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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☒
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2019 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
Incorporation or Organization)
 
 
(IRS Employer Identification No.)
 
 
 
 
 
 
 
 
 
 
 
100 Brookwood Place,
Birmingham,
AL
 
 
 
 
 
35209
(Address of Principal Executive Offices)
 
 
(Zip Code)
 
 
 
 
 
 
 
 
 
 
 
(205)
877-4400
 
 
 
(Registrant’s Telephone Number,
Including Area Code)
 
 
(Former Name, Former Address, and Former
Fiscal Year, if Changed Since Last Report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, par value $0.01 per share
PRA
New York Stock Exchange
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
☒
 
 
Accelerated filer
 
☐
Non-accelerated filer
 
☐
(Do not check if a smaller reporting company)
 
Smaller reporting company
 
☐
Emerging growth company
 
☐
 
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  ☐   No  ☒
As of October 31, 2019, there were 53,791,436 shares of the registrant’s common stock outstanding.

Table of Contents

Glossary of Terms and Acronyms

When the following terms and acronyms appear in the text of this report, they have the meanings indicated below.
Term
Meaning
AAD
Annual aggregate deductible
AOCI
Accumulated other comprehensive income (loss)
ASU
Accounting Standards Update
BEAT
Base erosion anti-abuse tax
Board
Board of Directors of ProAssurance Corporation
BOLI
Business owned life insurance
Council of Lloyd's
The governing body for Lloyd's of London
CODM
Chief Operating Decision Maker
Commutation
An agreement between a ceding insurer and the reinsurer that provides for the valuation, payment, and complete discharge of all obligations between the parties under a particular reinsurance contract
DPAC
Deferred policy acquisition costs
Eastern Re
Eastern Re, LTD, S.P.C.
EBUB
Earned but unbilled premium
E&O
Errors and Omissions
FAL
Funds at Lloyd's
FASB
Financial Accounting Standards Board
FHLB
Federal Home Loan Bank
FHLMC
Federal Home Loan Mortgage Corporation
FNMA
Federal National Mortgage Association
GAAP
Generally accepted accounting principles in the United States of America
GILTI
Global intangible low-taxed income
GNMA
Government National Mortgage Association
HCPL
Healthcare professional liability
IBNR
Incurred but not reported
Inova Re
Inova Re, LTD, S.P.C.
IRS
Internal Revenue Service
LIBOR
London Interbank Offered Rate
LLC
Limited liability company
Lloyd's
Lloyd's of London market
LP
Limited partnership
LPT
Loss portfolio transfer
Medical technology liability
Medical technology and life sciences products liability
Mortgage Loans
Two ten-year mortgage loans collectively with an original borrowing amount of approximately $40 million, each entered into by a subsidiary of ProAssurance
NAIC
National Association of Insurance Commissioners
NAV
Net asset value
NOL
Net operating loss
NRSRO
Nationally recognized statistical rating organization
NYSE
New York Stock Exchange
OCI
Other comprehensive income (loss)
OTTI
Other-than-temporary impairment
PCAOB
Public Company Accounting Oversight Board
Revolving Credit Agreement
ProAssurance's $250 million revolving credit agreement

2
Table of Contents

Term
Meaning
ROE
Return on equity
ROU
Right-of-use
SAP
Statutory accounting principles
SEC
Securities and Exchange Commission
SPA
Special Purpose Arrangement
SPC
Segregated portfolio cell
Specialty P&C
Specialty Property and Casualty
Syndicate 1729
Lloyd's of London Syndicate 1729
Syndicate 6131
Lloyd's of London Syndicate 6131, a Special Purpose Arrangement with Lloyd's of London Syndicate 1729
Syndicate Credit Agreement
Unconditional revolving credit agreement with the Premium Trust Fund of Syndicate 1729
TCJA
Tax Cuts and Jobs Act H.R.1 of 2017
U.K.
United Kingdom of Great Britain and Northern Ireland
ULAE
Unallocated loss adjustment expense
VIE
Variable interest entity

3
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Caution Regarding Forward-Looking Statements
Any statements in this Form 10-Q that are not historical facts are specifically identified as forward-looking statements. These statements are based upon our estimates and anticipation of future events and are subject to significant risks, assumptions and uncertainties that could cause actual results to vary materially from the expected results described in the forward-looking statements. Forward-looking statements are identified by words such as, but not limited to, "anticipate," "believe," "estimate," "expect," "hope," "hopeful," "intend," "likely," "may," "optimistic," "possible," "potential," "preliminary," "project," "should," "will" and other analogous expressions. There are numerous factors that could cause our actual results to differ materially from those in the forward-looking statements. Thus, sentences and phrases that we use to convey our view of future events and trends are expressly designated as forward-looking statements as are sections of this Form 10-Q that are identified as giving our outlook on future business.
Forward-looking statements relating to our business include among other things: statements concerning future liquidity and capital requirements, investment valuation and performance, return on equity, financial ratios, net income, premiums, losses and loss reserve, 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, court actions, legislative actions, payment or performance of obligations under indebtedness, payment of dividends and other matters.
These forward-looking statements are subject to significant risks, assumptions and uncertainties, including, among other things, the following factors that could affect the actual outcome of future events:
Ÿ
changes in general economic conditions, including the impact of inflation or deflation and unemployment;
Ÿ
our ability to maintain our dividend payments;
Ÿ
regulatory, legislative and judicial actions or decisions that could affect our business plans or operations, including the impact of Brexit;
Ÿ
the enactment or repeal of tort reforms;
Ÿ
formation or dissolution of state-sponsored insurance entities providing coverages now offered by ProAssurance which could remove or add sizable numbers of insureds from or to the private insurance market;
Ÿ
changes in the interest and tax rate environment;
Ÿ
resolution of uncertain tax matters and changes in tax laws, including the impact of the TCJA;
Ÿ
changes in laws or government regulations regarding financial markets or market activity that may affect our business;
Ÿ
changes in the ability of the U.S. government to meet its obligations that may affect the U.S. economy and our business;
Ÿ
performance of financial markets affecting the fair value of our investments or making it difficult to determine the value of our investments;
Ÿ
changes in requirements or accounting policies and practices that may be adopted by our regulatory agencies, the FASB, the SEC, the PCAOB or the NYSE that may affect our business;
Ÿ
changes in laws or government regulations affecting the financial services industry, the property and casualty insurance industry or particular insurance lines underwritten by our subsidiaries;
Ÿ
the effect on our insureds, particularly the insurance needs of our insureds, and our loss costs, of changes in the healthcare delivery system and/or changes in the U.S. political climate that may affect healthcare policy or our business;
Ÿ
consolidation of our insureds into or under larger entities which may be insured by competitors, or may not have a risk profile that meets our underwriting criteria or which may not use external providers for insuring or otherwise managing substantial portions of their liability risk;
Ÿ
uncertainties inherent in the estimate of our loss and loss adjustment expense reserve and reinsurance recoverable;
Ÿ
changes in the availability, cost, quality or collectability of insurance/reinsurance;
Ÿ
the results of litigation, including pre- or post-trial motions, trials and/or appeals we undertake;
Ÿ
effects on our claims costs from mass tort litigation that are different from that anticipated by us;
Ÿ
allegations of bad faith which may arise from our handling of any particular claim, including failure to settle;
Ÿ
loss or consolidation of independent agents, agencies, brokers or brokerage firms;
Ÿ
changes in our organization, compensation and benefit plans;

4
Table of Contents

Ÿ
changes in the business or competitive environment may limit the effectiveness of our business strategy and impact our revenues;
Ÿ
our ability to retain and recruit senior management;
Ÿ
the availability, integrity and security of our technology infrastructure or that of our third-party providers of technology infrastructure, including any susceptibility to cyber-attacks which might result in a loss of information or operating capability;
Ÿ
the impact of a catastrophic event, as it relates to both our operations and our insured risks;
Ÿ
the impact of acts of terrorism and acts of war;
Ÿ
the effects of terrorism-related insurance legislation and laws;
Ÿ
guaranty funds and other state assessments;
Ÿ
our ability to achieve continued growth through expansion into new markets or through acquisitions or business combinations;
Ÿ
changes to the ratings assigned by rating agencies to our insurance subsidiaries, individually or as a group;
Ÿ
provisions in our charter documents, Delaware law and state insurance laws may impede attempts to replace or remove management or may impede a takeover;
Ÿ
state insurance restrictions may prohibit assets held by our insurance subsidiaries, including cash and investment securities, from being used for general corporate purposes;
Ÿ
taxing authorities can take exception to our tax positions and cause us to incur significant amounts of legal and accounting costs and, if our defense is not successful, additional tax costs, including interest and penalties; and
Ÿ
expected benefits from completed and proposed acquisitions may not be achieved or may be delayed longer than expected due to business disruption; loss of customers, employees or key agents; increased operating costs or inability to achieve cost savings; and assumption of greater than expected liabilities, among other reasons.
Additional risks, assumptions and uncertainties that could arise from our membership in the Lloyd's market and our participation in Lloyd's Syndicates include, but are not limited to, the following:
Ÿ
members of Lloyd's are subject to levies by the Council of Lloyd's based on a percentage of the member's underwriting capacity, currently a maximum of 3%, but can be increased by Lloyd's;
Ÿ
Syndicate operating results can be affected by decisions made by the Council of Lloyd's which the management of Syndicate 1729 and Syndicate 6131 have little ability to control, such as a decision to not approve the business plan of Syndicate 1729 or Syndicate 6131, or a decision to increase the capital required to continue operations, and by our obligation to pay levies to Lloyd's;
Ÿ
Lloyd's insurance and reinsurance relationships and distribution channels could be disrupted or Lloyd's trading licenses could be revoked, making it more difficult for a Lloyd's Syndicate to distribute and market its products;
Ÿ
rating agencies could downgrade their ratings of Lloyd's as a whole; and
Ÿ
Syndicate 1729 and Syndicate 6131 operations are dependent on a small, specialized management team and the loss of their services could adversely affect the Syndicate’s business. The inability to identify, hire and retain other highly qualified personnel in the future could adversely affect the quality and profitability of Syndicate 1729’s or Syndicate 6131's business.
Our results may differ materially from those we expect and discuss in any forward-looking statements. The principal risk factors that may cause these differences are described in "Item 1A, Risk Factors" in our Form 10-K and other documents we file with the SEC, such as our current reports on Form 8-K and our regular reports on Form 10-Q.
We caution readers not to place undue reliance on any such forward-looking statements, which are based upon conditions existing only as of the date made, and advise readers that these factors could affect our financial performance and could cause actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements. Except as required by law or regulations, we do not undertake and specifically decline any obligation to publicly release the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

5
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TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

6
Table of Contents

ProAssurance Corporation and Subsidiaries
Condensed Consolidated Balance Sheets (Unaudited)
(In thousands, except share data)
 
September 30,
2019
 
December 31,
2018
Assets
 
 
 
Investments
 
 
 
Fixed maturities, available for sale, at fair value; amortized cost, $2,251,040 and $2,116,825, respectively
$
2,301,535

 
$
2,093,798

Fixed maturities, trading, at fair value; cost, $44,766 and $38,445, respectively
45,295

 
38,188

Equity investments, at fair value; cost, $389,319 and $450,931, respectively
409,100

 
442,937

Short-term investments
270,836

 
308,319

Business owned life insurance
65,653

 
64,096

Investment in unconsolidated subsidiaries
366,606

 
367,757

Other investments, $34,133 and $31,344 at fair value, respectively, otherwise at cost or amortized cost
37,049

 
34,287

Total Investments
3,496,074

 
3,349,382

Cash and cash equivalents
102,211

 
80,471

Premiums receivable
283,944

 
261,466

Receivable from reinsurers on paid losses and loss adjustment expenses
15,089

 
11,558

Receivable from reinsurers on unpaid losses and loss adjustment expenses
357,811

 
343,820

Prepaid reinsurance premiums
53,232

 
40,631

Deferred policy acquisition costs
58,099

 
54,116

Deferred tax asset, net
19,016

 
29,108

Real estate, net
30,629

 
31,114

Operating lease ROU assets
20,563

 
—

Intangible assets, net
72,284

 
76,776

Goodwill
210,725

 
210,725

Other assets
104,682

 
111,559

Total Assets
$
4,824,359

 
$
4,600,726

Liabilities and Shareholders' Equity
 
 
 
Liabilities
 
 
 
Policy liabilities and accruals
 
 
 
Reserve for losses and loss adjustment expenses
$
2,215,775

 
$
2,119,847

Unearned premiums
459,260

 
415,211

Reinsurance premiums payable
58,552

 
55,614

Total Policy Liabilities
2,733,587

 
2,590,672

Operating lease liabilities
21,298

 
—

Other liabilities
193,069

 
199,295

Debt less unamortized debt issuance costs
286,947

 
287,757

Total Liabilities
3,234,901

 
3,077,724

Shareholders' Equity
 
 
 
Common shares, par value $0.01 per share, 100,000,000 shares authorized, 63,115,253 and 62,989,421 shares issued, respectively
631

 
630

Additional paid-in capital
385,181

 
384,713

Accumulated other comprehensive income (loss), net of deferred tax expense (benefit) of $10,602 and ($4,355), respectively
39,134

 
(16,911
)
Retained earnings
1,581,789

 
1,571,847

Treasury shares, at cost, 9,352,373 shares as of each respective period end
(417,277
)
 
(417,277
)
Total Shareholders' Equity
1,589,458

 
1,523,002

Total Liabilities and Shareholders' Equity
$
4,824,359

 
$
4,600,726

See accompanying notes.

7
Table of Contents

ProAssurance Corporation and Subsidiaries
Condensed Consolidated Statements of Changes in Capital (Unaudited)
(In thousands)
 
 
 
Common Stock
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Retained Earnings
 
Treasury Stock
 
Total
Balance at July 1, 2019
 
$
631

 
$
385,200

 
$
31,729

 
$
1,581,273

 
$
(417,277
)
 
$
1,581,556

Common shares issued for compensation and effect of shares reissued to stock purchase plan
 
—

 
20

 
—

 
—

 
—

 
20

Share-based compensation
 
—

 
(11
)
 
—

 
—

 
—

 
(11
)
Net effect of restricted and performance shares issued
 
—

 
(28
)
 
—

 
—

 
—

 
(28
)
Dividends to shareholders
 
—

 
—

 
—

 
(16,677
)
 
—

 
(16,677
)
Other comprehensive income (loss)
 
—

 
—

 
7,405

 
—

 
—

 
7,405

Net income
 
—

 
—

 
—

 
17,193

 
—

 
17,193

Balance at September 30, 2019
 
$
631


$
385,181


$
39,134


$
1,581,789


$
(417,277
)

$
1,589,458

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Retained Earnings
 
Treasury Stock
 
Total
Balance at December 31, 2018
 
$
630

 
$
384,713

 
$
(16,911
)
 
$
1,571,847

 
$
(417,277
)
 
$
1,523,002

Cumulative-effect adjustment-
ASU 2018-07 adoption*
 
—

 
—

 
—

 
(444
)
 
—

 
(444
)
Common shares issued for compensation and effect of shares reissued to stock purchase plan
 
—

 
832

 
—

 
—

 
—

 
832

Share-based compensation
 
—

 
2,309

 
—

 
—

 
—

 
2,309

Net effect of restricted and performance shares issued
 
1

 
(2,673
)
 
—

 
—

 
—

 
(2,672
)
Dividends to shareholders
 
—

 
—

 
—

 
(49,992
)
 
—

 
(49,992
)
Other comprehensive income (loss)
 
—

 
—

 
56,045

 
—

 
—

 
56,045

Net income
 
—

 
—

 
—

 
60,378

 
—

 
60,378

Balance at September 30, 2019
 
$
631


$
385,181


$
39,134


$
1,581,789


$
(417,277
)

$
1,589,458

* See Note 1 for discussion of accounting guidance adopted during the period.
Continued on the following page.

8
Table of Contents

Continued from the previous page.
 
 
Common Stock
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Retained Earnings
 
Treasury Stock
 
Total
Balance at July 1, 2018
 
$
630

 
$
383,001

 
$
(16,143
)
 
$
1,625,137

 
$
(418,009
)
 
$
1,574,616

Common shares issued for compensation and effect of shares reissued to stock purchase plan
 
—

 
34

 
—

 
—

 
—

 
34

Share-based compensation
 
—

 
1,604

 
—

 
—

 
—

 
1,604

Net effect of restricted and performance shares issued
 
—

 
(1
)
 
—

 
—

 
—

 
(1
)
Dividends to shareholders
 
—

 
—

 
—

 
(16,622
)
 
—

 
(16,622
)
Other comprehensive income (loss)
 
—

 
—

 
(3,964
)
 
—

 
—

 
(3,964
)
Net income
 
—

 
—

 
—

 
31,228

 
—

 
31,228

Balance at September 30, 2018
 
$
630

 
$
384,638

 
$
(20,107
)
 
$
1,639,743

 
$
(418,009
)
 
$
1,586,895

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Retained Earnings
 
Treasury Stock
 
Total
Balance at December 31, 2017
 
$
628

 
$
383,077

 
$
14,911

 
$
1,614,186

 
$
(418,007
)
 
$
1,594,795

Cumulative-effect adjustment-
ASU 2016-01 adoption
 
—

 
—

 
—

 
8,334

 
—

 
8,334

Cumulative-effect adjustment-
ASU 2018-02 adoption
 
—

 
—

 
3,416

 
(3,416
)
 
—

 
—

Common shares issued for compensation and effect of shares reissued to stock purchase plan
 
—

 
1,350

 
—

 
—

 
(2
)
 
1,348

Share-based compensation
 
—

 
4,083

 
—

 
—

 
—

 
4,083

Net effect of restricted and performance shares issued
 
2

 
(3,872
)
 
—

 
—

 
—

 
(3,870
)
Dividends to shareholders
 
—

 
—

 
—

 
(50,868
)
 
—

 
(50,868
)
Other comprehensive income (loss)
 
—

 
—

 
(38,434
)
 
—

 
—

 
(38,434
)
Net income
 
—

 
—

 
—

 
71,507

 
—

 
71,507

Balance at September 30, 2018
 
$
630

 
$
384,638

 
$
(20,107
)
 
$
1,639,743

 
$
(418,009
)
 
$
1,586,895

 
See accompanying notes.

9
Table of Contents

ProAssurance Corporation and Subsidiaries
Condensed Consolidated Statements of Income and Comprehensive Income (Unaudited)
(In thousands, except per share data)
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2019
 
2018
 
2019
 
2018
Revenues
 
 
 
 
 
 
 
Net premiums earned
$
215,788

 
$
206,070

 
$
633,086

 
$
616,819

Net investment income
23,681

 
23,266

 
70,038

 
67,677

Equity in earnings (loss) of unconsolidated subsidiaries
(1,277
)
 
5,228

 
(7,240
)
 
12,247

Net realized investment gains (losses):
 
 
 
 
 
 
 
OTTI losses
(66
)
 
(86
)
 
(202
)
 
(490
)
Portion of OTTI losses recognized in other comprehensive income before taxes
36

 
—

 
124

 
—

Net impairment losses recognized in earnings
(30
)
 
(86
)
 
(78
)
 
(490
)
Other net realized investment gains (losses)
1,164

 
12,459

 
47,142

 
3,141

Total net realized investment gains (losses)
1,134

 
12,373

 
47,064

 
2,651

Other income
2,548

 
2,388

 
7,419

 
7,155

Total revenues
241,874

 
249,325

 
750,367

 
706,549

Expenses
 
 
 
 
 
 
 
Net losses and loss adjustment expenses
161,614

 
147,605

 
489,808

 
439,120

Underwriting, policy acquisition and operating expenses
 
 
 
 
 
 
 
Operating expense
32,778

 
35,213

 
100,729

 
101,634

DPAC amortization
29,083

 
26,631

 
85,231

 
77,178

Segregated portfolio cells dividend expense (income)
3,621

 
5,255

 
1,375

 
9,787

Interest expense
4,274

 
3,599

 
12,850

 
11,262

Total expenses
231,370

 
218,303

 
689,993

 
638,981

Income before income taxes
10,504

 
31,022

 
60,374

 
67,568

Provision for income taxes
 
 
 
 
 
 
 
Current expense (benefit)
3,013

 
(1,637
)
 
4,864

 
(4,140
)
Deferred expense (benefit)
(9,702
)
 
1,431

 
(4,868
)
 
201

Total income tax expense (benefit)
(6,689
)
 
(206
)
 
(4
)
 
(3,939
)
Net income
17,193

 
31,228

 
60,378

 
71,507

Other comprehensive income (loss), after tax, net of reclassification adjustments
7,405

 
(3,964
)
 
56,045

 
(38,434
)
Comprehensive income (loss)
$
24,598

 
$
27,264

 
$
116,423

 
$
33,073

Earnings per share
 
 
 
 
 
 
 
Basic
$
0.32

 
$
0.58

 
$
1.12

 
$
1.33

Diluted
$
0.32

 
$
0.58

 
$
1.12

 
$
1.33

Weighted average number of common shares outstanding:
 
 
 
 
 
 
 
Basic
53,762

 
53,620

 
53,732

 
53,585

Diluted
53,856

 
53,773

 
53,831

 
53,735

Cash dividends declared per common share
$
0.31

 
$
0.31

 
$
0.93

 
$
0.93

See accompanying notes.

10
Table of Contents

ProAssurance Corporation and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
 
Nine Months Ended September 30
 
2019
 
2018
Operating Activities
 
 
 
Net income
$
60,378

 
$
71,507

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization, net of accretion
14,073

 
16,544

(Increase) decrease in cash surrender value of BOLI
(1,557
)
 
(1,525
)
Net realized investment (gains) losses
(47,064
)
 
(2,651
)
Share-based compensation
2,323

 
4,145

Deferred income tax expense (benefit)
(4,868
)
 
201

Policy acquisition costs, net of amortization (net deferral)
(3,983
)
 
(5,989
)
Equity in (earnings) loss of unconsolidated subsidiaries
7,240

 
(12,247
)
Distributed earnings from unconsolidated subsidiaries
11,690

 
23,906

Other
2,026

 
490

Other changes in assets and liabilities:
 
 
 
Premiums receivable
(22,478
)
 
(45,602
)
Reinsurance related assets and liabilities
(27,185
)
 
5,741

Other assets
(3,552
)
 
(1,961
)
Reserve for losses and loss adjustment expenses
95,928

 
51,446

Unearned premiums
44,049

 
46,114

Other liabilities
1,783

 
(3,725
)
Net cash provided (used) by operating activities
128,803

 
146,394

Investing Activities
 
 
 
Purchases of:
 
 
 
Fixed maturities, available for sale
(553,186
)
 
(717,119
)
Fixed maturities, trading
(6,339
)
 
(33,086
)
Equity investments
(74,649
)
 
(169,160
)
Other investments
(24,088
)
 
(22,557
)
Funding of qualified affordable housing project tax credit partnerships
(322
)
 
(74
)
Investment in unconsolidated subsidiaries
(53,630
)
 
(54,496
)
Proceeds from sales or maturities of:
 
 
 
Fixed maturities, available for sale
416,805

 
809,095

Equity investments
149,720

 
138,423

Other investments
24,583

 
21,853

Return of invested capital from unconsolidated subsidiaries
35,902

 
48,545

Net sales or maturities (purchases) of short-term investments
37,975

 
227,513

Unsettled security transactions, net change
15,211

 
(4,273
)
Purchases of capital assets
(7,133
)
 
(7,672
)
Repayments (advances) under Syndicate Credit Agreement
13,450

 
(878
)
Other
(16
)
 
(1,331
)
Net cash provided (used) by investing activities
(25,717
)
 
234,783

Continued on the following page.
 
 
 


11
Table of Contents

 
Nine Months Ended September 30
 
2019
 
2018
Continued from the previous page.
 
 
 
Financing Activities
 
 
 
Repayments under Revolving Credit Agreement
—

 
(123,000
)
Repayments of Mortgage Loans
(1,086
)
 
(1,047
)
Dividends to shareholders
(76,574
)
 
(299,894
)
Capital contribution received from (return of capital to) external segregated portfolio cell participants
(983
)
 
(267
)
Other
(2,703
)
 
(3,905
)
Net cash provided (used) by financing activities
(81,346
)
 
(428,113
)
Increase (decrease) in cash and cash equivalents
21,740

 
(46,936
)
Cash and cash equivalents at beginning of period
80,471

 
134,495

Cash and cash equivalents at end of period
$
102,211

 
$
87,559

Significant Non-Cash Transactions
 
 
 
Dividends declared and not yet paid
$
16,677

 
$
16,622

Operating ROU assets obtained in exchange for operating lease liabilities
$
3,729

 
$
—


See accompanying notes.

12
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019


1. Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of ProAssurance Corporation and its consolidated subsidiaries (ProAssurance, PRA or the Company). The financial statements have been prepared in accordance with GAAP for interim financial information and with the 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 GAAP for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation, consisting of normal recurring adjustments, have been included. ProAssurance’s results for the nine months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019. The accompanying Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and Notes contained in ProAssurance’s December 31, 2018 report on Form 10-K. In connection with its preparation of the Condensed Consolidated Financial Statements, ProAssurance evaluated events that occurred subsequent to September 30, 2019 for recognition or disclosure in its financial statements and notes to financial statements.
ProAssurance operates in five reportable segments as follows: Specialty P&C, Workers' Compensation Insurance, Segregated Portfolio Cell Reinsurance, Lloyd's Syndicates and Corporate. For more information on the Company's segment reporting, including the nature of products and services provided and financial information by segment, refer to Note 14.
Other Liabilities
Other liabilities consisted of the following:
(In thousands)
 
September 30, 2019
 
December 31, 2018
SPC dividends payable
 
$
56,417

 
$
53,604

Unpaid shareholder dividends
 
16,677

 
43,446

All other
 
119,975

 
102,245

Total other liabilities
 
$
193,069

 
$
199,295


SPC dividends payable represents the undistributed equity contractually payable to the external cell participants of SPCs operated by ProAssurance's Cayman Islands subsidiaries, Inova Re and Eastern Re.
Unpaid dividends represent common stock dividends declared by ProAssurance's Board that had not yet been paid as of September 30, 2019. Unpaid dividends at December 31, 2018 included a special dividend declared in the fourth quarter of 2018 that was paid in January 2019.
Accounting Policies
Except as added below, the significant accounting policies followed by ProAssurance in making estimates that materially affect financial reporting are summarized in Note 1 of the Notes to Consolidated Financial Statements in ProAssurance’s December 31, 2018 report on Form 10-K.
Due to the adoption of ASU 2016-02 at the beginning of 2019, ProAssurance began following the accounting policy described below:
Leases
ProAssurance is involved in a number of leases, primarily for office facilities. The Company determines if an arrangement is a lease at the inception date of the contract and classifies all leases as either financing or operating. Operating leases are included in operating lease ROU assets and operating lease liabilities on the Condensed Consolidated Balance Sheet as of September 30, 2019. The ROU asset represents the right to use the underlying asset for the lease term. As of September 30, 2019, ProAssurance has no leases that are classified as financing leases.
Operating ROU assets and operating lease liabilities are initially recognized as of the lease commencement date based on the present value of the remaining lease payments, discounted over the term of the lease using a discount rate determined based on information available as of the commencement date. As the majority of ProAssurance's lessors do not provide an implicit discount rate, the Company uses its collateralized incremental borrowing rate in determining the present value of remaining lease payments. Due to the adoption of ASU 2016-02 (see further discussion that follows), the Company used its collateralized incremental borrowing rate as of January 1, 2019 for operating leases that commenced prior to that date. Subsequent to the initial recognition, the operating ROU asset is amortized over the lease term on a straight-line basis as operating lease expense which is included as a component of operating expense on the Condensed Consolidated Statements of Income and

13
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

Comprehensive Income for the three and nine months ended September 30, 2019 and 2018. Leases with an initial term of twelve months or less are considered short-term and are not recorded on the Condensed Consolidated Balance Sheet; lease expense for these leases is also recognized on a straight-line basis over the lease term. Additionally, for leases entered into or reassessed after the adoption of ASU 2016-02, ProAssurance accounts for lease and non-lease components of a contract as a single lease component.
Operating lease ROU assets are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The carrying amount of a ROU asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use of the underlying leased asset over the remaining lease term. That assessment is based on the carrying amount of the ROU asset at the date it is tested for recoverability and an impairment loss is measured and recognized as the amount by which the carrying amount of the ROU asset exceeds its fair value.
Accounting Changes Adopted
Leases (ASU 2016-02)
Effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years, the FASB issued guidance that requires a lessee to recognize for all leases (with the exception of short-term leases) a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis, and a right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. ProAssurance adopted the guidance as of January 1, 2019 using a modified retrospective application and elected the transition option provided that allows companies to continue to apply legacy GAAP in comparative periods. Also, ProAssurance elected the package of practical expedients permitted under the guidance, which allowed the Company to carryforward its historical lease classification, its assessment on whether a contract is or contains a lease and its initial direct costs for any leases that existed prior to adoption of the new standard. Furthermore, ProAssurance elected to combine lease and non-lease components and to keep leases with an initial term of 12 months or less off the Condensed Consolidated Balance Sheet and recognize the associated lease payments in the Condensed Consolidated Statements of Income and Comprehensive Income on a straight-line basis over the lease term. ProAssurance recognized total ROU assets and total lease liabilities of approximately $19 million on the Condensed Consolidated Balance Sheet as of January 1, 2019 which relate to ProAssurance's real estate operating leases; the Company does not consider these leases to be material to its financial position. Adoption of this guidance had no material impact on ProAssurance's results of operation or cash flows.
ProAssurance's Revolving Credit Agreement contains a financial covenant regarding permitted leverage ratios based upon Consolidated Funded Indebtedness to Consolidated Total Capitalization; however, adoption of this guidance had no material impact on this covenant. ProAssurance’s Mortgage Loans also contain a financial covenant regarding permitted leverage ratios, principally based upon SAP Consolidated Net Worth; however, as the NAIC did not adopt the principles found in ASU 2016-02, adoption of the guidance had no impact on this covenant.
Premium Amortization on Purchased Callable Debt Securities (ASU 2017-08)
Effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years, the FASB issued guidance that will require the premium for certain callable debt securities to be amortized over a shorter period than is currently required. Currently, amortization is permitted over the contractual life of the instrument, and the guidance shortens the amortization to the earliest call date. The purpose of the guidance is to more closely align the amortization period of premiums to expectations incorporated in market pricing on the underlying securities. ProAssurance adopted the guidance as of January 1, 2019. As ProAssurance amortizes the premium on callable debt securities to the earliest call date, adoption of the guidance had no material effect on ProAssurance’s results of operations, financial position or cash flows.
Derivatives and Hedging (ASU 2017-12)
Effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years, the FASB issued guidance to improve financial reporting of hedging relationships to better portray the entity's risk management activities in the consolidated financial statements. The new guidance eliminates the requirement to separately measure and report hedge ineffectiveness and requires the entire change in the fair value of a hedging instrument to be presented in the same income statement line as the hedged item. ProAssurance adopted the guidance as of January 1, 2019. ProAssurance's derivative instrument at September 30, 2019 is not designated as a hedging instrument; therefore, adoption had no effect on ProAssurance's results of operations, financial position or cash flows.

14
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

Improvements to Nonemployee Share-Based Payment Accounting (ASU 2018-07)
Effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years, the FASB issued guidance which reduces the complexity in accounting for nonemployee share-based payment awards. The new guidance substantially aligns the accounting for nonemployee share-based payment awards with the accounting guidance for employee share-based payment awards with certain exceptions, including the inputs used in estimating the fair value of the nonemployee awards and the period of time and pattern of expense recognition. ProAssurance adopted the guidance as of January 1, 2019 using a modified retrospective application and recorded a cumulative-effect adjustment of approximately $0.4 million to beginning retained earnings in the Condensed Consolidated Statement of Changes in Capital for the nine months ended September 30, 2019. Adoption had no material effect on ProAssurance's results of operations, financial position or cash flows.
Derivatives and Hedging - Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap as a Benchmark Interest Rate for Hedge Accounting Purposes (ASU 2018-16)
Effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years, the FASB issued new guidance that permits the use of the Overnight Index Swap Rate based on the Secured Financing Rate as a U.S. benchmark interest rate for hedge accounting purposes. ProAssurance adopted the guidance as of January 1, 2019. As of September 30, 2019, ProAssurance's derivative instrument is not designated as a hedging instrument; therefore, adoption had no effect on ProAssurance's results of operations, financial position or cash flows.
Accounting Changes Not Yet Adopted
Improvements to Financial Instruments - Credit Losses (ASU 2016-13)
Effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years, the FASB issued guidance that replaces the incurred loss impairment methodology, which delays recognition of credit losses until a probable loss has been incurred, with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. Under the new guidance, credit losses are required to be recorded through an allowance for credit losses account and the income statement will reflect the initial recognition of lifetime expected credit losses for any newly recognized financial assets as well as increases or decreases of expected credit losses that have taken place during the period. Credit losses on available-for-sale fixed maturity securities will be required to be presented as an allowance, rather than as a write-down of the asset, limited to the amount by which the fair value is below amortized cost. Adoption of this guidance is not expected to have a material impact on ProAssurance's available-for-sale fixed maturity portfolio. In addition, ProAssurance's premiums receivable and receivables from reinsurers are also included in the scope of this new guidance; however, ProAssurance has not historically experienced material credit losses due to the financial condition of an insured or reinsurer. ProAssurance plans to adopt the guidance beginning January 1, 2020 and is in the process of evaluating the effect the new guidance would have on its results of operations and financial position.
Simplifying the Test for Goodwill Impairment (ASU 2017-04)
Effective for the fiscal years beginning after December 15, 2019 and interim periods within those fiscal years, the FASB issued guidance that simplifies the requirements to test goodwill for impairment for business entities that have goodwill reported in their financial statements. The guidance eliminates the second step of the impairment test which measures a goodwill impairment loss by comparing the implied fair value of a reporting unit's goodwill with the carrying amount. In addition, the guidance also eliminates the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment. ProAssurance plans to adopt the guidance beginning January 1, 2020. Adoption is not expected to have a material effect on ProAssurance’s results of operations, financial position or cash flows.
Changes to the Disclosure Requirements for Fair Value Measurement (ASU 2018-13)
Effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years, the FASB issued guidance that eliminates, modifies and adds certain disclosure requirements related to fair value measurements. The new guidance eliminates the requirements to disclose the transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for the timing of transfers between levels of the fair value hierarchy and the valuation process for Level 3 fair value measurements while it modifies existing disclosure requirements related to measurement uncertainty and the requirement to disclose the timing of liquidation of an investee's assets for investments in certain entities that calculate NAV. The new guidance also adds requirements to disclose changes in unrealized gains and losses included in OCI for recurring Level 3 fair value measurements as well as the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. An entity is permitted to early adopt any eliminated or modified disclosure requirements and delay adoption of the additional disclosure requirements until the guidance is effective. During the third quarter of 2018, ProAssurance elected to early adopt the provisions that eliminate and modify certain disclosure requirements within Note 2 on a retrospective basis and

15
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

adoption of these certain provisions had no material effect on ProAssurance’s results of operations, financial position or cash flows as it affected disclosures only. ProAssurance plans to adopt the additional disclosure requirements beginning January 1, 2020 and adoption is not expected to have a material effect on ProAssurance’s results of operations, financial position or cash flows.
Intangibles - Goodwill and Other-Internal-Use Software (ASU 2018-15)
Effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years, the FASB amended the new standard regarding accounting for implementation costs in cloud computing arrangements. The amended guidance substantially aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. ProAssurance plans to adopt the guidance beginning January 1, 2020. Adoption is not expected to have a material effect on ProAssurance’s results of operations, financial position or cash flows.
Targeted Improvements to Related Party Guidance for VIEs (ASU 2018-17)
Effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years, the FASB amended guidance which improves the consistency of the application of the VIE guidance for common control arrangements. The amended guidance requires an entity to consider indirect interests held through related parties under common control on a proportional basis rather than as the equivalent of a direct interest in its entirety when determining whether a decision-making fee is a variable interest. ProAssurance plans to adopt the guidance beginning January 1, 2020. As of September 30, 2019 ProAssurance does not have any material indirect interests held through related parties under common control; therefore, adoption is not expected to have a material effect on ProAssurance’s results of operations, financial position or cash flows.
Collaborative Arrangements (ASU 2018-18)
Effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years, the FASB issued new guidance which clarifies how to assess whether certain transactions between participants in a collaborative arrangement should be accounted for under the revenue from contracts with customers accounting standard when the counterpart is a customer. In addition, the guidance precludes an entity from presenting consideration from a transaction in a collaborative arrangement as revenue from contracts with customers if the counterparty is not a customer for that transaction. ProAssurance plans to adopt the guidance beginning January 1, 2020 and adoption is not expected to have a material effect on ProAssurance’s results of operations, financial position or cash flows.


16
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

2. Fair Value Measurement
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A three level hierarchy has been established for valuing assets and liabilities based on how transparent (observable) the inputs are that are used to determine fair value, with the inputs considered most observable categorized as Level 1 and those that are the least observable categorized as Level 3. Hierarchy levels are defined as follows:
 
Level 1:
quoted (unadjusted) market prices in active markets for identical assets and liabilities. For ProAssurance, Level 1 inputs are generally quotes for debt or equity securities actively traded in exchange or over-the-counter markets.
 
Level 2:
market data obtained from sources independent of the reporting entity (observable inputs). For ProAssurance, Level 2 inputs generally include quoted prices in markets that are not active, quoted prices for similar assets or liabilities, and results from pricing models that use observable inputs such as interest rates and yield curves that are generally available at commonly quoted intervals.
 
Level 3:
the reporting entity’s own assumptions about market participant assumptions based on the best information available in the circumstances (non-observable inputs). For ProAssurance, Level 3 inputs are used in situations where little or no Level 1 or 2 inputs are available or are inappropriate given the particular circumstances. Level 3 inputs include results from pricing models for which some or all of the inputs are not observable, discounted cash flow methodologies, single non-binding broker quotes and adjustments to externally quoted prices that are based on management judgment or estimation.
Fair values of assets measured at fair value on a recurring basis as of September 30, 2019 and December 31, 2018 are shown in the following tables. Where applicable, the tables also indicate the fair value hierarchy of the valuation techniques utilized to determine those fair values. For some assets, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. When this is the case, the asset is categorized based on the level of the most significant input to the fair value measurement. Assessments of the significance of a particular input to the fair value measurement require judgment and consideration of factors specific to the assets being valued.

