since April 1995. Mr. Smithson started with the Company in 1972. Frederick W. Anton III has served as Chairman of the Board since 1995 and as a director of the Company since 1972. Mr. Anton served as Chairman of the Board and Chief Executive Officer from 1995 to May 1997, and as President and Chief Executive Officer from 1981 to 1995. Mr. Anton started with the Company in 1962. 30 Ronald S. Austin has served as the President and Chief Operating Officer of Caliber One Indemnity Company since 1997. From 1988 to 1997, Mr. Austin served as an officer and director of General Star Management Company, a member of the General Re Group. Vincent T. Donnelly has served as President and Chief Operating Officer of The PMA Insurance Group since February 1997. Mr. Donnelly served as Senior Vice President - Finance and Chief Actuary of The PMA Insurance Group from 1992 to 1997. Stephen G. Tirney has served as President and Chief Operating Officer of PMA Reinsurance Corporation since 1997. Mr. Tirney served as Executive Vice President of PMA Reinsurance Corporation from 1993 to 1997, as Senior Vice President of PMA Reinsurance Corporation from 1989 to 1993 and has been an employee of PMA Reinsurance Corporation since 1976. Francis W. McDonnell has served as Senior Vice President and Chief Financial Officer of the Company since 1995 and as Treasurer since 1997, and has served as Senior Vice President and Chief Financial Officer of PMA Reinsurance Corporation since 1995. From 1993 to 1995, Mr. McDonnell served as Vice President Finance of PMA Reinsurance Corporation. PART II Item 5. Market for the Registrant's Common Equity and Related Shareholder Matters The "Class A Common Stock Prices" and "Class A Common Stock Bids" under the caption "Quarterly Financial Information" and also in the last paragraph on page 80 of the Annual Report, as well as the information under the captions "Securities Listing" and "Dividends" on the inside back cover of the Annual Report are incorporated herein by reference. Further, the information in Note 15 to the Financial Statements in the Annual Report and under the caption "Regulation--Restrictions on Subsidiaries' Dividends and Other Payments" in Item 1 of this Form 10-K is incorporated herein by reference. Recent Sales of Unregistered Securities During the years ended December 31, 1997 and 1996, the Company sold shares of Class A Common Stock in connection with the exercise of employee stock options pursuant to the terms of the Company's stock option plans. In 1997, an aggregate of 162,248 shares were sold to fourteen officers and employees of the Company pursuant to such options at exercise prices ranging from $8.00 to $15.00 per share for an aggregate price of $1,424,349. Additionally, in 1997, the Company sold 1,000 shares to employees at $18.00 per share. In 1996, an aggregate of 97,150 shares were sold to five officers of the Company pursuant to such options at exercise prices ranging from $6.60 to $10.00 per share for an aggregate price of $806,000. The Company believes that these sales were made pursuant to the exemption afforded by Section 4(2) of the Securities Act inasmuch as the sales were made to a limited number of sophisticated investors in transactions not involving a public offering. No unregistered sales of Company securities were made in 1998. Item 6. Selected Financial Data The information under the caption "Selected Financial Data" on page 26 of the Annual Report is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 28 through 49 of the Annual Report is incorporated herein by reference. 31 Item 7A. Quantitative and Qualitative Disclosures About Market Risk The information under the caption "Market Risk of Financial Instruments" on pages 45 and 46 of the Annual Report is incorporated herein by reference. Item 8. Financial Statements and Supplementary Data The Company's Consolidated Financial Statements and Notes to Consolidated Financial Statements on pages 50 through 78 and the Report of Independent Accountants on page 79 of the Annual Report are incorporated herein by reference, as is the unaudited "Income Statement Data" and "Per Share Data" under the caption "Quarterly Financial Information" on page 80 of the Annual Report. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. PART III Item 10. Directors and Executive Officers of the Registrant See "Executive Officers of the Registrant" under Item 4 above. The information under the captions "Nominees For Election" and "Directors Continuing in Office" on pages 5 and 6 of the Company's 1999 Proxy Statement dated March 26, 1999 ("Proxy Statement") is incorporated herein by reference, as is the information under the caption "Section 16(a) Beneficial Reporting Compliance" on page 23 of the Proxy Statement. Item 11. Executive Compensation The information under the caption "Compensation of Executive Officers" on pages 8 through 12 and under the caption "Director Compensation" on page 7 of the Proxy Statement is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management The information under the caption "Beneficial Ownership of Common Stock" on pages 2 through 4 of the Proxy Statement is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions The information under the captions "Certain Transactions" on pages 18 and 19 as well as "Compensation Committee Interlocks and Insider Participation" on page 12 of the Proxy Statement is incorporated herein by reference. 32 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K FINANCIAL STATEMENTS AND SCHEDULES (a)(1) The following consolidated financial statements of PMA Capital and its subsidiary companies and Report on Independent Accountants, included on pages 50 through 79 of the Annual Report are incorporated herein by reference: . Consolidated Balance Sheets at December 31, 1998 and 1997. . Consolidated Statements of Operations for the years ended December 31, 1998, 1997 and 1996. . Consolidated Statements of Shareholders' Equity for the years ended December 31, 1998, 1997 and 1996. . Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996. . Consolidated Statements of Comprehensive Income for the years ended December 31, 1998, 1997 and 1996. . Notes to the Consolidated Financial Statements . Report of Independent Accountants (a)(2) The Financial Statement Schedules are listed in the Index to Financial Statement Schedules on page FS-1 All other schedules specified by Article 7 of Regulation S-X are not required pursuant to the related instructions or are inapplicable and, therefore, have been omitted. (a)(3) The Exhibits are listed in the Index to Exhibits on pages E-1 through E-3. (b) Reports on Form 8-K filed in the fourth quarter of 1998 During the last quarter of the fiscal year ended December 31, 1998, the registrant filed a Report under Item 5 on Form 8-K dated December 7, 1998, regarding (1) the change of its corporate name from "Pennsylvania Manufacturers Corporation" to "PMA Capital Corporation"; (2) the change of the trading symbol for the registrant's Class A Common Stock on the Nasdaq National Market from "PMFRA" to "PMACA"; and (3) a change of the address of its principal executive offices to 1735 Market Street, Suite 2800, Philadelphia, Pennsylvania 19103-7590. 33 Signatures Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf, and in the capacities indicated, by the undersigned, thereunto duly authorized. PMA CAPITAL CORPORATION Date: March 31, 1999 By: /s/ Francis W. McDonnell ----------------------------------- Francis W. McDonnell, Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 31, 1999. Signature* Title - --------- ----- John W. Smithson President and Chief Executive Officer and a Director (Principal Executive Officer) Frederick W. Anton III Chairman of the Board and a Director Paul I. Detwiler, Jr. Director Joseph H. Foster Director Anne S. Genter Director James F. Malone III Director A. John May Director Louis N. McCarter III Director John W. Miller, Jr. Director Edward H. Owlett Director Louis I. Pollock Director Roderic H. Ross Director L. J. Rowell, Jr. Director By: /s/ Charles A. Brawley, III ---------------------------- Charles A. Brawley, III Attorney-in-Fact 34 PMA CAPITAL CORPORATION INDEX TO FINANCIAL STATEMENT SCHEDULES --------------------------------------
Schedule No. Description Page II Condensed Financial Information of FS-2 to FS-4 Registrant as of December 31, 1998 and 1997 and for the years ended December 31, 1998, 1997 and 1996 III Supplementary Insurance Information for the FS-5 years ended December 31, 1998, 1997 and 1996 IV Reinsurance for the years ended December 31, FS-6 1998, 1997 and 1996 V Valuation and Qualifying Accounts for the FS-7 years ended December 31, 1998, 1997 and 1996 VI Supplemental Information Concerning FS-8 Property and Casualty Insurance Operations for the years ended December 31, 1998, 1997 and 1996 Report of Independent Accountants on Financial Schedules Statement FS-9
Certain financial statement schedules have been omitted because they are either not applicable or the required financial information is contained in the Company's 1998 consolidated financial statements and notes thereto. FS-1 PMA Capital Corporation Schedule II - Registrant Only Financial Statements Balance Sheets (Parent Company Only)
As of December 31, (dollar amounts in thousands) 1998 1997 ------------------------------------------------------------------------------------------------------------ Assets Cash $ - $ 253 Investment in subsidiaries 700,772 639,193 Deferred income taxes, net 8,078 29,163 Related party receivables - 561 Other assets 420 22,545 ------------------------------------ Total assets $ 709,270 $ 691,715 ================= ================= Liabilities Long-term debt $ 163,000 $ 203,000 Related party payables 14,354 - Dividends payable to shareholders 2,013 2,008 Other liabilities 18,423 8,360 ------------------------------------ Total liabilities 197,790 213,368 Shareholders' Equity Common stock, convertible, $5 par value (40,000,000 shares authorized; 1998 - 13,956,268 shares issued and 13,520,261 outstanding; 1997 - 15,286,263 shares issued and 14,850,789 outstanding) 69,781 76,431 Class A common stock, $5 par value (40,000,000 shares authorized; 1998 - 10,486,677 shares issued and 9,837,963 outstanding; 1997 - 9,156,682 shares issued and 9,117,735 outstanding) 52,433 45,783 Additional Paid-in Capital - Class A common stock 339 339 Retained earnings 377,601 343,368 Accumulated other comprehensive income 30,016 18,806 Notes receivable from officers (498) (198) Treasury stock, at cost: Common stock (1998-436,007 shares; 1997-435,474 shares) (5,582) (5,572) Class A common stock (1998-648,714 shares; 1997-38,947 shares) (12,610) (610) ------------------------------------ Total shareholders' equity 511,480 478,347 ------------------------------------ Total liabilities and shareholders' equity $ 709,270 $ 691,715 ================= =================
These financial statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto. FS-2 PMA Capital Corporation Schedule II Statements of Operations - Registrant Only Financial Statements (Parent Company Only)
Years ended December 31, (dollar amounts in thousands) 1998 1997 1996 ------------------------------------------------------------------------------------------------------------------------------- Revenues: Net investment (expense) income $ (18) $ 70 $ 183 Net realized investment (losses) gains (1,740) - 35 Other revenues 1,089 193 434 ----------------------------------------------------- Total revenues (669) 263 652 ----------------------------------------------------- Expenses: General expenses 10,834 6,911 7,347 Interest expense 15,221 15,764 16,774 ----------------------------------------------------- Total expenses 26,055 22,675 24,121 ----------------------------------------------------- Loss before income taxes and equity in earnings (losses) of subsidiaries (26,724) (22,412) (23,469) Provision (benefit) for income taxes 1,256 (14,271) (60,345) ----------------------------------------------------- (Loss) income before equity in earnings (losses) of subsidiaries and extraordinary loss (27,980) (8,141) 36,876 Equity in earnings (losses) of subsidiaries 72,714 27,894 (172,210) ----------------------------------------------------- Income (loss) before extraordinary loss 44,734 19,753 (135,334) Extraordinary loss from early extinguishment of debt (net of income tax benefit of $2,549) - (4,734) - ----------------------------------------------------- Net income (loss) $ 44,734 $ 15,019 $ (135,334) ==================== =============== ================
These financial statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto. FS-3 PMA Capital Corporation Schedule II Statement of Cash Flows - Registrant Only Financial Statements (Parent Company Only)
Years ended December 31, (dollar amounts in thousands) 1998 1997 1996 ----------------------------------------------------------------------------------------------------------- Cash Flows From Operating Activities: Net income (loss) $44,734 $15,019 $ (135,334) Adjustments to reconcile net income (loss) to net cash flows provided by operating activities: Equity in (earnings) losses of subsidiaries (72,714) (27,894) 172,210 Net realized investment losses (gains) 1,740 - (35) Provision (benefit) for deferred income taxes 21,085 9,614 (19,822) Extraordinary loss from early extinguishment of debt - (4,734) - Dividends received from subsidiaries 35,502 22,500 53,634 Net tax sharing payments received from subsidiaries 29,728 19,950 12,000 Other, net (11,957) (14,036) (42,283) -------------------------------------------- Net cash flows provided by operating activities 48,118 20,419 40,370 -------------------------------------------- Cash Flows From Investing Activities: Cash contributions to subsidiaries (480) (11,000) (50,000) Other - - 115 -------------------------------------------- Net cash flows used by investing activities (480) (11,000) (49,885) -------------------------------------------- Cash Flows From Financing Activities: Change in related party receivables and payables 14,915 (1,439) 10,863 Proceeds from issuance of long-term debt - 210,000 26,000 Repayments of long-term debt (40,000) (211,571) (25,000) Dividends paid to shareholders (7,939) (7,965) (7,926) Proceeds from exercised stock options and issuance of Class A common stock 4,283 1,442 1,577 Purchase of treasury stock (18,850) (597) (2,506) Net (issuance) repayments of notes receivable from officers (300) 964 2,734 --------------------------------------------- Net cash flows (used) provided by financing activities (47,891) (9,166) 5,742 --------------------------------------------- Net (decrease) increase in cash (253) 253 (799) Cash - beginning of year 253 - 799 ----------------------------------------------------- Cash - end of year $ - $ 253 $ - ====================================================
These financial statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto. FS-4 PMA Capital Corporation Schedule III Supplementary Insurance Information
Unpaid losses and Losses and loss Deferred policy loss adjustment Unearned Net premiums Net investment adjustment (dollar amounts in thousands) acquisiton costs expenses premiums earned income(1)(3) expenses - ----------------------------------------------------------------------------------------------------------------------------- Year ended December 31, 1998: The PMA Insurance Group $18,660 $1,250,694 $109,766 $241,928 $ 64,580 $ 197,525 PMA Re 30,446 668,604 109,675 223,559 54,734 154,062 Caliber One 2,009 33,147 8,504 1,750 1,453 1,402 Corporate and Other - (11,550) - (522) (642) (318) - ----------------------------------------------------------------------------------------------------------------------------- Total $51,115 $1,940,895 $227,945 $466,715 $120,125 $ 352,671 ============================================================================================================================= Year ended December 31, 1997: The PMA Insurance Group $20,010 $1,353,917 $115,998 $212,348 $ 81,927 $ 193,530 PMA Re 25,278 622,484 95,457 163,603 52,270 113,931 Corporate and Other - 26,786 - - (805) (180) - ----------------------------------------------------------------------------------------------------------------------------- Total $45,288 $2,003,187 $211,455 $375,951 $133,392 $ 307,281 ============================================================================================================================= Year ended December 31, 1996: The PMA Insurance Group $23,488 $1,501,897 $127,986 $268,601 $ 82,364 $ 424,900 PMA Re 20,518 589,175 77,996 151,974 48,676 111,937 Corporate and Other - - - - (203) (214) - ----------------------------------------------------------------------------------------------------------------------------- Total $44,006 $2,091,072 $205,982 $420,575 $130,837 $ 536,623 ============================================================================================================================= Acquisition Operating Net premiums (dollar ammounts in thousands) expenses expenses(2) written(3) - ------------------------------------------------------------------------- Year ended December 31, 1998: The PMA Insurance Group $ 45,190 $45,309 $234,837 PMA Re 64,689 13,134 234,010 Caliber One 958 2,449 6,436 Corporate and Other - 11,267 (522) - ------------------------------------------------------------------------- Total $110,837 $72,159 $474,761 ========================================================================= Year ended December 31, 1997: The PMA Insurance Group $ 48,343 $51,848 $203,348 PMA Re 45,158 10,827 177,934 Corporate and Other - 12,464 - - ------------------------------------------------------------------------- Total $ 93,501 $75,139 $381,282 ========================================================================= Year ended December 31, 1996: The PMA Insurance Group $ 52,706 $82,053 $272,479 PMA Re 37,586 6,320 164,053 Corporate and Other - 9,483 (3,557) - ------------------------------------------------------------------------- Total $ 90,292 $97,856 $432,975 =========================================================================
(1) Net investment income is based on each segment's invested assets. (2) Other operating expenses are allocated primarily on the specific identification basis. These amounts have been reclassified for 1997 and 1996 to reflect the changes related to the implementation of SFAS No. 131. (3) Certain prior year amounts have been reclassified to conform to current year presentation. FS-5 PMA Capital Corporation Schedule IV Reinsurance
Ceded to Percentage of Direct other Assumed from amount assumed (dollar amounts in thousands) amount companies other companies Net amount to net - ------------------------------------------------------------------------------------------------------------------------- Year Ended December 31, 1998: Property and liability insurance premiums $ 286,987 $ 96,961 $276,689 $466,715 59% ========= ========== =========== ============ ============== Year Ended December 31, 1997: Property and liability insurance premiums $ 277,871 $118,277 $216,357 $375,951 58% ========= =========== =========== ============ ============== Year Ended December 31, 1996: Property and liability insurance premiums $299,386 $ 88,499 $209,688 $420,575 50% ======== =========== =========== ============ ==============
FS-6 PMA Capital Corporation Schedule V Valuation and Qualifying Accounts
(dollar amounts in thousands) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at Charged to Deductions - write-offs Balance at end Description beginning period costs and expenses of uncollectible accounts of period ==================================================================================================================================== Year ended December 31, 1998: Allowance for uncollectible accounts: Premiums receivable $18,406 1,488 20 $19,874 Reinsurance receivables 2,096 108 26 2,178 - ------------------------------------------------------------------------------------------------------------------------------------ Year ended December 31, 1997: Allowance for uncollectible accounts: Premiums receivable $18,877 - 471 $18,406 Reinsurance receivables 2,603 - 507 2,096 - ------------------------------------------------------------------------------------------------------------------------------------ Year ended December 31, 1996: Allowance for uncollectible accounts: Premiums receivable $16,330 19,532 16,985 $18,877 Reinsurance receivables 6,208 222 3,827 2,603 -----------------------------------------------------------------------------------------------------------------------------------
FS-7 PMA Capital Corporation Schedule VI Supplemental Information Concerning Property and Casualty Insurance Operations
(dollar amounts in thousands) - ------------------------------------------------------------------------------------------------------------------------------------ Deferred Discount on reserves policy Reserves for unpaid for unpaid claims acquisition claims and claim and claim Affiliation with registrant costs adjustment expenses adjustment expenses(1) Unearned premiums Earned premiums - ------------------------------ ----------- ------------------- -------------------- ----------------- --------------- Consolidated property-casualty subsidiaries: Year Ended December 31, 1998 $51,115 $1,940,895 $194,327 $227,945 $466,715 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 ==================================================================================================================================== - ------------------------------------------------------------------------------------------------------------------------------------ Claims and claim adjustment expenses incurred related to Net investment ---------------------------- Acquisition Paid claims and Net premiums Affiliation with registrant income Current year Prior years(2) expenses adjustment expenses written - ------------------------------ -------------- ------------ -------------- ----------- ------------------- ------------ Consolidated property-casualty subsidiaries: Year Ended December 31, 1998 $120,125 $373,098 ($46,515) $110,837 $458,844 $474,761 Year Ended December 31, 1997 133,392 341,880 (86,006) 93,501 470,874 381,282 Year Ended December 31, 1996 130,837 323,069 156,074 90,292 510,621 432,975 ====================================================================================================================================
(1) - Workers' compensation reserves discounted at approximately 5%. (2) - Excludes accretion of loss reserve discount of $26,088, $51,407 and $57,480 in 1998, 1997 and 1996, respectively. FS-8 [Logo of PricewaterhouseCoopers LLP appears here] - -------------------------------------------------------------------------------- PricewaterhouseCoopers LLP 1177 Avenue of the Americas New York, NY. 10036 Telephone (212)596-8000 Facsimile (212)596-8910 REPORT OF INDEPENDENT ACCOUNTANTS February 5, 1999 To the Board of Directors and Shareholders PMA Capital Corporation Our report on the consolidated financial statements of PMA Capital Corporation has been incorporated by reference in this Form 10-K from page 79 of the 1998 Annual Report to Shareholders of PMA Capital Corporation. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed on the index on page FS-1 of this Form 10-K. In our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein. /s/PricewaterhouseCoopers LLP FS-9 INDEX TO EXHIBITS
Exhibit No. Description of Exhibit Method of Filing - -------------- ------------------------------------------------- (3) Articles of incorporation and bylaws: 3.1 Amended and Restated Articles of Incorporation Filed as exhibit 3.1 to the Company's Registration of the Company as last amended December 7, 1998. Statement on Form S-3/A, Amendment No. 2 (No. 333-63469) and incorporated herein by reference. 3.2 Amended and Restated Bylaws of the Company. Filed as exhibit 3.2 to the Company's Registration Statement on Form S-3, (No. 333-63469) and incorporated herein by reference. (10) Material Contracts: Exhibits 10.1 through 10.11 are management contracts or compensatory plans. 10.1 Employment Agreement dated April 1, 1995 between Filed as exhibit 10.1 to the Company's the Company and Frederick W. Anton III. Registration Statement on Form 10 dated June 26, 1997. 10.2 Employment Agreement dated May 1, 1995 between Filed as exhibit 10.2 to the Company's the Company and John W. Smithson. Registration Statement on Form 10 dated June 26, 1997 10.3 Company's EDC Plan Trust Agreement dated as of Filed as exhibit 10.3 to the Company's 1994. Registration Statement on Form 10 dated June 26, 1997 10.4 Company's Amended and Restated Executive Filed herewith. Deferred Compensation Plan 10.5 Company's Supplemental Executive Retirement Plan Filed as exhibit 10.4 to the Company's (SERP) dated July 1995. Registration Statement on Form 10 dated June 26, 1997 10.6 Company's Amended and Restated 1987 Incentive Filed as exhibit 10.5 to the Company's Stock Option Plan Registration Statement on Form 10 dated June 26, 1997 10.7 Company's Amended and Restated 1991 Equity Filed as exhibit 10.6 to the Company's Incentive Plan. Registration Statement on Form 10 dated June 26, 1997 10.8 Company's Amended and Restated 1993 Equity Filed as exhibit 10.7 to the Company's Incentive Plan. Registration Statement on Form 10 dated June 26, 1997 10.9 Company's Amended and Restated 1994 Equity Filed as exhibit 10.8 to the Company's Incentive Plan. Registration Statement on Form 10 dated June 26, 1997 10.10 Company's 1995 Equity Incentive Plan. Filed as exhibit 10.9 to the Company's Registration Statement on Form 10 dated June 26, 1997
E-1
Exhibit No. Description of Exhibit Method of Filing - -------------- ------------------------------------------------- 10.11 Company's 1996 Equity Incentive Plan. Filed as exhibit 10.10 to the Company's Registration Statement on Form 10 dated June 26, 1997 10.12 Credit Agreement dated as of March 14, 1997 by Filed as exhibit 10.13 to the Company's and among the Company, The Bank of New York, Registration Statement on Form 10 dated June 26, First Union National Bank of North Carolina, 1997 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. 10.13 Master Agreement dated as of February 7, 1997 Filed as exhibit 10.14 to the Company's between the Company and First Union National Registration Statement on Form 10 dated June 26, Bank of North Carolina. 1997 10.14 First Amended and Restated Letter of Credit Filed as exhibit 10.15 to the Company's Agreement, dated March 14, 1997, by and among Registration Statement on Form 10 dated June 26, the Company, the Bank of New York, Mellon Bank, 1997 N.A., Fleet Bank, National Association, PNC Bank, National Association and First Union Bank of North Carolina. 10.15 Amendment No. 1 and Restatement, dated September Filed herewith. 29, 1997, to the First Amended and Restated Letter of Credit Agreement, dated March 14, 1997 10.16 Amendment No. 2, dated September 28, 1998, to Filed herewith. the First Amended and Restated Letter of Credit Agreement, dated March 14, 1997 10.17 Amendment No. 3, dated October 2, 1998, to the Filed herewith. First Amended and Restated Letter of Credit Agreement, dated March 14, 1997 10.18 Caliber One Indemnity Company Purchase Agreement Filed as exhibit 10.17 to the Company's Annual dated December 15, 1997. Report on Form 10-K, for the year ended December 31, 1997 and incorporated herein by reference. (12) Computation of ratio of earnings to fixed Filed herewith. charges. (13) Portions of the Company's 1998 Annual Report to Filed herewith. Shareholders, which are expressly incorporated by reference in this Form 10-K, are "filed" as part of this Form 10-K (21) Subsidiaries of the Company. Filed herewith. (23) Consent of independent accountant Filed herewith. (24) Power of attorney
E-2
Exhibit No. Description of Exhibit Method of Filing - -------------- ------------------------------------------------- 24.1 Powers of attorney Filed herewith. 24.2 Certified resolutions Filed herewith. (27) Financial Data Schedule 27.1 Financial Data Schedule Filed herewith (EDGAR version only). 27.2 Restated Financial Data Schedule Filed herewith (EDGAR version only). 27.3 Restated Financial Data Schedule Filed herewith (EDGAR version only).
