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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 [Fee Required] for the fiscal year ended December
31, 2003, or
[ ] Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 [No Fee Required] for the transition period from
________ to _________.
Commission file number: 001-16533
ProAssurance Corporation*
---------------------------------
(Exact name of registrant as specified in its charter)
Delaware 63-1261433
- ------------------------ ------------------------------------
(State of incorporation (I.R.S. Employer Identification No.)
or organization)
100 Brookwood Place, Birmingham, AL 35209
-------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(205) 877-4400
----------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class On Which Registered
------------------- -------------------
Common Stock, par value $0.01 per share New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [ ]
The aggregate market value of voting stock held by non-affiliates of the
registrant at June 30, 2003 was $715,617,853.
As of March 1, 2004, the registrant had outstanding approximately 29,105,971
shares of its common stock.
Exhibit Index at page 108
Page 1 of 110 pages
Documents incorporated by reference in this Form 10-K:
(i) The definitive proxy statement for the 2004 Annual Meeting of
the Stockholders of ProAssurance Corporation (File No.
001-16533) is incorporated by reference into Part III of this
report.
(ii) The Registration Statement on Form S-4 of ProAssurance
Corporation (File No. 333-49378) is incorporated by reference
into Part IV of this report.
(iii) Registration Statement on Form S-4 of MAIC Holdings, Inc.
(File No. 33-91508) is incorporated by reference into Part IV
of this report.
(iv) The MAIC Holdings, Inc. Definitive Proxy Statement for the
1996 Annual Meeting (File No. 0-19439) is incorporated by
reference into Part IV of this report.
(v) The Registration Statement on Form S-4 of Professionals Group,
Inc. (File No. 333-3138) is incorporated by reference into
Part IV of this report.
(vi) The Registration Statement on Form S-4 of MEEMIC Holdings,
Inc. (File No. 333-66671) is incorporated by reference into
Part IV of this report.
(vii) The ProAssurance Corporation Quarterly Report on Form 10-Q for
the quarter ended June 30, 2001 (Commission File No.
001-16533) is incorporated by reference into Part IV of this
report.
(viii) The ProAssurance Corporation Quarterly Report on Form 10-Q for
the quarter ended September 30, 2001 (Commission File No.
001-16533) is incorporated by reference into Part IV of this
report.
(ix) The ProAssurance Corporation Annual Report on Form 10-K for
the year ended December 31, 2001 (Commission File No.
001-16533) is incorporated by reference into Part IV of this
report.
(x) The ProAssurance Corporation Quarterly Report on Form 10-Q for
the quarter ended June 30, 2002 (Commission File No.
001-16533) is incorporated by reference into Part IV of this
report.
(xi) The Registration Statement on Form S-3 of ProAssurance
Corporation (Commission File No. 333-100526) is incorporated
by reference into Part IV of this report.
(xii) The ProAssurance Annual Report on Form 10-K for the year ended
December 31, 2002 (File No. 001-16533) is incorporated in Part
IV of this report.
(xiii) The ProAssurance Corporation Quarterly Report on Form 10-Q for
the quarter ended June 30, 2003 (File No. 001-16533) is
incorporated in Part IV of this report.
(xiv) The Registration Statement on Form S-3 of ProAssurance
Corporation (File No. 333-109972) is incorporated by reference
in Part IV of this report.
2
PART I
ITEM 1. BUSINESS
GENERAL
We are a holding company for specialty property and casualty insurance
companies focused on the professional liability and the personal lines insurance
markets. Our executive offices are located at 100 Brookwood Place, Birmingham,
Alabama 35209 and our telephone number is (205) 877-4400. Our stock trades on
the New York Stock Exchange under the symbol "PRA."
Our website is www.ProAssurance.com. On our website we make available
all of the reports that we file with the Securities and Exchange Commission (the
"SEC"), including our annual report on Form 10K, our quarterly reports on Form
10Q and our current reports on Form 8K. We provide access to these reports, as
well as Forms 3, 4 and 5 detailing stock trading by corporate insiders, through
our website as soon as reasonably practical after they are filed with the SEC.
We provide access to these reports for at least one year after their filing. We
also provide similar access to news releases issued by the Company, and to major
investor presentations made by our executives.
We have a regional orientation, applying a focused underwriting
strategy to local markets where we have built a strong reputation among our
customers and producers. Our professional liability business is concentrated in
the southeast and midwest and serves physicians, dentists, other healthcare
providers and healthcare facilities. We believe we are the fourth largest active
writer of medical professional liability insurance in the United States. Our
personal lines segment focuses on educators and their families in Michigan. We
believe we are the tenth largest writer of personal automobile insurance in
Michigan.
By concentrating on specialty markets where customers have specialized
needs, we seek to provide value added solutions through our underwriting
expertise and our emphasis on strong customer service. Our regional presence
allows us to maintain active relationships with our customers and be more
responsive to their needs. We seek to maintain a strong financial position to
protect our customers. We believe these factors have allowed us to establish a
leading position in our markets, enabling us to compete on a basis other than
just price.
For the year ended December 31, 2003, we generated $740.1 million of
gross premiums written, $623.5 million of net premiums earned and $709.6 million
of total revenues. As of December 31, 2003, we had cash and invested assets of
$2.1 billion, total assets of $2.9 billion and stockholders' equity of $546.3
million.
CORPORATE ORGANIZATION AND HISTORY
We were incorporated in Delaware to serve as the holding company for
Medical Assurance, Inc. (Medical Assurance) in connection with its acquisition
of Professionals Group, Inc. (Professionals Group) in June 2001. Our principal
operating subsidiaries are The Medical Assurance Company, Inc., ProNational
Insurance Company, Red Mountain Casualty Insurance Company, Inc., and MEEMIC
Insurance Company. Our financial statements and other financial information
include Professionals Group only from the date of acquisition in compliance with
purchase accounting rules. We also write professional liability insurance
through Medical Assurance of West Virginia.
We are the successor to 11 insurance organizations. Our predecessor
company, Medical Assurance, was founded by physicians as a mutual company in
Alabama and began in 1977. We demutualized and became a public company in 1991.
Medical Assurance expanded through internal growth and the acquisition of
professional liability insurance companies with strong regional identities in
West Virginia, Indiana and Missouri, along with books of business in Ohio and
Missouri.
3
Professionals Group traces its roots to Brown-McNeeley Fund, which was
founded by the State of Michigan in 1975 to provide medical professional
liability insurance to physicians. Physicians Insurance Company of Michigan,
which ultimately became ProNational, was founded in 1980 to assume the business
of the Fund. That company also expanded through internal growth and the
acquisition of books of business in Illinois and Indiana and the acquisition of
a professional liability insurer in Florida.
MEEMIC Insurance Company was founded as a mutual company by Michigan
teachers and has provided personal lines insurance to the educational community
in that state since 1950. Professionals Group became affiliated with MEEMIC in
1997 and acquired majority ownership of MEEMIC Holdings, Inc. (MEEMIC Holdings)
in 1999.
In each acquisition we retained key personnel, allowing us to maintain
a local presence and preserve important institutional knowledge in claims
management and underwriting. We believe that this ability to utilize local
knowledge in claims and underwriting is a critical factor in the operation of
our companies. Our successful integration of each organization demonstrates our
ability to grow effectively through acquisitions.
SEGMENT OVERVIEW
We conduct our business through two operating segments, each of which
maintains a strong position in its local markets:
- Our professional liability segment, which represents our commercial
lines business, primarily focuses on providing medical professional
liability insurance. We provide protection against claims arising out
of the death, injury or disablement of a person resulting from a
negligent deviation from the standard of care by the professionals we
insure.
- Our personal lines segment offers personal automobile, and to a lesser
extent, homeowners, boat and umbrella insurance primarily to teachers,
administrators, professors and other members of the educational
community and their families in Michigan. Personal lines insurance
provides policyholders with protection against claims resulting from
bodily injury and property damage liability and physical damage to
property.
The following table illustrates our gross premiums written for our two
primary segments for each of the periods indicated:
Year Ended December 31
2003 2002 2001
--------------------------------------------------------------
Professional liability $ 543,323 73% $ 461,715 73% $ 315,698 81%
Personal lines 196,787 27% 174,441 27% 73,285 19%
--------------------------------------------------------------
Total $ 740,110 100% $ 636,156 100% $ 388,983 100%
==============================================================
4
Professional Liability Segment
In our professional liability segment, our top five states represented
74% of gross premiums written for the year ended December 31, 2003. The
following table displays the distribution of those gross premiums.
Year Ended December 31
2003 2002 2001
--------------------------------------------------------------
Ohio $ 123,205 23% $ 91,571 20% $ 51,520 16%
Alabama 106,437 20% 83,818 18% 74,917 24%
Florida 80,549 15% 71,366 15% 29,519 9%
Michigan 54,727 10% 52,203 11% 22,404 7%
Missouri 33,987 6% 23,786 5% 13,348 4%
All other states 144,418 26% 138,971 31% 123,990 40%
--------------------------------------------------------------
Total $ 543,323 100% $ 461,715 100% $ 315,698 100%
==============================================================
For the year ended December 31, 2003, our professional liability
segment produced a combined ratio of 112%. The combined ratio is the sum of the
underwriting expense ratio (the ratio of underwriting expenses to earned
premiums) and net loss ratio (the ratio of net losses and loss adjustment
expenses to net earned premiums).
A combined ratio below 100% generally indicates profitable underwriting
prior to the consideration of investment income. However, if investment income
is considered, companies writing professional liability insurance may be
profitable with combined ratios above 100%. Thus, the combined ratio may not
always be indicative of our ultimate results because of the "long tail" nature
of the professional liability business.
The term "long-tail" refers to the long period of time between
collecting the premium for insuring a risk and the ultimate payment of losses,
often exceeding five years. This "long tail" allows us to invest the premiums we
collect until we pay losses, which results in a higher level of invested assets
and investment income as compared to other lines of property and casualty
business.
