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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, 2004, 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 or organization) (I.R.S. Employer Identification No.)
100 Brookwood Place, Birmingham, AL 35209
(Address of principal executive offices) (Zip Code)
(205) 877-4400
(Registrant's Telephone Number, Including Area Code)
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 X No
----- -----
The aggregate market value of voting stock held by non-affiliates of the
registrant at June 30, 2004 was $995,191,723.
As of December 31, 2004, the registrant had outstanding approximately 29,204,463
shares of its common stock.
Exhibit Index at page 103
Page 1 of 108 pages
Documents incorporated by reference in this Form 10-K
(i) The definitive proxy statement for the 2005 Annual Meeting of the
Stockholders of ProAssurance Corporation (File No. 001-16533) is
incorporated by reference into Part III of this report.
(ii) Registration Statement on Form S-4 of MAIC Holdings, Inc. (File No.
33-91508) is incorporated by reference into Part IV of this report.
(iii) 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.
(iv) 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.
(v) The Registration Statement on Form S-4 of ProAssurance Corporation (File
No. 333-49378) is incorporated by reference into Part IV of this report.
(vi) 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.
(vii) 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.
(viii) 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.
(ix) 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.
(x) 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.
(xi) 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.
(xii) 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.
(xiii) The Registration Statement on Form S-3 of ProAssurance Corporation (File
No. 333-109972) is incorporated by reference in Part IV of this report.
(xiv) The ProAssurance Corporation Quarterly Report on form 10-Q for the quarter
ended June 30, 2004 (File No. 001-16533) is incorporated by reference into
Part IV of this report.
(xv) The ProAssurance Corporation Quarterly Report on form 10-Q for the quarter
ended March 31, 2004 (File No. 001-16533) is incorporated by reference into
Part IV of this report.
(xvi) The ProAssurance Corporation Report on Form 8-K for event occurring on
February 28, 2005 (File No. 001-16533) is incorporated by reference into
Part IV of this report.
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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 Company news releases, and to major investor
presentations made by our executives.
Our Board of Directors has adopted a Policy Regarding Determination of
Director Independence, including categorical standards to assist in determining
independence, has amended the charter of our Audit Committee and has adopted
charters for our Compensation and Nominating/Corporate Governance Committees as
well as our Corporate Governance Principles and our Code of Ethics and Conduct.
Copies of all these documents are available on our website at
http://www.proassurance.com. Printed copies of our committee charters, Corporate
Governance Principles, Code of Ethics and Conduct, and our Policy Regarding
Determination of Director Independence may be obtained by writing to: Frank
O'Neil, Senior Vice President, ProAssurance Corporation, either by mail or at
P.O. Box 590009, Birmingham, Alabama 35259-0009, or by telephone at (205)
877-4400 or (800) 282-6242.
Because the insurance business uses certain terms and phrases that
carry special and specific meaning, we urge you to read the Glossary included
at the end of Item I, prior to reading this report.
Our insurance companies are regionally-oriented. We sell professional
liability insurance to physicians, dentists, other healthcare providers and
healthcare facilities, principally in the midwest and southeast and automobile,
homeowners and associated coverages to educators and their families in Michigan.
We rigorously underwrite our risks and are focused on maintaining
adequate pricing for the risks. By ensuring that we charge an adequate rate, we
seek to maintain a strong financial position to protect our customers. Our
regional presence and service commitment allow 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.
For the year ended December 31, 2004, we generated $789.7 million of
gross premiums written, $696.0 million of net premiums earned and $794.6 million
of total revenues. As of December 31, 2004, we had cash and invested assets of
$2.5 billion, total assets of $3.2 billion and stockholders' equity of $611.0
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 core
operating subsidiaries are The Medical Assurance Company, Inc., ProNational
Insurance Company, Red Mountain Casualty Insurance Company, Inc., and MEEMIC
Insurance Company. We also write a limited amount of professional
3
liability insurance through Medical Assurance of West Virginia, Inc., which we
consider to be a non-core operating subsidiary.
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.
Professionals Group traces its roots to the 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 a book of business in Illinois and the acquisition of
professional liability insurers in Florida and Indiana.
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 2003, we increased our ownership of MEEMIC to 100%.
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.
BUSINESS OVERVIEW
In each of our segments we maintain a strong position in our local
markets. In our professional liability segment we focus on providing medical
professional liability insurance. In our personal lines segment we offer
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.
In professional liability, our top five states represented 71% of
gross premiums written for the year ended December 31, 2004. Our personal lines
business was substantially confined to Michigan in 2004. The following table
shows our gross premiums written in these lines and key states for each of the
periods indicated.
Gross Written Premiums-Years Ended December 31
($ in thousands)
--------------------------------------------------------
Professional Liability
--------------------------------------------------------
2004 2003 2002
-------------- ---------------------- --------------
Ohio $149,269 26% $123,205 23% $ 91,571 20%
Alabama 111,582 19% 106,437 20% 83,818 18%
Florida 69,899 12% 80,549 15% 71,366 15%
Michigan 45,578 8% 54,727 10% 52,203 11%
Missouri 35,217 6% 33,987 6% 23,786 5%
All other states 162,047 29% 144,418 26% 138,971 31%
-------- --- -------- --- -------- ---
Total $573,592 100% $543,323 100% $461,715 100%
======== === ======== === ======== ===
Personal Lines Premiums
---------------------------------------------------------
2004 2003 2002
-------------- ----------------------- --------------
Michigan $216,068 100% $196,787 100% $174,441 100%
======== === ======== === ======== ===
4
For the year ended December 31, 2004, professional liability produced
a combined ratio of 104.8% and personal lines reported a combined ratio of
83.4%.
