We understand...
We understand...
P R O A S S U R A N C E 2 0 0 2 A N N U A L R E P O R T
We understand...
Financial Highlights
In thousands
Fiscal Year Ended December 31
Total investments
Total assets
Reserve for losses and
loss adjustment expenses
Long-term debt
Total liabilities
2002
2001
$1,679,497
$1,521,279
2,586,650
2,238,325
1,622,468
1,442,341
72,500
82,500
2,055,086
1,802,606
P R O A S S U R A N C E 2 0 0 2 A N N U A L R E P O R T
...our priorities. At ProAssurance, our customers are the
focal point of everything we do. Our dedication to
long-term financial strength and security and our com-
mitment to customer service drives our business every
day. By keeping our unwavering promise of protection and
service, we do more than exceed our customers’ expecta-
tions—we achieve the results our shareholders expect.
...our future. Our future is determined by the decisions
we make today. The unmatched experience of our man-
agement team and employees gives us a unique insight
into the markets we serve. Our expertise is our edge, and
as we grow and expand in 2003, we’re confident our
knowledge will guide us toward a secure future.
We understand...
AT PROASSURANCE, FOR MORE THAN 25 YEARS WE’VE BEEN LEADERS IN DEVELOPING INSURANCE
SOLUTIONS FOR THE PROFESSIONALS WE SERVE. OUR EXPERIENCE GIVES US AN UNPARALLELED
INSIGHT INTO OUR CUSTOMERS’ NEEDS, THE UNIQUE DEMANDS OF EACH MARKET WE SERVE AND THE
RESPONSIBILITY WE HAVE TO OUR INSUREDS, OUR SHAREHOLDERS AND OUR EMPLOYEES.
WHETHER IT’S PROFESSIONAL LIABILITY FOR HEALTHCARE PROFESSIONALS, OR PERSONAL LINES
INSURANCE FOR EDUCATORS AND THEIR FAMILIES, WE UNDERSTAND EACH INSURED DEPENDS ON US
TO PROVIDE INSURANCE PROTECTION AND TO KEEP THE FINANCIAL PROMISES WE MAKE.
2
We Understand... ProAssurance 2002
Our Customers
insureds’ desire to protect their reputation
ProAssurance offers our insureds the benefits
when wrongfully accused of negligence, and
of more than twenty-five years of insight and
we strive to reach fair, equitable settlements
experience. As industry leaders, we combine
in those cases where negligence is a factor.
our breadth of experience with a deep knowl-
Our willingness to defend our insureds sets
edge of the evolving insurance needs of the
us apart and wins us unprecedented loyalty
health care environment. We provide a secure
from those we protect.
package of protection tailored to our cus-
But ProAssurance means much more than
tomers’ needs.
a promise of courtroom protection. As an
The practice of medicine is a unique and
example, our suite of risk management pro-
specialized endeavor. We understand that
grams ranges from in-depth seminars, to on-
our insureds expect a level of service that is
site evaluations, to CD-ROM material, to
delivered with an equal attention to care and
frequent newsletters. We provide each
detail. Our high level of policy renewal, and
insured with access to specific tools to help
our ongoing association with professional
them improve patient care and outcomes
societies, is evidence that we are delivering
while reducing the risk of a lawsuit.
on the promise we make to provide fast,
Our Advisory Boards and Committees
responsive service.
meet with us regularly to ensure that we are
Among the services most valued by our
kept abreast of changing patterns of practice
insureds is our approach to the defense of mal-
and evolving legal theories at the local level,
practice claims—we believe it remains the
so that we can remain responsive to our cus-
industry’s most aggressive. ProAssurance’s
tomers’ needs. In short, we understand our
subsidiaries tried the equivalent of one case
customers because we are involved with
per day in 2002. We understand our
them every day.
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PROASSURANCE:
A REGIONAL FOCUS WITH NATIONAL SCALE.
Our customers are located in the 18 blue states.
3
We understand...
Our Markets
customize our risk management efforts so that
Our history represents the combination of ten pol-
we can further reduce risk among our insureds.
icyholder-founded and policyholder-focused pro-
This ability to utilize the knowledge we have
fessional liability insurance companies. In many
obtained over the past three decades enhances
cases, the employees who joined us in those com-
our companies’ value to our insureds and has
binations were among the organizations’ original
helped us become the largest insurer in the states
employees—and they are still with us today.
in which we do business.
They provide us with an unequalled depth of
knowledge that allows us to respond quickly and
Our Responsibility
effectively to our customers’ needs, especially in
Underlying all we do is the ultimate truth that an
the defense of claims. With our dedication to the
insurance policy is only worth as much as the com-
defense of non-meritorious claims, a broad
pany standing behind it. ProAssurance’s track
knowledge of local claims environments is of
record of financial strength and security gives each
vital importance. We understand that each state,
of our insureds the confidence that we are manag-
and in many cases, regions within states, repre-
ing for the long term, planning to be here when
sents different claims environments, making our
they need us—no matter when they need us.
local approach to claims management an even
We manage our business to meet long-term
greater contributor to our ultimate success.
goals rather than short-term financial yardsticks.
Our local claims knowledge also feeds our
By managing for the long term, we maintain a
underwriting decision making, allowing us to
strong balance and best serve our customers’
more effectively screen risks and create policies
needs. This customer focus in turn, allows us to
and procedures to address emerging legal trends.
be the most successful company in our niche and
We are also able to leverage this knowledge to
build value for our shareholders.
professional liability
4
We Understand... ProAssurance 2002
THE VALUE OF MEEMIC
MEEMIC INSURANCE COMPANY BEGAN WITH A SIMPLE IDEA MANY DECADES AGO.
MICHIGAN TEACHERS BELIEVED THE EDUCATION PROFESSION NEEDED AN INSURANCE
COMPANY DEDICATED TO MEETING THEIR SPECIFIC NEEDS. FROM THAT BEGINNING,
MEEMIC INSURANCE COMPANY TOOK ROOT AND BEGAN TO GROW BY SAFEGUARDING THE
FAMILIES OF PROFESSIONALS WHO WORK TIRELESSLY IN CLASSROOMS ACROSS MICHIGAN.
TEACHER BY TEACHER, FAMILY BY FAMILY, MEEMIC INSURANCE COMPANY HAS EARNED A
REPUTATION FOR SERVICE, ACCESSIBILITY AND RELIABILITY.
SINCE MEEMIC’S FOUNDING, WE HAVE OFFERED HIGH QUALITY INSURANCE PRODUCTS,
BEGINNING WITH AUTOMOBILE COVERAGE AND BROADENING TO INCLUDE HOMEOWNERS,
BOAT AND PERSONAL UMBRELLA COVERAGES. OUR INSURANCE PRODUCTS REFLECT THE
SPECIALIZED REQUIREMENTS OF TODAY’S CUSTOMERS; AND, MEEMIC’S STABILITY IS
NOW ENHANCED AS A PART OF PROASSURANCE.
MEEMIC’S LONG-TERM FOCUS ON THE INSURANCE NEEDS OF EDUCATORS. OUR REP-
UTATION FOR INTEGRITY BUILDS THE CONFIDENCE OF OUR POLICYHOLDERS AND IS THE
FOUNDATION FOR CONTINUED GROWTH. MEEMIC PROUDLY REFLECTS OUR ROOTS IN
THE EDUCATIONAL COMMUNITY, AND IS COMMITTED TO GROWING WITH AND SERVICING
THE EVER-CHANGING NEEDS OF THIS IMPORTANT PROFESSION.
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5
L e t t e r t o S h a r e h o l d e r s
A. Derrill Crowe, M.D.
Chairman of the Board and CEO
IN OUR REPORT THIS YEAR, WE HIGHLIGHT THE SUCCESS WE’VE ACHIEVED BY CAPITALIZ-
ING ON THE CORE STRENGTHS OF OUR COMPANY—OUR UNDERSTANDING OF THE UNIQUE
NEEDS OF THE MARKETS WE SERVE AND OUR SOLID BASE OF FINANCIAL STRENGTH.
In 2002, we used these strengths to improve our
business and our return for shareholders, and we
believe we will continue to make progress in 2003.
A key component of our strength is the experi-
ence—an average of 23 years in the industry—of
our senior management team. Our ability to
understand the larger picture and see the need for
long-range goals helps us steer clear of the pitfalls
that befall less experienced or more short-sighted
competitors. We lead a team of equally experi-
enced employees, many of whom trace their roots
in our industry back two decades or more. Their
presence ensures that we understand our markets
and our customers—and our responsibilities to
them—like no one else.
Like you, we are investors in ProAssurance, and
are dedicated to the prudent stewardship of our
capital resources. The past year, and the first few
months of 2003, provide vivid examples of the pain
and problems that arise when insurers do not pro-
tect their balance sheets. We intend to preserve our
financial strength so that we are able to keep the
promises we make to our insureds. Further, by
operating from a position of financial strength, we
are best able to obtain additional capital, as we did
in 2002, to take advantage of the many growth
opportunities that are presented to us.
We continue to evaluate our need for, and use
of, capital and we may elect to raise additional
funds in the months ahead. Whatever our deci-
sion, you can be sure that we will act with the
best interests of our insureds and our sharehold-
ers in mind.
In our Professional Liability Segment, we are
carefully balancing the need for capital to support
growth. We are most confident in our ability to
grow in states where we already have a market
presence. In those states, we believe that over
$600 million of premiums has been displaced
from medical liability insurers that have failed or
retrenched. Other carriers have been downgraded
by the financial rating agencies and are losing
business as a result.
In light of these opportunities, we are making
capacity available for cautiously-underwritten
new business. At the same time, we are collecting
generally higher premiums on existing policies;
premiums increased 28% on average in 2002. We
believe premiums will continue to rise in 2003,
albeit at a slightly lower overall pace.
As rates have risen, so has the tenor of the debate
over Tort Reform. Several states have recently enact-
ed Tort Reforms to bring fairness to the medical/legal
environment. We have been, and will continue to be,
6
Letter to Shareholders
ProAssurance 2002
active in support of Tort Reform. However, we must caution that just as premiums rose over time
in response to increased losses, it will take time, and successful appellate court review, before Tort
Reforms can affect the loss data, and therefore premiums.
A state’s medical/legal environment is a key component in our deliberation over the use of
capital for expansion. As an example, we have expanded into Arkansas and Virginia to fill the
void left by carriers that have withdrawn from the market by choice or have been taken out of
the market by government action. Both states have legal climates we judge to be fair, and
Arkansas recently enacted new Tort Reform. We intend to limit ourselves to those states that
make sense from a geographic and competitive standpoint, and where the legal and regulatory
environments are not hostile.
Our ability to succeed where other medical liability companies have failed makes our med-
ical liability insurance subsidiaries, The Medical Assurance Company, Inc., ProNational
Insurance Company, Medical Assurance of West Virginia, Inc., and Red Mountain Casualty
Insurance Company, Inc., beacons for insureds who seek high quality insurance they can count
on, now and in the future.
Our Personal Lines Segment, which is MEEMIC Insurance Company, continues to be a
shining example of the success that can be achieved through selective underwriting in a preferred
market. On top of excellent execution of our business plan at MEEMIC, we had the benefit of
good weather in 2002. It was, to turn a phrase, nearly the perfect absence of a storm, and allowed
MEEMIC to continue to make an exceptional contribution to the bottom line of ProAssurance.
We have recently completed the purchase of those shares not held by ProAssurance, using
MEEMIC’s internal capital. We can report to you that MEEMIC is now a wholly-owned sub-
sidiary and ProAssurance will benefit from 100% of MEEMIC’s earnings going forward.
Given the stellar performance of MEEMIC and the resurgence of our professional liabili-
ty companies, we believe we can improve our results in 2003. For the long term, we are tar-
geting a Return on Equity of between 12% and 14%.
We also believe that premium increases, taken to balance rising loss costs, will continue to
support adequate reserves and strengthen our balance sheet. We believe a strong balance sheet is
the necessary foundation that will allow us to achieve considerable improvement in our overall
combined ratio in 2003. This will take us a long way to achieving our ultimate goals of prof-
itability and stability.
In closing, we urge your close attention to the in-depth discussion of our business and our
outlook presented in the following pages. We work each day throughout the year to reach goals
and meet the milestones, and we are proud of our team’s results during 2002. Our thanks goes
out to each of our employees, as well as to those insureds who serve on various advisory boards
and committees, for their hard work. And finally, our thanks to you, for the confidence you have
shown by investing with us in ProAssurance.
For the Board and Employees of ProAssurance,
TOTAL ASSETS
2002 $2,586,650
2001 $2,238,325
1998 $1,132,239
2000 $1,122,836
1999 $1,117,668
BOOK VALUE PER SHARE
2002 $17.49
2001 $16.02
2000 $15.22
1999 $13.92
1998 $13.24
A. Derrill Crowe, M.D.
Chairman of the Board and CEO
7
ProAssurance 2002 board of directors
DIRECTORS
SENIOR OFFICERS
A. Derrill Crowe, M.D. ●
Chairman, Chief Executive Officer
Victor T. Adamo, Esq., CPCU ●
Vice-Chairman, President,
Chief Operating Officer
Lucian Bloodworth ■
Chairman, Jay Electric Company
Paul R. Butrus ●
Vice-Chairman
Robert E. Flowers, M.D. ● ★
Retired Physician
Leon C. Hamrick, M.D. ■ ★ ▲
Physician
John J. McMahon, Jr. ★
Chairman, Ligon Industries
John P. North, Jr., CPA ■ ▲
Retired Accounting Firm Partner
John O. Bashant, CPCU
Chief Operating Officer, Northern Division
Senior Vice-President, Underwriting
Professional Liability Group
Jeffrey L. Bowlby, ARM
Senior Vice-President, Marketing & Sales
Professional Liability Group
Robert D. Francis
Senior Vice-President
Managing Director
Red Mountain Casualty Insurance Company, Inc.
Howard H. Friedman, ACAS, MAAA
Chief Financial Officer & Secretary
Senior Vice-President
ProAssurance Corporation
Lynn M. Kalinowski
President
MEEMIC Insurance Company
James J. Morello, CPA
Chief Accounting Officer
Treasurer & Senior Vice-President
ProAssurance Corporation
Ann F. Putallaz, Ph.D. ■
Vice President, Munder Capital Management
William H. Woodhams, M.D. ▲
Physician
Frank B. O’Neil
Investor Relations Officer
Senior Vice-President, Corporate Communications
ProAssurance Corporation
William P. Sabados
Chief Information Officer
Senior Vice-President
ProAssurance Corporation
Christine C. Schmitt, CPA
Chief Financial Officer & Treasurer
MEEMIC Insurance Company
Darryl K. Thomas, Esq.
Senior Vice-President, Claims
Professional Liability Group
Audit Committee: ■ Compensation Committee: ★
Nominating Committee: ▲ Executive Committee: ●
8
Washington, D.C. 20549
FORM 10-K / A
Amendment #1
(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, 2002, 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
(State of incorporation
or organization)
63-1261433
(I.R.S. Employer Identification No.)
100 Brookwood Place, Birmingham, AL 35209
(Zip Code)
(Address of principal executive offices)
(205) 877-4400
(Registrant’s Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Name of Each Exchange
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. [ ]
The aggregate market value of voting stock held by non-affiliates of the registrant at March 19, 2003 was
$672,619,509.
As of March 19, 2003, the registrant had outstanding approximately 28,880,185 shares of its common
stock.
Exhibit Index at page 104
Page 1 of 106 pages
Documents incorporated by reference in this Form 10-K:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
(viii)
(ix)
(x)
(xi)
(xii)
The definitive proxy statement for the 2003 Annual Meeting of the Stockholders of ProAssurance
Corporation (Commission File No. 001-16533) is incorporated by reference into Part III of this
report.
The Registration Statement on Form S-4 with respect to the Common Stock of ProAssurance
Corporation (Commission File No. 333-49378) is incorporated by reference into Part IV of this
report.
The ProAssurance Corporation Form 8-K/A for event occurring May 10, 2001 (Commission File No.
001-12129) is incorporated by reference into Part IV of this report.
Registration Statement on Form S-4 with respect to the Common Stock of MAIC Holdings, Inc.
(Commission File No. 33-91508) is incorporated by reference into Part IV of this report.
The MAIC Holdings, Inc. Definitive Proxy Statement for the 1996 Annual Meeting (Commission File
No. 0-19439) is incorporated by reference into Part IV of this report.
The Registration Statement on Form S-4 with respect to the Common Stock of Professionals
Group, Inc. (Commission File No. 333-3138) is incorporated by reference into Part IV of this report.
The Registration Statement on Form S-4 with respect to the Common Stock of MEEMIC Holdings,
Inc. (Commission File No. 333-66671) is incorporated by reference into Part IV of this report.
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.
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.
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.
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.
The Registration Statement on Form S-3 with respect to the Common Stock of ProAssurance
Corporation (Commission File No. 333-100526) is incorporated by reference into Part IV of this
report.
This Form 10K/A has been filed to add the consent of Ernst & Young LLP with respect to the
incorporation by reference of its report included herein into the ProAssurance Form S-8
registration statements and to correct certain clerical and/or typographical errors, including a
correction of a typographical error related to the pro forma per share effect of FAS 123 and a
clerical correction to the detailed information presented in Item 1 and Item 8 related to our
December 31, 2002 fixed maturity investments. The nature of the corrections to the detailed fixed
maturity security information is to reclassify certain securities from U. S. Treasury Securities and
Corporate Bonds to Asset Backed Securities. The corrections appear on pages 6, 21, 57, 74, 79,
80, 97 and 105 of the amended report and do not result in any changes to the Financial
Statements (other than Notes 1 and 4) or to Item 6. Selected Financial Information presented in
this report. The annual report of ProAssurance has been restated in its entirety in this Form
10K/A in order that the amendment and restated report can be used to satisfy the requirements of
Rule 14a-3.
2
PART I
ITEM 1. BUSINESS
General
We are a holding company for specialty property and casualty insurance companies focused on
the professional liability and the personal lines insurance markets. Our executive offices are located at
100 Brookwood Place, Birmingham, Alabama 35209. Our telephone number is (205) 877-4400 and our
website is www.ProAssurance.com. Our stock trades on the New York Stock Exchange under the symbol
“PRA.”
We have a regional orientation, applying a focused underwriting strategy to local markets where
we have built a strong reputation among our customers and producers. Our professional liability business
is concentrated in the southeast and midwest and serves physicians, dentists, other healthcare providers
and healthcare facilities. We believe we are the third largest active writer of medical professional liability
insurance in the United States. Our personal lines segment is solely in Michigan, focusing on educators
and their families. We believe we are the tenth largest writer of personal automobile insurance in
Michigan.
By concentrating on specialty markets where customers have specialized needs, we seek to
provide value added solutions through our underwriting expertise and our emphasis on strong customer
service. Our regional presence allows us to maintain active relationships with our customers and be more
responsive to their needs. We seek to maintain a strong financial position to protect our customers. We
believe these factors have allowed us to establish a leading position in our markets, enabling us to
compete on a basis other than just price.
For the year ended December 31, 2002, we generated $636.2 million of gross premiums written,
$477.4 million of net premiums earned and $555.8 million of total revenues. As of December 31, 2002,
we had cash and invested assets of $1.8 billion, total assets of $2.6 billion and stockholders’ equity of
$505.2 million. At December 31, 2002 our cash and invested assets totaled $63.12 per outstanding
share.
Corporate Organization and History
We were incorporated in Delaware to serve as the holding company for Medical Assurance in
connection with its acquisition of Professionals Group in June 2001. Our principal operating subsidiaries
are The Medical Assurance Company, Inc., ProNational Insurance Company, Medical Assurance of West
Virginia, Inc., Red Mountain Casualty Insurance Company, Inc., and MEEMIC Insurance Company. Our
financial statements and other financial information include Professionals Group only from the date of
acquisition in compliance with purchase accounting rules.
We 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
books of business in Illinois and Indiana and the acquisition of a professional liability insurer in Florida.
3
MEEMIC Insurance was founded as a mutual company by Michigan teachers and has provided
personal lines insurance to the education community in that state since 1950. Professionals Group
became affiliated with MEEMIC in 1997 and acquired majority ownership of MEEMIC Holdings, Inc.
(MEEMIC Holdings) in 1999.
In each acquisition we retained key personnel, allowing us to maintain a local presence and
preserve important institutional knowledge in claims management and underwriting. Our successful
integration of each organization demonstrates our ability to grow effectively through acquisitions.
Segment Overview
We conduct our business through two operating segments, each of which maintains a strong
position in its local markets:
• Our professional liability segment, which represents our commercial lines business, primarily
focuses on providing medical professional liability insurance. We provide protection against
claims arising out of the death, injury or disablement of a person resulting from a negligent
deviation from the standard of care by physicians and other healthcare professionals.
• Our personal lines segment offers personal automobile, and to a lesser extent, homeowners, boat
and umbrella insurance primarily to teachers, administrators, professors and other members of
the educational community and their families in Michigan. Personal lines insurance provides
policyholders with protection against claims resulting from bodily injury and property damage
liability and physical damage to property.
The following table illustrates our gross premiums written for our two primary segments for each
of the periods indicated:
2002
$
Professional liability
Personal lines
$
461,715
174,441
Year Ended December 31
2001
$
$
315,698
73,285
%
81%
19%
2000
$
%
$
223,871
-
100%
-
%
73%
27%
Total
$
636,156
100%
$
388,983
100%
$
223,871
100%
4
Professional Liability Segment:
In our professional liability segment, our top five states represented 73% of gross premiums
written for the year ended December 31, 2002. The following table displays the distribution of our gross
premiums written in states that represent 6% or more of our business in the professional liability segment.
2002
Year Ended December 31
2001
2000
$
%
$
%
$
%
Ohio
Alabama
Florida
Michigan
Indiana
All other states
91,571
83,818
71,366
52,203
41,925
120,832
20%
18%
15%
11%
9%
27%
51,520
74,917
29,519
22,404
25,130
112,208
16%
24%
9%
7%
8%
36%
30,357
66,123
7,636
-
13,667
106,088
14%
30%
3%
-
6%
47%
Total
461,715
100%
315,698
100%
223,871
100%
For the year ended December 31, 2002, our professional liability segment produced a combined
ratio of 125%. The combined ratio is the sum of the underwriting expense ratio (the ratio of underwriting
expenses to earned premiums) and net loss ratio (the ratio of losses and loss adjustment expenses to
earned premiums).
A combined ratio below 100% generally indicates profitable underwriting prior to the consideration
of investment income. However, if investment income is considered, companies writing professional
liability insurance may be profitable with combined ratios above 100%. This is due to the “long tail” nature
of this line of business.
The term “long-tail” refers to the long period of time between collecting the premium for insuring a
risk and the ultimate payment of losses, often exceeding five years. This “long tail” allows us to invest the
premiums we collect until we pay losses, which results in a higher level of invested assets and investment
income as compared to other lines of property and casualty business.
The combined ratio may not always be indicative of our ultimate results because of the “long tail”
nature of the professional liability business. We also measure our results by calculating our operating
ratio, which is the combined ratio offset by the benefit of investment income generated from our cash and
invested assets, also expressed as a percentage of net premiums earned. For the year ended December
31, 2002 our professional liability segment produced an operating ratio of 104%. A ratio below 100%
indicates profitability.
Personal Lines Segment:
Business in our personal lines segment is currently confined to Michigan. The following table
displays gross premiums written in this segment.
2002
Year ended December 31
2001
2000
$
%
$
%
$
%
Personal lines
$
174,441
100%
73,285
100%
-
Total
$
174,441
100%
$
73,285
100%
$
-
-
-
5
Personal lines insurance is generally referred to as “short tail”, due to shorter time periods
between insuring the risk and the ultimate payment of claims. As a result, there is less time to invest
premiums collected, which makes it necessary to achieve an underwriting profit in order to generate a
satisfactory return on equity. For the year ended December 31, 2002, MEEMIC reported a combined ratio
of 88%.
Recent Events
Purchase of Minority Shares of MEEMIC:
On January 29, 2003 MEEMIC Holdings, the parent company of MEEMIC Insurance Company,
purchased all of the issued and outstanding shares of its common stock, other than those held by
ProAssurance’s subsidiary, ProNational Insurance Company (ProNational). MEEMIC Holdings used its
internal funds in the approximate amount of $34.1 million to acquire all of the 1,062,298 shares of its
common stock not owned by ProNational, to pay for outstanding options for 120,000 shares, and to pay
the expenses of the transaction. The funds were derived from MEEMIC Holdings' cash and investment
resources.
As a result of the transaction, MEEMIC Holdings was delisted from the NASDAQ stock market,
and MEEMIC Insurance Company became a wholly-owned subsidiary of ProNational.
Follow-On Public Offering:
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 is using the proceeds from the
offering to support the growth of the professional liability insurance business and for general corporate
purposes.
