SM
2 0 0 9 A N N U A L R E P O R T
INTEGRITY
The core value at the heart
of every decision we make
FORESIGHT
The application of our experience
in an uncertain and evolving world
DISCIPLINE
The intense execution of a strateg y
designed for long-term success
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OPERATING INCOME
PER DILUTED SHARE (1)
NET INCOME
PER DILUTED SHARE
(1) SEE PAGE 138 FOR RECONCILIATION
OF OPERATING MEASURES TO GAAP
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BOOK VALUE
PER SHARE (2)
(2) TOTAL CAPITAL PER
SHARE OF COMMON
STOCK OUTSTANDING
1800
1500
1200
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5000
4000
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1000
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SHAREHOLDERS’
EQUITY
(IN MILLIONS)
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ASSETS (3)
(IN MILLIONS)
(3) EXCLUDES
DISCONTINUED
OPERATIONS
F I N A N CI A L H I GH L I GH T S
( i n t h o u s a n d s)
Income Statement Highlights(1)
Gross premiums written(2)
Total revenues(2)
Income (loss) from continuing operations,
net of tax
Operating income(3)
Net income(4)
Balance Sheet Highlights
Total investments(2)
Fiscal Years Ended December 31
2005
2006
2007
2008
2009
$ 572,960
$ 578,983
$ 549,074
$ 471,482
$ 553,922
647,950
737,598
706,068
567,162
672,683
80,026
79,580
113,457
126,984
129,459
236,425
168,186
172,406
168,186
177,725
206,980
177,725
222,026
215,210
222,026
$ 2,614,319
$ 3,492,098
$ 3,639,395
$ 3,575,942
$ 3,838,222
Total assets, continuing operations
$ 3,341,600
$ 4,342,853
$ 4,440,808
$ 4,280,938
$ 4,647,414
Total assets(5)
$ 3,909,379
$ 4,342,853
$ 4,440,808
$ 4,280,938
$ 4,647,414
Reserve for losses and loss adjustment
expenses(2)
Long-term debt(2)
$ 2,224,436
$ 2,607,148
$ 2,559,707
$ 2,379,468
$ 2,422,230
$
167,240
$
179,177
$
164,158
$
34,930
$
50,203
Total liabilities, continuing operations
$ 2,806,820
$ 3,224,306
$ 3,185,738
$ 2,857,353
$ 2,942,819
(1) Includes acquired entities since date of acquisition only (PICA Group was acquired on April 1, 2009; PIC Wisconsin was acquired on August 1, 2006;
NCRIC Corporation was acquired on August 3, 2005)
(2) Excludes discontinued operations
(3) See Page 138 for Reconciliation of Operating Measures to GAAP
(4) Years 2006 and prior include discontinued operations
(5) 2005 includes discontinued operations
SM
one
ProA ssurance ha s proven the value of
l o n g - t e r m r e s u l t s d e r i v e d f r o m t h e
persistent and skillf ul e xecution of an
e f f e c t i v e , d i s c ip l i n e d s t r a t e g y . We
ea ch take g r eat pr id e in ou r r e cor d
of f in an cia l su cce ss an d ope r at ion a l
prof iciency, attributes that def ine our
C om pa n y a n d pr o d u ce e x ce pt i on a l
r e s u l t s f o r o u r i n s u r e d s a n d o u r
s h a r e h o l d e r s . M o r e o v e r , w e t a k e
continuing pride in the role Treated
Fa i rly pl a y s in the achieve ment of our
goal s. Treated Fa irly illuminates our
path and ser ves a s the yard stick by
which we mea sure ou r e ve r y a ct ion .
To My Fellow Shareholders
How do you measure success?
I ask because 2009 was, by virtually every measure,
another successful year for ProAssurance. You and I,
as shareholders, have much to be proud of in our
results for this year, but I believe we can achieve more
in the years ahead.
As I review the results produced by our disciplined
operating strategy, I want to share with you our vision
of the future—the foresight we believe will allow
ProAssurance to be ever more successful in the future.
2009
Your management team believes the highest measure
of success in a long-term enterprise such as ours is the
overall worth of the enterprise, for that ensures our
ability to make—and keep—promises of value and
security to our insureds, our shareholders and those
agents and employees who depend upon us for their
livelihood. No matter how you choose to measure
the worth of ProAssurance, 2009 was an especially
successful year:
• Book Value per Share is the measurement of
choice for your management team because it
encapsulates the bottom line effects of all we do
in one easily defined and calculated number. In
2009, we grew Book Value per Share to $52.59,
a 23% increase over 2008. In the past two years,
arguably the most financially challenging years
in most of our lifetimes, we’ve grown Book
Value per Share by 36%.
• Shareholders’ Equity broadly defines the net
worth of ProAssurance. At the end of 2009,
Shareholders’ Equity stood at a record $1.7 billion,
an increase of almost 20% over 2008.
W. Stancil Starnes
Chief Executive Officer
two
Treated Fairly
T H E R E IS N O SU BS T I T U T E F O R
T H E D IS CI P L I N E D E X ECU T I O N
O F A LO N G -T E R M S T R AT EG Y I N
O U R B USI N E SS. T O K E E P T H E
P R OM ISE S W E M A K E
T O I NSU R E DS A N D BU I L D
SH A R E H O L D E R VA L U E , W E
M US T B E S T RO N GE R T O DAY
T H A N Y E S T E R DAY, A N D
T O MO R ROW W E M US T B E
S T R O N GE R S T I L L . W E ACH I E V E
T H AT GOA L BY PAT I E N T LY
BU I L D I N G F I N A N CI A L S T R E N G T H
Y E A R A F T E R Y E A R .
D
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BOOK VA L UE
P ER SH A R E
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Book Value per Share is the measurement of choice for
your management team because it encapsulates the
bottom line effects of all we do in one easily defined and
calculated number.
BO O K VA L U E GROW T H
10 year
5 year
1 year
Cumulative
278%
151%
23%
CAGR
14%
20%
23%
Measured through Year-End 2009
• Return on Equity may be the measure that
investors focus on the most, after the absolute
price per share. Our Return on Equity reached
14.2% in 2009, almost a full point higher than
in 2008.
These results should come as no surprise to those
shareholders who have owned a portion of our com-
pany for a number of years. The disciplined strategy
we execute on a daily basis demands our full attention
to enhancing the strength of our balance sheet.
We are also dedicated to enhancing the profitability
of the company, for it’s those profits that help us
build the balance sheet as the foundation for the
security we provide our insureds and the value we
create for our shareholders. In 2009, we grew Net
Income by 25%.
