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A PROVEN PAST
A PROMISING FUTURE
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2007 A N N U A L R E P O R T
P R O A S S U R A N C E S E L E C T E D F I N A N C I A L D A T A ( I N T H O U S A N D S )
Income Statement Highlights(1)
Gross premiums written(2)
Total revenues (2)
Income (loss) from continuing
operations, net of tax
Net income
Balance Sheet Highlights
Total investments (2)
Total assets, continuing operations
Total assets
Reserve for losses and loss
RR
adjustment expenses (2)
Long-term debt (2)
Total liabilities, continuing operations
2007
2006
2005
2004
2003
$549,074
$706,068
$168,186
$578,983
$737,598
$126,984
$572,960
$647,950
$80,026
$573,592
$607,557
$43,043
$543,323
$535,841
$15,345
$168,186
$236,425
$113,457
$72,811
$38,703
$3,629,607
$4,439,836
$4,439,836
$2,559,707
$3,492,098
$4,342,853
$4,342,853
$2,607,148
$2,614,319
$3,341,600
$3,909,379
$2,224,436
$2,145,609
$2,743,295
$3,239,198
$1,818,636
$1,792,323
$2,448,088
$2,879,352
$1,634,749
$164,158
$3,184,766
$179,177
$3,224,306
$167,240
$2,806,820
$151,480
$2,333,405
$104,789
$2,074,560
B O O K VA LU E
P E R S H A R E 3
S TO C K H O L D E R S ’ E Q U I T Y
$ I N M I L L I O N S
TOTA L A S S E T S
$ I N M I L L I O N S
$39
$34
1,255
1,119
4,343
4,440
$25
$21
$19
765
611
546
3,909
3,239
2,879
03 04 05
06
07
03
04 05
06
07
03
04
05
06
07
(1) Includes acquired entities since date of acquisition only. PIC Wisconsin was acquired on
acquired on August 3, 2005.
WW
August 1, 2006. NCRIC Corporation was
(2) Excludes Discontinued Operations.
(3) Total capital per share of common stock outstanding.
TO MY FE LLOW SHARE HOLDE RS,
The company in which you and I share an investment marked two major milestones as we achieved
excellent results in 2007. The first milestone concerns our past; the second marks a point of transition.
Our first milestone was the celebration of the 30th anniversary of the issuance of our first policy.
The ensuing three decades have witnessed our disciplined dedication to the protection of our insureds
through balance sheet strength, devotion to exceptional customer service, and a shared expectation of
shareholder returns. We do not intend to deviate from those ideals as they are all interwoven to create
the fabric of a company that seeks the best for its insureds, agents, employees, and investors.
Our second milestone was the retirement of Derrill Crowe as Chief Executive Officer. Dr. Crowe,
who remains as non-executive chairman, is rightly revered for his vision and leadership in building a
well-capitalized, highly respected organization which enjoys a position of unquestioned leadership in
our industry. You, I and every stakeholder owe him a debt of gratitude we can never repay.
Several weeks ago Dr. Crowe and I sat down to reflect on the three decades of challenges met
and opportunities seized. That conversation also gave me a chance to outline my vision for your
company. The relevant points of that discussion form the basis for our communication with you this
year. We want you to understand where we’ve been, and most importantly, where we’re going and
PROASSURANCE SENIOR OFFICERS
seated l-r: Victor T. Adamo, W. Stancil Starnes, Edward L. Rand, Jr.
standing l-r: Jeffrey P. Lisenby, Darryl K. Thomas, Hayes V. Whiteside,
Howard H. Friedman, Frank B. O’Neil, Jeffrey L. Bowlby
how we intend to get there.
On behalf of the industry’s most
experienced and tested management
team and employees, thank you for
the confidence you show in us by
remaining invested. As your new Chief
Executive Officer, I assure you that I
come to the office every day working to
achieve the best possible results for you
in 2008 and the years ahead.
Sincerely,
W. Stancil Starnes
Chief Executive Officer
“This company has a long and distinguished record.
Our approach has proven successful; we intend to
build on that success.”
STAN STARNES
THE DOCTORS...WANTED US TO
BE FINANCIALLY SOUND AND
ALWAYS BE PRESENT. MOST
IMPORTANT…WAS THEY WERE
TIRED OF SEEING CASES SETTLED
THAT DID NOT HAVE MERIT.
A. Derrill Crowe, M.D.
Chairman
T H E B E G I N N I N G
Crowe: About 1973…the carrier that brokered almost 90% of the coverage for the doctors [in
Alabama] made a decision to get out of the medical malpractice market. We looked for about six
months locally and could not find anybody to insure our practice. We went to Europe and still
could not find anybody. So a decision was made to form an insurance company, Mutual Assurance.
Doctors put up about $2.5 million at $1,000 a piece, so 2,500 physicians that were participating
gave us about $8 million. And we wrote our first policy on April 1, 1977.
The doctors gave us several mandates. Number one, they wanted us to be financially sound and
always be present. The second thing…most important…was they were tired of seeing cases settled
that did not have merit…settled for nuisance value.
Starnes: I remember it like it was yesterday. The thing that made [it] very different was that those
physicians recognized that what we were talking about was far more than money. Because when you
charge that a physician has injured or damaged his patient, you strike at the very core of who he is.
TODAY, THAT COMPANY
HAS…THE STAYING POWER
TO RESPOND TO THE NEEDS
OF ITS INSUREDS WHEN
THOSE NEEDS ARISE.
Stan Starnes
Chief Executive Officer
And if you settle a case in which he did nothing wrong, then the consequences reverberate throughout
the system. And these physicians in 1977 and 1978 were committed to the notion that that was not
going to happen any longer.
We pay indemnity dollars today in fewer than 12 percent of the cases that are filed against our
insureds. That means in 88 percent of the cases filed against our insureds, and in some states as high
as 95 percent of the cases, end with the physician being totally exonerated and completely vindicated.
Now, we have to spend millions of dollars to produce those results in terms of attorneys’ fees and costs.
But in my view, that’s what the physician deserves—an option for vindication.
Today, that company has…the staying power to respond to the needs of its insureds when those
needs arise. Frankly, it’s the most important legacy that that group of Alabama physicians have left
for the physicians practicing today; that is, a company that’s financially stable and that will provide
them a defense which offers them vindication when they deserve vindication.
O N O U R I N V E S T O R S …
Crowe: If we do a good job for our…policyholders, we’re going to do a good job for our shareholders. So there’s
absolutely a common interest here. We’re here for the long run. The opportunities are going to become abundant, in
my opinion, in the next five to ten years.
Starnes: We want our investors to share our commitment to our policyholders, to our customers. We want our investors
to understand that we’re in a long-term business…that we think is attractive to long-term investors. And if you look at what
Dr. Crowe did over the last thirty years, you will see that it’s been a very good place for long-term investors to be. We intend
to continue that rich tradition on the part of the company toward its investors.
We also continue to seek opportunities that will enable us to provide the sorts of returns to those investors that
they’ve enjoyed since the company went public in 1991. We’re probably not a place for a short-term investor; that’s not
the nature of this business. But we’ve had lots of shareholders who have been with us for lots and lots of years. And for
those shareholders, this has been an exceptionally good place to be.
One of the things of which I am the proudest is that there’s very much an identity of interest between our
policyholders and our shareholders. And indeed, many of our policyholders are also our shareholders.
O N O U R A G E N T S …
Starnes: The agents who we are privileged to have represent us are, in every sense of the word, our partners. We have
to depend on them to tell the ProAssurance story. We respect that relationship, and we will never impose arbitrary
burdens on them in terms of quotas and those sorts of things. We want to equip them with everything they need to tell
the ProAssurance story, because we think that when that story is told, we will be the preferred source of professional
liability protection throughout the United States.
It’s a great opportunity for us. It’s a great opportunity for our agents. And it’s important that we have a partnership
with our agents that lets us march down that road in a way that benefits both of us.
O N O U R E M P L O Y E E S …
Starnes: Our employees are the most important resource our company has. You know, we don’t have patents on what
we do. We don’t have trademarks on what we do. Our assets are our people. And the way we leverage those assets are by
having people committed to the whole notion of customer service. We want to ramp that up and every year take it to a
higher level than it had the year before. Because that’s the only reason we’re there, is to provide service to that physician
when he needs it.
Our employees must understand, from the top down, that every time we have an encounter with a physician, that’s
an opportunity to demonstrate how much that physician means to us.
A L E G A C Y O F S E C U R I T Y
Starnes: An insurance policy is simply a piece of paper, and it has no worth until the physician
is sued and needs a defense; or, until a judgment is returned against him and it needs to be paid.
It may be years after the physician bought this piece of paper before any of these things occur. The
only assurance the physician finds in that piece of paper is the financial strength of the company
that issued it, that wrote the insurance policy. So it is of extraordinary importance, if the company is
going to deliver on its promises to the physician, that the company remains financially strong. The
world of insurance is littered with the corpses of companies that did not do that.
Crowe: From the very beginning, we’ve had a total dedication and orientation around the desires of
the physicians. We have maintained that over the years…it’s what ProAssurance is—it’s a definition of
who we are.
Starnes: Dr. Crowe is exactly right. The core of what the company has been is the involvement of
physicians. And even today, we do not make any major decisions in any segment of our operations
without physician involvement. Everything we do at ProAssurance is informed by physicians; we
remain as committed to them as that small group of Alabama physicians were in 1975.
M A D E P O S S I B L E B Y G R O W T H
Crowe: The insurance industry is run on ratios, capital to premiums, capital to reserves, etc. Our
well-being depends upon our financial rating…so we began to look at the possibility of converting
from a mutual company to a stock company, specifically so we could raise additional capital. At the
same time, we were also looking nationwide, and we saw several companies beginning to get into
a little difficulty. We felt like there was going to be a roll-up in this industry. For those reasons, we
decided to demutualize, and in fact, we did in 1991.
Starnes: Looking back on it, it was the correct decision because it gives us the flexibility and the
capital we need in order to continue to be there for the physicians we serve.
Because we’re a public company with access to capital, we are not as vulnerable to the vagaries of
the marketplace as some of the mutual companies have been historically.
O N T H E T R A N S I T I O N …
Crowe: I’ve been in the business for thirty years, and I honestly didn’t think I’d retire until I was about 75; but things
happened. I had a 70th birthday; I was not enjoying it as much as I did when I was a younger man. And I thought that I
saw changes coming and I need to find someone who can adapt, who can look at it differently.
I’ve known Stan for a long time. I’ve always known that he was the one that should replace me. He’s an outstanding
thinker. Given the issues ahead of us, I felt like he would be better for this company than I would be.
Starnes: Dr. Crowe first mentioned it to me last April, and I was shocked. I had known him very well since 1978. He and I
worked together on almost a daily basis during that entire period; we became very close personal friends. I always figured…he
would be the CEO of ProAssurance until he was 80 years old; and second, I figured he would come to my funeral. So it really
never occurred to me that I would become the CEO when he decided that it was time for him to step aside.
And notice that I did not say that I would take his place, because nobody will take his place, ever. What he’s done with
that company over the last thirty years is phenomenal. And it’s just now beginning to be appropriately recognized. So while he
has retired, and there’s been the transition from him to me, as long as I’m there, he will continue to cast a very large shadow.
He’s taught the rest of us how it ought to be done when it’s time for one to step aside from the role he played. And he’s
just been extraordinary at it. The transition has been as graceful and elegant as the thirty years he spent with the company.
Starnes: By becoming a public company, ProAssurance has been able, through thirteen mergers and
acquisitions, to diversify its geographical base. And those mergers and acquisitions—that geographical
diversity—gives us additional safety.
I think the next four or five years are going to be a very exciting and very challenging time.
We’re in a soft market today [and] soft markets have produced the demise of insurance companies
who are not financially strong, so I think you’ll continue to see consolidation within the industry.
We at ProAssurance are going to be very opportunistic in that regard, attentive to those acquisition
opportunities that make sense for us.
My own view is that bigger changes are likely to emerge from the ongoing health care debate
in this country. Part of that action may well include changes to the professional liability arena, and
those changes could indeed produce extraordinary changes in what we are doing and the way we run
our business. We obviously have to be attuned to that. We have to be nimble enough to protect our
policyholders, as well as our shareholders, through all those changes.
E N S U R I N G A S O L I D F U T U R E
Crowe: I’ve been in the business thirty years, and I’ve seen a lot of mistakes made. I’ve seen a company
get in trouble because of bad investments and go out of business. I’ve seen companies get in trouble
because of mishandling claims and go out of business. But the most frequent trouble that companies get
into comes from their willingness to underwrite anything in their zeal to grow the top line.
I’ve known Stan for a long time. I’ve always known that he was the one that should replace me. He’s an
outstanding thinker. He looks at a situation [and] thinks through the process thoroughly. So I felt like, going
forward, he would be better for this company than I would be, to make it short and simple and sweet.
Starnes: It’s important to recognize that
healthy top line growth is important, and
over the long term, it’s essential. But I em-
phasize the word “healthy” top line growth.
Healthy top line growth comes from a
policy that is fairly priced. But growth
can jeopardize your bottom line. So that’s
why it’s very important to analyze top line
growth to see whether it’s a result of healthy, disciplined pricing or is it the result of irrational pricing. If it’s
the latter, then you cannot hope to attain any sort of bottom line growth. And indeed, your bottom line
growth will be put in jeopardy, and the existence of your company will be put in jeopardy.
We have to be disciplined in terms of the risks that we underwrite. We have to be disciplined in
terms of the premium that we charge. It can be intoxicating when you look out there and see all the
opportunities to add market share if you’ll simply reduce your premiums. But that’s a temptation that
must be avoided at all costs if you’re going to be there for your policyholders just a few years from now.
So we need to be very disciplined in terms
of maintaining fidelity to those principles
O U R C L A I M S P H I L O S O P H Y A N D T H E F U T U R E …
that have gotten us to where we are today;
we will continue to price our product in
order to deliver what our product promises.
We’re not going to change our business
practices just to try to chase the false allure
of market share.
The most important thing we can offer
to our policyholders is a capital base that
will withstand whatever the economy and
whatever the vagaries of this industry throw
at us. It’s that sound capital base which
enables us to be there tomorrow for our
shareholders. We want to make the appro-
priate use of that capital. We want to make
sure the capital is employed correctly for our
shareholders. We have the financial strength
and stability to see ourselves through the
vagaries of the soft market and to take
advantage of the opportunities of the hard
market. And we’re going to operate our
company with discipline, and we’re going to
operate our company with diversity in a way
Starnes: The claims philosophy of ProAssurance is very straight-
forward. If the physician did not breach the standard of care or if a
physician did not cause any injury or harm to his patient, then we
want to defend that case to the full extent that the law allows. If a
physician has breached the standard of care, which has caused injury or
death to his patient, then we want to settle that case as quickly as we can.
None of us know the changes that are coming in health care. But
one change that is certain to come is greater transparency between
what a physician does with the professional liability claim and the
public’s ability to learn the results of that claim. The whole world’s
going to see what happens to that claim. And the truth of the matter
is, when the general public sees that a physician has settled a claim,
the feeling is that the physician must have done something wrong.
That’s only human nature and, in fact, it usually indicates just that.
What we, as a company, have an opportunity to do in this world
of greater transparency is extend to others our ability to offer them
vindication. We price our product in order to afford the physician
that opportunity—in order to enable us to withstand the risk of
the trial. Most companies don’t do that. Most professional liability
insurance companies today, very subtly and very overtly, from the
moment the lawsuit comes in the door, attempt to get the physician
that will enable us to continue to provide very
to settle the lawsuit even when he didn’t do anything wrong.
beneficial returns for our shareholders.
B O A R D O F D I R E C T O R S
TT
DI RECTORS
A. Derrill Crowe, M.D.
W. Stancil Starnes, Esq.
Victor T. Adamo, Esq., C.P.C.
Lucian Bloodworth
Paul R. Butrus
Robert E.
Flowers, M.D.
RR
William J. Listwan, M.D.
U.
John J. McMahon, Jr.
Drayton Nabers, Jr., Esq.
John P. North, Jr., C.P.A.
Ann F. Putallaz, Ph.D.
FF
William H. Woodhams, M.D.
Wilfred W. Yeargan, M.D.
POSITION
Chairman, ProAssurancee
Chief Executive Officer, ProAssurance
President, ProAssurancee
Chairman, Cain Manufacturing Company, Inc.
Senior Advisor, ProAssurance
Retired Physician
Practicing Physician & Assistantt
Professor of Internal Medicine
Chairman, Ligon Industries
Attorneyy
Retired Accounting Firm Partnerr
Director of Data and Communication Services
Munder Capital Management
Practicing Physician
Practicing Physician
I N DE PE N DE NCE
M
M
M
I
M
I
I
I
I
I
I
I
I
COM M ITTE E(S)
1C
1
1
2,3,4
1
1
3
3, 4C
2C
2
4
3
M = Management,
Non-Independentt
I = Independentt
1 = Executive Committee
2 = Audit Committee
3 = Compensation Committee
4 = Nominating and Corporate
Governance Committee
C = Chairman
S E N I O R O F F I C E R S
Jeffrey L. Bowlby, A.R.M.
Howard H. Friedman, A.C.A.S., M.A.A.A. Co-President & Chief Underwriting Officer, Professional Liability Group
Chief Marketing Officer & Senior Vice-President, Professional Liability Group
Jeffrey P. Lisenby, Esq., C.P.C.U.
James J. Morello, C.P.A.
Frank B. O’Neil
Edward L. Rand, Jr., C.P.A.
RR
Darryl K. Thomas, Esq.
Senior Vice-President, ProAssurance
Corporate Secretary, General Counsel & Senior Vice-President, ProAssurance
Chief Accounting Officer & Treasurer
Senior Vice-President, ProAssurance
Communications Officer & Senior Vice-President, ProAssurance
Chief Financial Officer & Senior Vice-President, ProAssurance
Co-President & Chief Claims Officer, Professional Liability Group
Senior Vice-President, ProAssurance
Hayes V. Whiteside, M.D.
Chief Medical Officer & Senior Vice-President, Professional Liability Group
STOCK PRICE PE RFORMANCE
You may use the following information to compare the market value of our Common Stock with other public companies and public companies in
the insurance industry. The graph sets forth the cumulative total stockholder return of our stock during the five years ended December 31, 2007,
as well as the cumulative total stockholder return of overall stock market index (the Russell 2000) and a peer group index (the S
Casualty Insurance Index) for the five years ended December 31, 2007. All cumulative return data assumes the reinvestment of dividends.
NL Property &
RR
TOTAL RETU RN PE RFORMANCE
ProAssurance Corporation
ProAssurance Corporation
Russell 2000
Russell 2000
SNL Property & Casualty Insurance Index
SNL Property & Casualty Insurance Index
300
250
200
150
100
50
12/31/02
12/31/03
12/31/04
12/31/05
12/31/06
12/31/07
PE RIOD E N DI NG
I N DEX
ProAssurance Corporation
Russell 2000
SNL Property & Casualty
Insurance Index
12/31/02
12/31/03
12/31/04
12/31/05
12/31/06
12/31/07
100.00
100.00
100.00
153.10
147.25
123.73
186.24
174.24
135.62
231.62
182.18
148.25
237.71
215.64
172.81
261.52
212.26
186.59
United States
Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-K
(Mark One)
X
Annual report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 [Fee
Required] for the fiscal year ended December 31, 2007, 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
(Address of principal executive offices)
35209
(Zip Code)
(205) 877-4400
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Common Stock, par value $0.01 per share
Name of Each Exchange On Which Registered
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act. Yes X
No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section
15(d) of the Act. Yes
No X
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. [ X ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-
accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,"
"accelerated filer” and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer X Accelerated filer
Non-accelerated filer Smaller reporting company
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes No X
The aggregate market value of voting stock held by non-affiliates of the registrant at June 30, 2007 was
$1,692,091,431.
As of February 15, 2008, the registrant had outstanding approximately 32,203,785 shares of its common
stock.
Exhibit Index at page 113
Page 1 of 117 pages
Documents incorporated by reference in this Form 10-K
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
(viii)
(ix)
(x)
(xi)
(xii)
(xiii)
(xiv)
(xv)
The definitive proxy statement for the 2008 Annual Meeting of the Stockholders of ProAssurance
Corporation (File No. 001-16533) is incorporated by reference into Part III of this report.
The MAIC Holdings, Inc. Registration Statement on Form S-4 (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 (File No. 0-19439
is incorporated by reference into Part IV of this report.
The Professionals Group, Inc. Registration Statement on Form S-4 (File No. 333-3138) is
incorporated by reference into Part IV of this report.
The ProAssurance Corporation Registration Statement on Form S-4 (File No. 333-49378) is
incorporated by reference into Party 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 Annual Report on the Form 10-K for the year ended December 31,
2002 (File No. 001-16533) is incorporated by reference in Part IV of this report.
The ProAssurance Corporation Definitive Proxy Statement filed on April 16, 2004 (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,
2004 (File No. 001-16533) is incorporated by reference into Part IV of this report.
The ProAssurance Corporation Registration Statement of Form S-4 (File No. 333-124156) is
incorporated by reference in Part IV of this report.
The ProAssurance Corporation Current Report on Form 8-K for event occurring on November 4.
2005 (File No. 001-16533) is incorporated by reference into Part IV of this report
The ProAssurance Corporation Registration Statement of Form S-4 (File No. 333-131874) is
incorporated by reference in Part IV of this report.
The ProAssurance Corporation Current Report on Form 8-K for event occurring on September 13,
2006 (File No. 001-16533) is incorporated by reference into Part IV of this report.
The ProAssurance Corporation Current Report on Form 8-K for event occurring on May 12, 2007
(File No. 001-16533) is incorporated by reference into Part IV of this report.
The ProAssurance Corporation Current Report on Form 8-K for event occurring November 5, 2007
(File No. 001-16533) is incorporated by reference into Part IV of this report.
2
ITEM 1. BUSINESS.
General / Corporate Overview
PART I
We are a holding company for property and casualty insurance companies focused on
professional liability insurance. Our executive offices are located at 100 Brookwood Place, Birmingham,
Alabama 35209 and our telephone number is (205) 877-4400. Our stock trades on the New York Stock
Exchange under the symbol “PRA.” Our website is www.ProAssurance.com.
The Investor Home Page on our website provides many resources for investors seeking to learn
more about us. Whenever we file a document or report with the Securities and Exchange Commission
(the SEC) on its EDGAR system, we make the document available on our website as soon as reasonably
practical. This includes our annual report on Form 10K, our quarterly reports on Form 10Q and our
current reports on Form 8K. We show details about stock trading by corporate insiders by providing
access to SEC Forms 3, 4 and 5 when they are filed with the SEC. We maintain access to these reports
for at least one year after their filing.
In addition to federal filings on our website, we make available the financial statements we file
with state regulators, news releases that we issue, and certain investor presentations. We believe these
documents provide important additional information about our financial condition and operations.
The Governance section of our website provides copies of the Charters for our Audit Committee,
Internal Audit department, Compensation Committee and Nominating/Corporate Governance Committee.
In addition you will find our Code of Ethics and Conduct, Corporate Governance Principles, Policy
Regarding Determination of Director Independence and Share Ownership Guidelines for Management
and Directors. We also provide the Pre-Approval Policy and Procedures for our Audit Committee and our
Policy Regarding Stockholder-Nominated Director Candidates. Printed copies of these documents may
be obtained from Frank O’Neil, Senior Vice President, ProAssurance Corporation, either by mail at P.O.
Box 590009, Birmingham, Alabama 35259-0009, or by telephone at (205) 877-4400 or (800) 282-6242.
Because the insurance business uses certain terms and phrases that carry special and specific
meanings, we urge you to read the Glossary included in this section prior to reading this report.
Caution Regarding Forward-Looking Statements
Any statements in this Form 10K that are not historical facts are specifically identified as forward-
looking statements. These statements are based upon our estimates and anticipation of future events and
are subject to certain risks and uncertainties that could cause actual results to vary materially from the
expected results described in the forward-looking statements. Forward-looking statements are identified
by words such as, but not limited to, "anticipate", "believe", "estimate", "expect", "hope", "hopeful",
"intend", "may", "optimistic", "preliminary", "potential", "project", "should", "will" and other analogous
expressions. There are numerous factors that could cause our actual results to differ materially from
those in the forward-looking statements. Thus, sentences and phrases that we use to convey our view of
future events and trends are expressly designated as forward-looking statements as are sections of this
Form 10K that are identified as giving our outlook on future business.
Forward-looking statements relating to our business include among other things: statements
concerning liquidity and capital requirements, return on equity, financial ratios, net income, premiums,
losses and loss reserves, premium rates and retention of current business, competition and market
conditions, the expansion of product lines, the development or acquisition of business in new
geographical areas, the availability of acceptable reinsurance, actions by regulators and rating agencies,
court actions, legislative actions, payment or performance of obligations under indebtedness, payment of
dividends, and other matters.
3
These forward-looking statements are subject to significant risks, assumptions and uncertainties,
including, among other things, the following factors that could affect the actual outcome of future events:
– general economic conditions, either nationally or in our market area, that are worse than
–
anticipated;
regulatory, legislative and judicial actions or decisions that adversely affect our business
plans or operations;
–
inflation, particularly in loss costs trends;
– changes in the interest rate environment;
– performance of financial markets affecting the fair value of our investments or making it
difficult to determine the value of our investments;
– changes in laws or government regulations affecting medical professional liability
insurance;
the effects of changes in the health care delivery system;
– changes to our ratings assigned by rating agencies;
–
– uncertainties inherent in the estimate of loss and loss adjustment expense reserves and
the availability, cost, quality, or collectibility of
reinsurance, and changes
insurance/reinsurance;
the results of litigation, including pre-or-post-trial motions, trials and/or appeals we
undertake;
in
–
– bad faith litigation which may arise from our handling of any particular claim, including
failure to settle;
– changes in competition among insurance providers and related pricing weaknesses in
our markets;
loss of independent agents;
–
– our ability to purchase reinsurance and collect payments from our reinsurers;
–
– our ability to achieve continued growth through expansion into other states or through
increases in guaranty fund assessments;
–
acquisitions or business combinations;
the expected benefits from acquisitions may not be achieved or may be delayed longer
than expected due to, among other reasons, business disruption, loss of customers and
employees, increased operating costs or inability to achieve cost savings, and
assumption of greater than expected liabilities;
– changes in accounting policies and practices that may be adopted by our regulatory
agencies and the Financial Accounting Standards Board;
– changes in our organization, compensation and benefit plans; and
– our ability to retain and recruit senior management.
Our results may differ materially from those we expect and discuss in any forward-looking
statements. The principal risk factors that may cause these differences are described in "Item 1A, Risk
Factors" in this report and other documents we file with the Securities and Exchange Commission, such
as our current reports on Form 8-K, and our regular reports on Forms 10-Q and 10-K.
We caution readers not to place undue reliance on any such forward-looking statements, which
speak only as of the date made, and advise readers that the factors listed above could affect our financial
performance and could cause actual results for future periods to differ materially from any opinions or
statements expressed with respect to future periods in any current statements. Except as required by law
or regulations, we do not undertake and specifically decline any obligation to publicly release the result of
any revisions that may be made to any forward-looking statements to reflect events or circumstances
after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
4
GLOSSARY OF SELECTED INSURANCE AND RELATED FINANCIAL TERMS
In an effort to help our investors and other interested parties better understand our report, we are
providing a Glossary of Selected Insurance Terms. These definitions are taken from recognized industry
sources such as A. M. Best and The Insurance Information Institute. This list is intended to be informative
and explanatory, but we do not represent that it is a comprehensive glossary.
Accident year: The accounting period in which an insured event becomes a liability of the insurer.
Admitted company; admitted basis: An insurance company licensed and authorized to do business in
a particular state. An admitted company doing business in a state is said to operate on “an admitted
basis” and is subject to all state insurance laws and regulations pertaining to its operations. (See: Non-
admitted company)
Adverse selection: The tendency of those exposed to a higher risk to seek more insurance coverage
than those at a lower risk. Insurers react either by charging higher premiums or not insuring at all, as in
the case of floods. Adverse selection can be seen as concentrating risk instead of spreading it.
Agent: An individual or firm that represents an insurer under a contractual or employment agreement for
the purpose of selling insurance. There are two types of agents: independent agents, who represent one
or more insurance companies but are not employed by those companies and are paid on commission,
and exclusive or captive agents, who by contract are required to represent or favor only one insurance
company and are either salaried or work on commission. Insurance companies that use employee or
captive agents are called direct writers. Agents are compensated by the insurance company whose
products they sell. By definition, with respect to a given insurer, an agent is not a broker (See: Broker)
Alternative markets: Mechanisms used to fund self-insurance. This includes captives, which are insurers
owned by one or more insureds to provide owners with coverage. Risk-retention groups, formed by
members of similar professions or businesses to obtain liability insurance, are also a form of self-
insurance.
Assets; admitted; non-admitted: Property owned, in this case by an insurance company, including
stocks, bonds, and real estate. Because insurance accounting is concerned with solvency and the ability
to pay claims, insurance regulators require a conservative valuation of assets, prohibiting insurance
companies from listing assets on their balance sheets whose values are uncertain, such as furniture,
fixtures, debit balances, and accounts receivable that are more than 90 days past due (these are non-
admitted assets). Admitted assets are those assets that can be easily sold in the event of liquidation or
borrowed against, and receivables for which payment can be reasonably anticipated.
Bodily injury: Physical harm, sickness, disease or death resulting from any of these.
Broker: An intermediary between a customer and an insurance company. Brokers typically search the
market for coverage appropriate to their clients and they usually sell commercial, not personal, insurance.
Brokers are compensated by the insureds on whose behalf they are working. With respect to a given
insurer, a broker is not an agent. (See: Agent)
Bulk reserves: Reserves for losses that have occurred but have not been reported as well as anticipated
changes to losses on reported claims. Bulk reserves are the difference between (i) the sum of case
reserves and paid losses and (ii) an actuarially determined estimate of the total losses necessary for the
ultimate settlement of all reported and incurred but not reported claims, including amounts already paid.
(See: Case Reserves)
Capacity: For an individual insurer, the maximum amount of premium or risk it can underwrite based on
its financial condition. The adequacy of an insurer’s capital relative to its exposure to loss is an important
measure of solvency.
Capital: Stockholders’ equity (GAAP) and policyholders’ surplus (SAP). Capital adequacy is linked to the
riskiness of an insurer’s business. (See: Risk-Based Capital, Surplus, Solvency)
Case reserves: Reserves for future losses for reported claims as established by an insurer’s claims
department.
5
Casualty insurance: Insurance which is primarily concerned with the losses caused by injuries to third
persons (in other words, persons other than the policyholder) and the legal liability imposed on the
insured resulting therefrom. (See: Professional liability insurance, Medical professional liability insurance)
Cede, cedant; ceding company: When a party reinsures its liability with another, it ‘‘cedes’’ business
and is referred to as the ‘‘cedant’’ or ‘‘ceding company.’’
Claim: Written or oral demands, as well as civil and administrative proceedings.
Claims-made policy; coverage: A form of insurance that pays claims presented to the insurer during the
term of the policy or within a specific term after its expiration. It limits a liability insurers’ exposure to
unknown future liabilities. Under a claims-made policy, an insured event becomes a liability when the
event is first reported to the insurer.
Combined ratio: The sum of the underwriting expense ratio and net loss ratio, determined in accordance
with either SAP or GAAP.
Commission: Fee paid to an agent or insurance salesperson as a percentage of the policy premium.
The percentage varies widely depending on coverage, the insurer, and the marketing methods.
Consent to settle: Clause provided in some professional liability insurance policies requiring the insurer
to receive authority from an insured before settling a claim.
Damages; economic, non-economic and punitive: Monies awarded to a plaintiff or claimant. Economic
damages are intended to compensate a plaintiff or claimant for quantifiable past and future losses, such
as lost wages and/or medical costs. Non-economic damages are those awarded separately and apart
from economic damages, that are intended to compensate the claimant or plaintiff for non-quantifiable
losses such as pain and suffering or loss of consortium. Punitive damages are non-economic damages
intended to punish the defendant for perceived outrageous conduct.
Direct premiums written: Premiums charged by an insurer for the policies that it underwrites, excluding
any premiums that it receives as a reinsurer.
Direct writer(s): Insurance companies that sell directly to the public using exclusive agents or their own
employees.
Domestic insurance company: Term used by a state to refer to any company incorporated there.
Excess & surplus lines; surplus lines: Property/casualty insurance coverage that isn’t generally
available from insurers licensed in the state (See: Admitted company) and must be purchased from a
“non-admitted company”. Examples include risks of an unusual nature that require greater flexibility in
policy terms and conditions than exist in standard forms or where the highest rates allowed by state
regulators are considered inadequate by admitted companies. Laws governing surplus lines vary by state.
Excess coverage; excess limits: An insurance policy that provides coverage limits above another policy
with similar coverage terms, or above a self-insured amount.
Extended reporting endorsement: Also known as a “tail policy,” or “tail coverage.” Provides protection
for future claims filed after a claims-made policy has lapsed. Typically requires payment of an additional
premium, the “tail premium.” “Tail coverage” may also be granted if the insured becomes disabled, dies or
permanently retired from the covered occupation (i.e., the practice of medicine in medical liability
policies.)
Facultative reinsurance: A generic term describing reinsurance where the reinsurer assumes all or a
portion of a single risk. Each risk is separately evaluated and each contract is separately negotiated by
the reinsurer.
Financial Accounting Standards Board (FASB): An independent board that establishes and
communicates standards of financial reporting and reporting in the United States.
Frequency: Number of times a loss occurs per unit of risk or exposure. One of the criteria used in
calculating premium rates.
6
Front, fronting: A procedure in which a primary insurer acts as the insurer of record by issuing a policy,
but then passes all or virtually all of the risk to a reinsurer in exchange for a commission. Often, the
fronting insurer is licensed to do business in a state or country where the risk is located, but the reinsurer
is not. The reinsurer in this scenario is often a captive or an independent insurance company that cannot
sell insurance directly in a particular location.
Generally Accepted Accounting Principles; GAAP: A set of widely accepted accounting standards, set
primarily by the Financial Accounting Standards Board (FASB), and used to standardize financial
accounting of public companies.
Gross premiums written: Total premiums for direct insurance written and assumed reinsurance during a
given period. The sum of direct and assumed premiums written.
Guaranty fund; assessment(s): The mechanism by which all 50 states, the District of Columbia and
Puerto Rico ensure that solvent insurers fund the payment of claims against insurance companies that
fail. The type and amount of claim covered by the fund varies from state to state.
Incurred but not reported (IBNR): Actuarially estimated reserves for estimated losses that have been
incurred by insureds and reinsureds but not yet reported to the insurer or reinsurer including unknown
future developments on losses which are known to the insurer or reinsurer. Insurance companies
regularly adjust reserves for such losses as new information becomes available.
Incurred losses: Losses covered by the insurer within a fixed period, whether or not adjusted or paid
during the same period, plus changes in the estimated value of losses from prior periods.
Insolvent; insolvency: Insurer’s inability to pay debts. Typically the first sign of problems is inability to
pass the financial tests regulators administer as a routine procedure. (See: Risk-based capital)
Investment income: Income generated by the investment of assets. Insurers have two sources of
income, underwriting (premiums less claims and expenses) and investment income.