17
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

 
September 30, 2019
 
Fair Value Measurements Using
 
Total
(In thousands)
Level 1
 
Level 2
 
Level 3
 
Fair Value
Assets:
 
 
 
 
 
 
 
Fixed maturities, available for sale
 
 
 
 
 
 
 
U.S. Treasury obligations
$
—

 
$
120,920

 
$
—

 
$
120,920

U.S. Government-sponsored enterprise obligations
—

 
22,334

 
—

 
22,334

State and municipal bonds
—

 
293,397

 
—

 
293,397

Corporate debt, multiple observable inputs
—

 
1,344,542

 
—

 
1,344,542

Corporate debt, limited observable inputs
—

 
—

 
4,107

 
4,107

Residential mortgage-backed securities
—

 
201,843

 
—

 
201,843

Agency commercial mortgage-backed securities
—

 
10,182

 
—

 
10,182

Other commercial mortgage-backed securities
—

 
71,411

 
1,126

 
72,537

Other asset-backed securities
—

 
227,653

 
4,020

 
231,673

Fixed maturities, trading
—

 
45,295

 
—

 
45,295

Equity investments
 
 
 
 
 
 

Financial
60,565

 
—

 
—

 
60,565

Utilities/Energy
42,074

 
—

 
—

 
42,074

Consumer oriented
41,307

 
—

 
—

 
41,307

Industrial
40,880

 
—

 
—

 
40,880

Bond funds
164,399

 
—

 
—

 
164,399

All other
38,021

 
—

 
—

 
38,021

Short-term investments
229,787

 
41,049

 
—

 
270,836

Other investments
18

 
32,598

 
1,517

 
34,133

Other assets
—

 
675

 
—

 
675

Total assets categorized within the fair value hierarchy
$
617,051

 
$
2,411,899

 
$
10,770

 
3,039,720

Assets carried at NAV, which approximates fair value and which are not categorized within the fair value hierarchy, reported as a part of:
 
 
 
 
 
 
 
Equity investments
 
 
 
 
 
 
21,854

Investment in unconsolidated subsidiaries
 
 
 
 
 
 
274,517

Total assets at fair value
 
 
 
 
 
 
$
3,336,091


18
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

 
December 31, 2018
 
Fair Value Measurements Using
 
Total
(In thousands)
Level 1
 
Level 2
 
Level 3
 
Fair Value
Assets:
 
 
 
 
 
 
 
Fixed maturities, available for sale
 
 
 
 
 
 
 
U.S. Treasury obligations
$
—

 
$
120,201

 
$
—

 
$
120,201

U.S. Government-sponsored enterprise obligations
—

 
35,354

 
—

 
35,354

State and municipal bonds
—

 
293,772

 
—

 
293,772

Corporate debt, multiple observable inputs
2,319

 
1,216,834

 
—

 
1,219,153

Corporate debt, limited observable inputs
—

 
—

 
4,322

 
4,322

Residential mortgage-backed securities
—

 
181,238

 
—

 
181,238

Agency commercial mortgage-backed securities
—

 
13,108

 
—

 
13,108

Other commercial mortgage-backed securities
—

 
30,993

 
—

 
30,993

Other asset-backed securities
—

 
191,807

 
3,850

 
195,657

Fixed maturities, trading
—

 
38,188

 
—

 
38,188

Equity investments
 
 
 
 
 
 

Financial
62,344

 
—

 
—

 
62,344

Utilities/Energy
46,533

 
—

 
—

 
46,533

Consumer oriented
47,462

 
—

 
—

 
47,462

Industrial
41,487

 
—

 
—

 
41,487

Bond funds
174,753

 
—

 
—

 
174,753

All other
50,066

 
—

 
—

 
50,066

Short-term investments
265,910

 
42,409

 
—

 
308,319

Other investments
—

 
31,341

 
3

 
31,344

Other assets
—

 
1,884

 
—

 
1,884

Total assets categorized within the fair value hierarchy
$
690,874


$
2,197,129


$
8,175


2,896,178

Assets carried at NAV, which approximates fair value and which are not categorized within the fair value hierarchy, reported as a part of:
 
 
 
 
 
 
 
Equity investments
 
 
 
 
 
 
20,292

Investment in unconsolidated subsidiaries
 
 
 
 
 
 
268,436

Total assets at fair value
 
 
 
 
 
 
$
3,184,906


The fair values for securities included in the Level 2 category, with the few exceptions described below, were developed by one of several third party, nationally recognized pricing services, including services that price only certain types of securities. Each service uses complex methodologies to determine values for securities and subject the values they develop to quality control reviews. Management selected a primary source for each type of security in the portfolio and reviewed the values provided for reasonableness by comparing data to alternate pricing services and to available market and trade data. Values that appeared inconsistent were further reviewed for appropriateness. Any value that did not appear reasonable was discussed with the service that provided the value and adjusted, if necessary. There were no material changes to the values supplied by the pricing services during the three and nine months ended September 30, 2019.

19
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

Level 2 Valuations
Below is a summary description of the valuation methodologies primarily used by the pricing services for securities in the Level 2 category, by security type:
U.S. Treasury obligations were valued based on quoted prices for identical assets, or, in markets that are not active, quotes for similar assets, taking into consideration adjustments for variations in contractual cash flows and yields to maturity.
U.S. Government-sponsored enterprise obligations were valued using pricing models that consider current and historical market data, normal trading conventions, credit ratings, and the particular structure and characteristics of the security being valued, such as yield to maturity, redemption options, and contractual cash flows. Adjustments to model inputs or model results were included in the valuation process when necessary to reflect recent regulatory, government or corporate actions or significant economic, industry or geographic events affecting the security’s fair value.
State and municipal bonds were valued using a series of matrices that considered credit ratings, the structure of the security, the sector in which the security falls, yields, and contractual cash flows. Valuations were further adjusted, when necessary, to reflect the expected effect on fair value of recent significant economic or geographic events or ratings changes.
Corporate debt, multiple observable inputs consisted primarily of corporate bonds, but also included a small number of bank loans. The methodology used to value Level 2 corporate bonds was the same as the methodology previously described for U.S. Government-sponsored enterprise obligations. Bank loans were valued based on an average of broker quotes for the loans in question, if available. If quotes were not available, the loans were valued based on quoted prices for comparable loans or, if the loan was newly issued, by comparison to similar seasoned issues. Broker quotes were compared to actual trade prices to permit assessment of the reliability of the quotes; unreliable quotes were not considered in quoted averages.
Residential and commercial mortgage-backed securities were valued using a pricing matrix which considers the issuer type, coupon rate and longest cash flows outstanding. The matrix used was based on the most recently available market information. Agency and non-agency collateralized mortgage obligations were both valued using models that consider the structure of the security, current and historical information regarding prepayment speeds, ratings and ratings updates, and current and historical interest rate and interest rate spread data.
Other asset-backed securities were valued using models that consider the structure of the security, monthly payment information, current and historical information regarding prepayment speeds, ratings and ratings updates, and current and historical interest rate and interest rate spread data. Spreads and prepayment speeds consider collateral type.
Fixed maturities, trading, are held by the Lloyd's Syndicates segment and include U.S. Treasury obligations, U.S. Government-sponsored enterprise obligations, corporate debt with multiple observable inputs and other asset-backed securities. These securities were valued using the respective valuation methodologies discussed above for each security type.
Short-term investments were securities maturing within one year, carried at fair value which approximated the cost of the securities due to their short-term nature.
 Other investments consisted primarily of convertible bonds valued using a pricing model that incorporated selected dealer quotes as well as current market data regarding equity prices and risk free rates. If dealer quotes were unavailable for the security being valued, quotes for securities with similar terms and credit status were used in the pricing model. Dealer quotes selected for use were those considered most accurate based on parameters such as underwriter status and historical reliability.
Other assets consisted of an interest rate cap derivative instrument, which is discussed in Note 10, valued using a model which considers the volatilities from other instruments with similar maturities, strike prices, durations and forward yield curves.

20
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

Level 3 Valuations
Below is a summary description of the valuation methodologies used as well as quantitative information regarding securities in the Level 3 category, by security type:
Level 3 Valuation Methodologies
Corporate debt, limited observable inputs consisted of corporate bonds valued using dealer quotes for similar securities or discounted cash flow models using yields currently available for similar securities. Similar securities are defined as securities of comparable credit quality that have like terms and payment features. Assessments of credit quality were based on NRSRO ratings, if available, or were determined by management if not available. At September 30, 2019, 57% of the securities were rated and the average rating was BBB+. At December 31, 2018, 54% of the securities were rated and the average rating was BBB+.
Other commercial mortgage-backed and other asset-backed securities consisted of securitizations of receivables valued using dealer quotes for similar securities or discounted cash flow models using yields currently available for similar securities. Similar securities are defined as securities of comparable credit quality that have like terms and payment features. Assessments of credit quality were based on NRSRO ratings, if available, or were subjectively determined by management if not available. At September 30, 2019, 42% of the securities were rated and the average rating was AA-. At December 31, 2018, 25% of the securities were rated and the average rating was AAA.
Other investments consisted of convertible securities for which limited observable inputs were available at September 30, 2019 and December 31, 2018. The securities were valued internally based on expected cash flows, including the expected final recovery, discounted at a yield that considered the lack of liquidity and the financial status of the issuer.
Quantitative Information Regarding Level 3 Valuations
 
 
Fair Value at
 
 
 
 
 
 
($ in thousands)
 
September 30, 2019
 
December 31, 2018
 
Valuation Technique
 
Unobservable Input
 
Range
(Weighted Average)
Assets:
 
 
 
 
 
 
 
 
 
 
Corporate debt, limited observable inputs
 
$4,107
 
$4,322
 
Market Comparable
Securities
 
Comparability Adjustment
 
0% - 5% (2.5%)
 
 
 
 
 
 
Discounted Cash Flows
 
Comparability Adjustment
 
0% - 5% (2.5%)
Other commercial mortgage-backed securities
 
$1,126
 
—
 
Market Comparable
Securities
 
Comparability Adjustment
 
0% - 5% (2.5%)
 
 
 
 
 
 
Discounted Cash Flows
 
Comparability Adjustment
 
0% - 5% (2.5%)
Other asset-backed securities
 
$4,020
 
$3,850
 
Market Comparable
Securities
 
Comparability Adjustment
 
0% - 5% (2.5%)
 
 
 
 
 
 
Discounted Cash Flows
 
Comparability Adjustment
 
0% - 5% (2.5%)
Other investments
 
$1,517
 
$3
 
Discounted Cash Flows
 
Comparability Adjustment
 
0% - 10% (5%)

The significant unobservable inputs used in the fair value measurement of the above listed securities were the valuations of comparable securities with similar issuers, credit quality and maturity. Changes in the availability of comparable securities could result in changes in the fair value measurements.

21
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

Fair Value Measurements - Level 3 Assets
The following tables (the Level 3 Tables) present summary information regarding changes in the fair value of assets measured at fair value using Level 3 inputs.
 
September 30, 2019
 
Level 3 Fair Value Measurements – Assets
(In thousands)
Corporate Debt
 
Asset-backed Securities
 
Other investments
 
Total
Balance June 30, 2019
$
2,304

 
$
4,163

 
$
624

 
$
7,091

Total gains (losses) realized and unrealized:
 
 
 
 
 
 
 
Included in earnings, as a part of:
 
 
 
 
 
 
 
Net investment income
—

 
(23
)
 
—

 
(23
)
Net realized investment gains (losses)
—

 
—

 
2

 
2

Included in other comprehensive income
74

 
14

 
—

 
88

Purchases
1,545

 
—

 
1,296

 
2,841

Sales
(1,566
)
 
(24
)
 
—

 
(1,590
)
Transfers in
1,750

 
1,016

 
—

 
2,766

Transfers out
—

 
—

 
(405
)
 
(405
)
Balance September 30, 2019
$
4,107

 
$
5,146

 
$
1,517

 
$
10,770

Change in unrealized gains (losses) included in earnings for the above period for Level 3 assets held at period-end
$
—

 
$
—

 
$
2

 
$
2

 
September 30, 2019
 
Level 3 Fair Value Measurements – Assets
(In thousands)
Corporate Debt
 
Asset-backed Securities
 
Other investments
 
Total
Balance December 31, 2018
$
4,322

 
$
3,850

 
$
3

 
$
8,175

Total gains (losses) realized and unrealized:
 
 
 
 
 
 
 
Included in earnings, as a part of:
 
 
 
 
 
 
 
Net investment income
2

 
(163
)
 
—

 
(161
)
Net realized investment gains (losses)
—

 
—

 
35

 
35

Included in other comprehensive income
85

 
224

 
—

 
309

Purchases
2,850

 
—

 
1,466

 
4,316

Sales
(3,702
)
 
(30
)
 
—

 
(3,732
)
Transfers in
1,750

 
2,216

 
418

 
4,384

Transfers out
(1,200
)
 
(951
)
 
(405
)
 
(2,556
)
Balance September 30, 2019
$
4,107

 
$
5,146


$
1,517

 
$
10,770

Change in unrealized gains (losses) included in earnings for the above period for Level 3 assets held at period-end
$
—

 
$
—

 
$
35

 
$
35



22
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

 
September 30, 2018
 
Level 3 Fair Value Measurements – Assets
(In thousands)
Corporate Debt
 
Asset-backed Securities
 
Other investments
 
Total
Balance June 30, 2018
$
8,380

 
$
9,420

 
$
5

 
$
17,805

Total gains (losses) realized and unrealized:
 
 
 
 
 
 
 
Included in earnings, as a part of:
 
 
 
 
 
 
 
Net investment income
(37
)
 
1

 
—

 
(36
)
Net realized investment gains (losses)
—

 
—

 
1

 
1

Included in other comprehensive income
(12
)
 
15

 
—

 
3

Purchases
2,000

 
—

 
—

 
2,000

Sales
(926
)
 
—

 
—

 
(926
)
Transfers in
—

 
—

 
—

 
—

Transfers out
—

 
(2,277
)
 
—

 
(2,277
)
Balance September 30, 2018
$
9,405

 
$
7,159

 
$
6

 
$
16,570

Change in unrealized gains (losses) included in earnings for the above period for Level 3 assets held at period-end
$
—

 
$
—

 
$
1

 
$
1

 
September 30, 2018
 
Level 3 Fair Value Measurements – Assets
(In thousands)
Corporate Debt
 
Asset-backed Securities
 
Other investments
 
Total
Balance December 31, 2017
$
13,703

 
$
4,986

 
$
409

 
$
19,098

Total gains (losses) realized and unrealized:
 
 
 
 
 
 
 
Included in earnings, as a part of:
 
 
 
 
 
 
 
Net investment income
(111
)
 
2

 
—

 
(109
)
Net realized investment gains (losses)
(8
)
 
—

 
(37
)
 
(45
)
Included in other comprehensive income
(140
)
 
(126
)
 
—

 
(266
)
Purchases
8,005

 
16,678

 
—

 
24,683

Sales
(5,475
)
 
(185
)
 
(366
)
 
(6,026
)
Transfers in
2,627

 
—

 
—

 
2,627

Transfers out
(9,196
)
 
(14,196
)
 
—

 
(23,392
)
Balance September 30, 2018
$
9,405

 
$
7,159


$
6

 
$
16,570

Change in unrealized gains (losses) included in earnings for the above period for Level 3 assets held at period-end
$
—

 
$
—

 
$
(37
)
 
$
(37
)


23
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

Transfers
Transfers shown in the preceding Level 3 tables were as of the end of the quarter in which the transfer occurred. All transfers were to or from Level 2.
All transfers during the three and nine months ended September 30, 2019 and 2018 related to securities held for which the level of market activity for identical or nearly identical securities varies from period to period. The securities were valued using multiple observable inputs when those inputs were available; otherwise the securities were valued using limited observable inputs.
Fair Values Not Categorized
At September 30, 2019 and December 31, 2018, certain LPs/LLCs and investment funds measure fund assets at fair value on a recurring basis and provide a NAV for ProAssurance's interest. The carrying value of these interests is based on the NAV provided and was considered to approximate the fair value of the interests. For investment in unconsolidated subsidiaries, ProAssurance recognizes any changes in the NAV of its interests in equity in earnings (loss) of unconsolidated subsidiaries during the period of change. In accordance with GAAP, the fair value of these investments was not classified within the fair value hierarchy. The amount of ProAssurance's unfunded commitments related to these investments as of September 30, 2019 and fair values of these investments as of September 30, 2019 and December 31, 2018 were as follows:
 
Unfunded
Commitments
 
Fair Value
(In thousands)
September 30,
2019
 
September 30,
2019
 
December 31,
2018
Equity investments:
 
 
 
 
 
Mortgage fund (1)
None
 
$
21,854

 
$
20,292

Investment in unconsolidated subsidiaries:
 
 
 
 
 
Private debt funds (2)
$16,869
 
14,651

 
18,196

Long equity fund (3)
None
 
4,787

 
6,561

Long/short equity funds (4)
None
 
29,808

 
28,805

Non-public equity funds (5)
$77,188
 
124,759

 
114,811

Multi-strategy fund of funds (6)
None
 
9,739

 
9,322

Credit funds (7)
$2,216
 
41,889

 
29,164

Long/short commodities fund (8)
None
 
14,329

 
12,958

Strategy focused funds (9)
$46,945
 
34,555

 
48,619

 
 
 
274,517

 
268,436

Total investments carried at NAV
 
 
$
296,371


$
288,728

Below is additional information regarding each of the investments listed in the table above as of September 30, 2019.
(1) 
This investment fund is focused on the structured mortgage market. The fund will primarily invest in U.S. Agency mortgage-backed securities. Redemptions are allowed at the end of any calendar quarter with a prior notice requirement of 65 days and are paid within 45 days at the end of the redemption dealing day.
(2) 
This investment is comprised of interests in three unrelated LP funds that are structured to provide interest distributions primarily through diversified portfolios of private debt instruments. One LP allows redemption by special consent; the other two do not permit redemption. Income and capital are to be periodically distributed at the discretion of the LPs over an anticipated time frame that spans from three to eight years.
(3) 
This fund is a LP that holds long equities of public international companies. Redemptions are allowed at the end of any calendar month with a prior notice requirement of 15 days and are paid within 10 days of the end of the calendar month of the redemption request.
(4) 
This investment is comprised of interests in multiple unrelated LP funds. The funds hold primarily long and short North American equities and target absolute returns using strategies designed to take advantage of market opportunities. The funds generally permit quarterly or semi-annual capital redemptions subject to notice requirements of 30 to 90 days. For some funds, redemptions above specified thresholds (lowest threshold is 90%) may be only partially payable until after a fund audit is completed and are then payable within 30 days.

24
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

(5) 
This investment is comprised of interests in multiple unrelated LP funds, each structured to provide capital appreciation through diversified investments in private equity, which can include investments in buyout, venture capital, debt including senior, second lien and mezzanine, distressed debt, collateralized loan obligations and other private equity-oriented LPs. Two of the LPs allow redemption by terms set forth in the LP agreements; the others do not permit redemption. Income and capital are to be periodically distributed at the discretion of the LP over time frames that are anticipated to span up to ten years.
(6) 
This fund is a LLC structured to build and manage low volatility, multi-manager portfolios that have little or no correlation to the broader fixed income and equity security markets. Redemptions are not permitted but offers to repurchase units of the LLC may be extended periodically.
(7) 
This investment is comprised of four unrelated LP funds. Two funds seek to obtain superior risk-adjusted absolute returns through a diversified portfolio of debt securities, including bonds, loans and other asset-backed instruments. A third fund focuses on private middle market company mezzanine loans, while the remaining fund seeks event driven opportunities across the corporate credit spectrum. Two funds are allowed redemptions at any quarter-end with a prior notice requirement of 90 days, one fund permits redemption at any quarter-end with a prior notice requirement of 180 days and one fund does not allow redemptions.
(8) 
This fund is a LLC invested across a broad range of commodities and focuses primarily on market neutral, relative value strategies, seeking to generate absolute returns with low correlation to broad commodity, equity and fixed income markets. Following an initial one-year lock-up period, redemptions are allowed with a prior notice requirement of 30 days and are payable within 30 days.
(9) This investment is comprised of multiple unrelated LPs/LLCs funds. One fund is a LLC focused on investing in North American consumer products companies, comprised of equity and equity-related securities, as well as debt instruments. A second fund is focused on aircraft investments, along with components and assets related to aircrafts. For both funds, redemptions are not permitted. Another fund is a LP focused on North American energy infrastructure assets that allows redemption with consent of the General Partner. The remaining funds are real estate focused LPs, one of which allows for redemption with prior notice.
ProAssurance may not sell, transfer or assign its interest in any of the above LPs/LLCs without special consent from the LPs/LLCs.
Nonrecurring Fair Value Measurement
At September 30, 2019 and December 31, 2018, ProAssurance did not have any assets or liabilities that were measured at fair value on a nonrecurring basis.
Financial Instruments - Methodologies Other Than Fair Value
The following table provides the estimated fair value of the Company's financial instruments that, in accordance with GAAP for the type of investment, are measured using a methodology other than fair value. Fair values provided primarily fall within the Level 3 fair value category.
 
September 30, 2019
 
December 31, 2018
(In thousands)
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
Financial assets:
 
 
 
 
 
 
 
BOLI
$
65,653

 
$
65,653

 
$
64,096

 
$
64,096

Other investments
$
2,916

 
$
2,916

 
$
2,943

 
$
2,943

Other assets
$
27,880

 
$
27,885

 
$
35,921

 
$
35,468

Financial liabilities:
 
 
 
 
 
 
 
Senior notes due 2023*
$
250,000

 
$
272,735

 
$
250,000

 
$
264,810

Mortgage Loans*
$
37,978

 
$
37,978

 
$
39,064

 
$
39,064

Other liabilities
$
25,014

 
$
25,014

 
$
21,300

 
$
21,300

* Carrying value excludes unamortized debt issuance costs.

The fair value of the BOLI was equal to the cash surrender value associated with the policies on the valuation date.

25
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

Other investments listed in the table above include FHLB common stock carried at cost and an annuity investment carried at amortized cost. Two of ProAssurance's insurance subsidiaries are members of an FHLB. The estimated fair value of the FHLB common stock was based on the amount the subsidiaries would receive if their memberships were canceled, as the memberships cannot be sold. The fair value of the annuity represents the present value of the expected future cash flows discounted using a rate available in active markets for similarly structured instruments.
Other assets and other liabilities primarily consisted of related investment assets and liabilities associated with funded deferred compensation agreements. The fair value of the funded deferred compensation assets was based upon quoted market prices, which is categorized as a Level 1 valuation, and had a fair value of $25.2 million and $24.1 million at September 30, 2019 and December 31, 2018, respectively. The deferred compensation liabilities are adjusted to match the fair value of the deferred compensation assets. Other assets also included a secured note receivable and unsecured note receivable under two separate line of credit agreements. Fair value of these notes receivable was based on the present value of expected cash flows from the notes receivable, discounted at market rates on the valuation date for receivables with similar credit standings and similar payment structures.
The fair value of the debt was estimated based on the present value of expected future cash outflows, discounted at rates available on the valuation date for similar debt issued by entities with a similar credit standing to ProAssurance.



26
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

3. Investments
Available-for-sale fixed maturities at September 30, 2019 and December 31, 2018 included the following:
 
September 30, 2019
(In thousands)
Amortized
Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Fixed maturities, available for sale
 
 
 
 
 
 
 
U.S. Treasury obligations
$
118,938

 
$
2,095

 
$
113

 
$
120,920

U.S. Government-sponsored enterprise obligations
22,195

 
147

 
8

 
22,334

State and municipal bonds
282,398

 
11,093

 
94

 
293,397

Corporate debt
1,318,250

 
33,313

 
2,914

 
1,348,649

Residential mortgage-backed securities
199,386

 
2,980

 
523

 
201,843

Agency commercial mortgage-backed securities
9,926

 
274

 
18

 
10,182

Other commercial mortgage-backed securities
70,579

 
2,061

 
103

 
72,537

Other asset-backed securities
229,368

 
2,351

 
46

 
231,673

 
$
2,251,040

 
$
54,314

 
$
3,819

 
$
2,301,535

 
 
 
 
 
 
 
 
 
December 31, 2018
(In thousands)
Amortized
Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Fixed maturities, available for sale
 
 
 
 
 
 
 
U.S. Treasury obligations
$
121,274

 
$
331

 
$
1,404

 
$
120,201

U.S. Government-sponsored enterprise obligations
35,758

 
25

 
429

 
35,354

State and municipal bonds
289,544

 
4,877

 
649

 
293,772

Corporate debt
1,244,577

 
3,328

 
24,430

 
1,223,475

Residential mortgage-backed securities
184,463

 
814

 
4,039

 
181,238

Agency commercial mortgage-backed securities
13,296

 
12

 
200

 
13,108

Other commercial mortgage-backed securities
31,330

 
38

 
375

 
30,993

Other asset-backed securities
196,583

 
254

 
1,180

 
195,657

 
$
2,116,825

 
$
9,679

 
$
32,706

 
$
2,093,798



27
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

The recorded cost basis and estimated fair value of available-for-sale fixed maturities at September 30, 2019, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
(In thousands)
Amortized
Cost
 
Due in one
year or less
 
Due after
one year
through
five years
 
Due after
five years
through
ten years
 
Due after
ten years
 
Total Fair
Value
Fixed maturities, available for sale
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury obligations
$
118,938

 
$
20,157

 
$
79,402

 
$
20,928

 
$
433

 
$
120,920

U.S. Government-sponsored enterprise obligations
22,195

 
2,498

 
6,005

 
13,683

 
148

 
22,334

State and municipal bonds
282,398

 
12,027

 
119,996

 
128,137

 
33,237

 
293,397

Corporate debt
1,318,250

 
152,152

 
783,362

 
379,830

 
33,305

 
1,348,649

Residential mortgage-backed securities
199,386

 

 

 

 

 
201,843

Agency commercial mortgage-backed securities
9,926

 

 

 

 

 
10,182

Other commercial mortgage-backed securities
70,579

 

 

 

 

 
72,537

Other asset-backed securities
229,368

 

 

 

 

 
231,673

 
$
2,251,040

 
 
 
 
 
 
 
 
 
$
2,301,535


Excluding obligations of the U.S. Government, U.S. Government-sponsored enterprises and a U.S. Government obligations money market fund, no investment in any entity or its affiliates exceeded 10% of shareholders’ equity at September 30, 2019.
Cash and securities with a carrying value of $45.4 million at September 30, 2019 were on deposit with various state insurance departments to meet regulatory requirements.
As a member of Lloyd's and a capital provider to Syndicate 1729 and Syndicate 6131, ProAssurance is required to maintain capital at Lloyd's, referred to as FAL. At September 30, 2019, ProAssurance's FAL was comprised of available-for-sale fixed maturities with a fair value of $124.6 million and cash and cash equivalents of $10.1 million on deposit with Lloyd's in order to satisfy these FAL requirements.

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Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

Investments Held in a Loss Position
The following tables provide summarized information with respect to investments held in an unrealized loss position at September 30, 2019 and December 31, 2018, including the length of time the investment had been held in a continuous unrealized loss position.
 
September 30, 2019
 
Total
 
Less than 12 months
 
12 months or longer
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
(In thousands)
Value
 
Loss
 
Value
 
Loss
 
Value
 
Loss
Fixed maturities, available for sale
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury obligations
$
36,227

 
$
113

 
$
14,341

 
$
54

 
$
21,886

 
$
59

U.S. Government-sponsored enterprise obligations
5,492

 
8

 
—

 
—

 
5,492

 
8

State and municipal bonds
15,047

 
94

 
11,582

 
90

 
3,465

 
4

Corporate debt
171,938

 
2,914

 
87,163

 
1,530

 
84,775

 
1,384

Residential mortgage-backed securities
74,952

 
523

 
30,959

 
81

 
43,993

 
442

Agency commercial mortgage-backed securities
531

 
18

 
212

 
—

 
319

 
18

Other commercial mortgage-backed securities
8,950

 
103

 
5,081

 
87

 
3,869

 
16

Other asset-backed securities
37,152

 
46

 
16,362

 
13

 
20,790

 
33

 
$
350,289

 
$
3,819

 
$
165,700

 
$
1,855

 
$
184,589

 
$
1,964


 
December 31, 2018
 
Total
 
Less than 12 months
 
12 months or longer
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
(In thousands)
Value
 
Loss
 
Value
 
Loss
 
Value
 
Loss
Fixed maturities, available for sale
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury obligations
$
97,969

 
$
1,405

 
$
20,221

 
$
119

 
$
77,748

 
$
1,286

U.S. Government-sponsored enterprise obligations
33,677

 
429

 
20,479

 
126

 
13,198

 
303

State and municipal bonds
63,094

 
648

 
30,924

 
143

 
32,170

 
505

Corporate debt
938,651

 
24,429

 
447,891

 
8,804

 
490,760

 
15,625

Residential mortgage-backed securities
157,120

 
4,039

 
27,311

 
209

 
129,809

 
3,830

Agency commercial mortgage-backed securities
9,822

 
200

 
4,566

 
22

 
5,256

 
178

Other commercial mortgage-backed securities
22,924

 
375

 
13,348

 
164

 
9,576

 
211

Other asset-backed securities
142,470

 
1,181

 
70,218

 
236

 
72,252

 
945

 
$
1,465,727

 
$
32,706

 
$
634,958

 
$
9,823

 
$
830,769

 
$
22,883


As of September 30, 2019, excluding U.S. Government or U.S. Government-sponsored enterprise obligations, there were 291 debt securities (13.4% of all available-for-sale fixed maturity securities held) in an unrealized loss position representing 220 issuers. The greatest and second greatest unrealized loss positions among those securities were each approximately $0.2 million. The securities were evaluated for OTTI as of September 30, 2019.
As of December 31, 2018, excluding U.S. Government or U.S. Government-sponsored enterprise obligations, there were 1,044 debt securities (50.6% of all available-for-sale fixed maturity securities held) in an unrealized loss position representing 550 issuers. The greatest and second greatest unrealized loss positions among those securities were approximately $0.6 million and $0.5 million, respectively. The securities were evaluated for OTTI as of December 31, 2018.

29
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

Each quarter, ProAssurance performs a detailed analysis for the purpose of assessing whether any of the securities it holds in an unrealized loss position has suffered an OTTI. A detailed discussion of the factors considered in the assessment is included in Note 1 of the Notes to Consolidated Financial Statements included in ProAssurance's December 31, 2018 Form 10-K.
Fixed maturity securities held in an unrealized loss position at September 30, 2019, excluding asset-backed securities, have paid all scheduled contractual payments and are expected to continue doing so. Expected future cash flows of asset-backed securities, excluding those issued by GNMA, FNMA and FHLMC, held in an unrealized loss position were estimated as part of the September 30, 2019 OTTI evaluation using the most recently available six-month historical performance data for the collateral (loans) underlying the security or, if historical data was not available, sector based assumptions, and equaled or exceeded the current amortized cost basis of the security.
Other information regarding sales and purchases of fixed maturity available-for-sale securities is as follows:
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
(In millions)
2019
 
2018
 
2019
 
2018
Proceeds from sales (exclusive of maturities and paydowns)
$
21.9

 
$
61.3

 
$
115.2

 
$
556.3

Purchases
$
202.3

 
$
164.6

 
$
553.2

 
$
717.1


Equity Investments
ProAssurance's equity investments are carried at fair value with changes in fair value recognized in income as a component of net realized investment gains (losses) during the period of change. Equity investments on the Condensed Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018 primarily included stocks, bond funds and investment funds.
Short-term Investments
ProAssurance's short-term investments, which have a maturity at purchase of one year or less, are primarily comprised of investments in U.S. treasury obligations, commercial paper and money market funds. Short-term investments are carried at fair value which approximates the cost of the securities due to their short-term nature.
BOLI
ProAssurance holds BOLI policies that are carried at the current cash surrender value of the policies (original cost $33 million). All insured individuals were members of ProAssurance management at the time the policies were acquired. The primary purpose of the program is to offset future employee benefit expenses through earnings on the cash value of the policies. ProAssurance is the owner and beneficiary of these policies.
Net Investment Income
Net investment income by investment category was as follows:
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
(In thousands)
2019
 
2018
 
2019
 
2018
Fixed maturities
$
18,362

 
$
17,228

 
$
54,154

 
$
51,814

Equities
3,942

 
5,687

 
13,755

 
15,553

Short-term investments, including Other
2,012

 
1,330

 
5,466

 
3,968

BOLI
645

 
621

 
1,557

 
1,525

Investment fees and expenses
(1,280
)
 
(1,600
)
 
(4,894
)
 
(5,183
)
Net investment income
$
23,681

 
$
23,266

 
$
70,038

 
$
67,677



30
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

Investment in Unconsolidated Subsidiaries
ProAssurance's investment in unconsolidated subsidiaries were as follows:
 
September 30, 2019
 
Carrying Value
(In thousands)
Percentage
Ownership
 
September 30,
2019
 
December 31,
2018
Qualified affordable housing project tax credit partnerships
See below
 
$
50,989

 
$
65,677

Other tax credit partnerships
See below
 
2,570

 
3,757

All other investments, primarily investment fund LPs/LLCs
See below
 
313,047

 
298,323

 
 
 
$
366,606

 
$
367,757


Qualified affordable housing project tax credit partnership interests held by ProAssurance generate investment returns by providing tax benefits to fund investors in the form of tax credits and project operating losses. The carrying value of these investments reflects ProAssurance's total commitments (both funded and unfunded) to the partnerships, less any amortization. ProAssurance's ownership percentage relative to two of the tax credit partnership interests is almost 100%; these interests had a carrying value of $19.1 million at September 30, 2019 and $25.0 million at December 31, 2018. ProAssurance's ownership percentage relative to the remaining tax credit partnership interests is less than 20%; these interests had a carrying value of $31.9 million at September 30, 2019 and $40.7 million at December 31, 2018. Since ProAssurance has the ability to exert influence over the partnerships but does not control them, all are accounted for using the equity method. See further discussion of the entities in which ProAssurance holds passive interests in Note 12.
Other tax credit partnerships are comprised entirely of investments in historic tax credit partnerships. The historic tax credit partnerships generate investment returns by providing benefits to fund investors in the form of tax credits, tax deductible project operating losses and positive cash flows. The carrying value of these investments reflects ProAssurance's total funded commitments less any amortization. ProAssurance's ownership percentage relative to the historic tax credit partnerships is almost 100%. Since ProAssurance has the ability to exert influence over the partnerships but does not control them, all are accounted for using the equity method. See further discussion of the entities in which ProAssurance holds passive interests in Note 12.
ProAssurance holds interests in investment fund LPs/LLCs and other equity method investments and LPs/LLCs which are not considered to be investment funds. ProAssurance's ownership percentage relative to two of the LPs/LLCs is greater than 25%, which is expected to be reduced as the funds mature and other investors participate in the funds; these investments had a carrying value of $37.9 million at September 30, 2019 and $25.9 million at December 31, 2018. ProAssurance's ownership percentage relative to the remaining investments and LPs/LLCs is less than 25%; these interests had a carrying value of $275.1 million at September 30, 2019 and $272.4 million at December 31, 2018. ProAssurance does not have the ability to exert control over any of these funds.
Equity in Earnings (Loss) of Unconsolidated Subsidiaries
Equity in earnings (loss) of unconsolidated subsidiaries included losses from qualified affordable housing project tax credit partnerships and historic tax credit partnerships. Losses recorded reflect ProAssurance's allocable portion of partnership operating losses. Tax credits reduce income tax expense in the period they are recognized. Losses recorded and tax credits recognized related to ProAssurance's tax credit partnership investments were as follows:
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
(In thousands)
2019
 
2018
 
2019
 
2018
Qualified affordable housing project tax credit partnerships
 
 
 
 
 
 
 
Losses recorded
$
5,077

 
$
4,661

 
$
14,674

 
$
14,373

Tax credits recognized
$
4,531

 
$
4,618

 
$
13,594

 
$
13,855

 
 
 
 
 
 
 
 
Historic tax credit partnerships
 
 
 
 
 
 
 
Losses recorded
$
695

 
$
1,394

 
$
1,187

 
$
4,776

Tax credits recognized
$
103

 
$
570

 
$
309

 
$
1,925



31
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

Net Realized Investment Gains (Losses)
Realized investment gains and losses are recognized on the first-in, first-out basis. The following table provides detailed information regarding net realized investment gains (losses):
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
(In thousands)
2019
 
2018
 
2019
 
2018
Total OTTI losses:
 
 
 
 
 
 
 
Corporate debt
$
(66
)
 
$
(86
)
 
$
(202
)
 
$
(490
)
Portion of OTTI losses recognized in other comprehensive income before taxes:
 
 
 
 
 
 
 
Corporate debt
36

 
—

 
124

 
—

Net impairment losses recognized in earnings
(30
)
 
(86
)
 
(78
)
 
(490
)
Gross realized gains, available-for-sale fixed maturities
654

 
690

 
2,028

 
5,592

Gross realized (losses), available-for-sale fixed maturities
(124
)
 
(1,400
)
 
(493
)
 
(5,172
)
Net realized gains (losses), trading fixed maturities
8

 
(28
)
 
(18
)
 
(100
)
Net realized gains (losses), equity investments
2,451

 
4,689

 
13,459

 
17,395

Net realized gains (losses), other investments
397

 
561

 
974

 
1,652

Change in unrealized holding gains (losses), trading fixed maturities
278

 
(42
)
 
753

 
(261
)
Change in unrealized holding gains (losses), equity investments
(2,157
)
 
7,996

 
27,775

 
(15,104
)
Change in unrealized holding gains (losses), convertible securities, carried at fair value
(408
)
 
(260
)
 
2,597

 
(1,126
)
Other
65

 
253

 
67

 
265

Net realized investment gains (losses)
$
1,134

 
$
12,373

 
$
47,064

 
$
2,651


For the three and nine months ended September 30, 2019, ProAssurance recognized a nominal amount of both credit related OTTI in earnings and non-credit OTTI in OCI, both of which related to a corporate bond. ProAssurance recognized OTTI in earnings of $0.1 million and $0.5 million during the three and nine months ended September 30, 2018, respectively, related to debt instruments from two issuers in the energy sector.
The following table presents a roll forward of cumulative credit losses recorded in earnings related to impaired debt securities for which a portion of the OTTI was recorded in OCI.
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
(In thousands)
2019
 
2018
 
2019
 
2018
Balance beginning of period
$
142

 
$
1,313

 
$
93

 
$
1,313

Additional credit losses recognized during the period, related to securities for which:
 
 
 
 
 
 
 
No OTTI has been previously recognized
—

 
—

 
49

 
—

OTTI has been previously recognized
30

 
—

 
30

 
—

Reductions due to:
 
 
 
 
 
 
 
Securities sold during the period (realized)
—

 
(1,220
)
 
—

 
(1,220
)
Balance September 30
$
172

 
$
93

 
$
172

 
$
93



32
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

4. Retroactive Insurance Contracts
ProAssurance offers custom alternative risk solutions including loss portfolio transfers for healthcare entities who, most commonly, are exiting a line of business, changing an insurance approach or simply preferring to transfer risk. A loss portfolio transfer is a form of retroactive insurance coverage as the Company is assuming and accepting an entity’s existing open and future claim liabilities through the transfer of the entity’s loss reserves. If the contract includes both prospective (tail) coverage and retroactive coverage, ProAssurance bifurcates the provisions of the contract and accounts for each component separately. Retroactive and prospective (tail) coverages are fully written and earned as of the contract effective date. For additional information regarding ProAssurance's accounting policy for retroactive insurance contracts, see Note 1 of the Notes to Consolidated Financial Statements included in ProAssurance's December 31, 2018 report on Form 10-K.
During the third quarter of 2019, ProAssurance entered into a loss portfolio transfer with a regional hospital group to cover a specific inventory of existing claims as well as provide tail coverage. During the second quarter of 2018, ProAssurance entered into a loss portfolio transfer with a large healthcare organization to also cover a specific inventory of existing claims as well as provide tail coverage. The impact of each of these loss portfolio transfers on the Condensed Consolidated Statements of Income and Comprehensive Income for the three and nine months ended September 30, 2019 and 2018 is as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
(In millions)
2019
 
2018
 
2019
 
2018
Retroactive coverage
$
0.9

 
$
—

 
$
0.9

 
$
18.7

Prospective (tail) coverage
1.8

 
—

 
1.8

 
7.9

Net premiums earned
$
2.7

 
$
—

 
$
2.7

 
$
26.6

 
 
 
 
 
 
 
 
Net losses and loss adjustment expenses
$
2.1

 
$
—

 
$
2.1

 
$
25.4


For the loss portfolio transfer entered into during the second quarter of 2018, ProAssurance recorded a deferred gain of $0.6 million in the reserve for losses and loss adjustment expenses on the Condensed Consolidated Balance Sheet at June 30, 2018 representing the excess of premiums received over losses assumed related to the retroactive coverage which are amortized into earnings over the estimated claim payment period. Amortization of this deferred gain was insignificant during the three and nine months ended September 30, 2019 and 2018.
5. Income Taxes
ProAssurance estimates its annual effective tax rate at the end of each quarterly reporting period and uses this estimated rate as well as the tax effect of discrete items to record the provision for income taxes in the interim financial statements. The provision for income taxes is different from that which would be obtained by applying the statutory federal income tax rate to income before income taxes primarily because ProAssurance utilizes tax credit benefits transferred from tax credit partnership investments and because a portion of ProAssurance’s investment income is tax-exempt.
ProAssurance had a receivable for federal and U.K. income taxes carried as a part of other assets of $1.8 million at September 30, 2019 and $3.5 million at December 31, 2018. The liability for unrecognized tax benefits, which is included in the total receivable for federal and U.K. income taxes, was $4.5 million and $4.2 million at September 30, 2019 and December 31, 2018, respectively, which included an accrued liability for interest of approximately $0.8 million and $0.6 million, respectively.
Tax Cuts and Jobs Act
ProAssurance recognized a nominal amount of tax expense related to the GILTI provision of the TCJA during the three and nine months ended September 30, 2019. ProAssurance has not recognized any incremental tax expense related to the BEAT provision of the TCJA during the three and nine months ended September 30, 2019. For additional information regarding ProAssurance's accounting for certain provisions of the TCJA, see Note 6 of the Notes to Consolidated Financial Statements in ProAssurance's December 31, 2018 report on Form 10-K.