There are few businesses in the world that must set
a price for their product years before they know the
actual cost, yet that is our daily challenge. Thus we
approach top line growth with an equal measure
of discipline and dedication to strict underwriting
standards and adequate pricing. Taking shortcuts to
bolster the top line is a sure ticket to financial disaster,
as we’ve seen many times over in our industry. That
said, we did achieve 17% top line growth in 2009
through a careful mixture of prudent organic growth
and the addition of high quality premium from
thoughtfully executed M&A transactions. This growth
came at a time when almost every other property
casualty writer was experiencing a marked decline in
Gross Premiums Written.
ProAssurance 2009 Annual Report
three
We wrote $28 million of new premium in the book
of business that existed in ProAssurance prior to our
2009 acquisitions—what we term our “historical”
book of business. The majority of that business,
$22 million, was in our core physician business. This
increase was the result of carefully executed strategies
that utilized every operational department in the
company and our agents and representatives in a
team selling approach stressing the advantages that
make ProAssurance’s coverage and commitment so
much more valuable than that of our competitors.
Our demonstrated willingness to offer insureds an
unfettered defense of their claims, to the extent
allowed by law, is a key selling point. So too is our
vast, effective repertoire of print, on-line and in-person
risk management offerings. These advantages, encap-
sulated in the company-wide commitment to Treated
Fairly as the touchstone for every encounter within
and without the organization, have truly become
difference makers in the market for ProAssurance.
Our acquisitions of The PICA Group, Mid-Continent
General Agency (now ProAssurance Mid-Continent
Underwriters) and Georgia Lawyers Insurance
Company brought in $95 million of new, high
quality premium.
The premium from The PICA Group represented
the largest contribution, $77 million. ProAssurance
Mid-Continent Underwriters was responsible for
$14 million of new premium, and Georgia Lawyers,
which was folded into our existing legal professional
liability book within ProAssurance Casualty, brought
us an additional $4 million.
17%
Growth in Gross Written
Premium in 2009
25%
Increase in Net Income in 2009
four
Treated Fairly
O U R U N I QU E K N OW L E D GE O F
T H E M A R K E T S W E SE R V E
A L LOW S US T O D E V E LO P
I N N OVAT I V E I NSU R A N CE
S O L U T I O NS , P ROV I D E
E F F EC T I V E CL A I M S H A N D L I N G
A N D CR E AT E M E A N I N GF U L
R ISK M A N AGE M E N T
P R O GR A M S. BY A N T I CI PAT I N G
T H E N E E DS O F T H OSE W E
SER V E , W E DEL I V ER
INSUR A NCE S O L U T I O NS T H AT
W O R K H A N D - I N - H A N D W I T H O U R
U N WAV E R I N G COM M I T M E N T T O
TREATED FAIRLY. T H E R E SU LT
IS A COM PA N Y T H AT
CR E AT E S VA L U E F O R I NSU R E DS
A N D I N V E S T O R S A L I K E .
F
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Y E A R- END
SH A R E P R ICE
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We are focused on long-term success, but it’s remarkable
how much success we achieve every year when we do the
right thing to ensure long-term strength and stability.
SH A R E P R I CE S
S I N C E I N C E P T I O N
10 year
5 year
1 year
Cumulative
166%
37%
2%
CAGR
10%
7%
2%
Measured through Year-End 2009
We were also able to retain a remarkable 89% of all
expiring risks in our historical book of business in
2009. Retention at PICA was even higher, with 93%
of their expiring risks renewing. This is an outstand-
ing achievement, given the year of successful transition
at PICA, as they came into ProAssurance in a spon-
sored demutualization in April, 2009.
Our unmatched dedication to courtroom advocacy
on behalf of our insureds continued in 2009. Loss
trends of the past few years have been manageable in
our historical book of business, with lower frequency
in virtually every jurisdiction. Our inventory of open
claims has fallen from a high of 14,600 in 2005 to
8,171 at year-end 2009 (both numbers include PICA).
This lower frequency, offset by a 4%–5% annual
increase in the overall severity of claims, has allowed
us to reflect the improved loss climate in responsively
lower premiums over the past three years. Yet even as
we reflect loss trends in our pricing, we never forgo
the discipline that ensures each risk is priced in a
manner that supports our Return on Equity objectives
and ensures the future financial strength of the
company. In other words, we will never sacrifice the
safety and security of ProAssurance on the altar of
market share.
The Treated Fairly philosophy, which we unveiled
late in 2008, has, as I mentioned earlier, been a
measure of excellence for us. By saying to everyone
we encounter, but especially to our insureds, that we
affirm their right to be carefully heard and thought-
fully engaged in an open, transparent fashion, we
are reinforcing the values already present in our
relationship with our insureds. As you saw in last
ProAssurance 2009 Annual Report
five
year’s report, Treated Fairly means different things
to different insureds, but meeting those disparate
expectations ensures that we are the carrier of choice
for approximately 57,000 policyholders nationwide.
2010 and Beyond
Paraphrasing Disraeli, “The secret of success is to be
ready for opportunity when it comes.” ProAssurance
has always had the foresight and financial strength
to allow us to be successful by taking advantage of
opportunities as they arise. In many cases, our exper-
tise and capital allow us to create those opportunities.
We intend this to be the case as we move forward
this year and in the years ahead.
That preparation and foresight will require knowledge,
and we are well positioned with what I believe to be
the most experienced and effective management team
amongst the specialty property casualty companies
in America. Our average tenure in the insurance
industry is over two decades; we average a dozen
years working here at ProAssurance. That experience
has seen us successfully though several insurance
cycles and will see us successfully through the cycle
changes to come.
In addition to our human capital, we know the future
will also require monetary capital and we have not
hesitated to put that capital to work when the right
opportunities presented themselves. For example,
during the first half of 2009, with the capital markets
frozen, we were able to successfully consummate our
transactions with PICA, ProAssurance Mid-Continent
and Georgia Lawyers. The certainty of cash on hand
enabled us to complete these important additions to
our company.
57,000
Policyholders Nationwide
$95 MILLION
New Premiums from
Acquisitions in 2009
six
Treated Fairly
I N T EGR I T Y IS T H E CO R E VA L U E
AT P ROA SSU R A N CE T H AT
S TA N DS A BOV E A L L OT H E R S—
I N T EGR I T Y IS A O N E-S T R I K E
ISSU E AT P ROA SSU R A NCE . OUR
S T E A DFA S T CO M M I T M E N T T O
I N T EGR I T Y GO E S H A N D - I N - H A N D
W I T H T H E D I R EC T P ROM ISE O F
TREATED FAIRLY. E N G AG I N G
E V E R YO N E W E E N CO U N T E R I N A
FA I R , T R A NSPA R E N T FA SH I O N
E NSU R E S T H AT P R OA SSU R A N CE
IS T H E PA R T N E R O U R I NSU R E DS
A N D I N V E S T O R S W I L L VA L U E
F O R T H E LO N G T E R M .
