-----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, HqxiC5F7MvpVFWkjW0KlbsFskwcpasoWVVuTUOD8+9gV8Picd1sqV7EeYLWJmSXH etlRCEYyC6cL8xMs54FRoQ== 0000950144-03-012771.txt : 20031113 0000950144-03-012771.hdr.sgml : 20031113 20031113141740 ACCESSION NUMBER: 0000950144-03-012771 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20030930 FILED AS OF DATE: 20031113 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PROASSURANCE CORP CENTRAL INDEX KEY: 0001127703 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 631261433 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-16533 FILM NUMBER: 03997306 BUSINESS ADDRESS: STREET 1: 100 BROOKWOOD PLACE CITY: BIRMINGHAM STATE: AL ZIP: 35209 BUSINESS PHONE: 2058774400 10-Q 1 g85709e10vq.txt PROASSURANCE CORPORATION UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended SEPTEMBER 30, 2003 or ______ [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ______ to ______. Commission file number 0-16533 ProAssurance Corporation ------------------------------------------------------ (Exact name of registrant as specified in its charter) Delaware 63-1261433 - ---------------------------------------- ------------------------------------ (State or other jurisdiction of (IRS Employer Identification ID No.) incorporation of organization) 100 Brookwood Place, Birmingham, AL 35209 - ---------------------------------------- ------------------------------------ (Address of principal executive offices) (Zip Code) (205) 877-4400 -------------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]. Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.) Yes [X] No [ ]. As of September 30, 2003 there were 28,968,522 shares of the registrant's common stock outstanding. ProAssurance Corporation Form 10Q Table of Contents Part I - Financial Information Item l. Condensed Consolidated Financial Statements (Unaudited) of ProAssurance Corporation and Subsidiaries Condensed Consolidated Balance Sheets..................................... 3 Condensed Consolidated Statements of Changes in Capital................... 4 Condensed Consolidated Statements of Income............................... 5 Condensed Consolidated Statements of Comprehensive Income................. 6 Condensed Consolidated Statements of Cash Flows........................... 7 Notes to Condensed Consolidated Financial Statements...................... 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................................. 18 Item 3. Quantitative and Qualitative Disclosures about Market Risk................ 32 Item 4. Controls and Procedures................................................... 33 Forward-Looking Statements......................................................... 34 Part II - Other Information Item 1. Legal Proceedings......................................................... 35 Item 2. Changes in Securities and Use of Proceeds................................. 35 Item 6. Exhibits and Reports on Form 8-K.......................................... 36 Signature ......................................................................... 37
PROASSURANCE CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) (IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30 December 31 2003 2002 ------------------------------------ ASSETS Investments: Fixed maturities available for sale, at fair value $ 1,808,691 $ 1,328,897 Equity securities available for sale, at fair value 44,570 60,552 Equity securities, trading portfolio, at fair value 439 - Real estate, net 17,274 17,549 Short-term investments 60,626 252,854 Other 25,546 19,645 Business owned life insurance 51,057 - ------------------------------------ Total investments 2,008,203 1,679,497 Cash and cash equivalents 53,146 143,306 Premiums receivable 124,295 111,028 Receivable from reinsurers on unpaid losses and loss adjustment expenses 515,945 462,012 Prepaid reinsurance premiums 17,769 21,294 Deferred taxes 73,460 73,091 Other assets 104,437 96,422 ------------------------------------ $ 2,897,255 $ 2,586,650 ==================================== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Policy liabilities and accruals: Reserve for losses and loss adjustment expenses $ 1,823,868 $ 1,622,468 Unearned premiums 291,389 248,371 Reinsurance premiums payable 65,857 62,549 ------------------------------------ Total policy liabilities 2,181,114 1,933,388 Other liabilities 73,759 49,198 Long-term debt 104,715 72,500 ------------------------------------ Total liabilities 2,359,588 2,055,086 Minority interest - 26,370 Commitments and contingencies - - Stockholders' Equity: Common stock, par value $0.01 per share 100,000,000 shares authorized; 29,090,287 and 28,998,917 shares issued, respectively 291 290 Additional paid-in capital 309,915 308,501 Accumulated other comprehensive income, net of deferred tax expense of $22,471 and $19,612, respectively 41,727 35,545 Retained earnings 185,790 160,914 ------------------------------------ 537,723 505,250 Less treasury stock, at cost, 121,765 shares (56) (56) ------------------------------------ Total stockholders' equity 537,667 505,194 ------------------------------------ $ 2,897,255 $ 2,586,650 ====================================
See accompanying notes. 3 PROASSURANCE CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN CAPITAL (UNAUDITED) (IN THOUSANDS)
ACCUMULATED OTHER COMPREHENSIVE RETAINED OTHER CAPITAL TOTAL INCOME EARNINGS ACCOUNTS ----------------------------------------------------------------------- Balance at December 31, 2002 $ 505,194 $ 35,545 $ 160,914 $ 308,735 Net income 24,876 - 24,876 - Change in fair value of securities available for sale, net of reclassification adjustments and deferred taxes 5,296 5,296 - - Acquisition of minority interest 886 886 - - Common stock issued for compensation 1,073 - - 1,073 Common stock options exercised 342 - - 342 ----------------------------------------------------------------------- Balance at September 30, 2003 $ 537,667 $ 41,727 $ 185,790 $ 310,150 =======================================================================
Accumulated Other Comprehensive Retained Other Capital Total Income Earnings Accounts ----------------------------------------------------------------------- Balance at December 31, 2001 $ 413,231 $ 3,533 $ 148,707 $ 260,991 Net income 232 - 232 - Change in fair value of securities available for sale, net of reclassification adjustments, deferred taxes and minority interest 37,451 37,451 - - Change in minority interest 254 - - 254 Common stock issued for compensation 974 - - 974 Common stock options exercised 11 - - 11 ----------------------------------------------------------------------- Balance at September 30, 2002 $ 452,153 $ 40,984 $ 148,939 $ 262,230 =======================================================================
See accompanying notes. 4 PROASSURANCE CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 ----------------------------------------------------- 2003 2002 2003 2002 ----------------------------------------------------- Revenues: Gross premiums written $ 196,750 $ 160,875 $ 557,216 $ 465,063 ===================================================== Net premiums written $ 180,620 $ 130,653 $ 497,834 $ 386,306 ===================================================== Premiums earned $ 184,756 $ 151,023 $ 514,199 $ 419,555 Premiums ceded 19,326 29,076 62,889 73,525 ----------------------------------------------------- Net premiums earned 165,430 121,947 451,310 346,030 Net investment income 18,301 19,819 53,393 58,773 Net realized investment gains (losses) 1,436 (13,560) 4,149 (17,338) Other income 1,022 1,660 4,572 5,284 ----------------------------------------------------- Total revenues 186,189 129,866 513,424 392,749 Expenses: Losses and loss adjustment expenses 171,901 139,589 488,103 397,829 Reinsurance recoveries 26,118 23,721 85,972 67,698 ----------------------------------------------------- Net losses and loss adjustment expenses 145,783 115,868 402,131 330,131 Underwriting, acquisition and insurance expenses 26,438 21,380 77,094 65,862 Loss on early extinguishment of debt 305 - 305 - Interest expense 1,188 689 2,257 2,203 ----------------------------------------------------- Total expenses 173,714 137,937 481,787 398,196 ----------------------------------------------------- Income (loss) before income taxes, minority interest and cumulative effect of accounting change 12,475 (8,071) 31,637 (5,447) Provision for income taxes: Current expense (benefit) 4,624 (1,257) 10,763 378 Deferred expense (benefit) (1,884) (3,200) (4,183) (6,701) ----------------------------------------------------- 2,740 (4,457) 6,580 (6,323) Income (loss) before minority interest and cumulative effect of accounting change 9,735 (3,614) 25,057 876 Minority interest - 910 181 2,338 ----------------------------------------------------- Income (loss) before cumulative effective of accounting change 9,735 (4,524) 24,876 (1,462) Cumulative effect of accounting change, net of tax - - - 1,694 ----------------------------------------------------- Net income (loss) $ 9,735 $ (4,524) $ 24,876 $ 232 ===================================================== Earnings per share (basic): Income (loss) before cumulative effect of accounting change $ 0.34 $ (0.18) $ 0.86 $ (0.06) Cumulative effect of accounting change, net of tax - - - 0.07 ----------------------------------------------------- Net income (loss) $ 0.34 $ (0.18) $ 0.86 $ 0.01 ===================================================== Earnings per share (diluted): Income (loss) before cumulative effect of accounting change $ 0.33 $ (0.18) $ 0.85 $ (0.06) Cumulative effect of accounting change, net of tax - - - 0.06 ----------------------------------------------------- Net income (loss) $ 0.33 $ (0.18) $ 0.85 $ 0.00 ===================================================== Weighted average number of common shares outstanding: Basic 28,967 25,851 28,935 25,845 ===================================================== Diluted 29,165 25,851 29,108 25,862 =====================================================
See accompanying notes. 5 PROASSURANCE CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) (IN THOUSANDS)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 --------------------------------------------------- 2003 2002 2003 2002 --------------------------------------------------- Comprehensive income: Net income (loss) $ 9,735 $ (4,524) $ 24,876 $ 232 Change in fair value of securities available for sale, net of deferred taxes and minority interest (9,394) 20,634 7,849 26,181 Reclassification adjustment for realized (gains) losses included in income, net of deferred taxes (979) 8,814 (2,553) 11,270 --------------------------------------------------- Comprehensive income (loss) $ (638) $ 24,924 $ 30,172 $ 37,683 ===================================================
See accompanying notes. 6 PROASSURANCE CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)
NINE MONTHS ENDED SEPTEMBER 30 ----------------------------------- 2003 2002 ----------------------------------- OPERATING ACTIVITIES Net cash provided (used) by operating activities $ 217,772 $ 157,137 INVESTING ACTIVITIES Purchases of available-for-sale securities: Fixed maturities (916,128) (576,174) Equity (864) (21,975) Proceeds from sale or maturity of available-for-sale securities: Fixed maturities 456,971 448,724 Equities 20,160 6,556 Purchase of trading portfolio securities (436) - Purchase of other investments (6,750) (10,000) Net decrease in short-term investments 192,228 37,083 Purchase of business owned life insurance (50,000) - Other (1,552) 5,074 ----------------------------------- Net cash provided (used) by investing activities (306,371) (110,712) FINANCING ACTIVITIES Proceeds from issuance of debentures 104,641 - Repayment of debt (72,500) (7,500) Purchase of minority interest (33,304) - Other (398) - ----------------------------------- Net cash provided (used) by financing activities (1,561) (7,500) ----------------------------------- Increase (decrease) in cash and cash equivalents (90,160) 38,925 Cash and cash equivalents at beginning of period 143,306 53,163 ----------------------------------- Cash and cash equivalents at end of period $ 53,146 $ 92,088 ===================================
See accompanying notes. 7 PROASSURANCE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2003 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements include the accounts of ProAssurance Corporation and its subsidiaries (collectively "ProAssurance"). The financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been included. Operating results for the nine month period ended September 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. Certain reclassifications have been made to conform the 2002 financial statements to the 2003 presentation. These changes had no effect on previously reported results of operations or shareholders' equity. Stock-Based Compensation ProAssurance grants stock options to key employees under its Incentive Compensation Stock Plan ("the ProAssurance Plan") and accounts for such stock options under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations ("APB 25"). The following table illustrates the effect on net income (in thousands) and earnings per share as if ProAssurance had applied the fair value recognition provisions of Statement of Financial Accounting Standard (SFAS) No. 123, Accounting for Stock-Based Compensation, to options granted under the ProAssurance Plan.