33
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

6. Reserve for Losses and Loss Adjustment Expenses
The reserve for losses is established based on estimates of 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. Estimating the reserve, particularly the reserve appropriate for liability exposures, is a complex process. For a high proportion of the risks insured or reinsured by ProAssurance, claims may be resolved over an extended period of time, often five years or more, and may be subject to litigation. Estimating losses requires ProAssurance to make and revise judgments and assessments regarding multiple uncertainties over an extended period of time. As a result, the reserve estimate may vary considerably from the eventual outcome. The assumptions used in establishing ProAssurance’s reserve are regularly reviewed and updated by management as new data becomes available. Changes to estimates of previously established reserves are included in earnings in the period in which the estimate is changed.
ProAssurance believes that the methods it uses to establish reserves are reasonable and appropriate. Each year, ProAssurance uses internal actuaries to review the reserve for losses of each insurance subsidiary. ProAssurance also engages consulting actuaries to review ProAssurance claims data and provide observations regarding cost trends, rate adequacy and ultimate loss costs. ProAssurance considers the views of the actuaries as well as other factors, such as known, anticipated or estimated changes in frequency and severity of claims, loss retention levels and premium rates, in establishing the amount of its reserve for losses. The statutory filings of each insurance company with the insurance regulators must be accompanied by a consulting actuary's certification as to their respective reserves.
ProAssurance partitions its reserve by accident year, which is the year in which the claim becomes its liability. As claims are incurred (reported) and claim payments are made, they are aggregated by accident year for analysis purposes. ProAssurance also partitions its reserve by reserve type: case reserves and IBNR reserves. Case reserves are established by the claims department based upon the particular circumstances of each reported claim and represent ProAssurance’s estimate of the future loss costs (often referred to as expected losses) that will be paid on reported claims. Case reserves are decremented as claim payments are made and are periodically adjusted upward or downward as estimates regarding the amount of future losses are revised; a reported loss for an individual claim equates to the case reserve at any point in time plus the claim payments that have been made to date. IBNR reserves represent an estimate, in the aggregate, of future development on losses that have been reported to ProAssurance plus an estimate of losses that have been incurred but not reported.
Development of Prior Accident Years
In addition to setting the initial reserve for the current accident year, each period ProAssurance reassesses the amount of reserve required for prior accident years. The foundation of ProAssurance’s reserve re-estimation process is an actuarial analysis that is performed by both the internal and consulting actuaries. This detailed analysis projects ultimate losses based on partitions which include line of business, geography, coverage layer and accident year. The procedure uses the most representative data for each partition, capturing its unique patterns of development and trends. In all, there are over 200 different partitions of ProAssurance's business for purposes of this analysis. ProAssurance believes that the use of consulting actuaries provides an independent view of the loss data as well as a broader perspective on industry loss trends.

34
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

Activity in the reserve for losses and loss adjustment expenses is summarized as follows:
(In thousands)
Nine Months Ended September 30, 2019
 
Nine Months Ended September 30, 2018
 
Year Ended December 31, 2018
Balance, beginning of year
$
2,119,847

 
$
2,048,381

 
$
2,048,381

Less reinsurance recoverables on unpaid losses and loss adjustment expenses
343,820

 
335,585

 
335,585

Net balance, beginning of year
1,776,027

 
1,712,796

 
1,712,796

Net losses:
 
 
 
 
 
Current year*
532,020

 
506,269

 
685,326

Favorable development of reserves established in prior years, net
(42,212
)
 
(67,149
)
 
(92,116
)
Total
489,808

 
439,120

 
593,210

Paid related to:
 
 
 
 
 
Current year
(69,419
)
 
(69,881
)
 
(117,268
)
Prior years
(338,452
)
 
(314,763
)
 
(412,711
)
Total paid
(407,871
)
 
(384,644
)
 
(529,979
)
Net balance, end of period
1,857,964

 
1,767,272

 
1,776,027

Plus reinsurance recoverables on unpaid losses and loss adjustment expenses
357,811

 
332,555

 
343,820

Balance, end of period
$
2,215,775

 
$
2,099,827

 
$
2,119,847

* Current year net losses for the nine months ended September 30, 2019 included incurred losses of $2.1 million related to a loss portfolio transfer entered into during 2019. Current year net losses for the nine months ended September 30, 2018 and year ended December 31, 2018 included incurred losses of $25.4 million related to a loss portfolio transfer entered into during 2018. For additional information regarding these loss portfolio transfers see Note 4.

The favorable loss development recognized in the nine months ended September 30, 2019 primarily reflected a lower than anticipated claims severity trend (i.e., the average size of a claim) for accident years 2012 through 2015. The favorable loss development recognized in the nine months ended September 30, 2018 primarily reflected a lower than anticipated claims severity trend for accident years 2011 through 2015. The favorable loss development recognized in the twelve months ended December 31, 2018 primarily reflected a lower than anticipated claims severity trend for accident years 2011 through 2014.
For additional information regarding ProAssurance's reserve for losses, see Note 1 and Note 8 of the Notes to Consolidated Financial Statements included in ProAssurance's December 31, 2018 report on Form 10-K.

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Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

7. Commitments and Contingencies
ProAssurance is involved in various legal actions related to insurance policies and claims handling including, but not limited to, claims asserted by policyholders. These types of legal actions arise in the Company's ordinary course of business and, in accordance with GAAP for insurance entities, are considered as a part of the Company's loss reserving process, which is described in detail under the heading "Losses and Loss Adjustment Expenses" in the Accounting Policies section in Note 1 of the Notes to Consolidated Financial Statements in ProAssurance's December 31, 2018 Form 10-K.
As a member of Lloyd's, ProAssurance is required to provide capital to support its Lloyd's Syndicates through 2019 of up to $200 million, referred to as FAL. The Board, through a non-binding resolution, extended this commitment through 2022. At September 30, 2019, ProAssurance's FAL was comprised of investment securities and cash and cash equivalents on deposit with Lloyd's with a carrying value of $134.7 million (see Note 3).
ProAssurance has issued an unconditional revolving credit agreement to the Premium Trust Fund of Syndicate 1729 for the purpose of providing working capital with permitted borrowings of £30.0 million. In January 2019, the Syndicate Credit Agreement was amended to extend the current maturity to December 31, 2020 and to implement an annual auto-renewal feature which allows for ProAssurance to elect to non-renew if notice is given at least 30 days prior to the next auto-renewal date, which is one year prior to the maturity date. Under the Syndicate Credit Agreement, advances bear interest at 3.8% annually and may be repaid at any time but are repayable upon demand after December 31, 2020, subject to extension through the auto-renewal feature. During the second quarter of 2019, Syndicate 1729 repaid £24.2 million (approximately $30.7 million based on June 30, 2019 exchange rates) of the balance outstanding. As of September 30, 2019, the unused commitment under this agreement approximated £28.4 million (approximately $34.9 million).
ProAssurance has entered into financial instrument transactions that may present off-balance sheet credit risk or market risk. These transactions include a short-term loan commitment and commitments to provide funding to non-public investment entities. Under the short-term loan commitment, ProAssurance has agreed to advance funds on a 30 day basis to a counterparty provided there is no violation of any condition established in the contract. As of September 30, 2019, ProAssurance had total funding commitments of approximately $252.5 million which primarily represented funding commitments related to non-public investment entities as well as the short-term loan commitment which included the amount at risk if the full short-term loan is extended and the counterparties default. However, the credit risk associated with the short-term loan commitment is minimal as the counterparties to the contract are highly rated commercial institutions and to-date have been performing in accordance with their contractual obligations.
In October 2018, ProAssurance entered into an agreement with a company to provide data analytics services for certain product lines within the Company's HCPL book of business. The agreement contains a minimum two year commitment with optional extension features for an annual fee of approximately $4.8 million per year with additional variable quarterly incentive fees based on service utilization metrics prescribed in the contract. ProAssurance incurred operating expense associated with this agreement of $1.4 million and $3.7 million during the three and nine months ended September 30, 2019, respectively, and as of September 30, 2019, the remaining commitment under this agreement was approximately $4.9 million.

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Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

8. Leases
ProAssurance is involved in a number of operating leases primarily for office facilities. Office facility leases have remaining lease terms ranging from one year to thirteen years; some of which include options to extend the leases for up to ten years, and some of which include an option to terminate the lease within one year. ProAssurance subleases certain office facilities to third parties and classifies these leases as operating leases.
The following table provides a summary of the components of lease expense as well as the reporting location in the Condensed Consolidated Statements of Income and Comprehensive Income for the three and nine months ended September 30, 2019 and 2018.
(In thousands)
Location in the Condensed Consolidated Statements of Income and Comprehensive Income
Three Months Ended September 30
 
Nine Months Ended September 30
2019
2018
 
2019
2018
Operating lease expense (1)
Operating expense
$
1,184

$
1,246

 
$
3,112

$
3,774

Sublease income (2)
Other income
(38
)
(42
)
 
(114
)
(121
)
Net lease expense
 
$
1,146

$
1,204


$
2,998

$
3,653

(1) Includes short-term lease costs and variable lease costs, if applicable. For the three and nine months ended September 30, 2019, no short-term lease costs were recognized and variable lease costs were nominal in amount. For the three and nine months ended September 30, 2018, short-term lease costs and variable lease costs were each nominal in amount.
(2) Sublease income excludes rental income from owned properties of $0.7 million and $1.9 million during the three and nine months ended September 30, 2019, respectively, and $0.6 million and $1.7 million during the same respective periods of 2018, which is included in other income. See “Item 2. Properties” in ProAssurance's December 31, 2018 report on Form 10-K for a listing of currently owned properties.
The following table provides supplemental lease information for operating leases on the Condensed Consolidated Balance Sheet as of September 30, 2019.
($ in thousands)
September 30, 2019
Operating lease ROU assets
$
20,563

Operating lease liabilities
$
21,298

Weighted-average remaining lease term
8.66 years

Weighted-average discount rate
3.16
%
The following table provides supplemental lease information for the Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2019 and 2018.
 
Nine Months Ended September 30
(In thousands)
2019
2018
Cash paid for amounts included in the measurement of lease liabilities:
 
 
Operating cash flows from operating leases
$
735

$
246



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Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

The following table is a schedule of remaining future minimum lease payments for operating leases that had an initial or remaining non-cancellable lease term in excess of one year as of September 30, 2019. Operating lease payments exclude $3.4 million of total future minimum lease payments for two leases signed but not yet commenced as of September 30, 2019. One lease will commence in the fourth quarter of 2019 and the other will commence in the first quarter of 2020. The lease term for both leases is approximately eleven years.
(In thousands)
 
2019
$
1,121

2020
4,030

2021
3,764

2022
2,873

2023
2,165

Thereafter
10,448

Total future minimum lease payments
24,401

Less: Imputed interest
3,103

Total operating lease liabilities
$
21,298


9. Debt
ProAssurance’s outstanding debt consisted of the following:
(In thousands)
September 30,
2019
 
December 31,
2018
Senior Notes due 2023, unsecured, interest at 5.3% annually
$
250,000

 
$
250,000

Revolving Credit Agreement, outstanding borrowings are not permitted to exceed $250 million aggregately; Revolving Credit Agreement expires in 2020. The interest rate on borrowings is set at the time the borrowing is initiated or renewed.
—

 
—

Mortgage Loans, outstanding borrowings are secured by first priority liens on two office buildings, and bear an interest rate of three-month LIBOR plus 1.325% (3.45% and 4.10%, respectively) determined on a quarterly basis.
37,978

 
39,064

Total principal
287,978

 
289,064

Less unamortized debt issuance costs
1,031

 
1,307

Debt less unamortized debt issuance costs
$
286,947

 
$
287,757


Covenant Compliance
There are no financial covenants associated with the Senior Notes due 2023.
The Revolving Credit Agreement contains customary representations, covenants and events constituting default, and remedies for default. The Revolving Credit Agreement also defines financial covenants regarding permitted leverage ratios. ProAssurance is currently in compliance with all covenants of the Revolving Credit Agreement.
The Mortgage Loans contain customary representations, covenants and events constituting default, and remedies for default. The Mortgage Loans also define a financial covenant regarding a permitted leverage ratio for each of the two ProAssurance subsidiaries that entered into the Mortgage Loans. ProAssurance's subsidiaries are currently in compliance with the financial covenant of the Mortgage Loans.
Additional Information
For additional information regarding ProAssurance's debt, see Note 10 of the Notes to Consolidated Financial Statements included in ProAssurance's December 31, 2018 report on Form 10-K.

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Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

10. Derivatives
ProAssurance is exposed to certain risks relating to its ongoing business and investment activities. ProAssurance utilizes derivative instruments as part of its risk management strategy to reduce the market risk related to fluctuations in future interest rates associated with a portion of its variable-rate debt. As of September 30, 2019, ProAssurance has not designated any derivative instruments as hedging instruments and does not use derivative instruments for trading purposes.
ProAssurance utilizes an interest rate cap agreement with the objective of reducing the Company's exposure to interest rate risk related to its variable-rate Mortgage Loans. Additional information regarding the Company's Mortgage Loans is provided in Note 9. Under the terms of the interest rate cap agreement, ProAssurance paid a premium of $2 million for the right to receive cash payments based upon a notional amount of $35 million if and when the three-month LIBOR rises above 2.35%. The Company's variable-rate Mortgage Loans bear an interest rate of three-month LIBOR plus 1.325%. Therefore, this derivative instrument is effectively ensuring the interest rate related to the Mortgage Loans is capped at a maximum of 3.675% until expiration of the interest rate cap agreement in October 2027. During each of the three and nine months ended September 30, 2019, ProAssurance received a nominal cash payment associated with this agreement, which was recorded as a reduction to interest expense. ProAssurance has designated the interest rate cap as an economic hedge (non-hedging instrument) of interest rate exposure and any change in fair value of the derivative is immediately recognized in earnings during the period of change.
The following table provides a summary of the volume and fair value position of the interest rate cap as well as the reporting location in the Condensed Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018.
($ in thousands)
September 30, 2019
 
December 31, 2018
Derivatives Not Designated as Hedging Instruments
Location in the Condensed Consolidated Balance Sheets
Number of Instruments
Notional Amount (1)
Estimated Fair Value (2)
 
Number of Instruments
Notional Amount (1)
Estimated Fair Value (2)
Interest Rate Cap
Other assets
1
$
35,000

$
675

 
1
$
35,000

$
1,884

(1) Volume is represented by the derivative instrument's notional amount.
(2) Additional information regarding the fair value of the Company's interest rate cap is provided in Note 2.
The following table presents the pre-tax impact of the change in the fair value of the interest rate cap and the reporting location in the Condensed Consolidated Statements of Income and Comprehensive Income for the three and nine months ended September 30, 2019 and 2018.
 
Gains (Losses) Recognized in
Income on Derivatives
(In thousands)
Three Months Ended September 30
 
Nine Months Ended September 30
Derivatives Not Designated as Hedging Instruments
Location in the Condensed Consolidated Statements of Income and Comprehensive Income
2019
 
2018
 
2019
 
2018
Interest Rate Cap
Interest expense
$
(410
)
 
$
264

 
$
(1,209
)
 
$
1,121


As a result of this derivative instrument, ProAssurance is exposed to risk that the counterparty will fail to meet its contractual obligations. To mitigate this counterparty credit risk, ProAssurance only enters into derivative contracts with carefully selected major financial institutions based upon their credit ratings and monitors their creditworthiness. As of September 30, 2019, the counterparty had an investment grade rating of BBB- and has performed in accordance with their contractual obligations.

39
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

11. Shareholders’ Equity
At September 30, 2019 and December 31, 2018, ProAssurance had 100 million shares of authorized common stock and 50 million shares of authorized preferred stock. The Board has the authority to determine provisions for the issuance of preferred shares, including the number of shares to be issued, the designations, powers, preferences and rights, and the qualifications, limitations or restrictions of such shares. To date, the Board has not approved the issuance of preferred stock.
ProAssurance declared cash dividends of $0.31 per share during each of the first three quarters of both 2019 and 2018, totaling $50.0 million and $50.9 million, for each respective nine-month period.
At September 30, 2019, Board authorizations for the repurchase of common shares or the retirement of outstanding debt of $110 million remained available for use. ProAssurance did not repurchase any common shares during the nine months ended September 30, 2019 and 2018.
Share-based compensation expense and related tax benefits were as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
(In thousands)
2019
 
2018
 
2019
 
2018
Share-based compensation expense
$
3

 
$
1,628

 
$
2,323

 
$
4,145

Related tax benefits
$
1

 
$
342

 
$
488

 
$
870


ProAssurance awarded approximately 109,000 restricted share units and 25,000 base performance share units to employees in February 2019. The fair value of each unit awarded was estimated at $40.18, equal to the market value of a ProAssurance common share on the date of grant less the estimated present value of dividends during the vesting period. The majority of awards are charged to expense as an increase to additional paid-in capital over the service period (generally the vesting period) associated with the award. However, a nominal amount of awards are recorded as a liability as they are structured to be settled in cash. Restricted share units and performance share units vest in their entirety at the end of a three-year period following the grant date based on a continuous service requirement and, for performance share units, achievement of a performance objective. Partial vesting is permitted for retirees. For equity classified awards, a ProAssurance common share is issued for each unit once vesting requirements are met, except that units sufficient to satisfy required tax withholdings are paid in cash. The number of common shares issued for performance share units varies from 50% to 200% of base awards depending upon the degree to which stated performance objectives are achieved. ProAssurance issued approximately 64,500 and 34,300 common shares to employees in February 2019 related to restricted share units and performance share units, respectively, granted in 2016. Performance share units for the 2016 award were issued at a level of 95%. Liability classified awards, which are nominal in amount, are settled in cash at the end of the vesting period.
ProAssurance issued approximately 2,000 common shares to employees in February 2019 as bonus compensation, as approved by the Compensation Committee of the Board. The shares issued were valued at fair value (the market price of a ProAssurance common share on the date of award).
Other Comprehensive Income (Loss) and Accumulated Other Comprehensive Income (Loss)
For the three and nine months ended September 30, 2019 and 2018, OCI was almost entirely comprised of unrealized gains and losses, including non-credit impairment losses, arising during the period related to fixed maturity available-for-sale securities, less reclassification adjustments, as shown in the table that follows, net of tax. For the three and nine months ended September 30, 2019 and 2018, OCI also included changes related to the reestimation of the defined benefit plan liability assumed in the Eastern acquisition which were nominal in amount. The defined benefit plan is frozen as to the earnings of additional benefits and the benefit plan liability is reestimated annually.
At September 30, 2019 and December 31, 2018, AOCI was almost entirely comprised of accumulated unrealized gains and losses from fixed maturity available-for-sale securities, including accumulated non-credit impairments recognized through OCI of $0.2 million and $0.1 million, respectively, net of tax. At September 30, 2019 and December 31, 2018, accumulated changes in the defined benefit plan liability not yet recognized in earnings were nominal in amount. Due to the adoption of accounting guidance in the first quarter of 2018 related to certain impacts of the TCJA, ProAssurance increased AOCI by approximately $3.4 million with a corresponding decrease to retained earnings of the same amount as of the beginning of 2018. At September 30, 2019 and December 31, 2018, tax effects were computed using the enacted federal corporate tax rate of 21% with the exception of unrealized gains and losses on available-for-sale securities held at the Company's U.K. and Cayman Islands entities which in both periods were immaterial in amount.

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Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

Amounts reclassified from AOCI to net income and the amounts of deferred tax expense (benefit) included in OCI were as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
(In thousands)
2019
 
2018
 
2019
 
2018
Reclassifications from AOCI to net income:
 
 
 
 
 
 
 
Realized investment gains (losses)
$
500

 
$
(175
)
 
$
1,457

 
$
551

Non-credit impairment losses reclassified to earnings, due to sale of securities or reclassification as a credit loss
—

 
(621
)
 
—

 
(621
)
Total gains (losses) reclassified, before tax effect
500

 
(796
)
 
1,457

 
(70
)
Tax effect, calculated using the 21% federal statutory tax rate
(105
)
 
167

 
(306
)
 
15

Net reclassification adjustments
$
395

 
$
(629
)
 
$
1,151

 
$
(55
)
 
 
 
 
 
 
 
 
Deferred tax expense (benefit) included in OCI
$
1,975

 
$
(1,197
)
 
$
14,957

 
$
(10,442
)

12. Variable Interest Entities
ProAssurance holds passive interests in a number of entities that are considered to be VIEs under GAAP guidance. ProAssurance's VIE interests principally consist of interests in LPs/LLCs formed for the purpose of achieving diversified equity and debt returns. ProAssurance's VIE interests, carried as a part of investment in unconsolidated subsidiaries, totaled $304.0 million at September 30, 2019 and $285.8 million at December 31, 2018.
ProAssurance does not have power over the activities that most significantly impact the economic performance of these VIEs and thus is not the primary beneficiary. Therefore, ProAssurance has not consolidated these VIEs. ProAssurance’s involvement with each VIE is limited to its direct ownership interest in the VIE. Except for the funding commitments disclosed in Note 7, ProAssurance has no arrangements with any of the VIEs to provide other financial support to or on behalf of the VIE. At September 30, 2019, ProAssurance’s maximum loss exposure relative to these investments was limited to the carrying value of ProAssurance’s investment in the VIE.
13. Earnings Per Share
Diluted weighted average shares is calculated as basic weighted average shares plus the effect, calculated using the treasury stock method, of assuming that restricted share units, performance share units and purchase match units have vested. The following table provides the weighted average number of common shares outstanding used in the calculation of the Company's basic and diluted earnings per share:
(In thousands, except per share data)
Three Months Ended
September 30
 
Nine Months Ended
September 30
2019
 
2018
 
2019
 
2018
Weighted average number of common shares outstanding, basic
53,762

 
53,620

 
53,732

 
53,585

Dilutive effect of securities:
 
 
 
 
 
 
 
Restricted Share Units
73

 
83

 
69

 
78

Performance Share Units
—

 
48

 
13

 
52

Purchase Match Units
21

 
22

 
17

 
20

Weighted average number of common shares outstanding, diluted
53,856

 
53,773

 
53,831

 
53,735

Effect of dilutive shares on earnings per share
$
—

 
$
—

 
$
—

 
$
—


All dilutive common share equivalents are reflected in the earnings per share calculation while antidilutive common share equivalents are not reflected in the earnings per share calculation. There were no antidilutive common share equivalents for the three and nine months ended September 30, 2019. There were no antidilutive common share equivalents for the three months ended September 30, 2018. The diluted weighted average number of common shares outstanding for the nine months ended September 30, 2018 excludes approximately 3,000 common share equivalents issuable under the Company's stock compensation plans, as their effect would be antidilutive.

41
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

14. Segment Information
ProAssurance's segments are based on the Company's internal management reporting structure for which financial results are regularly evaluated by the Company's CODM to determine resource allocation and assess operating performance. The Company continually assesses its internal management reporting structure and information evaluated by its CODM to determine whether any changes have occurred that would impact its segment reporting structure. The Company operates in five segments that are organized around the nature of the products and services provided: Specialty P&C, Workers' Compensation Insurance, Segregated Portfolio Cell Reinsurance, Lloyd's Syndicates and Corporate. A description of each segment follows.
Specialty P&C includes professional liability insurance and medical technology liability insurance. Professional liability insurance is primarily offered to healthcare providers and institutions and, to a lesser extent, to attorneys and their firms. Medical technology liability insurance is offered to medical technology and life sciences companies that manufacture or distribute products including entities conducting human clinical trials. Prior to 2018, the Specialty P&C segment ceded certain premium to the Lloyd's Syndicates segment under a quota share agreement with Syndicate 1729; however, this agreement was not renewed on January 1, 2018. As discussed below, the Lloyd's Syndicates segment results are typically reported on a quarter lag. For consistency purposes, results from this ceding arrangement, other than cash receipts or disbursements, are reported within the Specialty P&C segment on the same one-quarter lag. In addition, the Specialty P&C segment's healthcare professional liability products also include custom alternative risk solutions including loss portfolio transfers and captive cell programs. For the alternative market captive cell programs, the Specialty P&C segment cedes either all or a portion of the premium to certain SPCs in the Company's Segregated Portfolio Cell Reinsurance segment.
Workers' Compensation Insurance includes workers' compensation products provided to employers with 1,000 or fewer employees. The segment's products include guaranteed cost, policyholder dividend policies, retrospectively-rated policies, deductible polices and alternative market solutions. Alternative market products include program design, fronting, claims administration, risk management, SPC rental, asset management and SPC management services. Alternative market premiums are 100% ceded to either SPCs in the Company's Segregated Portfolio Cell Reinsurance segment or, to a limited extent, to a captive insurer unaffiliated with ProAssurance.
Segregated Portfolio Cell Reinsurance reflects the operating results (underwriting profit or loss, plus investment results) of SPCs at Inova Re and Eastern Re, the Company's Cayman Islands SPC operations. Each SPC is owned, fully or in part, by an agency, group or association, and the operating results of the SPCs are due to the participants of that cell. ProAssurance participates to a varying degree in the results of selected SPCs. SPC operating results due to external cell participants are reflected as an SPC dividend expense (income) in the Segregated Portfolio Cell Reinsurance segment and in ProAssurance's Condensed Consolidated Statements of Income and Comprehensive Income. In addition, the Segregated Portfolio Cell Reinsurance segment includes the SPC investment results as the investments are solely for the benefit of the cell participants, and investment results due to external cell participants are reflected in the SPC dividend expense (income). The majority of SPCs assume workers' compensation insurance, healthcare professional liability insurance or a combination of the two from the Company's Workers' Compensation Insurance and Specialty P&C segments. In addition, one SPC at Eastern Re assumed an errors and omissions liability policy from a captive insurer unaffiliated with ProAssurance; the Company does not participate in the SPC that assumed this policy; therefore, the operating results of this policy are reflected in the SPC dividend expense (income).
Lloyd's Syndicates includes operating results from ProAssurance's participation in Lloyd's of London Syndicate 1729 and Syndicate 6131, which is an SPA that underwrites on a quota share basis with Syndicate 1729. The results of this segment are normally reported on a quarter lag, except when information is available that is material to the current period. Furthermore, investment results associated with the majority of investment assets solely allocated to Lloyd's Syndicate operations and certain U.S. paid administrative expenses are reported concurrently as that information is available on an earlier time frame. For the 2019 underwriting year, ProAssurance slightly decreased its participation in the operating results of Syndicate 1729 from 62% to 61%; however, due to the quarter lag these changes were not reflected in the Lloyd's Syndicates segment results until the second quarter of 2019. Furthermore, ProAssurance's 100% participation in Syndicate 6131 was not reflected in the Lloyd's Syndicates segment results until the second quarter of 2018 as Syndicate 6131 began writing business effective January 1, 2018. Syndicate 1729 underwrites risks over a wide range of property and casualty insurance and reinsurance lines in both the U.S. and international markets. Syndicate 6131 focuses on contingency and specialty property business, also within the U.S. and international markets.
Corporate includes ProAssurance's investment operations, other than those reported in the Company's Segregated Portfolio Cell Reinsurance and Lloyd's Syndicates segments, interest expense and U.S. income taxes. The segment also includes non-premium revenues generated outside of the Company's insurance entities and corporate expenses.

42
Table of Contents
ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

The accounting policies of the segments are the same as those described in Note 1 of the Notes to Consolidated Financial Statements in ProAssurance’s December 31, 2018 report on Form 10-K and Note 1 herein. ProAssurance evaluates the performance of its Specialty P&C and Workers' Compensation Insurance segments based on before tax underwriting profit or loss, which excludes investment performance. ProAssurance evaluates the performance of its Segregated Portfolio Cell Reinsurance segment based on before tax operating profit or loss, which includes the investment performance of assets solely allocated to SPC operations. Performance of the Lloyd's Syndicates segment is evaluated based on underwriting profit or loss, plus investment results of investment assets solely allocated to Lloyd's Syndicate operations, net of U.K. income tax expense. Performance of the Corporate segment is evaluated based on the contribution made to consolidated after-tax results. ProAssurance accounts for inter-segment transactions as if the transactions were to third parties at current market prices. Assets are not allocated to segments because investments, other than the investments discussed above that are solely allocated to the Segregated Portfolio Cell Reinsurance and Lloyd's Syndicates segments, and other assets are not managed at the segment level.
Financial results by segment were as follows:
 
Three Months Ended September 30, 2019
(In thousands)
Specialty P&C
 
Workers' Compensation Insurance
 
Segregated Portfolio Cell Reinsurance
 
Lloyd's Syndicates
 
Corporate
 
Inter-segment Eliminations
 
Consolidated
Net premiums earned
$
125,237

 
$
49,477

 
$
19,779

 
$
21,295

 
$
—

 
$
—

 
$
215,788

Net investment income
—

 
—

 
445

 
1,077

 
22,159

 
—

 
23,681

Equity in earnings (loss) of unconsolidated subsidiaries
—

 
—

 
—

 
—

 
(1,277
)
 
—

 
(1,277
)
Net realized gains (losses)
—

 
—

 
(98
)
 
285

 
947

 
—

 
1,134

Other income (expense)*
1,858

 
494

 
176

 
(165
)
 
963

 
(778
)
 
2,548

Net losses and loss adjustment expenses
(107,573
)
 
(32,356
)
 
(9,778
)
 
(11,907
)
 
—

 
—

 
(161,614
)
Underwriting, policy acquisition and operating expenses*
(29,700
)
 
(14,895
)
 
(5,951
)
 
(9,411
)
 
(2,682
)
 
778

 
(61,861
)
Segregated portfolio cells dividend (expense) income
—

 
—

 
(3,621
)
 
—

 
—

 
—

 
(3,621
)
Interest expense
—

 
—

 
—

 
—

 
(4,274
)
 
—

 
(4,274
)
Income tax benefit (expense)
—

 
—

 
—

 
161

 
6,528

 
—

 
6,689

Segment operating results
$
(10,178
)
 
$
2,720

 
$
952

 
$
1,335

 
$
22,364

 
$
—

 
$
17,193

Significant non-cash items:
 
 
 
 
 
 
 
 
 
 
 
 
 
Depreciation and amortization, net of accretion
$
1,568

 
$
957

 
$
(59
)
 
$
(1
)
 
$
1,955

 
$
—

 
$
4,420


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ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

 
Nine Months Ended September 30, 2019
(In thousands)
Specialty P&C
 
Workers' Compensation Insurance
 
Segregated Portfolio Cell Reinsurance
 
Lloyd's Syndicates
 
Corporate
 
Inter-segment Eliminations
 
Consolidated
Net premiums earned
$
375,315

 
$
141,990

 
$
58,566

 
$
57,215

 
$
—

 
$
—

 
$
633,086

Net investment income
—

 
—

 
1,261

 
3,282

 
65,495

 
—

 
70,038

Equity in earnings (loss) of unconsolidated subsidiaries
—

 
—

 
—

 
—

 
(7,240
)
 
—

 
(7,240
)
Net realized gains (losses)
—

 
—

 
1,949

 
725

 
44,390

 
—

 
47,064

Other income (expense)*
4,536

 
1,948

 
397

 
(278
)
 
2,701

 
(1,885
)
 
7,419

Net losses and loss adjustment expenses
(321,248
)
 
(93,424
)
 
(40,496
)
 
(34,640
)
 
—

 
—

 
(489,808
)
Underwriting, policy acquisition and operating expenses*
(89,177
)
 
(43,456
)
 
(17,091
)
 
(25,445
)
 
(12,676
)
 
1,885

 
(185,960
)
Segregated portfolio cells dividend (expense) income
—

 
—

 
(1,375
)
 
—

 
—

 
—

 
(1,375
)
Interest expense
—

 
—

 
—

 
—

 
(12,850
)
 
—

 
(12,850
)
Income tax benefit (expense)
—

 
—

 
—

 
161

 
(157
)
 
—

 
4

Segment operating results
$
(30,574
)
 
$
7,058

 
$
3,211

 
$
1,020

 
$
79,663

 
$
—

 
$
60,378

Significant non-cash items:
 
 
 
 
 
 
 
 
 
 
 
 
 
Depreciation and amortization, net of accretion
$
4,927

 
$
2,893

 
$
(45
)
 
$
(8
)
 
$
6,306

 
$
—

 
$
14,073


 
Three Months Ended September 30, 2018
(In thousands)
Specialty P&C
 
Workers' Compensation Insurance
 
Segregated Portfolio Cell Reinsurance
 
Lloyd's Syndicates
 
Corporate
 
Inter-segment Eliminations
 
Consolidated
Net premiums earned
$
120,789

 
$
47,296

 
$
18,963

 
$
19,022

 
$
—

 
$
—

 
$
206,070

Net investment income
—

 
—

 
371

 
783

 
22,112

 
—

 
23,266

Equity in earnings (loss) of unconsolidated subsidiaries
—

 
—

 
—

 
—

 
5,228

 
—

 
5,228

Net realized gains (losses)
—

 
—

 
1,397

 
(98
)
 
11,074

 
—

 
12,373

Other income (expense)*
1,426

 
376

 
86

 
352

 
699

 
(551
)
 
2,388

Net losses and loss adjustment expenses
(98,363
)
 
(30,650
)
 
(8,560
)
 
(10,032
)
 
—

 
—

 
(147,605
)
Underwriting, policy acquisition and operating expenses*
(27,931
)
 
(15,410
)
 
(5,516
)
 
(8,439
)
 
(5,053
)
 
505

 
(61,844
)
Segregated portfolio cells dividend (expense) income
—

 
—

 
(5,255
)
 
—

 
—

 
—

 
(5,255
)
Interest expense
—

 
—

 
—

 
—

 
(3,645
)
 
46

 
(3,599
)
Income tax benefit (expense)
—

 
—

 
—

 
361

 
(155
)
 
—

 
206

Segment operating results
$
(4,079
)
 
$
1,612

 
$
1,486

 
$
1,949

 
$
30,260

 
$
—

 
$
31,228

Significant non-cash items:
 
 
 
 
 
 
 
 
 
 
 
 
 
Depreciation and amortization, net of accretion
$
1,715

 
$
959

 
$
83

 
$
(2
)
 
$
2,751

 
$
—

 
$
5,506



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ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

 
Nine Months Ended September 30, 2018
(In thousands)
Specialty P&C
 
Workers' Compensation Insurance
 
Segregated Portfolio Cell Reinsurance
 
Lloyd's Syndicates
 
Corporate
 
Inter-segment Eliminations
 
Consolidated
Net premiums earned
$
378,355

 
$
135,230

 
$
54,247

 
$
48,987

 
$
—

 
$
—

 
$
616,819

Net investment income
—

 
—

 
1,100

 
2,370

 
64,207

 
—

 
67,677

Equity in earnings (loss) of unconsolidated subsidiaries
—

 
—

 
—

 
—

 
12,247

 
—

 
12,247

Net realized gains (losses)
—

 
—

 
467

 
(404
)
 
2,588

 
—

 
2,651

Other income (expense)*
3,945

 
1,828

 
176

 
247

 
2,737

 
(1,778
)
 
7,155

Net losses and loss adjustment expenses
(292,742
)
 
(87,794
)
 
(27,561
)
 
(31,023
)
 
—

 
—

 
(439,120
)
Underwriting, policy acquisition and operating expenses*
(83,833
)
 
(41,545
)
 
(16,070
)
 
(23,745
)
 
(15,351
)
 
1,732

 
(178,812
)
Segregated portfolio cells dividend (expense) income
—

 
—

 
(9,787
)
 
—

 
—

 
—

 
(9,787
)
Interest expense
—

 
—

 
—

 
—

 
(11,308
)
 
46

 
(11,262
)
Income tax benefit (expense)
—

 
—

 
—

 
355

 
3,584

 
—

 
3,939

Segment operating results
$
5,725

 
$
7,719

 
$
2,572

 
$
(3,213
)
 
$
58,704

 
$
—

 
$
71,507

Significant non-cash items:
 
 
 
 
 
 
 
 
 
 
 
 
 
Depreciation and amortization, net of accretion
$
5,343

 
$
2,873

 
$
393

 
$
(5
)
 
$
7,940

 
$
—

 
$
16,544

* Certain fees for services provided to the SPCs at Inova Re and Eastern Re are recorded as expenses within the Segregated Portfolio Cell Reinsurance segment and as other income within the Workers' Compensation Insurance segment. These fees are primarily SPC rental fees and are eliminated between segments in consolidation.



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ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019

The following table provides detailed information regarding ProAssurance's gross premiums earned by product as well as a reconciliation to net premiums earned. All gross premiums earned are from external customers except as noted. ProAssurance's insured risks are primarily within the U.S.
 