I
N
T
E
G
R
I
T
Y
Operating with integrity and informed by the principles of
Treated Fairly, ProAssurance delivers the kind of performance
that gets noticed by more than investors and insureds. For
the third year in a row, The Ward Group, a top independent
benchmarking firm, named ProAssurance as one of the
50 top performing property/casualty insurance companies
in America. The Ward’s 50 indentifies superior companies
that exceed Ward’s strict financial stability requirements
while growing their business, achieving solid underwriting
results and maintaining a strong capital position.
In the current investment climate, cash is often
preferable to stock, but we also have that currency
available for the right transaction. We have and will
continue to deploy our capital in other ways to maxi-
mize shareholder value. For example, we expect to
continue to buy back shares in a prudent manner,
neither jeopardizing our ability to build Book Value
per Share nor hampering our ability to execute trans-
actions or deploy capital to write new business. The
Board has been actively considering capital manage-
ment strategies and will continue to evaluate the best
way to balance our dedication to shareholder value
and our need to be positioned to take advantage of
future opportunities sure to come.
On the subject of acquisitions, long-term investors
are aware that ProAssurance and its subsidiaries are
built on the foundation of 19 successful M & A
transactions. We expect and intend to continue using
our capital to fund carefully selected acquisitions,
primarily in the area of healthcare professional liabil-
ity. Our vision is that we intend to maintain our
healthcare-centric focus on professional liability. It’s
proven to be an area of insurance where we have a
demonstrated expertise and see enormous potential.
At the same time, the volatile nature of the business
seems unfriendly to most potential competitors, thus
leaving opportunities for successful, experienced
Our commitment to the principles of Treated Fairly extends
throughout ProAssurance, affirming our employees’ dedi-
cation to treating each other with respect and dignity, and
serving as the basis of our commitment to their personal
well-being and professional growth. This commitment to, and
between, our employees enables the extension of Treated
Fairly to our customers, our agents and our shareholders and
allows us to attract and keep the top talent in our industry.
That’s why we’re proud to have been selected as America’s
Best Mid-Sized Insurance Employer by Business Insurance,
companies such as ProAssurance.
and just as proud to note that our employees’ survey
responses were a crucial part of the selection criteria.
We will also leverage our expertise and the benefits of
Treated Fairly when and where we are able to identify
good business in our existing markets. We are the
largest writer in just four of the 49 jurisdictions in
which we actively write business, Alabama, Delaware,
the District of Columbia and Wisconsin, and we are
a top five writer in just eleven of those 49 jurisdictions.
ProAssurance 2009 Annual Report
seven
This means there are plenty of areas in which we can
by chasing higher yields or seeking risky investments.
foresee potential growth, but not every one of those
Instead, we intend to bring sharper focus to our
jurisdictions meets our carefully established criteria
underwriting and claims operations.
for writing additional policies. Business retention and
new, well underwritten business remain key parts of
our long-term goals.
As I mentioned earlier, we have an exceptional man-
agement team that is well invested alongside each of
you, and an employee base that has a significant level
We expect the transactions we completed in 2009 to
of share ownership as well. Thus, each of us approaches
allow us to take advantage of the changing healthcare
our business every day as owners, not merely manag-
landscape. As I write this, the future of healthcare
ers. We are focused on long-term success, but it’s
reform is uncertain at best, but we are certain that
remarkable how much success we achieve every year
changes are coming in the delivery of healthcare. As
when we do the right thing to ensure long-term
cost containment efforts push the delivery of health-
strength and stability.
Sincerely,
W. Stancil Starnes
Chief Executive Officer
care further out of facilities and physicians’ practices
and into home settings and the like, experts expect a
growing demand for allied healthcare employees such
as physician extenders, home health providers and
others whose professional liability needs will provide
avenues of growth for us.
These policies are lower cost, higher volume than the
traditional policies sold in our historical book of
business. Thus we are excited about the capabilities
brought into the organization with the expertise and
systems at ProAssurance Mid-Continent, which
focuses on liability policies for allied healthcare per-
sonnel, among others, and at PICA, where a subsid-
iary has built exceptional expertise in writing higher
volume, lower cost business. With these capabilities,
we believe we are well positioned to take advantage
of any changes ahead in our core markets.
As I look ahead, I don’t want to underestimate the
challenges we face in 2010 and the years beyond. For
example, we, like other insurance companies, face a
decline in investment income due to the low interest
rate environment in the current economy. We do not
intend to endanger our secure investment portfolio
eight
Treated Fairly
D I R EC T O R S A N D O F F I CE R S
Board of Directors
Directors
W. Stancil Starnes, Esq.
Position
Independence
Audit
Compensation
Executive
Nominating
& Corporate
Governance
Committees
Chairman and Chief Executive Officer,
ProAssurance
Victor T. Adamo, Esq., C.P.C.U. President, ProAssurance
Lucian Bloodworth
Jerry D. Brant, D.P.M.
Chairman, Cain Manufacturing
Company, Inc.
President and Chief Executive Officer,
The PICA Group
Robert E. Flowers, M.D.
Retired Physician
William J. Listwan, M.D.
Practicing Physician and Assistant
Clinical Professor of Internal Medicine
John J. McMahon, Jr.
Chairman, Ligon Industries
Drayton Nabers, Jr., Esq.
Attorney
Ann F. Putallaz, Ph.D.
Vice-President, Munder Capital
Management
William H. Woodhams, M.D.
Practicing Physician
Wilfred W. Yeargan, M.D.
Practicing Physician
M
M
I
M
I
I
I
I
I
I
I
X
C, E
X
X
X
X C
X
X
X C
X
X C
X
M = Management, Non-Independent C = Chairman I = Independent E = Financial Expert X = Member
Senior Officers
Title
Jeffrey L. Bowlby, A.R.M.
Chief Marketing Officer and Senior Vice-President, Professional Liability Group
Howard H. Friedman, A.C.A.S., M.A.A.A.
Co-President and Chief Underwriting Officer, Professional Liability Group
Senior Vice-President, ProAssurance
Jeffrey P. Lisenby, Esq.
Corporate Secretary, General Counsel and Senior Vice-President, ProAssurance
Frank B. O’Neil
Communications Officer and Senior Vice-President, ProAssurance
Edward L. Rand, Jr., C.P.A.
Chief Financial Officer and Senior Vice-President, ProAssurance
Darryl K. Thomas, Esq.
Co-President and Chief Claims Officer, Professional Liability Group
Senior Vice-President, ProAssurance
Hayes V. Whiteside, M.D.
Chief Medical Officer and Senior Vice-President, Professional Liability Group
ProAssurance 2009 Annual Report
nine
S T O CK P E R F O R M A N CE CH A R T
12/31/04
12/31/05
12/31/06
12/31/07
12/31/08
12/31/09
You may use the following information to compare the market value of our Common Stock with other public
companies and public companies in the insurance industry. The graph sets forth the cumulative total share-
holder return of our stock during the five years ended December 31, 2009, as well as the cumulative total
shareholder return of overall stock market index (the Russell 2000) and a peer group index (the SNL Property
& Casualty Insurance Index) for the five years ended December 31, 2009. All cumulative return data assumes
the reinvestment of dividends.
