Treated Fairly
2008 ANNUAL REPORT
®
PROASSURANCE SELECTED FINANCIAL DATA (IN THOUSANDS)
FISCAL YEARS ENDED DECEMBER 31
2004
2005
2006
2007
2008
Income Statement Highlights(1)
Gross premiums written(2)
Total revenues(2)
Income (loss) from continuing
operations, net of tax
Operating income(3)
Net income(4)
Balance Sheet Highlights
Total investments(2)
Total assets, continuing operations
Total assets (5)
Reserve for losses and loss
adjustment expenses(2)
Long-term debt(2)
Total liabilities, continuing operations
$471,482
567,162
177,725
206,980
177,725
$3,575,942
4,280,938
4,280,938
2,379,468
34,930
2,857,353
(1) Includes acquired entities since date of acquisition only. PRA Wisconsin was acquired on August 1, 2006. NCRIC Corporation was acquired on August 3, 2005.
(2) Excludes discontinued operations.
(3) See Page 134 for Reconciliation of Operating Measures to GAAP.
(4) Years 2006 and prior include discontinued operations.
(5) Years 2005 and prior include discontinued operations.
OPERATING INCOME PER
DILUTED SHARE (1)
BOOK VALUE PER SHARE (2)
SHAREHOLDERS’ EQUITY
($ IN MILLIONS)
ASSETS (3)
($ IN MILLIONS)
$6.07
$42.69
$1,424
$4,281
04
05
06
07
08
04
05
06
07
08
04
05
06
07
08
04
05
06
07
08
FISCAL YEARS ENDED DECEMBER 31
(1) See Page 134 for Reconciliation of Operating Measures to GAAP.
(2) Total capital per share of common stock outstanding.
(3) Excludes discontinued operations.
Treating people fairly. It’s a simple principle, really.
“Treated Fairly” is the promise from everyone at
ProAssurance that all of our actions will deliver fair
treatment, informed by the core values that guide our
organization: integrity, respect, doctor involvement,
collaboration, communication, and enthusiasm. From
our founding by physician policyholders over three
decades ago, these values have been at the heart of
our company’s existence. We recognize that we may
not agree on every outcome, but we are committed to
ensuring everyone who deals with ProAssurance is
“Treated Fairly.”
®
There has never been a time when the
discipline and dedication of ProAssurance
has been more important to both our
investors and our insureds
To my fellow Shareholders:
There has never been a time when the
the strongest years in our history, despite the
discipline and dedication of ProAssurance has
tumult of 2008. We are confident that the best
been more important to both our investors
way forward lies along the same path that has
and our insureds. With “Treated Fairly” as our
allowed ProAssurance to succeed in a line of
touchstone, our disciplined operating strategy
business in which so many have failed, espe-
and dedication to unwavering balance sheet
cially with 2009 off to another turbulent start.
strength propelled ProAssurance to one of
The very nature of our professional liability
W. STANCIL STARNES
Chief Executive Officer
coverages requires that we have the financial
strength to respond on behalf of our insureds,
even when that response must come many
years into an unknowable future. Thus, our
strategy compels us to avoid undue risks in our
investment portfolio and adhere to a proven
operational strategy designed to ensure our
long-term ability to protect our insureds.
Our consistent approach has allowed us
to avoid much of the damage done to the
investment portfolios of so many insurance
companies and financial institutions in 2008.
The fact that we were able to grow Book Value
per Diluted Share by 10% and Shareholders’
Equity by 13% in 2008, even though we did have
investment losses, speaks volumes about the
wisdom of our approach. These results con-
tinue to strengthen ProAssurance, and they say
to our insureds that we are as serious about
protecting their long-term interests as we are
about building shareholder value.
We were able to grow Book Value per Diluted Share by
10% and Shareholders’ Equity by 13%
Our financial strength tells only part of the
believe will have an immediate, positive impact
story. The rest is in the long-standing relation-
on our top line, and provide a meaningful
ships we have built with our insureds and our
avenue for future growth.
agent partners. Our year-to-year success is
The largest of the three transactions, which
predicated on our ability to provide a broad
will bring the Podiatry Insurance Company of
range of professional liability coverages at the
America (PICA) into ProAssurance through a
lowest responsible price, backed by a commit-
sponsored demutualization, is expected to close
ment to service that our insureds cannot find
around the time we mail this report to you.
anywhere else. Our 88% retention ratio during
Our purchases of Georgia Lawyers Insurance
a time of intense competition offers proof that
Company and Mid-Continent General Agency
our message of long-term viability and value
have already closed.
resonates with our insureds.
Each of these transactions fulfills an impor-
We have been able to reduce the cost that
tant role in our plans for the future success of
our insureds pay for our policies by responding
ProAssurance. PICA, which insures 70% of the
to improved loss trends in an actuarially sound
nation’s podiatrists, brings
manner. While our pricing reflects a more
approximately $100 million in
benign loss environment, and our top line did
annualized premium into our
experience an expected decline in 2008, we
organization, and expands
believe that we continue to price our product
our business into 48 states,
to maintain the margins we need to ensure our
including California and
We remain committed to a disciplined
approach to our business, and will not
chase market share with inadequate
pricing or poor risk selection.
future financial strength.
New York, where we currently have no market
We remain committed to a disciplined
presence. PICA is a well-managed, highly-rated
approach to our business, and will not chase
organization, with a long track record of profit-
market share with inadequate pricing or poor
ability and brand loyalty.
risk selection. We want to grow when we can
Our purchase of Mid-Continent General
do so prudently and in furtherance of our long-
Agency, like our PICA transaction, opens
term objectives. Thus, in 2008 we were pleased
a window into a medical segment where
to identify three important transactions that we
we now have little presence, but where we
perceive big opportunities. As health care
We think the long-term benefit of this
reforms move the provision of care into the
public reaffirmation of our core beliefs will be
hands of non-physicians, we think the market
enormous. We are defining the honest, open
for insuring these ancillary providers will
manner in which we deal with our customers,
expand. Mid-Continent has a proven track
and as you’ll read elsewhere in this report,
record producing profitable business in this
“Treated Fairly” is already resonating with
growing segment, much of which will now be
our insureds.
moved to ProAssurance.
“Treated Fairly” is also the standard
Equally complementary is our transaction
that guides our interactions with our agent
with Georgia Lawyers Insurance Company.
partners, and, for our investors, “Treated
With that transaction, we have taken the first
Fairly” sets the bar for our commitment to
steps toward opening the southeast to our
transparency and drives our focus on build-
“Treated Fairly” sets the bar for
our commitment to transpar-
ency and drives our focus on
building shareholder value.
lawyers professional
ing shareholder value. For our employees,
liability program. We
“Treated Fairly” sets the stage for how we
have historically written
work with and for each other—and you. In
this business in Indiana,
short, “Treated Fairly” illuminates the day-to-
Michigan and Ohio,
day excellence we expect from everyone here.
and have set a goal of
And it is on behalf of those employees, our
doubling our premium, to approximately $20
dedicated senior management team and our
million per year, in this line. Georgia Lawyers
Board that I thank you for your confidence
gets us halfway to that goal and demonstrates
and investment in ProAssurance.
our commitment to the legal professional
liability line.
Sincerely,
Overarching all of these accomplishments,
and undergirding our plans for 2009 and
beyond, is our broad restatement of the prin-
ciple that has guided ProAssurance since its
W. Stancil Starnes
founding. We unveiled “Treated Fairly” in the
Chief Executive Officer
fourth quarter of 2008 after a year of intensive
research into the needs and wants of our
insureds and agents.
we listen
that’s only fair
I’ve watched ProAssurance live up to its promise of “Treated
Fairly” from almost every aspect of medicine. ProAssurance has
been a dedicated supporter of medicine and physicians in Ohio
and has never wavered in doing the right thing for its physicians.
As a member of a Claims and Underwriting review committee,
I’ve seen first hand how they involve their physicians in their
decision-making and work to understand each unique practice
situation. As a practicing physician, I’ve seen how they stand by
their insured physicians by doing important things such as orga-
nizing support groups for physicians facing a malpractice lawsuit.
As a leader in organized medicine, I’ve seen how seriously each
employee at ProAssurance, from the Chairman on down, takes
their commitment to treat everyone with fairness and respect.
CRAIG W. ANDERSON, M.D.
To me, “Treated Fairly” means keeping your promises. After all, an insurance
policy is simply a piece of paper until you need it, and that’s where ProAssurance
excels. In our Regional Advisory Board meetings we see how ProAssurance lives
up to their promise to offer insured physicians an unfettered defense of their
malpractice claim if there’s no negligence involved. They work with their insureds
to understand every aspect of the case and the desires of the defendant physician.
And in these uncertain financial times, it’s especially important to know that
ProAssurance has the financial strength to be there when they’re needed. That’s
the real message of “Treated Fairly.”
EVA V. ALLEN, M.D.
Pediatrics
Birmingham, Alabama
ProAssurance has deep roots in Florida and, to me, their long-term
commitment is a tremendous example of the concepts behind
“Treated Fairly.” When other companies withdrew from the state
or refused to write new policies because of financial difficulties,
ProAssurance put its financial strength to work to respond to the
needs of Florida doctors. In my mind, the message of “Treated
Fairly” is that ProAssurance keeps the long-term interests of its
insured physicians at the heart of every decision, and they actively
involve their insureds in the process.
MARY E. RAUM, M.D.
Gynecology
Ocala, Florida
BOARD OF DIRECTORS
DIRECTORS
POSITION
DIRECTORS
COMMITTEE(S)
SENIOR OFFICERS
STOCK PRICE PERFORMANCE
TOTAL RETURN PERFORMANCE
200
175
150
125
100
70
12/31/03
ProAssurance Corporation
Russell 2000
SNL Property & Casualty Insurance Index
12/31/04
12/31/05
12/31/06
12/31/07
12/31/08
YEAR
12/31/03
12/31/04
12/31/05
12/31/06
12/31/07
12/31/08
PERIOD ENDING
ProAssurance Corporation
Russell 2000
SNL Property & Casualty
Insurance Index
100.00
100.00
100.00
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, 2008, 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, 2008 was
$1,383,630,033.
As of February 13, 2009, the registrant had outstanding approximately 33,345,880 shares of its common
stock.
Exhibit Index at page 125
Page 1 of 128 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)
(xvi)
The definitive proxy statement for the 2009 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 Registration Statement on 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 Quarterly Report on Form 10-Q for the quarter ended
September 30, 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.
The ProAssurance Corporation Annual Report on Form 10-K for the year ended
December 31, 2007 (File No. 001-16533) is incorporated by reference into Part IV of this
report.
(xvii) The ProAssurance Corporation Registration Statement on Form S-8 (File No. 333-
156645) is incorporated by reference into Part IV of this report.
(xviii) The ProAssurance Corporation Definitive Proxy Statement filed on April 11, 2008 (File
No. 001-16533) is incorporated by reference into Part IV of this report.
(xix)
The ProAssurance Corporation Current Report on Form 8-K for the event occurring May
21, 2008 (File No. 001-16533) is incorporated by reference into Part IV of this report.
2
(xx)
The ProAssurance Corporation Current Report on Form 8-K for event occurring
November 13, 2008 as filed on November 17, 2008 and amended on December 24, 2008
(File No. 001-16533) is incorporated by reference into Part IV of this report.
3
ITEM 1. BUSINESS.
General / Corporate Overview
PART I
ProAssurance Corporation is a holding company for property and casualty insurance companies
focused on professional liability insurance. Throughout this report, references to ProAssurance, “we”, “us”
and “our” refers to ProAssurance Corporation and its consolidated subsidiaries. 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. Because the insurance business uses certain terms and phrases that carry
special and specific meanings, we encourage you to read the Glossary included in this section.
The Investor Home Page on our website provides many resources for investors seeking to learn
more about us. Our annual report on Form 10K, our quarterly reports on Form 10Q, and our current
reports on Form 8K are available on our website as soon as reasonably practical after filing with the
Securities and Exchange Commission (the SEC) on its EDGAR system. 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 (compiled under Statutory Accounting Principals as required by regulation), news
releases that we issue, a listing of our investment holdings, 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.
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, investment valuation and performance, 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.
4
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 areas, that are different
–
–
–
–
–
–
–
–
–
than anticipated;
regulatory, legislative and judicial actions or decisions could affect our business plans or
operations;
the enactment or repeal of tort reforms;
formation of state-sponsored malpractice insurance entities that could remove some
physicians from the private insurance market.
the impact of deflation or inflation;
changes in the interest rate environment;
the effect that changes in laws or government regulations affecting the U.S. economy or
financial institutions, including the Emergency Economic Stabilization Act of 2008 and the
American Recovery and Reinvestment Act of 2009, may have on the U.S. economy and
our business;
performance of financial markets affecting the fair value of our investments or making it
difficult to determine the value of our investments;
changes in accounting policies and practices that may be adopted by our regulatory
agencies and the Financial Accounting Standards Board, or the Securities and Exchange
Commission;
changes in laws or government regulations affecting medical professional liability
insurance or the financial community;
the effects of changes in the health care delivery system;
–
– uncertainties inherent in the estimate of loss and loss adjustment expense reserves and
reinsurance, and changes in the availability, cost, quality, or collectibility of
insurance/reinsurance;
the results of litigation, including pre-or-post-trial motions, trials and/or appeals we
undertake;
–
– bad faith litigation which may arise from our handling of any particular claim, including
failure to settle;
loss of independent agents;
changes in our organization, compensation and benefit plans;
our ability to retain and recruit senior management;
our ability to purchase reinsurance and collect payments from our reinsurers;
increases in guaranty fund assessments;
–
–
–
–
–
– our ability to achieve continued growth through expansion into other states or through
acquisitions or business combinations;
– changes to the ratings assigned by rating agencies to our insurance subsidiaries,
–
–
individually or as a group;
changes in competition among insurance providers and related pricing weaknesses in
our markets; and
the expected benefits from completed and proposed acquisitions may not be achieved or
may be delayed longer than expected due to business disruption, loss of customers and
employees, increased operating costs or inability to achieve cost savings, and
assumption of greater than expected liabilities, among other reasons.
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
5
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.
6
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. Most of the 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 (as defined in GAAP—see definition on page 9) or policyholders’ surplus
(as defined in SAP—see definition on page 12). 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.
7
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 accounting 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.
8
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 and reporting in the U.S.
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. Loss reserves are 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
medical professional service.
9
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.
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 to net premiums earned 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. Net earned premium is 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 paid losses, net of anticipated reinsurance recoveries related to those
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.
10
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 are generally 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.
Recorded Cost Basis: The original cost basis of the security less impairments recognized to-date plus
related accumulated accretion or minus related accumulated amortization.
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.
11
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.
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: Accounting rules imposed by state laws that emphasize the
solvency of insurance companies. A primary objective of SAP is to allow financial statement users to
evaluate whether an insurer has sufficient funds readily available to meet all anticipated insurance
obligations. SAP generally recognizes 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.
12
Business Overview
We operate in a single business segment in the 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.
Our top five states represented 56% of our gross premiums written for the year ended December
31, 2008. 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)
2008
2007
$ 91,116
75,859
33,822
32,640
31,946
206,099
$ 471,482
19%
16%
7%
7%
7%
44%
100%
$ 95,641
89,607
38,188
40,680
41,092
243,866
$ 549,074
(2)
2006
17%
16%
7%
7%
7%
46%
100%
$ 102,998
106,267
40,335
10,702
43,757
274,924
$ 578,983
18%
18%
7%
2%
8%
47%
100%
Alabama
Ohio
Indiana(1)
Wisconsin(2)
Michigan
All other states(3)
Total
(1) Not a top five state in 2007
(2) Not a top five state in 2006
(3) Florida was included in the top five states in 2007 and 2006 (gross premiums written of $41,291 and $53,469, respectively)
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.
During 2008 we introduced “Treated Fairly” a new branding strategy that is being used along with
our new logo to reinforce our public pledge that all of our actions will deliver fair treatment, informed by
the core values that guide our organization: integrity, respect, doctor involvement, collaboration,
communication, and enthusiasm. These values, along with our enduring commitment to financial strength,
the defense of non-meritorious claims and the prompt, fair settlement of those claims with merit, have
been at the heart of our existence since we were founded. Our new brand strategy is the result of almost
a year of intense research into how our target markets perceive ProAssurance and our competitors, and
how our customers expect to be treated.
We maintain 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.
13
Corporate Organization and History
We were incorporated in Delaware as the successor to our predecessor company, Medical
Assurance, Inc. in connection with its merger with Professionals Group, Inc. (Professionals Group) in
June 2001.The following table lists our core operating subsidiaries, most of which were renamed in 2008
in order to reinforce our corporate identity.
Core Operating Subsidiaries
Formerly Operating As:
ProAssurance Indemnity Company, Inc. (PRA Indemnity)
The Medical Assurance Company, Inc.*
ProAssurance Casualty Company (PRA Casualty)
ProNational Insurance Company
ProAssurance National Capital Insurance Company (PRA National)
NCRIC, Inc.
ProAssurance Wisconsin Insurance Company (PRA Wisconsin)
Physicians Insurance Company of Wisconsin, Inc.
ProAssurance Specialty Insurance Company, Inc. (PRA Specialty)
Red Mountain Casualty Insurance Company, Inc.
* We merged Woodbrook Casualty Insurance, Inc. into ProAssurance Indemnity Company, Inc. effective December 31, 2008. Woodbrook
ceased operations when the merger was effective, as PRA Indemnity assumed its policies and obligations.
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.
Recent Developments
In December 2008 we repurchased $23.0 million of our outstanding trust preferred securities for
approximately $18.4 million. We recognized a gain of approximately $4.6 million on the extinguishment of
debt which is discussed in more detail in Note 11 to the Consolidated Financial Statements. The
repurchased securities had been issued in April and May, 2004 as a part of a larger transaction wherein
we issued $45.0 million of trust preferred securities, having a 30-year maturity and callable at par
beginning in May 2009. The proceeds from the sale of the trust preferred securities were used for general
corporate purposes, including contributions to the capital of our insurance subsidiaries to support growth
in our insurance operations.
In December and November of 2008, ProAssurance announced the following acquisitions:
– We completed our purchases of Georgia Lawyers Insurance Company (Georgia Lawyers)
and Mid-Continent General Agency, Inc. (Mid-Continent) in the first quarter of 2009. Georgia
Lawyers provides professional liability insurance for lawyers in the state of Georgia and
reported premiums written of approximately $5.7 million in 2008. Mid-Continent is a
Managing General Agent, based in Houston, Texas producing approximately $26 million a
year in premiums from ancillary healthcare providers and other professional liability
coverages, including approximately $2.7 million of premium produced for ProAssurance.
– We have executed an agreement to acquire The PICA Group (PICA) through a cash
sponsored demutualization. We will purchase all of PICA’s stock for $120 million in cash and
provide a $15 million cash surplus contribution for premium credits to be given to eligible
policyholders over a three year period beginning in 2010. PICA primarily provides
professional liability insurance to podiatric physicians throughout the United States and had
gross written premium of approximately $96 million in 2008. The PICA transaction remains
subject to policyholder approval but is expected to close in the second quarter of 2009.
14
In August 2008 our Board of Directors authorized $100 million to be used for the repurchase of
our common stock or debt securities. As of December 31, 2008 we have used $7.2 million of that
authorization to repurchase approximately 165,000 shares of our common stock, and we used
approximately $18.4 million of that authorization for the repurchase of trust preferred securities, as
previously discussed in this section.
In July 2008, we converted all our outstanding Convertible Debentures (aggregate principal of
$107.6 million) into approximately 2,572,000 shares of ProAssurance common stock. No gain or loss was
recorded related to the conversion, which is discussed in more detail in Notes 11 and 12 to the
Consolidated Financial Statements, included herein.
In December 2007 we redeemed, at face value, for cash, outstanding subordinated debentures of
$15.5 million that became our obligation when we acquired NCRIC Corporation (NCRIC). In April 2007
our Board of Directors authorized $150 million to be used for the repurchase of our common stock and
debt securities. All of the authorization has been utilized for the repurchase of 2.6 million shares of
common stock in 2007 and 2008 and the redemption of the NCRIC debt, as previously discussed.
Effective July 1, 2007 A. Derrill Crowe, M.D. retired as Chief Executive Officer (CEO). 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, and as the Senior and Managing Partner of Starnes & Atchison, LLP, Attorneys at Law,
a firm extensively involved with ProAssurance and its predecessor companies in the defense of its
medical liability claims. On September 22, 2008, Dr. Crowe resigned as non executive Chairman of the
Board and from his position as a director, for personal reasons. On October 16, 2008, our Board of
Directors elected our CEO, W. Stancil Starnes, to serve as the Chairman of the Board.
Effective August 1, 2006 we completed our acquisition of Physicians Insurance Company of
Wisconsin, Inc., now PRA Wisconsin, in an all stock merger. PRA 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.
Effective January 1, 2006 we sold the operating subsidiaries that comprised our personal lines
operations, MEEMIC Insurance Company and MEEMIC Insurance Services (collectively, the MEEMIC
companies), 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. We
used the sale proceeds 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 4 to the Consolidated Financial Statements.
On August 3, 2005 we acquired all of the outstanding common stock of NCRIC Corporation and
its subsidiaries in an all stock merger. NCRIC’s primary business is a single insurance company that
provides medical professional liability insurance principally in the vicinity of the District of Columbia.
Products and Services
We sell professional liability insurance primarily to physicians, dentists, other healthcare providers
and healthcare facilities. We also have a small, but growing, book of legal professional liability business.
We are licensed to do business in every state but Connecticut, Maine, New Hampshire, New York and
Vermont.
We generate the majority of our medical professional liability 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.
15
Marketing
We utilize both direct marketing and independent agents to write our business. For the year
ended December 31, 2008, 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 of medical professional liability insurance 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. Through “Treated Fairly” we emphasize:
– 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.
16
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. In performing their 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 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 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 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 this investigation progresses, our claims department develops an
estimate of the case reserves for each claim. Thereafter, we monitor development of new information
about the claim and adjust the case reserve as loss cost estimates are revised.
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.
17
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, including a requirement that
securities in a loss position cannot be sold without specific authorization from us. See Note 5 to the
Consolidated Financial Statements for more information 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
investors, these are not ratings of our securities nor a recommendation to buy, hold or sell any of our
securities.
The following table presents the claims paying ratings of our group and our core subsidiaries as
of February 10, 2009:
Rating Agency
ProAssurance
Group
PRA
Indemnity
PRA
National
PRA
Wisconsin
PRA
Casualty
PRA
Specialty
Fitch
(www.fitchratings.com)
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)
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.
18
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.
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 compete in a fragmented market 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. We believe that
the largest competitors in our market area are The Medical Protective Company (Berkshire Hathaway)
and The Doctors Company.