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.
In order to measure the effect of investment income, we also measure
our results by calculating our operating ratio.
Recent Transactions
In April and May 2004, we received $44.9 million from the issuance of
$46.4 million of trust preferred securities. These securities were issued by
specially-created business trusts created solely for the purpose of issuing the
trust preferred securities. 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 from
the sale of the Convertible Debentures to repay our outstanding term loan. We
are using the balance of the net proceeds from the sale of the Convertible
Debentures and the trust preferred securities for general corporate purposes,
including contributions to the capital of our insurance subsidiaries to support
the growth in insurance operations. See Note 10 to our Consolidated Financial
Statements for more information regarding the Convertible Debentures and the
trust preferred securities.
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.
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.
Proposed Transaction
On February 28, 2005 ProAssurance Corporation and NCRIC Group, Inc.
(NASDAQ: NCRI) reached an agreement to merge NCRIC into ProAssurance in a $69.6
million, all-stock transaction which values NCRIC at $10.10 per share, based on
the closing price of ProAssurance common stock on February 25, 2005. See Note 19
of our Consolidated Financial Statements included herein for more information
regarding the merger.
5
PRODUCTS AND SERVICES
The following table shows Gross Written Premiums for our main lines of
business.
Years Ended December 31
($ in thousands)
------------------------------------------------
2004 2003 2002
-------------- -------------- --------------
Medical Professional Liability $561,907 71% $531,033 72% $448,136 70%
Professional Liability-Other(1) 11,685 2% 12,290 1% 13,579 3%
Private Passenger Auto 174,654 22% 161,399 22% 147,168 23%
Personal Lines - Other(2) 41,414 5% 35,388 5% 27,273 4%
-------- --- -------- --- -------- ---
$789,660 100% $740,110 100% $636,156 100%
======== === ======== === ======== ===
(1) Includes legal professional liability, workers' compensation and commercial
multi-peril coverages.
(2) Primarily homeowners coverage, but also includes boat, snowmobile and
personal umbrella coverage.
In professional liability we believe our size, financial strength and
flexibility of distribution differentiates us from our competitors. We primarily
offer 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 major physician groups as well as hospitals. While
most of our business is written in the standard market, we do offer medical
professional liability insurance on an excess and surplus lines basis to
healthcare professionals who generally do not qualify for standard coverage
because of their claim history or other factors. 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. We also
offer professional office package and workers' compensation insurance products
in connection with our medical professional liability products.
We write legal professional liability insurance in Michigan, Ohio and
Indiana, but that is a small percentage of our professional liability business.
In personal lines, 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.
MARKETING
In professional liability, 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 2004, Ohio, Alabama, Florida, Michigan, and Missouri represented our
five largest states. In personal lines, we market our products to members of the
educational community and their families in Michigan and Wisconsin.
We utilize direct marketing and independent agents to write
professional liability 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, 2004, we
estimate that approximately 65% 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.
Our marketing is primarily directed to physicians. We generally do not
target large physician 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:
6
- 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 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.
We sell our personal lines coverage through exclusive sales
representatives who produce business primarily for MEEMIC. Our representatives
are able to sell coverages that
MEEMIC does not underwrite. Those policies are written through MEEMIC's
wholly-owned insurance agency; both MEEMIC and our representatives receive
compensation from the companies that write those coverages.
For the year ended December 31, 2004, 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 2004.
UNDERWRITING
Our underwriting process is driven by individual risk selection rather
than by account. 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 professional liability 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 professional liability underwriting department classifies 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.
These 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.
In personal lines 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. Our underwriters then evaluate and accept applications for insurance
submitted by the sales representatives based on underwriting guidelines.
7
CLAIMS MANAGEMENT
In each of our segments our claims departments establish the
appropriate case reserves for each claim and monitor the level of each case
reserve as circumstances require.
In professional liability 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 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.
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 also offer professional liability claims management to
self-insuring entities on a fee-for-service basis. While we do not expect this
to become a major source of revenue for us, we believe it allows us to leverage
our claims-management expertise to produce some additional income as larger
groups and facilities decide to self-insure their malpractice risk.
Our personal lines claims operation is centralized in Auburn Hills,
Michigan, with 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 needed.
In responding to claims in personal lines, 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 which enables us to
quickly complete initial claim handling and ultimately reduces indemnity
payments such as rental and storage.
We have also established relationships with 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. Historically, less than 1% of all claims
result in litigation.
8
INVESTMENTS
We manage our investments at the holding company level, but allocate
portfolio assets and earnings to the individual segments. Our overall investment
strategy is to focus on maximizing current income from our investment portfolio
while maintaining safety, liquidity, duration and portfolio diversification. The
portfolio is generally managed by professional third party asset managers whose
results are evaluated periodically by management. The asset managers typically
have the authority to make investment decisions, subject to investment policies,
within the asset class they are responsible for managing. See Note 3 to our
Consolidated Financial Statements for more detail on our investments.