In order to measure the effect of investment income, we also measure
our results by calculating our operating ratio, which is the combined ratio
offset by the benefit of investment income generated from our cash and invested
assets. This ratio is expressed as a percentage of net premiums earned. For the
year ended December 31, 2003 our professional liability segment produced an
operating ratio of 98%. A ratio below 100% indicates profitability for the
segment.
Personal Lines Segment
Business in our personal lines segment is currently confined to
Michigan. The following table displays gross premiums written in this segment.
Year Ended December 31
2003 2002 2001 (1)
--------------------------------------------------------------
Michigan $ 196,787 100% $ 174,441 100% $ 73,285 100%
==============================================================
(1) The year ended December 31, 2001 includes gross premiums written since
June 27, 2001, the date of consolidation of Professionals Group and
Medical Assurance.
5
Personal lines insurance is generally referred to as "short tail", due
to shorter time periods between insuring the risk and the ultimate payment of
claims. As a result, there is less time to invest premiums collected, which
makes it necessary to achieve an underwriting profit in order to generate a
satisfactory return on equity. For the year ended December 31, 2003, MEEMIC
reported a combined ratio of 88%.
RECENT EVENTS
Details of Financing Transactions
In early July 2003 we received $104.6 million from the issuance of 3.9%
Convertible Debentures, due June 2023, having a face value of $107.6 million. We
utilized a substantial portion of the net proceeds to repay our outstanding term
loan. We are using the balance of the net proceeds for general corporate
purposes, including contributions to the capital of our insurance subsidiaries
to support the growth in insurance operations. See Note 11 to our Consolidated
Financial Statements for more information regarding the Convertible Debentures.
In the fourth quarter of 2002 ProAssurance sold 3,025,000 shares of
common stock at a price of $16.55 per share in an underwritten public offering.
ProAssurance received net proceeds from the offering in the amount of
approximately $46.5 million. ProAssurance used the proceeds from the offering to
support the growth of the professional liability insurance business and for
general corporate purposes.
Purchase of Minority Shares of MEEMIC
On January 29, 2003 MEEMIC Holdings, the parent company of MEEMIC
Insurance Company, purchased all of the issued and outstanding shares of its
common stock, other than those held by ProAssurance's subsidiary, ProNational
Insurance Company (ProNational). MEEMIC Holdings used its internal funds in the
approximate amount of $34.1 million to acquire all of the 1,062,298 shares of
its common stock not owned by ProNational, to pay for outstanding options for
120,000 shares, and to pay the expenses of the transaction. The funds were
derived from MEEMIC Holdings' cash and investment resources. As a result of the
transaction, MEEMIC Holdings was delisted from the NASDAQ stock market and
became a wholly-owned subsidiary of ProNational.
MANAGEMENT
Our senior management team is led by A. Derrill Crowe, M.D., our
Chairman and Chief Executive Officer, and Victor T. Adamo, Esq., our President
and Chief Operating Officer. Dr. Crowe has acted as the Chief Executive Officer
of Medical Assurance since its founding in 1977. He has applied a hands-on
management style in developing our underwriting and claims strategies and was
instrumental in establishing us as a leading professional liability specialist.
Mr. Adamo has held various positions with Professionals Group since 1985,
becoming its CEO in 1987 and being named President in 1989. He is largely
responsible for building Professionals Group into a successful regional
professional liability company.
Dr. Crowe practiced medicine as his principal occupation for more than
25 years and Mr. Adamo was in the private practice of law for 10 years,
providing them with knowledge of medical and legal issues that are critical to
our insurance operations. We also have a knowledgeable and experienced
management team with established track records in building and managing
successful insurance operations. In total, our senior management team has
average experience in the insurance industry of 23 years.
6
PRODUCTS AND SERVICES
Professional Liability Segment
We offer professional liability insurance for providers of medical and
other healthcare services. Although we generate a majority of our premiums from
individual and small group practices, we also insure several major physician
groups as well as several hospitals. We also offer professional liability
insurance for providers of legal services, and we offer professional office
package and workers' compensation insurance products in connection with our
professional liability products. We believe our size, financial strength and
flexibility of distribution differentiates us from our competitors. The
following table illustrates the distribution of our gross premiums written of
our professional liability segment by type of coverage for the periods
indicated.
Year Ended December 31
2003 2002 2001
----------------------------------------------------------------
Professional Liability-
Physicians & Dentists $ 488,625 90% $ 410,560 89% $ 228,139 72%
Professional Liability--Other (1) 42,408 7% 37,576 8% 39,080 12%
----------------------------------------------------------------
Total Medical Professional Liability 531,033 97% 448,136 97% 267,219 84%
Professional Liability--Legal 8,567 2% 5,968 1% 2,134 1%
Other Commercial Lines (2) $ 3,723 1% 7,611 2% 46,345 15%
----------------------------------------------------------------
Total Commercial Liability 12,290 3% 13,579 3% 48,479 16%
----------------------------------------------------------------
Professional Liability Total $ 543,323 100% $ 461,715 100% $ 315,698 100%
================================================================
(1) Primarily includes miscellaneous healthcare providers, hospitals and other
health care facilities.
(2) Primarily includes workers' compensation and commercial multi-peril
coverages. Prior to 2000 we marketed this coverage to a wide range of
accounts, primarily through fronting arrangements. However, in 2000 we began
non-renewing these coverages for any insured who was not a professional
liability policyholder. Our exit from this business allowed us to redeploy
needed capital to professional liability and allowed management to focus its
attention on our core professional liability business.
There are two predominant types of professional liability insurance
policies, occurrence and claims-made. Occurrence coverage provides permanent
insurance protection against claims arising from incidents that occur during the
policy period, regardless of when these claims may be reported. Due to the
long-tail nature of the professional liability business, it may be many years
before insurers become aware of claims under occurrence policies.
7
Claims-made coverage provides protection against only those claims
reported during the policy period, resulting from incidents that occurred while
continuously insured on a claims-made basis. Therefore, most claims are known,
although not resolved, at the end of the policy period. This allows us to
estimate our loss reserves for claims-made coverage with more certainty. The
basic claims-made policy does not provide protection against claims which are
reported after the policy period ends; the insured must either continue to renew
the claims-made policy or purchase extended reporting coverage in order to have
permanent protection. In the event of death, disability or qualified retirement,
most insureds receive extended reporting coverage as part of the policy terms.
In October 2002, we started offering professional liability insurance
to medical and other healthcare professionals who generally do not qualify for
standard coverage because of their claim history or other factors. This business
is written on an excess and surplus lines basis, which provides us with greater
flexibility in establishing prices and terms of coverage. Red Mountain Casualty
Insurance Company, Inc. is the main subsidiary in which this business is written
and we believe it provides profitable opportunities to expand our business. In
2002 this line of business produced $3.0 million in premiums and in 2003 this
line of business produced $20 million in premiums.
Personal Lines Segment
Our personal lines business is written through our subsidiary, MEEMIC,
which primarily serves educational employees and their families in Michigan.
Private passenger automobile insurance is our primary line of business. To
provide for the other insurance needs of our auto customers, we also offer
homeowners, boat and umbrella policies. The following table illustrates our
gross premiums written for each of our personal lines classes of business for
each of the periods indicated.
Year Ended December 31
2003 2002 2001 (1)
-----------------------------------------------------------------
Personal Automobile $ 161,399 82% $ 147,168 84% 62,422 85%
Homeowners 34,571 18% 26,600 16% 10,637 15%
Boat (2) 616 - 497 - 163 -
Umbrella (2) 201 - 176 - $ 63 -
-----------------------------------------------------------------
Total $ 196,787 100% $ 174,441 100% $ 73,285 100%
=================================================================
(1)The year ended December 31, 2001 includes gross premiums written since June
27, 2001, the date of consolidation of Professionals Group and Medical
Assurance.
(2) Less than 1%
MARKETING
Professional Liability Segment
We primarily write insurance in the southeast and midwest and are
licensed to do business in every state but Connecticut, Maine, New Hampshire,
New York and Vermont. Based on gross premiums written in 2003, Ohio, Alabama,
Florida, Michigan, and Missouri represented our five largest states.
We utilize direct marketing and independent agents to write business.
In Alabama, we rely solely on direct marketing, and in Florida and Missouri,
direct marketing accounts for a majority of our business. We use independent
agents to market our professional liability insurance products in other markets.
For the year ended December 31, 2003, we estimate that approximately 62% of our
gross professional liability premiums written were produced through independent
insurance agencies. These local agencies usually have one to three producers who
specialize in professional liability insurance and who we believe are able to
convey the factors that differentiate our professional liability insurance
product. No single agent or agency accounts for more than 10% of our total
direct premiums written.
8
We focus our marketing efforts on sole practitioners and small groups
of physicians. We generally do not target large groups or facilities because of
the difficulty in underwriting the individual risks and because their purchasing
decision is more focused on price. Our marketing efforts differentiate our
professional liability insurance products by emphasizing:
- excellent claims service and the other services and communications we
provide to our customers,
- the sponsorship of risk management education seminars as an accredited
provider of continuing medical education,
- risk management consultation, loss prevention seminars and other
educational programs,
- legislative oversight and active support of proposed legislation we
believe will have a positive effect on liability issues affecting the
healthcare industry,
- the preparation and dissemination of newsletters and other printed
material with information of interest to the healthcare industry, and
- endorsements by, and attendance at meetings of, the state and local
medical societies and related organizations.
These communications and services have helped us gain exposure among
potential insureds and demonstrate our understanding of the insurance needs of
the healthcare industry and promote a commonality of interest among us and our
insureds.
Personal Lines Segment
Our personal lines insurance products are personal automobile,
homeowners, boat and umbrella policies. We market these products to members of
the educational community and their families in Michigan. Our policies are sold
through our exclusive agents who are typically current or former teachers,
school administrators or other education professionals. We refer to this sales
method as peer-to-peer selling. We currently are licensed in Michigan,
Minnesota, Ohio and Wisconsin, but write insurance only in Michigan. Our plans
include expansion into at least one neighboring state within the next 18 months.