Liability insurance: A line of casualty insurance for amounts a policyholder is legally obligated to pay
because of bodily injury or property damage caused to another person. (See: Bodily Injury, Casualty
insurance, Professional liability insurance, Medical professional liability insurance)
Limits: The maximum amount payable under an insurance policy for a covered loss.
Long-tail: The long period of time between collecting the premium for insuring a risk and the ultimate
payment of losses. This allows insurance companies to invest the premiums until losses are paid, thus
producing a higher level of invested assets and investment income as compared to other lines of property
and casualty business. Medical professional liability is considered a long tail line of insurance. (See:
Medical professional liability, Professional liability)
Loss adjustment expenses (LAE): The expenses of settling claims, including legal and other fees and
the portion of general expenses allocated to claim settlement costs.
Loss costs: The portion of an insurance rate used to cover claims and the costs of adjusting claims.
Insurance companies typically determine their rates by estimating their future loss costs and adding a
provision for expenses, profit, and contingencies.
Loss ratio: The ratio of incurred losses and loss-adjustment expenses to net premiums earned. This ratio
helps measure the company's underlying profitability, or loss experience, on its total book of business.
Loss reserves: Liabilities established by insurers to reflect the estimated cost of claims payments and
the related expenses that the insurer will ultimately be required to pay in respect of insurance or
reinsurance it has written. They represent a liability on the insurer’s balance sheet.
Medical malpractice: An act or omission by a health care provider that falls below a recognized standard
of care. (See: Standard of Care)
Medical professional liability insurance: Insurance for the legal liability of an insured (and against loss,
damage or expense incidental to a claim of such liability) arising out of death, injury or disablement of a
person as the result of negligent deviation from the standard of care or other misconduct in rendering
professional service.
7
National Association of Insurance Commissioners: Generally referred to as the “NAIC.” The
organization of insurance regulators from the 50 states, the District of Columbia and the four U.S.
territories. The NAIC provides a forum for the development of uniform policy when uniformity is
appropriate.
Net losses: Incurred losses and loss adjustment expenses for the period, net of anticipated reinsurance
recoveries for the period.
Net loss ratio: The net loss ratio measures the ratio of net losses and loss adjustment expenses to net
earned premiums determined in accordance with SAP or GAAP.
Net paid losses: Paid losses and loss adjustment expenses for the period, net of related reinsurance
recoveries.
Net premium earned: The portion of net premium that is recognized for accounting purposes as income
during a particular period. Equal to net premiums written plus the change in net unearned premiums
during the period.
Net premiums written: Gross premiums written for a given period less premiums ceded to reinsurers
during such period.
Non-admitted company; basis: Insurers licensed in some states, but not others. States where an
insurer is not licensed call that insurer “non-admitted.” Non-admitted companies sell coverage that is
unavailable from licensed insurers within a state and are generally exempt from most state laws and
regulations related to rates and coverages. Policyholders of such companies generally do not have the
same degree of consumer protection and financial recourse as policyholders of admitted companies.
Non-admitted companies are said to operate on a “non-admitted” basis.
Nose coverage: See: Prior acts coverage.
Occurrence policy; coverage: Insurance that pays claims arising out of incidents that occur during the
policy term, even if they are filed many years later. Under an occurrence policy the insured event
becomes a liability when the event takes place.
Operating ratio: The operating ratio is the combined ratio, less the ratio of investment income (exclusive
of realized gains and losses) to net earned premiums, if determined in accordance with GAAP. While the
combined ratio strictly measures underwriting profitability, the operating ratio incorporates the effect of
investment income.
Paid loss ratio: The ratio of net paid losses to net premiums earned. (See Loss ratio)
Paid to incurred ratio: The ratio of net paid losses to net incurred losses.
Policy: A written contract for insurance between an insurance company and policyholder stating details
of coverage.
Premium: The price of an insurance policy; typically charged annually or semiannually.
Premiums written: The total premiums on all policies written by an insurer during a specified period of
time, regardless of what portions have been earned.
Premium tax: A state tax on premiums for policies issued in the state, paid by insurers.
Primary company: In a reinsurance transaction, the insurance company that is reinsured.
Prior acts coverage: An additional coverage for claims-made policies, optionally made available by an
insurer, that covers an insured for claims that occurred, but were not reported prior to the inception date,
or retroactive date, of the policy. Sometimes called “Nose Coverage.”
Professional liability insurance: Covers professionals for negligence and errors or omissions that
cause injury or economic loss to their clients. (See: Casualty insurance, Liability insurance, Medical
professional liability insurance)
Property casualty insurance: Covers damage to or loss of policyholders’ property and legal liability for
damages caused to other people or their property.
8
Rate: The cost of insurance for a specific unit of exposure, such as for one physician. Rates are based
primarily on historical loss experience for similar risks and may be regulated by state insurance offices.
Rating agencies: These agencies assess insurers’ financial strength and viability to meet claims
obligations. Some of the factors considered include company earnings, capital adequacy, operating
leverage, liquidity, investment performance, reinsurance programs, and management ability, integrity and
experience. A high financial rating is not the same as a high consumer satisfaction rating.
Reinsurance: Insurance bought by insurance companies. In a reinsurance contract the reinsurer agrees
to indemnify another insurance or reinsurance company, the ceding company, against all or a portion of
the insurance or reinsurance risks underwritten by the ceding company under one or more policies.
Reinsurers don’t pay policyholder claims. Instead, they reimburse insurers for claims paid.
Reinsured layer; retained layer: The retained layer is the cumulative portion of each loss, on a per-
claim basis, which is less than an insurer’s reinsurance retention for a given coverage year. Likewise, the
reinsured layer is the cumulative portion of each loss that exceeds the reinsurance retention. (See:
Reinsurance, Retention)
Reserves: A company’s best estimate of what it will pay at some point in the future, for claims for which it
is currently responsible.
Retention: The amount or portion of risk that an insurer retains for its own account. Losses in excess of
the retention level up to the outer limit, if any, are paid by the reinsurer. In proportional treaties, the
retention may be a percentage of the original policy’s limit. In excess of loss business, the retention is a
dollar amount of loss, a loss ratio or a percentage.
Retroactive date: Applicable only to claims-made policies. Claims that have occurred and have not been
reported prior to this date are excluded from coverage. The retroactive date is generally the date
coverage was first afforded to an insured by a company under a claims-made policy form, unless
extended into the past by Prior Acts Coverage. (See: Prior Acts Coverage)
Return on equity: Net Income (or if applicable, Income from Continuing Operations) divided by the
average of beginning and ending stockholders’ equity. This ratio measures a company's overall after-tax
profitability from underwriting and investment activity and shows how efficiently invested capital is being
used.
Risk-Based Capital (RBC): A regulatory measure of the amount of capital required for an insurance
company, based upon the volume and inherent riskiness of the insurance sold, the composition of its
investment portfolio and other financial risk factors. Higher-risk types of insurance, liability as opposed to
property business, generally necessitate higher levels of capital. The NAIC’s RBC model law stipulates
four levels of regulatory action with the degree of regulatory intervention increasing as the level of surplus
falls below a minimum amount as determined under the model law. (See: National Association of
Insurance Commissioners)
Risk management: Management of the varied risks to which a business firm or association might be
subject. It includes analyzing all exposures to gauge the likelihood of loss and choosing options to better
manage or minimize loss. These options typically include reducing and eliminating the risk with safety
measures, buying insurance, and self-insurance.
Self-insurance: The concept of assuming a financial risk oneself, instead of paying an insurance
company to take it on. Every policyholder is a self-insurer in terms of paying a deductible and co-
payments. Larger policyholders often self-insure frequent or predictable losses to avoid insurance
overhead expenses.
Severity: The average claim cost, statistically determined by dividing dollars of losses by the number of
claims.
Solvent; solvency: Insurance companies’ ability to pay the claims of policyholders. Regulations to
promote solvency include minimum capital and surplus requirements, statutory accounting conventions,
limits to insurance company investment and corporate activities, financial ratio tests, and financial data
disclosure.
9
Standard of care: The standard by which negligence is determined. The degree of skill associated with
the activities and treatment from a reasonable, prudent, ordinary practitioner acting under the same or
similar circumstances.
Statement of Financial Accounting Standards (SFAS): A formal document issued by the Financial
Accounting Standards Board (FASB), which details accounting standards and guidance on selected
accounting policies set out by the FASB.
Statutory Accounting Principles; SAP: More conservative standards than under GAAP accounting
rules, they are imposed by state laws that emphasize the present solvency of insurance companies. SAP
helps ensure that the company will have sufficient funds readily available to meet all anticipated
insurance obligations by recognizing liabilities earlier or at a higher value than GAAP and assets later or
at a lower value. For example, SAP requires that selling expenses be recorded immediately rather than
amortized over the life of the policy. (See: Generally Accepted Accounting Principles, Admitted assets)
Surplus; statutory surplus: The excess of assets over total liabilities (including loss reserves) that
protects policyholders in case of unexpectedly high claims. “Statutory Surplus” is determined in
accordance with Statutory Accounting Principles.
Tail: The period of time that elapses between the occurrence of the loss event and the payment in
respect thereof.
Tail coverage: See: Extended Reporting Endorsement
Third-party coverage: Liability coverage purchased by the policyholder as a protection against possible
lawsuits filed by a third party. The insured and the insurer are the first and second parties to the insurance
contract.
Tort: A civil wrong which may result in damages.
Treaty reinsurance: The reinsurance of a specified type or category of risks defined in a reinsurance
agreement (a ‘‘treaty’’) between a primary insurer and a reinsurer. Typically, in treaty reinsurance, the
primary insurer or reinsured is obligated to offer and the reinsurer is obligated to accept a specified
portion of all such type or category of risks originally written by the primary insurer or reinsured.
Underwriting: The insurer’s or reinsurer’s process of reviewing applications submitted for insurance
coverage, deciding whether to accept all or part of the coverage requested and determining the
applicable premiums.
Underwriting expense ratio: Under GAAP, the ratio of underwriting, acquisition and other insurance
expenses incurred to net premiums earned (for SAP, the ratio of underwriting expenses incurred to net
premiums written.)
Underwriting expenses: The aggregate of policy acquisition costs, including commissions, and the
portion of administrative, general and other expenses attributable to underwriting operations.
Underwriting income; loss: The insurer’s profit on the insurance sales after all expenses and losses
have been paid, before investment income or income taxes. When premiums aren’t sufficient to cover
claims and expenses, the result is an “underwriting loss.”
Underwriting profit: The amount by which net earned premiums exceed claims and expenses. (See:
Underwriting Income)
Unearned premium: The portion of premium that represents the consideration for the assumption of risk
for a future period. Such premium is not yet earned since the risk has not yet been assumed. May also be
defined as the pro-rata portion of written premiums that would be returned to policyholders if all policies
were terminated by the insurer on a given date.
10
Business Overview
We operate in a single business segment principally in the Mid-Atlantic, Midwest and Southern
United States. We sell professional liability insurance primarily to physicians, dentists, other healthcare
providers and healthcare facilities. We also have a small book of legal professional liability business in the
Midwest.
Our top five states represented 55% of our gross premiums written for the year ended December
31, 2007. The following table shows our gross premiums written in these states for each of the periods
indicated.
Gross Written Premiums–Years Ended December 31
($ in thousands)
2006(2)
2005(2)
2007
Alabama
$ 95,641
Ohio
89,607
Florida
41,291
Michigan
41,092
Wisconsin(1)
40,680
All other states
240,763
Total
$ 549,074
(1) Not a top five state in 2006 and 2005
(2) Indiana was included in the top five states in 2006 and 2005 (gross premiums written of $40,335 and $41,129, respectively)
$ 102,998
106,267
53,469
43,757
10,702
261,790
$ 578,983
$ 111,462
131,102
61,341
46,741
52
222,262
$ 572,960
18%
18%
9%
8%
2%
45%
100%
19%
23%
11%
8%
–
39%
100%
17%
16%
8%
7%
7%
45%
100%
We believe we differentiate ourselves from our competitors in several ways. Our financial
strength, commitment to a local market presence and personal service, and commitment to our physician
heritage have allowed us to establish what we believe to be a leading position in our markets, thus
enabling us to effectively compete on a basis other than just price.
We maintain 15 local claims and/or underwriting offices to ensure that we have a local presence
in the markets we serve. We believe this emphasis on local knowledge allows us to maintain active
relationships with our customers and be more responsive to their needs.
We believe our local knowledge also allows us to be more effective in evaluating claims because
we have a detailed understanding of the medical and legal climates of each market. We also believe our
insureds value our willingness and ability to defend non-meritorious claims.
Using our local knowledge and our experienced underwriting staff, we rigorously underwrite each
application for coverage to ensure that we understand the risks we accept, and are able to develop an
adequate price for that risk. By charging rates we believe to be adequate, we seek to maintain the strong
financial position that allows us to protect our customers in the long-term.
Corporate Organization and History
We were incorporated in Delaware in June 2001. Our core operating subsidiaries are The
Medical Assurance Company, Inc., ProNational Insurance Company, NCRIC, Inc., Physicians Insurance
Company of Wisconsin, Inc., and Red Mountain Casualty Insurance Company, Inc. We also write a
limited amount of medical professional liability insurance through Woodbrook Casualty Insurance, Inc.
(formerly Medical Assurance of West Virginia, Inc.), which we consider to be a non-core operating
subsidiary.
We are the successor to twelve insurance organizations and much of our growth has come
through mergers and acquisitions. In each, we retained key personnel, allowing us to maintain a local
presence and preserve important institutional knowledge in underwriting, claims, risk management and
marketing. We believe that our ability to utilize this local knowledge is a critical factor in the operation of
our companies. Our successful integration of each organization demonstrates our ability to grow
effectively through acquisitions.
Our predecessor company, Medical Assurance, Inc. (Medical Assurance) was founded by
physicians as a mutual company in Alabama and wrote its first policy in 1977. Medical Assurance
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.
11
Professionals Group, Inc. which was combined with Medical Assurance to form ProAssurance,
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 Insurance Company, was founded in 1980 to assume the
business of the Fund. That company also expanded through internal growth and the acquisition of a book
of business in Illinois and the acquisition of professional liability insurers in Florida and Indiana.
Recent Developments
In early July 2003 we received $104.6 million from the issuance of 3.9% Convertible Debentures,
due June 2023, having a face value of $107.6 million. We utilized a substantial portion of the net
proceeds from the sale of the Convertible Debentures to repay an outstanding term loan. We used the
balance of the net proceeds from the sale of the Convertible Debentures for general corporate purposes,
including contributions to the capital of our insurance subsidiaries to support the growth in insurance
operations.
In April and May 2004, we received net proceeds of $44.9 million from the issuance of $46.4
million of trust preferred securities. These trust preferred securities have a 30-year maturity and are
callable at par in December 2009. The interest rate on these securities adjusts quarterly to the 3-month
London Interbank Offered Rate (LIBOR) plus 385 basis points. We used the balance of the net proceeds
from the sale of the trust preferred securities for general corporate purposes, including contributions to
the capital of our insurance subsidiaries to support the growth in insurance operations. See Note 10 to the
Consolidated Financial Statements for more information regarding the Convertible Debentures and the
trust preferred securities.
On January 4, 2006 we sold our personal lines operations (the MEEMIC companies), effective
January 1, 2006, for $400 million before taxes and transaction expenses. We recognized a gain on the
sale in the first quarter of 2006 of $109.4 million after consideration of sales expenses and estimated
taxes. Sale proceeds are available to support the capital requirements of our professional liability
insurance subsidiaries and other general corporate purposes. Additional information regarding the sale of
the MEEMIC companies is provided in Note 3 to the Consolidated Financial Statements.
On August 3, 2005 we acquired all of the outstanding common stock of NCRIC Corporation and
its subsidiaries (NCRIC) in an all stock merger. NCRIC’s primary business is a single insurance company
that provides medical professional liability insurance in the District of Columbia, Delaware, Maryland,
Virginia and West Virginia.
Effective August 1, 2006 we completed our acquisition of Physicians Insurance Company of
Wisconsin, Inc. (PIC Wisconsin) in an all stock merger. PIC Wisconsin is a stock insurance company that
sells professional liability insurance to physicians, groups of physicians, dentists, and hospitals principally
in the state of Wisconsin as well as other Midwestern states.
These acquisitions strategically expanded our geographic footprint and were in keeping with our
desire to expand our professional liability operations through selective acquisitions. A more detailed
description of the merger transactions is included in Note 2 to the Consolidated Financial Statements
included herein.
Effective July 1, 2007 A. Derrill Crowe, M.D. retired as Chief Executive Officer (CEO), and
remains as non-executive Chairman of our Board. The Board of Directors elected W. Stancil Starnes to
succeed Dr. Crowe as CEO. Mr. Starnes formerly served as President, Corporate Planning and
Administration, of Brasfield & Gorrie, LLC, a large commercial construction firm. Prior to October 2006,
Mr. Starnes served as the Senior and Managing Partner of Starnes & Atchison, LLP, Attorneys at Law,
and was extensively involved with ProAssurance and its predecessor companies in the defense of its
medical liability claims.
In April 2007 our Board of Directors authorized $150 million to be used for the repurchase of our
common stock and debt securities. On December 4, 2007 we redeemed in cash the outstanding
debentures of NCRIC using $15.5 million of our outstanding authorization. These securities became our
obligation when we acquired NCRIC. As of January 31, 2008 we have also used $67.1 million of that
authorization to repurchase 1.2 million shares of our stock.
12
Products and Services
We sell professional liability insurance primarily to physicians, dentists, other healthcare providers
and healthcare facilities. We also have a small book of legal professional liability business in the Midwest.
We generate the majority of our premiums from individual and small group practices, but also insure large
physician groups as well as hospitals. While most of our business is written in the standard market, we
also offer medical professional liability insurance on an excess and surplus lines basis. We also offer
professional office package and workers’ compensation insurance products in connection with our
medical professional liability products. We are licensed to do business in every state but Connecticut,
Maine, New Hampshire, New York and Vermont.
Marketing
We utilize both direct marketing and independent agents to write our business. For the year
ended December 31, 2007, we estimate that approximately 69% of our gross premiums written were
produced through independent insurance agencies. These local agencies usually have producers who
specialize in professional liability insurance and who we believe are able to convey the factors that
differentiate our professional liability insurance products. No single agent or agency accounts for more
than 10% of our total direct premiums written.
Our marketing is primarily directed to individual physicians, and those in smaller groups. We
generally do not target large physician groups or facilities because of the difficulty in underwriting the
individual risks within those groups and because their purchasing decisions are more focused on price.
Our marketing emphasizes:
– excellent claims service,
–
the sponsorship of risk management education seminars as an accredited provider of
continuing medical education,
risk management consultation, loss prevention seminars and other educational programs,
legislative oversight and active support of proposed legislation we believe will have a
positive effect on liability issues affecting the healthcare industry,
the dissemination of newsletters and other printed material with information of interest to
the healthcare industry, and
–
–
–
– endorsements by, and attendance at meetings of medical societies and related
organizations.
These communications and services demonstrate our understanding of the insurance needs of
the healthcare industry and promote a commonality of interest among us and our insureds. We believe
that a local presence in our markets enables us to effectively provide these communications and services,
all of which have helped us gain exposure among potential insureds.
Underwriting
Our underwriting process is driven by individual risk selection rather than by the size or other
attributes of an account. Our pricing decisions are focused on achieving rate adequacy. We assess the
quality and pricing of the risk, emphasizing loss history, practice specialty and location 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 environments
through our six regional underwriting offices located in Alabama, Indiana, Missouri, Michigan, the District
of Columbia, and Wisconsin.
Our underwriters work with our field marketing force to identify business that meets our
established underwriting standards and to develop specific strategies to write the desired business. In
13
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 underwriters are also assisted by our local medical advisory committees that operate 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
issues.
Claims Management
We have 15 claims offices located in Alabama (2), Delaware, Florida (2), Illinois, Indiana,
Kentucky, Michigan, Missouri, Ohio (2), Virginia, the District of Columbia, and Wisconsin so that we can
provide localized and timely attention to claims. We offer our insureds a strong defense of claims that we
believe are non-meritorious or those we believe cannot be settled by reasonable, good faith negotiations.
Many of these claims are resolved by jury verdict, and we engage experienced trial attorneys in each
venue to handle the litigation in defense of our policyholders.
Our claims department promptly and thoroughly investigates the circumstances surrounding a
reported claim against an insured. As we investigate, our claims department establishes the appropriate
case reserves for each claim. Thereafter, we monitor development of new information about the claim
and adjust the case reserve as appropriate.
Through our investigation, and in consultation with the insured and appropriate experts, we
evaluate the merit of the claim and either seek reasonable good faith settlement or aggressively defend
the claim. If the claim is defended, our claims department carefully manages the case, including selecting
defense attorneys who specialize in professional liability defense and obtaining medical, legal and/or
other expert professionals to assist in the analysis and defense of the claim. As part of the evaluation and
preparation process for medical professional liability claims, we meet regularly with medical advisory
committees in our key states to examine claims, attempt to identify potentially troubling practice patterns
and make recommendations to our staff.
We believe that our claims philosophy contributes to lower overall loss costs and results in
greater customer loyalty. The success of this claims philosophy is based on our access to 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.
Investments
The majority of our assets are held in the operating insurance companies. We oversee our
investments to ensure that we apply a consistent management strategy to the entire portfolio.
Our overall investment strategy is to focus on maximizing current income from our investment
portfolio while maintaining safety, liquidity, duration and portfolio diversification. The portfolio is generally
managed by professional third party asset managers whose results we monitor and evaluate. The asset
managers typically have the authority to make investment decisions within the asset class they are
responsible for managing, subject to our investment policy and oversight. See Note 4 to the Consolidated
Financial Statements for more detail on our investments.
Rating Agencies
Our claims-paying ability and financial strength are regularly evaluated and rated by two major
rating agencies, A. M. Best and Fitch. In developing their claims-paying ratings, these agencies evaluate
an insurer’s ability to meet its obligations to policyholders. While these ratings may be of interest to
shareholders, these are not ratings of securities nor a recommendation to buy, hold or sell any security.
14
The following table presents the ratings of our group and our core subsidiaries as of February 28,
2008:
Company / Rating
Rating Agency
ProAssurance
Group
Medical
Assurance
NCRIC
PIC
Wisconsin
ProNational
Red
Mountain
Casualty
Woodbrook
Casualty
Fitch
(www.fitchratings.com)
A
(Strong)
A
(Strong)
A
(Strong)
A
(Strong)
A
(Strong)
A
(Strong)
A
(Strong)
A. M. Best
(www.ambest.com)
A-
(Excellent)
A-
(Excellent)
B++
(Good)
A-
(Excellent)
A-
(Excellent)
A-
(Excellent)
B
(Fair)
The rating process is dynamic and ratings can change. If you are seeking updated information
about our ratings, please visit the rating agency websites listed in the table.
Competition
Competition depends on a number of factors including pricing, size, name recognition, service
quality, market commitment, market conditions, breadth and flexibility of coverage, method of sale,
financial stability, ratings assigned by rating agencies and regulatory conditions. Many of these factors,
such as market conditions and regulatory conditions are beyond our control. However, for those factors
within our control, such as service quality, market commitment, financial strength and stability, we believe
we have competitive strengths that make us a viable competitor in those states where we are currently
writing insurance.
We believe that we have a competitive advantage due to our financial stability, local market
presence, service quality, size, geographic scope and name recognition, as well as our heritage as a
policyholder-founded company with a long-term commitment to the professional liability insurance
industry. We have achieved these advantages through our balance sheet strength, claims defense
expertise, strong ratings and ability to deliver a high level of service to our insureds and agents. We
believe that these competitive strengths make us a viable competitor in the states where we are currently
writing insurance.
We compete with many insurance companies and alternative insurance mechanisms such as risk
retention groups or self-insuring entities. Many of our competitors concentrate on a single state and have
an extensive knowledge of the local markets. We also compete with several large national insurers whose
financial strength and resources may be greater than ours. The following table shows the top five
companies that we believe are our direct competitors, based on 2006 Direct Written Premiums (latest
NAIC data available) in our business footprint.
Competitors
Medical Protective (Berkshire Hathaway)
ISMIE Mutual Group
MAG Mutual Group
State Volunteer Mutual Ins Co.
Health Care Indemnity Inc.
Improvements in loss cost trends have allowed us to reduce rates in certain markets and offer
targeted new business and renewal retention programs in selected markets. While both actions improve
policyholder retention, they decrease our average premiums. While we reflect loss cost trends in our
pricing, we have chosen not to aggressively compete on price alone, and we have not compromised our
commitment to strict underwriting.
In spite of these reductions we have lost some insureds due to aggressive price-based
competition which we face in virtually all of our markets. This competition comes mostly from established
insurers that are willing to write coverage at rates that we believe do not meet our long-term profitability
15
goals. We believe many competitors are also employing less-stringent underwriting standards than they
have in the past and they appear to be offering more liberal coverage options.
We have also lost insureds as some physicians and hospitals have entered into alternative risk
transfer mechanisms. Historically, these alternatives have been less attractive when prices soften in the
traditional insurance markets.
If competitors become less disciplined in their pricing, or more permissive in their coverage terms,
we would expect to lose additional business because our ongoing commitment to adequate rates and
strong underwriting standards affects our willingness to write new business and to renew existing
business in the face of this price-based competition. The combined effects of lower rates and the
challenges of writing new business are expected to cause our gross written premiums to continue to
decline in 2008.
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. Our operating insurance subsidiaries are domiciled in
Alabama, Michigan, the District of Columbia, and Wisconsin.
Insurance companies are also affected by a variety of state and federal legislative and regulatory
measures and judicial decisions. These could include new or updated definitions of risk exposure and
limitations on business practices. 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.
There is currently limited federal regulation of the insurance business, but 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
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.
Applicable state insurance laws, rather than federal bankruptcy laws, apply to the liquidation or
reorganization of insurance companies.
Insurance Regulation Concerning Change or Acquisition of Control
The insurance regulatory codes in our operating subsidiaries’ respective domiciliary states each
contain provisions (subject to certain variations) to the effect that the acquisition of “control” of a domestic
insurer or of any person that directly or indirectly controls a domestic insurer cannot be consummated
without the prior approval of the domiciliary insurance regulator. In general, a presumption of “control”
arises from the direct or indirect ownership, control or possession with the power to vote or possession of
proxies with respect to 10% (5% in Alabama) or more of the voting securities of a domestic insurer or of a
person that controls a domestic insurer. A person seeking to acquire control, directly or indirectly, of a
domestic insurance company or of any person controlling a domestic insurance company must generally
file an application for approval of the proposed change of control with the relevant insurance regulatory
authority.
In addition, certain state insurance laws contain provisions that require pre-acquisition notification
to state agencies of a change in control of a non-domestic insurance company admitted in that state.
While such pre-acquisition notification statutes do not authorize the state agency to disapprove the
change of control, such statutes do authorize certain remedies, including the issuance of a cease and
16
desist order with respect to the non-domestic admitted insurers 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 quarterly and annual reports with the state
insurance regulators in each of the states in which they do business, and their business and accounts are
subject to examination by such regulators at any time. The financial information in these reports is
prepared in accordance with Statutory Accounting Principles (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
Our operating subsidiaries are subject to various state statutory and regulatory restrictions which
limit the amount of dividends or distributions an insurance company may pay to its shareholders without
prior regulatory approval. Generally, dividends may be paid only out of earned surplus. In every case,
surplus subsequent to the payment of any dividends must be reasonable in relation to an insurance
company’s outstanding liabilities and must be adequate to meet its financial needs.
State insurance holding company acts generally require domestic insurers to obtain prior
approval of extraordinary dividends. Under the insurance holding company acts governing our principal
operating subsidiaries except NCRIC and PIC Wisconsin, a dividend is considered to be extraordinary if
the combined dividends and distributions to the parent holding company in any 12 month period are more
than the greater of either the insurer’s net income for the prior fiscal year or 10% of its surplus at the end
of the prior fiscal year.
The regulations governing District of Columbia insurers, which have jurisdiction over NCRIC,
deems a dividend to be extraordinary if the combined dividends and distributions made in any 12 month
period exceeds the lesser of:
(cid:120) net income less capital gains; or
(cid:120) 10% surplus at the prior calendar year end.
The regulations governing Wisconsin insurers deems a dividend to be extraordinary if the amount
exceeds the lesser of:
(cid:120) 10% of a company’s capital and surplus as of December 31 of the preceding
year; or
the greater of:
(cid:120)
(cid:120) Statutory net income for the preceding calendar year, minus realized
capital gains for that calendar year; or
(cid:120) The aggregate of statutory net income for the three previous
calendar years minus realized capital gains for those calendar years,
minus dividends paid or credited and distributions made within the
first two of the preceding three calendar years.
If insurance regulators determine that payment of a dividend or any other payments to an affiliate
(such as payments under a tax-sharing agreement or payments for employee or other services) would,
because of the financial condition of the paying insurance company or otherwise, be a detriment to such
insurance company’s policyholders, the regulators may prohibit such payments that would otherwise be
permitted.
Risk-Based Capital
In order to enhance the regulation of insurer solvency, the National Association of Insurance
Commissioners (NAIC) specifies risk-based capital (RBC) requirements for property and casualty
insurance companies. At December 31, 2007, all of ProAssurance’s insurance subsidiaries exceeded the
minimum RBC levels.
17
Investment Regulation
Our operating subsidiaries are subject to state laws and regulations that require diversification of
investment portfolios and that limit the amount of investments in certain investment categories. Failure to
comply with these laws and regulations may cause non-conforming investments to be treated as non-
admitted assets for purposes of measuring statutory surplus and, in some instances, would require
divestiture. We believe that our operating subsidiaries are in compliance with state investment
regulations.
Guaranty Funds
Admitted insurance companies are required to be members of guaranty associations which
administer state Guaranty Funds. These associations levy assessments (up to prescribed limits) on all
member insurers in a particular state on the basis of the proportionate share of the premiums written by
member insurers in the covered lines of business in that state. Maximum assessments permitted by law in
any one year generally vary between 1% and 2% of annual premiums written by a member in that state.
Some states permit member insurers to recover assessments paid through surcharges on policyholders
or through full or partial premium tax offsets, while other states permit recovery of assessments through
the rate filing process.
Shared Markets
State insurance regulations may force us to participate in mandatory property and casualty
shared market mechanisms or pooling arrangements that provide certain insurance coverage to
individuals or other entities that are otherwise unable to purchase such coverage in the commercial
insurance marketplace. Our operating subsidiaries’ participation in such shared markets or pooling
mechanisms is not material to our business at this time.
Changes in Legislation and Regulation
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.
Tort reforms generally restrict the ability of a plaintiff to recover damages by, among other
limitations, eliminating certain claims that may be heard in a court, limiting the amount or types of
damages, changing statutes of limitation or the period of time to make a claim, and limiting venue or court
selection. A number of states in which we do business have enacted, or are considering, tort reform
legislation. Because we cannot predict with any certainty how appellate courts will rule on these laws we
do not take them into account in our rate-making assumptions, except in Florida where such credit is
required by law.
While the effects of tort reform would appear to be beneficial to our business generally, there can
be no assurance that such reforms will be effective or ultimately upheld by the courts in the various
states. Further, if tort reforms are effective, the business of providing professional liability insurance may
become more attractive, thereby causing an increase in competition.
In addition, the enactment of tort reforms could be accompanied by legislation or regulatory
actions that may be detrimental to our business because of expected benefits which may or may not be
realized. These expectations could result in regulatory or legislative action limiting the ability of
professional liability insurers to raise or maintain rates at adequate levels. Coverage mandates or other
expanded insurance requirements could also be imposed. States may also consider state sponsored
malpractice insurance entities that could remove some physicians from the private insurance market.
18
We continue to monitor developments on a state-by-state basis, and make business decisions
accordingly. Several of the states in which we operate, notably Georgia, Florida, Illinois, Missouri, Ohio,
Texas, and West Virginia, have passed tort reform, but these laws have yet to materially affect our
business. In many of these states there are active challenges to tort reform and historically, many tort
reform laws have been invalidated in the appeals process.
(cid:120)
In 2007 a Circuit Court in Illinois struck down that state’s tort reforms. We
anticipate that a final ruling on the constitutionality of the tort reform package will
be made by Illinois’ Supreme Court sometime in the next 18 months.
(cid:120) A Circuit Court in Oklahoma struck down that state’s tort reforms in January
2008. That ruling will be appealed and we expect a ruling from that state’s
Supreme Court within 18 months.
(cid:120) Wisconsin’s caps on non-economic damages were ruled unconstitutional in
2005, and in 2006 the legislature enacted a new law that re-established caps on
non-economic damages at $750,000.
We believe there will be continuing court challenges in all states in the coming years.
Tort reform proposals are considered from time-to-time at the Federal level. This legislation has
had the backing of the Bush administration and passed the House of Representatives in 2007, as in prior
legislative sessions, but has never been approved in the Senate. We do not believe there will be Federal
tort reform in the foreseeable future. As in the states, passage of a Federal tort reform package would
likely be subject to judicial challenge and we cannot be certain that it would be upheld by the courts.
Healthcare reform could alter the healthcare delivery system or reimbursement plans. This could
have a material adverse effect on our business if it results in changes in how health care providers insure
their medical malpractice risks. A broad range of healthcare reform measures has been suggested, and
public discussion of such measures will likely continue in the future, especially during the 2008
presidential campaign. Proposals have included, among others, spending limits, price controls, limiting
increases in insurance premiums and/or health savings accounts, limiting the liability of doctors and
hospitals for tort claims, imposing liability on institutions rather than physicians, and restructuring the
healthcare insurance system. We cannot predict which, when, or if any reform proposals will be adopted
or what effect they may have on our business.
In addition to regulatory and legislative efforts, there have been significant market driven changes
in the healthcare environment that have negatively affected or threatened to affect the practices and
economic independence of our insureds. Medical professionals have found it more difficult to conduct a
traditional fee-for-service practice and many have been driven to join or contractually affiliate with larger
organizations.
These changes may result in the elimination of, or a significant decrease in, the role of the
physician in the medical malpractice insurance purchasing decision. They could also result in greater
emphasis on the role of professional managers, who may seek to purchase insurance on a price
competitive basis, and who may favor insurance companies that are larger and more highly rated than we
are. In addition, such change and consolidation could reduce our medical malpractice premiums as
groups of insurance purchasers generally retain more risk or self insure.
In addition there have been prior attempts to involve the federal government in the regulation of
the insurance industry at some level. While we do not have any reason to believe this will occur in the
near future, we cannot rule out that possibility.
Although the federal government does not regulate the business of insurance directly, federal
initiatives, including changes in patient protection legislation and the various health care reforms currently
under discussion may affect our business.
Employees
At December 31, 2007, we had 587 employees, none of whom are represented by a labor union.
We consider our employee relations to be good.
19
ITEM 1A. RISK FACTORS.
There are a number of factors, many beyond our control, which may cause results to differ
significantly from our expectations. Some of these factors are described below, while others having to do
with operational, liquidity, interest rate and other variables, are described elsewhere in this report. Any
factor described in this report could by itself, or together with one or more factors, have a negative effect
on our business, results of operations and/or financial condition. There may be factors not described in
this report that could also cause results to differ from our expectations.
Our operating results may be affected if actual insured losses differ from our loss reserves.