Shareholders may obtain copies of exhibits by writing to the Company at PMA Capital Corporation, 1735 Market Street, Suite 2800, Philadelphia, PA. 19103- 7590, Attn: Corporate Secretary E-3 EX-10.4 2 AMENDMENT AND RESTATED DEFERRED COMPENSATION PLAN EXHIBIT 10.4 PMA CAPITAL CORPORATION (FORMERLY PMC) EXECUTIVE DEFERRED COMPENSATION PLAN (AMENDED AND RESTATED AS OF DECEMBER 7, 1998) PMA CAPITAL CORPORATION (FORMERLY PMC) EXECUTIVE ------------------------------------------------ DEFERRED COMPENSATION PLAN -------------------------- TABLE OF CONTENTS ----------------- PAGE ---- INTRODUCTION 1 ARTICLE I. - DEFINITIONS.................................................... 1 1.1 "Administrator"............................................... 1 1.2 "Beneficiary"................................................. 1 1.3 "Benefit Distribution Date"................................... 1 1.4 "Committee"................................................... 1 1.5 "Compensation"................................................ 1 1.6 "Code"........................................................ 2 1.7 "Deferral Agreement".......................................... 2 1.8 "Deferred Benefit Accounts"................................... 2 1.9 "Determination Date".......................................... 2 1.10 "Disability".................................................. 2 1.11 "Early Retirement Age"........................................ 2 1.12 "Education Account"........................................... 2 1.13 "Eligible Dependent".......................................... 2 1.14 "Eligible Employee"........................................... 3 1.15 "Employers"................................................... 3 1.16 "Enrollment Period"........................................... 3 1.17 "Executive Deferral Contribution"............................. 3 1.18 "Fixed Period Benefit Account"................................ 3 1.19 "Investment Fund" or "Fund"................................... 3 1.20 "Matching Contribution"....................................... 3 1.21 "Participant"................................................. 3 1.22 "Plan"........................................................ 3 1.23 "Plan Sponsor"................................................ 3 1.24 "Plan Year"................................................... 4 1.25 "Restatement Effective Date".................................. 4 1.26 "Retirement".................................................. 4 1.27 "Retirement Account".......................................... 4 1.28 "Retirement Age".............................................. 4 1.29 "Vested"...................................................... 4 ARTICLE II. - MEMBERSHIP IN THE PLAN........................................ 4 -i- 2.1 Commencement of Participation................................ 4 2.2 Procedure For and Effect of Admission........................ 4 2.3 Cessation of Participation................................... 4 2.4 Recommencement of Participation.............................. 5 ARTICLE III. - PLAN CONTRIBUTIONS.......................................... 5 3.1 Executive Deferral Contribution.............................. 5 3.2 Rules Governing Executive Deferral Contributions............. 5 3.3 Matching Contribution........................................ 5 ARTICLE IV. - PARTICIPANTS' ACCOUNTS....................................... 6 4.1 Establishment of Accounts.................................... 6 4.2 Executive Benefit Allocation................................. 6 4.3 Irrevocable Allocation....................................... 6 4.4 Pre-1993 Directed Adjustment of Deferred Benefit Accounts.... 6 4.5 Post-1992 Directed Adjustment of Deferred Benefit Accounts... 7 4.6 Administration of Investments................................ 7 4.7 Valuation of Deferred Benefit Accounts....................... 7 4.8 Suballocation Within the Deferred Benefit Accounts........... 7 4.9 Investment Obligation of the Employer........................ 8 ARTICLE V. - VESTING....................................................... 8 5.1 Vesting Schedule............................................. 8 5.2 Forfeitures.................................................. 9 ARTICLE VI. - BENEFITS..................................................... 9 6.1 Retirement Account........................................... 9 6.2 Education Account............................................ 10 6.3 Fixed Period Benefit Account................................. 10 6.4 Restructuring of Deferred Benefit Accounts................... 11 6.5 Tax Withholding.............................................. 11 ARTICLE VII. - ADMINISTRATION.............................................. 11 7.1 Appointment of Administrator................................. 11 7.2 Administrator's Responsibilities............................. 11 7.3 Records and Accounts......................................... 12 7.4 Administrator's Specific Powers and Duties................... 12 7.5 Employer's Responsibility to Administrator................... 13 7.6 Expenses. 13 7.7 Liability.................................................... 13 7.8 Indemnification.............................................. 13 7.9 Procedure to Claim Benefits.................................. 13 -ii- ARTICLE VIII. - AMENDMENT AND TERMINATION.................................. 14 8.1 Plan Amendment............................................... 14 8.2 Termination of the Plan...................................... 14 8.3 Amendment or Termination Procedure........................... 14 ARTICLE IX. - MISCELLANEOUS................................................ 15 9.1 Funding...................................................... 15 9.2 No Assignment Permitted...................................... 15 9.3 Supplemental Benefits........................................ 15 9.4 Governing Law................................................ 15 9.5 Jurisdiction................................................. 15 9.6 Payments to Minors and Incompetents.......................... 15 9.7 Binding Terms................................................ 15 9.8 Status of Employment......................................... 16 9.9 Severability................................................. 16 9.10 Spendthrift Provision........................................ 16 9.11 Headings..................................................... 16 9.12 Rules of Interpretation...................................... 16 -iii- INTRODUCTION PMA CAPITAL CORPORATION (formerly Pennsylvania Manufacturers Corporation), a Pennsylvania corporation, maintains the PMC Deferred Compensation Plan (the "PMC Plan") and is the Plan Sponsor of the PMC Plan. The PENNSYLVANIA MANUFACTURERS' ASSOCIATION INSURANCE COMPANY, PMA REINSURANCE CORPORATION, PENNSYLVANIA MANUFACTURERS ASSOCIATION, CALIBER ONE INDEMNITY COMPANY, AND CALIBER ONE MANAGEMENT CORPORATION have adopted the PMC Plan with the consent of the Board of Directors of the Plan Sponsor. The Employee Benefits Plan Committee of the Plan Sponsor has reserved the right in Section 8.1 of the PMC Plan to amend the PMC Plan at any time subject to certain inapplicable limitations. The Employee Benefits Plan Committee now desires to amend and restate the PMC Plan in order to change its name to the PMA CAPITAL CORPORATION EXECUTIVE DEFERRED COMPENSATION PLAN effective December 7, 1998, to reflect the change of Pennsylvania Manufacturers Corporation's name to PMA CAPITAL CORPORATION. Accordingly, the Employee Benefits Committee hereby amends the PMC PLAN as follows: ARTICLE I. - DEFINITIONS 1.1 "Administrator" means the Committee unless some other individual or individuals have been appointed in lieu thereof by the Plan Sponsor's Board of Directors. 1.2 "Beneficiary" means the person, persons, trust or other entity, designated by written revocable designation filed with the Administrator by a Participant to receive payments in the event of the Participant's death. 1.3 "Benefit Distribution Date" means a future date selected by a Participant, within guidelines established by the Administrator, on which the Participant shall be entitled to a supplemental benefit pursuant to this Plan equal to all or a designated portion of the balance of his Fixed Period Benefit Account. 1.4 "Committee" means the Plan Sponsor's Employee Benefits Plan Committee, as from time to time constituted. 1.5 "Compensation" means a Participant's rate of base pay or salary, including Executive Deferral Contributions made hereunder and any pre-tax elective deferrals to any Employer -1- sponsored retirement savings plan or cafeteria plan, qualified pursuant to Section 401(k) or 125 of the Code, but excluding bonuses and overtime, all other Employer contributions to benefit plans and all other forms of remuneration or reimbursement. 1.6 "Code" means the Internal Revenue Code of 1986, as amended from time to time. 1.7 "Deferral Agreement" means a written agreement between a Participant and the Employer, whereby a Participant agrees to defer a portion of his Compensation and the Employer agrees to provide benefits pursuant to the provisions of the Plan. 1.8 "Deferred Benefit Accounts" means the bookkeeping accounts which are credited with a Participant's Executive Deferral and Matching Contributions and which may take the form of one or more of the following: a Retirement Account, an Education Account and a Fixed Period Benefit Account. 1.9 "Determination Date" shall mean March 31, June 30, September 30 and December 31 of each calendar year and, for each Participant, his date of death, Retirement, or other termination of employment. 1.10 "Disability" means for Plan Years prior to January 1, 1994 an illness or injury which completely prevents a Participant from performing the Participant's occupation. For Plan Years commencing on or after January 1, 1994, Disability means a medically determinable physical or mental impairment of a Participant which is of such severity as to make him eligible for benefits under the Employer's group long-term disability insurance policy. Disability shall be determined in a uniform manner by the Administrator. 1.11 "Early Retirement Age" means for Plan Years prior to January 1, 1993 the date on which the Participant has attained age 55 and has completed at least 5 years of employment with the Employer. For Plan Years commencing on and after January 1,1993, Early Retirement Age means a Participant's 50th birthday, provided the Participant shall have completed at least 5 years of service (as defined in Section 5.1 hereof) and further provided that the sum of the Participant's age (at his last birthday) and years of service on the date of retirement is at least 60. If the sum of a Participant's age and years of service by the date of the Participant's 50th birthday is less than 60, the Participant's Early Retirement Age shall be attained on the date on which the sum of the Participant's age and years of service reaches 60. 1.12 "Education Account" means a Deferred Benefit Account established pursuant to Section 4.1 hereof. 1.13 "Eligible Dependent" means an individual who is a child or stepchild or who is otherwise identified as a dependent of a Participant for federal income tax purposes who is living at any time throughout the Enrollment Period and who is either (i) younger than the age of 14 or (ii) younger than the age of 18, but for whom a subaccount was initially established, pursuant to Section -2- 4.8 hereof, prior to said dependent attaining the age of 14. Notwithstanding the foregoing, "age 16" shall be substituted for each reference to "age 14" in this Section 1.13 with respect to Plan Years commencing after December 31, 1991. 1.14 "Eligible Employee" means such officers and other highly compensated employees of the Employer who are identified and approved by the Committee. 1.15 "Employers" means the PLAN SPONSOR, PENNSYLVANIA MANUFACTURERS' ASSOCIATION INSURANCE COMPANY, PMA REINSURANCE CORPORATION, PENNSYLVANIA MANUFACTURERS ASSOCIATION, CALIBER ONE INDEMNITY COMPANY, AND CALIBER ONE MANAGEMENT CORPORATION, as well as any other related employer which adopts this Plan with the consent of the Plan Sponsor's Board of Directors. Each use of the singular shall be deemed a reference to each of the Employers individually. 1.16 "Enrollment Period" means the 61 day period ending on each December 31st. 1.17 "Executive Deferral Contribution" means the Plan contribution described in Section 3.1 hereof. 1.18 "Fixed Period Benefit Account" means a Deferred Benefit Account established pursuant to Section 4.1 hereof. 1.19 "Investment Fund" or "Fund" means the investments described in Section 4.4 hereof which shall serve as the means for measuring value increases or decreases with respect to a Participant's Deferred Benefit Accounts, provided that after December 31, 1992 Investment Fund or Fund means any of the mutual funds which comprise The Vanguard Group of Investment Companies, other than any such fund which is offered only to participants in tax-qualified retirement plans. 1.20 "Matching Contribution" means the Plan contribution described in Section 3.3 hereof. 1.21 "Participant" means an Eligible Employee who has met the conditions for participation as set forth in Article II hereof. 1.22 "Plan" means the PMA CAPITAL CORPORATION (FORMERLY PMC) EXECUTIVE DEFERRED COMPENSATION PLAN as amended and restated in this instrument and as it may be further amended from time to time. 1.23 "Plan Sponsor" means PMA CAPITAL CORPORATION (formerly Pennsylvania Manufacturers Corporation), a Pennsylvania corporation. -3- 1.24 "Plan Year" means the period from February 1, 1988 through December 31, 1988 and thereafter, the twelve (12) consecutive month period beginning on each January 1 and ending on each December 31. 1.25 "Restatement Effective Date" means December 7, 1998. 1.26 "Retirement" means any severance from full-time employment by a Participant after attaining his Retirement Age or Early Retirement Age. 1.27 "Retirement Account" means a Deferred Benefit Account established pursuant to Section 4.1 hereof. 1.28 "Retirement Age" means that date on which a Participant attains age 65. 1.29 "Vested" means the balance in a Participant's Deferred Benefit Accounts to which the Participant has a nonforfeitable right, as defined in Section 5.1 hereof. ARTICLE II. - MEMBERSHIP IN THE PLAN 2.1 Commencement of Participation. Each Eligible Employee who is an ----------------------------- Eligible Employee at any time during the Enrollment Period for any Plan Year shall be eligible to become a Participant in the Plan as of the first day of such Plan Year. Notwithstanding the foregoing, each employee who first becomes an Eligible Employee during the course of a Plan Year shall be eligible to become a Participant with respect to said Plan Year during a thirty day period commencing on the first day on which he is designated as an Eligible Employee. 2.2 Procedure For and Effect of Admission. Each individual who becomes ------------------------------------- eligible to participate in this Plan shall complete such forms and provide such data as are reasonably required by the Administrator as a condition of such participation. By becoming a Participant, each Eligible Employee shall for all purposes be deemed conclusively to have assented to the provisions of this Plan and all amendments hereto. 2.3 Cessation of Participation. A Participant shall cease to be a -------------------------- Participant the earlier of: A. The date on which the Plan terminates, or B. The date on which he ceases to be an Eligible Employee. Notwithstanding the foregoing, a Participant who is absent by reason of an authorized leave of absence shall remain a Participant for so long as such authorized absence continues, but shall be ineligible for further contributions to his Deferred Benefit Account, as described in Article III hereof. Moreover, a former active Participant, including, without limitation, any individual who is no longer -4- an Eligible Employee, will be deemed a Participant, for all purposes with respect to the Plan, except contributions as described in Article III hereof, as long as such former active Participant retains a benefit pursuant to the terms of Article VI hereof. 2.4 Recommencement of Participation. A former active Participant may ------------------------------- recommence participation following his reemployment or upon his again becoming an Eligible Employee during the thirty (30) day period commencing on the first day after the Committee confirms his status as an Eligible Employee. ARTICLE III - PLAN CONTRIBUTIONS 3.1 Executive Deferral Contribution. Subject to the provisions of Section ------------------------------- 3.2 hereof, each Eligible Employee may authorize the Employer to reduce his Compensation by any fixed dollar amount and to have a corresponding amount credited to his Deferred Benefit Accounts, in accordance with Section 4.2 hereof. Each Eligible Employee shall file a Deferral Agreement with the Administrator prior to the date on which the Participant performs services with respect to which the Compensation deferred hereunder is earned. 3.2 Rules Governing Executive Deferral Contributions ------------------------------------------------ A. Throughout any one Plan Year, a Participant may not defer less than $1,000 (excepting Plan Years in which the Participant elects not to defer any portion of his Compensation) or more than 25% of his Compensation, provided that this percentage limitation shall no longer apply to Plan Years beginning after December 31, 1993. B. A Participant shall not elect a Benefit Distribution Date with respect to a Fixed Period Benefit Account which occurs prior to the beginning of the third Plan Year following the Enrollment Period in which the Benefit Distribution Date is elected. C. The amount of Compensation that a Participant elects to defer shall be credited to the Participant's Deferred Benefit Accounts during each Plan Year on or about that date on which the Participant is paid the nondeferred portion of the Compensation which is the source of the deferral. D. An election to defer Compensation pursuant to this Plan is irrevocable and shall continue until the earlier of the Employee's termination of employment or the end of the Plan Year for which the deferral is effective. 3.3 Matching Contribution. The Employer shall make a Matching --------------------- Contribution for each Eligible Employee which shall equal $1.00 for each $1.00 of Executive Deferral Contribution. Notwithstanding the foregoing, no Matching Contribution shall be made with respect to a Participant's Executive Deferral Contribution in excess of 5% of his Compensation in effect on the -5- December 31st immediately preceding the Plan Year for which the Matching Contribution is being made and no Matching Contribution shall be made hereunder to the extent that the sum of such Matching Contribution and the matching contribution made on a Participant's behalf to the Employer's Section 401(k) plan also would exceed 5% of the Participant's Compensation in effect on the December 31st immediately preceding the Plan Year for which the Matching Contribution is being made. ARTICLE IV. - PARTICIPANTS' ACCOUNTS 4.1 Establishment of Accounts. One or more of the following Deferred ------------------------- Benefit Accounts shall be established with respect to each Participant: A. Retirement Account B. Education Account C. Fixed Period Benefit Account All contributions on behalf of a Participant shall be deposited to the appropriate Deferred Benefit Accounts, in accordance with Section 4.2 hereof. 4.2 Executive Benefit Allocation. Each Eligible Employee shall submit to ---------------------------- the Administrator before the close of the Enrollment Period for each Plan Year, a written statement specifying the Eligible Employee's allocation of his anticipated contributions with respect to his Deferred Benefit Accounts. 4.3 Irrevocable Allocation. Except as provided in Section 6.4 hereof, ---------------------- once an Eligible Employee has allocated anticipated contributions under the Plan and the Plan Year has begun, he may not modify, alter, amend or revoke said allocation. Notwithstanding the foregoing, a Participant may, prior to the commencement of a new Plan Year, elect to modify, alter, amend or revoke his future allocations to his Deferred Benefit Accounts, effective the first day of such Plan Year. 4.4 Pre-1993 Directed Adjustment of Deferred Benefit Accounts. For Plan --------------------------------------------------------- Years commencing prior to January 1, 1993 and except as provided herein, a Participant may direct that his Deferred Benefit Accounts be valued, in accordance with Section 4.7 hereof, as if the account were invested in one or both of the following Investment Funds: INVESTMENT FUND TYPE OF INVESTMENT --------------- ------------------ Guaranteed Fund An income fund which offers a guaranteed rate of return on an annual basis. -6- Equity Fund A common stock fund with an objective of long-term growth of capital and income through investment in a portfolio of "blue chip" stocks. A Participant shall submit to the Administrator in writing his investment selection. The Participant may select one or both of the Investment Funds in multiples of 25%. A Participant may make a separate selection with respect to each of his Deferred Benefit Accounts. 4.5 Post-1992 Directed Adjustment of Deferred Benefit Accounts. For Plan ---------------------------------------------------------- Years commencing on and after January 1, 1993 and except as provided herein, a Participant may direct that his Deferred Benefit Accounts be valued, in accordance with Section 4.7 hereof, as if the balance in the account were invested in one or more of the Investment Funds. The Participant may select to invest in one or more Investment Funds, but not more than four (4) (or such greater number as the Administrator may determine from time to time) in multiples of 25% (or such smaller percentage as the Administrator may determine from time to time). A Participant may make a separate selection with respect to each of his Deferred Benefit Accounts, but overall the Participant may not have investments in more than four (4) (or such greater number as the Administrator may determine from time to time) Investment Funds. 4.6 Administration of Investments. The investment gain or loss with ----------------------------- respect to contributions made to the Deferred Benefit Accounts on behalf of a Participation shall continue to be determined in the manner selected by the Participant, pursuant to Section 4.4 or 4.5 hereof (whichever is applicable), until a new designation is filed with the Administrator. If any Participant fails to file a designation, he shall be deemed to have elected to continue to follow the investment designation, if any, in effect for the immediately preceding Plan Year. A designation filed by a Participant changing his Investment Funds shall apply to future contributions and/or amounts already accumulated in his Deferred Benefit Accounts. A Participant may change his investment selection two (2) times throughout the course of each Plan Year beginning before January 1, 1994 and may change his investment selection on a quarterly basis during each Plan Year commencing on or after January 1, 1994. 4.7 Valuation of Deferred Benefit Accounts. The Deferred Benefit Accounts -------------------------------------- of each Participant shall be valued daily based upon the performance of the Investment Fund or Funds selected by the Participant. Such valuation shall reflect the net asset value expressed per share of each designated Investment Fund. The fair market value of an Investment Fund shall be determined by the Administrator. Each Deferred Benefit Account shall be valued separately. A valuation summary shall be prepared on each Determination Date. 4.8 Suballocation Within the Deferred Benefit Accounts. -------------------------------------------------- A. In the event a Participant shall allocate a portion of his anticipated contributions to an Education Account, the Participant may further allocate amongst subaccounts on behalf of any Eligible Dependent. In the absence of such suballocation, all contributions to the -7- Participant's Education Account shall be equally allocated to the Participant's Eligible Dependents. B. In the event a Participant shall allocate a portion of his anticipated contributions to a Fixed Period Benefit Account, the Participant may further allocate amongst subaccounts differentiated by Benefit Distribution Dates. C. Notwithstanding the foregoing, at any point in time, a Participant may not have more than a total of five (5) Accounts and subaccounts. D. A Participant's election pursuant to Section 4.4 or 4.5 hereof, whichever is applicable, shall apply uniformly to each subaccount established pursuant to this Section 4.8. 4.9 Investment Obligation of the Employer. Benefits are payable as they ------------------------------------- become due irrespective of any actual investments the Employer may make to meet its obligations. Neither the Employer, nor any trustee (in the event the Employer elects to use a grantor trust to accumulate funds) shall be obligated to purchase or maintain any asset, and any reference to investments or Investment Funds is solely for the purpose of computing the value of benefits. To the extent a Participant or any person acquires a right to receive payments from the Employer under this Plan, such right shall be no greater than the right of any unsecured creditor of the Employer. Neither this Plan nor any action taken pursuant to the terms of this Plan shall be considered to create a fiduciary relationship between the Employer and the Participants or any other persons or to establish a trust in which the assets are beyond the claims of any unsecured creditor of the Employer. ARTICLE V. - VESTING 5.1 Vesting Schedule. A Participant shall have a fully Vested interest ---------------- with respect to the Executive Deferral Contributions to his Deferred Benefit Accounts, in all instances. A Participant's Vested interest in the Matching Contributions to his Deferred Benefit Accounts shall be determined by the occurrence of the following events: A. 100% Vested upon death or Disability; B. 100% Vested upon the attainment of his Retirement Age or Early Retirement Age; C. 100% Vested upon Plan termination pursuant to Section 8.3 hereof; or D. Except as otherwise stated above, the Participant's Vested interest in the Matching Contributions made to his Deferred Benefit Accounts shall be 100% after the completion of one year of service. As used herein, year of service means a consecutive 12- -8- month period for which the Participant has been employed as a full-time Employee of the Employer. 5.2 Forfeitures. The Vested portion of the Matching Contributions ----------- allocated to the Participant's Deferred Benefit Accounts shall be determined in accordance with Section 5.1 hereof. The non-Vested portion shall be forfeited and shall be used to reduce future Matching Contributions to the Plan. ARTICLE VI. - BENEFITS 6.1 Retirement Account. ------------------ A. If a Participant remains continuously employed by the Employer until the earlier of his termination on or after his Retirement Age, Early Retirement Age, death, or Disability, the Employer shall pay to the Participant or to the Participant's Beneficiary, if applicable, a supplemental benefit equal to the balance in the Participant's Retirement Account, determined pursuant to Section 4.7 hereof. B. If a Participant should terminate employment for any reason other than one of those described in Paragraph A., above, the Employer shall pay to the Participant or to the Participant's Beneficiary, if applicable, a supplemental benefit equal to the Vested balance in the Participant's Retirement Account, determined pursuant to Section 4.7 hereof. C. In the event of a Participant's termination of employment for any reason, including, but not limited to, Retirement or death, the benefit to be paid to the Participant or Beneficiary, if applicable, shall take the form of a lump sum payment, installment payments or any combination of those two forms, as the Participant or Beneficiary, if applicable, may elect, provided that all payments hereunder must be completed by no later than the third January 1st following the end of the calendar year in which the Participant's termination of employment occurs (the "Maximum Deferral Date"). If a Participant dies prior to receiving all of the payments to which the Participant is entitled pursuant to the payment schedule he elected, the remaining payments shall be made to the Participant's Beneficiary. D. In addition to electing the form of payment, the Participant shall also elect the date on which the payments shall commence, provided that the payment of the balance, if any, in a Fixed Period Benefit Account may continue to commence on its scheduled Benefit Distribution Date. Notwithstanding the foregoing, in no event shall any payment of the Participant's supplemental benefit commence on any date which follows the Maximum Deferral Date. E. Notwithstanding any provision hereof to the contrary, if at the time benefits are to be paid, the Participant's Retirement Account has a Vested balance of less than $10,000, -9- the Administrator has the option of directing that the Participant's benefit hereunder shall be paid to the Participant as a lump sum on the first day of the first month following the Participant's date of termination. 6.2 Education Account. ----------------- A. If a Participant remains continuously employed by the Employer until January 1 of the calendar year in which an Eligible Dependent of the Participant attains a Determination Age, the Employer shall pay to the Participant a supplemental benefit, as soon as administratively possible, determined as follows: ELIGIBLE DEPENDENT'S PERCENTAGE OF ELIGIBLE DETERMINATION AGE DEPENDENT'S SUBACCOUNT ----------------- ---------------------- 18 25% 19 33% 20 50% 21 100% B. If a Participant should terminate his employment for any reason while having a balance in his Education Account, the Vested portion of the balance either shall be distributed in accordance with any pre-existing distribution schedule or shall be transferred to an existing or new Retirement Account and distributed to the Participant or Beneficiary, if applicable, in accordance with Section 6.1 hereof, as the Participant may elect, but regardless of which option the Participant elects, all distributions must be completed by the Maximum Deferral Date. 6.3 Fixed Period Benefit Account. ---------------------------- A. If a Participant remains continuously employed by the Employer until a designated Benefit Distribution Date, the Employer shall pay to the Participant a supplemental benefit equal to the Vested balance of the Participant's subaccount which has been earmarked with respect to said Benefit Distribution Date. B. If a Participant should terminate his employment for any reason while having a Vested balance in his Fixed Period Benefit Account, the Vested balance either shall be distributed in accordance with any pre- existing distribution schedule or shall be transferred to an existing or new Retirement Account and distributed to the Participant or Beneficiary, if applicable, in accordance with Section 6.1 hereof, as the Participant may elect, but regardless of which option the Participant elects, all distributions must be completed by the Maximum Deferral Date. -10- 6.4 Restructuring of Deferred Benefit Accounts. In accordance with ------------------------------------------ whatever rules and regulations may be adopted by the Administrator and subject to the restrictions set forth hereafter, a Participant may elect to restructure the Deferred Benefit Accounts to which Executive Deferral and Matching Contributions have been credited. A Participant restructures any of his Deferred Benefit Accounts by transferring all or any portion of the balance in one or more of the Deferred Benefit Accounts to one or more of the other Deferred Benefit Accounts. The following restrictions shall apply to any such transfers: A. Each election to restructure must be made during an Enrollment Period, but no later than during the Enrollment Period for the Plan Year in which a Benefit Distribution Date, Determination Date or any other payment date is scheduled to occur, provided that a restructuring election for the Plan Year beginning on January 1, 1994 may be made at any time during the annual Enrollment Period. B. In the event a restructuring will result in a further deferral of the Vested balance in one or more of the Participant's Deferred Benefit Accounts, the initial payment date for such further deferral may be no earlier than the second January 1st following the January 1st of the Plan Year in which the distribution would otherwise have been made. C. In the event a restructuring will result in an acceleration of the distribution of the Vested balance in one or more Deferred Benefit Accounts, the initial payment date for such accelerated deferral must occur no earlier than the third January 1st following the Enrollment Period in which the restructuring is elected. 6.5 Tax Withholding. To the extent required by the law in effect at the --------------- time benefits are distributed pursuant to this Article VI, the Employer or its agents shall withhold any taxes required by the federal or any state or local government from payments made hereunder. ARTICLE VII - ADMINISTRATION 7.1 Appointment of Administrator. The Administrator shall be the person ---------------------------- designated pursuant to Section 1.1 hereof. The Administrator may be removed by the Plan Sponsor's Board of Directors at any time and he may resign at any time by submitting his resignation in writing to the Plan Sponsor. Moreover, if the Administrator is an employee of the Employer, such individual shall be deemed to have resigned on the date his employment is terminated should he not have resigned or been removed prior to that date. A new Administrator shall be appointed as soon as possible in the event that the Administrator is removed or resigns from his position. Any person so appointed shall signify his acceptance by filing a written acceptance with the Plan Sponsor. 7.2 Administrator's Responsibilities. The Administrator is responsible -------------------------------- for the day to day operation and administration of the Plan. He may appoint other persons or entitles to perform any of his discretionary or ministerial functions. Such appointment shall be made and accepted by -11- the appointee in writing. The Administrator and any such appointee may employ advisors and other persons necessary or convenient to help him carry out his duties including, but not limited to, his discretionary duties. The Administrator shall have the right to remove any such appointee from his position. Any person, group of persons, or entity may serve in more than one fiduciary capacity. 7.3 Records and Accounts. The Administrator shall maintain or shall cause -------------------- to be maintained accurate and detailed records and accounts of Participants and of their rights under the Plan and of all investments, receipts, disbursements and other transactions. Such accounts, books and records relating thereto shall be open at all reasonable times to inspection and audit by the Employer and by persons designated thereby. 