Improvements in loss cost trends have allowed us to reduce rates in many markets and offer
targeted new business and renewal retention programs in selected markets. This improves policyholder
retention but decreases 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.
Thus, 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 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 continue to be less disciplined in their pricing, or become more permissive in their
coverage terms, we could lose 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.
19
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
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.
20
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 regulations generally require domestic insurers to obtain prior
approval of extraordinary dividends. Insurance holding company regulations that govern our principal
operating subsidiaries, except PRA National and PRA Wisconsin, deem a dividend as 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 PRA
National, deem 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, which have jurisdiction over PRA Wisconsin,
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 specifies risk-based capital requirements for property and casualty insurance companies.
At December 31, 2008, all of ProAssurance’s insurance subsidiaries exceeded the minimum RBC levels.
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.
21
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, notably Georgia, Florida, Illinois, Missouri, Ohio,
Texas, and West Virginia, enacted tort reform legislation in the early part of this decade as a response to
a rapid deterioration in loss trends. These reforms are generally thought to have contributed to the
improvement in the overall loss trends in those states, although loss trends have also been favorable in
states that did not pass any type of tort reform. In states where these reforms are perceived to have
improved the medical professional liability climate, we have noted an increase in competition.
Appeals are underway in most states where tort reforms were enacted and past experience leads
us to believe some of the reforms will be overturned, although we cannot predict with any certainty how
appellate courts will rule. We continue to monitor developments on a state-by-state basis, and make
business decisions accordingly.
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 2008, as in prior
legislative sessions, but has never been approved in the Senate. We do not expect passage of 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, which
could raise the cost sensitivity of our insureds, or change how health care providers insure their medical
malpractice risks. We expect that a broad range of healthcare reform measures will be proposed in the
newly-elected Congress, with the backing of the new administration. Prior proposals have included
spending limits, price controls, limiting increases in health 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 expect some type of
health care reform, but we cannot predict which reform proposals will be adopted, when proposals might
take effect 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
22
economic independence of our insureds. Medical professionals have found it more difficult to conduct a
traditional fee-for-service practice and many have joined or contractually affiliated 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.
Federal legislation could be passed that regulates the business of insurance directly. There
have been prior attempts to involve the federal government in the regulation of the insurance industry at
some level. We believe that federal regulation of the insurance industry will be considered by Congress
and the new administration. Other federal initiatives, including additional pro-patient protection legislation
that would ultimately affect our business, may also be undertaken.
Employees
At December 31, 2008, we had 551 employees, none of whom are represented by a labor union.
We consider our employee relations to be good.
23
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, each case that is litigated to a jury verdict
increases our risk of incurring a loss that has a material adverse affect on reserves.
To the extent loss reserves prove to be inadequate to meet future claim payments, we would
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 operations 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 or the rating agencies
significantly change the rating criteria that are used to determine ratings, we may not maintain 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.
24
The following table presents the claims paying ratings of our group and our core subsidiaries as
of February 10, 2009:
Rating Agency
ProAssurance
Group
PRA
Indemnity
PRA
National
PRA
Wisconsin
PRA
Casualty
PRA
Specialty
Fitch
(www.fitchratings.com)
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)
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, strong mutuals,
reciprocals, 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.
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
offer, or are currently offering, rates that are lower than we consider to be justified given the risk(s)
involved. 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, 2008 were $3.6 billion, of which $3.0 billion
was invested in fixed maturities. Unrealized pre-tax net investment losses on investments in available-for-
sale fixed maturities were approximately $43.3 million at December 31, 2008.
25
At December 31, 2008, we held equity investments having a fair value of $7.0 million in an
available-for-sale portfolio and held additional equity securities having a fair value of $11.9 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 credit and prepayment risk.
Our portfolio holds mortgage-backed securities which are subject to prepayment risk. A
prepayment is the unscheduled return of principal. When rates decline, the propensity for mortgage
refinancing may increase and the period of time we hold our mortgage-backed securities may shorten
due to prepayments. Prepayments may cause us to reinvest cash flows at lower yields than currently
recognized. Conversely, as rates increase, and motivations for mortgage refinancing lessen, the period
of time we hold our mortgage-backed securities may lengthen, 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
28% of our fixed maturities are asset-backed securities, which are investment grade, (96% AAA, 2% AA,
2% 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 subprime (See
“Investment Exposures” included in Item 7, page 47). We have no exposure to subprime 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
health insurance premiums and/or health savings accounts, limiting the liability of doctors and hospitals
for tort claims, imposing liability on institutions rather than physicians, limiting the premiums that can be
charged for professional liability insurance, 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 joined or contractually affiliated 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.
26
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
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 20.
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 handling 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. These actions have the potential to have a
material adverse effect on our financial condition and results of operations. 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.
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, notably Georgia, Florida, Illinois, Missouri, Ohio,
Texas, and West Virginia, enacted tort reform legislation in the early part of this decade as a response to
a rapid deterioration in loss trends. We cannot predict with any certainty how appellate courts will rule on
these laws. While the effects of tort reform have been generally beneficial to our business in states where
these laws have been enacted, there can be no assurance that such reforms will be ultimately upheld by
the courts. Further, if tort reforms are effective, the business of providing professional liability insurance
27
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 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, 2008 our
Receivable from Reinsurers on Unpaid Losses is $268 million and our Receivable from Reinsurers on
Paid Losses is $18 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.
28
In 2008, guaranty fund refunds/recoupments exceeded current year assessments by $1.3 million
which reduced total acquisition expenses. In 2007, guaranty fund assessments exceeded
refunds/recoupments by approximately $550,000, which increased our total acquisition expenses. 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 the guaranty funds do not provide sufficient information for development of
such ranges.
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.
The current economic environment may have a significant adverse effect on our financial condition and
results of operations.
Economic conditions and the stability of financial markets have significantly deteriorated in 2008,
both in the U.S. and globally. A significant portion of our assets ($3.6 billion or 84%) at December 31,
2008 are financial instruments whose value can be significantly affected by economic and market factors
beyond our control including, among others, the unemployment rate, the strength of the domestic housing
market, the price of oil, changes in interest rates and spreads, consumer confidence, investor confidence
regarding the economic prospects of the entities in which we invest, corrective or remedial actions taken
by the entities in which we invest, including mergers, spin-offs and bankruptcy filings, the actions of the
U.S. government, and global perceptions regarding the stability of the U.S. economy. The U.S.
government has undertaken measures to stabilize the U.S. economy and financial markets, including the
Emergency Economic Stabilization Act of 2008 and the American Recovery and Reinvestment Act of
2009, and measures are also being undertaken by the governments of other leading nations, but there is
no assurance that the measures will be effective. In such an uncertain economy there is increased risk
that the fair value of our investments may decline in the future. Additionally, the financial situation of our
insureds may also decline significantly which could result in an increase in non-renewals or reductions in
the level of coverage purchased. A worsening economy could cause shifts in the frequency and severity
of the claims filed against our insureds. Although we have not experienced such shifts to-date, a
worsening economy could result in actual claims experience that is worse than that estimated by us in
establishing our reserves and premium rates, making our operations less profitable or unprofitable. Our
reinsurers are subject to the same uncertainties and risks. If the downturn is prolonged or if losses
significantly increase, reinsurers may become less willing or unable to meet their obligations to us.
Also, actions of the U.S. government undertaken to improve the overall economy may have a
specific detrimental effect on the value of certain types of investments we own. While future actions
cannot be predicted, it is widely assumed that actions will be undertaken to reduce home mortgage
foreclosures, and it is possible that the actions taken may benefit homeowners more than holders of
mortgages. The fair value of our investments in non-agency mortgage-backed securities that might likely
be affected by mortgage modification efforts approximates $67.4 million ($75.1 million recorded cost
basis). We also hold agency mortgage-backed securities which are guaranteed by Ginnie Mae, Fannie
Mae, or Freddie Mac, having a combined fair value of $522.0 million ($506.3 million recorded cost basis).
Agency mortgage-backed securities may also be affected, although the guarantees provided are intended
to protect bond holders from credit loss.
29
In a period of market illiquidity and instability, the fair values of our investments are more difficult to
assess and our assessments may prove to be greater or less than amounts received in actual
transactions.
In accordance with applicable GAAP, we value 96% of our investments at fair value and the
remaining 4% at cost or equity (primarily holdings in private investment funds) or the current cash
surrender value (BOLI). See Notes 1 and 5 to the Consolidated Financial Statements for additional
information. Approximately 9% of our investments are traded in active markets and we use quoted market
prices to value those investments. We estimate fair values for the remaining 91% of our investments,
based on broker dealer quotes and various other valuation methodologies, which may require us to
choose among various input assumptions and which requires us to utilize judgment. When markets
exhibit much volatility, there is more risk that we may utilize a quoted market price, broker dealer quote,
valuation technique or input assumption that results in a fair value estimate that is either over or
understated as compared to actual amounts received upon disposition or maturity of the security. Also,
from time to time, changes to GAAP guidance may cause us to revise our methodology for valuing a
particular investments or type of investment, which may result in a fair value that differs significantly from
amounts previously determined.
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.
30
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
ITEM 2. PROPERTIES.
We own three office buildings, all of which are unencumbered. In Birmingham, Alabama we own
a 165,000 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 10 to the Consolidated
Financial Statements included herein.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
31
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 relevant background with
ProAssurance and former employers.
W. Stancil Starnes
Victor T. Adamo
Howard H. Friedman
Jeffrey P. Lisenby
Frank B. O’Neil
Edward L. Rand, Jr.
Mr. Starnes was appointed as Chief Executive Officer of ProAssurance
effective July 2, 2007 and has served as the Chairman of the Board
since October 2008. 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 60)
Mr. Adamo has been the President of ProAssurance since its inception.
Mr. Adamo joined the predecessor to Professionals Group in 1985 as
general counsel and was elected as Professionals Group CEO in 1987.
From 1975 to 1985, Mr. Adamo was in private legal practice and
represented the predecessor to Professionals Group. Mr. Adamo is a
Chartered Property Casualty Underwriter. (Age 60)
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 50)
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 has served as Vice President and head of the corporate
Legal Department since 2001. Mr. Lisenby also previously practiced law
privately 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 40)
Mr. O’Neil was appointed as our Senior Vice President of Corporate
Communications and Investor Relations in September 2001. Mr. O’Neil
first joined our predecessor in 1987 and has been our Senior Vice
President of Corporate Communications since 1997. (Age 55)
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 42)
32
Darryl K. Thomas
Mr. Thomas has been with ProAssurance since its inception and
currently serves as a Co-President of our Professional Liability Group, a
position he has held since October 2005, and as our Chief Claims
Officer. Previously, Mr. Thomas was Senior Vice President of Claims for
Professionals Group. Prior to joining the predecessor to Professionals
Group 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 51)
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.
33
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
At February 13, 2009, ProAssurance Corporation (PRA) had 3,853 stockholders of record and
33,345,880 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
2008
2007
High
$ 58.65
55.19
64.85
55.07
Low
$ 49.90
48.11
45.61
41.78
High
$ 52.83
57.30
56.17
57.19
Low
$ 48.67
51.00
48.69
50.46
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 20 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, 2008.
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)
1,179,061
$42.48*
2,000,000
–
–
–
*Exclusive of 165,403 performance shares which have no exercise price.
Issuer Purchases of Equity Securities
The following table provides information regarding ProAssurance's shares purchased as part of
publicly announced plans or programs.
Period
January 1-31, 2008
February 1-29, 2008
March 1-31, 2008
April 1-30, 2008
May 1-31, 2008
June 1-30, 2008
July 1-31,2008
August 1-31, 2008
September 1-30, 2008
October 1-31, 2008
November 1-30, 2008
December 1-31, 2008
Total
Total Number
of Shares
Purchased
239,966
–
205,247
3,000
241,162
544,527
359,617
–
–
–
118,400
46,144
1,758,063
Average
Price Paid
per Share
$ 53.95
–
$ 51.11
$ 52.02
$ 50.23
$ 50.11
$ 48.23
–
–
–
$ 43.54
$ 44.86
$ 49.81
Total Number of Shares
Purchased as Part of Publicly
Announced Plans or
Programs
239,966
–
205,247
3,000
241,162
544,527
359,617
–
–
–
118,400
46,144
1,758,063
Approximate Dollar Value of Shares
that May Yet Be Purchased Under
the Plans or Programs(1)
$ 67,389,790
$ 67,389,790
$ 56,899,430
$ 56,743,370
$ 44,628,753
$ 17,343,229
$ 100,000,088
$ 100,000,088
$ 100,000,088
$ 100,000,088
$ 94,844,686
$ 74,409,144
(1) Shown net of authorizations used for repurchase of debt.
34
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 revenues (3)
Total revenues (2)
Year Ended December 31
2008
2007
2006
2005
2004
(In thousands except per share data)
$ 471,482
$ 549,074
$ 578,983
$ 572,960
$ 573,592
429,007
506,397
543,376
521,343
535,028
503,579
585,310
627,166
596,557
555,524
(44,301)
(51,797)
(44,099)
(53,316)
(35,627)
459,278
533,513
583,067
543,241
519,897
158,384
171,308
147,450
98,293
76,627
(7,997)
(50,913)
8,410
1,630
(5,939)
5,556
2,339
(1,199)
5,941
900
912
4,604
1,042
7,572
2,419
567,162
706,068
737,598
647,950
607,557
Net losses and loss adjustment expenses (2)
Income (loss) from continuing operations
211,499
350,997
443,329
438,201
460,437
177,725
168,186
126,984
80,026
43,043
Net income
$ 177,725
$ 168,186
$ 236,425
$ 113,457
$ 72,811
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
$
$
$
$
5.43
5.22
5.43
5.22
$
$
$
$
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
32,750
34,362
32,960
35,823
32,044
34,925
30,049
32,908
29,164
31,984
$3,575,942
$3,639,395
$3,492,098
$2,614,319
$2,145,609
4,280,938
4,440,808
4,342,853
3,341,600
2,743,295
Total assets
4,280,938
4,440,808
4,342,853
3,909,379
3,239,198
Reserve for losses and loss
adjustment expenses (2)
Long-term debt (2)
Total liabilities from continuing operations
2,379,468
2,559,707
2,607,148
2,224,436
1,818,636
34,930
164,158
179,177
167,240
151,480
2,857,353
3,185,738
3,224,306
2,806,820
2,333,405
Total capital
$ 1,423,585
$1,255,070
$1,118,547
$ 765,046
$ 611,019
Total capital per share of common
stock outstanding
$
42.69
$
38.69
$
33.61
$
24.59
$
20.92
Common stock outstanding at end of year
(1) Includes acquired entities since date of acquisition, only. PRA Wisconsin was acquired on August 1, 2006. NCRIC Corporation was acquired on
31,109
33,276
33,346
32,443
29,204
August 3, 2005.
(2) Excludes discontinued operations.
(3) Includes a gain on extinguishment of debt of $4.6 million for the period ended December 31, 2008.
35
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 conformity with U.S. generally accepted
accounting principles (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 ongoing 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 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 claim 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, for medical professional liability, the trend of health care costs. 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 claims
frequency, historical paid and incurred loss development trends, the effect of inflation, general economic
trends and the legal and political 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.
External actuaries review our reserve for losses at least semiannually in order to provide
management with an independent viewpoint and broader perspective regarding our loss experience and
industry loss trends. We compile loss and exposure data from our own company experience which is
analyzed by both the external actuaries and our internal actuarial staff. In establishing reserves,
management considers the estimates and inputs of our internal actuarial staff as well as those of our
external actuaries. Factors considered by management and the actuaries in establishing reserves include
known or estimated changes in the frequency and severity of claims, loss retention levels and premium
rates.
36
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 professional liability losses, we establish the initial
loss estimates at a level which is approximately 8 to 10% above our pricing assumptions. This difference
recognizes the volatility of the professional liability loss environment and the risk in determining pricing
parameters. As each accident year matures we analyze reserves in a variety of ways and use multiple
actuarial methodologies in performing these analyses, including:
– Bornhuetter-Ferguson Method
– Paid Development Method
– Reported Development Method
– Average Paid Value Method
– Average Reported Value Method
– Backward Recursive Method
A brief description of each method follows. The descriptions require some explanation as to how
we and actuaries view our reserves. We segment our reserves by accident year, which is the year in
which the claim becomes our liability. As claim payments are made, they are aggregated by accident year
for analysis purposes. We also segment our reserves by reserve type: case reserves and IBNR (incurred
but not reported) reserves. Case reserves are established by our claims department based upon the
particular circumstances of each reported claim and represent our estimate of the future loss costs (often
referred to as expected losses) that will be paid on reported claims. Case reserves are decremented as
claim payments are made and are periodically adjusted upward or downward as claim department
estimates regarding the amount of future losses are revised; reported loss is the case reserve at any
point in time plus the claim payments that have been made to date. IBNR reserves represent our estimate
of the loss costs that will eventually be paid on all claims, less the case reserves we have established.
Bornhuetter-Ferguson Method. We use both the Paid and the Reported Bornhuetter-Ferguson
methods. The Paid method assigns partial weight to initial expected losses for each accident year (initial
expected losses being the first established case and IBNR reserves for a specific accident year) and
partial weight to paid to-date losses. The Reported method assigns partial weight to the initial expected
losses and partial weight to current reported losses. The weights assigned to the initial expected losses
decrease as the accident year matures.
Paid Development and Reported Development Method. These methods use historical, cumulative
losses (paid losses for the Paid Development Method, reported losses for the Reported Development
Method) by accident year and develops those actual losses to estimated ultimate losses based upon the
assumption that each accident year will develop to estimated ultimate cost in a manner that is analogous
to prior years, adjusted as deemed appropriate for the expected effects of known changes in the claim
payment environment (and case reserving environment for the Reported Development Method), and, to
the extent necessary, supplemented by analyses of the development of broader industry data.
Average Paid Value and Average Reported Value Methods. In these methods, average claim
cost data (paid claim cost for the Average Paid Value Method and reported claim cost for the Reported
Value Method) is developed to an ultimate average cost level by report year based on historical data.
Claim counts are similarly developed to an ultimate count level. The average claim cost (after rounding
and adjustment, if necessary, to accommodate report year data that is not considered to be predictive) is
then multiplied by the ultimate claim counts by report year to derive ultimate loss and ALAE.
Backward Recursive Development Method. This method is an extrapolation on the movements in
case reserve adequacy in order to estimate unpaid loss costs. Historical data showing incremental
changes to case reserves over progressive time periods is used to derive factors that represent the ratio
of case reserve values at successive maturities. Historical claim payments data showing the additional
payments in progressive time periods is used to derive factors that represent the portion of a case
reserve paid in the following period. Starting from the most mature period, after which all the case reserve
is paid and the case reserve is exhausted, the next prior ultimate development factor for the prior case
reserve can be calculated as the case factor times the established ultimate development factor plus the
37
paid factor. For each successive prior maturity, the ultimate development factor is calculated similarly.
The result of multiplying the ultimate development factor times the case reserve is the total indicated
unpaid.
Generally, methods such as the Bornhuetter-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.
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
$1.611 billion
$1.752 billion
Carried Reserve High End Point
$ 2.111 billion
$ 2.111 billion
$2.685 billion
$2.440 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 as has been the case in
2008, 2007 and 2006.
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.
38
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, 2008 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 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. 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 any 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. Also, 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. 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.
Investment Valuations
We adopted a new accounting pronouncement, Statement of Financial Accounting Standards
157, Fair Value Measurements, effective January 1, 2008. The new pronouncement revises the definition
of fair value and establishes a framework for measuring fair value. The pronouncement defines fair value
as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date. The framework establishes a three level hierarchy
for valuing assets and liabilities based on how transparent (observable) the inputs are that are used to
determine fair value. For example, a quoted market price for an actively traded security on an established
trading exchange is considered the most transparent (observable) input used to establish a fair value for
that security and is classified as a Level 1 in the fair value hierarchy. An investment valued using multiple
broker dealer quotes is considered to be valued using observable input that is not as transparent as a
quoted market price on an exchange and is classified as a Level 2. An investment valued using either a
single broker dealer quote or based on a cash flow valuation model is considered to be valued based on
limited observable input and a significant amount of judgment and is classified as Level 3. For further
information on the adoption of the pronouncement and the fair value of our investments, see Note 2 to the
Consolidated Financial Statements.
Virtually all of our financial assets are comprised of investments recorded at fair value. Of the
Company's investments recorded at fair value totaling $3.4 billion, approximately 98% of our investments
are based on observable market prices or observable market parameters (i.e. broker quotes, benchmark
yield curves, issuer spreads, bids, etc.). The availability of observable market prices and pricing
parameters (referred to as observable inputs) can vary from investment to investment. We utilize
observable inputs, where available, to value our investments. In many cases, we obtain multiple
observable inputs for an investment to derive the fair value without requiring significant judgments.
We use a pricing service, Interactive Data Corporation (IDC), to value our investments that have
an exchange traded price or multiple observable inputs. We do not utilize IDC to price investments that do
not have multiple observable inputs (Level 3). IDC discloses the inputs used for each asset class that it
prices. We review the inputs for the asset classes we own in order to make the appropriate level
designation.
All securities priced by IDC using an exchange traded price are designated by us as Level 1.
Level 1 investments are currently limited to exchange traded common and preferred equity securities, and
money market funds with quoted Net Asset Values (NAVs).
39
We designate as Level 2 those securities not actively traded on an exchange for which IDC uses
multiple verifiable observable inputs including last reported trade, non-binding broker quotes, benchmark
yield curves, issuer spreads, two sided markets, benchmark securities, bids, offers, and assumed
prepayment speeds.
IDC provides a single price per instrument quoted. We review the pricing for reasonableness
each quarter by comparing market yields generated by the supplied price versus market yields observed
in the market place. If a supplied price is deemed unreasonable, we will challenge the price with IDC and
make adjustments if deemed necessary. To date, we have not adjusted any prices supplied by IDC.
For securities that do not have multiple observable inputs (Level 3), we do not rely on a price from
IDC. Our Level 3 assets, which primarily are private placements and limited partnerships, are valued by
management either using non-binding broker quotes or pricing models that utilize market based
assumptions which have limited observable inputs including treasury yield levels, issuer spreads and non-
binding broker quotes. The valuation techniques involve some degree of judgment. Approximately $53
million (2% of investments recorded at fair value) are valued in this manner.
Most of our investments recorded at fair value are considered available-for-sale with a small
portion classified as trading. For investments considered available-for-sale, changes in the fair value are
recognized as unrealized gains and losses and are included, net of related tax effects, in stockholders'
equity as a component of other comprehensive income (loss). Gains or losses on these investments are
recognized in earnings in the period the investment is sold or an other-than-temporary impairment is
deemed to have occurred. Changes in the fair value of investments considered as trading are recorded in
realized investment gains and losses in the current period.