Due to the size of our reserve for loss and loss adjustment expenses, even a small percentage
adjustment to the assumptions we make in establishing our reserve can have a material effect on our
results of operations for the period in which the change is made. Significant periods of time often elapse
between the occurrence of an insured loss, the reporting of the loss by the insured and payment of that
loss. To recognize liabilities for unpaid losses, we establish reserves as balance sheet liabilities
representing estimates of amounts needed to pay reported and unreported losses and the related loss
adjustment expense. The process of estimating loss reserves is a difficult and complex exercise involving
many variables and subjective judgments. As part of the reserving process, we review historical data and
consider the impact of various factors such as:
trends in claim frequency and severity;
–
– changes in operations;
– emerging economic and social trends;
–
– changes in the regulatory and litigation environments.
inflation; and
This process assumes that past experience, adjusted for the effects of current developments and
anticipated trends, is an appropriate, but not necessarily accurate, basis for predicting future events.
There is no precise method for evaluating the impact of any specific factor on the adequacy of reserves,
and actual results are likely to differ from original estimates.
Our loss reserves also may be affected by court decisions that expand liability on our policies
after they have been issued and priced. In addition, a significant jury award, or series of awards, against
one or more of our insureds could require us to pay large sums of money in excess of our reserved
amounts. Due to uncertainties inherent in the jury system, the risk of incurring a loss that could have a
material adverse affect on reserves increases as the number of cases being litigated to a jury verdict
increases.
To the extent loss reserves prove to be inadequate in the future, we would need to increase our
loss reserves and incur a charge to earnings in the period the reserves are increased, which could have a
material adverse impact on our financial condition and results of operation and the price of our common
stock.
If we are unable to maintain a favorable financial strength rating, it may be more difficult for us to write
new business or renew our existing business.
Independent rating agencies assess and rate the claims-paying ability of insurers based upon
criteria established by the agencies. Periodically the rating agencies evaluate us to confirm that we
continue to meet the criteria of previously assigned ratings. The financial strength ratings assigned by
rating agencies to insurance companies represent independent opinions of financial strength and ability to
meet policyholder obligations and are not directed toward the protection of investors. Ratings by rating
agencies are not ratings of securities or recommendations to buy, hold or sell any security.
Our principal operating subsidiaries hold favorable financial strength ratings with A.M. Best and
Fitch. Financial strength ratings are used by agents and customers as an important means of assessing
the financial strength and quality of insurers. If our financial position deteriorates, we may not maintain
20
our favorable financial strength ratings from the rating agencies. A downgrade or involuntary withdrawal
of any such rating could limit or prevent us from writing desirable business.
The following table presents the ratings of our group and our core subsidiaries as of February 28,
2008:
Company / Rating
Rating Agency
ProAssurance
Group
Medical
Assurance
NCRIC
PIC
Wisconsin
ProNational
Red
Mountain
Casualty
Woodbrook
Casualty
Fitch
(www.fitchratings.com)
A
(Strong)
A
(Strong)
A
(Strong)
A
(Strong)
A
(Strong)
A
(Strong)
A
(Strong)
A. M. Best
(www.ambest.com)
A-
(Excellent)
A-
(Excellent)
B++
(Good)
A-
(Excellent)
A-
(Excellent)
A-
(Excellent)
B
(Fair)
The rating process is dynamic and ratings can change. If you are seeking updated information
about our ratings, please visit the rating agency websites listed in the table.
We operate in a highly competitive environment.
The property and casualty insurance business is highly competitive. We compete with large
national property and casualty insurance companies, locally-based specialty companies, self-insured
entities and alternative risk transfer mechanisms (such as captive insurers and risk retention groups)
whose activities are directed to limited markets in which they have extensive knowledge. Competitors
include companies that have substantially greater financial resources than we do, as well as mutual
companies and similar companies not owned by shareholders whose return on equity objectives may be
lower than ours.
Competition in the property and casualty insurance business is based on many factors, including
premiums charged and other terms and conditions of coverage, services provided, financial ratings
assigned by independent rating agencies, claims services, reputation, financial strength and the
experience of the insurance company in the line of insurance to be written. Increased competition could
adversely affect our ability to attract and retain business at current premium levels and reduce the profits
that would otherwise arise from operations.
Our revenues may fluctuate with insurance market conditions.
We derive a significant portion of our insurance premium revenue from medical malpractice risks.
Our policy is to charge adequate premiums on risks that meet our underwriting standards. We have
lowered our rates where warranted by loss cost improvements, however, some competitors may, or are
currently offering, rates that are lower than we consider to be justified. Increased competition in our
markets makes it difficult for us to develop new business and may reduce our retention of current
business, although our retention has not eroded significantly in the past year. Our competitors may
become even less disciplined in their pricing, or more permissive in their terms. We cannot predict
whether, when, or how market conditions will change, or the manner in which, or the extent to which, any
such changes may have an adverse effect on the results of our operations.
Our investment results will fluctuate as interest rates change.
Our investment portfolio is primarily comprised of interest-earning assets. Thus, prevailing
economic conditions, particularly changes in market interest rates, may significantly affect our operating
results. Changes in market interest rate levels generally affect our net income to the extent that
reinvestment yields are different than the yields on maturing securities. Changes in interest rates also can
affect the value of our interest-earning assets, which are principally comprised of fixed and adjustable-
rate investment securities. Generally, the values of fixed-rate investment securities fluctuate inversely with
changes in interest rates. Interest rate fluctuations could adversely affect our stockholders’ equity, income
and/or cash flows. Our total investments at December 31, 2007 were $3.6 billion, of which $3.2 billion
21
was invested in fixed maturities. Unrealized pre-tax net investment gains on investments in available-for-
sale fixed maturities were approximately $18.4 million at December 31, 2007.
At December 31, 2007, we held equity investments having a fair value of $7.6 million in an
available-for-sale portfolio and held additional equity securities having a fair value of $14.2 million in a
trading portfolio. The fair value of these securities fluctuates depending upon company specific and
general market conditions.
Any decline in the fair value of available-for-sale securities that we determine to be other-than-
temporary will reduce our current period net income. Any changes in the fair values of trading securities,
whether unrealized/realized gains or losses, will be included in current period net income.
Our investments are subject to prepayment and credit risk.
Our portfolio holds mortgage backed securities which are subject to prepayment risk. A
prepayment is the unscheduled return of principal. As rates decline, and the opportunity for mortgage
refinancing increases, the length of time we hold our mortgage backed securities may decrease due to
prepayments. Prepayments may cause us to reinvest cash flows at lower yields than currently
recognized. Conversely, as rates increase, and mortgage refinancing opportunities lessen, the length of
time we hold our mortgage backed securities may increase, causing us to not reinvest cash flows at then
higher available yields.
Our portfolio holds asset backed securities which consist of securitizations of underlying loans
collateralized by homes, autos, credit card receivables, commercial properties, hotels, and multi-family
housing. In addition to interest rate fluctuations, asset backed security values are subject to the existence
of US Government or Government-Sponsored Enterprise guarantees, the value and cash flows of the
underlying collateral, and the security’s seniority in the securitization’s capital structure. Approximately
29% of our fixed maturities are asset backed securities, all of which are investment grade, (97% AAA, 2%
AA, 1% A) as determined by Nationally Recognized Statistical Rating Organizations (NRSROs) (Moody’s,
Standard & Poor’s and Fitch). Ratings published by the NRSROs are one of the tools used to evaluate
the credit worthiness of our securities. The ratings are subject to error by the agencies, therefore, we may
be subject to additional credit exposure should the rating be misstated.
We have direct exposure to asset backed securitizations that we classify as sub-prime. (See Item
7 for details). We have no exposure to sub-prime loans through collateralized debt obligations (CDOs).
Changes in healthcare could have a material affect on our operations.
Proposals have included, among others, spending limits, price controls, limiting increases in
insurance premiums and/or health savings accounts, limiting the liability of doctors and hospitals for tort
claims, imposing liability on institutions rather than physicians, and restructuring the healthcare insurance
system. We cannot predict which, when, or if any reform proposals will be adopted or what effect they
may have on our business.
In addition to regulatory and legislative efforts, there have been significant market driven changes
in the healthcare environment that have negatively affected or threatened to affect the practices and
economic independence of our insureds. Medical professionals have found it more difficult to conduct a
traditional fee-for-service practice and many have been driven to join or contractually affiliate with larger
organizations.
These changes may result in the elimination of, or a significant decrease in, the role of the
physician in the medical malpractice insurance purchasing decision. They could also result in greater
emphasis on the role of professional managers, who may seek to purchase insurance on a price
competitive basis, and who may favor insurance companies that are larger and more highly rated than we
are. In addition, such change and consolidation could reduce our medical malpractice premiums as
groups of insurance purchasers generally retain more risk or self insure.
We are a holding company and are dependent on dividends and other payments from our operating
subsidiaries, which are subject to dividend restrictions.
We are a holding company whose principal source of funds is cash dividends and other permitted
payments from operating subsidiaries. If our subsidiaries are unable to make payments to us, or are able
22
to pay only limited amounts, we may be unable to make payments on our indebtedness. The payment of
dividends by these operating subsidiaries is subject to restrictions set forth in the insurance laws and
regulations of their respective states of domicile, as discussed under Item 1, “Insurance Regulatory
Matters” on page 17.
Regulatory requirements could have a material effect on our operations.
Our insurance businesses are subject to extensive regulation by state insurance authorities in
each state in which they operate. Regulation is intended for the benefit of policyholders rather than
shareholders. In addition to the amount of dividends and other payments that can be made to a holding
company by insurance subsidiaries, these regulatory authorities have broad administrative and
supervisory power relating to:
licensing requirements;
trade practices;
–
–
– capital and surplus requirements;
–
–
investment practices; and
rates charged to insurance customers.
These regulations may impede or impose burdensome conditions on rate increases or other
actions that we may want to take to enhance our operating results. In addition, we may incur significant
costs in the course of complying with regulatory requirements. Most states also regulate insurance
holding companies like us in a variety of matters such as acquisitions, changes of control and the terms of
affiliated transactions.
Future legislative or regulatory changes may also adversely affect our business operations.
Our claims settlement practices could result in a bad faith claim against us.
We could be sued for allegedly acting in bad faith during our handling of a claim. The damages in
actions for bad faith may include amounts owed by the insured in excess of the policy limits as well as
consequential and punitive damages. Awards above policy limits are possible whenever a case is taken
to trial, and they have been more common in recent years. Historically, we have been successful in
resolving actions alleging bad faith on terms that have no material adverse effect on our financial
condition and results of operations. These actions have the potential to have a material adverse effect on
our financial condition and results of operations.
The unpredictability of court decisions could have a material affect on our operations.
The financial position of our insurance subsidiaries may also be affected by court decisions that
expand insurance coverage beyond the intention of the insurer at the time it originally issued an
insurance policy. In addition, a significant jury award, or series of awards, against one or more of our
insureds could require us to pay large sums of money in excess of our reserve amounts.
The passage of tort reform or other legislation, and the subsequent review of such laws by the courts
could have a material impact on our operations.
Tort reforms generally restrict the ability of a plaintiff to recover damages by, among other
limitations, eliminating certain claims that may be heard in a court, limiting the amount or types of
damages, changing statutes of limitation or the period of time to make a claim, and limiting venue or court
selection. A number of states in which we do business have enacted, or are considering, tort reform
legislation. Because we cannot predict with any certainty how appellate courts will rule on these laws we
do not take them into account in our rate-making assumptions, except in Florida where such credit is
required by law.
While the effects of tort reform would appear to be beneficial to our business generally, there can
be no assurance that such reforms will be effective or ultimately upheld by the courts in the various
states. Further, if tort reforms are effective, the business of providing professional liability insurance may
become more attractive, thereby causing an increase in competition.
In addition, the enactment of tort reforms could be accompanied by legislation or regulatory
23
actions that may be detrimental to our business because of expected benefits which may or may not be
realized. These expectations could result in regulatory or legislative action limiting the ability of
professional liability insurers to raise or maintain rates at adequate levels. Coverage mandates or other
expanded insurance requirements could also be imposed. States may also consider state sponsored
malpractice insurance entities that could remove some physicians from the private insurance market.
We continue to monitor developments on a state-by-state basis, and make business decisions
accordingly.
Our business could be adversely affected by the loss of independent agents.
We depend in part on the services of independent agents in the marketing of our insurance
products. We face competition from other insurance companies for the services and allegiance of
independent agents. These agents may choose to direct business to competing insurance companies.
If market conditions cause reinsurance to be more costly or unavailable, we may be required to bear
increased risks or reduce the level of our underwriting commitments.
As part of our overall risk and capacity management strategy, we purchase reinsurance for
significant amounts of risk underwritten by our insurance company subsidiaries. Market conditions
beyond our control determine the availability and cost of the reinsurance, which may affect the level of our
business and profitability. We may be unable to maintain current reinsurance coverage or to obtain other
reinsurance coverage in adequate amounts and at favorable rates. If we are unable to renew our expiring
coverage or to obtain new reinsurance coverage, either our net exposure to risk would increase or, if we
are unwilling to bear an increase in net risk exposures, we would have to reduce the amount of our
underwritten risk.
We cannot guarantee that our reinsurers will pay in a timely fashion, if at all, and, as a result, we could
experience losses.
We transfer some of our risks to reinsurance companies in exchange for part of the premium we
receive in connection with the risk. Although reinsurance makes the reinsurer liable to us to the extent the
risk is transferred, it does not relieve us of our liability to our policyholders. If reinsurers fail to pay us or
fail to pay on a timely basis, our financial results would be adversely affected. At December 31, 2007 our
reinsurance recoverable on unpaid losses is $327 million and our receivable from reinsurers on paid
losses, which is classified as a part of Other Assets, is $40 million.
The guaranty fund assessments that we are required to pay to state guaranty associations may increase
and results of operations and financial condition could suffer as a result.
Each state in which we operate has 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
insolvent insurance companies. Most guaranty association laws enable the associations to make
assessments against member insurers to obtain funds to pay covered claims after a member insurer
becomes insolvent. 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, although one
notable exception occurred in Florida in 2006, when the state assessed all property casualty insurers a
total of 4% of their non-property premiums to offset bankruptcies caused by hurricane claims. 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.
24
Net property and casualty guaranty fund assessments incurred by us totaled $553,000 and $2.6
million for 2007 and 2006, respectively. Our policy is to accrue for the insurance insolvencies when
notified of assessments. We are not able to reasonably estimate the liabilities of an insolvent insurer or
develop a meaningful range of the insolvent insurer’s liabilities because of inadequate financial data with
respect to the estate of the insolvent company as supplied by the guaranty funds.
Our business could be adversely affected by the loss of one or more key employees.
We are heavily dependent upon our senior management and the loss of services of our senior
executives could adversely affect our business. Our success has been, and will continue to be,
dependent on our ability to retain the services of existing key employees and to attract and retain
additional qualified personnel in the future. The loss of the services of key employees or senior
managers, or the inability to identify, hire and retain other highly qualified personnel in the future, could
adversely affect the quality and profitability of our business operations.
Our board of directors regularly reviews succession planning relating to our Chief Executive
Officer as well as other senior officers. Mr. Starnes, our Chief Executive Officer, has indicated to the
board that he has no immediate plans for retirement.
Provisions in our charter documents, Delaware law and state insurance law may impede attempts to
replace or remove management or impede a takeover, which could adversely affect the value of our
common stock.
Our certificate of incorporation, bylaws and Delaware law contain provisions that may have the
effect of inhibiting a non-negotiated merger or other business combination. Additionally, the board of
directors may issue preferred stock, which could be used as an anti-takeover device, without a further
vote of our stockholders. We currently have no preferred stock outstanding, and no present intention to
issue any shares of preferred stock. However, because the rights and preferences of any series of
preferred stock may be set by the board of directors in its sole discretion, the rights and preferences of
any such preferred stock may be superior to those of our common stock and thus may adversely affect
the rights of the holders of common stock.
The voting structure of common stock and other provisions of our certificate of incorporation are
intended to encourage a person interested in acquiring us to negotiate with, and to obtain the approval of,
the board of directors in connection with a transaction. However, certain of these provisions may
discourage our future acquisition, including an acquisition in which stockholders might otherwise receive a
premium for their shares. As a result, stockholders who might desire to participate in such a transaction
may not have the opportunity to do so.
In addition, state insurance laws provide that no person or entity may directly or indirectly acquire
control of an insurance company unless that person or entity has received approval from the insurance
regulator. An acquisition of control would be presumed if any person or entity acquires 10% (5% in
Alabama) or more of our outstanding common stock, unless the applicable insurance regulator
determines otherwise.
These provisions apply even if the offer may be considered beneficial by stockholders.
If a change in management or a change of control is delayed or prevented, the market price of
our common stock could decline.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
25
ITEM 2. PROPERTIES.
We own three office buildings, all of which are unencumbered. In Birmingham, Alabama we own
a 156,000 square foot building in which we currently occupy approximately 82,000 square feet with the
remaining office space leased to unaffiliated persons or available to be leased. In Okemos, Michigan we
own, and fully occupy a 53,000 square foot building and in Madison, Wisconsin we own and fully occupy
a 38,000 square foot building.
ITEM 3. LEGAL PROCEEDINGS.
Our insurance subsidiaries are involved in various legal actions, a substantial number of which
arise from claims made under insurance policies. While the outcome of all legal actions is not presently
determinable, management and its legal counsel are of the opinion that these actions will not have a
material adverse effect on our financial position or results of operations. See Note 9 to the Consolidated
Financial Statements included herein.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
26
EXECUTIVE OFFICERS OF PROASSURANCE CORPORATION
The executive officers of ProAssurance Corporation (ProAssurance) serve at the pleasure of the
Board of Directors. We 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 19 years. Following is a brief description of each
executive officer of ProAssurance, including their principal occupation and employment during the last
five years.
W. Stancil Starnes
Victor T. Adamo
Howard H. Friedman
Jeffrey P. Lisenby
James J. Morello
Mr. Starnes was appointed as Chief Executive Officer of ProAssurance
effective July 2, 2007. Mr. Starnes served as President, Corporate
Planning and Administration, of Brasfield & Gorrie, LLC, a large
commercial construction firm from October, 2006 to May, 2007. Prior to
October 2006, Mr. Starnes served as the Senior and Managing Partner
of Starnes & Atchison, LLP, Attorneys at Law, and was extensively
involved with ProAssurance and its predecessor companies in the
defense of its medical liability claims. (Age 59)
Mr. Adamo has been the President of ProAssurance since its inception.
Mr. Adamo first joined the predecessor of Professionals Group (PICOM
Insurance Company) in 1985 as general counsel and was elected CEO
in 1987. From 1975 to 1985, Mr. Adamo was in private legal practice and
represented the company in corporate legal matters. Mr. Adamo is a
Chartered Property Casualty Underwriter. (Age 59)
Mr. Friedman is a Co-President of our Professional Liability Group, a
position he has held since October 2005, and is also our Chief
Underwriting Officer. Mr. Friedman has served in a number of positions
for ProAssurance, most recently as Chief Financial Officer and Corporate
Secretary. He was also
the Senior Vice President, Corporate
Development of Medical Assurance. Mr. Friedman is an Associate of the
Casualty Actuarial Society. (Age 49)
joined Medical Assurance,
Mr. Lisenby was appointed as a Senior Vice President in December
2007 and has served as our Corporate Secretary since January 1, 2006.
Mr. Lisenby
to
ProAssurance, in 2001 and has served as Vice President and head of
the corporate Legal Department since the creation of ProAssurance.
Prior to joining Medical Assurance, he was in private practice in
Birmingham, Alabama and served as a judicial clerk for the United States
District Court for the Northern District of Alabama. Mr. Lisenby is a
member of the Alabama State Bar and the United States Supreme Court
Bar and is a Chartered Property Casualty Underwriter. (Age 39)
the predecessor
Mr. Morello was appointed as a 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 the Chief
Financial Officer of Medical Assurance Company, Inc. since 1984. Mr.
Morello is a Certified Public Accountant. We announced on December 5,
2007 that Mr. Morello had informed us of his plans to resign from his
executive position on June 30, 2008. (Age 59)
27
Frank B. O’Neil
Edward L. Rand, Jr.
Darryl K. Thomas
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 54)
Mr. Rand was appointed Chief Financial Officer on April 1, 2005, having
joined ProAssurance as our Senior Vice President of Finance in
November 2004. Prior to joining ProAssurance Mr. Rand was the Chief
Accounting Officer and Head of Corporate Finance for PartnerRe Ltd.
Prior to that time Mr. Rand served as the Chief Financial Officer of
Atlantic American Corporation. Mr. Rand is a Certified Public Accountant.
(Age 41)
Mr. Thomas is a Co-President of our Professional Liability Group, a
position he has held since October 2005, and serves as our Chief Claims
Officer. Prior to the formation of ProAssurance, Mr. Thomas was Senior
Vice President of Claims for ProNational Insurance Company, one of
ProAssurance's predecessor companies. Prior to joining ProNational
Insurance Company in 1995, Mr. Thomas was Executive Vice President
of a national third-party administrator of professional liability claims. Mr.
Thomas was also Vice President and Litigation Counsel for the Kentucky
Hospital Association. (Age 50)
We have adopted a code of ethics that applies to our directors and executive officers, including
our principal executive officers, principal financial officer, and principal accounting officer. We also have
share ownership guidelines in place to ensure that management maintains a significant portion of their
personal investments in the stock of ProAssurance. See Item 1 for information regarding the availability of
the Code of Ethics and the Share ownership Guidelines.
28
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
At February 15, 2008, ProAssurance Corporation (PRA) had 3,903 stockholders of record and
32,203,785 shares of common stock outstanding. ProAssurance’s common stock currently trades on The
New York Stock Exchange (NYSE) under the symbol “PRA”.
Quarter
First
Second
Third
Fourth
2007
2006
High
$ 52.83
57.30
56.17
57.19
Low
$ 48.67
51.00
48.69
50.46
High
$ 53.08
51.22
51.69
52.11
Low
$ 48.95
45.96
46.18
47.84
ProAssurance has not paid any cash dividends on its common stock and does not currently have
a policy to pay regular dividends.
ProAssurance’s insurance subsidiaries are subject to restrictions on the payment of dividends to
the parent. Information regarding restrictions on the ability of the insurance subsidiaries to pay dividends
is incorporated by reference from the paragraphs under the caption “Insurance Regulatory Matters–
Regulation of Dividends and Other Payments from Our Operating Subsidiaries” in Item 1 on page 17 of
this 10-K.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information regarding ProAssurance's equity compensation plans as
of December 31, 2007.
Plan Category
Equity compensation
plans approved
by security holders
Equity compensation
plans not approved
by security holders
Number of securities to be
issued upon exercise of
outstanding options,
warrants and rights
(a)
Weighted-average
exercise price of
outstanding options,
warrants and rights
(b)
Number of securities remaining
available for future issuance under
equity compensation plans (excluding
securities reflected in column (a))
(c)
973,155
$ 40.55
1,452,304
–
–
–
Issuer Purchases of Equity Securities
The following table provides information regarding ProAssurance's shares purchased as part of
publicly announced plans or programs.
Period
October 1-31, 2007
November 1-30, 2007
December 1-31, 2007
Total
Total Number
of Shares
Purchased
–
121,116
120,900
242,016
Average
Price Paid
per Share
–
$
$ 52.93
$ 53.98
$ 53.45
(1) Shown net of authorizations used for repurchase of debt.
Total Number of Shares
Purchased as Part of
Publicly Announced Plans
or Programs
–
121,116
120,900
242,016
Approximate Dollar Value of
Shares that May Yet Be Purchased
Under the Plans or Programs(1)
$ 108,735,790
$ 102,325,239
$ 80,335,500
29
ITEM 6. SELECTED FINANCIAL DATA
Selected Financial Data (1)
Gross premiums written (2)
Net premiums written (2)
Premiums earned (2)
Premiums ceded (2)
Net premiums earned (2)
Net investment income (2)
Equity in earnings (loss) of unconsolidated
subsidiaries (2)
Net realized investment gains (losses) (2)
Other income (2)
Total revenues (2)
Net losses and loss adjustment expenses (2)
Income (loss) from continuing operations
Net income
Income (loss) from continuing operations
per share:
Basic
Diluted
Net income per share:
Basic
Diluted
Weighted average shares outstanding:
Basic
Diluted
Balance Sheet Data (as of December 31)
Total investments (2)
Total assets from continuing operations
Year Ended December 31
2007
2006
2005
2004
2003
(In thousands except per share data)
$ 549,074
$ 578,983
$ 572,960
$ 573,592
$ 543,323
506,397
543,376
521,343
535,028
497,659
585,310
627,166
596,557
555,524
509,260
(51,797)
(44,099)
(53,316)
(35,627)
(49,389)
533,513
583,067
543,241
519,897
459,871
171,308
147,450
98,293
76,627
64,232
1,630
(5,939)
5,556
2,339
(1,199)
5,941
900
912
4,604
1,042
7,572
2,419
300
5,858
5,580
706,068
737,598
647,950
607,557
535,841
350,997
443,329
438,201
460,437
439,368
168,186
126,984
80,026
168,186
236,425
113,457
43,043
72,811
15,345
38,703
$
$
$
$
5.10
4.78
5.10
4.78
$
$
$
$
3.96
3.72
7.38
6.85
$
$
$
$
2.66
2.52
3.77
3.54
$
$
$
$
1.48
1.44
2.50
2.37
$
$
$
$
0.53
0.53
1.34
1.33
32,960
35,823
32,044
34,925
30,049
32,908
29,164
31,984
28,956
30,389
$3,629,607
$3,492,098
$2,614,319
$2,145,609
$ 1,792,323
4,439,836
4,342,853
3,341,600
2,743,295
2,448,088
Total assets
4,439,836
4,342,853
3,909,379
3,239,198
2,879,352
Reserve for losses and loss
adjustment expenses (2)
Long-term debt (2)
Total liabilities from continuing operations
2,559,707
2,607,148
2,224,436
1,818,636
1,634,749
164,158
179,177
167,240
151,480
104,789
3,184,766
3,224,306
2,806,820
2,333,405
2,074,560
Total capital
1,255,070
1,118,547
765,046
611,019
546,305
Total capital per share of common
stock outstanding
$
38.69
$
33.61
$
24.59
$
20.92
$
18.77
Common stock outstanding at end of year
(1) Includes acquired entities since date of acquisition, only. PIC Wisconsin was acquired on August 1, 2006. NCRIC Corporation was acquired on August 3, 2005.
(2) Excludes discontinued operations.
29,204
31,109
32,443
33,276
29,105
30
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated Financial
Statements and Notes to those statements which accompany this report. Throughout the discussion,
references to ProAssurance, "we," "us" and "our" refers to ProAssurance Corporation and its consolidated
subsidiaries. The discussion contains certain forward-looking information that involves risks and
uncertainties. As discussed under "Forward-Looking Statements," our actual financial condition and
operating results could differ significantly from these forward-looking statements.
Critical Accounting Estimates
Our Consolidated Financial Statements are prepared in accordance with accounting principles
generally accepted in the United States of America (GAAP). Preparation of these financial statements
requires us to make estimates and assumptions that affect the amounts we report on those statements.
We evaluate these estimates and assumptions on an on-going basis based on current and historical
developments, market conditions, industry trends and other information that we believe to be reasonable
under the circumstances. There can be no assurance that actual results will conform to our estimates and
assumptions; reported results of operations may be materially affected by changes in these estimates
and assumptions.
Management considers the following accounting estimates to be critical because they involve
significant judgment by management and the effect of those judgments could result in a material effect on
our financial statements.
Reserve for Losses and Loss Adjustment Expenses (reserve for losses or reserve)
The largest component of our liabilities is our reserve for losses and the largest component of
expense for our operations is incurred losses. Net losses in any period reflect our estimate of net losses
incurred related to the premiums earned in that period as well as any changes to our estimates of the
reserve established for net losses of prior periods.
The estimation of medical professional liability losses is inherently difficult. Ultimate loss costs,
even for claims with similar characteristics, vary significantly depending upon many factors, including but
not limited to, the nature of the injury and the personal situation of the claimant or the claimant's family,
the outcome of jury trials, the legislative and judicial climate where the insured event occurred, general
economic conditions and the trend of health care costs. Medical professional liability claims are typically
resolved over an extended period of time, often five years or more. The combination of changing
conditions and the extended time required for claim resolution results in a loss cost estimation process
that requires actuarial skill and the application of judgment, and such estimates require periodic revision.
In establishing our reserve for losses management considers a variety of factors including
historical paid and incurred loss development trends, the effect of inflation on medical care, general
economic trends and the legal environment. We perform an in-depth review of our reserve for losses on a
semi-annual basis. Additionally, during each reporting period we update and review the data underlying
the estimation of our reserve for losses and make adjustments that we believe best reflect emerging data.
Any adjustments are reflected in the then-current operations. Due to the size of our reserve for losses,
even a small percentage adjustment to these estimates could have a material effect on our results of
operations for the period in which the adjustment is made.
31
External actuaries review our reserve for losses at least semi-annually. We consider the views of
the external actuaries as well as other factors, such as known, anticipated or estimated changes in
frequency and severity of claims, loss retention levels and premium rates in establishing our reserves.
As a result of the variety of factors that must be considered by management there is a significant
risk that actual incurred losses will develop differently from these estimates. In establishing our initial
reserves for a given accident year we rely significantly on the loss assumptions embedded within our
pricing. Because of the historically volatile nature of medical liability losses, we establish the initial loss
estimates at a level which is approximately 10% above the pricing assumptions. This difference
recognizes the volatility of the medical malpractice loss environment and the risk in determining pricing
parameters. As each accident year matures we analyze reserves in a variety of ways. We use a variety of
actuarial methodologies in performing these analyses. Among the methods that we have used are:
– Bornhuetter-Ferguson method
– Paid development method
– Reported development method
– Average paid value method
– Average reported value method
– Backward recursive method
Generally, methods such as the Bornheutter-Ferguson method are used on more recent accident
years where we have less data on which to base our analysis. As time progresses and we have an
increased amount of data for a given accident year we begin to give more confidence to the development
and average methods as these methods typically rely more heavily on our own historical data. Each of
these methods treats our assumptions differently, and thus provides a different perspective for our
reserve review.
The various actuarial methods discussed above are applied in a consistent manner from period to
period. In addition, we perform statistical reviews of claims data such as claim counts, average settlement
costs and severity trends.
In performing these analyses we partition our business by coverage type, geography, layer of
coverage and accident year. This procedure is intended to balance the use of the most representative
data for each partition, capturing its unique patterns of development and trends. For each partition, the
results of the various methods, along with the supplementary statistical data regarding such factors as the
current economic environment, are used to develop a point estimate based upon management’s
judgment and past experience. The process of selecting the point estimate from the set of possible
outcomes produced by the various actuarial methods is based upon the judgment of management and is
not driven by formulaic determination. For each partition of our business we select a point estimate with
due regard for the age, characteristics and volatility of the partition of the business, the volume of data
available for review and past experience with respect to the accuracy of estimates. This series of selected
point estimates is then combined to produce an overall point estimate for ultimate losses.
We have modeled implied reserve ranges around our single point reserve estimates for our
professional liability business assuming different confidence levels. The ranges have been developed by
aggregating the expected volatility of losses across partitions of our business to obtain a consolidated
distribution of potential reserve outcomes. The aggregation of this data takes into consideration the
correlation among our geographic and specialty mix of business. The result of the correlation approach to
aggregation is that the ranges are narrower than the sum of the ranges determined for each partition.
32
We have used this modeled statistical distribution to calculate an 80% and 60% confidence
interval for the potential outcome of our reserve for losses. The high and low end points of the
distributions are as follows:
80% Confidence Level
60% Confidence Level
Low End Point
$1.672 billion
$1.831 billion
Carried Reserve High End Point
$ 2.233 billion
$ 2.233 billion
$2.862 billion
$2.574 billion
The claims environment in which we and others in our industry operate is inherently uncertain.
The development of a statistical distribution models the uncertainty as well as the limited predictive power
of past loss data. The distributions represent an estimate of the range of possible outcomes and should
not be confused with a range of best estimates. Given the number of factors considered it is neither
practical nor meaningful to isolate a particular assumption or parameter of the process and calculate the
impact of changing that single item. Any change in our estimate of the reserve is reflected in then-current
operations. Due to the size of our reserve for losses, even a small percentage adjustment to these
estimates could have a material effect on our results of operations for the period in which the adjustment
is made.
Reinsurance
We use insurance and reinsurance (collectively, "reinsurance") to provide capacity to write larger
limits of liability, to provide protection against losses in excess of policy limits, and to stabilize underwriting
results in years in which higher losses occur. The purchase of reinsurance does not relieve us from the
ultimate risk on our policies, but it does provide reimbursement for certain losses we pay.
We evaluate each of our ceded reinsurance contracts at inception to determine if there is
sufficient risk transfer to allow the contract to be accounted for as reinsurance under current accounting
guidance. At December 31, 2007 all ceded contracts are accounted for as risk transferring contracts.
Our receivable from reinsurers on unpaid losses and loss adjustment expenses represents our
estimate of the amount of our reserve for losses that will be recoverable under our insurance and
reinsurance programs. We base our estimate of funds recoverable upon our expectation of ultimate
losses and the portion of those losses that we estimate to be allocable to reinsurers based upon the
terms of our reinsurance agreements. As losses are paid, the related amount expected to be collected
from reinsurers is recorded as a receivable in Other Assets.
We estimate premiums ceded under reinsurance agreements wherein the premium due to the
reinsurer, subject to certain maximums and minimums, is based in part on losses reimbursed or to be
reimbursed under the agreement. Our estimates of the amounts due from and to reinsurers are regularly
reviewed and updated by management as new data becomes available. Our assessment of the
collectibility of the recorded amounts receivable from reinsurers considers the payment history of the
reinsurer, publicly available financial and rating agency data, our interpretation of the underlying contracts
and policies, and responses by reinsurers. Appropriate reserves are established for balances we believe
may not be collected.
Given the uncertainty of the ultimate amounts of our losses, our estimates of losses and related
amounts recoverable may vary significantly from the eventual outcome. Any adjustments are reflected in
then-current operations. Due to the size of our reinsurance balances, an adjustment to these estimates
could have a material effect on our results of operations for the period in which the adjustment is made.
33
Investment Valuations
We evaluate our investments on at least a quarterly basis for declines in fair value below cost for
the purpose of determining whether these declines represent other-than-temporary declines. Some of the
factors we consider in the evaluation of our investments are:
(cid:16)
(cid:16)
(cid:16)
the extent to which the fair value of an investment is less than its cost basis,
the length of time for which the fair value of the investment has been less than its cost
basis,
the financial condition and near-term prospects of the issuer underlying the investment,
taking into consideration the economic prospects of the issuer's industry and
geographical region, to the extent that information is publicly available, and
(cid:16) our ability and intent to hold the investment for a period of time sufficient to allow for any
anticipated recovery in fair value.
Determining whether a decline in the fair value of investments is an other-than-temporary decline
may also involve a variety of assumptions and estimates, particularly for investments that are not actively
traded in established markets. For example, assessing the value of certain investments requires us to
perform an analysis of expected future cash flows or prepayments. Other investments, such as
collateralized mortgage or bond obligations, represent selected tranches of structured transactions
supported overall by underlying investments in a wide variety of issuers. When we judge a decline in fair
value below cost to be other-than-temporary we reduce the cost basis of the investment to fair value and
recognize a loss in the current period income statement for the amount of the reduction. In subsequent
periods, we base any measurement of gain or loss or decline in value upon the adjusted cost basis of the
investment. Our specific accounting policies related to our invested assets are discussed in Notes 1 and 4
to the Consolidated Financial Statements.