Three Months Ended September 30
 
Nine Months Ended September 30
(In thousands)
2019
 
2018
 
2019
 
2018
Specialty P&C Segment
 
 
 
 
 
 
 
Gross premiums earned:
 
 
 
 
 
 
 
Healthcare professional liability
$
130,633

 
$
126,012

 
$
387,547

 
$
390,904

Legal professional liability
6,771

 
6,606

 
20,039

 
19,486

Medical technology liability
8,519

 
9,080

 
25,177

 
26,372

Other
591

 
113

 
1,936

 
346

Ceded premiums earned
(21,277
)
 
(21,022
)
 
(59,384
)
 
(58,753
)
Segment net premiums earned
125,237

 
120,789

 
375,315

 
378,355

 
 
 
 
 
 
 
 
Workers' Compensation Insurance Segment
 
 
 
 
 
 
 
Gross premiums earned:
 
 
 
 
 
 
 
Traditional business
53,156

 
50,271

 
152,477

 
145,334

Alternative market business
21,247

 
21,564

 
63,084

 
61,593

Ceded premiums earned
(24,926
)
 
(24,539
)
 
(73,571
)
 
(71,697
)
Segment net premiums earned
49,477

 
47,296

 
141,990

 
135,230

 
 
 
 
 
 
 
 
Segregated Portfolio Cell Reinsurance Segment
 
 
 
 
 
 
 
Gross premiums earned:
 
 
 
 
 
 
 
Workers' compensation(1)
20,579

 
20,251

 
61,305

 
57,287

Healthcare professional liability(2)
1,399

 
1,225

 
4,071

 
3,782

Other
240

 
—

 
480

 
—

Ceded premiums earned
(2,439
)
 
(2,513
)
 
(7,290
)
 
(6,822
)
Segment net premiums earned
19,779

 
18,963

 
58,566

 
54,247

 
 
 
 
 
 
 
 
Lloyd's Syndicates Segment
 
 
 
 
 
 
 
Gross premiums earned:
 
 
 
 
 
 
 
Property and casualty(3)
26,399

 
23,050

 
72,225

 
60,289

Ceded premiums earned
(5,104
)
 
(4,028
)
 
(15,010
)
 
(11,302
)
Segment net premiums earned
21,295

 
19,022

 
57,215

 
48,987

 

 

 

 

Consolidated net premiums earned
$
215,788

 
$
206,070

 
$
633,086

 
$
616,819

(1) Premium for all periods is assumed from the Workers' Compensation Insurance segment.
(2) Premium for all periods is assumed from the Specialty P&C segment.
(3) Includes premium assumed from the Specialty P&C segment of $0.1 million for the nine months ended September 30, 2019 and $1.2 million and $4.5 million for three and nine months ended September 30, 2018, respectively.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements and Notes to those statements which accompany this report. Throughout the discussion we use certain terms and abbreviations, which can be found in the Glossary of Terms and Acronyms at the beginning of this report. In addition, a glossary of insurance terms and phrases is available on the investor section of our website. Throughout the discussion, references to "ProAssurance," "PRA," "Company," "we," "us" and "our" refer to ProAssurance Corporation and its consolidated subsidiaries. The discussion contains certain forward-looking information that involves significant risks, assumptions and uncertainties. As discussed under the heading "Caution Regarding Forward-Looking Statements," our actual financial condition and operating results could differ significantly from these forward-looking statements.
ProAssurance Overview
ProAssurance Corporation is a holding company for property and casualty insurance companies. Our wholly owned insurance subsidiaries provide professional liability insurance for healthcare professionals and facilities, professional liability insurance for attorneys and their firms, liability insurance for medical technology and life sciences risks and workers' compensation insurance. We are also the majority capital provider for Syndicate 1729 and the sole capital provider for Syndicate 6131 at Lloyd's of London.
We operate in five segments which are based on our internal management reporting structure for which financial results are regularly evaluated by our CODM to determine resource allocation and assess operating performance. Descriptions of ProAssurance's five operating and reportable segments are as follows:
•
Specialty P&C - This segment includes our professional liability business and medical technology liability business. Professional liability insurance is primarily offered to healthcare providers and institutions and, to a lesser extent, to attorneys and their firms. Medical technology liability insurance is offered to medical technology and life sciences companies that manufacture or distribute products including entities conducting human clinical trials. Our healthcare professional liability insurance products also include custom alternative risk solutions including loss portfolio transfers and captive cell programs. For our alternative market captive cell programs, we cede either all or a portion of the premium to certain SPCs in our Segregated Portfolio Cell Reinsurance segment.
•
Workers' Compensation Insurance - This segment includes our workers' compensation insurance business which is provided primarily to employers with 1,000 or fewer employees. Our workers' compensation products include guaranteed cost, policyholder dividend policies, retrospectively-rated policies, deductible policies and alternative market solutions. Alternative market premiums are 100% ceded to either SPCs in our Segregated Portfolio Cell Reinsurance segment or, to a limited extent, an unaffiliated captive insurer.
•
Segregated Portfolio Cell Reinsurance - This segment reflects the operating results (underwriting profit or loss, plus investment results) of SPCs at Inova Re and Eastern Re, our Cayman Islands SPC operations. Each SPC is owned, fully or in part, by an agency, group or association and the operating results of the SPCs are due to the participants of that cell. We participate to a varying degree in the results of selected SPCs and, for the SPCs in which we participate, our participation interest ranges from a low of 20% to high of 85%. SPC operating results due to external cell participants are reflected as an SPC dividend expense (income) in our Segregated Portfolio Cell Reinsurance segment. The majority of SPCs only assume workers' compensation insurance, healthcare professional liability insurance or a combination of the two from our Workers' Compensation Insurance and Specialty P&C segments. In addition, an SPC at Eastern Re assumed an errors and omissions liability policy from a captive insurer unaffiliated with ProAssurance. We do not participate in the SPC that assumed this policy; therefore, the operating results of this policy are reflected in the SPC dividend expense (income).
•
Lloyd's Syndicates - This segment includes the operating results from our participation in Lloyd's of London Syndicate 1729 and our 100% participation in Syndicate 6131, which is an SPA that underwrites on a quota share basis with Syndicate 1729. The results of this segment are normally reported on a quarter lag, except when information is available that is material to the current period. For the 2019 underwriting year, we slightly decreased our participation in the operating results of Syndicate 1729 from 62% to 61%; however, due to the quarter lag these changes were not reflected in our Lloyd's Syndicates segment results until the second quarter of 2019. Furthermore, our participation in Syndicate 6131 was not reflected in our Lloyd's Syndicates segment results until the second quarter of 2018 as Syndicate 6131 began writing business effective January 1, 2018. Syndicate 1729 underwrites risks over a wide range of property and casualty insurance and reinsurance lines in both the U.S. and international markets while Syndicate 6131 focuses on contingency and specialty property business, also within the U.S. and international markets.

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•
Corporate - This segment includes our investment operations, other than those reported in our Segregated Portfolio Cell Reinsurance and Lloyd's Syndicates segments, interest expense and U.S. income taxes. This segment also includes non-premium revenues generated outside of our insurance entities and corporate expenses.
Additional information regarding our segments is included in Note 14 of the Notes to Condensed Consolidated Financial Statements and in the Segment Operating Results sections that follow.
Critical Accounting Estimates
Our Condensed Consolidated Financial Statements are prepared in conformity with GAAP. Preparation of these financial statements requires us to make estimates and assumptions that affect the amounts we report on those statements. We evaluate these estimates and assumptions on an ongoing basis based on current and 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; reported results of operations may be materially affected by changes in these estimates and assumptions.
Management considers the following accounting estimates to be critical because they involve significant judgment by management and those judgments could result in a material effect on our financial statements.
Reserve for Losses and Loss Adjustment Expenses
The largest component of our liabilities is our reserve for losses and loss adjustment expenses ("reserve for losses" or "reserve"), and the largest component of expense for our operations is incurred losses and loss adjustment expenses (also referred to as “losses and loss adjustment expenses,” “incurred losses,” “losses incurred” and “losses”). Incurred losses reported in any period reflect our estimate of losses incurred related to the premiums earned in that period as well as any changes to our previous estimate of the reserve required for prior periods.
As of September 30, 2019, our reserve is comprised almost entirely of long-tail exposures. The estimation of long-tailed losses is inherently difficult and is subject to significant judgment on the part of management. Due to the nature of our claims, our loss costs, even for claims with similar characteristics, can vary significantly depending upon many factors, including but not limited to the specific characteristics of the claim and the manner in which the claim is resolved. Long-tailed insurance is characterized by the extended period of time typically required both to assess the viability of a claim and potential damages, if any, and to reach a resolution of the claim. The claims resolution process may extend to more than five years. The combination of continually changing conditions and the extended time required for claim resolution results in a loss cost estimation process that requires actuarial skill and the application of significant judgment, and such estimates require periodic modification.
Our reserve is established by management after taking into consideration a variety of factors including premium rates, claims frequency and severity, historical paid and incurred loss development trends, the expected effect of inflation, general economic trends, the legal and political environment and the conclusions reached by our internal and consulting actuaries. We update and review the data underlying the estimation of our reserve for losses each reporting period and make adjustments to loss estimation assumptions that we believe best reflect emerging data. Both our internal and consulting actuaries perform an in-depth review of our reserve for losses on at least a semi-annual basis using the loss and exposure data of our insurance subsidiaries.
Our reserving process can be broadly grouped into three areas: the establishment of the reserve for the current accident year (the initial reserve), the re-estimation of the reserve for prior accident years (development of prior accident years) and the establishment of the initial reserve for risks assumed in business combinations, applicable only in periods in which acquisitions occur (the acquired reserve).
Current Accident Year - Initial Reserve
Considerable judgment is required in establishing our initial reserve for any current accident year period, as there is limited data available upon which to base our estimate. Our process for setting an initial reserve considers the unique characteristics of each product, but in general we rely heavily on the loss assumptions that were used to price business, as our pricing reflects our analysis of loss costs that we expect to incur relative to the insurance product being priced.
Specialty P&C Segment. Loss costs within this segment are impacted by many factors including but not limited to the nature of the claim, including whether or not the claim is an individual or a mass tort claim, the personal situation of the claimant or the claimant's family, the outcome of jury trials, the legislative and judicial climate where any potential litigation may occur, general economic conditions and, for claims involving bodily injury, the trend of healthcare costs. Within our Specialty P&C segment, for our HCPL business (75% of our consolidated gross reserve for losses and loss adjustment expenses as of December 31, 2018), we set an initial reserve upon our evaluation of the current loss environment, plus an additional provision in consideration of the historical loss volatility we and others in the industry have experienced. For our HCPL business, our expected loss ratio during recent accident years has ranged from 79% to 87%. Changes in the overall claims environment

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as well as pricing adequacy can result in variations from these levels. The additional provision for loss volatility has ranged from 8 to 12 percentage points. We believe the use of an additional provision for volatility appropriately considers the inherent risks and limitations of our rate development process and the historic volatility of professional liability losses (the industry has experienced accident year loss ratios as high as 138% and as low as 54% over the past 30 years) and produces a reasonable best estimate of the reserve required to cover actual ultimate unpaid losses for the current accident year. This practice has produced an overall average initial loss ratio for our HCPL business ranging from 87% to 99%. We have recently trended towards the higher end of this range given our concern around increases in loss severity in the broader HCPL industry. A similar practice is followed for our legal professional liability business (3% of our consolidated gross reserve for losses and loss adjustment expenses as of December 31, 2018).
The risks insured in our medical technology liability business (4% of our consolidated gross reserve for losses and loss adjustment expenses as of December 31, 2018) are more varied, and policies are individually priced based on the risk characteristics of the policy and the account. The insured risks range from startup operations to large multinational entities, and the larger entities often have significant deductibles or self-insured retentions. Reserves are established using our most recently developed actuarial estimates of losses expected to be incurred based on factors which include results from prior analysis of similar business, industry indications, observed trends and judgment. Claims in this line of business primarily involve bodily injury to individuals and are affected by factors similar to those of our HCPL line of business. For the medical technology liability business, we also establish an initial reserve using a loss ratio approach, including a provision in consideration of historical loss volatility that this line of business has exhibited.
Workers' Compensation Insurance Segment. Many factors affect the ultimate losses incurred for our workers' compensation coverages (11% of our consolidated gross reserve for losses and loss adjustment expenses as of December 31, 2018) including but not limited to the type and severity of the injury, the age and occupation of the injured worker, the estimated length of disability, medical treatment and related costs, and the jurisdiction and workers' compensation laws of the state of the injury occurrence. We use various actuarial methodologies in developing our workers’ compensation reserve, combined with a review of the exposure base generally based upon payroll of the insured. For the current accident year, given the lack of seasoned information, the different actuarial methodologies produce results with significant variability; therefore, more emphasis is placed on supplementing results from the actuarial methodologies with trends in exposure base, medical expense inflation, general inflation, severity, and claim counts, among other things, to select an expected loss ratio.
Segregated Portfolio Cell Reinsurance Segment. The factors that affect the ultimate losses incurred for the workers' compensation and healthcare professional liability coverages assumed by the SPCs at Inova Re and Eastern Re (3% of our consolidated gross reserve for losses and loss adjustment expenses as of December 31, 2018) are consistent with that of our Workers’ Compensation Insurance and Specialty P&C segments, respectively.
Lloyd's Syndicates Segment. Due to the relatively short history of Syndicate 1729 (January 1, 2014) we are influenced by historical claims experience of the Lloyd's market for similar risks in estimating the appropriate initial reserves for our Lloyd's Syndicates segment (4% of our consolidated gross reserve for losses and loss adjustment expenses as of December 31, 2018). We expect loss ratios to fluctuate from quarter to quarter as Syndicate 1729 writes more business and the book begins to mature. Loss ratios can also fluctuate due to the timing of earned premium adjustments. Such adjustments may be the result of premiums for certain policies and assumed reinsurance contracts being reported subsequent to the coverage period and may be subject to adjustment based on loss experience. Premium and exposure for some of Syndicate 1729's insurance policies and reinsurance contracts are initially estimated and subsequently recorded over an extended period of time as reports are received under delegated underwriting authority programs. When reports are received, the premium, exposure and corresponding loss estimates are revised accordingly. Changes in loss estimates due to premium or exposure fluctuations are incurred in the accident year in which the premium is earned.
For significant property catastrophe exposures, Syndicate 1729 uses third-party catastrophe models to accumulate a listing of potentially affected policies. Each identified policy is given an estimate of loss severity based upon a combination of factors including the probable maximum loss of each policy, market share analytics, underwriting judgment, client/broker estimates and historical loss trends for similar events. These models are inherently uncertain, reliant upon key assumptions and management judgment and are not always a representation of actual events and ensuing potential loss exposure. Determination of actual losses may take an extended period of time until claims are reported and resolved, including coverage litigation.
Syndicate 6131 follows a process similar to Syndicate 1729 for the establishment of initial reserves. Loss assumptions by risk category incorporated into the 2019 business plan submitted to Lloyd's were influenced by historical claims experience of the Lloyd's market for similar risks. We expect the loss ratios of Syndicate 6131 to fluctuate from quarter to quarter as Syndicate 6131 assumes more business from Syndicate 1729 and the book begins to mature.

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Development of Prior Accident Years
In addition to setting the initial reserve for the current accident year, each period we reassess the amount of reserve required for prior accident years.
Our reserve re-estimation process is based upon the most recently completed actuarial analysis supplemented by any new analysis, information or trends that have emerged since the date of that study. We also take into account currently available industry trend information. Changes to previously established reserve estimates are recognized in the current period if management’s best estimate of ultimate losses differs from the estimate previously established. While management considers a variety of variables in determining its best estimate, in general, as claims age, our methodologies give more weight to actual loss costs which, for the majority of our reserves, continue to indicate that ultimate loss costs will be lower than our previous estimates. The discussion in our Critical Accounting Estimates section in Item 7 of our December 31, 2018 report on Form 10-K includes additional information regarding the methodologies used to evaluate our reserve.
Any change in our estimate of net ultimate losses for prior accident years is reflected in net income in the period in which such changes are made. In recent years such changes have reduced our estimate of net ultimate losses, resulting in a reduction of reported losses for the period and a corresponding increase in pre-tax income.
Due to the size of our consolidated reserve for losses and the large number of claims outstanding at any point in time, even a small percentage adjustment to our total reserve estimate could have a material effect on our results of operations for the period in which the adjustment is made.
Use of Judgment
Even though the actuarial process is highly technical, it is also highly judgmental, both as to the selection of the data used in the various actuarial methodologies (e.g., initial expected loss ratios and loss development factors) and in the interpretation of the output of the various methods used. Each actuarial method generally returns a different value and for the more recent accident years the variations among the various methodologies can be significant. In order to project ultimate losses, we partition our reserves for analysis such as by line of business, geography, coverage layer or accident year; in all, there are over 200 different partitions of our business used for actuarial evaluation. For each partition of our reserves, we evaluate the results of the various methods, along with the supplementary statistical data regarding such factors as closed with and without indemnity ratios, claim severity trends, the expected duration of such trends, changes in the legal and legislative environment and the current economic environment to develop a point estimate based upon management's judgment and past experience. The series of selected point estimates is then combined to produce an overall point estimate for ultimate losses.
Given the potential for unanticipated volatility for long-tailed lines of business, we are cautious in giving full credibility to emerging trends that, when more fully mature, may lead to the recognition of either favorable or adverse development of our losses. There may be trends, both positive and negative, reflected in the numerical data both within our own information and in the broader marketplace that mitigate or reverse as time progresses and additional data becomes available. This is particularly true for our HCPL business which has historically exhibited significant volatility as previously discussed.
HCPL. Over the past several years the most influential factor affecting the analysis of our HCPL reserves and the related development recognized has been an observed increase in claim severity for the broader HCPL industry as well as higher initial loss expectations on incurred claims. The severity trend is an explicit component of our pricing models, whereas in our reserving process the severity trend's impact is implicit. Our estimate of this trend and our expectations about changes in this trend impact a variety of factors, from the selection of expected loss ratios to the ultimate point estimates established by management.
Because of the implicit and wide-ranging nature of severity trend assumptions on the loss reserving process, it is not practical to specifically isolate the impact of changing severity trends. However, because severity is an explicit component of our HCPL pricing process we can better isolate the impact that changing severity can have on our loss costs and loss ratios in regards to our pricing models for this business component. Our current HCPL pricing models assume a severity trend of approximately 3% in most states and products. We have observed higher severity trends in our case reserve estimates; however, we are not yet certain of the impact that this will have on our future claim payments. If the severity trend were to be higher by 1 percentage point, the impact would be an increase in our expected loss ratio for this business of 3.2 percentage points, based on current claim disposition patterns. An increase in the severity trend of 3 percentage points would result in a 10.1 percentage point increase in our expected loss ratio. Due to the long-tailed nature of our claims and the previously discussed historical volatility of loss costs, selection of a severity trend assumption is a subjective process that is inherently likely to prove inaccurate over time. Given the long tail and volatility, we are generally cautious in making changes to the severity assumptions within our pricing models. All open claims and accident years are generally impacted by a change in the severity trend, which compounds the effect of such a change.

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Although the future degree and impact of the ultimate severity trend remains uncertain due to the long-tailed nature of our business, we have given consideration to observed loss costs in setting our rates. For our HCPL business this practice had generally resulted in rate reductions as claim frequency declined and remained at historically low levels. For example, on average, excluding our podiatry business acquired in 2009, we had gradually reduced the premium rates we charged on our standard physician renewal business (our largest HCPL line) by approximately 17% from the beginning of 2006 to December 31, 2016. However, from early 2017 to September 30, 2019, the average charged premium rates on our standard physician renewal business have increased by approximately 4% per annum, and we anticipate further rate increases due to indications of increasing loss severity. Initial loss ratios for recent accident years have thus remained fairly constant because expected loss changes have generally been offset by higher rates; however, we have recognized a higher current accident year net loss ratio during 2019 due to continued concern regarding recent severity indications.
Workers' Compensation. The projection of changes in claim severity trend has not historically been an influential factor affecting our analysis of workers' compensation reserves, as claims are typically resolved more quickly than the industry norm. As previously mentioned, the determination and calculation of loss development factors, in particular, the selection of tail factors which are used to extend the projection of losses beyond historical data, requires considerable judgment.
Loss Development
We recognized net favorable reserve development of $15.9 million during the three months ended September 30, 2019, of which favorable development of $10.8 million related to our Specialty P&C segment, $1.4 million related to our Workers' Compensation Insurance segment, $3.3 million related to our Segregated Portfolio Cell Reinsurance segment and $0.5 million related to our Lloyd's Syndicates segment. We recognized net favorable reserve development of $42.2 million during the nine months ended September 30, 2019, of which favorable development of $31.0 million related to our Specialty P&C segment, $3.4 million related to our Workers' Compensation Insurance segment, $7.8 million related to our Segregated Portfolio Cell Reinsurance segment, slightly offset by a nominal amount of unfavorable development related to our Lloyd's Syndicates segment.
Net favorable development recognized within our Specialty P&C segment primarily reflected a lower than anticipated claims severity trend (i.e., the average size of a claim) for accident years 2012 through 2015. While we are observing an increase in claim severity in the broader HCPL industry, this severity is modestly more favorable than the cautious expectations we have established for our reserves for prior periods.
Net favorable development recognized within our Workers' Compensation Insurance segment reflected overall favorable trends in claim closing patterns primarily in the 2016 accident year.
Net favorable development recognized within our Segregated Portfolio Cell Reinsurance segment primarily reflected better than expected claim trends in the 2015, 2016 and 2017 accident years. The improved claim trends reflected lower frequency and severity than anticipated at the time the reserves were established.
Net unfavorable development recognized within our Lloyd's Syndicates segment for the nine months ended September 30, 2019 was driven by higher than expected losses and development on certain large claims which resulted in unfavorable development with respect to a previous year of account. See further discussion in our Segment Operating Results - Lloyd's Syndicates section that follows.
Investment Valuations
We record the majority of our investments at fair value as shown in the table below. At September 30, 2019, the distribution of our investments based on GAAP fair value hierarchies (levels) was as follows:
 
Distribution by GAAP Fair Value Hierarchy
 
 
 
 
 
Level 1
 
Level 2
 
Level 3
 
Not Categorized
 
Total
Investments
Investments recorded at:
 
 
 
 
 
 
 
 
 
Fair value
18%
 
68%
 
1%
 
8%
 
95%
Other valuations
 
 
 
 
 
 
 
 
5%
Total Investments
 
 
 
 
 
 
 
 
100%
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. All of our fixed maturity and equity investments are carried at fair value. The fair value of our short-term securities approximates the cost of the securities due to their short-term nature.
Because of the number of securities we own and the complexity of developing accurate fair values, we utilize multiple independent pricing services to assist us in establishing the fair value of individual securities. The pricing services provide fair

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values based on exchange-traded prices, if available. If an exchange-traded price is not available, the pricing services, if possible, provide a fair value that is based on multiple broker/dealer quotes or that has been developed using pricing models. Pricing models vary by asset class and utilize currently available market data for securities comparable to ours to estimate a fair value for our securities. The pricing services scrutinize market data for consistency with other relevant market information before including the data in the pricing models. The pricing services disclose the types of pricing models used and the inputs used for each asset class. Determining fair values using these pricing models requires the use of judgment to identify appropriate comparable securities and to choose a valuation methodology that is appropriate for the asset class and available data.
The pricing services provide a single value per instrument quoted. We review the values provided for reasonableness each quarter by comparing market yields generated by the supplied value versus market yields observed in the marketplace. We also compare yields indicated by the provided values to appropriate benchmark yields and review for values that are unchanged or that reflect an unanticipated variation as compared to prior period values. We utilize a primary pricing service for each security type and compare provided information for consistency with alternate pricing services, known market data and information from our own trades, considering both values and valuation trends. We also review weekly trades versus the prices supplied by the services. If a supplied value appears unreasonable, we discuss the valuation in question with the pricing service and make adjustments if deemed necessary. Historically our review has not resulted in any material changes to the values supplied by the pricing services. The pricing services do not provide a fair value unless an exchange-traded price or multiple observable inputs are available. As a result, the pricing services may provide a fair value for a security in some periods but not others, depending upon the level of recent market activity for the security or comparable securities.
Level 1 Investments
Fair values for a majority of our equity securities and portions of our corporate debt, short-term and convertible securities are determined using exchange-traded prices. There is little judgment involved when fair value is determined using an exchange-traded price. In accordance with GAAP, we classify securities valued using an exchange-traded price as Level 1 securities.
Level 2 Investments
Most fixed income securities do not trade daily; thus, exchange-traded prices are generally not available for these securities. However, market information (often referred to as observable inputs or market data, including but not limited to, last reported trade, non-binding broker quotes, bids, benchmark yield curves, issuer spreads, two-sided markets, benchmark securities, offers and recent data regarding assumed prepayment speeds, cash flow and loan performance data) is available for most of our fixed income securities. We determine fair value for a large portion of our fixed income securities using available market information. In accordance with GAAP, we classify securities valued based on multiple market observable inputs as Level 2 securities.
Level 3 Investments
When a pricing service does not provide a value for one of our fixed maturity securities, management estimates fair value using either a single non-binding broker quote or pricing models that utilize market based assumptions which have limited observable inputs. The process involves significant judgment in selecting the appropriate data and modeling techniques to use in the valuation process. In accordance with GAAP, we classify securities valued using limited observable inputs as Level 3 securities.
Fair Values Not Categorized
We hold interests in certain investment funds, primarily LPs/LLCs, which measure fund assets at fair value on a recurring basis and provide us with a NAV for our interest. As a practical expedient, we consider the NAV provided to approximate the fair value of the interest. In accordance with GAAP, we do not categorize these investments within the fair value hierarchy.
Nonrecurring Fair Value Measurements
We measure the fair value of certain assets on a nonrecurring basis when events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. These assets include investments carried principally at cost, investments in tax credit partnerships, fixed assets, goodwill and other intangible assets. These assets would also include any equity method investments that do not provide a NAV.

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Investments - Other Valuation Methodologies
Certain of our investments, in accordance with GAAP for the type of investment, are measured using methodologies other than fair value. At September 30, 2019, these investments represented approximately 5% of total investments, and are detailed in the following table. Additional information about these investments is provided in Notes 2 and 3 of the Notes to Condensed Consolidated Financial Statements.
(In millions)
Carrying Value
 
GAAP Measurement Method
Other investments:
 
 
 
Other, principally FHLB capital stock
$
2.9

 
Principally Cost
Investment in unconsolidated subsidiaries:
 
 
 
Investments in tax credit partnerships
53.6

 
Equity
Equity method investments, primarily LPs/LLCs
38.5

 
Equity
 
92.1

 
 
BOLI
65.7

 
Cash surrender value
Total investments - Other valuation methodologies
$
160.7

 
 
Other-than-temporary Impairments
We evaluate our available-for-sale investment securities on at least a quarterly basis for the purpose of determining whether declines in fair value below recorded cost basis represent OTTI. We consider an OTTI to have occurred:
•
if there is intent to sell the security;
•
if it is more likely than not that the security will be required to be sold before full recovery of its amortized cost basis; or
•
if the entire amortized basis of the security is not expected to be recovered.
The assessment of whether the amortized cost basis of a security, particularly an asset-backed debt security, is expected to be recovered requires management to make assumptions regarding various matters affecting future cash flows. The choice of assumptions is subjective and requires the use of judgment. Actual credit losses experienced in future periods may differ from management’s estimates of those credit losses. Methodologies used to estimate the present value of expected cash flows are:
For non-structured fixed maturities (obligations of states, municipalities and political subdivisions and corporate debt) the estimate of expected cash flows is determined by projecting a recovery value and a recovery time frame and assessing whether further principal and interest will be received. We consider various factors in projecting recovery values and recovery time frames, including the following:
•
third-party research and credit rating reports;
•
the current credit standing of the issuer, including credit rating downgrades, whether before or after the balance sheet date;
•
the extent to which the decline in fair value is attributable to credit risk specifically associated with the security or its issuer;
•
internal assessments and the assessments of external portfolio managers regarding specific circumstances surrounding an investment, which indicate the investment is more or less likely to recover its amortized cost than other investments with a similar structure;
•
for asset-backed securities, the origination date of the underlying loans, the remaining average life, the probability that credit performance of the underlying loans will deteriorate in the future and our assessment of the quality of the collateral underlying the loan;
•
failure of the issuer of the security to make scheduled interest or principal payments;
•
any changes to the rating of the security by a rating agency; and
•
recoveries or additional declines in fair value subsequent to the balance sheet date.
For structured securities (primarily asset-backed securities), management estimates the present value of the security’s cash flows using the effective yield of the security at the date of acquisition (or the most recent implied rate used to accrete the security if the implied rate has changed as a result of a previous impairment or changes in expected cash flows). We consider the most recently available six month averages of the levels of delinquencies, defaults, severities, and prepayments for the collateral (loans) underlying the securitization or, if historical data is not available, sector based assumptions to estimate expected future cash flows of these securities.

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Exclusive of securities where there is an intent to sell or where it is not more likely than not that the security will be required to be sold before recovery of its amortized cost basis, OTTI for debt securities is separated into a credit component and a non-credit component. The credit component of an OTTI is the difference between the security’s amortized cost basis and the present value of its expected future cash flows, while the non-credit component is the remaining difference between the security’s fair value and the present value of expected future cash flows. The credit component of the OTTI is recognized in earnings while the non-credit component is recognized in OCI.
Investments in tax credit partnerships are evaluated for OTTI by considering both qualitative and quantitative factors. These factors include, but are not limited to:
•
our ability and intent to hold the investment until the recovery of its carrying value; and
•
in situations where there was not a previous OTTI for the investment, whether the current expected cash flows from the investment, primarily tax benefits, are less than those expected at the time the investment was acquired due to various factors, such as a change in the statutory tax rate; or
•
in situations where there was a previous OTTI for the investment, whether the expected cash flows from the investment at the time of the OTTI, primarily tax benefits, are less than its current carrying value.
Investments which are accounted for under the equity method are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value of the investment might not be recoverable. These circumstances include, but are not limited to, evidence of the inability to recover the carrying value of the investment, the inability of the investee to sustain an earnings capacity that would justify the carrying value of the investment or the current fair value of the investment is less than the carrying value.
We recognize OTTI, exclusive of non-credit OTTI, in earnings as a part of net realized investment gains (losses). In subsequent periods, any measurement of gain, loss or impairment is based on the revised amortized basis of the security. Non-credit OTTI on debt securities and declines in fair value of available-for-sale securities not considered to be other-than-temporary are recognized in OCI.
Asset-backed debt securities that have been impaired due to credit reasons or are below investment grade quality are accounted for under the effective yield method. Under the effective yield method, estimates of cash flows expected over the life of asset-backed securities are used to recognize income on the investment balance for subsequent accounting periods.
Deferred Policy Acquisition Costs
Policy acquisition costs (primarily commissions, premium taxes and underwriting salaries) which are directly related to the successful acquisition of new and renewal premiums are capitalized as DPAC and charged to expense, net of ceding commissions earned, as the related premium revenue is recognized. We evaluate the recoverability of our DPAC at the segment level each reporting period, and any amounts estimated to be unrecoverable are charged to expense in the current period. As of September 30, 2019 we have not determined any amounts to be unrecoverable.
Estimation of Taxes / Tax Credits
For interim periods, we determine our provision (benefit) for income taxes based on the current estimate of our annual effective tax rate. Items which are unusual, infrequent, or that cannot be reliably estimated are considered in the effective tax rate in the period in which the item is included in income, and are referred to as discrete items. In calculating our estimated annual effective tax rate, we include the estimated benefit of tax credits for the annual period based on the most recently available information provided by the tax credit partnerships; the actual amounts of credits provided by the tax credit partnerships may prove to be different than our estimates. The effect of such a difference is recognized in the period identified.
Deferred Taxes
Deferred federal income taxes arise from the recognition of temporary differences between the basis of assets and liabilities determined for financial reporting purposes and the basis determined for income tax purposes. Our temporary differences principally relate to our loss reserve, unearned premiums, DPAC, unrealized investment gains (losses) and basis differences on fixed assets and investment assets. Deferred tax assets and liabilities are measured using the enacted tax rates expected to be in effect when such benefits are realized. We review our deferred tax assets quarterly for impairment. If we determine that it is more likely than not that some or all of a deferred tax asset will not be realized, a valuation allowance is recorded to reduce the carrying value of the asset. In assessing the need for a valuation allowance, management is required to make certain judgments and assumptions about our future operations based on historical experience and information as of the measurement period regarding reversal of existing temporary differences, carryback capacity, future taxable income (including its capital and operating characteristics) and tax planning strategies.

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A valuation allowance has been established against the deferred tax asset related to the NOL carryforwards for the U.K. operations as management concluded that it was more likely than not that the deferred tax asset will not be realized. In 2018, management also established a valuation allowance against the deferred tax assets of certain SPCs at our recently formed wholly owned Cayman Islands reinsurance subsidiary, Inova Re. Due to the limited operations of these recently formed SPCs as of December 31, 2018, management concluded that a valuation allowance was required. As of September 30, 2019, management concluded a valuation allowance was still required against the deferred tax assets related to the NOL carryforwards for the U.K. operations and against the deferred tax assets at Inova Re. See further discussion in Note 6 of the Notes to Consolidated Financial Statements in our December 31, 2018 Form 10-K.
Tax Cuts and Jobs Act
The TCJA introduced a minimum tax on payments made to related foreign entities referred to as the BEAT. The BEAT is imposed by adding back into the U.S. tax base any base erosion payment made by the U.S. taxpayer to a related foreign entity and applying a minimum tax rate to this newly calculated modified taxable income. Base erosion payments represent any amount paid or accrued by the U.S. taxpayer to a related foreign entity for which a deduction is allowed. Premiums we cede to the SPCs at Inova Re, one of our wholly owned Cayman Islands reinsurance subsidiaries, do not fall within the scope of base erosion payments as the SPCs at Inova Re intend to elect to be taxed as U.S. taxpayers. However, premiums that we cede to any active SPC at our other wholly owned Cayman Islands reinsurance subsidiary, Eastern Re, fall within the scope of base erosion payments and therefore could be significantly impacted by the BEAT. We have evaluated our exposure to the BEAT and have concluded that our expected outbound deductible payments to related foreign entities are below the threshold for application of the BEAT; therefore, we have not recognized any incremental tax expense for the BEAT provision of the TCJA for the three and nine months ended September 30, 2019. See further discussion on our Cayman Islands SPC operations in the Segment Operating Results - Segregated Portfolio Cell Reinsurance section that follows. See further discussion in Note 5 of the Notes to Condensed Consolidated Financial Statements.
The TCJA also requires a U.S. shareholder of a controlled foreign corporation to include its GILTI in U.S. taxable income. The GILTI amount is based on the U.S. shareholder’s aggregate share of the gross income of the controlled foreign corporation reduced by certain exceptions and a net deemed tangible income return. The net deemed tangible income return is based on the controlled foreign corporation’s basis in the tangible depreciable business property. Cell rental fee income earned by Inova Re and Eastern Re fall within the scope of the GILTI provisions of the TCJA. We have evaluated the new GILTI provisions of the TCJA and we have made an accounting policy election to treat the taxes due on inclusions of GILTI in U.S. taxable income as a current period expense when incurred. We recognized a nominal amount of tax expense for the GILTI provision of the TCJA during the three and nine months ended September 30, 2019. See further discussion in Note 5 of the Notes to Condensed Consolidated Financial Statements.
Unrecognized Tax Benefits
We evaluate tax positions taken on tax returns and recognize positions in our financial statements when it is more likely than not that we will sustain the position upon resolution with a taxing authority. If recognized, the benefit is measured as the largest amount of benefit that has a greater than 50% probability of being realized. We review uncertain tax positions each period, considering changes in facts and circumstances, such as changes in tax law, interactions with taxing authorities and developments in case law, and make adjustments as we consider necessary. Adjustments to our unrecognized tax benefits may affect our income tax expense, and settlement of uncertain tax positions may require the use of cash. Other than differences related to timing, no significant adjustments were considered necessary during the three and nine months ended September 30, 2019 or 2018. At September 30, 2019, our liability for unrecognized tax benefits approximated $3.7 million.
Goodwill
Impairment of goodwill is tested at the reporting unit level, which is consistent with our reportable segments identified in Note 14 of the Notes to Condensed Consolidated Financial Statements. Of the five reporting units, three have goodwill - Specialty P&C, Workers' Compensation Insurance and Segregated Portfolio Cell Reinsurance. We evaluate goodwill for impairment annually on October 1, upon the occurrence of certain triggering events or substantive changes in circumstances that indicate the fair value of goodwill may be impaired, and immediately before and after a reorganization that affects the composition of one or more of our reporting units. As of the most recent evaluation date on October 1, 2018, we elected to perform a quantitative goodwill impairment assessment for our Specialty P&C, Workers' Compensation Insurance and Segregated Portfolio Cell Reinsurance reporting units. As of that evaluation date, management concluded that the fair value of each of our three reporting units that have goodwill were greater than their carrying value; therefore, goodwill was not impaired and no further impairment testing was required. There have been no events or changes in circumstances since that evaluation date that would indicate the carrying amount of goodwill is not recoverable. Additional information regarding our goodwill assessment at the reporting unit level is included in Note 1 of the Notes to Consolidated Financial Statements included in ProAssurance's December 31, 2018 report on Form 10-K.

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Intangibles
Intangible assets with definite lives are amortized over the estimated useful life of the asset. Amortizable intangible assets primarily consist of agency and policyholder relationships, renewal rights and trade names. Intangible assets with an indefinite life, primarily state licenses, are not amortized. Intangible assets are evaluated for impairment on an annual basis or upon the occurrence of certain triggering events or substantive changes in circumstances that indicate the fair value of the asset may be impaired. Additional information regarding our intangible assets is included in Note 1 of the Notes to Consolidated Financial Statements included in ProAssurance's December 31, 2018 report on Form 10-K.
Leases
During the first quarter of 2019, we adopted ASU 2016-02, which requires us to make certain estimates and assumptions in applying the requirements of this new guidance. We are involved in a number of leases, primarily for office facilities. We determine if an arrangement is a lease at the inception date of the contract and classify all leases as either financing or operating. As of September 30, 2019, all of our leases were classified as operating. Operating ROU assets and operating lease liabilities are recognized as of the lease commencement date based on the present value of the remaining lease payments, discounted over the term of the lease using a discount rate determined based on information available as of the commencement date. The ROU asset represents the right to use the underlying asset (office space) for the lease term. As the majority of our lessors do not provide an implicit discount rate, we use our collateralized incremental borrowing rate in determining the present value of remaining lease payments. For leases entered into or reassessed after the adoption of ASU 2016-02, we account for lease and non-lease components of a contract as a single lease component.
We evaluate our operating lease ROU assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The carrying amount of a ROU asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use of the underlying leased asset over the remaining lease term. That assessment is based on the carrying amount of the ROU asset at the date it is tested for recoverability and an impairment loss is measured and recognized as the amount by which the carrying amount of the ROU asset exceeds its fair value. Additional information regarding our leases is included in Note 1 and Note 8 of the Notes to Condensed Consolidated Financial Statements.
Audit Premium
Workers’ compensation premiums are determined based upon the payroll of the insured, respective premium rates and, where applicable, an experience-based modification factor. An audit of the policyholders’ records is conducted after policy expiration to make a final determination of applicable premiums. Audit premium due from or due to a policyholder as a result of an audit is reflected in net premiums written and earned when billed. We track, by policy, the amount of additional premium billed in final audit invoices as a percentage of payroll exposure and use this information to estimate the probable additional amount of EBUB premium as of the balance sheet date. We include changes to the EBUB premium estimate in net premiums written and earned in the period recognized.
Lloyd’s Premium Estimates
For certain insurance policies and reinsurance contracts written in our Lloyd’s Syndicates segment, premiums are initially recognized based upon estimates of ultimate premium. Estimated ultimate premium consists primarily of premium written under delegated underwriting authority arrangements, which consist primarily of binding authorities, and certain assumed reinsurance agreements. These estimates of ultimate premium are judgmental and are dependent upon certain assumptions, including historical premium trends for similar agreements. As reports are received from programs, ultimate premium estimates are revised, if necessary, with changes reflected in current operations.
Accounting Changes
We did not have any change in accounting estimate or policy that had a material effect on our results of operations or financial position during the nine months ended September 30, 2019. We are not aware of any accounting changes not yet adopted as of September 30, 2019 that would have a material effect on our results of operations or financial position. Note 1 of the Notes to Condensed Consolidated Financial Statements provides additional detail regarding accounting changes not yet adopted.