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 --------------------------------------------- 2003 2002 2003 2002 --------------------------------------------- Net income (loss), as reported $ 9,735 $ (4,524) $ 24,876 $ 232 Add: Stock-based employee compensation expense recognized under APB 25 with the exercise of options, net of tax 18 - 59 - Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (218) (94) (628) (470) --------------------------------------------- Pro forma net income (loss) $ 9,535 $ (4,618) $ 24,307 $ (238) ============================================= Earnings (loss) per share: Basic--as reported $ 0.34 $ (0.18) $ 0.86 $ 0.01 ============================================= Basic--pro forma $ 0.33 $ (0.18) $ 0.84 $ (0.01) ============================================= Diluted--as reported $ 0.33 $ (0.18) $ 0.85 $ 0.00 ============================================= Diluted--pro forma $ 0.33 $ (0.18) $ 0.84 $ (0.02) =============================================
At September 30, 2003, ProAssurance has 290,500 options outstanding under the plan that were granted in 2003 with an exercise price of $22 per share. The estimated fair value of each option is $8.46, using the Black-Scholes option pricing model and the following model assumptions: risk-free interest rate of 3.1%; volatility of 0.34; expected life of 6 years; and dividend yield of 0%. 8 PROASSURANCE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2003 2. SEGMENT INFORMATION ProAssurance operates in the United States of America in two reportable industry segments: the professional liability insurance segment and the personal lines segment. The professional liability insurance segment principally provides professional liability insurance for providers of health care services, and to a limited extent, providers of legal services. The professional liability segment includes the operating results of four significant insurance companies: The Medical Assurance Company, Inc., Medical Assurance of West Virginia Inc., ProNational Insurance Company, and Red Mountain Casualty Insurance Company, Inc. The personal lines segment provides personal auto, homeowners, boat and umbrella coverages primarily to educational employees and their families through a single insurance company, MEEMIC Insurance Company. The accounting policies of the segments are consistent with those described in the Notes to the Consolidated Financial Statements included in ProAssurance's December 31, 2002 Annual Report on Form 10-K. Other than cash and marketable securities owned directly by the parent company, the identifiable assets of ProAssurance are allocated to the reportable operating segments. Except for investment income earned directly by the parent company and interest expense related to long-term debt held by the parent company, all revenues and expenses of ProAssurance are allocated to the operating segments for purposes of SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. Revenue is primarily from unaffiliated customers and the effects of transactions between segments have been eliminated. 9 PROASSURANCE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2003 2. SEGMENT INFORMATION (CONTINUED) The table below provides a reconciliation of segment information to total consolidated information (in thousands).
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 -------------------------------------------------------- 2003 2002 2003 2002 -------------------------------------------------------- Revenues: Professional liability lines $ 139,163 $ 88,021 $ 377,728 $ 273,372 Personal lines 46,920 41,845 135,521 119,377 Corporate investment income 106 - 175 - -------------------------------------------------------- Total $ 186,189 $ 129,866 $ 513,424 $ 392,749 ======================================================== Income (loss) before cumulative effect of accounting change: Professional liability lines $ 8,667 $ (8,984) $ 13,573 $ (12,487) Personal lines 1,969 4,915 12,854 12,464 Corporate (901) (455) (1,551) (1,439) -------------------------------------------------------- Total $ 9,735 $ (4,524) $ 24,876 $ (1,462) ======================================================== Net income (loss): Professional liability lines $ 8,667 $ (8,984) $ 13,573 $ (10,793) Personal lines 1,969 4,915 12,854 12,464 Corporate (901) (455) (1,551) (1,439) -------------------------------------------------------- Total $ 9,735 $ (4,524) $ 24,876 $ 232 ========================================================
SEPTEMBER 30 DECEMBER 31 2003 2002 -------------------------------- Identifiable Assets: Professional liability lines $ 2,443,170 $ 2,184,551 Personal lines 417,596 372,086 Corporate 36,489 30,013 -------------------------------- Total assets $ 2,897,255 $ 2,586,650 ================================
10 PROASSURANCE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2003 3. INVESTMENTS The amortized cost of available for sale fixed maturities and equity securities was $1.789 billion and $1.334 billion at September 30, 2003 and December 31, 2002, respectively. Operating results for the nine months ended September 30, 2003 and 2002 included the following (in millions):
NINE MONTHS ENDED SEPTEMBER 30 --------------------------- 2003 2002 --------------------------- Proceeds from sales, excluding maturities and paydowns $ 274.3 $ 278.8 Gross realized gains $ 6.4 $ 6.8 Gross realized (losses) (2.0) (8.8) Other than temporary impairment losses (0.3) (15.3) Trading portfolio gains (losses) - - --------------------------- Net realized investment gains (losses) $ 4.1 $ (17.3) ===========================
4. RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES ProAssurance establishes reserves for losses and loss adjustment expenses based on its estimates of the future amounts necessary to pay claims and expenses associated with the investigation and settlement of claims. ProAssurance considers expected outcomes for individual claims and actuarially determined estimates of future losses based on ProAssurance's past loss experience, available industry data and projections as to future claims frequency, severity, inflationary trends and settlement patterns. ProAssurance believes that the methods it uses to establish reserves are reasonable and appropriate. However, estimating reserves, especially professional liability reserves, is a complex process which is heavily dependent on judgment and involves many uncertainties. As a result, reserve estimates may vary significantly from the eventual outcome. The assumptions used in establishing ProAssurance's reserves are regularly reviewed and updated by management as new data becomes available. Any adjustments necessary are reflected in then current operations. ProAssurance's management believes the unearned premiums under contracts together with the related anticipated investment income to be earned are adequate to discharge the related contract liabilities. 5. DEFERRED POLICY ACQUISITION COSTS Costs that vary with and are directly related to the production of new and renewal premiums (primarily premium taxes, commissions and underwriting salaries) are deferred to the extent they are recoverable against unearned premiums and are amortized as related premiums are earned. Amortization of deferred acquisition costs, net of ceding commissions earned, amounted to approximately $39.8 million and $29.0 million for the nine months ended September 30, 2003 and 2002, respectively. 6. INCOME TAXES The provision for income taxes is different from that which would be obtained by applying the statutory Federal income tax rate to income before taxes because a portion of ProAssurance's investment income is tax-exempt. 11 PROASSURANCE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2003 7. LONG-TERM DEBT In early July 2003, ProAssurance issued $107.6 million of 3.90% Convertible Debentures (Debentures) in a Private Offering transaction, net of an underwriter's discount of $3.0 million. ProAssurance used the net proceeds to pay off its existing term loan having an outstanding principal balance of $67.5 million. The balance of the net proceeds will be used for general corporate purposes, which may include contributions to the capital of its insurance subsidiaries to support the expected growth in insurance operations. Summarized information regarding the structure and terms of the Debentures follows: Issue Price. The Debentures were issued at 97.25% of their principal amount and each Debenture has a principal amount at maturity of $1,000. Maturity Date. June 30, 2023. Ranking. The Debentures are unsecured obligations and rank equally in right of payment with all other existing and future unsecured and unsubordinated obligations. The Debentures are not guaranteed by any of ProAssurance's subsidiaries and, accordingly, the Debentures are effectively subordinated to the indebtedness and other liabilities of ProAssurance's subsidiaries, including insurance policy-related liabilities. Interest. Interest is payable on June 30 and December 30 of each year, beginning December 30, 2003, at an annual rate of 3.90%. In addition, ProAssurance may be required to pay contingent interest, as set forth below under Contingent Interest. Contingent Interest. Contingent interest is due to the holders of the Debentures during any six-month period from June 30 to December 29 and from December 30 to June 29 commencing with the six-month period beginning June 30, 2008, if the average market price of a Debenture for the five trading days ending on the second trading day immediately preceding the relevant six-month period equals 120% or more of the principal amount of the Debentures. The amount of contingent interest payable in respect of any six-month period will equal 0.1875% of the average market price of a Debenture for the five trading day period referred to above. 12 PROASSURANCE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2003 7. LONG-TERM DEBT (CONTINUED) Conversion Rights. Holders may convert the Debentures at any time prior to stated maturity from and after the date of the following events: - if the sale price of ProAssurance's common stock for at least 20 trading days in the 30 trading-day period ending on the last trading day of the immediately preceding fiscal quarter exceeds 120% of the conversion price on that 30th trading day; - if ProAssurance calls the Debentures for redemption; or - upon the occurrence of certain corporate transactions. For each $1,000 principal amount of Debentures surrendered for conversion, holders initially will receive 23.9037 shares of common stock. This represents an initial conversion price of approximately $41.83 per share of common stock. The conversion rate may be adjusted for certain reasons, but will not be adjusted for accrued interest or contingent interest, if any. Upon conversion, holders will generally not receive any cash payment representing accrued interest or contingent interest, if any. Instead, accrued interest and contingent interest will be deemed paid by the common stock received by the holders on conversion. Debentures called for redemption may be surrendered for conversion until the close of business two business days prior to the redemption date. Upon conversion, ProAssurance has the right to deliver, in lieu of common stock, cash or a combination of cash and shares of common stock. Payment at Maturity. Each holder of $1,000 Debentures will be entitled to receive $1,000 at maturity, plus accrued interest, including contingent interest, if any. Sinking Fund. None. Optional Redemption. ProAssurance may not redeem the Debentures prior to July 7, 2008. ProAssurance may redeem some or all of the Debentures for cash on or after July 7, 2008, upon at least 30 days but not more than 60 days notice by mail to holders at par. Repurchase Right of Holders. Each holder of the Debentures may require ProAssurance to repurchase all or a portion of the holder's Debentures on June 30, 2008, June 30, 2013 and June 30, 2018 at a purchase price equal to the principal amount of the Debentures plus accrued and unpaid interest, including contingent interest, if any, to the date of repurchase. ProAssurance may choose to pay the purchase price in cash, shares of common stock, or a combination of cash and shares of common stock. If ProAssurance elects to pay all or a portion of the repurchase price in common stock, the shares of