Deferred Policy Acquisition Costs
Policy acquisition costs, primarily commissions, premium taxes and underwriting salaries, which
are primarily and directly related to the acquisition of new and renewal premiums are capitalized as
deferred policy acquisition costs and charged to expense as the related premium revenue is recognized.
We evaluate the recoverability of our deferred policy acquisition costs and any amounts estimated to be
unrecoverable are charged to expense in the current period.
Goodwill
In accordance with Statement of Financial Accounting Standards No. 142 “Goodwill and Other
Intangible Assets” we make an annual assessment as to whether the value of our goodwill assets is
impaired. We completed such assessments in 2007, 2006 and 2005 and concluded that the value of our
goodwill assets related to continuing operations was not impaired. As of December 31, 2007 goodwill
totaled approximately $72.2 million. We use market-based valuation models to estimate the fair value.
These models require the use of numerous assumptions regarding market perceptions of value as related
to our consolidated and reporting unit historical and projected operating results and those of other
economically similar entities. Changes to these assumptions could significantly lower our estimates of fair
value and result in a determination that goodwill has suffered impairment in value. Any determined
impairment would be reflected as an expense in the period identified.
34
ProAssurance Overview
We are an insurance holding company and our operating results are primarily derived from the
operations of our insurance subsidiaries, all of which principally write medical professional liability
insurance.
Corporate Strategy
Our mission is to be the preferred source of professional liability protection by providing
unparalleled claims defense, highly responsive customer service and innovative risk management while
maintaining our commitment to long-term financial strength. According to A.M. Best’s analysis of 2006
data, we are the fourth largest medical liability insurance writer in the nation, and we believe we are the
largest medical liability writer in our collective states of operation. 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, over the long-term, to profitably expand our position in select states.
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 emphasize disciplined underwriting and
do not manage our business to achieve a certain level of premium growth or market share. 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 addition to prudent risk selection, we seek to control our
underwriting results through effective claims management. We investigate each claim and have fostered
a strong culture of defending claims that we believe have no merit. We manage claims at the local level,
tailoring claims handling to the legal climate of each state, which we believe differentiates us from
national writers.
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 allow us to compete on a
basis other than just price. We also believe that our presence in local markets allows us to monitor and
understand changes in the liability climate and thus develop better business strategies in a timely
manner.
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 that our customers and
producers place on the strong ratings of our principal insurance subsidiaries and we intend to manage our
business to protect our financial security.
We measure performance in a number of ways, but particularly focus on our combined ratio and
investment returns, both of which directly affect our return on equity (ROE). We target a long-term
average ROE of 12% to 14%.
We believe that a focus on rate adequacy, selective underwriting and effective claims
management is required if we are to achieve our ROE targets. We closely monitor premium revenues,
losses and loss adjustment costs, and acquisition, underwriting and insurance expenses. Our overall
investment strategy is to focus on maximizing current income from our investment portfolio while
maintaining safety, liquidity, duration and portfolio diversification. We engage in activities that generate
other income; however, such activities, principally fee and agency services, do not constitute a significant
use of our resources or a significant source of revenues or profits.
Growth Opportunities and Outlook
We expect our long-term growth to come through controlled expansion in states where we are
already writing business and into additional states within, or adjacent to, our existing business footprint.
We also look to expand through the acquisition of other companies or books of business; however, such
expansion is opportunistic and cannot be predicted.
We face price-based competition in virtually all of our markets, with some competitors offering
coverage at rates that we believe do not meet our long-term profitability goals. Additionally, a number of
physicians and hospitals are seeking to lower their costs through the use of alternative risk transfer
35
approaches such as self insurance and risk sharing pools, although these alternatives become less
attractive as prices soften in the traditional insurance markets.
Our on-going commitment to adequate rates and strong underwriting standards affects our
willingness to write new business and to renew existing business in the face of this price-based
competition. Improvements in loss cost trends have allowed us to reduce rates in certain markets during
2007 and to offer targeted new business and renewal retention programs in selected markets. While both
actions improve policyholder retention, they decrease our average premiums. The combined effects of
lower rates and the challenges of writing new business are expected to cause our gross written premiums
to continue to decline in 2008.
Accounting Changes
We adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an
interpretation of FAS 109, Accounting for Income Taxes (FIN 48) as of its effective date, January 1, 2007.
FIN 48 creates a single model to address accounting for uncertainty in tax positions and clarifies the
accounting for income taxes by prescribing a minimum recognition threshold that a tax position is required
to meet before being recognized in the financial statements. FIN 48 also provides guidance on
derecognition, measurement, classification, interest and penalties, accounting for interim periods,
disclosure and transition. The cumulative effect of adopting FIN 48 increased retained earnings and
reduced our tax liability by $2.7 million at January 1, 2007.
Recent Accounting Pronouncements and Guidance
In December 2007 the FASB issued SFAS 160, Noncontrolling Interests in Consolidated
Financial Statements (SFAS 160). SFAS 160 amends Accounting Research Bulletin (ARB) 51 to
establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the
deconsolidation of a subsidiary. The Statement is effective for fiscal years, and interim periods within
those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. We will adopt
the Statement on its effective date. The adoption is not expected to have a significant effect on our results
of operations or financial position.
In December 2007 the FASB issued SFAS 141 (Revised December 2007) Business
Combinations (SFAS 141R). SFAS 141R replaces FASB Statement No. 141, Business Combinations but
retains the fundamental requirement in SFAS 141 that the acquisition method (referred to as the
purchase method in SFAS 141) of accounting be used for all business combinations. SFAS 141R
provides new or additional guidance with respect to business combinations including: defining the
acquirer in a transaction, the valuation of assets and liabilities when noncontrolling interests exist, the
treatment of contingent consideration, the treatment of costs incurred to effect the acquisition, the
treatment of reorganization costs, and the valuation of assets and liabilities when the purchase price is
below the net fair value of assets acquired. SFAS 141R applies prospectively to business combinations
for which the acquisition date is on or after the beginning of the first annual reporting period beginning on
or after December 15, 2008. Earlier adoption is prohibited. We will adopt the Statement on its effective
date.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets
and Financial Liabilities–Including an Amendment of FASB Statement No. 115 (SFAS 159). SFAS 159
allows many financial assets and liabilities and other items to be reported at fair value that are not
currently measured at fair value; unrealized gains and losses on items for which the fair value option has
been elected would be reported in earnings at each subsequent reporting date. SFAS 159 also
establishes new disclosure requirements with respect to fair values. SFAS 159 is effective for fiscal years
beginning after November 15, 2007, unless early adopted. We will adopt SFAS 159 on its effective date.
Upon adoption, we do not plan to select the fair value alternative for any financial assets or liabilities that
are not currently measured at fair value. We do not expect adoption to have a material effect on our
results of operations or financial condition.
In September 2006, the FASB issued SFAS 157, Fair Value Measurements (SFAS 157). The
standard establishes a framework for measuring fair value under GAAP and expands disclosures about
fair value measurements. SFAS 157 is applicable to other accounting pronouncements that require or
permit fair value measurements but does not require any new fair value measurements. The statement is
effective for fiscal years beginning after November 15, 2007, unless early adopted. We will adopt SFAS
36
157 on its effective date. We do not expect adoption to have a material effect on our results of operations
or financial condition.
Recent Significant Events
Effective January 1, 2006, we sold our personal lines operations and recognized a gain on the
sale of $109.4 million after consideration of sales expenses and estimated taxes. Additional information
regarding the sale is provided in Note 3 to the Notes to the Consolidated Financial Statements.
Effective August 1, 2006 we acquired Physicians Insurance Company of Wisconsin, Inc. (PIC
Wisconsin) in an all stock merger. The acquisition of PIC Wisconsin allowed ProAssurance to expand its
medical professional liability business into the state of Wisconsin and adjacent states and into Nevada.
This transaction strategically expanded our geographic footprint and was in keeping with our desire to
expand our professional liability operations through selective acquisitions. A more detailed description of
the merger transaction is provided in Note 2 to the Consolidated Financial Statements.
During the first quarter of 2007 we reached a confidential settlement that ended all litigation and
appeals stemming from, and related to, a $217 million judgment on a malpractice verdict against insureds
of one of our subsidiaries entered in Tampa, Florida in October 2006. The effect of the settlement has
been reflected in our financial statements.
On April 2, 2007 our Board authorized $150 million to repurchase our shares or debt securities.
The timing and quantity of any repurchase is dependent upon market conditions and any changes in
ProAssurance's capital requirements, as well as limitations imposed by applicable securities laws and
regulations, and the rules of the New York Stock Exchange. As of December 31, 2007 we have
repurchased approximately 1.0 million common shares at a total cost of approximately $54.2 million. On
December 4, 2007 we utilized approximately $15.5 million of the authorization to redeem our outstanding
2032 Subordinated Debentures.
A. Derrill Crowe, M.D. retired as Chief Executive Officer (CEO), effective July 1, 2007 and
remains as non-executive Chairman of our Board. The Board of Directors elected W. Stancil Starnes to
succeed Dr. Crowe as CEO. Mr. Starnes formerly served as President, Corporate Planning and
Administration, of Brasfield & Gorrie, LLC, a large commercial construction firm. Prior to October 2006,
Mr. Starnes served as the Senior and Managing Partner of Starnes & Atchison, LLP, Attorneys at Law,
and was extensively involved with ProAssurance and its predecessor companies in the defense of its
medical liability claims.
Reclassifications
Due to the increasing significance of the amounts involved, for all periods presented, we have
separately stated our investments in unconsolidated subsidiaries and our equity in the earnings of
unconsolidated subsidiaries. Previously, investments in unconsolidated subsidiaries were included as a
component of other investments, and earnings of unconsolidated subsidiaries were considered as a
component of net investment income. The reclassification had no effect on income from continuing
operations, net income or total assets.
Liquidity and Capital Resources and Financial Condition
Overview
ProAssurance Corporation is a holding company and is a legal entity separate and distinct from
its subsidiaries. Because it has no other business operations, dividends from its operating subsidiaries
represent a significant source of funds for its obligations, including debt service. The ability of our
insurance subsidiaries to pay dividends is subject to limitation by state insurance regulations. See our
discussions under "Regulation of Dividends and Other Payments from Our Operating Subsidiaries" in Part
I, and in Note 15 of our Notes to the Consolidated Financial Statements for additional information
regarding the ordinary dividends that can be paid by our insurance subsidiaries in 2008. At December 31,
2007 we held cash and investments of approximately $195 million outside of our insurance subsidiaries
that are available for use without regulatory approval.
37
Cash Flows
The principal components of our cash flow are the excess of net investment income and
premiums collected over net losses paid and operating costs, including income taxes. Timing delays exist
between the collection of premiums and the ultimate payment of losses. Premiums are generally collected
within the twelve-month period after the policy is written while our claim payments are generally paid over
a more extended period of time. Likewise timing delays exist between the payment of claims and the
collection of reinsurance recoveries.
Our operating activities provided positive cash flows of approximately $244.1 million during the
year ended December 31, 2007, which is composed of $201.4 million from routine insurance operations
and proceeds of $42.7 million related to the sale of trading securities. In 2006, cash provided by operating
activities of $182.8 million is composed of net positive cash flows from routine insurance operations of
$289.0 million, offset by tax payments related to the sale of our personal lines operations of
approximately $54.6 million and purchases of trading securities of approximately $51.6 million.
Exclusive of cash flows related to trading securities and the taxes paid on the MEEMIC
transaction, the decline in operating cash flows during 2007 is principally attributable to an increase in
payments for losses and loss adjustment expenses, net of reinsurance reimbursements received. A
number of factors influenced the increase in losses paid, including an additional seven months of PIC
Wisconsin payment activity, the maturing of claims incurred during the last several years of growth, and
an increase in the number of large indemnity payments, net of amounts received from reinsurers.
Two metrics commonly used to analyze the operating cash flows of insurance companies are the
paid-to-incurred ratio and the paid loss ratio.
Paid-to-incurred ratio
Paid loss ratio
Year Ended December 31
2007
101.1%
66.5%
2006
62.0%
47.2%
Our paid-to-incurred and paid loss ratios are higher in 2007 than in 2006 primarily due to the
2007 increase in net loss payments. The ratios also increased in 2007 because the denominators of each
ratio (net losses and loss adjustment expenses for the paid-to-incurred ratio; net earned premiums for the
paid loss ratio) decreased in 2007 as compared to 2006. For a long-tailed business such as
ProAssurance, the ratios for a short period of time should not be viewed in isolation. Both changes in
premium volume and the recognition of reserve development can impact the calculation of these ratios.
The timing of our indemnity payments is affected by many factors, including the nature and
number of the claims in process in any one period and the speed at which cases work through the trial
and appellate process. In the contractual obligations table included in Part II of our December 31, 2006
Form 10K we projected, largely based on historical payment patterns, that we would pay gross losses of
$546 million during 2007 related to the reserves that were established at December 31, 2006. Actual
gross loss and loss adjustment expenses paid during 2007 were $486 million, which, while lower than our
2006 estimate, reflects the unpredictable nature of our business. Cash flows in 2007 were also reduced
due to a decline in premium receipts. These decreases to operating cash flows were partially offset by
growth in cash flows from investment earnings, and a reduction in premium payments to our reinsurers.
Investments
We manage our investments to ensure that we will have sufficient liquidity to meet our
obligations, taking into consideration the timing of cash flows from our investments as well as the
expected cash flows to be generated by our operations. At our insurance subsidiaries the primary outflow
of cash is related to net losses paid and operating costs, including income taxes. The payment of
individual claims cannot be predicted with certainty; therefore, we rely upon the history of paid claims in
estimating the timing of future claims payments. To the extent that we have an unanticipated shortfall in
cash we may either liquidate securities or borrow funds under previously established borrowing
arrangements. However, given the relatively short duration of our investments, we do not foresee any
such shortfall.
38
We invest most of the cash generated from operations into debt and equity securities. We held
cash and short-term securities of $259.1 million at December 31, 2007 as compared to $213.4 million at
December 31, 2006. Since December 31, 2006 we have held additional funds in our short-term portfolio
both as a means of managing the duration of our overall investment portfolio, and as a means of
increasing our flexibility in a volatile investment market.
During 2007 we sold the securities held in our fixed maturities trading portfolio (primarily treasury
indexed) because we believed active trading of these securities no longer offered superior returns.
Other investments increased from $39.5 million at December 31, 2006 to $54.9 million at
December 31, 2007. In January 2007 we contributed high-yield asset-backed bonds from our available-
for-sale investment portfolio to a fund created for the purpose of managing such investments. We
maintain a direct beneficial interest in securities originally contributed to the fund, which are included in
our Balance Sheet as a component of other investments at fair value ($16.2 million at December 31,
2007). Cash flows from our initial investment in the fund, which approximate $10.3 million at December
31, 2007, are being re-invested in an undivided interest of the fund. The undivided interest is considered
as an investment in an unconsolidated subsidiary and is accounted for using the equity method.
As of December 31, 2007 our available-for-sale fixed maturity securities of $3.24 billion comprise
89% of our total investments. The approximate $108 million net increase as compared to our December
31, 2006 holdings reflects the investment of operating cash flows, as well as an increase in fair value
attributable to lower interest rates (as discussed below).
Substantially all of our fixed maturities are either United States government agency obligations or
investment grade securities as determined by national rating agencies. Our available-for-sale fixed
maturities have a dollar weighted average rating of "AA+" at December 31, 2007. The weighted average
effective duration of our fixed maturity securities at December 31, 2007 is 4.13 years; the weighted
average effective duration of our fixed maturity securities and our short-term securities combined is 3.88
years.
Changes in market interest rate levels generally affect our net income to the extent that
reinvestment yields are different than the yields on maturing securities. Changes in market interest rates
also affect the fair value of our fixed maturity securities. On a pre-tax basis, net unrealized gains on our
available-for-sale fixed maturity securities are comprised as follows:
Gross unrealized gains
Gross unrealized (losses)
Net unrealized gains (losses)
In millions
Year Ended December 31
2007
$ 37.2
(18.8)
$ 18.4
2006
$ 22.7
(25.2)
$ (2.5)
Approximately 85% of the unrealized loss positions in our portfolio are interest-rate related. We
have the intent and, due to the duration of our overall portfolio and positive operating cash flows, believe
we have the ability, to hold these bonds to recovery of book value or maturity and do not consider the
declines in value to be other-than-temporary. For a discussion of the potential effects that future changes
in interest rates may have on our investment portfolio see Item 7A, "Quantitative and Qualitative
Disclosures about Market Risk."
As of December 31, 2007, our fixed maturity securities include securities with a fair value of
approximately $21.4 million (including unrealized losses of $1.1 million) that are supported by collateral
we classify as sub-prime, of which approximately 68% are AAA rated, 26% are AA+, and 6% are A.
Additionally, we have approximately $4.0 million (including unrealized losses of $3.3 million) of securities
exposure to below investment grade fixed income securities with sub-prime exposure within a high-yield
investment fund; the average rating of the securities is BB+. In 2007, we evaluated our exposure to the
sub-prime market and determined that $6.5 million of writedowns were warranted for other than
temporary impairments. We have no exposure to sub-prime through collateralized debt obligations.
Equity investments represent less than 1% of our total investments and less than 2% of our
stockholders' equity at both December 31, 2007 and 2006. At December 31, 2007, the carrying value of
our equity investments (including equities in our available-for-sale and trading portfolios) totaled $21.8
million as compared to $14.9 million at December 31, 2006.
39
Losses
The following table, known as the Reserve Development Table, presents information over the
preceding ten years regarding the payment of our losses as well as changes to (the development of) our
estimates of losses during that time period. Years prior to 2001 relate only to the reserves of Medical
Assurance. In years 2001 and thereafter the table reflects the reserves of ProAssurance, formed in 2001
in order to merge Medical Assurance and Professionals Group. NCRIC reserves are included only in the
year 2005 and thereafter. PIC Wisconsin reserves are included in the year 2006 and thereafter. The table
does not include the reserves of personal lines operations, which are reflected in our financial statements
as discontinued operations.
The table includes losses on both a direct and an assumed basis and is net of reinsurance
recoverables. The gross liability for losses 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 reserve for losses to present value. Information presented in the 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 reserve for losses; 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 is not appropriate to extrapolate future
redundancies or deficiencies based on this table.
The following may be helpful in understanding the Reserve Development Table:
– The line entitled “Reserve for losses, undiscounted and net of reinsurance
recoverables” reflects our reserve for losses and loss adjustment expense, less the
receivables
financial
from reinsurers, each as showing
statements at the end of each year (the Balance Sheet Reserves).
in our consolidated
– 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.
40
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In each year reflected in the table, we have estimated our reserve for losses utilizing the actuarial
methodologies discussed in critical accounting estimates. These techniques are applied to the data in a
consistent manner and the resulting projections are evaluated by management to establish the estimate
of reserve.
Factors that have contributed to the variation in loss development are primarily related to the
extended period of time required to resolve medical malpractice claims and include the following:
– Reserves in the earlier years of the table include prior accident year amounts dating
back to the mid- and late-1980's. When these reserves were originally established,
our estimates were strongly influenced by dramatic increases to frequency and
severity trends that we, and the industry as a whole, experienced in the mid-1980s.
Some of these trends moderated, and in some cases, reversed, in the late 1980s or
early 1990s, but the extended time required for claims resolution delayed our
recognition of the improved environment
– Prior to the mid to late 1990's our business was largely based in Alabama. When we
began to expand geographically, we utilized industry based data as well as our own
data to support our actuarial projection process. Our own claims experience proved
to be better than the projected experience, but again, this was not known for some
time after the reserves were established. Ultimately, as actual results proved better
than that suggested by historical trends and industry claims data, redundancies
developed and were recognized.
– The medical professional liability legal environment deteriorated once again in the
late 1990’s. 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 reserves slowed in 2000 and reversed in 2001 and 2002.
We have addressed these trends through increased rates, stricter underwriting and
modifications to claims handling procedures.
– During 2005, 2006 and 2007 we have recognized favorable development related to
our previously established reserves for accident years 2001 through 2005 because
we have reduced our estimates of claims severity related to those years. Based on
recent internal and industry claims data, we believe claims severity (i.e., the average
size of a claim) is increasing at a rate slower than we estimated when our reserves
for those years were established.
42
Activity in our net reserve for losses during 2007, 2006 and 2005 is summarized below:
Balance, beginning of year
Less receivable from reinsurers
Net balance, beginning of year
Reserves acquired from acquisitions, net of
receivable from reinsurers of $57.2 million
in 2006 and $43.5 million in 2005
Incurred related to:
Current year
Prior years
Total incurred
Paid related to:
Current year
Prior years
Total paid
Net balance, end of year
Plus receivable from reinsurers
Balance, end of year
In thousands
Year Ended December 31
2006
$ 2,224,436
327,693
1,896,743
2005
$ 1,818,636
273,654
1,544,982
2007
$ 2,607,148
370,763
2,236,385
–
171,246
139,672
455,982
(104,985)
350,997
479,621
(36,292)
443,329
461,182
(22,981)
438,201
(23,492)
(331,294)
(354,786)
2,232,596
327,111
$ 2,559,707
(32,325)
(242,608)
(274,933)
2,236,385
370,763
$ 2,607,148
(26,495)
(199,617)
(226,112)
1,896,743
327,693
$ 2,224,436
At December 31, 2007 our gross reserve for losses included case reserves of approximately
$1.180 billion and IBNR reserves of approximately $1.380 billion. Our consolidated reserve for losses on
a GAAP basis exceeds the combined reserves of our insurance subsidiaries on a statutory basis by
approximately $39.7 million, which is principally due to the portion of the GAAP reserve for losses that is
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.
Reinsurance
We use reinsurance to provide capacity to write larger limits of liability, to provide protection
against losses in excess of policy limits, and to stabilize underwriting results in years in which higher
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.
We generally reinsure professional liability risks under annual treaties pursuant to which the
reinsurer agrees to assume all or a portion of all risks that we insure above our individual risk retention of
$1 million per claim, up to the maximum individual limit offered (currently $16 million). 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. Periodically, we provide insurance to
policyholders above the maximum limits of our primary 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 our risk appetite and the
capital we have to support it, the price and availability of reinsurance, volume of business, level of
experience and our analysis of the potential underwriting results within each state. Our 2007-2008
reinsurance treaties renewed on October 1, 2007 without significant change in cost or structure. We
purchase reinsurance from a number of companies to mitigate concentrations of credit risk. Our
reinsurance broker assists us in the analysis of the credit quality of our reinsurers. We base our
reinsurance buying decisions on an evaluation of the then-current financial strength, rating and stability of
prospective reinsurers. However, the financial strength of our reinsurers, and their corresponding ability to
pay us, may change in the future due to forces or events we cannot control or anticipate.
We have not experienced any significant difficulties in collecting amounts due from reinsurers due
to the financial condition of the reinsurer. Should future events lead us to believe that any reinsurer is
43
unable to meet its obligations to us, adjustments to the amounts recoverable would be reflected in the
results of current operations.
At December 31, 2007 our reinsurance recoverable on unpaid losses is $327 million and our
receivable from reinsurers on paid losses, which is classified as a part of Other Assets, is $39.6 million.
The following table identifies our reinsurers from which our recoverables (net of amounts due to the
reinsurer) are $10 million or more as of December 31, 2007:
Reinsurer
Hannover Ruckversicherung AG
General Reinsurance Corp
Transatlantic Reins Co
AXA Re
Lloyd's Syndicate 2791
PMA Capital Insurance Company
A.M. Best
Company Rating
A
A++
A+
A-
A
B
In thousands
Net Amounts Due
From Reinsurer
$ 35,139
$ 33,997
$ 19,283
$ 17,308
$ 15,205
$ 12,666
Off Balance Sheet Arrangements/Guarantees
As discussed in Note 10 to the Consolidated Financial Statements, our 2034 Debentures are held
by, and are the sole assets of, related business trusts. The PRA Trusts purchased the 2034 Debentures
with proceeds from related trust preferred stock (TPS) issued and sold by each trust. The terms and
maturities of the 2034 Subordinated Debentures mirror those of the related TPS. The PRA Trusts will use
the debenture interest and principal payments we pay into each trust to meet their TPS obligations. In
accordance with the guidance given in Financial Accounting Standards Board Interpretation No. 46R,
“Variable Interest Entities,” (FIN 46R) the PRA Trusts are not included in our consolidated financial
statements because we are not the primary beneficiary of either trust.
ProAssurance has issued guarantees that amounts paid to the PRA Trusts related to the 2034
Subordinated Debentures will subsequently be remitted to the holders of the related TPS.
Debt
Our long-term debt at December 31, 2007 is comprised of the following.
Convertible Debentures
2034 Subordinated Debentures
2034 Surplus Notes
In thousands, except %
Rate
3.9%, fixed
8.7%, Libor adjusted
7.7%, fixed until May 2009
2007
$ 105,973
46,395
11,790
$ 164,158
First
Redemption Date
July 2008
May 2009
May 2009*
*Subject to approval by the Wisconsin Commissioner of Insurance
Our Convertible Debentures may be converted at the option of holders when the price of our
common stock exceeds a specified price (currently $50.19) during 20 of the last 30 days of any quarter.
Upon conversion, holders will receive 23.9037 shares of common stock for each $1,000 principal amount
of debentures surrendered for conversion. The criterion allowing conversion was met during the quarter
ended December 31, 2007 and holders may convert through March 31, 2008. To-date, no holders have
requested conversion. If converted, we have the right to deliver cash or a combination of cash and
common stock, in lieu of common stock.
After July 7, 2008 we may redeem our convertible debt at face value, for cash, with at least 30
days but not more than 60 days notice. Debentures called for redemption are convertible by the holder
into common stock; we can elect to pay holders in cash or a combination of cash and common stock. We
have not yet made any decision regarding such a redemption. Also, on June 30, 2008 holders may
require us to repurchase all or a portion of the Convertible Debentures at face value, plus interest. We
may elect to pay all or a portion of the repurchase price in common stock. If the Convertible Debt is
repaid, the related unamortized loan discounts and loan costs, which total $2.0 million at December 31,
2007, will be charged to expense in the period of repayment.
44
We utilized cash of $15.5 million to redeem our 2032 Subordinated Debentures at face value in
December, 2007.
A more detailed description of our debt is provided in Note 10 to the Consolidated Financial
Statements.
Contractual Obligations
A schedule of our non-cancelable contractual obligations at December 31, 2007 follows:
Payments due by period
In thousands
Loss and loss adjustment expenses
Interest on long-term debt
Long-term debt obligations
Operating lease obligations
Total
Total
$ 2,559,707
203,645
165,995
5,046
$ 2,934,393
Less than
1 year
$ 540,733
9,223
–
2,243
$ 552,199
1-3 years
$ 896,888
18,718
–
2,635
$ 918,241
3-5 years
$ 597,484
18,757
–
168
$ 616,409
More than
5 years
$ 524,602
156,947
165,995
–
$ 847,544
For the purposes of this table, all long-term debt is assumed to be settled at its contractual
maturity and interest on long-term debt is calculated using interest rates in effect at December 31, 2007
for variable rate debt. The anticipated payout of loss and loss adjustment expenses is based upon our
historical payout patterns. Both the timing and amount of these payments may vary from the payments
indicated. Our operating lease obligations are primarily for the rental of office space, office equipment,
communications lines and equipment.
Each of our debt instruments allows for repayment before maturity, at our option, on or after
certain dates. Additionally, holders of our convertible debt can request early redemption under specified
circumstances. For more information on our debt see Note 10 to the Consolidated Financial Statements.
Litigation
We are involved in various legal actions arising primarily from claims against us related to
insurance policies and claims handling, including, but not limited to, claims asserted by our policyholders.
Legal actions are generally divided into two categories: Legal actions dealing with claims and claim-
related actions which we consider in our evaluation of our reserve for losses and legal actions falling
outside of these areas which we evaluate and reserve for separately as a part of our Other Liabilities.
Claim-related actions are considered as a part of our reserving process under the guidance
provided by SFAS 60 Accounting and Reporting by Insurance Enterprises. We evaluate the likely
outcomes from these actions giving consideration to the facts and laws applicable to each case, appellate
issues, coverage issues, potential recoveries from our insurance and reinsurance programs, and
settlement discussions as well as our historical claims resolution practices. This data is then given
consideration in the overall evaluation of our reserve for losses.
For non-claim-related actions we evaluate each case separately and establish what we believe is
an appropriate reserve under the guidance provided by SFAS 5 Accounting for Contingencies. As a result
of the acquisition of NCRIC, ProAssurance assumed the risk of loss for a judgment entered against
NCRIC on February 20, 2004 by a District of Columbia Superior Court in favor of Columbia Hospital for
Women Medical Center, Inc. (CHW) in the amount of $18.2 million (the CHW judgment). The CHW
judgment is now on appeal to the District of Columbia Court of Appeals. ProAssurance has established a
liability for this judgment of $21.7 million, which includes the estimated costs associated with pursuing the
post-trial motions or appeal of a final judgment and projected post-trial interest, $19.5 million of which was
established as a component of the fair value of assets acquired and liabilities assumed in the allocation of
the NCRIC purchase price.
There are risks, as outlined in our Risk Factors, that individual actions could cost us more than
our estimates. In particular, we or our insureds may receive adverse verdicts; post-trial motions may be
denied, in whole or in part; any appeals that may be undertaken may be unsuccessful; we may be
unsuccessful in our legal efforts to limit the scope of coverage available to insureds; and we may become
a party to bad faith litigation over the settlement of a claim. To the extent that the cost of resolving these
45
actions exceeds our estimates, the legal actions could have a material effect on ProAssurance's results of
operations in the period in which any such action is resolved.
Effect of Acquisitions (2007–2006)
We acquired PIC Wisconsin effective August 1, 2006. Operating results for the year ended
December 31, 2007 include PIC Wisconsin results for the entire period. Our results for the year ended
December 31, 2006 include PIC Wisconsin results only for the five-month period subsequent to the date
of acquisition.
In certain of the tables and discussions that follow, we have segregated and identified as "PIC
Wisconsin" the results that are directly attributable to PIC Wisconsin, and have identified all other results
as "PRA" or "PRA pre-acquisition business".
Overview of Results–Years Ended December 31, 2007 and 2006
Income from continuing operations increased to $168.2 million for the year ended December 31,
2007 from $127.0 million for 2006, an increase of 32%. Income from continuing operations per diluted
share increased to $4.78 from $3.72 for the same comparative period.
Our 2007 results benefited from an increased amount of favorable loss development. We
recognized favorable loss development in 2007 of $105 million as compared to $36 million in 2006. Also,
net investment income increased by almost $24 million in 2007 due to growth in our invested assets and
a modest improvement in yields. These benefits were partially offset by a decline in net premiums earned
of $50 million, an increase in our current year loss ratio of approximately 3 percentage points and an
increase in our expense ratio of almost 2 percentage points.
46
Results of Operations–Year Ended December 31, 2007 Compared to Year Ended December 31,
2006
Selected consolidated financial data for each period is summarized in the table below.
$ in thousands
Year Ended December 31
2006
2007
Change
Revenues:
Gross premiums written
Net premiums written
Premiums earned
Premiums ceded
Net premiums earned
Net investment income
Equity in earnings of unconsolidated subsidiaries
Net realized investment gains (losses)
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
$549,074
$ 578,983
$(29,909)
$506,397
$ 543,376
$(36,979)
$585,310
(51,797)
533,513
171,308
1,630
(5,939)
5,556
$ 627,166
(44,099)
583,067
147,450
2,339
(1,199)
5,941
$ (41,856)
(7,698)
(49,554)
23,858
(709)
(4,740)
(385)
706,068
737,598
(31,530)
438,527
(87,530)
350,997
106,751
11,981
475,997
(32,668)
443,329
106,369
11,073
(37,470)
(54,862)
(92,332)
382
908
469,729
560,771
(91,042)
Income from continuing operations before income taxes
236,339
176,827
59,512
Income taxes
68,153
49,843
18,310
Income from continuing operations
168,186
126,984
41,202
Income from discontinued operations, net of tax
–
109,441
(109,441)
Net income
$168,186
$ 236,425
$ (68,239)
Diluted earnings per share:
Income from continuing operations
Income from discontinued operations
Net income
Continuing Operations:
Net loss ratio
Underwriting expense ratio
Combined ratio
Operating ratio
$
$
4.78
–
4.78
$
$
3.72
3.13
6.85
$
$
1.06
(3.13)
(2.07)
65.8%
20.0%
85.8%
53.7%
76.0%
18.2%
94.2%
68.9%
(10.2)
1.8
(8.4)
(15.2)
Return on equity
14.2%
13.5%
0.7
47
Premiums
Gross premiums written
2007
$ 549,074
2006
$ 578,983
Change
$ (29,909)
(5%)
$ in thousands
Year Ended December 31
Premiums earned
Premiums ceded
Net premiums earned
$ 585,310
(51,797)
$ 533,513
$ 627,166
(44,099)
$ 583,067
$ (41,856)
(7%)
(7,698) 17%
(8%)
$ (49,554)
Gross Written Premiums
Premiums written declined during 2007 as compared to 2006 due to the effects of increased
competition and rate reductions. Additional premiums from the acquisition of PIC Wisconsin partially
offset the reduction in premium in our existing book of business. (The operations of PIC Wisconsin are
included for twelve months in 2007 versus five months in 2006.) In periods of market softening, our
strategy is to maintain our underwriting and pricing discipline and grow primarily through selective
acquisitions.
We face strong price-based competition in virtually all of our markets, with some competitors
offering coverage at rates that we do not believe to be profitable on a long-term basis. Additionally, a
number of physicians and hospitals are seeking to lower their costs through the use of alternative risk
transfer approaches such as self insurance and risk sharing pools, although these alternatives become
less attractive as prices soften in the traditional insurance markets.
Our ongoing commitment to adequate rates and strong underwriting standards affects our
willingness to write new business and to renew existing business in the face of this price-based
competition. Improvements in loss cost trends have allowed us to reduce rates in certain markets during
2007 and to offer targeted new business and renewal retention programs in selected markets. While this
improves retention of business, it decreases our average premium rates. The combined effects of lower
rates and the challenges of writing new business are expected to cause our gross written premiums to
continue to decline in 2008.
Physician premiums represent 84% and 85% of gross written premiums for the years ended
December 31, 2007 and 2006, respectively. As compared to 2006, physician premiums decreased by 6%
during 2007.
$ in thousands
Year Ended December 31
2007
2006
Change
$403,384
56,225
$459,609
$473,038
17,538
$490,576
$ (69,654)
38,687
$ (30,967)
(15%)
n/a
(6%)
Physician Premiums*
PRA pre-acquisition business
PIC Wisconsin acquisition
*Exclusive of tail premiums
Our overall retention rate (exclusive of PIC Wisconsin and excess and surplus lines business)
based on the number of physician risks that renew with us is approximately 86% for the year ended
December 31, 2007, as compared to 84% for the year ended December 31, 2006. Our charged rates for
physicians that renewed during 2007 reflect a decrease of approximately 2.3%. Charged rates include the
effects of filed rates, surcharges and discounts.