Our sales representatives also have access to other insurance products
underwritten by other carriers in Michigan who pay us commissions for their
sales. In general, these carriers offer products that we do not currently offer,
or insure a class of business that does not meet our underwriting guidelines. By
offering complementary insurance products, our sales representatives provide our
customers with the convenience of being able to purchase a full range of
insurance products through a single agent, thus allowing our representatives to
compete with independent agents. We also benefit by having potential customers
for products we may offer in the future.
We conduct quarterly meetings with our sales representatives, establish
benchmarks and goals, and conduct technical training and sponsor continuing
education programs. Our representatives provide us with important information
about market conditions and feedback from our customers regarding their
insurance requirements and our level of service provided. This information is
used to develop new products and new product features. We recruit and train new
sales representatives to work in under-represented areas of the state. Sales
representatives are paid a fixed commission with some opportunity for contingent
bonuses, based upon the representative's production and loss ratios.
For the year ended December 31, 2003, one sales representative
accounted for approximately 5% of our direct premiums written within our
personal lines segment. The top 10 sales representatives accounted for
approximately 34% of our direct premiums written in 2003.
9
UNDERWRITING
Professional Liability Segment
Because we focus our primary efforts on sole practitioners and small
groups, our underwriting process is driven by individual risk selection rather
than by account, and our pricing decisions are focused on achieving rate
adequacy. We assess the quality and pricing of the risk, primarily emphasizing
loss history, practice specialty and location of practice in making our
underwriting decision. Our underwriters work closely with our local claims
departments. This includes consulting with staff about claims histories and
patterns of practice in a particular locale as well as monitoring claims
activity.
Our underwriting focuses on knowledge of local market conditions and
legal environment. Through our five regional underwriting offices located in
Alabama, Florida, Indiana, Missouri and Michigan, we have established a local
presence within our targeted markets to obtain better information more quickly.
Our underwriting department establishes guidelines to classify risks by
practice specialty and by location. Our underwriters work with our field
marketing force to identify business that meets these established underwriting
standards and to develop specific strategies to write the desired business. In
performing this assessment, our underwriters may also consult with internal
actuaries regarding loss trends and pricing and utilize loss-rating models to
assess the projected underwriting results of certain insured risks. Our agents
are permitted to bind professional liability coverage within our underwriting
guidelines, but binding authority is exercised only after authorization from our
underwriting staff.
Our underwriters are also assisted by our local medical advisory
committees that we have established in our key states. These committees are
comprised of local physicians, dentists and representatives of hospitals and
healthcare entities and help us maintain close ties to the medical communities
in these states, provide information on the practice of medicine in each state
and provide guidance on critical underwriting and claims issues.
Personal Lines Segment
As we evaluate risks, we rely to a significant degree on information
provided by our sales representatives in underwriting risks. The majority of our
sales representatives are, or were, teachers. This enhances the sales
representatives' ability to act as field underwriters since they have a general
understanding of lifestyles and insurance needs within the educational community
to effectively pre-screen applicants. We believe that the educational community
in Michigan provides better than average risk-selection, which contributes to
our historically profitable underwriting results.
Our underwriters then evaluate and accept applications for insurance
submitted by the sales representatives based on consistently applied
underwriting guidelines. Our system allows for some flexibility in the
application of these guidelines by individual underwriters, and underwriting
supervisors regularly audit their work and ensure exceptions fall within
acceptable limits. Our underwriters monitor policyholder deviations from the
underwriting guidelines to assist in decisions related to cancellation and
non-renewal.
CLAIMS MANAGEMENT
Professional Liability Segment
We have claims offices throughout the states in which we write business
in order to provide localized and timely attention to claims. Our claims
department investigates the circumstances surrounding a medical incident from
which a covered claim arises against an insured. Upon investigation, and in
consultation with the insured and appropriate experts, we evaluate the merit of
the claim and either seek reasonable settlement or aggressively defend the
claim. If the claim is defended, our claims
10
department manages the case, including selecting defense attorneys who
specialize in medical liability cases, planning the defense and obtaining
medical and/or other professional experts to assist in the analysis and defense
of the claim.
Our claims department establishes the appropriate case reserves for
each claim and monitors the level of each case reserve as circumstances require.
The department also decides when and if to settle all but the most
significant claims, which are currently reviewed by an internal committee made
up of our Chairman and Chief Executive Officer, our Senior Vice President -
Claims, and our outside legal counsel. In each of the states in which we
operate, we meet regularly with our local medical advisory committees to examine
claims, attempt to identify potentially troubling practice patterns and make
recommendations to our staff.
We aggressively defend claims against our insureds that we believe have
no merit or those we believe cannot be reasonably settled. As a result of this
policy, many of our claims are litigated, and we engage experienced trial
attorneys in each venue to handle the litigation in defense of our
policyholders.
Our aggressive claims management approach generally results in
increased loss adjustment expenses compared to those of other property and
casualty lines or other companies specializing in professional liability
insurance. However, we believe that our approach contributes to lower overall
loss costs and results in greater customer loyalty. The success of this claims
philosophy is based on our ability to develop relationships with attorneys who
have significant experience in the defense of professional liability claims and
who are able to defend claims in an aggressive, cost-efficient manner.
We began offering our professional liability claims management to
self-insuring entities on a fee-for-service basis in 2003. While we do not
expect this to become a major source of revenue for us, we believe it will allow
us to leverage our claims-management expertise to produce some additional income
as larger groups and facilities decide to self-insure their malpractice risk.
Personal Lines Segment
In responding to claims, we emphasize timely investigation, evaluation
and fair settlement while controlling claims expense and maintaining adequate
reserves. We have a year-round, 24-hour claim reporting telephone service for
insureds and third-party claimants. This reporting methodology enables us to
more quickly complete initial claim handling and ultimately reduce indemnity
payments such as rental and storage.
Our claims operation is centralized in Auburn Hills, Michigan, but we
also employ resident adjusters located in cities throughout Michigan. These
employee adjusters settle a majority of our claims, and independent multi-line
adjusters are used on a contract basis when claim volume rises. We have also
established a network of auto repair shops and other repair facilities that
provide damage appraisals and repairs according to established company
guidelines. An inspection audit program ensures that repairs are completed
timely, economically and to the satisfaction of the customer.
Audits of liability claim files are conducted regularly by claims
department managers and reinsurers. We decide which claims we seek to settle and
which claims we defend. Historically, less than 1% of all claims result in
litigation.
Our claims department actively monitors all litigation including
selecting defense attorneys who specialize in insurance defense cases, planning
the defense, and obtaining professional experts to assist in the analysis and
defense of the claim. The department establishes the appropriate case reserves
for each claim and monitors the level of each case reserve as circumstances
require.
11
INVESTMENTS
Our overall investment strategy is to focus on maximizing current
income from our investment portfolio while maintaining safety, liquidity,
duration of liabilities and portfolio diversification. The portfolio is
generally managed by professional third party asset managers whose results are
evaluated periodically by management and its consultants. The asset managers
typically have the authority to make investment decisions, subject to investment
policies, within the asset class they are responsible for managing.
RATING AGENCIES
Our principal insurance subsidiaries are rated "A-" (Excellent) by A.M.
Best, its fourth highest category out of 15 categories. Standard & Poor's rates
our principal insurance subsidiaries "A-" (Strong), its seventh highest category
out of 21 categories, and maintained a negative outlook on the rating at
December 31, 2003.
In developing these ratings, A.M. Best and Standard & Poor's evaluate
an insurer's ability to meet its obligations to policyholders, and are not
directed toward the protection of stockholders. These ratings are neither
ratings of securities nor a recommendation to buy, hold or sell any security.
Our West Virginia-based subsidiary, Medical Assurance of West Virginia
(MAWV), which accounts for less than two percent of ProAssurance's book of
business, is rated "B" (Fair) by Best. Best downgraded MAWV on December 24, 2003
as a result of our decision to terminate a reinsurance contract between MAWV and
our Alabama-based subsidiary, The Medical Assurance Company, Inc. Standard &
Poor's downgraded MAWV on December 19, 2003, then withdrew the rating at our
request.
COMPETITION
Competition depends on several factors including pricing, size, name
recognition, service quality, market commitment, breadth and flexibility of
coverage, method of sale, financial stability and ratings assigned by A.M. Best
and Standard & Poor's. Many of these factors, such as market conditions, the
ratings assigned by rating agencies, and regulatory conditions are out of our
control. However, for those factors over which we do have control, such as
service quality, market commitment, financial strength and stability, we believe
we have competitive strengths that make us a viable competitor in those states
where we are currently writing insurance.
Professional Liability Segment
We compete with insurance companies and self-insuring entities in the
medical professional liability market. Many of the competing companies
concentrate on a single state and have an extensive knowledge of the local
markets. We also compete with large national insurers that may have greater
financial strength and other resources than we do.
Self-insuring entities are emerging as an alternative to the
traditional insurance market as insureds seek greater control over the
professional liability premiums. We assist groups with the formation and
administration of self-insuring entities, and earn fee income for the management
and services we provide. We do not expect this to become a major source of
revenue for us, but we hope to produce additional income to offset some of the
potential lost business as growth in this segment of the market removes
potential insureds from the traditional insurance market.
We believe that we have a competitive advantage in the current market
due to our size, geographic scope and name recognition, as well as our heritage
as a policyholder-founded company with a long-term commitment to the
professional liability insurance industry. These advantages have been achieved
through our balance sheet strength, claims defense expertise, strong ratings and
ability to deliver a high level of service to our insureds and agents. We
believe that these competitive strengths make us a viable competitor in those
states where we are currently writing insurance.
12
Since 1999, insurance companies focused on medical professional
liability coverage have experienced higher claim costs on business written in
prior years than they had reserved for initially. This has resulted in
significant losses, reduced capital to support current and future business, and
higher premium rates to meet expected higher claims costs.
Reduced profitability, reductions in surplus and capacity constraints
have led many professional liability carriers focused on medical professional
liability coverages to withdraw from, or limit new business in, one or more
markets. For example, in 2002 The St. Paul Companies, then the leading writer of
medical professional liability insurance withdrew from the market and in 2003
Farmers Insurance Company exited medical professional liability insurance.