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Liquidity and Capital Resources and Financial Condition
Overview
ProAssurance Corporation is a holding company and is a legal entity separate and distinct from its subsidiaries. As a holding company our principal source of external revenue is our investment revenues. In addition, dividends from our operating subsidiaries represent a significant source of funds for our obligations, including debt service and shareholder dividends. We also charge our operating subsidiaries within our Specialty P&C and Workers' Compensation Insurance segments a management fee based on the extent to which services are provided to the subsidiary and the amount of gross premium written by the subsidiary. At September 30, 2019, we held cash and liquid investments of approximately $227 million outside our insurance subsidiaries that were available for use without regulatory approval or other restriction. We also have $200 million in permitted borrowings under our Revolving Credit Agreement and an accordion feature available which, if subscribed successfully, would allow another $50 million in available funds. As of October 31, 2019, no borrowings were outstanding under our Revolving Credit Agreement.
To date, during 2019, our operating subsidiaries have paid dividends to us of approximately $103 million, which included $52 million that was paid in October 2019. Dividends paid in October 2019 have not been included in our cash and liquid investments held outside of our insurance subsidiaries at September 30, 2019. After considering the dividends paid in October 2019, our insurance subsidiaries, in the aggregate, are permitted to pay additional dividends of approximately $28 million over the remainder of 2019 without prior approval of state insurance regulators. However, the payment of any dividend requires prior notice to the insurance regulator in the state of domicile, and the regulator may reduce or prevent the dividend if, in its judgment, payment of the dividend would have an adverse effect on the surplus of the insurance subsidiary. We make the decision to pay dividends from an insurance subsidiary based on the capital needs of that subsidiary, and may pay less than the permitted dividend or may also request permission to pay an additional amount (an extraordinary dividend).
Cash Flows
Cash flows between periods compare as follows:
 
Nine Months Ended September 30
(In thousands)
2019
 
2018
 
Change
Net cash provided (used) by:
 
 
 
 
 
Operating activities
$
128,803

 
$
146,394

 
$
(17,591
)
Investing activities
(25,717
)
 
234,783

 
(260,500
)
Financing activities
(81,346
)
 
(428,113
)
 
346,767

Increase (decrease) in cash and cash equivalents
$
21,740

 
$
(46,936
)
 
$
68,676

 
Nine Months Ended September 30
(In thousands)
2018
 
2017
 
Change
Net cash provided (used) by:
 
 
 
 
 
Operating activities
$
146,394

 
$
118,181

 
$
28,213

Investing activities
234,783

 
232,152

 
2,631

Financing activities
(428,113
)
 
(348,675
)
 
(79,438
)
Increase (decrease) in cash and cash equivalents
$
(46,936
)
 
$
1,658

 
$
(48,594
)
The principal components of our operating cash flows are the excess of premiums collected and net investment income over losses paid and operating costs, including income taxes. Timing delays exist between the collection of premiums and the payment of losses associated with the premiums. Premiums are generally collected within the twelve-month period after the policy is written, while our claim payments are generally paid over a more extended period of time. Likewise, timing delays exist between the payment of claims and the collection of any associated reinsurance recoveries.
The decrease in operating cash flows for the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018 of $17.6 million was primarily due to an increase in paid losses of $19.0 million and a decrease in cash received from investment income of $16.0 million. The increase in paid losses was driven by our Workers' Compensation Insurance and Specialty P&C segments primarily due to the timing of loss payments between periods. The decrease in cash received from investment income was primarily due to a decline in distributed earnings from our unconsolidated subsidiaries. In addition, the decrease in operating cash flows reflected a decrease in net cash received of $7.1 million associated with the cash settlement of the 2017 and 2016 calendar year quota share reinsurance arrangements between our Specialty P&C segment and Syndicate 1729 due to the reduction in premiums ceded to Syndicate 1729. The decrease in operating cash flows was

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partially offset by an increase in net premium receipts of $20.5 million and a decrease in cash paid for operating expenses of $3.7 million. The increase in net premium receipts was primarily due to the growth in written premium in our Lloyd's Syndicates and Specialty P&C segments. The decrease in cash paid for operating expenses was largely attributable to a decrease in other compensation related costs in our Corporate segment, primarily as a result of lower bonuses, and, to a lesser extent, our Lloyd's Syndicates segment primarily due to the effect of higher operational expenses incurred during 2018 associated with the establishment of Syndicate 6131. The remaining variance in operating cash flows for the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018 was comprised of individually insignificant components.
The increase in operating cash flows for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017 of $28.2 million was primarily due to an increase in premium receipts of $52.9 million and a decrease in 2018 estimated tax payments as compared to 2017 of $9.9 million, partially offset by an increase in paid losses of $28.6 million, an increase in cash paid for operating expenses of $5.4 million and a decrease in cash received from investment income of $2.6 million. The increase in premium receipts was driven by our Specialty P&C segment, primarily due to premium received from a loss portfolio transfer entered into during the second quarter of 2018 and, to a lesser extent, our Workers' Compensation Insurance segment, primarily due to premiums received related to the third quarter 2017 acquisition of the Great Falls book of business. The increase in paid losses was driven by all of our operating segments, particularly in our Lloyd's Syndicates segment, primarily due to storm-related losses related to 2017 Hurricanes Harvey, Irma and Maria, and our Specialty P&C segment. The increase in cash paid for operating expenses was primarily due to an increase in compensation related costs and commission expenses and the decrease in cash received from investment income was primarily due to a reduction in dividends received on our fixed maturities portfolio resulting from lower average balances. The remaining variance in operating cash flows for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017 was comprised of individually insignificant components.
We manage our investing cash flows to ensure that we will have sufficient liquidity to meet our obligations, taking into consideration the timing of cash flows from our investments, including interest payments, dividends and principal payments, as well as the expected cash flows to be generated by our operations as discussed in this section under the heading "Investing Activities and Related Cash Flows."
Our financing cash flows are primarily composed of dividend payments and borrowings and repayments under our Revolving Credit Agreement. See further discussion of our financing activities in this section under "Financing Activities and Related Cash Flows."

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Operating Activities and Related Cash Flows
Reinsurance
Within our Specialty P&C segment, we use insurance and reinsurance (collectively, “reinsurance”) to provide capacity to write larger limits of liability, to provide reimbursement for losses incurred under the higher limit coverages we offer and to provide protection against losses in excess of policy limits. Within our Workers' Compensation Insurance segment, we use reinsurance to reduce our net liability on individual risks, to mitigate the effect of significant loss occurrences (including catastrophic events), to stabilize underwriting results, and to increase underwriting capacity by decreasing leverage. In both our Specialty P&C and Workers' Compensation Insurance segments, we use reinsurance in risk sharing arrangements to align our objectives with those of our strategic business partners and to provide custom insurance solutions for large customer groups. The purchase of reinsurance does not relieve us from the ultimate risk on our policies; however, it does provide reimbursement for certain losses we pay. We pay our reinsurers a premium in exchange for reinsurance of the risk. In certain of our excess of loss arrangements, the premium due to the reinsurer is determined by the loss experience of the business reinsured, subject to certain minimum and maximum amounts. Until all loss amounts are known, we estimate the premium due to the reinsurer. Changes to the estimate of premium owed under reinsurance agreements related to prior periods are recorded in the period in which the change in estimate occurs and can have a significant effect on net premiums earned.
We offer alternative market solutions whereby we cede certain premiums from our Workers' Compensation Insurance and Specialty P&C segments to either the SPCs at Inova Re or Eastern Re, our Cayman Islands reinsurance subsidiaries which are reported in our Segregated Portfolio Cell Reinsurance segment, or, to a limited extent, an unaffiliated captive insurer. During the three and nine months ended September 30, 2019, we wrote total alternative market premium of approximately $17.4 million and $73.0 million, respectively, and approximately $17.5 million and $73.1 million during the same respective periods of 2018. The majority of these policies ($17.3 million and $70.1 million of premium for the three and nine months ended September 30, 2019, respectively, and $16.8 million and $68.3 million for the same respective periods of 2018) are reinsured to the SPCs at Inova Re or Eastern Re, net of a ceding commission. Each SPC at Inova Re and Eastern Re is owned, fully or in part, by an agency, group or association and the operating results of the SPCs are due to the participants of that cell. We participate to a varying degree in the results of selected SPCs and, for the SPCs in which we participate, our participation interest ranges from a low of 20% to high of 85%. SPC operating results due to external cell participants are reflected as an SPC dividend expense (income) in our Segregated Portfolio Cell Reinsurance segment. See further discussion on our SPC operations in the Segment Operating Results - Segregated Portfolio Cell Reinsurance section that follows. The alternative market workers' compensation policies are ceded from our Workers' Compensation Insurance segment to the SPCs under 100% quota share reinsurance agreements. The alternative market professional liability policies are ceded from our Specialty P&C segment to the SPCs under either excess of loss or quota share reinsurance agreements, depending on the structure of the individual program, and the nominal portion of the risk that is not ceded to an SPC is retained in our Specialty P&C segment and may also be reinsured under our standard healthcare professional liability reinsurance program depending on the policy limits provided. The remaining premium written in our alternative market business of $2.4 million for the 2019 nine-month period and $0.5 million and $4.3 million for the 2018 three- and nine- month periods, respectively, is 100% ceded to an unaffiliated captive insurer.
For all of our segments, we make a determination of the amount of insurance risk we choose to retain based upon numerous factors, including our risk tolerance and the capital we have to support it, the price and availability of reinsurance, the volume of business, our level of experience with a particular set of claims and our analysis of the potential underwriting results. We purchase excess of loss reinsurance to limit the amount of risk we retain and we do so from a number of companies to mitigate concentrations of credit risk. We utilize reinsurance brokers to assist us in the placement of these reinsurance programs and in the analysis of the credit quality of our reinsurers. The determination of which reinsurers we choose to do business with is based upon an evaluation of their then current financial strength, rating and stability. However, the financial strength of our reinsurers and their corresponding ability to pay us may change in the future due to forces or events we cannot control or anticipate.

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Excess of Loss Reinsurance Agreements
We generally reinsure risks under treaties (our excess of loss reinsurance agreements) pursuant to which the reinsurers agree to assume all or a portion of all risks that we insure above our individual risk retention levels, up to the maximum individual limits offered. These agreements are negotiated and renewed annually. Renewal dates for our healthcare professional liability, medical technology liability and workers' compensation treaties are October 1, January 1 and May 1, respectively. There were no significant changes in the cost or structure of our professional liability and medical technology liability treaties which renewed October 1, 2019 and January 1, 2019, respectively. Our workers' compensation treaty renewed May 1, 2019 at a lower rate; however, the renewed treaty includes the addition of an AAD and the elimination of the return premium component of the contract. The significant coverages provided by our current excess of loss reinsurance agreements are detailed in the following table.
Excess of Loss Reinsurance Agreements
reinsurancechart.jpg
 
Healthcare Professional Liability
 
Medical Technology & Life Sciences Products
 
Workers'
Compensation - Traditional
(1) Historically, retention has ranged from 5% to 32.5%.
(2) Historically, retention has been as high as $2M.
(3) Includes an AAD where retention is the greater of $3.9M or 2.1% of subject premium in annual losses otherwise recoverable in excess of the $500k retention per loss occurrence.
Large professional liability risks that are above the limits of our basic reinsurance treaties are reinsured on a facultative basis, whereby the reinsurer agrees to insure a particular risk up to a designated limit. We also have in place a number of risk sharing arrangements that apply to the first $1 million of losses for certain large healthcare systems and other insurance entities, as well as with certain insurance agencies that produce business for us.

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Other Reinsurance Arrangements
For the workers' compensation business ceded to Inova Re and Eastern Re, each SPC has in place its own reinsurance arrangements; which are illustrated in the following table.
Segregated Portfolio Cell Reinsurance
capturea24.jpg
Per Occurrence Coverage
 
Aggregate Coverage (1)
(1) Prior to May 1, 2018, ProAssurance assumed 100% of aggregate losses in excess of an aggregate attachment point with a maximum loss limit of $100K. Effective May 1, 2018, ProAssurance no longer participates in the aggregate reinsurance coverage.
(2) The attachment point is based on a percentage of written premium within individual cells (average is 89%) and varies by cell.
Each SPC has participants and the profit or loss of each cell accrues fully to these cell participants. As previously discussed, we participate in certain SPCs to a varying degree. Each SPC maintains a loss fund initially equal to the difference between premium assumed by the cell and the ceding commission. The external participants of each cell provide a letter of credit to us that is initially equal to the difference between the loss fund of the SPC (amount of funds available to pay losses after deduction of ceding commission) and the aggregate attachment point of the reinsurance. Over time, an SPC's retained profits are considered in the determination of the collateral amount required to be provided by the cell's external participants.
Within our Lloyd's Syndicates segment, Syndicate 1729 utilizes reinsurance to provide capacity to write larger limits of liability on individual risks, to provide protection against catastrophic loss and to provide protection against losses in excess of policy limits. The level of reinsurance that Syndicate 1729 purchases is dependent on a number of factors, including its underwriting risk appetite for catastrophic exposure, the specific risks inherent in each line or class of business written and the pricing, coverage and terms and conditions available from the reinsurance market. Reinsurance protection by line of business is as follows:
•
Reinsurance is utilized on a per risk basis for the property insurance and casualty coverages in order to mitigate risk volatility.
•
Catastrophic protection is utilized on both our property insurance and casualty coverages to protect against losses in excess of policy limits as well as natural catastrophes.
•
Both quota share reinsurance and excess of loss reinsurance are utilized to manage the net loss exposure on our property reinsurance coverages.

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•
Property umbrella excess of loss reinsurance is utilized for peak catastrophe and frequency of catastrophe exposures.
•
External excess of loss reinsurance is utilized by Syndicate 1729 to manage the net loss exposure on the specialty property and contingency coverages ceded to Syndicate 6131 (see further discussion in Segment Operating Results - Lloyd's Syndicates section that follows).
Syndicate 1729 may still be exposed to losses that exceed the level of reinsurance purchased as well as to reinstatement premiums triggered by losses exceeding specified levels. Cash demands on Syndicate 1729 can vary significantly depending on the nature and intensity of a loss event. For significant reinsured catastrophe losses, the inability or unwillingness of the reinsurer to make timely payments under the terms of the reinsurance agreement could have an adverse effect on Syndicate 1729's liquidity.
Litigation
We are involved in various legal actions related to insurance policies and claims handling including, but not limited to, claims asserted against us by policyholders. These types of legal actions arise in the ordinary course of business and, in accordance with GAAP for insurance entities, are generally considered as a part of our loss reserving process, which is described in detail in our Critical Accounting Estimates section under the heading "Reserve for Losses and Loss Adjustment Expenses." We also have other direct actions against the Company unrelated to our claims activity which we evaluate and account for as a part of our other liabilities. For these corporate legal actions, we evaluate each case separately and establish what we believe is an appropriate reserve based on GAAP guidance related to contingent liabilities. As of September 30, 2019 there were no material reserves established for corporate legal actions.

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Investing Activities and Related Cash Flows
Our investments at September 30, 2019 and December 31, 2018 are comprised as follows:
 
September 30, 2019
 
December 31, 2018
($ in thousands)
Carrying
Value
% of Total Investment
 
Carrying
Value
% of Total Investment
Fixed maturities, available for sale
 
 
 
 
 
U.S. Treasury obligations
$
120,920

3
%
 
$
120,201

4
%
U.S. Government-sponsored enterprise obligations
22,334

1
%
 
35,354

1
%
State and municipal bonds
293,397

8
%
 
293,772

9
%
Corporate debt
1,348,649

39
%
 
1,223,475

37
%
Residential mortgage-backed securities
201,843

6
%
 
181,238

5
%
Commercial mortgage-backed securities
82,719

2
%
 
44,101

1
%
Other asset-backed securities
231,673

7
%
 
195,657

6
%
Total fixed maturities, available for sale
2,301,535

66
%
 
2,093,798

63
%
Fixed maturities, trading
45,295

1
%
 
38,188

1
%
Total fixed maturities
2,346,830

67
%
 
2,131,986

64
%
 
 

 
 
 
Equity investments
409,100

12
%
 
442,937

13
%
Short-term investments
270,836

8
%
 
308,319

9
%
BOLI
65,653

2
%
 
64,096

1
%
Investment in unconsolidated subsidiaries
366,606

10
%
 
367,757

11
%
Other investments
37,049

1
%
 
34,287

2
%
Total investments
$
3,496,074

100
%
 
$
3,349,382

100
%
At September 30, 2019, 99% of our investments in available-for-sale fixed maturity securities were rated and the average rating was A+. The distribution of our investments in available-for-sale fixed maturity securities by rating were as follows:
 
September 30, 2019
 
December 31, 2018
 ($ in thousands)
Carrying
Value
% of Total Investment
 
Carrying
Value
% of Total Investment
Rating*
 
 
 
 
 
AAA
$
706,875

31
%
 
$
645,300

31
%
AA+
83,868

3
%
 
101,328

5
%
AA
138,901

6
%
 
120,801

6
%
AA-
155,946

7
%
 
155,352

7
%
A+
177,490

8
%
 
190,595

9
%
A
341,298

15
%
 
311,036

15
%
A-
157,089

7
%
 
146,721

7
%
BBB+
187,486

8
%
 
133,199

6
%
BBB
159,508

7
%
 
118,864

6
%
BBB-
53,222

2
%
 
50,466

2
%
Below investment grade
130,710

5
%
 
100,447

5
%
Not rated
9,142

1
%
 
19,689

1
%
Total
$
2,301,535

100
%
 
$
2,093,798

100
%
*Average of three NRSRO sources, presented as an S&P equivalent. Source: S&P, Copyright ©2019, S&P Global Market Intelligence

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A detailed listing of our investment holdings as of September 30, 2019 is located under the Financial Information heading on the Investor Relations page of our website which can be reached directly at www.proassurance.com/investmentholdings or through links from the Investor Relations section of our website, investor.proassurance.com.
We manage our investments to ensure that we will have sufficient liquidity to meet our obligations, taking into consideration the timing of cash flows from our investments, including interest payments, dividends and principal payments, as well as the expected cash flows to be generated by our operations. In addition to the interest and dividends we will receive, we anticipate that between $40 million and $90 million of our investments will mature (or be paid down) each quarter over the next twelve months and become available, if needed, to meet our cash flow requirements. The primary outflow of cash at our insurance subsidiaries is related to paid losses and operating costs, including income taxes. The payment of individual claims cannot be predicted with certainty; therefore, we rely upon the history of paid claims in estimating the timing of future claims payments. To the extent that we may have an unanticipated shortfall in cash, we may either liquidate securities or borrow funds under existing borrowing arrangements through our Revolving Credit Agreement and the FHLB system. As of October 31, 2019, $250 million could be made available for use through our Revolving Credit Agreement, as discussed in this section under the heading "Debt." Given the duration of our investments, we do not foresee a shortfall that would require us to meet operating cash needs through additional borrowings. Additional information regarding our Revolving Credit Agreement is detailed in Note 9 of the Notes to Condensed Consolidated Financial Statements.
At September 30, 2019, our FAL was comprised of fixed maturity securities with a fair value of $124.6 million and cash and cash equivalents of $10.1 million deposited with Lloyd's. See further discussion in Note 3 of the Notes to Condensed Consolidated Financial Statements.
Our investment portfolio continues to be primarily composed of high quality fixed income securities with approximately 94% of our fixed maturities being investment grade securities as determined by national rating agencies. The weighted average effective duration of our fixed maturity securities at September 30, 2019 was 2.95 years; the weighted average effective duration of our fixed maturity securities combined with our short-term securities was 2.64 years.
The carrying value and unfunded commitments for certain of our investments were as follows:
 
Carrying Value
 
September 30, 2019
($ in thousands, except expected funding period)
September 30, 2019
December 31, 2018
 
Unfunded Commitment
Expected funding period in years
Qualified affordable housing project tax credit partnerships (1)
$
50,989

$
65,677

 
$
885

6
Historic tax credit partnerships (2)
2,570

3,757

 
276

1
All other investments, primarily investment fund LPs/LLCs
313,047

298,323

 
176,343

5
Total
$
366,606

$
367,757

 
$
177,504

 
(1) The carrying value reflects our total commitments (both funded and unfunded) to the partnerships, less any amortization, since our initial investment. We fund these investments based on funding schedules maintained by the partnerships.
(2) The carrying value reflects our funded commitments less any amortization.
Investment fund LPs/LLCs are by nature less liquid and may involve more risk than other investments. We manage our risk through diversification of asset class and geographic location. At September 30, 2019, we had investments in 38 separate investment funds with a total carrying value of $313.0 million which represented approximately 9% of our total investments. We review and monitor the performance of these investments on a quarterly basis.

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Financing Activities and Related Cash Flows
Treasury Shares
During the nine months ended September 30, 2019 and 2018, we did not repurchase any common shares and, as of October 31, 2019, our remaining Board authorization was approximately $110 million.
ProAssurance Shareholder Dividends
Our Board declared quarterly cash dividends of $0.31 per share during each of the first three quarters of both 2019 and 2018, each of which was paid in the following quarter. Dividends paid in the first nine months of 2019 and 2018 included special dividends of $0.50 and $4.69 per share, respectively, declared in the fourth quarters of 2018 and 2017, respectively. Any decision to pay future cash dividends is subject to the Board’s final determination after a comprehensive review of financial performance, future expectations and other factors deemed relevant by the Board.
Debt
At September 30, 2019 our debt included $250 million of outstanding unsecured senior notes. The notes bear interest at 5.3% annually and are due in 2023 although they may be redeemed in whole or part prior to maturity. There are no financial covenants associated with these notes.
We have a Revolving Credit Agreement, which expires in June 2020, that may be used for general corporate purposes, including, but not limited to, short-term working capital, share repurchases as authorized by the Board and support for other activities. Our Revolving Credit Agreement permits borrowings of up to $200 million, and has available a $50 million accordion feature, which, if successfully subscribed, would expand permitted borrowings up to $250 million. At September 30, 2019, there were no outstanding borrowings on our Revolving Credit Agreement; we are in compliance with the financial covenants of the Revolving Credit Agreement.
We have Mortgage Loans with one lender in connection with the recapitalization of two office buildings, which mature in December 2027. The Mortgage Loans accrue interest at three-month LIBOR plus 1.325% with principal and interest payable on a quarterly basis. At September 30, 2019, the outstanding balance of the Mortgage Loans was approximately $38 million; we are in compliance with the financial covenant of the Mortgage Loans.
Additional information regarding our debt is provided in Note 9 of the Notes to Condensed Consolidated Financial Statements.
We utilize an interest rate cap agreement with a notional amount of $35 million to manage our exposure to increases in LIBOR on our Mortgage Loans. Per the interest rate cap agreement, we are entitled to receive cash payments if and when the three-month LIBOR exceeds 2.35%. Additional information on our interest rate cap agreement is provided in Note 10 of the Notes to Condensed Consolidated Financial Statements.
Two of our insurance subsidiaries are members of an FHLB. Through membership, those subsidiaries have access to secured cash advances which can be used for liquidity purposes or other operational needs. In order for us to use FHLB proceeds, regulatory approvals may be required depending on the nature of the transaction. To date, those subsidiaries have not materially utilized their membership for borrowing purposes.
Off-Balance Sheet Arrangements
We have no significant off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. See more information on our off-balance sheet arrangements in Note 7 of the Notes to Condensed Consolidated Financial Statements.

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Results of Operations – Three and Nine Months Ended September 30, 2019 Compared to Three and Nine Months Ended September 30, 2018
Selected consolidated financial data for each period is summarized in the table below.
 
Three Months Ended September 30
 
 
Nine Months Ended September 30
 
($ in thousands, except per share data)
2019
2018
Change
 
 
2019
2018
Change
 
Revenues:
 
 
 
 
 
 
 
 
 
Net premiums written
$
228,058

$
229,329

$
(1,271
)
 
 
$
663,784

$
652,230

$
11,554

 
Net premiums earned
$
215,788

$
206,070

$
9,718

 
 
$
633,086

$
616,819

$
16,267

 
Net investment result
22,404

28,494

(6,090
)
 
 
62,798

79,924

(17,126
)
 
Net realized investment gains (losses)
1,134

12,373

(11,239
)
 
 
47,064

2,651

44,413

 
Other income
2,548

2,388

160

 
 
7,419

7,155

264

 
Total revenues
241,874

249,325

(7,451
)
 
 
750,367

706,549

43,818

 
 
 
 
 
 
 
 
 
 
 
Expenses:
 
 
 
 
 
 
 
 
 
Net losses and loss adjustment expenses
161,614

147,605

14,009

 
 
489,808

439,120

50,688

 
Underwriting, policy acquisition and operating expenses
61,861

61,844

17

 
 
185,960

178,812

7,148

 
Segregated portfolio cells dividend expense (income)
3,621

5,255

(1,634
)
 
 
1,375

9,787

(8,412
)
 
Interest expense
4,274

3,599

675

 
 
12,850

11,262

1,588

 
Total expenses
231,370

218,303

13,067

 
 
689,993

638,981

51,012

 
Income before income taxes
10,504

31,022

(20,518
)
 
 
60,374

67,568

(7,194
)
 
Income tax expense (benefit)
(6,689
)
(206
)
(6,483
)
 
 
(4
)
(3,939
)
3,935

 
Net income
$
17,193

$
31,228

$
(14,035
)
 
 
$
60,378

$
71,507

$
(11,129
)
 
Non-GAAP operating income
$
16,269

$
22,417

$
(6,148
)
 
 
$
24,567

$
69,858

$
(45,291
)
 
Earnings per share:
 
 
 
 
 
 
 
 
 
Basic
$
0.32

$
0.58

$
(0.26
)
 
 
$
1.12

$
1.33

$
(0.21
)
 
Diluted
$
0.32

$
0.58

$
(0.26
)
 
 
$
1.12

$
1.33

$
(0.21
)
 
Non-GAAP operating earnings per share:
 
 
 
 
 
 
 
 
 
Basic
$
0.30

$
0.42

$
(0.12
)
 
 
$
0.46

$
1.30

$
(0.84
)
 
Diluted
$
0.30

$
0.42

$
(0.12
)
 
 
$
0.46

$
1.30

$
(0.84
)
 
Net loss ratio
74.9
%
71.6
%
3.3

pts
 
77.4
%
71.2
%
6.2

pts
Underwriting expense ratio
28.7
%
30.0
%
(1.3
)
pts
 
29.4
%
29.0
%
0.4

pts
Combined ratio
103.6
%
101.6
%
2.0

pts
 
106.8
%
100.2
%
6.6

pts
Operating ratio
92.6
%
90.3
%
2.3

pts
 
95.7
%
89.2
%
6.5

pts
Effective tax rate
(63.7
%)
(0.7
%)
(63.0
)
pts
 
—
%
(5.8
%)
5.8

pts
Return on equity*
4.3
%
7.9
%
(3.6
)
pts
 
5.2
%
6.0
%
(0.8
)
pts
 
 
 
 
 
 
 
 
 
 
* Annualized
In all tables that follow, the abbreviation "nm" indicates that the information or the percentage change is not meaningful.



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Executive Summary of Operations
The following sections provide an overview of our consolidated and segment results of operations for the three and nine months ended September 30, 2019 as compared to the three and nine months ended September 30, 2018. See the Segment Operating Results sections that follow for additional information regarding each segment's operating results.
Revenues
The following table shows our consolidated and segment net premiums earned:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Net premiums earned
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Specialty P&C
$
125,237

 
$
120,789

 
$
4,448

 
3.7
%
 
$
375,315

 
$
378,355

 
$
(3,040
)
 
(0.8
%)
Workers' Compensation Insurance
49,477

 
47,296

 
2,181

 
4.6
%
 
141,990

 
135,230

 
6,760

 
5.0
%
Segregated Portfolio Cell Reinsurance
19,779

 
18,963

 
816

 
4.3
%
 
58,566

 
54,247

 
4,319

 
8.0
%
Lloyd's Syndicates
21,295

 
19,022

 
2,273

 
11.9
%
 
57,215

 
48,987

 
8,228

 
16.8
%
Consolidated total
$
215,788

 
$
206,070

 
$
9,718

 
4.7
%
 
$
633,086

 
$
616,819

 
$
16,267

 
2.6
%
Consolidated net premiums earned for the three and nine months ended September 30, 2019 included $2.7 million of premium written and fully earned from a loss portfolio transfer entered into during the third quarter of 2019 in our Specialty P&C segment. For the nine months ended September 30, 2018, our consolidated net premiums earned included $26.6 million of premium written and fully earned from a loss portfolio transfer entered into during the second quarter of 2018 in our Specialty P&C segment. See further discussion of these loss portfolio transfers in our Segment Operating Results - Specialty Property & Casualty section that follows. After removing the impacts of the 2019 and 2018 loss portfolio transfers, consolidated net premiums earned increased $7.0 million and $40.2 million during the three and nine months ended September 30, 2019, respectively, as compared to the same periods of 2018. All of our operating segments contributed to the remaining increase in consolidated net premiums earned during three and nine months ended September 30, 2019 as compared to the same respective periods of 2018. For the 2019 nine-month period, the remaining increase was driven by our Specialty P&C segment due to the pro rata effect of an increase in the volume of written premium during the preceding twelve months, predominantly in our healthcare facilities and physicians lines of business, driven by an increase in renewal pricing.
The following table shows our consolidated net investment result:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Net investment income
$
23,681

 
$
23,266

 
$
415

 
1.8
%
 
$
70,038

 
$
67,677

 
$
2,361

 
3.5
%
Equity in earnings (loss) of unconsolidated subsidiaries
(1,277
)
 
5,228

 
(6,505
)
 
(124.4
%)
 
(7,240
)
 
12,247

 
(19,487
)
 
(159.1
%)
Net investment result
$
22,404

 
$
28,494

 
$
(6,090
)
 
(21.4
%)
 
$
62,798

 
$
79,924

 
$
(17,126
)
 
(21.4
%)
The decrease in our consolidated net investment result for the three and nine months ended September 30, 2019 as compared to the same periods of 2018 was primarily attributable to a decrease in earnings from our unconsolidated subsidiaries, somewhat offset by an increase in net investment income. The decrease in earnings from our unconsolidated subsidiaries for the three and nine months ended September 30, 2019 was driven by lower reported earnings from two LP investments. The increase in net investment income for the three and nine months ended September 30, 2019 was primarily due to higher earnings from our fixed maturity securities and short-term investments due to higher yields in certain asset classes within those portfolios as compared to the same periods of 2018.

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The following table shows our total consolidated net realized investment gains (losses):
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Net impairment losses recognized in earnings
$
(30
)
 
$
(86
)
 
$
56

 
(65.1
%)
 
$
(78
)
 
$
(490
)
 
$
412

 
(84.1
%)
Other net realized investment gains (losses)
1,164

 
12,459

 
(11,295
)
 
(90.7
%)
 
47,142

 
3,141

 
44,001

 
1,400.9
%
Net realized investment gains (losses)
$
1,134

 
$
12,373

 
$
(11,239
)
 
(90.8
%)
 
$
47,064

 
$
2,651

 
$
44,413

 
1,675.3
%
For the three and nine months ended September 30, 2019, we recognized a nominal amount of both credit related OTTI in earnings and non-credit OTTI in OCI, both of which related to a corporate bond. We recognized OTTI in earnings of $0.1 million and $0.5 million during the 2018 three- and nine- month periods, respectively, related to debt instruments from two issuers in the energy sector.
Other net realized investment gains primarily reflected changes in the value of our equity trading portfolio and realized gains and losses from the sale of equity securities during the 2019 three- and nine- month periods. See further discussion in our Segment Operating Results - Corporate section that follows.
Expenses
The following table shows our consolidated and segment net loss ratios and net prior accident year loss development:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Current accident year net loss ratio
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated ratio
82.3
%
 
82.1
%
 
0.2

pts
 
84.0
%
 
82.1
%
 
1.9

pts
Specialty P&C
94.5
%
 
93.4
%
 
1.1

pts
 
93.9
%
 
91.9
%
 
2.0

pts
Workers' Compensation Insurance
68.2
%
 
70.7
%
 
(2.5
)
pts
 
68.2
%
 
68.0
%
 
0.2

pts
Segregated Portfolio Cell Reinsurance
66.1
%
 
64.8
%
 
1.3

pts
 
82.5
%
 
66.0
%
 
16.5

pts
Lloyd's Syndicates
58.3
%
 
56.1
%
 
2.2

pts
 
60.5
%
 
62.7
%
 
(2.2
)
pts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Calendar year net loss ratio
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated ratio
74.9
%
 
71.6
%
 
3.3

pts
 
77.4
%
 
71.2
%
 
6.2

pts
Specialty P&C
85.9
%
 
81.4
%
 
4.5

pts
 
85.6
%
 
77.4
%
 
8.2

pts
Workers' Compensation Insurance
65.4
%
 
64.8
%
 
0.6

pts
 
65.8
%
 
64.9
%
 
0.9

pts
Segregated Portfolio Cell Reinsurance
49.4
%
 
45.1
%
 
4.3

pts
 
69.1
%
 
50.8
%
 
18.3

pts
Lloyd's Syndicates
55.9
%
 
52.7
%
 
3.2

pts
 
60.5
%
 
63.3
%
 
(2.8
)
pts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Favorable (unfavorable) net loss development, prior accident years
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
$
15,941

 
$
21,549

 
$
(5,608
)
 
 
$
42,212

 
$
67,149

 
$
(24,937
)
 
Specialty P&C
$
10,750

 
$
14,400

 
$
(3,650
)
 
 
$
31,030

 
$
55,045

 
$
(24,015
)
 
Workers' Compensation Insurance
$
1,388

 
$
2,788

 
$
(1,400
)
 
 
$
3,413

 
$
4,163

 
$
(750
)
 
Segregated Portfolio Cell Reinsurance
$
3,301

 
$
3,724

 
$
(423
)
 
 
$
7,815

 
$
8,248

 
$
(433
)
 
Lloyd's Syndicates
$
502

 
$
637

 
$
(135
)
 
 
$
(46
)
 
$
(307
)
 
$
261

 
The slight increase in our consolidated current accident year net loss ratio during the 2019 three-month period as compared to the same respective period of 2018 was primarily due to a higher current accident year net loss ratio in our Specialty P&C segment, largely offset by a lower current accident year net loss ratio in our Workers' Compensation Insurance segment. The current accident year net loss ratio in our Specialty P&C segment was higher due to our continued concern

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around loss trends in the broader HCPL industry. Additionally, as compared to the 2018 three-month period, the current accident year net loss ratio in our Specialty P&C segment was higher due to the effect of a reduction in the 2018 three-month period to ceded premiums owed under reinsurance agreements with variable premium components for prior accident years which increased net premiums earned during the 2018 three-month period; however, no such adjustment was made during the 2019 three-month period (see further discussion in our Segment Operating Results - Specialty P&C section that follows under the heading "Ceded Premiums Written"). Furthermore, the increase in the current accident year net loss ratio in our Specialty P&C segment during the three-month period was due to changes in the mix of business including a higher volume of earned premium in our excess and surplus lines of business, which carries a higher loss ratio as compared to the segment's overall book of business. In our Workers' Compensation Insurance segment, the current accident year net loss ratio for the 2018 three-month period was higher as compared to the 2019 three-month period due to an increase to the ratio during the third quarter of 2018 driven by the impact of severity-related claim activity related to economic growth trends and the increase in new and less experienced workers to the workforce.
As shown in the table below, two one-time events impacted our net loss ratios and affected the comparability between the nine months ended September 30, 2019 and the nine months ended September 30, 2018. For the nine months ended September 30, 2019, our consolidated and Segregated Portfolio Cell Reinsurance segment net loss ratios were affected by a $10 million reserve that an SPC at Eastern Re established during the second quarter of 2019 associated with an errors and omissions ("E&O") liability policy. We do not participate in the SPC that assumed this policy; therefore, these losses are the obligation of the external cell participants and are reflected in the SPC dividend expense (income), which is an offset to expenses, and thus has no effect on our net income or Segregated Portfolio Cell Reinsurance segment operating results for the nine months ended September 30, 2019 (see further discussion in our Segment Operating Results - Segregated Portfolio Cell Reinsurance section that follows). Furthermore, for the nine months ended September 30, 2018, our consolidated and Specialty P&C segment net loss ratios were affected by a loss portfolio transfer ($26.6 million of net premiums earned at a 95% loss ratio) entered into during the second quarter of 2018 (see further discussion in our Segment Operating Results - Specialty Property & Casualty section that follows).
Given the significance of these two one-time events, we have removed the impact of each from the consolidated loss ratios below (as shown in the columns labeled "Adjusted") in order to assist in the comparability between periods. Consolidated net loss ratios for the nine months ended September 30, 2019 and 2018 were as follows:
 
Nine Months Ended September 30
 
2019
 
2018
 
Change
 
As reported
E&O reserve impact
Adjusted
 
As reported
LPT impact
Adjusted
 
As reported
Adjusted
Calendar year net loss ratio
77.4
%
1.6
pts
75.8
%
 
71.2
%
1.2
pts
70.0
%
 
6.2

pts
5.8
pts
Less impact of prior accident years on the net loss ratio
(6.6
%)
0.1
pts
(6.7
%)
 
(10.9
%)
0.5
pts
(11.4
%)
 
4.3

pts
4.7
pts
Current accident year net loss ratio
84.0
%
1.5
pts
82.5
%
 
82.1
%
0.7
pts
81.4
%
 
1.9

pts
1.1
pts
Excluding the impact of the previously discussed one-time events as shown in the table above, our consolidated current accident year net loss ratio for the 2019 nine-month period increased approximately 1.1 percentage points as compared to the same period of 2018. The increase during the 2019 nine-month period was primarily due to a higher current accident year net loss ratio in our Specialty P&C segment due to the same factors as previously discussed that drove the segment's higher loss ratio for the 2019 three-month period, partially offset by a lower current accident year net loss ratio in our Lloyd's Syndicates segment driven by an increase in estimated reinsurance recoveries related to property and catastrophe related losses as compared to the prior year period.
In both the 2019 and 2018 three- and nine- month periods, our consolidated calendar year net loss ratio was lower than our consolidated current accident year net loss ratio due to the recognition of net favorable prior year reserve development, as shown in the previous tables. Net favorable prior year reserve development recognized in the 2019 three- and nine- month periods was lower as compared to same respective periods of 2018 primarily due to the observed increase in claim severity in the broader HCPL industry as well as prior year loss volatility in large account business in our Specialty P&C segment.

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Our consolidated and segment underwriting expense ratios were as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Underwriting Expense Ratio
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
28.7
%
 
30.0
%
 
(1.3
)
pts
 
29.4
%
 
29.0
%
 
0.4

pts
Specialty P&C
23.7
%
 
23.1
%
 
0.6

pts
 
23.8
%
 
22.2
%
 
1.6

pts
Workers' Compensation Insurance
30.1
%
 
32.6
%
 
(2.5
)
pts
 
30.6
%
 
30.7
%
 
(0.1
)
pts
Segregated Portfolio Cell Reinsurance
30.1
%
 
29.1
%
 
1.0

pts
 
29.2
%
 
29.6
%
 
(0.4
)
pts
Lloyd's Syndicates
44.2
%
 
44.4
%
 
(0.2
)
pts
 
44.5
%
 
48.5
%
 
(4.0
)
pts
Corporate*
1.2
%
 
2.5
%
 
(1.3
)
pts
 
2.0
%
 
2.5
%
 
(0.5
)
pts
*There are no net premiums earned associated with the Corporate segment. Ratios shown are the contribution of the Corporate segment to the consolidated ratio (Corporate operating expenses divided by consolidated net premium earned).
Our consolidated underwriting expense ratio decreased for the 2019 three-month period as compared to the same respective period of 2018 driven by a decrease in consolidated share-based compensation expenses and other compensation related costs and, to a lesser extent, a decrease in operating expenses in our Lloyd's Syndicates segment primarily due to the effect of higher operational expenses incurred during the 2018 three- and nine- month periods associated with the establishment of Syndicate 6131. The decrease in our consolidated underwriting expense ratio for the 2019 three-month period was partially offset by an increase in operating expenses in our Specialty P&C segment driven by fees associated with a data analytics services agreement entered into in the fourth quarter of 2018 and, to a lesser extent, an increase in consolidated DPAC amortization which somewhat outpaced the increase in consolidated net premiums earned.
Our consolidated underwriting expense ratio slightly increased for the 2019 nine-month period as compared to the same respective period of 2018 due to the effect of a loss portfolio transfer (net premiums earned with minimal associated operating expenses) entered into during the second quarter of 2018 in our Specialty P&C segment (see further discussion in our Segment Operating Results - Specialty Property & Casualty section that follows). Excluding the impact of the 2018 loss portfolio transfer, our consolidated underwriting expense ratio for the 2019 nine-month period decreased approximately 1.0 percentage point driven by an increase in consolidated net premiums earned, excluding the impact of the 2018 loss portfolio transfer, which outpaced the increase in consolidated DPAC amortization and a decrease in consolidated share-based compensation expenses and other compensation related costs.
Taxes
Our effective tax rates for the nine months ended September 30, 2019 and 2018 were as follows:
 
Nine Months Ended September 30
 
2019
 
2018
Projected annual effective tax rate
(54.4
%)
 
(3.0
%)
Tax effect of discrete items
54.4
%
 
(2.8
%)
Total effective tax rate
—
%
 
(5.8
%)
Our projected annual effective tax rates were benefits of 54.4% and 3.0% as of September 30, 2019 and 2018, respectively, before discrete items were considered. These discrete items increased our effective tax rate by 54.4% and reduced our effective tax rate by 2.8% for the 2019 and 2018 nine-month periods, respectively, as shown in the table above. For the 2019 and 2018 nine-month periods, the most significant discrete item that affected our effective tax rate was the treatment of net realized investment gains. This treatment of net realized investment gains of $44.4 million and $2.6 million in our Corporate segment for the nine months ended September 30, 2019 and 2018, respectively, accounted for an increase of 55.4% and 0.9% in the effective tax rate in the same respective periods.
Our projected annual effective tax rates as of September 30, 2019 and 2018 were different from the statutory federal income tax rate of 21% primarily due to a portion of our investment income being tax-exempt and the utilization of tax credits transferred to us from our tax credit partnership investments. See further discussion in the Segment Operating Results - Corporate section that follows under the heading "Taxes."