common stock will be valued at 97.5% of the average sale price for the 20 trading days immediately preceding and including the third day prior to the repurchase date. 13 PROASSURANCE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2003 7. LONG-TERM DEBT (CONTINUED) Change of Control. Upon a change of control of ProAssurance, holders may require ProAssurance, subject to conditions, to repurchase all or a portion of the Debentures. Depending upon the date at which the change of control occurs, ProAssurance will pay a purchase price equal to a varying percentage of the applicable principal amount of such Debentures plus accrued and unpaid interest, including contingent interest and additional amounts, if any. The percentage ranges from 110% for dates before June 29, 2004 to 100% for dates after June 30, 2008. ProAssurance may choose to pay the repurchase price in cash, shares of common stock, shares of common stock of the surviving corporation or a combination of cash and shares of the applicable common stock. If ProAssurance elects to pay all or a portion of the repurchase price in shares of common stock, the shares of the applicable common stock will be valued at 97.5% of the average sale price of the applicable common stock for 20 trading days commencing after the third trading day following notice of the occurrence of a change of control. Events of Default. If there is an event of default under the Debentures, the principal amount of the Debentures, plus accrued interest, including contingent interest, if any, may be declared immediately due and payable. These amounts automatically become due and payable if an event of default relating to certain events of bankruptcy, insolvency or reorganization occurs. Registration Rights. On October 24, 2003 ProAssurance filed a shelf registration statement with the SEC with respect to the resale of the Debentures and the shares of common stock issuable upon conversion of the Debentures pursuant to a registration rights agreement. The registration rights agreement requires ProAssurance to use reasonable best efforts to cause such shelf registration statement to become effective within 180 days after the original issuance of the Debentures. ProAssurance has also agreed to keep the shelf registration statement effective until the earliest of: - two years after the last date of original issuance of any of the Debentures; - the date when the holders of the Debentures and common stock issuable upon conversion of the Debentures are able to sell all such securities immediately pursuant to Rule 144 under the Securities Act; - the date when all of the Debentures and common stock issuable upon conversion of the Debentures are registered upon the shelf registration statement and sold in accordance with it; or - the date when all of the Debentures and common stock issuable upon conversion of the Debentures have ceased to be outstanding. ProAssurance will be required to pay additional amounts if its obligations to register the Debentures and the shares of common stock issuable upon conversion of the Debentures are not fulfilled within the specified time periods. The Debentures do not require ProAssurance to maintain minimum financial covenants. 14 PROASSURANCE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2003 8. STOCKHOLDERS' EQUITY At September 30, 2003 ProAssurance had 100 million shares of authorized common stock and 50 million shares of authorized preferred stock. The Board of Directors has the authorization to determine the provisions for the issuance of shares of the preferred stock, including the number of shares to be issued and the designations, powers, preferences and rights and the qualifications, limitations or restrictions of such shares. At September 30, 2003, the Board of Directors had not authorized the issuance of any preferred stock nor determined any provisions for the preferred stock. 9. COMMITMENTS AND CONTINGENCIES ProAssurance is involved in various legal actions arising primarily from claims related to insurance policies. At other times legal actions may arise from claims asserted by policyholders. The legal actions arising from these claims have been considered by ProAssurance in establishing its reserves. While the outcome of all legal actions is not presently determinable, ProAssurance's management is of the opinion, based on consultation with legal counsel, that the settlement of these actions will not have a material adverse effect on ProAssurance's financial position. However, to the extent that the settlement of these actions exceeds the corresponding reserves, the settlements could have a material effect on ProAssurance's results of operations for the period in which the settlements are made. 10. CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE AND NEW ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141 Business Combinations. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations with a closing date after June 30, 2001. SFAS No. 141 includes guidance on the initial recognition and measurement of goodwill and other intangible assets in a business combination. The FASB has also issued SFAS No. 142 Goodwill and Other Intangible Assets, effective for fiscal years beginning after December 15, 2001. SFAS No. 142 addresses how goodwill and other intangible assets should be accounted for in financial statements upon acquisition and how these items should be accounted for subsequent to acquisition. SFAS No. 142 does not presume that goodwill and all other intangible assets are wasting assets requiring amortization. Instead, goodwill and intangible assets that have indefinite useful lives are tested at least annually for impairment. ProAssurance does not believe that any of its recorded goodwill or intangible assets has suffered impairment. ProAssurance adopted SFAS Nos. 141 and 142 effective January 1, 2002. Upon adoption, ProAssurance discontinued amortizing its recorded goodwill and deferred credits and wrote-off unamortized deferred credits of $1.7 million that existed at December 31, 2001 related to business combinations completed prior to July 1, 2001. The write-off was recognized as the cumulative effect of a change in accounting principle. There was no tax effect related to the write-off because the deferred credits were not amortizable for tax purposes. In January 2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, An Interpretation of ARB No. 51. FIN 46 defines variable interest entities (VIEs) as those entities or activities that distribute either profits or losses to beneficiaries through established contractual, ownership, or other interests. The interpretation introduced a new consolidation model which determines control (and consolidation) based on primary beneficiary status of a VIE. The primary beneficiary is defined as that interest that receives over half the expected losses, or over half of the expected returns. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after December 15, 2003. 15 PROASSURANCE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2003 10. CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE AND NEW ACCOUNTING PRONOUNCEMENTS (CONTINUED) ProAssurance does not believe that the adoption of FIN 46 will have a material impact on its financial statements. ProAssurance holds passive investments in four limited partnerships/ limited liability companies that it believes will be considered a VIE under FIN 46. ProAssurance does not believe it is the primary beneficiary relative to these entities and would not be required to consolidate the entities under FIN 46. These investments are included in Other Investments and total $25.5 million at September 30, 2003 and $19.6 million at December 31, 2002. On May 15, 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 requires certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equities to be classified as liabilities. For public companies, SFAS No. 150 is effective for all financial instruments created or modified after May 31, 2003 and for other instruments at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS 150 had no effect on ProAssurance's financial condition or results of operations. 11. MINORITY INTEREST On January 29, 2003 ProAssurance's indirect subsidiary, MEEMIC Holdings, Inc. (MEEMIC Holdings) repurchased all of the outstanding shares of its common stock that were not owned by ProAssurance's subsidiary, ProNational Insurance Company. MEEMIC Holdings used its internal funds in the approximate amount of $34.1 million to acquire 1,062,298 shares of its common stock, to pay for outstanding options representing 120,000 shares, and to pay the expenses of the transaction. The funds were derived from MEEMIC Holdings' cash and investment resources. As a result of the transaction MEEMIC Holdings is now a wholly-owned indirect subsidiary of ProAssurance. ProAssurance recognized goodwill of $7.6 million related to the transaction. Income for the nine months ended September 30, 2003 was reduced by the income attributable (16%) to the MEEMIC Holdings minority interest for the period from January 1, 2003 to January 29, 2003. MEEMIC Holdings is the 100% owner of MEEMIC Insurance Company. 16 PROASSURANCE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2003 12. EARNINGS PER SHARE The following represents a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations (amounts are in thousands, except per share data):
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 --------------------------------------------------- 2003 2002 2003 2002 --------------------------------------------------- BASIC EARNINGS PER SHARE CALCULATION: Numerator: Income (loss) before cumulative effect of accounting change $ 9,735 $ (4,524) $ 24,876 $ (1,462) Cumulative effect of accounting change - - - 1,694 --------------------------------------------------- Net income $ 9,735 $ (4,524) $ 24,876 $ 232 =================================================== Denominator: Weighted average number of common shares outstanding 28,967 25,851 28,935 25,845 =================================================== Basic earnings per share: Income (loss) before cumulative effect of accounting change $ 0.34 $ (0.18) $ 0.86 $ (0.06) Cumulative effect of accounting change - - - 0.07 --------------------------------------------------- Net income $ 0.34 $ (0.18) $ 0.86 $ 0.01 =================================================== DILUTED EARNINGS PER SHARE CALCULATION: Numerator: Income (loss) before cumulative effect of accounting change $ 9,735 $ (4,524) $ 24,876 $ (1,462) Dilutive effect of stock options held by minority shareholders - (58) - (151) --------------------------------------------------- Income (loss) before cumulative effect of accounting change-diluted computation 9,735 (4,582) 24,876 (1,613) Cumulative effect of accounting change - - - 1,694 --------------------------------------------------- Net income-diluted computation $ 9,735 $ (4,582) $ 24,876 $ 81 =================================================== Denominator: Weighted average number of common shares outstanding 28,967 25,851 28,935 25,845 Assumed conversion of dilutive stock options and awards 198 - 173 17 --------------------------------------------------- Diluted weighted average number of common shares outstanding 29,165 25,851 29,108 25,862 =================================================== Diluted earnings per share Income (loss) before cumulative effect of accounting change $ 0.33 $ (0.18) $ 0.85 $ (0.06) Cumulative effect of accounting change - - - 0.06 --------------------------------------------------- Net income $ 0.33 $ (0.18) $ 0.85 $ 0.00 ===================================================