In 2002 several medical liability insurance companies were forced from
the market due to financial difficulties and in 2003 The Reciprocal of America
was placed under regulatory supervision. The failure of these companies placed
hundreds of physicians at personal risk in the event of a judgment against them.
We believe these events have heightened the sensitivity of our target market to
this issue.
Given the continued reduction in capacity and the uncertainty
surrounding several writers in the medical professional liability market, we
believe there will be a "flight to quality" as insurers place greater emphasis
on financial strength and stability. We believe this trend will continue through
2004 and into at least the first half of 2005.
Personal Lines Segment
Personal lines insurance is highly competitive and some of these
competitors are substantially larger than we are and have much greater
financial, technical and operating resources. Competition depends on several
factors including the price and quality of insurance products, the quality and
speed of service and claims response, financial strength, sales and marketing
capability, technical expertise and ratings assigned by A.M. Best and Standard &
Poor's.
We believe we have a competitive advantage because of our peer-to-peer
sales model. Our approach of "teachers serving teachers and their families" as
well as management's emphasis on high quality customer service have contributed
to high customer loyalty with a long-term policyholder retention rate of nearly
95%.
INSURANCE REGULATORY MATTERS
We are subject to regulation under the insurance and insurance holding
company statutes, of various jurisdictions, including the domiciliary states of
our insurance subsidiaries and other states in which our insurance subsidiaries
do business.
General
Insurance companies are also affected by a variety of state and federal
legislative and regulatory measures and judicial decisions that define and
qualify the risks and benefits for which insurance is sought and provided. These
include redefinitions of risk exposure in such areas as medical liability,
product liability, environmental damage and workers' compensation. In addition,
individual state insurance departments may prevent premium rates for some
classes of insureds from reflecting the level of risk assumed by the insurer for
those classes. Although there is limited federal regulation of the insurance
business, each state has a comprehensive system for regulating insurers
operating in that state. In addition, these insurance regulators periodically
examine each insurer's financial condition, adherence to statutory accounting
practices, and compliance with insurance department rules and regulations.
Our operating subsidiaries are required to file detailed annual
reports with the state insurance regulators in each of the states in which they
do business. The laws of the various states establish supervisory agencies with
broad authority to regulate, among other things, licenses to transact business,
premium rates for certain types of coverage, trade practices, agent licensing,
policy forms, underwriting and
13
claims practices, reserve adequacy, transactions with affiliates, and insurer
solvency. Many states also regulate investment activities on the basis of
quality, distribution and other quantitative criteria. States have also enacted
legislation regulating insurance holding company systems, including
acquisitions, the payment of dividends, the terms of affiliate transactions, and
other related matters. Our insurance subsidiaries are domiciled in Michigan,
Alabama and West Virginia.
Applicable state insurance laws, rather than federal bankruptcy laws,
apply to the liquidation or reorganization of insurance companies.
Insurance Regulation Concerning Change or Acquisition of Control
The insurance regulatory codes in our operating subsidiaries'
respective domiciliary states each contain similar provisions (subject to
certain variations) to the effect that the acquisition of "control" of a
domestic insurer or of any person that directly or indirectly controls a
domestic insurer cannot be consummated without the prior approval of the
domiciliary insurance regulator. In general, a presumption of "control" arises
from the direct or indirect ownership, control, possession with the power to
vote or possession of proxies with respect to 10% (5% in Alabama) or more of the
voting securities of a domestic insurer or of a person that controls a domestic
insurer. A person seeking to acquire control, directly or indirectly, of a
domestic insurance company or of any person controlling a domestic insurance
company must generally file an application for approval of the proposed change
of control with the relevant insurance regulatory authority.
In addition, certain state insurance laws contain provisions that
require pre-acquisition notification to state agencies of a change in control of
a non-domestic insurance company admitted in that state. While such
pre-acquisition notification statutes do not authorize the state agency to
disapprove the change of control, such statutes do authorize certain remedies,
including the issuance of a cease and desist order with respect to the
non-domestic admitted insurer's doing business in the state if certain
conditions exist, such as undue market concentration.
Statutory Accounting and Reporting
Insurance companies are required to file detailed annual reports with
the state insurance regulators in each of the states in which they do business,
and their business and accounts are subject to examination by such regulators at
any time. The financial information in these reports is prepared in accordance
with the accounting requirements of the state regulatory authorities. The
accounting principles differ from Generally Accepted Accounting Principles
("GAAP") and are referred to as Statutory Accounting Practices ("SAP").
Insurance regulators periodically examine each insurer's financial condition,
adherence to SAP, and compliance with insurance department rules and
regulations.
Regulation of Dividends and Other Payments from Our Operating Subsidiaries
We are a legal entity separate and distinct from our subsidiaries. As a
holding company with no other business operations, our primary sources of cash
to meet our obligations, including principal and interest payments with respect
to indebtedness, are available dividends and other statutorily permitted
payments, such as tax allocation payments and management and other fees, from
our operating subsidiaries.
Our operating subsidiaries are subject to various state statutory and
regulatory restrictions, applicable generally to any insurance company in its
state of domicile, which limit the amount of dividends or distributions an
insurance company may pay to its stockholders without prior regulatory approval.
The restrictions are generally based on certain levels or percentages of
surplus, investment income and operating income, as determined in accordance
with SAP. Generally, dividends may be paid only out of earned surplus. In every
case, surplus subsequent to the payment of any dividends must be reasonable in
relation to an insurance company's outstanding liabilities and must be adequate
to meet its financial needs.
14
State insurance holding company acts generally require domestic
insurers to obtain prior approval of extraordinary dividends. Under the
insurance holding company acts governing our principle operating subsidiaries, a
dividend is considered to be extraordinary if the combined dividends and
distributions to the parent holding company in any 12 month period are more than
the greater of either the insurer's net income for the prior fiscal year or 10%
of its surplus at the end of the prior fiscal year.
If insurance regulators determine that payment of a dividend or any
other payments to an affiliate (such as payments under a tax-sharing agreement
or payments for employee or other services) would, because of the financial
condition of the paying insurance company or otherwise, be a detriment to such
insurance company's policyholders, the regulators may prohibit such payments
that would otherwise be permitted without prior approval.
Risk-Based Capital
In order to enhance the regulation of insurer solvency, the National
Association of Insurance Commissioners (NAIC) specifies risk-based capital (RBC)
requirements for property and casualty insurance companies. These RBC
requirements are designed to monitor capital adequacy and to raise the level of
protection that statutory surplus provides for policyholders. The NAIC's RBC
model law stipulates four levels of regulatory action with the degree of
regulatory intervention increasing as the level of surplus falls below a minimum
amount as determined under the model law. At December 31, 2003, all
ProAssurance's insurance subsidiaries exceeded the minimum level and, as a
result, no regulatory response or action was required.
Investment Regulation
Our operating subsidiaries are subject to state laws and regulations
that require diversification of investment portfolios and that limit the amount
of investments in certain investment categories. Failure to comply with these
laws and regulations may cause non-conforming investments to be treated as
non-admitted assets for purposes of measuring statutory surplus and, in some
instances, would require divestiture. We believe our operating subsidiaries are
in compliance with state investment regulations.
Guaranty Funds
All fifty states have separate insurance guaranty fund laws requiring
admitted property and casualty insurance companies doing business within their
respective jurisdictions to be members of their guaranty associations.
These associations are organized to pay covered claims (as defined and
limited by the various guaranty association statutes) under insurance policies
issued by insurance companies that become insolvent. Such guaranty association
laws create post-assessment associations, which make assessments against member
insurers to obtain funds to pay association covered claims after the insolvency
of an insurer occurs. These associations levy assessments (up to prescribed
limits) on all member insurers in a particular state on the basis of the
proportionate share of the premiums written by member insurers in the covered
lines of business in that state. Maximum assessments permitted by law in any one
year generally vary between 1% and 2% of annual premiums written by a member in
that state. Some states permit member insurers to recover assessments paid
through surcharges on policyholders or through full or partial premium tax
offsets, while other states permit recovery of assessments through the rate
filing process.
Shared Markets
Our operating subsidiaries are required to participate in mandatory
property and casualty shared market mechanisms or pooling arrangements that
provide certain insurance coverage to individuals or other entities that are
otherwise unable to purchase such coverage in the commercial insurance
marketplace. Our operating subsidiaries' participation in such shared markets or
pooling mechanisms is not material to our business at this time.
15
Possible Legislative and Regulatory Changes
In recent years, the insurance industry has been subject to increased
scrutiny by regulators and legislators. The NAIC and a number of state
legislatures have considered or adopted legislative proposals that alter and, in
many cases, increase the authority of state agencies to regulate insurance
companies and insurance holding company systems.
In addition, several committees of Congress have made inquiries and
conducted hearings as part of a broad study of the regulation of insurance
companies, and legislation has been introduced in several of the past sessions
of Congress which, if enacted, could result in the federal government assuming
some role in the regulation of the insurance industry. Although the federal
government does not regulate the business of insurance directly, federal
initiatives often affect the insurance business in a variety of ways. Current
and proposed federal measures that may significantly affect the insurance
business include changes in medical patient protection laws such as the
"Patients Bill of Rights," tort reform and environmental laws.
The Legislatures in various states are currently considering, or being
asked to consider, changes to the laws governing medical liability lawsuits. The
changes are collectively called Tort Reforms. There are also Tort Reform
proposals being considered at the Federal level. In general, the changes would
place limits of non-economic damages, allow insurers more flexibility in paying
large judgments, and would alter some of the rules governing legal proceedings
and qualification of expert witnesses. In certain states, Tort Reform
legislation may also place limits on the ability of medical liability insurers
to raise or maintain rates at adequate levels.
We do not believe it is possible to predict the outcome of any of the
foregoing legislative, administrative or congressional activities or the
potential effects thereof on us.
16
EMPLOYEES
At December 31, 2003, we employed 617 persons, including 424 employees
in our Professional Liability segment and 193 employees at MEEMIC. None of our
employees is represented by a labor union. We consider our employee relations to
be good.