RATING AGENCIES
Our principal insurance subsidiaries are rated "A-" (Excellent) by
A.M. Best, its fourth highest category out of 15 categories. Best maintained a
"Stable" Outlook on these subsidiaries at December 31, 2004. Standard & Poor's
rates our principal insurance subsidiaries "A-" (Strong), its seventh highest
category out of 21 categories, and maintained a "Stable" outlook on the rating
at December 31, 2004.
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 with a "Positive" outlook. 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 and then
withdrew the rating at our request.
As a result of our proposed transaction with NCRIC, as discussed under
"Recent Transactions", A.M. Best has placed the financial strength rating of
ProAssurance Group under review with negative implications. The negative
implications signal that the ratings could either remain the same or be
downgraded following the completion of the under review process.
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 beyond our
control. However, for those factors within our 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.
In professional liability we compete with insurance companies and
self-insuring entities 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 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. However, 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.
9
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. We have achieved these advantages
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 the
states where we are currently writing insurance.
Beginning in 1999, insurance companies focused on medical professional
liability coverage experienced higher claim costs on business written in prior
years than they had reserved for initially. In many cases this resulted in
significant losses and reduced the capital available to support current and
future business. This led many professional liability carriers focused on
medical professional liability coverages to withdraw from, or limit new business
in, one or more markets.
In 2002 several medical liability insurance companies were forced from
the market due to financial difficulties. The St. Paul Companies, then the
leading writer of medical professional liability insurance withdrew from the
market. In 2003 Farmers Insurance Company exited medical professional liability
insurance and The Reciprocal of America was placed under regulatory supervision.
We believe these events have heightened the sensitivity of our target market to
this issue.
Given this reduction in capacity and the uncertainty surrounding
several writers in the medical professional liability market, we believe there
has been a "flight to quality" as insureds place greater emphasis on financial
strength and stability. We believe this trend will continue through 2005.
However, small competitors, focused on limited pools of risk or geographic
areas, are entering the market in a few areas and as a result we cannot be
certain how long current market conditions will persist.
Our personal lines insurance subsidiary operates in a highly
competitive market and some of our 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.
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.
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 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
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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 or 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 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 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 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.
State insurance holding company acts generally require domestic
insurers to obtain prior approval of extraordinary dividends. Under the
insurance holding company acts governing our principal 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.
11
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. At December 31,
2004, all of 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 that our operating subsidiaries
are in compliance with state investment regulations.
Guaranty Funds
Admitted insurance companies are required to be members of guaranty
associations which administer state Guaranty Funds. 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
State insurance regulations may force us 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.
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.
Several of the states in which we operate, notably Ohio and West
Virginia, have passed Tort Reform, but these laws have yet to materially affect
our business. However, we believe they will be challenged in court and past
history tells us that they may be invalidated in the appeals process. Because we
cannot predict with any certainty how appellate courts will rule on these laws
we do not take them into account in our rate-making assumptions, except in
Florida where such credit is required by law.
Legislatures in other states in which we operate are currently
considering, or being asked to consider Tort Reform, but we cannot predict in
which states those efforts will be successful. In certain states, Tort Reform
may also place limits on the ability of medical liability insurers to raise
12
or maintain rates at adequate levels. We continue to monitor developments on a
state-by-state basis, and make business decisions accordingly.
The professional liability market in Florida is also likely to be
changed by three constitutional amendments that were approved by voters in
November 2004. The first amendment places limits on fees plaintiff attorneys may
collect in medical liability cases and could result in fewer malpractice claims
being filed.
The second amendment would take away the license of any physician who
has three malpractice judgments or adverse findings by a licensing review
organization. We believe this could cause physicians to demand settlements in
malpractice cases which could generate more lawsuits and drive up costs.
The third amendment gives the public greater rights to see previously
confidential state complaints filed against doctors and institutions, incident
reports filed after medical errors, and documents from error reviews done by
hospitals. This could have a detrimental effect on peer review activities.
All three amendments are being challenged in court and are subject to
further legislative interpretation. We are unable to predict how they will
affect our business until we know exactly how and when they will be implemented.
There are also Tort Reform proposals being considered at the Federal
level. This legislation has the backing of the Bush administration and has
repeatedly passed the House of Representatives. The legislation has never been
approved in the Senate and while there are more Republicans now serving in the
Senate, we do not know if there are enough votes to enact these reforms. As in
the states, passage of a federal Tort Reform package would likely be subject to
judicial challenge and we cannot be certain that it would be upheld by the
courts.
In addition, several committees of Congress have made inquiries and
conducted hearings as part of a broad study on 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. 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.
EMPLOYEES
At December 31, 2004, we employed 632 persons. None of our employees
are 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 are identified by
words such as, but not limited to, "believe", "expect", "intend", "anticipate",
"estimate", "project" and other analogous expressions. Forward-looking
statements relating to our business 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 debentures,
payment of dividends, and other matters. In addition, forward-looking statements
may also relate to the proposed merger between ProAssurance and NCRIC Group,
Inc. as well as the goals, plans, objectives, intentions, expectations,
financial condition, results of operations, future performance and business of
the combined company including, without limitation, statements relating to the
benefits of the merger, such as future financial and operating results, cost
savings, enhanced revenues and the accretion to reported earnings that may be
realized from the merger and statements regarding certain
13
of ProAssurance's and/or NCRIC's goals and expectations with respect to
earnings, earnings per share, revenue, expenses and the growth rate in such
items, as well as other measures of economic performance.