ProAssurance excluded outstanding options for the purchase of approximately 3,000 common shares from its September 30, 2003 diluted earnings per share computations because the effect of doing so would have been antidilutive. ProAssurance's diluted earnings per share computations for the three months ended September 30, 2002 did not consider the effect of outstanding stock options because the effect would have been antidilutive. Options for the purchase of approximately 1,116,000 shares of common stock were outstanding at September 30, 2002. 17 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS For purposes of this management discussion and analysis, references to ProAssurance," "we," "us," and "our" refers to ProAssurance Corporation and its subsidiaries. You should read this discussion in conjunction with the consolidated financial statements and notes thereto in our Annual Form 10-K/A for the year ended December 31, 2002. The following discussion of the financial condition and results of operations contains certain forward-looking information that involves risk and uncertainties. Our financial condition and operating results could differ significantly from these forward-looking statements; see "Forward-Looking Statements." Important factors that could cause or contribute to such differences or changes include those discussed in our Annual Report on Form 10-K/A for the year ended December 31, 2002. CRITICAL ACCOUNTING POLICIES We are required to make estimates and assumptions in certain circumstances that affect amounts reported in our consolidated financial statements and related footnotes. We evaluate these estimates and assumptions on an on-going basis based on historical developments, market conditions, industry trends and other information that we believe to be reasonable under the circumstances. There can be no assurance that actual results will conform to our estimates and assumptions, and that reported results of operations will not be materially adversely affected from time to time by the need to make accounting adjustments reflecting changes in these estimates and assumptions. We believe the following policies are the most sensitive to estimates and judgments. Premium Income: We recognize insurance premium income on a monthly pro rata basis over the respective terms of the policies in force. Unearned premiums represent the portion of premiums written applicable to the unexpired terms of the policies in force. Reserve for Losses and Loss Adjustment Expenses ("losses and LAE"): Our reserve for losses and LAE represents our estimate of the future amounts necessary to pay claims and expenses associated with investigation and settlement of claims. These estimates consist of case reserves and bulk reserves. Case reserves are estimates of future losses and LAE for reported claims and are established by our claims departments. Bulk reserves, which include a provision for losses that have occurred but have not been reported to us as well as development on reported claims, are the difference between (i) the sum of case reserves and paid losses and (ii) an actuarially determined estimate of the total losses and LAE necessary for the ultimate settlement of all reported claims and incurred but not reported claims, including amounts already paid. The estimates take into consideration our past loss experience, available industry data and projections as to future claims frequency, severity, inflationary trends and settlement patterns. Independent actuaries review our reserves for losses and LAE each year and prepare reports that include recommendations as to the level of reserves. We consider these recommendations as well as other factors, such as known, anticipated or estimated changes in frequency and severity of claims and loss retention levels and premium rates, in establishing the amount of our reserves for losses and LAE. Estimating professional liability reserves is a particularly complex process because such estimates reflect multiple judgments involving many uncertainties made over an extended period of time, often exceeding five years, during which these claims are resolved. Our reserve estimates may vary significantly from the eventual outcome. The assumptions used in establishing our reserves are regularly reviewed and updated by management as new data becomes available. Any adjustments necessary are reflected in then current operations. Due to the size of our reserves, even a small percentage adjustment to these estimates could have a material effect on our results of operations for the period in which the change is made. Reinsurance: Our receivable from reinsurers represents our estimate of the amount of our future loss and LAE payments that will be reimbursed by reinsurers. These estimates are based upon our estimates of the ultimate losses and LAE that we expect to incur and the portion of those losses that we expect to be allocable to reinsurers based upon the terms of our reinsurance agreements. We also estimate premiums ceded under reinsurance agreements wherein the premium due to the reinsurer, subject to certain maximums and minimums, is a percentage of the losses reimbursed under the 18 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) agreement. Given the uncertainty of the ultimate amounts of our losses and LAE, these estimates may vary significantly from the eventual outcome. Our estimates of the amounts receivable from and due to reinsurers are regularly reviewed and updated by management as new data becomes available. Our assessment of the collectibility of the recorded amounts receivable from reinsurers is based primarily upon public financial statements and rating agency data. Any adjustments necessary are reflected in then current operations. Due to the size of our receivable from reinsurers, even a small adjustment to these estimates could have a material effect on our results of operations for the period in which the change is made. At September 30, 2003, we considered all of our receivable from reinsurers to be collectible. Investments: We consider our fixed maturity securities as available-for-sale and our equity securities as either available-for-sale or trading portfolio securities. Our available-for-sale securities are available to be sold in response to a number of issues, including our liquidity needs, changes in market interest rates and investment management strategies, among others. Available-for-sale securities are recorded at fair value, with unrealized gains and losses, net of the related income tax effect, excluded from income and reported as a component of stockholders' equity. In prior years, we did not designate any of our securities as trading portfolio securities. However, since January 1, 2003 certain of our equity security purchases have been designated as trading portfolio securities. A trading portfolio is more responsive to a highly volatile equity market since a trading portfolio is carried at fair value with the holding gains and losses included in realized investment gains and losses in the current period. We evaluate the securities in our available-for-sale investment portfolio on at least a quarterly basis for declines in market value below cost for the purpose of determining whether these declines represent other than temporary declines. The evaluation involves judgment by management. Some of the factors we consider in the evaluation of our investments are: - the extent to which the market value of the security is less than its cost basis - the length of time for which the market value of the security has been less than its cost basis - the financial condition and near-term prospects of the security's issuer, taking into consideration the economic prospects of the issuers' industry and geographical region, to the extent that information is publicly available - ProAssurance's ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value A decline in the fair value of an available-for-sale security below cost that we judge to be other than temporary is realized as a loss in the current period and reduces the cost basis of the security. In subsequent periods, we base any measurement of gain or loss or decline in value upon the adjusted cost basis of the security. Business Owned Life Insurance (BOLI): During 2003 we purchased business owned life insurance ("BOLI") policies on certain key employees at a cost of approximately $50 million. The primary purpose of the program is to offset future employee benefit expenses through earnings on the cash value of the policies. We are the owner and principal beneficiary of these policies; however, approximately 1% ($50,000 per insured employee) of the total estimated death proceeds are payable to employee designated beneficiaries. These life insurance contracts are carried at their current cash surrender value. Changes in the cash surrender value are included in income in the current period as investment income. The death proceeds and the related payable to the employee's beneficiary are recorded upon the insured employee's death. 19 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) LIQUIDITY AND CAPITAL RESOURCES We need liquid funds to pay losses and loss adjustment expenses (losses and LAE) and operating expenses in the ordinary course of business and to meet our debt service requirements. Cash provided by our operating activities was sufficient to meet those needs during the nine months ended September 30, 2003. We believe that our operating activities will provide sufficient cash to meet our liquidity needs during the next twelve months. Our net reserves for losses and LAE (net of amounts receivable from reinsurers) at September 30, 2003 increased approximately $147.5 million over those at December 31, 2002. Substantially all of this increase is in our professional liability segment, a "long tailed" business. A characteristic of a "long tailed" business is that there is a long length of time between the occurrence of an insured event and significant payment on that event. Because of this characteristic, it is not unusual for reserves to increase, especially during periods of business growth. We have not experienced difficulties in collecting amounts due from reinsurers. Recently, there has been public speculation about the ability of Gerling Global Reinsurance Corporation of America (Gerling) and PMA Capital Insurance Company (PMA) to pay claims. Neither company is accepting new reinsurance business. Gerling is not rated by A.M. Best and PMA has been downgraded to B++. Neither company participates in our current reinsurance treaties but both have been part of previous reinsurance programs. At December 31, 2002 our recorded receivable from these two companies was $63.5 million, approximately 65% of which related to our estimates of IBNR and its allocation to the various reinsurance treaties. Based upon information available to us, including statements made by Gerling and PMA, we anticipate that both companies will meet their obligations to us. Our positive cash flow from operations for the nine months ended September 30, 2003 of approximately $218 million primarily results from timing delays that exist between the collection of premiums and the payment of losses and from growth in our premiums written, which is discussed in more detail in the following section, "Results of Operations." Investments and cash and cash equivalents increased by approximately $240.6 million during the nine months ended September 30, 2003. Approximately $37 million of that increase represents the net proceeds from the debentures issued in July less the funds utilized to payoff our bank term loan. The remaining increase primarily resulted from the cash flow from operations offset by the funds that were expended to purchase the MEEMIC Holdings, Inc. (MEEMIC Holdings) minority interest, as discussed below. On January 29, 2003 ProAssurance's subsidiary, MEEMIC Holdings repurchased all of the outstanding shares of its common stock that were not owned by ProAssurance's subsidiary, ProNational Insurance Company (ProNational). MEEMIC Holdings used its internal funds in the approximate amount of $34.1 million to acquire 1,062,298 shares of its common stock to pay for outstanding options representing 120,000 shares, and to pay the expenses of the transactions. The funds were derived from MEEMIC Holdings' cash and investment resources. As a result of the transaction MEEMIC Holdings is now a wholly-owned indirect subsidiary of ProAssurance. Goodwill of approximately $7.6 million was recorded related to the transaction. 