FORWARD-LOOKING STATEMENTS
Any written or oral statements made by us or on our behalf may include
forward-looking statements that reflect our current views with respect to future
events and financial performance. Forward-looking statements (identified by
words such as, but not limited to, "believe", "expect", "intend", "anticipate",
"estimate", "project" and other analogous expressions) include among other
things statements concerning: liquidity and capital requirements, return on
equity, financial ratios, net income, premiums, losses and loss reserves,
premium rates and retention of current business, competition and market
conditions, the expansion of product lines, the development or acquisition of
business in new geographical areas, the availability of acceptable reinsurance,
actions by regulators and rating agencies, payment or performance of our
obligations under the debenture agreement, payment of dividends, and other
matters.
These forward-looking statements are based upon our estimates and
anticipation of future events that are subject to certain risks and
uncertainties that could cause actual results to vary materially from the
expected results described in the forward-looking statements. Due to such risks
and uncertainties, you are urged not to place undue reliance on forward-looking
statements. All forward-looking statements included in this document are based
upon information available to us on the date hereof, and we undertake no
obligation to publicly update or revise any forward-looking statements, whether
as a result of new information, future events or otherwise.
Risks that could adversely affect our operations or cause actual
results to differ materially from anticipated results include, but are not
limited to, the following:
- underwriting losses on the risks we insure are higher or lower than
expected,
- unexpected changes in loss trends and reserving assumptions which might
require the reevaluation of the liability for loss and loss adjustment
expenses, thus resulting in an increase or decrease in the liability
and a corresponding adjustment to earnings,
- our ability to retain current business, acquire new business, expand
product lines and a variety of other factors affecting daily operations
such as, but not limited to, economic, legal, competitive and market
conditions which may be beyond our control and are thus difficult or
impossible to predict,
- changes in the interest rate environment and/or the securities markets
that adversely impact the fair value of our investments or our income,
- inability on our part to achieve continued growth through expansion
into other states or through acquisitions or business combinations,
- general economic conditions that are worse than anticipated,
- inability on our part to obtain regulatory approval of, or to
implement, premium rate increases,
- the effects of weather-related events,
- changes in the legal system, including retroactively applied decisions
that affect the frequency and severity of claims,
17
- significantly increased competition among insurance providers and
related pricing weaknesses in some markets,
- changes in the availability, cost, quality or collectibility of
reinsurance,
- changes to our ratings by rating agencies,
- regulatory and legislative actions or decisions that adversely affect
us, and
- our ability to utilize loss carryforwards and other deferred tax
assets.
ITEM 2. PROPERTIES
We own a 156,000 square foot office building located in Birmingham,
Alabama where we currently occupy approximately 55,000 square feet and plan to
occupy approximately 14,500 square feet of additional office space. The
remaining office space is leased to unaffiliated persons or is available to be
leased. We also own a 53,000 square foot office building in Okemos, Michigan
that we fully occupy. Both buildings are currently unencumbered. MEEMIC leases
its principal executive offices in Auburn Hills, Michigan. MEEMIC owns,
primarily for investment purposes, an 11.5-acre vacant parcel of land in Auburn
Hills, Michigan. We lease other office facilities in various locations and lease
computer and operating equipment under cancelable and non-cancelable agreements.
18
ITEM 3. LEGAL PROCEEDINGS
Our insurance subsidiaries are involved in various legal actions, a
substantial number of which arise from claims made under insurance policies.
While the outcome of all legal actions is not presently determinable, management
and its legal counsel are of the opinion that these actions will not have a
material adverse effect on our financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
EXECUTIVE OFFICERS OF PROASSURANCE CORPORATION
The executive officers of ProAssurance serve at the pleasure of the
Board of Directors. Set forth below are the current executive officers of
ProAssurance and a brief description of their principal occupation and
employment during the last five years.
A. DERRILL CROWE, M.D. Dr. Crowe has served as Chairman of our Board and our
Chief Executive Officer since we began operations in
June 2001. Dr. Crowe has also served as President,
Chairman of the Board and Chief Executive Officer of
Medical Assurance since its formation in 1995, and as
President, Chief Executive Officer, and a director of
Medical Assurance Company since its founding in 1977.
Dr. Crowe also serves as chairman of the board of
MEEMIC Holdings. (Age 67)
VICTOR T. ADAMO, ESQ. Mr. Adamo has served as our Vice Chairman, President,
and Chief Operating Officer since we began operations
in June 2001. Mr. Adamo also serves as President,
Chief Executive Officer and a director of
Professionals Group. Mr. Adamo has served as a
director of ProNational since 1990, and was its Chief
Executive Officer since 1987. Mr. Adamo is the Chief
Executive Officer and a director of MEEMIC Holdings.
(Age 56)
19
PAUL R. BUTRUS Mr. Butrus has served as our Vice Chairman and a
director of ProAssurance since we began operations in
June 2001. Mr. Butrus has been Executive Vice
President and a director of Medical Assurance since
its incorporation in 1995. Mr. Butrus has been
employed by Medical Assurance Company and its
subsidiaries since 1977, most recently as Executive
Vice President and Chief Operating Officer since
1993. (Age 63)
HOWARD H. FRIEDMAN Mr. Friedman was appointed as our Senior Vice
President, Chief Financial Officer, and Secretary in
June 2001. Mr. Friedman has served in a number of
positions for Medical Assurance since 1996, most
recently as Senior Vice President, Corporate
Development of Medical Assurance. Mr. Friedman is an
Associate of the Casualty Actuarial Society. He also
serves as a director of MEEMIC. (Age 45)
JAMES J. MORELLO Mr. Morello was appointed as our Senior Vice
President, Chief Accounting Officer and Treasurer in
June 2001. Mr. Morello has been Senior Vice President
and Treasurer for Medical Assurance since its
formation in 1995. Mr. Morello has been employed as
Treasurer and Chief Financial Officer of Medical
Assurance Company since 1984. He also serves as a
director of Medical Assurance's insurance
subsidiaries and as treasurer for ProNational. Mr.
Morello is a certified public accountant. (Age 55)
20
FRANK B. O'NEIL Mr. O'Neil was appointed as our Senior Vice President
of Corporate Communications and Investor Relations in
September 2001. Mr. O'Neil has been Senior Vice
President of Corporate Communications for Medical
Assurance since 1997 and employed by Medical
Assurance Company and its subsidiaries since 1987.
(Age 50)
LYNN M. KALINOWSKI Mr. Kalinowski has been President of MEEMIC Holdings
and MEEMIC since September 2001. Mr. Kalinowski
previously served as President of MEEMIC from January
1993 to May 1997 and as Executive Vice President of
MEEMIC from May 1997 to September 2001. Prior to
joining MEEMIC in 1993, Mr. Kalinowski was the
President of Southern Michigan Mutual Insurance
Company and previously served as Director of
Financial Analysis for the Michigan Insurance Bureau
(now the State of Michigan Office of Financial and
Insurance Services). Mr. Kalinowski has been a
director of MEEMIC Holdings since 1998. (Age 52)
20
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
At March 1, 2004, ProAssurance Corporation (PRA) had 3,605 stockholders
of record and 29,105,971 shares of common stock outstanding. ProAssurance's
common stock currently trades on The New York Stock Exchange (NYSE) under the
symbol "PRA".
2003 2002
-------------------------------------------------
Quarter HIGH LOW High Low
- ------- -------------------------------------------------
First $ 23.92 $ 20.69 $ 18.22 $ 15.99
Second 30.50 23.40 19.70 16.01
Third 28.90 24.50 18.00 14.20
Fourth 32.97 26.86 21.11 15.78
ProAssurance has not paid any cash dividends on its common stock and
does not currently have a policy to pay regular dividends.
ProAssurance's insurance subsidiaries are subject to restrictions on
the payment of dividends to the parent. Information regarding restrictions on
the ability of the insurance subsidiaries to pay dividends is incorporated by
reference from the paragraphs under the caption "Insurance Regulatory Matters --
Regulation of Dividends and Other payments from Our Operating Subsidiaries" in
Item 1 on page 14 of this 10-K.
21
ITEM 6. SELECTED FINANCIAL DATA
Year ended December 31
SELECTED FINANCIAL DATA 2003 2002 2001 2000 1999
------------------------------------------------------------------------
(in thousands, except per share amounts)
Gross premiums written (1) $ 740,110 $ 636,156 $ 388,983 $ 223,871 $ 201,593
Net premiums written (1) 668,909 537,123 310,291 194,279 156,923
Premiums earned (1) 698,347 576,414 381,510 216,297 207,492
Premiums ceded (1) (74,833) (99,006) (68,165) (38,701) (43,068)
Net premiums earned (1) 623,514 477,408 313,345 177,596 164,424
Net investment income (1) 73,619 76,918 59,782 41,450 39,273
Net realized investment gains (losses) (1) 5,992 (5,306) 5,441 913 1,787
Other income (1) 6,515 6,747 3,987 2,630 2,545
Total revenues 709,640 555,767 382,555 222,589 208,029
Net losses and loss adjustment expenses (1) 551,376 448,029 298,558 155,710 104,657
Income before cumulative effect
of accounting change 38,703 10,513 12,450 24,300 46,700
Net income (1) (3) 38,703 12,207 12,450 24,300 46,700
Income per share before cumulative
effect of accounting change (1) (2)
Basic $ 1.34 $ 0.40 $ 0.51 $ 1.04 $ 1.95
Diluted $ 1.33 $ 0.39 $ 0.51 $ 1.04 $ 1.95
Net income per share: (1) (2) (3)
Basic $ 1.34 $ 0.47 $ 0.51 $ 1.04 $ 1.95
Diluted $ 1.33 $ 0.46 $ 0.51 $ 1.04 $ 1.95
Weighted average number of
shares outstanding: (2)
Basic 28,956 26,231 24,263 23,291 23,992
Diluted 29,144 26,254 24,267 23,291 24,008
BALANCE SHEET DATA (as of December 31)
Total investments $2,055,672 $1,679,497 $1,521,279 $ 796,526 $ 761,918
Total assets 2,879,352 2,586,650 2,238,325 1,122,836 1,117,668
Reserve for losses and loss
adjustment expenses 1,814,584 1,622,468 1,442,341 659,659 665,792
Long-term debt 104,789 72,500 82,500 - -
Total liabilities 2,333,047 2,055,086 1,802,606 777,669 791,944
Total capital 546,305 505,194 413,231 345,167 325,724
Total capital per share of common
stock outstanding (2) $ 18.77 $ 17.49 $ 16.02 $ 15.22 $ 13.92
Common stock outstanding at
end of year (2) 29,105 28,877 25,789 22,682 23,401
(1) Operating results include the operating results of Professionals Group
since the date of consolidation, June 27, 2001. See Note 2 to the
Consolidated Financial Statements.
