Business Combination

6 Months Ended

Jun. 30, 2021

Business Combination and Asset Acquisition [Abstract]

On May 5, 2021, ProAssurance completed its acquisition of NORCAL by purchasing over 98% of its stock in exchange for total consideration transferred of $448.8 million. This transaction provides strategic and financial benefits including additional scale and geographic diversification in the physician professional liability market. ProAssurance funded the acquisition with $248.0 million of cash on hand, and NORCAL paid $1.8 million to policyholders who elected to receive a discounted cash option for their allocated share of the converted company's equity. Additional consideration transferred, with a principal amount of $191.0 million and a fair value of $175.0 million, is in the form of Contribution Certificates issued to certain NORCAL policyholders in the conversion, and those instruments are an obligation of NORCAL Insurance Company, the successor of NORCAL Mutual Insurance Company (see Note 11 for further discussion of the terms of the Contribution Certificates). Policyholders who elected to receive NORCAL stock and tender it to ProAssurance are also eligible for a share of contingent consideration in an amount of up to approximately $84.0 million depending upon the after-tax development of NORCAL's ultimate net losses between December 31, 2020 and December 31, 2023. The estimated fair value of this contingent consideration was $24.0 million as of May 5, 2021 and June 30, 2021.

ProAssurance's results for the three and six months ended June 30, 2021 included NORCAL's results since the date of acquisition (revenue of $53.3 million and net loss of $5.0 million). ProAssurance incurred expenses related to the acquisition of approximately $20.3 million and $21.2 million during the three and six months ended June 30, 2021, respectively, and approximately $0.6 million and $1.1 million during the three and six months ended June 30, 2020, respectively. These expenses were included as a component of operating expenses in the periods incurred in ProAssurance's Condensed Consolidated Statements of Income and Comprehensive Income.

ProAssurance accounted for its acquisition of NORCAL in accordance with GAAP relating to business combinations. The total acquisition consideration was allocated to the acquired tangible and identifiable intangible assets and assumed liabilities of NORCAL based on their estimated fair values on the acquisition date, as shown in the following table. Subsequent to the preliminary valuation of net assets acquired, any adjustment identified associated with the purchase price allocation will be evaluated to determine whether the adjustment represents a measurement period adjustment in accordance with GAAP. If the adjustment is deemed to be a measurement period adjustment and is identified within one year of the acquisition, then the measurement period adjustment will be recorded in the current reporting period with a corresponding adjustment to the gain on bargain purchase.

A $74.4 million gain on bargain purchase was recognized on the date of the acquisition as the fair value of the consideration transferred was less than the fair value of the net assets acquired. This gain is presented as a separate line item in ProAssurance's Condensed Consolidated Statement of Income and Comprehensive Income for the three and six months ended June 30, 2021. ProAssurance believes it was able to acquire NORCAL for less than the fair value of its net assets due to several contributing factors including the soft medical professional liability market at the time the transaction was initially announced and the value attributed to certain assets. Before the acquisition, NORCAL had recorded a valuation allowance against the full value of its net deferred tax assets. In conjunction with acquisition accounting, ProAssurance recorded $46.8 million of net deferred tax assets reflecting the remeasurement of NORCAL's historical net deferred tax assets, as such deferred taxes were subject to recalculation following application of all purchase accounting adjustments, and its assessment of the realizability of NORCAL's historical deferred tax assets. Based upon the assessment of the realizability of NORCAL's historical deferred tax assets, ProAssurance management concluded that these deferred tax assets are now realizable, which increased the net assets acquired. In addition, based upon the historical performance of NORCAL, ProAssurance did not attribute any value to intangible assets in determining the initial base consideration of $450.0 million per the acquisition agreement, whereas ProAssurance identified $14.0 million of intangible assets as a part of its estimated allocation of final acquisition consideration. Other changes in the fair values of NORCAL's assets and liabilities from the time ProAssurance entered into the definitive acquisition agreement in February 2020 to the close of the transaction in May 2021 also contributed to the increase in net assets acquired and gain on bargain purchase.

The preliminary allocation of acquisition consideration is shown in the table below.


(In thousands)
Fixed maturities, available for sale	$	1,100,058
Equity investments, available for sale	374,484
Short-term investments	61,289
Business owned life insurance	12,581
Investment in unconsolidated subsidiaries	26,948
Other investments	32,461
Cash and cash equivalents	28,233
Premiums receivable	110,905
Receivable from reinsurers on paid losses and loss adjustment expenses	266
Receivable from reinsurers on unpaid losses and loss adjustment expenses	93,342
Prepaid reinsurance premiums	9,238
Deferred tax asset, net	46,759
Operating lease ROU assets	4,385
Intangible assets	14,000
Other assets	38,648
Reserve for losses and loss adjustment expenses	(1,182,445)
Unearned premiums	(178,400)
Reinsurance premiums payable	(12,981)
Operating lease liabilities	(5,275)
Other liabilities	(51,279)
Total identifiable net assets acquired	$	523,217
Gain on bargain purchase	(74,408)
Total acquisition consideration	$	448,809

The estimated fair values of intangible assets were determined based on 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. Intangible assets were identified that met either the separability criterion or the contractual-legal criterion under the acquisition method of accounting. Intangible assets acquired included the following:


(In thousands)	Estimated Fair Value on Acquisition Date		Estimated Useful Life
Trade name	$	1,000	3
Licenses	13,000		Indefinite
Total	$	14,000