7.4 Administrator's Specific Powers and Duties. In addition to other ------------------------------------------ powers, rights and duties set forth elsewhere in the Plan, the Administrator shall have the following powers and duties: A. To appoint, retain, and terminate such persons as it deems necessary or advisable to assist in the administration of the Plan or to render advice with respect to the responsibilities of the Administrator under the Plan, including accountants, actuaries, attorneys and physicians; B. To make use of the services of the employees of the Employer in administrative matters; C. To obtain and act on the basis of all tables, valuations, certificates, opinions, and reports furnished by the persons described in Paragraph A. or B., above. Any determination of Actuarially Equivalent benefits by the actuary selected by the Administrator shall be conclusive and binding on the Employer, the Administrator and all Participants; D. To determine all benefits and resolve all questions pertaining to the administration and interpretation of the Plan provisions, either by rules of general applicability or by particular decisions. To the maximum extent permitted by law, all interpretations of the Plan and other decisions of the Administrator shall be conclusive and binding on all parties; E. To adopt such forms, rules and regulations as it shall deem necessary or appropriate for the administration of the Plan and the conduct of its affairs, provided that any such forms, rules and regulations shall not be inconsistent with the provisions of the Plan; F. To remedy any inequity from incorrect information received or communicated or from administrative error; G. To commence or defend any litigation arising from the operation of the Plan in any legal or administrative proceeding; -12- H. To direct the Employer to pay benefits under the Plan, and to give such other directions and instructions as may be necessary for the proper administration of the Plan; and I. To be responsible for the preparation, filing and disclosure on behalf of the Plan of such documents and reports as are required by any applicable federal or state law. 7.5 Employer's Responsibility to Administrator. The Employer shall ------------------------------------------ furnish the Administrator such data and information as he may require. The records of the Employer shall be determinative of each Participant's period of employment, termination of employment and the reason therefor, leave of absence, reemployment, years of service, personal data, and compensation reductions. Participants and their Beneficiaries shall furnish to the Administrator such evidence, data, or information, and execute such documents as the Administrator requests. 7.6 Expenses. All expenses incident to the operation and administration -------- of the Plan reasonably incurred, including, without limitation by way of specification, the fees and expenses of attorneys and advisors, and for such other professional, technical and clerical assistance as may be required, shall be paid by each Employer. 7.7 Liability. Neither the Administrator nor the Employer shall be liable --------- to any person for any action taken or omitted in connection with the administration of this Plan unless attributable to his own fraud or willful misconduct; nor shall the Employer be liable to any person for such action unless attributable to fraud or willful misconduct on the part of the director, officer or employee of the Employer. 7.8 Indemnification. To the extent coverage is not provided by any --------------- applicable insurance policy, the Plan Sponsor hereby agrees to indemnify the Administrator and each of its members, and to hold them harmless against any and all liability for their acts, omissions and conduct and for the acts, omissions and conduct of their duly appointed agents made in good faith pursuant to the provisions of the Plan, including, without limitation, any out-of-pocket expenses reasonably incurred in the defense of any claim relating thereto; provided, however, that no person or entity so indemnified shall voluntarily assume or admit any liability, nor, except at its or his own cost, shall any of the foregoing make any payment, assume any obligations or incur any expense without the prior written consent of the Plan Sponsor. The Plan Sponsor may purchase, at its expense, liability insurance to protect each Employer and the persons indemnified hereunder from liability incurred in the good faith administration of this Plan. 7.9 Procedure to Claim Benefits. Each Participant or Beneficiary must --------------------------- claim any benefit to which he is entitled under this Plan by a written notification to the Administrator. If a claim is denied, it must be denied within a reasonable period of time, and be contained in a written notice stating the following: A. The specific reason for the denial. -13- B. Specific reference to the Plan provision on which the denial is based. C. Description of additional information necessary for the claimant to present his claim, if any, and an explanation of why such material is necessary. D. An explanation of the Plan's claim review procedure. The claimant will have 60 days to request a review of the denial by the Administrator, who will provide a full and fair review. The request for review must be written and submitted to the same person who handles initial claims. The claimant may review pertinent documents, and he may submit issues and comments in writing. The decision by the Administrator with respect to the review must be given within 60 days after receipt of the request, unless special circumstances require an extension (such as the need for a hearing). In no event shall the decision be delayed beyond 120 days after receipt of the request for review. The decision shall be written in a manner calculated to be understood by the claimant, and it shall include specific reasons and refer to specific Plan provisions as to its effect. ARTICLE VIII - AMENDMENT AND TERMINATION 8.1 Plan Amendment. The Plan may be amended in whole or in part by the -------------- Committee at any time, provided, however, that no such action by the Committee shall reduce the amount of a Participant's benefit accrued as of the time thereof. Notice of any such amendment shall be given in writing to each Participant and each Beneficiary of a deceased Participant. 8.2 Termination of the Plan. The Committee shall have the right to ----------------------- terminate the Plan and/or the Deferral Agreement pertaining to a Participant at any time prior to the commencement of benefits, but only in the event that the Committee, in its sole discretion, shall determine that the economics of the Plan have been adversely and materially affected by a change in the tax laws, by any other government action or by any other event beyond the control of the Participant and the Committee or that the termination of the Plan is otherwise in the best interest of each Employer. In the event of any such termination, the Employer shall pay a benefit to the Participant or to the Beneficiary of any deceased Participant, in lieu of other benefits hereunder, equal to the full value of Participant's Deferred Benefit Accounts determined pursuant to Section 4.7 hereof. Moreover, in the event of any such termination, earnings shall continue to be credited in accordance with Section 4.7 hereof to the balance in the Participant's Deferred Benefit Accounts as of the Plan termination date. 8.3 Amendment or Termination Procedure. Each amendment shall be set forth ---------------------------------- in a written instrument and shall be authorized and approved by a resolution of the Committee. Similarly, the termination of the Plan shall be authorized and approved by a resolution of the Committee. -14- ARTICLE IX. - MISCELLANEOUS 9.1 Funding. Benefits payable under this Plan to a Participant or ------- Beneficiary, if applicable, shall be paid directly by each Employer from a so- called "rabbi trust", to the extent that such benefits are not paid from the general assets of the Employer. The rabbi trust is an irrevocable grantor trust, the assets of which are subject to the claims of the general creditors of each Employer in the event of its insolvency. Except as to any amounts paid or payable to the rabbi trust, the Employer shall not be obligated to set aside, earmark or escrow any funds or other assets to satisfy its obligations under this Plan, and the Participant and his Beneficiary shall not have any property interest in any specific assets of the Employer other than an unsecured right to receive payments from the Employer as provided herein. In the event that the amounts accumulated in the rabbi trust are not sufficient to pay the benefits payable under this Plan, such benefits shall be paid directly from the general assets of each Employer. 9.2 No Assignment Permitted. No Participant, Beneficiary or heir shall ----------------------- have any right to commute, sell, transfer, assign, alienate or otherwise convey the right to receive any payment under the terms of this Plan. Any such attempted assignment or alienation shall be considered null and void. 9.3 Supplemental Benefits. The benefits provided for the Participants --------------------- under this Plan are in addition to benefits provided by any other plan or program of the Employer and, except as otherwise expressly provided for herein, the benefits of this Plan shall supplement and shall not supersede any plan or agreement between the Employer and any Participant or any provisions contained therein. 9.4 Governing Law. The Plan shall be governed and construed under the ------------- internal laws of the Commonwealth of Pennsylvania, except to the extent preempted by Federal law. 9.5 Jurisdiction. The courts of the Commonwealth of Pennsylvania shall ------------ have exclusive jurisdiction in any and all actions arising under this Plan. 9.6 Payments to Minors and Incompetents. If a Participant or Beneficiary ----------------------------------- entitled to receive any benefits hereunder is a minor or is deemed by the Administrator or is adjudged to be legally incapable of giving a valid receipt and discharge for such benefits, they will be paid to the duly appointed guardian of such minor or incompetent or to such other legally appointed person as the Administrator may designate. Such payment shall, to the extent made, be deemed a complete discharge of any liability for such payment under the Plan. 9.7 Binding Terms. The terms of this Plan shall be binding upon and inure ------------- to the benefit of the Participants, Beneficiaries and Employer, their respective heirs, executors, administrators, successors and assigns. -15- 9.8 Status of Employment. Nothing herein contained shall be deemed: (1) -------------------- to give any Participant the right to be retained in the employ of the Employer or a subsidiary or affiliate; (2) to affect the right of the Employer to discipline or discharge any Participant at any time; (3) to give the Employer or a subsidiary or affiliate the right to require any Participant to remain in its employ; or (4) to affect any Participant's right to terminate his employment at any time. 9.9 Severability. In case any provision of this Plan shall be held ------------ illegal or invalid for any reason, such illegality or invalidity shall not affect the remaining provisions of the Plan, and the Plan shall be construed and enforced as if such illegal and invalid provisions had never been set forth. 9.1 Spendthrift Provision. The interest of any Participant or any --------------------- Beneficiary receiving payments hereunder shall not be subject to anticipation or assignment, nor to voluntary or involuntary alienation until distribution is actually made. 9.1 Headings. All headings preceding the text of the several Articles and -------- Sections hereof are inserted solely for convenience of reference and shall not constitute a part of this Plan, nor affect its meaning, construction or effect. 9.1 Rules of Interpretation. Where the context admits, words in the ----------------------- masculine gender shall include the feminine and neuter genders, and the singular shall mean the plural. -16- EX-10.15 3 AMENDMENT NO 1 AND RESTATEMENT EXHIBIT 10.15 AMENDMENT NO. 1 AND RESTATEMENT AMENDMENT NO. 1 AND RESTATEMENT, dated as of September 29, 1997 (this "Amendment and Restatement"), to the First Amended and Restated Letter of Credit ------------------------- Agreement, dated as of March 14, 1997 (the "Letter of Credit Agreement"), by and -------------------------- among PENNSYLVANIA MANUFACTURERS CORPORATION, a Pennsylvania corporation (the "Applicant") the Banks party thereto, CORESTATES BANK, N.A., as Co-Agent and THE --------- BANK OF NEW YORK, in its capacity as Agent and as Issuing Bank. RECITALS -------- A. Capitalized terms used herein which are not otherwise defined herein shall have the respective meanings ascribed thereto in the Letter of Credit Agreement. B. Prior to giving effect to this Amendment and Restatement, the Termination Date is October 27, 1997. C. The Applicant has requested that the Agent and the Banks agree to amend and restate the Letter of Credit Agreement upon the terms and conditions contained herein, and the Agent and the each of the Banks (other than Mellon Bank, N.A.) is willing so to agree (such Banks being referred to herein as the "Consenting Banks"). In addition, the Consenting Banks desire to assume a ---------------- portion of the Commitment of Mellon Bank, N.A. and each of the Consenting Banks to reallocate its rights and obligations under the Credit Documents upon the terms, and subject to the conditions, herein contained. Accordingly, in consideration of the Recitals and the covenants and conditions hereinafter set forth, and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, each of the Applicant, the Agent and each of the Consenting Banks hereby agrees that the Letter of Credit Agreement is hereby amended in accordance with the following and, immediately thereafter, shall be deemed to be restated in its entirety: 1. The Applicant hereby represents and warrants to the Agent, the Co-Agent, the Issuing Bank and each Bank that no Default or Event of Default exists and is continuing. 2. Prior to giving effect to this Amendment and Restatement, the Commitment Percentage of each Bank is as set forth in Exhibit A to the Letter of Credit Agreement and there have been no drawings under Letters of Credit which have not been reimbursed. 3. By signing below, (i) each Consenting Bank consents to this Amendment and Restatement and (ii) each Consenting Bank agrees to assume a portion of the Commitment of Mellon Bank, N.A. to the extent and at the time set forth in paragraph 5 hereof. 4. Subject to receipt by the Agent during the Extension Consent Period of a counterpart of this Amendment and Restatement signed by the Applicant, each Consenting Bank and Mellon Bank, N.A., and provided that the Applicant shall have fully reimbursed the Issuing Bank and/or the Banks for all drafts drawn on any Letter of Credit on or before the first day of such Extension Consent Period (the "Restatement Effective Date"), then, effective on the Restatement Effective -------------------------- Date: (a) the Termination Date shall be the date which is 364 days after the Restatement Effective Date, or such earlier date on which the Commitment is terminated, or if the Commitment is extended with the consent of the Banks pursuant to Section 2.6, such later date; and (b) each Consenting Bank hereby assumes from Mellon Bank, N.A. such rights, and Mellon Bank, N.A. hereby assigns to each Consenting Bank such obligations, as shall cause the Commitment Percentage of each Consenting Bank to be as set forth in Exhibit A to the Letter of Credit Agreement in the form attached hereto, which form shall be substituted for Exhibit A annexed to the Letter of Credit Agreement. 5. From and after the Restatement Effective Date, the Agent shall make all payments in respect of the interests assigned hereby to each Consenting Bank in proportion to their respective Commitment Percentages as set forth on such revised Exhibit A. 6. Mellon Bank, N.A. hereby represents and warrants to each Consenting Bank, which representations and warranties shall survive the consummation of the assignment provided for herein, that on and as of the date hereof and on the Restatement Effective Date, it is and shall be the legal and beneficial owner of the interests being assigned by it hereunder. 7. On the date hereof the Applicant hereby (i) reaffirms and admits the validity and enforceability of the Credit Documents and all of its obligations thereunder, (ii) agrees and admits that it has no defenses to or offsets against any such obligation, (ii) represents and warrants that no Event of Default, or event or condition which, with the giving of notice, the lapse of time, or any other condition, would, unless cured or waived, become an Event of Default, has occurred and is continuing, and that each of the representations and warranties made by it in the Credit Documents is true and correct with the same effect as though such representation and warranty had been made on such date, and (iv) certifies that no amendment, supplement, or modification to the certificate of incorporation or by-laws of the Applicant has been made since March 14, 1997. -2- 8. In all other respects, the Credit Documents shall remain in full force and effect, and no amendment in respect of any term or condition of any Credit Document contained herein shall be deemed to be an amendment in respect of any other term or condition contained in any Credit Document. 9. This Amendment and Restatement may be executed in any number of counterparts all of which, taken together, shall constitute one agreement. In making proof of this Amendment and Restatement, it shall only be necessary to produce the counterpart executed and delivered by the party to be charged. 10. This Amendment and Restatement embodies the entire agreement and understanding among the parties hereto with respect to the subject matter hereof and supersedes all other prior arrangements and understandings among the parties hereto with respect to the subject matter hereof. 11. This Amendment and Restatement is being delivered in and is intended to be performed in the State of New York and shall be construed and enforceable in accordance with, and be governed by, the internal laws of the State of New York without regard to principles of conflict of laws. -3- IN WITNESS WHEREOF, each of the parties has caused this Amendment No. 1 and Restatement to be executed by its duly authorized officer as of the date and year first written above. PENNSYLVANIA MANUFACTURERS CORPORATION By: /s/Edward Hochberg ________________________________ Name: Edward Hochberg Title:Vice President-Finance THE BANK OF NEW YORK, Individually and as Agent and Issuing Bank By: /s/Lizanne T. Eberle ________________________________ Name: Lizanne T. Eberle Title:Vice President CORESTATES BANK, N.A. Individually and as Co-Agent By: /s/ H.P. Tamimie ________________________________ Name: H.P. Tamimie Title: Vice President MELLON BANK, N.A. By: /s/ Joanna Patterson ________________________________ Name: Joanna Patterson Title: Officer -4- FLEET NATIONAL BANK By: /s/ Michael M. Sinisgalli ________________________________ Name: Michael M. Sinisgalli Title: Vice President PNC BANK, NATIONAL ASSOCIATION By: /s/ Kirk Seagers ________________________________ Name: Kirk Seagers Title: Vice President FIRST UNION NATIONAL BANK OF NORTH CAROLINA By: /s/ Gail M. Golightly ________________________________ Name: Gail M. Golightly Title: Senior Vice President -5- EX-10.16 4 AMENDMENT NO 2, DATED SEPTEMBER 28, 1998 EXHIBIT 10.16 AMENDMENT NO.2 TO LETTER OF CREDIT AGREEMENT -------------------------------------------- AMENDMENT NO. 2 (this "Amendment"), dated as of September 28, 1998, under --------- the First Amended and Restated Letter of Credit Agreement, dated as of March 14, 1997, among PENNSYLVANIA MANUFACTURERS CORPORATION, a Pennsylvania corporation (the "Applicant"), the Banks party thereto, FIRST UNION NATIONAL BANK, as --------- successor to CoreStates Bank N.A., as Co-Agent, and THE BANK OF NEW YORK, as Issuing Bank and as agent for the Banks (in such capacity, the "Agent"), as ----- amended by Amendment No. 1, dated September 29, 1997 (as so amended, the "Agreement"). --------- RECITALS -------- A. Capitalized terms used herein which are not defined herein shall have the respective meanings ascribed thereto in the Agreement. B. The Applicant desires that the Banks agree to extend the Commitment and Termination Date by 364 days and make certain other changes to the Agreement as set forth herein. C. The Banks signing below agree to such extension subject to the terms and conditions set forth below. Accordingly, in consideration of the terms and conditions hereinafter set forth, and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties hereto agree as follows: 1. The definition of Applicable Fee Percentage contained in Section 1.1 of the Agreement is amended in its entirety to read as follows: "Applicable Fee Percentage" means with respect to the Letter of Credit ------------------------- Commissions and Commitment Fees (i) with respect to Letter of Credit Commissions, (x) in the case of each Secured Letter of Credit, 0.325% and (y) in the case of each Unsecured Letter of Credit, the applicable percentage based on the Capitalization Ratio calculated as provided below set forth in the following table under the heading "Applicable Fee Percentage for Unsecured Letters of Credit" and (ii) with respect to Commitment Fees, the applicable percentage based on the Capitalization Ratio calculated as provided below set forth in the following table under the heading "Commitment Fee Percentage":
- ----------------------------------------------------------------------------------------------- CAPITALIZATION APPLICABLE FEE PERCENTAGE FOR COMMITMENT FEE RATIO UNSECURED LETTERS OF CREDIT PERCENTAGE - ----------------------------------------------------------------------------------------------- less than 0.20:1.00 0.350% 0.125% - ----------------------------------------------------------------------------------------------- greater than or equal to 0.20:1.00 and less than 0.25:1.00 0.450% 0.150% - ----------------------------------------------------------------------------------------------- greater than or equal to 0.25:1.00 and less than 0.30:1.00 0.550% 0.200% - ----------------------------------------------------------------------------------------------- greater than or equal to 0.30:1.00 0.650% 0.225% - -----------------------------------------------------------------------------------------------
From the Amendment Effective Date (as defined in Amendment No. 2 to this Agreement) until reset as set forth below, the Applicable Fee Percentage shall be based on the Capitalization Ratio as of the last day of the fiscal quarter ended June 30, 1998. The Applicable Fee Percentage shall be reset from time to time in accordance with the above table on the day of the delivery by the Applicant in accordance with Sections 5.1(a) and 5.1(b) of financial statements together with a Compliance Certificate attaching a Covenant Compliance Worksheet (reflecting the computation of the Capitalization Ratio as of the last day of the preceding fiscal quarter, beginning with the fiscal quarter ending September 30, 1998) that provides for a change in the Applicable Fee Percentage from that then in effect. If the Applicant shall fail to deliver a Compliance Certificate attaching a Covenant Compliance Worksheet within sixty (60) days after the end of each of the first three fiscal quarters (or one hundred twenty (120) days after the end of the last fiscal quarter), the Applicable Fee Percentage for Letter of Credit Commissions and Commitment Fees shall be 0.650% and 0.225%, respectively, for the period from and including the 61st day (the 121st day in the case of the last quarter) after the end of such fiscal quarter to the date of the delivery by the Applicant to the Administrative Agent of a Compliance Certificate attaching a Covenant Compliance Worksheet demonstrating that a different Applicable Fee Percentage is applicable. 2. Section 2.16 of the Agreement is amended by substituting the phrase "Applicable Fee Percentage" for "0.1875%" in the third line thereof. 3. Notwithstanding provisions of Section 2.6 to the contrary, each Bank consents to the extension of the Commitment and Termination Date for 364 days from the date hereof. 4. Paragraphs 1-3 of this Amendment shall not be effective until the prior or simultaneous fulfillment of the following conditions: (the "Amendment --------- Effective Date"): - -------------- -2- (a) the Agent shall have received this Amendment, duly executed by a duly authorized officer or officers of the Applicant, the Agent and each Bank; (b) the Agent shall have received a certificate of the Secretary or Assistant Secretary of the Applicant (i) attaching a true and complete copy of the resolutions of its board of directors authorizing this Amendment, in form and substance satisfactory to the Agent, (ii) certifying that its certificate of incorporation and by-laws have not been amended since March 14, 1997, or, if so, setting forth the same and (iii) setting forth the incumbency of its officer or officers who may sign this Amendment, including therein a signature specimen of such officer or officers; (c) a favorable opinion of Duane, Morris & Hecksher, counsel for the Applicant, addressed to the Agent and the Banks, in form and substance satisfactory to the Agent; and (d) the Agent shall have received such other documents as it shall reasonably request. 5. The Applicant hereby (i) reaffirms and admits the validity and enforceability of the Agreement and the other Credit Documents and all of its obligations thereunder, (ii) represents and warrants that there exists no Default or Event of Default immediately after giving effect to this Amendment, and (iii) represents and warrants that the representations and warranties contained in the Credit Documents, including the Agreement as amended by this Amendment (other than the representations and warranties made as of a specific date), are true and correct in all material respects on and as of the date hereof. 6. In all other respects, the Agreement and the other Credit Documents shall remain in full force and effect. 7. This Amendment may be executed in any number of counterparts, each of which shall be an original and all of which shall constitute one agreement. It shall not be necessary in making proof of this Amendment to produce or account for more than one counterpart signed by the party against which enforcement is sought. -3- 8. This Amendment is being delivered in and is intended to be performed in the State of New York and shall be construed and enforceable and be governed by, the internal laws of the State of New York without regard to principles of conflict of laws. [signature pages follow] -4- AS EVIDENCE of the agreement by the parties hereto to the terms and conditions herein contained, each such party has caused the Amendment No. 2 to the Letter of Credit Agreement to be executed on its behalf. PENNSYLVANIA MANUFACTURERS CORPORATION By:/s/Edward Hochberg _________________________________ Name:Edward Hochberg _______________________________ Title:Vice President ______________________________ PENNSYLVANIA MANUFACTURERS CORPORATION AMENDMENT NO. 2 TO LETTER OF CREDIT AGREEMENT THE BANK OF NEW YORK, Individually and as Agent and as Issuing Bank By:/s/Lizanne T. Eberle __________________________________ Name:Lizanne T. Eberle ________________________________ Title:Vice President _______________________________ PENNSYLVANIA MANUFACTURERS CORPORATION AMENDMENT NO. 2 TO LETTER OF CREDIT AGREEMENT FIRST UNION NATIONAL BANK, Individually and as Co-Agent By:/s/Thomas L. Stitchberg __________________________________ Name:Thomas L. Stitchberg ________________________________ Title:Senior Vice President _______________________________ PENNSYLVANIA MANUFACTURERS CORPORATION AMENDMENT NO. 2 TO LETTER OF CREDIT AGREEMENT FLEET NATIONAL BANK By:/s/William A. Bagley __________________________________ Name:William A. Bagley ________________________________ Title:Senior Vice President _______________________________ PENNSYLVANIA MANUFACTURERS CORPORATION AMENDMENT NO. 2 TO LETTER OF CREDIT AGREEMENT PNC BANK, NATIONAL ASSOCIATION By:/s/Kirk Seagers __________________________________ Name:Kirk Seagers ________________________________ Title:Vice President _______________________________ EX-10.17 5 AMENDMENT NO. 3, DATED OCTOBER 2, 1998 EXHIBIT 10.17 AMENDMENT NO. 3 TO LETTER OF CREDIT AGREEMENT --------------------------------------------- AMENDMENT NO. 3 (this "Amendment"), dated as of October 2, 1998, under --------- the First Amended and Restated Letter of Credit Agreement, dated as of March 14, 1997, among PENNSYLVANIA MANUFACTURERS CORPORATION, a Pennsylvania corporation (the "Applicant"), the Banks party thereto, FIRST UNION NATIONAL BANK, as --------- successor to CoreStates Bank N.A., as Co-Agent, and THE BANK OF NEW YORK, as Issuing Bank and as agent for the Banks (in such capacity, the "Agent"), as ----- amended by Amendment No. 1, dated September 29, 1997 and Amendment No. 2, dated September 28, 1998 (as so amended, the "Agreement"). --------- RECITALS -------- A. Capitalized terms used herein which are not defined herein shall have the respective meanings ascribed thereto in the Agreement. B. Pursuant to Consent No. 1, dated as of September 24, 1998, to the Agreement, Required Banks consented to the PMA Cayman Sale (as defined below). C. The Applicant has requested that the Agreement be amended to permit it to issue the Capital Securities referred to below and the Banks signing below are willing to approve such request subject to the terms and conditions set forth below. Accordingly, in consideration of the terms and conditions hereinafter set forth, and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties hereto agree as follows: 1. Section 1.1 of the Agreement is amended by adding the following definitions in their appropriate alphabetical order: "Capital Securities" shall mean preferred securities in an aggregate ------------------ face amount of up to $150,000,000 (i) to be issued by a Delaware business trust to be formed by the Applicant and (ii) guaranteed by the Applicant, the proceeds from the original issuance of which shall be used to purchase the Applicant's subordinated debentures issued under a subordinated debenture indenture. "Capital Securities Program Documents" shall mean, collectively, ------------------------------------ all documents executed and delivered in connection with the issuance of the Capital Securities and the subordinated debentures referred to in the definition of Capital Securities. "PMA Cayman Sale" shall mean the sale by Mid-Atlantic States --------------- Investment Company of all of its capital stock in PMA Cayman. "Subordinated Debentures" shall have the meaning set forth in ----------------------- Section 7.2(x). "Subordinated Guaranty" shall have the meaning set forth in --------------------- Section 7.2(x). 2. The definition of "Material Subsidiary" contained in Section 1.1 of the Agreement is amended by adding "provided, however, that on and after the consummation of the PMA Cayman Sale, PMA Cayman shall cease to be a Material Subsidiary" prior to the "." at the end of such definition. 3. The proviso contained in the definition of "Contingent Obligation" in Section 1.1 of the Agreement is amended to read as follows: provided, however, that, with respect to the Applicant and its -------- ------- Subsidiaries, the term Contingent Obligation shall not include (x) the Subordinated Guaranty, (y) endorsements for collection or deposit in the ordinary course of business or (z) obligations entered into by an Insurance Subsidiary in the ordinary course of its business under insurance policies or contracts issued by it or to which it is a party, including reinsurance agreements (and security posted by any such Insurance Subsidiary in the ordinary course of its business to secure obligations thereunder). 4. The definition of "Consolidated Net Worth" contained in Section 1.1 of the Agreement is amended in its entirety to read as follows: "Consolidated Net Worth" shall mean, at any time, the net worth ---------------------- of the Applicant and its Subsidiaries at such time, determined on a consolidated basis in accordance with Generally Accepted Accounting Principles plus the redemption value or liquidation preference (or, if ---- less, the original issuance price) of the Capital Securities but (i) excluding any preferred stock or other class of equity -2- securities (other than the Capital Securities) that, by its stated terms (or by the terms of any class of equity securities issuable upon conversion thereof or in exchange therefor), or upon the occurrence of any event, matures or is mandatorily redeemable, or is redeemable at the option of the holders thereof, in whole or in part, and (ii) without regard to the requirements of Statement of Financial Accounting Standards No. 115 issued by the Financial Accounting Standards Board. 5. Clauses (i) and (ii) of the definition of "Indebtedness" contained in Section 1.1 of the Agreement are amended to read as follows: (i) all indebtedness of such Person for borrowed money or in respect of loans or advances (other than indebtedness in respect of the Subordinated Debentures), (ii) all obligations of such Person evidenced by notes, bonds, debentures (other than the Subordinated Debentures) or similar instruments, 6. Section 7.2 of the Agreement is hereby amended by deleting the word "and" at the end of section 7.2(viii), by substituting "; and" for the period at the end of 7.2(ix) and adding the following clause at the end thereof: (x) the Applicant may issue subordinated debentures (the "Subordinated ------------ Debentures") to the trust issuing the Capital Securities in an aggregate ---------- principal amount not to exceed $150,000,000 and, without duplication, may guaranty the payment of the Capital Securities on a subordinated basis (the "Subordinated Guaranty"), in each case in connection with the issuance of --------------------- the Capital Securities, provided that: (A) no Default or Event of Default would exist before and after giving effect thereto, the representations and warranties set forth in Section 4 and in the other Credit Documents shall be true and correct (except to the extent that any such representation and warranty is expressly stated to have been made as of a specific date in which case such representation and warranty shall be true and correct as of such date) and the Agent shall have received a certificate of a financial officer of the Applicant, in form and substance satisfactory to the Agent, to the foregoing effects; (B) the terms of the Capital Securities, Subordinated Debentures and the Subordinated Guaranty shall be in all material respects substantially as described in Appendix A to Amendment No. 3 to this -3- Agreement or no less favorable to the Banks than as set forth in such Appendix A and in any event, shall contain the following features: (i) neither the Capital Securities nor the Subordinated Debentures shall by their terms mature or become mandatorily redeemable, or be redeemable or subject to any mandatory prepayment or repurchase requirement at the option of the holder, at any time on or prior to ten years after issuance of such securities, (ii) the Applicant shall have the right (so long as no event of default exists with respect to such securities) to defer the payment of interest on the Subordinated Debentures from time to time for a deferral period comprised of consecutive payment periods aggregating at least five years and, upon such election by the Applicant, the trust issuing the Capital Securities shall have a corresponding obligation to defer distributions with respect to the Capital Securities, and (iii) the Capital Securities, the Subordinated Debentures and the Subordinated Guaranty shall be fully subordinate and junior in right and time of payment to the Indebtedness evidenced by this Agreement and shall have other terms of subordination consistent with those prevailing in the market for similar subordinated securities as of the date of Amendment No. 3 to this Agreement; and (C) the Agent and each Bank shall have received a certificate of an executive officer of the Applicant attaching true and complete copies of all Capital Securities Program Documents. 7. Section 8.1 of the Agreement is amended by substituting "; or" for the period at the end of subsection (n) thereof and by adding a new subsection (o) to read as follows: (o) The occurrence of an event of default in respect of the Capital Securities or any other event shall occur or condition exist in respect thereof, the effect of which is to cause, or permit the holder of any Capital Security (or a trustee or agent on its or their behalf) to cause (with the giving of notice, lapse of time, or both), such Capital Security to become due, or to be prepaid, redeemed, purchased or defeased, prior to its stated maturity. 8. Section 5.1(b) of the Agreement is amended by adding the phrase "for each fiscal year prior to the fiscal year in which the PMA Cayman Sale is consummated," at the beginning of clause (iii) thereof. 9. Attachment A to Exhibit E-2 (Form of Covenant Compliance Certificate (Statutory Financial Statements) is amended by adding to the end of Item 1(h) thereof "(enter zero after the consummation of the PMA Cayman Sale)". -4- 10. Paragraphs 1-9 of this Amendment shall not be effective until the prior or simultaneous fulfillment of the following conditions: (the "Amendment --------- Effective Date"): - -------------- (a) the Agent shall have received this Amendment, duly executed by a duly authorized officer or officers of the Applicant, the Agent and Required Banks; (b) the Agent shall have received a certificate of the Secretary or Assistant Secretary of the Applicant (i) attaching a true and complete copy of the resolutions of the Executive and Finance Committees of its Board of Directors authorizing this Amendment, in form and substance satisfactory to the Agent, (ii) certifying that its certificate of incorporation and by- laws have not been amended since March 14, 1997, or, if so, setting forth the same and (iii) setting forth the incumbency of its officer or officers who may sign this Amendment, including therein a signature specimen of such officer or officers; (c) the Agent shall have received a copy of an amendment to the Revolving Credit Agreement, in form and substance satisfactory to it, which amendment shall have been executed by the Agents and Required Banks (as defined therein); (d) the reasonable fees and expenses of Special Counsel incurred to date, shall have been paid; and (e) the Agent shall have received such other documents as it shall reasonably request. 11. The Applicant hereby (i) reaffirms and admits the validity and enforceability of the Agreement and the other Credit Documents and all of its obligations thereunder, (ii) represents and warrants that there exists no Default or Event of Default immediately after giving effect to this Amendment, and (iii) represents and warrants that the representations and warranties contained in the Credit Documents, including the Agreement as amended by this Amendment (other than the representations and warranties made as of a specific date), are true and correct in all material respects on and as of the date hereof. -5- 12. In all other respects, the Agreement and the other Credit Documents shall remain in full force and effect. 13. This Amendment may be executed in any number of counterparts, each of which shall be an original and all of which shall constitute one agreement. It shall not be necessary in making proof of this Amendment to produce or account for more than one counterpart signed by the party against which enforcement is sought. 14. This Amendment is being delivered in and is intended to be performed in the State of New York and shall be construed and enforceable and be governed by, the internal laws of the State of New York without regard to principles of conflict of laws. [signature pages follow] -6- AS EVIDENCE of the agreement by the parties hereto to the terms and conditions herein contained, each such party has caused this Amendment No. 3 to the Letter of Credit Agreement to be executed on its behalf. PENNSYLVANIA MANUFACTURERS CORPORATION By:/s/Edward Hochberg _______________________ Name:Edward Hochberg _____________________ Title:Vice Presdent- Finance ______________________ PENNSYLVANIA MANUFACTURERS CORPORATION AMENDMENT NO. 3 TO LETTER OF CREDIT AGREEMENT THE BANK OF NEW YORK, Individually and as Agent and as Issuing Bank By:/s/Lizanne T. Eberle _________________________________ Name:Lizanne T. Eberle _______________________________ Title:Vice President ______________________________ -2- PENNSYLVANIA MANUFACTURERS CORPORATION AMENDMENT NO. 3 TO LETTER OF CREDIT AGREEMENT FIRST UNION NATIONAL BANK, Individually and as Co-Agent By:/s/Thomas L. Stitchberg ________________________________ Name:Thomas L. Stitchberg ______________________________ Title:Senior Vice President _____________________________ -3- PENNSYLVANIA MANUFACTURERS CORPORATION AMENDMENT NO. 3 TO LETTER OF CREDIT AGREEMENT FLEET NATIONAL BANK By:/s/William A. Bagley ________________________________ Name:William A. Bagley ______________________________ Title:Senior Vice President _____________________________ -4- PENNSYLVANIA MANUFACTURERS CORPORATION AMENDMENT NO. 3 TO LETTER OF CREDIT AGREEMENT PNC BANK, NATIONAL ASSOCIATION By:/s/Kirk Seagers ________________________________ Name:Kirk Seagers ______________________________ Title:Vice President _____________________________ -5- EX-12 6 COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES Exhibit 12 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (1) (In Thousands, except ratio)