(2) The Board of Directors declared a special stock dividend in December 1999
(5%). All net income per share and total capital per share data on this
page have been restated as if the dividends had been declared on January 1,
1999. Additionally, treasury stock is excluded from the date of acquisition
for purposes of determining the weighted average number of shares
outstanding used in the computation of net income per share of common
stock.
(3) Net income for the year ended December 31, 2002 was increased by $1.7
million due to the adoption of SFAS 141 and 142. See Note 14 to our
consolidated financial statements. In accordance with SFAS 142, we wrote
off the unamortized balance of deferred credits that related to business
combinations completed prior to July 1, 2001. The cumulative effect
increased net income per share (basic and diluted) by $0.07 per share.
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
consolidated financial statements and notes to the consolidated financial
statements appearing elsewhere in this report. Throughout the discussion,
references to ProAssurance, "we," "us" and "our" refers to ProAssurance
Corporation and its subsidiaries. The discussion contains certain
forward-looking information that involves risks and uncertainties. As discussed
under "Forward-Looking Statements," our actual financial condition and operating
results could differ significantly from these forward-looking statements.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements have been prepared in accordance
with accounting principles generally accepted (GAAP) in the United States of
America. Preparation of these financial statements requires us to make estimates
and assumptions in certain circumstances that affect the amounts reported in our
consolidated financial statements and related footnotes. We evaluate these
estimates and assumptions on an on-going basis based on historical developments,
market conditions, industry trends and other information that we believe to be
reasonable under the circumstances. There can be no assurance that actual
results will conform to our estimates and assumptions, and that reported results
of operations will not be materially adversely affected from time-to-time by the
need to make accounting adjustments reflecting changes in these estimates and
assumptions. Management considers an accounting estimate to be critical if:
- it requires assumptions to be made based on data that was not
final at the time the estimate was made; and
- changes in the estimate, or the selection of a different estimate,
could have a material effect on our consolidated results of
operations or financial condition.
We believe the following policies used in the preparation of the
consolidated financial statements are the most sensitive to estimates and
judgments.
Reserve for Losses and Loss Adjustment Expenses (reserve for losses)
Our reserve for losses represents our estimate of the future amounts
necessary to pay claims and expenses associated with investigation and
settlement of claims. These estimates consist of case reserves and bulk
reserves. Case reserves are estimates of future losses and loss adjustment
expenses (losses) for reported claims and are established by our claims
departments. Bulk reserves, which include a provision for insured events that
have occurred but have not been reported to us as well as development on
reported claims, are the difference between (i) the sum of case reserves and
paid losses and (ii) an actuarially determined estimate of the total losses
necessary for the ultimate settlement of all reported claims and incurred but
not reported claims, including amounts already paid. The estimates take into
consideration our past loss experience, available industry data and projections
as to future claims frequency, severity, inflationary trends and settlement
patterns. Independent actuaries review our reserves for losses each year and
prepare reports that include recommendations as to the level of reserves. We
consider these recommendations as well as other factors, such as known,
anticipated or estimated changes in frequency and severity of claims and loss
retention levels and premium rates, in establishing the amount of our reserves
for losses Estimating casualty insurance reserves, and particularly professional
liability reserves, is a complex process. These claims are typically resolved
over an extended period of time, often five years or more, and estimating loss
costs for these claims requires multiple judgments involving many uncertainties
made over an extended period of time. Our reserve estimates may vary
significantly from the eventual outcome. The assumptions used in establishing
our reserves are regularly reviewed and updated by management as new data
becomes available. Any
23
adjustments necessary are reflected in then current operations. Due to the size
of our reserves, even a small percentage adjustment to these estimates could
have a material effect on our results of operations for the period in which the
change is made. See the discussion under "Overview" in this section for a
history of our loss reserve development.
Reinsurance
Our receivable from reinsurers represents our estimate of the amount of
our future loss payments that will be recoverable from our reinsurers. These
estimates are based upon our estimates of the ultimate losses that we expect to
incur and the portion of those losses that we expect to be allocable to
reinsurers based upon the terms of our reinsurance agreements. We also estimate
premiums ceded under reinsurance agreements wherein the premium due to the
reinsurer, subject to certain maximums and minimums, is a percentage of the
losses reimbursed under the agreement. Given the uncertainty of the ultimate
amounts of our losses, these estimates may vary significantly from the eventual
outcome. Our estimates of the amounts receivable from and due to reinsurers are
regularly reviewed and updated by management as new data becomes available. Our
assessment of the collectibility of the recorded amounts receivable from
reinsurers is based primarily upon public financial statements and rating agency
data. Any adjustments necessary are reflected in then current operations. Due to
the size of our receivable from reinsurers, even a small adjustment to these
estimates could have a material effect on our results of operations for the
period in which the change is made. At December 31, 2003, we considered all of
our receivable from reinsurers to be collectible.
Investments
We consider our fixed maturity securities as available-for-sale and our
equity securities as either available-for-sale or trading portfolio securities.
Our available-for-sale securities are available to be sold in response
to a number of issues, including our liquidity needs, changes in market interest
rates and investment management strategies, among others. Available-for-sale
securities are recorded at fair value. The related unrealized gains and losses,
net of income tax effects, are excluded from net income and reported as a
component of stockholders' equity.
We evaluate the securities in our available-for-sale investment
portfolio on at least a quarterly basis for declines in market value below cost
for the purpose of determining whether these declines represent other than
temporary declines. Some of the factors we consider in the evaluation of our
investments are:
- the extent to which the market value of the security is less than
its cost basis,
- the length of time for which the market value of the security has
been less than its cost basis,
- the financial condition and near-term prospects of the security's
issuer, taking into consideration the economic prospects of the
issuers' industry and geographical region, to the extent that
information is publicly available, and
- our ability and intent to hold the investment for a period of time
sufficient to allow for any anticipated recovery in market value.
24
A decline in the fair value of an available-for-sale security below
cost that we judge to be other than temporary is realized as a loss in the
current period and reduces the cost basis of the security. In subsequent
periods, we base any measurement of gain or loss or decline in value upon the
adjusted cost basis of the security.
Since January 1, 2003, we have designated certain of our equity
security purchases as trading portfolio securities. A trading portfolio is
carried at fair value with the holding gains and losses included in realized
investment gains and losses in the current period. Therefore results of current
operations reflect both positive and negative changes in the market value of
these securities.
LIQUIDITY AND CAPITAL RESOURCES AND FINANCIAL CONDITION
Our primary need for liquid funds is to pay losses and operating
expenses in the ordinary course of business and to meet our debt service
requirements.
Our operating activities provided positive cash flow of $283 million
during 2003. Our operating cash flows are primarily derived from net investment
income received and from the excess of premiums collected over paid net losses
and operating costs. Timing delays exist between the collection of premiums and
the payment of losses, particularly so with regard to our professional liability
premiums. In periods of premium growth such as in 2003, premium collections
generally exceed losses paid in the calendar year.
We believe that premium adequacy is critical to our long-term
liquidity. We continually review rates, particularly professional liability
rates, and submit requests for rate increases to state insurance departments as
we consider necessary to maintain rate adequacy. We achieved average overall
rate increases of 28% in 2003 and 2002. We are unable to predict whether we will
continue to receive approval for our requests for higher rates.
We transfer most of the cash generated from operations into our
investment portfolio, primarily into investment grade fixed maturity securities.
Our investments, cash and cash equivalents at December 31, 2003 total $2.103
billion, an increase of $280 million as compared to December 31, 2002. At
December 31, 2003, our investment portfolio includes net before-tax unrealized
gains of $53.0 million. Our fixed maturity portfolio has a market value of
$1.791 billion, including net before-tax unrealized gains of $48.8 million.
Substantially all of our fixed maturities are either United States
government or agency obligations or investment grade securities as determined by
national rating agencies. The fixed maturity securities in our investment
portfolio had a dollar weighted average rating of "AA," at December 31, 2003.
Our fixed maturities are purchased with the intent to hold such investments to
maturity; however, we consider these securities as available-for-sale because we
may dispose of the securities prior to their maturity in order to meet the
Company's then current objectives. Our investment policies implement an asset
allocation that uses length to maturity as one method of managing our long term
rate of return. The weighted average modified duration of our fixed maturity
securities at December 31, 2003 is 3.5 years. The average length to maturity of
the fixed maturity portfolio was shortened somewhat during 2003. Throughout 2003
longer term fixed maturity securities were available only at historically low
rates, and we maintained a shorter portfolio so as to provide additional
investment flexibility should market interest rates rise. We regularly evaluate
the interest rate environment, and adjust our duration targets to maximize
investment yield.
Changes in market interest rate levels generally affect our net income
to the extent that reinvestment yields are different than the original yields on
maturing securities. Additionally, changes in market interest rates may also
affect the fair value of our fixed maturity securities. For a more detailed
discussion of the effect of changes in interest rates on our investment
portfolio see "Item 7A - Quantitative and Qualitative Disclosures about Market
Risk."
25
Our current investment policy requires that the market value of our
equity investment portfolio not exceed 50% of our capital at the end of the
prior year. At December 31, 2003, equity investments represented approximately
2% of our total investments, and approximately 9% of our capital. Our equity
investments are diversified primarily among domestic growth and value holdings
through common and preferred stock.