48
Premiums written for non-physician coverages represent 11% and 10% of our total gross written
premiums for the years ended December 31, 2007 and 2006, respectively, and include premiums
attributable to the PIC Wisconsin acquisition as follows:
Non-physician Premiums*
Hospital and facility coverages:
PRA pre-acquisition business
PIC Wisconsin acquisition
Other non-physician coverages:
PRA pre-acquisition business
PIC Wisconsin acquisition
*Exclusive of tail premiums
$ in thousands
Year Ended December 31
2007
2006
Change
$ 23,674
10,563
34,237
$ 29,426
4,068
33,494
$ (5,752)
6,495
743
25,825
2,966
28,791
$ 63,028
24,775
1,445
26,220
$ 59,714
1,050
1,521
2,571
$ 3,314
(20%)
n/a
2%
4%
n/a
10%
6%
Hospital and facility coverages are the most significant component of non-physician premiums
and represent approximately 6% of our total gross premiums written during both 2007 and 2006. Other
non-physician coverages consist primarily of professional liability coverages provided to lawyers and to
health care professionals such as dentists and nurses.
We are required to offer extended reporting endorsement or "tail" policies to insureds that are
discontinuing their claims-made coverage with us, but we do not market such coverages separately. The
amount of tail premium written and earned can vary widely from period to period. Because of this
volatility, we separate premiums associated with tail coverages from our other premiums. In 2007, tail
premiums totaled $26.4 million (5% of gross written premiums), a decrease of $2.3 million as compared to
2006.
Premiums Earned
Premiums Earned
PRA pre-acquisition business
PIC Wisconsin acquisition
$ in thousands
Year Ended December 31
2007
2006
Change
$ 506,529
78,781
$ 585,310
$ 592,975 $ (86,446)
34,191 44,590
$ 627,166 $ (41,856)
(15%)
n/a
(7%)
Because premiums are generally earned pro rata over the entire policy period, fluctuations in
premiums earned tend to lag those of premiums written. Our policies generally carry a term of one year.
Tail premiums are 100% earned in the period written because the policies insure only incidents that
occurred in prior periods and are not cancellable.
Exclusive of the effect of tail premiums, the decline in premiums earned in 2007 reflects on a pro
rata basis declines in gross premiums written during 2006 and 2007, as well as reduced earned premium
benefit related to acquisitions.
In the twelve months that follow the acquisition of an insurance subsidiary, our premiums earned
include premiums related to the subsidiary's unexpired policies on the date of acquisition (unearned
premium). Such premiums are earned over the remaining term of the associated policy. In 2007, earned
premium includes approximately $10.1 million related to the unexpired policies acquired in the PIC
Wisconsin transaction. In 2006, earned premium includes approximately $38.3 million related to
unexpired policies acquired in the PIC Wisconsin and NCRIC transactions.
As discussed under Gross Premiums Written, our written premiums declined in 2007;
consequently, premiums earned are likely to decrease during 2008.
49
Premiums Ceded
Premiums ceded represent the portion of earned premiums that we pay our reinsurers for their
assumption of a portion of our losses. The premium that we cede to our reinsurers is determined, in part,
by the loss experience (subject to minimums and maximums) of the business ceded to them. It takes a
number of years before all losses are known, and in the intervening period premiums due to the reinsurer
are estimated. Ceded premium estimates are revised as loss estimates are revised.
During 2007, we reduced premiums ceded by approximately $3.3 million due to the commutation
of certain reinsurance arrangements. During 2006 we reduced premiums ceded by approximately $2.7
million due to the commutation of certain reinsurance arrangements.
We increased ceded premiums by $2.7 million in 2007 and reduced ceded premiums by $10.5
million in 2006 to reflect changes to our estimates of the amount of reinsurance premiums due for prior
accident years. The amount of reinsurance premiums incurred for prior accident years can vary
significantly because certain prior year reinsurance agreements adjust premiums based on loss
experience; others do not. Also we have reached premium maximums for certain agreements, but not for
others.
The following table shows the effect of the above amounts on our premiums ceded for 2007 and
2006.
Premiums ceded, before commutations
and estimate changes
Effect of commutations
Estimate changes, prior accident years
Premiums ceded, as reported
in millions
Year Ended December 31
2007
2006
$ 52.4
(3.3)
2.7
$ 51.8
$ 57.3
(2.7)
(10.5)
$ 44.1
Exclusive of the amounts in the preceding paragraphs, our reinsurance expense ratio (ceded
premiums as a percentage of premiums earned) is 9.0% for the year ended December 31, 2007, as
compared to 9.1% for the same period in 2006.
50
Net Investment Income, Net Realized Investment Gains (Losses); Equity (Loss) in Earnings of
Unconsolidated Subsidiaries
Net Investment Income
Net investment income
$ in thousands
Year Ended December 31
2007
$ 171,308
2006
$147,450
Change
$ 23,858 16%
Net investment income is primarily derived from the interest income earned by our fixed maturity
securities and also includes interest income from short-term, trading portfolio and cash equivalent
investments, dividend income from equity securities, earnings from other investments and increases in
the cash surrender value of business owned executive life insurance contracts. Investment fees and
expenses are deducted from investment income.
Net investment income by investment category is as follows:
Fixed maturities
Equities
Short-term investments
Other invested assets
Business owned life insurance
Investment expenses
Net investment income
In thousands
Year Ended December 31
2007
$ 149,494
377
14,713
9,228
1,889
(4,393)
$ 171,308
2006
$ 130,335
414
15,567
2,970
2,285
(4,121)
$ 147,450
The 2007 increase in net investment income from fixed maturities reflects both higher average
invested funds and improved yields. The positive cash flows from our insurance operations and the PIC
Wisconsin merger significantly increased average invested funds during 2007 as compared to 2006.
Market interest rates of the past several years have allowed us to consistently invest new and matured
funds at rates that exceed the average held in our portfolio. Average yields for our available-for-sale fixed
maturity securities during 2007 and 2006 are as follows:
Average income yield
Average tax equivalent income yield
Year Ended December 31
2007
4.7%
5.4%
2006
4.5%
5.1%
The small decline in investment income from short term investments reflects lower average
balances in 2007. Income from other invested assets is principally derived from non-public investment
partnerships/limited liability companies accounted for on a cost basis. Because we recognize income
related to these investments as it is distributed to us, our income from these holdings varies from period
to period. Business owned life insurance is lower in 2007 due to a one time reduction in the growth of
cash surrender values due to a restructuring of this portfolio.
51
Net Realized Investment Gains (Losses)
The components of net realized investment gains (losses) are shown in the following table.
Net gains (losses) from sales
Other-than-temporary impairment losses
Trading portfolio gains (losses)
Net realized investment gains (losses)
In thousands
Year Ended December 31
2007
$ 1,801
(7,753)
13
$ (5,939)
2006
$ 1,717
(3,037)
121
$ (1,199)
During 2007 we recognized other-than-temporary impairment losses of $6.5 million related to
asset backed bonds (particularly those with sub-prime loan exposures). We also recognized impairments
of approximately $1.1 million related to a passive investment that we hold in a non-public investment pool
and impairments of $185,000 related to corporate bonds that have suffered a significant decline in value.
Equity in Earnings (Loss) of Unconsolidated Subsidiaries
Equity in earnings (loss) of unconsolidated subsidiaries is derived from our ownership interests in
non-public investment entities accounted for on the equity basis. During 2007 two such investment
entities reported losses for the year. Our income from these holdings varies from period to period.
$ in thousands
Year Ended December 31
Change
2006
2007
$ 1,630 $ 2,339
$ (709)
(30%)
Equity in earnings (loss) of unconsolidated subsidiaries
52
Losses and Loss Adjustment Expenses
The determination of calendar year losses involves the actuarial evaluation of incurred losses for
the current accident year and the actuarial re-evaluation of incurred losses for prior accident years,
including an evaluation of the reserve amounts required for losses in excess of policy limits.
Accident year refers to the accounting period in which the insured event becomes a liability of the
insurer. For occurrence policies the insured event becomes a liability when the event takes place; for
claims-made policies the insured event generally 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 the estimate of the losses incurred related to those policy premiums.
The following table summarizes calendar year net losses and net loss ratios for the years ended
December 31, 2007 and 2006 by separating losses between the current accident year and all prior
accident years.
In millions
Net Losses
Year Ended December 31
2006
$ 479.6
(36.3)
$ 443.3
Change
$ (23.6)
(68.7)
$ (92.3)
2007
$ 456.0
(105.0)
$ 351.0
Current accident year
Prior accident years
Calendar year
Net Loss Ratios*
Year Ended December 31
2006
82.3%
(6.3%)
76.0%
Change
3.2
(13.4)
(10.2)
2007
85.5%
(19.7%)
65.8%
*Net losses as specified divided by net premiums earned.
Our current accident year loss ratio has increased in 2007 as compared to 2006 for several
reasons. We have booked higher initial loss ratios in the states in which PIC Wisconsin operates as we
wait for the impact of our post acquisition rate filings in those states to take effect. The 2007 ratio is also
impacted by an increase in our estimates for losses in excess of policy limits as compared to the prior
year and an increase in the reserve for the death, disability and retirement provision (DDR) in our claims-
made policies.
PIC Wisconsin accounted for approximately $65.6 million and $34.3 million of our calendar year
net losses for the years ended December 31, 2007 and 2006, respectively. PIC Wisconsin is included in
our results for all 12 months of our 2007 fiscal year as compared to only 5 months during 2006.
Based upon recent claims data, both internal and industry figures, we have reduced our
expectation of claims severity. As a result during calendar year 2007 we recognized net favorable
development of $105 million generally related to our previously established (prior accident year) reserves.
In particular we have observed claims severity, within the first $1 million of coverage, for the 2003 through
2005 accident years below our initial expectations. Given both the long tailed nature of our business and
the past volatility of claims, we are generally cautious in recognizing the impact of the underlying trends
that lead to the recognition of favorable development. As we conclude that sufficient data with respect to
these trends exists to credibly impact our actuarial analysis we take appropriate actions. In the case of
the claims severity trends for 2003-2005, we believe it is appropriate to recognize the impact of these
trends in our actuarial evaluation of prior period loss estimates while also remaining cautious about the
past volatility of claims severity.
In our exposures greater than $1 million, which are generally reinsured with third parties, we
observed a trend that was somewhat counter to the trend discussed above. In particular, given the
number of large verdicts experienced by the industry we increased our reserves for these exposures
resulting in a $44 million increase to gross losses. The effect of this increase was largely offset by a
corresponding increase to the anticipated recoverables from our reinsurers. Our analysis of 2007 data
indicates increased claims severity and frequency trends related to losses in both categories. We believe
the recognition of these trends represents a cautious approach to what we are observing.
53
During the year ended December 31, 2006 we recognized net favorable development of $36.3
million related to our previously established (prior accident year) reserves, primarily to reflect reductions in
our estimates of claim severity, within our retained layer of risk, for the 2002, 2003 and 2004 accident
years. In 2006, we also recognized $12.4 million decrease to gross losses which was offset by a
corresponding decrease to the recoverable from our reinsurer.
Assumptions used in establishing our reserve are regularly reviewed and updated by
management as new data becomes available. Any adjustments necessary are reflected in then current
operations. Due to the size of our reserve, even a small percentage adjustment to the assumptions can
have a material effect on our results of operations for the period in which the change is made.
Underwriting, Acquisition and Insurance Expenses
$ in thousands
Underwriting, Acquisition and Insurance Expenses
Year Ended December 31
2006
$106,369
2007
$ 106,751
Change
n/a
382
$
Underwriting Expense Ratio
Year Ended December 31
2007
20.0%
2006
18.2%
Change
1.8
Underwriting, operating and acquisition expenses remained fairly flat in 2007 as compared to
2006. The most significant changes between the two periods are an increase in stock based
compensation costs ($3.6 million), a decrease in expenses related to guaranty fund assessments ($2.1
million), and lower acquisition expenses due to the decrease in premiums earned ($2.0 million).
The increase in underwriting expense ratio is primarily due to the effect of lower premium volume
in 2007. The PIC Wisconsin acquisition has little effect on the underwriting expense ratio.
Underwriting, acquisition and insurance expenses include stock based compensation expense of
approximately $8.3 million in 2007 and $4.7 million in 2006. In 2007, we awarded 100,000 vested options
to our new CEO. The options were fully expensed in 2007, which increased underwriting expenses by
$1.8 million and increased the 2007 underwriting expense ratio by 0.3 points. Also, $1.2 million of stock
based compensation expense for 2007 relates to awards given to employees who are eligible for
retirement as compared to $980,000 in 2006. Awards issued to retirement eligible employees are
expensed when granted rather than over the vesting period of the award.
Net guaranty fund assessments totaled approximately $550,000 and $2.6 million for the years
ended December 31, 2007 and 2006, respectively. The 2007 decrease reflects lower assessments during
the year as well as a benefit of approximately $675,000 for amounts recouped from our insureds related
to assessments from the Florida Insurance Guaranty Association, Inc. Guaranty Fund. Expenses for the
years ended December 31, 2007 and 2006 included Florida assessments of $1.0 million and $2.3 million,
respectively.
54
Interest Expense
Approximately $670,000 of the 2007 increase in interest expense is related to long term debt
($11.6 million) assumed in the PIC Wisconsin merger. Interest expense also increased because our
Subordinated Debentures carry variable rates based on LIBOR and the average LIBOR reset rate for our
debt increased an average of approximately half a percentage point in 2007 as compared to 2006.
Interest expense by debt obligation is provided in the following table:
Convertible Debentures
2032 Subordinated Debentures
2034 Subordinated Debentures
Surplus Notes
Other
In thousands
Year Ended December 31
2007
$ 4,565
1,639
4,625
1,138
14
$ 11,981
2006
$ 4,565
1,535
4,483
471
19
$ 11,073
Change
$
–
104
142
667
(5)
$ 908
Taxes
Our effective tax rate for each period is significantly lower than the 35% statutory rate because a
considerable portion of our net investment income is tax-exempt. In 2007 our taxable income grew at a
faster rate than did our tax-exempt income which increased our overall effective tax rate. The effect of
tax-exempt income on our effective tax rate is shown in the table below:
Statutory rate
Tax-exempt income
Other
Effective tax rate
Year Ended December 31
2007
35%
(7%)
1%
29%
2006
35%
(8%)
1%
28%
55
Effect of Acquisitions (2006–2005)
We acquired PIC Wisconsin effective August 1, 2006 and our results for the year ended
December 31, 2006 include PIC Wisconsin results for the five-month period subsequent to the date of
acquisition. Our operating results for 2005 do not include PIC Wisconsin results. Due to the short period
since completion of the acquisition, the effect of the PIC Wisconsin acquisition on our 2006 results can be
readily segregated and is separately presented in a number of the tables that follow.
We acquired NCRIC effective August 3, 2005 and our results for the year ended December 31,
2006 include NCRIC results for the entire period. Our results for the year ended December 31, 2005
include NCRIC results only for the five-month period subsequent to the date of acquisition. During 2006,
as a means of effectively utilizing capital, a number of policies previously written by NCRIC have been
renewed through our other insurance subsidiaries and NCRIC's administrative and operating functions
have, in many instances, been combined with those of our other insurance operations. Consequently, the
effect of the NCRIC acquisition cannot be readily segregated in 2006.
56
Results of Operations – Year Ended December 31, 2006 Compared to Year Ended December 31,
2005
Selected consolidated financial data for each period is summarized in the table below.
Revenues:
Gross premiums written
Net premiums written
Premiums earned
Premiums ceded
Net premiums earned
Net investment income
Equity in earnings of unconsolidated subsidiaries
Net realized investment gains (losses)
Other income
$ in thousands
Year Ended December 31
2006
2005
Change
$ 578,983
$ 572,960
$ 6,023
$ 543,376
$ 521,343
$ 22,033
$ 627,166
(44,099)
583,067
147,450
2,339
(1,199)
5,941
$ 596,557
(53,316)
543,241
98,293
900
912
4,604
$ 30,609
9,217
39,826
49,157
1,439
(2,111)
1,337
Total revenues
737,598
647,950
89,648
Expenses:
Losses and loss adjustment expenses
Reinsurance recoveries
Net losses and loss adjustment expenses
Underwriting, acquisition and insurance expenses
Interest expense
Total expenses
475,997
(32,668)
443,329
106,369
11,073
479,300
(41,099)
438,201
91,957
8,929
(3,303)
8,431
5,128
14,412
2,144
560,771
539,087
21,684
Income from continuing operations before income taxes
176,827
108,863
67,964
Income taxes
Income from continuing operations
Income from discontinued operations, net of tax
49,843
28,837
21,006
126,984
109,441
80,026
46,958
33,431
76,010
Net income
$ 236,425
$ 113,457
$122,968
Diluted earnings per share:
Income from continuing operations
Income from discontinued operations
Net income
$
$
3.72
3.13
6.85
$
$
2.52
1.02
3.54
$
$
1.20
2.11
3.31
Continuing Operations:
Net loss ratio
Underwriting expense ratio
Combined ratio
Operating ratio
Return on equity
76.0%
18.2%
94.2%
68.9%
13.5%
80.7%
16.9%
97.6%
79.5%
11.6%
(4.7)
1.3
(3.4)
(10.6)
1.9
57
Premiums
$ in thousands
Year Ended December 31
Gross premiums written
2006
$ 578,983
2005
$ 572,960
Change
6,023
1%
$
Premiums earned
Premiums ceded
Net premiums earned
$ 627,166
(44,099)
$ 583,067
$ 596,557
(53,316)
$ 543,241
$ 30,609
9,217
$ 39,826
5%
(17%)
7%
Gross Premiums Written
Gross premiums written increased in 2006 due to the acquisition of PIC Wisconsin in August
2006 and NCRIC in August 2005; however, reductions in premium from a more competitive market
significantly mitigated overall premium growth. These results are consistent with our strategy to grow
through selective acquisitions and to maintain our underwriting and pricing discipline in periods of market
softening.
Physician premiums comprised 85% of total premiums in 2006 and 84% of total premiums in
2005.
Physician Premiums*
PRA pre-acquisition business
PIC Wisconsin acquisition
* Exclusive of tail premiums
$ in thousands
Year Ended December 31
2006
2005
Change
$473,038
17,538
$490,576
$483,070
–
$483,070
$ (10,032)
17,538
$ 7,506
(2%)
n/a
2%
The overall increase in physician premiums reflects additional premiums from the PIC Wisconsin
and NCRIC acquisitions offset by a decrease in premiums written in our organic book of business. The
decline in physician premiums in our organic book of business is attributable to several factors. In 2006,
our rate increases were not at a level that would offset the effects of lost business. Loss costs have
moderated somewhat and, as a result, we have implemented smaller rate increases than in prior years
and have held rates constant or lowered rates in some markets.
Our average rate increase on physician renewals (exclusive of PIC Wisconsin) is approximately
3% for 2006 as compared to 11% for 2005. Premiums written for physician coverages have also declined
due to an increasingly competitive landscape. In a number of our markets established providers have
become more aggressive and new providers, including off-shore providers, self-insurance and risk
retention groups, have begun to pursue business. The additional competition, which is frequently focused
on price, has reduced both our retention rate and the amount of new business we have chosen to write.
We are focused on marketing our policies based on our stability, strength and policyholder defense.
However, we remain committed to an adequate rate structure and will continue our policy of foregoing
business that cannot be written at our profit goals. Our overall retention rate (exclusive of PIC Wisconsin)
for the number of standard physician risks that we insure is 84% for the year ended December 31, 2006
as compared to 85% for the year ended December 31, 2005. The competitive pricing in the marketplace
makes it more difficult for us to attract new business.
58
Premiums written for non-physician coverages totaled $59.7 million for the year ended December
31, 2006 as compared to $60.9 million for the year ended December 31, 2005 and include premiums
attributable to the PIC Wisconsin acquisition as follows:
Non-physician Premiums*
Hospital coverages:
PRA pre-acquisition business
PIC Wisconsin acquisition
Other non-physician coverages:
PRA pre-acquisition business
PIC Wisconsin acquisition
* Exclusive of tail premiums
$ in thousands
Year Ended December 31
2006
2005
Change
$ 29,426
4,068
$ 33,494
$ 36,475
–
$ 36,475
$
$
(7,049)
4,068
(2,981)
24,775
1,445
26,220
$ 59,714
24,464
–
24,464
$ 60,939
311
1,445
1,756
(1,225)
$
(19%)
n/a
(8%)
1%
n/a
7%
(2%)
Excluding premiums written by PIC Wisconsin, the decline in hospital and facility coverages of
$7.0 million is largely due to the nonrenewal of two large policies. This segment of business is highly price
sensitive and individual policies for these coverages can carry large amounts of premiums. As in all our
lines, we choose not to compete primarily on price because our focus is on maintaining adequate margins
on the policies we sell. Thus, premiums for these coverages can fluctuate widely from period to period.
Extended reporting endorsement or "tail" policies are offered to insureds that are discontinuing
their claims-made coverage with us. The amount of tail premium written in any annual period varies, but
represented approximately 5% of total premiums in both 2006 and 2005. As competition in the medical
professional liability industry has intensified, it is common for insurers to write prior acts coverage to new
insureds, which has reduced the amount of tail premium that we write. Our preference is to sell less rather
than more of this coverage since it represents a long-term liability with increased pricing risk. Tail
premiums, exclusive of PIC Wisconsin, declined by approximately $1.9 million in 2006 as compared to
2005.
Premiums Earned
Because premiums are generally earned pro rata over the policy period, fluctuations in premiums
earned tend to lag those of premiums written. Our policies generally carry a term of one year. Tail
premiums are 100% earned in the period written because the policies insure only incidents that occurred
in prior periods and are not cancellable.
In the twelve months that follow the acquisition of an insurance subsidiary, our premiums earned
include premiums earned related to the subsidiary's unexpired policies on the date of acquisition
(unearned premium). Such premiums are earned over the remaining term of the associated policy.
Premiums Earned
PRA pre-acquisition business
PIC Wisconsin acquisition
$ in thousands
Year Ended December 31
2006
2005
Change
$592,975
34,191
$627,166
$596,557
–
$596,557
$
(3,582)
34,191
$ 30,609
(1%)
n/a
5%
Premiums earned for the year ended December 31, 2006 as compared to the same period in
2005 reflects the changes in written premiums that have occurred during 2006 and 2005, on a pro rata
basis, as well as the premiums earned related to the unexpired policies acquired in the PIC Wisconsin
and NCRIC transactions. Such additional earned premium approximated $38.3 million for the year ended
December 31, 2006 and approximated $28.4 million for the year ended December 31, 2005.
59
Premiums Ceded
Premiums ceded represent the portion of earned premiums that we pay to our reinsurers for their
assumption of a portion of our losses. The amount of premium that is due to our reinsurers is determined,
in part, by the loss experience of the business ceded to them. We reduced ceded premiums by $10.5
million in 2006 to reflect changes in our estimates of the amount of reinsurance premiums due for certain
prior accident years, based on the provisions of the reinsurance contracts and our estimates of the
reinsured losses for those prior accident years. We also reduced ceded premiums in 2006 by $2.7 million
related to the commutation of all of our outstanding reinsurance arrangements with the Converium group
of companies. After adjustment for these two items, and excluding PIC Wisconsin, 2006 ceded premiums
are 8.4% of 2006 earned premiums as compared to approximately 8.9% in 2005. The difference is largely
due to improved loss experience relative to business we ceded to reinsurers in 2006 which resulted in a
lower amount of ceded premium.
Net Investment Income, Net Realized Investment Gains (Losses); Equity (Loss) in Earnings of
Unconsolidated Subsidiaries
Net Investment Income
$ in thousands
Year Ended December 31
2006
2005
Change
Net investment income:
PRA pre-acquisition business
PIC Wisconsin acquisition
Consolidated
$ 140,746
6,704
$ 147,450
$ 98,293
–
$ 98,293
$ 42,453 43.2%
n/a
$ 49,157 50.0%
6,704
Net investment income is primarily derived from the interest income earned by our fixed maturity
securities and includes interest income from short-term, trading portfolio and cash equivalent
investments, dividend income from equity securities, earnings from other investments and increases in
the cash surrender value of business owned executive life insurance contracts. Investment fees and
expenses are deducted from investment income.
The increase in net investment income for the year 2006 as compared to 2005 is due to several
factors, the most significant being higher average invested funds. The proceeds from the sale of the
MEEMIC companies received in early January, the PIC Wisconsin and NCRIC mergers, and positive
cash flow generated by our insurance operations significantly increased our average invested funds
during 2006.
Rising market interest rates of the past several years have further contributed to the improvement
in net investment income. We have been able to invest new and matured funds at higher rates and this
has steadily increased the average yield of our portfolio. Our average yields for the years ended
December 31, 2006 and 2005 are as follows:
Average income yield
Average tax equivalent income yield
Year Ended December 31
2006
4.5%
5.1%
2005
4.2%
4.8%
60
Net investment income by investment category is as follows:
Fixed maturities
Equities
Short-term investments
Other invested assets
Business owned life insurance
Investment expenses
Net investment income
In thousands
Year Ended December 31
2006
$ 130,335
414
15,567
2,970
2,285
151,571
(4,121)
$ 147,450
2005
$ 90,496
773
3,608
4,145
2,298
101,320
(3,027)
$ 98,293
PIC Wisconsin investment income is almost entirely derived from fixed maturities. Other than the
effect of PIC Wisconsin, the variations in the categories between years largely reflect growth of our
investment portfolio and improved yields as already discussed. Income from short-term investments
increased during 2006 largely because proceeds from the sale of our personal lines segment were
invested in short term investments during most of 2006 which increased average invested balances, but
also increased as a result of higher yields and additional income from PIC Wisconsin.
Net Realized Investment Gains (Losses)
The components of net realized investment gains (losses) are shown in the following table.
In thousands
Year Ended December 31
Net gains (losses) from sales*
Other-than-temporary impairment losses
Trading portfolio gains (losses)
Net realized investment gains (losses)
*Amounts for 2006 include PIC Wisconsin net gains (losses) of $761,000.
2006
$ 1,717
(3,037)
121
$ (1,199)
2005
$ 1,567
(768)
113
$ 912
Other-than-temporary impairment losses recognized during 2006 include $2.6 million related to
our high-yield asset backed bond portfolio. In the latter part of the year market assumptions regarding
default rates on asset backed securities increased leading to an indication of impairment for these
securities.
Equity in Earnings (Loss) of Unconsolidated Subsidiaries
Equity in earnings (loss) of unconsolidated subsidiaries is derived from our ownership interests in
non-pubic investment entities accounted for on the equity basis. One such entity reported higher earnings
during 2006 as compared to 2005. Our income from these holdings varies from period to period.
$ in thousands
Year Ended December 31
Change
2006
2005
$ 2,339 $ 900 $ 1,439
160%
Equity in earnings (loss) of unconsolidated subsidiaries
61
Losses and Loss Adjustment Expenses
The determination of calendar year losses involves the actuarial evaluation of incurred losses for
the current accident year and the actuarial re-evaluation of incurred losses for prior accident years.
Accident year refers to the accounting 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 generally 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. Calendar year results include
the operating results for the current accident year and any changes in estimates related to prior accident
years.
The following tables summarize net losses and net loss ratios for the years ended December 31,
2006 and 2005 by separating losses between the current accident year and all prior accident years.
In millions
Net Losses
Year Ended December 31
2005
Change
2006
Net Loss Ratios*
Year Ended December 31
2005
2006
Change
Current accident year:
PRA pre-acquisition business
PIC Wisconsin acquisition
Consolidated
Prior accident years, all PRA:
Calendar year:
PRA pre-acquisition business
PIC Wisconsin acquisition
Consolidated
$ 445.3
34.3
$ 479.6
$ 461.2
–
$ 461.2
$ (15.9)
34.3
$ 18.4
80.1%
127.5%
82.3%
84.9%
–
84.9%
(4.8)
n/a
(2.6)
$ (36.3)
$ (23.0)
$ (13.3)
(6.6%)
(4.2%)
(2.4)
$ 409.0
34.3
$ 443.3
$ 438.2
–
$ 438.2
$ (29.2)
34.3
$ 5.1
73.5%
127.5%
76.0%
80.7%
–
80.7%
(7.2)
n/a
(4.7)
*Net losses as specified divided by net premiums earned.
We focus on developing and maintaining adequate rates. Exclusive of PIC Wisconsin, as a
percentage of net earned premiums (the net loss ratio) current accident year net losses have declined 4.8
points during 2006. This decline in the PRA current accident year net loss ratio is attributable to the
improved rate adequacy of premiums earned in 2006. The decrease in the dollar amount of PRA current
accident year net losses for 2006 principally reflects decreases in the number of insured risks in 2006 as
compared to 2005.
PIC Wisconsin's current accident year net loss ratio is higher than that of our other subsidiaries
for a number of reasons. PIC Wisconsin losses for prior accident years developed adversely during 2006,
in the amount of $5.8 million. Because PIC Wisconsin was acquired by PRA during 2006, these losses
are considered to be current year losses for PRA. As a result of this loss development, PIC Wisconsin
incurred additional reinsurance expense under the retrospective premium provisions of its reinsurance
contracts. The combination of increased net losses and reduced net premium resulted in an unusually
high loss ratio. Rate increases have been implemented in an attempt to bring PIC Wisconsin's loss ratio
to more acceptable levels.
During calendar year 2006 we recognized favorable development of $36.3 million related to our
previously established (prior accident year) reserves, primarily to reflect reductions in our estimates of
claim severity, within our retained layer of risk, for the 2002, 2003 and 2004 accident years. Over the past
several years we have seen claims severity (i.e., the average size of a claim) increase at a rate slower
than initially expected. Given both the long tailed nature of our business and the past volatility of claims,
we are generally cautious in recognizing the impact of the underlying trends that lead to the recognition of
favorable development. As we conclude that sufficient data with respect to these trends exists to credibly
impact our actuarial analysis we take appropriate actions. In the case of the claims severity trends for
2002-2004, we believe it is appropriate to recognize the favorable impact of trends on prior period loss
estimates while also remaining cautious about the past volatility of claims severity. While we have begun
to see an increase in the number of larger verdicts being rendered this has not had a meaningful impact
on the severity of claims within the first $1 million of risk.
62
During 2006, we have seen an increased number of verdicts in excess of the policy limits that we
offer to our insureds. As a part of our reserving process we evaluate the likely outcomes from these
verdicts giving consideration to appellate issues, coverage issues, potential recoveries from our insurance
and reinsurance programs, and settlement discussions as well as our historical claims resolution
practices. This information is then used in evaluating the overall adequacy of our reserve.
In the risk layers above $1 million, generally the business for which we purchase reinsurance, we
recognized approximately $12.4 million of favorable development of gross losses, offset by a
corresponding decrease in the recoverable from our reinsurers. Our 2006 analysis of the long-term data
does indicate an overall improvement in the severity trends at this level, despite the increased frequency
of verdicts in excess of policy limits, and we believe the amount of favorable development represents a
cautious recognition of this trend within the excess layers.
Assumptions used in establishing our reserve are regularly reviewed and updated by
management as new data becomes available. Any adjustments necessary are reflected in then current
operations. Due to the size of our reserve, even a small percentage adjustment to the assumptions can
have a material effect on our results of operations for the period in which the change is made.
Two measures often used to gauge insurance operations are the paid to incurred ratio and the
paid loss ratio. These ratios are affected by changes in the timing and volume of losses paid, which
generally relate to losses incurred in prior periods, and by changes in the level of incurred losses (paid to
incurred ratio) or the volume of premiums earned (the paid loss ratio) in the current calendar year. Our
paid to incurred loss ratios for the years ended December 31, 2006 and 2005 are 62.0% and 51.6%,
respectively. Our paid loss ratio for the years ended December 31, 2006 and 2005 are 47.2% and 41.6%,
respectively.
Underwriting, Acquisition and Insurance Expenses
The increase in underwriting, acquisition and insurance expenses for 2006 reflects additional
costs related to the addition of NCRIC and PIC Wisconsin operations, higher compensation costs,
principally from the recognition of stock-based compensation costs, and an increase in guaranty fund
assessments.
The increase in the underwriting expense ratio for 2006 is attributable to higher compensation
costs referred to above and additionally the increase in guaranty fund assessments. The additional
NCRIC and PIC Wisconsin expenses had little effect on the expense ratio due to the corresponding
increase in earned premium resulting from the acquisition.
$ in thousands
Underwriting, Acquisition
and Insurance Expenses
Year Ended December 31
PRA pre-acquisition business
PIC Wisconsin acquisition
Consolidated
2006
$ 100,867
5,502
$ 106,369
2005
$ 91,957
–
$ 91,957
Change
$ 8,910
5,502
9.7%
n/a
$ 14,412 15.7%
Underwriting Expense Ratio
Year Ended December 31
2006
18.1%
20.5%
18.2%
2005
16.9%
–
16.9%
Change
1.2
n/a
1.3
On January 1, 2006 we adopted SFAS 123R which requires share-based compensation to be
recognized at its fair value over the period in which employee services are provided. We previously
valued stock option awards based on their intrinsic value which generally did not result in compensation
expense related to those awards. Stock-based compensation expense increased our expenses by
63
approximately $4.7 million (0.8% of net premiums earned) in 2006. Guaranty fund assessments were
approximately $2.6 million (0.4% of net premiums earned) for 2006 as compared to approximately
$226,000 for 2005. In 2006 we received assessments totaling $2.3 million from the Florida Insurance
Guaranty Association, Inc. related to catastrophic weather events during the year 2004. We will endeavor
to recoup this expense with a premium surcharge to our Florida insureds.
Interest Expense
Interest expense increased approximately $1.5 million during 2006 as compared to 2005 due to
debt we assumed in our acquisitions of NCRIC (principal of $15.5 million in August 2005) and PIC
Wisconsin (principal of $12.0 million in August 2006). Interest expense also increased because our
Subordinated Debentures carry variable rates based on LIBOR and the LIBOR reset rate for our
outstanding debt increased an average of approximately 2 percentage points in 2006 as compared to
2005. Interest expense by debt obligation is provided in the following table:
Convertible Debentures
2032 Subordinated Debentures
2034 Subordinated Debentures
Surplus Notes
Other
In thousands
Year Ended December 31
2005
$ 4,565
509
3,659
–
196
$ 8,929
Change
$
–
1,026
824
471
(177)
$ 2,144
2006
$ 4,565
1,535
4,483
471
19
$ 11,073
Taxes
Our effective tax rate for each period is significantly lower than the 35% statutory rate because a
considerable portion of our net investment income is tax-exempt. The effect of tax-exempt income on our
effective tax rate is shown in the table below:
Year Ended December 31
2006
Statutory rate
Tax-exempt income
Other
Effective tax rate
35%
(8%)
1%
28%
2005
35%
(9%)
–
26%
The increase in our 2006 effective tax rate is primarily the result of our tax-exempt income being
a smaller percentage of total income than in prior periods.
64
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.
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. Certain of the securities are held in an unrealized loss position; we
have the current ability and intent to hold such securities until recovery of book value or maturity.
The following table summarizes estimated changes in the fair value of our available-for-sale and
trading fixed maturity securities for specific hypothetical changes in interest rates as of December 31,
2007.
In millions, except duration
Interest Rates
200 basis point rise
100 basis point rise
Current rate *
100 basis point decline
200 basis point decline
*Current rates are as of December 31, 2007 and December 31, 2006.
December 31, 2007
Change in
Value
$ (284)
$ (142)
$
–
$ 129
$ 249
Portfolio
Value
$ 2,961
$ 3,103
$ 3,245
$ 3,374
$ 3,494
Effective
Duration
4.62
4.52
4.13
3.67
3.48
December 31, 2006
Portfolio
Value
$ 2,911
$ 3,057
$ 3,185
$ 3,306
$ 3,422
Effective
Duration
4.31
4.20
3.89
3.55
3.51
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.