Management
Our senior management team is led by A. Derrill Crowe, M.D., our Chairman and Chief Executive
Officer, and Victor T. Adamo, Esq., our President and Chief Operating Officer. Dr. Crowe has acted as the
Chief Executive Officer of Medical Assurance since its founding in 1977. He has applied a hands-on
management style in developing our underwriting and claims strategies and was instrumental in
establishing us as a leading professional liability specialist. Mr. Adamo has held various positions with
Professionals Group since 1985, becoming its CEO in 1987 and being named President in 1989. He is
largely responsible for building Professionals Group into a successful regional professional liability
company.
Dr. Crowe practiced medicine as his principal occupation for more than 25 years and Mr. Adamo
was in the private practice of law for 10 years, providing them with knowledge of medical and legal issues
that are critical to our insurance operations. We also have a knowledgeable and experienced
management team with established track records in building and managing successful insurance
operations. In total, our senior management team has average experience in the insurance industry of 22
years.
Corporate Strategy
Our objective is to build value for our stockholders through superior underwriting of classes of
business in which we have a comprehensive understanding and which offer us the opportunity to
generate competitive returns on capital. We target a return on equity of 12% to 14% over the long term.
Over the five years ending December 31, 2002, however, we achieved an average return on equity of
8.6%, with a high of 15.9% in 1998 and a low of 2.3% in 2002. The major elements of our strategy are:
6
Adhere to a Strict Underwriting Philosophy:
We emphasize disciplined underwriting and do not manage our business to achieve a certain
level of premium growth or market share. In our professional liability business, we apply our local
knowledge to individual risk selection, and determine the appropriate price based on our assessment of
the specific characteristics of each risk. In our personal lines business, we target the educational
community, which we believe provides a preferred, stable and predictable group of risks.
Aggressively Manage Policyholder Claims:
In addition to prudent risk selection, we seek to control our underwriting results through effective
claims management. We investigate each professional liability claim and have fostered a strong culture of
aggressively defending those claims that we believe have no merit. We manage these claims at the local
level, tailoring claims handling to the legal climate of each state, which we believe differentiates us from
national writers. In our personal lines business, we seek to quickly and efficiently settle claims through an
established network of auto repair shops and other repair facilities, focusing on minimizing the cost of
handling each claim.
Operate Through Regional Offices in Local Markets:
By concentrating on specialty markets where customers have specialized needs, we seek to
provide value added solutions through our underwriting expertise and our emphasis on strong customer
service. Through our regional underwriting and claims office structure, we are able to gain a strong
understanding of local market conditions and efficiently adapt our underwriting and claims strategies to
regional conditions. Our regional presence also allows us to maintain active relationships with our
customers and be more responsive to their needs. We believe these factors have allowed us to establish
a leading position in our markets, enabling us to compete on a basis other than just price.
Expand Our Position in Regional Markets:
Our goal is to build upon our position as a leading writer of professional liability and personal lines
insurance and expand within a defined geographic area, while maintaining our commitment to disciplined
underwriting and aggressive claims management. We believe we are the third largest active medical
liability insurance writer in the nation, and we believe we are the largest medical liability writer in our
states of operation. The withdrawal and reduced capacity of several competitors in the medical
professional liability market has provided new business opportunities. We believe that our strong
reputation in our regional markets, combined with our financial strength, strong customer service and
proven ability to manage claims, should enable us to profitably expand our position in select states. In our
personal lines business, we estimate that we currently insure approximately 23% of educational
professionals in Michigan. We expect to increase our penetration of the educational community by
appointing additional agents and broadening our existing relationships with educational institutions and
their employees.
Pursue Consolidating Acquisitions:
We have successfully acquired and integrated companies and books of business in the past and
believe our financial size and strength make us an attractive acquirer. We continually evaluate
opportunities to acquire professional liability companies or books of business that leverage our core
underwriting and claims expertise.
7
Maintain Our Financial Strength and Security:
We have sustained our financial stability during difficult market conditions through responsible
pricing and loss reserving practices. We are committed to maintaining prudent operating and financial
leverage and conservatively investing our assets. We recognize the importance of our “A–” (Excellent)
A.M. Best rating to our customers and producers and intend to manage our business to protect our
financial security.
Products and Services
Professional Liability Segment:
We offer professional liability insurance for providers of medical and other healthcare services.
Although we generate a majority of our premiums from individual and small group practices, we also
insure several major physician groups as well as several hospitals. We also offer professional liability
insurance for providers of legal services, and we offer professional office package and workers’
compensation insurance products, primarily in connection with our professional liability products. We
believe our size, financial strength and flexibility of distribution differentiates us from our competitors. The
following table illustrates the distribution of our gross premiums written of our professional liability
segment by type of coverage for the periods indicated.
2002
Year ended December 31
2001
2000
$
%
$
%
$
%
Professional Liability--
Physicians & Dentists
Professional Liability--Other (1)
Total Medical Professional Liability
Professional Liability--Legal
Other Commercial Lines (2)
Total Commercial Liability
Professional Liability total
$
410,560
37,576
448,136
5,968
7,611
13,579
461,715
$
89%
8%
97%
1%
2%
3%
100%
$
228,139
39,080
267,219
2,134
46,345
48,479
315,698
$
72%
12%
84%
1%
15%
16%
100%
$
161,113
18,175
179,288
-
44,583
44,583
223,871
$
72%
8%
80%
-
20%
20%
100%
(1) Primarily includes miscellaneous healthcare providers, hospitals and other health care facilities.
(2) Primarily includes workers’ compensation and commercial multi-peril coverages.
There are two predominant types of professional liability insurance policies, occurrence and
claims-made. Occurrence coverage provides permanent insurance protection against claims arising from
incidents that occur during the policy period, regardless of when these claims may be reported. Due to
the long-tail nature of our business, it may be many years before we become aware of claims under
occurrence policies. Claims-made coverage provides protection against only those claims reported during
the policy period, resulting from incidents that occurred while continuously insured on a claims-made
basis. Therefore, most claims are known, although not resolved, at the end of the policy period. This
allows us to estimate our loss reserves for claims-made coverage with more certainty. The basic claims-
made policy does not provide protection against claims which are reported after the policy period ends;
the insured must either continue to renew the claims-made policy or purchase extended reporting
coverage in order to have permanent protection. In the event of death, disability or qualified retirement,
most insureds receive extended reporting coverage as part of the policy terms. Approximately 86% of our
direct premiums written for the year ended December 31, 2002 were for claims-made policies.
8
We previously offered accident and health and workers’ compensation insurance and reinsurance
through various programs to entities and individuals other than healthcare providers. We ceased our
marketing of these programs in order to focus on our core professional liability products. We began
terminating these programs in 2000 and substantially completed our withdrawal from this business in
2002.
In October 2002, we started offering professional liability insurance to medical and other
healthcare professionals who generally do not qualify for standard coverage because of their claim history
or other factors. We write this business on an excess and surplus lines basis, which provides us with
greater flexibility in establishing prices and terms of coverage. While we do not expect this class of
insured to become a major portion of our business, we believe this provides profitable opportunities to
expand our business. In 2002 this line of business produced $3.0 million in premiums. This business is
written primarily through our subsidiary Red Mountain Casualty Insurance Company, Inc.
Personal Lines Segment:
Our personal lines business is written through our subsidiary, MEEMIC, which primarily serves
educational employees and their families in Michigan. Private passenger automobile insurance is our
primary line of business. To provide for the other insurance needs of our auto customers, we also offer
homeowners, boat and umbrella policies. The following table illustrates our gross premiums written for
each of our personal lines classes of business for each of the periods indicated.
2002
Years ended December 31
2001 (1)
2000
$
%
$
%
$
%
Personal Automobile
Homeowners
Boat (2)
Umbrella (2)
Total
$
147,168
26,600
497
176
174,441
$
84%
16%
*
*
100%
$
$
62,422
10,637
163
63
73,285
85%
15%
*
*
100%
-
$
-
-
-
$
-
-
-
-
-
-
(1) The year ended December 31, 2001 includes gross premiums written since June 27, 2001, the
date of consolidation of Professionals Group and Medical Assurance.
(2) Less than 1%
Marketing
Professional Liability Segment:
We primarily write insurance in the southeast and midwest and are licensed to do business in
every state but Connecticut, Maine, New Hampshire, New York and Vermont. Based on gross premiums
written in 2002, Ohio, Alabama, Florida, Michigan, and Indiana represented our five largest states.
We utilize direct marketing and independent agents to write business. In Alabama, we rely solely
on direct marketing, and in Florida and Missouri, direct marketing accounts for a majority of our business.
We use independent agents to market our professional liability insurance products in other markets. For
the year ended December 31, 2002, we estimate that approximately 60% 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.
9
We focus our marketing efforts on sole practitioners and small groups of physicians. We
generally do not target large groups or facilities because of the difficulty in underwriting the individual risks
and because their purchasing decision is usually based primarily on price. Our marketing efforts
differentiate our professional liability insurance products by emphasizing claims service and the other
services and communications we provide to our customers including:
•
•
•
•
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 opposition to proposed legislation relating to liability
issues affecting the healthcare industry;
the preparation and dissemination of newsletters and other printed material with information of
interest to the healthcare industry; and
• endorsements by, and attendance at meetings of, the state and local medical societies and
related organizations.
These communications and services have helped us gain exposure among potential insureds
and demonstrate our understanding of the insurance needs of the healthcare industry and promote a
commonality of interest among us and our insureds.
Personal Lines Segment:
We market our personal lines insurance products, personal automobile, homeowners, boat and
umbrella policies, to members of the educational community and their families in Michigan. Our policies
are sold through our exclusive agents who are typically current or former teachers, school administrators
or other education professionals. We currently are licensed in Minnesota, Michigan, and Ohio, but write
insurance only in Michigan.
Our sales representatives also have access to other insurance products underwritten by other
carriers in Michigan who pay us commissions for such sales. In general, these carriers offer products that
we do not currently offer, or insure a class of business that does not meet our underwriting guidelines. By
offering complementary insurance products, our sales representatives provide our customers with the
convenience of being able to purchase a full range of insurance products through a single agent, thus
allowing our representatives to compete with independent agents. We benefit by having potential
customers for products we may offer in the future.
We conduct quarterly meetings with our sales representatives, establish benchmarks and goals,
and conduct technical training and sponsor continuing education programs. Our representatives provide
us with important information about market conditions and feedback from our customers regarding their
insurance requirements and our level of service provided. This information is used to develop new
products and new product features. We recruit and train new sales representatives to work in under-
represented areas of the state. Sales representatives are paid a fixed commission with some opportunity
for contingent bonuses, based upon the representative’s production and loss ratios.
For the year ended December 31, 2002, one sales representative accounted for approximately
5% of our direct premiums written within our personal lines segment. No other sales representative
accounted for more than 4% of our direct premiums written in 2002. The top 10 sales representatives
accounted for approximately 35% of our direct premiums written in 2002.
10
We provide personal computer software that allows sales representatives to quote rates for auto,
homeowners and boat insurance. In addition, we have a web site on the internet for the public that is
periodically updated with pertinent information on MEEMIC, its products, and how to locate a sales
representative.
Underwriting
Professional Liability Segment:
Because we focus our primary efforts on sole practitioners and small groups, our underwriting
process is driven by individual risk selection rather than by account, and our pricing decisions are focused
on achieving rate adequacy. We assess the quality and pricing of the risk, primarily emphasizing loss
history, practice specialty and location of practice in making our underwriting decision. Our underwriters
work closely with our local claims departments. This includes consulting with staff about claims histories
and patterns of practice in a particular locale as well as monitoring claims activity.
Our underwriting focuses on knowledge of local market conditions and legal environment.
Through our five local 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. These offices are staffed by underwriting professionals who report to the branch vice presidents
of their respective local office. The underwriting offices each report to a regional vice president who is
ultimately responsible for the pricing and underwriting decisions in their region.
Our underwriting department establishes guidelines to classify risks by practice specialty and by
location. Our underwriters work with our field marketing force to identify business that meets these
established underwriting standards and to develop specific strategies to write the desired business. In
performing this assessment, our underwriters may also consult with internal actuaries regarding loss
trends and pricing and utilize loss-rating models to assess the projected underwriting results of certain
insured risks. Our agents are permitted to bind professional liability coverage within our underwriting
guidelines, but binding authority is exercised only after authorization from our underwriting staff.
Our underwriters are also assisted by our local medical advisory committees that we have
established in our key states. These committees are comprised of local physicians, dentists and
representatives of hospitals and healthcare entities and help us maintain close ties to the medical
communities in these states, provide information on the practice of medicine in each state and provide
guidance on critical underwriting and claims issues.
Personal Lines Segment:
We rely to a significant degree on information provided by our sales representatives in
underwriting risks. The majority of our sales representatives are, or were, teachers. This enhances the
sales representatives’ ability to act as field underwriters since they have a general understanding of
lifestyles and insurance needs within the educational community to effectively pre-screen applicants. We
believe that the educational community in Michigan provides better than average risk-selection, which
contributes to our historically profitable underwriting results.
Our underwriters then evaluate and accept applications for insurance submitted by the sales
representatives based on consistently applied underwriting guidelines. Our processing system allows for
some modification of these guidelines by individual underwriters, and underwriting supervisors regularly
audit their work and ensure these exceptions fall within acceptable limits. Our underwriters monitor
policyholder deviations from the underwriting guidelines to assist in decisions related to cancellation and
non-renewal.
11
Claims Management
Professional Liability Segment:
We have claims offices throughout the states in which we write business in order to provide
localized and timely attention to claims. Our claims department investigates the circumstances
surrounding a medical incident from which a covered claim arises against an insured. Upon investigation,
and in consultation with the insured and appropriate experts, we evaluate the merit of the claim and either
seek reasonable settlement or aggressively defend the claim. If the claim is defended, our claims
department manages the case, including selecting defense attorneys who specialize in medical liability
cases, planning the defense and obtaining medical and/or other professional experts to assist in the
analysis and defense of the claim.
Our claims department establishes the appropriate case reserves for each claim and monitors the
level of each case reserve as circumstances require.
The department also decides when and if to settle all but the most significant claims, which are
currently reviewed by an internal committee made up of our Chairman and Chief Executive Officer, our
Senior Vice President – Claims, and our outside legal counsel. In each of the states in which we operate,
we meet regularly with our local medical advisory committees to examine claims, attempt to identify
potentially troubling practice patterns and make recommendations to our staff.
We aggressively defend claims against our insureds that we believe have no merit or those we
believe cannot be reasonably settled. As a result of this policy, many of our claims are litigated, and we
engage experienced trial attorneys in each venue to handle the litigation in defense of our policyholders.
Our aggressive claims management approach generally results in increased loss adjustment
expenses compared to those of other property and casualty lines or other companies specializing in
professional liability insurance. However, we believe that our approach contributes to lower overall loss
costs and results in greater customer loyalty. The success of this claims philosophy is based on our ability
to develop relationships with attorneys who have significant experience in the defense of professional
liability claims and who are able to defend claims in an aggressive, cost-efficient manner.
Personal Lines Segment:
In responding to claims, we emphasize timely investigation, evaluation and fair settlement while
controlling claims expense and maintaining adequate reserves. We have a year-round, 24-hour claim
reporting telephone service for insureds and third-party claimants. This reporting methodology enables us
to more quickly complete initial claim handling and ultimately reduce indemnity payments such as rental
and storage.
Our claims operation is centralized in Auburn Hills, Michigan, but we also employ resident
adjusters located in cities throughout Michigan. These employee adjusters settle a majority of our claims,
and independent multi-line adjusters are used on a contract basis when claim volume rises. We have also
established a network of auto repair shops and other repair facilities that provide damage appraisals and
repairs according to established company guidelines. An inspection audit program ensures that repairs
are completed timely, economically and to the satisfaction of the customer.
Audits of liability claim files are conducted regularly by claims department managers and
reinsurers. We decide which claims we seek to settle and which claims we defend. We believe that less
than 1% of all claims result in litigation.
12
Our claims department actively monitors all litigation including selecting defense attorneys who
specialize in insurance defense cases, planning the defense, and obtaining professional experts to assist
in the analysis and defense of the claim. The department establishes the appropriate case reserves for
each claim and monitors the level of each case reserve as circumstances require.
Loss Reserves
We establish our reserves based on our estimates of the future amounts necessary to pay claims
and expenses associated with the investigation and settlement of claims. Losses and loss adjustment
expenses (LAE) reserves are determined on the basis of individual claims and actuarially determined
estimates of future losses based on our past loss experience, available industry data and projections as
to future claims frequency, severity, inflationary trends, judicial trends, legislative changes and settlement
patterns.
Many of these items are not definitively quantifiable. Additionally, there may be significant
reporting lags between the occurrence of an insurable event and the time it is reported to us. The
assumptions used in establishing our reserves are regularly reviewed and updated by management as
new data becomes available. The reserves for losses and LAE of each of our insurance subsidiaries are
reviewed by its independent actuaries for each year. The independent actuaries prepare reports that
include recommendations as to the level of reserves. We consider these recommendations as well as
other factors, such as known, anticipated or estimated changes in frequency and severity of claims and
loss retention levels and premium rates, in establishing the amount of our reserves for losses and LAE.
The statutory filings of each insurance company with the insurance regulators must be accompanied by
an actuary’s certification as to its reserves in accordance with the requirements of the National
Association of Insurance Commissioners (the “NAIC”).
We believe the methods we use to establish our reserves for losses and LAE are reasonable and
appropriate. However, estimating reserves, especially professional liability reserves, is a complex process
heavily dependent on judgment. We believe that past experience, adjusted for the effects of current
developments and anticipated trends, is an appropriate and reasonable basis for evaluating the adequacy
of our loss reserves. There is no precise method for evaluating the adequacy of reserves and changes
are made to the amount of the reserves as estimates change based on current information. Changes in
the amount of reserves for losses and LAE are reflected in current earnings. Because of the size of our
reserves, a small percentage change in the amount of the reserves can have a material effect on our
results of operations for the period in which the change is made.
We believe we do not have any exposure to asbestos claims that are currently prevalent in the
insurance industry. Although our policies do not contain specific terrorism exclusions we do not believe
we have a material exposure to terrorism losses.
13
Claims Reconciliation
The following table reconciles beginning and ending reserves for losses and LAE as shown in our
consolidated financial statements for the years indicated. As of December 31, 2002, our insurance
subsidiaries had consolidated reserves for losses and LAE on a GAAP basis that exceeded those on a
statutory basis by approximately $19.5 million, which is principally due to the portion of GAAP reserves
that are reflected for statutory accounting purposes as unearned premiums. These unearned premiums
are applicable to extended reporting endorsements (“tail” coverage) issued without a premium charge
upon death, disability, or retirement of an insured.
Year ended December 31
2001
2000
2002
Balance, beginning of year
Less reinsurance recoverables
Net balance, beginning of year
$
1,442,341
374,056
1,068,285
$
659,659
166,202
493,457
$
665,786
179,507
486,279
Net reserves acquired from Professionals Group
-
557,284
-
Incurred related to:
Current year
Prior years
Change in death, disability and retirement reserve
Total incurred
439,600
8,429
-
448,029
303,387
13,818
(18,647)
298,558
178,210
(12,500)
(10,000)
155,710
Paid related to:
Current year
Prior years
Total paid
Net balance, end of year
Plus reinsurance recoverables
Balance, end of year
(84,376)
(271,482)
(355,858)
1,160,456
462,012
1,622,468
$
(137,121)
(143,893)
(281,014)
1,068,285
374,056
1,442,341
$
(14,909)
(133,623)
(148,532)
493,457
166,202
659,659
$
14
Loss Reserve Development Table
The Loss Reserve Development Table includes information regarding the development of our
reserves for the liability of unpaid losses and LAE for the years ended December 31, 1992 through 2002.
The table includes losses and LAE on both a direct and an assumed basis and is net of reinsurance
recoverables. The following definitions may be helpful in understanding the Loss Reserve Development
Table:
• The line entitled “Losses and LAE Reserves, undiscounted and net of reinsurance recoverables”
reflects the amount recorded as the reserve for liability for unpaid losses and LAE in the
consolidated balance sheet at the end of each year (the Balance Sheet Reserves).
• The section entitled “Cumulative net paid, as of” reflects the cumulative amounts paid as of the
end of each succeeding year with respect to the previously recorded Balance Sheet Reserves.
• The section entitled “Re-estimated net liability as of” reflects the re-estimated amount of the
liability previously recorded as Balance Sheet Reserves that includes the cumulative amounts
paid and an estimate of additional liability based upon claims experience as of the end of each
succeeding year (the Net Re-estimated Liability).
• The line entitled “Net cumulative redundancy, (deficiency)” reflects the difference between the
previously recorded Balance Sheet Reserve for each applicable year and the Net Re-estimated
Liability relating thereto as of the end of the most recent fiscal year.
The gross liability for losses and LAE before reinsurance, as shown on the balance sheet, and
the reconciliation of that gross liability to amounts net of reinsurance are reflected below the table. We do
not discount our reserves to present value.
Information presented in the following table is cumulative and, accordingly, each amount includes
the effects of all changes in amounts for prior years. The table presents the development of our balance
sheet reserves; it does not present accident year or policy year development data. Conditions and trends
that have affected the development of liabilities in the past may not necessarily occur in the future.
Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on this
table.
In each year reflected in the table, we have utilized actuarial methodologies, including incurred
loss development, paid loss development and frequency-severity projections, to estimate reserves. These
techniques are applied to the data and the resulting projections are evaluated by management to
establish the estimate of reserves.
15
Analysis of Losses and Loss Reserve Development
(in thousands)
December 31,
1992 (a)
1993 (a)
1994 (a)
1995 (a)
1996 (a)
1997 (a)
1998 (a)
1999 (a)
2000 (a)
2001 (b)
2002 (b)
$
252,739
$
272,392
$
295,541
$
352,521
$
440,040
$
464,122
$
480,741
$
486,279
$
493,457
$
1,068,285
$
1,160,456
19,752
36,185
52,550
58,526
63,325
68,021
71,466
72,352
72,305
73,149
21,296
40,988
53,186
61,153
66,419
73,308
76,716
76,821
77,713
24,102
42,115
58,793
65,520
76,291
81,722
82,605
84,649
27,532
58,769
80,061
107,005
120,592
129,043
135,620
48,390
98,864
136,992
173,352
191,974
204,013
67,383
128,758
194,139
227,597
252,015
89,864
192,716
257,913
308,531
133,832
239,872
313,993
143,892
251,855
271,482
Losses and LAE Reserves,
undiscounted and net of
reinsurance recoverables
Cumulative net paid
as of:
One Year Later
Two Years Later
Three Years Later
Four Years Later
Five Years Later
Six Years Later
Seven Years Later
Eight Years Later
Nine Years Later
Ten Years Later
Re Estimated Net Liability As Of:
End of Year
One Year Later
Two Years Later
Three Years Later
Four Years Later
Five Years Later
Six Years Later
Seven Years Later
Eight Years Later
Nine Years Later
Ten Years Later
$
252,739
241,655
221,236
190,744
167,062
136,996
108,862
94,908
84,719
79,788
76,086
$
272,392
251,445
220,385
194,213
159,096
126,379
106,403
92,954
88,828
83,251
$
295,541
268,154
239,243
200,311
157,836
122,570
105,779
99,787
94,192
$
352,521
325,212
280,518
237,280
190,110
173,148
168,828
160,784
$
440,040
393,363
347,258
294,675
264,714
259,195
248,698
$
464,122
416,814
364,196
333,530
323,202
320,888
$
480,741
427,095
398,308
400,333
414,008
$
486,279
463,779
469,934
488,426
$
493,457
507,275
529,698
$
1,068,285
1,076,714
Net cumulative redundancy
(deficiency)
176,653
189,141
201,349
191,737
191,342
143,234
66,733
(2,147)
(36,241)
(8,429)
Original gross liability - end of year
311,394
355,735
432,937
548,732
614,720
660,631
665,786
659,659
1,442,341
Less: reinsurance recoverables
(39,002)
(60,194)
(80,416)
(108,692)
(150,598)
(179,890)
(179,507)
(166,202)
(374,056)
Original net liability - end of year
272,392
295,541
352,521
440,040
464,122
480,741
486,279
493,457
1,068,285
Gross re-estimated liability - latest
92,070
124,809
188,809
299,934
418,566
547,964
624,886
666,822
1,464,052
Re-estimated reinsurance recoverables
(8,819)
(30,617)
(28,025)
(51,236)
(97,678)
(133,956)
(136,460)
(137,124)
(387,338)
Net re-estimated liability - latest
83,251
94,192
160,784
248,698
320,888
414,008
488,426
529,698
1,076,714
Gross cumulative redundancy
(deficiency)
219,324
230,926
244,128
248,798
196,154
112,667
40,900
(7,163)
(21,711)
(a)
(b)
Reflects reserves of Medical Assurance excluding Professionals Group reserves, which were acquired on June 27, 2001.
Accordingly, the gross and net reserve development (reserves recorded at the end of the year, as originally estimated,
less reserves re-estimated as of subsequent years) relates only to the operations of Medical Assurance and does not
include Professionals Group.
Reflects combined reserves of Medical Assurance and Professionals Group.