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Operating Ratio
Our operating ratio is our combined ratio, less our investment income ratio. This ratio provides the combined effect of underwriting profitability and investment income. Our operating ratio for the three months ended September 30, 2019 and 2018 was as follows:
 
Three Months Ended September 30
 
2019
 
2018
 
Change
Combined ratio
103.6
%
 
101.6
%
 
2.0

pts
Less: investment income ratio
11.0
%
 
11.3
%
 
(0.3
)
pts
Operating ratio
92.6
%
 
90.3
%
 
2.3

pts
Our operating ratio for the 2019 three-month period as compared to the same period of 2018 increased by approximately 2.3 percentage points driven by a higher combined ratio in our Specialty P&C segment, partially offset by a lower expense ratio in our Corporate segment. The higher combined ratio in our Specialty P&C segment was due to our continued concern around loss trends in the broader HCPL industry and prior year loss volatility on large account business, both of which led to a lower amount of prior accident year favorable development, and, to a lesser extent, changes in the mix of premiums earned which contributed to a higher current accident year net loss ratio. The lower expense ratio in our Corporate segment was driven by a decrease in share-based compensation expenses and other compensation related costs.
As shown in the table below, two one-time events impacted our operating ratios and affected the comparability between the nine months ended September 30, 2019 and the nine months ended September 30, 2018. During the nine months ended September 30, 2019, an SPC at Eastern Re established a $10 million reserve, as previously discussed, which increased our consolidated net loss ratio (see further discussion in our Segment Operating Results - Segregated Portfolio Cell Reinsurance section that follows). We do not participate in the SPC that assumed this policy; therefore, these losses are the obligation of the external cell participants and are reflected in the SPC dividend expense (income). As the SPC dividend expense (income) is not included in the calculation of our expense ratio, our combined ratio for the nine months ended September 30, 2019 was affected by this reserve. Furthermore, for the nine months ended September 30, 2018, our investment income ratio was affected by the 2018 loss portfolio transfer ($26.6 million of net premiums earned with no immediate effect on net investment income).
Given the significance of these two one-time events, we have removed the impact of each from the ratios below for the nine months ended September 30, 2019 and 2018 (as shown in the columns labeled "Adjusted") in order to assist in the comparability between periods. Our operating ratio for the nine months ended September 30, 2019 and 2018 was as follows:
 
Nine Months Ended September 30
 
2019
 
2018
 
Change
 
As reported
E&O reserve impact
Adjusted
 
As reported
LPT impact
Adjusted
 
As reported
Adjusted
Combined ratio
106.8
%
1.6
pts
105.2
%
 
100.2
%
(0.2
)
pts
100.4
%
 
6.6

pts
4.8

pts
Less: investment income ratio
11.1
%
—
pts
11.1
%
 
11.0
%
(0.5
)
pts
11.5
%
 
0.1

pts
(0.4
)
pts
Operating ratio
95.7
%
1.6
pts
94.1
%
 
89.2
%
0.3

pts
88.9
%
 
6.5

pts
5.2

pts
Excluding the impact of the previously discussed one-time events as shown in the table above, our operating ratio for the 2019 nine-month period increased by approximately 5.2 percentage points driven by the same factors as previously discussed that drove the higher operating ratio for the 2019 three-month period.

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ROE
ROE is calculated as annualized net income for the period divided by the average of beginning and ending shareholders’ equity. This ratio measures our overall after-tax profitability and shows how efficiently capital is being used. ROE for the three and nine months ended September 30, 2019 and 2018 was as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2019
2018
Change
 
2019
2018
Change
ROE
4.3
%
7.9
%
(3.6
)
pts
 
5.2
%
6.0
%
(0.8
)
pts
The decrease in our ROE for the 2019 three- and nine- month periods as compared to the same periods of 2018 was due to the decrease in net income, driven by a higher combined ratio in our Specialty P&C segment, as previously discussed, and, to a lesser extent, a decrease in earnings from our unconsolidated subsidiaries. For the 2019 three-month period, the decrease in our ROE also reflected a decrease in net realized investment gains as compared to the same period of 2018. For the 2019 nine-month period, the increase in net realized investment gains as compared to the same period of 2018 largely offset the decreasing effect of a higher combined ratio in our Specialty P&C segment on our ROE.
Book Value per Share
Book value per share is calculated as total shareholders’ equity at the balance sheet date divided by the total number of common shares outstanding. This ratio measures the net worth of the Company to shareholders on a per-share basis. Our book value per share at September 30, 2019 as compared to December 31, 2018 is shown in the following table.
 
Book Value Per Share
Book Value Per Share at December 31, 2018
$
28.39

Increase (decrease) to book value per share during the nine months ended September 30, 2019 attributable to:
 
Dividends declared
(0.93
)
Net income
1.12

OCI
1.04

Other *
(0.06
)
Book Value Per Share at September 30, 2019
$
29.56

* Includes the impact of cumulative effect adjustments related to ASUs adopted during 2019.

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Non-GAAP Financial Measures
Non-GAAP operating income is a financial measure that is widely used to evaluate performance within the insurance sector. In calculating Non-GAAP operating income, we have excluded the after-tax effects of the items listed in the following table that do not reflect normal operating results. We believe Non-GAAP operating income presents a useful view of the performance of our insurance operations, however it should be considered in conjunction with net income computed in accordance with GAAP.
The following table is a reconciliation of net income to Non-GAAP operating income:
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
(In thousands, except per share data)
2019
 
2018
 
2019
 
2018
Net income
$
17,193

 
$
31,228

 
$
60,378

 
$
71,507

Items excluded in the calculation of Non-GAAP operating income:
 
 
 
 
 
 
 
Net realized investment (gains) losses
(1,134
)
 
(12,373
)
 
(47,064
)
 
(2,651
)
Net realized gains (losses) attributable to SPCs which no profit/loss is retained (1)
(132
)
 
1,130

 
1,531

 
387

Guaranty fund assessments (recoupments)
96

 
90

 
202

 
177

Pre-tax effect of exclusions
(1,170
)
 
(11,153
)
 
(45,331
)
 
(2,087
)
Tax effect, at 21% (2)
246

 
2,342

 
9,520

 
438

After-tax effect of exclusions
(924
)
 
(8,811
)
 
(35,811
)
 
(1,649
)
Non-GAAP operating income
$
16,269

 
$
22,417

 
$
24,567

 
$
69,858

Per diluted common share:
 
 
 
 
 
 
 
Net income
$
0.32

 
$
0.58

 
$
1.12

 
$
1.33

Effect of exclusions
(0.02
)
 
(0.16
)
 
(0.66
)
 
(0.03
)
Non-GAAP operating income per diluted common share
$
0.30

 
$
0.42

 
$
0.46

 
$
1.30

(1) Net realized investment gains (losses) on investments related to SPCs are recognized in our Segregated Portfolio Cell Reinsurance segment and the portion of operating earnings, including the gain or loss, net of our participation, is due to the external cell participants through the SPC dividend expense (income). To be consistent with our exclusion of net realized investment gains (losses) recognized in earnings, we are excluding the portion of net realized investment gains (losses) that is included in the SPC dividend expense (income) which is due to the external cell participants.
(2) The 21% rate is the annual expected statutory tax rate associated with the taxable or tax deductible items listed above. Excluding net realized investment (gains) losses, which are discrete items and are tax effected at the annual expected statutory tax rate in the period they are included in net income, our effective tax rate for the respective periods was applied to these items in calculating net income. See previous discussion in this section under the heading "Taxes."

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Segment Operating Results - Specialty Property & Casualty
Our Specialty P&C segment focuses on professional liability insurance and medical technology liability insurance as discussed in Note 14 of the Notes to Condensed Consolidated Financial Statements. Segment operating results reflected pre-tax underwriting profit or loss from these insurance lines, exclusive of investment results, which are included in our Corporate segment. Segment operating results included the following:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
2018
Change
 
2019
2018
Change
Net premiums written
$
141,299

$
143,921

$
(2,622
)
 
(1.8
%)
 
$
393,210

$
394,601

$
(1,391
)
 
(0.4
%)
 
 
 
 
 
 
 
 
 
 
 
 
Net premiums earned
$
125,237

$
120,789

$
4,448

 
3.7
%
 
$
375,315

$
378,355

$
(3,040
)
 
(0.8
%)
Other income
1,858

1,426

432

 
30.3
%
 
4,536

3,945

591


15.0
%
Net losses and loss adjustment expenses
(107,573
)
(98,363
)
(9,210
)
 
9.4
%
 
(321,248
)
(292,742
)
(28,506
)
 
9.7
%
Underwriting, policy acquisition and operating expenses
(29,700
)
(27,931
)
(1,769
)
 
6.3
%
 
(89,177
)
(83,833
)
(5,344
)
 
6.4
%
Segment operating results
$
(10,178
)
$
(4,079
)
$
(6,099
)

149.5
%
 
$
(30,574
)
$
5,725

$
(36,299
)

(634.0
%)
 
 
 
 
 
 
 
 
 
 
 
 
Net loss ratio
85.9%
81.4%
4.5

pts
85.6%
77.4%
8.2

pts
Underwriting expense ratio
23.7%
23.1%
0.6

pts
23.8%
22.2%
1.6

pts
Segment operating results for the three and nine months ended September 30, 2019 and nine months ended September 30, 2018 included the effect of two separate loss portfolio transfers; one entered into during the third quarter of 2019 and one entered into during the second quarter of 2018. A loss portfolio transfer is a form of retroactive insurance coverage as we are assuming and accepting an entity’s existing open and future claim liabilities through the transfer of the entity’s loss reserves. The loss portfolio transfer entered into during the third quarter of 2019 resulted in total net premiums written and earned of $2.7 million (consisting of $0.9 million of retroactive premium and $1.8 million of prospective (tail) premium) and total net losses and loss adjustment expenses of $2.1 million. The loss portfolio transfer entered into during the second quarter of 2018 resulted in total net premiums written and earned of $26.6 million (consisting of $18.7 million of retroactive premium and $7.9 million of prospective (tail) premium) and total net losses and loss adjustment expenses of $25.4 million. See further discussion of these loss portfolio transfers in Note 4 of the Notes to Condensed Consolidated Financial Statements.
Premiums Written
Changes in our premium volume within our Specialty P&C segment are driven by four primary factors: (1) the amount of new business, (2) our retention of existing business, (3) the premium charged for business that is renewed, which is affected by rates charged and by the amount and type of coverage an insured chooses to purchase and (4) the timing of premium written through multi-period policies. In addition, premium volume may periodically be affected by shifts in the timing of renewals between periods. The healthcare professional liability market, which accounts for a majority of the revenues in this segment, remains challenging as physicians continue joining hospitals or larger group practices and are thus no longer purchasing individual or group policies in the standard market. In addition, some competitors have chosen to compete primarily on price; both factors may impact our ability to write new business and retain existing business.
Gross, ceded and net premiums written were as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Gross premiums written
$
164,991

 
$
167,639

 
$
(2,648
)
 
(1.6
%)
 
$
459,324

 
$
456,137

 
$
3,187

 
0.7
%
Less: Ceded premiums written
23,692

 
23,718

 
(26
)
 
(0.1
%)
 
66,114

 
61,536

 
4,578

 
7.4
%
Net premiums written
$
141,299

 
$
143,921

 
$
(2,622
)
 
(1.8
%)
 
$
393,210

 
$
394,601

 
$
(1,391
)
 
(0.4
%)

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Table of Contents

Gross Premiums Written
Gross premiums written by component were as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Professional liability
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Physicians (1)(8)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Twelve month term
$
106,993

 
$
110,730

 
$
(3,737
)
 
(3.4
%)
 
$
288,090

 
$
274,494

 
$
13,596

 
5.0
%
Twenty-four month term
6,368

 
4,898

 
1,470

 
30.0
%
 
23,054

 
17,719

 
5,335

 
30.1
%
Total Physicians
113,361

 
115,628

 
(2,267
)
 
(2.0
%)
 
311,144

 
292,213

 
18,931

 
6.5
%
Healthcare facilities (2)(8)
17,329

 
20,178

 
(2,849
)
 
(14.1
%)
 
53,617

 
49,312

 
4,305

 
8.7
%
Other healthcare providers (3)
10,189

 
9,972

 
217

 
2.2
%
 
27,471

 
25,755

 
1,716

 
6.7
%
Legal professionals (4)
6,595

 
6,771

 
(176
)
 
(2.6
%)
 
21,410

 
21,233

 
177

 
0.8
%
Tail coverages (5)(6)
7,237

 
5,905

 
1,332

 
22.6
%
 
16,418

 
21,676

 
(5,258
)
 
(24.3
%)
Retroactive coverages (6)
900

 
—

 
900

 
nm

 
900

 
18,708

 
(17,808
)
 
(95.2
%)
Total professional liability
155,611

 
158,454

 
(2,843
)
 
(1.8
%)
 
430,960

 
428,897

 
2,063

 
0.5
%
Medical technology liability (7)
9,223

 
9,061

 
162

 
1.8
%
 
26,363

 
26,882

 
(519
)
 
(1.9
%)
Other (9)
157

 
124

 
33

 
26.6
%
 
2,001

 
358

 
1,643

 
458.9
%
Total
$
164,991

 
$
167,639

 
$
(2,648
)
 
(1.6
%)
 
$
459,324

 
$
456,137

 
$
3,187

 
0.7
%
(1) 
Physician policies were our greatest source of premium revenues in both 2019 and 2018. The decrease in twelve month term premiums during the 2019 three-month period as compared to the same period of 2018 was driven by the pending renewal of a $3.6 million policy. Excluding the effect of this timing difference, twelve month term premiums remained relatively unchanged during the 2019 three-month period as compared to the same period of 2018 primarily due to an increase in renewal pricing and new business written, almost entirely offset by retention losses and a decrease in premiums assumed in which we participate on a quota share basis due to the timing of the prior year policy renewal. The increase in twelve month term premiums during the 2019 nine-month period included net timing differences of $4.0 million primarily related to the prior year renewal of certain policies. Excluding the effect of these timing differences, twelve month term premiums increased approximately $9.6 million as compared to the same period of 2018. The remaining increase during the 2019 nine-month period was due to new business written, including the addition of three large policies totaling $10.3 million and, to a lesser extent, an increase in renewal pricing, partially offset by retention losses. Renewal pricing increases in both the 2019 three- and nine- month periods are reflective of our concern about increases in loss severity. We also offer twenty-four month term premiums to our physician insureds in one selected jurisdiction. The increase in twenty-four month term premiums during the 2019 three- and nine- month periods, as compared to the same respective periods in 2018, primarily reflected the normal cycle of renewals (policies subject to renewal in 2019 were previously written in 2017 rather than in 2018).
(2) 
Our healthcare facilities premium (which includes hospitals, surgery centers and other similar facilities) decreased for the 2019 three-month period driven by retention losses, partially offset by timing differences of $1.0 million primarily related to the renewal of a few large policies, new business written and an increase in renewal pricing. The increase in the 2019 nine-month period was driven by new business written, including three large policies totaling $4.1 million, and an increase in renewal pricing, partially offset by retention losses and, to a lesser extent, timing differences of $1.7 million primarily related to the renewal of a few large policies. Given the loss environment and initial loss indications we are seeing in the healthcare facilities space, we are seeking rate increases where we believe appropriate. As a result of our underwriting evaluation, we decided not to renew certain products written on an excess and surplus lines basis which drove the lower retention in both periods. As we continue to reevaluate certain books of business, we anticipate our retention to remain at a lower than historic level. In addition, retention in both periods was impacted by the loss of two large policies totaling $1.7 million due to price competition.
(3) 
Our other healthcare providers are primarily dentists, chiropractors and allied health professionals.
(4) 
Our legal professionals policies are primarily individual and small group policies in select areas of practice. Our legal professionals premium remained relatively unchanged for both the 2019 three- and nine- month periods as compared to the same periods of 2018 as new business written and renewal pricing increases were offset by retention losses. The increase in renewal pricing in both periods was primarily the result of an increase in the rate charged for certain renewed policies in select states due to rate filings.

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(5) 
We offer extended reporting endorsement or "tail" coverage to insureds who discontinue their claims-made coverage with us, and we also periodically offer tail coverage through custom policies. Tail coverage premiums are generally 100% earned in the period written because the policies insure only incidents that occurred in prior periods and are not cancellable. The amount of tail coverage premium written can vary significantly from period to period. The increase in tail premiums during the 2019 three-month period as compared to the same period of 2018 was driven by $1.8 million of tail coverage provided in connection with a loss portfolio transfer entered into during the third quarter of 2019, as previously discussed. The decrease in tail premiums during the 2019 nine-month period was driven by $7.9 million of tail coverage provided in connection with a loss portfolio transfer entered into during the second quarter of 2018, partially offset by the aforementioned third quarter 2019 loss portfolio transfer.
(6) 
We offer custom alternative risk solutions including loss portfolio transfers for healthcare entities who, most commonly, are exiting a line of business, changing an insurance approach or simply preferring to transfer risk. In the third quarter of 2019, we entered into a loss portfolio transfer with a regional hospital group which resulted in $0.9 million of retroactive premium written and fully earned in the 2019 three- and nine- month periods. In the second quarter of 2018, we entered into a loss portfolio transfer with a large healthcare organization which resulted in $18.7 million of retroactive premium written and fully earned in the 2018 nine-month period. See Note 4 of the Notes to the Condensed Consolidated Financial Statements for further information on these transactions.
(7) 
Our medical technology liability business is marketed throughout the U.S.; coverage is typically offered on a primary basis, within specified limits, to manufacturers and distributors of medical technology and life sciences products including entities conducting human clinical trials. In addition to the previously listed factors that affect our premium volume, our medical technology liability premium is impacted by the sales volume of insureds. Our medical technology liability premium remained relatively unchanged during the 2019 three-month period. The decrease during the 2019 nine-month period was primarily due to retention losses, partially offset by new business written and, to a lesser extent, an increase in renewal pricing. Changes in renewal pricing during the 2019 three- and nine- month periods were primarily due to changes in the sales volume of certain insureds. Retention losses in the 2019 three- and nine- month periods are largely attributable to an increase in competition on terms and pricing.
(8) 
Certain components of our gross premiums written include alternative market premiums. We cede either all or a portion of the alternative market premium, net of reinsurance, to certain SPCs of our wholly owned Cayman Islands reinsurance subsidiaries, Inova Re and Eastern Re, which are reported in our Segregated Portfolio Cell Reinsurance segment (see further discussion in the Ceded Premiums Written section that follows). The portion not ceded to the SPCs is retained within our Specialty P&C segment. Alternative market gross premiums written by component for the 2019 and 2018 three- and nine- month periods were as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in millions)
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Physicians
$
—

 
$
—

 
$
—

 
—
%
 
$
1.4

 
$
1.4

 
$
—

 
—
%
Healthcare facilities
0.7

 
0.7

 
—

 
—
%
 
4.6

 
4.2

 
0.4

 
9.5
%
Total
$
0.7


$
0.7

 
$
—

 
—
%
 
$
6.0


$
5.6


$
0.4

 
7.1
%
Alternative market gross premiums written remained relatively unchanged during the 2019 three- and nine- month periods as compared to the same periods of 2018.
(9) 
This component of gross premiums written includes all other product lines within our Specialty P&C segment. The increase during the 2019 nine-month period was due to a $1.5 million specialty contractual liability policy.
We are committed to a rate structure that will allow us to fulfill our obligations to our insureds, while generating competitive returns for our shareholders. Our pricing continues to be based on expected losses as indicated by our historical loss data and available industry loss data. In recent years, this practice has resulted in gradual rate increases and we anticipate further rate increases due to indications of increasing loss severity. Additionally, the pricing of our business includes the effects of filed rates, surcharges and discounts. Renewal pricing also reflects changes in our exposure base, deductibles, self-insurance retention limits and other policy items.

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The change in renewal pricing for our Specialty P&C segment, including by major component, was as follows:
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2019
 
2019
Specialty P&C segment (1)
7
%
 
6
%
Physicians (1)(2)
8
%
 
6
%
Healthcare facilities (1)(2)
12
%
 
15
%
Other healthcare providers (1)
5
%
 
5
%
Legal professionals (2)
3
%
 
2
%
Medical technology liability (2)
(1
%)
 
1
%
(1) Excludes certain policies written on an excess and surplus lines basis as the terms and conditions of these policies are not consistent between periods.
(2) See Gross Premiums Written section for further explanation of changes in renewal pricing.
New business written by major component on a direct basis was as follows:
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
(In millions)
2019
 
2018
 
2019
 
2018
Physicians
$
5.8

 
$
6.2

 
$
23.3

 
$
14.9

Healthcare facilities
0.9

 
8.9

 
7.8

 
13.2

Other healthcare providers
0.6

 
0.4

 
1.3

 
2.1

Legal professionals
0.4

 
0.7

 
2.1

 
2.4

Medical technology liability
1.3

 
0.6

 
3.5

 
2.4

Total
$
9.0

 
$
16.8

 
$
38.0

 
$
35.0

For our Specialty P&C segment, we calculate our retention rate as annualized renewed premium divided by all annualized premium subject to renewal. Retention rates are affected by a number of factors. We may lose insureds to competitors or to alternative insurance mechanisms such as risk retention groups or self-insurance entities (often when physicians join hospitals or large group practices) or due to pricing or other issues. We may choose not to renew an insured as a result of our underwriting evaluation. Insureds may also terminate coverage because they have left the practice of medicine for various reasons, principally for retirement, death or disability, but also for personal reasons.
Retention for our Specialty P&C segment, including by major component, was as follows:
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2019
 
2018
 
2019
 
2018
Specialty P&C segment (1)
86
%
 
89
%
 
87
%
 
89
%
Physicians (1)
89
%
 
89
%
 
89
%
 
90
%
Healthcare facilities (1)(2)
57
%
 
82
%
 
69
%
 
86
%
Other healthcare providers (1)
87
%
 
87
%
 
88
%
 
87
%
Legal professionals
88
%
 
89
%
 
88
%
 
85
%
Medical technology liability (2)
85
%
 
93
%
 
85
%
 
90
%
(1) Excludes certain policies written on an excess and surplus lines basis as the terms and conditions of these policies are not consistent between periods.
(2) See Gross Premiums Written section for further explanation of retention decline in 2019.

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Ceded Premiums Written
Ceded premiums represent the amounts owed to our reinsurers for their assumption of a portion of our losses. Through our current excess of loss reinsurance arrangements we generally retain the first $1 million in risk insured by us and cede coverages in excess of this amount. For our healthcare professional liability coverages, we also retain from 4% - 9% of the next $25 million of risk for coverages in excess of $1 million. For our medical technology liability coverages, we also retain 10% of the next $9 million of risk for coverages in excess of $1 million. We pay our reinsurers a ceding premium in exchange for their accepting the risk, and in certain of our excess of loss arrangements, the ultimate amount of which is determined by the loss experience of the business ceded, subject to certain minimum and maximum amounts.
Ceded premiums written were as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
2018
Change
 
2019
2018
Change
Excess of loss reinsurance arrangements (1)
$
9,580

$
9,722

$
(142
)
(1.5
%)
 
$
27,562

$
27,460

$
102

0.4
%
Premium ceded to Syndicate 1729 (2)
—

—

—

—
%
 
—

2,105

(2,105
)
nm

Other shared risk arrangements (3)
12,703

13,456

(753
)
(5.6
%)
 
30,556

28,321

2,235

7.9
%
Premium ceded to SPCs (4)
575

524

51

9.7
%
 
5,465

5,041

424

8.4
%
Other ceded premiums written
834

856

(22
)
(2.6
%)
 
2,531

2,508

23

0.9
%
Adjustment to premiums owed under reinsurance agreements, prior accident years, net (5)
—

(840
)
840

nm

 
—

(3,899
)
3,899

nm

Total ceded premiums written
$
23,692

$
23,718

$
(26
)
(0.1
%)
 
$
66,114

$
61,536

$
4,578

7.4
%
(1) 
We generally reinsure risks under our excess of loss reinsurance arrangements pursuant to which the reinsurers agree to assume all or a portion of all risks that we insure above our individual risk retention levels, up to the maximum individual limits offered. In certain of our excess of loss reinsurance arrangements, the premium due to the reinsurer is determined by the loss experience of that business reinsured, subject to certain minimum and maximum amounts. Premium due to reinsurers also fluctuates with the volume of written premium subject to cession under the arrangement. For the 2019 three- and nine- month periods, the change in ceded premiums written under our excess of loss reinsurance arrangements primarily reflected changes in the overall volume of gross premiums written subject to cession.
(2) 
Prior to January 1, 2018, our Specialty P&C segment ceded premiums to Syndicate 1729 under a quota share reinsurance agreement. We record our participation in Syndicate 1729 in our Lloyd's Syndicates segment on a quarter lag, except when information is material to the current period. We also recorded the cession to Syndicate 1729 from our Specialty P&C segment on the same quarter lag as the amounts were not material and that permitted the cession to be reported by both our Lloyd's Syndicates segment and our Specialty P&C segment in the same reporting period. The decrease in premiums ceded to Syndicate 1729 during the 2019 nine-month period is due to the non-renewal of the quota share reinsurance agreement with Syndicate 1729 on January 1, 2018; the impact of which was not reflected in ceded premiums written until the second quarter of 2018 due to the previously mentioned quarter lag. See the Segment Operating Results - Lloyd's Syndicates section for further discussion on the quota share agreement.
(3) 
We have entered into various shared risk arrangements, including quota share, fronting, and captive arrangements, with certain large healthcare systems and other insurance entities. These arrangements include our Ascension Health and CAPAssurance programs. While we cede a large portion of the premium written under these arrangements, they provide us an opportunity to grow net premium through strategic partnerships. For the 2019 three-month period, the decrease in ceded premiums written under our shared risk arrangements was primarily due to changes in exposure related to one of our Ascension Health programs, partially offset by growth in certain of our other shared risk arrangements. For the 2019 nine-month period, the increase in ceded premiums written under our shared risk arrangements was primarily driven by growth in our CAPAssurance program.
(4) 
As previously discussed, as a part of our alternative market solutions, all or a portion of certain healthcare premium written is ceded to SPCs in our Segregated Portfolio Cell Reinsurance segment under either excess of loss or quota share reinsurance agreements, depending on the structure of the individual program. See the Segment Operating Results - Segregated Portfolio Cell Reinsurance section for further discussion on the cession to the SPCs from our Specialty P&C segment. Premiums ceded to SPCs during the 2019 three- and nine- month periods remained relatively unchanged as compared to the same periods of 2018.

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(5) 
Given the length of time that it takes to resolve our claims, many years may elapse before all losses recoverable under a reinsurance arrangement are known. As a part of the process of estimating our loss reserve we also make estimates regarding the amounts recoverable under our reinsurance arrangements. As previously discussed, the premiums ultimately ceded under certain of our excess of loss reinsurance arrangements are subject to the losses ceded under the arrangements. As part of the review of our reserves during both the 2019 three- and nine- month periods, we concluded that our current estimate of expected losses and associated recoveries for prior year ceded losses was reasonable; therefore, we did not adjust our estimate of ceded premiums owed to reinsurers during the 2019 three- and nine- month periods. For the 2018 three- and nine- month periods, we reduced our estimate of expected losses and associated recoveries for prior year ceded losses, as well as our estimate of ceded premiums owed to reinsurers. Changes to estimates of premiums ceded related to prior accident years are fully earned in the period the changes in estimates occur.
Ceded Premiums Ratio
As shown in the table below, our ceded premiums ratio was affected in 2018 by revisions to our estimate of premiums owed to reinsurers related to coverages provided in prior accident years.
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2019
 
2018
Change
 
2019
 
2018
Change
Ceded premiums ratio, as reported
14.4
%
 
14.1
%
0.3

pts
 
14.4
%
 
13.5
%
0.9
pts
Less the effect of adjustments in premiums owed under reinsurance agreements, prior accident years (as previously discussed)
—
%
 
(0.5
%)
0.5

pts
 
—
%
 
(0.9
%)
0.9
pts
Ratio, current accident year
14.4
%
 
14.6
%
(0.2
)
pts
 
14.4
%
 
14.4
%
—
pts
The slight decrease in the current accident year ceded premiums ratio during the 2019 three-month period was primarily due to a decrease in premiums ceded under our other shared risk arrangements, primarily due to changes in exposure related to one of our Ascension Health programs. For the 2019 nine-month period, the current accident year ceded premiums ratio was unchanged as compared to the same period of 2018 due to offsetting factors. While the effect of the non-renewal of the quota share reinsurance agreement with Syndicate 1729 decreased the current accident year ceded premiums ratio, the impact was offset by the effect of the loss portfolio transfer entered into during the second quarter of 2018 (increase in gross premiums written with no premium ceded). See discussion above under the heading "Ceded Premiums Written."
Net Premiums Earned
Net premiums earned consist of gross premiums earned less the portion of earned premiums that we cede to our reinsurers for their assumption of a portion of our losses. Because premiums are generally earned pro rata over the entire policy period, fluctuations in premiums earned tend to lag those of premiums written. Generally, our policies carry a term of one year; however, as discussed above, we write certain policies with a twenty-four month term, and a few of our medical technology liability policies have a multi-year term. Tail coverage premiums are generally 100% earned in the period written because the policies insure only incidents that occurred in prior periods and are not cancellable. Retroactive coverage premiums are 100% earned at the inception of the contract, as all of the underlying loss events occurred in the past. Additionally, ceded premium changes due to changes to estimates of premiums owed under reinsurance agreements for prior accident years are fully earned in the period of change.
Net premiums earned were as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Gross premiums earned
$
146,514

 
$
141,811

 
$
4,703

 
3.3
%
 
$
434,699

 
$
437,108

 
$
(2,409
)
 
(0.6
%)
Less: Ceded premiums earned
21,277

 
21,022

 
255

 
1.2
%
 
59,384

 
58,753

 
631

 
1.1
%
Net premiums earned
$
125,237

 
$
120,789

 
$
4,448

 
3.7
%
 
$
375,315

 
$
378,355

 
$
(3,040
)
 
(0.8
%)
The increase in gross premiums earned during the 2019 three-month period was primarily due to a loss portfolio transfer entered into during the third quarter of 2019 which resulted in $2.7 million of one-time premium written and fully earned in the current period (see discussion under the heading "Gross Premiums Written"). Additionally, the increase in gross premiums earned during the 2019 three-month period reflected the pro rata effect of an increase in the volume of written premium during the preceding twelve months, predominantly in our physicians line of business driven by increases in renewal pricing. The decrease in gross premiums earned during the 2019 nine-month period was due to the loss portfolio transfer entered into during the second quarter of 2018 which resulted in $26.6 million of one-time premium written and fully earned in the prior period (see discussion under the heading "Gross Premiums Written"). After removing the impact of the loss portfolio transfer, gross

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premiums earned increased during the 2019 nine-month period driven by the pro rata effect of an increase in the volume of written premium during the preceding twelve months, predominantly in our healthcare facilities and physicians lines of business driven by an increase in renewal pricing.
The increase in ceded premiums earned during the 2019 three- and nine- month periods as compared to the same periods of 2018 reflected the effect of adjustments made during the 2018 three- and nine- month periods to ceded premiums owed under reinsurance agreements related to prior accident year losses; no such adjustments were made during the same respective periods of 2019 (see previous discussion in footnote 5 under the heading "Ceded Premiums Written"). After removing the effect of the prior accident year ceded premium adjustments in 2018, ceded premiums earned decreased during the 2019 three- and nine- month periods approximately $0.6 million and $3.3 million, respectively, as compared to the same periods of 2018. The decrease in ceded premiums earned during both the 2019 three- and nine- month periods was driven by the non-renewal of the quota share reinsurance agreement with Syndicate 1729, partially offset by the pro rata effect of an increase in premiums ceded under our shared risk arrangements during the preceding twelve months, predominately in our CAPAssurance program.
Losses and Loss Adjustment Expenses
The determination of calendar year losses involves the actuarial evaluation of incurred losses for the current accident year and the actuarial re-evaluation of incurred losses for prior accident years, including an evaluation of the reserve amounts required for losses in excess of policy limits.
Accident year refers to the accounting period in which the insured event becomes a liability of the insurer. For claims-made policies, which represent the majority of the premiums written in our Specialty P&C segment, the insured event generally becomes a liability when the event is first reported to us. For occurrence policies, the insured event becomes a liability when the event takes place. For retroactive coverages, the insured event becomes a liability at inception of the underlying contract. We believe that measuring losses on an accident year basis is the best measure of the underlying profitability of the premiums earned in that period, since it associates policy premiums earned with the estimate of the losses incurred related to those policy premiums.
The following table summarizes calendar year net loss ratios by separating losses between the current accident year and all prior accident years. Additionally, the table shows our current accident year net loss ratios for the three and nine months ended September 30, 2018 were affected by revisions to our estimate of premiums owed to reinsurers related to coverages provided in prior accident years. The net loss ratios for our Specialty P&C segment were as follows:
 
Net Loss Ratios (1)
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Calendar year net loss ratio
85.9
%
 
81.4
%
 
4.5
pts
 
85.6
%
 
77.4
%
 
8.2
pts
Less impact of prior accident years on the net loss ratio
(8.6
%)
 
(12.0
%)
 
3.4
pts
 
(8.3
%)
 
(14.5
%)
 
6.2
pts
Current accident year net loss ratio
94.5
%
 
93.4
%
 
1.1
pts
 
93.9
%
 
91.9
%
 
2.0
pts
Less estimated ratio increase (decrease) attributable to:
 
 
 
 

 
 
 
 
 
 
 
 
Ceded premium adjustments, prior accident years (2)
—
%
 
(0.7
%)
 
0.7
pts
 
—
%
 
(1.0
%)
 
1.0
pts
Current accident year net loss ratio, excluding the effect of prior year ceded premium (3)
94.5
%
 
94.1
%
 
0.4
pts
 
93.9
%
 
92.9
%
 
1.0
pts
(1) 
Net losses, as specified, divided by net premiums earned.
(2) 
Reductions to premiums owed under reinsurance agreements for prior accident years increased net premiums earned (the denominator of the current accident year ratio) for the 2018 three- and nine- month periods. No such adjustments were made during the 2019 three- and nine- month periods. See the discussion in the Premiums section for our Specialty P&C segment under the heading "Ceded Premiums Written" for additional information.
(3) 
The current accident year net loss ratio for the 2019 three- and nine- month periods as compared to the same periods of 2018, excluding the effect of prior year ceded premium adjustments (as shown in the table above), was higher due to our continued concern around loss trends in the broader HCPL industry. Furthermore, the increase in the current accident year net loss ratio during the 2019 three- and nine- month periods was due to changes in the mix of business including a higher volume of earned premium in our excess and surplus lines of business, which carries a higher loss ratio as compared to the segment's overall book of business. The increase in the current accident year net loss ratio during the 2019 nine-month period was partially offset by the effect of the loss portfolio transfer (net premiums earned at a 95% loss ratio) entered into during the second quarter of 2018, as previously discussed under the heading "Gross Premiums Written."
We recognized net favorable loss development related to our previously established reserves of $10.8 million and $31.0 million during the three and nine months ended September 30, 2019, respectively, and $14.4 million and $55.0 million during

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the same respective periods of 2018. We re-evaluate our previously established reserve each quarter based upon the most recently completed actuarial analysis supplemented by any new analysis, information or trends that have emerged since the date of that study. We also take into account currently available industry trend information. Development recognized during the three and nine months ended September 30, 2019 principally related to accident years 2012 through 2015. Development recognized during the three and nine months ended September 30, 2018 principally related to accident years 2011 through 2015. While our reserves continue to develop favorably, net favorable prior year reserve development recognized in the 2019 three- and nine- month periods was lower as compared to the same respective periods of 2018 primarily due to the observed increase in claim severity in the broader HCPL industry as well as prior year loss volatility in large account business.
A detailed discussion of factors influencing our recognition of loss development is included in our Critical Accounting Estimates section under the heading "Reserve for Losses and Loss Adjustment Expenses" and in our 2018 Form 10-K under the same heading. Assumptions used in establishing our reserve are regularly reviewed and updated by management as new data becomes available. Any adjustments necessary are reflected in the then current operations. Due to the size of our reserve, even a small percentage adjustment to the assumptions can have a material effect on our results of operations for the period in which the change is made, as was the case in both 2019 and 2018.
Underwriting, Policy Acquisition and Operating Expenses
Our Specialty P&C segment underwriting, policy acquisition and operating expenses were comprised as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
 
2018
 
Change
 
2019
 
2018
 
Change
DPAC amortization
$
13,733

 
$
12,901

 
$
832

 
6.4
%
 
$
42,268

 
$
38,886

 
$
3,382

 
8.7
%
Management fees
1,925

 
2,018

 
(93
)
 
(4.6
%)
 
5,365

 
5,504

 
(139
)
 
(2.5
%)
Other underwriting and operating expenses
14,042

 
13,012

 
1,030

 
7.9
%
 
41,544

 
39,443

 
2,101

 
5.3
%
Total
$
29,700

 
$
27,931

 
$
1,769

 
6.3
%
 
$
89,177

 
$
83,833

 
$
5,344

 
6.4
%
DPAC amortization increased for the three and nine months ended September 30, 2019 as compared to the same respective periods of 2018 driven by an increase in earned premium, excluding the effects of the premium earned from the loss portfolio transfers from the third quarter of 2019 and the second quarter of 2018 as there were no deferred acquisition costs associated with those transactions (see discussion under the heading "Gross Premiums Written"). For the 2019 three-month period, the increase in DPAC amortization was partially offset by an increase in ceding commission income, which is an offset to expense, primarily due to growth in certain of our shared risk arrangements. For the 2019 nine-month period, the increase in DPAC amortization also reflected a decrease in ceding commission income due to the reduction in premiums ceded to Syndicate 1729, partially offset by an increase in ceding commission income from certain of our shared risk arrangements.
Management fees are charged pursuant to a management agreement by the Corporate segment to the operating subsidiaries within our Specialty P&C segment for services provided, based on the extent to which services are provided to the subsidiary and the amount of premium written by the subsidiary. While the terms of the management agreement were consistent between 2018 and 2019, fluctuations in the amount of premium written by each subsidiary can result in corresponding variations in the management fee charged to each subsidiary during a particular period.
Other underwriting and operating expenses increased during the 2019 three- and nine- month periods as compared to the same respective periods of 2018 due to fees incurred associated with a data analytics services agreement entered into during the fourth quarter of 2018 of $1.4 million and $3.7 million, respectively, partially offset by a decrease in compensation related costs as a result of lower bonuses. See Note 7 of the Notes to Condensed Consolidated Financial Statements for further information on the data analytics services agreement.