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,
- 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.
Risks that could adversely affect our proposed transaction with NCRIC
include but are not limited to the following:
- the business of ProAssurance and NCRIC may not be combined
successfully, or such combination may take longer to accomplish than
expected;
- the cost savings from the merger may not be fully realized or may take
longer to realize than expected;
- operating costs, customer loss and business disruption following the
merger, including adverse effects on relationships with employees, may
be greater than expected;
- governmental approvals of the merger may not be obtained, or adverse
regulatory conditions may be imposed in connection with governmental
approvals of the merger;
- there may be restrictions on our ability to achieve continued growth
through expansion into other states or through acquisitions or
business combinations; and
- the stockholders of NCRIC may fail to approve the merger.
14
GLOSSARY OF SELECTED INSURANCE AND RELATED FINANCIAL TERMS
In an effort to help our investors and other interested parties better
understand our report, we are providing a Glossary of Selected Insurance Terms.
These definitions are taken from recognized industry sources such as A. M. Best
and The Insurance Information Institute. This list is intended to be informative
and explanatory, but we do not represent that it is a comprehensive glossary.
Accident year ...................... The accounting period in which an insured
event becomes a liability of the insurer.
Admitted company; admitted basis ... An insurance company licensed and
authorized to do business in a particular
state. An admitted company doing business
in a state is said to operate on "an
admitted basis" and is subject to all
state insurance laws and regulations
pertaining to its operations. (See:
Non-admitted company)
Adverse selection .................. The tendency of those exposed to a higher
risk to seek more insurance coverage than
those at a lower risk. Insurers react
either by charging higher premiums or not
insuring at all, as in the case of
floods. Adverse selection can be seen as
concentrating risk instead of spreading
it.
Agent .............................. An individual or firm that represents an
insurer under a contractual or employment
agreement for the purpose of selling
insurance. There are two types of agents:
independent agents, who represent one or
more insurance companies but are not
employed by those companies and are paid
on commission, and exclusive or captive
agents, who by contract are required to
represent or favor only one insurance
company and are either salaried or work
on commission. Insurance companies that
use employee or captive agents are called
direct writers. Agents are compensated
by the insurance company whose products
they sell. By definition, with respect to
a given insurer, an agent is not a broker
(See: Brokers)
Alternative markets ................ Mechanisms used to fund self-insurance.
This includes captives, which are
insurers owned by one or more
non-insurers to provide owners with
coverage. Risk-retention groups, formed
by members of similar professions or
businesses to obtain liability insurance,
are also a form of self-insurance.
Assets; admitted; non-admitted ..... Property owned, in this case by an
insurance company, including stocks,
bonds, and real estate. Because insurance
accounting is concerned with solvency and
the ability to pay claims, insurance
regulators require a conservative
valuation of assets, prohibiting
insurance companies from listing assets
on their balance sheets whose values are
uncertain, such as furniture, fixtures,
debit balances, and accounts receivable
that are more than 90 days past due
(these are non-admitted assets). Admitted
assets are those assets that can be
easily sold in the event of
15
liquidation or borrowed against, and
receivables for which payment can be
reasonably anticipated.
Broker ............................. An intermediary between a customer and an
insurance company. Brokers typically
search the market for coverage
appropriate to their clients and they
usually sell commercial, not personal,
insurance. Brokers are compensated by the
insureds on whose behalf they are
working. With respect to a given insurer,
a broker is not an agent. (See: Agent)
Bulk reserves ...................... Reserves for losses that have occurred
but have not been reported as well as
anticipated changes to losses on reported
claims. Bulk reserves 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 and incurred but not
reported claims, including amounts
already paid. (See: Case Reserves)
Capacity ........................... For an individual insurer, the maximum
amount of premium or risk it can
underwrite based on its financial
condition. The adequacy of an insurer's
capital relative to its exposure to loss
is an important measure of solvency.
Capital ............................ Stockholder's equity (for publicly-traded
insurance companies) and policyholders'
surplus (for mutual insurance companies).
Capital adequacy is linked to the
riskiness of an insurer's business. (See:
Risk-Based Capital, Surplus, Solvency)
Case reserves ...................... Reserves for future losses for reported
claims as established by an insurer's
claims department.
Casualty insurance ................. Insurance which is primarily concerned
with the losses caused by injuries to
third persons (in other words, persons
other than the policyholder) and the
legal liability imposed on the insured
resulting therefrom. (See: Professional
liability insurance, Medical professional
liability insurance)
Catastrophe ........................ Term used for statistical recording
purposes to refer to a single incident or
a series of closely related incidents
causing severe insured property losses
totaling more than a given amount.
Catastrophe Reinsurance ............ Reinsurance (insurance for insurers) for
catastrophic losses.
Cede, cedant; ceding company ....... When a party reinsures its liability with
another, it "cedes" business and is
referred to as the "cedant" or "ceding
company."
Claims-made policy; coverage ....... A form of insurance that pays claims
presented to the insurer during the term
of the policy or within a specific term
after its expiration. It limits liability
insurers' exposure to unknown future
liabilities. Under a claims-made policy,
an insured event becomes a liability when
the event is first reported to the
insurer.
16
Combined ratio ..................... The sum of the underwriting expense ratio
and net loss ratio, determined in
accordance with either statutory
accounting principles (SAP) or GAAP.