ProAssurance's cash and short-term investment portfolio at December 31, 2007 was on a cost
basis which approximates its fair value. This portfolio lacks significant interest rate sensitivity due to its
short duration.
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, 2007, 98.4% of our fixed maturity securities are rated investment grade as
determined by a nationally recognized statistical rating agency. 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, even investment grade securities can rapidly deteriorate and result in
significant losses.
As of December 31, 2007, our fixed maturity securities include securities with a fair value of
approximately $21.4 million (including unrealized losses of $1.1 million) that are supported by collateral
we classify as sub-prime, of which approximately 68% are AAA rated, 26% are AA+, and 6% are A.
Additionally, we have approximately $4.0 million (including unrealized losses of $3.3 million) of exposure
to below investment grade fixed income securities with sub-prime exposure within a high-yield investment
fund; the average rating of these securities is BB+. In 2007, we evaluated our exposure to the sub-prime
market and determined that $6.5 million of writedowns were warranted for other-than-temporary
impairments. We have no exposure to sub-prime loans through collateralized debt obligations.
65
Equity Price Risk
At December 31, 2007 the fair value of our investment in common stocks was $21.5 million.
These securities are subject to equity price risk, which is defined as the potential for loss in fair value due
to a decline in equity prices. The weighted average Beta of this group of securities is 0.97. Beta measures
the price sensitivity of an equity security or group of equity securities to a change in the broader equity
market, in this case the S&P 500 Index. If the value of the S&P 500 Index increased by 10%, the fair
value of these securities would be expected to increase by 9.7% to $23.6 million. Conversely, a 10%
decrease in the S&P 500 Index would imply a decrease of 9.7% in the fair value of these securities to
$19.4 million. The selected hypothetical changes of plus or minus 10% do not reflect what could be
considered the best or worst case scenarios and are used for illustrative purposes only.
66
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 72. The
Supplementary Financial Information required by Item 302 of Regulation S-K is included in Note 17 to the
Consolidated Financial Statements of ProAssurance and its subsidiaries.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not Applicable.
ITEM 9A. CONTROLS AND PROCEDURES.
Disclosure Controls
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 as of the end of the fiscal year ended December 31,
2007. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded
that these controls and procedures are effective.
Disclosure controls and procedures are defined in Exchange Act Rule 13a-15(e) and include 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.
Management's Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over
financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the
supervision and with the participation of our management, including our Chief Executive Officer and Chief
Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial
reporting as of December 31, 2007 based on the framework in Internal Control–Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on
that evaluation, our management concluded that our internal control over financial reporting was effective
as of December 31, 2007 and that there was no change in the Company's internal controls during the
fiscal quarter then ended that has materially effected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
Ernst & Young LLP, an independent registered public accounting firm, has audited the
effectiveness of our internal controls over financial reporting as of December 31, 2007 as stated in their
report which is included elsewhere herein.
ITEM 9B. OTHER INFORMATION.
None
67
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of ProAssurance Corporation
We have audited ProAssurance Corporation and subsidiaries’ internal control over financial
reporting as of December 31, 2007, based on criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the
COSO criteria). ProAssurance Corporation and subsidiaries’ management is responsible for maintaining
effective internal control over financial reporting, and for its assessment of the effectiveness of internal
control over financial reporting included in the accompanying Management’s Annual Report on Internal
Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial reporting was maintained in
all material respects. Our audit included obtaining an understanding of internal control over financial
reporting, assessing the risk that a material weakness exists, testing and evaluating the design and
operating effectiveness of internal control based on the assessed risk, and performing such other
procedures as we considered necessary in the circumstances. We believe that our audit provides a
reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles. A company’s internal
control over financial reporting includes those policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the
assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
In our opinion, ProAssurance Corporation and subsidiaries maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2007, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets as of December 31, 2007 and 2006,
and the related consolidated statements of changes in capital, income and cash flow for each of the three
years in the period ended December 31, 2007, of ProAssurance Corporation and subsidiaries and our
report dated February 28, 2008 expressed an unqualified opinion thereon.
Birmingham, Alabama
February 28, 2008
Ernst & Young LLP
68
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 27 and 28) 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 2008
Annual Meeting of its Stockholders to be filed with the Securities and Exchange Commission pursuant to
Regulation 14A on or before April 11, 2008.
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 2008 Annual Meeting of its
Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A on or
before April 11, 2008.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
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 2008 Annual Meeting of its
Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A on or
before April 11, 2008.
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 2008 Annual Meeting of its
Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A on or
before April 11, 2008.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
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 2008 Annual Meeting of its
Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A on or
before April 11, 2008.
69
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(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, 2007 and 2006
Consolidated Statements of Changes in Capital – years ended December 31,
2007, 2006 and 2005
Consolidated Statements of Income – years ended December 31, 2007, 2006
and 2005
Consolidated Statements of Cash Flow – years ended December 31, 2007, 2006
and 2005
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
(Registrant Only)
Schedule III – Supplementary Insurance Information
Schedule IV – Reinsurance
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 exhibits required to be filed by Item 15(b) are listed herein in the Exhibit Index.
70
SIGNATURES
Pursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized, on this the 28th day of February 2008.
PROASSURANCE CORPORATION
By: /s/ W. Stancil Starnes
W. Stancil Starnes
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below
by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Name
Title
Date
/s/W. Stancil Starnes
W. Stancil Starnes
/s/Edward L. Rand, Jr.
Edward L. Rand, Jr.
/s/James J. Morello
James J. Morello
/s/A. Derrill Crowe, M.D.
A. Derrill Crowe, M.D.
/s/Victor T. Adamo, Esq.
Victor T. Adamo, Esq.
/s/Paul R. Butrus
Paul R. Butrus
/s/Lucian F. Bloodworth
Lucian F. Bloodworth
/s/Robert E. Flowers, M.D.
Robert E. Flowers, M.D.
/s/William J. Listwan, M.D.
William J. Listwan, M.D.
/s/John J. McMahon, Jr., Esq.
John J. McMahon, Jr., Esq.
/s/Drayton Nabers, Jr.
Drayton Nabers, Jr.
/s/John P. North, Jr.
John P. North, Jr.
/s/Ann F. Putallaz, Ph.D.
Ann F. Putallaz, Ph.D.
/s/William H. Woodhams, M.D.
William H. Woodhams, M.D.
/s/Wilfred W. Yeargan, Jr., M.D.
Wilfred W. Yeargan, Jr., M.D.
Chief Executive Officer
(Principal Executive Officer)
and Director
February 28, 2008
Chief Financial Officer
February 28, 2008
Chief Accounting Officer
February 28, 2008
Chairman of the Board
and Director
Director
Director
Director
Director
Director
Director
Director
Director
Director
Director
Director
71
February 28, 2008
February 28, 2008
February 28, 2008
February 28, 2008
February 28, 2008
February 28, 2008
February 28, 2008
February 28, 2008
February 28, 2008
February 28, 2008
February 28, 2008
February 28, 2008
ProAssurance Corporation and Subsidiaries
Consolidated Financial Statements
Years ended December 31, 2007, 2006 and 2005
Table of Contents
Report of Independent Registered Public Accounting Firm........................................................................73
Audited Consolidated Financial Statements
Consolidated Balance Sheets .....................................................................................................................74
Consolidated Statements of Changes in Capital ........................................................................................ 75
Consolidated Statements of Income ........................................................................................................... 76
Consolidated Statements of Cash Flow...................................................................................................... 77
Notes to Consolidated Financial Statements ..............................................................................................79
72
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of ProAssurance Corporation
We have audited the accompanying consolidated balance sheets of ProAssurance Corporation
and subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of changes
in capital, income and cash flow for each of the three years in the period ended December 31, 2007. Our
audits also included the financial statement schedules listed in the Index at Item 15(a). These financial
statements and schedules are the responsibility of the Company'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 the standards of the Public Company Accounting
Oversight Board (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 financial statements referred to above present fairly, in all material respects,
the consolidated financial position of ProAssurance Corporation and subsidiaries at December 31, 2007
and 2006, and the consolidated results of their operations and their cash flow for each of the three years
in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.
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 1 to the consolidated financial statements, ProAssurance Corporation
changed its method of accounting for income taxes as of January 1, 2007 in accordance with adoption of
Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes,
an interpretation of Statement of Financial Accounting Standards No. 109.
We also have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), ProAssurance Corporation’s internal control over financial reporting as
of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February
28, 2008 expressed an unqualified opinion thereon.
Ernst & Young LLP
Birmingham, Alabama
February 28, 2008
73
ProAssurance Corporation and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share data)
Assets
Investments
Fixed maturities available for sale, at fair value
Fixed maturities, trading, at fair value
Equity securities, available for sale, at fair value
Equity securities, trading, at fair value
Short-term investments
Business owned life insurance
Investment in unconsolidated subsidiaries
Other
Total Investments
Cash and cash equivalents
Premiums receivable
Receivable from reinsurers on unpaid losses and loss adjustment expenses
Prepaid reinsurance premiums
Deferred taxes
Real estate, net
Other assets
Total Assets
Liabilities and Stockholders' Equity
Liabilities
Policy liabilities and accruals:
December 31
December 31
2007
2006
$ 3,244,593
$ 3,136,222
–
7,597
14,173
220,029
61,509
26,767
54,939
49,218
7,220
7,638
184,280
58,721
9,331
39,468
3,629,607
3,492,098
39,090
98,693
327,111
14,835
103,105
24,004
203,391
29,146
113,023
370,763
18,954
112,201
23,135
183,533
$ 4,439,836
$ 4,342,853
Reserve for losses and loss adjustment expenses
$ 2,559,707
$ 2,607,148
Unearned premiums
Reinsurance premiums payable
Total Policy Liabilities
Other liabilities
Long-term debt
Total Liabilities
218,028
128,582
253,773
106,176
2,906,317
2,967,097
114,291
164,158
78,032
179,177
3,184,766
3,224,306
Commitments and contingencies
–
–
Stockholders' Equity
Common stock, par value $0.01 per share
100,000,000 shares authorized, 33,570,685 and
33,398,028 shares issued, respectively
Additional paid-in capital
Accumulated other comprehensive income (loss), net of deferred
tax expense (benefit) of $5,334 and $62, respectively
Retained earnings
336
505,923
9,902
793,166
334
495,848
111
622,310
1,309,327
1,118,603
Treasury stock, at cost, 1,128,111 shares and 121,765 shares, respectively
(54,257)
(56)
Total Stockholders' Equity
Total Liabilities and Stockholders' Equity
1,255,070
1,118,547
$ 4,439,836
$ 4,342,853
See accompanying notes.
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C
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
Equity in earnings (loss) of unconsolidated subsidiaries
Net realized investment gains (losses)
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
Year Ended December 31
2006
2007
2005
$ 549,074
$ 578,983
$ 572,960
$ 506,397
$ 543,376
$ 521,343
$ 585,310
(51,797)
533,513
171,308
1,630
(5,939)
5,556
706,068
438,527
(87,530)
350,997
106,751
11,981
469,729
$ 627,166
(44,099)
583,067
147,450
2,339
(1,199)
5,941
737,598
475,997
(32,668)
443,329
106,369
11,073
560,771
$ 596,557
(53,316)
543,241
98,293
900
912
4,604
647,950
479,300
(41,099)
438,201
91,957
8,929
539,087
Income from continuing operations before income taxes
236,339
176,827
108,863
Provision for income taxes:
Current expense (benefit)
Deferred expense (benefit)
64,329
3,824
68,153
48,456
1,387
49,843
Income from continuing operations
168,186
126,984
Income from discontinued operations, net of tax
–
109,441
28,130
707
28,837
80,026
33,431
Net income
$ 168,186
$ 236,425
$ 113,457
Basic earnings per share:
Income from continuing operations
Income from discontinued operations
Net income
Diluted earnings per share:
Income from continuing operations
Income from discontinued operations
Net income
Weighted average number of common shares outstanding:
Basic
Diluted
$
$
$
$
5.10
–
5.10
4.78
–
4.78
$
$
$
$
3.96
3.42
7.38
3.72
3.13
6.85
$
$
$
$
2.66
1.11
3.77
2.52
1.02
3.54
32,960
35,823
32,044
34,925
30,049
32,908
See accompanying notes.
76
ProAssurance Corporation and Subsidiaries
Consolidated Statements of Cash Flow
(In thousands)
Year Ended December 31
2006
2007
2005
Continuing Operations:
Operating Activities
Net income
Income from discontinued operations, net of tax
Adjustments to reconcile income to net cash provided by operating activities:
Amortization
Depreciation
Increase in cash surrender value of business owned life insurance
Net realized investment (gains) losses
Net (purchases) sales of trading portfolio securities
Share-based compensation
Deferred income taxes
Policy acquisition costs deferred, net of related amortization
Taxes paid related to gain on sale of discontinued operations
Other
Changes in assets and liabilities:
Premiums receivable
Receivable from reinsurers
Prepaid reinsurance premiums
Other assets
Reserve for losses and loss adjustment expenses
Unearned premiums
Reinsurance premiums payable
Other liabilities
Net cash provided by operating activities of continuing operations
Investing Activities
Purchases of:
Fixed maturities available for sale
Equity securities available for sale
Other investments
Cash investment in unconsolidated subsidiaries
Proceeds from sale or maturities of:
Fixed maturities available for sale
Equity securities available for sale
Other investments
Net (increase) decrease in short-term investments
Cash proceeds, net of sales expenses of $4,080, from sale of personal lines operations
Other
Net cash used by investing activities of continuing operations
Financing Activities
Repayment of long-term debt
Repurchase of treasury shares
Other
Net cash provided by (used by) financing activities of continuing operations
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning at period
Cash and cash equivalents at end of period
(continued)
$ 168,186
–
$ 236,425
(109,441)
$ 113,457
(33,431)
12,587
3,500
(1,889)
5,939
42,683
8,326
3,824
1,643
–
(4,839)
14,664
4,164
(2,285)
1,199
(51,585)
4,669
1,387
2,845
(54,565)
516
20,274
3,727
(2,298)
(912)
(917)
–
707
(1,002)
–
(701)
14,330
43,652
4,119
(24,767)
(47,441)
(35,745)
22,406
27,592
244,106
17,868
14,122
7,817
(19,017)
154,274
(48,130)
642
7,261
182,830
19,104
(10,553)
1,119
(1,272)
222,643
(23,514)
14,182
2,977
323,590
(1,394,695)
(948)
(551)
(15,806)
1,276,191
270
10,443
(35,749)
–
(5,610)
(166,455)
(2,384,986)
(407)
(25,364)
–
1,873,041
38,801
25,074
(83,415)
371,037
(3,426)
(189,645)
(900,481)
(777)
(2,386)
–
597,472
44,773
–
(51,903)
–
(124)
(313,426)
(15,464)
(54,201)
1,958
(67,707)
–
–
1,455
1,455
–
–
3,644
3,644
9,944
29,146
$ 39,090
(5,360)
34,506
$ 29,146
13,808
20,698
$ 34,506
See accompanying notes.
77
ProAssurance Corporation and Subsidiaries
Consolidated Statements of Cash Flow
(In thousands)
Year Ended December 31
2006
2007
2005
Discontinued Operations:
Net cash provided by (used in) operating activities of discontinued operations
Net cash provided by (used in) investing activities of discontinued operations
Net cash provided by (used in) financing activities of discontinued operations
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental Disclosure of Cash Flow Information:
Net cash paid (received) during the year for income taxes:
Continuing operations
Discontinued operations
Cash paid during the year for interest:
Continuing operations
Discontinued operations
$
$
–
–
–
–
–
–
$
$
–
–
–
–
–
–
$ 40,920
2,415
–
43,335
9,386
$ 52,721
$ 45,249
–
$
$ 95,748
–
$
$ 25,998
$ 15,528
$ 10,956
–
$
$ 10,192
–
$
$ 8,034
–
$
Significant non-cash transactions:
Fixed maturities securities received as proceeds from sale of discontinued operations
Fixed maturities securities transferred, at fair value, to other investments
Common shares issued in acquisition
$
–
$ 34,732
–
$
$ 24,819
–
$
$ 99,128
–
$
–
$
$ 67,066
See accompanying notes.
78
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
1. Accounting Policies
Organization and Nature of Business
ProAssurance Corporation (ProAssurance or PRA), a Delaware corporation, is an insurance
holding company for wholly-owned specialty property and casualty insurance companies that principally
provide professional liability insurance for providers of health care services, and to a lesser extent,
providers of legal services. ProAssurance operates in the United States of America (U.S.), principally in
the Mid-Atlantic, Midwest and South. ProAssurance’s operations are in a single reportable segment.
Segment Information / Discontinued Operations
In January 2006 ProAssurance sold its Personal Lines Division consisting of its wholly-owned
subsidiaries, MEEMIC Insurance Company, Inc. and MEEMIC Insurance Services (collectively, the
MEEMIC Companies). The MEEMIC Companies were formerly considered as a separate reportable
industry segment. In accordance with Statement of Financial Accounting Standard (SFAS) No. 144
Accounting for the Impairment or Disposal of Long-lived Assets, ProAssurance’s personal lines
operations have been classified in this report as discontinued operations in all periods presented. See
Note 3 for further discussion of discontinued operations.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of ProAssurance
Corporation and its wholly-owned subsidiaries. Investments in entities where ProAssurance holds a
greater than minor interest but does not hold a controlling interest are accounted for using the equity
method. All significant intercompany accounts and transactions are eliminated in consolidation.
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.
Reclassifications
In 2007, due to the increased significance of the amounts involved, ProAssurance has separately
reported its investments in unconsolidated subsidiaries and its equity in the earnings of unconsolidated
subsidiaries. Previously, investments in unconsolidated subsidiaries were included as a component of
other investments and earnings of unconsolidated subsidiaries were considered as a component of net
investment income. Prior period balances in this report have been reclassified to conform to the 2007
presentation. The reclassification had no effect on income from continuing operations, net income or total
assets.
Accounting Policies
The significant accounting policies followed by ProAssurance in making estimates that materially
affect financial reporting are summarized in these notes to the consolidated financial statements.
79
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
1. Accounting Policies (continued)
Investments; Investment in Unconsolidated Subsidiaries
Fixed Maturities and Equity Securities
Fair Values
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.
Valuations of securities obtained from pricing services are reviewed for accuracy based upon the
specifics of the security, including class, maturity, credit rating, durations, collateral, and comparable
markets for similar securities.
Asset backed security valuations are subject to prospective adjustments in yield due to changes
in prepayment assumptions. Under the prospective method, the recalculated effective yield will equate
the carrying amount of the investment to the present value of the anticipated future cash flows. The
recalculated yield is then used to accrue income on the investment balance for subsequent accounting
periods.
Asset backed securities that have been impaired due to credit or are below investment grade
quality are accounted for under the effective yield method discussed in FASB Emerging Issues Task
Force (EITF) 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets". Under the effective yield method estimates of cash
flows expected over the life of asset backed securities are updated quarterly. If there are adverse
changes in cash flow projections, considering timing and amount, an other-than-temporary impairment
loss is recognized.
Fixed maturities and equity securities are considered as either available-for-sale or trading securities.
Available for Sale
Available-for-sale securities are carried at fair value, and unrealized gains and losses on such
available-for-sale securities are included, net of related tax effects, in Stockholders’ Equity as a
component of Accumulated Other Comprehensive Income (Loss).
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.
Trading
Trading portfolio securities are carried at fair value with the holding gains and losses included in
realized investment gains and losses in the current period.
Short-term Investments
Short-term investments, which have an original maturity of one year or less, are primarily
comprised of investments in U.S. Treasury obligations and commercial paper. All balances are reported
at amortized cost, which approximates fair value.
Other Investments; Investment in Unconsolidated Subsidiaries
Investments in limited partnerships/liability companies where ProAssurance has virtually no
influence over the operating and financial policies of an investee are accounted for using the cost method.
Investments in limited partnerships/liability companies where ProAssurance is deemed to have influence
because it holds a greater than minor interest are accounted for using the equity method.
Other Investments are primarily comprised of equity interests in non-public investment funds,
accounted for using the cost method. In 2007, Other Investments also includes available-for-sale fixed
80
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
1. Accounting Policies (continued)
maturity securities accounted for at fair value in which ProAssurance maintains a direct beneficial interest
but that are held by a separate investment entity.
Investments in unconsolidated subsidiaries consist of ownership interests in non-public
investment funds that are accounted for using the equity method.
Business Owned Life Insurance (BOLI)
ProAssurance owns life insurance contracts on certain management employees. The life
insurance contracts are carried at their current cash surrender value. Changes in the cash surrender
value are included in income in the current period as investment income. Death proceeds from the
contracts are recorded when the proceeds become payable under the policy terms.
Realized Gains and Losses
Realized investment gains and losses are recognized on the specific identification basis.
Other-than-temporary Impairments
In accordance with 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
fair value below cost for the purpose of determining whether these declines represent other-than-
temporary declines. A decline in the fair value of a 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 among those considered in determining whether an
investment’s decline is other-than-temporary:
–
–
–
the extent to which the fair value of the security is less than its cost basis,
the length of time for which the fair value of the security has been less than its cost basis,
the financial condition and near-term prospects of the security’s issuer, taking into
consideration the economic prospects of the issuer’s industry and geographical region, to
the extent that information is publicly available, and
– ProAssurance’s ability and intent to hold the investment for a period of time sufficient to
allow for any anticipated recovery in market value.
Cash and Cash Equivalents
For purposes of the consolidated balance sheets and statements of cash flow, ProAssurance
considers all demand deposits and overnight investments to be cash equivalents.
Real Estate
Real Estate balances are reported at cost or, for properties acquired in business combinations,
estimated fair value on the date of acquisition, less accumulated depreciation. Real estate consists of
properties primarily in use as corporate offices and land held for sale of $2.1 million. Depreciation is
computed over the estimated useful lives of the related property using the straight-line method. Excess
office capacity is leased or made available for lease; rental income is included in other income and real
estate expenses are included in underwriting, acquisition and insurance expenses.
81
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
1. Accounting Policies (continued)
Real estate accumulated depreciation is approximately $13.6 million and $12.5 million at
December 31, 2007 and 2006, respectively. Real estate depreciation expense for the three years ended
December 31, 2007, 2006 and 2005 is $1.1 million, $1.3 million and $1.2 million, respectively.
Reinsurance
ProAssurance enters into reinsurance agreements whereby other insurance entities agree to
assume a portion of the risk associated with the policies issued by ProAssurance. In return,
ProAssurance agrees to pay a premium to the reinsurer. ProAssurance purchases (cedes) reinsurance to
provide for greater diversification of business and to allow management to control exposure to potential
losses arising from large risks.
Receivable from Reinsurers is the estimated amount of future loss payments that will be
recoverable from reinsurers. Reinsurance Recoveries are the portion of losses incurred during the period
that are estimated to be allocable to reinsurers. Premiums ceded are the estimated premiums that will be
due to reinsurers with respect to premiums earned and losses incurred during the period.
These estimates are based upon management’s estimates of ultimate losses and the portion of
those losses that are allocable to reinsurers under the terms of the related reinsurance agreements.
Given the uncertainty of the ultimate amounts of losses, these estimates may vary significantly from the
eventual outcome. Management regularly reviews these estimates and any adjustments necessary are
reflected in the period in which the estimate is changed. Due to the size of the receivable from reinsurers,
even a small adjustment to the estimates could have a material effect on ProAssurance’s results of
operations for the period in which the change is made.
Reinsurance contracts do not relieve ProAssurance from its obligations to policyholders.
ProAssurance continually monitors its reinsurers to minimize its exposure to significant losses from
reinsurer insolvencies. Any amount determined to be uncollectible is written off in the period in which the
uncollectible amount is identified.
Goodwill
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 is not
amortized. Goodwill is 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 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. Goodwill of $72.2 million is included as a component of Other Assets.
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. Deferred
Policy Acquisition Costs are included in the Consolidated Balance Sheets as a component of Other
Assets.
Reserve for Losses and Loss Adjustment Expenses
ProAssurance establishes its reserve for losses and loss adjustment expenses (reserve for
losses) based on estimates of the future amounts necessary to pay claims and expenses (losses)
associated with the investigation and settlement of claims. The reserve for losses is determined on the
basis of individual claims and payments thereon as well as actuarially determined estimates of future
82
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
1. Accounting Policies (continued)
losses based on past loss experience, available industry data and projections as to future claims
frequency, severity, inflationary trends, judicial trends, legislative changes and settlement patterns.
External actuaries review the reserve for losses of each insurance subsidiary at least semi-
annually. ProAssurance considers the views of the external actuaries as well as other factors, such as
known, anticipated or estimated changes in frequency and severity of claims, loss retention levels and
premium rates in establishing its reserves. Estimating casualty insurance reserves, and particularly
liability reserves, is a complex process. Claims may be resolved over an extended period of time, often
five years or more, and may be subject to litigation. Estimating losses for liability claims requires
ProAssurance to make and revise judgments and assessments regarding multiple uncertainties over an
extended period of time. As a result, reserve estimates may vary significantly from the eventual outcome.
Reserve estimates and the assumptions on which these estimates are predicated are regularly reviewed
and updated as new information becomes available. Any adjustments necessary are reflected in then
current operations. Due to the size of ProAssurance’s reserve for losses, even a small percentage
adjustment to these estimates could have a material effect on earnings in the period in which the
adjustment is made.
The effect of adjustments made to reinsured losses is mitigated by the corresponding adjustment
that is made to reinsurance recoveries. Thus, in any given year, ProAssurance may make significant
adjustments to gross losses that have little effect on its net losses.
Recognition of Revenues
Insurance premiums are recognized as revenues pro rata over the terms of the policies, which
are generally one year in duration.
Share-Based Compensation
In 2007 and 2006, ProAssurance recognized compensation cost for share-based payments
(including stock options and performance shares) under the recognition and measurement principles
(modified prospective method) of SFAS 123 (revised 2004) Share-Based Payment (SFAS 123(R)).
Compensation cost for awards that were granted prior to January 1, 2006 and had not yet vested on
January 1, 2006 is recognized over the remaining service period related to those awards, based on
amounts, including grant-date fair values, previously reported in SFAS 123 pro forma disclosures.
Compensation cost for awards granted after January 1, 2006 is recognized based on the grant-date fair
value of the award over the relevant service period of the award; for awards that vest in increments
(graded vesting), compensation cost is recognized over the relevant service period for each separately
vested portion of the award. Note 12 provides detailed information regarding the determination of grant
date fair values.
In 2005, ProAssurance recognized compensation cost for option awards under the intrinsic-value
provisions set forth in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations (collectively referred to as APB 25) as permitted by SFAS 123. No
compensation cost is generally recognized under APB 25 since ProAssurance options are granted with
an exercise price equal to the fair value of ProAssurance's common shares on the date of grant.
In 2007 and 2006, “excess tax benefits" (tax deductions realized in excess of the compensation
costs recognized for the exercise of the awards, multiplied by the incremental tax rate) are reported as
financing cash inflows. In 2005, “excess tax benefits” are included within operating cash flows.
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 for income tax reporting, and the limitation of the unearned premiums
deduction for income tax reporting. ProAssurance recognizes tax-related interest and penalties as
components of tax expense.
83
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
1. Accounting Policies (continued)
Accounting Changes
In December 2007 the Financial Accounting Standards Board (FASB) issued SFAS 160,
Noncontrolling Interests in Consolidated Financial Statements (SFAS 160). SFAS 160 amends
Accounting Research Bulletin (ARB) 51 to establish accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The Statement is
effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15,
2008. Earlier adoption is prohibited. ProAssurance will adopt the Statement on its effective date. Adoption
is not expected to have a significant effect on ProAssurance's results of operations or financial position.
In December 2007 the FASB issued SFAS 141 (Revised 2007) Business Combinations (SFAS
141R). SFAS 141R replaces FASB Statement No. 141, Business Combinations, but retains the
fundamental requirement in SFAS 141 that the acquisition method (referred to as the purchase method in
SFAS 141) of accounting be used for all business combinations. SFAS 141R provides new or additional
guidance with respect to business combinations including: defining the acquirer in a transaction, the
valuation of assets and liabilities when noncontrolling interests exist, the treatment of contingent
consideration, the treatment of costs incurred to effect the acquisition, the treatment of reorganization
costs, and the valuation of assets and liabilities when the purchase price is below the net fair value of
assets acquired. SFAS 141R applies prospectively to business combinations for which the acquisition
date is on or after the beginning of the first annual reporting period beginning on or after December 15,
2008. Earlier adoption is prohibited. ProAssurance will adopt the Statement on its effective date.
In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and
Financial Liabilities – Including an Amendment of FASB Statement No. 115 (SFAS 159). SFAS 159
allows many financial assets and liabilities and other items to be reported at fair value that are not
currently measured at fair value. Unrealized gains and losses on items for which the fair value has been
elected would be reported in earnings at each subsequent reporting date. SFAS 159 also establishes new
disclosure requirements with respect to fair values. SFAS 159 is effective for fiscal years beginning after
November 15, 2007, unless early adopted. ProAssurance will adopt SFAS 159 on its effective date.
ProAssurance does not plan to select the fair value alternative for financial assets or liabilities that are not
currently measured at fair value and does not expect adoption to have an effect on its results of
operations or financial condition.
In September 2006, the FASB issued SFAS 157, Fair Value Measurements (SFAS 157). The
standard establishes a framework for measuring fair value under GAAP, and expands disclosures about
fair value measurements. SFAS 157 is applicable to other accounting pronouncements that require or
permit fair value measurements but does not require any new fair value measurements. The statement is
effective for fiscal years beginning after November 15, 2007, unless early adopted. ProAssurance will
adopt SFAS 157 on its effective date, and does not expect the implementation of SFAS 157 to have a
material effect on its results of operations or financial condition.
In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income
Taxes, an interpretation of FAS 109, Accounting for Income Taxes (FIN 48), to create a single model to
address accounting for uncertainty in tax positions. FIN 48 clarifies the accounting for income taxes by
prescribing a minimum recognition threshold that a tax position is required to meet before being
recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement,
classification, interest and penalties, accounting for interim periods, disclosure and transition. FIN 48 is
effective for fiscal years beginning after December 15, 2006. ProAssurance adopted FIN 48 as of January
1, 2007. The cumulative effect of adopting FIN 48 reduced tax liabilities and increased retained earnings
by $2.7 million. The disclosures required by FIN 48 are provided in Note 6.
84
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
1. Accounting Policies (continued)
On December 16, 2004 the FASB issued SFAS 123(R) Share-Based Payment, which is a
revision of SFAS 123, which superseded APB 25, and amends SFAS 95, Statement of Cash Flows.
ProAssurance adopted SFAS 123(R) on its effective date, January 1, 2006, using the modified
prospective method permitted by the statement, which does not require restatement of prior periods nor
recognition of a cumulative effect of adoption. Information regarding the effect of adoption is provided in
Note 12.
2. Acquisitions
ProAssurance acquired 100% of the outstanding shares of Physicians Insurance Company of
Wisconsin, Inc. (PIC Wisconsin) on August 1, 2006 and acquired 100% of the outstanding shares of
NCRIC Corporation (NCRIC) on August 3, 2005, as a means of expanding its operations geographically.
PIC Wisconsin is an insurance company that focuses on medical professional liability insurance. PIC
Wisconsin's largest premium states are Wisconsin and Iowa. NCRIC is a holding company; its primary
subsidiary is NCRIC, Inc., an insurance company also focused on providing medical professional liability
insurance. NCRIC, Inc.'s premium revenues are concentrated in the District of Columbia and adjacent
states.
Both acquisitions were stock-for-stock transactions accounted for as purchase transactions in
accordance with SFAS 141. In the PIC Wisconsin transaction ProAssurance issued approximately 2.0
million common shares which were valued in the determination of the purchase price at $49.76 per share,
which is the average PRA share price for three days before and after July 31, 2006, the date on which the
number of shares issued in the transaction was determined. In the NCRIC transaction, PRA issued
approximately 1.7 million common shares which were valued in the determination of the purchase price at
$40.54 per share, which is the average PRA share price for three days before and after February 28,
2005 (the date the terms of the acquisition were agreed to and publicly announced). In both transactions,
the purchase price was allocated to the assets acquired and liabilities assumed based on estimates of
their respective fair values at the date of acquisition. Goodwill of $42.7 million (PIC Wisconsin) and $25.0
million (NCRIC) was recognized equal to the excess of the purchase price over the fair values of the
identifiable net assets acquired. The goodwill is not expected to be tax deductible.
The following chart summarizes the total cost of the acquisitions and the allocation of the
purchase price (in millions):
Aggregate Purchase Price:
Fair value of ProAssurance common shares issued
Other acquisition costs
Aggregate purchase price
Assets (liabilities) acquired, at fair value:
Fixed maturities, available for sale
Equity securities, available for sale
Short-term investments
Premiums receivable
Receivable from reinsurers on unpaid losses and
loss adjustment expenses
Other assets
Reserve for losses and loss adjustment expenses
Unearned premiums
Long-term debt
Liability for judgment
Other liabilities
Fair value of net assets acquired
PIC Wisconsin
NCRIC
$
99.1
4.6
$ 103.7
$
$
67.1
4.1
71.2
$ 199.3
34.4
7.8
24.3
$ 185.0
27.8
3.2
9.1
57.2
45.4
(228.4)
(37.6)
(11.6)
–
(29.8)
61.0
$
43.5
46.7
(183.2)
(39.2)
(15.5)
(19.5)
(11.7)
46.2
$
85
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
2. Acquisitions (continued)
The fair values of the reserves for losses and related reinsurance recoverables (the net loss
reserves) acquired in the PIC Wisconsin and NCRIC transactions were estimated as of the dates of
acquisition based on present value of the expected underlying net cash flows, and include a profit margin
and a risk premium.
Each company's historical undiscounted loss reserve, which had been determined based on a
recent actuarial review, was discounted to present value assuming payment patterns actuarially
developed from the historical loss data of each company. The discount rates used, 4.86% for PIC
Wisconsin and 4.31% for NCRIC, approximate the risk-free treasury rate on the acquisition date for
maturities similar to the estimated duration of the reserve being valued. For each estimate 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 partner in the purchase of loss reserves). Additionally, in consideration of the long-tail nature and
the related high degree of uncertainty of such loss reserves, an estimated risk premium of 5% was also
applied to the discounted loss reserves. In both instances, the calculation resulted in a fair value estimate
which was not materially different than the historical loss reserves and therefore did not result in an
adjustment to the historical reserve amount.
3. Discontinued Operations
Effective January 1, 2006 ProAssurance sold its wholly owned subsidiaries, MEEMIC Insurance
Company and MEEMIC Insurance Services (collectively, the MEEMIC Companies) to Motors Insurance
Corporation, a subsidiary of GMAC Insurance Holdings, Inc., for total consideration of $400 million before
taxes and
the only active entities of
ProAssurance's personal lines operations.
transaction expenses. The MEEMIC Companies were
On December 28, 2005, ProAssurance sold ConsiCare, a non-insurance subsidiary acquired
August 3, 2005 in the NCRIC transaction, for approximately $1.7 million. No gain or loss was recognized
related to the sale because the carrying value for ConsiCare's net assets approximated the sales price
less sale expenses.
In accordance with SFAS 144, the assets, liabilities and operating results attributed to the
personal lines operations and the operating results of ConsiCare are reported as discontinued operations
in the Consolidated Financial Statements.