The estimated fair value of the reserve for losses and loss adjustment expenses and related reinsurance recoverables was based on three components: an actuarial estimate of the expected future net cash flows, a reduction to those cash flows for the time value of money determined utilizing the U.S. Treasury Yield Curve and a risk margin adjustment to reflect the net present value of profit that an investor would demand in return for the assumption of the development risk associated with the reserve. The fair value of the net reserve, including the risk margin adjustment and related reinsurance receivables, exceeded the actuarial estimate of NORCAL’s undiscounted loss reserve as of May 5, 2021. The fair value adjustment on the gross reserve of approximately $42.2 million was recorded to the reserve for losses and loss adjustment expenses and the fair value adjustment on the related reinsurance recoverables of approximately $3.5 million was recorded to the receivable from reinsurers on unpaid losses and loss adjustment expenses on the Condensed Consolidated Balance Sheet. These net fair value adjustments of $38.7 million will be amortized over a period utilizing loss payment patterns as a net reduction to prior accident year net losses and loss adjustment expenses.

The estimated fair value of VOBA was determined based on 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 estimated using the income approach. The estimated negative VOBA recorded on the assumed unearned premium of $12.4 million was recorded to the

reserve for losses and loss adjustment expenses and the fair value adjustment on the related reinsurance recoverables of $0.7 million was recorded to receivable from reinsurers on unpaid losses and loss adjustment expenses on the Condensed Consolidated Balance Sheet. The net VOBA on unearned premium of $11.7 million will be amortized over a period in proportion to the earn-out of the premium as a reduction to current accident year net losses and loss adjustment expenses. The estimated negative VOBA recorded on the assumed DDR reserve totaling $3.5 million was also recorded to the reserve for losses and loss adjustment expenses on the Condensed Consolidated Balance Sheet and will be amortized over a period in proportion to the approximate consumption of losses as a reduction to prior accident year net losses and loss adjustment expenses.

The following table reflects the fair value adjustment on the net reserve for losses and loss adjustment expenses, the negative net VOBA recorded on the assumed unearned premium and negative VOBA recorded on the DDR reserve, as well as the expected amortization of each for the five years following the acquisition.


(In thousands)	Amount at May 5, 2021		Estimated amortization period (years)	Expected pre-tax amortization for year following the acquisition
				2021		2022		2023		2024		2025		Thereafter
Fair value adjustment on reserves, net (1)	$	38,701	7	$	7,768	$	10,595	$	8,090	$	5,083	$	3,107	$	4,058
Unearned premium VOBA, net (2)	11,676		1	6,737		4,939		—		—		—		—
DDR reserve VOBA (1)	3,467		15	139		224		243		243		243		2,375
Total	$	53,844		$	14,644	$	15,758	$	8,333	$	5,326	$	3,350	$	6,433
(1) Amortization will be recorded as a reduction to prior accident year net losses and loss adjustment expenses.
(2) Amortization will be recorded as a reduction to current accident year net losses and loss adjustment expenses

Unaudited Supplemental Pro Forma Information

The following table provides Pro Forma Consolidated Results and Actual Consolidated Results for the three and six months ended June 30, 2021 and 2020 as if the NORCAL transaction had occurred on January 1, 2020.

The pro forma financial information is presented for comparative purposes only and is not necessarily indicative of the operating results that may have actually occurred had the acquisition of NORCAL been completed on January 1, 2020. In addition, the unaudited pro forma financial information does not give effect to any anticipated cost savings, operating efficiencies or other synergies that may be associated with the acquisition, or any estimated costs that have been or will be incurred to integrate the assets and operations of NORCAL.


	Three Months Ended June 30				Six Months Ended June 30
(In thousands)	2021		2020		2021		2020
Revenue:
ProAssurance Pro Forma Consolidated Results	$	315,947	$	305,326	$	624,423	$	602,840
ProAssurance Actual Consolidated Results	$	281,628	$	221,742	$	501,644	$	418,443
Net income (loss):
ProAssurance Pro Forma Consolidated Results	$	32,926	$	(15,647)	$	45,326	$	40,714
ProAssurance Actual Consolidated Results	$	92,050	$	(18,099)	$	99,785	$	(40,053)

The ProAssurance Pro Forma Consolidated Results reflect pro forma adjustments, net of related tax effects, to give effect to certain events that are directly attributable to the acquisition. These pro forma adjustments primarily include:

•The addition of NORCAL's operating results prior to the acquisition to ProAssurance's Actual Consolidated Results in all periods shown.

•A reduction in expenses for the three and six months ended June 30, 2021 and a corresponding increase for the six months ended June 30, 2020 for transaction-related costs, including other costs associated with the acquisition such as compensation costs related to change in control payments.

•The effect of the amortization of intangible assets, VOBA and the fair value adjustment on the reserve. See previous amortization schedules for reference.

•The non-taxable gain on bargain purchase of $74.4 million that was included in ProAssurance's Actual Consolidated Results for the three and six months ended June 30, 2021 has been reported in the Pro Forma Consolidated Results as being recognized during the six months ended June 30, 2020.

•An adjustment to net investment income for the amortization of the fair value adjustment to NORCAL's investments.

•An increase to interest expense for the interest on the Contribution Certificates (see Note 11 for further discussion of the terms of the Contribution Certificates).