Commission ......................... Fee paid to an agent or insurance
salesperson as a percentage of the policy
premium. The percentage varies widely
depending on coverage, the insurer, and
the marketing methods.
Direct premiums written ............ Premiums charged by an insurer for the
policies that it underwrites, excluding
any premiums that it receives as a
reinsurer.
Direct writer(s) ................... Insurance companies that sell directly to
the public using exclusive agents or
their own employees.
Domestic insurance company ......... Term used by a state to refer to any
company incorporated there.
Excess & Surplus Lines;
Surplus lines ...................... Property/casualty insurance coverage that
isn't generally available from insurers
licensed in the state (See: Admitted
companies) and must be purchased from a
"non-admitted company". Examples include
risks of an unusual nature that require
greater flexibility in policy terms and
conditions than exist in standard forms
or where the highest rates allowed by
state regulators are considered
inadequate by admitted companies. Laws
governing surplus lines vary by state.
Excess coverage; excess limits ..... An insurance policy that provides
coverage limits above another policy with
similar coverage terms, or above a
self-insured amount.
Extended Reporting Endorsement...... Also known as a "tail policy" or "tail
premium." Tail coverage provides
protection for future claims filed after
a claims-made policy has lapsed.
Typically requires payment of an
additional premium, the "tail premium."
"Tail coverage" may also be granted if
the insured becomes disabled, dies or
permanently retired from the covered
occupation (i.e., the practice of
medicine in medical liability policies.)
Facultative reinsurance ............ A generic term describing reinsurance
where the reinsurer assumes all or a
portion of a single risk. Each risk is
separately evaluated and each contract is
separately negotiated by the reinsurer.
Frequency .......................... Number of times a loss occurs per unit of
risk or exposure. One of the criteria
used in calculating premium rates.
Front, fronting .................... A procedure in which a primary insurer
acts as the insurer of record by issuing
a policy, but then passes all or
virtually all of the risk to a reinsurer
in exchange for a commission. Often, the
fronting insurer is licensed to do
business in a state or country where the
risk is located, but the reinsurer is
not. The reinsurer in this scenario is
often a captive or an independent
insurance company that cannot sell
insurance directly in a particular
country.
17
Gross premiums written ............. Total premiums for direct insurance
written and assumed reinsurance during a
given period. The sum of direct and
assumed premiums written.
Guaranty Fund; assessment(s) ....... The mechanism by which solvent insurers
ensure that some of the policyholder and
third party claims against insurance
companies that fail are paid. Such funds
are required in all 50 states, the
District of Columbia and Puerto Rico, but
the type and amount of claim covered by
the fund varies from state to state.
Homeowners insurance ............... The typical homeowners insurance policy
covers the house, the garage and other
structures on the property, as well as
personal possessions inside the house
such as furniture, appliances and
clothing, against a wide variety of
perils including windstorms, fire and
theft. The extent of the perils covered
depends on the type of policy. An
all-risk policy offers the broadest
coverage. This covers all perils except
those specifically excluded in the policy.
Incurred but not reported (IBNR) ... Actuarially estimated reserves for
estimated losses that have been incurred
by insureds and reinsureds but not yet
reported to the insurer or reinsurer
including unknown future developments on
losses which are known to the insurer or
reinsurer. Insurance companies regularly
adjust reserves for such losses as new
information becomes available.
Incurred losses .................... Losses covered by the insurer within a
fixed period, whether or not adjusted or
paid during the same period, plus changes
in the estimated value of losses from
prior periods.
Insolvent; insolvency .............. Insurer's inability to pay debts.
Typically the first sign of problems is
inability to pass the financial tests
regulators administer as a routine
procedure. (See: Risk-based capital)
Investment income .................. Income generated by the investment of
assets. Insurers have two sources of
income, underwriting (premiums less
claims and expenses) and investment
income.
Liability insurance ................ A line of casualty insurance for amounts
a policyholder is legally obligated to
pay because of bodily injury or property
damage caused to another person. (See:
Casualty insurance, Professional
liability insurance, Medical professional
liability insurance)
Limits ............................. Maximum amount of insurance that can be
paid for a covered loss.
Long-tail; short-tail .............. The long period of time between
collecting the premium for insuring a
risk and the ultimate payment of losses.
This allows insurance companies to invest
the premiums until losses are paid, thus
producing a higher level of invested
assets and investment income as compared
to other lines of property and casualty
business. Medical professional liability
is considered a
18
long tail line of insurance. Personal
lines is primarily considered a short
tail line of insurance 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. (See:
Medical professional liability,
Professional liability)
Loss adjustment expenses (LAE) ..... The expenses of settling claims,
including legal and other fees and the
portion of general expenses allocated to
claim settlement costs.
Loss costs ......................... The portion of an insurance rate used to
cover claims and the costs of adjusting
claims. Insurance companies typically
determine their rates by estimating their
future loss costs and adding a provision
for expenses, profit, and contingencies.
Loss ratio ......................... Percentage of each premium dollar an
insurer spends on claims.
Loss reserves ...................... Liabilities established by insurers and
reinsurers to reflect the estimated cost
of claims payments and the related
expenses that the insurer or reinsurer
will ultimately be required to pay in
respect of insurance or reinsurance it
has written. They represent a liability
on the insurer's balance sheet.