The following tables provide detailed information regarding the financial statement lines identified
as discontinued operations.
Personal Lines results:
Net premiums earned
Net investment income
Other revenues
Net losses and loss adjustment expenses
Underwriting, acquisition and insurance expenses
Gain from sale of discontinued operations
Provision for income taxes
Personal lines results, net of tax
ConsiCare results, net of tax
Income from discontinued operations, net of tax
$
$
2007
2006
In thousands
2005
–
–
–
–
–
–
–
–
–
–
$
–
–
–
–
–
164,006
(54,565)
109,441
–
$ 109,441
$ 187,903
12,817
2,871
(110,929)
(43,323)
–
(15,805)
33,534
(103)
$ 33,431
86
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
4. Investments
The amortized cost and estimated fair value of available-for-sale fixed maturities and equity
securities are as follows:
Fixed Maturities
U.S. treasury securities
Government-sponsored enterprises
State and municipal bonds
Corporate bonds
Asset-backed securities
Equity securities
Fixed Maturities
U.S. treasury securities
Government-sponsored enterprises
State and municipal bonds
Corporate bonds
Asset-backed securities
Equity securities
Cost
or
Amortized
Cost
$ 107,027
179,603
1,328,410
659,057
952,043
3,226,140
4,985
$ 3,231,125
Cost
or
Amortized
Cost
$
57,400
232,193
1,190,651
629,809
1,028,595
3,138,648
4,618
$ 3,143,266
December 31, 2007
Gross
Unrealized
Gains
Gross
Unrealized
(Losses)
Estimated
Fair
Value
In thousands
$
$
$
$
2,811
2,440
15,174
6,551
10,270
37,246
2,724
39,970
$
$
(12)
(33)
(2,088)
(9,675)
(6,985)
(18,793)
(112)
(18,905)
$ 109,826
182,010
1,341,496
655,933
955,328
3,244,593
7,597
$ 3,252,190
December 31, 2006
Gross
Unrealized
Gains
Gross
Unrealized
(Losses)
Estimated
Fair
Value
In thousands
105
129
10,497
4,356
7,638
22,725
2,602
25,327
$
$
(528)
(1,373)
(2,921)
(9,162)
(11,167)
(25,151)
–
(25,151)
$
56,977
230,949
1,198,227
625,003
1,025,066
3,136,222
7,220
$ 3,143,442
The following table provides summarized information with respect to available-for-sale securities
held in an unrealized loss position at December 31, 2007, including the length of time the securities have
been held in a continuous unrealized loss position.
Fixed maturities, available for sale
U.S. treasury securities
Government-sponsored enterprises
State and municipal bonds
Corporate bonds
Asset-backed securities
Equity securities, available for sale
Available for sale securities held
with unrealized losses
Total
Fair
Value
Unrealized
Loss
December 31, 2007
Less than 12 months
Unrealized
Loss
Fair
Value
In thousands
More than 12 months
Fair
Value
Unrealized
Loss
$
4,025
23,469
234,925
346,537
403,023
1,011,979
1,026
$
(12)
(33)
(2,088)
(9,675)
(6,985)
(18,793)
(112)
$
– $
–
153,844
116,874
81,305
352,023
1,026
–
–
(1,499)
(3,747)
(2,856)
(8,102)
(112)
$
4,025 $
23,469
81,081
229,663
321,718
659,956
–
(12)
(33)
(589)
(5,928)
(4,129)
(10,691)
–
$ 1,013,005
$ (18,905)
$ 353,049
$
(8,214)
$ 659,956
$ (10,691)
87
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
4. Investments (continued)
After an evaluation of each security, management concluded that these securities have not
suffered an other-than-temporary impairment in value that had not otherwise been recognized. Of the
fixed maturity unrealized losses aggregated in the above table, 85% are considered to be interest rate
related. Each fixed maturity security has paid all scheduled contractual payments. Management believes
that each issuer has the capacity to meet the remaining contractual obligations of the security, including
payment at maturity. In total, there are approximately 679 fixed maturity securities in an unrealized loss
position. Management considers the unrealized loss on nine of those securities to be credit related; the
unrealized losses related to these securities total approximately $2.8 million. The single greatest credit-
related unrealized loss position approximates $610,000; the second greatest credit-related unrealized
loss position is an unrealized loss of approximately $524,000. Management believes each of the equity
securities in an unrealized loss position, given the characteristics of the underlying company, industry,
and price volatility of the security, has a reasonable probability of being valued at or above book value in
the near term.
Management has the intent and believes ProAssurance has the ability, due to the duration of
ProAssurance’s overall portfolio and positive operating cash flows, to hold the securities (that are in
unrealized loss positions) to recovery of book value or maturity.
The amortized cost and estimated fair value of available-for-sale fixed maturities at December 31,
2007, 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.
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
Amortized
Cost
Estimated
Fair
Value
In thousands
$ 242,945
722,858
768,453
539,841
952,043
$ 3,226,140
$ 243,001
727,295
776,919
542,050
955,328
$ 3,244,593
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, 2007.
At December 31, 2007 ProAssurance has available-for-sale securities with a fair value of $15.8
million on deposit with various state insurance departments to meet regulatory requirements.
Business Owned Life Insurance
ProAssurance holds BOLI policies on management employees that were purchased at a cost of
approximately $51 million. The primary purpose of the program is to offset future employee benefit
expenses through earnings on the cash value of the policies. ProAssurance is the owner and principal
beneficiary of these policies.
88
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
4. Investments (continued)
Net Investment Income / Net Realized Investment Gains (Losses)
Net investment income by investment category is as follows:
Fixed maturities
Equities
Short-term investments
Other invested assets
Business owned life insurance
Investment expenses
Net investment income
2007
$ 149,494
377
14,713
9,228
1,889
175,701
(4,393)
$ 171,308
2006
In thousands
$ 130,335
414
15,567
2,970
2,285
151,571
(4,121)
$ 147,450
2005
$ 90,496
773
3,608
4,145
2,298
101,320
(3,027)
$ 98,293
Net realized investment gains (losses) are as follows:
Gross gains, available-for-sale and short-term securities
Gross losses, available-for-sale and short-term securities
Net realized gains (losses), trading securities
Change in unrealized holding gains (losses), trading securities
Other than temporary impairments
Net realized investment gains (losses)
2007
$ 2,944
(1,143)
(284)
297
(7,753)
$ (5,939)
2006
In thousands
$ 5,127
(3,410)
(138)
259
(3,037)
$ (1,199)
2005
$ 3,488
(1,921)
51
62
(768)
$ 912
Net gains (losses) related to fixed maturities included in the above table are ($483,000), ($2.5)
million and $836,000 during 2007, 2006 and 2005, respectively.
Proceeds from sales (excluding maturities and paydowns) of available-for-sale securities were
$1.1 billion, $1.6 billion and $441.0 million during 2007, 2006 and 2005, respectively, including proceeds
from sales of adjustable rate, short-duration fixed maturities of approximately $691.5 million, $1.2 billion,
and $138.3 million, respectively. Purchases of adjustable rate, short-duration
fixed maturities
approximated $576.7 million, $1.4 billion, and $120.9 million during the same respective periods.
In January 2007, ProAssurance transferred high yield asset backed bonds (previously considered
as available-for-sale securities) having a fair value of approximately $34.7 million to an investment fund
created for the purpose of managing such investments. ProAssurance holds a separate and direct
beneficial interest in the securities contributed to the fund. Cash flows from the initial investment,
including net investment earnings and proceeds from maturities, approximately $10.3 million in 2007, are
being re-invested in a joint fund in which ProAssurance holds an undivided interest.
The securities in which ProAssurance holds a direct beneficial interest are included in the
ProAssurance Balance Sheet as a component of Other Investments, at fair value ($16.2 million at
December 31, 2007, including net unrealized losses of $5.8 million). During the first quarter of 2007
ProAssurance recognized other-than-temporary impairments of $4.2 million related to the securities
contributed to the above fund; the $5.8 million unrealized loss originated subsequent to the first quarter.
Management has not recognized additional impairment at December 31, 2007 because an evaluation of
the metrics underlying the securities indicated that the decline in value was not due to prospective default
of the underlying loans. Management intends and believes it has the ability to hold the securities until
recovery.
89
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
4. Investments (continued)
ProAssurance holds a non-controlling interest in the undivided fund and accounts for the fund
using the equity method. At December 31, 2007 the carrying value of the undivided interest of $10.0
million is included in Investments in Unconsolidated Subsidiaries. (The carrying value reflects losses
recognized under the equity method of approximately $350,000.)
5. Reinsurance
ProAssurance has various quota share, excess of loss, and cession reinsurance agreements.
Historically, professional liability per claim retention levels have varied between 90% and 100% of the first
$200,000 to $2 million and between 0% and 10% of claims exceeding those levels depending on the
coverage year and the state in which business was written. ProAssurance also insures some large
professional liability risks that are above the limits of its basic reinsurance treaties. These risks are
reinsured 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 is as follows:
2007 Premiums
2006 Premiums
2005 Premiums
Written
Earned
Written
Earned
Written
Earned
In thousands
Direct
Assumed
Ceded
Net premiums
$ 549,034
40
(42,677)
$ 506,397
$ 585,267
43
(51,797)
$ 533,513
$ 578,963
20
(35,607)
$ 543,376
$ 627,148
18
(44,099)
$ 583,067
$ 572,692
268
(51,617)
$ 521,343
$ 596,289
268
(53,316)
$ 543,241
Reinsurance contracts do not relieve ProAssurance from its obligations to policyholders and
ProAssurance remains liable to its policyholders whether or not reinsurers honor their contractual
obligations to ProAssurance. ProAssurance continually monitors its reinsurers to minimize its exposure to
significant losses from reinsurer insolvencies.
At December 31, 2007, all reinsurance recoverables are considered collectible. Reinsurance
recoverables totaling approximately $33.2 million are collateralized by letters of credit or funds withheld.
At December 31, 2007 no amounts due from individual reinsurers exceed 5% of stockholders’ equity.
During 2007, ProAssurance commuted
reinsurance
arrangements for approximately $6.3 million in cash. The commutations reduced Receivable from
Reinsurers by approximately $477,000 (net of cash received) and reduced Reinsurance Premiums
Payable by approximately $3.3 million. During 2006, ProAssurance commuted various outstanding
reinsurance arrangements for approximately $5.5 million in cash. The commutations reduced Receivable
from Reinsurers by approximately $427,000 (net of cash received) and reduced Reinsurance Premiums
Payable by approximately $2.7 million.
(terminated) various outstanding
90
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
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 assets and liabilities are as follows:
Deferred tax assets
Unpaid loss discount
Unearned premium adjustment
CHW and other contingencies (see Note 9)
Loss and credit carryovers
Basis differences–investments
Compensation related
Other
Total deferred tax assets
Deferred tax liabilities
Deferred acquisition costs
Basis difference on convertible debentures
Unrealized gains on investments, net
Other
Total deferred tax liabilities
Net deferred tax assets
2007
2006
In thousands
$ 84,549
17,954
7,989
2,322
6,598
8,495
1,635
129,542
$ 88,988
18,939
7,636
3,366
5,350
5,286
2,199
131,764
7,742
8,814
5,334
4,547
26,437
$ 103,105
8,453
6,528
62
4,520
19,563
$ 112,201
In December 2006 ProAssurance received approval from the Internal Revenue Service to change
its income tax method of accounting for interest on its Convertible Debentures which were issued in 2003.
The new method, the "comparable yield" method, accelerates recognition of interest expense for tax
purposes. The change in method, recorded in 2006, decreased current tax expense and increased
deferred tax expense by $6.5 million, of which $4.4 million related to pre-2006 interest periods.
In management’s opinion, 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.
At December 31, 2007 ProAssurance has available net operating loss (NOL) carryforwards of
$4.8 million and Alternative Minimum Tax (AMT) credit carryforwards of $639,000. The NOL
carryforwards will expire in 2019; the AMT credit carryforwards have no expiration date. ProAssurance
files income tax returns in the U.S. federal jurisdiction and various states, and generally remains open to
income tax examinations by tax authorities for filings for years beginning with 2004 for federal and 2003
for state.
ProAssurance adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty
in Income Taxes, on January 1, 2007. The cumulative effect of adopting FIN 48 reduced tax liabilities and
increased retained earnings by $2.7 million. At December 31, 2007 ProAssurance has no unrecognized
tax benefits and did not record any activity related to unrecognized tax benefits during the year ended
December 31, 2007.
91
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
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 follows:
Computed “expected” tax expense
Tax-exempt income
Other
Total
2007
2006
2005
$ 82,719
(15,827)
1,261
$ 68,153
In thousands
$ 61,890
(13,217)
1,170
$ 49,843
$ 38,102
(9,548)
283
$ 28,837
No significant interest or penalties were accrued or paid during the year ended December 31,
2007 nor was there any significant liability for such amounts at December 31, 2007.
7. Deferred Policy Acquisition Costs
Policy acquisition costs, most significantly commissions, premium taxes, and underwriting
salaries, that are primarily and directly related to the production of new and renewal premiums are
capitalized as policy acquisition costs and amortized to expense as the related premium revenues are
earned.
Amortization of deferred acquisition costs, included in continuing operations, amounted to
approximately $52.9 million, $56.9 million, and $54.0 million for the years ended December 31, 2007,
2006 and 2005, respectively. Unamortized deferred acquisition costs are included in Other Assets and
are $22.1 million and $23.8 million at December 31, 2007 and 2006, respectively.
8. Reserve for Losses and Loss Adjustment Expenses
The reserve for losses is established based on estimates of individual claims and actuarially
determined estimates of future losses based on ProAssurance’s past loss experience, available industry
data and projections as to future claims frequency, severity, inflationary trends and settlement patterns.
Estimating reserves, and particularly liability reserves, is a complex process. Claims may be resolved
over an extended period of time, often five years or more, and may be subject to litigation. Estimating
losses for liability claims requires ProAssurance to make and revise judgments and assessments
regarding multiple uncertainties over an extended period of time. 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. Changes to
estimates of previously established reserves are included in earnings in the period in which the estimate
is changed.
ProAssurance believes that the methods it uses to establish reserves are reasonable and
appropriate. Each year, ProAssurance uses external actuaries to review the reserve for losses of each
92
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
8. Reserve for Losses and Loss Adjustment Expenses (continued)
insurance subsidiary. ProAssurance considers the views of the external actuaries 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 reserve for losses. 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).
Activity in the reserve for losses and loss adjustment expenses is summarized as follows:
Balance, beginning of year
Less reinsurance recoverables
Net balance, beginning of year
2007
$ 2,607,148
370,763
2,236,385
2006
In thousands
$ 2,224,436
327,693
1,896,743
2005
$ 1,818,636
273,654
1,544,982
Net reserves acquired in PIC Wisconsin transaction
Net reserves acquired in NCRIC transaction
–
–
171,246
–
–
139,672
Net losses:
Current year
Favorable development of reserves
established in prior years
Total
Paid related to:
Current year
Prior years
Total paid
Net balance, end of year
Plus reinsurance recoverables
Balance, end of year
455,982
479,621
461,182
(104,985)
350,997
(36,292)
443,329
(22,981)
438,201
(23,492)
(331,294)
(354,786)
(32,325)
(242,608)
(274,933)
(26,495)
(199,617)
(226,112)
2,232,596
327,111
$ 2,559,707
2,236,385
370,763
$ 2,607,148
1,896,743
327,693
$ 2,224,436
As discussed in Note 1, estimating liability reserves is complex and requires the use of many
assumptions. As time passes and ultimate losses for prior years are either known or become subject to a
more precise estimation, ProAssurance increases or decreases the reserve estimates established in prior
periods. The favorable development recognized in 2007 was primarily due to reductions in estimates of
claims severity for the 2003, 2004 and 2005 accident years. The favorable development recognized in
2006 was primarily due to reductions in estimates of claims severity for the 2002, 2003 and 2004 accident
years. The favorable development recognized in 2005 was primarily due to reductions in estimates of
claims severity for the 2003 accident year; however, favorable development was also seen in accident
years 2002 and prior. Actuarial evaluations of both internal and industry actual claims data in 2007, 2006
and 2005 all indicated that claims severity (i.e., the average size of a claim) is increasing more slowly
than was anticipated when the reserves for 2003, 2004 and 2005 were initially established.
93
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
9. Commitments and Contingencies
As a result of the acquisition of NCRIC, ProAssurance assumed the risk of loss for a judgment
entered against NCRIC on February 20, 2004 by a District of Columbia Superior Court in favor of
Columbia Hospital for Women Medical Center, Inc. (“CHW”) in the amount of $18.2 million (the “CHW
Judgment”). The judgment is now on appeal to the District of Columbia Court of Appeals. ProAssurance
has established a liability related to the judgment of $21.7 million, which includes the estimated costs
associated with pursuing the post-trial motions or appeal of a final judgment and projected post-trial
interest, $19.5 million of which was established as a component of the fair value of assets acquired and
liabilities assumed in the allocation of the NCRIC purchase price. ProAssurance has posted a $20.5
million appellate bond to secure payment of the CHW judgment plus interest and court costs, in the event
the judgment is ultimately affirmed and paid.
ProAssurance is involved in various other legal actions arising primarily from claims against
ProAssurance related to insurance policies and claims handling, including, but not limited to claims
asserted by policyholders. Such legal actions have been considered by ProAssurance in establishing its
loss and loss adjustment expense reserves. The outcome of such legal actions is not presently
determinable for a number of reasons. For example, in the event that ProAssurance or its insureds
receive adverse verdicts, post-trial motions may be denied, in whole or in part; any appeals that may be
undertaken may be unsuccessful; ProAssurance may be unsuccessful in legal efforts to limit the scope of
coverage available to its insureds; and ProAssurance may become a party to bad faith litigation over the
amount of the judgment above an insured's policy limits. ProAssurance's management is of the opinion,
based on consultation with legal counsel, that the resolution of these actions will not have a material
adverse effect on ProAssurance's financial position. However, the ultimate cost of resolving these legal
actions may differ from the reserves established; the resulting difference could have a material effect on
ProAssurance's results of operations for the period in which any such action is resolved.
ProAssurance is involved in a number of operating leases primarily for office space, office
equipment, and communication lines. The following is a schedule of future minimum lease payments for
operating leases that had initial or remaining noncancelable lease terms in excess of one year as of
December 31, 2007.
Operating Leases
In thousands
2008
2009
2010
2011
Thereafter
Total minimum lease payments
$ 2,243
1,445
1,190
153
15
$ 5,046
ProAssurance incurred rent expense of $2.9 million, $2.8 million and $2.4 million in the years
ended December 31, 2007, 2006 and 2005, respectively.
94
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
10. Long-term Debt
Outstanding long-term debt, as of December 31, 2007 and December 31, 2006, consists of the
following:
Convertible Debentures due June 2023 (the Convertible Debentures), unsecured,
principal of $107.6 million bearing a fixed interest rate of 3.9%, net of unamortized
discounts of $1.6 million and $1.9 million at December 31, 2007 and 2006,
respectively.
Trust Preferred Subordinated Debentures (the 2032 Subordinated Debentures; the
2034 Subordinated Debentures), unsecured, bearing interest at a floating rate,
adjustable quarterly.
Due
December 2032
April 2034
May 2034
12/31/2007 Rate
–
8.7%
8.7%
Surplus Notes due May 2034 (the Surplus Notes), unsecured, net of unamortized
discounts of $0.2 and $0.4 million at December 31, 2007 and 2006, principal of
$12.0 million bearing a fixed interest rate of 7.7%, until May 2009.
2007
2006
In thousands
$ 105,973
$ 105,677
–
13,403
32,992
15,464
13,403
32,992
11,790
$ 164,158
11,641
$ 179,177
Convertible Debentures Due June 30, 2023 (the Convertible Debentures)
The Convertible Debentures were issued by ProAssurance in July 2003 in a Private Offering
transaction, net of an initial purchaser’s discount of $3.0 million. Summarized information regarding the
structure and terms of the Convertible Debentures follows:
Issue Price. The Convertible Debentures were issued at 100.0% of their principal amount
and each Convertible Debenture has a principal amount at maturity of $1,000.
Maturity Date. June 30, 2023.
Ranking. The Convertible Debentures are unsecured obligations and rank equally in right
of payment with all other existing and future unsecured and unsubordinated obligations.
The Convertible Debentures are not guaranteed by any of ProAssurance’s subsidiaries
and, accordingly, the Convertible Debentures are effectively subordinated to the
indebtedness and other liabilities of ProAssurance’s subsidiaries, including insurance
policy-related liabilities.
Interest. Interest is payable on June 30 and December 30 of each year, at an annual rate
of 3.90%. In addition, ProAssurance may be required to pay contingent interest, as set
forth below under Contingent Interest.
Contingent Interest. Contingent interest is due to the holders of the Convertible
Debentures during any six-month period from June 30 to December 29 and from
December 30 to June 29 commencing with the six-month period beginning June 30,
2008, if the average market price of a Convertible Debenture for the five trading days
ending on the second trading day immediately preceding the relevant six-month period
equals 120% or more of the principal amount of the Convertible Debentures. The amount
of contingent interest payable in respect of any six-month period will equal 0.1875% of
the average market price of a Convertible Debenture for the five trading day period
referred to above.
95
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
10. Long-term Debt (continued)
Conversion Rights. Holders may convert the Convertible Debentures at any time prior to
stated maturity from and after the date of the following events:
–
–
if the sale price of ProAssurance’s common shares for at least 20
trading days in the 30 trading-day period ending on the last trading
day of the immediately preceding fiscal quarter exceeds 120% of
the conversion price on that 30th trading day,
if ProAssurance calls the Convertible Debentures for redemption,
or
– upon the occurrence of certain corporate transactions.
The share price criterion allowing conversion was met during the quarter ended
December 31, 2007 and holders may convert through March 31, 2008. To date, no
holders have requested conversion.
At December 31, 2007 conversion would be at a rate of 23.9037 common shares for
each $1,000 principal amount of Convertible Debentures; this represents a conversion
price of approximately $41.83 per common share. The conversion rate is subject to future
adjustment should certain corporate events occur, as defined by the related indenture
agreement. Upon conversion, holders will generally not receive any cash payment
representing accrued interest or contingent interest, if any. Instead, accrued interest and
contingent interest will be deemed paid by the common shares received by the holders
on conversion. Convertible Debentures called for redemption may be surrendered for
conversion until the close of business two business days prior to the redemption date.
Upon conversion, ProAssurance has the right to deliver, in lieu of common shares, cash
or a combination of cash and common shares.
Payment at Maturity. Each holder of $1,000 Convertible Debentures will be entitled to
receive $1,000 at maturity, plus accrued interest, including contingent interest, if any.
Sinking Fund. None.
Optional Redemption. ProAssurance may not redeem the Convertible Debentures prior to
July 7, 2008. ProAssurance may redeem some or all of the Convertible Debentures for
cash on or after July 7, 2008, upon at least 30 days but not more than 60 days notice by
mail to holders.
Repurchase Right of Holders. Each holder of the Convertible Debentures may require
ProAssurance to repurchase all or a portion of the holder’s Convertible Debentures on
June 30, 2008, June 30, 2013 and June 30, 2018 at a purchase price equal to the
principal amount of the Convertible Debentures plus accrued and unpaid interest,
including contingent interest, if any, to the date of repurchase. ProAssurance may choose
to pay the purchase price in cash, common shares, or a combination of cash and
common shares. If ProAssurance elects to pay all or a portion of the repurchase price in
common shares, the common shares will be valued at 97.5% of the average sale price
for the 20 trading days immediately preceding and including the third day prior to the
repurchase date.
96
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
10. Long-term Debt (continued)
Change of Control. Upon a change of control of ProAssurance, holders may require
ProAssurance, subject to conditions, to repurchase all or a portion of the Convertible
Debentures. Depending upon the date at which the change of control occurs,
ProAssurance will pay a purchase price equal to a varying percentage of the applicable
principal amount of such Convertible Debentures plus accrued and unpaid interest,
including contingent interest and additional amounts, if any. The percentage is 102% until
June 30, 2008 when it becomes 100%.
ProAssurance may choose to pay the repurchase price in cash, common shares,
common shares of the surviving corporation or a combination of cash and common
shares. If ProAssurance elects to pay all or a portion of the repurchase price in common
shares, the applicable common shares will be valued at 97.5% of the average sale price
of the applicable common shares for 20 trading days commencing after the third trading
day following notice of the occurrence of a change of control.
Events of Default. If there is an event of default under the Convertible Debentures, the
principal amount of the Convertible Debentures, plus accrued interest, including
contingent interest, if any, may be declared immediately due and payable. These
amounts automatically become due and payable if an event of default relating to certain
events of bankruptcy, insolvency or reorganization occurs.
The Convertible Debentures do not require ProAssurance to maintain minimum financial
covenants.
Trust Preferred Subordinated Debentures
The 2032 Subordinated Debentures
In December 2007 ProAssurance redeemed, at face value, the 2032 Subordinated Debentures of
its subsidiary, NCRIC Corporation for cash of $15.5 million.
The 2034 Subordinated Debentures
In April and May 2004, ProAssurance formed two business trusts, (the PRA Trusts) for the sole
purpose of issuing, in private placement transactions, $45.0 million of trust preferred securities (PRA
TPS) and using the proceeds thereof, together with the equity proceeds received from ProAssurance in
the initial formation of the PRA Trusts, to purchase $46.4 million of variable rate subordinated debentures
(the 2034 Subordinated Debentures) issued by ProAssurance. ProAssurance owns all voting securities of
the PRA Trusts and the 2034 Subordinated Debentures are the sole assets of the PRA Trusts. The PRA
Trusts will meet the obligations of the PRA TPS with the interest and principal paid on the 2034
Subordinated Debentures. ProAssurance received net proceeds from the PRA TPS transactions, after
commissions and other costs of issuance, of $44.9 million.
The 2034 Subordinated Debentures are uncollateralized and have the same maturities and other
applicable terms and features as the associated trust preferred securities. Neither requires PRA to
maintain minimum financial covenants. Early redemption is allowed beginning in May 2009. Interest is
payable quarterly at LIBOR + 3.85%, set quarterly based upon the three-month LIBOR rate on the date
that is two banking days preceding the applicable interest payment dates of February 15, May 15, August
15, and November 15, with a maximum rate through May 2009 of 12.5%. Payment of interest may be
deferred for up to 20 consecutive quarters; however, stockholder dividends cannot be paid during any
extended interest payment period or at any time the debentures are in default.
97
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
10. Long-term Debt (continued)
Surplus Notes
The Surplus Notes were assumed in ProAssurance's acquisition of PIC Wisconsin and are
unsecured obligations of PIC Wisconsin, subordinated and junior in the right of payment to the prior
payment in full of all Senior Claims and Senior Indebtedness of PIC Wisconsin. The Surplus Notes are
not guaranteed by ProAssurance, nor any of its subsidiaries, and are effectively subordinated to the
indebtedness and other liabilities of ProAssurance and its other subsidiaries, including insurance policy-
related liabilities. PIC Wisconsin may redeem some or all of the Surplus Notes for cash beginning in May
2009.
Interest is payable quarterly at a fixed annual rate of 7.7% until May 2009. Thereafter the Surplus
Notes bear interest at LIBOR + 3.85%. Each payment of interest and principal, including redemption, may
be made only with the prior approval of the Office of the Commissioner of Insurance of the State of
Wisconsin and only to the extent PIC Wisconsin has sufficient surplus to make such payment.
The Surplus Notes were recorded at fair value on the acquisition date estimated in accordance
with the purchase accounting requirement of SFAS 141. The discount recorded at the acquisition date
totaled $420,000 and is being amortized over the remaining expected life of the debt (until May 2009, the
first redemption date) using the effective interest method. Such amortization is included in the
accompanying financial statements as an addition to interest expense.
Debt Guarantees
ProAssurance has guaranteed that amounts paid to the PRA Trusts under the 2034 Subordinated
Debentures will be remitted to the holders of the associated trust preferred securities. These guarantees,
when taken together with the obligations of ProAssurance under the subordinated debentures, the
Indentures pursuant to which those debentures were issued, and the related trust agreements (including
obligations to pay related trust cost, fees, expenses, debt and other obligations for the Trusts other than
with respect to the common and trust preferred securities of the Trusts), provide a full and unconditional
guarantee of amounts due on the TPS.
Fair Value
At December 31, 2007, the fair value of the Convertible Debentures is approximately 136% of
face value of $107.6 million based on available independent market quotes. At December 31, 2007, the
fair value of the Surplus Notes approximates 101% of their face value of $12.0 million based on available
third party valuation information. The fair value of the 2034 Subordinated Debentures approximates the
face value of the debentures.
98
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
11. Stockholders’ Equity
At December 31, 2007 ProAssurance had 100 million authorized common shares and 50 million
authorized preferred shares. The Board of Directors has the authority to determine the provisions for the
issuance of the preferred shares, including the number of shares to be issued, the designations, powers,
preferences and rights, and the qualifications, limitations or restrictions of such shares. At December 31,
2007, the Board of Directors had not authorized the issuance of any preferred shares nor determined any
provisions for the preferred shares.
At December 31, 2007 approximately 1.5 million of ProAssurance’s authorized common shares
are reserved by the Board of Directors of ProAssurance for award or issuance under incentive
compensation plans as described in Note 12. Additionally, approximately 1.1 million common shares are
reserved for the exercise of outstanding options and unvested performance shares, and 2.6 million
common shares are reserved for issuance related to the Convertible Debentures.
As discussed in Note 1, ProAssurance adopted FIN 48 on January 1, 2007. In accordance with
the guidance provided by FIN 48, retained earnings increased as of January 1, 2007 by the $2.7 million
cumulative effect of adoption.
In April 2007, the Board of Directors of ProAssurance Corporation authorized $150 million to
repurchase its common shares or debt securities. The authorization was effective immediately, but the
timing and quantity of any purchases will depend upon market conditions and changes in ProAssurance's
capital requirements. Additionally, ProAssurance's repurchase activity is subject to limitations that may be
imposed on such purchases by applicable securities laws and regulations, and the rules of the New York
Stock Exchange. During the year ended December 31, 2007 approximately $15.5 million of the
authorization was utilized to redeem debt (see Note 10) and approximately $54.2 million was utilized to
repurchase common shares. As of December 31, 2007 approximately $80.3 million of the authorization
remains available for use.
During 2007, ProAssurance repurchased approximately 1.0 million common shares, all of which
are being held as treasury shares. Treasury shares are reported at cost, and are reflected on the balance
sheet as an unallocated reduction of total equity.
Accumulated other comprehensive income is comprised entirely of unrealized gains and losses
from available-for sale securities, net of tax. For all periods presented, other comprehensive income is
comprised of unrealized gains and losses (net of tax) arising during the period related to available-for-sale
securities less reclassification adjustments for gains (losses) from available-for-sale securities recognized
in current period net income.
Reclassification adjustments related to continuing operations for the years ended December 31,
2007, 2006 and 2005 are as follows (in thousands):
Gains (losses) included in the calculation of income from
continuing operations
Tax effect (at 35%)
Net amount reclassified from other comprehensive income
2007
2006
2005
$ (5,940)
2,079
$ (3,861)
$ 806
$ (1,320)
462
(282)
(858) $ 524
$
Reclassification adjustments related to discontinued operations for the years ended December
31, 2006 and 2005 are as follows (in thousands):
Gains (losses) included in the calculation of income from
discontinued operations
Tax effect (at 35%)
Net amount reclassified from other comprehensive income
2006
2005
$ (574)
201
$ (373)
$ 498
(174)
$ 324
99
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
12. Stock Options and Share-Based Payments
ProAssurance recognized,
in continuing operations, share-based compensation cost of
approximately $8.3 million and $4.7 million and a related tax benefit of approximately $2.8 million and
$1.5 million during the years ended December 31, 2007 and 2006, respectively; share-based
compensation costs are primarily classified as underwriting, acquisition and insurance expenses. In 2006
ProAssurance also recognized, as a component of the gain on the sale of the MEEMIC companies,
share-based compensation expense of approximately $642,000 and a related
tax benefit of
approximately $225,000 related to the accelerated vesting of options held by MEEMIC employees.
ProAssurance provides performance-based stock compensation to employees under the
ProAssurance 2004 Equity Incentive Plan and the ProAssurance Corporation Incentive Compensation
Stock Plan (the Plans). The Compensation Committee of the Board of Directors is responsible for the
administration of the Plans.
Options granted under the Plans since 2002 generally vest at a rate of 20% annually beginning
six months after the grant date. Options granted prior to 2002 were fully vested at the grant date. Options
are generally granted with an exercise price equal to the market price of ProAssurance's common shares
on the date of grant, and have an original term of ten years. ProAssurance issues new shares for options
exercised. In 2007, ProAssurance granted 100,000 options to its new CEO, with the same terms as those
of other options granted under the plan, except that the options vested on the date of grant.
The weighted average fair values of options granted during 2007, 2006 and 2005 and the
assumptions (on a weighted-average basis) used to estimate those fair values as of the date of grant
using the Black-Scholes option pricing model are shown in the following table.
Weighted average fair value
Assumptions:
Risk-free interest rate
Expected volatility
Dividend yield
Expected average term (in years)
2007
$ 16.41
2006
$ 18.37
2005
$ 16.52
4.6%
0.22
0%
5
4.7%
0.25
0%
6
4.3%
0.33
0%
6
Because ProAssurance has limited historical data regarding exercise behavior of its employees,
the expected term of 2007 and 2006 option grants (awarded after adoption of SFAS 123(R)) was
estimated using the methodology provided for in the U.S. Securities and Exchange Commission's Staff
Accounting Bulletin 107, which is the mid-point between the vesting date and the end of the contractual
term of the option. The expected term of 2005 option grants (awarded prior to adoption of SFAS 123R))
was estimated by Management after consideration of publicly available statistics regarding option
behavior. The risk-free interest rate assumptions were based upon a U.S. Treasury instrument with a term
that is similar to the expected term of the option grant. The volatility assumptions were based on the
historical volatility of ProAssurance's stock price for the most recent period (as of the grant date) equal to
the shorter of either the expected term of the option or the period since June 27, 2001, when
ProAssurance was formed. Dividend yields were assumed to be zero since ProAssurance has historically
not paid dividends.
100
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
12. Stock Options and Share-Based Payments (continued)
The following table provides information regarding ProAssurance's outstanding options:
Outstanding at December 31, 2006
Granted under incentive plans
Exercised
Forfeited
Outstanding at December 31, 2007
Exercisable at December 31, 2007
Outstanding, vested or expected to vest
at December 31, 2007
Aggregate
Intrinsic
Value
(in thousands) (1)
Weighted
Average Remaining
Contractual Term
Weighted
Average
Exercise
Price
$ 32.81
$ 53.72
$ 25.81
$ 29.79
$ 40.55
$ 37.02
Options
982,303
268,173
(273,943)
(3,378)
973,155
604,977
– (2)
$ 7,976
$
86
$ 13,984
$ 10,829
959,049
$ 40.46
$ 13,868
7.3 years
7.1 years
7.3 years
(1) Intrinsic value is the difference in the market value of a ProAssurance common share at a given point in time and the option exercise
price
(2) As of the date of grant; all options were granted with an exercise price equal to the current market value of the ProAssurance common
share
At December 31, 2007, unrecognized compensation cost related to non-vested options granted
under ProAssurance's stock compensation plans approximated $2.9 million. That cost is expected to be
recognized over a weighted average period of 1.8 years.