1998 1997 1996 1995 1994 ----------- ----------- ------------- ---------- ----------- EARNINGS Pre-tax income (loss) $55,069 $25,153 $(191,394) $34,913 $65,380 Fixed charges 15,865 16,683 17,913 19,594 13,911 ------------------------------------------------------------------ Total(a) $70,934 $41,836 $(173,481) $54,507 $79,291 ================================================================== FIXED CHARGES Interest expense and amortization of debt discount and premium on all indebtedness $15,009 $15,768 $ 17,052 $18,734 $13,051 Interest portion of rental expense 856 915 861 860 860 ------------------------------------------------------------------ Total fixed charges (b) $15,865 $16,683 $ 17,913 $19,594 $13,911 ================================================================== Ratio of earnings to fixed charges(a)/(b) 4.5x 2.5x (2) 2.8x 5.7x
(1) For purposes of determining this ratio, earnings (loss) consist of income 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 are representative of the interest factor. (2) Earnings were insufficient to cover fixed charges by $191.4 million in 1996. EX-13 7 PORTIONS OF COMPANY'S 1998 ANNUAL REPORT
Exhibit 13 P M A C A P I T A L Selected Financial Data For the years ended December 31, (dollar amounts in thousands, except share and per share data) 1998(1) 1997(1) 1996(1) 1995(1) 1994(1) - ----------------------------------------------------------------------------------------------------------------------------------- Net premiums written $ 474,761 $ 381,282 $ 432,975 $ 485,876 $ 465,502 ====================================================================================== Consolidated Results of Operations: Net premiums earned $ 466,715 $ 375,951 $ 420,575 $ 484,952 $ 466,534 Net investment income 120,125 133,392 130,837 138,111 138,719 Net realized investment gains 21,745 8,598 2,984 31,923 47,521 Other revenues 14,896 13,617 12,288 6,350 3,380 -------------------------------------------------------------------------------------- Total consolidated revenues $ 623,481 $ 531,558 $ 566,684 $ 661,336 $ 656,154 ====================================================================================== Income (loss) before extraordinary loss $ 44,734 $ 19,753 $ (135,334) $ 24,130 $ 57,250 Extraordinary loss from early extinguishment of debt, net of related tax effect(2) -- (4,734) -- -- -- -------------------------------------------------------------------------------------- Net income (loss) $ 44,734 $ 15,019 $ (135,334) $ 24,130 $ 57,250 ====================================================================================== Per Share Data: Weighted average shares: Basic(3) 23,608,618 23,855,031 23,800,791 23,816,088 23,897,263 Diluted(3),(4) 24,524,888 24,567,378 23,800,791 24,781,949 24,650,741 Income (loss) before extraordinary loss, net of related tax effect Basic(3) $ 1.89 $ 0.83 $ (5.68) $ 1.01 $ 2.40 Diluted(3),(4) 1.82 0.80 (5.68) 0.97 2.32 Net income (loss) per share: Basic(3) 1.89 0.63 (5.68) 1.01 2.40 Diluted(3),(4) 1.82 0.61 (5.68) 0.97 2.32 Dividends paid per common share 0.32 0.32 0.32 0.32 0.32 Dividends paid per Class A common share 0.36 0.36 0.36 0.36 0.36 Shareholders' equity per share 21.90 19.96 17.86 25.53 22.10 Consolidated Financial Position: Total investments $ 2,325,409 $ 2,194,738 $ 2,261,353 $ 2,455,949 $ 2,313,261 Total assets 3,460,718 3,057,258 3,117,516 3,258,572 3,181,979 Reserves for unpaid losses and LAE 1,940,895 2,003,187 2,091,072 2,069,986 2,103,714 Long-term debt 163,000 203,000 204,699 203,848 203,975 Shareholders' equity(5) 511,480 478,347 425,828 609,668 524,862
(1) Operating results in 1998, 1997, 1996 and 1995 were impacted by approximately $2.1 million, $12.1 million, $223.1 million and $8.4 million,respectively, of restructuring and other special charges. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" for further information. In addition, 1994 operating results included a charge of approximately $4.9 million to write down the value of the Company's former headquarters building. (2) In 1997, the Company refinanced substantially all of its long-term debt resulting in a $4.7 million extraordinary loss, net of tax effect. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." (3) In 1997, the Company adopted SFAS No. 128, "Earnings Per Share," which requires the presentation of basic and diluted earnings per share. See Notes 2-H and 16 to the Company's Consolidated Financial Statements for additional information. All prior periods' presentation of earnings per share data has been restated to conform to SFAS No. 128. (4) 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. (5) In 1994, shareholders' equity increased $45.3 million related to the adoption of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." (6) Pre-tax operating income (loss) excludes net realized investment gains. Pre-tax operating income by business segment for all periods is unaudited and has been presented in accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which the Company adopted on January 1, 1998. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 17 to the Company's Consolidated Financial Statements. 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 current operating fundamentals or 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. 26 P M A C A P I T A L Management's Discussion and Analysis of Financial Condition and Results of Operations The following section provides a discussion of the financial results and material changes in financial position for PMA Capital Corporation and its consolidated subsidiaries ("PMA Capital" or the "Company") for the years ended December 31, 1998, 1997 and 1996. The balance sheet information presented below is as of December 31 for each respective year. The statement of operations information is for the years ended December 31 for each respective year. The term "SAP" refers to the statutory accounting practices prescribed or permitted by applicable state insurance departments and the term "GAAP" refers to generally accepted accounting principles. In the discussion below, pre-tax operating income (loss) is defined as income (loss) before extra-ordinary loss and before income taxes, but excluding net realized investment gains. Operating revenues consist of all of the Company's revenues, except net realized investment gains. Consolidated Results The table below presents the major components of net income (loss):
(dollar amounts in thousands, except per share data) 1998 1997 1996 - ------------------------------------------------------------------------------------------ Pre-tax operating income (loss) $ 33,324 $ 16,555 $(194,378) Net realized investment gains 21,745 8,598 2,984 ----------------------------------- Income (loss) before income taxes 55,069 25,153 (191,394) Provision (benefit) for income taxes 10,335 5,400 (56,060) ----------------------------------- Income (loss) before extraordinary loss 44,734 19,753 (135,334) Extraordinary loss, net of related taxes -- (4,734) -- ----------------------------------- Net income (loss) $ 44,734 $ 15,019 $(135,334) =================================== Per basic share: Income (loss) before extraordinary loss $ 1.89 $ 0.83 $ (5.68) Extraordinary loss -- (0.20) -- ----------------------------------- Net income (loss) $ 1.89 $ 0.63 $ (5.68) =================================== Per diluted share: Income (loss) before extraordinary loss $ 1.82 $ 0.80 $ (5.68) Extraordinary loss -- (0.19) -- ----------------------------------- Net income (loss) $ 1.82 $ 0.61 $ (5.68) ===================================
As of January 1, 1998, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures About Segments of an Enterprise and Related Information," which establishes standards for the reporting of information about operating segments. SFAS No. 131 also establishes standards for related disclosures about products and services, geographic areas and major customers. In connection with the adoption of SFAS No. 131, the Company has identified four reportable segments: (i) PMA Re, which provides property and casualty reinsurance products and services; (ii) The PMA Insurance Group, which writes workers' compensation and other standard lines of commercial insurance; (iii) Caliber One, which writes specialty insurance focusing on excess and surplus lines; and (iv) Corporate and Other, which includes unallocated investment income; expenses, including debt service; and taxes, as well as the results of certain of the Company's real estate properties. SFAS No. 131 requires only additional disclosures and does not affect the Company's financial position or results of operations. Because Caliber One's operating results were not significant in 1997, Caliber One's financial information was included within the Corporate and Other segment in 1997. 28 P M A C A P I T A L 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 current operating fundamentals or 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 investment gains (losses) that do not relate to the operations of the individual segments (see "Net Realized Investment Gains" below for additional discussion). Pursuant to the adoption of SFAS No. 131, the Company has restated the corresponding information for 1997 and 1996 for comparability, primarily related to certain corporate expenses that were previously allocated to the operating segments that are now reported in the Corporate and Other segment (see Note 17 to the Company's Consolidated Financial Statements for additional information). The Company's pre-tax operating income (loss) by principal business segment is as follows:
(dollar amounts in thousands) 1998 1997 1996 - --------------------------------------------------------------------------------------------- PMA Re $ 46,408 $ 45,957 $ 44,807 The PMA Insurance Group: Excluding Run-off Operations 10,018 (3,607) (215,669) Run-off Operations(1) 452 (73) -- ----------------------------------- Total 10,470 (3,680) (215,669) Caliber One (1,606) -- -- Corporate and Other (6,939) (9,954) (6,464) ----------------------------------- Pre-tax operating income (loss) before interest expense 48,333 32,323 (177,326) Interest expense 15,009 15,768 17,052 ----------------------------------- Pre-tax operating income (loss) $ 33,324 $ 16,555 $(194,378) ===================================
(1) Run-off Operations of The PMA Insurance Group were classified by management and segregated from ongoing operations effective December 31, 1996. See "The PMA Insurance Group" for additional discussion of Run-off Operations. In 1998, the Company reported consolidated pre-tax operating income of $33.3 million compared to $16.6 million in 1997. The improvement in the 1998 results was due primarily to increased pre-tax operating income generated by The PMA Insurance Group and PMA Re, as well as the absence of charges related to The PMA Insurance Group's continued restructuring and cost reduction initiatives of $9.2 million in 1997. The Company reported consolidated pre-tax operating income of $16.6 million in 1997 compared to a $194.4 million pre-tax operating loss for 1996. The improvement in 1997 was primarily due to increased pre-tax operating income generated by PMA Re and the absence of pre-tax charges totalling $221.3 million for The PMA Insurance Group primarily related to reserve strengthening and restructuring and cost reduction activities. The Company currently expects earnings to continue to improve in 1999 reflecting higher earnings from PMA Re and The PMA Insurance Group. This expectation may differ materially from actual results because of the risk factors noted in the "Cautionary Statements" on page 49. Consolidated net income (loss) was $44.7 million in 1998, $15.0 million in 1997 and ($135.0) million 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 (the "Credit Facility"). In connection with this refinancing, the Company recognized an extraordinary loss, net of tax, from the early extinguishment of debt of $4.7 million in 1997. 29 P M A C A P I T A L Management's Discussion and Analysis (continued) PMA Re Summarized financial results of PMA Re are as follows: (dollar amounts in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------- Net premiums written $234,010 $177,934 $164,053 ================================= Net premiums earned $223,559 $163,603 $151,974 Net investment income 54,734 52,270 48,676 --------------------------------- Operating revenues 278,293 215,873 200,650 --------------------------------- Losses and Loss Adjustment Expenses incurred 154,062 113,931 111,937 Acquisition and operating expenses 77,823 55,985 43,906 --------------------------------- Total losses and expenses 231,885 169,916 155,843 --------------------------------- Pre-tax operating income $ 46,408 $ 45,957 $ 44,807 ================================= GAAP loss and LAE ratio 68.9% 69.6% 73.7% GAAP combined ratio 103.7% 103.8% 102.6% SAP loss and LAE ratio 68.6% 69.5% 73.7% SAP combined ratio 104.3% 103.8% 104.4% Operating Results PMA Re's pre-tax operating income increased to $46.4 million in 1998 compared to $46.0 million in 1997, primarily due to higher premium volume and higher investment income, partially offset by increased acquisition costs. The increase in PMA Re's pre-tax operating income to $46.0 million in 1997 compared to $44.8 million in 1996 was due to higher premium volume, improved underwriting results and higher investment income, partially offset by increased acquisition costs. Premium Revenues The following table indicates PMA Re's gross and net premiums written by major category of business: 1998 1997 (dollar amounts in thousands) 1998 1997 1996 Change % Change % - -------------------------------------------------------------------------------- Gross premiums written: Casualty lines $206,317 $151,901 $143,991 35.8% 5.5% Property lines 76,975 72,625 63,325 6.0% 14.7% Other lines 1,044 795 842 31.3% (5.6)% -------------------------------------------------- Total $284,336 $225,321 $208,158 26.2% 8.2% ================================================== Net premiums written: Casualty lines $168,452 $118,889 $122,008 41.7% (2.6)% Property lines 64,497 58,257 41,240 10.7% 41.3% Other lines 1,061 788 805 34.6% (2.1)% -------------------------------------------------- Total $234,010 $177,934 $164,053 31.5% 8.5% ================================================== 30 P M A C A P I T A L In 1998 and 1997, net premiums written increased 31.5% and 8.5%, respectively. The increases in 1998 and 1997 primarily reflect expanding relationships with PMA Re's existing clients, as well as new contracts with targeted clients. In addition, as a result of the increased business flow generated by these activities, estimated net premiums written and not received increased by $16.6 million in the fourth quarter of 1998. Partially offsetting these increases in 1998 and 1997 were the effects of highly competitive conditions in the U.S. reinsurance market, which has caused PMA Re not to renew certain accounts largely due to inadequate rates and/or other underwriting concerns. PMA Re's net casualty premiums written increased $49.6 million, or 41.7%, in 1998 compared to 1997 and decreased $3.1 million, or 2.6%, in 1997 compared to 1996. The growth in 1998 was due to the generation of new business resulting from the expansion of relationships with existing clients, which accounted for approximately $33 million of net casualty premiums written in 1998, as well as the development of relationships with new clients, which accounted for approximately $17 million of net casualty premiums written in 1998. The decrease in 1997 was primarily attributable to increased retrocessional protection purchased, which offset increases in gross casualty premiums relating to new business with existing clients and larger participation on existing programs. PMA Re's net property premiums written increased 10.7% in 1998 compared to 1997 and 41.3% during 1997 compared to 1996. The growth in 1998 was primarily attributable to the addition of new programs covering allied lines. The increase in net property premiums written in 1997 was primarily the result of lower property premiums ceded in 1997. Net premiums earned increased 36.6% in 1998 compared to 1997 and 7.7% in 1997 compared to 1996. Each year's increase corresponds to the increase in net premiums written. Generally, trends in net premiums earned follow patterns similar to net premiums written, with premiums being earned principally on a pro rata basis over the terms of the contracts. Losses and Expenses The following table indicates the components of PMA Re's combined ratios, as computed on a GAAP basis (1): 1998 1997 1996 - ------------------------------------------------------------------------------ Loss and LAE ratio 68.9% 69.6% 73.7% ------------------------------------- Expense ratio: Acquisition expenses 28.9% 27.6% 24.7% Operating expenses 5.9% 6.6% 4.2% ------------------------------------- Total expense ratio 34.8% 34.2% 28.9% ------------------------------------- Combined ratio-GAAP 103.7% 103.8% 102.6% ===================================== (1) The combined ratio computed on a GAAP basis is equal to losses and loss adjustment expenses ("LAE"), plus the sum of acquisition expenses, operating expenses and policyholders' dividends (where applicable), all divided by net premiums earned. PMA Re's loss and LAE ratio decreased 0.7 points to 68.9% in 1998 compared to 69.6% in 1997. This decrease was primarily attributable to net favorable development on prior years' unpaid losses and LAE of $25.0 million. Net favorable development on prior years' unpaid losses and LAE was $23.3 million and $28.6 million in 1997 and 1996, respectively. In 1997, PMA Re's loss and LAE ratio declined 4.1 points to 69.6% compared to 73.7% in 1996, largely due to increased retrocessional protection purchased for the 1997 accident year. 31 P M A C A P I T A L Management's Discussion and Analysis (continued) The ratio of acquisition expenses to net premiums earned (the "Acquisition Expense Ratio") increased to 28.9% in 1998 from 27.6% and 24.7% in 1997 and 1996, respectively, primarily reflecting the increasingly competitive conditions in the U.S. reinsurance market. Additionally, the ceding commissions that PMA Re received related to its retrocessional catastrophe cover were lower in 1997 than in 1996, which also contributed to the higher Acquisition Expense Ratio in 1997. The ratio of operating expenses to net premiums earned (the "Operating Expense Ratio") decreased 0.7 points to 5.9% in 1998 compared to 6.6% in 1997. The improvement in the Operating Expense Ratio primarily reflects faster growth in premiums than in operating expenses. The Operating Expense Ratio increased 2.4 points in 1997 to 6.6% compared to 4.2% in 1996. This increase reflects higher 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, 1998, PMA Re has continued to add staff in response to increased premium volume and to increase the level of specialized services provided to customers. Net Investment Income Net investment income increased 4.7% to $54.7 million in 1998 from $52.3 million in 1997, which represented a 7.4% increase from $48.7 million in 1996. Such increases were primarily attributable to the overall increase in PMA Re's invested assets, as well as changes in portfolio holdings. At amortized cost, PMA Re's cash and invested assets increased $52.5 million, or 6.0%, and $49.0 million, or 5.9%, during 1998 and 1997, respectively. During 1998 and 1997, PMA Re shifted some of its holdings from government securities to corporate and asset-backed securities, which generally yield higher levels of investment income. The PMA Insurance Group The PMA Insurance Group is comprised of Pennsylvania Manufacturers' Association Insurance Company, Manufacturers Alliance Insurance Company and Pennsylvania Manufacturers Indemnity Company (collectively, the "Pooled Companies"), as well as PMA Management Corp., Pennsylvania Manufacturers International Insurance, Limited and Run-off Operations. Run-off operations ("Run-off Operations") of The PMA Insurance Group were classified by management and segregated from ongoing operations effective December 31, 1996 and include Mid-Atlantic States Casualty Company, PMA Life Insurance Company, PMA International Insurance, Cayman Limited and PMA Insurance, Cayman Limited, which was sold effective July 1, 1998 (see discussion below for further details). The Run-off Operations have been established internally to reinsure certain obligations primarily associated with workers' compensation claims written by the Pooled Companies for the years 1991 and prior. The Run-off Operations have been segregated into separate legal entities and substantially all of the assets of the Run-off Operations are held in trust for the benefit of the Pooled Companies. 32 P M A C A P I T A L Summarized financial results of The PMA Insurance Group are as follows: (dollar amounts in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------- Net premiums written: Workers' compensation $ 187,033 $ 175,301 $ 187,698 Commercial Lines 57,204 79,669 84,781 Run-off Operations(1) (9,400) (51,622) -- -------------------------------------- Total $ 234,837 $ 203,348 $ 272,479 ====================================== Net premiums earned: Workers' compensation $ 185,132 $ 189,773 $ 176,380 Commercial Lines 66,196 74,197 92,221 Run-off Operations(1) (9,400) (51,622) -- -------------------------------------- Total 241,928 212,348 268,601 -------------------------------------- Net investment income: Excluding Run-off Operations 50,419 53,796 82,364 Run-off Operations(1) 14,161 28,131 -- -------------------------------------- Total 64,580 81,927 82,364 -------------------------------------- Other revenues 9,722 10,482 9,280 -------------------------------------- Operating revenues 316,230 304,757 360,245 -------------------------------------- Losses and LAE incurred: Excluding Run-off Operations 196,018 220,990 424,900 Run-off Operations(1) 1,507 (27,460) -- -------------------------------------- Total 197,525 193,530 424,900 -------------------------------------- Acquisition and operating expenses: Excluding Run-off Operations 87,697 96,149 134,759 Run-off Operations(1) 2,802 4,042 -- -------------------------------------- Total 90,499 100,191 134,759 -------------------------------------- Dividends to policyholders 17,736 14,716 16,255 -------------------------------------- Total losses and expenses 305,760 308,437 575,914 -------------------------------------- Pre-tax operating income (loss) $ 10,470 $ (3,680) $(215,669) ====================================== GAAP loss and LAE ratio 81.6% 91.1% 158.2% GAAP combined ratio 122.6% 140.8% 211.4% SAP loss and LAE ratio(2) 78.2% 84.0% 125.7% SAP combined ratio(2) 113.7% 119.0% 175.6% (1) Run-off Operations were classified by management and segregated from ongoing operations effective December 31, 1996. (2) The SAP loss and LAE and combined ratios above relate to the operations of the Pooled Companies. Operating Results The PMA Insurance Group increased its pre-tax operating income in 1998 to $10.5 million, compared to a pre-tax operating loss of $3.7 million in 1997, primarily due to improved loss experience in workers' compensation business, reduced exposures in other commercial lines of business and lower operating expenses resulting from ongoing cost reduction initiatives. The PMA Insurance Group decreased its pre-tax operating loss in 1997 to $3.7 million, compared to a pre-tax operating loss of $215.7 million in 1996, primarily due to the absence of a pre-tax charge of $221.3 million ($143.8 million after-tax) to strengthen loss and LAE reserves, to recognize restructuring costs in connection with staff reductions and to write-off certain accounts receivable, as well as lower operating expenses reflecting the impact of cost savings initiatives implemented in late 1996 and in 1997. 33 P M A C A P I T A L Management's Discussion and Analysis (continued) The PMA Insurance Group Excluding Run-off Operations Premium Revenues Net premiums written, which represent direct premiums written plus premiums assumed, less premiums ceded, decreased in the three-year period ended December 31, 1998. Between 1998 and 1997, net premiums written decreased 4.2%, and between 1997 and 1996, net premiums written decreased 6.4%. The decline in 1998 primarily reflects a decrease of $28.4 million in 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"), partially offset by a decrease of $15.1 million in reinsurance premiums ceded and an increase of $2.4 million in direct premiums written for workers' compensation. The decline in 1997 primarily reflects decreases of $10.1 million in direct premiums written for workers' compensation and $4.4 million in reinsurance premiums assumed, as well as an increase of $13.9 million in reinsurance premiums ceded, partially offset by an increase of $10.9 million in direct premiums written for Commercial Lines. Direct workers' compensation premiums written were higher in 1998 compared to 1997 due to an increase in risks underwritten during 1998, partially offset by manual rate reductions averaging approximately 13% in its principal marketing territories and continued intense price competition. The decline in direct workers' compensation written premiums in 1997 compared to 1996 was due primarily to rate reductions associated with workers' compensation benefit reform laws and continued intense price competition, partially offset by an increase in risks underwritten. The enactment of workers' compensation benefit reform laws in The PMA Insurance Group's marketing territory has caused manual rates for workers' compensation to decline in the past three years. Because manual rate reductions directly affect the prices that The PMA Insurance Group can charge for its rate sensitive workers' compensation products, such declines in manual rate levels have had a significant effect on workers' compensation premium volume. The premium charged on a fixed-cost policy is based upon the manual rates filed with the state insurance department and does not increase or decrease prospectively based upon the losses incurred during the policy period. In terms of manual rates, average rate levels declined approximately 13%, 25% and 7% in 1998, 1997 and 1996, respectively. The decline in rate levels for workers' compensation has been most pronounced in Pennsylvania, where the most significant benefit reforms have occurred. These benefit reform laws also have had a favorable impact on losses and LAE for business written on policies subject to such reform laws (see "Losses and Expenses" below). The PMA Insurance Group has shifted its workers' compensation premiums towards lower hazard lines of business such as health care, schools/colleges and retail which comprised 25.8%, 20.6% and 12.9% of total workers' compensation premiums written in 1998, 1997 and 1996, respectively, away from higher hazard lines of business, including construction and manufacturing which comprised 43.1%, 46.4% and 52.0% of total workers' compensation premiums written in 1998, 1997 and 1996, respectively. Direct workers' compensation premiums were also impacted by changes in the level of premium adjustments, primarily related to audit premiums and retrospective policies. Under retrospectively rated policies, The PMA Insurance Group receives an up-front provisional premium, which is adjusted based upon the actual loss experience of the insured. In 1998, such adjustments decreased premiums written by $4.7 million ($13.2 million in audit premiums billed and $17.9 million in retrospective premiums 34 P M A C A P I T A L returned). 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). Changes in actuarial estimates of future premium adjustments on retrospective policies are recorded directly in net premiums written and net premiums earned in the period they are identified (see the Company's 1998 Form 10-K and Note 2-L to the Company's Consolidated Financial Statements for further discussion). During 1998, direct writings of Commercial Lines decreased $28.4 million primarily due to planned reductions in such lines as well as continued competitive conditions. Rather than lower prices to what it believes are unacceptable levels, The PMA Insurance Group has chosen not to renew some of its business in the Commercial Lines. In 1998, ceded Commercial Lines premiums decreased $6.4 million compared to 1997 due to the reduction in direct Commercial Lines business written. During 1997, direct writings of Commercial Lines increased $10.9 million due primarily to rate increases on existing business, as well as additional companion commercial business associated with new workers' compensation customers. The $12.8 million increase in ceded Commercial Lines premiums in 1997 reflects the reduction in the per risk attachment point to $175,000 from $500,000 on a reinsurance treaty that covers substantially all of the Commercial Lines casualty business. Net premiums earned decreased 4.8% in 1998 compared to 1997 and 1.7% in 1997 compared to 1996. Each year's decrease corresponds to the decrease in net premiums written. Generally, trends in net premiums earned follow patterns similar to net premiums written, with premiums being earned principally on a pro rata basis over the terms of the policies. Losses and Expenses The following table reflects the components of the GAAP combined ratios for The PMA Insurance Group, excluding Run-off Operations: 1998 1997 1996(1) - ---------------------------------------------------------------------------- Loss and LAE ratio 78.0% 83.7% 158.2% ------------------------------ Expense ratio: Acquisition expenses 18.0% 18.3% 19.7% Operating expenses(2) 13.3% 14.6% 27.4% ------------------------------ Total expense ratio 31.3% 32.9% 47.1% ------------------------------ Policyholders' dividend ratio 7.1% 5.6% 6.1% ------------------------------ Combined ratio-GAAP 116.4% 122.2% 211.4% ============================== The components of the loss and LAE ratio are as follows: 1998 1997 1996(1) - ---------------------------------------------------------------------------- Current accident year - undiscounted 80.0% 81.0% 81.4% Accretion of discount for prior accident years greater than (less than) discounting of current accident year (0.2)% 3.1% 5.5% Prior year reserve (redundancy) deficiency (1.8)% (0.4)% 71.3% ------------------------------ Loss and LAE ratio 78.0% 83.7% 158.2% ============================== (1) Ratios for 1996 include the results of operations that were classified as Run-off Operations effective December 31, 1996. (2) The GAAP Operating Expense Ratio excludes $9.0 million, $9.3 million and $8.2 million in 1998, 1997 and 1996, respectively, of PMA Management Corp. direct expenses related to service revenues, which are not included in premiums earned. 