Our net reserves for losses (net of amounts receivable from reinsurers)
at December 31, 2003 are approximately $1.370 billion, an increase of $209.3
million over net reserves at December 31, 2002. Substantially all of this
increase is in our professional liability segment, a "long tailed" business. A
characteristic of a "long tailed" business is that there is a long length of
time between the occurrence of an insured event and significant payment on that
event. Because of this characteristic, it is not unusual for reserves to
increase, especially during periods of business growth. Activity in the net
reserve for losses during 2003 and 2002 is summarized below:
Year Ended December 31
2003 2002 2001
--------------------------------------------------
In Thousands
Balance, beginning of year $ 1,622,468 $ 1,442,341 $ 659,659
Less reinsurance recoverables 462,012 374,056 166,202
--------------------------------------------------
Net balance, beginning of year 1,160,456 1,068,285 493,457
Net reserves acquired from Professionals Group - - 557,284
Incurred related to:
Current year 562,256 439,600 303,387
Prior years (10,880) 8,429 13,818
Change in death, disability, and retirement
reserve - - (18,647)
--------------------------------------------------
Total incurred 551,376 448,029 298,558
Paid related to:
Current year (94,824) (84,376) (137,121)
Prior years (247,235) (271,482) (143,893)
--------------------------------------------------
Total paid (342,059) (355,858) (281,014)
--------------------------------------------------
Net balance, end of year 1,369,773 1,160,456 1,068,285
Plus reinsurance recoverables 444,811 462,012 374,056
--------------------------------------------------
Balance, end of year $ 1,814,584 $ 1,622,468 $ 1,442,341
==================================================
As of December 31, 2003, our insurance subsidiaries had consolidated
reserves for losses and loss adjustment expenses on a GAAP basis that exceeded
those on a statutory basis by approximately $19.7 million, which is principally
due to the portion of GAAP reserves that are reflected for statutory accounting
purposes as unearned premiums. These unearned premiums are applicable to
extended reporting endorsements ("tail" coverage) issued without a premium
charge upon death, disability, or retirement of an insured.
We use reinsurance to provide capacity to write large limits of
liability, to reduce losses of a catastrophic nature and to stabilize
underwriting results in those years in which such losses occur. The purchase of
reinsurance does not relieve us from the ultimate risk on our policies, but it
does provide reimbursement from the reinsurer for certain losses paid by us.
The effective transfer of risk is dependent on the credit-worthiness of
the reinsurer. We purchase reinsurance from a number of companies to mitigate
concentrations of credit risk. Our reinsurance brokers assist us in the analysis
of the credit quality of our reinsurers. We base our reinsurance buying
decisions on an evaluation of the then-current financial strength and stability
of prospective reinsurers. 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.
26
At December 31, 2003 our receivable from reinsurers approximated $444.8
million. The following table identifies our reinsurers from which our
recoverables (net of amounts due to the reinsurer) are $10 million or more as
of December 31, 2003:
Net
A. M. Best Amounts Due
Reinsurer Company Rating From Reinsurer
- ------------------------------------------- -------------- --------------
Michigan Catastrophic Claims Association Not rated $ 86,470
Hannover RuckvericherungsAG A $ 53,776
General Reinsurance Corp A++ $ 43,661
PMA Capital Insurance Company B++ $ 28,893
Gerling Global Reins Corp NR-3 $ 20,933
American Rein Co A+ $ 13,511
Lloyd's Syndicate 435 A- $ 13,474
St. Paul Reinsurance Company Ltd (Uk Corp) A $ 12,299
Transatlantic Reinsurance, SA A++ $ 10,745
AXA Reinsurance SA A- $ 10,458
We have not experienced any difficulties in collecting amounts due from
reinsurers due to financial instability of the reinsurer. As of December 31,
2003 we do not believe we have any reinsurance recoverables that are
uncollectible. Should future events lead us to believe that any reinsurer is
unable to meet its obligations to us, adjustments to the amounts recoverable
would be reflected in the results of current operations.
The Michigan Catastrophic Claims Association (MCCA) is an
unincorporated nonprofit association created by Michigan law, and every insurer
engaged in writing personal protection automobile insurance coverage in Michigan
is required to be a member of the MCCA. The MCCA charges an annual assessment,
based on the number of vehicles for which coverage is written, to cover the
losses reported by all member companies. Michigan law provides that the MCCA
assessments charged to member companies for this protection can be recognized in
the rate-making process and passed on to policyholders. We treat any amounts due
from the MCCA as reinsurance and the assessments due to MCCA as ceded premiums.
Two of our reinsurers, Gerling Global Reinsurance Corporation of
America (Gerling) and PMA Capital Insurance Company (PMA) have discontinued
reinsurance operations and are no longer accepting new business. Neither company
participates in our current reinsurance treaties but both have been part of
previous reinsurance programs. Approximately 58% of recorded receivables from
these reinsurers relates to our estimates of loss development and its allocation
to the various reinsurance treaties. Based upon information available to us,
including statements made by Gerling and PMA, we anticipate that both companies
will meet their obligations to us.
As our premiums have grown, so has our need for capital to support our
insurance operations and maintain our ratings. We have experienced significant
growth with respect to our professional liability premiums and expect continued
growth in 2004. This growth has primarily come as a result of increased prices
but is also a result of reduced competition in the professional liability
market. We have taken actions to obtain additional capital in order to support
growth by our insurance subsidiaries and believe we have the ability to raise
the capital required to support our current plans for growth.
In late 2002, we raised $46.5 million through the sale of our common
stock in an underwritten public offering. In early July 2003 we received $104.6
million from the issuance of 3.9% Convertible Debentures, due June 2023, having
a face value of $107.6 million. We utilized $67.5 million of the net proceeds to
repay our term loan and did not replace the related line of credit.
27
Through December 31, 2003 approximately $36.0 million of the net
proceeds have been contributed to the capital of our professional liability
insurance subsidiaries to support the growth in insurance operations. In
February 2004 we contributed an additional $20.0 million to the capital of our
insurance subsidiaries. After making those contributions to our subsidiaries, we
have $15.0 million available at the parent holding company for general corporate
purposes.
On February 9, 2004 we filed a universal shelf registration statement
with the Securities and Exchange Commission (SEC) that would allow us to offer
from time-to-time up to $250 million in common stock, preferred stock or debt
securities. We may sell any class of the registered securities or combinations
thereof in one or more separate offerings at a total price up to the amount
registered with the amount, price and terms of the securities sold in each
offering to be determined at the time of sale. We have no present commitments to
sell securities under the shelf registration. Our ability to sell any of these
securities will depend in part on our ability to continue profitable operations
and maintain the credit ratings assigned to us by A. M. Best and Standard &
Poor's. Any sale would require us to file a supplemental prospectus that
specifies the terms of the securities to be sold. If securities are sold, we
expect that the net proceeds will be used for general corporate purposes, which
may include contributions to the capital and surplus of our subsidiaries, the
repurchase of outstanding debt securities, or the repayment of other
indebtedness.
On January 29, 2003 ProAssurance's subsidiary, MEEMIC Holdings
repurchased 1,062,298 outstanding common shares and 120,000 vested options for
its common stock that were not owned by ProAssurance's subsidiary, ProNational.
The total cost of the transaction approximated $34.1 million. The funds used for
the purchase were derived from MEEMIC Holdings' cash and investment resources.
As a result of the transaction MEEMIC Holdings is now a wholly-owned indirect
subsidiary of ProAssurance. Goodwill of approximately $7.6 million was recorded
related to the transaction.
Off Balance Sheet Arrangements / Contractual Obligations
We have no 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.
A schedule of our contractual obligations at December 31, 2003 follows:
Payments due by period
-----------------------------------------------------------------------
Less than More than
Total 1 year 1-3 years 3-5 years 5 years
-----------------------------------------------------------------------
In Thousands
Contractual Obligations
Long-term debt obligations $ 104,600 $ - $ - $ - $ 104,600
Operating lease obligations 9,487 3,655 4,898 880 54
-------------------------------------------------------------------------
Total $ 114,087 $ 3,655 $ 4,898 $ 880 $ 104,654
=======================================================================
Our operating lease obligations are primarily for the rental of office
space, office equipment, and communications lines and equipment.
Parent Holding Company
The parent holding company is a legal entity separate and distinct from
its subsidiaries. Because the parent holding company has no other business
operations, dividends from its operating subsidiaries represent a significant
source of funds for its obligations, including debt service. The ability of
those insurance subsidiaries to pay dividends is subject to limitation by state
insurance regulations. See our discussions under "Regulation of Dividends...
from Our Operating Subsidiaries" in Part I, and in Note 17 of our Notes to
Consolidated Financial Statements for additional information regarding dividend
limitations.
28
OVERVIEW
ProAssurance Corporation is an insurance holding company and its
operating results are almost entirely derived from the operations of its
insurance subsidiaries. ProAssurance operates in two industry segments:
professional liability insurance and personal lines insurance.
The professional liability segment is our largest segment, representing
over 73% of 2003 written premiums and 84% of total assets. This segment
principally provides liability insurance for providers of health care services
in the south and midwest, and, to a limited extent, providers of legal services
in the midwest. The principal operating insurance subsidiaries of this segment
are: The Medical Assurance Company, Inc., ProNational Insurance Company and Red
Mountain Casualty Insurance Company, Inc. We also write professional liability
insurance through Medical Assurance of West Virginia, Inc.
Our personal lines segment provides personal property and casualty
insurance primarily to members of the educational community and their families
in the state of Michigan. Our personal lines segment includes the operations of
a single insurance company, MEEMIC Insurance Company (MEEMIC), which we acquired
in June 2001 as a part of the Professionals Group consolidation transaction.
Corporate Strategy
Our objective is to build value for our stockholders through superior
underwriting of classes of business in which we have a comprehensive
understanding and which offer us the opportunity to generate competitive returns
on capital. We target a return on equity of 12% to 14% over the long term. Over
the five years ending December 31, 2003, however, we achieved an average return
on equity of 6.9%, with a high of 14.4% in 1999 and a low of 2.3% in 2002.