We also have other investments, primarily comprised of equity interests in private investment
funds (non-public investment partnerships and limited liability companies), $44.5 million of which are
accounted for using the equity method and $31.0 million of which are carried at cost. We evaluate these
investments for other-than-temporary impairment by considering any declines in fair value below the
recorded value. Determining whether there has been a decline in fair value involves assumptions and
estimates as there are typically no observable inputs to determine the fair value of these investments.
We evaluate all our investments on at least a quarterly basis for declines in fair value that
represent other-than-temporary impairments. Some of the factors we consider in the evaluation of our
investments are:
(cid:16) the extent to which the fair value of an investment is less than its recorded basis,
(cid:16) the length of time for which the fair value of the investment has been less than its
recorded basis,
(cid:16) 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,
(cid:16) third party research and credit rating reports,
(cid:16) the extent to which the decline in fair value is attributable to credit risk specifically
associated with an investment or its issuer,
(cid:16) the extent to which we believe market assessments of credit risk for a specific
investment or category of investments are either well founded or are speculative,
(cid:16) our internal assessments and those of our external portfolio managers regarding
specific circumstances surrounding an investment, which can cause us to believe
the investment is more or less likely to recover its value than other investments
with a similar structure,
(cid:16) for asset-backed securities: the origination date of the underlying loans, the
remaining average life, the probability that credit performance of the underlying
loans will deteriorate in the future, and our assessment of the quality of the
collateral underlying the loan, 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.
40
Determining whether a decline in the fair value of investments is an other-than-temporary
impairment may also involve a variety of assumptions and estimates, particularly for investments that are
not actively traded in established markets or during periods of market dislocation. For example, assessing
the value of certain investments requires us to perform an analysis of expected future cash flows or
prepayments. For investments in tranches of structured transactions, we are required to assess the credit
worthiness of the underlying investments of the structured transaction.
When we judge a decline in fair value to be other-than-temporary, we reduce the 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
recorded cost basis of the investment.
Deferred Policy Acquisition Costs
Policy acquisition costs, primarily commissions, premium taxes and underwriting salaries, which
are 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 each reporting period and any amounts estimated to
be unrecoverable are charged to expense in the current period.
Deferred Taxes
Deferred federal income taxes arise from the recognition of temporary differences between the
basis of assets and liabilities determined for financial reporting purposes and the basis determined for
income tax purposes. Our temporary differences principally relate to loss reserves, unearned premiums,
deferred policy acquisition costs, unrealized investment gains (losses) and investment impairments.
Deferred tax assets and liabilities are measured using the enacted tax rates expected to be in effect when
such benefits are realized. We review our deferred tax assets quarterly for impairment. If we determine
that it is more likely than not that some or all of a deferred tax asset will not be realized, a valuation
allowance is recorded to reduce the carrying value of the asset. In assessing the need for a valuation
allowance, management is required to make certain judgments and assumptions about the future
operations of ProAssurance based on historical experience and information as of the measurement
period regarding reversal of existing temporary differences, carryback capacity, future taxable income,
including its capital and operating characteristics, and tax planning strategies.
Goodwill
We make at least an annual assessment as to whether the value of our goodwill assets is
impaired. Management evaluates the carrying value of goodwill annually during the fourth quarter and
before the annual evaluation if events occur or circumstances change that would more likely than not
reduce the fair value below the carrying value. In assessing goodwill, management estimates the fair
value of the reporting unit and compares that estimate to external indictors such as market capitalization.
We concluded in 2008, 2007 and 2006 that the fair value of our reporting unit exceeded the carrying
value and no adjustment to impair goodwill was necessary.
41
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 and other 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 2007
data, we are the fifth largest medical professional liability insurance writer in the nation, and we believe
we are the largest medical professional 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 understand the importance of the professional
identity and reputation of our insureds. An important part of our strategy is to emphasize the needs of our
insureds throughout our operations. We attempt to further our understanding of those needs through the
use of advisory boards and operational committees that ensure we understand the challenges facing our
insureds and ways we may best assist them. We also believe that it is important to employ medical and
legal professionals throughout our organization, especially on our senior management team. We
emphasize our pledge that each insured professional will be treated fairly in all of our conduct with them
and that all of our business actions will be informed by the core values that guide our organization:
integrity, respect, doctor involvement, collaboration, communication and enthusiasm. We believe our
strategy allows 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 and through conservative investment 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 financial strength 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.
42
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
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
2008 and to offer targeted new business and renewal retention programs in selected markets. In 2008 we
launched a new branding campaign, “Treated Fairly”, which we believe will help us emphasize our fair
treatment of our insureds and other important stakeholders. We are emphasizing “Treated Fairly” in all of
our activities, and we believe that as we reach more customers with this message we will both improve
retention and add new insureds, both of which will help offset the effects of lower rates.
We also believe our recent acquisition of Georgia Lawyers (which will be merged into PRA
Casualty) and Mid-Continent, along with our pending acquisition of PICA will add at least $100 million of
premium during 2009. In addition to providing an avenue for premium growth, we believe these
transactions will also broaden our business footprint and diversify our book of business.
PICA will become part of ProAssurance in the second quarter of 2009 if its eligible policyholders
approve the planned sponsored demutualization. PICA is the nation's leading provider of professional
liability insurance to doctors of podiatric medicine, with a market share of approximately 70%. PICA
insures approximately 9,800 podiatric physicians in 47 states and the District of Columbia, and its PACO
subsidiary provides professional liability insurance for approximately 7,000 chiropractors and writes Errors
& Omissions insurance for a small, but growing, number of independent insurance agents. PICA wrote
approximately $96 million in premium in 2008, has $336 million in total assets and has maintained an
A.M. Best rating of "A-" (Excellent) for the past 13 years.
PICA’s near-universal licensure will help us become a national writer of medical professional
liability insurance, and its experience in markets in which we do not write could make it easier for us to
expand our existing medical professional liability lines. Further, its experience in writing high volume,
lower cost professional liability policies, such as those for chiropractors, will be advantageous as we
expand our allied health care professional liability business.
We expect our acquisition of Mid-Continent, which closed in January of 2009, to also broaden our
market presence in the rapidly expanding professional liability market for allied health care providers such
as nurse practitioners, home health care nurses, medical technicians and other similar professionals.
Under almost every likely healthcare reform scenario these professionals are likely to have a greater role
in the delivery of health care and we believe their need for professional liability coverages will expand as
their responsibilities expand.
Mid-Continent, which underwrote approximately $26 million in premium in 2008, also underwrites
other lines of professional and general liability coverage. In 2008, Mid-Continent generated approximately
$2.7 million of premium for ProAssurance. Business they underwrite, but do not place with ProAssurance,
will generate commission income for us.
Our acquisition of Georgia Lawyers was completed in February of 2009, and we believe we can
use that business as a springboard for expansion in the legal professional liability market throughout the
southeast. We have written legal professional liability
43
insurance for attorneys in Indiana, Michigan and Ohio since 1995. We have publicly stated our intention
to double our premiums from this line of business to $20 million, and we expect Georgia Lawyers to help
us achieve that goal. Georgia Lawyers wrote approximately $5.7 million of direct written premium in 2008,
and insured about 2,700 attorneys, most in small-to-medium sized practices. This increases the size of
our legal professional liability book, in terms of both premium and insureds, by approximately 50%.
We have also taken steps to broaden the distribution of our legal professional liability policies by
adding business through Grayhawk General Agency, Inc. (Grayhawk) and ProLawyer Insurance, LLC
(ProLawyer).
Grayhawk, which is based in the Phoenix area, solicits business in Arizona, California, Colorado,
Nevada, and Washington, and seeks to expand its business throughout the west. ProLawyer, based in
Philadelphia, writes business in Delaware, the District of Columbia, Maryland, New Jersey, Pennsylvania,
and Virginia, and seeks to expand in the mid-Atlantic states.
Recent Accounting Pronouncements and Guidance
In May 2008, the FASB issued FASB Staff Position (FSP) APB 14-1, Accounting for Convertible
Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement),
which will alter the accounting for our Convertible Debentures. FSP APB 14-1 requires issuers to account
for convertible debt securities that allow for either mandatory or optional cash settlement (including partial
cash settlement) by separating the liability and equity components in a manner that reflects the issuer's
nonconvertible debt borrowing rate at the time of issuance and requires recognition of additional (non-
cash) interest expense in subsequent periods based on the nonconvertible rate. Additionally, FSP APB
14-1 requires that when such debt instruments are repaid or converted any consideration transferred at
settlement is to be allocated between the extinguishment of the liability component and the reacquisition
of the equity component. FSP APB 14-1 will become effective for ProAssurance on January 1, 2009 and
must be applied retrospectively with a cumulative effect adjustment being made as of the earliest period
presented. Early adoption is not permitted. In July of 2008 we converted all of our outstanding Convertible
Debentures and are currently assessing the impact that the adoption will have on our financial condition
and results of operations but expect no impact on total Stockholders' Equity.
In December 2007 the FASB issued SFAS 160, Noncontrolling Interests in Consolidated
Financial Statements. 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 an effect on our results of operations or financial
position.
In December 2007 the FASB issued SFAS 141 (Revised December 2007), Business
Combinations. 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.
44
Accounting Changes
FSP EITF 99-20-1, Amendments to the Impairment Guidance of EITF Issue No 99-20, was
issued in January 2009 to amend the impairment guidance in EITF Issue No. 99-20, Recognition of
Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue
to Be Held by a Transferor in Securitized Financial Assets. EITF 99-20 specifies that an impairment is
considered other-than-temporary if, based on an estimate of cash flows that a market participant would
use in determining the current fair value, there has been an adverse change in those estimated cash
flows. FSP EITF 99-20-1 alters this guidance by specifying that an impairment be considered other-than-
temporary if it is “probable” there has been an adverse change in the holder’s estimated cash flows from
those previously projected. We adopted FSP EITF 99-20-1 as of December 31, 2008 and considered the
guidance provided therein in our impairment evaluations performed as of December 31, 2008. There was
no material effect from adoption.
In September 2006, the FASB issued SFAS 157, Fair Value Measurements. The standard
revises the definition of fair value, 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 establish new guidance
regarding the assets and liabilities required or allowed to be measured at fair value. The statement is
effective for fiscal years beginning after November 15, 2007, with early adoption permitted. We adopted
SFAS 157 on January 1, 2008. We did not recognize any cumulative effect related to the adoption of
SFAS 157 and the adoption did not have a significant effect on our 2008 results of operations or financial
condition.
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 permits many
financial assets and liabilities to be reported at fair value that are not otherwise required under GAAP to
be measured at fair value. Under SFAS 159 guidance, the election of fair value treatment is specific to
individual assets and liabilities, with changes in fair value recognized in earnings as they occur. The
election of fair value measurement is generally irrevocable. SFAS 159 is effective for fiscal years
beginning after November 15, 2007, with early adoption permitted. We adopted SFAS 159 on January 1,
2008 but did not elect fair value measurement for any financial assets or liabilities that were not otherwise
required to be measured at fair value.
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 16 of our Notes to the Consolidated Financial Statements for additional information
regarding the ordinary dividends that can be paid by our insurance subsidiaries in 2009. At December 31,
2008 we held cash and investments of approximately $204 million outside of our insurance subsidiaries
that are available for use without regulatory approval. Cash of approximately $135 million will be used in
the ProAssurance-sponsored demutualization of PICA, $15 million of which will be a surplus contribution
to PICA. The transaction is expected to close in the second quarter of 2009 (see Note 10 to the
Consolidated Financial Statements).
45
Cash Flows
The principal components of our operating cash flows 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 any associated reinsurance recoveries. Our operating activities provided positive
cash flows of approximately $164.8 million and $244.1 million for the years ended December 31, 2008
and 2007, respectively.
The decline in operating cash flows during 2008 as compared to 2007 is primarily attributable to:
(In millions)
Cash Flow
Increase (Decrease)
Lower premium receipts due to the decline in premiums written
Increase in net premium payments to reinsurers, including the effect of refunds
received related to prior years; greater refunds were received in 2007
Net trading securities purchases in 2008 versus net trading securities sales in 2007
Decrease in gross losses paid
Increase in reinsurance recoveries, including commutation receipts of $27 million
Other amounts not individually significant, net
Net decrease in operating cash flows
$ (96)
(19)
(46)
38
37
7
$ (79)
Two metrics commonly used to analyze the operating cash flows of insurance companies are the
net paid-to-incurred ratio and the net paid loss ratio.
Net paid-to-incurred ratio
Net paid loss ratio
Year Ended December 31
2008
157.4%
72.5%
2007
101.1%
66.5%
The net paid-to-incurred ratio is calculated as net paid losses divided by net incurred losses. The
net paid loss ratio is calculated as net paid losses divided by net premiums earned. In calculating both of
these ratios, net paid losses is defined as losses and loss adjustment expenses paid during the period,
net of the anticipated reinsurance recoveries related to those losses.
For a long-tailed business such as ProAssurance, fluctuations in the ratios over short periods of
time are not unexpected and are not necessarily indicative of either positive or negative changes in loss
experience. The timing of our indemnity payments is affected by many factors, including the nature and
number of the claims in process during any one period and the speed at which cases work through the
trial and appellate process. The ratios are affected not only by variations in net paid losses, but also by
variations in premium volume and the recognition of reserve development.
While net paid losses decreased in 2008 as compared to 2007 both the net paid loss ratio and
net paid-to-incurred ratio increased. The increase in the net paid-to-incurred ratio is caused by the decline
in incurred losses, the denominator of the ratio. Likewise, the increase in the net paid loss ratio is caused
by the decline in earned premiums, the denominator of the ratio.
46
Investment Exposures
The following table provides summarized information regarding our investments as of December
(In thousands)
Carrying
Value
Gross
Gain
Gross
Loss
Average
Rating
% Total
Investments
State and Municipal Bonds
1,356,206
26,268
(19,492)
AA
31, 2008:
Fixed Maturities:
Government
U.S. Treasury
U.S. Agency
Total government
Corporate Bonds
Financial institutions
Communications
Utilities
Consumer cyclical
Consumer non-cyclical
Energy
Basic materials
Industrial
Technology
Other
Total corporate bonds
Asset-backed Securities
Agency mortgage-backed securities
Non-agency mortgage-backed securities
Subprime
Alt A
Commercial mortgage-backed securities
Credit card
Automobile
Other
Total asset-backed securities
Total fixed maturities
Equities
Equity–common
Financial
Energy
Consumer non-cyclical
Technology
Industrial
All other
Total equities–common
Equity–preferreds
Total equities
$
98,540
78,628
177,168
$ 2,376
4,616
6,992
$
(2,477)
–
(2,477)
AAA
AAA
AAA
290,421
55,665
42,265
22,786
47,276
30,448
26,082
45,805
10,696
22,338
593,782
522,036
44,262
11,700
11,397
170,859
40,697
24,903
8,558
834,412
2,904
710
990
143
754
133
132
354
264
439
6,823
15,758
1,395
40
859
–
–
–
–
18,052
(20,013)
(2,967)
(862)
(2,967)
(4,078)
(1,669)
(3,417)
(3,312)
(493)
(1,074)
(40,852)
(36)
(5,231)
(2,528)
(2,286)
(22,878)
(1,766)
(3,225)
(617)
(38,567)
A
BBB+
A
A-
BBB+
BBB+
BBB
A-
A
BBB+
A-
AAA
AA+
AA+
A
AAA
AAA
AA+
AA-
AAA
2,961,568
58,135
(101,388)
AA
2,365
3,634
3,304
1,487
1,479
3,971
16,240
2,593
18,833
9,487
5,088
23,073
6,010
1,925
45,583
63,440
28,498
11,781
4,243
44,522
441,996
119
14
208
7
198
12
558
–
558
–
–
–
–
–
–
–
–
–
–
–
–
(8)
–
(34)
(168)
(10)
(229)
(449)
(1,077)
(1,526)
(11,001)
–
–
–
–
(11,001)
–
AA
–
–
–
–
–
3%
2%
5%
38%
8%
2%
1%
1%
1%
1%
1%
1%
–
1%
17%
15%
1%
–
–
5%
1%
1%
–
23%
83%
–
–
–
–
–
–
–
–
1%
–
–
1%
–
–
1%
2%
1%
–
–
1%
12%
100%
Other Investments
High yield asset-backed securities
Federal Home Loan Bank capital stock
Private fund–primarily invested in distressed stock
Private fund–primarily invested in long/short equities
Other
Total other investments
BOLI
Investment in Unconsolidated Subsidiaries
Private fund–primarily invested in high yield asset-backed securities
Private fund–primarily invested in long/short equities
Private fund–primarily invested in equities
Total investment in unconsolidated subsidiaries
Short Term
Total Investments
$ 3,575,942
$ 58,693
$ (113,915)
47
A complete listing of our investment holdings as of December 31, 2008, may be obtained from the
“Investor Home Page–Supplemental Investor Information” section of our website.
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, including interest
payments, dividends and principal payments, as well as the expected cash flows to be generated by our
operations. Approximately $50 million of our investments mature or are paid down in a given quarter and
are available, if needed, to meet our cash flow requirements. At our insurance subsidiaries' level, the
primary outflow of cash is related to net paid losses 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.
We held cash and short-term securities of $445.5 million at December 31, 2008 as compared to
$260.1 million at December 31, 2007. The increased balance as of December 31, 2008 reflected our
intent to hold additional highly liquid assets in response to the instability of credit markets as well as to
meet the funding requirements for our planned acquisitions with PICA, Mid-Continent and Georgia
Lawyers.
The weighted average effective duration of our fixed maturity securities at December 31, 2008 is
4.0 years; the weighted average effective duration of our fixed maturity securities and our short-term
securities combined is 3.5 years. The duration of our fixed maturity securities has shortened due to
expected prepayments on mortgage-backed securities increasing.
In September 2008, unprecedented events occurred in the financial markets which affected our
investment results. Our investment portfolio was directly affected by the U.S. Treasury conservatorship of
Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation
(Freddie Mac), the declaration of bankruptcy by Lehman Brothers Holding, Inc. (Lehman), the Federal
Reserve’s lending facility to American International Group, Inc. (AIG), and the ratings downgrades and
subsequent FDIC facilitated sale of Washington Mutual Bank (Washington Mutual). In connection with
these events, the net asset value of our investment in the Reserve Primary Fund (the Reserve Fund), a
money market fund, fell below $1 per share on a market value basis due to a combination of holdings of
short-term securities issued by Lehman Brothers and major shareholder redemptions. During 2008, our
portfolio of asset-backed securities, particularly mortgage-backed securities, has been impacted by the
dramatic deterioration of the real estate market due to a significant increase in home foreclosures and
commercial delinquencies.
We realized the following losses on our investments in 2008:
(In thousands)
Net gains from sales
Other-than-temporary impairment losses:
Corporate(1)
Equity(2)
Asset-backed securities
Other
Trading portfolio losses
Net realized investment losses
2008
$ 1,533
(25,347)
(10,564)
(9,140)
(1,969)
(47,020)
(5,426)
$ (50,913)
(1)Includes $19.5 million related to Lehman.
(2)Includes $9.5 million related to Fannie Mae and Freddie Mac preferred stock.
Due to our financial strength and capital position, these realized losses have not had and are not
expected to have an impact on our ability to fund capital requirements. Furthermore, we have
accumulated sufficient liquidity in the form of highly liquid assets to meet our capital needs until order is
restored to the market. Our investment portfolio continues to be comprised of high quality fixed income
securities with approximately 98% of our fixed maturities being either United States government agency
or investment grade securities as determined by national rating agencies.
48
As a result of the turmoil in the U.S. credit markets, the overall value of fixed maturity securities
declined in 2008. At December 31, 2008 we continue to hold fixed maturity securities in an unrealized
loss position with pretax net unrealized losses of approximately $43 million as compared to pretax net
unrealized gains of $20 million as of December 31, 2007. The declines reflect the effect of increased
market rates for securities not considered risk-free as well as widespread concern regarding the credit
quality of mortgages and financial institutions, the future of the U.S. credit markets in general and fears
that the U.S. will experience a severe economic recession. It is our belief that we will recover the recorded
cost basis of the fixed maturity securities that we hold in an unrealized loss position. We consider the
declines in value to be temporary because we have the intent, and, due to the duration of our overall
portfolio and positive cash flows, we have the ability to hold the securities to recovery of book value or
maturity.
At December 31, 2008 we held asset-backed securities with a fair value of $834.4 million
(recorded cost basis of $854.9 million). In 2008, we realized $9.1 million of losses on asset-backed
securities (as reflected in the table above) primarily relating to mortgage-backed securities impacted by
the deterioration of the housing market. In performing our other-than-temporary impairment assessment
of mortgage-backed securities, management projects expected cash flows, making assumptions
regarding expected foreclosure rates and the value of collateral available to recover losses. If estimated
cash flows project a loss, an other-than-temporary impairment is realized for the difference between the
book value and fair value of the security in accordance with generally accepted accounting principles. In
some cases, the impairment loss is greater than the projected loss because market values are depressed
as a result of market uncertainty and an aversion to risk by market participants. If we continue to hold
these securities, and our estimates of projected loss prove over time to be accurate, the economic loss
that we ultimately realize will be less than the impairment loss that has been recorded. Conversely,
because our judgments about future foreclosure rates, the timing of expected cash flows and the
estimated value of collateral may not prove over time to be accurate, we may experience losses on asset-
backed securities that we are not currently projecting.
Mortgage-backed securities are generally categorized according to the expected credit quality of
underlying mortgage loans. Generally, subprime loans are issued to borrowers with lower credit ratings
while Alt-A borrowers have better credit ratings but the mortgage loan is of a type regarded as having a
higher risk profile. As of December 31, 2008, we directly hold securities with a fair value of approximately
$11.7 million (recorded cost basis of approximately $14.2 million and rated: 55% AAA, 32% AA, 10%A,
3% BBB or BB) and a beneficial interest in securities with a fair value of approximately $635,000
(recorded cost basis of approximately $5.3 million and average rating of B) that are supported by
collateral we classify as subprime. We also have subprime exposure of approximately $4.4 million
through our interests in private investments funds. We also hold securities with a fair value of
approximately $11.4 million (recorded cost basis of approximately $12.8 million) that are supported by
privately issued residential mortgage-backed securities we classify as Alt-A, of which approximately 23%
are AAA rated, 27% are AA, 50% are A. Ratings given are as of December 31, 2008. During 2008 we
evaluated our securities with subprime and Alt-A exposures and recognized other-than-temporary
impairments of $5.2 million for the year ended December 31, 2008.
Some of our investments have become less liquid than they have historically been due to the
extreme market volatility and disruption experienced in 2008. While the markets for these securities have
temporarily become more intermittent and less active, trades are occurring. We determine the fair value of
these securities by obtaining information from IDC which includes trade data. We confirmed the
reasonableness of the fair value of these securities as of December 31, 2008 by reviewing market yields
of the securities. Current yields are substantially elevated and reflect those seen on similar securities of
similar credit quality and collateral. In addition to those securities which have become illiquid as a result of
current market disruptions, we have historically purchased certain other investments that do not have a
readily available market, including private placements, limited partnerships, inverse coupon mortgage-
backed securities, municipal auction rate securities and Federal Home Loan Bank (FHLB) capital stock.