The fair value of options vested during the years ended December 31, 2007, 2006 and 2005 is
$17.0 million, $15.3 million and $11.1 million, respectively. The intrinsic value of options exercised during
2006 and 2005 is $7.9 million and $5.0 million, respectively.
Cash proceeds from options exercised during the years ended December 31, 2007, 2006, and
2005, respectively, totaled $128,000, $210,000, and $3.6 million.
ProAssurance also granted Performance Shares awards to employees in 2007 and 2006 under
the ProAssurance 2004 Equity Incentive Plan. The awards were issued to two groups of employees: PRA
executive officers and other managers. The Performance Shares vest at the end of a three year service
period if one of two Performance Measures is attained. For both groups one Performance Measure is
achievement of a specified financial goal; the other Performance Measure requires achievement of a
specified peer group ranking. The number of Performance Shares that vest if performance criteria are
met can vary (from 75% to 125% of the target award) depending upon the degree to which Performance
Measures are attained. The fair value of each Performance Share was estimated as the market value of
ProAssurance's common shares on the respective date of grant. The following table provides information
regarding ProAssurance's Performance Shares:
100% vesting date
Shares awarded (target)
Grant date fair value
Performance Shares
2006
2007
12/31/2008
12/31/2009
72,000
58,000
$ 51.38
$ 51.48
At December 31, 2007, based on current achievement of the Performance Measures, it is
estimated that approximately 150,000 Performance Shares, having an estimated grant date fair value of
approximately $7.7 million, will ultimately vest. At December 31, 2007 the unrecognized compensation
cost related to Performance Shares is estimated as $4.0 million and is expected to be recognized over a
weighted average period of 1.6 years. Performance Shares having a grant date fair value of
approximately $231,000 at the target level were forfeited in 2007; none were forfeited in 2006.
101
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
12. Stock Options and Share-Based Payments (continued)
Prior to the adoption of SFAS 123(R) ProAssurance applied the intrinsic-value provisions set forth
in APB 25 as permitted by SFAS 123. Accordingly, no compensation expense was recognized for option
grants prior to 2006 since the exercise price of options granted equaled the fair value of ProAssurance’s
common shares on the date of grant. Share-based compensation expense recorded in accordance with
SFAS 123(R) decreased earnings for the year ended December 31, 2006 as follows (in thousands,
except per share data):
Income from continuing operations, before tax
Income from continuing operations, after tax
Income from discontinued operations
Net income
2006
$ 4,669
$ 3,184
$ 417
$ 3,601
Income per share from continuing operations:
Basic
Diluted
$ 0.10
$ 0.09
Net Income:
Basic
Diluted
$ 0.11
$ 0.10
SFAS 123(R) increased 2006 cash flow from financing activities by $1.2 million and decreased
cash flow from operations by the same amount.
No restatement of prior periods is required when SFAS 123(R) is adopted using the modified
prospective transition method. SFAS 123(R) does, however, require disclosure of the effect that applying
the fair value recognition provisions of SFAS 123 would have had on prior periods. The following table
provides the required disclosure (in thousands, except per share data):
Income from continuing operations, as reported
Add: Share-based employee compensation expense included in reported net
income, net of related income taxes
Less: Share-based employee compensation expense determined under fair value
based method of all awards, net of related income taxes
Pro forma income from continuing operations
Earnings per share, continuing operations:
Basic–as reported
Basic–pro forma
Diluted–as reported
Diluted–pro forma
2005
$ 80,026
84
(1,808)
$ 78,302
$
$
$
$
2.66
2.61
2.52
2.47
102
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
13. Earnings Per Share
The following table provides detailed information regarding the calculation of basic and diluted
earnings per share for each period presented:
2007
2005
2006
In thousands except per share data
Basic earnings per share calculation:
Numerator:
Income from continuing operations, net of tax
Income from discontinued operations, net of tax
Net income
Denominator:
Weighted average number of common shares outstanding
$ 168,186
–
$ 168,186
$ 126,984
109,441
$ 236,425
$ 80,026
33,431
$ 113,457
32,960
32,044
30,049
Basic earnings per share:
Income from continuing operations
Income from discontinued operations
Net income
Diluted earnings per share calculation:
Numerator:
$
$
5.10
–
5.10
$
$
3.96
3.42
7.38
$
$
2.66
1.11
3.77
Income from continuing operations, net of tax
$ 168,186
$ 126,984
$ 80,026
Effect of assumed conversion of contingently convertible
debt instruments
Income from continuing operations─diluted computation
Income from discontinued operations, net of tax
Net income–diluted computation
Denominator:
Weighted average number of common shares outstanding
Assumed conversion of dilutive stock options/issuance
of performance shares
Assumed conversion of contingently convertible debt instruments
Diluted weighted average equivalent shares
2,967
171,153
–
$ 171,153
2,967
129,951
109,441
$ 239,392
2,967
82,993
33,431
$ 116,424
32,960
32,044
30,049
291
2,572
35,823
309
2,572
34,925
287
2,572
32,908
Diluted earnings per share:
Income from continuing operations
Income from discontinued operations
Net income
$
$
4.78
–
4.78
$
$
3.72
3.13
6.85
$
$
2.52
1.02
3.54
In accordance with SFAS 128 “Earnings per Share”, the diluted weighted average number of
shares outstanding includes an incremental adjustment for the assumed exercise of dilutive stock options.
The adjustment is computed quarterly; the annual incremental adjustment is the average of the quarterly
adjustments. Stock options are considered dilutive stock options if the assumed conversion of the
options, using the treasury stock method as specified by SFAS 128, produces an increased number of
shares. The average number of ProAssurance’s outstanding options that were not considered to be
dilutive approximated 211,000 during 2007, 180,000 during 2006 and 158,000 during 2005.
103
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
14. Benefit Plans
ProAssurance currently maintains a defined contribution savings and retirement plan that is
intended to provide retirement income to eligible employees. ProAssurance also maintains a non-qualified
deferred compensation plan which allows participating management employees to defer a portion of their
current salary. ProAssurance’s contribution to the savings and retirement plan was $3.3 million, $3.2
million and $2.3 million during the years ended December 31, 2007, 2006 and 2005, respectively.
ProAssurance's contribution to the deferred compensation plan was approximately $125,000 during each
of the years ended December 31, 2007 and 2006; there was no contribution in 2005. ProAssurance's
liability related to the deferred compensation plan consists primarily of employee salary deferrals and
approximated $3.1 million at December 31, 2007 and $1.8 million at December 31, 2006.
When acquired, both PIC Wisconsin and NCRIC maintained defined contribution retirement
benefit plans which were assumed by ProAssurance. On January 1, 2006 the NCRIC plan was merged
into ProAssurance’s existing plan. The PIC Wisconsin plan was similarly merged on January 1, 2007.
ProAssurance incurred expense of approximately $205,000 in 2006 related to the PIC Wisconsin plan
and expense of approximately $72,000 in 2005 related to the NCRIC plan.
15. 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 and certain software and equipment costs which are
deferred under GAAP but expensed for statutory purposes (b) certain deferred income taxes which are
recorded under GAAP but not for statutory purposes and (c) for 2006, the recognition of statutory income
from the sale of the MEEMIC companies which exceeded the gain recorded for GAAP purposes.
The NAIC specifies risk-based capital requirements for property and casualty insurance
providers. At December 31, 2007 statutory capital for each insurance subsidiary was sufficient to satisfy
regulatory requirements. Net earnings and surplus of ProAssurance’s insurance subsidiaries on a
statutory basis are shown in the following table. For all years the table excludes MEEMIC Insurance
Company sold in early 2006 (see Note 3); however, the table does include statutory income of
approximately $282 million related to the sale of the MEEMIC companies. The table includes the statutory
earnings of PIC Wisconsin and NCRIC in the year of acquisition and thereafter (see Note 2). The net
earnings so included are the earnings for the statutory annual period. Consolidated net income, on a
GAAP basis, includes the earnings of PIC Wisconsin and NCRIC only for the periods following
acquisition: August 2006 for PIC Wisconsin and August 2005 for NCRIC.
Net Earnings
2006
2005
2007
Surplus
2007
2006
$ 171
$ 400
$ 69
$1,001
$ 839
In millions
ProAssurance’s insurance subsidiaries are permitted to pay dividends of approximately $162
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.
104
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
16. Variable Interest Entities
ProAssurance holds passive interests in seven limited partnerships/limited liability companies that
are considered to be VIEs under FIN 46(R) guidance. ProAssurance is not the primary beneficiary relative
to these entities and is not required to consolidate the entities under FIN 46(R). The entities are all non-
public investment pools formed for the purpose of achieving diversified equity and debt returns.
ProAssurance's maximum loss exposure relative to these investments is limited to the carrying value of
ProAssurance's investment in the entity. The interests were acquired at various times since January 1,
2001.
ProAssurance's investment in four of the entities represents an ownership interest of less than
7%. These interests are accounted for on the cost basis because ProAssurance has virtually no influence
over the entity. These investments are included in Other Investments and total $34.0 million at December
31, 2007 and $35.1 million at December 31, 2006.
ProAssurance's investment in three of the entities represents an ownership interest of between
9% and 32%. These investments are accounted for using the equity method of accounting because
ProAssurance has a greater than minor interest in the entity. ProAssurance’s investment in these three
entities totals $26.8 million at December 31, 2007 and is included in Investment in Unconsolidated
Subsidiaries.
ProAssurance also holds a direct and beneficial interest in certain high-yield asset backed bonds
contributed to an investment fund created for the purpose of managing such investments. The Company’s
direct beneficial interest in the securities contributed to the fund qualifies as a silo under FIN 46(R).
ProAssurance is considered the primary beneficiary of this silo, and therefore has consolidated its interest
in these securities. The securities are included in Other Investments at fair value ($16.2 million at
December 31, 2007). See Note 4.
ProAssurance also holds all the voting securities issued by certain trusts (the Trusts) as
discussed in Note 10 and such trusts are considered to be VIEs. The Trusts are not consolidated
because ProAssurance is not the primary beneficiary of these trusts. The 2034 Subordinated Debentures
are reported in the accompanying Consolidated Balance Sheet as a component of long-term debt.
ProAssurance’s equity investments in the Trusts total $1.4 million and are included in Other Assets.
105
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007
17. Quarterly Results of Operations (unaudited)
The following is a summary of unaudited quarterly results of operations for 2007 and 2006:
Net premiums earned(1)
Net losses and loss adjustment expenses(1)
Income from continuing operations(2)
Net income
Basic earnings per share:
Income from continuing operations
Net income
Diluted earnings per share:
Income from continuing operations
Net income
Net premiums earned(1)
Net losses and loss adjustment expenses(1)
Income from continuing operations(2)
Income from discontinued operations(2)
Net income
Basic earnings per share:
Income from continuing operations
Income from discontinued operations
Net income
Diluted earnings per share:
Income from continuing operations
Income from discontinued operations
Net income
2007
1st
2nd
3rd
4th
In thousands except per share data
$ 137,177
99,047
36,090
36,090
$ 132,663
98,793
37,621
37,621
$ 135,508
88,108
43,112
43,112
$ 128,165
65,049
51,363
51,363
1.08
1.08
1.02
1.02
1.13
1.13
1.06
1.06
1.32
1.32
1.23
1.23
1.58
1.58
1.47
1.47
1st
2nd
3rd
4th
2006
$ 142,430
111,132
27,835
109,441
137,276
In thousands except per share data
$ 137,420
103,110
29,991
–
29,991
$ 149,444
114,037
33,368
–
33,368
$ 153,772
115,050
35,790
–
35,790
0.89
3.51
4.40
0.84
3.21
4.05
0.96
–
0.96
0.90
–
0.90
1.03
–
1.03
0.96
–
0.96
1.08
–
1.08
1.01
–
1.01
Quarterly and year-to-date computations of per share amounts are made independently; therefore, the sum of per share amounts for the
quarters may not equal per share amounts for the year. In 2006, the difference in the sum of the quarterly per share amounts for
discontinued operations and net income also differ from the annual computation of these amounts due to the shares issued in the
acquisition of PIC Wisconsin in the third quarter of 2006.
(1)From continuing operations
(2)Net of tax
106
ProAssurance Corporation and Subsidiaries
Schedule I – Summary of Investments – Other Than Investments in Related Parties
December 31, 2007
Type of Investment
Fixed Maturities
Bonds:
U.S. Government or government agencies and authorities
States, municipalities and political subdivisions
Foreign governments
Public utilities
All other corporate bonds
Certificates of deposit
Redeemable preferred stock
Total Fixed Maturities
Equity Securities, available-for-sale
Common Stocks:
Banks, trusts and insurance companies
Industrial, miscellaneous and all other
Non redeemable preferred stocks
Total Equity Securities, available-for-sale
Equity Securities, trading
Common Stocks:
Public utilities
Banks, trusts and insurance companies
Industrial, miscellaneous and all other
Total Equity Securities, trading
Other long-term investments(1)
Short-term investments
Total Investments
Cost
or
Amortized
Cost
Amount
Which is
Presented
in the
Balance Sheet
Fair
Value
In thousands
$ 837,778
1,183,990
997
144,420
1,043,958
270
14,727
3,226,140
$ 847,874
1,195,733
990
145,763
1,040,860
270
13,103
3,244,593
$ 847,874
1,195,733
990
145,763
1,040,860
270
13,103
3,244,593
922
3,772
291
4,985
446
2,886
9,812
13,144
1,336
5,980
281
7,597
551
2,594
11,028
14,173
1,336
5,980
281
7,597
551
2,594
11,028
14,173
142,830
220,029
$ 3,607,128
150,254
220,029
$ 3,636,646
143,215
220,029
$ 3,629,607
(1) Other investments include investments reported at cost and investments reported at fair value. Thus, the balance sheet amount
is greater than the "cost" column but less than the "fair value" column.
107
ProAssurance Corporation and Subsidiaries
Schedule II – Condensed Financial Information of Registrant
ProAssurance Corporation – Registrant Only
Condensed Balance Sheets
Assets
Investment in subsidiaries, at equity
Fixed maturities available for sale, at fair value
Equity securities available for sale, at fair value
Equity securities, trading, at fair value
Short-term investments
Cash and cash equivalents
Due from subsidiaries
Other assets
Liabilities and Stockholders’ Equity
Liabilities:
Payable to subsidiaries
Other liabilities
Long-term debt
Stockholders’ Equity:
Common stock
Other stockholders’ equity, including unrealized
gains (losses) on securities of subsidiaries
Total stockholders’ equity
December 31
2007
2006
In thousands
$ 1,250,690
62,493
281
5,203
71,181
3,680
18,848
10,312
$ 1,422,688
$ 1,041,230
204,562
–
–
25,953
366
–
10,603
$ 1,282,714
$
–
15,250
152,368
167,618
336
$
4,369
7,726
152,072
164,167
334
1,254,734
1,255,070
$ 1,422,688
1,118,213
1,118,547
$ 1,282,714
ProAssurance Corporation – Registrant Only
Condensed Statements of Income
Revenues:
Investment income including net realized
investment gains (losses) of $(405),
($1,450) and $63, respectively
Other Income
Expenses:
Interest expense
Other expenses
Income (loss) before income tax expense (benefit)
and equity in net income of subsidiaries
Income tax expense (benefit)
Income (loss) before equity in net income of
subsidiaries
Equity in net income of subsidiaries
Net income
2007
Year Ended December 31
2006
In thousands
2005
$
8,281
131
8,412
$
6,407
174
6,581
$ 2,407
62
2,469
9,204
4,269
13,473
(5,061)
(2,911)
9,063
3,538
12,601
(6,020)
(2,632)
8,416
3,923
12,339
(9,870)
(3,491)
(2,150)
170,336
$ 168,186
(3,388)
239,813
$ 236,425
(6,379)
119,836
$ 113,457
108
ProAssurance Corporation and Subsidiaries
Schedule II – Condensed Financial Information of Registrant (continued)
ProAssurance Corporation – Registrant Only
Condensed Statements of Cash Flow
2007
Year Ended December 31
2006
In thousands
2005
Cash provided (used) by operating activities
$ (21,175)
$
2,529
$
(4,858)
Investing activities
Purchases of:
Fixed maturities, available for sale
Equity securities, available for sale
Proceeds from sale of fixed maturities, available for sale
Net decrease (increase) in short-term investments
Dividends from subsidiaries
Contribution of capital to subsidiaries
Other
(270,449)
(291)
411,996
(45,228)
7,000
(41,202)
3,731
65,557
(416,691)
–
252,360
(15,217)
200,000
(30,410)
(2,794)
(12,752)
(45,734)
–
60,162
(8,059)
3,000
(5,937)
(3,517)
(85)
Financing activities
Repurchase of treasury stock
Subsidiary payments for common shares and share-based
compensation awarded to subsidiary employees
Other
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period
(54,201)
11,175
1,958
(41,068)
3,314
366
$ 3,680
–
7,702
1,453
9,155
(1,068)
1,434
366
$
–
1,990
3,644
5,634
691
743
$ 1,434
Notes to Condensed Financial Statements of Registrant
1. Basis of Presentation
The registrant-only financial statements should be read in conjunction with ProAssurance Corporation’s (PRA Holding)
consolidated financial statements. At December 31, 2007, 2006 and 2005 PRA Holding’s investment in subsidiaries is
stated at the initial consolidation value plus equity in the undistributed earnings of subsidiaries since the date of
acquisition.
Acquisitions/Dispositions
In August 2006 PRA Holding purchased Physicians Insurance Company of Wisconsin, Inc. The acquisition is described in
Note 2 to the Consolidated Financial Statements. In January 2006 PRA Holding sold its indirect subsidiaries, MEEMIC
Insurance Company and MEEMIC Insurance Services, as described in Note 3 to the Consolidated Financial Statements.
The proceeds from the sale of $400 million were paid to an indirect subsidiary of PRA Holding.
109
ProAssurance Corporation and Subsidiaries
Schedule II – Condensed Financial Information of Registrant (continued)
Notes to Condensed Financial Statements of Registrant (continued)
2. Long-term Debt
Outstanding long-term debt, as of December 31, 2007 and December 31, 2006, consisted of the following:
Convertible Debentures due June 2023 (the Convertible Debentures),
unsecured, principal of $107.6 million bearing a fixed interest rate
of 3.9%, net of unamortized discounts of $1.6 million and $1.9
million at December 31, 2007 and 2006, respectively.
Trust Preferred Subordinated Debentures (the 2034 Subordinated
Debentures), unsecured, bearing interest at a floating rate,
adjustable quarterly.
Due
April 2034
May 2034
12/31/2007
Rate
8.7%
8.7%
2007
2006
$ In thousands
$ 105,973
$ 105,677
13,403
32,992
$ 152,368
13,403
32,992
$ 152,072
See Note 10 of the Notes to the Consolidated Financial Statements of PRA Holding and its subsidiaries included herein
for a detailed description of the terms of the long-term debt.
3. Related Party Transactions
PRA Holding received dividends from its subsidiaries of $7.0 million, $200.0 million and $3.0 million during the years
ended December 31, 2007, 2006 and 2005. PRA Holding contributed capital to its subsidiaries of $41.2 million, $30.4
million and $5.9 million during the years ended December 31, 2007, 2006 and 2005.
4. Income Taxes
Under terms of PRA Holding’s tax sharing agreement with its subsidiaries, income tax provisions for individual companies
are allocated on a separate company basis.
5. Cash Flow
In 2007, 2006 and 2005, ProAssurance received reimbursement from its subsidiaries related to share based
compensation that was paid or is to be paid in future periods to employees of the subsidiaries. These reimbursements are
more properly classified as financing activities in the statement of cash flows. In 2006 and 2005, these reimbursements
($7.7 million and $2.0 million, respectively) were classified as a component of cash flow from operations. To conform to
the current year presentation, these amounts have been reclassified from (reducing) cash flow from operations to
(increasing) cash flow from financing activities.
110
ProAssurance Corporation and Subsidiaries
Schedule III–Supplementary Insurance Information
Years Ended December 31, 2007, 2006, and 2005
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
Paid losses and loss adjustment expenses
net of reinsurance
Underwriting, acquisition and insurance expenses:
2007
Continuing Operations
2006
In thousands
2005
22,120
$
2,559,707
218,028
533,513
171,308
$
23,763
2,607,148
253,773
583,067
147,450
$
22,256
2,224,436
264,258
543,241
98,293
455,982
479,621
461,182
(104,985)
(36,292)
(22,981)
(354,786)
(274,933)
(226,112)
Amortization of deferred policy acquisition costs
Other underwriting, acquisition and insurance expenses
Net premiums written
52,855
53,896
506,397
56,944
49,425
543,376
53,967
37,990
521,343
Note: all amounts above are derived entirely from consolidated property and casualty entities.
111
ProAssurance Corporation and Subsidiaries
Schedule IV–Reinsurance
Years Ended December 31, 2007, 2006, and 2005
Property and Liability(1)
Premiums earned
Premiums ceded
Premiums assumed
Net premiums earned
2007
Continuing Operations
2006
In thousands
$ 585,267
(51,797)
43
$ 533,513
$ 627,148
(44,099)
18
$ 583,067
2005
$ 596,289
(53,316)
268
$ 543,241
Percentage of amount assumed to net
0.01%
0.00%
0.05%
(1) All of ProAssurance's premiums are related to property and liability coverages.
112
Exhibit
Number
2
2.1
2.2
2.3
EXHIBIT INDEX
Description
Schedules to the following documents are omitted; the contents of
the schedules are generally described in the documents; and
ProAssurance will upon
the Commission
supplementally a copy of any omitted schedule.
request
furnish
to
Agreement and Plan of Merger among ProAssurance, NCRIC
Group, Inc. and NCP Merger Corporation, dated February 28, 2005,
as amended (1)
Stock Purchase Agreement dated November 7, 2005, among Motors
Insurance Corporation, MEEMIC Insurance Company, MEEMIC
Insurance Services Corporation, MEEMIC Holdings,
Inc. and
ProAssurance Corporation (2)
Agreement and Plan of Merger, dated as of December 8, 2005,
between ProAssurance and PIC Wisconsin, as amended February
14, 2006 (3)
3.1(a)
Certificate of Incorporation of ProAssurance (4)
3.1(b)
Certificate of Amendment
ProAssurance (5)
to Certificate of
Incorporation of
3.2
4
First Restatement of the Bylaws of ProAssurance (6)
ProAssurance will file with the Commission upon request pursuant to
the requirements of Item 601 (b)(4) of Regulation S-K documents
defining rights of holders of ProAssurance’s long-term indebtedness.
10.1(a)
Medical Assurance,
Incentive Compensation Stock Plan
(formerly known as the Mutual Assurance, Inc. 1995 Stock Award
Plan) (7)
Inc.
10.1(b)
Amendment and Assumption Agreement by and between
ProAssurance and Medical Assurance, Inc. (5)
10.1(c)
Amendment and Assumption Agreement by and between Mutual
Assurance, Inc. and MAIC Holdings, Inc. dated April 8, 1996 (8)
10.2
Professionals Insurance Company Management Group 1996 Long
Term Incentive Plan (9)
10.3(a)
ProAssurance Corporation 2004 Equity Incentive Plan (10)
10.3(b)
First amendment to 2004 Equity Incentive Plan (15)
113
10.4
Form of Release and Severance Compensation Agreement dated as
of January 1, 2008 between ProAssurance and each of the following
named executive officers:
Edward L. Rand, Jr.
Howard H. Friedman
Jeffrey P. Lisenby
Darryl K. Thomas
Frank B. O'Neil
10.5
Release and Severance Compensation Agreement between
ProAssurance and Victor T. Adamo effective as of January 1, 2008,
10.6(a)
Employment Agreement between ProAssurance and W. Stancil
Starnes dated as of May 1, 2007 (12)
10.6(b)
Amendment to Employment Agreement (May 1, 2007) with W.
Stancil Starnes effective as of January 1, 2008
10.7
10.8
10.9
10.10
Employment Agreement between ProAssurance and A. Derrill Crowe
effective as of July 1, 2007 (13)
Employment Agreement between ProAssurance and Paul R. Butrus
effective as of January 1, 2008
Consulting Agreement between ProAssurance and William J.
Listwan (11)
Form of Indemnification Agreement between ProAssurance and
each of the following named executive officers and directors of
ProAssurance: (14)
Victor T. Adamo
Lucian F. Bloodworth
Paul R. Butrus
A. Derrill Crowe
Robert E. Flowers
Howard H. Friedman
Jeffrey P. Lisenby
William J. Listwan
John J. McMahon
James J. Morello
Drayton Nabers
John P. North, Jr.
Frank B. O'Neil
Ann F. Putallaz
Edward L. Rand, Jr.
W. Stancil Starnes
Darryl K. Thomas
William H. Woodhams
Wilfred W. Yeargan, Jr.
10.11
ProAssurance Group Employee Benefit Plan which includes the
Executive Supplemental Life Insurance Program (Article VIII) (6)
114
10.12
10.13
21.1
23.1
31.1
31.2
32.1
32.2
Amendment and Restatement of the Executive Non-Qualified Excess
Plan and Trust effective January 1, 2008
Amendment and Restatement of Director Deferred Compensation
Plan effective January 1, 2008
Subsidiaries of ProAssurance Corporation
Consent of Ernst & Young LLP
Certification of Principal Executive Officer of ProAssurance as
required under SEC Rule 13a-14(a)
Certification of Principal Financial Officer of ProAssurance as
required under SEC Rule 13a-14(a)
Certification of Principal Executive Officer of ProAssurance as
required under SEC Rule 13a-14(b) and Section 1350 of Chapter 63
of Title 18 of the United States Code, as amended (18 U.S.C. 1350)
Certification of Principal Financial Officer of ProAssurance as
required under SEC Rule 13a-14(b) and 18 U.S.C. 1350
115
Footnotes
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
Filed as an Exhibit to ProAssurance’s Registration Statement on Form S-
4 (File No. 333-124156) and incorporated herein by reference pursuant
to SEC Rule 12b-32.
Filed as an Exhibit to ProAssurance’s Current Report on Form 8-K for
event occurring November 4, 2005
(File No. 001-16533) and
incorporated herein by reference pursuant to SEC Rule 12b-32.
Filed as an Exhibit to ProAssurance’s Registration Statement on Form S-
4 (File No. 333-131874) and incorporated by reference pursuant to SEC
Rule 12b-32.
Filed as an Exhibit to ProAssurance’s Registration Statement on Form S-
4 (File No. 333-49378) and incorporated herein by reference pursuant to
Rule 12b-32 of the Securities and Exchange Commission (SEC).
Filed as an Exhibit to ProAssurance’s Annual Report on Form 10-K for
the year ended December 31, 2001 (File No. 001-16533) and
incorporated herein by reference pursuant to SEC Rule 12b-32.
Filed as an Exhibit to ProAssurance's Annual Report on Form 10-K for
the year ended December 31, 2004 (File No. 001-16533) and
incorporated herein by reference pursuant to SEC Rule 12b-32.
Filed as an Exhibit to MAIC Holding’s Registration Statement on Form S-
4 (File No. 33-91508) and incorporated herein by reference pursuant to
SEC Rule 12b-32.
Filed as an Exhibit to MAIC Holding’s Proxy Statement for the 1996
Annual Meeting (File No. 0-19439) is incorporated herein by reference
pursuant to SEC Rule 12b-32.
Filed as an Exhibit to Professionals Group’s Registration Statement on
Form S-4 (File No. 333-3138) and incorporated herein by reference
pursuant to SEC Rule 12b-32.
Filed as an Exhibit to ProAssurance’s Definitive Proxy Statement (File
No. 001-165333) on April 16, 2004 and incorporated herein by reference
pursuant to SEC Rule 12b-32.
Filed as an Exhibit to ProAssurance's Current Report on Form 8-K for
event occurring on September 13, 2006 (File No. 001-16533) and
incorporated herein by reference pursuant to SEC Rule 12b-32.
116
(12)
(13)
(14)
(15)
Filed as an Exhibit to ProAssurance’s Current Report on Form 8-K for
the event occurring May 13, 2007 (File No. 001-16533) and incorporated
herein by reference pursuant to SEC Rule 12b-32.
Filed as an Exhibit to ProAssurance’s Current Report on Form 8-K for
event occurring on November 5, 2007 (File No. 001-16533) and
incorporated herein by reference pursuant to SEC Rule 12b-32.
Filed as an Exhibit to ProAssurance's Annual Report on Form 10-K for
the year ended December 31, 2002 (File No. 001-16533) and
incorporated herein by this reference pursuant to SEC Rule 12b-32.
Filed as an Exhibit to ProAssurance's Quarterly Report on Form 10-Q for
the quarter ended September 30, 2006 (File No. 001-16533) and
incorporated herein by this reference pursuant to SEC Rule 12b-32.
117
(This page intentionally left blank)
Exhibit 31.1
CERTIFICATION
I, W. Stancil Starnes, certify that:
1. I have reviewed this report on Form 10-K of ProAssurance Corporation;
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial information included in this
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 report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15 (e)) and
internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the
registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, 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 report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented
in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that
occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the
case of an annual report) that has materially affected, or is reasonably likely to materially affect, the
registrant’s internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal control
over financial reporting which are reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant's internal control over financial reporting.
Date: February 28, 2008
/s/ W. Stancil Starnes
W. Stancil Starnes
Chief Executive Officer
Exhibit 31.2
CERTIFICATIONS
I, Edward L. Rand, Jr., certify that:
1. I have reviewed this report on Form 10-K of ProAssurance Corporation;
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial information included in this
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 report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15 (e)) and
internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the
registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, 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 report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented
in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that
occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the
case of an annual report) that has materially affected, or is reasonably likely to materially affect, the
registrant’s internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal control
over financial reporting which are reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant's internal control over financial reporting.
Date: February 28, 2008
/s/ Edward L. Rand, Jr.
Edward L. Rand, Jr.
Chief Financial Officer
A signed original of this written statement required by Section 906 has been provided to ProAssurance
Corporation and will be retained by ProAssurance Corporation and furnished to the Securities and
Exchange Commission or its staff upon request.
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of ProAssurance Corporation (the “Company”) on Form 10-K for the
year ending December 31, 2007 as filed with the Securities and Exchange Commission on the date
hereof (the “Report”), I, W. Stancil Starnes, Chief Executive Officer of the Company, certify, pursuant to
18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) of the Securities Exchange
Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial
condition and result of operations of the Company.
February 28, 2008
/s/ W. Stancil Starnes
W. Stancil Starnes
Chief Executive Officer
A signed original of this written statement required by Section 906 has been provided to ProAssurance
Corporation and will be retained by ProAssurance Corporation and furnished to the Securities and
Exchange Commission or its staff upon request.
Exhibit 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of ProAssurance Corporation (the “Company”) on Form 10-K for the
year ending December 31, 2007 as filed with the Securities and Exchange Commission on the date
hereof (the “Report”), I, Edward L. Rand, Jr., Chief Financial Officer of the Company, certify, pursuant to
18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) of the Securities Exchange
Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial
condition and result of operations of the Company.
February 28, 2008
/s/ Edward L. Rand, Jr.
Edward L. Rand, Jr.
Chief Financial Officer
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I N V E S T O R I N F O R M A T I O N
There were 32,099,947 shares of ProAoo ssurance
AA
Corporation
published in our proxy statement which is mailed to
common stock outstanding at March 15, 2008. On that date,
stockholders and filed with the Securities and Exchange
EE
Commission
we had 3,872 stockholders of record. Our common stock trades
(the “SEC”). Our filings with the SEC are available in the Investor
on The New York Stock Exchange under the symbol P
EE
RA. Our
stock is listed as ProAoo sr in the stock section of
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USA Today and
y
many major newspapers, and as ProAoo ssurance in
AA
The Wall Street
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Relations section of our website, and from the
EDGAR section of
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the SEC’s website, www.sec.gov/edgar.shtml.
Our Board of Directors has adopted charters for our Audit,
AA
Journal.ll We also post the price of our stock on our website,
WW
Compensation, and Nominating/Corporate Governance Commit-
www.ProAoo ssurance.com.
AA
YOU R SHARES
If you hold your shares through a brokerage account, your
broker or a customer service representative at that firm should
be able to answer questions about your holdings.
If you hold your shares in certificate form, or have shares
held in direct registration (DRS), you may contact our transfer
agent, BNYMYY ellon Shareowner Services, for address changes,
transfer of certificates, and replacement of share certificates
that have been lost or stolen.
You may reach BNYMYY ellon Shareowner Services in a
variety of ways:
Phone
(800) 851-9677
(201) 680-6578
Internet information about your account
www.bnymellon.com/shareowner/isd
tees. In addition the Board has established and adopted Corporate
Governance Principles and a Code of Ethics and
EE
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Conduct. We make
these documents, and other information such as committee compo-
sition and leadership, director independence, and stock ownership
guidelines available in the Governance section of our website.
Our Chairman and then Chief Executive Officer, A. Derrill
Crowe, M.D., submitted the required Section 12(a) CEO
Certification to The New York Stock Exchange in a timely manner
EE
on June 8, 2007. Additionally, we have been timely in the filing
AA
of CEO/CFO certifications as required in Section 302 of the
Sarbanes-Oxley Act. These certifications are published as exhibits
AA
K
in our Form 10K filed with the
SEC on February 28, 2008.
I NVESTOR RE LATIONS
The Investor Relations section of our website also contains
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detailed financial information, SEC filings, the latest news
releases about the Company, and our latest presentation
Hearing Impaired
General information about Mellon
materials. We also maintain an archive of this material,
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(800) 231-5469
www.bnymellon.com
although you should realize that archived information, by its
(201) 680-6610
Mail
BNYMYY ellon Shareowner Services
480 Washington Boulevard
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P.O. Box 358015
very nature, may no longer be accurate.
OBTAI N I NG I N FORMATION DI RECTLY FROM PROASSU RANCE
Any of the documents mentioned above may be obtained
from our Communications and Investor Relations
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Department
N
Jersey City, NJ 07310-1900
Pittsburgh, PAPP . 15252-8015
using one of the contact methods below:
IF YOU STILL HOLD SHARES OF PHYSICIANS INSURANCE
COMPANY OF WISCONSIN (PIC Wisconsin) stock, you should
act quickly to convert your PIC Wisconsin shares into shares of
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ProAoo ssurance. Please phone our
AA
Investor Relations department
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for assistance.
CORPORATE GOVERNANCE AND COMPLIANCE WITH REGULATORY
AND NEW YORK STOCK EXCHANGE REQUIREMENTS
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We post detailed information in the
Corporate Governance and
Investor Relations sections of our website, www.Pro
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AA
Aoo ssurance.com.
Our Board of Directors has adopted a policy regarding
determination of director independence, including categorical
standards to assist in determining independence. These are
E-mail
Mail
Investor@ProAoo ssurance.com Pro
AA
Assurance Corporation
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Investor Relations &
Communications
Phone or Fax
Phone: (205) 877-4400
P.O. Box 590009
Birmingham, AL 35259-0009
(800) 282-6242
Fax: (205) 802-4799
AN N UAL M E ETI NG
The 2008 Annual
AA
Meeting is scheduled for 10:00 AM CDT on
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Wednesday,
May 21, 2008 at the headquarters of ProAoo ssurance
AA
Corporation, 100 Brookwood Place, Birmingham, Alabama 35209.
AA
100 BROOKWOOD PLACE
BIRMINGHAM, ALABAMA 35209
205 8774400
800 2826242
WWW.PROASSURANCE.COM