Losses and LAE reserves associated with medical professional liability coverage tend to be
higher than those associated with most other types of property and casualty insurance for two primary
reasons. First, overall costs of providing professional liability insurance coverage historically have been
among the highest of the property and casualty insurance lines. These costs can be attributed principally
to increases in both the frequency and severity of professional liability claims. Second, the complexity of
professional liability claims increases LAE. In addition, delays between the collection of premiums and the
payment of losses are generally longer for professional liability insurance than other property and
casualty lines. Frequently, injuries are not discovered until years after an incident, or the claimant may
delay pursuing the recovery of damages. As a result of the delay, a component of the loss reserves for
occurrence coverage and “tail” coverage includes an estimate of the claims that have been incurred but
not yet reported (IBNR).
16
Medical professional liability loss experience is volatile and cyclical. Over the past twenty-five
years, the industry has experienced several periods of increasing claim frequency and severity, followed
by periods of relative stability. At other times, due to tort reform, favorable judicial decisions, favorable
economic conditions or other unknown factors, claim frequency or severity have decreased. Malpractice
claims generally require an extended period of time to resolve, and the average life of a claim can be five
years or more. The combination of changing conditions and the extended time required for claim
resolution result in a loss cost estimation process that requires actuarial skill and the application of
judgment, and such estimates require periodic revision. We believe it is prudent to establish initial losses
and LAE reserves that are reasonable and are based on historical experience as well as on facts and
circumstances known at the balance sheet date. To the extent that actual results deviate from
expectations, reserve estimates are subsequently adjusted and ultimate paid losses and LAE are more or
less than the original estimates.
Prior to 2001, our reserves were solely for the Professional Liability Segment. Our losses and
LAE reserves developed favorably in many prior years for several reasons:
• Substantially all of our business was derived from medical professional liability insurance written
in Alabama until we began to geographically expand our business in the mid to late 1990s. We
utilized a rigorous and disciplined approach to investigating, managing and defending claims.
This philosophy generally produced results in Alabama that were better than industry averages in
terms of loss payments and the proportion of claims closed without indemnity payment.
• Our volume of business in the late 1980’s and early 1990’s, while substantial, was not of a
sufficient size to fully support the actuarial projection process; thus, our data was supplemented
with industry-based data. Ultimately, actual results proved better than the industry data, creating
redundancies.
• Our reserves established in the late 1980’s and early 1990’s were strongly influenced by the
dramatically increased frequency and severity that we, and the industry as a whole, experienced
during the mid-1980s. Some of these trends moderated, and in some cases, reversed, by the late
1980s or early 1990s. However, the ability to recognize the improved environment was delayed
due to the extended time required for claims resolution. When these negative trends moderated,
the reserves we established during those periods proved to be redundant.
• We prudently established accident year loss reserves, resulting in some initial accident year net
loss ratios that were higher than industry averages. In some instances, these net loss and LAE
ratios proved to be accurate, while in other cases, experience has been better than we expected
and redundancies developed.
The professional liability legal environment deteriorated once again during the past several years.
Beginning in 2000, we recognized adverse trends in claim severity, causing increased estimates of
certain loss liabilities. As a result, favorable development of prior year loss reserves slowed in 2000 and
reversed in 2001. We have addressed these trends through increased rates, stricter underwriting and
modifications to claims handling procedures.
Due to the size of our reserves, even a small percentage adjustment can have a material effect
on our results of operations for the period in which the change is made.
17
Reinsurance
General:
We use reinsurance to provide capacity to write large limits of liability, to reduce losses of a
catastrophic nature and to stabilize underwriting results in those years in which such losses occur. The
purchase of reinsurance does not relieve us from the ultimate risk on our policies, but it does provide
reimbursement from the reinsurer for certain losses paid by us.
The effective transfer of risk is dependent on the creditworthiness of the reinsurer. We purchase
reinsurance from a number of individual companies to avoid concentrations of credit risk. Our reinsurance
brokers assist us in the analysis of the credit quality of our reinsurers.
We have not experienced any difficulties in collecting amounts due from reinsurers. As of
December 31, 2002 we do not believe we have any reinsurance recoverables that are uncollectible.
Should future events lead us to believe that any reinsurer is unable to meet its obligations to us,
adjustments to the amounts recoverable would be reflected in the results of then current operations.
The following table identifies our reinsurers from which our recoverables are $10 million or more
as of December 31, 2002:
Reinsurer
A. M. Best
Company Rating
Amounts Due
From Reinsurer
Michigan Catastrophic Claims Association
Not rated
Hannover Ruckversicherungs Ag
PMA Capital Insurance Company
General Reinsurance Corp
Continental Casualty Company
A+
A-
A++
A
Gerling Global Reins Corp
Not rated
Transatlantic Reins Company
Lloyds Syndicate 435
Converium Rein North America Inc.
St. Paul Reinsurance Company Ltd.
A++
A-
A
A
$ 56,769
$ 51,889
$ 35,236
$ 34,115
$ 31,144
$ 28,268
$ 18,572
$ 13,808
$ 11,763
$ 11,121
18
Recently, there has been public speculation about the ability of Gerling Global Reinsurance
Corporation of America (Gerling) to pay claims. Gerling is not accepting new business, and is therefore
not rated by A.M. Best. Gerling does not participate in our current reinsurance treaties, however it has
been part of previous reinsurance programs. At December 31, 2002 our recorded receivable from them
was $28.3 million of which approximately 85% related to our estimates of IBNR and its allocation to the
various reinsurance treaties. Based upon information available to us, including statements made by
Gerling, we anticipate that Gerling will meet its obligations to us.
Professional Liability Segment:
We reinsure risks under treaties pursuant to which the reinsurer agrees to assume all or a portion
of all risks that we insure above our individual risk retention and up to the maximum individual limit offered
(currently $16 million). Periodically, we provide insurance to policyholders above the maximum limits of
our reinsurance treaties. In those situations, we reinsure the excess risk above the limits of our
reinsurance treaties on a facultative basis, whereby the reinsurer agrees to insure a particular risk up to a
designated limit.
Our risk retention level is dependent upon numerous factors including the price and availability of
reinsurance, volume of business, level of experience and our analysis of the potential underwriting results
within each state. Historically, per claim retention levels have varied between the first $200,000 and the
first $2 million depending on the coverage year and the state in which business was written.
Effective October 1, 2002, the professional liability segment has a uniform retention of
$1,000,000.
Personal Lines Segment:
The Michigan Catastrophic Claims Association (MCCA) covers all automobile related personal
injury incurred losses in excess of $300,000. The MCCA is an unincorporated nonprofit association
created by Michigan law, and every insurer engaged in writing personal protection automobile insurance
coverage in Michigan is required to be a member of the MCCA. The MCCA charges an annual
assessment, based on the number of vehicles for which coverage is written, to cover the losses reported
by all member companies. Michigan law provides that the MCCA assessments charged to member
companies for this protection can be recognized in the rate-making process and passed on to
policyholders. We treat any amounts due from the MCCA as reinsurance and the assessments due to
MCCA as ceded premiums.
We currently reinsure our other personal lines risks in excess of $250,000 per loss. Individual
property risks are covered up to $1 million per risk and casualty risks other than personal automobile are
covered on an excess of loss basis up to $3 million per occurrence.
Catastrophic reinsurance provides additional protection from significant aggregate loss exposure
arising from a single event such as windstorm, hail, tornado, earthquake, riot, blizzard, freezing
temperatures or other extraordinary events. We have purchased catastrophe reinsurance for automobile
physical damage, homeowners and boat property damage in four layers up to $15,000,000 in excess of
$1,000,000 with each layer subject to a retention of 5%. Since we began offering umbrella policies in
2000, we have a quota share reinsurance arrangement under which we retain 5% and cede 95% of our
liability on these policies.
19
Investments
Our overall investment strategy is to focus on maximizing current income from our investment
portfolio while maintaining safety, liquidity, duration of liabilities and portfolio diversification. Although fixed
maturity securities are purchased with the initial intent to hold such securities until their maturity, disposals
of securities prior to their respective maturities may occur if management believes such disposals are
consistent with our overall investment strategy, including maximizing after-tax yields. This investment
strategy is implemented through investment guidelines that are established from time to time by our board
of directors with the assistance of outside consultants.
Our investment portfolio had an estimated fair value of $1,409 million at December 31, 2002. The
portfolio is generally managed by professional third party asset managers whose results are evaluated
periodically by management and its consultants. The asset managers typically have the authority to make
investment decisions, subject to investment policies, within the asset class they are responsible for
managing.
We categorize our marketable securities as debt securities (cash equivalents, debt instruments,
convertible debentures and preferred stocks having scheduled redemption provisions) and equity
securities (common stocks, convertible preferred stocks and preferred stocks that do not have mandatory
redemption provisions).
We currently classify all debt and equity securities as available-for-sale and report such
investments at market value.
At December 31, 2002 we held investments, excluding real estate, with a market value of $1,409
million and a net unrealized gain of $35.5 million. The fixed maturity securities in our investment portfolio
had a dollar weighted average rating of “AA,” a weighted average modified duration of 3.7 years and an
average yield of 5.2% before investment expenses at December 31, 2002. Average yield is calculated by
dividing annualized investment income from fixed maturities by the book value of fixed maturities.
Because most of our investment portfolio is comprised of fixed maturity securities, periodic
changes in interest rate levels generally affect our financial results to the extent that reinvestment yields
are different than the original yields on maturing securities. For a more detailed discussion of the impact
of changes in interest rates on our investment portfolio see “Management’s Discussion and Analysis —
Market Sensitive Instruments — Interest Rate Risk.”
20
The following table reflects the amortized cost and fair market value of the investment portfolio for
both of our segments at December 31, 2002:
Amortized
Cost
Estimated Percentage of
Fair Value
Fair Value
($ in thousands)
Fixed maturities
U.S. Treasury Securities ............................... $
131,542
$
135,316
10%
State and Municipal Bonds............................
399,899
Corporate Bonds ...........................................
396,510
Asset Backed Securities................................
346,984
Certificates of Deposit ...................................
570
Total Fixed Maturities ....................
1,275,505
Equity Securities...................................................
77,556
416,788
418,769
357,454
570
1,328,897
80,197
29
30
25
(*)
94
6
Total Investments.......................... $
1,353,061
$
1,409,094
100%
(*) Less than 0.1%.
Substantially all of the fixed maturities are either United States government or agency obligations
or investment grade securities as determined by national rating agencies. Although accounted for as
available-for-sale, our fixed maturities are purchased with the intent to hold such investments to maturity.
Our investment policies implement an asset allocation that uses length to maturity as one method of
managing our long term rate of return. The following table reflects the estimated fair value of our fixed
maturities by contractual maturity at December 31, 2002.
Estimated
Fair Value
Percent
of Total
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Asset-backed securities
Total
($ in thousands)
4%
$
49,993
357,195
378,120
186,135
357,454
27
28
14
27
$ 1,328,897
100%
The table below shows investment income information for the years ended December 31, 2002
and December 31, 2001. The yield on fixed maturity securities is calculated by dividing gross earnings on
fixed maturity securities by the average of the quarterly ending book value balances of such securities.
21
We have significant amounts invested in tax-exempt state and municipal bonds. These bonds pay
lower interest rates than securities that are subject to federal income taxes. We have, therefore,
calculated a tax equivalent yield. The gross earnings on fixed maturity securities is increased to calculate
gross earnings as though all of our fixed maturity securities are taxable. The tax adjusted gross earnings
are divided by the average of the quarterly ending book value balances of fixed maturity securities to
determine the tax equivalent yield on fixed maturity securities.
Year Ended
December 31,
2002
Year Ended
December 31,
2001
($ in thousands)
Net Investment Income
Net Realized Investment (Losses) Gains
Yield on Fixed Maturity Securities
Tax Equivalent Yield on Fixed Maturity Securities
$ 76,918
(5,306)
5.5%
6.1%
$ 59,782
5,441
5.6%
6.6%
Our current investment policy requires that the market value of our equity investment portfolio not
to exceed 50% of our capital at the end of the prior year. At December 31, 2002, equity investments
represented 6% of the total market value of our portfolio, and 16% of our capital. Our equity investments
are diversified primarily among domestic growth and value holdings through common and convertible
preferred stock.
Rating Agencies
Our insurance subsidiaries are all rated “A–” (Excellent) by A.M. Best, its fourth highest category
out of 15 categories. They are rated “A–” (Strong) with a negative outlook by Standard & Poor’s, its
seventh highest category out of 21 categories. 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.
Competition
Competition depends on several factors including pricing, size, name recognition, service quality,
market commitment, breadth and flexibility of coverage, method of sale, financial stability and ratings
assigned by A.M. Best and Standard & Poor’s. Many of these factors, such as market conditions, the
ratings assigned by rating agencies, and regulatory conditions are out of our control. However, for those
factors over which we do have control, such as service quality, market commitment, financial strength and
stability, we believe we have competitive strengths that make us a viable competitor in those states where
we are currently writing insurance.
Professional Liability Segment:
We compete with insurance companies and self-insuring entities in the medical professional
liability market. Many of the competing companies concentrate on a single state and have an extensive
knowledge of the local markets. We also compete with large national insurers that may have greater
financial strength and other resources than we do.
22
We believe that we have a competitive advantage in the current market due to our size,
geographic scope and name recognition, as well as our heritage as a policyholder-founded company with
a long-term commitment to the professional liability insurance industry. These advantages have been
achieved through our balance sheet strength, claims defense expertise, strong ratings and ability to
deliver a high level of service to our insureds and agents. We believe that these competitive strengths
make us a viable competitor in those states where we are currently writing insurance.
Since 1999, insurance companies focused on medical professional liability coverage have
experienced higher claim costs on business written in prior years than they had reserved for initially. This
has resulted in significant losses, reduced capital to support current and future business, and higher
premium rates to meet expected higher claims costs.
Reduced profitability, reductions in surplus and capacity constraints have led many professional
liability carriers focused on medical professional liability coverages to withdraw from, or limit new business
in, one or more markets. Given the continued reduction in capacity and the uncertainty surrounding
several writers in the medical professional liability market, we believe there will be a “flight to quality” as
insurers place greater emphasis on financial strength and stability. We believe this trend will continue at
least until 2004.
Personal Lines Segment:
Personal lines insurance is highly competitive and some of these competitors are substantially
larger than we are and have much greater financial, technical and operating resources. Competition
depends on several factors including the price and quality of insurance products, the quality and speed of
service and claims response, financial strength, sales and marketing capability, technical expertise and
ratings assigned by A.M. Best and Standard & Poor’s.
Our strong capitalization provides operational
flexibility allowing growth and expansion
capabilities for current and new product lines. Offsetting these strengths is our geographic concentration
in a single state (Michigan) and our increasing exposure to large weather-related losses due to our
growing homeowners book of business.
Growth Opportunities and Outlook
We expect to achieve our growth primarily as a result of (i) the withdrawal of competitors from
actively writing business in certain states, (ii) increased prices in our professional liability business and (iii)
expansion of our personal lines business in Michigan.
We believe we are viewed as a market leader because of our financial strength and stability, and
our ability to deliver excellent service at the local level. This reputation allows us to take advantage of
marketing conditions that are improving as price increases are implemented and earned. Our stability
also makes us an attractive insurer in light of the highly publicized insolvencies in our industry, as well as
the regulatory actions taken against several former competitors.
We expect the growth of our professional liability business will be primarily generated through
increased pricing across our book of business. In 2002, we achieved average gross price increases of
approximately 28% on renewal business (weighted by premium volume). In 2001 we achieved average
gross renewal price increases of approximately 23% (weighted by premium volume).
We expect our future growth will also be supported by controlled expansion in our primary market
area and in states where we have recently commenced writing business but have little or no presence.
These states include Arkansas and Virginia, where The St. Paul Companies was a leading writer prior to
its departure from the market and which we believe have favorable medical and legal climates.
23
We also believe there will be additional opportunities for profitable expansion as a number of
insurers are experiencing financial difficulties, requiring them to reduce their business or completely exit
the marketplace. This may also lead to opportunities to expand through the acquisition of other
companies or books of business.
We believe we can achieve our growth while improving our combined ratio. Based on price
increases achieved to date, our objective is to achieve a combined ratio on our professional liability
business of 102% or lower. This takes into account expected increases in the cost of claims and
reinsurance protection purchased. As with all property and casualty companies, we expect the beneficial
impact of price increases and any development of losses to be fully reflected in our financial results over
time. We recognize the impact of higher prices as the associated premiums are earned which generally
occurs over the course of the year after the policy is written. In our personal lines business our objective
is to achieve an underwriting profit, which is in line with our historical financial results.
Insurance Regulatory Matters
We are subject to regulation under the insurance and insurance holding company statutes, of
various jurisdictions, including the domiciliary states of our insurance subsidiaries and other states in
which our insurance subsidiaries do business.
General:
Insurance companies are also affected by a variety of state and federal legislative and regulatory
measures and judicial decisions that define and qualify the risks and benefits for which insurance is
sought and provided. These include redefinitions of risk exposure in such areas as medical liability,
product liability, environmental damage and workers compensation. In addition, individual state insurance
departments may prevent premium rates for some classes of insureds from reflecting the level of risk
assumed by the insurer for those classes. Although there is limited federal regulation of the insurance
business, each state has a comprehensive system for regulating insurers operating in that state. In
addition, these insurance regulators periodically examine each insurer’s financial condition, adherence to
statutory accounting practices, and compliance with insurance department rules and regulations.
Our operating subsidiaries are required to file detailed annual reports with the state insurance
regulators in each of the states in which they do business. The laws of the various states establish
supervisory agencies with broad authority to regulate, among other things, licenses to transact business,
premium rates for certain types of coverage, trade practices, agent licensing, policy forms, underwriting
and claims practices, reserve adequacy, transactions with affiliates, and insurer solvency. Many states
also regulate investment activities on the basis of quality, distribution and other quantitative criteria.
States have also enacted legislation regulating insurance holding company systems, including
acquisitions, the payment of dividends, the terms of affiliate transactions, and other related matters. Our
principal 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.
24
Insurance Regulation Concerning Change or Acquisition of Control:
The insurance regulatory codes in our operating subsidiaries’ respective domiciliary states each
contain similar provisions (subject to certain variations) to the effect that the acquisition of “control” of a
domestic insurer or of any person that directly or indirectly controls a domestic insurer cannot be
consummated without the prior approval of the domiciliary insurance regulator. In general, a presumption
of “control” arises from the direct or indirect ownership, control, possession with the power to vote or
possession of proxies with respect to 10% (5% in Alabama) or more of the voting securities of a domestic
insurer or of a person that controls a domestic insurer. A person seeking to acquire control, directly or
indirectly, of a domestic insurance company or of any person controlling a domestic insurance company
must generally file an application for approval of the proposed change of control with the relevant
insurance regulatory authority.
In addition, certain state insurance laws contain provisions that require pre-acquisition notification
to state agencies of a change in control of a non-domestic insurance company admitted in that state.
While such pre-acquisition notification statutes do not authorize the state agency to disapprove the
change of control, such statutes do authorize certain remedies, including the issuance of a cease and
desist order with respect to the non-domestic admitted insurer’s doing business in the state if certain
conditions exist, such as undue market concentration.
Statutory Accounting and Reporting:
Insurance companies are required to file detailed annual reports with the state insurance
regulators in each of the states in which they do business, and their business and accounts are subject to
examination by such regulators at any time. The financial information in these reports is prepared in
accordance with the accounting requirements of the state regulatory authorities. The accounting
principles differ from Generally Accepted Accounting Principles (“GAAP”) and are referred to as Statutory
Accounting Practices (“SAP”). Insurance regulators periodically examine each insurer’s financial
condition, adherence to SAP, and compliance with insurance department rules and regulations.
Regulation of Dividends and Other Payments from Our Operating Subsidiaries:
We are a legal entity separate and distinct from our subsidiaries. As a holding company with no
other business operations, our primary sources of cash to meet our obligations, including principal and
interest payments with respect to indebtedness, are available dividends and other statutorily permitted
payments, such as tax allocation payments and management and other fees, from our operating
subsidiaries.
Our operating subsidiaries are subject to various state statutory and regulatory restrictions,
applicable generally to any insurance company in its state of domicile, which limit the amount of dividends
or distributions an insurance company may pay to its stockholders without prior regulatory approval. The
restrictions are generally based on certain levels or percentages of surplus, investment income and
operating income, as determined in accordance with SAP. Generally, dividends may be paid only out of
earned surplus. In every case, surplus subsequent to the payment of any dividends must be reasonable
in relation to an insurance company’s outstanding liabilities and must be adequate to meet its financial
needs.
State insurance holding company acts generally require domestic insurers to obtain prior
approval of extraordinary dividends. Under the insurance holding company acts governing our principle
operating subsidiaries, a dividend is considered to be extraordinary if the combined dividends and
distributions to the parent holding company in any 12 month period is 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.
25
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 hazardous to such
insurance company’s policyholders, the regulators may prohibit such payments that would otherwise be
permitted without prior approval.
Risk-Based Capital:
In order to enhance the regulation of insurer solvency, the National Association of Insurance
Commissioners (NAIC) specifies risk-based capital (RBC) requirements for property and casualty
insurance companies. These RBC requirements are designed to monitor capital adequacy and to raise
the level of protection that statutory surplus provides for policyholders. The NAIC’s RBC model law
stipulates four levels of regulatory action with the degree of regulatory intervention increasing as the level
of surplus falls below a minimum amount as determined under the model law. At December 31, 2002, all
ProAssurance’s insurance subsidiaries exceeded the minimum level and, as a result, no regulatory
response or action was required.
Investment Regulation:
Our operating subsidiaries are subject to state laws and regulations that require diversification of
investment portfolios and that limit the amount of investments in certain investment categories. Failure to
comply with these laws and regulations may cause non-conforming investments to be treated as non-
admitted assets for purposes of measuring statutory surplus and, in some instances, would require
divestiture.
Guaranty Funds:
All fifty states have separate insurance guaranty fund laws requiring admitted property and
casualty insurance companies doing business within their respective jurisdictions to be members of their
guaranty associations.
These associations are organized to pay covered claims (as defined and limited by the various
guaranty association statutes) under insurance policies issued by insurance companies that become
insolvent. Such guaranty association
laws create post-assessment associations, which make
assessments against member insurers to obtain funds to pay association covered claims after the
insolvency of an insurer occurs. These associations levy assessments (up to prescribed limits) on all
member insurers in a particular state on the basis of the proportionate share of the premiums written by
member insurers in the covered lines of business in that state. Maximum assessments permitted by law in
any one year generally vary between 1% and 2% of annual premiums written by a member in that state.
Some states permit member insurers to recover assessments paid through surcharges on policyholders
or through full or partial premium tax offsets, while other states permit recovery of assessments through
the rate filing process.
Shared Markets:
Our operating subsidiaries are required to participate in mandatory property and casualty shared
market mechanisms or pooling arrangements that provide certain insurance coverage to individuals or
other entities that are otherwise unable to purchase such coverage in the commercial insurance
marketplace. Our operating subsidiaries’ participation in such shared markets or pooling mechanisms is
not material to our business at this time.
26
Possible Legislative and Regulatory Changes:
In recent years, the insurance industry has been subject to increased scrutiny by regulators and
legislators. The NAIC and a number of state legislatures have considered or adopted legislative proposals
that alter and, in many cases, increase the authority of state agencies to regulate insurance companies
and insurance holding company systems.
In addition, several committees of Congress have made inquiries and conducted hearings as part
of a broad study of the regulation of insurance companies, and legislation has been introduced in several
of the past sessions of Congress which, if enacted, could result in the federal government assuming
some role in the regulation of the insurance industry. Although the federal government does not regulate
the business of insurance directly, federal initiatives often affect the insurance business in a variety of
ways. Current and proposed federal measures that may significantly affect the insurance business
include changes in medical patient protection laws such as the “Patients Bill of Rights,” tort reform and
environmental laws.
The Legislatures in various states are currently considering, or being asked to consider, changes
to the laws governing medical liability lawsuits. The changes are collectively called Tort Reforms. There
are also Tort Reform proposals being considered at the Federal level. In general, the changes would
place limits of non-economic damages, allow insurers more flexibility in paying large judgments, and
would alter some of the rules governing legal proceedings and qualification of expert witnesses. In certain
states, Tort Reform legislation may also place limits on the ability of medical liability insurers to raise or
maintain rates at adequate levels.
We do not believe it is possible to predict the outcome of any of the foregoing legislative,
administrative or congressional activities or the potential effects thereof on us.
Employees
At December 31, 2002, we employed 580 persons, including 386 employees in our Professional
Liability segment and 194 employees at MEEMIC. None of our employees is represented by a labor
union. We consider our employee relations to be good.
Forward-Looking Statements
Any written or oral statements made by us or on our behalf may include forward-looking
statements that reflect our current views with respect to future events and financial performance.
Forward-looking statements (identified by words such as, but not limited to, “believe”, “expect”, “intend”,
“anticipate”, “estimate”, “project” and other analogous expressions) include among other things
statements concerning: liquidity and capital requirements, return on equity, financial ratios, net income,
premiums, losses and loss reserves, premium rates and retention of current business, competition and
market conditions, the expansion of product lines, the development or acquisition of business in new
geographical areas, the availability of acceptable reinsurance, actions by regulators and rating agencies,
the effect of the consolidation of Medical Assurance and Professionals Group into ProAssurance, the
effects of the merger of MEEMIC into ProAssurance, compliance with our credit agreement, payment of
dividends, and other matters.