TOTAL RETURN PERFORMANCE
200
150
100
50
200
150
100
50
12/31/04
12/31/05
12/31/06
12/31/07
12/31/08
12/31/09
12/31/04
12/31/05
12/31/06
12/31/07
12/31/08
12/31/09
ProAssurance Corporation
Russell 2000
SNL Insurance P&C
Period Ending
Index
12/31/04
12/31/05
12/31/06
12/31/07
12/31/08
12/31/09
ProAssurance Corporation
Russell 2000
SNL Insurance P&C
100.00
100.00
100.00
124.37
104.55
109.31
127.64
123.76
127.42
140.42
121.82
137.59
134.95
80.66
106.50
137.33
102.58
115.13
ten
200
150
100
50
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, 2009, 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.
No X
Yes
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if
any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T
(§232.405 of this chapter), during the preceding 12 months (or for such shorter period that the registrant was
required to submit and post such files). Yes _____ No _____
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X
No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained
herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is 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, 2009 was
$1,496,129,618.
As of February 15, 2010, the registrant had outstanding approximately 32,411,990 shares of its common stock.
Page 1 of 133 pages
Documents incorporated by reference in this Form 10-K
(i)
(ii)
(iii)
(iv)
(v)
(vi)
The definitive proxy statement for the 2010 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 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.
(vii)
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.
(viii) The ProAssurance Corporation Registration Statement of Form S-4 (File No. 333-
124156) is incorporated by reference in Part IV of this report.
(ix)
(x)
(xi)
(xii)
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.
(xiii) 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.
(xiv) 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.
(xv)
The ProAssurance Corporation Registration Statement on Form S-8 (File No. 333-
156645) is incorporated by reference into Part IV of this report.
(xvi) 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.
(xvii) 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
(xviii) 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” refer 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 that is posted on the investor section of our
website.
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 Principles 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
4
regulators and rating agencies, court actions, legislative actions, payment or performance of obligations
under indebtedness, payment of dividends, and other matters.
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 that could affect our business
plans or operations;
the enactment or repeal of tort reforms;
formation or dissolution of state-sponsored malpractice insurance entities that could
remove or add sizable groups of 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 collectability 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;
–
– our ability to achieve continued growth through expansion into other states or through
increases in guaranty fund assessments;
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
5
Factors" in this report and other documents we file with the Securities and Exchange Commission, such
as our current reports on Form 8-K, and our regular reports on Forms 10-Q and 10-K.
We caution readers not to place undue reliance on any such forward-looking statements, which
speak only as of the date made, and advise readers that the factors listed above could affect our financial
performance and could cause actual results for future periods to differ materially from any opinions or
statements expressed with respect to future periods in any current statements. Except as required by law
or regulations, we do not undertake and specifically decline any obligation to publicly release the result of
any revisions that may be made to any forward-looking statements to reflect events or circumstances after
the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
6
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 other professional liability business.
Our top five states represented 48% of our gross premiums written for the year ended December
31, 2009. The following table shows our gross premiums written in these states for each of the periods
indicated.
Alabama(1)
Ohio
Florida(2)
Indiana(3)
Michigan
All other states
Total
Gross Premiums Written–Years Ended December 31
($ in thousands)
2008
2007
2009
$
96,307
69,300
35,428
33,304
32,842
286,741
$ 553,922
17%
13%
6%
6%
6%
52%
100%
$ 91,116
75,859
31,914
33,822
31,946
206,825
$ 471,482
19%
16%
7%
7%
7%
44%
100%
$ 95,641
89,607
41,291
38,188
41,092
243,255
$ 549,074
17%
16%
8%
7%
7%
45%
100%
(1) Includes premium related to policies with a two year term of $23.0 million in 2009 and $2.7 million in 2008.
(2) Not a top five state in 2008
(3) Not a top five state in 2007
We believe we differentiate ourselves from our competitors in several ways. Our financial
strength, commitment to local market knowledge, and dedication to meeting the needs of our insureds
have allowed us to establish what we believe is a leading position in many of our markets, thus enabling
us to effectively compete on a basis other than just price.
During 2008 we introduced “Treated Fairly” a branding strategy that is used along with our 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 in our healthcare insurance
activities, 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.
We believe our local market 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.
We maintain multiple claims and underwriting offices, each primarily focused on a specific
market, which allows us to maintain active relationships with our customers and be more responsive to
their needs. Using our local market knowledge and our experienced underwriting staff, we rigorously
underwrite each application for coverage to ensure that we understand the risks we accept, and 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.
7
Corporate Organization and History
We were incorporated in Delaware as the successor to Medical Assurance, Inc. in connection
with its merger with Professionals Group, Inc. (Professionals Group) in June 2001.
We are the successor to fifteen insurance organizations and much of our growth has come
through mergers and acquisitions. In each, we retained key personnel, allowing us to maintain market
knowledge and preserve important institutional knowledge in underwriting, claims, risk management and
marketing. We believe that our ability to utilize this 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
The Board of Directors of ProAssurance authorized $100 million in September 2009 to be used
for the repurchase of our common stock or debt securities, which was in addition to previous
authorizations of $150 million in April 2007 and $100 million in August 2008. As of December 31, 2009
approximately $115.4 million of the total amount authorized by the Board remains available for use.
On April 1, 2009 we acquired Podiatry Insurance Company of America and subsidiaries (PICA)
through a cash sponsored demutualization as a means of expanding our professional liability insurance
operations. PICA provides professional liability insurance primarily to podiatric physicians, chiropractors
and other healthcare providers throughout the United States and had gross written premium of
approximately $96.7 million for the calendar year of 2009. We completed our purchases of Georgia
Lawyers Insurance Company (Georgia Lawyers), now a part of ProAssurance Casualty Company, and
Mid-Continent General Agency, Inc. (Mid-Continent), now ProAssurance Mid-Continent Underwriters,
Inc., 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 $4.0 million in 2009. Mid-Continent
is a general agency that provides professional liability insurance to ancillary healthcare providers as well
as other professional liability coverages. In 2009 Mid-Continent produced $16.6 million of premium for
ProAssurance. See Note 3 to the Consolidated Financial Statements included herein for additional
information regarding acquisitions.
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 10 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 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 10 and 11 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).
Effective August 1, 2006 we completed our acquisition of Physicians Insurance Company of
Wisconsin, Inc., now ProAssurance Wisconsin Insurance Company (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
8
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.
On August 3, 2005 we acquired all of the outstanding common stock of NCRIC Corporation and
its subsidiaries in an all stock merger. At the time of acquisition, NCRIC was a holding company that
owned a single insurance company providing medical professional liability insurance in the vicinity of the
District of Columbia.