20 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) As premiums grow so does our need for capital to support our insurance operations. We have experienced significant growth with respect to our professional liability premiums and expect continued growth throughout the remainder of 2003 and into 2004. This growth has primarily come as a result of increased prices but is also a result of reduced competition in the professional liability market. We have taken actions to provide the additional capital needed to take advantage of these favorable market conditions. In late 2002, we raised $46.5 million through the sale of our common stock in an underwritten public offering, and applied $36 million to the capital of our insurance subsidiaries. In early July 2003 we received $104.6 million from the issuance of 3.9% Convertible Debentures, due June 2023, having a face value of $107.6 million. We utilized a substantial portion of the net proceeds to repay our outstanding term loan, as discussed in the following paragraph. We will use the balance of the net proceeds for general corporate purposes, which may include contributions to the capital of our insurance subsidiaries to support the expected growth in insurance operations. We repaid the entire balance of our $67.5 million term loan on July 23, 2003 and canceled the credit agreement under which the loan had been provided. There were no fees or penalties associated with the prepayment or the cancellation of the credit agreement. Given our current capital position, we are considering whether or not to replace the line of credit previously provided under the credit agreement. Through 2006, the annual cash outflows are expected to be significantly less for the Debentures than for the term loan. The term loan required minimum annual principal payments of $10 million and the entire remaining loan balance became due in 2006. The Debentures do not require annual repayments of principal and are not due until 2023, although holders may require ProAssurance to repurchase the Debentures on June 30 of 2008, 2013, 2018 or upon a change in control. See Note 7 of our condensed consolidated financial statements for a description of the Debentures. 21 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) RESULTS OF OPERATIONS - OVERVIEW We operate in two industry segments: professional liability insurance and personal lines insurance. Our professional liability insurance segment principally provides liability insurance for providers of health care services, and, to a limited extent, providers of legal services. The principal operating insurance subsidiaries of this segment are: The Medical Assurance Company, Inc., Medical Assurance of West Virginia, Inc., ProNational Insurance Company and Red Mountain Casualty Insurance Company, Inc. Our personal lines segment provides personal property and casualty insurance to individuals through the operations of a single insurance company, MEEMIC Insurance Company. All of our revenues and expenses are allocated to the operating segments, other than investment income earned directly by the parent holding company and interest expense related to long-term debt held by the parent. Our consolidated net income is $9.7 million, or $0.33 per diluted share for the three months ended September 30, 2003 and $24.9 million, or $0.85 per diluted share for the nine months ended September 30, 2003. The operating results of each of our reportable industry segments are discussed separately in the following sections. We recorded a loss from debt retirement of $0.3 million during the third quarter of 2003 related to the repayment of our bank term loan before its scheduled maturity date. Although there were no penalties or fees associated with the repayment, at the time of repayment we expensed the remaining unamortized debt issue costs associated with the loan. Interest expense increased to $1.2 million for the three month period ended September 30, 2003 as compared to $0.7 million for the same period in 2002. The increase results from a higher rate of interest on the debentures issued in July 2003 as compared to the bank term loan and an increase in the total amount of outstanding debt. Management elected to replace the term loan with the debentures because the debentures provided a longer-term source of capital at a fixed interest rate. Interest expense increased to $2.3 million from $2.2 million for the nine month period ended September 30, 2003 as compared to the same period in 2002. This increase is due to the higher interest costs in the third quarter of 2003, as discussed in the preceding paragraph, as offset by lower interest costs for the first six months of 2003. Interest expense was lower in the first six months of 2003 as compared to 2002 because both the average outstanding balance on the term loan and the variable interest rate on the term loan were lower in 2003. For all periods presented, the provision for income taxes is different from that which would be obtained by applying the statutory Federal income tax rate to income before taxes because a portion of ProAssurance's investment income is tax-exempt. Minority interest in both 2003 and 2002 relates entirely to the minority interest in the income of MEEMIC Holdings. As discussed under "Liquidity and Capital Resources" we purchased this minority interest on January 29, 2003. In 2003, earnings were allocable to the minority interest only for the period from January 1 to January 29. In 2002, earnings were allocable to the minority interest for the entire period. 22 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) PROFESSIONAL LIABILITY INSURANCE SEGMENT Operating results for our professional liability insurance segment for the three and nine months periods ended September 30, 2003 and 2002 are summarized in the table below (dollars in thousands).
THREE MONTHS ENDED SEPTEMBER 30 NINE MONTHS ENDED SEPTEMBER 30 ---------------------------------------- ------------------------------------ INCREASE INCREASE 2003 2002 (DECREASE) 2003 2002 (DECREASE) ---------------------------------------- ------------------------------------ Gross premiums written $ 145,526 $ 115,372 $ 30,154 $ 411,342 $ 335,713 $ 75,629 ======================================== ==================================== Net premiums written $ 134,126 $ 89,026 $ 45,100 $ 364,916 $ 266,896 $ 98,020 ======================================== ==================================== Revenues: Premiums earned $ 136,277 $ 108,243 $ 28,034 $ 375,031 $ 299,810 $ 75,221 Premiums ceded 14,601 25,212 (10,611) 49,951 63,615 (13,664) ---------------------------------------- ------------------------------------ Net premiums earned 121,676 83,031 38,645 325,080 236,195 88,885 Net investment income 15,583 17,352 (1,769) 45,574 51,247 (5,673) Net realized investment gains (losses) 1,431 (13,547) 14,978 4,043 (17,969) 22,012 Other income 473 1,185 (712) 3,031 3,899 (868) ---------------------------------------- ------------------------------------ Total revenues 139,163 88,021 51,142 377,728 273,372 104,356 Expenses: Net losses and loss adjustment expenses 116,140 91,030 25,110 318,142 256,704 61,438 Underwriting, acquisition and insurance expenses 16,360 12,790 3,570 48,658 41,119 7,539 ---------------------------------------- ------------------------------------ Total expenses 132,500 103,820 28,680 366,800 297,823 68,977 ---------------------------------------- ------------------------------------ Income (loss) before income taxes $ 6,663 $ (15,799) $ 22,462 $ 10,928 $ (24,451) $ 35,379 ======================================== ==================================== Net loss and LAE ratio* 95.5% 109.6% (14.1)% 97.9% 108.7% (10.8)% Underwriting expense ratio* 13.4% 15.4% (2.0)% 15.0% 17.4% (2.4)% ---------------------------------------- ------------------------------------ Combined ratio 108.9% 125.0% (16.1)% 112.9% 126.1% (13.2)% Less: Investment income ratio* 12.8% 20.9% (8.1)% 14.0% 21.7% (7.7)% ---------------------------------------- ------------------------------------ Operating ratio 96.1% 104.1% (8.0)% 98.9% 104.4% (5.5)% ======================================== ====================================
September 30 December 31 2003 2002 ----------------------------- Net reserves for loss and LAE $ 1,237,733 $ 1,096,205 =============================
* Ratios shown are expressed as a percentage of net premiums earned. 23 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) PREMIUMS Premiums written: Our professional liability insurance segment principally provides liability insurance for providers of medical and other health care services, and to a limited extent, providers of legal services. Premiums written for the professional liability segment increased by $30.2 million for the three months and $75.6 million for the nine months ended September 30, 2003 as compared to the same periods in 2002, principally due to rate increases. We experienced significant premium growth from new business in states where competitors have left the professional liability market. The growth in new business has largely been offset by policies that did not renew due to higher rates and our own underwriting decisions. We have implemented and we plan to continue to implement rate increases based on loss trends; however, our ability to implement those rate increases is subject to regulatory approval. We estimate that, on average, 2003 renewals to date are at rates that are more than 25% higher than 2002 rates. However, we do not expect premium growth to reflect the full amount of the rate increases because retention of our insureds may be reduced by the higher rates. Additionally, we are in the process of converting any remaining occurrence coverages to claims-made coverages. Since first-year claims-made coverage has a significantly lower premium than occurrence coverage due to lower loss exposure, the conversion will reduce gross premiums written. Premiums earned: Premiums earned for the professional liability segment increased $28.0 million for the three months and $75.2 million for the nine months ended September 30, 2003 as compared to the same periods in 2002. Premiums are earned pro rata over the entire policy period (generally one year) after the policy is written. The increase in 2003 earned premiums therefore reflects on a pro rata basis the changes in written premiums that occurred during both 2003 and 2002. Thus earned premiums have increased as discussed in the section on premiums written. Premiums ceded: Premiums ceded represent the premiums we must ultimately pay to our reinsurers for their assumption of a portion of our losses. Premiums ceded decreased by $10.6 million and $13.7 million, respectively, for the three and nine month periods ended September 30, 2003 as compared to the same periods in 2002. We have reduced the portion of our losses that we cede to our reinsurers. Under reinsurance contracts that became effective in October 2002, our retention levels for medical liability losses became $1.0 million in all states whereas previously our retention in many states was as low as $250,000. Premiums ceded have decreased both in total dollars and as a percentage of premiums earned because we have ceded a smaller portion of our risk. 24 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) LOSSES AND LOSS ADJUSTMENT EXPENSES Our net reserve for losses and LAE represents our estimate of the future amounts necessary to pay claims and expenses associated with investigation and settlement of claims. The resulting net losses and loss adjustment expenses (hereafter referred to as "net losses and LAE") may be summarized into three components of these estimates: (i) actuarial evaluation of incurred loss levels for the current accident year; (ii) actuarial re-evaluation of incurred loss levels for prior accident years; and (iii) actuarial re-evaluation of the reserve for the death, disability and retirement provision. Accident year refers to the accounting period in which the insured event becomes a liability of the insurer. For occurrence policies the insured event becomes a liability when the event takes place; for claims-made policies the insured event becomes a liability when the event is first reported to the insurer. We believe that measuring losses on an accident year basis is the most indicative measure of the underlying profitability of the premiums earned in that period since it associates policy premiums earned with our estimate of the losses incurred related to those policy premiums. The following table summarizes professional net losses and LAE and net loss ratios for the three and nine month periods ended September 30, 2003 and 2002 by separating losses between the current accident year and all prior accident years (dollars in thousands). The net loss ratios shown are calculated by dividing the applicable net losses and LAE by calendar year net premiums earned.