These forward-looking statements are based upon our estimates and anticipation of future events
that are subject to certain risks and uncertainties that could cause actual results to vary materially from
the expected results described in the forward-looking statements. Due to such risks and uncertainties,
you are urged not to place undue reliance on forward-looking statements. All forward-looking statements
included in this document are based upon information available to us on the date hereof, and we
undertake no obligation to publicly update or revise any forward-looking statements, whether as a result
of new information, future events or otherwise.
27
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.
ITEM 2: PROPERTIES
We own a 156,000 square foot office building located in Birmingham, Alabama where we
currently occupy approximately 55,000 square feet and plan to occupy approximately 14,500 square feet
of additional office space. The remaining office space is leased to unaffiliated persons or is available to be
leased. We also own a 53,000 square foot office building in Okemos, Michigan that we fully occupy. Both
buildings are currently unencumbered. MEEMIC leases its principal executive offices in Auburn Hills,
Michigan. MEEMIC owns, primarily for investment purposes, an 11.5-acre vacant parcel of land in Auburn
Hills, Michigan. We lease other office facilities in various locations and lease computer and operating
equipment under cancelable and non-cancelable agreements.
28
ITEM 3: LEGAL PROCEEDINGS
Our insurance subsidiaries are involved in various legal actions, a substantial number of which
arise from claims made under insurance policies. While the outcome of all legal actions is not presently
determinable, management and its legal counsel are of the opinion that these actions will not have a
material adverse effect on our financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
Executive Officers of ProAssurance Corporation
The executive officers of ProAssurance serve at the pleasure of the Board of Directors. Set forth
below are the current executive officers of ProAssurance and a brief description of their principal
occupation and employment during the last five years.
A. Derrill Crowe, M.D.
Victor T. Adamo, Esq.
Dr. Crowe has served as Chairman of our Board and our Chief Executive
Officer since we began operations in June 2001. Dr. Crowe has also
served as President, Chairman of the Board and Chief Executive Officer
of Medical Assurance since its formation in 1995, and as President,
Chief Executive Officer, and a director of Medical Assurance Company
since its founding in 1977. Dr. Crowe also serves as chairman of the
board of MEEMIC Holdings. (Age 66)
Mr. Adamo has served as our Vice Chairman, President, and Chief
Operating Officer since we began operations in June 2001. Mr. Adamo
also serves as President, Chief Executive Officer and a director of
Professionals Group. Mr. Adamo has served as a director of ProNational
since 1990, and was its Chief Executive Officer since 1987. Mr. Adamo
is the Chief Executive Officer and a director of MEEMIC Holdings.
(Age 55)
29
Paul R. Butrus
Howard H. Friedman
James J. Morello
Mr. Butrus has served as our Vice Chairman and a director of
ProAssurance since we began operations in June 2001. Mr. Butrus has
been Executive Vice President and a director of Medical Assurance
since its incorporation in 1995. Mr. Butrus has been employed by
Medical Assurance Company and its subsidiaries since 1977, most
recently as Executive Vice President and Chief Operating Officer since
1993. (Age 62)
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 44)
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 54)
30
Frank B. O’Neil
William P. Sabados
Lynn M. Kalinowski
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 49)
Mr. Sabados has served as our Chief Information Officer since we began
operations in June 2001 and for Professionals Group since July 1998.
Mr. Sabados has been Senior Vice President and Chief Information
Officer of MEEMIC since 1997. In addition, he currently serves as
director and Chief Information Officer for ProNational. (Age 53)
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 50)
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
At March 17, 2003, ProAssurance Corporation (PRA) had 3,736 stockholders of record and
28,880,185 shares of common stock outstanding. ProAssurance’s common stock currently trades on The
New York Stock Exchange (NYSE) under the symbol “PRA".
ProAssurance had no outstanding shares prior to the completion of the consolidation of Medical
Assurance, Inc. (NYSE:MAI) and Professionals Group, Inc. (NASDAQ:PICM) on June 27, 2001. As a
result of the consolidation, each share of Medical Assurance stock was converted to a share of stock in
ProAssurance; the conversion ratio of Professionals Group shares was based on the market value of
Medical Assurance stock during a period immediately preceding the consolidation. Shares of Medical
Assurance and Professionals Group ceased trading and were delisted from their respective public
markets following the close of business on June 27, 2001.
31
ProAssurance common stock began trading on the NYSE on June 28, 2001. Because the NYSE
considered the consolidation as the formation of a holding company for Medical Assurance and a change
of its corporate name, the quotations below reflect prices for Medical Assurance common stock prior to
June 28, 2001, and for ProAssurance common stock from that date forward. All quotations reflect trading
on the NYSE.
Quarter
2002
2001
First
Second
Third
Fourth
High
Low
$18.22
19.70
18.00
21.11
$15.99
16.01
14.20
15.78
High
$18.06
16.49
19.13
17.99
Low
$12.00
12.30
14.50
13.49
Neither Medical Assurance nor ProAssurance has paid any cash dividends on its common stock
and ProAssurance does not currently have a policy to pay regular dividends. ProAssurance is limited in
its ability to pay cash dividends by certain covenants in its credit agreement with the banks that provided
financing for the consolidation. Generally, ProAssurance may not, without the consent of the lending
bankers, declare any cash dividends or repurchase its stock if the total funds to be expended would
exceed 25% of its cumulative net income earned after June 27, 2001.
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 25 of
this 10-K.
32
ITEM 6. SELECTED FINANCIAL DATA
Selected Financial Data
Gross premiums written (C)
Net premiums written (C)
$ 636,156
537,123
$ 388,983
310,291
$ 223,871
194,279
$ 201,593
156,923
$ 192,479
141,787
2002
2001
2000
1999
1998
(in thousands, except per share amounts)
Premiums earned (C)
Premiums ceded (C)
Net premiums earned (C)
Net investment income (C)
Net realized investment gains (losses) (C)
Other income (C)
576,414
(99,006)
477,408
76,918
(5,306)
6,747
555,767
381,510
(68,165)
313,345
59,782
5,441
3,987
382,555
216,297
(38,701)
177,596
41,450
913
2,630
222,589
207,492
(43,068)
164,424
39,273
1,787
2,545
208,029
195,515
(54,199)
141,316
39,402
11,281
1,604
193,603
Total revenues
Net losses and loss
adjustment expenses (C)
Income before cumulative effect of
accounting change
Net income (A) (C) (D)
Income per share before cumulative
effect of accounting change (B) (C)
Basic
Diluted
Net income per share: (B) (C) (D)
Basic
Diluted
Weighted average number
of shares outstanding: (B)
Basic
Diluted
BALANCE SHEET DATA:
(as of December 31)
Total investments
Total assets
Reserve for losses and
loss adjustment expenses
Long-term debt
Total liabilities
Total capital
Total capital per share of
448,029
298,558
155,710
104,657
93,893
10,513
12,207
12,450
12,450
24,300
24,300
46,700
46,700
48,523
47,400
$ 0.40
$ 0.39
$ 0.47
$ 0.46
$ 0.51
$ 0.51
$0.51
$0.51
$ 1.04
$ 1.04
$1.04
$1.04
$ 1.95
$ 1.95
$1.95
$1.95
$ 1.96
$ 1.96
$1.92
$1.92
26,231
26,254
24,263
24,267
23,291
23,291
23,992
24,008
24,729
24,731
$ 1,679,497
2,586,650
$1,521,279
2,238,325
$ 796,526
1,122,836
$ 761,918
1,117,668
$ 791,579
1,132,239
1,622,468
1,442,341
72,500 82,500
2,055,086 1,802,606
505,194 413,231
659,659
--
777,669
345,167
665,792
--
791,944
325,724
660,640
--
808,059
324,180
common stock outstanding (B)
$ 17.49
$ 16.02
$ 15.22
$ 13.92
$ 13.24
Common stock outstanding
at end of year (B)
28,877
25,789
22,682
23,401
24,477
(A) Net income for 1998 was reduced by $1.1 million, which represents the cumulative effect (net of tax) of an accounting change
for guaranty fund assessments due to the adoption of the American Institute of Certified Public Accountants’ Statement of
Position 97-3. The cumulative effect reduced net income per share of common stock (basic and diluted) by $0.04 per share.
(B) The Board of Directors declared special stock dividends in December 1999 (5%) and 1998 (10%). All net income per share and
total capital per share data on this page has been restated as if the dividends had been declared on January 1, 1998.
Additionally, treasury stock is excluded from the date of acquisition for purposes of determining the weighted average number
of shares outstanding used in the computation of net income per share of common stock.
(C) Operating results include the operating results of Professionals Group since the date of consolidation, June 27, 2001. See Note
2 to the Consolidated Financial Statements.
(D) 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 10 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.
33
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Liquidity and Capital Resources and Financial Condition
We need liquid funds to pay losses and loss adjustment expenses (losses and LAE) and
operating expenses in the ordinary course of business and to meet our debt service requirements. Cash
provided by our operating activities was sufficient to meet those needs in 2002, 2001 and 2000. We
believe that our operating activities will provide sufficient cash to meet our liquidity needs during 2003.
During the fourth quarter of 2002, ProAssurance sold 3,025,000 shares at $16.55 per share in a
public offering that generated additional capital of $46.5 million. As of December 31, 2002, we have
increased the statutory surplus of our professional liability segment by $36 million in support of the growth
of that segment and expect to use the remaining proceeds from the sale to support additional growth of
our professional liability insurance business and for general corporate purposes.
Our positive cash flow from operations of $195 million plus the $46.5 million proceeds from the
public offering are the principal reasons for the $248.4 million increase during 2002 in our Invested Assets
and Cash and Cash Equivalents.
Our reserves for net losses and loss adjustment expenses (net of amounts receivable from
reinsurers) at December 31, 2002 increased approximately $92.2 million over those at December 31,
2001. Substantially all of this increase is in our professional liability segment, a “long tailed” business. A
characteristic of a “long tailed” business is that there is a long length of time between the occurrence of
an insured event and significant payment on that event. Because of this characteristic, it is not unusual for
reserves to increase as our business increases.
At December 31, 2002 we have a term loan balance of $72.5 million remaining from the $110
million that we borrowed in order to fund the cash requirements of the consolidation with Professionals
Group. We are required to pay quarterly principal repayments of $2.5 million, and beginning in 2003, an
additional annual principal payment equal to the lower of either 50% of our parent company only
operating cash flow for the preceding year or $15 million. We have made all quarterly payments on the
loan, and we also made a $22.5 million optional prepayment in September 2001. The term loan bears
interest at a variable rate based on the London Interbank Offered Rate (LIBOR) or the bank’s base rate at
our election. At December 31, 2002 the interest rate was 2.9%. The required 2003 annual repayment
based on parent-only adjusted cash flow is $0.
The credit agreement also provides for a revolving line of credit in the amount of $40 million. The
revolving line of credit is available for our operating and working capital requirements. We have not
borrowed any funds under the line and expect to renew the line at the same or a greater amount of credit
when the line expires in May 2003.
The borrowings under the credit agreement are secured by a pledge of the outstanding stock of
all of our significant subsidiaries other than MEEMIC Holdings and its subsidiaries. The credit agreement
for the term loan, as is customary for credit agreements of this size and nature, requires that
ProAssurance maintain certain financial standards, otherwise known as loan covenants. As of December
31, 2002 we were in compliance with all loan covenants.
See Notes 2 and 12 to our Consolidated Financial Statements for more information regarding the
consolidation transaction and the terms of the credit agreement, including the financial covenants.
34
ProAssurance did not repurchase any shares of our common stock during the year ended
December 31, 2002. Our board has authorized stock repurchases of up to approximately one million
shares.
At December 31, 2002 ProAssurance indirectly owned 84% of MEEMIC Holdings, Inc. 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
transactions. The funds were derived from MEEMIC Holdings’ cash and investment resources.
Overview
ProAssurance commenced operations on June 27, 2001 through a transaction that joined
Medical Assurance and Professionals Group as the wholly owned subsidiaries of ProAssurance. The
consolidation of Medical Assurance into ProAssurance was in the form of a corporate reorganization and
the assets, liabilities, stockholders’ equity and results of operations of Medical Assurance are included in
ProAssurance’s consolidated financial statements for the entirety of all periods presented. Prior to June
27, 2001 ProAssurance’s consolidated financial statements do not include the assets, liabilities or results
of operations of Professionals Group because
into
ProAssurance was in the form of a purchase transaction. For additional information about the
consolidation, see Note 2 to the Consolidated Financial Statements.
the consolidation of Professionals Group
Segment Overview:
We operate in two industry segments: professional liability insurance and personal lines
insurance. Prior to the consolidation, we operated only in the professional liability segment. Our
operations have included a personal lines segment since June 27, 2001, when MEEMIC Insurance
Company was acquired as a part of the Professionals Group consolidation transaction.
liability
Our professional
insurance and
reinsurance for providers of health care services, and, to a limited extent, providers of legal services. The
principal operating insurance subsidiaries of this segment are: The Medical Assurance Company, Inc.,
Medical Assurance of West Virginia, Inc, ProNational Insurance Company and Red Mountain Casualty
Insurance Company, Inc.
insurance segment principally provides
liability
Our personal lines insurance segment provides personal property and casualty insurance to
individuals. Our personal lines segment includes the operations of a single insurance company, MEEMIC
Insurance Company.
All of our revenues and expenses are allocated to the operating segments, other than investment
income earned directly by the parent holding company and interest expense related to long-term debt
held by the parent.
35
Critical Accounting Policies
We are required to make estimates and assumptions in certain circumstances that affect amounts
reported in our consolidated financial statements and related footnotes. We evaluate these estimates and
assumptions on an on-going basis based on historical developments, market conditions, industry trends
and other information that we believe to be reasonable under the circumstances. There can be no
assurance that actual results will conform to our estimates and assumptions, and that reported results of
operations will not be materially adversely affected from time to time by the need to make accounting
adjustments reflecting changes in these estimates and assumptions. We believe the following policies are
the most sensitive to estimates and judgments.
Premium Income: We recognize insurance premium income on a monthly pro rata basis over the
respective terms of the policies in force. Unearned premiums represent the portion of premiums written
applicable to the unexpired terms of the policies in force.
Reserve for Losses and Loss Adjustment Expenses (“losses and LAE”): Our reserve for losses
and LAE represents our estimate of the future amounts necessary to pay claims and expenses
associated with investigation and settlement of claims. These estimates consist of case reserves and bulk
reserves. Case reserves are estimates of future losses and LAE for reported claims and are established
by our claims departments. Bulk reserves, which include a provision for losses that have occurred but
have not been reported to us as well as development on reported claims, are the difference between (i)
the sum of case reserves and paid losses and (ii) an actuarially determined estimate of the total losses
and LAE necessary for the ultimate settlement of all reported claims and incurred but not reported claims,
including amounts already paid. The estimates take into consideration our past loss experience, available
industry data and projections as to future claims frequency, severity, inflationary trends and settlement
patterns. Independent actuaries review our reserves for losses and LAE each year and prepare reports
that include recommendations as to the level of reserves. We consider these recommendations as well as
other factors, such as known, anticipated or estimated changes in frequency and severity of claims and
loss retention levels and premium rates, in establishing the amount of our reserves for losses and loss
adjustment expenses. Estimating reserves is a complex process that is heavily dependent on judgment
and involves many uncertainties. This is particularly true of our professional liability reserves since these
claims are typically resolved over a long period time, often exceeding five years. As a result, 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 current operations. Due to the size of our reserves, even a small
percentage adjustment to the assumptions can have a material effect on our results of operations for the
period in which the change is made.
Reinsurance: Loss recoveries and receivables from reinsurers are estimates of the ultimate
amount of our losses and LAE that will be reimbursed by reinsurers. We also estimate premiums ceded
under reinsurance agreements wherein the premium, subject to certain maximums and minimums, due to
the reinsurer is a percentage of the losses paid under the agreement. These estimates are based upon
our estimates of the ultimate losses and LAE that we expect to incur and the portion of those losses that
we expect to be allocable to reinsurers based upon the terms of our reinsurance agreements. Given the
uncertainty of the ultimate amounts of our losses and LAE, these estimates may vary significantly from
the eventual outcome. Our estimates of the amounts receivable from and due to reinsurers are regularly
reviewed and updated by management as new data becomes available. Any adjustments necessary are
reflected in then current operations.
36
Investments: We consider our fixed maturity and equity securities as available-for-sale, which
means they are available to be sold in response to our liquidity needs, changes in market interest rates
and investment management strategies, among others. Available-for-sale securities are recorded at fair
value, with unrealized gains and losses, net of the related income tax effect, excluded from income and
reported as a separate component of shareholders' equity.
We evaluate the securities in our investment portfolio on at least a quarterly basis for declines in
market value below cost for the purpose of determining whether these declines represent other than
temporary declines. The evaluation involves judgment by management. Some of the factors we consider
in the evaluation of our investments are:
•
•
•
the extent to which the market value of the security is less than its cost basis
the length of time for which the market value of the security has been less than its cost basis
the financial condition and near-term prospects of the security’s issuer, taking into consideration
the economic prospects of the issuers’ industry and geographical region, to the extent that
information is publicly available
• ProAssurance’s ability and intent to hold the investment for a period of time sufficient to allow for
any anticipated recovery in market value
A decline in the fair value of an available-for-sale security below cost that we judge to be other
than temporary is realized as a loss in the current period and reduces the cost basis of the security. In
subsequent periods, we base any measurement of gain or loss or decline in value upon the adjusted cost
basis of the security.
37
Results of Operations—Year ended December 31, 2002 Compared to Year Ended December 31,
2001
Our consolidated income before cumulative effect of accounting change is $10.5 million, or $0.40
per share, for the year ended December 31, 2002. The operating results of each of our reportable
industry segments are discussed separately in the following sections.
The year ended December 31, 2002 includes Professionals Group activity for the entire period,
while the year ended December 31, 2001 includes Professionals Group activity only since June 27, 2001.
Thus, when the two periods are compared, significant variances are created because 2001 operating
results do not include Professionals Group operating results for the first six months of 2001.
Net income for 2002 was reduced by net realized investment losses of $5.3 million while net
income for 2001 was increased by net realized investment gains of $5.4 million. During 2002, we
recognized losses of $21.3 million for other than temporary declines in the market value of our equity and
fixed maturity securities. Approximately $18.2 million of the impairment losses related to our investments
in common stock. Gains realized during 2002 from sales of fixed maturity securities largely offset the
impairment losses. We purchase fixed maturity securities with the initial intent to hold such securities until
their maturity; however, we may dispose of securities prior to their respective maturities if we believe such
disposals are consistent with our overall investment objectives, including maximizing total yields over
time, maximizing after-tax profits and disposing of securities that no longer meet our risk management
criteria. Throughout 2002 but particularly in the latter half of 2002, bond prices increased substantially,
both in response to historically low market interest rates and in response to uncertainty in the equity
market. In response to these market conditions, we undertook a significant restructuring of our fixed
maturity portfolio during the fourth quarter and sold $304.5 million of fixed maturity securities for net gains
of approximately $16.5 million. These sales contributed to the shortening of our investment portfolio and
reduced the weighted average yield of our fixed maturity portfolio.
Interest expense of $2.9 million in 2002 and $2.6 million in 2001 relates entirely to the bank loan
that provided financing for the consolidation with Professionals Group. The debt bears interest at a
variable rate based on the London Interbank Offered Rate (LIBOR), or at our election, the bank's base
rate. The interest rate is 2.9% on December 31, 2002. We initially borrowed $110 million on June 27,
2001 to finance the consolidation. Because the cash requirements of the consolidation were lower than
we originally anticipated, we made a $22.5 million prepayment on the loan in September 2001.
Interest expense increased during 2002 as compared to 2001 because there was no outstanding
loan balance for the first six months of 2001. The increase was limited to approximately $284,000
because interest rates were lower throughout 2002 as compared to 2001 and we repaid principal during
2002 as required under the loan agreement.
We recognized tax benefits of $188,000 and $2.9 million for the years ended December 31, 2002
and 2001, respectively. Our effective rate for both years is significantly lower than the expected 35%
statutory rate because approximately 25% in 2002 and 37% in 2001 of our investment income was
earned from tax-exempt sources. After adjustment for tax-exempt income, we experienced a taxable loss
for the years ended December 31, 2002 and 2001.
Minority interest in both 2002 and 2001 relates entirely to the minority interest in MEEMIC
Holdings. This minority interest was purchased on January 29, 2003 as discussed under “Liquidity and
Capital Resources.”
After adjustment for our tax liability for the year ended December 31, 2002, we have available
approximately $10.1 million in Federal tax loss carryforwards related to tax years ending on or before
December 31, 2001 that will expire in the year 2021. We also have available approximately $7.9 million
38
in Alternative Minimum tax carryforwards that can be applied against any future regular tax payable. The
Alternative Minimum tax carryforwards have no expiration date.
Professional Liability Insurance Segment
Operating results for our professional liability insurance segment for the years ended December
31, 2002 and 2001 are summarized in the table below (dollars in thousands).
Year ended
December 31
2002
2001
Increase
(Decrease)
461,715
$
315,698
$
146,017
376,702
$
238,867
$
137,835
412,656
$
310,222
$
102,434
85,011
66,307
18,704
Gross premiums written
Net premiums written
Revenues:
Premiums earned
Premiums ceded
$
$
$
Net premiums earned
327,645
243,915
83,730
Net investment income
Net realized investment
gains (losses)
Other income
66,790
54,339
12,451
(6,099)
5,441
(11,540)
4,960
3,130
1,830
Total revenues
393,296
306,825
86,471
Expenses:
Net losses and loss
adjustment expenses
Underwriting, acquisition
351,320
250,257
101,063
and insurance expenses
56,613
55,021
1,592
Total expenses
407,933
305,278
102,655
Income (loss)
before income taxes
$
(14,637)
$
1,547
$
(16,184)
Net loss and LAE ratio
Underwritng expense ratio
Combined ratio
107.2
17.3
124.5
%
%
102.6
22.6
125.2
%
%
4.6
(5.3)
(0.7)
%
%
December 31
2002
2001
Net reserves for loss and LAE
$
1,096,205
$
1,004,462
39
Premiums
Premiums written:
Our professional liability insurance segment principally provides liability insurance for providers of
medical and other healthcare services, and to a limited extent providers of legal services (Professional
Coverages). The professional liability segment also includes accident and health and workers’
compensation insurance (Other Coverages).
Premiums written for the professional liability segment for the year ended December 31, 2002
were $461.7 million, which is an increase of $146.0 million as compared to the same period of 2001. This
increase is comprised of a $184.7 million increase related to Professional Coverages offset by a $38.7
million decrease related to Other Coverages.
Professional Coverages premiums written increased to $457.2 million for the year ended
December 31, 2002. The increase is primarily due to the consolidation with Professionals Group but also
reflects the beneficial effect of rate increases implemented during 2002 and 2001. We have implemented
and we plan to continue to implement rate increases based on loss trends, subject to our receipt of
regulatory approval. We have experienced some loss of insureds due to the higher rates. However, to
date, our premium renewals and new business at the higher rates have more than offset the effect of non-
renewals. We estimate that, on average, 2002 renewals were at rates that were approximately 28%
higher than 2001 rates.
Gross written premiums for Other Coverages were approximately $4.5 million for the year ended
December 31, 2002 as compared to $43.2 million for the same period in 2001. Our Other Coverages
premiums were primarily written in conjunction with and through third parties as a means of utilizing our
capital. During the latter half of 2000 we decided to significantly decrease our commitment to these
programs and have since allowed existing contractual relationships to expire. The decline in Other
Coverages premiums is the expected result of this decision.
Premiums earned:
Premiums earned for the year ended December 31, 2002 increased by $102.4 million as
compared to the year ended December 31, 2001. As with written premiums, this increase is comprised of
an increase related to Professional Coverages offset by a decrease related to Other Coverages.
Our Professional Coverages premiums earned for the year ended December 31, 2002 increased
by $139.4 million to $404.0 million. The increase is primarily due to the additional premiums earned as a
result of the consolidation but, as with written premiums, also reflects the beneficial impact of rate
increases. Rate increases implemented after January 1, 2002 have not yet been fully reflected in
premiums earned since premiums are earned over the entire policy period (usually one year) after the
policy is written.
Other Coverages premiums earned for the year ended December 31, 2002 were $8.7 million, a
decrease of $37.0 million as compared to the year ended December 31, 2001, reflecting our decreased
commitments to the programs that generated these premiums, as previously discussed. We do not
expect to earn any significant amount of Other Coverage premiums in 2003.
40
Premiums ceded:
Premiums ceded for the year ended December 31, 2002 increased by $18.7 million as compared
to the year ended December 31, 2001. The increase is comprised of a $23.4 million increase related to
Professional Coverages offset by a $4.7 million decrease related to Other Coverages.