The net unrealized gains (losses) as of December 31, 2008 associated with securities currently
considered to be illiquid are detailed in the following table.
49
Values at December 31, 2008
(In thousands)
Fair Value
Fixed maturities, available for sale
Mortgage-backed securities classified as:
Inverse coupon
Alt-A
Subprime
Prime, privately issued
Prime, agency issued
Other asset-backed securities:
Timber land
Hotel
Manufactured housing
Other
Corporate bonds:
Privately placed
Municipal auction rated bonds
Equity, available for sale:
Privately placed
$ 24,157
10,160
11,700
20,949
536
791
985
228
7,342
36,472
10,025
357
$ 123,702
Net Unrealized
Gains (Losses)
$ 3,532
(2,268)
(2,488)
(4,232)
46
(209)
(16)
(65)
(534)
259
–
–
(5,975)
$
We believe the fair values of these securities reflect declines due to the market disruptions and
are below the true economic value. The unrealized losses should reverse over the remaining lives of the
securities should no further deterioration of collateral relative to our position in the securities’ capital
structures be experienced.
Financial institutions and asset-backed securities, as a whole, have been particularly affected by
the market events noted above. The overall U.S. economy has also experienced a downturn which is
expected to continue in 2009. The U.S. Government recently enacted legislation and created several
programs to help stabilize credit markets and financial institutions and restore liquidity, including the
Emergency Economic Stabilization Act of 2008 (EESA), the Federal Reserve’s Commercial Paper
Funding Facility (CPFF) and Money Market Investor Funding Facility and the Federal Deposit Insurance
Corporations (FDIC) Temporary Liquidity Guarantee Program. The EESA authorizes the Secretary of the
U.S. Treasury to establish the Troubled Asset Relief Program (TARP) for the repurchase of up to $700
billion of mortgage-backed securities and other troubled financial instruments from financial institutions.
Among other EESA provisions are tax code revisions, budget measures, guidance related to the
administration of TARP, and measures intended to mitigate mortgage foreclosures. Additional
government actions are expected in 2009 to stimulate the economy. It is difficult to predict how recently
enacted legislation and future government actions will impact the economy, certain industry sectors and
specifically the value of certain investments we hold.
We continue to monitor our exposure to financial institutions. Our largest exposures, including
both fixed maturity and equity securities, are to Bank of America ($27.3 million), Morgan Stanley ($24.3
million), and Wells Fargo ($20.9 million). Our concentration of exposure to these institutions has
increased as a result of the acquisition of Merrill Lynch by Bank of America and the acquisition of
Wachovia by Wells Fargo.
50
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
ProAssurance’s predecessor, 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. PRA National reserves are included only in the year 2005 and thereafter. PRA Wisconsin
reserves are included only in the year 2006 and thereafter. The table does not include the reserves of our
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 from reinsurers, each as reported in our consolidated financial
statements at the end of each year (the Balance Sheet Reserves).
– The section entitled “Cumulative net paid, as of” reflects the cumulative amounts paid
as of the end of each succeeding year with respect to the previously recorded
Balance Sheet Reserves.
– The section entitled “Re-estimated net liability as of” reflects the re-estimated amount
of the liability previously recorded as Balance Sheet Reserves that includes the
cumulative amounts paid and an estimate of additional liability based upon claims
experience as of the end of each succeeding year (the Net Re-estimated Liability).
– The line entitled "Net cumulative redundancy (deficiency)" reflects the difference
between the previously recorded Balance Sheet Reserve for each applicable year
and the Net Re-estimated Liability relating thereto as of the end of the most recent
fiscal year.
51
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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 the reserve.
Factors that have contributed to the variation in loss development are primarily related to the
extended period of time required to resolve medical professional liability claims and include the following:
– 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 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 addressed these trends
through increased rates, stricter underwriting and modifications to claims handling
procedures.
– During 2006, 2007 and 2008 we have recognized favorable development related to
our previously established reserves primarily for accident years 2002 through 2006
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.
Activity in our net reserve for losses during 2008, 2007 and 2006 is summarized below:
(In thousands)
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
Incurred related to:
Current year
Prior years
Total incurred
Paid related to:
Current year
Prior years
Total paid
2008
$ 2,559,707
327,111
2,232,596
Year Ended December 31
2007
$ 2,607,148
370,763
2,236,385
2006
$ 2,224,436
327,693
1,896,743
–
–
171,246
396,750
(185,251)
211,499
(20,635)
(312,348)
(332,983)
455,982
(104,985)
350,997
479,621
(36,292)
443,329
(23,492)
(331,294)
(354,786)
(32,325)
(242,608)
(274,933)
Net balance, end of year
Plus receivable from reinsurers
Balance, end of year
2,111,112
268,356
$ 2,379,468
2,232,596
327,111
$ 2,559,707
2,236,385
370,763
$ 2,607,148
At December 31, 2008 our gross reserve for losses included case reserves of approximately
$1.078 billion and IBNR reserves of approximately $1.301 billion. Our consolidated reserve for losses on
a GAAP basis exceeds the combined reserves of our insurance subsidiaries on a statutory basis by
approximately $43.4 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.
53
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 reinsurance treaties are renegotiated annually. There was no significant change in the cost or
structure of the treaties renewed on October 1, 2008.
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. 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 significant collection difficulties due to the financial condition of any
reinsurer; however, periodically, reinsurers may dispute our claim for reimbursement from them. We have
established appropriate reserves for any balances that we believe may not be ultimately collected. Should
future events lead us to believe that any reinsurer will not meet its obligations to us, adjustments to the
amounts recoverable would be reflected in the results of current operations. Such an adjustment has the
potential to be significant to the results of operations in the period in which it is recorded; however, we
would not expect such an adjustment to have a material effect on our capital position or our liquidity.
At December 31, 2008 our receivable from reinsurers on unpaid losses is $268.4 million and our
receivable from reinsurers on paid losses is $17.8 million. The following table identifies our reinsurers
from which our recoverables (net of amounts due to the reinsurer) are $10 million or more as of
December 31, 2008:
(In thousands)
Reinsurer
General Reinsurance Corporation
Hannover Rueckversicherung AG
Transatlantic Reinsurance Company
AXA Reassurances SA
Lloyd's Syndicate No. 2791
A.M. Best
Company Rating
A++
A
A
NR-4
A
Net Amounts Due
From Reinsurer
$ 24,557
$ 21,433
$ 18,744
$ 11,846
$ 10,409
54
Debt
Our long-term debt as of December 31, 2008 is comprised of the following:
(In thousands, except %)
Rate
December 31
2008
First
Redemption
Date
Trust Preferred Securities/Debentures Due 2034
6.0% (LIBOR plus 3.85%, adjusted quarterly)
$22,992
May 2009
Surplus Notes due 2034
7.7%, until May 2009, adjusted quarterly to
LIBOR plus 3.85% afterwards
11,938
$34,930
May 2009*
*Subject to approval by the Wisconsin Commissioner of Insurance
A detailed description of our debt is provided in Note 11 to the Consolidated Financial
Statements.
As discussed in Note 11, we completed the conversion of all our outstanding Convertible
Debentures (aggregate principal of $107.6 million) in July 2008. Approximately 2,572,000 shares of our
common stock were issued in the transaction (conversion rate was 23.9037 shares per $1,000
debenture). Of the common shares issued, approximately 2,120,000 were reissued Treasury Shares and
450,000 were newly issued shares. The transaction resulted in a $112.5 million net increase to
Stockholders’ Equity in the third quarter of 2008. No gain or loss was recorded related to the conversion.
Book value increased approximately $0.28 per share from the conversion.
As discussed in Note 11, in mid-December 2008 we extinguished approximately $23 million of
our Trust Preferred Securities/Debentures due in 2034 (the TPS/TPS Debentures) for approximately
$18.4 million, and recognized a gain on the extinguishment of $4.6 million.
Off Balance Sheet Arrangements/Guarantees
As discussed in Note 11 to the Consolidated Financial Statements, our TPS Debentures are held
by, and are the sole assets of two related business trusts (the Trusts). The Trusts purchased the TPS
Debentures with proceeds from related trust preferred stock issued and sold by each trust. The terms and
maturities of the TPS Debentures mirror those of the related TPS. The Trusts will use the debenture
interest and principal payments we pay into each trust to meet their TPS obligations. In December 2008,
ProAssurance reacquired TPS having a face value of $23 million. When the TPS were reacquired,
ProAssurance became the primary beneficiary of one of the trusts (Trust-1) and consequently, following
the guidance of FASB Interpretation No. 46R “Variable Interest Entities” (FIN 46R), we have consolidated
Trust-1 as of December 31, 2008. The remaining trust (Trust-2) was not consolidated because we are not
the primary beneficiary of Trust-2.
ProAssurance has issued guarantees that amounts paid to the Trusts related to the TPS
Subordinated Debentures will subsequently be remitted to the holders of the related TPS.
Contractual Obligations
A schedule of our non-cancelable contractual obligations at December 31, 2008 follows:
(In thousands)
Payments due by period
Loss and loss adjustment expenses
Interest on long-term debt
Long-term debt obligations
Operating lease obligations
Total
Total
$ 2,379,468
52,978
34,930
8,269
$ 2,475,645
Less than
1 year
$ 519,943
2,160
–
1,980
$ 524,083
1-3 years
$ 811,964
4,225
–
2,729
$ 818,918
3-5 years
$ 535,700
4,225
–
1,284
$ 541,209
More than
5 years
$ 511,861
42,368
34,930
2,276
$ 591,435
55
For the purposes of this table, all long-term debt is assumed to be settled at its contractual
maturity and interest on variable rate long-term debt is calculated using interest rates in effect at
December 31, 2008. 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 and office equipment.
Each of our debt instruments allows for repayment before maturity, at our option, on or after
certain dates. For more information on our debt see Note 11 to the Consolidated Financial Statements.
Treasury Stock
The Board of Directors of ProAssurance authorized $150 million in April 2007, of which $80.3
million was available for use at January 1, 2008, and $100 million in August 2008 for the repurchase of
common shares or the retirement of outstanding debt. During the year ended December 31, 2008, we
repurchased approximately 1.8 million of our common shares having a total cost of $87.6 million and
reacquired debt for $18.4 million. As of December 31, 2008, the repurchase authorization remaining
available for use is approximately $74.4 million.
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: (1) those dealing with claims and claim-related
activities which we consider in our evaluation of our reserve for losses, and (2) those falling outside of
these areas which we evaluate and account for 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 in 2005, we assumed the risk of loss for a judgment entered against PRA
National 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 judgment). The judgment was
appealed to the District of Columbia Court of Appeals, which affirmed the judgment in October 2008 and
denied PRA National’s petition for rehearing in January 2009. We included a liability of $19.5 million
related to the judgment and post-trial interest as a component of the fair value of assets acquired and
liabilities assumed in the allocation of the PRA National purchase price in 2005, and have continued to
accrue additional post-trial interest. The judgment plus post-trial interest is expected to be paid in the
second quarter of 2009.
There are risks, as outlined in our Risk Factors in Part 1, that any of these 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 resolution of a claim. To the extent that the cost of resolving these
actions exceeds our estimates, the legal actions could have a material effect on our results of operations
in the period in which any such action is resolved.
56
Overview of Results–Years Ended December 31, 2008 and 2007
Net income totals $177.7 million for the year ended December 31, 2008 as compared to $168.2
million for the year ended December 31, 2007. Net income per diluted share is $5.22 and $4.78 for the
years ended December 31, 2008 and 2007, respectively. The increase in diluted earnings per share is
attributable both to the increase in net income and a decrease in diluted weighted average shares
outstanding.
Results from the years ended December 31, 2008 and 2007, respectively, compare as follows:
Revenues
Net premiums earned have declined in 2008 by approximately $74.2 million (14%). The decline
reflects rate reductions implemented to reflect favorable loss trends and the effects of a highly competitive
market place.
Our net investment result, which includes both net investment income and earnings from
unconsolidated subsidiaries, has declined in 2008 by $22.6 million (13%). The decline primarily reflects
lower interest rates on short-term funds during 2008 and unfavorable conditions in the credit markets.
Net realized investment losses during 2008 are almost $51 million as compared to net realized
investment losses of $5.9 million in 2007, primarily due to other-than-temporary impairments of $47.0
million in 2008. The 2008 impairments are primarily related to our investments in the preferred stock of
Fannie Mae and Freddie Mac, and debt securities issued by Lehman Brothers.
Revenues for 2008 include a $4.6 million gain related to the extinguishment of $23 million of our
Trust Preferred Debentures.
Expenses
Net losses have decreased in 2008 as compared to 2007 by $139.5 million due to a decline in
insured risks and favorable prior year loss development in 2008 of $185.3 million versus $105.0 million in
2007.
Underwriting, acquisition and insurance expenses have declined by approximately $6.4 million,
principally due to the decline in policy acquisition costs.
Interest expense has declined by $5.1 million primarily because of lower average outstanding
debt during 2008.
Ratios
Our net loss ratio has decreased in 2008 by 19.7 points due to the increased amount of favorable
net loss development as discussed above. Our expense ratio has increased by 1.9 points primarily due to
the decline in premium. Our operating ratio is lower by 20.2 points. Return on equity is 13.3% for 2008 as
compared to 14.2% for 2007.
57
Results of Operations–Year Ended December 31, 2008 Compared to Year Ended December 31,
2007
Selected consolidated financial data for each period is summarized in the table below.
($ in thousands, except 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)
Gain on extinguishment of debt
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
2007
Change
2008
$471,482
$549,074
$(77,592)
$429,007
$506,397
$(77,390)
$503,579
(44,301)
459,278
158,384
$585,310
(51,797)
533,513
171,308
$(81,731)
7,496
(74,235)
(12,924)
(7,997)
(50,913)
4,571
3,839
567,162
1,630
(5,939)
–
5,556
706,068
(9,627)
(44,974)
4,571
(1,717)
(138,906)
267,412
(55,913)
211,499
438,527
(87,530)
350,997
(171,115)
31,617
(139,498)
100,385
6,892
318,776
106,751
11,981
469,729
(6,366)
(5,089)
(150,953)
Income before income taxes(1)
248,386
236,339
12,047
Income taxes
Net income(1)
Earnings per share:(1)
Basic
Diluted
Net loss ratio
Underwriting expense ratio
Combined ratio
Operating ratio
Return on equity
(1)No discontinued operations during 2008 or 2007
70,661
68,153
2,508
$177,725
$168,186
$ 9,539
$
$
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5.22
$
$
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4.78
$ 0.33
$ 0.44
46.1%
21.9%
68.0%
33.5%
13.3%
65.8%
20.0%
85.8%
53.7%
14.2%
(19.7)
1.9
(17.8)
(20.2)
(0.9)
58
Premiums
($ in thousands)
Year Ended December 31
Gross premiums written
2008
$ 471,482
2007
$ 549,074
Change
$ (77,592) (14.1%)
Premiums earned
Premiums ceded
Net premiums earned
$ 503,579
(44,301)
$ 459,278
$ 585,310
(51,797)
$ 533,513
$ (81,731) (14.0%)
(14.5%)
$ (74,235) (13.9%)
7,496
Gross Premiums Written
Gross premiums written declined 14.1% during 2008 as compared to 2007, reflecting the effects
of lower premium rates and a very competitive insurance market. The change in premiums is driven by
three primary factors, our ability and desire to retain expiring business, the change in premium rates we
charge on the business we do renew, which can also be affected by the coverage an insured chooses to
purchase, and the production of new business.
During 2008 our retention rate remained above 85% which is consistent with prior years. The
professional liability market place remains extremely competitive and many of our competitors have been
aggressive, particularly in pricing their products to retain their existing business as well as in seeking new
business.
The decline in premiums during 2008 also reflects the fact that overall, we are charging our
insureds less given the favorable trends that have been emerging in losses. During 2007 and 2008 we
have recognized improving loss trends in our rate making analysis, and have lowered the rates we charge
our insureds where indicated. As policies take effect at these lower rates our premiums written have
declined. For our physician business, which is discussed in more detail below, our charged rates on
renewed business reflect an average decrease of 6% for 2008. Charged rates include the effects of filed
rates, surcharges and discounts.
Finally, the acquisition of new business continues to be challenging. Despite competitive
pressures, we remain committed to a rate structure that will allow us to fulfill our obligations to our
insureds, while still generating fair returns for our stockholders.
Physician premiums represent 83% and 84% of gross premiums written during 2008 and 2007,
respectively. Amounts written in 2008 have declined as compared to 2007, as shown below.
($ in thousands)
Year Ended December 31
Physician Premiums*
2008
$ 389,492
2007
$ 459,609
Change
$ (70,117)
(15.3%)
*Exclusive of tail premiums as discussed below
Our overall retention rate is approximately 88% for the year ended December 31, 2008, as
compared to 86% for the year ended December 31, 2007. The retention rate is driven by several factors.
Our underwriting evaluation may cause us to non-renew an insured. An insured may leave the practice of
medicine through death, disability or retirement and, finally, we may lose business due to pricing or other
issues, to our competitors or to self-insurance mechanisms.
Premiums written for non-physician coverages represent 12% and 11% of our total gross
premiums written for years ended December 31, 2008 and 2007, respectively.
($ in thousands)
Year Ended December 31
2008
2007
Change
Non-physician Premiums*
Hospital and facility
Other non-physician
$ 31,229
27,241
$ 58,470
$ 34,237
28,791
$ 63,028
$ (3,008)
(1,550)
$ (4,558)
(8.8%)
(5.4%)
(7.2%)
*Exclusive of tail premiums as discussed below
Hospital and facility coverages are the most significant component of non-physician premiums
and represent 7% and 6% of our total gross premiums written for the years ended December 31, 2008
59
and 2007, respectively. Other non-physician coverages consist primarily of professional liability
coverages provided to lawyers and to other health care professionals such as dentists and allied health
professionals. We are seeing the same competitive pressures in these areas as we are seeing in our
physician business.
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. Tail premiums totaled
approximately $23.5 million and $26.4 million (5% gross written premiums for both comparative periods)
for the years ended December 31, 2008 and 2007, respectively, representing a decrease of $2.9 million.
Many of our competitors are offering prior acts coverage to induce insureds to change insurance carriers.
The availability of prior acts coverage negates the need for a non-renewing insured to purchase a tail
policy.
Premiums Earned
($ in thousands)
Year Ended December 31
Premiums earned
2008
$ 503,579
2007
$ 585,310
Change
$ (81,731)
(14.0%)
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 for the year ended
December 31, 2008 as compared to the same period in 2007 reflects declines in gross premiums written
during 2007 and 2008. Also, premiums earned in 2007 include $10.1 million that originated from
unearned premiums acquired in the merger with PRA Wisconsin.
During the twelve months preceding December 31, 2008, our written premiums have declined as
compared to written premiums for the twelve months preceding December 31, 2007. Consequently, 2009
earned premiums are expected to continue to be lower than 2008 earned premiums.
Premiums Ceded
($ in thousands)
Year Ended December 31
Premiums ceded
2008
$ 44,301
2007
$ 51,797
Change
$ (7,496)
(14.5%)
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
reinsurers are estimated.
Exclusive of amounts included in the following table, our reinsurance expense ratio (premiums
ceded as a percentage of premiums earned) averages 9.0% in both 2008 and 2007.
Premiums ceded in both 2008 and 2007 include amounts related to commutations and amounts
resulting from changes to our estimates of reinsurance premiums incurred for prior accident years, as
follows.
(In millions)
Premiums ceded, before commutations and estimate changes
Effect of commutations
Estimate changes, prior accident years
Premiums ceded, adjusted
Year Ended December 31
2008
$ 45.5
–
(1.2)
$ 44.3
2007
$ 52.4
(3.3)
2.7
$ 51.8
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.
60
Net Investment Income, Net Realized Investment Gains (Losses); Equity in Earnings (Loss) of
Unconsolidated Subsidiaries
Net Investment Income
($ in thousands)
Year Ended December 31
Net investment income
2008
$158,384
2007
$171,308
Change
$ (12,924)
(7.5%)
Net investment income is primarily derived from the income earned by our fixed maturity
securities and also includes income from our 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:
(In thousands)
Fixed maturities
Equities
Short-term investments
Other invested assets
Business owned life insurance
Investment expenses
Net investment income
$
Year Ended December 31
2007
$149,494
377
14,713
9,228
1,889
(4,393)
$171,308
Change
591
854
(7,822)
(6,427)
43
(163)
$ (12,924)
2008
$ 150,085
1,231
6,891
2,801
1,932
(4,556)
$ 158,384
Fixed Maturities. The increase in income from our investment in fixed maturities primarily reflects some
improvement in yields, which are more pronounced on a tax equivalent basis because we shifted funds
into state and municipal bonds as 2008 progressed. Although bond yields increased in 2008, we did not
increase our fixed maturity holdings significantly due to unstable market conditions. Average yields for our
available-for-sale fixed maturity securities during 2008 and 2007 are as follows:
Average income yield
Average tax equivalent income yield
Year Ended December 31
2008
4.8%
5.6%
2007
4.7%
5.4%
Short-term Investments. The decrease in earnings from short-term investments reflects a decline in
market interest rates (an average of 350 basis points) in 2008 as compared to 2007.
Other Invested Assets. The decline in income from other invested assets reflects a $5.8 million reduction
in distributions from our investment in a private fund accounted for on a cost basis, as a result of turmoil
in the debt markets. Because we recognize income related to these funds as it is distributed to us, our
income from these holdings can vary significantly from period to period.
Equity in Earnings (Loss) of Unconsolidated Subsidiaries
(In thousands)
Equity in earnings (loss) of
Year Ended December 31
2007
Change
2008
unconsolidated subsidiaries
$ (7,997)
$ 1,630
$ (9,627)
Equity in earnings (loss) of unconsolidated subsidiaries is derived from our investment interests in
three private funds accounted for on the equity method. The funds primarily hold trading portfolios, and
changes in the fair value of securities held by the fund are included in current earnings of the fund. The
performance of two funds reflects the decline and volatility of equity and credit markets, and we
experienced negative returns from our interest in these funds during 2008. The third fund is an early
phase private equity fund of funds that is still incurring the costs associated with its startup phase.
61
Net Realized Investment Gains (Losses)
The components of net realized investment gains (losses) are shown in the following table.
(In thousands)
Net gains (losses) from sales
Other-than-temporary impairment (losses):
Corporate(1)
Equity(2)
Asset-backed securities
Other
Trading portfolio gains (losses)
Net realized investment gains (losses)
Year Ended December 31
2008
$ 1,533
2007
$ 1,801
(25,347)
(10,564)
(9,140)
(1,969)
(47,020)
(5,426)
$ (50,913)
(185)
–
(6,460)
(1,108)
(7,753)
13
$ (5,939)
(1)Includes $19.5 million related to Lehman.