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Underwriting Expense Ratio (the Expense Ratio)
Our expense ratio for the Specialty P&C segment for the three and nine months ended September 30, 2019 and 2018, respectively, was as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Underwriting expense ratio
23.7
%
 
23.1
%
 
0.6
pts
 
23.8
%
 
22.2
%
 
1.6
pts
The underwriting expense ratio increased in the 2019 three- and nine- month periods as compared to the same periods of 2018. Excluding the impacts of the loss portfolio transfers entered into during the third quarter of 2019 and the second quarter of 2018 (net premiums earned with minimal associated operating expenses), the underwriting expense ratio for the 2019 three- and nine- month periods increased 1.1 percentage points and 0.2 percentage points, respectively, as compared to the same periods of 2018. The increase in the underwriting expense ratio in the 2019 three- and nine- month periods as compared to the same periods of 2018 was driven by the fees associated with a data analytics services agreement, as discussed above, partially offset by a decrease in compensation related costs as a result of lower bonuses.

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Segment Operating Results - Workers' Compensation Insurance
Our Workers' Compensation Insurance segment includes workers' compensation products provided to employers generally with 1,000 or fewer employees, as discussed in Note 14 of the Notes to Condensed Consolidated Financial Statements. Workers' compensation products offered include guaranteed cost policies, policyholder dividend policies, retrospectively-rated policies, deductible policies and alternative market solutions. Alternative market products include program design, fronting, claims administration, risk management, SPC rental, asset management and SPC management services. Alternative market premiums are 100% ceded to either the SPCs within our Segregated Portfolio Cell Reinsurance segment or, to a limited extent, an unaffiliated captive insurer. Our Workers' Compensation Insurance segment operating results reflected pre-tax underwriting profit or loss from these workers' compensation products, exclusive of investment results, which are included in our Corporate segment. Segment operating results included the following:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
2018
Change
 
2019
2018
Change
Net premiums written
$
49,663

$
45,945

$
3,718

8.1
%
 
$
146,101

$
150,581

$
(4,480
)
(3.0
%)
 
 
 
 
 
 
 
 
 
 
Net premiums earned
$
49,477

$
47,296

$
2,181

4.6
%
 
$
141,990

$
135,230

$
6,760

5.0
%
Other income
494

376

118

31.4
%
 
1,948

1,828

120

6.6
%
Net losses and loss adjustment expenses
(32,356
)
(30,650
)
(1,706
)
5.6
%
 
(93,424
)
(87,794
)
(5,630
)
6.4
%
Underwriting, policy acquisition and operating expenses
(14,895
)
(15,410
)
515

(3.3
%)
 
(43,456
)
(41,545
)
(1,911
)
4.6
%
Segment operating results
$
2,720

$
1,612

$
1,108

68.7
%
 
$
7,058

$
7,719

$
(661
)
(8.6
%)
 
 
 
 
 
 
 
 
 
 
Net loss ratio
65.4%
64.8%
0.6

pts
 
65.8
%
64.9
%
0.9

pts
Underwriting expense ratio
30.1%
32.6%
(2.5
)
pts
 
30.6
%
30.7
%
(0.1
)
pts
Premiums Written
Our workers’ compensation premium volume is driven by five primary factors: (1) the amount of new business written, (2) audit premium, (3) retention of our existing book of business, (4) premium rates charged on our renewal book of business and (5) changes in payroll exposure.
Gross, ceded and net premiums written were as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
2018
Change
 
2019
2018
Change
Gross premiums written
$
70,066

$
65,719

$
4,347

6.6
%
 
$
223,638

$
228,271

$
(4,633
)
(2.0
%)
Less: Ceded premiums written
20,403

19,774

629

3.2
%
 
77,537

77,690

(153
)
(0.2
%)
Net premiums written
$
49,663

$
45,945

$
3,718

8.1
%
 
$
146,101

$
150,581

$
(4,480
)
(3.0
%)
Gross Premiums Written
Gross premiums written by product were as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Traditional business:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Guaranteed cost
$
44,164

 
$
39,601

 
$
4,563

 
11.5
%
 
$
124,460

 
$
122,474

 
$
1,986

 
1.6
%
Policyholder dividend
4,718

 
4,551

 
167

 
3.7
%
 
16,972

 
17,737

 
(765
)
 
(4.3
%)
Deductible
2,199

 
2,277

 
(78
)
 
(3.4
%)
 
5,276

 
7,236

 
(1,960
)
 
(27.1
%)
Retrospective
36

 
369

 
(333
)
 
(90.2
%)
 
3,073

 
6,013

 
(2,940
)
 
(48.9
%)
Other
2,220

 
2,123

 
97

 
4.6
%
 
6,822

 
7,305

 
(483
)
 
(6.6
%)
Alternative market business
16,729

 
16,798

 
(69
)
 
(0.4
%)
 
67,035

 
67,506

 
(471
)
 
(0.7
%)
Total
$
70,066

 
$
65,719

 
$
4,347

 
6.6
%
 
$
223,638

 
$
228,271

 
$
(4,633
)
 
(2.0
%)

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Gross premiums written in our traditional business increased during the three months ended September 30, 2019 as compared to the same period of 2018, which primarily reflected new business written, including the addition of four large policies totaling $3.9 million, and an increase in audit premium, partially offset by a decrease in renewal pricing and the renewal retention rate. Gross premiums written in our traditional business decreased during the nine months ended September 30, 2019 as compared to the same period of 2018, which reflected our reaction to underpricing that is occurring in a very competitive market. New business written, renewal pricing and the renewal retention rate all declined during the 2019 nine-month period as compared to the same period of 2018. Retrospective policy premiums written include an estimate for retrospective premium adjustments, which are based on the loss experience of the underlying policies. Retrospective premium adjustments decreased premiums written by $0.4 million and $1.8 million in the 2019 three- and nine- month periods, respectively, compared to adjustments that decreased premiums written by $0.2 million and increased premiums written by $0.4 million for the same respective periods of 2018.
New business opportunities, renewal pricing and retention continue to be a challenge as a result of intense competition, especially from package carriers that are willing to underprice their workers’ compensation products to offset other coverages. This has resulted in fewer new business opportunities, which is reflected in a 13% decline in submissions during the 2019 nine-month period. However, new business written was higher for the three and nine months ended September 30, 2018 as it included approximately $3.1 million and $11.1 million, respectively, of premiums written related to the acquisition of the Great Falls renewal book of business. Renewal pricing decreases reflect the competitive market, as well as the impact of state loss cost decreases in the majority of the states in which we write business. In addition, the decrease in the retention rate during the 2019 nine-month period reflected the loss of two large policies totaling approximately $3.3 million during the second quarter of 2019. If these two policies would have renewed, the retention rate for the segment during the 2019 nine-month period would have been 1.4 percentage points higher as compared to the same period of 2018.
Gross premiums written in our alternative market business decreased during the 2019 three- and nine- month periods as compared to the same periods in 2018. New business and renewal pricing trends in our alternative market business for the 2019 nine-month period were relatively consistent with the trends in our traditional business. We retained all 16 of the available workers' compensation alternative market programs up for renewal during the nine months ended September 30, 2019. During the third quarter of 2019, we added one new alternative market program at Inova Re.
New business, audit premium, retention and renewal price changes for both the traditional business and the alternative market business are shown in the table below:
 
Three Months Ended September 30
 
2019
 
2018
($ in millions)
Traditional Business
Alternative Market Business
Segment
Results
 
Traditional Business
Alternative Market Business
Segment
Results
New business
$
10.5

$
0.8

$
11.3

 
$
10.2

$
1.6

$
11.8

Audit premium (including EBUB)
$
1.4

$
0.4

$
1.8

 
$
0.6

$
0.6

$
1.2

Retention rate (1)
81
%
96
%
84
%
 
85
%
87
%
85
%
Change in renewal pricing (2)
(4
%)
(5
%)
(4
%)
 
1
%
1
%
1
%
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30
 
2019
 
2018
($ in millions)
Traditional Business
Alternative Market Business
Segment
Results
 
Traditional Business
Alternative Market Business
Segment
Results
New business
$
22.3

$
3.0

$
25.3

 
$
34.2

$
7.0

$
41.2

Audit premium (including EBUB)
$
2.3

$
1.3

$
3.6

 
$
2.6

$
1.0

$
3.6

Retention rate (1)
81
%
93
%
84
%
 
85
%
91
%
87
%
Change in renewal pricing (2)
(3
%)
(4
%)
(3
%)
 
(1
%)
—
%
—
%
 
 
 
 
 
 
 
 
(1) We calculate our workers' compensation retention rate as annualized expiring renewed premium divided by all annualized expiring premium subject to renewal. Our retention rate can be impacted by various factors, including price or other competitive issues, insureds being acquired, or a decision not to renew based on our underwriting evaluation.
(2) The pricing of our business includes an assessment of the underlying policy exposure and the effects of current market conditions. We continue to base our pricing on expected losses, as indicated by our historical loss data.

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Ceded Premiums Written
Ceded premiums written were as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Premiums ceded to SPCs
$
16,706

 
$
16,275

 
$
431

 
2.6
%
 
$
64,610

 
$
63,214

 
$
1,396

 
2.2
%
Premiums ceded to external reinsurers
3,471

 
3,429

 
42

 
1.2
%
 
10,287

 
9,502

 
785

 
8.3
%
Premiums ceded to unaffiliated captive insurers
23

 
523

 
(500
)
 
(95.6
%)
 
2,425

 
4,292

 
(1,867
)

(43.5
%)
Change in return premium estimate under external reinsurance
203

 
(453
)
 
656

 
144.8
%
 
215

 
682

 
(467
)
 
(68.5
%)
Total ceded premiums written
$
20,403

 
$
19,774

 
$
629

 
3.2
%
 
$
77,537

 
$
77,690

 
$
(153
)
 
(0.2
%)
Our Workers' Compensation Insurance segment cedes alternative market business under a 100% quota share reinsurance agreement, net of a ceding commission, to SPCs in our Segregated Portfolio Cell Reinsurance segment.
Under our external reinsurance agreement, we retain the first $0.5 million in risk insured by us and cede losses in excess of this amount on each loss occurrence under our primary external reinsurance treaty. Effective May 1, 2019, our primary reinsurance layer was renewed with an AAD equal to the greater of $3.9 million or 2.1% of subject premium, in excess of the $0.5 million retention per loss occurrence, and the elimination of the return premium component of the contract. The addition of the AAD was partially offset by a reduction in the reinsurance rates under our renewed program. Per our reinsurance agreements, we cede premiums related to our traditional business on an earned premium basis. The increase in premiums ceded to external reinsurers during the three and nine months ended September 30, 2019 primarily reflected an increase in earned premium, partially offset by the impact of lower reinsurance rates for the treaty year effective May 1, 2019.
The decrease in premiums ceded to unaffiliated captive insurers during the three and nine months ended September 30, 2019 reflected the impact of a novation of an unaffiliated captive program into an SPC at Inova Re during the fourth quarter of 2018. The premium now written through this SPC is reflected in premiums ceded to SPCs in the table above. As of September 30, 2019, there is only one remaining unaffiliated captive program.
Changes in the return premium estimate reflected the loss experience under the reinsurance contract for the three and nine months ended September 30, 2019 and 2018. The change in estimated return premium for the three and nine months ended September 30, 2019 reflected prior year unfavorable loss development on reinsured claims.
Ceded Premiums Ratio
Ceded premiums ratio was as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Ceded premiums ratio, as reported
33.5
%
 
34.2
%
 
(0.7
)
pts
 
34.1
%
 
34.6
%
 
(0.5
)
pts
Less the effect of:
 
 
 
 


 
 
 
 
 
 


 
Premiums ceded to SPCs (100%)
25.4
%
 
25.8
%
 
(0.4
)
pts
 
26.2
%
 
25.0
%
 
1.2

pts
Retrospective premium adjustments
—
%
 
—
%
 
—

pts
 
0.1
%
 
—
%
 
0.1

pts
Premiums ceded to unaffiliated captive insurers (100%)
1.2
%
 
2.4
%
 
(1.2
)
pts
 
1.1
%
 
2.7
%
 
(1.6
)
pts
Return premium estimated under external reinsurance
0.4
%
 
(0.9
%)
 
1.3

pts
 
0.1
%
 
0.5
%
 
(0.4
)
pts
Assumed premiums earned (not ceded to external reinsurers)
(0.3
%)
 
(0.3
%)
 
—

pts
 
(0.3
%)
 
(0.3
%)
 
—

pts
Ceded premiums ratio (related to external reinsurance), less the effects of above
6.8
%

7.2
%

(0.4
)
pts
 
6.9
%

6.7
%
 
0.2

pts
The above table reflects ceded premiums earned as a percent of gross premiums earned. As discussed above, we cede premiums related to our traditional business to external reinsurers on an earned premium basis. For the three months ended September 30, 2019, the ceded premiums ratio, excluding the effects in the table above, decreased as compared to the same period in 2018 which primarily reflected the impact of lower reinsurance rates for the treaty year effective May 1, 2019.

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Net Premiums Earned
Net premiums earned were as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
2018
Change
 
2019
2018
Change
Gross premiums earned
$
74,403

$
71,835

$
2,568

3.6
%
 
$
215,561

$
206,927

$
8,634

4.2
%
Less: Ceded premiums earned
24,926

24,539

387

1.6
%
 
73,571

71,697

1,874

2.6
%
Net premiums earned
$
49,477

$
47,296

$
2,181

4.6
%
 
$
141,990

$
135,230

$
6,760

5.0
%
Net premiums earned consist of gross premiums earned less the portion of earned premiums that we cede to SPCs in our Segregated Portfolio Cell Reinsurance segment, external reinsurers or to any unaffiliated captive insurers. Because premiums are generally earned pro rata over the entire policy period, fluctuations in premiums earned tend to lag those of premiums written. Our workers’ compensation policies are twelve month term policies, and premiums are earned on a pro rata basis over the policy period. Net premiums earned also include premium adjustments related to the audit of our insureds' payrolls. Payroll audits are conducted subsequent to the end of the policy period and any related adjustments are recorded as fully earned in the current period. In addition, we record an estimate for EBUB and evaluate the estimate on a quarterly basis. We did not adjust the EBUB estimate during the three and nine months ended September 30, 2019 or 2018. The increase in net premiums earned primarily reflected the pro rata effect of higher net premiums written during the preceding twelve months, partially offset by retrospective premium adjustments, as previously discussed.
Losses and Loss Adjustment Expenses
We estimate our current accident year loss and loss adjustment expenses based on an expected loss ratio. Incurred losses and loss adjustment expenses are determined by applying the expected loss ratio to net premiums earned, which includes audit premium, for the respective period. The following table summarizes calendar year net loss ratios by separating losses between the current accident year and all prior accident years. Calendar year and current accident year net loss ratios by component were as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Calendar year net loss ratio
65.4
%
 
64.8
%
 
0.6

pts
 
65.8
%
 
64.9
%
 
0.9
pts
Less impact of prior accident years on the net loss ratio
(2.8
%)
 
(5.9
%)
 
3.1

pts
 
(2.4
%)
 
(3.1
%)
 
0.7
pts
Current accident year net loss ratio
68.2
%
 
70.7
%
 
(2.5
)
pts
 
68.2
%
 
68.0
%
 
0.2
pts
The addition of the AAD under the reinsurance treaty effective May 1, 2019 slightly increased the current accident year net loss ratios for both the three and nine months ended September 30, 2019 as compared to the same periods of 2018 (see previous discussion under the heading "Ceded Premiums Written"). For the 2019 three-month period, the impact of the AAD on the change in the current accident year net loss ratio as compared to the 2018 three-month period was more than offset by the effect of a higher current accident year net loss ratio in the 2018 three-month period due to an increase to the ratio during the third quarter of 2018 driven by the impact of severity-related claim activity related to economic growth trends and the increase in new and less experienced workers to the workforce. The impact of renewal rate decreases on the current accident year net loss ratio for the 2019 three- and nine- month periods was offset by favorable claim trends during 2019.
Calendar year incurred losses (excluding IBNR) ceded to our external reinsurers decreased $5.2 million and $11.2 million for the 2019 three- and nine- month periods, respectively, as compared to the same periods of 2018. Current accident year ceded incurred losses decreased $9.9 million and $7.0 million during the 2019 three- and nine- month periods, respectively, as compared to the same periods of 2018.
We recognized net favorable prior year development related to our previously established reserve of $1.4 million and $3.4 million for the three and nine months ended September 30, 2019, respectively, as compared to $2.8 million and $4.2 million for the same respective periods of 2018. The net favorable prior year development for the three and nine months ended September 30, 2019 reflected overall favorable trends in claim closing patterns, primarily in the 2016 accident year. Net favorable development for the three and nine months ended September 30, 2018 primarily related to the 2015 and 2016 accident years. For both the three and nine months ended September 30, 2019 and 2018, the net favorable prior year development included $0.4 million and $1.2 million, respectively, related to the amortization of the purchase accounting fair value adjustment.

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Underwriting, Policy Acquisition and Operating Expenses
Underwriting, policy acquisition and operating expenses includes the amortization of commissions, premium taxes and underwriting salaries, which are capitalized and deferred over the related workers’ compensation policy period, net of ceding commissions earned. The capitalization of underwriting salaries can vary as they are subject to the success rate of our contract acquisition efforts. These expenses also include a management fee charged by our Corporate segment, which represents intercompany charges pursuant to a management agreement, and the amortization of intangible assets, primarily related to the acquisition of Eastern by ProAssurance. The management fee is based on the extent to which services are provided to the subsidiary and the amount of premium written by the subsidiary.
Our Workers' Compensation Insurance segment underwriting, policy acquisition and operating expenses were comprised as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
 
2018
 
Change
 
2019
 
2018
 
Change
DPAC amortization
$
9,021

 
$
9,793

 
$
(772
)
 
(7.9
%)
 
$
26,072

 
$
24,798

 
$
1,274

 
5.1
%
Management fees
525

 
492

 
33

 
6.7
%
 
1,677

 
1,707

 
(30
)
 
(1.8
%)
Other underwriting and operating expenses
9,939

 
9,957

 
(18
)
 
(0.2
%)
 
29,122

 
28,340

 
782

 
2.8
%
SPC ceding commission offset
(4,590
)
 
(4,832
)
 
242

 
(5.0
%)
 
(13,415
)
 
(13,300
)
 
(115
)
 
0.9
%
Total
$
14,895

 
$
15,410

 
$
(515
)
 
(3.3
%)
 
$
43,456

 
$
41,545

 
$
1,911

 
4.6
%
The decrease in DPAC amortization for the three months ended September 30, 2019 as compared to the same respective period in 2018 was driven by the impact of higher capitalized underwriting salaries during the first half of 2018 and the resulting increase in amortization recognized during the third quarter of 2018. The increase in DPAC amortization for the nine months ended September 30, 2019 primarily reflected the increase in net premiums earned. The increase in other underwriting and operating expenses for the nine months ended September 30, 2019 reflected an increase in compensation and benefit related costs, professional fees and, to a lesser extent, an increase in the allocation of technology costs charged by our Corporate segment. As previously discussed, alternative market premiums written through our Workers' Compensation Insurance segment's alternative market business unit are 100% ceded, less a ceding commission, to either the SPCs in our Segregated Portfolio Cell Reinsurance segment or, to a limited extent, an unaffiliated captive insurer. The ceding commission consists of an amount for fronting fees, cell rental fees, commissions, premium taxes, claims administration fees and risk management fees. The fronting fees, commissions, premium taxes and risk management fees are recorded as an offset to underwriting, policy acquisition and operating expenses. Cell rental fees are recorded as a component of other income and claims administration fees are recorded as ceded ULAE. The increase in SPC ceding commissions earned for nine months ended September 30, 2019 as compared to the same respective period of 2018 primarily reflected the increase in alternative market earned premium.
Underwriting Expense Ratio (the Expense Ratio)
The underwriting expense ratio included the impact of the following:
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Underwriting expense ratio, as reported
30.1
%
 
32.6
%
 
(2.5
)
pts
 
30.6
%
 
30.7
%
 
(0.1
)
pts
Less estimated ratio increase (decrease) attributable to:
 
 
 
 
 
 
 
 
 
 
 
 
 
Impact of ceding commissions received from SPCs
2.6
%
 
3.2
%
 
(0.6
)
pts
 
2.9
%
 
2.9
%
 
—

pts
Retrospective premium adjustment
0.1
%
 
0.1
%
 
—

pts
 
0.2
%
 
(0.1
%)
 
0.3

pts
Impact of audit premium
(0.6
%)
 
(0.2
%)
 
(0.4
)
pts
 
(0.3
%)
 
(0.4
%)
 
0.1

pts
Impact of return premium estimate
0.1
%
 
(0.2
%)
 
0.3

pts
 
—
%
 
0.1
%
 
(0.1
)
pts
Underwriting expense ratio, less listed effects
27.9
%
 
29.7
%
 
(1.8
)
pts
 
27.8
%
 
28.2
%
 
(0.4
)
pts
The decrease in the expense ratio for the three and nine months ended September 30, 2019, excluding the items noted in the table, primarily reflected the increase in net premiums earned. Additionally, the decrease for the 2019 three-month period also reflected a decrease in DPAC amortization, as previously discussed.

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Table of Contents

Segment Operating Results - Segregated Portfolio Cell Reinsurance
The Segregated Portfolio Cell Reinsurance segment reflects the operating results (underwriting profit or loss, plus investment results) of SPCs at Inova Re and Eastern Re, our Cayman Islands SPC operations, as discussed in Note 14 of the Notes to Condensed Consolidated Financial Statements. SPCs are segregated pools of assets and liabilities that provide an insurance facility for a defined set of risks. Assets of each SPC are solely for the benefit of that individual cell and each SPC is solely responsible for the liabilities of that individual cell. Assets of one SPC are statutorily protected from the creditors of the others. Each SPC is owned, fully or in part, by an agency, group or association and the operating results of the SPCs are due to the participants of that cell. We participate to a varying degree in the results of selected SPCs and, for the SPCs in which we participate, our participation interest ranges from a low of 20% to a high of 85%. SPC operating results due to external cell participants are reflected as an SPC dividend expense (income) in our Segregated Portfolio Cell Reinsurance segment. In addition, our Segregated Portfolio Cell Reinsurance segment includes the SPC investment results as the investments are solely for the benefit of the cell participants and investment results due to external cell participants are reflected in the SPC dividend expense (income). As of September 30, 2019, there were 27 (23 active) SPCs. The majority of the SPCs only assume workers' compensation insurance, healthcare professional liability insurance or a combination of the two from our Workers' Compensation Insurance and Specialty P&C segments. In addition, an SPC at Eastern Re assumed an errors and omissions liability policy from a captive insurer unaffiliated with ProAssurance.
Segment operating results reflects our share of the underwriting and investment results of the SPCs in which we participate, and included the following:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
2018
Change
 
2019
2018
Change
Net premiums written
$
15,268

$
14,832

$
436

2.9
%
 
$
62,886

$
60,709

$
2,177

3.6
%
 
 
 
 
 
 
 
 
 
 
Net premiums earned
$
19,779

$
18,963

$
816

4.3
%
 
$
58,566

$
54,247

$
4,319

8.0
%
Net investment income
445

371

74

19.9
%
 
1,261

1,100

161

14.6
%
Net realized gains (losses)
(98
)
1,397

(1,495
)
(107.0
%)
 
1,949

467

1,482

317.3
%
Other income
176

86

90

104.7
%
 
397

176

221

125.6
%
Net losses and loss adjustment expenses
(9,778
)
(8,560
)
(1,218
)
14.2
%
 
(40,496
)
(27,561
)
(12,935
)
46.9
%
Underwriting, policy acquisition and operating expenses
(5,951
)
(5,516
)
(435
)
7.9
%
 
(17,091
)
(16,070
)
(1,021
)
6.4
%
SPC net operating results
4,573

6,741

(2,168
)
(32.2
%)
 
4,586

12,359

(7,773
)
(62.9
%)
SPC dividend (expense) income (1)
(3,621
)
(5,255
)
1,634

(31.1
%)
 
(1,375
)
(9,787
)
8,412

(86.0
%)
Segment operating results (2)
$
952

$
1,486

$
(534
)
(35.9
%)

$
3,211

$
2,572

$
639

24.8
%
 
 
 
 
 
 
 
 
 
 
Net loss ratio
49.4
%
45.1%
4.3

pts
 
69.1
%
50.8
%
18.3

pts
Underwriting expense ratio
30.1
%
29.1%
1.0

pts
 
29.2
%
29.6
%
(0.4
)
pts
(1) Represents the operating (profit) loss due to external cell participants.
(2) Represents our share of the operating profit (loss) of the SPCs in which we participate.

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Premiums Written
The majority of premiums in our Segregated Portfolio Cell Reinsurance segment are assumed from either our Workers' Compensation Insurance or Specialty P&C segments. Premium volume is driven by five primary factors: (1) the amount of new business written, (2) retention of the existing book of business, (3) premium rates charged on the renewal book of business and, for workers' compensation business, (4) audit premium and (5) changes in payroll exposure.
Gross, ceded and net premiums written were as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Gross premiums written
$
17,281

 
$
16,799

 
$
482

 
2.9
%
 
$
70,556

 
$
68,255

 
$
2,301

 
3.4
%
Less: Ceded premiums written
2,013

 
1,967

 
46

 
2.3
%
 
7,670

 
7,546

 
124

 
1.6
%
Net premiums written
$
15,268

 
$
14,832

 
$
436

 
2.9
%
 
$
62,886

 
$
60,709

 
$
2,177

 
3.6
%
Gross Premiums Written
Gross premiums written reflected reinsurance premiums assumed by component as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Workers' compensation
$
16,706

 
$
16,275

 
$
431

 
2.6
%
 
$
64,610

 
$
63,214

 
$
1,396

 
2.2
%
Healthcare professional liability
575

 
524

 
51

 
9.7
%
 
5,465

 
5,041

 
424

 
8.4
%
Other
—

 
—

 
—

 
nm

 
481

 
—

 
481

 
nm

Gross Premiums Written
$
17,281

 
$
16,799

 
$
482

 
2.9
%
 
$
70,556

 
$
68,255

 
$
2,301

 
3.4
%
Gross premiums written for the 2019 and 2018 three- and nine- month periods were primarily comprised of workers' compensation coverages assumed from our Workers' Compensation Insurance segment. The increase in gross premiums written during the 2019 three- and nine- month periods as compared to the same periods of 2018 was driven by new business written and an increase in the renewal retention rate, partially offset by a decrease in renewal pricing related to the competitive workers' compensation marketplace. We retained all 18 of the available alternative market programs, including 16 workers' compensation programs and 2 healthcare professional liability programs up for renewal during the nine months ended September 30, 2019. During the third quarter of 2019, we added one new alternative market program at Inova Re.
New business, audit premium, retention and renewal price changes for the assumed workers' compensation premium is shown in the table below:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in millions)
2019
 
2018
 
2019
 
2018
New business
$
0.8

 
$
1.6

 
$
3.0

 
$
7.0

Audit premium (including EBUB)
$
0.4

 
$
0.6

 
$
1.3

 
$
1.0

Retention rate (1)
96
%
 
87
%
 
93
%
 
91
%
Change in renewal pricing (2)
(5
%)
 
1
%
 
(4
%)
 
—
%
(1) We calculate our workers' compensation retention rate as annualized expiring renewed premium divided by all annualized expiring premium subject to renewal. Our retention rate can be impacted by various factors, including price or other competitive issues, insureds being acquired, or a decision not to renew based on our underwriting evaluation.
(2) The pricing of our business includes an assessment of the underlying policy exposure and the effects of current market conditions. We continue to base our pricing on expected losses, as indicated by our historical loss data.

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Ceded Premiums Written
Ceded premiums written were as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
2018
Change
 
2019
2018
Change
Ceded premiums written
$
2,013

$
1,967

$
46

2.3
%
 
$
7,670

$
7,546

$
124

1.6
%
For the workers' compensation business, each SPC has in place its own external reinsurance arrangements. The healthcare professional liability business is assumed net of reinsurance from our Specialty P&C segment; therefore, there are no ceded premiums related to the healthcare professional liability business reflected in the table above. The risk retention for each loss occurrence for the workers' compensation business ranges from $0.3 million to $0.35 million based on the program, with limits up to $119.7 million. In addition, each program has aggregate reinsurance coverage between $1.1 million and $2.1 million on a program year basis. Per the SPC external reinsurance agreements, premiums are ceded on a written premium basis and changes in ceded premiums written during the 2019 three- and nine- month periods primarily reflected changes in gross written premium, as compared to the same respective periods in 2018. External reinsurance rates vary based on the alternative market program.
Ceded Premiums Ratio
Ceded premiums ratio was as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Ceded premiums ratio
12.0%
 
12.1%
 
(0.1
)
pts
 
11.9%
 
11.9%
 
—
pts
The above table reflects ceded premiums as a percent of gross premiums written for the workers' compensation business only; healthcare professional liability business is assumed net of reinsurance, as discussed above. The ceded premiums ratio remained relatively unchanged for the 2019 three- and nine- month periods as compared to the same respective periods of 2018.
Net Premiums Earned
Gross, ceded and net premiums earned were as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
2018
Change
 
2019
2018
Change
Gross premiums earned
$
22,218

$
21,476

$
742

3.5
%
 
$
65,856

$
61,069

$
4,787

7.8
%
Less: Ceded premiums earned
2,439

2,513

(74
)
(2.9
%)
 
7,290

6,822

468

6.9
%
Net premiums earned
$
19,779

$
18,963

$
816

4.3
%
 
$
58,566

$
54,247

$
4,319

8.0
%
Net premiums earned consist of gross premiums earned less the portion of earned premiums that the SPCs cede to external reinsurers. Because premiums are generally earned pro rata over the entire policy period, fluctuations in premiums earned tend to lag those of premiums written. Policies ceded to the SPCs are twelve month term policies and premiums are earned on a pro rata basis over the policy period. Net premiums earned also include premium adjustments related to the audit of workers' compensation insureds' payrolls. Payroll audits are conducted subsequent to the end of the policy period and any related adjustments are recorded as fully earned in the current period. The increase in net premiums earned primarily reflected the pro rata effect of higher net premiums written during the preceding twelve months.
Net Investment Income and Net Realized Investment Gains (Losses)
Net investment income for the 2019 and 2018 three- and nine- month periods was primarily attributable to interest earned on available-for-sale fixed maturity investments, which primarily includes investment-grade corporate debt securities. Net realized investment gains and losses during the 2019 and 2018 three- and nine- month periods primarily reflected changes in the value of the SPCs' equity securities portfolio.

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Losses and Loss Adjustment Expenses
The following table summarizes the calendar year net loss ratios by separating losses between the current accident year and all prior accident years. The current accident year net loss ratio for our Segregated Portfolio Cell Reinsurance segment reflects the aggregate loss ratio for all programs. Loss reserves are estimated for each program on a quarterly basis. Due to the size of some of the programs, quarterly claims activity can cause the current accident year net loss ratio to fluctuate significantly from period to period.
Calendar year and current accident year net loss ratios for the three months ended September 30, 2019 and 2018 was as follows:
 
Three Months Ended September 30
 
2019
 
2018
 
Change
Calendar year net loss ratio
49.4
%
 
45.1
%
 
4.3

pts
Less impact of prior accident years on the net loss ratio
(16.7
%)
 
(19.7
%)
 
3.0

pts
Current accident year net loss ratio
66.1
%
 
64.8
%
 
1.3

pts
The increase in the current accident year net loss ratio for the 2019 three-month period primarily reflected the effect of the continuation of intense price competition and the resulting renewal rate decreases.
For the nine months ended September 30, 2019, our Segregated Portfolio Cell Reinsurance segment net loss ratios were affected by a $10 million reserve that an SPC at Eastern Re established during the second quarter of 2019. This SPC previously assumed an errors and omissions liability policy that provides coverage for losses up to a lifetime maximum of $10 million from a captive insurer unaffiliated with ProAssurance. During the second quarter of 2019, a claim was filed under this policy that met the lifetime maximum limit and, accordingly, a $10 million reserve was recorded. We do not participate in the SPC that assumed this policy; therefore, these losses are the obligation of the external cell participants and are reflected in the SPC dividend expense (income) and have no effect on our Segregated Portfolio Cell Reinsurance segment operating results for the nine months ended September 30, 2019. Given the significance of this one-time event, we have removed the impact of the policy from each of the ratios below (as shown in the columns labeled "Adjusted") in order to assist in the comparability between periods. Calendar year and current accident year net loss ratios for the nine months ended September 30, 2019 and 2018 was as follows:
 
Nine Months Ended September 30
 
2019
 
2018
 
Change
 
As reported
 
E&O reserve impact
Adjusted
 
As reported
 
As reported
Adjusted
Calendar year net loss ratio
69.1
%
 
16.6
pts
52.5
%
 
50.8
%
 
18.3
pts
1.7
pts
Less impact of prior accident years on the net loss ratio
(13.4
%)
 
0.1
pts
(13.5
%)
 
(15.2
%)
 
1.8
pts
1.7
pts
Current accident year net loss ratio
82.5
%
 
16.5
pts
66.0
%
 
66.0
%
 
16.5
pts
—
pts
Excluding the impact of the errors and omissions liability policy, as shown in the table above, the current accident year net loss ratio for the 2019 nine-month period was unchanged as compared to the same period of 2018.
Calendar year incurred losses ceded to our external reinsurers increased $0.5 million and $1.9 million for the 2019 three- and nine- month periods, respectively, as compared to the same periods of 2018. Current accident year ceded incurred losses totaled $1.8 million and $2.0 million for the 2019 three- and nine- month periods, respectively, compared to $1.3 million for the 2018 nine-month period. There were no current accident year ceded incurred losses reported in the 2018 three-month period.
We recognized net favorable prior year reserve development of $3.3 million and $7.8 million for the three and nine months ended September 30, 2019, respectively, and $3.7 million and $8.2 million for the same respective periods of 2018. The net favorable prior year reserve development for the three and nine months ended September 30, 2019 primarily reflected better than expected claim trends in the 2015 through 2018 accident years due to lower frequency and severity than anticipated at the time the reserves were established. The net favorable prior year reserve development for the three and nine months ended September 30, 2018 reflected overall favorable trends in claim closing patterns, primarily in the 2015 and 2016 accident years.

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Underwriting, Policy Acquisition and Operating Expenses
Our Segregated Portfolio Cell Reinsurance segment underwriting, policy acquisition and operating expenses were comprised as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
 
2018
 
Change
 
2019
 
2018
 
Change
DPAC amortization
$
5,493

 
$
5,291

 
$
202

 
3.8
%
 
$
16,159

 
$
15,448

 
$
711

 
4.6
%
Other underwriting and operating expenses
458

 
225

 
233

 
103.6
%
 
932

 
622

 
310

 
49.8
%
Total
$
5,951

 
$
5,516

 
$
435

 
7.9
%
 
$
17,091

 
$
16,070

 
$
1,021

 
6.4
%
DPAC amortization primarily represented ceding commissions, which vary by program and are paid to our Workers' Compensation Insurance and Specialty P&C segments for premiums assumed. Ceding commissions include an amount for fronting fees, commissions, premium taxes and risk management fees, which are reported as an offset to underwriting, policy acquisition and operating expenses within our Workers' Compensation Insurance and Specialty P&C segments. In addition, ceding commissions paid to our Workers' Compensation Insurance segment include cell rental fees which are recorded as other income within our Workers' Compensation Insurance segment. The increase in other underwriting and operating expenses for the three and nine months ended September 30, 2019 as compared to the same periods of 2018 primarily reflected an increase in fees related to letters of credit posted as program collateral.
Underwriting Expense Ratio (the Expense Ratio)
The underwriting expense ratio included the impact of the following:
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Underwriting expense ratio, as reported
30.1
%
 
29.1
%
 
1.0
pts
 
29.2
%
 
29.6
%
 
(0.4
)
pts
Less impact of audit premium on expense ratio
(0.5
%)
 
(1.0
%)
 
0.5
pts
 
(0.5
%)
 
(0.5
%)
 
—

pts
Underwriting expense ratio, excluding the effect of audit premium
30.6
%
 
30.1
%
 
0.5
pts
 
29.7
%
 
30.1
%
 
(0.4
)
pts
The underwriting expense ratio primarily reflects the weighted average ceding commission percentage of all SPC programs.