Professional Coverages premiums ceded were $78.4 million for the year ended December 31,
2002. The primary reasons for the increase are the growth in premiums earned that resulted from the
consolidation with Professionals Group and rate increases.
Other Coverages premiums ceded were $6.6 million for the year ended December 31, 2002,
reflecting the decline in related earned premiums, as previously discussed.
Losses and Loss Adjustment Expenses
As discussed in our critical accounting policies, our reserve for losses and loss adjustment
expenses represents our estimate of the future amounts necessary to pay claims and expenses
associated with investigation and settlement of claims. The resulting net losses and loss adjustment
expenses (hereafter referred to as “net losses”) may be summarized into three components of these
estimates: (i) actuarial evaluation of incurred loss levels for the current accident year; (ii) actuarial re-
evaluation of incurred loss levels for prior accident years and (iii) actuarial re-evaluation of the reserve for
the death, disability and retirement provision.
Accident year refers to the period in which the insured event becomes a liability of the insurer. For
occurrence policies the insured event becomes a liability when the event takes place; for claims-made
policies the insured event becomes a liability when the event is first reported to the insurer. We believe
that measuring losses on an accident year basis is the most indicative measure of the underlying
profitability of the premiums earned in that period, since it associates policy premiums earned with our
estimate of the losses incurred related to those policy premiums.
41
The following table summarizes net losses and net loss ratios for 2002 and 2001 by type of
coverage and by separating losses between the current accident year and all prior years (dollars in
thousands). The net loss ratios shown are calculated by dividing the applicable net losses by current
calendar year net premiums earned.
Current accident year net losses
and LAE:
Professional Coverages
Other Coverages
Change in prior accident
year net losses *
Change in death, disability and
retirement reserves
Calendar year net losses
Current accident year net loss ratio:
Professional Coverages
Other Coverages
Net loss ratio attributable to:
Current accident year net losses
Prior accident year net losses
Change in death, disability
and retirement reserves
Year ended
December 31
2002
2001
$
331,494
1,666
$
231,489
23,597
18,160
13,818
-
351,320
$
(18,647)
250,257
$
101.8
77.9
%
%
108.8
75.9
%
%
%
101.7
5.5
-
107.2
%
%
104.6
5.7
(7.7)
102.6
%
* All losses incurred in 2001 related to the book of business acquired from
Professionals Group are considered to be current accident year losses because
there was no liability for these losses prior to the consolidation transaction.
Professional Coverages:
Current accident year net losses related to Professional Coverages for the year ended December
31, 2002 increased by $100.0 million as compared to the year ended December 31, 2001. Our
consolidation with Professionals Group and the resulting increase in premiums is the primary reason for
the increase. The current accident year net loss ratio for Professional Coverages for the year ended
December 31, 2002 as compared to the same period in 2001 has decreased from 108.8% to 101.8 %.
The improvement in the loss ratio primarily reflects the effects of a more adequate premium structure as a
result of rate increases implemented during 2002 and 2001.
Other Coverages:
Current accident year net losses related to Other Coverages decreased by $21.9 million year
ended December 31, 2002 as compared to the same periods of 2001. The decrease resulted from the
termination of the programs that generated these losses, as previously discussed with respect to Other
Coverages premiums.
42
Prior Year Net Losses/ Change in Death, Disability and Retirement Reserves
We increased our estimates of professional liability prior accident year net losses by $18.2 million
during 2002. In 2001, we increased our estimates of prior year losses by $13.8 million. In both periods,
our estimates of losses related to prior year were adjusted based upon actuarial evaluations performed
during the period
In 2001, we decreased our estimate of the reserves required for death, disability and retirement
by $18.6 million. The decrease was primarily related to the ProNational book of business and was
principally the result of an increase in the premium rate loads and a decrease in the number of insureds.
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 current
operations. Due to the size of our reserves, even a small percentage adjustment to the assumptions can
have a material effect on our results of operations for the period in which the change is made.
Net Investment Income
Our professional liability segment investment income is primarily derived from the interest income
earned by our fixed maturity securities but also includes interest income from short-term and cash
equivalent investments, dividend income from equity securities, and rental income earned by our
commercial real estate holdings. Investment fees and expenses and real estate expenses are deducted
from investment income. Our net investment income for the year ended December 31, 2002 increased
by $12.5 million as compared to the same period in 2001. The primary reason for the increase is the
additional investment income earned as a result of the consolidation with Professionals Group.
During 2002, we experienced a decline in overall investment yields as a result of lower market
interest rates, both short and long-term. Our investment opportunities for new and matured funds have
been at rates that are less favorable than the rates available in recent years. Our average investment in
lower yielding short-term and overnight cash investments increased during 2002 due to a lack of more
desirable long-term investment opportunities. Additionally, as we have invested new and matured funds,
we have utilized shorter maturities. We believe a shorter, more liquid portfolio is currently advantageous,
even preferable, although such a strategy reduces current yields.
Interest income from fixed maturity investments comprised 93% of our total investment income in
2002 and 88% of our total investment income in 2001. The weighted average tax equivalent book yield
(tax adjusted gross earnings divided by the average quarterly ending book value) of our professional
liability segment fixed maturity investments was 6.1% for 2002 as compared to 6.6% for the year ended
December 31, 2001. The weighted average tax equivalent book yield of the securities in our fixed maturity
portfolio at December 31, 2002 was 6.3%.
43
Net Realized Investment Gains (Losses)
Net realized investment gains (losses) includes gains and losses realized on sales of investment
securities and realized losses for other than temporary impairments in the fair value of investment
securities, as shown in the following table.
2002
2001
Net gains from sales
Other than temporary impairment losses
$
15,205
(21,304)
$
5,850
(409)
Net realized investment gains (losses)
$
(6,099)
$
5,441
Approximately $18.2 million of the impairments recognized during 2002 were related to our equity
securities; approximately $3.1 million of the impairments were related to fixed maturity securities.
Approximately $14.7 million of our net gains from sales were from sales of fixed maturity
securities. We purchase fixed maturity securities with the initial intent to hold such securities until their
maturity, however, we may dispose of securities prior to their respective maturities if we believe such
disposals are consistent with our overall investment objectives, including maximizing total yields over
time, maximizing after-tax profits and disposing of securities that no longer meet our risk management
criteria. Throughout 2002 but particularly in the latter half of 2002, bond prices increased substantially,
both in response to historically low market interest rates and in response to uncertainty in the equity
market. In response to these market conditions we undertook a significant restructuring of our fixed
maturity portfolio during the fourth quarter. Most of the gains recognized for 2002 resulted from these
restructuring activities.
Underwriting, Acquisition and Insurance Expenses
Underwriting, acquisition and insurance expenses increased by $1.6 million for the year ended
December 31, 2002 as compared to the same period in 2001. Expenses related to Professional
Coverages premiums earned increased by $15.9 million, however, this increase was largely offset by a
$14.3 million decrease in expenses related to Other Coverages premiums earned. The increase in
Professional Coverages expenses primarily reflects the additional six months of Professionals Group
activity that is included in 2002. The decrease in Other Coverages expenses is due to the termination of
these programs as previously discussed.
The underwriting expense ratio (underwriting, acquisition and insurance expenses divided by net
premiums earned) decreased as compared to 2001. The ratio for the year ended December 31, 2002 is
17.3% as compared to 22.6% for the same period in 2001. The decrease in Other Coverages acquisition
costs discussed above reduced the ratio by 3.5%. The remaining 1.8% decrease in the ratio is primarily
due to operating efficiencies realized in 2002 and the effect of rate increases.
Guaranty fund assessments for the years ended December 31, 2002 and 2001 were
approximately $1.9 million and $1.3 million, respectively. We are required by most states to be a member
of its insolvency or guaranty fund association and, as such, must make payments to the association when
so assessed by the state. Such assessments can and do vary from year to year.
44
Personal Lines Insurance Segment
Our personal lines segment is comprised of the operations of a single insurance company,
MEEMIC Insurance Company, acquired on June 27, 2001 as a part of the consolidation with
Professionals Group. The year ended December 31, 2002 includes twelve months of MEEMIC operations
while the year ended December 31, 2001 includes only six months of MEEMIC operations. Selected
financial data for our personal lines insurance segment is summarized in the table below (dollars in
thousands).
Year ended
December 31
2002
2001
Increase
(Decrease)
$
$
$
$
$
$
174,441
160,421
163,758
13,995
149,763
10,071
793
1,787
162,414
96,709
34,640
131,349
73,285
71,424
71,288
1,858
69,430
5,003
-
857
75,290
48,301
15,416
63,717
$
$
$
101,156
88,997
92,470
12,137
80,333
5,068
793
930
87,124
48,408
19,224
67,632
$
31,065
$
11,573
$
19,492
Gross premiums written
Net premiums written
Revenues:
Premiums earned
Premiums ceded
Net premiums earned
Net investment income
Net realized investment
gains (losses)
Other income
Total revenues
Expenses:
Net losses and loss
adjustment expenses
Underwriting, acquisition
and insurance expenses
Total expenses
Income (loss)
before income taxes
and minority interest
Net loss and LAE ratio
Underwritng expense ratio
Combined ratio
64.6
23.1
87.7
%
%
69.6
22.2
91.8
%
%
(5.0)
0.9
(4.1)
%
%
December 31
2002
2001
Net reserves for loss and LAE
$
64,251
$
63,823
45
Premiums
Premiums written:
Gross written premiums increased by $101.2 million to $174.4 million for the year ended
December 31, 2002 as compared to the year ended December 31, 2001. For all lines, the principal
reason for the increase is the inclusion of an additional six months of MEEMIC activity in 2002.
Premiums by line of business for each year are as follows (dollars in thousands):
Year Ended December 31
Automobile
Homeowners
Boat, umbrella and other
2002
Amount
$ 147,168
26,600
673
$ 174,441
2001
%
84.4%
Amount
$ 62,422
%
85.2%
14.5%
0.3%
226
100.0% $ 73,285 100.0%
10,637
15.2%
0.4%
Automobile premiums also increased due to growth in the number of policyholders, an increase in
the value of autos insured and an increase in the MCCA mandatory statutory assessments that are
passed through to automobile policyholders. During 2002 the number of vehicles insured grew by
approximately 4.5%.
Homeowner premiums also increased due to average rate increases of approximately 20%, an
increase in the value of homes insured and growth in the number of policyholders. During 2002 the
number of homes insured grew by approximately 14.5%.
Premiums earned:
Premiums earned for the year ended December 31, 2002 increased by $92.5 million as
compared to the year ended December 31, 2001. As with written premiums, this increase is primarily due
to the inclusion of an additional six months of MEEMIC activity in 2002 but also increased due to the
effects of rate increases and growth in the number of insureds.
Premiums ceded:
Premiums ceded are the portion of our earned premiums due to reinsurers in return for the
transfer of a portion of our risk to them. Premiums ceded for the year ended December 31, 2002
increased by $12.1 million as compared to the year ended December 31, 2001. Approximately $11.2
million of this increase is attributable to an increase in the premiums due to a single reinsurer, the MCCA.
The remainder of the increase is primarily attributable to the additional six months of MEEMIC activity in
2002.
46
Losses and Loss Adjustment Expenses
The following table summarizes personal lines net losses and net loss ratios for 2002 and 2001
by separating losses between the current accident year and all prior accident years (dollars in
thousands). The net loss ratios shown are calculated by dividing the applicable net losses by current
calendar year net premiums earned.
Year ended
December 31
2002
2001
Net losses and LAE:
Current accident year
Prior accident years *
Calendar year net losses and LAE
$
$
106,440
(9,731)
96,709
$
$
48,301
-
48,301
Net loss ratio attributable to:
Current accident year net losses and LAE
Prior accident year net losses and LAE
Calendar year net loss ratio
71.1
(6.5)
64.6
%
%
69.6
-
69.6
%
%
∗ All losses incurred in 2001 are considered to be current accident year losses because
there was no liability for personal lines losses prior to the consolidation transaction.
Calendar year net losses and loss adjustment expenses increased from $48.3 million for the year
ended December 31, 2001 to $96.7 million for the year ended December 31, 2002, an increase of $48.4
million. The principal reason for the increase is the inclusion of an additional six months of MEEMIC
activity in 2002. The 2002 current accident year net loss ratio (current accident year losses divided by net
earned premiums) is 71.1% and reflects decreases in both the frequency and severity of auto liability
claims and the positive effect of mild weather conditions during 2002.
We reduced losses during 2002 by $9.7 million as a result of favorable developments in our
estimates of prior years' auto liability reserves. This was primarily the result of lower-than-expected claims
frequency, which is a continuing result of the 1994 legislative tort reforms in the State of Michigan. This
legislation has had the effect of reducing frequency and shortening the reporting pattern of claims. While
the legislation became effective in 1996, the effects were uncertain for several years and could be
changed through additional legislation or court decisions. We established initial reserves that considered
the various possible outcomes and recognize favorable results as they materialize. Uncertainties
inherent in the loss estimation process will invariably cause differences in actual ultimate liabilities from
estimates.
47
Net Investment Income
Our net investment income is comprised of the interest and dividend income from our fixed
maturity, short-term, cash equivalent and equity investments, net of investment expenses. Net
investment income increased by approximately $5.1 million for the year ended December 31, 2002 as
compared to the year ended December 31, 2001, primarily because 2001 includes only six months of
personal lines activity.
Interest income from fixed maturity investments represents more than 86% of our net investment
income. The tax equivalent book yield (tax adjusted gross earnings divided by the average quarterly
ending book value) of the personal lines segment fixed maturity investments for the year ended
December 31, 2002 is 6.1% as compared to 6.2% for the year ended December 31, 2001. The average
yield is reduced because market rates available for the investment of new and matured funds were lower
in 2002. The weighted average tax equivalent book yield of the fixed maturity securities that we held at
December 31, 2002 is 6.5%.
Net Realized Investment Gains (Losses)
Net realized investment gains and losses for the year ended December 31, 2002 of $793,000 did
not include any realized losses for other than temporary impairments.
Underwriting, Acquisition and Insurance Expenses
Underwriting, acquisition and insurance expenses consist of normal, recurring expenses such as
commissions, salaries and other expenses. Underwriting, acquisition and insurance expenses for the year
ended December 31, 2002 were $34.6 million as compared to $15.4 million for the year ended December
31, 2001. The increase is primarily due to the additional six months of MEEMIC activity in 2002 but also is
due to higher underwriting and acquisition costs resulting from premium growth. The underwriting
expense ratio (underwriting, acquisition and insurance expenses divided by net premiums earned) for the
year ended December 31, 2002 was 23.1% as compared to 22.2% for the year ended December 31,
2001. The increase in the ratio is primarily due to an increase in our statutory and guaranty fund
assessments in 2002.
Guaranty fund assessments total $331,000 in 2002; there were no guaranty fund assessments in
2001.
48
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Our consolidated income before cumulative effect was $12.5 million, or $0.51 per share, for the
year ended December 31, 2001. The operating results of our reportable industry segments are discussed
separately in the following discussion.
Interest expense for the year ended December 31, 2001 of $2.6 million relates entirely to the term
loan obtained in order to finance our consolidation with Professionals Group. The debt bears interest at a
variable rate based on LIBOR or the bank’s base rate. At December 31, 2001 the interest rate was 3.4%.
We recognized a tax benefit of $2.8 million for the year ended December 31, 2001 as compared
to a tax expense of $4.0 million for the year ended December 31, 2000. Our tax-exempt investment
income is the primary reason that our effective rates for both years are significantly lower than the
expected statutory rate of 35%. We earned tax-exempt investment income of approximately $18.7 million
in 2001 and $17.4 million in 2000. Because tax-exempt income is not included as taxable income, we
experienced a taxable loss for the year ended December 31, 2001 as compared to taxable income for the
year ended December 31, 2000.
49
Professional Liability Segment
We have summarized the operating results for our professional liability segment for the years
ended December 31, 2001 and 2000 in the table below.
Year Ended
December 31
2001
2000
Increase
(Decrease)
315,698
$
223,871
$
91,827
$
310,222
(66,307)
243,915
54,339
5,441
3,130
306,825
$
216,297
(38,701)
177,596
41,450
913
2,630
222,589
93,925
(27,606)
66,319
12,889
4,528
500
84,236
250,257
155,710
94,547
55,021
305,278
38,579
194,289
16,442
110,989
$
$
Gross premiums written
Revenues:
Premiums earned
Premiums ceded
Net premiums earned
Net investment income
Net realized investment
gains (losses)
Other income
Total revenues
Expenses:
Net losses and LAE
Underwriting, acquisition
and insurance expenses
Total expenses
Income
before income taxes
$
1,547
$
28,300
$
(26,753)
Net loss and LAE ratio
Underwriting expense ratio
Combined ratio
102.6
22.6
125.2
%
%
87.7
21.7
109.4
%
%
14.9
0.9
15.8
%
%
Premiums
Gross Premiums Written:
Professional liability segment gross premiums written for the year ended December 31, 2001
increased by $91.8 million as compared to 2000. Our consolidation with Professionals Group is the
primary reason that our gross premiums written increased. Our rate increases implemented during 2001
also contributed to the increase.
We implemented rate increases on our Professional Coverages averaging approximately 23% on
2001 renewals weighted by premium volume. We plan to continue to implement rate increases based on
loss trends, subject to regulatory approval. To date, premiums renewed at the higher rates coupled with
new business have more than offset the effect of premiums lost due to decreased retention of insureds.
However, the higher rates may result in a greater loss of insureds in future periods.
50
Premiums Earned:
As with gross premiums written, the increase in premiums earned for the year ended December
31, 2001 as compared to 2000 is primarily attributable to our consolidation with Professionals Group. The
beneficial impact of rate increases will be reflected in our financial results over time. Rate increases
implemented after January 1, 2001 have not yet been fully reflected in premiums earned since premiums
are earned over the entire policy period (usually one year) after the policy is written.
Reinsurance premiums ceded are estimated based on the terms of the respective reinsurance
agreements. We continually review the estimated expense and any adjustments that we believe
necessary are included in current operations. Several factors contributed to the increase in reinsurance
premiums ceded for 2001 as compared to 2000. The increase in premiums earned as a result of the
consolidation accounted for approximately 30% of the increase. During the fourth quarter of 2000, we
increased the amount of reinsurance coverage in certain markets which resulted in more of our premiums
earned being ceded to reinsurers in 2001. Also, in 2001 more premiums were earned in markets where
we rely more heavily on reinsurance.
Net premiums earned for the years ended December 31, 2001, and 2000 include Other
Coverages of approximately $38.8 million and $34.8 million, respectively. We have historically written
accident and health, workers compensation and multi-line premiums from time to time as favorable
opportunities arose to utilize capital. During 2000 we decided to decrease our commitment to these
programs. However, we continued to write and earn premiums for Other Coverages during 2001 and
2000 to honor existing contractual relationships. Our premiums during 2001 reflect both volume increases
and higher rates charged on Other Coverages.
51
Losses and Loss Adjustment Expenses
Professional liability segment losses and loss adjustment expenses and the related current
accident year net loss and LAE ratio are summarized in the following table.
Incurred losses and LAE related to:
Current accident year
Prior accident years
Change in death, disability and
retirement reserves
Net incurred losses and LAE
Net loss and LAE ratio:
Current accident
year net loss ratio
Prior accident years ratio
Change in death, disability
and retirement reserves
ratio
Total calendar year net loss
and LAE ratio
Year Ended
December 31
2001
2000
$
255,086
13,818
$
178,210
(12,500)
(18,647)
250,257
$
(10,000)
155,710
$
%
104.6
5.7
%
100.3
(7.0)
(7.7)
(5.6)
102.6
%
87.7
%
During 2001, we recognized $13.8 million of additional net losses related to prior accident years.
This represented approximately 1.4% of our December 31, 2001 professional liability segment net
reserves of $1.0 billion. In 2001, the $18.6 million decrease in our reserve for death, disability and
retirement is principally the result of an increase in premium rate loads and a decrease in the number of
insureds primarily related to the ProNational book of business.
The current accident year net loss and LAE ratio in the table above is calculated by dividing
current accident year incurred losses by net premiums earned. The principal reason for the increase in
that ratio in 2001 is the effect of the inclusion of Professionals Group’s premiums and losses.
52
Net Investment Income and Net Realized Investment Gains (Losses)
Earnings on our professional liability segment investment portfolio increased by $12.9 million as
compared to the year ended December 31, 2000. The increase is primarily due to the net increase in the
investment portfolio as a result of the consolidation with Professionals Group.
At December 31, 2001, our professional liability segment investment portfolio of approximately
$1.3 billion consisted of 78% taxable securities and 22% tax-exempt securities.
Net realized investment gains increased from approximately $900,000 in 2000 to $5.4 million in
2001. This increase primarily resulted from additional sales of investment securities related to our efforts
to restructure our professional liability segment investment portfolio.
Underwriting, Acquisition and Insurance Expenses
Underwriting, acquisition and insurance expenses increased approximately $16.4 million for the
year ended December 31, 2001 as compared to 2000 due to our consolidation with Professionals Group.
The underwriting expense ratio also increased to 22.6% for 2001 as compared to 21.7% for 2000. The
increase in the ratio is primarily due to an increase in guaranty fund assessments. The remaining
increase is due to normal fluctuations in acquisition expenses between years.
Guaranty fund assessments for the year ended December 31, 2001 were $1.3 million. There
were no significant guaranty fund charges in 2000. We are required by most states to be a member of the
state’s insolvency or guaranty fund association and, as such, we must make payments to the association
when so assessed by the state.
53
Personal Lines Segment
Our personal lines segment is comprised of the operations of a single insurance company,
MEEMIC Insurance Company, acquired on June 27, 2001. Operating results for our personal lines
segment for the six months ended December 31, 2001 are summarized in the table below.
Six months ended
December 31
2001
$
$
Gross premiums written
Revenues:
Premiums earned
Premiums ceded
Net premiums earned
Net investment income
Net realized investment
gains (losses)
Other income
Total revenues
Expenses:
Net losses and LAE
Underwriting, acquisition
and insurance expenses
Total expenses
73,285
71,288
(1,858)
69,430
5,003
-
857
75,290
48,301
15,416
63,717
Income before income taxes and
minority interest
$
11,573
Net loss and LAE ratio
Underwriting expense ratio
Combined ratio
69.6%
22.2%
91.8%
Premiums
Gross premiums written were $73.3 million and net premiums earned were $69.4 million related
to our personal lines segment for the six months ended December 31, 2001. Gross premiums written for
personal automobile coverage represent approximately 85.2% of the total, and premiums from
homeowners coverage represent approximately 14.5% of the total.
54
Losses and Loss Adjustment Expenses
Net losses and LAE incurred related to our personal lines segment were $48.3 million for the six
months ended December 31, 2001. The incurred loss and LAE ratio was 69.6% during the six months
ended December 31, 2001.
Net Investment Income and Net Realized Investment Gains (Losses)
Our net investment income is comprised of the earnings on our personal lines segment
investment portfolio and totaled $5.1 million for the six months ended December 31, 2001.
At December 31, 2001, our personal lines segment investment portfolio consisted of 48% taxable
securities and 52% tax-exempt securities. At December 31, 2001, the average yield of our personal lines
segment fixed maturity investments was 5.0%.
Net realized investment gains (losses) are insignificant during the six months ended December
31, 2001.
Underwriting, Acquisition and Insurance Expenses
Underwriting, acquisition and insurance expenses related to our personal lines segment were
$15.4 million for the period ended December 31, 2001, consisting of normal, recurring expenses such as
commissions, salaries and other expenses. The underwriting expense ratio was 22.2% for the six months
ended December 31, 2001. No guaranty fund assessments were included in underwriting, acquisition and
insurance expenses in 2001.
55
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We believe that we are principally exposed to three types of market risk related to our investment
operations. These risks are interest rate risk, credit risk and equity price risk.
The term market risk refers to the risk of loss arising from adverse changes in market rates and
prices, such as interest rates, equity prices and foreign currency exchange rates.
All market sensitive instruments discussed here relate to our investment assets which are
classified as available for sale.
As of December 31, 2002, our fair value investment in fixed income securities was $1,329 million.
These securities are subject primarily to interest rate risk and credit risk. We have not and currently do not
intend to enter into derivative transactions.
Interest Rate Risk
Our fixed maturities portfolio is exposed to interest rate risk. Fluctuations in interest rates have a
direct impact on the market valuation of these securities. As interest rates rise, market values of fixed
income portfolios fall and vice versa. We believe we are in a position to keep our fixed income
investments until maturity as we do not invest in fixed maturity securities for trading purposes.
Interest
Rates
Portfolio Change in Modified
Duration
Value
Years
$ Millions
Value
$ Millions
200 basis point rise
100 basis point rise
Current rate*
100 basis point decline
200 basis point decline
$
$
$
$
$
1,227
1,281
1,329
1,379
1,430
(102)
$
(48)
$
$
-
$
50
$
101
4.31
4.00
3.72
3.67
3.91
*Current rates are as of December 31, 2002
At December 31, 2002, the fair value of our investment in preferred stocks was $33.6 million,
including net unrealized gains of $0.8 million. Preferred stocks are primarily subject to interest rate risk
because they bear a fixed rate of return. The investments in the above table do not include preferred
stocks.