(2)Includes $9.5 million related to Fannie Mae and Freddie Mac preferred
stock.
During 2008 we recognized other-than-temporary impairment losses of $857,000 during the first
quarter, $5.5 million during the second quarter, $29.9 million during the third quarter, and $10.9 million
during the fourth quarter.
Losses and Loss Adjustment Expenses
The determination of calendar year losses involves the actuarial evaluation of incurred losses for
the current accident year and the actuarial re-evaluation of incurred losses for prior accident years,
including an evaluation of the reserve amounts required for losses in excess of policy limits.
Accident year refers to the accounting period in which the insured event becomes a liability of the
insurer. For occurrence policies the insured event becomes a liability when the event takes place; for
claims-made policies, which represent the majority of the Company's business, the insured event
generally becomes a liability when the event is first reported to the insurer. We believe that measuring
losses on an accident year basis is the most indicative measure of the underlying profitability of the
premiums earned in that period since it associates policy premiums earned with the estimate of the
losses incurred related to those policy premiums.
The following table summarizes calendar year net losses and net loss ratios for the years ended
December 31, 2008 and 2007 by separating losses between the current accident year and all prior
accident years.
($ In millions)
Current accident year
Prior accident years
Calendar year
Net Losses
Year Ended December 31
2007
$ 456.0
(105.0)
$ 351.0
Change
$ (59.2)
(80.3)
$ (139.5)
2008
$ 396.8
(185.3)
$ 211.5
Net Loss Ratios*
Year Ended December 31
2007
2008
85.5%
86.4%
(19.7%)
(40.3%)
65.8%
46.1%
Change
0.9
(20.6)
(19.7)
*Net losses as specified divided by net premiums earned.
Our current accident year loss ratio increased in 2008, as compared to 2007. The increase in our
2008 current accident year ratio primarily reflects an increase to our reserve for the death, disability and
retirement provision (DDR) in our claims-made policies.
During 2008, we recognized favorable loss development of $185.3 million, on a net basis, related
to reserves established in prior years. Principally this is due to favorable net loss development for the
2004 to 2006 accident years within our retained layers of coverage ($1 million and below), but also
includes favorable development of $3.7 million due to the commutation of prior year reinsurance
agreements during 2008. The 2004-2006 favorable development is based upon observation of actual
claims data which indicates that claims severity is 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 net loss development. As we
conclude that sufficient data with respect to these trends exists to credibly impact our actuarial analysis
62
we take appropriate actions. In the case of the claims severity trends for 2004-2006, 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.
During 2007 we recognized favorable net loss development of $105.0 million, related to our
previously established (prior accident year) reserves, primarily to reflect reductions in our estimates of
claim severity, within our retained layer of risk, for the 2003 through 2005 accident years.
Assumptions used in establishing our reserve are regularly reviewed and updated by
management as new data becomes available. Any adjustments necessary are reflected in then current
operations. Due to the size of our reserve, even a small percentage adjustment to the assumptions can
have a material effect on our results of operations for the period in which the change is made.
Underwriting, Acquisition and Insurance Expenses
($ in thousands)
Underwriting, Acquisition and Insurance Expenses
Year Ended December 31
2008
$100,385
2007
$106,751
Change
$ (6,366)
(6.0%)
Underwriting Expense Ratio
Year Ended December 31
2007
2008
20.0%
21.9%
Change
1.9
The increase in the underwriting expense ratio (expense ratio) is primarily the result of the decline
in net premiums earned. The fixed costs associated with our insurance operations were only modestly
higher, while underwriting and acquisition expenses declined due to the decrease in net earned premium.
Underwriting, acquisition and insurance expenses include share-based compensation expense of
approximately $7.8 million and $8.3 million for the years ended December 31, 2008 and 2007,
respectively. Share-based compensation expense for 2007 reflects a one-time expense of $1.8 million
related to options awarded to our CEO upon his hiring. Awards to retirement eligible employees are fully
expensed when granted and were approximately $680,000 and $1.2 million for the years ended
December 31, 2008 and 2007.
Guaranty fund assessments, in general, are recorded when they are declared by state regulatory
authorities. Periodically we receive refunds of previous assessments. Additionally, certain states permit us
to recoup previous guaranty fund assessments through surcharges to our insureds. In 2008
refunds/recoupments exceeded assessments and reduced underwriting expense by $1.3 million. In 2007
net guaranty fund assessments increased underwriting expense by approximately $550,000. The
amounts recouped through surcharges collected from our insureds approximated $1.1 million for 2008
and $706,000 for 2007. During both 2008 and 2007, the amounts recouped primarily relate to
assessment previously paid to the Florida Insurance Guaranty Association, Inc. We estimate that
recoupments in 2009 will approximate $824,000; we are unable to estimate assessments that might be
declared in 2009.
63
Interest Expense
Interest expense decreased in 2008 as compared to 2007 primarily because our average
outstanding debt declined from $179 million in 2007 to $110 million in 2008 (see Note 11 for details of
debt redemption and conversion). A decline in the average interest rate for our TPS/TPS Debentures of
approximately 200 basis points also reduced interest expense (rates adjust quarterly based on three-
month LIBOR).
Interest expense by debt obligation is provided in the following table:
(In thousands)
Year Ended December 31
2007
Change
2008
Convertible Debentures
$ 2,283
$ 4,565
$ (2,282)
2032 Subordinated Debentures
–
1,639
(1,639)
TPS/TPS Debentures
3,463
4,625
(1,162)
Surplus Notes
Other
1,138
1,138
–
8
$ 6,892
14
$11,981
(6)
$ (5,089)
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. During 2009 our tax-exempt income
grew at a faster rate than did our taxable income which decreased 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
2008
35.0%
(7.0%)
0.4%
28.4%
2007
35.0%
(6.7%)
0.5%
28.8%
We did not recognize any valuation allowance related to our deferred tax assets in 2008. We
expect to be able to realize the full benefit of deferred tax assets associated with impairment losses
because capital gains were recognized during the statutory carryback period that are sufficient to absorb
the impairment losses.
64
Effect of Acquisition (2007–2006)
We acquired PRA Wisconsin effective August 1, 2006. Operating results for the year ended
December 31, 2007 include PRA Wisconsin results for the entire period. Our results for the year ended
December 31, 2006 include PRA 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 separately identified
the results that are directly attributable to PRA Wisconsin.
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 $50 million, an increase in our current year loss ratio of approximately 3 percentage points and an
increase in our expense ratio of almost 2 percentage points.
65
Results of Operations–Year Ended December 31, 2007 Compared to Year Ended December 31,
2006
Selected consolidated financial data for each period is summarized in the table below.
($ in thousands, except share data)
Revenues:
Gross premiums written
Year Ended December 31
2006
Change
2007
$549,074
$ 578,983
$(29,909)
Net premiums written
$506,397
$ 543,376
$(36,979)
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
$585,310
(51,797)
533,513
171,308
$ 627,166
(44,099)
583,067
147,450
$ (41,856)
(7,698)
(49,554)
23,858
1,630
(5,939)
5,556
706,068
2,339
(1,199)
5,941
737,598
(709)
(4,740)
(385)
(31,530)
Expenses:
Losses and loss adjustment expenses
Reinsurance recoveries
Net losses and loss adjustment expenses
Underwriting, acquisition and insurance
expenses
Interest expense
Total expenses
438,527
(87,530)
350,997
475,997
(32,668)
443,329
(37,470)
(54,862)
(92,332)
106,751
11,981
469,729
106,369
11,073
560,771
382
908
(91,042)
Income from continuing operations before
income taxes
236,339
176,827
59,512
Income taxes
Income from continuing operations
68,153
168,186
49,843
126,984
18,310
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
$
$
4.78
–
4.78
$
$
3.72
3.13
6.85
$
$
1.06
(3.13)
(2.07)
Continuing Operations:
Net loss ratio
Underwriting expense ratio
Combined ratio
Operating ratio
Return on equity
65.8%
20.0%
85.8%
53.7%
14.2%
76.0%
18.2%
94.2%
68.9%
13.5%
(10.2)
1.8
(8.4)
(15.2)
0.7
66
Premiums
($ in thousands)
Year Ended December 31
Gross premiums written
2007
$ 549,074
2006
$ 578,983
Change
$ (29,909)
(5%)
Premiums earned
Premiums ceded
Net premiums earned
$ 585,310
(51,797)
$ 533,513
$ 627,166
(44,099)
$ 583,067
$ (41,856)
(7,698)
$ (49,554)
(7%)
17%
(8%)
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 PRA Wisconsin partially
offset the reduction in premium in our existing book of business (The operations of PRA 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.
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
Physician Premiums*
PRA pre-acquisition business
PRA Wisconsin acquisition
$403,384
56,225
$459,609
$473,038
17,538
$490,576
$ (69,654)
38,687
$ (30,967)
(15%)
n/a
(6%)
*Exclusive of tail premiums as discussed below
Our overall retention rate (exclusive of PRA 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.
67
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 PRA Wisconsin acquisition as follows:
($ in thousands)
Year Ended December 31
2007
2006
Change
Non-physician Premiums*
Hospital and facility:
PRA pre-acquisition business
PRA Wisconsin acquisition
Other non-physician:
PRA pre-acquisition business
PRA Wisconsin acquisition
$ 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%
*Exclusive of tail premiums as discussed below
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 $2.3 million as compared to
2006.
Premiums Earned
($ in thousands)
Year Ended December 31
2007
2006
Change
Premiums Earned
PRA pre-acquisition business
PRA Wisconsin acquisition
$ 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 PRA
Wisconsin transaction. In 2006, earned premium includes approximately $38.3 million related to
unexpired policies acquired in the PRA Wisconsin and PRA National transactions.
68
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.
(In millions)
Premiums ceded, before commutations
and estimate changes
Effect of commutations
Estimate changes, prior accident years
Premiums ceded, as adjusted
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.
69
Net Investment Income, Net Realized Investment Gains (Losses); Equity in Earnings (Loss) of
Unconsolidated Subsidiaries
Net Investment Income
($ in thousands)
Year Ended December 31
Net investment income
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:
(In thousands)
Year Ended December 31
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
(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 PRA
Wisconsin merger significantly increased average invested funds during 2007 as compared to 2006.
Market interest rates of the past several years 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.
70
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)
Equity in earnings (loss) of unconsolidated subsidiaries
Year Ended December 31
Change
2006
2007
$ 1,630 $ 2,339
$ (709)
(30%)
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)
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 subprime 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 $185,000 related to corporate bonds that have suffered a significant decline in value.
71
Losses and Loss Adjustment Expenses
The determination of calendar year losses involves the actuarial evaluation of incurred losses for
the current accident year and the actuarial re-evaluation of incurred losses for prior accident years,
including an evaluation of the reserve amounts required for losses in excess of policy limits.
Accident year refers to the accounting period in which the insured event becomes a liability of the
insurer. For occurrence policies the insured event becomes a liability when the event takes place; for
claims-made policies the insured event generally becomes a liability when the event is first reported to the
insurer. We believe that measuring losses on an accident year basis is the most indicative measure of the
underlying profitability of the premiums earned in that period since it associates policy premiums earned
with the estimate of the losses incurred related to those policy premiums.
The following table summarizes calendar year net losses and net loss ratios for the years ended
December 31, 2007 and 2006 by separating losses between the current accident year and all prior
accident years.
($ In millions)
Current accident year
Prior accident years
Calendar year
Net Losses
Year Ended December 31
2007
$ 456.0
(105.0)
$ 351.0
2006
$ 479.6
(36.3)
$ 443.3
Change
$ (23.6)
(68.7)
$ (92.3)
*Net losses as specified divided by net premiums earned.
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%
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 PRA 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.
PRA 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. PRA 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.
72
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 a $12.4 million decrease to gross losses which was offset by a
corresponding decrease to the recoverable from our reinsurer.
Assumptions used in establishing our reserve are regularly reviewed and updated by
management as new data becomes available. Any adjustments necessary are reflected in then current
operations. Due to the size of our reserve, even a small percentage adjustment to the assumptions can
have a material effect on our results of operations for the period in which the change is made.
Underwriting, Acquisition and Insurance Expenses
($ in thousands)
Underwriting, Acquisition and Insurance Expenses
Year Ended December 31
2007
$ 106,751
2006
$106,369
$
382
Change
n/a
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 the underwriting expense ratio is primarily due to the effect of lower premium
volume in 2007. The PRA 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.
73
Interest Expense
Approximately $670,000 of the 2007 increase in interest expense is related to long term debt
($11.6 million) assumed in the PRA 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:
(In thousands)
Year Ended December 31
Convertible Debentures
2032 Subordinated Debentures
TPS/TPS Debentures
Surplus Notes
Other
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%
74
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,
2008.
(In millions, except duration)
Interest Rates
200 basis point rise
100 basis point rise
Current rate *
100 basis point decline
200 basis point decline
Portfolio
Value
$ 2,712
$ 2,835
$ 2,962
$ 3,069
$ 3,137
December 31, 2008
Change in
Value
$ (250)
$ (127)
$
–
$ 107
$ 175
Effective
Duration
4.20
4.18
3.98
3.19
2.44
December 31, 2007
Effective
Portfolio
Duration
Value
4.62
$ 2,953
4.52
$ 3,095
4.13
$ 3,237
3.67
$ 3,366
3.48
$ 3,486
*Current rates are as of December 31, 2008 and December 31, 2007.
At December 31, 2008, the fair value of our investment in preferred stocks was $2.6 million,
including net unrealized losses of $1.1 million. Preferred stocks traditionally have been primarily subject
to interest rate risk because they bear a fixed rate of return, but may also be subject to credit and equity
price risk. The investments in the above table do not include preferred stocks.
Computations of prospective effects of hypothetical interest rate changes are based on numerous
assumptions, including the maintenance of the existing level and composition of fixed income security
assets, and should not be relied on as indicative of future results.
Certain shortcomings are inherent in the method of analysis presented in the computation of the
fair value of fixed rate instruments. Actual values may differ from those projections presented should
market conditions vary from assumptions used in the calculation of the fair value of individual securities,
including non-parallel shifts in the term structure of interest rates and changing individual issuer credit
spreads.
ProAssurance's cash and short-term investment portfolio at December 31, 2008 was on a cost
basis which approximated 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, 2008, 97.7% of our fixed maturity securities are rated investment grade as
determined by Nationally Recognized Statistical Rating Organizations (NRSROs), (e.g. Moody's,
Standard & Poor's and Fitch). We believe that this concentration in investment grade securities reduces
our exposure to credit risk on our fixed income investments to an acceptable level. However, investment
grade securities, in spite of their rating, can rapidly deteriorate and result in significant losses. Ratings
published by the NRSROs are one of the tools used to evaluate the credit worthiness of our securities.
The ratings reflect the subjective opinion of the rating agencies as to the credit worthiness of the
securities, and therefore, we may be subject to additional credit exposure should the rating prove to be
unreliable.
75
We hold $1.36 billion of municipal bonds, approximately $860 million (63%) of which are insured.
Although these bonds may have enhanced credit ratings as a result of guarantees by a monoline insurer,
we require the bonds that we purchase to meet our credit criteria on a stand-alone basis. As of December
31, 2008, our municipal bonds have a weighted average rating of AA, even when the benefits of
insurance protection are excluded. Even though a number of the monoline insurers have had their ratings
downgraded, our municipal bonds continue to be investment grade quality.
Equity Price Risk
At December 31, 2008 the fair value of our investment in common stocks was $16.2 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 0.98. 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 9.8% to $17.8 million. Conversely, a 10%
decrease in the S&P 500 Index would imply a decrease of 9.8% in the fair value of these securities to
$14.7 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.
76
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 82. The
Supplementary Financial Information required by Item 302 of Regulation S-K is included in Note 18 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,
2008. 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, 2008 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, 2008 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, 2008 as stated in their
report which is included elsewhere herein.
ITEM 9B. OTHER INFORMATION.
None
77
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, 2008, 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, 2008, 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, 2008 and 2007,
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, 2008, of ProAssurance Corporation and subsidiaries and our
report dated February 24, 2009 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Birmingham, Alabama
February 24, 2009
78
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 32 and 33) 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 2009
Annual Meeting of its Stockholders to be filed with the Securities and Exchange Commission pursuant to
Regulation 14A on or before April 11, 2009.
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 2009 Annual Meeting of its
Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A on or
before April 11, 2009.
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 2009 Annual Meeting of its
Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A on or
before April 11, 2009.
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 2009 Annual Meeting of its
Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A on or
before April 11, 2009.
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 2009 Annual Meeting of its
Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A on or
before April 11, 2009.
79
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, 2008 and 2007
Consolidated Statements of Changes in Capital – years ended December 31,
2008, 2007 and 2006
Consolidated Statements of Income – years ended December 31, 2008, 2007
and 2006
Consolidated Statements of Cash Flow – years ended December 31, 2008, 2007
and 2006
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.
80
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 24th day of February 2009.
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/Victor T. Adamo
Victor T. Adamo
/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.
John J. McMahon, Jr.
/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.
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
and Director
February 24, 2009
Chief Financial Officer
February 24, 2009
February 24, 2009
February 24, 2009
February 24, 2009
February 24, 2009
February 24, 2009
February 24, 2009
February 24, 2009
February 24, 2009
February 24, 2009
February 24, 2009
Director
Director
Director
Director
Director
Director
Director
Director
Director
Director
81
ProAssurance Corporation and Subsidiaries
Consolidated Financial Statements
Years ended December 31, 2008, 2007 and 2006
Table of Contents
Report of Independent Registered Public Accounting Firm........................................................................ 83
Audited Consolidated Financial Statements
Consolidated Balance Sheets ..................................................................................................................... 84
Consolidated Statements of Changes in Capital ........................................................................................ 85
Consolidated Statements of Income ........................................................................................................... 86
Consolidated Statements of Cash Flow...................................................................................................... 87
Notes to Consolidated Financial Statements ..............................................................................................89
82
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, 2008 and 2007, 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, 2008. 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, 2008
and 2007, and the consolidated results of their operations and their cash flow for each of the three years
in the period ended December 31, 2008, 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.
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, 2008, 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
24, 2009 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Birmingham, Alabama
February 24, 2009
83
ProAssurance Corporation and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share data)
Assets
Investments
Fixed maturities available for sale, at fair value
Equity securities, available for sale, at fair value
Equity securities, trading, at fair value
Short-term investments
Business owned life insurance
Investment in unconsolidated subsidiaries
Other investments
Total Investments
Cash and cash equivalents
Premiums receivable
Receivable from reinsurers on paid losses and loss adjustment expenses
Receivable from reinsurers on unpaid losses and loss adjustment expenses
Prepaid reinsurance premiums
Deferred policy acquisition costs
Deferred taxes
Real estate, net
Goodwill
Other assets
Total Assets
Liabilities and Stockholders' Equity
Liabilities
Policy liabilities and accruals
December 31
December 31
2008
2007
$ 2,961,568
$ 3,236,739
6,981
11,852
441,996
63,440
44,522
45,583
15,451
14,173
229,817
61,509
26,767
54,939
3,575,942
3,639,395
3,459
86,137
17,826
268,356
13,009
19,505
138,034
23,496
72,213
62,961
30,274
98,693
39,567
327,111
14,835
22,120
103,105
24,004
72,213
69,491
$ 4,280,938
$ 4,440,808
Reserve for losses and loss adjustment expenses
$ 2,379,468
$ 2,559,707
Unearned premiums
Reinsurance premiums payable
Total Policy Liabilities
Other liabilities
Long-term debt
Total Liabilities
Stockholders' Equity
Common stock, par value $0.01 per share
100,000,000 shares authorized, 34,109,196 and
33,570,685 shares issued, respectively
Additional paid-in capital
Accumulated other comprehensive income (loss), net of deferred
tax expense (benefit) of $(19,328) and $5,334 respectively
Retained earnings
185,756
127,877
2,693,101
129,322
34,930
218,028
128,582
2,906,317
115,263
164,158
2,857,353
3,185,738
341
518,687
(35,898)
970,891
336
505,923
9,902
793,166
1,454,021
1,309,327
Treasury stock, at cost, 763,316 shares and 1,128,111 shares, respectively
(30,436)
(54,257)
Total Stockholders' Equity
1,423,585
1,255,070
Total Liabilities and Stockholders' Equity
$ 4,280,938
$ 4,440,808
See accompanying notes.
84
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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)
Gain on extinguishment of debt
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
2007
2008
2006
$ 471,482
$ 549,074
$ 578,983
$ 429,007
$ 506,397
$ 543,376
$ 503,579
(44,301)
459,278
158,384
(7,997)
(50,913)
4,571
3,839
567,162
267,412
(55,913)
211,499
100,385
6,892
318,776
$ 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
Income from continuing operations before income taxes
248,386
236,339
176,827
Provision for income taxes
Current expense (benefit)
Deferred expense (benefit)
70,894
(233)
70,661
64,329
3,824
68,153
48,456
1,387
49,843
Income from continuing operations
177,725
168,186
126,984
Income from discontinued operations, net of tax
–
–
109,441
Net income
$ 177,725
$ 168,186
$ 236,425
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
$
$
$
$
5.43
–
5.43
5.22
–
5.22
$
$
$
$
5.10
–
5.10
4.78
–
4.78
$
$
$
$
3.96
3.42
7.38
3.72
3.13
6.85
Weighted average number of common shares outstanding
Basic
Diluted
32,750
34,362
32,960
35,823
32,044
34,925
See accompanying notes.
86
ProAssurance Corporation and Subsidiaries
Consolidated Statements of Cash Flow
(In thousands)
Year Ended December 31
2007
2008
2006
Operating Activities
Net income
Income from discontinued operations, net of tax
Adjustments to reconcile income to net cash provided by operating activities
Amortization
Depreciation
Gain on extinguishment of debt
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
$ 177,725
–
$ 168,186
–
$ 236,425
(109,441)
13,424
3,147
(4,571)
(1,931)
50,913
(3,104)
7,763
(233)
2,615
–
6,633
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
Premiums receivable
Receivable from reinsurers on unpaid losses and loss adjustment expenses
Prepaid reinsurance premiums
Other assets
Receivable from reinsurers on paid losses and loss adjustment expense
Reserve for losses and loss adjustment expenses
Unearned premiums
Reinsurance premiums payable
Other liabilities
Net cash provided by operating activities of continuing operations
12,556
58,755
1,826
13,685
21,741
(180,239)
(32,272)
(705)
17,047
164,775
14,330
43,652
4,119
(3,952)
(20,815)
(47,441)
(35,745)
22,406
27,592
244,106
17,868
14,122
7,817
(12,406)
(6,611)
154,274
(48,130)
642
7,261
182,830
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 trust preferred securities
Repurchase of treasury shares
Book overdraft
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)
(737,851)
(2,701)
(278)
(25,752)
903,575
956
4,238
(212,179)
–
(21,581)
(91,573)
–
(18,366)
(87,561)
5,807
103
(100,017)
(1,407,147)
(948)
(551)
(15,806)
1,276,174
270
10,443
(37,626)
–
6,858
(168,333)
(2,383,596)
(407)
(25,364)
–
1,873,100
38,801
25,074
(85,414)
371,037
(4,875)
(191,644)
(15,464)
–
(54,201)
972
1,958
(66,735)
–
–
–
–
1,455
1,455
(26,815)
30,274
$ 3,459
9,038
21,236
$ 30,274
(7,359)
28,595
$ 21,236
See accompanying notes.