Products and Services
We sell medical professional liability insurance primarily to physicians, other healthcare
providers and healthcare facilities. We also have a small, but growing, book of other professional liability
business. We are licensed to do business in every state.
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 professional liability insurance on an excess and
surplus lines basis.
Marketing
We utilize both direct marketing and independent agents to write our business. For the year ended
December 31, 2009, we estimate that approximately 65% 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 knowledge of our markets enables us to effectively provide these communications and services, all
of which have helped us gain exposure among potential insureds.
Underwriting
Our underwriting process is driven by individual risk selection. Our pricing decisions are focused
on achieving rate adequacy. We assess the quality and pricing of the risk, emphasizing loss history, areas
of practice and location in making our underwriting decision. In performing their assessment, our
9
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 concentrates on knowledge of local market conditions and legal environments
through nine market-focused underwriting offices located in Alabama, Georgia, Indiana, Missouri,
Michigan, Tennessee, Texas, the District of Columbia, and Wisconsin. Our underwriters work closely
with our 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 medical advisory committees that operate in our key
markets. These committees are comprised of physicians, other healthcare providers and representatives of
hospitals and healthcare entities and help us maintain close ties to the medical communities in these
markets, provide information on the practice of medicine in each market and provide guidance on critical
underwriting issues.
Claims Management
We have 17 claims offices located in Alabama (2), Delaware, Florida (2), Illinois, Indiana,
Kentucky, Michigan, Missouri, Ohio (2), Tennessee, Texas, Virginia, the District of Columbia, and
Wisconsin so that we can provide specialized 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 markets to examine claims, attempt to identify potentially troubling practice
patterns and make recommendations to our staff.
We believe that our claims philosophy contributes to lower overall loss costs and results in
greater customer loyalty. The success of this claims philosophy is based on our access to attorneys who
have significant experience in the defense of professional liability claims and who are able to defend
claims in an aggressive, cost-efficient manner.
Investments
Although the majority of our assets are held in our operating insurance companies, 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 targets 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 4 to the
Consolidated Financial Statements for more information on our investments.
10
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, 2010:
Rating Agency
ProAssurance
Group
ProAssurance
Indemnity
Company, Inc.
ProAssurance
National Capital
Insurance Co.
ProAssurance
Wisconsin
Insurance Co.
ProAssurance
Casualty Co.
ProAssurance
Specialty
Insurance
Company, Inc.
Podiatry
Insurance
Company of
America
PACO
Assurance
Company,
Inc.
A. M. Best
(www.ambest.com)
A
(Excellent)
A
(Excellent)
B++
(Good)
A-
(Excellent)
A
(Excellent)
A
(Excellent)
A-
(Excellent)
A-
(Excellent)
Fitch
(www.fitchratings.com)
A
(Strong)
A
(Strong)
A
(Strong)
A
(Strong)
A
(Strong)
A
(Strong)
A
(Strong)
A
(Strong)
The rating process is dynamic and ratings can change. If you are seeking updated information
about our ratings, please visit the rating agency websites listed in the table.
Competition
Competition depends on a number of factors including pricing, size, name recognition, service
quality, market commitment, market conditions, breadth and flexibility of coverage, method of sale,
financial stability, ratings assigned by rating agencies and regulatory conditions. Many of these factors,
such as market conditions and regulatory conditions are beyond our control.
We believe that we have a competitive advantage due to our financial stability, local market
knowledge, 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.
11
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.
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, Illinois, 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
12
order with respect to the non-domestic admitted insurers doing business in the state if certain conditions
exist, such as undue market concentration.
Statutory Accounting and Reporting
Insurance companies are required to file detailed quarterly and annual reports with the state
insurance regulators in each of the states in which they do business, and their business and accounts are
subject to examination by such regulators at any time. The financial information in these reports is
prepared in accordance with Statutory Accounting Principles (SAP). Insurance regulators periodically
examine each insurer’s financial condition, adherence to SAP, and compliance with insurance department
rules and regulations.
Regulation of Dividends and Other Payments from Our Operating Subsidiaries
Our operating subsidiaries are subject to various state statutory and regulatory restrictions which
limit the amount of dividends or distributions an insurance company may pay to its shareholders without
prior regulatory approval. Generally, dividends may be paid only out of earned surplus. In every case,
surplus subsequent to the payment of any dividends must be reasonable in relation to an insurance
company’s outstanding liabilities and must be adequate to meet its financial needs.
State insurance holding company 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:
− net income less capital gains; or
− 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:
− 10% of a company’s capital and surplus as of December 31 of the preceding year; or
−
the greater of:
−
−
statutory net income for the preceding calendar year, minus realized capital
gains for that calendar year; or
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.
13
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, 2009, 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 applicable state investment
regulations.
Guaranty Funds
Admitted insurance companies are required to be members of guaranty associations which
administer state Guaranty Funds. These associations levy assessments (up to prescribed limits) on all
member insurers in a particular state on the basis of the proportionate share of the premiums written by
member insurers in the covered lines of business in that state. Maximum assessments permitted by law in
any one year generally vary between 1% and 2% of annual premiums written by a member in that state.
Some states permit member insurers to recover assessments paid through surcharges on policyholders or
through full or partial premium tax offsets, while other states permit recovery of assessments through the
rate filing process.
Shared Markets
State insurance regulations may force us to participate in mandatory property and casualty shared
market mechanisms or pooling arrangements that provide certain insurance coverage to individuals or
other entities that are otherwise unable to purchase such coverage in the commercial insurance
marketplace. Our operating subsidiaries’ participation in such shared markets or pooling mechanisms is
not material to our business at this time.
Changes in Legislation and Regulation
In recent years, the insurance industry has been subject to increased scrutiny by regulators and
legislators. The NAIC and a number of state legislatures have considered or adopted legislative proposals
that alter and, in many cases, increase the authority of state agencies to regulate insurance companies and
insurance holding company systems.
Tort reforms generally restrict the ability of a plaintiff to recover damages by, among other
limitations, eliminating certain claims that may be heard in a court, limiting the amount or types of
damages, changing statutes of limitation or the period of time to make a claim, and limiting venue or
court selection. A number of states in which we do business, notably Georgia, Florida, Illinois, Missouri,
Ohio, Texas, and West Virginia, enacted tort reform legislation in the previous 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. The Illinois statute was
overturned in early 2010. We believe some of the other state reforms may also be overturned, although
we cannot predict with any certainty how appellate courts will rule. We continue to monitor developments
14
on a state-by-state basis, and make business decisions accordingly.