Medical professional
liability insurance ................ Insurance against the legal liability of
an insured (and against loss, damage or
expense incidental to a claim of such
liability) arising out of death, injury
or disablement of a person as the result
of negligent deviation from the standard
of care or other misconduct in rendering
professional service.
NAIC ............................... The National Association of Insurance
Commissioners is the organization of
insurance regulators from the 50 states,
the District of Columbia and the four
U.S. territories. The NAIC provides a
forum for the development of uniform
policy when uniformity is appropriate.
Net loss ratio ..................... The net loss ratio measures the ratio of
net losses to earned premiums determined
in accordance with SAP or GAAP.
Net premium earned ................. The portion of net premium written that
is recognized for accounting purposes as
income during a particular period. Equal
to net premiums written plus the change
in net unearned premiums during the
period.
Net premiums written ............... Gross premiums written for a given period
less premiums ceded to reinsurers during
such period.
Non-admitted company; basis ........ Insurers licensed in some states, but not
others. States where an insurer is not
licensed call that insurer
"non-admitted." Non-admitted companies
sell coverage that is unavailable from
licensed insurers within a state and are
generally exempt from most state laws and
regulations related to rates and
19
coverages. Policyholders of such
companies generally do not have the same
degree of consumer protection and
financial recourse as policyholders of
admitted companies. Non-admitted
companies are said to operate on a
"non-admitted" basis.
Occurrence policy; coverage......... Insurance that pays claims arising out of
incidents that occur during the policy
term, even if they are filed many years
later. Under an occurrence policy the
insured event becomes a liability when
the event takes place.
Operating ratio .................... The operating ratio is the combined
ratio, less the ratio of investment
income (exclusive of realized gains and
losses) to net earned premiums, if
determined in accordance with GAAP. While
the combined ratio strictly measures
underwriting profitability, the operating
ratio incorporates the effect of
investment income.
Personal lines insurance ........... Property and casualty insurance written
for an individual and on the personal and
real property of an individual such as
homeowners insurance and personal
automobile insurance.
Policy ............................. A written contract for insurance between
an insurance company and policyholder
stating details of coverage.
Premium ............................ The price of an insurance policy,
typically charged annually or
semiannually.
Premiums written ................... The total premiums on all policies
written by an insurer during a specified
period of time, regardless of what
portions have been earned.
Premium tax ........................ A state tax on premiums for policies
issued in the state, paid by insurers.
Primary Company .................... In a reinsurance transaction, the
insurance company that is reinsured.
Professional liability insurance ... Covers professionals for negligence and
errors or omissions that cause injury or
economic loss to their clients. (See:
Casualty insurance, Liability insurance,
Medical professional liability insurance)
Property/casualty insurance ........ Covers damage to or loss of
policyholders' property and legal
liability for damages caused to other
people or their property.
Rate ............................... The cost of insurance for a specific unit
of exposure, such as for one physician.
Rates are based on historical loss
experience for similar risks and may be
regulated by state insurance offices.
Rating agencies .................... These agencies assess insurers' financial
strength and viability to meet
claims obligations. Some of the factors
considered include company earnings,
capital adequacy, operating leverage,
liquidity, investment performance,
reinsurance programs, and management
ability, integrity and experience. A high
financial rating is not the same as a
high consumer satisfaction rating.
20
Reinsurance ........................ Insurance bought by insurance companies.
In a reinsurance contract the reinsurer
agrees to indemnify another insurance or
reinsurance company, the ceding company,
against all or a portion of the insurance
or reinsurance risks underwritten by the
ceding company under one or more policies.
Reinsurers may have their own reinsurers,
called retrocessionaires. Reinsurers don't
pay policyholder claims. Instead, they
reimburse insurers for claims paid.
Reinsured layer; retained layer ... The retained layer is the cumulative
portion of each loss, on a per-claim
basis, which is less than an insurer's
reinsurance retention for a given coverage
year. Likewise, the reinsured layer is the
cumulative portion of each loss that
exceeds the reinsurance retention. (See:
Reinsurance, Retention)
Reserves .......................... A company's best estimate of what it will
pay, at some point in the future, for
claims for which it is currently
responsible.
Retention ......................... The amount or portion of risk that an
insurer retains for its own account.
Losses in excess of the retention level up
to the outer limit, if any, are paid by
the reinsurer. In proportional treaties,
the retention may be a percentage of the
original policy's limit. In excess of loss
business, the retention is a dollar amount
of loss, a loss ratio or a percentage.
Risk-Based Capital (RBC) .......... A regulatory measure of the amount of
capital required for an insurance company,
based upon the volume and inherent
riskiness of the insurance sold, the
composition of its investment portfolio
and other financial risk factors.
Higher-risk types of insurance, liability
as opposed to property business, generally
necessitate higher levels of capital. 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. (See: NAIC)
Risk management ................... Management of the varied risks to which a
business firm or association might be
subject. It includes analyzing all
exposures to gauge the likelihood of loss
and choosing options to better manage or
minimize loss. These options typically
include reducing and eliminating the risk
with safety measures, buying insurance,
and self-insurance.
Self-insurance .................... The concept of assuming a financial risk
oneself, instead of paying an insurance
company to take it on. Every policyholder
is a self-insurer in terms of paying a
deductible and co-payments. Larger
policyholders often self-insure frequent
or predictable losses to avoid insurance
overhead expenses.