87
ProAssurance Corporation and Subsidiaries
Consolidated Statements of Cash Flow
(In thousands)
Year Ended December 31
2007
2008
2006
Supplemental Disclosure of Cash Flow Information
Net cash paid (received) during the year for income taxes–continuing operations
Cash paid during the year for interest–continuing operations
$ 48,479
$ 6,439
$ 45,249
$ 10,956
$ 95,748
$ 10,192
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
Unsettled redemption of short-term money market investment
Equity increase due to conversion of debt–see Notes 11 and 12
–
$
–
$
$
–
$ 9,427
$ 112,478
$
–
$ 34,732
–
$
–
$
–
$
$ 24,819
$
–
$ 99,128
–
$
–
$
See accompanying notes.
88
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
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.) 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 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, the gain from the sale of ProAssurance’s personal lines
operations recorded in 2006 is reported as Income from Discontinued Operations. See Note 4 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 conformity with U.S. generally accepted accounting
principles (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 2008, ProAssurance has reported Receivable from Reinsurers on Paid Losses and Loss
Adjustment Expenses, Deferred Policy Acquisition Costs, and Goodwill as separate line items on the
Balance Sheet. Previously, these line items were included as components of Other Assets. Prior period
balances in this report have been reclassified to conform to the 2008 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.
89
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
1. Accounting Policies (continued)
Investments; Investment in Unconsolidated Subsidiaries
Fair Values
Fair values for actively traded securities, which for ProAssurance are primarily equity securities,
are based on quoted market prices. Fair values for securities not actively traded, which for ProAssurance
are primarily fixed maturity securities, are estimated using values obtained from an independent pricing
service. The pricing service uses exchange traded prices, when available. If exchange traded prices are
not available, the pricing service prepares valuations using multiple observable inputs. Management
reviews valuations of securities obtained from the pricing services for accuracy based upon the specifics
of the security, including class, maturity, credit rating, durations, collateral, and comparable markets for
similar securities.
Multiple observable inputs are not available for certain of our investments, primarily private
placements and limited partnerships. Management values these investments either using non-binding
broker quotes or pricing models that utilize market based assumptions that have limited observable inputs
including treasury yield levels, issuer spreads and non-binding broker quotes.
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 and FASB Staff Position (FSP) EITF 99-20-1,
Amendments to the Impairment Guidance of EITF 99-20. 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
Fixed maturities and equity securities are considered as either available-for-sale or trading
securities.
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 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.
90
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
1. Accounting Policies (continued)
Other Investments are primarily comprised of equity interests in private investment funds,
accounted for using the cost method. Other Investments also includes available-for-sale fixed 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 private 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 recorded cost basis 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 fair 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.
Real estate accumulated depreciation is approximately $14.6 million and $13.6 million at
December 31, 2008 and 2007, respectively. Real estate depreciation expense for the three years ended
December 31, 2008, 2007 and 2006 is $1.0 million, $1.1 million and $1.3 million, respectively.
91
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
1. Accounting Policies (continued)
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 on Paid Losses is the estimated amount of losses already paid that
will be recoverable from reinsurers. Receivable from Reinsurers on Unpaid Losses 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.
92
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
1. Accounting Policies (continued)
Income Taxes/Deferred Taxes
ProAssurance files a consolidated federal income tax return. Tax-related interest and penalties
are recognized as components of tax expense.
Deferred federal income taxes arise from the recognition of temporary differences between the
basis of assets and liabilities determined for financial reporting purposes and the basis determined for
income tax purposes. ProAssurance’s temporary differences principally relate to loss reserves, unearned
premium, deferred policy acquisition costs, unrealized investment gains (losses) and investment
impairments. Deferred tax assets and liabilities are measured using the enacted tax rates expected to be
in effect when such benefits are realized. ProAssurance reviews its deferred tax assets quarterly for
impairment. If management determines that it is more likely than not that some or all of a deferred tax
asset will not be realized, a valuation allowance is recorded to reduce the carrying value of the asset. In
assessing the need for a valuation allowance, management is required to make certain judgments and
assumptions about the future operations of ProAssurance based on historical experience and information
as of the measurement period regarding reversal of existing temporary differences, carryback capacity,
future taxable income, including its capital and operating characteristics, and tax planning strategies.
Goodwill
In accordance with SFAS 142, Goodwill and Other Intangible Assets, ProAssurance makes at
least an annual assessment as to whether the value of its goodwill assets is impaired. Management
evaluates the carrying value of goodwill during the fourth quarter and before the annual evaluation if
events occur or circumstances change that would more likely than not reduce the fair value below the
carrying value. In assessing goodwill, management estimates the fair value of the reporting unit and
compares that estimate to external indictors such as market capitalization. Management concluded in
2008, 2007 and 2006 that no adjustment to impair goodwill was necessary.
Deferred Policy Acquisition Costs
Costs that vary with and are directly related to the production of new and renewal premiums
(primarily premium taxes, commissions and underwriting salaries) are deferred to the extent they are
recoverable against unearned premiums and are amortized as related premiums are earned.
Reserve for Losses and Loss Adjustment Expenses
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
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.
Internal and external actuaries review the reserve for losses of each insurance subsidiary at least
semi-annually. ProAssurance considers the views of the 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
93
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
1. Accounting Policies (continued)
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, as is the case in 2008, 2007 and 2006.
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
ProAssurance recognizes 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. Compensation cost for awards granted prior
to January 1, 2006 but not vested on January 1, 2006 is recognized over the remaining service period
related to those awards, based on amounts, including grant-date fair values, used prior to the adoption of
SFAS 123(R) to calculate the pro forma disclosures required by SFAS 123(R). 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. 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.
Accounting Changes
FSP EITF 99-20-1, Amendments to the Impairment Guidance of EITF Issue No 99-20, was
issued in January 2009 to amend the impairment guidance in EITF Issue No. 99-20, Recognition of
Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue
to Be Held by a Transferor in Securitized Financial Assets. EITF 99-20 specifies that an impairment is
considered other-than-temporary if, based on an estimate of cash flows that a market participant would
use in determining the current fair value, there has been an adverse change in those estimated cash
flows. FSP EITF 99-20-1 alters this guidance by specifying that an impairment be considered other-than-
temporary if it is “probable” there has been an adverse change in the holder’s estimated cash flows from
those previously projected. ProAssurance adopted FSP EITF 99-20-1 as of December 31, 2008 and
considered the guidance provided therein in its impairment evaluations performed as of December 31,
2008. There was no material effect from adoption.
94
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
1. Accounting Policies (continued)
In May 2008, the FASB issued FSP APB 14-1, Accounting for Convertible Debt Instruments That
May Be Settled in Cash upon Conversion (Including Partial Cash Settlement), which will alter the
accounting for ProAssurance's Convertible Debentures. FSP APB 14-1 requires issuers to account for
convertible debt securities that allow for either mandatory or optional cash settlement (including partial
cash settlement) by separating the liability and equity components in a manner that reflects the issuer's
nonconvertible debt borrowing rate at the time of issuance and requires recognition of additional (non-
cash) interest expense in subsequent periods based on the nonconvertible rate. Additionally, FSP APB
14-1 requires that when such debt instruments are repaid or converted any consideration transferred at
settlement is to be allocated between the extinguishment of the liability component and the reacquisition
of the equity component. FSP APB 14-1 is effective for ProAssurance on January 1, 2009, and must be
applied retrospectively with a cumulative effect adjustment being made as of the earliest period
presented. Early adoption is not permitted. ProAssurance is currently assessing the impact that the
adoption will have on its financial condition and results of operations, but expects no impact on ending
total Stockholders' Equity.
In December 2007 the FASB issued SFAS 160, Noncontrolling Interests in Consolidated
Financial Statements. 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
141(R) 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 141(R) 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 141(R) 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 September 2006, the FASB issued SFAS 157, Fair Value Measurements. The standard
establishes a revised definition of fair value: fair value is the price that would be received to sell an asset
or paid to transfer a liability in an orderly transaction between market participants at the measurement
date. SFAS 157 also 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 establish new guidance regarding the assets
and liabilities required or allowed to be measured at fair value. The statement is effective for fiscal years
beginning after November 15, 2007, with early adoption permitted. ProAssurance adopted SFAS 157 on
January 1, 2008. ProAssurance did not recognize any cumulative effect related to the adoption of SFAS
157 and adoption did not have a significant effect on ProAssurance's 2008 results of operations or
financial condition.
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 permits many
financial assets and liabilities to be reported at fair value that are not otherwise required under GAAP to
be measured at fair value. Under SFAS 159 guidance, the election of fair value treatment is specific to
individual assets and liabilities, with changes in fair value recognized in earnings as they occur. The
election of fair value measurement is generally irrevocable. SFAS 159 is effective for fiscal years
beginning after November 15, 2007, with early adoption permitted. ProAssurance adopted SFAS 159 on
January 1, 2008 but did not elect fair value measurement for any financial assets or liabilities that were
not otherwise required to be measured at fair value.
95
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
1. Accounting Policies (continued)
FASB Interpretation (FIN) 48, Accounting for Uncertainty in Income Taxes, an interpretation of
FAS 109, Accounting for Income Taxes, was issued in June 2006 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.
2. Fair Value Measurement
Effective January 1, 2008 ProAssurance adopted SFAS 157 which establishes a framework for
measuring fair value and requires specific disclosures regarding assets and liabilities that are measured
at fair value.
As defined in SFAS 157, fair value is the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at the measurement date. SFAS
157 establishes a three level hierarchy for valuing assets and liabilities based on how transparent
(observable) the inputs are that are used to determine fair value, with the inputs considered most
observable categorized as Level 1 and those that are the least observable categorized as Level 3.
Hierarchy levels are defined by SFAS 157 as follows:
Level 1: quoted (unadjusted) market prices in active markets for identical assets and
liabilities. For ProAssurance, Level 1 inputs are generally quotes for debt or
equity securities actively traded in exchange or over-the-counter markets.
Level 2: market data obtained from sources independent of the reporting entity
Level 3:
(observable inputs). For ProAssurance, Level 2 inputs generally include quoted
prices in markets that are not active, quoted prices for similar assets/liabilities,
and other observable inputs such as interest rates and yield curves that are
generally available at commonly quoted intervals.
the reporting entity's own assumptions about market participant assumptions
based on the best information available in the circumstances (unobservable
inputs). For ProAssurance, Level 3 inputs are used in situations where little or
no Level 1 or 2 inputs are available or are inappropriate given the particular
circumstances. Level 3 inputs include results from pricing models and
discounted cash flow methodologies as well as adjustments to externally
quoted prices that are based on management judgment or estimation.
The following tables present information about ProAssurance's assets measured at fair value on
a recurring basis as of December 31, 2008, and indicate the fair value hierarchy of the valuation
techniques utilized to determine such value. No liabilities are measured at fair value at December 31,
2008. For some assets, the inputs used to measure fair value may fall into different levels of the fair value
hierarchy. When this is the case, the asset is categorized in the table based on the lowest level input that
is significant to the fair value measurement in its entirety. ProAssurance's assessment of the significance
of a particular input to the fair value measurement in its entirety requires judgment, and considers factors
specific to the assets being valued.
96
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
2. Fair Value Measurement (continued)
Assets measured at fair value on a recurring basis as of December 31, 2008 are as follows:
December 31, 2008
(In thousands)
Assets:
Fixed maturities, available for sale
Government/Government agencies
State and municipal bonds
Corporate bonds
Asset-backed securities
Equity securities, available-for-sale
Equity securities, trading
(1)
Short-term investments
Other investments
(2)
Total assets
Fair Value Measurements Using
Level 2
Level 1
Level 3
$
–
–
–
–
6,624
11,852
305,235
–
$323,711
$ 177,168
1,356,206
557,310
833,085
–
–
136,761
–
$ 3,060,530
$
–
–
36,472
1,327
357
–
–
14,576
$ 52,732
Total
Fair Value
$ 177,168
1,356,206
593,782
834,412
6,981
11,852
441,996
14,576
$ 3,436,973
(1) Short-term investments are reported at amortized cost, which approximates fair value.
(2) Other investments also include investments of $31.0 million accounted for using the cost method that are not included in the table above.
Level 3 assets in the above table consist primarily of private placement senior notes (included in
Corporate bonds), asset-backed securities (as shown in the above table) and a beneficial interest in
asset-backed securities held in a private investment fund (included in Other Investments). The private
placement senior notes are unconditionally guaranteed by large regional banks rated A or better. The fair
value of these assets are primarily derived using pricing models that may require multiple market input
parameters as is considered appropriate for the asset being valued. The asset-backed securities have a
weighted average rating of AA or better, and are collateralized by a timber trust and a Fannie Mae
mortgage-backed security. The asset-backed securities held in a private investment fund are primarily
backed by manufactured housing, recreational vehicle receivables, and subprime securities, have an
average rating of BB, and are valued using a broker dealer quote.
The following table presents additional information about assets measured at fair value using
Level 3 inputs for the year ended December 31, 2008:
(In thousands)
Balance January 1, 2008
Total gains (losses), realized and unrealized:
Included in earnings, as a part of net
realized investment gains (losses)
Included in other comprehensive income
Purchases, sales or settlements
Transfers in
Transfers out
Balance December 31, 2008
The amount of total gains (losses) for the year
ended December 31, 2008 included in
earnings attributable to the change in
unrealized gains (losses) relating to
assets still held at December 31, 2008
December 31, 2008
Fair Value Measurements
Asset-
backed
Securities
$ 33,283
Corporate
Bonds
$ 86,969
State and
Municipal
Bonds
$ 7,183
Equity
Securities
$
–
Other
Invested
Assets
$ 20,981
Total
$ 148,416
–
(1,938)
(426)
–
(29,592)
$ 1,327
286
(261)
(10,527)
–
(39,995)
$ 36,472
–
(886)
(159)
7,025
(13,163)
–
$
(384)
–
741
–
–
$ 357
–
(5,175)
(1,230)
–
–
$ 14,576
(98)
(8,260)
(11,601)
7,025
(82,750)
$ 52,732
$
–
$
(429)
$
–
$ (383)
$
–
$
(812)
97
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
2. Fair Value Measurement (continued)
Certain municipal bonds in the ProAssurance portfolio are not widely traded. When observable
inputs (Level 2) are not available such bonds have been valued using either a pricing model or a single
dealer quote. Trades of these bonds by market participants were completed during the year, which
provided more transparent inputs for establishing the fair value of these municipal bonds as of December
31, 2008. The municipal bond transfers in and out of Level 3 are due to the availability/non-availability of
Level 2 inputs for these bonds.
At the time of adoption of SFAS 157, ProAssurance had previously used either a pricing model or
a single broker dealer quote to value approximately $30 million of asset-backed bonds and $40 million of
bank loans that were not widely traded. ProAssurance has since been able to obtain multiple observable
inputs (Level 2) for the valuation of these holdings, including pricing services that use multiple broker
quotes for assessing fair value.
3. Acquisitions
ProAssurance acquired 100% of the outstanding shares of Physicians Insurance Company of
Wisconsin, Inc., subsequently renamed ProAssurance Wisconsin Insurance Company (PRA Wisconsin),
on August 1, 2006 as a means of expanding its medical professional liability insurance operations
geographically. PRA Wisconsin's largest premium states are Wisconsin and Iowa.
The acquisition was a stock-for-stock transaction accounted for as a purchase transaction in
accordance with SFAS 141. The total cost of the acquisition and the allocation of the purchase price are:
(In millions)
Aggregate Purchase Price:
Fair value of 2.0 million ProAssurance common shares issued
Other acquisition costs
Aggregate purchase price
Assets (liabilities) acquired, at fair value on the date of
acquisition:
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
Other liabilities
Fair value of identifiable net assets acquired
Excess of purchase price over identifiable net assets acquired,
recognized as goodwill
Total purchase price allocated
PRA
Wisconsin
$
99.1
4.6
$ 103.7
$ 199.3
34.4
7.8
24.3
57.2
45.4
(228.4)
(37.6)
(11.6)
(29.8)
61.0
42.7
$ 103.7
ProAssurance common shares 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. The goodwill recognized in the
transaction is not expected to be tax deductible.
98
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
3. Acquisitions (continued)
The fair value of the reserve for losses and related reinsurance recoverable (the net loss reserve)
acquired was estimated as of the date of acquisition based on present value of the expected underlying
net cash flows, and includes a profit margin and a risk premium, as follows:
Physicians Insurance Company of Wisconsin Inc.’s (now PRA Wisconsin) historical
undiscounted loss reserve (determined based on a recent actuarial review) was
discounted to present value assuming payment patterns actuarially developed from the
historical loss data using a discount rate of 4.86%. This rate approximates the risk-free
treasury rate on the acquisition date for maturities similar to the estimated duration of the
reserve being valued. An expected profit margin of 5% was then applied to the
discounted loss reserve 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). Further, in consideration of the long-tail
nature and the related high degree of uncertainty of such loss reserve, an estimated risk
premium of 5% was also applied to the discounted loss reserve. The calculation resulted
in a fair value estimate which was not materially different from the historical loss reserve
and therefore did not result in an adjustment to the historical reserve amount.
4. Discontinued Operations
Effective January 1, 2006 ProAssurance sold its wholly owned subsidiaries, MEEMIC Insurance
Company and MEEMIC Insurance Services (collectively, the MEEMIC Companies), for total consideration
of $400 million before taxes and transaction expenses. In accordance with SFAS 144, the gain from the
sale is reported as discontinued operations in the Consolidated Financial Statements. The following table
provides detailed information regarding the financial statement lines identified as discontinued operations:
(In thousands)
Gain from sale of discontinued operations
Provision for income taxes
Income from discontinued operations, net of tax
2006
$ 164,006
(54,565)
$ 109,441
99
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
5. Investments
The recorded cost basis and estimated fair value of available-for-sale fixed maturities and equity
securities are as follows:
(In thousands)
Fixed Maturities
Government/Government Agencies
State and municipal bonds
Corporate bonds
Asset-backed securities
Equity securities
(In thousands)
Fixed Maturities
Government/Government Agencies
State and municipal bonds
Corporate bonds
Asset-backed securities
Equity securities
December 31, 2008
Recorded
Cost
Basis
Gross
Unrealized
Gains
Gross
Unrealized
(Losses)
Estimated
Fair
Value
$ 172,653
1,349,430
627,811
854,927
3,004,821
7,949
$ 3,012,770
Recorded
Cost
Basis
$ 286,630
1,328,410
650,111
952,043
3,217,194
13,931
$ 3,231,125
$
$
$
$
6,992
26,268
6,823
18,052
58,135
558
58,693
$
$
(2,477)
(19,492)
(40,852)
(38,567)
(101,388)
(1,526)
(102,914)
$ 177,168
1,356,206
593,782
834,412
2,961,568
6,981
$ 2,968,549
December 31, 2007
Gross
Unrealized
Gains
Gross
Unrealized
(Losses)
Estimated
Fair
Value
5,251
15,174
6,551
10,270
37,246
2,724
39,970
$
$
(45)
(2,088)
(8,583)
(6,985)
(17,701)
(1,204)
(18,905)
$ 291,836
1,341,496
648,079
955,328
3,236,739
15,451
$ 3,252,190
The following table provides summarized information with respect to available-for-sale securities
held in an unrealized loss position at December 31, 2008, including the length of time the securities have
been held in a continuous unrealized loss position.
(In thousands)
Fixed maturities, available for sale
Government/Government Agencies
State and municipal bonds
Corporate bonds
Asset-backed securities
Equity securities, available for sale
Total
Fair
Value
Unrealized
Loss
December 31, 2008
Less than 12 months
Unrealized
Loss
Fair
Value
More than 12 months
Unrealized
Loss
Fair
Value
$
54,410
420,064
352,516
301,503
1,128,493
4,188
$
(2,477)
(19,492)
(40,852)
(38,567)
(101,388)
(1,526)
$ 54,410
358,088
277,565
209,606
899,669
2,079
$
(2,477)
(12,500)
(19,200)
(21,145)
(55,322)
(661)
$
–
61,976
74,951
91,897
228,824
2,109
$
–
(6,992)
(21,652)
(17,422)
(46,066)
(865)
$ 1,132,681
$ (102,914)
$ 901,748
$ (55,983)
$ 230,933
$ (46,931)
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, 95% are considered to be interest rate
and spread related. Each fixed maturity security has paid all scheduled contractual payments.
Management believes it will recover the recorded cost basis of each security. In total, there are
approximately 1,890 fixed maturity securities in an unrealized loss position. Management considers the
unrealized loss on ten of those securities to be
100
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
5. Investments (continued)
credit related; the unrealized losses related to these securities total approximately $4.8 million. The single
greatest credit-related unrealized loss position approximates $1.3 million; the second greatest
credit-related unrealized loss position is an unrealized loss of approximately $1.0 million.
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 will be 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 recorded cost basis and estimated fair value of available-for-sale fixed maturities at
December 31, 2008, 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.
(In thousands)
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
Recorded
Cost
Basis
$ 101,087
785,853
827,047
435,907
854,927
$ 3,004,821
Estimated
Fair
Value
$ 100,849
775,448
830,216
420,643
834,412
$ 2,961,568
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, 2008.
At December 31, 2008 ProAssurance has available-for-sale securities with a fair value of $16.5
million on deposit with various state insurance departments to meet regulatory requirements.
Business Owned Life Insurance (BOLI)
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.
Net Investment Income / Net Realized Investment Gains (Losses)
Net investment income by investment category is as follows:
(In thousands)
2008
2007
2006
Fixed maturities
Equities
Short-term investments
Other invested assets
Business owned life insurance
Investment expenses
Net investment income
$ 150,085
1,231
6,891
2,801
1,932
162,940
(4,556)
$ 158,384
$ 149,494
377
14,713
9,228
1,889
175,701
(4,393)
$ 171,308
$ 130,335
414
15,567
2,970
2,285
151,571
(4,121)
$ 147,450
101
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
5. Investments (continued)
Net realized investment gains (losses) are as follows:
(In thousands)
2008
2007
2006
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)
$ 8,038
(6,505)
(890)
(4,536)
(47,020)
$ (50,913)
$ 2,944
(1,143)
(284)
297
(7,753)
$ (5,939)
$ 5,127
(3,410)
(138)
259
(3,037)
$ (1,199)
Net gains (losses) related to fixed maturities included in the above table are ($32.0) million,
($483,000) and ($2.5) million during 2008, 2007 and 2006, respectively.