Tort reform proposals are considered from time-to-time at the Federal level. 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 is a stated priority of the current presidential administration, but the future of
healthcare reform is unclear. Conflicting healthcare reform bills have been passed by the House and the
Senate and work is underway on compromise legislation, but there is no certainty that such efforts will be
successful or what reform measures will be included in the final bill, if one is passed. The earliest date for
implementation of major proposed healthcare reforms in the current legislation is 2013, which does give
us time to assess the likely effect of the proposals on our business and develop new products, or revise
existing policies to compete effectively in a changed market place.
If passed, reforms would alter the healthcare delivery system or reimbursement plans, which
could raise the cost sensitivity of our insureds. Neither bill, as written, would implement Tort Reforms
that would directly affect the filing or outcome of lawsuits against our insureds. The current proposed
legislation provides incentives and funding for a limited number of demonstration projects intended to
develop alternatives to our current tort system for managing medical malpractice disputes.
In addition to regulatory and legislative efforts, there have been significant market-driven
changes in the healthcare environment that have negatively affected, or threaten 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.
The sum of these changes may result in a significant decrease in the number of physicians in
private practice and the role of the insured in the medical professional liability insurance purchasing
decision. Under economic pressure, practices may employ 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. Such change and consolidation could reduce our medical professional
liability premiums as groups of insurance purchasers generally seek to control costs by retaining more
risk or moving to self insurance arrangements.
Other federal legislation has been proposed that would bring about federal regulation of
insurance companies, which could replace state regulation, or work beside state regulation. Legislation to
repeal the anti-trust exemptions granted to insurance companies under the provisions of the McCarran-
Ferguson Act was proposed in conjunction with healthcare reforms, but that legislation no longer contains
language applying to medical professional liability insurers.
Other federal initiatives, including additional pro-patient protection legislation that would
ultimately affect our business, may also be proposed, although we believe such legislation would most
likely have a more direct effect on healthcare insurers and providers. New legislation could indirectly
affect our business if our insureds face different risk and cost environments. We are unable to predict the
likelihood of any particular type of legislation becoming effective or the likely ramifications to our
business.
Employees
At December 31, 2009, we had 689 employees, none of whom are represented by a labor union.
We consider our employee relations to be good.
15
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. 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 revenues may fluctuate with insurance market conditions.
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, geographic scope, local presence,
agent and client relationships, 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, impact our market share and reduce the profits that would otherwise
arise from operations.
Our operating results and financial condition may be affected if actual insured losses differ from our loss
reserves.
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. Our largest liability is our reserve for loss and loss adjustment expenses. 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.
The process of estimating loss reserves is complex. 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. Ultimate loss costs, even for claims with similar characteristics, can 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. Consequently, the loss cost estimation process requires actuarial skill and the
application of judgment, and such estimates require periodic revision. As part of the reserving process, we
review the known facts surrounding reported claims as well as historical claims data and consider the
impact of various factors such as:
–
for reported claims, the nature of the claim and the jurisdiction in which the claim occurred;
–
trends in paid and incurred loss development;
–
trends in claim frequency and severity;
– emerging economic and social trends;
–
–
– changes in the regulatory legal and political environment.
trend of health care costs for medical professional liability;
inflation; and
16
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.
We purchase reinsurance to mitigate the effect of losses under higher coverage limits policies and
for a portion of all losses on certain types of policies. 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.
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. 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. Any
adjustments are reflected in then-current operations.
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 or 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 our reinsurance agreements make the reinsurer liable to us
to the extent the risk is transferred, the liability to our policyholders remains our responsibility. If
reinsurers fail to pay us or fail to pay on a timely basis, our financial results and/or cash flows would be
adversely affected. At December 31, 2009 our Receivable from Reinsurers on Unpaid Losses is $262.7
million and our Receivable from Reinsurers on Paid Losses is $16.8 million.
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
17
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.
Changes in healthcare policy could have a material effect on our operations.
Healthcare reform is a stated priority of the current presidential administration and healthcare
reform is currently under consideration by Congress. The proposed legislation, which remains subject to
substantial revision and may or may not become law, focuses primarily on expanding health insurance
coverage in the U.S., but also includes measures designed to promote additional competition among
health insurers, and measures that might increase Federal oversight of insurers. There is much speculation
as to what would be the indirect effects of the legislation as now proposed, including the economic effects
on physicians, other health care workers, hospitals, and other types of healthcare facilities. If passed,
reforms could result in significant changes in the demand for and profitability of our current insurance
products as well as significant changes to the competitive environment in which we operate. It may be
difficult to successfully change our insurance products and current business model quickly enough to
maintain profitable operations. It does seem likely that there will be several years between the passage of
any reforms and the effective date of the reforms. We hope it will allow us to make the adjustments
needed to our products and business model, but there is no certainty that we will be successful in our
efforts.
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 previous decade as a response to a
rapid deterioration in loss trends. The Illinois statute was overturned in early 2010. We cannot predict
with any certainty how other state 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 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.
A significant amount of our business is concentrated in certain states so that our performance is
dependent on the business, economic, regulatory and legislative conditions in those states.
Our top five states, Alabama, Ohio, Florida, Indiana and Michigan, represented 48% of our
gross premiums written for the year ended December 31, 2009. Moreover, during the three years
ended December 31, 2009, Alabama and Ohio accounted for 30%, 35%, and 33%, respectively, of our
gross premiums written in each year during that time period. Because of this concentration,
18
unfavorable business, economic or regulatory conditions in any of these states could have a
disproportionately greater effect on us than they would if we were less geographically concentrated.
We may be unable to identify future strategic acquisitions or expected benefits from completed and
proposed acquisitions may not be achieved or may be delayed longer than expected.
Our corporate strategy anticipates growth through the acquisition of other companies or books
of business. However, such expansion is opportunistic and there is no guarantee that we will be able to
identify strategic acquisition targets in the future. Additionally, if we are able to identify a strategic
target for acquisition, state insurance regulation concerning change or acquisition of control could
delay or prevent us from growing through acquisitions. Many states' insurance regulatory codes
provide 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. There is no assurance that we will receive such approval from the
respective insurance regulator.
In the event we are able to complete an acquisition, there is no guarantee that the expected
benefits will be achieved as planned. The process of integrating an acquired company or business can
be complex and costly, and may create unforeseen operating difficulties and expenditures. This can be
due to, among other reasons, business disruption, loss of customers and employees, the ineffective
integration of underwriting, claims handling and actuarial practices, the increase in the inherent
uncertainty of reserve estimates for a period of time until stable trends reestablish themselves within
the combined organization, diversion of management time and resources to acquisition integration
challenges, the cultural challenges associated with integrating employees, increased operating costs or
inability to achieve cost savings, and the assumption of greater than expected liabilities. There is no
guarantee that any businesses acquired in the future will be successfully integrated, and the ineffective
integration of our businesses and processes may result in substantial costs or delays and adversely
affect our ability to compete.
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 Fitch and A.M.
Best. 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.