Computations of prospective effects of hypothetical interest rate changes are based on numerous
assumptions, including the maintenance of the existing level and composition of fixed income security
assets, and should not be relied on as indicative of future results.
Certain shortcomings are inherent in the method of analysis presented in the computation of the
fair value of fixed rate instruments. Actual values may differ from those projections presented should
market conditions vary from assumptions used in the calculation of the fair value of individual securities,
including non-parallel shifts in the term structure of interest rates and changing individual issuer credit
spreads.
56
Credit Risk
We have exposure to credit risk primarily as a holder of fixed income securities. We control this
exposure by emphasizing investment grade credit quality in the fixed income securities we purchase.
As of December 31, 2002, 99.4% of our fixed income portfolio consisted of securities rated
investment grade. We believe that this concentration in investment grade securities reduces our exposure
to credit risk on these fixed income investments to an acceptable level. However, in the current
environment even investment grade securities can rapidly deteriorate and result in significant losses.
Equity Price Risk
At December 31, 2002 the fair value of our investment in common stocks, excluding preferred
stocks as discussed in the preceding paragraphs, was $46.5 million, which included net unrealized gains
of $1.9 million. These securities are subject to equity price risk, which is defined as the potential for loss
in market value due to a decline in equity prices. A hypothetical 10% increase in the market prices as of
December 31, 2002 would increase the fair value of these securities to $51.2 million; a hypothetical 10%
decrease in the price of each of these marketable securities would reduce the fair value to $41.9 million.
The selected hypothetical change does not reflect what could be considered the best or worst scenarios.
ProAssurance’s cash and short-term investment portfolio at December 31, 2002 was on a cost
basis which approximates its fair value. This portfolio lacks significant market rate sensitivity due to its
short duration.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Consolidated Financial Statements and Financial Statement Schedules of ProAssurance
Corporation and subsidiaries listed in Item 15(a) have been included herein beginning on page 64. The
Supplementary Financial Information required by Item 302 of Regulation S-K is included in Note 17 of the
Notes to Consolidated Financial Statements of ProAssurance and its subsidiaries.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not Applicable.
57
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item regarding executive officers is included in Part I of the Form
10K (Pages 29, 30 and 31) in accordance with Instruction 3 of the Instructions to Paragraph (b) of Item
401 of Regulation S-K.
The information required by this Item regarding directors is incorporated by reference pursuant to
General Instruction G (3) of Form 10K from ProAssurance’s definitive proxy statement for the 2003
Annual Meeting of its Stockholders to be filed with the Securities and Exchange Commission pursuant to
Regulation 14A on or before April 30, 2003.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference pursuant to General Instruction
G (3) of Form 10K from ProAssurance’s definitive proxy statement for the 2003 Annual Meeting of its
Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A on or
before April 30, 2003.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item is incorporated by reference pursuant to General Instruction
G (3) of Form 10K from ProAssurance’s definitive proxy statement for the 2003 Annual Meeting of its
Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A on or
before April 30, 2003.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is incorporated by reference pursuant to General Instruction
G (3) of Form 10K from ProAssurance’s definitive proxy statement for the 2003 Annual Meeting of its
Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A on or
before April 30, 2003.
ITEM 14. CONTROLS AND PROCEDURES
Under the supervision and with the participation of management, including the Chief Executive
Officer and Chief Financial Officer, the Company has evaluated the effectiveness of the design and
operation of our disclosure controls and procedures within ninety (90) days of the filing of this Annual
Report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer
have concluded that these controls and procedures are effective. There were no significant changes in
the internal controls or in other factors that could significantly affect these controls subsequent to the date
of their evaluation.
Disclosure controls and procedures are the Company’s controls and other procedures that are
designed to ensure that information, required to be disclosed by the Company in the reports that it files or
submits under the Exchange Act, is accumulated and communicated to management, including the Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure.
58
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a)
Financial Statements. The following consolidated financial statements of ProAssurance
Corporation and subsidiaries are included herein in accordance with Item 8 of Part II of this
report.
Report of Independent Auditors
Consolidated Balance Sheets - December 31, 2002 and 2001
Consolidated Statements of Changes in Capital - years ended December 31, 2002, 2001
and 2000
Consolidated Statements of Income - years ended December 31, 2002, 2001 and 2000
Consolidated Statements of Cash Flows - years ended December 31, 2002, 2001 and
2000
Notes to Consolidated Financial Statements.
Financial Statement Schedules. The following consolidated financial statement schedules of
ProAssurance Corporation and subsidiaries are included herein in accordance with Item 14(d):
Schedule I - Summary of Investments - Other than Investments in Related Parties.
Schedule II - Condensed Financial Information of ProAssurance Corporation.
Schedule III - Supplementary Insurance Information.
Schedule IV - Reinsurance.
Schedule VI - Supplementary Property and Casualty Insurance Information.
All other schedules to the consolidated financial statements required by Article 7 of Regulation
S-X are not required under the related instructions or are inapplicable and therefore have been
omitted.
(b)
The registrant filed a report on Form 8-K to report a news release issued on October 11, 2002 in
accordance with Rule 100 of Regulation F-D.
(c)
The exhibits required to be filed by Item 15(c) are listed herein in the Exhibit Index.
59
SIGNATURES
Pursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, the
Registrant has duly caused Amendment No. 1 to this report to be signed on its behalf by the undersigned,
thereunto duly authorized, on this the 10th day of April 2003.
PROASSURANCE CORPORATION
By:/s/James J. Morello
James J. Morello
Sr. Vice President and
Chief Accounting Officer
60
This page is intentionally blank.
61
I, A. Derrill Crowe, certify that:
CERTIFICATION
1. I have reviewed this annual report on Form 10-K of ProAssurance Corporation;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or
omit to state a material fact necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial information included in this
annual report, fairly present in all material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant and have:
a) Designed such disclosure controls and procedures to ensure that material information relating to
the registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date
within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to
the registrant's auditors and the audit committee of registrant's board of directors (or persons performing
the equivalent function):
a) All significant deficiencies in the design or operation of internal controls which could adversely
affect the registrant's ability to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there
were significant changes in internal controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: April 9, 2003
/s/A. Derrill Crowe, M.D.
A. Derrill Crowe, M.D.
Chief Executive Officer
62
CERTIFICATION
I, Howard H. Friedman, certify that:
1. I have reviewed this annual report on Form 10-K of ProAssurance Corporation;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or
omit to state a material fact necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial information included in this
annual report, fairly present in all material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant and have:
a) Designed such disclosure controls and procedures to ensure that material information relating to
the registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date
within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to
the registrant's auditors and the audit committee of registrant's board of directors (or persons performing
the equivalent function):
a) All significant deficiencies in the design or operation of internal controls which could adversely
affect the registrant's ability to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there
were significant changes in internal controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: April 9, 2003
/s/Howard H. Friedman
Howard H. Friedman
Chief Financial Officer
63
ProAssurance Corporation and Subsidiaries
Consolidated Financial Statements
Years ended December 31, 2002, 2001 and 2000
Contents
Report of Independent Auditors .................................................................................................................. 65
Audited Consolidated Financial Statements
Consolidated Balance Sheets ..................................................................................................................... 66
Consolidated Statements of Changes in Capital ........................................................................................ 68
Consolidated Statements of Income ........................................................................................................... 69
Consolidated Statements of Cash Flows .................................................................................................... 70
Notes to Consolidated Financial Statements .............................................................................................. 71
64
Report of Independent Auditors
The Board of Directors
ProAssurance Corporation
We have audited the accompanying consolidated balance sheets of ProAssurance Corporation and
subsidiaries (ProAssurance) as of December 31, 2002 and 2001, and the related consolidated statements
of changes in capital, income and cash flows for each of the three years in the period ended December
31, 2002. Our audits also included the financial statement schedules listed in the Index at Item 14(a).
These financial statements and schedules are the responsibility of ProAssurance's management. Our
responsibility is to express an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material
respects, the consolidated financial position of ProAssurance Corporation and subsidiaries at December
31, 2002 and 2001, and the consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States. Also, in our opinion, the related financial statement schedules, when
considered in relation to the basic financial statements taken as a whole, present fairly in all material
respects the information set forth therein.
As discussed in Note 10 to the consolidated financial statements, in 2002 ProAssurance changed its
method of accounting for goodwill.
February 21, 2003
Birmingham, Alabama
Ernst & Young LLP
65
ProAssurance Corporation and Subsidiaries
Consolidated Balance Sheets
(in thousands, except share data)
Assets
Investments:
Fixed maturities available for sale, at fair value
Equity securities available for sale, at fair value
Real estate, net
Short-term investments
Total investments
December 31
2002
December 31
2001
$
1,328,897
80,197
17,549
252,854
1,679,497
$
1,281,779
85,550
17,936
136,014
1,521,279
Cash and cash equivalents
Premiums receivable
Receivable from reinsurers on unpaid losses and loss
adjustment expenses
Prepaid reinsurance premiums
Deferred taxes
Other assets
143,306
111,028
462,012
21,294
73,091
96,422
53,163
77,766
374,056
20,265
90,565
101,231
$
2,586,650
$
2,238,325
See accompanying notes.
66
ProAssurance Corporation and Subsidiaries
Consolidated Balance Sheets
(in thousands, except share data)
Liabilities and Stockholders' Equity
Liabilities:
Policy liabilities and accruals:
Reserve for losses and loss adjustment expenses
Unearned premiums
Reinsurance premiums payable
Total policy liabilities
Other liabilities
Long-term debt
Total liabilities
Minority interest
Commitments and contingencies
Stockholders' Equity:
Common stock, par value $0.01 per share
100,000,000 shares authorized;
28,998,917 and 25,911,234 shares
issued in 2002 and 2001, respectively
Additional paid-in capital
Accumulated other comprehensive gain, net of
deferred tax expense of $19,612 and $2,208, respectively
Retained earnings
Less treasury stock at cost, 121,765 shares
Total stockholders' equity
December 31
2002
December 31
2001
$
1,622,468
248,371
62,549
1,933,388
49,198
72,500
2,055,086
$
1,442,341
188,630
48,704
1,679,675
40,431
82,500
1,802,606
26,370
22,488
-
-
290
308,501
35,545
160,914
505,250
(56)
505,194
259
260,788
3,533
148,707
413,287
(56)
413,231
$
2,586,650
$
2,238,325
See accompanying notes.
67
ProAssurance Corporation and Subsidiaries
Consolidated Statements of Changes in Capital
(in thousands)
Common
Stock
Additional
Paid-In
Capital
Accumulated
Other
Comprehensive
Income (Loss)
$
$
25,103
4
-
-
$
231,941
58
-
(11)
$
(5,424)
-
-
-
4,570
-
(854)
-
-
-
-
-
-
-
4,387
-
3,533
-
-
231,988
184
-
(46,207)
22,476
49,378
2,952
17
-
-
260,788
980
265
46,468
-
-
25,107
1
-
(2,405)
(22,476)
32
-
-
-
-
259
-
-
31
-
-
Retained
Earnings
Treasury
Stock
111,957
-
-
-
-
24,300
136,257
-
-
-
-
-
-
-
-
12,450
148,707
$
$
(37,853)
-
(9,557)
79
-
-
(47,331)
-
(1,337)
48,612
-
-
-
-
-
-
(56)
-
-
-
-
-
Total
325,724
62
(9,557)
68
28,870
345,167
185
(1,337)
-
-
49,410
2,952
17
-
-
16,837
413,231
980
265
46,499
-
-
44,219
505,194
-
-
32,012
-
-
12,207
$
290
$
308,501
$
35,545
$
160,914
$
(56)
$
Balance at January 1, 2000
Common stock issued for compensation
Purchase of treasury stock
Sale of treasury stock
Comprehensive income:
Change in fair value of securities
available for sale, net of deferred taxes
Net income
Total comprehensive income
Balance at December 31, 2000
Common stock issued for compensation
Purchase of treasury stock
Retirement of treasury stock
Conversion of par value to $0.01
Equity issued in consolidation:
Common stock issued to Professionals
Group shareholders
Fair value of options assumed
Stock options exercised
Comprehensive income:
Change in fair value of securities
available for sale, net of deferred
taxes and minority interest
Net income
Total comprehensive income
Balance at December 31, 2001
Common stock issued for compensation
Stock options exercised
Offering of common stock
Comprehensive income:
Change in fair value of securities
available for sale, net of deferred
taxes, reclassification adjustments
and minority interest
Net income
Total comprehensive income
Balance at December 31, 2002
*Cash was paid in lieu of fractional shares
See accompanying notes.
68
ProAssurance Corporation and Subsidiaries
Consolidated Statements of Income
(in thousands, except per share data)
Revenues:
Gross premiums written
Net premiums written
Premiums earned
Premiums ceded
Net premiums earned
Net investment income
Net realized investment (losses) gains
Other income
Total revenues
Expenses:
Losses and loss adjustment expenses
Reinsurance recoveries
Net losses and loss adjustment expenses
Underwriting, acquisition
and insurance expenses
Interest expense
Total expenses
Income before income taxes, minority interest
and cumulative effect of accounting change
Provision for income taxes:
Current expense (benefit)
Deferred expense
Income before minority interest and
cumulative effect of accounting change
Minority interest
Income before cumulative effect of accounting
change
Cumulative effect of accounting change, net of tax
2002
Year Ended December 31
2001
2000
$
$
$
636,156
537,123
576,414
(99,006)
477,408
76,918
(5,306)
6,747
555,767
569,099
(121,070)
448,029
91,253
2,875
542,157
$
$
$
388,983
310,291
381,510
(68,165)
313,345
59,782
5,441
3,987
382,555
344,202
(45,644)
298,558
70,437
2,591
371,586
$
$
$
223,871
194,279
216,297
(38,701)
177,596
41,450
913
2,630
222,589
190,458
(34,748)
155,710
38,579
-
194,289
13,610
10,969
28,300
(275)
87
(188)
13,798
(3,285)
10,513
1,694
(4,567)
1,720
(2,847)
3,146
854
4,000
13,816
24,300
(1,366)
-
12,450
24,300
-
-
Net income
$
12,207
$
12,450
$
24,300
Basic earnings per share:
Income before cumulative effect of accounting
change
Cumulative effect of accounting change, net of tax
Net income
Diluted earnings per share:
Income before cumulative effect of accounting
change
Cumulative effect of accounting change, net of tax
Net income
Weighted average number
of common shares outstanding:
Basic
Diluted
$
$
$
$
0.40
0.07
0.47
0.39
0.07
0.46
$
$
$
$
0.51
-
0.51
0.51
-
0.51
$
$
$
$
1.04
-
1.04
1.04
-
1.04
26,231
26,254
24,263
24,267
23,291
23,291
See accompanying notes.
69
ProAssurance Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(in thousands)
Year Ended December 31
2002
2001
2000
$
12,207
$
12,450
$
24,300
Operating Activities
Net income
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation
Amortization
Net realized capital gains
Deferred income taxes
Policy acquisition costs deferred,
net of related amortization
Other
Changes in assets and liabilities, net of the effects
from the consolidation with Professionals Group:
Premiums receivable
Receivable from reinsurers
Prepaid reinsurance premiums
Other assets, excluding capital purchases
Reserve for losses and loss
adjustment expenses
Unearned premiums
Reinsurance premiums payable
Other liabilities
Minority interest in net income
Net cash provided by operating activities
Investing Activities
Purchases of:
Fixed maturities available for sale
Equity securities available for sale
Proceeds from sale or maturities of:
Fixed maturities available for sale
Equity securities available for sale
Net decrease (increase) in short-term investments
Cash used in consolidation,
net of cash acquired of $72,245
Other
Net cash used by investing activities
Financing Activities
Proceeds from stock issuance
Proceeds from long term debt
Repayment of debt
Purchases of treasury stock
Other
Net cash provided by (used by) financing activities
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
4,337
10,707
5,306
87
(7,241)
(812)
(32,963)
(87,956)
(1,029)
8,275
180,127
59,742
13,845
9,044
3,285
176,961
(897,928)
(25,932)
900,641
20,235
(116,841)
-
(2,785)
(122,610)
46,499
-
(10,000)
-
(707)
35,792
90,143
53,163
3,243
8,603
(5,441)
1,720
545
(655)
18,726
(8,633)
(9,496)
4,109
21,148
7,471
12,236
(6,131)
1,366
61,261
(656,101)
(5,797)
681,219
25,286
(15,801)
(124,059)
(3,666)
(98,919)
-
110,000
(27,500)
(1,337)
1,108
82,271
44,613
8,550
53,163
706
2,442
1,833
4,499
(913)
854
(2,542)
(544)
(1,656)
13,306
12,959
(1,486)
(6,133)
7,570
(7,672)
(8,040)
-
36,335
(94,775)
(50,799)
143,715
11,048
(38,428)
-
(8,398)
(37,637)
-
-
-
(9,557)
-
(9,557)
(10,859)
19,409
8,550
1,929
-
$
$
$
Cash and cash equivalents at end of period
$
143,306
Supplemental Disclosure of Cash Flow Information
Net cash (received) paid during the year for income taxes
Net cash paid during the year for interest
$
$
(8,884)
2,714
$
$
$
See accompanying notes.
70
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
1. Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of ProAssurance Corporation
(a Delaware corporation) and its subsidiaries (“ProAssurance”). All significant intercompany accounts and
transactions between consolidated companies have been eliminated.
Basis of Presentation
The preparation of financial statements in accordance with accounting principles generally accepted in
the United States (GAAP) requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Certain reclassifications have been made to conform the 2001 financial statements to the 2002
presentation. These changes had no effect on previously reported results of operations or shareholders’
equity.
The significant accounting policies followed by ProAssurance that materially affect financial reporting are
summarized in these notes to the consolidated financial statements.
Segment Information
ProAssurance operates in the United States of America and in two reportable industry segments. As
discussed in Note 3, the professional liability segment principally provides professional and general
liability insurance for providers of health care services, and to a lesser extent, providers of legal services.
The personal lines segment provides private passenger automobile, homeowner, boat, and umbrella
insurance products primarily for educational employees and their families exclusively in the state of
Michigan.
Investments
ProAssurance considers all fixed maturity and equity securities as available-for-sale. Available-for-sale
securities are carried at fair value, and unrealized gains and losses on such available-for-sale securities
are excluded from earnings and reported, net of tax effect, in stockholders’ equity as “Accumulated other
comprehensive income (loss)” until realized. ProAssurance invests only in fixed income securities that are
investment grade at the time of purchase.
Investment income includes amortization of premium and accretion of discount related to debt securities
acquired at other than par value. Debt securities and mandatorily redeemable preferred stock with
maturities beyond one year when purchased are classified as fixed maturities.
71
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31,2002
1. Accounting Policies (continued)
Fair values for fixed maturity and equity securities are based on quoted market prices, where available.
For fixed maturity and equity securities not actively traded, fair values are estimated using values
obtained from independent pricing services. The carrying amounts reported in the balance sheet for cash
and cash equivalents and short-term investments approximate their fair values. Real estate is reported at
cost, less allowances for depreciation. Short-term investments, primarily composed of investments in
United States (U.S.) Treasury obligations and commercial paper, are reported at cost, which
approximates fair value.
In accordance with Statement of Financial Accounting Standard (SFAS) No. 115, “Accounting for Certain
Investments in Debt and Equity Securities,” ProAssurance evaluates its investment securities 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. A decline in the fair value of an available-for-sale
security below cost judged to be other than temporary is recognized as a loss in the then current period
and reduces the cost basis of the security. In subsequent periods, ProAssurance measures any gain or
loss or decline in value against the adjusted cost basis of the security. The following factors are
considered in determining whether an investment’s decline is other than temporary:
•
•
•
the extent to which the market value of the security is less than its cost basis
the length of time for which the market value of the security has been less than its cost basis
the financial condition and near-term prospects of the security’s issuer, taking into consideration
the economic prospects of the issuers’ industry and geographical region, to the extent that
information is publicly available
• ProAssurance’s ability and intent to hold the investment for a period of time sufficient to allow for
any anticipated recovery in market value
Real Estate
Property and certain leasehold improvements are classified as investment real estate. All balances are
stated on the basis of cost. Depreciation is computed over their estimated useful lives using the straight-
line method. Accumulated depreciation was approximately $7.9 million and $6.9 million at December 31,
2002 and 2001, respectively. Rental income and expenses are included in net investment income.
Cash and Cash Equivalents
For purposes of the consolidated balance sheets and statements of cash flows, ProAssurance considers
all demand deposits and overnight investments to be cash equivalents.
72
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31,2002
1. Accounting Policies (continued)
Intangible Assets
Intangible assets consist primarily of the excess of cost over the fair value of net assets acquired (i.e.,
goodwill). In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, goodwill can no
longer be amortized. It must, however, be tested annually for impairment. ProAssurance regularly reviews
its goodwill and other intangibles to determine if any adverse conditions exist that could indicate
impairment. Conditions that could trigger an impairment include, but are not limited to, a significant
adverse change in legal factors or business climate that could affect the value of an asset or an adverse
action or assessment by a regulator. ProAssurance does not believe that any of its recorded goodwill or
intangible assets has suffered impairment.
Reinsurance
Certain premiums are assumed from and ceded to other insurance companies under various reinsurance
agreements. ProAssurance cedes reinsurance to provide for greater diversification of business, allow
management to control exposure to potential losses arising from large risks, and provide additional
capacity for growth. A significant portion of the reinsurance is effected under reinsurance contracts known
as treaties and, in some instances, by negotiation on individual risks.
Reinsurance expense is estimated based on the terms of the respective reinsurance agreements. The
estimated expense is continually reviewed and any adjustments which become necessary are included in
current operations. Amounts recoverable from reinsurers are estimated in a manner consistent with the
loss liability associated with the reinsured policies.
Deferred Policy Acquisition Costs
Costs that vary with and are directly related to the production of new and renewal premiums (primarily
premium taxes, commissions and underwriting salaries) are deferred to the extent they are recoverable
against unearned premiums and are amortized as related premiums are earned.
Reserve for Losses and Loss Adjustment Expenses
The reserve for losses and loss adjustment expenses represents management’s estimates, using
methods it considers reasonable and appropriate, of the ultimate cost of all losses incurred but unpaid.
The estimated liability is continually reviewed, and any adjustments which become necessary, are
included in current operations.
Recognition of Revenues
Insurance premiums are recognized as revenues pro rata over the terms of the policies.
73
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31,2002
1. Accounting Policies (continued)
Stock Options
As allowed by SFAS No. 123, “Accounting for Stock-Based Compensation,” ProAssurance elected to
continue use of Accounting Principles Board Opinion (APB) No. 25 “Accounting for Stock Issued to
Employees” to measure employee stock compensation expense with pro forma disclosure of net income
and earnings per share determined as if the fair value method had been applied in measuring
compensation cost.
The fair value method of SFAS 123 measures stock-based compensation expense based on the fair
value of options on the date of grant. During 2002, the ProAssurance granted 415,000 stock options; no
stock options were granted in 2001 and 2000. Had ProAssurance’s determined compensation expense
for these options using the fair value method of SFAS No. 123 net income would have been reduced by
$0.6 million, or $0.02 earnings per share (basic and diluted) in 2002. There would be no effect on net
income or earnings per share in 2000 or 2001. The effect on net income for 2002 is not representative of
the pro forma effect on net income for future years because additional stock option awards could be
made in future years.
Income Taxes
ProAssurance files a consolidated federal income tax return. Deferred income taxes are provided for
temporary differences between financial and income tax reporting relating primarily to unrealized gains on
securities, discounting of losses and loss adjustment expenses for income tax reporting, and the limitation
of the unearned premiums deduction for income tax reporting.
Earnings Per Share
Earnings per share is computed by dividing net income by the weighted average number of shares of
common stock outstanding during each year after giving effect to stock dividends and treasury shares.
Accounting Changes
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141 “Business
Combinations.” SFAS No. 141 requires that the purchase method of accounting be used for all business
combinations with a closing date after June 30, 2001. The FASB has also issued SFAS No. 142 “Goodwill
and Other Intangible Assets,” which is effective for fiscal years beginning after December 15, 2001. See
Note 10 for the effects of ProAssurance’s adoption of SFAS Nos. 141 and 142.
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation –
Transition and Disclosure,” which amends the disclosure provisions of SFAS No. 123, “Accounting for
Stock-Based Compensation.” SFAS 148 became effective for financial statements for fiscal years ending
after December 15, 2002. ProAssurance has adopted the provisions of SFAS 148.
74
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
2. Consolidation of Medical Assurance and Professionals Group
ProAssurance Corporation began operations on June 27, 2001 in a transaction referred to hereafter as
the consolidation (“consolidation”).
The consolidation of Medical Assurance, Inc. into ProAssurance was in the form of a corporate
reorganization and was treated in a manner similar to a pooling of interests. Upon consummation of the
consolidation, each outstanding share of Medical Assurance common stock, par value $1.00 per share,
was converted into one share of ProAssurance common stock, par value $0.01 per share. Approximately
22.6 million ProAssurance shares were issued to Medical Assurance shareholders.