Other information regarding available-for-sale securities:
(In millions)
2008
2007
2006
Proceeds from sales (exclusive of maturities and paydowns):
Adjustable rate, short-duration fixed maturity securities
Other available-for-sale securities
Total
$ 148.1
400.3
$ 548.4
$ 691.5
360.6
$ 1,052.1
$ 1,235.5
344.1
$ 1,579.6
Purchases of adjustable rate short-duration fixed maturity securities
$ 106.7
$ 576.7
$ 1,438.3
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 a private investment
fund that is primarily focused on managing such investments. ProAssurance maintains a direct beneficial
interest (the separate interest) in the securities originally contributed to the fund. The securities held in the
separate interest are included in Other Investments, at fair value totaling $9.5 million at December 31,
2008 (net of unrealized losses of $11.0 million). Cash flows of the separate interest, including net
investment earnings and proceeds from sales or maturities, (totaling $13.6 million to date), are routinely
transferred to a joint interest (the joint interest) of the fund. ProAssurance recognized an impairment of
$4.2 million related to these securities in 2007. Management reviewed information relevant to the likely
collectability of the underlying securities as of December 31, 2008 and determined that it was probable
that contractual or estimated cash flows from the securities will be received. Based on discussions with
the fund managers regarding this review, management judged the declines in value of the separate
interest not to be other-than-temporary.
The joint interest is accounted for using the equity method and is included in Investment in
Unconsolidated Subsidiaries. In March 2008 ProAssurance contributed an additional $20 million to the
joint interest to take advantage of current dislocations in the credit market. At December 31, 2008 the
carrying value of the joint interest is $28.5 million and ProAssurance's ownership interest approximates
22.7%.
102
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
6. 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 (in thousands):
2008 Premiums
2007 Premiums
2006 Premiums
Written
Earned
Written
Earned
Written
Earned
Direct
Assumed
Ceded
Net premiums
$ 471,510
(28)
(42,475)
$ 429,007
$ 503,607
(28)
(44,301)
$ 459,278
$ 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
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, 2008, all reinsurance recoverables are considered collectible. Reinsurance
recoverables totaling approximately $26.7 million are collateralized by letters of credit or funds withheld.
At December 31, 2008 no amounts due from individual reinsurers exceed 5% of stockholders’ equity.
During 2008, ProAssurance commuted (terminated) various outstanding reinsurance
arrangements for approximately $42.7 million in cash. The commutations reduced Receivable from
Reinsurers on Paid Losses and Receivable from Reinsurers on Unpaid Losses, combined, by
approximately $3.9 million (net of cash received) and reduced Reinsurance Premiums Payable by
approximately $122,000.
During 2007, ProAssurance commuted (terminated) various outstanding reinsurance
arrangements for approximately $6.3 million in cash. The commutations reduced Receivable from
Reinsurers on Paid Losses and Receivable from Reinsurers on Unpaid Losses, combined, 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 on Paid
Losses and Receivable from Reinsurers on Unpaid Losses, combined, by approximately $427,000 (net of
cash received) and reduced Reinsurance Premiums Payable by approximately $2.7 million.
103
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
7. 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:
(In thousands)
2008
2007
Deferred tax assets
Unpaid loss discount
Unearned premium adjustment
CHW and other contingencies (see Note 10)
Loss and credit carryovers
Basis differences–investments
Compensation related
Unrealized losses on investments, net
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
$ 76,351
14,528
7,868
1,276
18,217
7,725
20,555
2,859
149,379
$ 84,549
17,954
7,989
2,322
6,598
8,495
–
1,635
129,542
6,827
–
–
4,518
11,345
$ 138,034
7,742
8,814
5,334
4,547
26,437
$ 103,105
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, 2008 ProAssurance has available net operating loss (NOL) carryforwards of
$1.8 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 2005.
ProAssurance adopted the provisions of FIN 48 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 had no unrecognized tax benefits and did not record any activity related to
unrecognized tax benefits during the year ended December 31, 2007. A reconciliation of the beginning
and ending amounts of unrecognized tax benefits for 2008 is, as follows:
(In thousands)
Balance at January 1
Additions for tax positions taken during the current year
Balance at December 31
2008
–
$
3,755
$ 3,755
The unrecognized tax benefits at December 31, 2008, if recognized, would not affect the effective
tax rate but would accelerate the payment of tax. The unrecognized tax benefits relate primarily to market
values of certain securities and therefore it is reasonably possible the amount could change significantly
during the next twelve months. Due to the nature of the uncertainty the range of such a change cannot be
estimated.
104
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
7. 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:
(In thousands)
2008
2007
2006
Computed “expected” tax expense
Tax-exempt income
Other
Total
$ 86,935
(17,270)
996
$ 70,661
$ 82,719
(15,827)
1,261
$ 68,153
$ 61,890
(13,217)
1,170
$ 49,843
In December 2006, with required Internal Revenue Service approval, ProAssurance changed its
income tax method of accounting for the interest on its outstanding Convertible Debentures (since
converted, see Note 11) to the "comparable yield" method, which accelerates recognition of interest
expense. The effect of the change was to decrease current tax expense and increase deferred tax
expense for the year ended December 31, 2006 by $6.5 million, of which $4.4 million related to pre-2006
interest periods.
No significant interest or penalties were accrued or paid during the year ended December 31,
2008 nor was there any significant liability for such amounts at December 31, 2008.
8. 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 amounted to approximately $45.9 million, $52.9 million,
and $56.9 million for the years ended December 31, 2008, 2007 and 2006, respectively.
9. 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 internal and external actuaries to review the reserve for
losses of each insurance subsidiary. ProAssurance considers the views of the 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).
105
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
9. Reserve for Losses and Loss Adjustment Expenses (continued)
Activity in the reserve for losses and loss adjustment expenses is summarized as follows:
(In thousands)
2008
2007
2006
Balance, beginning of year
Less reinsurance recoverables
Net balance, beginning of year
$ 2,559,707
327,111
2,232,596
$ 2,607,148
370,763
2,236,385
$ 2,224,436
327,693
1,896,743
Net reserves acquired in PRA Wisconsin transaction
–
–
171,246
Net losses:
Current year
Favorable development of reserves
established in prior years
Total
Paid related to:
Current year
Prior years
Total paid
396,750
455,982
479,621
(185,251)
211,499
(104,985)
350,997
(36,292)
443,329
(20,635)
(312,348)
(332,983)
(23,492)
(331,294)
(354,786)
(32,325)
(242,608)
(274,933)
Net balance, end of year
Plus reinsurance recoverables
Balance, end of year
2,111,112
268,356
$ 2,379,468
2,232,596
327,111
$ 2,559,707
2,236,385
370,763
$ 2,607,148
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 2008 was primarily due to reductions in estimates of
claims severity for the 2004, 2005 and 2006 accident years. 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. Actuarial evaluations of both internal and
industry actual claims data in 2008, 2007 and 2006 all indicated that claims severity (i.e., the average size
of a claim) is increasing more slowly than was anticipated when the reserves for 2002 through 2006 were
initially established.
106
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
10. Commitments and Contingencies
As a result of the acquisition of NCRIC Corporation in 2005, ProAssurance assumed the risk of
loss for a judgment entered against PRA National 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 judgment). The judgment was appealed to the District of Columbia Court of Appeals,
which affirmed the judgment in October 2008 and denied PRA National’s petition for rehearing in January
2009. ProAssurance included a liability of $19.5 million related to the judgment and post trial interest as a
component of the fair value of assets acquired and liabilities assumed in the allocation of the NCRIC
purchase price in 2005, and has continued to accrue additional post trial interest through December 31,
2008. The judgment and accrued interest are expected to be paid in the second quarter of 2009.
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.
In October 2008, ProAssurance reached an agreement to acquire the PICA Group (PICA)
through a cash-sponsored demutualization, for $120 million in cash to be paid to PICA policyholders and
$15 million in cash in the form of a surplus contribution to PICA for premium credits usable by eligible
PICA policyholders over a three year period beginning in 2010. PICA primarily provides professional
liability insurance to podiatric physicians throughout the United States and had gross written premium of
approximately $96 million in 2008 (unaudited). The PICA transaction remains subject to policyholder
approval but is expected to close in the second quarter of 2009.
ProAssurance is involved in a number of operating leases primarily for office space and office
equipment. 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, 2008.
Operating Leases
(In thousands)
2009
2010
2011
2012
Thereafter
Total minimum lease payments
$ 1,980
1,897
832
625
2,935
$ 8,269
ProAssurance incurred rent expense of $2.8 million, $2.9 million and $2.8 million in the years
ended December 31, 2008, 2007 and 2006, respectively.
107
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
11. Long-term Debt
Outstanding long-term debt, as of December 31, 2008 and December 31, 2007, consists of the
following:
(In thousands)
2008
2007
Convertible Debentures due June 2023 but converted into common stock in July
2008, see below. Unsecured, principal of $107.6 million bearing a fixed interest
rate of 3.9%, net of unamortized discount of $1.6 million at December 31, 2007.
$
–
$ 105,973
Trust Preferred Securities/Debentures due 2034, unsecured, bearing interest at a
floating rate of 6.0% at December 31, 2008, rate adjusted quarterly.
22,992
46,395
Surplus Notes due May 2034, unsecured, principal of $12 million, net of unamortized
discounts of $62,000 and $0.2 million at December 31 2008 and December 31,
2007, bearing a fixed interest rate of 7.7%, until May 2009, when the rate converts
to a floating rate of LIBOR plus 3.85%, adjusted quarterly.
11,938
$ 34,930
11,790
$ 164,158
Convertible Debentures Due June 30, 2023 (the Convertible Debentures)
ProAssurance completed the conversion of all of its outstanding Convertible Debentures
(aggregate principal of $107.6 million) in July 2008. Approximately 2,572,000 shares of ProAssurance
common stock were issued in the transaction (conversion rate was 23.9037 per $1,000 debenture). Of
the common shares issued, approximately 2.12 million were reissued Treasury Shares and 450,000 were
newly issued shares. No gain or loss was recorded related to the conversion.
Trust Preferred Securities/Trust Preferred Subordinated Debentures (TPS/TPS Debentures)
In 2004, ProAssurance formed two business trusts, (the Trusts) for the sole purpose of issuing, in
private placement transactions, $45.0 million of trust preferred securities and using the proceeds thereof,
together with the equity proceeds received from ProAssurance in the initial formation of the Trusts, to
purchase $46.4 million of variable rate subordinated debentures issued by ProAssurance. In December
2008, ProAssurance reacquired all of the outstanding TPS of one of the trusts and a portion of the
outstanding TPS of the other trust, having a combined face value of $23 million, for approximately $18.4
million and recognized a gain on the extinguishment of the debt of $4.6 million.
ProAssurance owns all voting securities of the Trusts and the TPS Debentures are the sole
assets of the Trusts. The Trusts meet the obligations of the TPS with the interest and principal paid on the
TPS Debentures. Initially, ProAssurance was not the primary beneficiary of the Trusts and in accordance
with the provisions of FIN 46(R), Consolidation of Variable Interest Entities, did not consolidate the Trusts.
When the TPS were reacquired in 2008, ProAssurance became the primary beneficiary of one of the
trusts (Trust-1) and has consolidated Trust-1 as of December 31, 2008. The effect of consolidation is to
reduce both Other Assets and Long-term Debt by approximately $400,000 which is the amount by which
the TPS Debentures issued by ProAssurance and held by Trust-1 exceeded the TPS issued by Trust-1.
The TPS Debentures and the TPS are uncollateralized, do not require maintenance of minimum
financial covenants, and carry nearly identical terms. Maturity is in 2034, but early redemption is allowed
beginning in May 2009. Interest is payable quarterly at LIBOR + 3.85%, set and paid quarterly, 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.
108
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
11. Long-term Debt (continued)
Surplus Notes Due 2034 (the Surplus Notes)
The Surplus Notes were assumed in ProAssurance's acquisition of PRA Wisconsin and are
unsecured obligations of PRA Wisconsin, subordinated and junior in the right of payment to the prior
payment in full of all senior claims and senior indebtedness of PRA Wisconsin. The Surplus Notes are not
guaranteed by ProAssurance or 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. PRA 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 PRA 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 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.
Redemption of 2032 Subordinated Debentures
In December 2007 ProAssurance redeemed its outstanding 2032 Subordinated Debentures, at
face value, for cash of $15.5 million. The 2032 Subordinated Debentures were the only assets of a trust
wholly owned by ProAssurance (the TPS Trust). The TPS Trust used the proceeds received to redeem its
only liabilities, a like amount of outstanding trust preferred securities which were of the same maturity,
terms and features as the 2032 Subordinated Debentures: due in 2032, redeemable after December 2,
2007, interest due and reset quarterly based on the three-month LIBOR rate.
Debt Guarantees
ProAssurance has guaranteed that amounts paid to the Trusts under the TPS Debentures will be
remitted to the holders of the TPS. These guarantees, when taken together with the obligations of
ProAssurance under the TPS 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, 2008, the fair value of the outstanding TPS Debentures approximated 66% of
their $23.0 million face value and the fair value of the Surplus Notes approximated 68% of their $12.0
million face value, based on the present value of underlying cash flows discounted at rates available at
December 31, 2008 for similar debt.
109
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
12. Stockholders’ Equity
At December 31, 2008 ProAssurance had 100 million shares of authorized common stock and 50
million shares of authorized preferred stock. The Board of Directors of ProAssurance Corporation (the
Board) has the authority to determine the provisions for the issuance of 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, 2008, the Board of Directors has not approved
the issuance of preferred stock.
At December 31, 2008 approximately 2.0 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 13. Additionally, approximately 1.2 million common shares are
reserved for the exercise of outstanding options and unvested performance shares.
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,
2008, 2007 and 2006 are as follows:
(In thousands)
Net realized investment losses included in the calculation of
income from continuing operations
Tax effect (at 35%)
Net realized investment losses reclassified from other
2008
2007
2006
$
(44,485)
15,570
$ (5,940) $ (1,320)
462
2,079
comprehensive income
$
(28,915)
$ (3,861) $
(858)
Reclassification adjustments related to discontinued operations for the year ended December 31,
2006 are as follows:
(In thousands)
Net realized investment losses included in the calculation of
income from discontinued operations
Tax effect (at 35%)
Net realized investment losses reclassified from other
comprehensive income
2006
$ (574)
201
$ (373)
As of January 1, 2007, retained earnings was increased by $2.7 million for the cumulative effect
of the adoption of FIN 48 (as discussed in Note 1).
The Board of Directors of ProAssurance authorized $150 million in April 2007 and $100 million in
August 2008 for the repurchase of common shares or the retirement of outstanding debt. As of December
31, 2008, the repurchase authorization remaining available for use is approximately $74.4 million. The
timing and quantity of purchases depends upon market conditions and changes in ProAssurance’s capital
requirements and 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.
ProAssurance used approximately $18.4 million and $15.5 million of the authorization to redeem
debt during the years ended December 31, 2008 and 2007, respectively (see Note 11). ProAssurance
repurchased approximately 1.0 million common shares (at a cost of $54.2 million) and approximately 1.8
million common shares (at a cost of $87.6 million) during the years ended December 31, 2007 and 2008,
respectively. Treasury shares are reported at cost, and are reflected on the balance sheets as an
unallocated reduction of total equity.
110
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
12. Stockholders’ Equity (continued)
As discussed in Note 11, on July 2, 2008 approximately 2.12 million treasury shares and 450,000
newly issued common shares were used to complete the conversion of ProAssurance's Convertible
Debentures. The conversion of the debt increased Stockholders’ Equity by $112.5 million, consisting of
the carrying amount of the Convertible Debentures (principal of $107.6 million, less the unamortized
portion of related loan discounts and costs of $1.8 million) and a $6.7 million tax benefit from the reversal
of interest-related deferred tax liabilities.
13. Stock Options and Share-Based Payments
ProAssurance recognized, in continuing operations, share-based compensation cost of $7.8
million, $8.3 million and $4.7 million and a related tax benefit of $2.6 million, $2.8 million and $1.5 million
during the years ended December 31, 2008, 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 primarily provided performance-based stock compensation to employees during
2008, 2007 and 2006 under the ProAssurance Corporation 2004 Equity Incentive Plan but adopted a new
plan in May 2008, The ProAssurance Corporation 2008 Equity Incentive Plan, that will be used for future
awards. Prior to 2005, awards were made under the ProAssurance Corporation Incentive Compensation
Stock Plan. The Compensation Committee of the Board of Directors is responsible for the administration
of all three Plans.
Options generally vest in five equal installments, the first installment occurring six months after
the grant date and the other installments occurring annually thereafter. All options are granted with an
exercise price equal to the market price of ProAssurance's common shares on the date of grant, and 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 2008, 2007 and 2006 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)
2008
$16.49
2007
$ 16.41
2006
$ 18.37
3.1%
0.23
0%
6
4.6%
0.22
0%
5
4.7%
0.25
0%
6
Because ProAssurance has limited historical data regarding exercise behavior of its employees,
the expected term of the above option grants 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 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
common shares 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.
111
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
13. Stock Options and Share-Based Payments (continued)
The following table provides information regarding ProAssurance option activity:
2008
2007
2006
Weighted
Average
Exercise
Price
$ 40.55
54.28
34.33
52.76
42.48
39.32
Options
973,155
132,500
(68,470)
(23,527)
1,013,658
725,458
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
Weighted
Average
Exercise
Price
$ 28.73
51.33
24.36
22.13
32.81
28.03
Options
1,162,863
116,584
(294,408)
(2,736)
982,303
584,369
Outstanding at beginning of year
Granted
Exercised
Forfeited or expired
Outstanding at end of year
Exercisable at end of year
Outstanding at end of year,
vested or expected to vest
999,044
42.36
959,049
40.46
943,630
32.50
At December 31, 2008, unrecognized compensation cost related to non-vested options granted
under ProAssurance's stock compensation plans approximated $1.8 million. That cost is expected to be
recognized over a weighted average period of 1.7 years.
The fair value of options vested during the years ended December 31, 2008, 2007 and 2006 is
$11.8 million, $17.0 million and $15.3 million, respectively. The aggregate intrinsic value of options
exercised during 2008, 2007 and 2006 is $1.4 million, $8.0 million and $7.9 million, respectively.
Additional information regarding ProAssurance options as of December 31, 2008:
Options outstanding
Options outstanding, vested or expected to vest
Options exercisable
$ 10.4
$ 10.4
$ 9.8
6.9
6.9
6.3
Aggregate Intrinsic
Value
(In millions)
Weighted Average
Remaining Contractual Term
(In years)
There were no cash proceeds from options exercised during the year ended December 31, 2008.
Cash proceeds from options exercised during the years ended December 31, 2007 and 2006 totaled
$128,000 and $210,000, respectively.
ProAssurance also granted Performance Shares awards to employees in 2008, 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
2008
12/31/2010
73,000
$ 54.28
Performance Shares
2007
12/31/2009
58,000
$ 51.48
2006
12/31/2008
72,000
$ 51.38
112
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
13. Stock Options and Share-Based Payments (continued)
At December 31, 2008, based on current achievement of the Performance Measures, it is
estimated that approximately 250,000 Performance Shares, having an estimated grant date fair value of
approximately $13.1 million, will ultimately vest. At December 31, 2008 the unrecognized compensation
cost related to Performance Shares is estimated as $4.7 million and is expected to be recognized over a
weighted average period of 1.5 years. Performance share forfeitures have not been significant.
14. Earnings Per Share
The following table provides detailed information regarding the calculation of basic and diluted
earnings per share for each period presented:
(In thousands except per share data)
2008
2007
2006
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
Basic earnings per share:
Income from continuing operations
Income from discontinued operations
Net income
Diluted earnings per share calculation:
Numerator:
Income from continuing operations, net of tax
Effect of assumed conversion of contingently convertible
debt instruments
Income from continuing operations(cid:326)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 and issuance
$ 177,725
–
$ 177,725
$ 168,186
–
$ 168,186
$ 126,984
109,441
$ 236,425
32,750
32,960
32,044
$
$
5.43
–
5.43
$
$
5.10
–
5.10
$
$
3.96
3.42
7.38
$ 177,725
$ 168,186
$ 126,984
1,484
179,209
–
$ 179,209
2,967
171,153
–
$ 171,153
2,967
129,951
109,441
$ 239,392
32,750
32,960
32,044
of performance shares, weighted for period outstanding
319
291
309
Assumed conversion of contingently convertible debt
instruments, weighted for period outstanding
Diluted weighted average equivalent shares
1,293
34,362
2,572
35,823
2,572
34,925
Diluted earnings per share:
Income from continuing operations
Income from discontinued operations
Net income
$
$
5.22
–
5.22
$
$
4.78
–
4.78
$
$
3.72
3.13
6.85
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.
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
389,000 during 2008, 211,000 during 2007 and 180,000 during 2006.
113
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
15. 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 $3.5 million, $3.3
million and $3.2 million during the years ended December 31, 2008, 2007 and 2006, respectively.
ProAssurance's contribution to the deferred compensation plan was approximately $288,000 for the year
ended December 31, 2008, and $125,000 during each of the years ended December 31, 2007 and 2006.
ProAssurance's liability related to the deferred compensation plan consists primarily of employee salary
deferrals and approximated $3.5 million at December 31, 2008 and $3.1 million at December 31, 2007.
When acquired, PRA Wisconsin maintained defined contribution retirement benefit plans which
were assumed by ProAssurance. On January 1, 2007 the PRA Wisconsin plans were merged into
ProAssurance’s existing plan. ProAssurance incurred expense of approximately $205,000 in 2006 related
to the PRA Wisconsin plan.
16. Statutory Accounting and Dividend Restrictions
ProAssurance's insurance subsidiaries are required to file statutory financial statements with
state insurance regulatory authorities, prepared based upon statutory accounting practices prescribed or
permitted by regulatory authorities. Differences between net income prepared in accordance with GAAP
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, 2008 statutory capital for each of ProAssurance’s insurance subsidiaries 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. MEEMIC Insurance Company was sold
in early 2006 (see Note 4); 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 PRA
Wisconsin in the year of acquisition and thereafter (see Note 3). The net earnings so included are the
earnings for the statutory annual period. Consolidated net income, on a GAAP basis, includes the
earnings of PRA Wisconsin only for the periods following acquisition (August 2006).
(In millions)
Net Earnings
2007
2006
2008
Surplus
2008
2007
$191
$ 171
$400
$1,084
$1,001
ProAssurance’s insurance subsidiaries, in aggregate, are permitted to pay dividends of
approximately $191 million during 2009 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.