19
The following table presents the claims paying ratings of our group and our core subsidiaries as
of February 10, 2010:
Rating Agency
ProAssurance
Group
ProAssurance
Indemnity
Company, Inc.
ProAssurance
National Capital
Insurance Co.
ProAssurance
Wisconsin
Insurance Co.
ProAssurance
Casualty Co.
ProAssurance
Specialty
Insurance
Company, Inc.
Podiatry
Insurance
Company of
America
PACO
Assurance
Company,
Inc.
A. M. Best
(www.ambest.com)
A
(Excellent)
A
(Excellent)
B++
(Good)
A-
(Excellent)
A
(Excellent)
A
(Excellent)
A-
(Excellent)
A-
(Excellent)
Fitch
(www.fitchratings.com)
A
(Strong)
A
(Strong)
A
(Strong)
A
(Strong)
A
(Strong)
A
(Strong)
A
(Strong)
A
(Strong)
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.
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.
Our business could be adversely affected by the loss of one or more key employees.
We are heavily dependent upon our senior management and the loss of services of our senior
executives could adversely affect our business. Our success has been, and will continue to be, dependent
on our ability to retain the services of existing key employees and to attract and retain additional qualified
personnel in the future. The loss of the services of key employees or senior managers, or the inability to
identify, hire and retain other highly qualified personnel in the future, could adversely affect the quality
and profitability of our business operations.
Our board of directors regularly reviews succession planning relating to our Chief Executive
Officer as well as other senior officers. Mr. Starnes, our Chief Executive Officer, has indicated to the
board that he has no immediate plans for retirement.
Provisions in our charter documents, Delaware law and state insurance law may impede attempts to
replace or remove management or impede a takeover, which could adversely affect the value of our
common stock.
Our certificate of incorporation, bylaws and Delaware law contain provisions that may have the
effect of inhibiting a non-negotiated merger or other business combination. Additionally, the board of
directors may issue preferred stock, which could be used as an anti-takeover device, without a further vote
of our stockholders. We currently have no preferred stock outstanding, and no present intention to issue
any shares of preferred stock. However, because the rights and preferences of any series of preferred
stock may be set by the board of directors in its sole discretion, the rights and preferences of any such
preferred stock may be superior to those of our common stock and thus may adversely affect the rights of
the holders of common stock.
The voting structure of common stock and other provisions of our certificate of incorporation are
intended to encourage a person interested in acquiring us to negotiate with, and to obtain the approval of,
the board of directors in connection with a transaction. However, certain of these provisions may
discourage our future acquisition, including an acquisition in which stockholders might otherwise receive
a premium for their shares. As a result, stockholders who might desire to participate in such a transaction
may not have the opportunity to do so.
In addition, state insurance laws provide that no person or entity may directly or indirectly
20
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.
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 in Item 1 Insurance Regulatory Matters.
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 changes 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.
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
21
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.
In 2009 and 2008, guaranty fund refunds/recoupments exceeded current year assessments by
$533,000 and $1.3 million, respectively, which reduced 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 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. Significant movements in interest rates potentially expose us to lower yields or lower asset values.
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 investments are subject to credit and prepayment risk.
A significant portion of our assets ($3.8 billion or 83%) at December 31, 2009 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. Adverse economic and
market conditions could cause investment losses or other-than-temporary impairments of our securities,
which could affect our financial condition, results of operations, or cash flows.
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 affected by the existence
of U.S. 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
20% of our fixed maturities are asset-backed securities, 97% of which are investment grade, (91% AAA,
3% AA, 5% BBB, 1% B) as determined by Nationally Recognized Statistical Rating Organizations
(NRSROs) (Moody’s, Standard & Poor’s and Fitch). Ratings published by the NRSROs are among 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 45). We have no exposure to subprime loans through
collateralized debt obligations (CDOs).
Our asset-backed securities are also subject to prepayment risk. A prepayment is the unscheduled
return of principal. When rates decline, the propensity for refinancing may increase and the period of time
we hold our asset-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 refinancing lessen, the period of time we hold our asset-backed securities may lengthen,
causing us to not reinvest cash flows at then higher available yields.
22
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 97% of our investments at fair value and the
remaining 3% at cost or the current cash surrender value (BOLI). See Notes 1, 2 and 4 to the
Consolidated Financial Statements for additional information. Approximately 6% 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.
The current economic environment may have a significant adverse effect on our financial condition and
results of operations.
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. In addition, the U.S. Treasury, the Federal Reserve, and FDIC began several programs to provide
liquidity support to the financial system in 2008 and 2009: Commercial Paper Funding Facility (CPFF),
Term-Asset Backed Loan Facility (TALF), the Temporary Guaranty Liquidity Program (TGLP), and the
Public-Private Investment Program (PPIP), among others. Although the measures appear to have been
positive for the economy and the financial markets, there is no assurance that the markets will further
improve or maintain stability once these measures expire or are discontinued. 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, particularly mortgage-
backed securities. While future actions cannot be predicted, many observers in the financial community
believe additional measures will be undertaken to reduce home mortgage foreclosures, some of which
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 $36.2 million ($38.0 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 $504.5 million ($484.9 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.
The reduction of or discontinued purchases of agency mortgage-backed securities by the Federal Reserve
could cause the fair value of our Fannie Mae and Freddie Mac mortgage-backed securities to decline if
there is no other market support for those bonds. The continued lack of congressional action in
determining the future structure of Fannie Mae and Freddie Mac could also impact the fair value of our
holdings. While the two government-sponsored enterprises currently have U.S. Government support
through 2012, there is no assurance that the support will continue thereafter.
23
The economic downturn has lessened tax receipts and other revenues in many states and their
municipalities and the frequency of credit downgrades of these entities has increased. At December 31,
2009 the fair value of our state/municipal portfolio is $1.45 billion (recorded cost basis of $1.40 billion).
While our state/municipal portfolio has a high average credit rating (AA on average) which indicates a
strong ability to pay, there is no assurance that there will not be a credit related event in our state and
municipal bond portfolios which would cause fair values to decline.
The company holds $92.6 million of Commercial Mortgage-Backed Securities (CMBS) which
are affected by the general health of the economy. Commercial mortgage delinquencies have risen in the
last 24 months as occupancy rates for commercial buildings and hotels have declined and fair values for
many CMBS securities have declined. The recent PPIP program helped improve the fair values of the
CMBS market, but there is no guarantee that it will continue. While we primarily hold high quality
CMBS in our portfolio (average rating is AAA), there is no guarantee that fair values will be maintained
in the future if delinquencies continue or increase or the economy does not maintain stability.
We maintain banking deposits with banks that are subject to a variety of regulatory regimes.