Severity .......................... The average claim cost, statistically
determined by dividing dollars of losses
by the number of claims.
21
Solvent, solvency ................. Insurance companies' ability to pay the
claims of policyholders. Regulations to
promote solvency include minimum capital
and surplus requirements, statutory
accounting conventions, limits to
insurance company investment and corporate
activities, financial ratio tests, and
financial data disclosure.
Statutory Accounting Principles;
SAP ............................ More conservative standards than under
GAAP accounting rules, they are imposed by
state laws that emphasize the present
solvency of insurance companies. SAP helps
ensure that the company will have
sufficient funds readily available to meet
all anticipated insurance obligations by
recognizing liabilities earlier or at a
higher value than GAAP and assets later or
at a lower value. For example, SAP
requires that selling expenses be recorded
immediately rather than amortized over the
life of the policy. (See: Generally
Accepted Accounting Principles, Admitted
assets)
Surplus; statutory surplus ........ The excess of admitted assets over total
liabilities (including loss reserves) that
protects policyholders in case of
unexpectedly high claims. "Statutory
Surplus" is determined in accordance with
Statutory Accounting Principles.
Tail .............................. The period of time that elapses between
the occurrence of the loss event and the
payment in respect thereof.
Third-party coverage .............. Liability coverage purchased by the
policyholder as a protection against
possible lawsuits filed by a third party.
The insured and the insurer are the first
and second parties to the insurance
contract.
Treaty reinsurance ................ The reinsurance of a specified type or
category of risks defined in a reinsurance
agreement (a "treaty") between a primary
insurer or other reinsured and a
reinsurer. Typically, in treaty
reinsurance, the primary insurer or
reinsured is obligated to offer and the
reinsurer is obligated to accept a
specified portion of all such type or
category of risks originally written by
the primary insurer or reinsured.
Umbrella coverage ................. Insurance protection for all classes of
business, including automobile, fire,
general liability, homeowners, multiple
peril, burglary, and glass, combining the
coverages for these classes of business
into one insurance contract. Typically
provides coverage limits in excess of
other insurance policies.
Underwriting ...................... The insurer's or reinsurer's process of
reviewing applications submitted for
insurance coverage, deciding whether to
accept all or part of the coverage
requested and determining the applicable
premiums.
Underwriting expense ratio ........ The ratio of underwriting, acquisition and
other insurance expenses incurred to net
premiums earned (for statutory purposes,
the ratio of underwriting expenses
incurred to net premiums written.)
22
Underwriting expenses ............. The aggregate of policy acquisition costs,
including commissions, and the portion of
administrative, general and other expenses
attributable to underwriting operations.
Underwriting income; loss ......... The insurer's profit on the insurance sale
after all expenses and losses have been
paid, before investment income or income
taxes. When premiums aren't sufficient to
cover claims and expenses, the result is
an "underwriting loss."
Underwriting profit ............... The amount by which net earned premiums
exceed Underwriting Income; the sum of
losses, loss adjustment expenses and
underwriting expenses (See: Underwriting
Income)
Unearned premium .................. The portion of premium that represents the
consideration for the assumption of risk
in the future. Such premium is not yet
earned since the risk has not yet been
assumed. May also be defined as the
pro-rata portion of written premiums that
would be returned to policyholders if all
policies were terminated by the insurer on
a given date.
23
ITEM 2. PROPERTIES
We own a 156,000 square foot office building located in Birmingham,
Alabama where we currently occupy approximately 78,000 square feet. 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 corporate offices in Auburn Hills, Michigan. In 2005 MEEMIC plans to begin
construction of new corporate offices on an 11.5-acre vacant parcel of land
currently owned in Auburn Hills, Michigan. We lease other office facilities in
various locations and lease computer and operating equipment under cancelable
and non-cancelable agreements.
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.
See Note 8 to our Consolidated Financial Statements included herein.
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.
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 (Age 68) 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 (Age 57) 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 22 years.
Here are the other executive officers of ProAssurance and a brief
description of their principal occupation and employment during the last five
years.
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. (Age 64)
24
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 46)
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 56)
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 51)
EDWARD L. RAND Mr. Rand was appointed as our Senior Vice President of
Finance in November 2004. Prior to joining ProAssurance Mr.
Rand was the Chief Accounting Officer and Head of Corporate
Finance for PartnerRe Ltd. Prior to that time Mr. Rand
served as the Chief Financial Officer of Atlantic American
Corporation. (Age 38)
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 53)
ProAssurance has adopted a code of ethics that applies to its directors and
executive officers, including its principal executive officers, principal
financial officer, and principal accounting officer. See Item 1 for information
regarding the availability of the Code of Ethics.
25
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
At March 2, 2005, ProAssurance Corporation (PRA) had 3,535 stockholders
of record and 29,205,007 shares of common stock outstanding. ProAssurance's
common stock currently trades on The New York Stock Exchange (NYSE) under the
symbol "PRA".
2004 2003
--------------- ---------------
Quarter HIGH LOW High Low
- ------- ------ ------ ------ ------
First $35.00 $30.33 $23.92 $20.69
Second 37.42 32.83 30.50 23.40
Third 35.20 30.20 28.90 24.50
Fourth 40.57 33.48 32.97 26.86
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 11 of this 10-K.