35 P M A C A P I T A L Management's Discussion and Analysis (continued) The shift in the mix of business toward workers' compensation premiums had a favorable impact on the loss and LAE ratio in 1998, as workers' compensation business has had better loss experience than other Commercial Lines in The PMA Insurance Group's marketing territory. In addition, measures to control medical costs and LAE in workers' compensation have improved the overall loss and LAE ratio. Medical costs have improved primarily due to The PMA Insurance Group's affiliation with a national preferred provider organization, which became effective in the fourth quarter of 1997. This affiliation has enabled The PMA Insurance Group to lower its cost in providing medical benefits to injured workers. In addition to this improvement in loss costs, LAE have decreased as well, primarily due to continued use of certain claims resolution practices. By using techniques such as managed care and commutations, The PMA Insurance Group has reduced the amount and number of outstanding claims and the amount of time that a claim remains open. This in turn has lowered costs associated with managing open claims. Benefit reforms enacted by states in which The PMA Insurance Group transacts business, most significantly Pennsylvania, have had a beneficial impact on more recent accident year loss and LAE ratios. The principal revisions of 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 health care providers as well as a substantial reduction in the indemnity benefit periods in Pennsylvania. Since 1996, the impact on the loss and LAE ratio from the effects of discounting loss reserves has declined due mainly to the effect of commutations and lower business writings. The PMA Insurance Group has been executing programs under which it commuted, or settled, a large number of workers' compensation claims. Commutations are agreements whereby the claimants, in exchange for a lump sum payment, release their rights to future indemnity payments from The PMA Insurance Group. The PMA Insurance Group paid approximately $64.9 million, $113.0 million and $17.8 million in 1998, 1997 and 1996, respectively, to commute workers' compensation indemnity claims. The commutation programs resulted in payments, which were less than the corresponding carried reserves. Savings associated with these claims were consistent with management's expectations. As substantially all of these reserves were carried on a discounted basis, the ultimate level of discount on The PMA Insurance Group's carried reserves decreased. As stated above, during the past five years, direct premiums written for workers' compensation have declined significantly and benefit reforms in The PMA Insurance Group's marketing territory have reduced loss costs in more recent years. As a result, loss reserve levels have declined and the level of discount on such reserves has also declined. In 1998, The PMA Insurance Group recorded favorable prior year reserve development of $4.6 million (excluding the accretion of discount), $6.9 million of favorable loss development for workers' compensation reserves, partially offset by $2.3 million of adverse development in Commercial Lines and LAE. In 1997, The PMA Insurance Group recorded favorable prior year development of $1.0 million (excluding the accretion of discount), reflecting favorable development of $6.0 million on workers' compensation reserves, partially offset by reserve strengthening of $5.0 million in commercial multi-peril business. In 1996, adverse prior year development was $191.4 million associated with the following lines of business: workers' compensation, $110.0 million; asbestos and environmental, $60.4 million; and other lines of business, $21.0 million (see Note 4 to the Company's Consolidated Financial Statements for additional information). 36 P M A C A P I T A L The 1998 expense ratio declined 1.6 points compared to 1997, which declined 14.2 points compared to 1996, due to reductions in both the Acquisition Expense Ratio and the Operating Expense Ratio. The 1998 Acquisition Expense Ratio decreased 0.3 points compared to 1997, primarily due to a change in the mix of business to workers' compensation business, which has a lower acquisition rate than Commercial Lines. The 1997 Acquisition Expense Ratio decreased 1.4 points compared to 1996, primarily due to ceding commissions received by The PMA Insurance Group on its reinsurance arrangement for commercial lines casualty business, which are recorded as a reduction of acquisition expenses. The 1998 Operating Expense Ratio decreased 1.3 points to 13.3% from 14.6% in 1997. The 1997 Operating Expense Ratio decreased 12.8 points to 14.6% compared to 27.4% in 1996. Each year's lower Operating Expense Ratio is primarily attributable to cost reduction programs begun in 1996 at The PMA Insurance Group. Such programs have resulted in lower payroll and related expenses of approximately $5.0 million in 1998 and $4.9 million in 1997. In addition, in 1997, operating expenses decreased $22.5 million compared to 1996 due to the absence of expenses in 1996 such as $7.6 million for a voluntary early retirement program, $4.8 million associated with a change in depreciable lives of computer equipment and $10.1 million in premium balances written off. The policyholders' dividend ratios was 7.1%, 5.6% and 6.1% for the years ended December 31, 1998, 1997 and 1996, respectively, primarily reflecting more favorable loss experience. Under policies that are subject to dividend plans, the customer may receive a dividend based upon loss experience during the policy period. Net Investment Income Net investment income was $3.4 million lower in 1998 compared to 1997, as lower average investment balances resulting from the pay-down of loss reserves from prior accident years primarily related to the commutation programs and decreasing premium volume were offset by higher investment yields associated with a shift in invested assets towards higher yielding invested assets, such as asset-backed securities. Investment income in 1997 was $28.6 million lower than in 1996, primarily due to the fact that Run-off Operations were not segregated in 1996. In 1997, Run-off Operations had $28.1 million of net investment income. Run-off Operations The following table reflects the components of The PMA Insurance Group - Run-off Operations' operating results. The operating results for 1996 are not displayed, as Run-off Operations were not segregated until December 31, 1996. (dollar amounts in thousands) 1998 1997 - ----------------------------------------------------------------------------- Net premiums earned $ (9,400) $(51,622) Net investment income 14,161 28,131 ------------------------- Operating revenues 4,761 (23,491) Losses and LAE incurred 1,507 (27,460) Operating expenses 2,802 4,042 ------------------------- Total losses and expenses 4,309 (23,418) ------------------------- Pre-tax operating income (loss) $ 452 $ (73) ========================= 37 P M A C A P I T A L Management's Discussion and Analysis (continued) Losses and LAE of the Run-off Operations consist of discount accretion on established loss reserves within the Run-off Operations, partially offset in 1998 by favorable loss development of $10.3 million (of which $9.4 million was returned to the Pooled Companies as a profit commission and recorded as a premium adjustment by the Run-off Operations) and more than offset in 1997 by $51.8 million of favorable loss development. Favorable loss development in 1997 included $37.0 million related to retrospectively rated policies. Furthermore, incurred losses on prior accident years were also favorably affected by the cession of prior year reserves of $14.8 million to a third party reinsurer in 1997. The favorable loss development in 1997 was offset by reductions in earned premiums for the Run-off Operations. Net investment income for the Run-off Operations decreased $14.0 million in 1998 compared to 1997, primarily due to the sale of PMA Insurance, Cayman Ltd. ("PMA Cayman"), which decreased invested assets. Effective July 1, 1998, the Company sold PMA Cayman for a purchase price of $1.8 million and recorded an after-tax loss of $1.6 million. This transaction included the transfer of $231.5 million in cash and invested assets to the buyer. At December 31, 1998, the Company had recorded $248.6 million in reinsurance receivables from the buyer related to this transaction, all of which are secured by assets in a trust and by letters of credit (see Note 19 to the Company's Consolidated Financial Statements for additional discussion). See "The PMA Insurance Group - Run-off Operations" in the Company's 1998 Form 10-K for additional discussion of Run-off Operations. Loss Reserves Unpaid losses and LAE reflect management's best estimate of future amounts needed to pay claims and related settlement costs with respect to insured events which have occurred, including events that have not been reported to the Company. In many cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured loss, the reporting of the loss to the Company and the Company's payment of that loss. In general, liabilities for reinsurers become known more slowly than for primary insurers and are subject to more unforeseen development. As part of the process in determining these amounts, historical data is reviewed and consideration is given to the impact of various factors, such as legal developments, changes in social attitudes and economic conditions. Unpaid losses for the Company's workers' compensation claims, net of reinsurance, at December 31, 1998 and 1997 were $515.6 million and $816.1 million, net of discount of $194.3 million and $460.2 million, respectively. The approximate discount rate used was 5% at December 31, 1998 and 1997. Estimating reserves for workers' compensation claims is difficult for several reasons, including (i) the long payment "tail" associated with the business; (ii) the impact of social, political, case law 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. If necessary, adjustments will be made to such reserves as they are identified if loss patterns develop differently than forecasted or if new information becomes available and such adjustments may be material to results of operations, financial condition and liquidity. 38 P M A C A P I T A L Management believes that its unpaid losses and LAE are fairly stated at December 31, 1998. 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 differ substantially from the amounts recorded at December 31, 1998, the related adjustments could have a material adverse impact on the Company's financial condition and results of operations. At December 31, 1998, 1997 and 1996, the Company's gross reserves for asbestos-related losses were $67.9 million, $76.7 million and $80.1 million, respectively ($43.6 million, $48.6 million and $53.3 million, net of reinsurance, respectively). At December 31, 1998, 1997 and 1996, the Company's gross reserves for environmental-related losses were $47.0 million, $45.1 million and $35.6 million, respectively ($29.4 million, $31.7 million and $34.6 million, net of reinsurance, respectively). Estimating reserves for asbestos and environmental exposures continues to be difficult because of several factors, including: (i) evolving methodologies for the estimation of the liabilities; (ii) lack of reliable historical claim data; (iii) uncertainties with respect to insurance and reinsurance coverage related to these obligations; (iv) changing judicial interpretations; and (v) changing government standards. To reserve for environmental claims, the Company currently utilizes a calendar year development technique known as aggregate loss development. This technique focuses on the aggregate losses paid as of a particular date and aggregate payment patterns associated with such claims. Several elements including remediation studies, remediation, defense, declaratory judgment and third party bodily injury claims were considered in estimating the costs and payment patterns of the environmental and toxic tort losses. Prior to the development of these techniques, there was a substantial range in the nature of reserving for environmental and toxic tort liabilities. In 1996, the Company performed a ground up analysis of loss reserves for direct asbestos exposures 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. Management believes that its reserves for asbestos and environmental claims are appropriately established based upon known facts, existing case law and generally accepted actuarial methodologies. However, due to changing interpretations by courts involving coverage issues, the potential for changes in federal and state standards for clean-up and liability as well as issues involving policy provisions, allocation of liability among participating insurers, proof of coverage and other factors, the Company's ultimate exposure for these claims may vary significantly from the amounts currently recorded, resulting in a potential future adjustment that could be material to the Company's financial condition and results of operations (see "Loss Reserves" in the Company's 1998 Form 10-K and Note 4 to the Company's Consolidated Financial Statements for additional discussion). 39 P M A C A P I T A L Management's Discussion and Analysis (continued) Caliber One Summarized financial results of Caliber One for the year ended December 31, 1998 are as follows: (dollar amounts in thousands) - ------------------------------------------------------------------------------ Net premiums written $ 6,436 ======= Net premiums earned $ 1,750 Net investment income 1,453 ------- Operating revenues 3,203 ------- Losses and LAE incurred 1,402 Acquisition and operating expenses 3,407 ------- Total losses and expenses 4,809 ------- Pre-tax operating loss $(1,606) ======= In December 1997, PMA Reinsurance Corporation acquired 100% of the outstanding common stock of Caliber One Indemnity Company, domiciled in Delaware and formerly known as Lincoln Insurance Company, for approximately $16.0 million and made a capital contribution of approximately $11.3 million to Caliber One Indemnity Company. All of Caliber One Indemnity Company's acquired loss reserves were reinsured with an affiliate of its former parent for adverse development and uncollectible reinsurance (the "Reserve Guarantee") in the amount of the recorded reserves plus $68.5 million (see Note 1 to the Consolidated Financial Statements for additional discussion). Upon the purchase of Caliber One Indemnity Company, management valued the amount of the Reserve Guarantee at approximately $5.0 million 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. Management believes that the reinsurance obtained as part of the purchase will be adequate to cover any future reserve development or uncollectible reinsurance on the acquired reserves. PMA Reinsurance Corporation intends to maintain Caliber One Indemnity Company's surplus at not less than $25.0 million, the minimum capital and surplus required by many states in order to be an eligible surplus lines carrier. In 1998, Caliber One recorded a pre-tax operating loss of $1.6 million, primarily related to start-up costs. Gross premiums written and net premiums written for Caliber One for the year ended December 31, 1998 were $11.8 million and $6.4 million, respectively. As expected, operating expenses, which include start-up costs, were high in 1998 relative to operating revenues. Corporate and Other The Corporate and Other segment includes unallocated investment income; expenses, including debt service; and taxes, as well as the results of certain of the Company's real estate properties. For the year ended December 31, 1998, Corporate and Other recorded a pre-tax operating loss before interest expense of $6.9 million compared to $10.0 million in 1997. The decrease in the operating loss in 1998 compared to 1997 was primarily due to lower net expenses from non-core real estate properties in 1998. Additionally, during 1997, the Company incurred $1.8 million of severance and related restructuring costs and pre-operating charges of approximately $900,000 in establishing Caliber One. In 1997, Corporate and Other's pre-tax operating loss was $10.0 million compared to $6.5 million in 1996. The decline in the operating results of Corporate and Other operations in 1997 was due mainly to a $2.2 million increase in operating costs related to certain corporate properties disposed of during 1997, as well as $1.8 million of expenses incurred for severance and related restructuring costs. In addition, pre-operating charges of approximately $900,000 associated with establishing Caliber One were reported in Corporate and Other in 1997. 40 P M A C A P I T A L Interest expense decreased to $15.0 million in 1998 from $15.8 million in 1997 and $17.1 million in 1996, primarily due to the refinancing of the Company's debt with the Credit Facility in March of 1997(see "Liquidity" below for further discussion). Net Realized Investment Gains Net realized investment gains amounted to $21.7 million, $8.6 million and $3.0 million in 1998, 1997 and 1996, respectively. During the three-year period ended December 31, 1998, 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; and (iii) transactions based upon an assessment of the interest rate environment. Gains and losses on the sale of investments are recognized as a component of net income, but the timing and recognition of such gains and losses are unpredictable and are not indicative of current or future results. Accordingly, such gains and losses are not included as a component of operating income. In 1998, the Company diversified its investment portfolio by increasing its holdings of mortgage-backed and other asset-backed securities, while reducing holdings in government securities. In 1997, the Company repositioned its investment portfolio to improve its pre-tax investment yield, while maintaining the maturity matching structure between investments and liability cash flow projections. During 1996, 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 projected tax position. 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. PMA Capital's primary sources of liquidity are dividends from subsidiaries, net tax payments received from subsidiaries and borrowings. At December 31, 1998, the Company had $163.0 million outstanding under its existing Credit Facility compared to $203.0 million outstanding at December 31, 1997. In 1998, the Company made an unscheduled debt repayment of $40.0 million to reduce the outstanding debt to $163.0 million and increase the amount available under the Credit Facility to $72.0 million. In 1997, the Company made scheduled debt payments of $7.3 million as well as an additional debt repayment of $8.0 million before refinancing all of its credit agreements not already maturing in 1997. During 1996, the Company made scheduled repayments on its senior note facilities of $25.1 million through drawdowns on its revolving Credit Facility. The final expiration of the Credit Facility will be December 31, 2002, maturing in an installment of $38.0 million in 2000 and installments of $62.5 million in 2001 and 2002. The Company paid interest of $14.9 million, $19.8 million and $16.6 million in 1998, 1997 and 1996, respectively. In addition to the Credit Facility, the Company maintains a committed facility of $50.0 million for letters of credit (the "Letter of Credit Facility"). The Letter of Credit Facility is utilized primarily for securing reinsurance obligations of the Company's insurance subsidiaries. As of December 31, 1998, the Company had $46.9 million outstanding in letters of credit under the Letter of Credit Facility. 41 P M A C A P I T A L Management's Discussion and Analysis (continued) The Company's domestic insurance subsidiaries' ability to pay dividends to the holding 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 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) SAP net income for the preceding year, but in no event to exceed unassigned funds. Under this standard, the Pooled Companies and PMA Re can pay an aggregate of $51.8 million of dividends without the prior approval of the Commissioner during 1999. Caliber One Indemnity Company is directly owned by PMA Reinsurance Corporation and, as such, its dividends may not be paid directly to PMA Capital. Dividends from subsidiaries were $35.5 million, $22.5 million and $53.6 million in 1998, 1997 and 1996, respectively. Net tax payments received from subsidiaries were $29.7 million, $20.0 million and $12.0 million in 1998, 1997 and 1996, respectively. In December 1998, the Company received a refund from the Internal Revenue Service ("IRS") of approximately $15.0 million relating to Federal income taxes paid by the Company. The refund relates to a claim for refund filed by the Company with regard to its 1992 U.S. Federal income tax return. In 1997, the Company received a refund from the IRS of approximately $16.8 million as a result of a net operating loss, which was generated in 1996 and carried back to 1993, 1994 and 1995 (see Note 8 to the Company's Consolidated Financial Statements for additional discussion of income taxes). PMA Capital's dividends to shareholders are restricted by its debt agreements. Based upon the terms of the Credit Facility and the Letter of Credit Facility, under the most restrictive debt covenant, PMA Capital would be able to pay dividends of approximately $15.6 million in 1999. The Company paid dividends to shareholders of $7.9 million, $8.0 million and $7.9 million in 1998, 1997 and 1996, respectively. In December 1997, PMA Reinsurance Corporation acquired 100% of the outstanding common stock of Caliber One Indemnity Company for approximately $16.0 million and made a capital contribution of approximately $11.3 million to Caliber One Indemnity Company (see "Caliber One" herein for additional discussion). PMA Capital also made cash capital contributions to its subsidiaries totaling $480,000, $11.0 million and $50.0 million in 1998, 1997 and 1996, respectively. In February of 1998, the Company's Board of Directors authorized a plan to repurchase shares of common stock and Class A common stock in an amount not to exceed $25.0 million. During 1998, the Company repurchased a total of 996,442 shares at a total cost of $18.9 million (average per share price was $18.92), leaving $6.1 million of share repurchase authorization under its February 1998 repurchase program. In February 1999, PMA Capital's Board of Directors authorized an additional $20.0 million of share repurchase authority. Decisions regarding share repurchases are subject to prevailing market conditions and the costs and benefits associated with alternative uses of capital. 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 increased to $3,460.7 million at December 31, 1998 from $3,057.3 million at December 31, 1997. Total investments increased $130.7 million to $2,325.4 million at December 31, 1998. The increase in investments is primarily attributable to the Company's securities lending program, which increased invested assets by $421.1 million (see Note 3 to the Company's Consolidated Financial Statements for additional discussion), partially offset by the sale of PMA Cayman (see "The PMA Insurance Group - Run-off Operations" herein and Note 19 to the 42 P M A C A P I T A L Company's Consolidated Financial Statements for additional discussion). All other assets increased $272.8 million at December 31, 1998 compared to December 31, 1997, primarily due to an increase of $277.9 million in reinsurance receivables. The increase in reinsurance receivables primarily relates to the sale of PMA Cayman, which resulted in the recording of reinsurance receivables of $248.6 million. Presently, management believes that the existing capital structure is appropriate. However, management continually monitors the capital structure in light of developments in the business, and the present assessment could change as management becomes aware of new opportunities and challenges in the Company's business. The Company actively manages its exposure to catastrophes through its underwriting process, where the Company generally monitors the accumulation of insurable values in catastrophe prone regions. Also, in writing property reinsurance coverages, PMA Re typically requires per occurrence loss limitations for contracts that could have catastrophe exposure. Through per risk reinsurance, the Company also manages its net retention in each exposure. In addition, PMA Re maintains retrocessional protection of $48.0 million in excess of $2.0 million per occurrence and The PMA Insurance Group maintains catastrophe reinsurance protection of $27.7 million excess of $850,000. As a result, the Company's loss and LAE ratios have not been significantly impacted by catastrophes in 1998, 1997 or 1996. Although the Company believes that it has adequate reinsurance to protect against the estimated probable maximum gross loss from a catastrophe, an especially severe catastrophe or series of catastrophes could exceed the Company's reinsurance and/or retrocessional protection and may have a material adverse impact on the Company's results of operations and financial condition. At December 31, 1998, the Company's reinsurance and retrocessional protection was as follows: Retention Limits (1) - ------------------------------------------------------------------------- PMA Re Per Occurrence: Casualty lines $ 2.8 million $ 17.5 million Workers' compensation $ 2.0 million $ 98.0 million Property lines $ 2.0 million $ 48.0 million Per Risk: Property lines $ 800,000 $ 4.3 million Casualty lines $ 1.5 million $ 6.0 million The PMA Insurance Group Per Occurrence: Workers' compensation $ 1.5 million(2) $103.5 million Per Risk: Property lines $ 500,000(3) $ 19.5 million Auto physical damage $ 500,000 $ 2.0 million Other casualty lines $ 175,000(4) $ 4.8 million Caliber One Per Occurrence and Per Risk: Property lines $ 200,000 $ 4.8 million Casualty lines $ 500,000 $ 4.5 million (1) Represents the amount of loss protection above the Company's level of loss retention. (2) Effective January 1, 1999, The PMA Insurance Group's net retention on workers' compensation has been reduced to $150,000. (3) This coverage also provides protection of $48.5 million per occurrence over its combined net retention of $500,000. (4) This coverage also provides protection of $49.8 million per occurrence over its combined net retention of $175,000. 43 P M A C A P I T A L Management's Discussion and Analysis (continued) The Company performs extensive credit reviews on its reinsurers, focusing on, among other things, financial capacity, stability, trends and commitment to the reinsurance business. Prospective and existing reinsurers failing to meet the Company's standards are excluded from the Company's reinsurance programs. In addition, the Company requires letters of credit or other acceptable collateral to support balances due from reinsurers not authorized to transact business in the applicable jurisdictions (see Note 5 to the Company's Consolidated Financial Statements for a listing of reinsurance recoverables due from unaffiliated single reinsurers in excess of 3% of shareholders' equity as of December 31, 1998). Investments The Company's investment policy objectives are to (i) seek competitive after-tax income and total return, (ii) maintain high investment 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's investment strategy includes guidelines for asset quality standards, asset allocations and other relevant criteria for its portfolio. In addition, maturities are structured after projecting liability cash flows with actuarial models. The Company's portfolio does not contain any significant concentrations in single issuers (other than U.S. treasury and agency obligations), industry segments or geographic regions.The Company has no investments which are not dollar denominated as of December 31, 1998. The following table summarizes the Company's investments by fair value as of December 31:
1998 1997 ----------------------------------------- (dollar amounts in millions) Fair Value Percent Fair Value Percent - --------------------------------------------------------------------------------------------- U.S. Treasury securities and obligations of U.S. Government agencies $ 827.2 35.5% $ 1,134.9 51.7% Obligations of states, political subdivisions and foreign governments 24.9 1.1% -- -- Corporate debt securities 420.3 18.1% 477.0 21.7% Mortgage-backed and other asset-backed securities 555.0 23.9% 317.6 14.5% Short-term investments 498.0 21.4% 265.2 12.1% ----------------------------------------- Total $ 2,325.4 100.0% $ 2,194.7 100.0% =========================================
Mortgage-backed and other asset-backed securities include collateralized mortgage obligations ("CMOs") of $100.0 million and $4.2 million carried at fair value as of December 31, 1998 and 1997, respectively. CMO holdings are concentrated in securities with limited prepayment, extension and default risk, such as planned amortization class bonds. 44 P M A C A P I T A L The following table indicates the composition of the Company's fixed maturities portfolio at fair value, excluding short-term investments, by rating as of December 31: (dollar amounts in millions) 1998 1997 ------------------------------------------ Ratings (1) Fair Value Percent Fair Value Percent - ------------------------------------------------------------------------------- U.S. Treasury securities and AAA $ 1,355.2 74.2% $ 1,449.0 75.1% AA 100.5 5.5% 150.0 7.8% A 266.4 14.6% 282.2 14.6% BBB 105.3 5.7% 48.3 2.5% ------------------------------------------ Total $ 1,827.4 100.0% $ 1,929.5 100.0% ========================================== (1) Ratings as assigned by Standard and Poor's. Such ratings are generally assigned at the time of the issuance of the securities, subject to revision on the basis of ongoing evaluations. The following table reflects the Company's investment results: (dollar amounts in millions) 1998 1997 1996 - ----------------------------------------------------------------------------- Average invested assets(1) $ 2,048.5 $ 2,236.0 $ 2,371.6 Net investment income(2) $ 119.1 $ 132.8 $ 130.8 Net effective yield(3) 5.82% 5.94% 5.52% (1) Average invested assets throughout the year, at amortized cost, excluding amounts related to securities lending activities. (2) Gross investment income less investment expenses. Excludes net realized investment gains and amounts related to securities lending activities. (3) Net investment income for the period divided by average invested assets for the same period. As of December 31, 1998, the duration of the Company's investments was 5.1 years and the duration of its insurance reserves was 4.9 years. See "Business - Investments" in the Company's 1998 Form 10-K and Notes 2-B and 3 to the Company's Consolidated Financial Statements for additional discussion. Market Risk of Financial Instruments A significant portion of PMA Capital's assets and liabilities are financial instruments, which are subject to the market risk of potential losses from adverse changes in market rates and prices. The Company's primary market risk exposures relate to interest rate risk on fixed rate domestic medium-term instruments and, to a lesser extent, domestic short- and long-term instruments. The Company has established strategies, asset quality standards, asset allocations and other relevant criteria for its portfolio to manage its exposure to market risk. In addition, maturities are structured after projecting liability cash flows with actuarial models. The Company currently has only one derivative instrument outstanding, an interest rate swap on its Credit Facility, which is used as a hedge. All of the Company's financial instruments are held for purposes other than trading. The Company's portfolio does not contain any significant concentrations in single issuers (other than U.S. treasury and agency obligations), industry segments or geographic regions (see Notes 3, 6 and 10 to the Company's Consolidated Financial Statements for additional discussion). Caution should be used in evaluating PMA Capital's overall market risk from the information below, since actual results could differ materially because the information was developed using estimates and assumptions as described below, and because insurance liabilities and reinsurance receivables are excluded in the hypothetical effects (insurance liabilities represent 73.5% of total liabilities and reinsurance receivables on unpaid losses represent 17.2% of total assets). 45 P M A C A P I T A L Management's Discussion and Analysis (continued) The hypothetical effects of changes in market rates or prices on the fair values of financial instruments as of December 31, 1998, excluding insurance liabilities and reinsurance receivables on unpaid losses because such insurance related assets and liabilities are not carried at fair value, would have been as follows: . If interest rates had increased by 100 basis points, there would have been no significant change in the fair value of the Company's long-term debt or the related swap agreement. The change in fair values was determined by estimating the present value of future cash flows using models that measure the change in net present values arising from selected hypothetical changes in market interest rates. . If interest rates had increased by 100 basis points, there would have been an approximate $106.8 million net decrease in the fair value of the Company's investment portfolio. The change in fair values was determined by estimating the present value of future cash flows using various models, primarily duration modeling. Other Matters The Company's businesses are subject to a changing social, economic, legal, legislative and regulatory environment that could affect them. Some of the changes include initiatives to restrict insurance pricing and the application of underwriting standards and reinterpret insurance contracts long after the policies were written to provide coverage unanticipated by the Company. The eventual effect on the Company of the changing environment in which it operates remains uncertain (see Notes 4, 8, 11 and 13 to the Company's Consolidated Financial Statements for additional discussion). Year 2000 Issue As a consequence of the programming convention which utilized a two-digit field rather than a four-digit field, certain information technology ("IT") systems and non-IT systems, such as equipment with embedded chips or microprocessors, require reprogramming or replacement to enable them to perform correctly date operations involving year 2000 or later ("Year 2000 Issue"). With the assistance of outside consulting groups, the Company began evaluating and reprogramming its IT systems to address the Year 2000 Issue in late 1995. The Company's Year 2000 systems' program consists of four phases: (i) identifying systems requiring remediation; (ii) assessing the requirements to remediate those systems; (iii) remediating those systems to make them Year 2000 ready by either modifying or replacing them; and (iv) testing the systems for Year 2000 readiness, including, where applicable, that they properly interface with third parties. The Company has completed the identification and assessment phases with respect to its IT systems that are critical to maintaining operations or the failure of which would result in significant costs or disruption of operations ("mission critical systems"). As of February 28, 1999, the Company had remediated and tested all of its mission critical systems. In addition, the Company will continue to test its mission critical systems under varying testing scenarios throughout 1999. The Company has identified all of its non-IT systems that may require Year 2000 remediation, including office equipment and physical facilities, which contain microprocessors or other embedded technology over which it has control. As of February 28, 1999, substantially all of these non-IT systems are believed to be Year 2000 ready to the extent reasonably necessary to conduct the Company's day-to-day operations. Because the Company is not materially dependent upon non-IT systems, the effect of a failure of these systems is not expected to be material to the Company's financial condition or results of operations. 