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 --------------------------------------------------------- 2003 2002 2003 2002 --------------------------------------------------------- Net losses and LAE: Current accident year $ 116,140 $ 91,030 $ 317,392 $ 254,304 Prior accident years - - 750 2,400 Change in death, disability, and retirement reserves - - - - --------------------------------------------------------- Calendar year net losses and LAE $ 116,140 $ 91,030 $ 318,142 $ 256,704 ========================================================= Net loss ratio attributable to: Current accident year net losses and LAE 95.5% 109.6% 97.7% 107.7% Prior accident years net losses and LAE - - 0.2% 1.0% Change in death, disability, and retirement reserves - - - - --------------------------------------------------------- Calendar year net loss ratio 95.5% 109.6% 97.9% 108.7% =========================================================
Current accident year net losses and LAE increased by $25.1 million and $63.1 million, respectively, for the three and nine month periods ended September 30, 2003 as compared to the three and nine month periods ended September 30, 2002, primarily due to increased loss costs. The current accident year net loss ratio for the three months ended September 30, 2003, as compared to the same period in 2002, has decreased from 109.6% to 95.5%. The current accident year net loss ratio for the nine months ended September 30, 2003, as compared to the same period in 2002, has decreased from 107.7% to 97.7%. The improvement in the loss ratio primarily reflects the effects of a more adequate premium structure as a result of rate increases implemented during 2003 and 2002. 25 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS (LOSSES) Our professional liability segment investment income is primarily derived from the interest income earned by our fixed maturity securities but also includes interest income from short-term and cash equivalent investments, dividend income from equity securities, increases in the cash surrender value of BOLI contracts, and rental income earned by our commercial real estate holdings. Investment fees and expenses and real estate expenses are deducted from investment income. Our net investment income decreased by $1.8 million and $5.7 million, respectively, for the three and nine month periods ended September 30, 2003 as compared to the same periods in 2002. The decrease occurred even though our average invested funds increased in 2003. The positive effect of additional invested funds was more than offset by the effect of lower average yields. The weighted average tax equivalent book yield (tax adjusted gross earnings divided by the average quarterly ending book value) of our professional liability segment fixed maturity investments is 4.4% and 4.7%, respectively, for the three and nine months ended September 30, 2003 as compared to 5.9% and 6.2%, respectively, for the same periods in 2002. The average yield is reduced as compared to 2002 because market rates available for the investment of new and matured funds were lower in 2003. Also, in the fourth quarter of 2002 we sold a significant portion of our fixed maturity portfolio in order to realize capital gains and these securities were reinvested at substantially lower rates. Net realized investment gains (losses) include gains and losses realized on sales of investment securities and realized losses for other than temporary impairments in the fair value of investment securities, as shown in the following table (in thousands).
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 -------------------------------------------------------- 2003 2002 2003 2002 -------------------------------------------------------- Net gains (losses) from sales $ 1,428 $ (273) $ 4,362 $ (2,695) Other than temporary impairment losses - (13,274) (322) (15,274) Holding gains (losses) on trading portfolio 3 - 3 - -------------------------------------------------------- Net realized investment gains (losses) $ 1,431 $ (13,547) $ 4,043 $ (17,969) ========================================================
26 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) UNDERWRITING, ACQUISITION AND INSURANCE EXPENSES Underwriting, acquisition and insurance expenses increased by approximately $3.6 million and $7.5 million, respectively, for the three and the nine month periods ended September 30, 2003 as compared to the same periods in 2002. These expenses are comprised of variable costs, such as commissions and premium taxes that are directly related to premiums earned, and fixed costs that have no direct relationship to premium volume, such as the costs of our underwriting department and guaranty fund assessments. The 2003 increase in expenses is due to higher costs incurred as a result of premium growth, somewhat offset by reductions in certain costs. Guaranty fund assessments were lower by approximately $400,000 and $1.6 million, respectively, during the three and nine month periods ended September 30, 2003 as compared to the same periods in 2002. Also, as discussed under the caption "Other Income" late in the second quarter of 2003 we ceased to provide medical credentialing services. Termination of this business activity reduced expenses by approximately $500,000 and $600,000, respectively, during the three and nine month periods ended September 30, 2003. The underwriting expense ratio is the total of underwriting, acquisition and insurance expenses divided by net premiums earned. This ratio is 13.4% and 15.0%, respectively, for the three and nine month periods ended September 30, 2003 as compared to 15.4% and 17.4% for the same periods in 2002. The ratio decreased because there was no significant change in our fixed costs, other than the previously discussed decrease in guaranty fund assessments, while premiums earned increased in both the three and the nine month periods. OTHER INCOME We have historically provided medical credentialing services for a fee. These services did not contribute significantly to our bottom line and we ceased to provide these services late in the second quarter of 2003. The cessation of these services reduced fee income by approximately $0.6 million for both the three and the nine month periods ended September 30, 2003 as compared to the same periods in 2002 and is the primary reason for the overall decline in 2003 other income. 27 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) PERSONAL LINES INSURANCE OPERATIONS SEGMENT Our personal lines segment is comprised of the operations of a single insurance company, MEEMIC Insurance Company. Selected financial data for our personal lines insurance segment is summarized in the table below (dollars in thousands).