114
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
17. Variable Interest Entities
ProAssurance holds passive interests in six limited partnerships/limited liability companies that
are considered to be Variable Interest Entities (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 funds 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 three of the entities represents an ownership interest of less than
7%. These interests are accounted for on the cost basis because ProAssurance has essentially no
influence over the entity. These investments are included in Other Investments and total $31.0 million at
December 31, 2008 and $34.0 million at December 31, 2007.
ProAssurance's investment in three of the entities represents an ownership interest of between
9% and 23%. Because ProAssurance is deemed to have a greater than minor interest in these entities,
they are accounted for using the equity method. ProAssurance’s investment in these three entities totals
$44.5 million and $26.8 million at December 31, 2008 and 2007, respectively, 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 ($9.5 million and $16.2
million at December 31, 2008 and 2007, respectively). See Note 5.
As discussed in Note 11, ProAssurance owns all voting securities in the Trusts associated with its
TPS/TPS Debentures, but is the primary beneficiary of only one trust, Trust-1, which has been
consolidated as of December 31, 2008. ProAssurance’s equity investment in Trust-2 totals $992,000 and
is included in Other Assets.
115
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2008
18. Quarterly Results of Operations (unaudited)
The following is a summary of unaudited quarterly results of operations for 2008 and 2007 (there
were no discontinued operations in either period):
(In thousands except per share data)
1st
2nd
3rd
4th
Net premiums earned
Net losses and loss adjustment expenses:
Current year
Prior year
Net income
Basic earnings per share
Diluted earnings per share
$ 120,577
$ 115,768
$ 113,449
$ 109,484
101,682
(20,000)
35,868
1.11
1.04
96,921
(31,250)
43,318
1.36
1.27
95,273
(30,050)
22,247
0.66
0.66
102,873
(103,951)
76,292
2.28
2.26
2008
(In thousands except per share data)
1st
2nd
3rd
4th
Net premiums earned
Net losses and loss adjustment expenses:
Current year
Prior year
Net income
Basic earnings per share
Diluted earnings per share
$ 137,177
$ 132,663
$ 135,508
$ 128,165
114,600
(15,553)
36,090
1.08
1.02
118,793
(20,000)
37,621
1.13
1.06
113,108
(25,000)
43,112
1.32
1.23
109,481
(44,432)
51,363
1.58
1.47
2007
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.
19. Subsequent Event
ProAssurance completed purchases of Georgia Lawyers Insurance Company (Georgia
Lawyers) and Mid-Continent General Agency, Inc. (Mid-Continent) in the first quarter of 2009.
Georgia Lawyers provides professional liability insurance for lawyers in the state of Georgia and
reported premiums written of approximately $5.7 million in 2008 (unaudited). Mid-Continent is a
Managing General Agent, based in Houston, Texas, producing approximately $26 million (unaudited)
a year in premiums from ancillary healthcare providers and other professional liability coverages,
including approximately $2.7 million (unaudited) of premium produced through ProAssurance.
116
ProAssurance Corporation and Subsidiaries
Schedule I – Summary of Investments – Other than Investments in Related Parties
December 31, 2008
Type of Investment
Fixed Maturities
Bonds:
(In thousands)
U.S. Government or government agencies and authorities
States, municipalities and political subdivisions
Foreign governments
Public utilities
All other corporate bonds
Certificates of deposit
Total Fixed Maturities
Equity Securities, available-for-sale
Common Stocks:
Public utilities
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
Recorded
Cost
Basis
Fair
Value
Amount
Which is
Presented
in the
Balance Sheet
$ 678,968
1,222,604
1,999
164,233
936,717
300
3,004,821
$ 699,204
1,228,338
1,982
165,440
866,304
300
2,961,568
$ 699,204
1,228,338
1,982
165,440
866,304
300
2,961,568
107
514
4,469
2,859
7,949
963
1,492
12,903
15,358
105
634
4,232
2,010
6,981
851
1,131
9,870
11,852
105
634
4,232
2,010
6,981
851
1,131
9,870
11,852
164,546
441,996
$ 3,634,670
147,781
441,996
$ 3,570,178
153,545
441,996
$ 3,575,942
(1) Other investments include investments reported at cost and investments reported at fair value. Thus, the balance sheet
amount is less than the "cost" column but greater than the "fair value" column.
117
ProAssurance Corporation and Subsidiaries
Schedule II – Condensed Financial Information of Registrant
ProAssurance Corporation – Registrant Only
Condensed Balance Sheets
(In thousands)
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
Investment in unconsolidated subsidiaries
Cash and cash equivalents
Due from subsidiaries
Other assets
Total Assets
Liabilities and Stockholders’ Equity
Liabilities:
Other liabilities
Long-term debt
Total Liabilities
Stockholders’ Equity:
Common stock
Other stockholders’ equity, including unrealized gains (losses) on
securities of subsidiaries
Total Stockholders’ Equity
December 31
2008
2007
$ 1,265,452
$ 1,250,690
12,101
412
5,629
131,647
17,159
3
33,613
17,475
62,493
281
5,203
71,181
–
3,680
18,848
10,312
$ 1,483,491
$ 1,422,688
$
36,914
$
15,250
22,992
59,906
152,368
167,618
341
336
1,423,244
1,254,734
1,423,585
1,255,070
Total Liabilities and Stockholders’ Equity
$ 1,483,491
$ 1,422,688
118
ProAssurance Corporation and Subsidiaries
Schedule II – Condensed Financial Information of Registrant
ProAssurance Corporation – Registrant Only
Condensed Statements of Income
(In thousands)
2008
2007
2006
Year Ended December 31
Revenues:
Investment income including net realized investment gains
(losses) of $(3,379), ($405) and ($1,450), respectively
$
(34)
$
8,281
$
6,407
Gain on extinguishment of debt
Other income (loss)
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
4,571
(2,734)
1,803
5,815
5,157
10,972
(9,169)
(3,325)
(5,844)
–
131
8,412
9,204
4,269
13,473
(5,061)
(2,911)
(2,150)
–
174
6,581
9,063
3,538
12,601
(6,020)
(2,632)
(3,388)
Equity in net income of subsidiaries
183,569
170,336
239,813
Net income
$ 177,725
$ 168,186
$ 236,425
119
ProAssurance Corporation and Subsidiaries
Schedule II – Condensed Financial Information of Registrant
ProAssurance Corporation – Registrant Only
Condensed Statements of Cash Flow
(In thousands)
2008
Year Ended December 31
2007
2006
Cash provided (used) by operating activities
$
9,603
$ (21,175)
$
2,529
Investing activities
Purchases of:
Fixed maturities, available for sale
Equity securities, available for sale
Cash investment in unconsolidated subsidiaries
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
Financing activities
Repurchase of treasury stock
Subsidiary payments for common shares and share-based
compensation awarded to subsidiary employees
Book overdraft
Other
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period
(28,881)
(354)
(20,000)
78,961
(64,717)
104,800
(450)
(3,608)
65,751
(270,449)
(291)
–
411,996
(45,228)
7,000
(41,202)
3,731
65,557
(87,561)
(54,201)
8,023
315
192
(79,031)
(3,677)
3,680
3
$
11,175
–
1,958
(41,068)
3,314
366
$ 3,680
Significant non-cash transactions:
Extinguishment of debt as a result of Trust Preferred Securities
reacquired by wholly owned subsidiaries–See Note 2
Equity increase due to conversion of debt–see Notes 11 and 12
of the ProAssurance Consolidated Financial Statements
$ 23,403
$
$ 112,478
$
–
–
(416,691)
–
–
252,360
(15,217)
200,000
(30,410)
(2,794)
(12,752)
–
7,702
–
1,453
9,155
(1,068)
1,434
366
–
–
$
$
$
120
ProAssurance Corporation and Subsidiaries
Schedule II – Condensed Financial Information of Registrant
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, 2008 and 2007,
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. (now PRA Wisconsin). The acquisition is described in Note 3 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 4 to the Consolidated Financial
Statements. The proceeds from the sale of $400 million were paid to an indirect subsidiary of
PRA Holding.
2. Long-term Debt
Outstanding long-term debt, as of December 31, 2008 and December 31, 2007,
consisted of the following:
$ In thousands
2008
2007
Convertible Debentures due June 2023 but converted into common stock in July
2008. Unsecured, principal of $107.6 million bearing a fixed interest rate of
3.9%, net of unamortized discount of $1.6 million at December 31, 2007.
Trust Preferred Securities/Debentures due 2034, unsecured, bearing interest at a
floating rate of 6% at December 31, 2008, rate adjusted quarterly (see below).
$
–
$ 105,973
22,992
$ 22,992
46,395
$ 152,368
In 2008 wholly owned subsidiaries of ProAssurance reacquired outstanding Trust
Preferred Securities having a face value of $23 million, which effectively extinguished the related
Trust Preferred Debentures issued by PRA Holding. Trust Preferred amounts shown in the above
table are shown net of the reacquired Trust Preferred Securities held by PRA Holding’s
subsidiaries. A gain of $4.6 million was recognized on the extinguishment of the debt.
See Note 11 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 $104.8 million, $7.0 million and
$200.0 million during the years ended December 31, 2008, 2007 and 2006. PRA Holding
contributed capital to its subsidiaries of $450,000, $41.2 million and $30.4 million during the years
ended December 31, 2008, 2007 and 2006.
121
ProAssurance Corporation and Subsidiaries
Schedule II – Condensed Financial Information of Registrant
Notes to Condensed Financial Statements of Registrant (continued)
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. Commitments and Contingencies
In October 2008, ProAssurance reached an agreement to acquire the PICA Group (PICA)
through a cash sponsored demutualization, to be paid $135 million in cash, of which $15 million is to be
in the form of a surplus contribution to PICA. The PICA transaction is expected to close in the second
quarter of 2009. Additional information regarding the PICA transaction is provided in Note 10 to the
Consolidated Financial Statements, included herein.
122
ProAssurance Corporation and Subsidiaries
Schedule III – Supplementary Insurance Information
Years Ended December 31, 2008, 2007 and 2006
(In thousands)
2008
Continuing Operations
2007
2006
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:
Amortization of deferred policy acquisition costs
Other underwriting, acquisition and insurance expenses
Net premiums written
$
19,505
2,379,468
185,756
459,278
158,384
$
22,120
2,559,707
218,028
533,513
171,308
$
23,763
2,607,148
253,773
583,067
147,450
396,750
455,982
479,621
(185,251)
(332,983)
45,880
54,505
429,007
(104,985)
(354,786)
52,855
53,896
506,397
(36,292)
(274,933)
56,944
49,425
543,376
Note: all amounts above are derived entirely from consolidated property and casualty entities.
123
ProAssurance Corporation and Subsidiaries
Schedule IV – Reinsurance
Years Ended December 31, 2008, 2007 and 2006
(In thousands)
Property and Liability(1)
Premiums earned
Premiums ceded
Premiums assumed
Net premiums earned
2008
Continuing Operations
2007
2006
$ 503,607
(44,301)
(28)
$ 459,278
$ 585,267
(51,797)
43
$ 533,513
$ 627,148
(44,099)
18
$ 583,067
Percentage of amount assumed to net
(0.01%)
0.01%
0.00%
(1) All of ProAssurance's premiums are related to property and liability coverages.
124
EXHIBIT INDEX
Exhibit
Number
2
2.1
2.2
2.3
2.4
2.5
3.1(a)
3.1(b)
3.2
4
10.1(a)
10.1(b)
10.1(c)
Description
Schedules to the following documents are omitted; the contents of the schedules are
generally described in the documents; and ProAssurance will upon request furnish to the
Commission supplementally a copy of any omitted schedule.
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 Physicians Insurance Company of Wisconsin, as amended February 14, 2006 (3)
Plan of Conversion of PICA as filed with the Illinois Director of Insurance on November 13,
2008 (4)
Stock Purchase Agreement executed by ProAssurance Corporation and PICA dated
October 28, 2008 (4)
Certificate of Incorporation of ProAssurance (5)
Certificate of Amendment to Certificate of Incorporation of ProAssurance (6)
Second Restatement of the Bylaws of ProAssurance (7)
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.
Medical Assurance, Inc. Incentive Compensation Stock Plan (formerly known as the Mutual
Assurance, Inc. 1995 Stock Award Plan) (8)*
Amendment and Assumption Agreement by and between ProAssurance and Medical
Assurance, Inc. (6)*
Amendment and Assumption Agreement by and between Mutual Assurance, Inc. and
MAIC Holdings, Inc. dated April 8, 1996 (9)*
10.3(a)
ProAssurance Corporation 2004 Equity Incentive Plan (11)*
10.3(b)
First amendment to 2004 Equity Incentive Plan (12)*
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 (13) *:
Edward L. Rand, Jr.
Howard H. Friedman
Jeffrey P. Lisenby
Darryl K. Thomas
Frank B. O'Neil
10.5
10.6(a)
Release and Severance Compensation Agreement effective as of January 1, 2008,
between ProAssurance and Victor T. Adamo (13)*
Employment Agreement between ProAssurance and W. Stancil Starnes dated as of May 1,
2007 (14)*
125
10.6(b)
Amendment to Employment Agreement with W. Stancil Starnes (May 1, 2007) effective as
of January 1, 2008 (13)*
10.7
10.8
10.9
10.10
Employment Agreement between ProAssurance and A. Derrill Crowe effective as of July 1,
2007 (15)*
Employment Agreement between ProAssurance and Paul R. Butrus dated as of January 1,
2008 (13)*
Consulting Agreement between ProAssurance and William J. Listwan (16) *
Form of Indemnification Agreement between ProAssurance and each of the following
named executive officers and directors of ProAssurance: (17)
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
10.12
10.13
10.14
10.15
21.1
23.1
31.1
31.2
32.1
32.2
ProAssurance Group Employee Benefit Plan which includes the Executive Supplemental
Life Insurance Program (Article VIII) (8)*
Amendment and Restatement of the Executive Non-Qualified Excess Plan and Trust
effective January 1, 2008 (13)*
Amendment and Restatement of Director Deferred Compensation Plan effective January 1,
2008 (13)*
ProAssurance Corporation 2008 Equity Incentive Plan (17)*
ProAssurance Corporation 2008 Annual Incentive Compensation Plan (18)*
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
* Denotes a management contract or compensatory plan, contact or arrangement required to be filed as
an exhibit to this report.
126
Footnotes
(1) 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.
(2) 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.
(3) 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.
(4) Filed as an Exhibit to ProAssurance’s Current Report on Form 8-K for event occurring
November 13, 2008 (File No. 001-16533) and incorporated herein by reference pursuant to
SEC Rule 12b-32.
(5) 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).
(6) 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.
(7) Filed as an Exhibit to ProAssurance’s Current Report on Form 8-K for the event occurring May
21, 2008 (File No. 001-16533) and incorporated herein by reference pursuant to SEC Rule 12b-
32.
(8) 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.
(9) 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.
(10) 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.
(11) 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.
(12) 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.
(13) Filed as an Exhibit to ProAssurance's Annual Report on Form 10-K for year ended December
31, 2007 (File No. 001-16533) and incorporated herein by this reference pursuant to SEC Rule
12b-32.
(14) 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.
(15) 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.
(16) 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.
(17) Filed as an Exhibit to ProAssurance's Annual Report on Form 10-K for the quarter ended
December 31, 2002 (File No. 001-16533) and incorporated herein by this reference pursuant to
SEC Rule 12b-32.
127
(18) Filed as an Exhibit to ProAssurance’s Registration Statement on Form S-8 (File No. 333-
156645) and incorporated herein by reference pursuant to SEC Rule 12b-32.
(19) Filed as an Exhibit to ProAssurance’s Definitive Proxy Statement (File No. 001-165333)
on April 11, 2008 and incorporated herein by reference pursuant to SEC Rule 12b-32.
128
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 24, 2009
/s/ W. Stancil Starnes
W. Stancil Starnes
Chief Executive Officer
129
Exhibit 31.2
CERTIFICATION
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 24, 2009
/s/ Edward L. Rand, Jr.
Edward L. Rand, Jr.
Chief Financial Offic
130
Exhibit 32.1
CERTIFICATION
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.
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, 2008 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 24, 2009
/s/ W. Stancil Starnes
W. Stancil Starnes
Chief Executive Officer
131
Exhibit 32.2
CERTIFICATION
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.
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, 2008 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 24, 2009
/s/ Edward L. Rand, Jr.
Edward L. Rand, Jr.
Chief Financial Officer
132
Annual Report Appendix A
Non-GAAP Financial Measures
Operating Income is a “Non-GAAP” financial measure that is widely used in our industry to evaluate the
performance of underwriting operations. Operating Income excludes the after-tax effects of realized
investment gains or losses, gains or losses on the extinguishment of debt, and guaranty fund assessment or
recoupments. We believe Operating Income presents a meaningful view of the performance of our insurance
operations. While we believe disclosure of certain Non-GAAP information is appropriate, you should not
consider this information without also considering the information we present in accordance with GAAP, which
includes the effect of net realized investment losses incurred in 2008, 2007 and 2006. The following table is a
reconciliation of Income from Continuing Operations to Operating Income for the years covered in tables and
charts in this report:
Reconciliation of Income from Continuing Operations to Operating Income:
(in thousands except per share data)
2008
Year Ended December 31
2006
2007
2005
2004
Income from Continuing Operations
Adjustments, net of tax effects:
Add:
$ 177,725
$ 168,186
$ 126,984
$ 80,026
$ 43,043
Net realized investment losses
Guaranty fund assessments
33,093
-
3,860
360
779
1,696
-
147
-
258
Subtract:
Net realized investment gains
Guaranty fund recoupments
Gain on extinguishment of debt
Operating Income
Per diluted common share:
-
867
2,971
$ 206,980
-
-
-
$ 172,406
-
-
-
$ 129,459
593
-
-
$ 79,580
4,922
-
-
$ 38,379
Income from Continuing Operations
Effect of adjustments
Operating Income per diluted common share
$
$
$
5.22
0.85
6.07
$
$
$
4.78
0.12
4.90
$
$
$
3.72
0.07
3.79
$
$
$
2.52
(0.01)
2.51
$
$
$
1.44
(0.15)
1.29
This page is not a part of ProAssurance’s Annual Report on Form 10K, and was not filed with the Securities & Exchange Commission.
134
INVESTOR INFORMATION
There were 33,083,968 shares of ProAssurance Corporation
and filed with the Securities and Exchange Commission (the “SEC”).
common stock outstanding at March 15, 2009. On that date, we
Our filings with the SEC are available in the Investor Relations section
had 3,816 shareholders of record. Our common stock trades
of our website, and from the EDGAR section of the SEC’s website,
on The New York Stock Exchange under the symbol PRA. Our
www.sec.gov/edgar.shtml.
stock is listed as ProAsr in the stock section of USA Today and
y
Our Board of Directors has adopted charters for our Audit,
many major newspapers, and as ProAssurance in the Wall
Compensation, and Nominating/Corporate Governance Committees.
Street Journal. We also post the price of our stock on our
In addition the Board has established and adopted Corporate Gover-
website, www.ProAssurance.com.
nance Principles and a Code of Ethics and Conduct. We make these
YOUR SHARES
documents, and other information such as committee composition
and leadership, director independence and stock ownership guide-
If you hold your shares through a brokerage account, your
lines available in the Governance section of our website.
broker or a customer service representative at that firm should
W. Stancil Starnes, our Chief Executive Officer, submitted the
be able to answer questions about your holdings.
required Section 12(a) CEO Certification to the New York Stock
If you hold your shares in certificate form, or have shares
Exchange in a timely manner on June 20, 2008. Additionally, we
held in direct registration (DRS), you may contact our transfer
have been timely in the filing of CEO/CFO certifications as required
agent, BNYMellon Shareowner Services, for address changes,
by Section 302 of the Sarbanes-Oxley Act. These certifications are
transfer of certificates, and replacement of share certificates
published as exhibits in our Form 10K filed with the SEC on
that have been lost or stolen.
February 25, 2009.
You may reach BNYMellon Shareowner Services in a variety
of ways:
PHONE
INTERNET INFORMATION ABOUT
(800) 851-9677
YOUR ACCOUNT
(201) 680-6578
www.bnymellon.com/shareowner/isd
HEARING IMPAIRED
GENERAL INFORMATION ABOUT MELLON
(800) 231-5469
www.bnymellon.com
(201) 680-6610
MAIL
INVESTOR RELATIONS
The Investor Relations section of our website also contains
detailed financial information, SEC filings, the latest news releases
about the Company and our latest presentation materials. We also
maintain an archive of this material, although you should realize that
archived information, by its very nature, may no longer be accurate.
OBTAINING INFORMATION DIRECTLY FROM PROASSURANCE
Any of the documents mentioned above may be obtained from
our Communications and Investor Relations Department using one
BNYMellon Shareowner Services
of the contact methods below:
480 Washington Boulevard
P.O. Box 358015
Jersey City, NJ 07310-1900
Pittsburgh, PA 15252-8015
E-MAIL
U. S. POSTAL SERVICE
Investor@ProAssurance.com ProAssurance Corporation
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 ProAssurance. For assistance, please phone our Investor
Relations department at (800) 282-6242.
CORPORATE GOVERNANCE AND COMPLIANCE WITH REGULA-
TORY AND NEW YORK STOCK EXCHANGE REQUIREMENTS
We post detailed information in the Corporate Governance and
Investor Relations sections of our website, www.ProAssurance.com.
Our Board of Directors has adopted a policy regarding
determination of director independence, including categorical
standards to assist in determining independence. These are pub-
lished in our proxy statement which is mailed to shareholders
Investor Relations & Communications
P.O. Box 590009
Birmingham, AL 35259-0009
PHONE OR FAX
Phone: (205) 877-4400
(800) 282-6242
Fax: (205) 802-4799
ANNUAL MEETING
The 2009 Annual Meeting is scheduled for 10:00 AM CDT on
Wednesday, May 20, 2009 at the headquarters of ProAssurance
Corporation, 100 Brookwood Place, Birmingham, Alabama 35209.
The cover and narrative of this report are printed on Mohawk Options PC White, which is manufactured
entirely with Green e-certified wind generated electricity on 100% post-consumer waste. Using this paper
eliminates 118 lbs of ghg emissions and saves 980 cubic feet of natural gas.
We are distributing our materials for our annual meeting in compliance with the SEC’s e-Proxy rules for
Notice & Access. This eliminates the printing of approximately 12,500 sets of material resulting in the following:
27 trees preserved for the future
76 lbs. waterborne waste not created
11,284 gallons of wastewater flow saved
1,248 lbs. solid waste not generated
2,458 lbs. net greenhouse gases prevented
18,815,600 BTUs energy not consumed
®
100 Brookwood Place
Birmingham, Alabama 35209
(205) 877-4400
(800) 282-6242
www.ProAssurance.com