46 P M A C A P I T A L The cost of the Company's Year 2000 readiness work through December 31, 1998 has been approximately $5.4 million, including approximately $1.5 million incurred during 1998. The Company does not expect to incur material costs in 1999 in connection with the Year 2000 Issue. The Company also is continuing to evaluate its relationships with certain third parties with which the Company has a direct and material relationship to determine whether they are Year 2000 ready, such as banks, brokers, reinsurers, third party service providers, software and other service vendors, and agents and other intermediaries. As of February 28, 1999, the responses received from such third parties to inquiries made by the Company indicate that these third parties either are or expect to be Year 2000 ready by December 31, 1999. Even assuming that all material third parties provide a timely representation concerning their Year 2000 readiness, 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 ready. Consequently, the effect, if any, on the Company's results of operations from the failure of such third parties to be Year 2000 ready is not reasonably estimable. However, the failure of one or more third parties with whom the Company has a material relationship to be Year 2000 ready 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 ready include replacing the third party, performing directly the services performed by the third party and maintaining liquidity under the Company's Credit Facility. Although the Company believes that Year 2000 Issues related to its hardware and internal software programs are not likely to result in any material adverse disruptions in the Company's computer systems or its other business operations, it has begun, but not yet completed, an analysis of the operational problems that the Company believes would be reasonably likely to result from the failure by the Company and certain third parties to successfully complete efforts necessary to achieve Year 2000 readiness on a timely basis. The Company expects to complete this analysis in the second quarter of 1999. The Company is also developing contingency plans to provide for the resumption of its computer systems and its other business operations in the event such Year 2000 problems occur. These plans are expected to be completed in the second quarter of 1999; however, the Company intends throughout 1999 to review and modify such plans on an ongoing basis as new information becomes available or circumstances materially change. The costs of the Company's Year 2000 efforts and the dates on which the Company believes it will complete such efforts are based on management's best estimates, which were derived using numerous assumptions regarding future events, including the continued availability of certain resources, third-party remediation plans, and other factors. There can be no assurance that these estimates will prove to be accurate, and actual results could differ materially from those currently anticipated. Specific factors that could cause such material differences include, but are not limited to, the availability and costs of personnel trained in Year 2000 Issues; the Company's ability to identify, assess, remediate and test all relevant computer codes and embedded technology; the risk that reasonable testing will not uncover all Year 2000 problems; and similar uncertainties. 47 P M A C A P I T A L Management's Discussion and Analysis (continued) In addition to the costs and risks associated with internal systems and third parties, the Company may have underwriting exposure related to the Year 2000 Issue. Businesses materially damaged as a result of the Year 2000 Issue may attempt to recoup their losses by claiming coverage under various types of insurance policies underwritten by the Company and by ceding companies to whom the Company provides reinsurance. The Company is attempting, whenever possible, to avoid or otherwise limit its potential Year 2000 exposure through its underwriting process. In the event that claims for Year 2000 Issues are asserted against the Company, it is not possible to predict whether or to what extent any such coverage could ultimately be found to exist by courts in various jurisdictions, or, if found, the effect thereof on the Company. In addition, even if such coverage were found not to exist, which cannot be predicted, the costs of litigation could be material. In the absence of any claims experience at this time, such losses and costs are not currently reasonably estimable. Comparison of SAP and GAAP Results The results presented above vary in certain respects from statutory accounting practices prescribed or permitted by the Pennsylvania Insurance Department and the Delaware Insurance Department, (collectively "SAP"). Prescribed SAP includes state laws, regulations and general administrative rules, as well as a variety of National Association of Insurance Commissioners ("NAIC") publications. Permitted SAP encompasses all accounting practices that are not prescribed. In 1998, the NAIC adopted the Codification of Statutory Accounting Principles ("Codification") guidance, which will replace the current Accounting Practices and Procedures manual as the NAIC's primary guidance on statutory accounting. Codification provides guidance for areas where statutory accounting has been silent and changes current statutory accounting in some areas, such as deferred income taxes, which will be recorded under Codification. The Insurance Department of Pennsylvania has adopted Codification, effective January 1, 2001. The Company is in the process of estimating the impact that Codification will have on its statutory surplus (see Note 18 to the Company's Consolidated Financial Statements for additional discussion). Recent Accounting Pronouncements In June 1996, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("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. In December 1996, FASB issued SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125," which deferred for one year certain provisions of SFAS No. 125. As of January 1, 1998, the Company adopted SFAS No. 130, "Comprehensive Income," which establishes standards for the reporting and disclosure of comprehensive income and its components (revenues, expenses, gains and losses). SFAS No. 130 requires that all items required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. As of January 1, 1998, the Company adopted SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information" (see "Results of Operations" above for additional discussion). In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," which revises employers' disclosures about pensions and other post-retirement benefit plans. SFAS No. 132 does not change the measurement or recognition of those plans and was effective for fiscal years beginning after December 15, 1997. 48 P M A C A P I T A L 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. The impact of adopting SOP 97-3 will be reflected as a cumulative effect of an accounting change in the first quarter of 1999 and is not expected to exceed $5.0 million on a pre-tax basis. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as "derivatives") and for hedging activities. SFAS No. 133 requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. 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. See Note 2-K to the Company's Consolidated Financial Statements for additional discussion. Cautionary Statements Except for historical information provided in this Management's Discussion and Analysis and otherwise in this report, statements made throughout this report are forward-looking and contain information about financial results, economic conditions, trends and known uncertainties. These forward-looking statements are based on currently available financial, competitive and economic data and the Company's current operating plans based on assumptions regarding future events. The Company's actual results could differ materially from those expected by the Company's management. The factors that could cause actual results to vary materially, some of which are described with the forward-looking statements, include, but are not limited to, changes in general economic conditions, including the performance of financial markets and interest rates; regulatory or tax changes, including changes in risk-based capital or other regulatory standards that affect the ability of the Company to conduct its business; competitive or regulatory changes that affect the cost of or demand for the Company's products; the Company's ability to meet its marketing objectives; the effect of changes in workers' compensation statutes and their administration; the Company's ability to predict and effectively manage claims related to insurance and reinsurance policies; reliance on key management; adequacy of reserves for claim liabilities; adverse property and casualty loss development for events the Company insured in prior years; adequacy and collectibility of reinsurance purchased by the Company; severity of natural disasters and other catastrophes; and other factors disclosed from time to time in reports filed by the Company with the Securities and Exchange Commission. Investors should not place undue reliance on any such forward-looking statements. 49 P M A C A P I T A L Consolidated Balance Sheets
December 31, (in thousands, except share data) 1998 1997 - ---------------------------------------------------------------------------------------------------------------------- Assets: Investments: Fixed maturities available for sale, at fair value (amortized cost: 1998 - $1,781,188; 1997 - $1,900,594) $ 1,827,354 $ 1,929,518 Equity securities, at fair value (cost: 1998 - $5; 1997 - $5) 17 13 Short-term investments, at cost which approximates fair value 498,038 265,207 ------------------------------ Total investments 2,325,409 2,194,738 Cash 2,562 32,148 Accrued investment income 19,900 23,818 Premiums receivable (net of valuation allowance: 1998 - $19,874; 1997 - $18,406) 279,633 252,425 Reinsurance receivables (net of valuation allowance: 1998 - $2,178; 1997 - $2,096) 610,291 332,406 Deferred income taxes, net 63,929 70,391 Deferred acquisition costs 51,115 45,288 Other assets 107,879 106,044 ------------------------------ Total assets $ 3,460,718 $ 3,057,258 ============================== Liabilities: Unpaid losses and loss adjustment expenses $ 1,940,895 $ 2,003,187 Unearned premiums 227,945 211,455 Long-term debt 163,000 203,000 Accounts payable and accrued expenses 107,952 81,524 Funds held under reinsurance treaties 77,674 69,545 Dividends to policyholders 10,700 10,200 Payable under securities loan agreements 421,072 -- ------------------------------ Total liabilities 2,949,238 2,578,911 ------------------------------ Commitments and contingencies (Note 13) Shareholders' Equity: Common stock, $5 par value (40,000,000 shares authorized; 1998 - 13,956,268 shares issued and 13,520,261 outstanding; 1997 - 15,286,263 shares issued and 14,850,789 outstanding) 69,781 76,431 Class A common stock, $5 par value (40,000,000 shares authorized; 1998 - 10,486,677 shares issued and 9,837,963 outstanding; 1997 - 9,156,682 shares issued and 9,117,735 outstanding) 52,433 45,783 Additional paid-in capital - Class A common stock 339 339 Retained earnings 377,601 343,368 Accumulated other comprehensive income 30,016 18,806 Notes receivable from officers (498) (198) Treasury stock, at cost: Common stock (1998 - 436,007 shares; 1997 - 435,474 shares) (5,582) (5,572) Class A common stock (1998 - 648,714 shares; 1997 - 38,947 shares) (12,610) (610) ------------------------------ Total shareholders' equity 511,480 478,347 ------------------------------ Total liabilities and shareholders' equity $ 3,460,718 $ 3,057,258 ==============================
See accompanying notes to the consolidated financial statements. 50 P M A C A P I T A L Consolidated Statements of Operations
For the years ended December 31, (in thousands, except per share data) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------ Revenues: Net premiums written $ 474,761 $ 381,282 $ 432,975 Change in net unearned premiums (8,046) (5,331) (12,400) ----------------------------------------------- Net premiums earned 466,715 375,951 420,575 Net investment income 120,125 133,392 130,837 Net realized investment gains 21,745 8,598 2,984 Other revenues 14,896 13,617 12,288 ----------------------------------------------- Total revenues 623,481 531,558 566,684 ----------------------------------------------- Losses and Expenses: Losses and loss adjustment expenses 352,671 307,281 536,623 Acquisition expenses 110,837 93,501 90,292 Operating expenses 72,159 75,139 97,856 Dividends to policyholders 17,736 14,716 16,255 Interest expense 15,009 15,768 17,052 ----------------------------------------------- Total losses and expenses 568,412 506,405 758,078 ----------------------------------------------- Income (loss) before income taxes and extraordinary loss 55,069 25,153 (191,394) ----------------------------------------------- Provision (benefit) for income taxes: Current 9,910 (4,506) (44,572) Deferred 425 9,906 (11,488) ----------------------------------------------- Total 10,335 5,400 (56,060) ----------------------------------------------- Income (loss) before extraordinary loss 44,734 19,753 (135,334) Extraordinary loss from early extinguishment of debt (net of income tax benefit of $2,549) -- (4,734) -- ----------------------------------------------- Net income (loss) $ 44,734 $ 15,019 $(135,334) =============================================== Income (loss) per share: Basic: Income (loss) before extraordinary loss $ 1.89 $ 0.83 $ (5.68) Extraordinary loss -- (0.20) -- ----------------------------------------------- Net income (loss) $ 1.89 $ 0.63 $ (5.68) =============================================== Diluted: Income (loss) before extraordinary loss $ 1.82 $ 0.80 $ (5.68) Extraordinary loss -- (0.19) -- ----------------------------------------------- Net income (loss) $ 1.82 $ 0.61 $ (5.68) ===============================================
See accompanying notes to the consolidated financial statements. 51 P M A C A P I T A L Consolidated Statements of Shareholders' Equity
For the years ended December 31, (in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------ Common stock: Balance at beginning of year $ 76,431 $ 80,477 $ 85,223 Conversion of Common stock into Class A common stock (6,650) (4,046) (4,746) ----------------------------------------------- Balance at end of year 69,781 76,431 80,477 ----------------------------------------------- Class A common stock: Balance at beginning of year 45,783 41,239 36,493 Conversion of Common stock into Class A common stock 6,650 4,046 4,746 Issuance of shares -- 498 -- ----------------------------------------------- Balance at end of year 52,433 45,783 41,239 ----------------------------------------------- Additional paid-in capital - Class A common stock: Balance at beginning of year 339 -- -- Issuance of shares -- 339 -- ----------------------------------------------- Balance at end of year 339 339 -- ----------------------------------------------- Retained earnings: Balance at beginning of year 343,368 336,921 480,181 Net income 44,734 15,019 (135,334) Common stock dividends declared (4,527) (4,842) (5,138) Class A common stock dividends declared (3,417) (3,147) (2,788) Reissuance of treasury shares under employee benefit plans (2,557) (583) -- ----------------------------------------------- Balance at end of year 377,601 343,368 336,921 ----------------------------------------------- Accumulated other comprehensive income (loss): Balance at beginning of year 18,806 (24,874) 17,511 Other comprehensive income (loss) (net of tax effect: 1998 - ($6,036); 1997 - ($23,520); 1996 - $22,823) 11,210 43,680 (42,385) ----------------------------------------------- Balance at end of year 30,016 18,806 (24,874) ----------------------------------------------- Notes receivable from officers: Balance at beginning of year (198) (1,162) (3,896) (Issuance) repayment of notes receivable from officers (300) 964 2,734 ----------------------------------------------- Balance at end of year (498) (198) (1,162) ----------------------------------------------- Treasury stock - Common: Balance at beginning of year (5,572) (5,408) (4,769) Purchase of treasury shares (10) (164) (639) ----------------------------------------------- Balance at end of year (5,582) (5,572) (5,408) ----------------------------------------------- Treasury stock - Class A common: Balance at beginning of year (610) (1,365) (1,075) Purchase of treasury shares (18,840) (433) (1,867) Reissuance of treasury shares under employee benefit plans 6,840 1,188 1,577 ----------------------------------------------- Balance at end of year (12,610) (610) (1,365) ----------------------------------------------- Total shareholders' equity: Balance at beginning of year 478,347 425,828 609,668 Issuance of shares -- 837 -- Net income (loss) 44,734 15,019 (135,334) Common stock dividends declared (4,527) (4,842) (5,138) Class A common stock dividends declared (3,417) (3,147) (2,788) Other comprehensive income (loss) 11,210 43,680 (42,385) (Issuance) repayment of notes receivable from officers (300) 964 2,734 Purchase of treasury shares (18,850) (597) (2,506) Reissuance of treasury shares under employee benefit plans 4,283 605 1,577 ----------------------------------------------- Balance at end of year $ 511,480 $ 478,347 $ 425,828 ===============================================
See accompanying notes to the consolidated financial statements. 52 P M A C A P I T A L Consolidated Statements of Cash Flows
For the years ended December 31, (in thousands) 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income (loss) $ 44,734 $ 15,019 $ (135,334) Adjustments to reconcile net income (loss) to net cash flows used in operating activities: Depreciation and amortization 5,895 8,690 12,511 Provision (benefit) for deferred income taxes 425 9,906 (11,488) Extraordinary loss from early extinguishment of debt -- (4,734) -- Net realized investment gains (21,745) (8,598) (2,984) Change in: Premiums receivable and unearned premiums, net (10,718) 39,030 17,983 Dividends to policyholders 500 (2,324) (632) Reinsurance receivables (60,348) (74,423) 6,664 Unpaid losses and loss adjustment expenses (62,292) (87,885) 21,086 Accrued investment income 3,918 6,577 5,188 Deferred acquisition costs (5,827) (1,282) (6,105) Other, net 25,806 (6,753) (22,834) ------------------------------------------------- Net cash flows used in operating activities (79,652) (106,777) (115,945) ------------------------------------------------- Cash flows from investing activities: Fixed maturity investments available for sale: Purchases (1,741,790) (1,963,492) (1,227,173) Maturities or calls 207,285 168,304 52,280 Sales 1,468,231 2,072,842 1,210,114 Equity securities: Purchases -- -- (5,196) Sales -- 254 16,984 Net sales (purchases) of short-term investments 176,658 (130,391) 78,935 Proceeds from sale of PMA Insurance, Cayman Ltd. 2,902 -- -- Purchase of Caliber One Indemnity Company, net of acquired cash -- (11,481) -- Other, net (414) 3,568 (6,723) ------------------------------------------------- Net cash flows provided by investing activities 112,872 139,604 119,221 ------------------------------------------------- Cash flows from financing activities: Proceeds from issuance of long-term debt -- 210,000 26,000 Repayments of long-term debt (40,000) (211,699) (25,149) Dividends paid to shareholders (7,939) (7,965) (7,926) Proceeds from exercised stock options and issuance of Class A common stock 4,283 1,442 1,577 Purchase of treasury stock (18,850) (597) (2,506) Net (issuance) repayments of notes receivable from officers (300) 964 2,734 ------------------------------------------------- Net cash flows used in financing activities (62,806) (7,855) (5,270) ------------------------------------------------- Net (decrease) increase in cash (29,586) 24,972 (1,994) Cash - beginning of year 32,148 7,176 9,170 ------------------------------------------------- Cash - end of year $ 2,562 $ 32,148 $ 7,176 ================================================= Supplementary cash flow information: Income tax (refunds) paid $ (15,170) $ (19,112) $ 5,525 Interest paid $ 14,895 $ 19,776 $ 16,622
See accompanying notes to the consolidated financial statements. 53 P M A C A P I T A L Consolidated Statements of Comprehensive Income
For the years ended December 31, (in thousands) 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------- Net income (loss) $ 44,734 $ 15,019 $(135,334) ----------------------------------------------- Other comprehensive income (loss), net of tax: Unrealized gain (loss) on securities: Holding gain (loss) arising during the period 25,344 49,269 (40,445) Less: reclassification adjustment for gains included in net income (net of tax effect: 1998 - $7,611; 1997 - $3,009; 1996 - $1,044) (14,134) (5,589) (1,940) ----------------------------------------------- Other comprehensive income (loss), net of tax 11,210 43,680 (42,385) ----------------------------------------------- Comprehensive income (loss) $ 55,944 $ 58,699 $(177,719) ===============================================
See accompanying notes to the consolidated financial statements. 54 P M A C A P I T A L Notes to Consolidated Financial Statements 1. Business Description The accompanying consolidated financial statements include the accounts of PMA Capital Corporation and its wholly and majority owned subsidiaries ("PMA Capital" or the "Company"). PMA Capital is an insurance holding company that operates three specialty risk management businesses, which are more fully described below. Reinsurance -- PMA Capital's reinsurance operations ("PMA Re") consist mainly of PMA Reinsurance Corporation, a Pennsylvania domiciled insurance company, and emphasize risk-exposed, excess of loss reinsurance and operate in the brokered market. PMA Re's business is predominantly in casualty lines of reinsurance. Workers' Compensation and Primary Standard Insurance -- PMA Capital's property and casualty insurance subsidiaries ("The PMA Insurance Group") include Pennsylvania domiciled insurance companies as well as certain foreign subsidiaries. The PMA Insurance Group primarily writes workers' compensation, and to a lesser extent, 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 Reinsurance Corporation acquired 100% of the outstanding common stock of Caliber One Indemnity Company, domiciled in Delaware and formerly known as Lincoln Insurance Company, for approximately $16.0 million and made a capital contribution of approximately $11.3 million to Caliber One Indemnity Company. All of Caliber One Indemnity Company's acquired loss reserves were reinsured with an affiliate of its former parent for adverse development and uncollectible reinsurance (the "Reserve Guarantee") in the amount of the recorded reserves plus $68.5 million. Upon the purchase of Caliber One Indemnity Company, management valued the amount of the Reserve Guarantee at approximately $5.0 million 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. PMA Reinsurance Corporation intends to maintain Caliber One Indemnity Company's surplus at not less than $25.0 million, the minimum capital and surplus required for many states in order to be an eligible surplus lines carrier. During 1998, Caliber One primarily wrote primary and excess products liability, other commercial liability and certain property exposures. Because Caliber One's results were not significant in 1997, its financial information was included within the Corporate and Other segment in 1997, including pre-opening costs of approximately $900,000, which were expensed as incurred. 2. Summary of Significant Accounting Policies A. Basis of Presentation -- The consolidated financial statements have been prepared in accordance with generally accepted accounting principles ("GAAP"). All significant intercompany accounts and transactions have been eliminated in consolidation. The preparation of consolidated financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. In addition, certain prior year amounts have been restated to conform to the current year classification. B. Investments -- Fixed maturity investments include U.S. Treasury securities and obligations of U.S. Government agencies; obligations of states, political subdivisions and foreign governments; corporate debt securities; and mortgage-backed and other asset-backed securities. All fixed maturity investments are classified as available-for-sale and, accordingly, are carried at fair value with changes in fair value, net of income tax effects, reflected in accumulated other comprehensive income. 55 P M A C A P I T A L Notes to Consolidated Financial Statements (continued) Equity securities for all periods are stated at fair value with changes in fair value, net of income tax effects, reflected in accumulated other comprehensive income. Short-term investments, which have an original maturity of one year or less, are carried at cost, which approximates fair value. Realized gains and losses, determined by specific identification where possible and the first-in, first-out method in other instances, are reflected in income in the period in which the sale transaction occurs. 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. The estimated premiums receivable on retrospectively rated policies are reported as a component of premiums receivable (see Note 2-L). 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 not been material. D. Unpaid Losses and Loss Adjustment Expenses -- Unpaid losses and loss adjustment expenses, which are stated net of estimated salvage and subrogation, are estimates of losses and loss adjustment expenses on known claims, and estimates of losses and loss adjustment expenses incurred but not reported ("IBNR"). IBNR reserves are calculated utilizing various actuarial methods. Unpaid losses on certain workers' compensation claims are discounted to present value using the Company's payment experience and mortality and interest assumptions in accordance with statutory accounting practices prescribed or permitted by the Pennsylvania Insurance Department and the Delaware Insurance Department (collectively "SAP") (see Note 4). 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 -- Costs that directly relate to and vary with acquisition of new and renewal business are deferred and amortized over the period during which the related premiums are earned. Such direct costs include commissions, brokerage and premium taxes, as well as other policy issuance costs and underwriting expenses. The Company determines whether deferred acquisition costs are recoverable considering future losses and loss adjustment expenses, maintenance costs and anticipated investment income. To the extent that deferred acquisition costs are not recoverable, the deficiency is charged to income currently. F. Dividends to Policyholders -- The PMA Insurance Group issues certain workers' compensation insurance policies with dividend payment features. These policyholders share in the operating results of their respective policies in the form of dividends declared at the discretion of the Board of Directors of The PMA Insurance Group's operating companies. Dividends to policyholders are accrued during the period in which the related premiums are earned and are determined based on the terms of the individual policies. G. Income Taxes -- The Company records deferred tax assets and liabilities 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, PMA Capital and a majority of its subsidiaries have a tax-sharing agreement which allocates to 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 PMA Capital. 56 P M A C A P I T A L H. Per Share Data -- Earnings per share data for all periods is presented in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share." Basic earnings per share: For years 1998, 1997 and 1996, basic earnings per share was based upon the weighted average number of common and Class A common shares outstanding during the year. Diluted earnings per share: For years 1998 and 1997, diluted earnings per share was based upon the weighted average number of common and Class A common shares outstanding during the year and common stock equivalents. In 1996, diluted earnings per share was based upon the weighted average common and Class A common shares outstanding during the year. Common stock equivalents were excluded because they would have had an anti-dilutive effect on the net loss per share (see Note 16). I. Stock-Based Compensation -- The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's Class A common stock at grant date or other measurement date over the amount an employee must pay to acquire the Class A common stock. J. Other Revenues -- Other revenues include service revenues related to unbundled claims, risk management and related services provided by The PMA Insurance Group, which are earned over the term of the related contracts in proportion to the actual services rendered, and other miscellaneous revenues. K. Recent Accounting Pronouncements -- In June 1996, the Financial Accounting Standards Board ("FASB") 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. In December 1996, FASB issued SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125," which deferred for one year certain provisions of SFAS No. 125. As a result of adopting SFAS No. 125 and SFAS No. 127 during 1998, the Company recorded short-term investments, and a corresponding liability representing cash collateral received in conjunction with the Company's securities lending program, of $421.1 million as of December 31, 1998 (see Note 3). As of January 1, 1998, the Company adopted SFAS No. 130, "Comprehensive Income," which establishes standards for the reporting and disclosure of comprehensive income and its components (revenues, expenses, gains and losses). SFAS No. 130 requires that all items required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS No. 130 requires only additional disclosures and does not affect the Company's financial position or results of operations. As of January 1, 1998, the Company adopted SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information," which establishes standards for the reporting of information about operating segments. SFAS No. 131 also establishes standards for related disclosures about products and services, geographic areas and major customers. In connection with the adoption of SFAS No. 131, the Company has identified four reportable segments: (i) PMA Re, which provides property and casualty reinsurance products and services; (ii) The PMA Insurance Group, which writes workers' compensation and other standard lines of commercial insurance; (iii) Caliber One, which writes specialty insurance focusing on excess and surplus lines; and (iv) Corporate and Other, which includes unallocated investment income; expenses, including debt service; and taxes, as well as the results of certain of the Company's real estate properties. SFAS No. 131 requires only additional disclosures (see Note 17) and does not affect the Company's financial position or results of operations. 57 P M A C A P I T A L Notes to Consolidated Financial Statements (continued) In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," which revises employers' disclosures about pensions and other post-retirement benefit plans. SFAS No. 132 does not change the measurement or recognition of those plans and was effective for fiscal years beginning after December 15, 1997. The Company has applied the guidelines of SFAS No. 132 in its pension and other postretirement related disclosures (see Note 9). In 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. The impact of adopting SOP 97-3 will be reflected as a cumulative effect of an accounting change in the first quarter of 1999 and is not expected to exceed $5.0 million on a pre-tax basis. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as "derivatives") and for hedging activities. SFAS No. 133 requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation. 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. L. Accrued Retrospective Premiums -- Accrued retrospective premiums, which are a component of premiums receivable, are based upon actuarial estimates of expected ultimate losses and resulting estimated premium adjustments relating to retrospectively rated policies. The change in accrued retrospective premiums is a component of net premiums written and 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 underlying estimated losses on such policies. In addition, accrued retrospective premiums are increased (decreased) based upon retrospective policy adjustments paid (billed). 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, (dollar amounts in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------- Estimated retrospective policy adjustments related to current accident year $ (9,204) $(12,460) $(18,767) Revision of estimate of retrospective policy adjustments related to prior accident years (11,684) (44,719) (9,888) Retrospective policy adjustments paid 17,888 20,179 23,155 Uncollectible write-off -- -- (5,000) -------------------------------- Total $ (3,000) $(37,000) $(10,500) ================================ The $44.7 million revision of estimate of accrued retrospective premiums in 1997 related 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 ($9.0 million). The reduction for accident years 1991 and prior primarily relates to the commutation program for such years initiated in late 1996. 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 loss adjustment expenses associated with such 58 P M A C A P I T A L 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 4). The effects of the commutations on these prior loss reserves, as well as the intent of The PMA Insurance 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 and 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. 3. Investments The Company's investment portfolio is diversified and contains no significant concentrations in any specific industry, business segment or individual issuer. The amortized cost and fair value of the Company's investment portfolio are as follows:
Gross Gross Amortized Unrealized Unrealized Fair (dollar amounts in thousands) Cost Gains Losses Value - --------------------------------------------------------------------------------------------------------------------- December 31, 1998 Fixed maturities available for sale: U.S. Treasury securities and obligations of U.S. Government agencies $ 801,174 $ 27,112 $ 1,097 $ 827,189 States, political subdivisions and foreign government securities 24,634 236 9 24,861 Corporate debt securities 406,707 14,267 632 420,342 Mortgage-backed and other asset- backed securities 548,673 7,263 974 554,962 ------------------------------------------------------------- Total fixed maturities available for sale 1,781,188 48,878 2,712 1,827,354 Equity securities 5 12 -- 17 Short-term investments 498,038 -- -- 498,038 ------------------------------------------------------------- Total investments $2,279,231 $ 48,890 $ 2,712 $2,325,409 ============================================================= December 31, 1997 Fixed maturities available for sale: U.S. Treasury securities and obligations of U.S. Government agencies $1,121,112 $ 17,267 $ 3,564 $1,134,815 States, political subdivisions and foreign government securities 100 -- -- 100 Corporate debt securities 464,925 12,197 115 477,007 Mortgage-backed and other asset- backed securities 314,457 3,305 166 317,596 ------------------------------------------------------------- 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 =============================================================
59 P M A C A P I T A L The amortized cost and fair value of fixed maturities at December 31, 1998, by contractual maturity are as follows.