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 ------------------------------------ ------------------------------------- INCREASE INCREASE 2003 2002 (DECREASE) 2003 2002 (DECREASE) ------------------------------------ ------------------------------------- Gross premiums written $ 51,224 $ 45,503 $ 5,721 $ 145,874 $ 129,350 $ 16,524 ==================================== ------------------------------------- Net premiums written $ 46,494 $ 41,627 $ 4,867 $ 132,918 $ 119,410 $ 13,508 ==================================== ===================================== Revenues: Premiums earned $ 48,479 $ 42,780 $ 5,699 $ 139,168 $ 119,745 $ 19,423 Premiums ceded 4,725 3,864 861 12,938 9,910 3,028 ------------------------------------ ------------------------------------- Net premiums earned 43,754 38,916 4,838 126,230 109,835 16,395 Net investment income 2,612 2,467 145 7,644 7,526 118 Net realized investment gains (losses) 5 (13) 18 106 631 (525) Other income 549 475 74 1,541 1,385 156 ------------------------------------ ------------------------------------- Total revenues 46,920 41,845 5,075 135,521 119,377 16,144 Expenses: Net losses and loss adjustment expenses 29,643 24,838 4,805 83,989 73,427 10,562 Underwriting, acquisition and insurance expenses 10,078 8,590 1,488 28,436 24,743 3,693 ------------------------------------ ------------------------------------- Total expenses 39,721 33,428 6,293 112,425 98,170 14,255 ------------------------------------ ------------------------------------- Income (loss) before income taxes $ 7,199 $ 8,417 $ (1,218) $ 23,096 $ 21,207 $ 1,889 ==================================== ===================================== Net losses and LAE ratio* 67.7% 63.8% 3.9% 66.5% 66.9% (0.4%) Underwriting expenses ratio* 23.0% 22.1% 0.9% 22.5% 22.5% 0.0% ------------------------------------ ------------------------------------- Combined ratio 90.7% 85.9% 4.8% 89.0% 89.4% (0.4%) Less: Investment income ratio* 6.0% 6.3% (0.3%) 6.1% 6.9% (0.8%) ------------------------------------ ------------------------------------- Operating ratio* 84.7% 79.6% 5.1% 82.9% 82.5% 0.4% ==================================== =====================================
SEPTEMBER 30 December 31 2003 2002 -------------------------------- Net reserves for loss and LAE $ 70,191 $ 64,251 ================================
* Ratios shown are expressed as a percentage of net premiums earned. 28 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) PREMIUMS Premiums written: Gross premiums written for the three and nine month periods ended September 30, 2003, respectively, increased by $5.7 and $16.5 million as compared to the same periods in 2002. Premiums by line of business for each period are as follows (dollars in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 ------------------------------------------------------ 2003 2002 2003 2002 ------------------------------------------------------ Automobile $ 40,942 $ 36,752 $ 119,308 $ 109,046 Homeowners 10,012 8,519 25,845 19,709 Boat, umbrella, and other 270 232 721 595 ------------------------------------------------------ $ 51,224 $ 45,503 $ 145,874 $ 129,350 ======================================================
Automobile premiums are higher during 2003 for both the three and the nine month periods primarily due to increases in the number of autos insured and increases in the value of those autos. The number of insured vehicles increased from 182,058 at September 30, 2002 to 190,815 at September 30, 2003. Automobile premiums have also grown due to a 2% rate increase that became effective on October 1, 2002 and a 0.6% increase that became effective on July 1, 2003. Homeowners premiums are higher during 2003 in both the three and the nine month periods primarily due to a 22% rate increase that became effective on July 1, 2002 and a 7.6% rate increase that became effective April 1, 2003. Homeowners premiums have also grown due to increases in the number of homes insured and the value of those homes. The number of insured homes increased from 53,554 at September 30, 2002 to 59,606 at September 30, 2003. Premiums earned: Premiums earned increased by $5.7 million and $19.4 million, respectively, for the three and nine month periods ended September 30, 2003 as compared to the same periods in 2002. As with premiums written, this growth is primarily due to increases in the number of autos and homes insured and increases in the values of those autos and homes. Premiums ceded: Premiums ceded represent the premiums we must ultimately pay to our reinsurers for their assumption of a portion of our losses. Premiums ceded increased for both the three and the nine month periods ended September 30, 2003 as compared to the same periods in 2002. The increases are primarily due to the increased volume of our business and increased rates charged by our reinsurers. Premiums ceded were reduced by $1.0 million in September 2003 and $1.3 million in March 2002 due to decreases in our estimates of the amounts due to our reinsurers related to prior year coverages. 29 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) LOSSES AND LOSS ADJUSTMENT EXPENSES The following table summarizes personal lines net losses and LAE and net loss ratios for the three and nine month periods ended September 30, 2003 and 2002 by separating losses between the current accident year and all prior accident years (dollars in thousands). The net loss ratios shown are calculated by dividing the applicable net losses and LAE by current calendar year net premiums earned.
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 ----------------------------------------------------- 2003 2002 2003 2002 ----------------------------------------------------- Net losses and LAE: Current accident year $ 33,289 $ 27,366 $ 91,095 $ 78,291 Prior accident years (3,646) (2,528) (7,106) (4,864) ----------------------------------------------------- Calendar year net losses and LAE $ 29,643 $ 24,838 $ 83,989 $ 73,427 ====================================================== Net loss ratio attributable to: Current accident year net losses and LAE 76.0% 70.3% 72.1% 71.3% Prior accident year net losses and LAE (8.3%) (6.5%) (5.6%) (4.4%) ----------------------------------------------------- Calendar year net loss ratio 67.7% 63.8% 66.5% 66.9% ======================================================
As compared to the same periods in 2002, current accident year net losses and LAE of $33.3 million for the three months and $91.1 million for the nine months ended September 30, 2003 increased by $5.9 million and $12.8 million, respectively, principally due to an increased number of insureds and loss cost inflation. The current accident year net loss ratios for 2003 reflect rate increases for auto and homeowners, offset by increases in homeowners property claims from an increased frequency in fires and losses from the August 2003 Midwestern power outage. The adjustments to prior year losses recorded in 2003 and 2002 were made in the normal course of business as a part of our recurring review of loss reserves and reflect favorable development in our estimates of prior years' loss reserves. NET INVESTMENT INCOME AND NET REALIZED INVESTMENT GAINS (LOSSES) Our net investment income is comprised of the interest and dividend income from our fixed maturity, short-term, cash equivalents and equity investments, net of investment expenses. There is no significant change in our net investment income for either the three month or the nine month period ended September 30, 2003 as compared to the same periods in 2002, primarily because increases in the size of the portfolio were offset by declines in market interest rates. The weighted average tax equivalent book yield (tax adjusted gross earnings divided by the average quarterly ending book value) of the personal lines segment fixed maturity investments are 5.7% and 5.8%, respectively, for the three and nine months ended September 30, 2003 as compared to 6.0% and 6.1%, respectively, for the three and nine month periods ended September 30, 2002. The average yield is reduced as compared to 2002 because market rates available for the investment of new and matured funds were lower in 2003. Net realized investment gains and losses for the three and nine month periods ended September 30, 2003 and 2002 did not include any realized losses for other than temporary impairments. 30 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) UNDERWRITING, ACQUISITION AND INSURANCE EXPENSES Underwriting, acquisition and insurance expenses consist of normal, recurring expenses such as commissions, salaries and other expenses. These expenses increased by approximately $1.5 million and $3.7 million, respectively, for the three and nine month periods ended September 30, 2003 as compared to the same periods in 2002, primarily due to higher underwriting and acquisition costs from premium growth. The underwriting expense ratio is the total of underwriting, acquisition and insurance expenses divided by net premiums earned. This ratio is 23.0% and 22.5%, respectively, for the three and nine month periods ended September 30, 2003 and is higher for the three months ended September 30, 2003 as compared to the same period in 2002 due to increased mandatory statutory assessments. 31 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We believe that we are principally exposed to three types of market risk related to our investment operations. These risks are interest rate risk, credit risk and equity price risk. The term market risk refers to the risk of loss arising from adverse changes in market rates and prices, such as interest rates, equity prices and foreign currency exchange rates. All market sensitive instruments discussed here relate to our investment assets that are classified as available for sale. As of September 30, 2003, our fair value investment in fixed income securities was $1.809 billion. These securities are subject primarily to interest rate risk and credit risk. At September 30, 2003 we own no equity or fixed income securities that require treatment as derivatives under generally accepted accounting principles and we have no plans to acquire securities that would require such treatment. INTEREST RATE RISK Our fixed maturities portfolio is exposed to interest rate risk. Fluctuations in interest rates have a direct impact on the market valuation of these securities. As interest rates rise, market values of fixed income portfolios fall and vice versa. We believe we are in a position to keep our fixed income investments until maturity, as we do not invest in fixed maturity securities for trading purposes. The table below displays the anticipated effect of market interest rate fluctuations on the value and weighted average modified duration of our fixed maturity portfolio (dollars in millions.)