26
ITEM 6. SELECTED FINANCIAL DATA
Year ended December 31
---------------------------------------------------------------
SELECTED FINANCIAL DATA (1) 2004 2003 2002 2001 2000
- --------------------------- ---------- ----------- ---------- ---------- ----------
(In thousands except per share data)
Gross premiums written $ 789,660 $ 740,110 $ 636,156 $ 388,983 $ 223,871
Net premiums written 717,059 668,909 537,123 310,291 194,279
Premiums earned 765,643 698,347 576,414 381,510 216,297
Premiums ceded (69,623) (74,833) (99,006) (68,165) (38,701)
Net premiums earned 696,020 623,514 477,408 313,345 177,596
Net investment income 87,225 73,619 76,918 59,782 41,450
Net realized investment gains (losses) 7,609 5,992 (5,306) 5,441 913
Other income 3,699 6,515 6,747 3,987 2,630
Total revenues 794,553 709,640 555,767 382,555 222,589
Net losses and loss adjustment expenses 572,881 551,376 448,029 298,558 155,710
Income before cumulative effect
of accounting change 72,811 38,703 10,513 12,450 24,300
Net income (2) 72,811 38,703 12,207 12,450 24,300
Income per share before cumulative
effect of accounting change (3)
Basic $ 2.50 $ 1.34 $ 0.40 $ 0.51 $ 1.04
Diluted $ 2.37 $ 1.32 $ 0.39 $ 0.51 $ 1.04
Net income per share: (2) (3)
Basic $ 2.50 $ 1.34 $ 0.47 $ 0.51 $ 1.04
Diluted $ 2.37 $ 1.32 $ 0.46 $ 0.51 $ 1.04
Weighted average number of
shares outstanding: (3)
Basic 29,164 28,956 26,231 24,263 23,291
Diluted 31,984 30,389 26,254 24,267 23,291
BALANCE SHEET DATA (as of December 31)
Total investments $2,455,053 $2,055,672 $1,679,497 $1,521,279 $ 796,526
Total assets 3,239,198 2,879,352 2,586,650 2,238,325 1,122,836
Reserve for losses and loss
adjustment expenses 2,029,592 1,814,584 1,622,468 1,442,341 659,659
Long-term debt 151,480 104,789 72,500 82,500 -
Total liabilities 2,628,179 2,333,047 2,055,086 1,802,606 777,669
Total capital 611,019 546,305 505,194 413,231 345,167
Total capital per share of common
stock outstanding $ 20.92 $ 18.77 $ 17.49 $ 16.02 $ 15.22
Common stock outstanding at
end of year 29,204 29,105 28,877 25,789 22,682
(1) Includes Professionals Group since the date of consolidation, June 27,
2001.
(2) 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 13 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.
(3) Diluted net income per share for 2003 has been restated to reflect
implementation of Emerging Issues Task Force 04-8, "The Effect of
Contingently Convertible Debt on Diluted Earnings per Share". The
restatement reduced previously reported diluted net income per share by
$0.01.
27
ITEM 7. 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 in the United States of America
(GAAP). 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 affected by the need to make accounting
adjustments reflecting changes in these estimates and assumptions. Management
considers an accounting policy to be critical if it involves significant
judgment by management and if the effect of those judgments could result in a
material effect on the financial statements.
We believe the following critical accounting 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 the investigation and
settlement of claims. These estimates consist of case reserves and bulk
reserves. 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. Our reserve estimates may vary significantly from
the eventual outcome. The assumptions used in establishing our reserves are
regularly reviewed and updated by management as new data becomes available. Any
adjustments necessary are reflected in then current operations. Due to the size
of our reserves, even a small percentage adjustment to these estimates could
have a material effect on our results of operations for the period in which the
adjustment 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 payable to reinsurers
are regularly reviewed and updated by management as new data becomes available.
Our assessment of the collectibility of the
28
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 adjustment is
made. At December 31, 2004, we considered all of our receivables 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. Both available-for-sale and trading portfolio securities are carried
at fair value. Positive and negative changes in the market value (unrealized
gains and losses) of available-for-sale securities are included, net of the
related tax effect, in accumulated comprehensive income, a component of
stockholders' equity, and are excluded from current period net income. Positive
and negative changes in the market value of trading portfolio securities are
included in current period net income as a component of net realized investment
gains (losses).
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
issuer's 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.
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 income statement 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.
Deferred Policy Acquisition Costs
Policy acquisition costs, primarily commissions, premium taxes and
underwriting salaries, vary directly with, and are primarily related to, the
acquisition of new and renewal premiums. Such costs are capitalized and charged
to expense as the related premium revenue is recognized. We evaluate the
recoverability of our deferred policy acquisition costs based on our estimates
of the profitability of the underlying business and any amounts estimated to be
unrecoverable are charged to expense in the current period.
Goodwill
In accordance with Statement of Financial Accounting Standards No. 142
"Goodwill and Other Intangible Assets" we make an annual assessment by reporting
unit as to whether the value of our goodwill assets is impaired. We completed
such assessments in 2004 and 2003 and concluded that the value of our goodwill
assets of approximately $23.7 million was not impaired. We use both market-based
valuation models and a capital assets pricing model to estimate the fair value
of each reporting unit. These models require the use of numerous assumptions
regarding market perceptions of value as related to our consolidated and
reporting unit historical and projected operating results and those of other
economically similar entities. Changes to these assumptions could signif