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Segment Operating Results - Lloyd's Syndicates
Our Lloyd's Syndicates segment includes operating results from our participation in certain Syndicates at Lloyd's of London. We have a total capital commitment to support our Lloyd's Syndicate operations through 2019 of up to $200 million, referred to as FAL. The Board, through a non-binding resolution, extended this commitment through 2022. For the 2019 underwriting year, our FAL was comprised of investment securities and cash and cash equivalents deposited with Lloyd's which at September 30, 2019 had a fair value of approximately $134.7 million, as discussed in Note 3 of the Notes to Condensed Consolidated Financial Statements.
We normally report results from our involvement in Lloyd's Syndicates on a quarter lag, except when information is available that is material to the current period (see discussion that follows under the heading "Property and Natural Catastrophe Losses"). Furthermore, the investment results associated with our FAL investments and certain U.S. paid administrative expenses are reported concurrently as that information is available on an earlier time frame.
Lloyd's Syndicate 1729. We are the majority capital provider to Syndicate 1729, which covers a range of property and casualty insurance and reinsurance lines. For the 2019 underwriting year, we slightly decreased our participation in the operating results of Syndicate 1729 from 62% to 61% which, due to the quarter lag, was not reflected in our Lloyd's Syndicates segment results until the second quarter of 2019. The remaining capital for Syndicate 1729 is provided by unrelated third parties, including private names and other corporate members. Syndicate 1729 has a maximum underwriting capacity of £128 million for the 2019 underwriting year, of which £78 million (approximately $96 million based on September 30, 2019 exchange rates) is our allocated underwriting capacity.
Lloyd's Syndicate 6131. We are the sole (100%) capital provider to an SPA, Syndicate 6131, which focuses on contingency and specialty property business. As an SPA, Syndicate 6131 is only allowed to underwrite one quota share reinsurance contract with Syndicate 1729. Due to the quarter lag, our participation in Syndicate 6131 was not reflected in our Lloyd's Syndicates segment results until the second quarter of 2018 as Syndicate 6131 began writing business effective January 1, 2018. For the 2019 underwriting year, Syndicate 6131 has a maximum underwriting capacity of £12 million (approximately $15 million based on September 30, 2019 exchange rates).
In addition to the results of our participation in Lloyd's Syndicates, as discussed above, our Lloyd's Syndicates segment also includes 100% of the operating results of our wholly owned subsidiaries that support our operations at Lloyd's. For the three and nine months ended September 30, 2019 and 2018, the results of our Lloyd's Syndicates segment were as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
2018
Change
 
2019
2018
Change
Gross premiums written
$
30,427

$
26,387

$
4,040

15.3
%
 
$
83,247

$
62,949

$
20,298

32.2
%
Ceded premiums written
(8,599
)
(1,756
)
(6,843
)
389.7
%
 
(21,660
)
(16,610
)
(5,050
)
30.4
%
Net premiums written
$
21,828

$
24,631

$
(2,803
)
(11.4
%)
 
$
61,587

$
46,339

$
15,248

32.9
%
 
 
 
 
 
 
 
 
 
 
Net premiums earned
$
21,295

$
19,022

$
2,273

11.9
%
 
$
57,215

$
48,987

$
8,228

16.8
%
Net investment income
1,077

783

294

37.5
%
 
3,282

2,370

912

38.5
%
Net realized gains (losses)
285

(98
)
383

390.8
%
 
725

(404
)
1,129

279.5
%
Other income (loss)
(165
)
352

(517
)
(146.9
%)
 
(278
)
247

(525
)
(212.6
%)
Net losses and loss adjustment expenses
(11,907
)
(10,032
)
(1,875
)
18.7
%
 
(34,640
)
(31,023
)
(3,617
)
11.7
%
Underwriting, policy acquisition and operating expenses
(9,411
)
(8,439
)
(972
)
11.5
%
 
(25,445
)
(23,745
)
(1,700
)
7.2
%
Income tax benefit (expense)
161

361

(200
)
(55.4
%)
 
161

355

(194
)
(54.6
%)
Segment operating results
$
1,335

$
1,949

$
(614
)
(31.5
%)
 
$
1,020

$
(3,213
)
$
4,233

131.7
%
 
 
 
 
 
 
 
 
 
 
Net loss ratio
55.9%
52.7%
3.2

pts
 
60.5%
63.3%
(2.8
)
pts
Underwriting expense ratio
44.2%
44.4%
(0.2
)
pts
 
44.5%
48.5%
(4.0
)
pts

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Property and Natural Catastrophe Losses
As previously mentioned, we normally report results from our involvement in Lloyd's Syndicates on a quarter lag; however, during the fourth quarter of 2018, we accelerated our reporting of approximately $6.8 million, net of reinsurance and reinstatement premiums, of storm-related losses in connection with Hurricane Michael, which affected the northwest portion of Florida during October 2018. These losses would have normally been reported in the first quarter of 2019 due to the aforementioned quarter lag. However, due to the availability and significance of these estimates, we accelerated our reporting of these storm-related losses into the fourth quarter of 2018, which is consistent with our policy of reporting significant losses in the period in which they become known to us. No such adjustments were made during the three and nine months ended September 30, 2019 or 2018.
Gross Premiums Written
Changes in our premium volume within our Lloyd's Syndicates segment are driven by four primary factors: (1) the amount of new business and the channels in which the business is written, (2) our retention of existing business, (3) the premium charged for business that is renewed, which is affected by rates charged and by the amount and type of coverage an insured chooses to purchase and (4) the timing of premium written through multi-period policies.
Gross premiums written during the nine months ended September 30, 2019 consisted of property insurance coverages (45% of total gross premiums written), casualty coverages (30%), catastrophe reinsurance coverages (15%), specialty property coverages (7%) and property reinsurance coverages (3%). Gross premiums written increased during the 2019 three- and nine- month periods as compared to the same respective periods of 2018 driven by volume increases on renewal business and renewal pricing increases, as well as new business written, primarily property insurance coverages.
As discussed in our Specialty P&C segment operating results, prior to January 1, 2018 Syndicate 1729 served as a reinsurer on a quota share basis for a wholly owned insurance subsidiary in our Specialty P&C segment. Premiums assumed from our Specialty P&C segment were approximately $1.2 million during the nine months ended September 30, 2018. The 2017 and 2016 calendar year quota share arrangements with our Specialty P&C segment were commuted in December 2018 and 2017, respectively. Due to the quarter lag, the effects of the 2017 and 2016 commutations were reported in both segments' results during the first quarters of 2019 and 2018, respectively, and are reflected in the Lloyd's Syndicates segment results for the nine months ended September 30, 2019 and 2018, respectively. The commutations did not differ significantly from previously recorded amounts.
Ceded Premiums Written
Syndicate 1729 utilizes reinsurance to provide the capacity to write larger limits of liability on individual risks, to provide protection against catastrophic loss and to provide protection against losses in excess of policy limits. Ceded premiums written increased for the three and nine months ended September 30, 2019 primarily due to the increased utilization and cost associated with reinsurance on property and catastrophe business. For the 2019 three-month period, the increase in ceded premiums written also reflected the timing of and revised contract terms related to the renewal of a catastrophe reinsurance agreement that renewed during the third quarter of 2019 instead of during the second quarter, which has been the typical renewal period.
Net Premiums Earned
Net premiums earned consist of gross premiums earned less the portion of earned premiums that we cede to our reinsurers for their assumption of a portion of our losses. Premiums written through open-market channels are generally earned pro rata over the entire policy period, which is predominately twelve months; whereas premiums written through delegated underwriting authority arrangements are earned over twenty-four months. Therefore, net premiums earned is affected by shifts in the mix of policies written between the open-market and delegated underwriting authority arrangements. Additionally, fluctuations in premiums earned tend to lag those of premiums written. Premiums for certain policies and assumed reinsurance contracts are reported subsequent to the coverage period and/or may be subject to adjustment based on loss experience. These premium adjustments are earned when reported, which can result in further fluctuation in earned premium.
Gross, ceded and net premiums earned were as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Gross premiums earned
$
26,399

 
$
23,050

 
$
3,349

14.5
%
 
$
72,225

 
$
60,289

 
$
11,936

19.8
%
Less: Ceded premiums earned
5,104

 
4,028

 
1,076

26.7
%
 
15,010

 
11,302

 
3,708

32.8
%
Net premiums earned
$
21,295

 
$
19,022

 
$
2,273

11.9
%
 
$
57,215

 
$
48,987

 
$
8,228

16.8
%

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The increase in gross premiums earned during the three and nine months ended September 30, 2019 as compared to the same respective periods of 2018 was driven by the pro rata effect of higher premiums written during the preceding twelve months, primarily property insurance coverages, and, to a greater extent for the 2019 nine-month period, the pro rata effect of shifts in the mix of premiums written during the preceding twelve months; a larger proportion of premiums were written through the open-market, as compared to previous years, which are predominately earned over twelve months. For the 2019 nine-month period, the increase in gross premiums earned also reflected the increase in our participation in Syndicate 1729 and Syndicate 6131 at the beginning of 2018 which was not reflected in our Lloyd's Syndicates segment results until the second quarter of 2018.
The increase in ceded premiums earned during the 2019 three- and nine- month periods was driven by the pro rata effect of an increase in premiums ceded under reinsurance arrangements during the preceding twelve months.
Gross and net premiums earned included a nominal amount of premium assumed from our Specialty P&C segment during the 2019 nine-month period as compared to approximately $1.2 million and $4.5 million during the 2018 three- and nine- month periods, respectively.
Net Losses and Loss Adjustment Expenses
Losses for the period were primarily recorded using the loss assumptions by risk category incorporated into the business plan submitted to Lloyd's for Syndicate 1729 with consideration given to loss experience incurred to date. The assumptions used in the business plan were consistent with loss results reflected in Lloyd's historical data for similar risks. Syndicate 6131 follows a process similar to Syndicate 1729 for the establishment of initial reserves. We expect loss ratios to fluctuate from quarter to quarter as Syndicate 1729 writes more business and the book begins to mature. We also expect loss ratios of Syndicate 6131 to fluctuate from quarter to quarter as Syndicate 6131 assumes more business from Syndicate 1729. The loss ratios will also fluctuate due to the timing of earned premium adjustments (see discussion in this section under the heading "Net Premiums Earned"). Premium and exposure for some of Syndicate 1729's insurance policies and reinsurance contracts are initially estimated and subsequently adjusted over an extended period of time as underlying premium reports are received from cedants and insureds. When reports are received, the premium, exposure and corresponding loss estimates are revised accordingly. Changes in loss estimates due to premium or exposure fluctuations are incurred in the accident year in which the premium is earned.
The following table summarizes calendar year net loss ratios by separating losses between the current accident year and all prior accident years. Net loss ratios for the period were as follows:
 
Net Loss Ratios
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Calendar year net loss ratio
55.9
%
 
52.7
%
 
3.2
pts
 
60.5
%
 
63.3
%
 
(2.8
)
pts
Less impact of prior accident years on the net loss ratio
(2.4
%)
 
(3.4
%)
 
1.0
pts
 
—
%
 
0.6
%
 
(0.6
)
pts
Current accident year net loss ratio
58.3
%
 
56.1
%
 
2.2
pts
 
60.5
%
 
62.7
%
 
(2.2
)
pts
The current accident year net loss ratio increased during the three months ended September 30, 2019 as compared to the same period of 2018 driven by a decrease in estimated reinsurance recoveries related to property and catastrophe related losses as compared to the same period of 2018 and, to a lesser extent, the effect of the increase in ceded premiums earned, as previously discussed. A larger portion of property and catastrophe related losses during the 2018 three-month period exceeded the reinsurance retention limits whereas Syndicate 1729 retained more of these losses during the 2019 three-month period due to certain excess of loss reinsurance agreement terms. The decrease in the current accident year net loss ratio during the nine months ended September 30, 2019 as compared to the same period of 2018 was driven by an increase in estimated reinsurance recoveries related to property and catastrophe related losses as compared to the prior year period, partially offset by the increase in ceded premiums earned.
We recognized $0.5 million of favorable prior year development and a nominal amount of unfavorable prior year development for the three and nine months ended September 30, 2019, respectively, as compared to $0.6 million of favorable prior year development and $0.3 million of unfavorable prior year development for the same respective periods of 2018.

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Underwriting, Policy Acquisition and Operating Expenses
Underwriting, policy acquisition and operating expenses increased by $1.0 million and $1.7 million for the 2019 three- and nine- month periods, respectively, as compared to the same periods in 2018. The increase during the 2019 three- and nine- month periods was primarily due to the growth in Syndicate 1729 operations and an increase in DPAC amortization primarily due to an increase in net premiums earned, partially offset by the effect of higher operational expenses incurred during the 2018 three- and nine- month periods associated with establishing Syndicate 6131.
The underwriting expense ratio decreased during the 2019 three- and nine- month periods as compared to the same periods in 2018 primarily due to the increased volume of earned premium as a result of the growth of the Syndicates. In addition, the decrease in the underwriting expense ratio in both periods as compared to the same periods in 2018 reflected the effect of higher operational expenses incurred during the 2018 three- and nine- month periods associated with the establishment of Syndicate 6131.
Investments
Net investment income for the 2019 and 2018 three- and nine- month periods was primarily attributable to interest earned on our FAL investments, which primarily includes investment-grade corporate debt securities. Syndicate 1729's fixed maturities portfolio includes certain debt securities classified as trading securities. Investment results associated with these fixed maturity trading securities are reported on the same quarter lag.
Taxes
Operating results of this segment are subject to U.K. income tax law.

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Segment Operating Results - Corporate
Our Corporate segment includes investment operations, other than those reported in our Segregated Portfolio Cell Reinsurance and Lloyd's Syndicates segments, interest expense and U.S. income taxes as discussed in Note 14 of the Notes to Condensed Consolidated Financial Statements. Our Corporate segment also includes non-premium revenues generated outside of our insurance entities and corporate expenses. Segment operating results for our Corporate segment were net earnings of $22.4 million and $79.7 million for the three and nine months ended September 30, 2019, respectively, as compared to $30.3 million and $58.7 million for the same respective periods of 2018 and included the following:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
2018
Change
 
2019
2018
Change
Net investment income
$
22,159

$
22,112

$
47

0.2
%
 
$
65,495

$
64,207

$
1,288

2.0
%
Equity in earnings (loss) of unconsolidated subsidiaries
$
(1,277
)
$
5,228

$
(6,505
)
(124.4
%)
 
$
(7,240
)
$
12,247

$
(19,487
)
(159.1
%)
Net realized gains (losses)
$
947

$
11,074

$
(10,127
)
(91.4
%)
 
$
44,390

$
2,588

$
41,802

1,615.2
%
Other income
$
963

$
699

$
264

37.8
%
 
$
2,701

$
2,737

$
(36
)
(1.3
%)
Operating expense
$
2,682

$
5,053

$
(2,371
)
(46.9
%)
 
$
12,676

$
15,351

$
(2,675
)
(17.4
%)
Interest expense
$
4,274

$
3,645

$
629

17.3
%
 
$
12,850

$
11,308

$
1,542

13.6
%
Income tax expense (benefit)
$
(6,528
)
$
155

$
(6,683
)
(4,311.6
%)
 
$
157

$
(3,584
)
$
3,741

104.4
%
Net Investment Income, Equity in Earnings (Loss) of Unconsolidated Subsidiaries, Net Realized Investment Gains (Losses)
Net Investment Income
Net investment income is primarily derived from the income earned by our fixed maturity securities and also includes dividend income from equity securities, income from our short-term and cash equivalent investments, earnings from other investments and increases in the cash surrender value of BOLI contracts. Investment fees and expenses are deducted from net investment income.
Net investment income by investment category was as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Fixed maturities
$
17,020

 
$
16,038

 
$
982

 
6.1
%
 
$
49,852

 
$
48,244

 
$
1,608

 
3.3
%
Equities
3,943

 
5,687

 
(1,744
)
 
(30.7
%)
 
13,756

 
15,553

 
(1,797
)
 
(11.6
%)
Short-term investments, including Other
1,758

 
1,276

 
482

 
37.8
%
 
4,874

 
3,795

 
1,079

 
28.4
%
BOLI
645

 
621

 
24

 
3.9
%
 
1,557

 
1,525

 
32

 
2.1
%
Investment fees and expenses
(1,207
)
 
(1,510
)
 
303

 
(20.1
%)
 
(4,544
)
 
(4,910
)
 
366

 
(7.5
%)
Net investment income
$
22,159

 
$
22,112

 
$
47

 
0.2
%
 
$
65,495

 
$
64,207

 
$
1,288

 
2.0
%
Fixed Maturities
The increase in income from our fixed maturities during the 2019 three- and nine- month periods was primarily due to higher yields from certain asset classes in our fixed maturity portfolio. In addition, on an overall basis, our average investment in fixed maturity securities was approximately 5% and 1% higher for the 2019 three- and nine- month periods, respectively, as compared to the same respective periods of 2018.
Average yields for our fixed maturity portfolio were as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2019
 
2018
 
2019
 
2018
Average income yield
3.4%
 
3.3%
 
3.4%
 
3.3%
Average tax equivalent income yield
3.4%
 
3.4%
 
3.4%
 
3.4%

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Equities
Income from our equity portfolio decreased during the 2019 three- and nine- month periods as compared to the same respective periods of 2018 which reflected a decrease in our allocation to this asset category as well as a different mix of equities owned.
Other Investments and Short-term Investments
Short-term investments, which have a maturity at purchase of one year or less are carried at fair value, which approximates their cost basis, and are primarily composed of investments in U.S. treasury obligations, commercial paper and money market funds. Income from our other investments and short-term investments increased during the 2019 three- and nine- month periods primarily attributable to higher yields as compared to the same respective periods of 2018.
Equity in Earnings (Loss) of Unconsolidated Subsidiaries
Equity in earnings (loss) of unconsolidated subsidiaries was as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
 
2018
 
Change
 
2019
 
2018
 
Change
All other investments, primarily investment fund LPs/LLCs
$
4,495

 
$
11,283

 
$
(6,788
)
 
(60.2
%)
 
$
8,621

 
$
31,396

 
$
(22,775
)
 
(72.5
%)
Tax credit partnerships
(5,772
)
 
(6,055
)
 
283

 
(4.7
%)
 
(15,861
)
 
(19,149
)
 
3,288

 
(17.2
%)
Equity in earnings (loss) of unconsolidated subsidiaries
$
(1,277
)
 
$
5,228

 
$
(6,505
)
 
(124.4
%)
 
$
(7,240
)
 
$
12,247

 
$
(19,487
)
 
(159.1
%)
We hold interests in certain LPs/LLCs that generate earnings from trading portfolios, secured debt, debt securities, multi-strategy funds and private equity investments. The performance of the LPs/LLCs is affected by the volatility of equity and credit markets. For our investments in LPs/LLCs, we record our allocable portion of the partnership operating income or loss as the results of the LPs/LLCs become available. Our investment results from our portfolio of investments in LPs/LLCs decreased for the 2019 three- and nine- month periods driven by lower reported earnings from two LP investments which accounted for $6.2 million and $17.7 million, respectively, of the decrease as compared to the 2018 three- and nine- month periods.
Our tax credit partnership investments are designed to generate returns in the form of tax credits and tax-deductible project operating losses and are comprised of qualified affordable housing project tax credit partnerships and historic tax credit partnerships. We account for our tax credit partnership investments under the equity method and record our allocable portion of the operating losses of the underlying properties based on estimates provided by the partnerships. For our qualified affordable housing project tax credit partnerships, we adjust our estimates of our allocable portion of operating losses periodically as actual operating results of the underlying properties become available. Our historic tax credit partnerships are short-term in nature and remaining operating losses are expected to be recognized primarily in 2019. The results from our tax credit partnership investments for the three and nine months ended September 30, 2019 reflected lower partnership operating losses as compared to the same respective periods of 2018. In addition, based on operating results received, we increased our estimate of partnership operating losses by $1.5 million and $3.0 million in the three and nine months ended September 30, 2019, respectively, as compared to $0.4 million and $3.1 million for the same respective periods of 2018.
The tax benefits received from our tax credit partnerships, which are not reflected in our investment results above, reduced our tax expense in 2019 and 2018 as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
(In millions)
2019
 
2018
 
2019
 
2018
Tax credits recognized during the period
$
4.6

 
$
5.2

 
$
13.9

 
$
15.8

Tax benefit of tax credit partnership operating losses
$
1.2

 
$
1.3

 
$
3.3

 
$
4.0

Tax credits provided by the underlying projects of the historic tax credit partnerships are typically available in the tax year in which the project is put into active service, whereas the tax credits provided by qualified affordable housing project tax credit partnerships are provided over approximately a ten year period. The decrease in tax credits recognized for the three and nine months ended September 30, 2019 was primarily attributable to our historic tax credit partnership investments.

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Non-GAAP Financial Measure – Tax Equivalent Investment Result
We believe that to fully understand our investment returns it is important to consider the current tax benefits associated with certain investments as the tax benefit received represents a portion of the return provided by our tax-exempt bonds, BOLI, common and preferred stocks, and tax credit partnership investments (collectively, our tax-preferred investments). We impute a pro forma tax-equivalent result by estimating the amount of fully-taxable income needed to achieve the same after-tax result as is currently provided by our tax-preferred investments. We believe this better reflects the economics behind our decision to invest in certain asset classes that are either taxed at lower rates and/or result in reductions to our current federal income tax expense. Our pro forma tax-equivalent investment result is shown in the table that follows as well as a reconciliation of our GAAP net investment result to our tax equivalent result.
 
Three Months Ended September 30
 
Nine Months Ended September 30
(In thousands)
2019
 
2018
 
2019
 
2018
GAAP net investment result:
 
 
 
 
 
 
 
Net investment income
$
22,159

 
$
22,112

 
$
65,495

 
$
64,207

Equity in earnings (loss) of unconsolidated subsidiaries
(1,277
)
 
5,228

 
(7,240
)
 
12,247

GAAP net investment result
$
20,882

 
$
27,340

 
$
58,255

 
$
76,454

 
 
 
 
 
 
 
 
Pro forma tax-equivalent investment result
$
27,209

 
$
34,554

 
$
77,306

 
$
98,524

 
 
 
 
 
 
 
 
Reconciliation of pro forma and GAAP tax-equivalent investment result:
 
 
 
 
 
 
 
GAAP net investment result
$
20,882

 
$
27,340

 
$
58,255

 
$
76,454

Taxable equivalent adjustments, calculated using the 21% federal statutory tax rate
 
 
 
 
 
 
 
State and municipal bonds
191

 
332

 
659

 
1,082

BOLI
171

 
165

 
414

 
405

Dividends received
99

 
150

 
379

 
608

Tax credit partnerships
5,866

 
6,567

 
17,599

 
19,975

Pro forma tax-equivalent investment result
$
27,209

 
$
34,554

 
$
77,306

 
$
98,524



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Net Realized Investment Gains (Losses)
The following table provides detailed information regarding our net realized investment gains (losses).
 
Three Months Ended September 30
 
Nine Months Ended September 30
(In thousands)
2019
 
2018
 
2019
 
2018
OTTI losses, total:
 
 
 
 
 
 
 
Corporate debt
$
(66
)
 
$
(86
)
 
$
(202
)
 
$
(490
)
Portion of OTTI losses recognized in other comprehensive income before taxes:
 
 
 
 
 
 
 
Corporate debt
36

 
—

 
124

 
—

Net impairment losses recognized in earnings
(30
)
 
(86
)
 
(78
)
 
(490
)
Gross realized gains, available-for-sale fixed maturities
651

 
690

 
1,877

 
5,589

Gross realized (losses), available-for-sale fixed maturities
(125
)
 
(1,371
)
 
(453
)
 
(5,099
)
Net realized gains (losses), equity investments
1,935

 
4,689

 
12,902

 
17,208

Net realized gains (losses), other investments
397

 
561

 
974

 
1,652

Change in unrealized holding gains (losses), equity investments
(1,427
)
 
6,599

 
26,504

 
(15,411
)
Change in unrealized holding gains (losses), convertible securities, carried at fair value as a part of other investments
(519
)
 
(260
)
 
2,597

 
(1,126
)
Other
65

 
252

 
67

 
265

Net realized investment gains (losses)
$
947

 
$
11,074

 
$
44,390

 
$
2,588

For the three and nine months ended September 30, 2019, we recognized a nominal amount of both credit related OTTI in earnings and non-credit OTTI in OCI, both of which related to a corporate bond. We recognized OTTI in earnings of $0.1 million and $0.5 million during the 2018 three- and nine- month periods, respectively, related to debt instruments from two issuers in the energy sector.
We recognized $0.9 million and $44.4 million of net realized investment gains during the 2019 three- and nine- month periods, respectively. Net realized investment gains for the 2019 three-month period were driven by realized gains from the sale of equity investments, partially offset by unrealized holding losses on our equity portfolio during the period. For the 2019 nine-month period, net realized investment gains were driven by unrealized holding gains on our equity portfolio and realized gains from the sale of equity investments during the period. The primary driver of the unrealized holding gains during the 2019 nine-month period was the improvement in the market since December 31, 2018, which caused our equity securities to increase in value. The most significant sectors that benefited were the financial and energy sectors.

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Operating Expenses
Corporate segment operating expenses were comprised as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Operating expenses
$
7,056

 
$
9,461

 
$
(2,405
)
 
(25.4
%)
 
$
25,083

 
$
27,702

 
$
(2,619
)
 
(9.5
%)
Management fee offset
(4,374
)
 
(4,408
)
 
34

 
(0.8
%)
 
(12,407
)
 
(12,351
)
 
(56
)
 
0.5
%
Segment Total
$
2,682

 
$
5,053

 
$
(2,371
)
 
(46.9
%)
 
$
12,676

 
$
15,351

 
$
(2,675
)
 
(17.4
%)
The decrease in operating expenses for the 2019 three- and nine- month periods was primarily driven by a decrease in share-based compensation expenses and other compensation related costs, primarily as a result of lower bonuses. The decrease in share-based compensation expenses in the 2019 three- and nine- month periods was attributable to a decrease in the value of the projected awards based upon the decline of one of the associated performance metrics as well as fewer awards outstanding as compared to the same periods of 2018. In addition, the 2019 three- and nine- month periods reflected a decrease in technology expenses due to an increase in the allocation of technology costs to the operating subsidiaries within our Specialty P&C and Workers' Compensation Insurance segments from our Corporate segment.
Operating subsidiaries within our Specialty P&C and Workers' Compensation Insurance segments are charged a management fee by the Corporate segment for services provided to these subsidiaries. The management fee is based on the extent to which services are provided to the subsidiary and the amount of gross premium written by the subsidiary. Under the arrangement, the expenses associated with such services are reported as expenses of the Corporate segment, and the management fees charged are reported as an offset to Corporate operating expenses. While the terms of the arrangement were consistent between 2018 and 2019, fluctuations in the amount of gross premium written by each subsidiary can result in corresponding variations in the management fee charged to each subsidiary during a particular period.
Interest Expense
Consolidated interest expense for the three and nine months ended September 30, 2019 and 2018 was comprised as follows:
 
Three Months Ended September 30
 
Nine Months Ended September 30
($ in thousands)
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Senior Notes due 2023
$
3,357

 
$
3,357

 
$
—

 
—
%
 
$
10,071

 
$
10,071

 
$
—

 
—
%
Revolving Credit Agreement (including fees and amortization)
156

 
131

 
25

 
19.1
%
 
474

 
1,255

 
(781
)
 
(62.2
%)
Mortgage Loans (including amortization)*
351

 
375

 
(24
)
 
(6.4
%)
 
1,096

 
1,038

 
58

 
5.6
%
(Gain)/loss on interest rate cap
410

 
(264
)
 
674

 
(255.3
%)
 
1,209

 
(1,121
)
 
2,330

 
(207.9
%)
Other
—

 
—

 
—

 
nm

 
—

 
19

 
(19
)
 
nm

Interest expense
$
4,274

 
$
3,599

 
$
675

 
18.8
%
 
$
12,850

 
$
11,262

 
$
1,588

 
14.1
%
* During each of the three and nine months ended September 30, 2019, we received a nominal cash payment associated with our interest rate cap which was recorded as a reduction to interest expense associated with our Mortgage Loans.
Consolidated interest expense increased during the three and nine months ended September 30, 2019 as compared to the same respective periods of 2018 driven by the change in fair value of our interest rate cap. The interest rate cap is designated as an economic hedge of interest rate risk associated with our variable rate Mortgage Loans. Excluding the impact of the change in fair value of our interest rate cap, consolidated interest expense remained relatively unchanged for the 2019 three-month period and decreased for the 2019 nine-month period as compared to the same respective periods of 2018. The decrease during the nine months ended September 30, 2019 was due to lower interest expense on our Revolving Credit Agreement as we did not have any outstanding borrowings during the 2019 nine-month period compared to weighted average outstanding borrowings of $55 million during the 2018 nine-month period. Interest expense on our Revolving Credit Agreement for the three and nine months ended September 30, 2019 and for the three months ended September 30, 2018 primarily reflected unused commitment fees as there were no outstanding borrowings during those periods. See further discussion of our outstanding debt in Note 9 and further discussion of our interest rate cap agreement in Note 10 of the Notes to Condensed Consolidated Financial Statements.

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Taxes
Tax expense allocated to our Corporate segment includes U.S. tax only, which would include U.S. tax expense incurred from our corporate membership in Lloyd's of London and tax expense incurred from SPCs at Inova Re, one of our Cayman Islands reinsurance subsidiaries, which intend to elect to be taxed as U.S. taxpayers. The U.K. tax expense incurred by the U.K. based subsidiaries of our Lloyd's Syndicates segment is allocated to that segment. Consolidated tax expense (benefit) reflects the tax expense (benefit) of both segments, as shown in the table below:
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
(In thousands)
2019
 
2018
 
2019
 
2018
Corporate segment income tax expense (benefit)
$
(6,528
)
 
$
155

 
$
157

 
$
(3,584
)
Lloyd's Syndicates segment income tax expense (benefit)
(161
)
 
(361
)
 
(161
)
 
(355
)
Consolidated income tax expense (benefit)
$
(6,689
)
 
$
(206
)
 
$
(4
)
 
$
(3,939
)
Factors affecting our consolidated effective tax rate include the following:
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2019
 
2018
 
2019
 
2018
Statutory rate
21.0
%
 
21.0
%
 
21.0
%
 
21.0
%
Tax-exempt income*
(3.7
%)
 
(1.7
%)
 
(2.0
%)
 
(3.0
%)
Tax credits
(44.1
%)
 
(16.7
%)
 
(23.1
%)
 
(23.3
%)
Non-U.S. operating results
(2.4
%)
 
(1.1
%)
 
(0.3
%)
 
1.1
%
Tax deficiency (excess tax benefit) on share-based compensation
(0.6
%)
 
(0.1
%)
 
—
%
 
(0.1
%)
Other
(33.9
%)
 
(2.1
%)
 
4.4
%
 
(1.5
%)
Total effective tax rate
(63.7
%)
 
(0.7
%)
 
—
%
 
(5.8
%)
*Includes tax-exempt interest, dividends received deduction and change in cash surrender value of BOLI.
The provision (benefit) for income taxes and the effective tax rate for the 2019 and 2018 three- and nine- month periods are determined based upon our current estimate of our annual effective tax rate at the end of each quarterly reporting period (the projected annual effective tax rate) plus the impact of certain discrete items that are not included in the projected annual effective tax rate. Our projected annual effective tax rates for 2019 and 2018 were benefits of 54.4% and 3.0% at September 30, 2019 and 2018, respectively, before consideration of discrete items. Our projected annual effective tax rates for both the 2019 and 2018 nine-month periods were different from the statutory federal income tax rate primarily due to the utilization of tax credits transferred to us from our tax credit partnership investments and a portion of our investment income being tax-exempt. Tax credits recognized during the three and nine months ended September 30, 2019 were $4.6 million and $13.9 million, respectively, as compared to $5.2 million and $15.8 million for the same respective periods of 2018. While projected tax credits for 2019 are less than 2018, they continue to have a significant impact on the effective tax rate for the 2019 three- and nine- month periods.
Our projected annual effective tax rate was a benefit of 54.4% as of September 30, 2019, which was entirely offset by the impact of discrete items of 54.4% resulting in an effective tax rate for the 2019 nine-month period of 0.0%. Our projected annual effective tax rate was a benefit of 3.0% as of September 30, 2018, which was reduced by the impact of discrete items of 2.8% resulting in an effective tax rate for the 2018 nine-month period of a benefit of 5.8%.
For the 2019 and 2018 nine-month periods, the most significant discrete item that affected our effective tax rate was the treatment of net realized investment gains and losses. Net realized investment gains and losses are treated as discrete items and reflected in the effective tax rate in the period in which they are included in income. This treatment of net realized investment gains of $44.4 million and $2.6 million in our Corporate segment for the nine months ended September 30, 2019 and 2018, respectively, accounted for an increase of 55.4% and 0.9% in the effective tax rate in the same respective periods.

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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. We are also exposed to interest rate risk related to our variable rate Mortgage Loans and Revolving Credit Agreement. We have limited exposure to foreign currency risk as we issue few insurance contracts denominated in currencies other than the U.S. dollar and we have few monetary assets or obligations denominated in foreign currencies.
Interest Rate Risk
Investments
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. Certain of the securities are held in an unrealized loss position; we do not intend to sell and believe we will not be required to sell any debt security held in an unrealized loss position before its anticipated recovery.
The following tables summarize estimated changes in the fair value of our available-for-sale fixed maturity securities for specific hypothetical changes in interest rates by asset class at September 30, 2019 and December 31, 2018. There are principally two factors that determine interest rates on a given security: changes in the level of yield curves and credit spreads. As different asset classes can be affected in different ways by movements in those two factors, we have separated our portfolio by asset class in the following tables.
 
Interest Rate Shift in Basis Points
 
September 30, 2019
($ in millions)
(200)
 
(100)
 
Current
 
100
 
200
Fair Value:
 
 
 
 
 
 
 
 
 
Fixed maturities, available for sale:
 
 
 
 
 
 
 
 
 
U.S. Treasury obligations
$
128

 
$
125

 
$
121

 
$
117

 
$
114

U.S. Government-sponsored enterprise obligations
23

 
23

 
22

 
22

 
21

State and municipal bonds
316

 
304

 
293

 
283

 
272

Corporate debt
1,437

 
1,392

 
1,349

 
1,307

 
1,267

Asset-backed securities
539

 
528

 
516

 
504

 
491

Total fixed maturities, available for sale
$
2,443

 
$
2,372

 
$
2,301

 
$
2,233

 
$
2,165

 
 
 
 
 
 
 
 
 
 
Duration:
 
 
 
 
 
 
 
 
 
Fixed maturities, available for sale:
 
 
 
 
 
 
 
 
 
U.S. Treasury obligations
3.04

 
2.96

 
2.89

 
2.81

 
2.74

U.S. Government-sponsored enterprise obligations
0.77

 
0.72

 
1.26

 
3.04

 
4.07

State and municipal bonds
3.66

 
3.61

 
3.61

 
3.67

 
3.75

Corporate debt
3.18

 
3.12

 
3.10

 
3.09

 
3.06

Asset-backed securities
2.03

 
2.07

 
2.27

 
2.57

 
2.74

Total fixed maturities, available for sale
2.96

 
2.92

 
2.95

 
3.03

 
3.07



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Interest Rate Shift in Basis Points
 
December 31, 2018
($ in millions)
(200)
 
(100)
 
Current
 
100
 
200
Fair Value:
 
 
 
 
 
 
 
 
 
Fixed maturities, available for sale:
 
 
 
 
 
 
 
 
 
U.S. Treasury obligations
$
127

 
$
124

 
$
120

 
$
117

 
$
114

U.S. Government-sponsored enterprise obligations
36

 
36

 
35

 
34

 
33

State and municipal bonds
316

 
305

 
294

 
283

 
273

Corporate debt
1,300

 
1,261

 
1,224

 
1,187

 
1,153

Asset-backed securities
443

 
432

 
421

 
409

 
396

Total fixed maturities, available for sale
$
2,222

 
$
2,158

 
$
2,094

 
$
2,030

 
$
1,969

 
 
 
 
 
 
 
 
 
 
Duration:
 
 
 
 
 
 
 
 
 
Fixed maturities, available for sale:
 
 
 
 
 
 
 
 
 
U.S. Treasury obligations
2.77

 
2.70

 
2.63

 
2.57

 
2.50

U.S. Government-sponsored enterprise obligations
0.66

 
0.98

 
2.65

 
3.77

 
4.18

State and municipal bonds
3.61

 
3.58

 
3.59

 
3.64

 
3.73

Corporate debt
2.98

 
2.97

 
2.93

 
2.89

 
2.83

Asset-backed securities
2.18

 
2.46

 
2.86

 
3.11

 
3.23

Total fixed maturities, available for sale
2.86

 
2.91

 
2.99

 
3.04

 
3.04

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.
Certain shortcomings are inherent in the method of analysis presented in the computation of the fair value of fixed rate instruments. Actual values may differ from the 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, 2019, our fixed maturities portfolio includes fixed maturities classified as trading securities which do not have a significant amount of exposure to market interest rates or credit spreads.
Our cash and short-term investments at September 30, 2019 were carried at fair value which approximates their cost basis due to their short-term nature. Our cash and short-term investments lack significant interest rate sensitivity due to their short duration.
Debt
Our variable interest rate Mortgage Loans are exposed to interest rate risk. However, a 1% change in LIBOR will not materially impact our annualized interest expense. Additionally, we have economically hedged the risk of a change in interest rates in excess of 1% on the Mortgage Loans through the purchase of an interest rate cap derivative instrument, which effectively caps our annual interest rate on the Mortgage Loans at a maximum of 3.675% (see Note 10 of the Notes to Condensed Consolidated Financial Statements for additional information). The fair value of the interest rate cap is not materially impacted by a 1% change in LIBOR; however, the carrying value of the interest rate cap is impacted by future expectations for LIBOR as well as estimations of volatility in the future yield curve.
Our Revolving Credit Agreement is exposed to interest rate risk as it is LIBOR based and a 1% change in LIBOR will impact annual interest expense only to the extent that there is an outstanding balance. For every $100 million drawn on our Revolving Credit Agreement, a 1% change in interest rates will change our annual interest expense by $1 million. Any outstanding balances on the Revolving Credit Agreement can be repaid on each maturity date, which has typically ranged from one to three months. As of September 30, 2019, no borrowings were outstanding under our Revolving Credit Agreement.

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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.
As of September 30, 2019, 94% of our fixed maturity securities were rated investment grade as determined by NRSROs, such as Fitch, Moody’s and Standard & Poor’s. We believe that this concentration in investment grade securities reduces our exposure to credit risk on our fixed income investments to an acceptable level. However, investment grade securities, in spite of their rating, can rapidly deteriorate and result in significant losses. Ratings published by the NRSROs are one of the tools used to evaluate the creditworthiness of our securities. The ratings reflect the subjective opinion of the rating agencies as to the creditworthiness of the securities; therefore, we may be subject to additional credit exposure should the ratings prove to be unreliable.
We also have exposure to credit risk related to our receivables from reinsurers. Our receivables from reinsurers (with regard to both paid and unpaid losses) approximated $373 million at September 30, 2019 and $355 million at December 31, 2018. We monitor the credit risk associated with our reinsurers using publicly available financial and rating agency data. We have not historically experienced material credit losses due to the financial condition of a reinsurer.
Equity Price Risk
At September 30, 2019, the fair value of our equity investments, excluding our equity investments in bond investment funds as discussed in the following paragraph, was $223 million. These equity securities are subject to equity price risk, which is defined as the potential for loss in fair value due to a decline in equity prices. The weighted average beta of this group of securities was 0.91. Beta measures the price sensitivity of an equity security or group of equity securities to a change in the broader equity market, in this case the S&P 500 Index. If the value of the S&P 500 Index increased by 10%, the fair value of these securities would be expected to increase by 9.1% to $243 million. Conversely, a 10% decrease in the S&P 500 Index would imply a decrease of 9.1% in the fair value of these securities to $203 million. The selected hypothetical changes of plus or minus 10% do not reflect what could be considered the best or worst case scenarios and are used for illustrative purposes only.
Our equity investments include equity investments in certain bond investment funds which are not subject to significant equity price risk, and thus we have excluded these investments from the above analysis.

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ITEM 4. CONTROLS AND PROCEDURES.
The principal executive officer and principal financial officer of the Company participated in management’s evaluation of our disclosure controls and procedures (as defined in SEC Rule 13a-15(e)) as of September 30, 2019. ProAssurance’s disclosure controls and procedures are designed to reasonably assure that information required to be disclosed by us in reports we file or submit under the Exchange Act is accumulated and communicated to our management as appropriate to allow timely decisions regarding disclosure and is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Based on that evaluation, the principal executive officer and principal financial officer have concluded that our disclosure controls and procedures are effective.
Changes in Internal Control over Financial Reporting
There have been no significant changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, those controls during the quarter.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
See Note 7 of the Notes to Condensed Consolidated Financial Statements.
ITEM 1A. RISK FACTORS.
There are no changes to the "Risk Factors" in Part 1, Item 1A of the December 31, 2018 report on Form 10-K.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
(a)
Not applicable.
(b)
Not applicable.
(c)
Information required by Item 703 of Regulation S-K.
Period
 
Total Number of Shares Purchased
 
Average Price Paid per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
 
Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs* (In thousands)
July 1 - 31, 2019
 
—

 
N/A
 
—

 
$109,643
August 1 - 31, 2019
 
—

 
N/A
 
—

 
$109,643
September 1 - 30, 2019
 
—

 
N/A
 
—

 
$109,643
Total
 
—

 
$—
 
—

 
 
*
Under its current plan begun in November 2010, the Board has authorized $600 million for the repurchase of common shares or the retirement of outstanding debt. This is ProAssurance’s only plan for the repurchase of common shares, and the plan has no expiration date.

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ITEM 6. EXHIBITS
Exhibit Number
 
Description
 
 
 
 
 
 
 
Employment Agreement between ProAssurance and Edward L. Rand, Jr. dated as of July 1, 2019.
 
 
 
 
Certification of Principal Executive Officer of ProAssurance as required under SEC rule 13a-14(a).
 
 
 
Certification of Principal Financial and Accounting Officer of ProAssurance as required under SEC rule 13a-14(a).
 
 
 
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).
 
 
 
Certification of Principal Financial and Accounting 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).
 
 
 
XBRL Instance Document
 
 
 
XBRL Taxonomy Extension Schema Document
 
 
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
 
XBRL Taxonomy Extension Definition Linkbase Document
 
 
 
XBRL Taxonomy Extension Labels Linkbase Document
 
 
 
XBRL Taxonomy Extension Presentation Linkbase Document

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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 5, 2019
 
/s/    Dana S. Hendricks
Dana S. Hendricks
Chief Financial Officer
(Duly authorized officer and principal financial officer)

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