The consolidation of Professionals Group, Inc. into ProAssurance was treated as a purchase transaction.
Each outstanding share of Professionals Group common stock was converted into the right to receive, at
the holder’s election, either (a) 0.897 of a share of ProAssurance common stock plus $13.47 in cash, or
(b) $27.47 in cash. Aggregate consideration paid to the Professionals Group shareholders consisted of
approximately $196 million in cash and 3.2 million shares of ProAssurance common stock, valued at
approximately $50 million. The fair value of ProAssurance shares issued was $15.59 per share based on
the average Medical Assurance common stock price for a few days prior to June 27, 2001. ProAssurance
funded the cash requirements of the consolidation with the proceeds of a $110 million term loan facility
(see Note 12) and with internal funds generated from dividends paid to ProAssurance by Medical
Assurance and Professionals Group at the time of closing.
The total cost of the purchase transaction of approximately $252 million has been allocated to the assets
acquired and the liabilities assumed based on estimates of their respective fair values. The estimated fair
value of identifiable assets acquired totaled $1,165 million and the estimated fair value of the liabilities
assumed totaled $931 million. The estimated excess of the total cost of the acquisition over the fair value
of net assets acquired of approximately $18.4 million was recorded as goodwill.
The preliminary fair value of Professionals Group’s reserves for losses and loss adjustment expenses and
related reinsurance recoverables was estimated based on the present value of the expected underlying
cash flows of the loss reserves and reinsurance recoverables and includes a risk premium and a profit
margin. In determining the preliminary fair value estimate, management discounted Professionals Group’s
historical GAAP undiscounted net loss reserves to present value assuming a 5% discount rate, which
approximated the current U.S. Treasury rate at the date of the consolidation. The discounting pattern was
actuarially developed from Professionals Group’s historical loss data. An expected profit margin of 5%
was applied to the discounted loss reserves, which is consistent with management’s understanding of the
returns anticipated by the reinsurance market (the reinsurance market representing a willing party in the
purchase of loss reserves). Additionally, for the professional liability loss reserves of Professionals Group,
an estimated risk premium of 5% was applied to the discounted reserves, which is deemed to be
reasonable and consistent with expectations in the marketplace given the long-tail nature and the related
high degree of uncertainty of such reserves. For the personal lines loss reserves (homeowners and
automobile) of Professionals Group, an estimated risk premium of 2% was applied to discounted loss
reserves as such reserves develop over a much shorter period of time and, generally, are less volatile
than professional liability reserves. ProAssurance has not recognized any adjustments to that preliminary
fair value.
75
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
2. Consolidation of Medical Assurance and Professionals Group (continued)
ProAssurance was required to incorporate Professionals Group’s activity commencing upon the effective
date of the acquisition. The unaudited pro forma information below presents combined results of
operations as if the acquisition had occurred on January 1, 2001 after giving effect to certain adjustments,
including increased interest expense on debt related to the acquisition and lower investment income due
to cash used to fund a portion of the consolidation, and related tax effects. Professionals Group’s
nonrecurring and transaction related expenses were excluded from the pro forma financial information.
The unaudited pro forma information is not necessarily indicative of the results of operations of the
combined company had the acquisition occurred at the beginning of the periods presented, nor is it
necessarily indicative of future results (in thousands, except per share data).
ProForma Results
Year Ended
December 31, 2001
Revenues
Net loss
Net loss per share:
Basic and diluted
$
533,310
$
(4,992)
$
(0.18)
76
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
3. Segment Information
ProAssurance operates in the United States of America and, prior to the consolidation, operated in only
one reportable industry segment, the professional liability insurance segment, that principally provides
professional liability insurance and reinsurance for providers of health care services, and to a limited
extent providers of legal services. The professional liability segment includes the operating results of four
significant insurance companies: The Medical Assurance Company, Inc. (“MA-Alabama”), Medical
Assurance of West Virginia (“MA-West Virginia”), Inc., ProNational Insurance Company (“ProNational”),
and Red Mountain Casualty Insurance Company, Inc. (“Red Mountain”).
As a result of the consolidation, ProAssurance is now engaged in an additional segment, which is
providing personal property and casualty insurance to individuals (the personal lines segment). At
December 31, 2002, ProAssurance owned 84% of the stock of MEEMIC Holdings, Inc. (“MEEMIC
Holdings”), a publicly traded insurance holding company that provides personal auto, homeowners, boat
and umbrella coverages primarily to educational employees and their families through its wholly-owned
subsidiary, MEEMIC Insurance Company (“MEEMIC”). As discussed in Note 18 of the Consolidated
Financial Statements, ProAssurance increased its ownership percentage of MEEMIC Holdings to 100% in
January 2003.
The accounting policies of each segment are consistent with those described in the basis of presentation
footnote of ProAssurance’s consolidated financial statements. Identifiable assets of ProAssurance are
primarily cash and marketable securities. Other than cash and marketable securities owned directly by
the parent company, the identifiable assets of ProAssurance are allocated to the reportable operating
segments. Other than investment income earned directly by the parent company and interest expense
related to long-term debt held by the parent company, all revenues and expenses of ProAssurance are
allocated to the operating segments for purposes of SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. Revenue is primarily from unaffiliated customers and the effect of
transactions between segments has been eliminated.
77
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
3. Segment Information (continued)
The table below provides a reconciliation of segment information to total consolidated information (in
millions).
Revenues:
Professional liability lines
Personal lines
Corporate (investment income)
Total revenues
Income (loss) before cumulative
effect of accounting change:
Professional liability lines
Personal lines
Corporate
Total
Net income (loss):
Professional liability lines
Personal lines
Corporate
Total net income (loss)
Identifiable assets:
Professional liability lines
Personal lines
Corporate
Total assets
Year ended
December 31
2002
2001
393.3
162.4
0.1
555.8
(6.3)
18.6
(1.8)
10.5
(4.6)
18.6
(1.8)
12.2
$
$
$
$
$
$
306.8
75.3
0.5
382.6
6.8
7.1
(1.4)
12.5
6.8
7.1
(1.4)
12.5
December 31
2002
2001
2,184.6
372.1
30.0
2,586.7
$
$
1,913.5
324.7
0.1
2,238.3
$
$
$
$
$
$
$
$
78
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
4. Investments
The amortized cost and estimated fair value of fixed maturities and equity securities (in thousands) are as
follows:
December 31, 2002
Gross
Unrealized
Gains
Gross
Unrealized
(Losses)
Estimated
Fair
Value
Amortized
Cost
U. S. Treasury securities
State and municipal bonds
Corporate bonds
Asset-backed securities
Certificates of deposit
Equity securities
U. S. Treasury securities
State and municipal bonds
Corporate bonds
Asset-backed securities
Certificates of deposit
Equity securities
$
$
$
$
131,542
399,899
396,510
346,984
570
1,275,505
77,556
1,353,061
3,786
17,370
23,986
10,554
-
55,696
4,401
60,097
(12)
(481)
(1,727)
(84)
-
(2,304)
(1,760)
(4,064)
135,316
416,788
418,769
357,454
570
1,328,897
80,197
1,409,094
$
$
$
$
December 31, 2001
Gross
Unrealized
Gains
Gross
Unrealized
(Losses)
Estimated
Fair
Value
Amortized
Cost
$
$
$
$
58,768
407,738
423,143
379,817
570
1,270,036
90,985
1,361,021
905
5,410
9,853
4,079
-
20,247
5,080
25,327
(249)
(2,149)
(2,508)
(3,598)
-
(8,504)
(10,515)
(19,019)
59,424
410,999
430,488
380,298
570
1,281,779
85,550
1,367,329
$
$
$
$
79
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
4. Investments (continued)
The amortized cost and estimated fair value of fixed maturities (in thousands) at December 31, 2002, by
contractual maturity, are shown below. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
ProAssurance uses the call date as the contractual maturity for prerefunded state and municipal bonds
which are 100% backed by U.S. Treasury obligations.
Amortized
Cost
Estimated
Fair
Value
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Asset-backed securities
$
49,189
344,443
356,134
178,755
346,984
1,275,505
$
$
49,993
357,195
378,120
186,135
357,454
1,328,897
$
Excluding investments in bonds and notes of the U.S. Government, a U.S. Government agency, or
prerefunded state and municipal bonds which are 100% backed by U.S. Treasury obligations, no
investment in any person or its affiliates exceeded 10% of stockholders' equity at December 31, 2002.
Amounts of investment income by investment category (in thousands) are as follows:
2002
Year ended December 31
2001
2000
$
$
52,419
3,062
1,496
4,786
1,237
63,000
(3,218)
59,782
34,370
3,408
1,472
3,961
852
44,063
(2,613)
41,450
$
$
Fixed maturities
Equities
Real estate
Short-term investments
Other
Investment expenses
Net investment income
$
$
73,008
3,435
1,428
2,922
174
80,967
(4,049)
76,918
80
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
4. Investments (continued)
Net realized investment gains and losses, including other than temporary impairments, are as follows (in
thousands):
Year ended December 31
2002
2000
2001
Gross gains
Gross losses
Other than temporary impairments
$
26,040
(10,042)
(21,304)
$
8,619
(2,769)
(409)
$
3,542
(2,629)
-
Net realized investment (losses) gains
$
(5,306)
$
5,441
$
913
The above gains and losses are primarily derived from sales of investment securities and impairments.
These realized gains and losses, net of related tax expense (benefit) of ($1.9) million, $1.9 million, and
$0.3 million, respectively, were reclassified from “Accumulated other comprehensive income (loss)”
included in stockholders’ equity to “Net realized investment gains (losses)” in the Consolidated
Statements of Income.
Proceeds from sales (excluding maturities and paydowns) of available-for-sale securities were $646.4
million, $565.3 million and $108.5 million during 2002, 2001, and 2000, respectively.
At December 31, 2002 ProAssurance had investment securities with a carrying value of $11.8 million on
deposit with various state insurance departments to meet regulatory requirements.
5. Reinsurance
ProAssurance has various quota share, excess of loss assumption, and cession reinsurance
agreements. ProAssurance generally retains the risk for losses between $250,000 and $1 million.
ProAssurance reinsures individual risks above the maximum limits of its reinsurance treaties on a
facultative basis whereby the reinsurer agrees to insure a particular risk up to a designated limit.
The effect of reinsurance on premiums written and earned (in thousands) is as follows:
2002
Premiums
2001
Premiums
2000
Premiums
Written
Earned
Written
Earned
Written
Earned
Direct
Assumed
Ceded
Net Premiums
$
$
634,142
2,014
(99,033)
537,123
$
$
573,423
2,991
(99,006)
477,408
$
368,804
20,179
(78,692)
310,291
$
$
358,183
23,327
(68,165)
313,345
$
$
$
195,915
27,956
(29,592)
194,279
$
$
190,664
25,633
(38,701)
177,596
81
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
5. Reinsurance (continued)
Reinsurance contracts do not relieve ProAssurance from its obligations to policyholders. A contingent
liability exists with respect to reinsurance ceded to the extent that any reinsurer does not meet the
obligations assumed under the reinsurance agreements. ProAssurance continually monitors its reinsurers
to minimize its exposure to significant losses from reinsurer insolvencies.
At December 31, 2002, all reinsurance recoverables are considered collectible; the amounts as shown in
the accompanying consolidated balance sheets approximate the fair value of the amounts recoverable
from reinsurers. As required by the various state insurance laws, reinsurance recoverables totaling
approximately $12.7 million are collateralized by letters of credit or funds withheld.
At December 31, 2002 amounts due from individual reinsurers that exceed 5% of stockholders’ equity are
as follows (amounts in millions):
Reinsurer
Amount Due
From Reinsurer
Michigan Catastrophic Claims Association
Hannover Ruckversicherungs Ag
PMA Capital Insurance Company
General Reinsurance Corp
Continental Casualty Company
Gerling Global Reins Corp
$ 56.8
$ 51.9
$ 35.2
$ 34.1
$ 31.1
$ 28.3
6. Income Taxes
Deferred income taxes reflect the net tax effects of temporary differences between the amount of assets
and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant
components of ProAssurance's deferred tax liabilities and assets (in thousands) are as follows:
82
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
6. Income Taxes (continued)
Deferred tax liabilities:
Deferred acquisition costs
Unrealized gains on investments, net
Other
Total deferred tax liabilities
Deferred tax assets:
Unpaid loss discount
Unearned premium adjustment
Net operating losses
Alternative Minimum Tax Credits
Tax basis in intangibles
Other
Total deferred tax assets
Net deferred tax assets
December 31
2002
2001
$
7,727
19,612
-
27,339
$
5,420
2,208
4,055
11,683
60,737
17,266
3,526
7,894
10,337
670
56,502
12,836
20,093
2,448
10,369
-
100,430
73,091
$
102,248
90,565
$
In the opinion of management, it is more likely than not that ProAssurance will realize the benefit of the
deferred tax assets, and therefore, no valuation allowance has been established.
83
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
6. Income Taxes (continued)
A reconciliation of “expected” income tax expense (35% of income before income taxes) to actual income
tax expense in the accompanying financial statements (in thousands) follows:
Computed "expected" tax expense
Tax-exempt municipal and state bond income
Other
$
Year ended December 31
2002
2000
2001
4,764
9,905
3,839
(5,757)
(6,082)
(6,544)
805
177
(142)
$
$
Total
$
(188)
$
(2,847)
$
4,000
ProAssurance, after adjustment for its tax liability for the year ended December 31, 2002, has available
approximately $10.1 million in Federal tax loss carryforwards that will expire in the year 2021 and
approximately $7.9 million in Alternative Minimum tax credit carryforwards that can be applied against any
future regular tax payable. The Alternative Minimum tax credit carryforwards have no expiration date.
7. Deferred Policy Acquisition Costs
Underwriting and insurance costs directly related to the production of new and renewal premiums are
considered as acquisition costs and are capitalized and amortized to expense over the period in which
the related premiums are earned. As is common practice within the industry, reinsurance ceding
commissions due ProAssurance are considered as a reduction of acquisition costs, and therefore reduce
the total amount capitalized.
Amortization of deferred acquisition costs amounted to approximately $41.8 million, $37.8 million, and
$21.1 million for the years ended December 31, 2002, 2001 and 2000, respectively. Unamortized
deferred acquisition costs are included in other assets on the consolidated balance sheets and amounted
to approximately $22.7 million and $15.5 million at December 31, 2002 and 2001, respectively.
8. Reserves for Losses and Loss Adjustment Expenses
ProAssurance establishes reserves based on its estimates of the future amounts necessary to pay claims
and expenses associated with investigation and settlement of claims. These estimates consist of case
reserves and bulk reserves. Case reserves are estimates of future losses and loss adjustment expenses
(“losses and LAE”) for reported claims and are established by ProAssurance’s claims department. Bulk
reserves, which include a provision for losses that have occurred but have not been reported to
ProAssurance as well as development on reported claims, are the difference between (i) the sum of case
reserves and paid losses and (ii) an actuarially determined estimate of the total losses and LAE
necessary for the ultimate settlement of all reported claims and incurred but not reported claims, including
amounts already paid.
84
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
8. Reserve for Losses and Loss Adjustment Expenses (continued)
Losses and LAE reserves are determined on the basis of individual claims and actuarially determined
estimates of future losses based on ProAssurance’s past loss experience, available industry data and
projections as to future claims frequency, severity, inflationary trends and settlement patterns. Estimating
reserves, especially professional liability reserves, is a complex process which is heavily dependent on
judgment and involves many uncertainties. As a result, reserve estimates may vary significantly from the
eventual outcome. The assumptions used in establishing ProAssurance’s reserves are regularly reviewed
and updated by management as new data becomes available. Any adjustments necessary are reflected
in current operations.
ProAssurance believes that the methods it uses to establish reserves are reasonable and appropriate.
Each year, ProAssurance obtains an independent actuarial review of the reserves for losses and LAE of
each insurance subsidiary. The independent actuaries prepare reports that include recommendations as
to the level of reserves. ProAssurance considers 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 its reserves for losses and LAE. The statutory filings of
each insurance company with the insurance regulators must be accompanied by an actuary’s certification
as to their respective reserves in accordance with the requirements of the National Association of
Insurance Commissioners (NAIC).
85
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
8. Reserve for Losses and Loss Adjustment Expenses (continued)
Activity in the reserve for losses and loss adjustment expenses (reserves) is summarized as follows (in
thousands):
Balance, beginning of year
Less reinsurance recoverables
Net balance, beginning of year
$
Year ended December 31
2001
659,659
166,202
493,457
2002
1,442,341
374,056
1,068,285
$
$
2000
665,792
179,508
486,284
Net reserves acquired from Professionals Group
-
557,284
-
Incurred related to:
Current year
Prior years
Change in death, disability and retirement reserve
Total incurred
439,600
8,429
448,029
303,387
13,818
(18,647)
298,558
178,210
(12,500)
(10,000)
155,710
Paid related to:
Current year
Prior years
Total paid
Net balance, end of year
Plus reinsurance recoverables
Balance, end of year
(84,376)
(271,482)
(355,858)
1,160,456
462,012
1,622,468
$
(137,121)
(143,893)
(281,014)
1,068,285
374,056
1,442,341
$
(14,909)
(133,628)
(148,537)
493,457
166,202
659,659
$
Professional liability reserves comprise a substantial portion of ProAssurance’s reserves. Professional
liability reserves established in the early 1990’s were strongly influenced by the dramatically increased
frequency and severity experienced by ProAssurance, and the industry as a whole, during the mid-
1980’s. As a result, ProAssurance established prudent accident year reserves, resulting in accident year
loss ratios in excess of 100% of earned premium. Some of these trends moderated, and in some cases,
reversed, which in the past has resulted in the recognition of redundancies related to prior accident year
reserves.
The professional liability legal environment has deteriorated once again during the past several years.
Beginning in 2000, ProAssurance recognized adverse trends in claim severity, causing increased
estimates of certain loss liabilities. As a result, favorable development of prior year loss reserves slowed
during 2000 and some amount of adverse development occurred during 2002 and 2001. ProAssurance's
management believes the unearned premiums under contracts, together with the related anticipated
liabilities.
investment
the related contract
to be earned,
to discharge
is adequate
income
86
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
9. Commitments and Contingencies
ProAssurance is involved in various legal actions arising primarily from claims related to insurance
policies. At other times legal actions may arise from claims asserted by policyholders. The legal actions
arising from these claims have been considered by ProAssurance in establishing its reserves. While the
outcome of all legal actions is not presently determinable, ProAssurance's management is of the opinion,
based on consultation with legal counsel, that the settlement of these actions will not have a material
adverse effect on ProAssurance's financial position or results of operations.
10. Cumulative Effect of Change in Accounting Principle
SFAS No. 141 eliminated the pooling-of-interest method of accounting for business combinations. This
statement also includes guidance on the initial recognition and measurement of goodwill and other
intangible assets in a business combination. SFAS No. 142 addresses how goodwill and other intangible
assets should be accounted for in financial statements upon acquisition and how these items should be
accounted for subsequent to acquisition. SFAS No. 142 requires goodwill and intangible assets that have
indefinite useful lives to be tested at least annually for impairment. If goodwill and intangible assets are
deemed to be impaired, the change is included in then current operations. ProAssurance adopted SFAS
Nos. 141 and 142 effective January 1, 2002.
In accordance with SFAS Nos. 141 and 142, ProAssurance discontinued amortizing its recorded goodwill
and deferred credits and recognized the unamortized balance of deferred credits of $1.7 million that
existed at December 31, 2001 related to business combinations completed prior to July 1, 2001. The
write-off has been recognized as the cumulative effect of a change in accounting principle. There is no tax
effect related to the write-off because the deferred credits were not amortizable for tax purposes.
87
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
10. Cumulative Effect of Change in Accounting Principle (continued)
The table below presents comparative income for the years ended December 31, 2002 and 2001,
reflecting the pro forma effects of SFAS Nos. 141 and 142 on 2001 data:
Reported income before cumulative
effect of accounting change
Amortization of deferred credits,
net of goodwill amortization
Adjusted income before cumulative
effect of accounting change
Year ended
December 31
2002
2001
$
10,513
$
12,450
-
154
$
10,513
$
12,604
Adoption of SFAS Nos. 141 and 142 did not have a significant per share effect.
At December 31, 2002 goodwill and intangible assets from business combinations, net of accumulated
amortization, are approximately $23.3 million. ProAssurance does not believe that any of its recorded
goodwill or intangible assets has suffered impairment.
11. Pension Plans
ProAssurance and its subsidiaries currently maintain several defined contribution employee benefit plans
that are intended to provide additional income to eligible employees upon retirement. ProAssurance’s
contributions to these plans are primarily based on various percentages of compensation, and in some
instances are based upon the amount of the employees’ contributions to the plans. ProAssurance’s
expense under all benefit plans was $3.1 million, $2.3 million, and $1.2 million in 2002, 2001 and 2000,
respectively.
88
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
12. Long-term Debt
On June 27, 2001, ProAssurance borrowed $110 million under a term loan facility in order to fund the
consolidation. The debt bears interest at a variable rate based on the London Interbank Offered Rate
(LIBOR) or the bank’s base rate as elected from time to time by ProAssurance. At December 31, 2002
the interest rate was 2.9%.
The debt requires quarterly principal repayments of $2.5 million. Beginning in 2003, ProAssurance must
also repay an additional annual installment equal to 50% of the adjusted parent-only annual cash flow for
the prior fiscal year, up to a maximum of $15 million. ProAssurance has made all required quarterly
repayments on the loan and also made a $22.5 million optional prepayment on the loan in September
2001. The required 2003 annual repayment based on adjusted parent only cash flow is $0.
Excluding any required annual cash flow repayments, the aggregate remaining amounts of maturities of
long-term debt for the next five years are as follows: $10 million each year from 2003 to 2005, and in
2006 the remaining balance becomes due on May 31.
The term loan is part of a credit facility provided to ProAssurance by a bank syndicate under the terms of
a credit agreement that also provides for a line of credit in the amount of $40 million. ProAssurance has
not borrowed any funds under the revolving line of credit. Should ProAssurance choose to do so, the
borrowed funds are repayable when the line expires in May 2003. ProAssurance expects to renew the
line at its expiration date.
The credit facility, as is customary for credit agreements of this size and nature, requires that
ProAssurance maintain certain financial standards, otherwise known as loan covenants, including:
• a consolidated debt coverage ratio of 3.0 to 1;
• minimum consolidated tangible net worth equal to the sum of (i) 90% of the consolidated net
worth of ProAssurance as of June 30, 2001, and (ii) 75% of cumulative consolidated net income
after June 30, 2001;
• a consolidated fixed charge coverage ratio of 1.5 to 1;
• a funded debt to adjusted statutory capital ratio of 0.35 to 1; and
• maintenance of statutory Risk-Based Capital ratios (as defined by the NAIC) of 3.5 to 1 by two of
its insurance companies, The Medical Assurance Company, Inc. and ProNational Insurance
Company, Inc.
As of December 31, 2002, ProAssurance was in compliance with the aforementioned loan covenants.
89
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
13. Stockholders’ Equity
On November 13, 2002, ProAssurance sold 2.65 million shares at an offering price of $16.55 per share.
The offering generated net proceeds of $40.6 million. ProAssurance used the net proceeds from the sale
of the newly issued shares to support the growth of its professional liability insurance business and for
general corporate purposes. The underwriting agreement granted the underwriters a thirty-day over-
allotment option for up to 375,000 shares that was exercised on December 4, 2002 and that generated
additional net proceeds of $5.9 million.
At December 31, 2002 ProAssurance had 100 million shares of authorized common stock and 50 million
shares of authorized preferred stock. The Board of Directors has the authorization to determine the
provisions for the issuance of shares of the preferred stock, including the number of shares to be issued
and the designations, powers, preferences and rights and the qualifications, limitations or restrictions of
such shares. At December 31, 2002, the Board of Directors had not authorized the issuance of any
preferred stock nor determined any provisions for the preferred stock.
At December 31, 2002 approximately 2.1 million of ProAssurance’s authorized shares of common stock
are reserved by the Board of Directors of ProAssurance for the award or issuance of shares under the
ProAssurance Incentive Compensation Stock Plan and the Professionals Group, Inc.'s 1996 Long-term
Stock Incentive Plan, as discussed in Note 14.
“Accumulated other comprehensive income (loss)” shown in the Consolidated Statements of Changes in
Capital is solely comprised of net unrealized gains (losses) on securities available for sale, net of taxes.
14. Stock Options
ProAssurance has an Incentive Compensation Stock Plan (the “ProAssurance Plan”) available to provide
performance-based compensation to employees of ProAssurance and its subsidiaries. All terms and
conditions of any grants under the ProAssurance Plan are at the discretion of the compensation
committee. At December 31, 2002 there were approximately 813,000 options outstanding under the Plan.
No stock options were granted in 2001 and 2000. During 2002, the ProAssurance Plan granted 415,000
stock options, 83,000 of which are exercisable as of December 31, 2002. All options have been granted
at a price equal to the market price of the stock on the date of grant. The stock options that were granted
during 2002 vest at a rate of 20% each July 15, beginning with July 15, 2002 and expire after ten years.