Interest Portfolio Weighted Average Rates Value Change in Value Modified Duration - ---------------------------------------------------------------------------------------- 200 basis point rise $ 1,681 $ (128) 3.84 100 basis point rise $ 1,746 $ (63) 3.65 Current rate* $ 1,809 $ - 3.59 100 basis point decline $ 1,876 $ 67 3.56 200 basis point decline $ 1,943 $ 134 3.61
* Current rates are as of September 30, 2003. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including the maintenance of the existing level and composition of fixed income security assets, and should not be relied on as indicative of future results. 32 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED) Certain limitations are inherent in the method of analysis presented in the computation of the fair value of fixed rate instruments. Actual values may differ from those projections presented should market conditions vary from assumptions used in the calculation of the fair value of individual securities, including non-parallel shifts in the term structure of interest rates and changing individual issuer credit spreads. At September 30, 2003, the fair value of our investment in preferred stocks was $30.3 million, including net unrealized gains of $1.4 million. Preferred stocks are primarily subject to interest rate risk because they bear a fixed rate of return. The investments in the above table do not include preferred stocks. CREDIT RISK We have exposure to credit risk primarily as a holder of fixed income securities. We control this exposure by emphasizing investment grade credit quality in the fixed income securities we purchase. We believe that this concentration in investment grade securities reduces our exposure to credit risk on these fixed income investments to an acceptable level. However, in the current environment even investment grade securities can rapidly deteriorate and result in significant losses. EQUITY PRICE RISK At September 30, 2003 the fair value of our investment in common stocks excluding preferred stocks as discussed in the preceding paragraphs, was $14.3 million, which included net unrealized gains of $1.3 million. These securities are subject to equity price risk, which is defined as the potential for loss in market value due to a decline in equity prices. A hypothetical 10% increase in the market prices as of September 30, 2003 would increase the fair value of these securities to $15.7 million; a hypothetical 10% decrease in the price of each of these marketable securities would reduce the fair value to $12.8 million. The selected hypothetical change does not reflect what could be considered the best or worst scenarios. ProAssurance's cash and short-term investment portfolio at September 30, 2003 was on a cost basis which approximates its fair value. This portfolio lacks significant market rate sensitivity due to its short duration. ITEM 4. CONTROLS AND PROCEDURES The Chief Executive Officer and Chief Financial Officer of the Company evaluated the effectiveness of our disclosure controls and procedures (as defined in SEC Rule 13a-15(e)) as of September 30, 2003. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective. During the quarter ended September 30, 2003, there was no change in our internal control over financial reporting (as defined in Rule 13a-15(f)) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 33 FORWARD-LOOKING STATEMENTS The U.S. securities laws, including the Private Securities Litigation Reform Act of 1995, provide a "safe harbor" for certain forward-looking statements. This report and the documents incorporated by reference herein contain statements concerning our future results and performance and other matters that are "forward-looking" statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. The words "anticipates," "believes," "estimates," "expects," "plans," "intends" and similar expressions are intended, but are not the exclusive means, to identify these forward-looking statements. These forward-looking statements include among other things statements concerning: liquidity and capital requirements, return on equity, financial ratios, net income, premiums, losses and loss reserves, premium rates and retention of current business, competition and market conditions, the expansion of product lines, the development or acquisition of business in new geographical areas, the availability of acceptable reinsurance, actions by regulators and rating agencies, payment of dividends, and other matters. These forward-looking statements are based upon our estimates and anticipation of future events that are subject to certain risks and uncertainties that could cause actual results to vary materially from historical or expected results described in the forward-looking statements. Due to such risks and uncertainties, you are urged not to place undue reliance on forward-looking statements. Risks that could adversely affect our operations or cause actual results to differ materially from anticipated results include, but are not limited to, the following: - underwriting losses on the risks we insure are higher or lower than expected; - unexpected changes in loss trends and reserving assumptions which might require the reevaluation of the liability for loss and loss adjustment expenses, thus resulting in an increase or decrease in the liability and a corresponding adjustment to earnings; - our ability to retain current business, acquire new business, expand product lines and a variety of other factors affecting daily operations such as, but not limited to, economic, legal, competitive and market conditions which may be beyond our control and are thus difficult or impossible to predict; - changes in the interest rate environment and/or the securities markets that adversely impact the fair value of our investments or our income; - inability on our part to achieve continued growth through expansion into other states or through acquisitions or business combinations; - general economic conditions that are worse than anticipated; - inability on our part to obtain regulatory approval of, or to implement, premium rate increases; - the effects of weather-related events; - changes in the legal system, including retroactively applied decisions that affect the frequency and severity of claims; - a verdict against one of our insureds that is in excess of policy limits could expose us to bad faith litigation by the insured; - significantly increased competition among insurance providers and related pricing weaknesses in some markets; - the loss of an agent or agents who produce a significant portion of our business; - changes in the availability, cost, quality or collectibility of reinsurance; - changes to our ratings by rating agencies; - regulatory and legislative actions or decisions that adversely affect us; and - our ability to utilize loss carryforwards and other deferred tax assets. All forward-looking statements included in this document are based upon information available to us on the date hereof, and we undertake no obligation, other than as may be required under the federal securities laws, to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. We do not assume responsibility for the accuracy and completeness of the forward-looking statements. We caution you that these risk factors may not be exhaustive. We operate in a continually changing business environment, and new risk factors emerge from time to time. We cannot predict such new risk factors, nor can we assess the impact, if any, of such new risk factors on our businesses or the extent to which any factor or combination of factors may cause actual results to differ materially from those expressed or implied by any forward-looking statements. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this prospectus might not occur. For these statements, we claim the protection of the safe harbor for forward-looking statements contained in Section 27A of the Securities Act. 34 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS See Note 9 to the condensed consolidated financial statements. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. On July 7, 2003, ProAssurance issued and sold, in a private placement, $100 million aggregate principal amount of its 3.90% Convertible Senior Debentures due 2023 (the Debentures). On July 16, 2003, ProAssurance issued and sold, in a private placement, $7.6 million aggregate principal amount of the Debentures pursuant to an option to purchase additional Debentures granted to the initial purchasers. The Debentures are senior unsecured obligations of ProAssurance and rank equally with ProAssurance's other unsecured and unsubordinated obligations. The Debentures were sold to Banc of America Securities LLC and Cochran, Caronia Securities LLC, as the initial purchasers, as "accredited investors" within the meaning of Rule 501 under the Securities Act of 1933, as amended (the Securities Act), in reliance upon the private placement exemption afforded by the Securities Act, and were offered and sold to "qualified institutional buyers" under Rule 144A under the Securities Act. Pursuant to a registration rights agreement entered into in connection with the private offering, ProAssurance agreed to file with the Securities and Exchange Commission a registration statement under the Securities Act to permit registered resales of the Debentures and the shares of ProAssurance's common stock issuable upon the conversion of the Debentures. The Debentures were issued in the principal amount of $107.6 million. After giving effect to a 2.75% ($3.0 million) underwriters' discount, net proceeds from the offering were approximately $104.6 million. ProAssurance used the net proceeds to pay off its existing term loan having an outstanding principal balance of $67.5 million. The balance of the net proceeds will be used for general corporate purposes, which may include contributions to the capital of its insurance subsidiaries to support the expected growth in insurance operations. The Debentures are convertible, upon the occurrence of certain events, into shares of common stock of ProAssurance at an initial conversion rate of 23.9037 shares for each $1,000 principal amount of the Debentures, which is equivalent to an initial conversion price of approximately $41.83 per share. ProAssurance's common stock is traded on the New York Stock Exchange under the symbol "PRA". See Note 7 of the Notes to Condensed Consolidated Financial Statements of ProAssurance and subsidiaries included elsewhere herein for a description of the conversion rights and other terms of the Debentures. 35 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. 31.1 Certification of Principal Executive Officer of ProAssurance as required under SEC rule 13a-14(a) 31.2 Certification of Principal Financial Officer of ProAssurance as required under SEC rule 13a-14(a) 32.1 Certification of Principal Executive Officer of ProAssurance as required under SEC Rule 13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code, as amended (18 U.S.C. 1350) 32.2 Certification of Principal Financial Officer of ProAssurance as required under SEC Rule 13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code, as amended (18 U.S.C. 1350) (b) Reports on Form 8-K. ProAssurance filed a Current Report on Form 8-K on July 1, 2003 that furnished information regarding the pricing and terms of its private offering of convertible debentures that was publicly released on that same day. ProAssurance filed a Current Report on Form 8-K on July 8, 2003 that furnished information regarding the closing of its private offering of convertible debentures that was publicly released on that same day. ProAssurance filed a Current Report on Form 8-K on July 8, 2003 that furnished information regarding A.M. Best's affirmation of ProAssurance's Financial Strength Rating and Best's rating of the company's recently issued debentures that was publicly released on that same day. ProAssurance filed a Current Report on Form 8-K on July 15, 2003 that furnished information regarding the exercise of an over-allotment option in connection with the company's recently issued debentures that was publicly released on that same day. ProAssurance filed a Current Report on Form 8-K on August 6, 2003 that furnished information publicly released on that same day regarding the merger of the Medical Assurance, Inc. Pension Plan and the Professionals Group Employee Stock Ownership Plan into the ProAssurance Group Savings and Retirement Plan. ProAssurance filed a Current Report on Form 8-K on August 11, 2003 that furnished information publicly released on that same day regarding operating results for the quarter period and six month period ended June 30, 2003. ProAssurance filed a Current Report on Form 8-K on September 3, 2003 that furnished the information publicly released on that same day regarding its participation in a panel discussion at an investor conference sponsored by Sandler O'Neill and Partners. 36 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PROASSURANCE CORPORATION November 10, 2003 /s/ Howard H. Friedman ----------------------------------------- Howard H. Friedman, Chief Financial Officer (Duly authorized officer and principal financial officer) 37
EX-31.1 3 g85709exv31w1.txt EX-31.1 SECTION 302 CERTIFICATION OF THE PEO EXHIBIT 31.1 CERTIFICATIONS I, A. Derrill Crowe, certify that: 1. I have reviewed this report on Form 10-Q of ProAssurance Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15 (e)): a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 10, 2003 /s/ A. Derrill Crowe, M.D. -------------------------- A. Derrill Crowe, M.D. Chief Executive Officer EX-31.2 4 g85709exv31w2.txt EX-31.2 SECTION 302 CERTIFICATION OF THE PFO EXHIBIT 31.2 CERTIFICATIONS I, Howard H. Friedman, certify that: 1. I have reviewed this report on Form 10-Q of ProAssurance Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15 (e)): a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 10, 2003 /s/ Howard H. Friedman ----------------------------------- Howard H. Friedman Chief Financial Officer EX-32.1 5 g85709exv32w1.txt EX-32.1 SECTION 906 CERTIFICATION OF THE PEO EXHIBIT 32.1 A signed original of this written statement required by Section 906 has been provided to ProAssurance Corporation and will be retained by ProAssurance Corporation and furnished to the Securities and Exchange Commission or its staff upon request. CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of ProAssurance Corporation (the "Company") on Form 10-Q for the quarter ending September 30, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, A. Derrill Crowe, M.D., Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ A. Derrill Crowe, M.D ------------------------- A. Derrill Crowe, M.D. Chief Executive Officer November 10, 2003 EX-32.2 6 g85709exv32w2.txt EX-32.2 SECTION 906 CERTIFICATION OF THE PFO EXHIBIT 32.2 A signed original of this written statement required by Section 906 has been provided to ProAssurance Corporation and will be retained by ProAssurance Corporation and furnished to the Securities and Exchange Commission or its staff upon request. CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of ProAssurance Corporation (the "Company") on Form 10-Q for the quarter ending September 30, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Howard H. Friedman, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Howard H. Friedman ---------------------- Howard H. Friedman Chief Financial Officer November 10, 2003
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