Amortized Fair (dollar amounts in thousands) Cost Value - ------------------------------------------------------------------------------------------------------------- 1999 $ 167,448 $ 168,648 2000-2003 526,127 532,894 2004-2008 192,348 198,097 2009 and thereafter 346,592 372,753 Mortgage-backed and other asset-backed securities 548,673 554,962 -------------------------------- $ 1,781,188 $ 1,827,354 ================================ Net investment income consists of the following: For the years ended December 31, (dollar amounts in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------- Fixed maturities $ 115,414 $ 128,400 $ 131,530 Short-term investments 7,959 7,282 7,711 Other 1,590 1,116 300 ----------------------------------------------------- Total investment income 124,963 136,798 139,541 Investment expenses 4,838 3,406 8,704 ----------------------------------------------------- Net investment income $ 120,125 $ 133,392 $ 130,837 ===================================================== Net realized investment gains consist of the following: For the years ended December 31, (dollar amounts in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------- Realized gains: Fixed maturities $ 28,140 $ 20,899 $ 12,762 Equity securities -- -- 4,351 ----------------------------------------------------- 28,140 20,899 17,113 Realized losses: Fixed maturities (6,070) (12,203) (12,861) Equity securities -- -- (436) ----------------------------------------------------- (6,070) (12,203) (13,297) Other realized losses, net (325) (98) (832) ----------------------------------------------------- Total net realized investment gains $ 21,745 $ 8,598 $ 2,984 =====================================================
The change in unrealized appreciation (depreciation) of investments for 1998, 1997 and 1996 was $17.2 million, $67.2 million and ($65.2) million, respectively, primarily attributable to fixed maturities. On December 31, 1998, the Company had securities with a total amortized cost of $30.0 million and fair value of $30.4 million on deposit with various governmental authorities, as required by law. In addition, at December 31, 1998, securities with a total amortized cost of $12.2 million and fair value of $12.9 million, were pledged as collateral for letters of credit issued on behalf of the Company. 60 P M A C A PI T A L During 1997, the Company established a securities lending program through which securities are lent from the Company's portfolio to qualifying third parties, subject to certain limits, via a lending agent for short periods of time. Borrowers of these securities must provide collateral equal to a minimum of 102% of the market value and accrued interest of the lent securities. Acceptable collateral may be in the form of either cash or securities. Cash received as collateral is invested in short-term investments, and all securities received as collateral are of similar quality to those securities lent by the Company. The Company is not permitted by contract to sell or repledge the securities received as collateral. Additionally, the Company limits securities lending to 40% of SAP admitted assets of its insurance subsidiaries, with a 2% limit on SAP admitted assets to any individual borrower. The Company receives either a fee from the borrower or retains a portion of the income earned on the collateral. Under the terms of the securities lending program, the Company is indemnified against borrower default, with the lending agent responsible to the Company for any deficiency between the cost of replacing a security that was not returned and the amount of collateral held by the Company. The Company recognized income from securities lending transactions of $1.0 million and $524,000 in 1998 and 1997, respectively, net of lending fees, which was included in investment income. At December 31, 1998, the Company had approximately $424.1 million of collateral related to securities on loan of which $421.1 million was cash received and subsequently reinvested in short-term investments. 4. Unpaid Losses and Loss Adjustment Expenses Activity in the liability for unpaid losses and loss adjustment expenses ("LAE") is summarized as follows:
For the years ended December 31, (dollar amounts in thousands) 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------- Balance at January 1 $ 2,003,187 $ 2,091,072 $ 2,069,986 Less: reinsurance recoverable on unpaid losses and LAE 332,284 256,576 261,492 ----------------------------------------------------- Net balance at January 1 1,670,903 1,834,496 1,808,494 ----------------------------------------------------- Losses and LAE incurred, net: Current year, net of discount 373,098 341,880 323,069 Prior years (46,515) (86,006) 156,074 Accretion of prior years' discount 26,088 51,407 57,480 ----------------------------------------------------- Total losses and LAE incurred, net 352,671 307,281 536,623 ----------------------------------------------------- Losses and LAE paid, net: Current year (96,658) (72,399) (72,194) Prior years (362,186) (398,475) (438,427) ----------------------------------------------------- Total losses and LAE paid, net (458,844) (470,874) (510,621) ----------------------------------------------------- Reserves transferred in sale of subsidiary (217,536) -- -- ----------------------------------------------------- Net balance at December 31 1,347,194 1,670,903 1,834,496 Reinsurance recoverable on unpaid losses and LAE 593,701 332,284 256,576 ----------------------------------------------------- Balance at December 31 $ 1,940,895 $ 2,003,187 $ 2,091,072 =====================================================
The Company's results of operations included a decrease in estimated incurred losses and LAE related to prior accident years of $46.5 million and $86.0 million in 1998 and 1997, respectively, and an increase of $156.1 million in 1996. During 1998, PMA Re and The PMA Insurance Group recorded favorable reserve development on prior accident years of $31.5 million and $15.0 million, respectively. PMA Re recorded favorable reserve development on prior accident years due to re-estimated loss trends for such years that are lower than previous expectations. The favorable reserve development at The PMA Insurance Group primarily relates to the formal commutation programs, which resulted in early liability settlements made during 1998 to reduce future claim payments. 61 P M A C A P I T A L Notes to Consolidated Financial Statements (continued) During 1997, PMA Re and The PMA Insurance Group recorded favorable reserve development of $32.1 million and $53.9 million, respectively. Favorable loss development at The PMA Insurance Group in 1997 can be attributed to the following: favorable reserve development of approximately $37.0 million related to retrospectively rated policies for Run-off Operations; the cession of prior year reserves of $14.8 million from Run-off Operations to a third party reinsurer; and favorable reserve development of $7.1 million on guaranteed cost workers' compensation reserves, partially offset by reserve strengthening of $5.0 million in commercial multi-peril business. The increase in estimated incurred losses and LAE during 1996 is primarily due to a loss reserve strengthening charge of $191.4 million. This loss reserve strengthening was associated with the following lines of business: workers' compensation, $110.0 million; asbestos and environmental, $60.4 million; and other commercial lines of business, primarily general liability claims, $21.0 million. Unpaid losses and LAE reflect management's best estimate of future amounts needed to pay claims and related settlement costs with respect to insured events which have occurred, including events that have not been reported to the Company. In many cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured loss, the reporting of the loss to the Company and the Company's payment of that loss. In general, liabilities for reinsurers become known more slowly than for primary insurers and are subject to more unforeseen development. As part of the process in determining these amounts, historical data is reviewed and consideration is given to the impact of various factors, such as legal developments, changes in social attitudes and economic conditions. Unpaid losses for the Company's workers' compensation claims, net of reinsurance, at December 31, 1998 and 1997 were $515.6 million and $816.1 million, net of discount of $194.3 million and $460.2 million, respectively. The approximate discount rate used was 5% at December 31, 1998 and 1997. Since 1996, the impact on losses from the effects of discounting loss reserves at The PMA Insurance Group has declined due mainly to the effect of commutations and lower business writings. The PMA Insurance Group has been executing programs under which it commuted, or settled, a large number of workers' compensation claims. Commutations are agreements whereby the claimants, in exchange for a lump sum payment, release their rights to future indemnity payments from The PMA Insurance Group. The PMA Insurance Group paid approximately $64.9 million, $113.0 million and $17.8 million in 1998, 1997 and 1996, respectively, to commute workers' compensation indemnity claims. The commutation program resulted in payments, which were less than the corresponding carried reserves. Savings associated with these claims were consistent with management's expectations. As substantially all of these reserves were carried on a discounted basis, the ultimate level of discount on The PMA Insurance Group's carried reserves decreased. Estimating reserves for workers' compensation claims is difficult for several reasons, including (i) the long payment "tail" associated with the business; (ii) the impact of social, political, case law 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. If necessary, adjustments will be made to such reserves as they are identified if loss patterns develop differently than forecasted or if new information becomes available and such adjustments may be material to results of operations, financial condition and liquidity. 62 P M A C A P I T A L Management believes that its unpaid losses and LAE are fairly stated at December 31, 1998. 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 differ substantially from the amounts recorded at December 31, 1998, the related adjustments could have a material adverse impact on the Company's results of operations, financial condition and liquidity. The Company's asbestos-related losses were as follows:
For the years ended December 31, (dollar amounts in thousands) 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------- Gross of reinsurance: Beginning reserves $ 76,726 $ 80,055 $ 27,611 Incurred losses and LAE (1,976) 2,435 62,854 Calendar year payments for losses and LAE (6,893) (5,764) (10,410) -------------------------------------------- Ending reserves $ 67,857 $ 76,726 $ 80,055 ============================================ Net of reinsurance: Beginning reserves $ 48,578 $ 53,300 $ 23,443 Incurred losses and LAE (2,754) (36) 39,427 Calendar year payments for losses and LAE (2,268) (4,686) (9,570) -------------------------------------------- Ending reserves $ 43,556 $ 48,578 $ 53,300 ============================================ The Company's environmental-related losses were as follows: For the years ended December 31, (dollar amounts in thousands) 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------- Gross of reinsurance: Beginning reserves $ 45,108 $ 35,626 $ 20,134 Incurred losses and LAE 11,895 1,130 22,143 Reserves acquired through purchase of Caliber One Indemnity Company(1) -- 13,060 -- Calendar year payments for losses and LAE (9,967) (4,708) (6,651) -------------------------------------------- Ending reserves $ 47,036 $ 45,108 $ 35,626 ============================================ Net of reinsurance: Beginning reserves $ 31,695 $ 34,592 $ 20,134 Incurred losses and LAE 3,644 1,068 21,109 Calendar year payments for losses and LAE (5,983) (3,965) (6,651) -------------------------------------------- Ending reserves $ 29,356 $ 31,695 $ 34,592 ============================================
(1) Such acquired reserves have been reinsured by an affiliate of the former parent (see Note 5). 63 P M A C A P I T A L Notes to Consolidated Financial Statements (continued) Of the total net asbestos reserves, approximately $34.2 million, $41.9 million and $46.5 million related to IBNR losses at December 31, 1998, 1997 and 1996, respectively. Of the total net environmental reserves, approximately $20.3 million, $20.5 million and $22.1 million related to IBNR losses at December 31, 1998, 1997 and 1996, respectively. All incurred asbestos and environmental losses were for accident years 1986 and prior. Estimating reserves for asbestos and environmental exposures continues to be difficult because of several factors, including: (i) evolving methodologies for the estimation of the liabilities; (ii) lack of reliable historical claim data; (iii) uncertainties with respect to insurance and reinsurance coverage related to these obligations; (iv) changing judicial interpretations; and (v) changing government standards. To reserve for environmental claims, the Company currently utilizes a calendar year development technique known as aggregate loss development. This technique focuses on the aggregate losses paid as of a particular date and aggregate payment patterns associated with such claims. Several elements including remediation studies, remediation, defense, declaratory judgment and third party bodily injury claims were considered in estimating the costs and payment patterns of the environ-mental 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. In 1996, the Company performed a ground up analysis of loss reserves for direct asbestos exposures 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. Management believes that its reserves for asbestos and environmental claims are appropriately established based upon known facts, existing case law and generally accepted actuarial methodologies. However, due to changing interpretations by courts involving coverage issues, the potential for changes in federal and state standards for clean-up and liability, as well as issues involving policy provisions, allocation of liability among participating insurers, proof of coverage and other factors, the Company's ultimate exposure for these claims may vary significantly from the amounts currently recorded, resulting in a potential future adjustment that could be material to the Company's financial condition and results of operations. The Company's loss reserves were stated net of salvage and subrogation of approximately $60.4 million and $59.9 million at December 31, 1998 and 1997, respectively. 5. Reinsurance In the ordinary course of business, PMA Capital's reinsurance and insurance subsidiaries assume and cede premiums with other insurance companies and are members of various pools and associations. The reinsurance and insurance subsidiaries cede business, primarily on an excess of loss basis, in order to limit the maximum net loss from large risks and limit the accumulation of many smaller losses from a catastrophic event. The reinsurance and insurance subsidiaries remain primarily liable to their clients in the event their reinsurers are unable to meet their financial obligations. 64 P M A C A P I T A L The components of net premiums earned and losses and LAE incurred are as follows: For the years ended December 31, (dollar amounts in thousands) 1998 1997 1996 - ---------------------------------------------------------------------------- Earned premiums: Direct $ 286,987 $ 277,871 $ 299,386 Assumed 276,689 216,357 209,688 Ceded (96,961) (118,277) (88,499) --------------------------------------- Net $ 466,715 $ 375,951 $ 420,575 ======================================= Losses and LAE incurred: Direct $ 250,641 $ 244,429 $ 420,157 Assumed 184,309 166,202 163,799 Ceded (82,279) (103,350) (47,333) --------------------------------------- Net $ 352,671 $ 307,281 $ 536,623 ======================================= At December 31, 1998, the Company had reinsurance receivables due from the following unaffiliated single reinsurers in excess of 3% of shareholders' equity: (dollar amounts in thousands) Gross amount due Reinsurer to the Company - --------------------------------------------------------------------------- London Life Reinsurance Group $264,166 United States Fidelity and Guaranty Company 85,724 American Re-Insurance Corporation 33,652 Essex Insurance Company 30,143 Kemper Reinsurance Corporation 21,714 Continental Casualty Company 16,326 The Company performs extensive credit reviews of its reinsurers focusing on, among other things, financial capacity, stability, trends and commitment to the reinsurance business. Prospective and existing reinsurers failing to meet the Company's standards are excluded from the Company's reinsurance programs. In addition, the Company requires letters of credit or other acceptable collateral to support balances due from reinsurers not authorized to transact business in the applicable jurisdictions. The Company maintained funds held to collateralize the above balances in the amount of $74.9 million at December 31, 1998. In addition, the entire receivable from the London Life Reinsurance Group is secured by assets in trust ($240.8 million) and by letters of credit ($23.4 million). 6. Long-Term Debt Long-term debt consisted of $163.0 million and $203.0 million outstanding under the Company's revolving credit facility as of December 31, 1998 and 1997, respectively. The revolving credit facility matures as follows: $38.0 million in 2000, $62.5 million in 2001 and $62.5 million in 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 $235.0 million revolving credit facility (the "Credit Facility"). The early extinguishment of the senior note agreements resulted in an extraordinary loss of $4.7 million ($7.3 million pre-tax). The Credit Facility bears interest at the London InterBank Offered Rate ("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 in the future based upon the Company's debt-to-capitalization ratios. As of December 31, 1998, the interest rate on the utilized portion of the Credit Facility was 5.95%. The Company has entered into an interest rate swap agreement in its management of its existing interest rate exposures with a notional principal balance of $150.0 million at December 31, 1998. The rate on the swap resets every three months such that it effectively converts the Company's interest rate exposure on $150.0 million of the Credit Facility, which has a floating rate, to a fixed obligation (7.24% at December 31, 1998). The swap involves the exchange of interest payment obligation without 65 P M A C A P I T A L Notes to Consolidated Financial Statements (continued) the exchange of underlying principal. The differential to be paid or received is recognized as an adjustment of interest expense. In the event that a counterparty fails to meet the terms of the swap, the Company's exposure is limited to the interest rate differential on the notional principal amount ($150.0 million). Management believes such credit risk is minimal and any loss would not be significant. Effective March 14, 1997, the Company modified its letter of credit agreement with a group of banks (the "Letter of Credit Agreement") to reduce its aggregate outstanding face amount to $50.0 million. The agreement requires the Company to pay a commitment fee, which is adjustable downward in the future based upon the Company's debt-to-capitalization ratios. At December 31, 1998, the commitment fee was 0.225% per annum. At December 31, 1998 and 1997, the aggregate outstanding face amount of letters of credit issued was $46.9 million. The Letter of Credit Agreement primarily secures reinsurance liabilities of the insurance subsidiaries of the Company. The debt covenants supporting the Credit Facility and the Letter of Credit Agreement contain provisions that, among other matters, limit the Company's ability to incur additional indebtedness, merge, consolidate and acquire or sell assets. The debt covenants also require the Company to satisfy certain ratios related to net worth, debt-to-capitalization and interest coverage. Additionally, the debt covenants place restrictions on dividends to shareholders (see Note 15). 7. Stock Options The Company currently has six stock option plans in place for stock options granted to officers and other key employees for the purchase of the Company's Class A common stock, under which 3,478,761 Class A common shares were reserved for issuance at December 31, 1998. The stock options are granted under terms and conditions determined by the Stock Option Committee of the Board of Directors. Stock options granted have a maximum term of ten years, vest over periods ranging between zero and five years, and are typically granted with an exercise price approximating the fair market value of the Class A common stock on the date the options are granted. Information regarding these option plans are as follows:
1998 1997 1996 ------------------------------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Shares Price Shares Price Shares Price - ---------------------------------------------------------------------------------------------------------------------- Options outstanding, beginning of year 3,117,612 $ 13.18 3,242,160 $ 12.43 3,087,260 $ 11.80 Options granted 826,500 17.12 324,500 17.00 325,000 17.00 Options exercised (386,142) (11.07) (162,248) (8.78) (99,150) (8.33) Options forfeited or expired (111,800) (12.26) (286,800) (11.53) (70,950) (11.55) ------------------------------------------------------------------------------------- Options outstanding, end of year(1) 3,446,170 $ 14.39 3,117,612 $ 13.18 3,242,160 $ 12.43 ===================================================================================== Options exercisable, end of year 2,468,233 $ 13.32 2,556,087 $ 12.42 2,642,085 $ 11.75 ===================================================================================== Option price range at end of year $8.00 to $19.00 $8.00 to $17.00 $8.00 to $17.00 Option price range for exercised shares $8.00 to $17.00 $8.00 to $15.00 $6.60 to $10.00 Options available for grant at end of year 7,591 747,291 921,566
(1) Included in the options outstanding at the end of 1998 are 420,000 options with an exercise price of $17.00 which become exercisable based on the Company's Class A common stock achieving certain target prices, with one-half of those options becoming exercisable at $28.00 and the remaining one-half becoming exercisable at $32.00. 66 P M A C A P I T A L Of the total options granted in 1998, 96% were granted with an exercise price that exceeded the market value on the grant date ("out-of-the-money"), and such options had a weighted average exercise price of $17.03 per share and a weighted average fair value of $3.65 per share. The remaining 4% were granted with an exercise price that was lower than the market value on the grant date ("in-the-money"), and such options had a weighted average exercise price of $19.00 per share and a weighted average fair value of $7.59 per share. In 1997, all options were granted out-of-the-money at an exercise price of $17.00 per share and a fair value of $5.79 per share. In 1996, all options were granted at market value equal to $17.00 per share and a fair value of $6.40 per share. Stock options outstanding at December 31, 1998 and related exercise price and weighted average remaining life information is as follows:
Weighted Average Options Options Remaining Life Exercise Prices Outstanding Exercisable (in years) - ------------------------------------------------------------------------------- $ 8.00 to $12.00 1,141,205 1,141,205 4.11 $12.01 to $16.00 849,765 849,765 6.08 $16.01 to $19.00 1,455,200 477,263 7.08 ------------------------- 3,446,170 2,468,233 5.50 =========================
The fair value of options at date of grant was estimated using a binomial option pricing model with the following weighted average assumptions: 1998 1997 1996 - ---------------------------------------------------- Expected life (years) 7.5 10 10 Risk-free interest rate 5.5% 6.3% 6.3% Expected volatility 26% 18% 18% Expected dividend yield 1.9% 2.3% 2.3% The Company has adopted the disclosure-only provision of SFAS No. 123, "Accounting for Stock-Based Compensation." Accordingly, compensation cost that was recognized in 1998 for the stock option plans was not significant. Had compensation costs for the Company's stock option plans been determined based on the fair value at the grant date for awards granted during the year, pre-tax income would have been reduced by $3.2 million, $1.9 million and $2.1 million in 1998, 1997 and 1996, respectively. After-tax income would have been reduced by $2.1 million, $1.2 million and $1.4 million or $0.09, $0.05 and $0.06 per basic share and $0.08, $0.05 and $0.06 per diluted share in 1998, 1997 and 1996, respectively. 8. Income Taxes The components of the Federal income tax provision (benefit) from continuing operations are as follows: For the years ended December 31, (dollar amounts in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Current $ 9,910 $ (4,506) $(44,572) Deferred 425 9,906 (11,488) --------------------------------- Provision (benefit) for income taxes $ 10,335 $ 5,400 $(56,060) ================================= In addition, the Company recognized current and deferred Federal income tax benefits of $374,000 and $2.2 million, respectively, related to the extraordinary loss recorded in 1997. 67 P M A C A P I T A L Notes to Consolidated Financial Statements (continued) A reconciliation between the total provision (benefit) for income taxes and the amounts computed at the Statutory Federal income tax rate of 35% is as follows:
For the years ended December 31, (dollar amounts in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------------ Computed at the Statutory Federal income tax rate $ 19,274 $ 8,804 $(66,988) (Decrease) increase in taxes resulting from: Tax-exempt interest -- (61) (4,547) Losses of foreign reinsurance affiliate -- -- 16,060 Reversal of income tax accruals (12,637) (3,703) -- Other 3,698 360 (585) -------------------------------- Provision (benefit) for income taxes $ 10,335 $ 5,400 $(56,060) ================================
The tax effects of significant temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that represent the net deferred tax asset are as follows: December 31, (dollar amounts in thousands) 1998 1997 - ----------------------------------------------------------------------------- Discounting of unpaid losses and LAE $ 55,945 $ 63,743 Operating loss carryforwards 29,039 46,088 Unearned premiums 14,305 13,756 Allowance for uncollectible accounts 6,822 6,839 Postretirement benefit obligation 5,160 5,139 Other 12,823 18,919 ------------------------- Gross deferred tax asset 124,094 154,484 ------------------------- Deferred acquisition costs (17,377) (15,723) Unrealized appreciation of investments (16,163) (10,126) Losses of foreign reinsurance affiliate (24,542) (55,087) Other (2,083) (3,157) ------------------------- Gross deferred tax liability (60,165) (84,093) ------------------------- Net deferred tax asset $ 63,929 $ 70,391 ========================= At December 31, 1998, the Company had approximately $48.1 million of net operating loss carryforwards ($40.1 million expiring in 2011 and $8.0 million expiring in 2012) and approximately $11.9 million of alternative minimum tax credit carryforwards, which do not expire. Management believes that it is more likely than not that the benefit of its deferred tax asset will be fully realized, and therefore has not recorded a valuation allowance. The Company's Federal income tax returns are subject to audit by the Internal Revenue Service ("IRS"), and provisions are made in the financial statements in anticipation of the results of these audits. In December 1998, the IRS completed their examination of the 1994 and 1995 U.S. Federal tax returns. In management's opinion, adequate liabilities have been established for all years. In December 1998, the Company received a refund from the IRS of approximately $15.0 million. The refund relates to a claim for refund filed by the Company with regard to its 1992 income tax return. In 1997, the Company received a refund from the IRS of approximately $16.8 million as a result of a net operating loss, which was generated in 1996 and carried back to 1993, 1994 and 1995. 68 P M A C A P I T A L 9. Employee Retirement, Postretirement and Postemployment benefits A. Pension and Other Postretirement Benefits: Pension Benefits - The Company sponsors a qualified non-contributory defined benefit pension plan (the "Qualified Pension Plan") covering substantially all employees. After meeting certain qualifications, an employee acquires a vested right to future benefits. The benefits payable under the plan are generally determined on the basis of an employee's length of employment and career average salary. The Company's policy is to fund pension costs in accordance with the Employee Retirement Income Security Act of 1974. The Company also maintains a non-qualified unfunded supplemental defined benefit pension plan (the "Non-qualified Pension Plan") for the benefit of certain key employees. The projected benefit obligation and accumulated benefit obligation for the Nonqualified Pension Plan were $2.8 million and $1.8 million, respectively, as of December 31, 1998. Other Postretirement Benefits - In addition to providing pension benefits, the Company provides certain health care benefits for retired employees and their spouses. Substantially all of the Company's employees may become eligible for those benefits if they have worked 15 or more years with the Company and have attained the age of 50 while in the service of the Company. For employees who retired on or subsequent to January 1, 1993, the Company will pay a fixed portion of medical insurance premiums. Retirees will absorb future increases in medical premiums. The Company also provides Medicare Part B reimbursement for certain retirees as well as retiree life insurance. The following tables set forth the amounts recognized in the Company's financial statements with respect to Pension Benefits and Other Postretirement Benefits:
Pension Benefits Other Postretirement Benefits December 31, December 31, (dollar amounts in thousands) 1998 1997 1998 1997 - ------------------------------------------------------------------------------------------------------------- Change in benefit obligation: Benefit obligation at beginning of year $ 47,125 $ 51,464 $ 9,673 $ 9,754 Service cost 1,780 1,468 271 237 Interest cost 3,201 3,200 594 655 Plan amendments 310 -- -- -- Actuarial gain (loss) 168 (605) (870) (522) Settlements -- (5,451) -- -- Benefits paid (2,304) (2,951) (499) (451) ----------------------------------------------------------- Benefit obligation at end of year $ 50,280 $ 47,125 $ 9,169 $ 9,673 ----------------------------------------------------------- Change in plan assets: Fair value of plan assets at beginning of year $ 40,600 $ 46,739 $ -- $ -- Actual return on plan assets 2,660 3,412 -- -- Employer contributions 1,860 -- -- -- Divestitures -- (6,600) -- -- Benefits paid (2,304) (2,951) -- -- ----------------------------------------------------------- Fair value of plan assets at end of year $ 42,816 $ 40,600 $ -- $ -- ----------------------------------------------------------- Benefit obligation in excess of the fair value of plan assets $ (7,464) $ (6,525) $ (9,169) $ (9,673) ----------------------------------------------------------- Unrecognized actuarial loss (gain) 5,894 4,859 (4,137) (3,455) Unrecognized prior service cost (700) (1,101) (1,198) (1,317) Unrecognized net transition obligation 316 313 -- -- ----------------------------------------------------------- Accrued benefit at end of year $ (1,954) $ (2,454) $(14,504) $(14,445) ===========================================================
69 PMA CAPITAL Notes to Consolidated Financial Statements (continued)
Pension Benefits Other Postretirement Benefits December 31, December 31, (dollar amounts in thousands) 1998 1997 1996 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------- Components of net periodic benefit cost: Service cost $ 1,780 $ 1,468 $ 1,763 $ 271 $ 237 $ 248 Interest cost 3,201 3,200 3,098 594 655 561 Expected return on plan assets (3,496) (3,159) (3,458) -- -- -- Amortization of transition obligation (3) (23) (23) -- -- -- Amortization of prior service cost (91) (99) (97) (119) (119) (119) Recognized actuarial gain (11) -- -- (188) (123) (132) Settlement charge -- 115 4,300 -- -- 975 ------------------------------------------------------------------------ Net periodic benefit cost $ 1,380 $ 1,502 $ 5,583 $ 558 $ 650 $ 1,533 ======================================================================== Weighted average assumptions: Discount rate 6.75% 7.00% 7.50% 6.75% 7.00% 7.50% Expected return on plan assets 9.00% 9.00% 8.00% -- -- -- Rate of compensation increase 4.50% 4.50% 5.00% -- -- --
For the measurement of Other Postretirement Benefits, a 7.00% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1998. The rate was assumed to decrease gradually to 5.50% for 2002 and remain at that level thereafter. A one-percentage point change in assumed health care cost trend rates would have an immaterial impact on the total service and interest cost components of the net periodic benefit cost and the postretirement benefit obligation. Qualified Pension Plan assets consist of equity securities, fixed maturity securities and fixed income contracts. In addition, the Pension Plan owned approximately 249,000 shares of the Company's common stock at December 31, 1998 and 1997. During 1997, an annuity contract with a third party was terminated, resulting in a one-time settlement charge of approximately $115,000, as well as a decrease in the benefit obligation of $5.5 million and a decrease in plan assets of $6.6 million. B. Defined Contribution Savings Plan -- 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 $2.0 million, $1.7 million and $2.2 million in 1998, 1997 and 1996, respectively. C. Postemployment Benefits -- The Company provides certain benefits to employees subsequent to their employment, but prior to retirement including severance, long-term and short-term disability payments, salary continuation, postemployment health benefits, supplemental unemployment benefits and other related payments. Postemployment benefits attributable to prior service and/or that relate to benefits that vest or accumulate are accrued presently if the payments are probable and reasonably estimable. Postemployment benefits that do not meet such criteria are accrued when payments are probable and reasonably estimable. During 1996, The PMA Insurance 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 $7.6 million in connection with the VERIP. The components of this accrual are as follows: pension costs, $4.3 million; postemployment costs, $2.4 million; and postretirement costs, $975,000. The Company did not offer a VERIP in 1998 or 1997, and as such, did not incur any VERIP expenses. The Company did, however, incur certain restructuring and other charges during 1997 (see Note 14). 70 P M A C A P I T A L 10. Fair Value of Financial Instruments As of December 31, 1998 and 1997, the carrying amounts for the Company's financial instruments approximated their estimated fair value, except for interest rate swaps which had a carrying value of zero and a fair value of ($5.8) million and ($3.4) million at December 31, 1998 and 1997, respectively. The Company measures the fair value of fixed maturities and interest rate swaps based upon quoted market prices or by obtaining quotes from dealers. The fair value of long-term debt is estimated using discounted cash flow calculations based upon the Company's current incremental borrowing rate for similar types of borrowing facilities or the rate utilized to prepay obligations, where applicable. For other financial instruments, the carrying values approximate their fair values. Certain financial instruments, specifically amounts relating to insurance contracts, are excluded from this disclosure. 11. Disclosure of Certain Risks and Uncertainties As stated in Note 1, PMA Capital is an insurance holding company that sells property and casualty reinsurance and insurance through its insurance subsidiaries. The following summarizes the relative significance of the segments and lines of insurance in terms of net premiums written: Percent of the Company's Net Premiums Written 1998 1997 1996 - ---------------------------------------------------------------------------- PMA Re 49.2% 46.7% 37.6% The PMA Insurance Group 49.4 53.3 62.4 Caliber One 1.4 -- -- ---------------------------------- Total 100.0% 100.0% 100.0% ================================== PMA Re distributes its products through major reinsurance brokers, and PMA Re's top four such brokers accounted for approximately 90% of PMA Re's gross premiums in force at December 31, 1998. In 1998, 1997 and 1996, casualty reinsurance lines at PMA Re represented 35.5%, 31.2% and 28.2%, respectively, of the Company's total net premiums written. The PMA Insurance Group's operations are concentrated in seven contiguous states in the Mid-Atlantic and Southern regions of the U.S. As such, economic trends in individual states may not be independent of one another. Also, The PMA Insurance Group's products are highly regulated by each of these states. For many of The PMA Insurance Group's products, the insurance departments of the states in which it conducts business must approve rates and policy forms. In addition, workers' compensation benefits are determined by statutes and regulations in each of these states. While The PMA Insurance Group considers factors such as rate adequacy, regulatory climate and economic factors in its underwriting process, unfavorable developments in these factors could have an adverse impact on the Company's financial condition and results of operations. In 1998, 1997 and 1996, workers' compensation net premiums at The PMA Insurance Group represented 39.4%, 46.0% and 43.4%, respectively, of the Company's total net premiums written. The Company actively manages its exposure to catastrophes through its underwriting process, where the Company generally monitors the accumulation of insurable values in catastrophe prone regions. Also, in writing property reinsurance coverages, PMA Re typically requires per occurrence loss limitations for contracts that could have catastrophe exposure. Through per risk reinsurance, the Company also manages its net retention in each exposure. In addition, PMA Re maintains retrocessional protection of $48.0 million excess of $2.0 million per occurrence and The PMA Insurance Group maintains catastrophe reinsurance protection of $27.7 million excess of $850,000. As a result, the Company's loss and LAE ratios have not been significantly impacted by catastrophes in 1998, 1997 and 1996. Although the Company believes that it has adequate reinsurance to protect against the estimated probable maximum gross loss from a catastrophe, an especially severe catastrophe or series of catastrophes could exceed the Company's reinsurance and/or retrocessional protection, and may have a material adverse impact on the Company's results of operations and financial condition. 