We emphasize disciplined underwriting and do not manage our business to
achieve a certain level of premium growth or market share. In our professional
liability business, we apply our local knowledge to individual risk selection,
and determine the appropriate price based on our assessment of the specific
characteristics of each risk. In our personal lines business, we target the
educational community, which we believe provides a preferred, stable and
predictable group of risks.
In addition to prudent risk selection, we seek to control our
underwriting results through effective claims management. We investigate each
professional liability claim and have fostered a strong culture of aggressively
defending those claims that we believe have no merit. We manage these claims at
the local level, tailoring claims handling to the legal climate of each state,
which we believe differentiates us from national writers. In our personal lines
business, we seek to quickly and efficiently resolve claims through an
established network of auto repair shops and other repair facilities, focusing
on minimizing the cost of handling each claim.
By concentrating on specialty markets where customers have specialized
needs, we seek to provide value added solutions through our underwriting
expertise and our emphasis on strong customer service. Through our regional
underwriting and claims office structure, we are able to gain a strong
understanding of local market conditions and efficiently adapt our underwriting
and claims strategies to regional conditions. Our regional presence also allows
us to maintain active relationships with our customers and be more responsive to
their needs. We believe these factors have allowed us to establish a leading
position in our markets, enabling us to compete on a basis other than just
price. We also believe that our presence in local markets allows us to monitor
and understand changes in the liability climate and thus develop better business
strategies in a more timely manner than our competitors.
Our goal is to build upon our position as a leading writer of
professional liability and personal lines insurance and expand within a defined
geographic area, while maintaining our commitment to disciplined underwriting
and aggressive claims management. According to A.M. Best, we are the fourth
largest active medical liability insurance writer in the nation, and we believe
we are the largest medical liability writer in
29
our states of operation. The withdrawal and reduced capacity of several
competitors in the medical professional liability market has provided new
business opportunities. We believe that our strong reputation in our regional
markets, combined with our financial strength, strong customer service and
proven ability to manage claims, should enable us to profitably expand our
position in select states. In our personal lines business, we estimate that we
currently insure approximately 16% of the educational community (active and
retired teaching professionals and service employees) in Michigan. We expect to
increase our penetration of the educational community by appointing additional
agents and broadening our existing relationships with educational institutions
and their employees.
We have successfully acquired and integrated companies and books of
business in the past and believe our financial size and strength make us an
attractive acquirer. The current professional liability climate may also provide
us with the opportunity to undertake additional mergers or acquisitions of
companies or books of business within or adjacent to, our states of operation.
We continually evaluate these opportunities to leverage our core underwriting
and claims expertise.
We have sustained our financial stability during difficult market
conditions through responsible pricing and loss reserving practices. We are
committed to maintaining prudent operating and financial leverage and
conservatively investing our assets. We recognize the importance our customers
and producers place on the strong ratings of our principal insurance
subsidiaries and we intend to manage our business to protect our financial
security.
Growth Opportunities and Outlook
We expect to achieve our growth in our Professional Liability segment
primarily as a result of (i) the withdrawal of competitors from actively writing
business in certain states, and (ii) increased prices in our professional
liability business.
We believe we are viewed as a market leader because of our financial
strength and stability, and our ability to deliver excellent service at the
local level. This reputation allows us to take advantage of marketing conditions
that are improving as price increases are implemented and earned. Our stability
also makes us an attractive insurer in light of the highly publicized
insolvencies in our industry, as well as the regulatory actions taken against
several former competitors.
In 2003 and in 2002, our professional liability segment achieved
average gross price increases of approximately 28% on renewal business (weighted
by premium volume). In 2004 we expect professional liability pricing to continue
to increase, although not at the levels of 2002 and 2003. We expect to increase
the number of policies written as our competitors' withdraw from markets and
their capacity becomes increasingly constrained. We also expect our balance
sheet strength to become a further differentiating factor in the market.
Additionally, we plan to appoint new agents in underserved areas in the states
where we write business and we believe that will bring us additional business as
well.
We expect our future growth in professional liability will be supported
by controlled expansion in states where we are already writing business. This
includes states we recently entered such as Arkansas, Delaware, North Carolina
and Virginia, that we believe have relatively favorable medical and legal
climates. We also expect to expand into additional states within, or adjacent
to, our existing business footprint as opportunities present themselves.
We also believe there will be additional opportunities for profitable
expansion of our professional liability business as insurers continue
experiencing financial difficulties, requiring them to reduce their business or
completely exit the marketplace. This may also lead to opportunities to expand
through the acquisition of other companies or books of business.
In the Personal Lines segment, our strong capitalization provides
operational flexibility allowing growth and expansion capabilities for current
and new product lines in Michigan, and expansion outside of the state.
30
We believe we can achieve our growth in both segments while improving
our combined ratio. As with all property and casualty companies, we expect the
beneficial impact of price increases and any development of losses to be fully
reflected in our financial results over time. We recognize the effect of higher
prices as the associated premiums are earned which generally occurs over the
course of the year after the policy is written.
Segments
Revenues and expenses are attributable to the operating segments with
the exception of corporate income, which consists of investment income earned
directly by the parent holding company and interest expense related to long-term
debt held by the parent. We experienced a significant improvement in earnings
during the year ended December 31, 2003 as compared to the years ended December
31, 2002 and 2001, primarily due to improvement by the professional liability
segment, as shown in the table below:
2003 2002
vs vs
2002 2001
Increase Increase
2003 2002 2001 (Decrease) (Decrease)
------------------------------------------------------------
In Thousands
Income before income taxes, minority interest
and cumulative effect:
Professional Liability Segment $20,657 $(14,637) $ 1,547 $ 35,294 $ (16,184)
Personal Lines Segment 33,124 31,065 11,573 2,059 19,492
Corporate (unallocated to segments) (3,447) (2,818) (2,151) (629) (667)
------------------------------------------------------------
Consolidated $50,334 $ 13,610 $10,969 $ 36,724 $ 2,641
============================================================
Our professional liability segment operates in a challenging
environment. Beginning in 2000, virtually all providers of medical professional
liability began to recognize adverse trends in claim severity, causing increased
estimates of current and prior losses. Throughout the industry, premiums
previously considered adequate to cover expected losses and provide some profit
were found to be inadequate. We began to address these trends in 2000 by seeking
to increase premium rates in order to more closely align revenues with expected
losses. We have implemented rate increases in all states, even when this has
resulted in non-renewal of business. We have been more selective in our
underwriting criteria and have elected to not-renew business that we did not
expect to write profitably. At the same time, we have also worked to contain
losses and to improve operating efficiencies. Our ability to successfully
implement premium rate increases has been the most significant factor in
improving the underwriting results of this segment.
Investment income is a substantial revenue source for the professional
liability segment because, on average, premiums are collected several years
before the related losses are paid. Additionally, we consider realized capital
gains to be a significant part of our investment strategy and realized capital
gains and losses can have a substantial effect on our revenues. Prevailing
market interest rates have been at historically low levels in recent years which
has reduced our investment income. The decline in investment income somewhat
offsets any improvement that results from premium increases. In an attempt to
mitigate that risk, state regulators require us to take interest rates into
account as we develop our rates.
Our personal lines segment operates in a highly competitive environment
dominated by larger insurance organizations. We must provide a high level of
service while operating efficiently in order to competitively price our products
and obtain positive financial results. The personal lines segment has
contributed significantly to our consolidated profits since the segment was
acquired in June 2001.
Investment income is a less significant component of revenues for the
personal lines segment than for the professional lines segment because the
length of time between the collection of premiums
31
and the settlement of claims is generally short; approximately 75% of claims
are paid within one year after the claim is filed. Investment income has
increased only slightly because increases in the investment portfolio have
been offset by declines in yields.
Losses and Reinsurance
Losses are the largest component of expense for both the professional
liability segment and the personal lines segment. In 2003, the consolidated net
loss ratio (the income statement line "Net losses and loss adjustment expenses"
divided by the income statement line "Net premiums earned") is 88.4%, reflecting
a net loss ratio of 96.9 % for the professional liability segment and 65.8% for
the personal lines segment. As discussed in critical accounting policies, net
losses in any period reflects our estimate of net losses related to the premiums
earned in that period as well as any changes to our estimates of reserves
required for net losses of prior periods.
The estimation of losses is particularly difficult for our professional
liability segment. Loss reserves associated with medical professional liability
coverage tend to be higher than those associated with most other types of
property and casualty insurance for two primary reasons. First, overall costs of
providing professional liability insurance coverage historically have been among
the highest of the property and casualty insurance lines. These costs can be
attributed principally to increases in both the frequency and severity of
professional liability claims. Second, the complexity of professional liability
claims increases losses. In addition, delays between the collection of premiums
and the payment of losses are generally longer for professional liability
insurance than other property and casualty lines. Frequently, injuries are not
discovered until years after an incident, or the claimant may delay pursuing the
recovery of damages. As a result of the delay, a component of the loss reserves
for occurrence coverage and "tail" coverage includes an estimate of the claims
that have been incurred but not yet reported (IBNR).
Medical professional liability loss experience is volatile and
cyclical. Over the past twenty-five years, the industry has experienced several
periods of increasing claim frequency and severity, followed by periods of
relative stability. At other times, due to tort reform, favorable judicial
decisions, favorable economic conditions or other unknown factors, claim
frequency or severity have decreased. Malpractice claims generally require an
extended period of time to resolve, and the average life of a claim can be five
years or more. The combination of changing conditions and the extended time
required for claim resolution result in a loss cost estimation process that
requires actuarial skill and the application of judgment, and such estimates
require periodic revision. We believe it is prudent to establish initial losses
that are based on historical experience as well as on facts and circumstances
known at the balance sheet date. To the extent that actual results deviate from
expectations, reserve estimates are subsequently adjusted.
Losses for the personal lines segment are delineated between property
and liability loss due to their differing characteristics. Losses for property
claims comprise approximately 70% of the personal lines loss expense. Such
claims are typically settled and paid without litigation within one year after
the claim is reported. Losses for personal liability claims more closely
resemble medical professional liability losses and are more complex to estimate.
Injuries and their severity may not be discovered until several years after an
incident and the delay between the collection of premium a