The remaining options expire in ten years and were fully vested at the grant date.
Additionally, as a part of the consolidation with Professionals Group, ProAssurance assumed all options
previously granted under Professionals Group, Inc.'s 1996 Long-term Stock Incentive Plan. Each
outstanding and unexercised option was converted into an option to purchase 1.76 shares of
ProAssurance Common Stock at an option price to be determined by dividing the option price for the
subject share of Professionals Group common stock by the exchange ratio of 1.76, resulting in 458,680
options outstanding after conversion. The options assumed were fully vested. No additional options are
expected to be issued related to the Professionals Group, Inc.'s 1996 Long-term Stock Incentive Plan.
90
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
14. Stock Options (continued)
Information regarding ProAssurance outstanding options under both plans for the year ending December
31, 2002 follows:
2002
Weighted
Average
Exercise
Price
Shares
Outstanding at beginning of year
719,313
$ 20.82
Granted
Exercised
Canceled
Outstanding at end of year
415,000
(31,276)
—
1,103,037
Options exercisable at end of year
771,037
$ 16.80
$ 15.54
—
$ 19.46
$ 20.60
Outstanding ProAssurance options as of December 31, 2002 consisted of the following:
Range
of
Exercise
Prices
Options Outstanding
Options Exercisable
Weighted
Average
Remaining
Contractual
Life
Weighted
Average
Exercise
Price
Number
Weighted
Average
Exercise
Price
Number
$9.23 - $26.03
1,103,037
6.8 years
$ 19.46
771,037
$ 20.60
The fair value of options granted during 2002 was $6.97 per share, and was estimated using the Black-
Scholes option pricing model based on the following weighted average assumptions: risk-free interest
rate of 4.6%; volatility of 0.34; expected life of 6 years; and dividend yield of 0%.
91
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
14. Stock Options (continued)
ProAssurance applies APB Opinion 25 and related interpretations in accounting for these plans.
Accordingly, no compensation cost has been recognized for these stock option plans. Had compensation
cost for these plans been determined based on the fair value at the grant dates for awards under those
plans consistent with the method of SFAS No. 123, ProAssurance’s net income would have been reduced
by $0.6 million, or $0.02 earnings per share (basic and diluted) in 2002. There would be no effect on net
income or earnings per share in 2000 or 2001. The effect on net income for 2002 is not representative of
the pro forma effect on net income for future years because additional stock option awards could be
made in future years.
92
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
15. Earnings Per Share
The following represents a reconciliation from the basic to the diluted numerator and denominator used in
calculating the diluted earnings per share:
Year ended December 31
2001
2002
2000
Basic earnings per share calculation:
Numerator:
Income before cumulative effect
of accounting change
Cumulative effect of accounting change
Net income
Denominator:
Weighted average number of
common shares outstanding
Basic earnings per share:
Income before cumulative effect
of accounting change
Cumulative effect of accounting change
Net income
Diluted earnings per share calculation:
Numerator:
Income before cumulative effect
of accounting change
Effect of MEEMIC Holdings stock
options on minority interest
Income before cumulative effect
of accounting change--diluted computation
Cumulative effect of accounting change
Net income--diluted computation
Denominator:
Weighted average number of
common shares outstanding
Assumed conversion of dilutive stock
options and awards
Diluted weighted average number of
common shares outstanding
Diluted earnings per share:
Income before cumulative effect
of accounting change
Cumulative effect of accounting change
Net income
$
$
10,513
1,694
12,207
$
$
12,450
-
12,450
$
$
24,300
-
24,300
26,231
24,263
23,291
$
$
$
$
$
$
0.51
-
0.51
1.04
-
1.04
0.40
0.07
0.47
$
10,513
$
12,450
$
24,300
(210)
(82)
-
10,303
1,694
11,997
$
12,368
-
12,368
$
24,300
-
24,300
$
26,231
24,263
23,291
23
4
-
26,254
24,267
23,291
$
$
$
$
$
$
0.51
-
0.51
1.04
-
1.04
0.39
0.07
0.46
Approximately 411,000, 588,000 and 399,000 employee stock options were excluded from the
computation of diluted earnings per share for the years ending December 31, 2002, 2001 and 2000,
respectively, because the effect of including the options would have been antidilutive.
93
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
16. Statutory Accounting and Dividend Restrictions
ProAssurance's insurance subsidiaries are required to file statutory financial statements with state
insurance regulatory authorities. GAAP differs from statutory accounting practices prescribed or permitted
by regulatory authorities. Differences between financial statement net income and statutory net income
are principally due to: (a) policy acquisition costs which are deferred under GAAP but expensed for
statutory purposes; (b) statutory accounting prescribes the method for valuing investments in affiliates
and does not permit consolidation; and (c) deferred income taxes which are recorded under GAAP but
not for statutory purposes.
The NAIC specifies risk-based capital requirements for property and casualty insurance providers. At
December 31, 2002, statutory capital for each insurance subsidiary was sufficient to satisfy regulatory
requirements. Statutory surplus and net income (loss) for each of ProAssurance’s insurance subsidiaries
for the years ended December 31, 2002 and 2001 are as follows (in thousands):
Statutory Surplus
as of
December 31, 2002
Statutory
Net Income (Loss)
for the year ended
December 31, 2002
The Medical Assurance Company, Inc.
ProNational Insurance Company
Red Mountain Casualty Insurance Company, Inc.
Medical Assurance of West Virginia, Inc.
MEEMIC Insurance Company
$ 193,335
196,955
15,829
9,998
95,514
$ (19,096)
9,915
767
563
15,870
Statutory Surplus
as of
December 31, 2001
Statutory
Net Income (Loss)
for the year ended
December 31, 2001**
The Medical Assurance Company, Inc.
ProNational Insurance Company
Red Mountain Casualty Insurance Company, Inc.
Medical Assurance of West Virginia, Inc.
MEEMIC Insurance Company
$ 172,841
175,874
12,007
10,301
80,093
$
(5,874)
18,966
203
1,918
7,017
**ProNational Insurance Company, ProNational Casualty Company (now known as Red Mountain
Casualty Insurance Company, Inc.) and MEEMIC Insurance Company were acquired as a result of the
consolidation with Professionals Group and are included in the consolidated results of operations only
since the date of consolidation. The statutory income shown in the table is the income for the period
since June 27, 2001.
94
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
16. Statutory Accounting and Dividend Restrictions (continued)
Consolidated retained earnings are comprised primarily of subsidiaries' retained earnings.
ProAssurance’s insurance subsidiaries are permitted to pay dividends of approximately $40
million during the next year without prior approval. However, the payment of any dividend requires
prior notice to the insurance regulator in the state of domicile and the regulator may prevent the
dividend if, in its judgment, payment of the dividend would have an adverse effect on the surplus
of the insurance subsidiary.
17. Quarterly Results of Operations (unaudited)
The following is a summary of unaudited quarterly results of operations (in thousands, except per
share amounts) for 2002 and 2001:
Net premiums earned
Net losses and LAE
Income (loss) before cumulative effect
Net income (loss)
Basic earnings per share:
Income before cumulative effect
Diluted earnings per share:
Income before cumulative effect
Net premiums earned
Net losses and LAE
Income before cumulative effect
Net income
Basic and diluted earnings per share
2002
$
1st
110,489
107,199
1,978
3,672
$
2nd
113,594
107,064
1,084
1,084
$
3rd
121,947
115,868
(4,524)
(4,524)
$
4th
131,378
117,898
11,975
11,975
0.08
0.08
0.04
0.04
2001
(0.18)
(0.18)
0.44
0.43
$
1st
49,545
46,986
2,273
2,273
0.10
$
2nd
46,677
43,803
2,987
2,987
0.13
$
3rd
105,492
101,339
2,936
2,936
0.11
$
4th
111,631
106,430
4,254
4,254
0.16
The sum of the above amounts may vary from the annual amounts because of rounding.
95
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
18. Subsequent Events
At December 31, 2002 ProAssurance indirectly owned 84% of MEEMIC Holdings. 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.
96
PROASSURANCE CORPORATION AND SUBSIDIARIES
SCHEDULE I -- SUMMARY OF INVESTMENTS -- OTHER THAN
INVESTMENTS IN RELATED PARTIES
December 31, 2002
(in thousands)
Type of Investment
Cost
or
Amortized
Cost
Amount
at Which
Shown in the
Balance Sheet
Fair
Value
Fixed Maturities:
Bonds:
U.S. Treasury securities.............................
State and municipal bonds.........................
Corporate bonds........................................
Asset-backed securities.............................
Certificates of deposit................................
Total fixed maturities..............................
Equity securities
Real estate, net..............................................
Short-term investments..................................
Total investments...................................
$
$
131,542
399,899
396,510
346,984
570
1,275,505
77,556
17,549
252,854
1,623,464
$
$
$
135,316
416,788
418,769
357,454
570
1,328,897
80,197
$
$
135,316
416,788
418,769
357,454
570
1,328,897
80,197
17,549
252,854
1,679,497
97
PROASSURANCE CORPORATION AND SUBSIDIARIES
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PROASSURANCE CORPORATION
Condensed Balance Sheets--Registrant Only
(in thousands)
Assets
Investment in subsidiaries - at equity
Cash
Other assets
Liabilities and stockholders' equity
Payable to subsidiaries
Other liabilities
Long-term debt
Stockholders' equity
Common stock
Other stockholders' equity, including unrealized
gains or losses on securities of subsidiaries
Total stockholders' equity
December 31
2002
2001
$
$
$
$
532,119
30,013
19,467
581,599
3,506
399
72,500
290
504,904
505,194
581,599
$
$
$
$
481,444
47
19,754
501,245
4,960
554
82,500
259
412,972
413,231
501,245
Revenues:
Investment income
Expenses:
Interest expense
Other expenses
Loss before income tax (benefit) and equity in
undistributed net income of subsidiaries
Federal and state income tax (benefit)
Loss before equity in
net income of subsidiaries
Equity in net income of subsidiaries
Net income
ProAssurance Corporation
Condensed Statements of Income--Registrant Only
(in thousands)
Year ended December 31
2002
2001
$
57
$
440
2,875
1,441
4,316
(4,259)
(1,491)
(2,768)
14,975
12,207
$
2,591
466
3,057
(2,617)
(835)
(1,782)
14,232
12,450
$
98
PROASSURANCE CORPORATION AND SUBSIDIARIES
SCHEDULE II--CONTINUED
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
ProAssurance Corporation
Condensed Statements of Cash Flows--Registrant Only
December 31, 2002 and 2001
(in thousands)
Year Ended December 31
2002
2001
Cash used by operating activities
$
(6,533)
$
(2,325)
Investing activities
Cash distribution to
Professionals Group shareholders
Cash dividends from subsidiaries
Cash received from stock offering
Financing activities
Proceeds from long term debt
Principal payments on long-term debt
Other
Increase in cash
Cash, beginning of period
-
-
46,499
46,499
-
(10,000)
-
(10,000)
29,966
47
Cash, end of period
$
30,013
$
(196,304)
116,274
-
(80,030)
110,000
(27,500)
(98)
82,402
47
-
47
Notes to Condensed Financial Statements of Registrant
1. Formation of ProAssurance Corporation
ProAssurance Corporation was formed in October 2000 as a holding company (ProAssurance Holding Company) for the
purpose of consolidating Medical Assurance, Inc. (Medical Assurance) and Professionals Group, Inc. (Professionals
Group). ProAssurance Holding Company did not commence operations until completion of the consolidation on June 27,
2001. The consolidation of ProAssurance Holding Company and Medical Assurance was in the form of a corporate
reorganization and was accounted for in a manner similar to a pooling of interests. The consolidation was a non-cash
transaction whereby one share of ProAssurance common stock was exchanged for each outstanding share of Medical
Assurance stock. The consolidation with Professionals Group was accounted for as a purchase transaction and involved
the exchange of ProAssurance stock and cash, or cash only, as elected by the shareholder, for each share of
Professionals Group stock.
2. Basis of Presentation
ProAssurance Holding Company’s initial investment in Medical Assurance is valued at the net book value of Medical
Assurance on the consolidation date, June 27, 2001. The consolidation with Professionals Group was accounted for as a
purchase transaction and involved the exchange of ProAssurance stock and cash, or cash only, as elected by the
shareholder, for each share of Professionals Group stock. ProAssurance Holding Company’s initial investment in
Professionals Group is valued at the fair value of the net assets acquired on the consolidation date of June 27, 2001. At
December 31, 2002 and 2001 ProAssurance Holding Company’s investment in subsidiaries is stated at the initial values
described plus equity in the undistributed earnings of subsidiaries since the date of acquisition less dividends received
from the subsidiaries. Goodwill of approximately $18.2 million was recorded related to the consolidation with Professionals
Group and is included in other assets. The parent-only financial statements should be read in conjunction with
ProAssurance’s consolidated financial statements.
99
PROASSURANCE CORPORATION AND SUBSIDIARIES
SCHEDULE II--CONTINUED
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
Notes to Condensed Financial Statements of Registrant (continued)
3. Related Party Transactions
ProAssurance Holding Company received no cash dividends during 2002 and received cash dividends of $70.8 million
from Medical Assurance and $41.6 million from Professionals Group during the year ended December 31, 2001.
All of ProAssurance Holding Company’s treasury shares are owned by its subsidiaries. In the parent-only financial
statements, stockholders' equity has been reduced by the cost of these treasury shares and ProAssurance Holding
Company’s investment in subsidiaries has been reduced by the cost of the treasury shares owned by the subsidiaries.
4. Income Taxes
Under terms of ProAssurance’s tax sharing agreement with its subsidiaries, income tax provisions for individual
companies are computed on a separate company basis.
100
PROASSURANCE CORPORATION AND SUBSIDIARIES
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
Years Ended December 31, 2002, 2001, and 2000
(in thousands)
Deferred policy acquisition costs............................................. $
Reserve for losses and loss adjustment expenses................
Unearned premiums................................................................
Net premiums earned..............................................................
Premiums assumed from other companies.............................
Net investment income............................................................
Net losses and loss adjustment expenses...............................
Underwriting, acquisition and insurance expenses:
Amortization of deferred policy acquisition costs................
Other underwriting, acquisition
and insurance expenses................................................
Net premiums written..............................................................
2002
2001
2000
22,729
1,622,468
248,371
477,408
2,991
76,918
448,029
$
15,489
1,442,341
188,630
313,345
23,327
59,782
298,558
$
10,350
659,659
78,495
177,596
25,633
41,450
155,710
41,800
37,792
21,077
49,453
537,123
32,645
310,291
17,502
194,279
101
PROASSURANCE CORPORATION AND SUBSIDIARIES
SCHEDULE IV - REINSURANCE
Years Ended December 31, 2002, 2001, and 2000
(dollars in thousands)
PROPERTY & CASUALTY
Premiums earned
Premiums ceded
Premiums assumed
2002
2001
2000
$
573,091
(98,918)
2,516
$
357,394
(67,650)
7,129
$
185,141
(33,549)
11,312
Net premiums earned
$
476,689
$
296,873
$
162,904
Percentage of amount assumed to net
0.53%
2.40%
6.94%
ACCIDENT AND HEALTH
Premiums earned
Premiums ceded
Premiums assumed
Net premiums earned
Percentage of amount assumed to net
OTHER
Premiums earned
Premiums ceded
Premiums assumed
Net premiums earned
$
$
$
$
332
(88)
475
$
789
(515)
16,198
5,528
(5,152)
14,316
719
$
16,472
$
14,692
66.06%
98.34%
97.44%
-
-
-
-
$
-
-
-
-
$
-
-
-
-
Percentage of amount assumed to net
0.00%
0.00%
0.00%
Total net premiums earned
$
477,408
$
313,345
$
177,596
102
PROASSURANCE CORPORATION AND SUBSIDIARIES
SCHEDULE VI - SUPPLEMENTARY PROPERTY AND CASUALTY INSURANCE INFORMATION
Years Ended December 31, 2002, 2001, and 2000
(in thousands)
$
Deferred policy acquisition costs…..…..…................................
Reserve for losses and loss adjustment expenses….....…........
Unearned premiums........................................…......................
Net premiums earned.....................................…..….................
Net investment income...................................….......…............
Losses and loss adjustment expenses incurred
related to current year, net of reinsurance…...................…..
Losses and loss adjustment expenses incurred
related to prior year, net of reinsurance…...…......................
Amortization of deferred policy acquisition costs….......….........
Paid losses and loss adjustment expenses related to
current year losses, net of reinsurance.….....…..…..............
Paid losses and loss adjustment expenses related to
prior year losses, net of reinsurance....…......…...................
2002
22,729
1,622,468
248,371
477,408
76,918
$
$
2001
15,489
1,442,341
188,630
313,345
59,782
2000
10,350
659,659
78,495
177,596
41,450
439,600
284,740
178,210
8,429
41,800
13,818
37,792
(22,500)
21,077
(84,376)
(137,121)
(14,909)
(271,482)
(143,893)
(133,623)
103
Exhibit
Number
Description
EXHIBIT INDEX
2.1
2.2
2.2 (a)
3.1(a)
3.1(b)
3.2
4.1
10.1(a)
10.1(b)
Agreement to Consolidate by and between Medical Assurance, Inc.
and Professionals Group, Inc. dated June 22, 2000 as amended as
of November 1, 2000. (1)
Agreement and Plan of Merger dated as of July 9, 2002 among
ProNational Insurance Company, MEEMIC Merger Corp. and
MEEMIC Holdings (2)
Amendment No. 1 to Agreement and Plan of Merger dated as of July
9, 2002 among ProNational Insurance Company, MEEMIC Merger
Corp. and MEEMIC Holdings, Inc. made on September 18, 2002*
Certificate of Incorporation of ProAssurance (1)
Certificate of Amendment of ProAssurance (3)
Bylaws of ProAssurance (1)
Credit Agreement among ProAssurance and lending banks (4)
Amendment and Assumption Agreement by and between
ProAssurance and Medical Assurance, Inc. (3)
Medical Assurance, Inc. Incentive Compensation Stock Plan
(formerly known as the Mutual Assurance, Inc. 1995 Stock Award
Plan) (5)
10.1(c)
Amendment and Assumption Agreement by and between Mutual
Assurance, Inc. and MAIC Holdings, Inc. dated April 8, 1996 (6)
10.2
10.3
10.4
10.5(a)
10.5(b)
10.5(c)
10.5(d)
Professionals Insurance Company Management Group 1996 Long
Term Incentive Plan (7)
MEEMIC Holdings Stock Compensation Plan (8)
MEEMIC Incentive Plan Trust (3)
Release and Severance Agreement between Victor T. Adamo and
ProAssurance (9)
Amendment to Release and Severance Compensation Agreement of
Victor T. Adamo (10)
Release and Severance Agreement between William P. Sabados
and ProAssurance (11)
Release and Severance Agreement between Lynn M. Kalinowski
and ProAssurance (11)
104
10.5(e)
10.5(f)
10.5(g)
10.6
10.7
Release and Severance Agreement between Howard H. Friedman
and ProAssurance (10)
Release and Severance Agreement between James J. Morello and
ProAssurance (10)
Release and Severance Agreement between Frank B. O'Neil and
ProAssurance*
Employment Agreement of A. Derrill Crowe, as amended (10)
Form of Indemnification Agreement between ProAssurance and
each of the following named executive officers and directors of
ProAssurance:*
Victor T. Adamo
Lucian F. Bloodworth
Paul R. Butrus
A. Derrill Crowe
Robert E. Flowers
Howard H. Friedman
Leon C. Hamrick
Lynn M. Kalinowski
John J. McMahon
James J. Morello
Drayton Nabers
John P. North
Frank B. O'Neil
Ann F. Putallaz
William P. Sabados
William H. Woodhams
21
23.1
99.1
99.2
Subsidiaries of ProAssurance Corporation*
Consent of Ernst & Young LLP
Certification of Chief Executive Officer required under 18 U.S.C. §
1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
Certification of Chief Financial Officer required under 18 U.S.C. §
1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
Footnotes:
* Previously filed with this report.
(1)
(2)
Filed as an Exhibit to ProAssurance’s Registration Statement on Form S-4 (Commission
File No. 333-49378) and incorporated herein by reference pursuant to Rule 12b-32 of the
Securities and Exchange Commission.
Filed as an Exhibit to ProAssurance's Quarterly Report on Form 10-Q for the period
ended June 30, 2002 (File No. 001-16533) and incorporated herein by reference
pursuant to Rule 12b-32 of the Securities and Exchange Commission.
105
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
Filed as an Exhibit to ProAssurance's Quarterly Report on Form 10-Q for the period
ended June 30, 2002 (File No. 001-16533) and incorporated herein by reference
pursuant to Rule 12b-32 of the Securities and Exchange Commission.
Filed as an Exhibit to ProAssurance's Annual Report on Form 10-K for the year ended
December 31, 2001 (Commission File No. 001-16533) and incorporated herein by
reference pursuant to Rule 12b-32 of the Securities and Exchange Commission.
Filed as an Exhibit to ProAssurance’s Form 8-K/A for event occurring May 10, 2000
(Commission File No. 001-12129) and incorporated herein by this reference pursuant to
Rule 12b-32 of the Securities and Exchange Commission.
Filed as an Exhibit to MAIC Holding’s Registration Statement on Form S-4 (Commission
File No. 33-91508) and incorporated herein by reference pursuant to Rule 12b-32 of the
Securities and Exchange Commission.
Filed as an Exhibit to MAIC Holding’s Proxy Statement for the 1996 Annual Meeting
(Commission File No. 0-19439) is incorporated herein by reference pursuant to Rule 12b-
32 of the Securities and Exchange Commission.
Filed as an Exhibit to Professionals Group’s Registration Statement on Form S-4
(Commission File No. 333-3138) and incorporated herein by reference pursuant to Rule
12b-32 of the Securities and Exchange Commission.
Filed as an Exhibit to MEEMIC Holding’s Registration Statement on Form S-4
(Commission File No. 333-66671) and incorporated herein by reference pursuant to Rule
12b-32 of the Securities and Exchange Commission.
Filed as an Exhibit to ProAssurance’s Form 10-Q (Commission File No. 001-16533) for
the quarter ended June 30, 2001 and incorporated herein by reference pursuant to Rule
12b-32 of the Securities and Exchange Commission.
Filed as an Exhibit to ProAssurance's Registration Statement on Form S-3 (Commission
File No. 333-100526), as amended, and incorporated herein by reference pursuant to
Rule 12b-32 of the Securities and Exchange Commission.
Filed as an Exhibit to ProAssurance’s Form 10-Q (Commission File No. 001-16533) for
the quarter ended September 30, 2001 and incorporated herein by reference pursuant to
Rule 12b-32 of the Securities and Exchange Commission.
106
ProAssurance 2002 Investor Information
ProAssurance Corporation had 28,880,185 shares of com-
mon stock outstanding, and 3,736 shareholders of record at
FINANCIAL INFORMATION & INVESTOR RELATIONS
Analysts, stockholders and any other parties interested
March 15, 2003. The common stock of ProAssurance
in obtaining additional information may access
Corporation trades on The New York Stock Exchange under
www.ProAssurance.com or contact:
the symbol PRA. Investors may find the Company’s stock
Frank B. O’Neil
prices reported as ProAsr in the stock section of USA Today
Senior Vice President,
and major newspapers, and as ProAssurance in the Wall
Corporate Communications & Investor Relations
Street Journal.
TRANSFER AGENT
Mellon Investor Services, LLC
Telephone: 800-851-4218
Internet: www.melloninvestor.com
(205) 877-4461
info@ProAssurance.com
Howard H. Friedman
Chief Financial Officer
(205) 877-4400
General inquiries and address changes may be also conveyed
CORPORATE HEADQUARTERS
in writing to:
Mellon Investor Services, LLC
P. O. Box 3338
South Hackensack, NJ 07606-1916
Certificates to be transferred should be sent via insured,
registered mail to:
Mellon Investor Services, LLC
Stock Transfer Department
P. O. Box 3312
ProAssurance Corporation
100 Brookwood Place
Birmingham, AL 35209-6811
(205) 877-4400 • (800) 282-6242
FAX: (205) 802-4799
www.ProAssurance.com
ANNUAL MEETING
The 2003 Annual Meeting is scheduled for 10:30 a.m. on
May 28, 2003 at the Harbert Center, 2019 4th Avenue
South Hackensack, NJ 07606-1912
North, Birmingham, AL.
Shareholders who wish to report lost or stolen stock certifi-
cates should contact:
Mellon Investor Services, LLC
Estoppel Department
P. O. Box 3317
South Hackensack, NJ 07606-1917
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100 Brookwood Place,
Birmingham, AL 35209
2600 Professionals Drive
Okemos, MI 48864
100 Brookwood Place,
Birmingham, AL 35209
(800) 282-6242
www.MedicalAssurance.com
(800) 292-1036
www.ProNational.com
(800) 282-6242
www.ProAssurance.com/RedMountain
691 North Squirrel Road,
Suite 200
Auburn Hills, MI 48326
(888) 4 MEEMIC
www.MEEMIC.com