71 P M A C A P I T A L Notes to Consolidated Financial Statements (continued) 12. Transactions With Related Parties The Company's largest shareholder is PMA Foundation (the "Foundation"), a not-for-profit corporation qualified under Section 501(c)(6) of the Internal Revenue Code, whose purposes include the promotion of the common business interests of its members and the economic prosperity of the Commonwealth of Pennsylvania. As of December 31, 1998, the Foundation owned 4,561,225 shares of common stock (33.7% of the class) and 912,225 shares of Class A common stock (9.3% of the class), which constitutes 32.1% 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 $14,000, $34,000 and $82,000 for the years ended December 31, 1998, 1997 and 1996, respectively. The Foundation also leases its Harrisburg, Pennsylvania headquarters facility from a subsidiary of the Company under an operating lease presently requiring rent payments of $25,000 per month, and reimburses a subsidiary of the Company for its use of office space in the Blue Bell, Pennsylvania facility. Rent and related reimbursements paid to the Company's affiliates by the Foundation amounted to $262,000, $250,000 and $247,000 for the years ended December 31, 1998, 1997 and 1996, respectively. The Company incurred legal and consulting fees aggregating approximately $6.5 million in 1998 and 1997 and $7.9 million in 1996 from firms in which directors of the Company are partners or principals. 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 generally at a maximum 50% loan to value ratio. The Company has agreed to purchase loans made under this program from the financial institution in the event that the borrower defaults on such loan while employed by the Company. The amount of loans outstanding to current employees at December 31, 1998 under this program was $3.6 million. The Company has notes receivable from officers that are accounted for as a reduction of shareholders' equity in the accompanying balance sheets. Such notes receivable had balances of $498,000 and $198,000 as of December 31, 1998 and 1997, respectively. The interest rates on the notes range between 6.0% and 8.0%. 13. Commitments and Contingencies For the years ended December 31, 1998, 1997 and 1996, total rent expense was $2.6 million, $2.8 million and $2.6 million, respectively. At December 31, 1998, the Company was obligated under noncancelable operating leases for office space with aggregate minimum annual rentals of $2.8 million in 1999, $2.7 million in 2000, $2.8 million in 2001, $2.6 million in 2002, $2.1 million in 2003 and $163,000 thereafter. In the event a property and casualty insurer operating in a jurisdiction where the Company's insurance subsidiaries also operate becomes or is declared insolvent, state insurance regulations provide for the assessment of other insurers to fund any capital deficiency of the insolvent insurer. Generally, this assessment is based upon the ratio of an insurer's voluntary premiums written to the total premiums written for all insurers in that particular jurisdiction. The Company is not aware of any material potential assessments at December 31, 1998 (see Note 2-K regarding SOP 97-3). The Company has provided guarantees of approximately $11.5 million, primarily related to loans on properties in which the Company has an interest. The Company is continuously involved in numerous lawsuits arising, for the most part, in the ordinary course of business, either as a liability insurer defending third-party claims brought against its insureds, or as an insurer defending coverage claims brought against it by its policyholders or other insurers. While the outcome of all litigation involving the Company, including insurance-related 72 P M A C A P I T A L litigation, cannot be determined, litigation is not expected to result in losses that differ from recorded reserves by amounts that would be material to results of operations, liquidity or financial condition. In addition, reinsurance recoveries related to claims in litigation, net of the allowance for uncollectible reinsurance, are not expected to result in recoveries that differ from recorded recoverables by amounts that would be material to the results of operations, liquidity or financial condition. 14. Cost Reduction Initiatives During 1997, the Company recorded a $7.0 million pre-tax charge ($4.6 million after-tax) in operating expenses for costs associated with nonvoluntary terminations of approximately 60 employees in various operational and management positions. As of December 31, 1998, approximately $1.8 million of such charges remained in accounts payable and accrued expenses on the balance sheet. 15. Shareholders' Equity The Company has two classes of common stock, Class A common stock and common stock. The Company's bylaws limit the classes of persons who may own the common stock. Holders of common stock may elect to convert any or all such shares into Class A common stock on a share-for-share basis. The Company's Class A common stock and common stock generally vote without regard to class on matters submitted to shareholders, with the Class A common stock having one vote per share and the common stock having ten votes per share. With respect to dividend rights, the Class A common stock is entitled to cash dividends at least 10% higher than those declared and paid on the common stock. In 1998, 1997 and 1996, the Company declared dividends on its common stock and Class A common stock of $0.32 per share and $0.36 per share, respectively. Changes in common stock and Class A common stock shares were as follows: December 31, 1998 1997 1996 - ------------------------------------------------------------------------------- Common stock: Balance at beginning of year 15,286,263 16,095,416 17,044,580 Conversion of common stock into Class A common stock (1,329,995) (809,153) (949,164) ---------------------------------------- Balance at end of year 13,956,268 15,286,263 16,095,416 ======================================== Class A common stock: Balance at beginning of year 9,156,682 8,247,804 7,298,640 Conversion of common stock into Class A common stock 1,329,995 809,153 949,164 Issuance of shares -- 99,725 -- ---------------------------------------- Balance at end of year 10,486,677 9,156,682 8,247,804 ======================================== Treasury stock - Common: Balance at beginning of year 435,474 425,364 392,564 Purchase of treasury shares 533 10,110 32,800 ---------------------------------------- Balance at end of year 436,007 435,474 425,364 ======================================== Treasury stock - Class A common: Balance at beginning of year 38,947 74,781 73,408 Purchase of treasury shares 995,909 27,689 100,523 Reissuance of treasury shares under employee benefit plans (386,142) (63,523) (99,150) ---------------------------------------- Balance at end of year 648,714 38,947 74,781 ======================================== 73 P M A C A P I T A L Notes to Consolidated Financial Statements (continued) Under the insurance laws and regulations of Pennsylvania, PMA Capital's insurance subsidiaries may not pay dividends to PMA Capital 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, 1998, the maximum amount available to be paid as dividends from the Company's insurance subsidiaries to PMA Capital, without the prior consent of the Pennsylvania Insurance Department, was $51.8 million. PMA Capital's dividends to shareholders are restricted by its debt agreements. Under the terms of the Credit Facility and the Letter of Credit Agreement under the most restrictive debt covenant, the Company could pay dividends of approximately $15.6 million in 1999. In February of 1998, the Company's Board of Directors authorized a plan to repurchase shares of common stock and Class A common stock in an amount not to exceed $25.0 million. During 1998, the Company repurchased a total of 996,442 shares at a total cost of $18.9 million (average per share price was $18.92), leaving $6.1 million of share repurchase authorization under its February 1998 repurchase program. In February 1999, PMA Capital's Board of Directors authorized an additional $20.0 million of share repurchase authority. Decisions regarding share repurchases are subject to prevailing market conditions and the costs and benefits associated with alternative uses of capital. 16. Earnings Per Share A reconciliation of the shares used as the denominator of the basic and diluted earnings per share computations is presented below. For all years presented, there were no differences in the numerator (income before extraordinary item) for the basic and diluted earnings per share calculation. 1998 1997 1996 - ------------------------------------------------------------------------------- Basic shares - weighted average common and Class A common shares outstanding 23,608,618 23,855,031 23,800,791 Dilutive stock options 916,270 712,347 -- ------------------------------------ Total diluted shares 24,524,888 24,567,378 23,800,791 ==================================== Options to purchase shares of Class A common stock are excluded from the computation of diluted earnings per share if they would have been anti-dilutive, and for 1998, 1997 and 1996, such anti-dilutive options were 42,000, 646,000 and 3.2 million, respectively. 74 17. Business Segments The following table indicates the Company's revenues, all of which are generated within the U.S., and pre-tax operating income (loss) by principal business segment for the years ended December 31:
(dollar amounts in thousands) 1998 1997 1996 - ---------------------------------------------------------------------------------------------------------- Revenues: PMA Re $ 278,293 $ 215,873 $ 200,650 The PMA Insurance Group: Excluding Run-off Operations 311,469 328,248 360,245 Run-off Operations 4,761 (23,491) -- ----------------------------------------------- Total 316,230 304,757 360,245 Caliber One 3,203 -- -- Corporate and Other 4,010 2,330 2,805 Net realized investment gains 21,745 8,598 2,984 ----------------------------------------------- Total revenues $ 623,481 $ 531,558 $ 566,684 =============================================== Pre-tax operating income (loss)(1): PMA Re $ 46,408 $ 45,957 $ 44,807 The PMA Insurance Group: Excluding Run-off Operations 10,018 (3,607) (215,669) Run-off Operations 452 (73) -- ----------------------------------------------- Total 10,470 (3,680) (215,669) Caliber One (1,606) -- -- Corporate and Other (6,939) (9,954) (6,464) ----------------------------------------------- Pre-tax operating income (loss) before interest expense 48,333 32,323 (177,326) Interest expense 15,009 15,768 17,052 ----------------------------------------------- Pre-tax operating income (loss) 33,324 16,555 (194,378) Net realized investment gains 21,745 8,598 2,984 ----------------------------------------------- Income (loss) before income taxes and extraordinary loss 55,069 25,153 (191,394) Provision (benefit) for income taxes 10,335 5,400 (56,060) ----------------------------------------------- Income (loss) before extraordinary loss 44,734 19,753 (135,334) Extraordinary loss -- (4,734) -- ----------------------------------------------- Net income (loss) $ 44,734 $ 15,019 $(135,334) ===============================================
(1) The Company has excluded net realized investment gains (losses) from the profit and loss measure it utilizes to assess the performance of its operating segments because: (i) net realized investment gains (losses) are unpredictable and not necessarily indicative of current operating fundamentals or future performance, and; (ii) in many instances, decisions to buy and sell securities are made at the 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 Company recorded amortization and depreciation expense of $5.9 million, $8.7 million and $12.5 million in 1998, 1997 and 1996, respectively. PMA Re and The PMA Insurance Group recorded amortization and depreciation expense of $1.1 million and $3.9 million, respectively, in 1998; $1.0 million and $5.1 million, respectively, in 1997; and $900,000 and $10.9 million, respectively, in 1996. 75 P M A C A P I T A L Notes to Consolidated Financial Statements (continued) The following table indicates the Company's total assets by principal business segment at December 31: (dollar amounts in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------ Assets(1): PMA Re $ 1,417,901 $ 1,102,242 $ 1,031,149 The PMA Insurance Group: Excluding Run-off Operations 1,883,575 1,452,469 1,533,142 Run-off Operations 95,110 398,959 505,347 ---------------------------------------- Total 1,978,685 1,851,428 2,038,489 Caliber One 69,083 64,302 -- Corporate and Other (4,951) 39,286 47,878 ---------------------------------------- Total assets $ 3,460,718 $ 3,057,258 $ 3,117,516 ======================================== (1) Equity investments in subsidiaries, which eliminate in consolidation, are excluded from total assets for each segment. During 1998 and 1997, the Company had one broker that represented more than 10% of the Company's total revenues amounting to $70.6 million and $54.8 million, respectively. There were no brokers or customers that represented more than 10% of the Company's total revenues in 1996. 18. Statutory Financial Information These consolidated financial statements vary in certain respects from those prepared using statutory accounting practices prescribed or permitted by the Pennsylvania Insurance Department and the Delaware Insurance Department, (collectively "SAP"). Prescribed SAP includes state laws, regulations and general administrative rules, as well as a variety of National Association of Insurance Commissioners ("NAIC") publications. Permitted SAP encompasses all accounting practices that are not prescribed. In 1998, the NAIC adopted the Codification of Statutory Accounting Principles ("Codification") guidance which will replace the current Accounting Practices and Procedures manual as the NAIC's primary guidance on statutory accounting beginning in 2001. Codification provides guidance for areas where statutory accounting has been silent and changes current statutory accounting in some areas, such as deferred income taxes, which will be recorded under Codification. The Insurance Department of Pennsylvania has adopted Codification guidance, effective January 1, 2001. The Company is in the process of estimating the impact that Codification will have on its statutory surplus. 76 P M A C A P I T A L SAP net income (loss) and capital and surplus for PMA Capital's domestic insurance subsidiaries are as follows: (dollar amounts in thousands) 1998 1997 1996 - ----------------------------------------------------------------------------- SAP net income (loss): PMA Reinsurance Corporation $ 29,746 $ 25,752 $ 26,338 The PMA Insurance Group (domestic insurance subsidiaries) 23,034 10,785 (191,640) Caliber One Indemnity Company (90) -- -- ------------------------------------ Total $ 52,690 $ 36,537 $(165,302) ==================================== SAP capital and surplus: PMA Reinsurance Corporation(1) $ 287,466 $ 271,154 $ 260,853 The PMA Insurance Group (domestic insurance subsidiaries) 281,947 281,071 279,764 ------------------------------------ Total $ 569,413 $ 552,225 $ 540,617 ==================================== (1) The SAP capital and surplus of PMA Reinsurance Corporation includes PMA Reinsurance Corporation's investment in Caliber One Indemnity Company of $25.0 million in 1998 and 1997. A reconciliation of PMA Capital's domestic insurance subsidiaries' SAP net income (loss) to the Company's GAAP net income (loss) is as follows: For the years ended December 31, (dollar amounts in thousands) 1998 1997 1996 - ----------------------------------------------------------------------------- Net income (loss): SAP net income (loss) - domestic insurance subsidiaries $ 52,690 $ 36,537 $(165,302) GAAP adjustments: Change in deferred acquisition costs 4,504 1,282 6,105 Benefit for deferred income taxes 14,012 4,725 11,488 Other 4,366 1,131 (6,331) ----------------------------------- GAAP net income (loss) - domestic insurance subsidiaries 75,572 43,675 (154,040) Other entities and eliminations (30,838) (23,922) 18,706 Extraordinary loss -- (4,734) -- ----------------------------------- GAAP net income (loss) $ 44,734 $ 15,019 $(135,334) =================================== 77 P M A C A P I T A L Notes to Consolidated Financial Statements (continued) A reconciliation of PMA Capital's domestic insurance subsidiaries' SAP capital and surplus to the Company's GAAP shareholders' equity is as follows: December 31, (dollar amounts in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------ Shareholders' equity SAP capital and surplus - domestic insurance subsidiaries $ 569,413 $ 552,225 $ 540,617 GAAP adjustments: Deferred acquisition costs 49,118 45,288 44,006 Deferred income taxes 71,443 52,571 101,642 Allowance for doubtful accounts (19,650) (19,700) (26,214) Retirement accruals (10,244) (10,653) (14,571) Reversal of non-admitted assets 22,711 21,330 25,599 Unrealized gain (loss) on fixed maturity investments available for sale 27,506 19,380 (38,271) Other 13,569 3,254 (338) ----------------------------------- GAAP shareholders' equity - domestic insurance subsidiaries 723,866 663,695 632,470 Other entities and eliminations (212,386) (185,348) (206,642) ----------------------------------- GAAP shareholders' equity $ 511,480 $ 478,347 $ 425,828 =================================== 19. Dispositions Effective July 1, 1998, the Company sold PMA Insurance, Cayman Ltd. ("PMA Cayman"), one of the entities included in The PMA Insurance Group's Run-off Operations, which reinsures claims for certain policies written by other members of The PMA Insurance Group, to a third party for a purchase price of $1.8 million and recorded an after-tax loss of $1.6 million. This transaction included the transfer of $231.5 million in cash and invested assets to the buyer. At December 31, 1998, the Company has recorded $248.6 million in reinsurance receivables related to this transaction, all of which are secured by assets in trust or by letters of credit. If the actual claim payments in the aggregate exceed the estimated payments upon which the loss reserves have been established, the Company has agreed to indemnify the buyer, up to a maximum of $15.0 million. If the actual claim payments in the aggregate are less than the estimated payments upon which the loss reserves have been established, the Company will participate in such favorable loss reserve development. 78 P M A C A P I T A L Report of Independent Accountants To the Board of Directors and Shareholders PMA Capital Corporation In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, shareholders' equity, cash flows and comprehensive income present fairly, in all material respects, the financial position of PMA Capital Corporation and its subsidiaries at December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. These 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 of these consolidated financial statements in accordance with generally accepted auditing standards, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ PricewaterhouseCoopers LLP 1177 Avenue of the Americas New York, New York February 5, 1999 79 P M A C A P I T A L Quarterly Financial Information (Unaudited) The following unaudited quarterly financial data are presented on a consolidated basis for each of the years ended December 31, 1998 and 1997. Quarterly financial results necessarily rely on estimates and caution is required in drawing specific conclusions from quarterly consolidated results.
First Second Third Fourth Quarter Quarter Quarter Quarter - --------------------------------------------------------------------------------------------- 1998 Income Statement Data(1): Total revenues $ 149,386 $ 153,743 $ 149,471 $ 170,881 Income before income taxes 14,741 10,775 12,584 16,969 Net income 12,088 9,357 10,552 12,737 Per Share Data: Net income (Basic) $ 0.51 $ 0.39 $ 0.45 $ 0.54 Net income (Diluted) 0.49 0.38 0.43 0.52 Class A Common Stock Prices(2): High $ 19.38 $ 23.00 $ 22.69 $ 19.63 Low 15.75 17.63 17.25 16.75 Close 18.00 23.00 19.50 19.56 1997 Income Statement Data(1): Total revenues $ 145,094 $ 148,873 $ 105,528 $ 132,063 Income (loss) before income taxes 7,318 (4,698) 11,516 11,017 Income before extraordinary loss 4,757 520 7,344 7,132 Net income 23 520 7,344 7,132 Per Share Data: Basic: Income before extraordinary loss $ 0.20 $ 0.02 $ 0.31 $ 0.30 Net income -- 0.02 0.31 0.30 Diluted: Income before extraordinary loss 0.19 0.02 0.30 0.29 Net income -- 0.02 0.30 0.29 Class A Common Stock Bids(2): High $ 16.13 $ 16.00 $ 16.75 $ 18.00 Low 15.63 14.00 15.00 16.00 Close 16.00 15.00 16.75 16.00
(1) Over the past two years, the Company's results have been impacted by restructuring charges and other special items. During 1998, the Company incurred restructuring and other charges of approximately $814,000, $1.3 million, $54,000 and $2,000 for the first, second, third and fourth quarter, respectively. During 1997, the Company incurred restructuring and other charges of approximately $775,000, $3.5 million, $2.7 million and $5.2 million for the first, second, third and fourth quarter, respectively. (2) The Company's Class A common stock began trading on the NASDAQ National Market System effective February 5, 1998. Prior to that date, the Class A common stock was not traded on an established exchange, but 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 for 1997 for the Class A common stock is 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. Transactions in the common stock were conducted privately among persons qualified to own the common stock. No price information was available for such transactions. The Company had 378 record holders of Class A common stock and 177 record holders of common stock at January 31, 1999. For each of the quarters in the two years ended December 31, 1998, the Company declared a quarterly dividend of $0.08 and $0.09 per share for its common stock and Class A common stock, respectively. 80 (back cover) Securities Listing The Corporation's Class A Common stock is listed on the Nasdaq National Market System. It trades under the stock symbol:PMACA Dividends PMA Capital Corporation's quarterly dividends on Common Stock and Class A Common Stock are paid on or about the first day of January, April, July and October. Each share of Class A Common Stock is entitled to a cash dividend at least 10% higher than any cash dividend paid on the Common Stock. EX-21 8 SIGNIFICANT SUBSIDIARIES OF REGISTRANT EXHIBIT 21 PMA CAPITAL CORPORATION SIGNIFICANT SUBSIDIARIES OF REGISTRANT AS OF DECEMBER 31, 1998 PMA Capital Corporation (Pennsylvania) PMA Reinsurance Corporation (Pennsylvania) Caliber One Indemnity Company (Delaware) Pennsylvania Manufacturers' Association Insurance Company (Pennsylvania) PMA Management Corporation (Pennsylvania) PMA Services Incorporated (Pennsylvania) Presque Enterprises Incorporated (Pennsylvania) Pennsylvania Manufacturers Indemnity Company (Pennsylvania) Manufacturers Alliance Insurance Company (Pennsylvania) Mid Atlantic States Investment Company (Delaware) Mid-Atlantic States Casualty Company (Pennsylvania) PMA Holdings Cayman, Ltd. PMA International Insurance Cayman, Ltd. High Mountain Reinsurance, Ltd. (Cayman) Caliber One Management Company, Inc. (Delaware) PMA Holdings Limited (Bermuda) Pennsylvania Manufacturers International Insurance, Ltd. (Bermuda) PMA Life Insurance Company (Pennsylvania) EX-23 9 CONSENT OF INDEPENDENT ACCOUNTANTS EXHIBIT 23 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the Registration Statements of PMA Capital Corporation on Form S-3(File No. 333-63469) and on Form S-8(File No. 333-45949 and File No. 333-68855) of our reports dated February 5, 1999, on our audits of the consolidated financial statements and financial statement schedules of PMA Capital Corporation as of December 31, 1998 and 1997, and for the years ended December 31, 1998, 1997, and 1996, which reports are included or incorporated by reference in this Annual Report on Form 10-K. /s/PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP New York, New York March 26, 1999 EX-24.1 10 POWERS OF ATTORNEY Exhibit 24.1 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, the Chairman of the Board of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1998 and all amendments thereto; (ii) any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, a registration statement on Form S-8 for the offering of shares of PMA Class A Common Stock under PMA's 1999 Equity Incentive Plan and amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2000. IN WITNESS WHEREOF, the undersigned has executed this document as of the 17th day of March 1999. /s/ Frederick W. Anton III -------------------------- Frederick W. Anton III KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1998 and all amendments thereto; (ii) any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, a registration statement on Form S-8 for the offering of shares of PMA Class A Common Stock under PMA's 1999 Equity Incentive Plan and amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2000. IN WITNESS WHEREOF, the undersigned has executed this document as of the 17th day of March 1999. /s/ Paul I. Detwiler, Jr. ------------------------- Paul I. Detwiler, Jr. POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1998 and all amendments thereto; (ii) any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, a registration statement on Form S-8 for the offering of shares of PMA Class A Common Stock under PMA's 1999 Equity Incentive Plan and amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2000. IN WITNESS WHEREOF, the undersigned has executed this document as of the 17th day of March 1999. /s/ Joseph H. Foster -------------------- Joseph H. Foster POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1998 and all amendments thereto; (ii) any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, a registration statement on Form S-8 for the offering of shares of PMA Class A Common Stock under PMA's 1999 Equity Incentive Plan and amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2000. IN WITNESS WHEREOF, the undersigned has executed this document as of the 17th day of March 1999. /s/ Anne S. Genter ------------------ Anne S. Genter POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1998 and all amendments thereto; (ii) any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, a registration statement on Form S-8 for the offering of shares of PMA Class A Common Stock under PMA's 1999 Equity Incentive Plan and amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2000. IN WITNESS WHEREOF, the undersigned has executed this document as of the 17th day of March 1999. /s/ James F. Malone, III ------------------------ James F. Malone, III POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1998 and all amendments thereto; (ii) any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, a registration statement on Form S-8 for the offering of shares of PMA Class A Common Stock under PMA's 1999 Equity Incentive Plan and amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2000. IN WITNESS WHEREOF, the undersigned has executed this document as of the 23rd day of March 1999. /s/ A. John May --------------- A. John May POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1998 and all amendments thereto; (ii) any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, a registration statement on Form S-8 for the offering of shares of PMA Class A Common Stock under PMA's 1999 Equity Incentive Plan and amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2000. IN WITNESS WHEREOF, the undersigned has executed this document as of the 17th day of March 1999. /s/ Louis N. McCarter, III -------------------------- Louis N. McCarter, III POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1998 and all amendments thereto; (ii) any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, a registration statement on Form S-8 for the offering of shares of PMA Class A Common Stock under PMA's 1999 Equity Incentive Plan and amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2000. IN WITNESS WHEREOF, the undersigned has executed this document as of the 19th day of March 1999. /s/ John W. Miller, Jr. ----------------------- John W. Miller, Jr. POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1998 and all amendments thereto; (ii) any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, a registration statement on Form S-8 for the offering of shares of PMA Class A Common Stock under PMA's 1999 Equity Incentive Plan and amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2000. IN WITNESS WHEREOF, the undersigned has executed this document as of the 18th day of March 1999. /s/ Edward H. Owlett -------------------- Edward H. Owlett POWER OF ATTORNEY POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1998 and all amendments thereto; (ii) any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, a registration statement on Form S-8 for the offering of shares of PMA Class A Common Stock under PMA's 1999 Equity Incentive Plan and amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2000. IN WITNESS WHEREOF, the undersigned has executed this document as of the 22nd day of March 1999. /s/ Louis I. Pollock -------------------- Louis I. Pollock POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1998 and all amendments thereto; (ii) any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, a registration statement on Form S-8 for the offering of shares of PMA Class A Common Stock under PMA's 1999 Equity Incentive Plan and amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2000. IN WITNESS WHEREOF, the undersigned has executed this document as of the 17th day of March 1999. /s/ Roderic H. Ross ------------------- Roderic H. Ross POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1998 and all amendments thereto; (ii) any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, a registration statement on Form S-8 for the offering of shares of PMA Class A Common Stock under PMA's 1999 Equity Incentive Plan and amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2000. IN WITNESS WHEREOF, the undersigned has executed this document as of the 23rd day of March 1999. /s/ L.J. Rowell, Jr. -------------------- L.J. Rowell, Jr. POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned, a director and officer of PMA Capital Corporation, a Pennsylvania corporation ("PMA"), hereby makes, designates, constitutes and appoints Francis W. McDonnell and Charles A. Brawley, III, and each of them (with full power to act without the other), as the undersigned's true and lawful attorneys-in-fact and agents, with full power and authority to act in any and all capacities for and in the name, place and stead of the undersigned (A) in connection with the filing with the Securities and Exchange Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, both as amended, of: (i) PMA's Annual Report on Form 10-K for the year ended December 31, 1998 and all amendments thereto; (ii) any and all registration statements pertaining to employee benefit plans of PMA or its subsidiaries, and all amendments thereto, including, without limitation, a registration statement on Form S-8 for the offering of shares of PMA Class A Common Stock under PMA's 1999 Equity Incentive Plan and amendments to PMA's registration statements on Form S-8 (Registration Numbers 333-68855 and 333-45949); and (B) in connection with the preparation, delivery and filing of any and all registrations, amendments, qualifications or notifications under the applicable securities laws of any and all states and other jurisdictions with respect to securities of PMA, of whatever class or series, offered, sold, issued, distributed, placed or resold by PMA, any of its subsidiaries, or any other person or entity. Such attorneys-in-fact and agents, or any of them, are also hereby granted full power and authority, on behalf of and in the name, place and stead of the undersigned, to execute and deliver all such registration statements, reports, registrations, amendments, qualifications and notifications to execute and deliver any and all such other documents, and to take further action as they, or any of them, deem appropriate. The powers and authorities granted herein to such attorneys-in-fact and agents, and each of them, also include the full right, power and authority to effect necessary or appropriate substitutions or revocations. The undersigned hereby ratifies, confirms, and adopts, as his own act and deed, all action lawfully taken by such attorneys-in-fact and agents, or any of them, or by their respective substitutes, pursuant to the powers and authorities herein granted. This Power of Attorney expires by its terms and shall be of no further force and effect on May 15, 2000. IN WITNESS WHEREOF, the undersigned has executed this document as of the 16th day of March 1999. /s/ John W. Smithson -------------------- John W. Smithson EX-24.2 11 SECRETARY'S CERTIFICATE Exhibit 24.2 SECRETARY'S CERTIFICATE I, ROBERT L. PRATTER, Secretary of PMA CAPITAL CORPORATION, a corporation organized and existing under the laws of the COMMONWEALTH OF PENNSYLVANIA, hereby certify that the following resolution was adopted at the March 3, 1999 meeting of the Executive Committee: RESOLVED, that each Officer and Director of the Corporation who may be required to execute (whether on behalf of the Corporation or as an Officer or Director thereof) the Corporation's Annual Report on form 10-K for the year ended December 31, 1998, and any amendments thereto, (the "Form 10-K") is hereby authorized to execute and deliver a power of attorney appointing such person or persons named therein as true and lawful attorneys and agents to execute in the name, place and stead (in any such capacity) of any such Officer or Director and to file any such power of attorney together with the Form 10-K with the Securities and Exchange Commission. RESOLVED, that the Officers of the Corporation, and each of them, are hereby authorized to sign the Form 10-K in the name and on behalf of the Corporation and as attorneys for each of its Directors and Officers who execute and deliver the aforesaid powers of attorney. IN WITNESS WHEREOF, I have hereunto set my hand and affixed the seal of the Corporation, this 24th day of March, 1999. /s/Robert L. Pratter -------------------- Secretary (SEAL) EX-27.1 12 FINANCIAL DATA SCHEDULE
7 This schedule contains summary financial information extracted from the financial statements contained in Form 10-K for the fiscal year ended December 31, 1998 for PMA Capital Corporation and is qualified in its entirety by reference to such statements. 1,000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 1,827,354 0 0 17 0 0 2,325,409 2,562 610,291 51,115 3,460,718 1,940,895 227,945 0 10,700 163,000 0 0 122,214 389,266 3,460,718 466,715 120,125 21,745 14,896 352,671 110,837 89,895 55,069 10,335 0 0 0 0 44,734 1.89 1.82 1,670,903 373,098 (46,515) 96,658 362,186 1,347,194 (46,515) Reserve balance is shown net of reinsurance receivables on unpaid losses and LAE Excludes impact of accretion of prior years discount of $26,088. Reserves of $217,536 were transferred to a third party as the result of a sale of a subsidiary.
EX-27.2 13 RESTATED FINANCIAL DATA SCHEDULE
7 This schedule contains summary financial information extracted from the financial statements contained on Form 10-K for the fiscal year ended December 31, 1998 and Forms 10-Q for the quarters ended March 31, 1998, June 30, 1998 and September 30, 1998 for PMA Capital Corporation and is qualified in its entirety by reference to such statements. 1,000 9-MOS 6-MOS 3-MOS 12-MOS DEC-31-1998 DEC-31-1998 DEC-31-1998 DEC-31-1997 JAN-01-1998 JAN-01-1998 JAN-01-1998 JAN-01-1997 SEP-30-1998 JUN-30-1998 MAR-31-1998 DEC-31-1997 1,875,910 1,995,653 1,984,800 1,929,518 0 0 0 0 0 0 0 0 15 15 14 13 0 0 0 0 0 0 0 0 2,432,154 2,686,599 2,725,500 2,194,738 7,595 7,585 2,267 32,148 604,108 347,821 354,113 332,406 55,958 53,363 56,562 45,288 3,598,926 3,604,228 3,655,309 3,057,258 1,951,497 1,939,568 1,989,115 2,003,187 253,216 243,012 261,045 211,455 0 0 0 0 9,605 10,779 9,317 10,200 203,000 203,000 203,000 203,000 0 0 0 0 0 0 0 0 122,214 122,214 122,214 122,214 395,366 374,169 357,279 356,133 3,598,926 3,604,228 3,655,309 3,057,258 335,593 221,576 106,922 375,951 92,260 63,850 31,930 133,392 15,362 11,263 7,514 8,598 9,385 6,440 3,020 13,617 256,230 172,757 84,857 307,281 77,748 51,763 22,703 93,501 69,291 45,630 23,384 89,855 38,100 25,516 14,741 25,153 6,103 4,071 2,653 5,400 0 0 0 0 0 0 0 0 0 0 0 (4,734) 0 0 0 0 31,997 21,445 12,088 15,019 1.35 0.90 0.51 0.63 1.30 0.87 0.49 0.61 0 0 0 1,834,496 0 0 0 341,880 0 0 0 (86,006) 0 0 0 72,399 0 0 0 398,475 0 0 0 1,670,903 0 0 0 (86,006) Amounts have been restated to reflect the adoption of SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." Amounts have been restated to conform to year end 1998 classification. Reserve balance is shown net of reinsurance receivables on unpaid losses and LAE. Excludes impact of accretion of prior years' discount of $51,407.
EX-27.3 14 RESTATED FINANCIAL DATA SCHEDULE
7 This schedule contains summary financial information extracted from the financial statements contained on Forms 10-Q for the quarters ended March 31, 1997, June 30, 1997 and September 30, 1997 for PMA Capital Corporation and is qualified in its entirety by reference to such statements. 1,000 9-MOS 6-MOS 3-MOS 12-MOS DEC-31-1997 DEC-31-1997 DEC-31-1997 DEC-31-1996 JAN-01-1997 JAN-01-1997 JAN-01-1997 JAN-01-1996 SEP-30-1997 JUN-30-1997 MAR-31-1997 DEC-31-1996 2,060,521 2,014,684 2,101,914 2,126,120 0 0 0 0 0 0 0 0 261 264 262 262 0 0 0 0 0 0 0 0 2,202,645 2,067,828 2,143,426 2,261,353 1,895 87,738 13,986 7,176 294,506 284,465 277,977 257,983 49,033 47,829 53,980 44,006 3,066,361 3,085,640 3,114,205 3,117,516 1,989,160 2,052,791 2,085,732 2,091,072 239,112 236,169 258,434 205,982 0 0 0 0 10,704 13,407 12,100 12,524 203,000 203,049 203,232 204,699 0 0 0 0 0 0 0 0 121,716 121,716 121,716 121,716 324,548 293,404 263,250 304,112 3,066,361 3,085,640 3,114,205 3,117,516 285,371 222,401 107,950 420,575 99,802 68,459 35,847 130,837 3,600 (1,931) (1,251) 2,984 10,722 5,038 2,548 12,288 240,919 193,134 94,904 536,623 66,562 46,469 18,339 90,292 65,853 43,522 20,199 114,111 14,136 2,620 7,318 (191,394) 1,515 (2,657) 2,561 (56,060) 0 0 0 0 0 0 0 0 (4,734) (4,734) (4,734) 0 0 0 0 0 7,887 543 23 135,334 0.33 0.02 0.00 (5.68) 0.32 0.02 0.00 (5.68) 0 0 0 1,808,494 0 0 0 323,069 0 0 0 156,074 0 0 0 72,194 0 0 0 438,427 0 0 0 1,834,496 0 0 0 156,074 Amounts have been restated to conform to year end 1998 classification. Reserve balance is shown net of reinsurance receivables on unpaid losses and lae. Excludes impact of accretion of prior year's discount of $57,480.
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