During late 2008 and all of 2009, all commercial deposits had unlimited FDIC insurance under the
Transaction Account Guarantee (TAG) as part of the Temporary Liquidity Guarantee Program. The TAG
program expired at the end of 2009, and became an optional election for banks thereafter. Three of our
primary banks did not elect to continue participation in the TAG. We have $38.4 million of uninsured
deposits at December 31, 2009. Absent the unlimited FDIC insurance, we assess the creditworthiness of
our banks in determining how much exposure we have to each bank. While we believe we have
reasonable exposures to each of the banks given their creditworthiness in excess of FDIC insurance, given
the current economic conditions and the efforts of the FDIC to maintain a healthy banking system, there is
no assurance that a bank with which we do business will not have difficulty in the future if economic
conditions were to worsen.
Resolution of uncertain income tax matters and changes in tax laws could adversely affect our results of
operations or cash flow.
Our provision for income taxes, our recorded tax liabilities and net deferred tax assets, including
any valuation allowances, are recorded based on estimates. These estimates require us to make significant
judgments regarding a number of factors, including, among others, the applicability of various federal and
state laws, the interpretations given to those tax laws by taxing authorities, courts and ProAssurance, the
timing of future income and deductions, and our expected levels and source of future taxable income. We
believe our tax positions are supportable under tax laws and that our estimates are prepared in accordance
with GAAP. Nevertheless, we are periodically under routine examination by various federal, state and
local authorities regarding income tax matters and our tax positions could be successfully challenged; the
costs of defending our tax position could be considerable. Additionally, from time to time there are
changes to tax laws and interpretations of tax laws which could change our estimates of the amount of tax
benefits or deductions expected to be available to us in future periods. In either case, changes to our prior
estimates would be reflected in the period changed and could have a material effect on our effective tax
rate, financial position, results of operations and cash flow.
ProAssurance is subject to U. S. federal and various state income taxes, and generally remains
open to income tax examinations by tax authorities for years beginning with 2006. From time to time, we
have tax positions being reviewed by the IRS or state taxing authorities. Our expectation regarding the
resolution of those reviews is reflected in our then-current period financial statements. At this time, we do
not have any matters under review for which we do not expect to prevail that we consider to be a material
amount, separately or in the aggregate. As of December 31, 2009 our current tax liability is approximately
$17.0 million, and we have a net deferred tax asset of approximately $68.8 million.
24
New or changes in existing accounting standards, practices and/or policies, and also subjective
assumptions, estimates and judgments by management related to complex accounting matters could
significantly affect our financial results.
U.S.generally accepted accounting principles (GAAP) and related accounting pronouncements,
implementation guidelines and interpretations with regard to a wide range of matters that are relevant to
our business, such as revenue recognition, estimation of losses, determination of fair value, asset
impairment (particularly investment securities and goodwill) and tax matters, are highly complex and
involve many subjective assumptions, estimates and judgments. Changes in these rules or their
interpretation or changes in underlying assumptions, estimates, or judgments could significantly change
our reported or expected financial performance or financial condition. See Note 1 of the Consolidated
Financial Statements for the discussion on accounting policies.
ProAssurance is primarily a holding company of insurance subsidiaries and is required to comply
with statutory accounting principles (SAP). SAP and its components are subject to review by the National
Association of Insurance Commissioners (NAIC) and state insurance departments. The NAIC Accounting
Practices and Procedures manual provides that a state insurance department may allow insurance
companies that are domiciled in that state to depart from SAP by granting them permitted non-SAP
accounting practices. This permission may allow for more favorable treatment to competitors. We cannot
predict whether or how reforms will be enacted, or whether the enacted reforms will have a positive or
negative effect. We can also give no assurance that future changes to SAP or its components or the grant
of permitted non-SAP accounting practices to our competitors will not negatively affect our financial
results or operations. See the Insurance Regulatory Matters section in Item 1 for the full discussion on
regulatory matters.
25
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
ITEM 2. PROPERTIES.
We own five 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 and in
Franklin, Tennessee we own a 103,000 square foot building in which we currently occupy 51,000 square
feet; the remaining office space in these buildings is leased to unaffiliated persons or available for lease.
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. In Brentwood, Tennessee we own a
25,000 square foot building all of which is either leased to unaffiliated persons or is available for lease
and is held for sale.
ITEM 3. LEGAL PROCEEDINGS.
Our insurance subsidiaries are involved in various legal actions, a substantial number of which
arise from claims made under insurance policies. While the outcome of all legal actions is not presently
determinable, management and its legal counsel are of the opinion that these actions will not have a
material adverse effect on our financial position or results of operations. See Note 9 to the Consolidated
Financial Statements included herein.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
26
EXECUTIVE OFFICERS OF PROASSURANCE CORPORATION
The executive officers of ProAssurance Corporation (ProAssurance) serve at the pleasure of the
Board of Directors. We have a knowledgeable and experienced management team with established track
records in building and managing successful insurance operations. In total, our senior management team
has average experience in the insurance industry of 19 years. Following is a brief description of each
executive officer of ProAssurance, including their principal occupation, and relevant background with
ProAssurance and former employers.
W. Stancil Starnes
Victor T. Adamo
Howard H. Friedman
Jeffrey P. Lisenby
Frank B. O’Neil
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 61)
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 61)
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 51)
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 41)
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 56)
27
Edward L. Rand, Jr.
Darryl K. Thomas
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 43)
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 52)
We have adopted a code of ethics that applies to our directors and executive officers, including
our principal executive officers, principal financial officer, and principal accounting officer. We also have
share ownership guidelines in place to ensure that management maintains a significant portion of their
personal investments in the stock of ProAssurance. See Item 1 for information regarding the availability
of the Code of Ethics and the Share ownership Guidelines.
28
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
At February 15, 2010, ProAssurance Corporation (PRA) had 3,779 stockholders of record and
32,411,990 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
2009
2008
High
$ 51.34
51.35
53.62
54.95
Low
$ 40.66
43.17
44.80
49.84
High
$ 58.65
55.19
64.85
55.07
Low
$ 49.90
48.11
45.61
41.78
ProAssurance has not paid any cash dividends on its common stock and does not currently have a
policy to pay regular dividends.
ProAssurance’s insurance subsidiaries are subject to restrictions on the payment of dividends to the
parent. Information regarding restrictions on the ability of the insurance subsidiaries to pay dividends is
incorporated by reference from the paragraphs under the caption “Insurance Regulatory Matters–Regulation
of Dividends and Other Payments from Our Operating Subsidiaries” in Item 1 on page 13 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, 2009.
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)
1,176,308
$ 42.66*
1,820,096
–
–
–
*Exclusive of 212,000 performance shares and 29,000 restricted share units 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, 2009
February 1-28, 2009
March 1-31, 2009
April 1-30, 2009
May 1-31, 2009
June 1-30, 2009
July 1-31, 2009
August 1-31, 2009
September 1-30, 2009
October 1-31, 2009
November 1-30, 2009
December 1-31, 2009
Total
Total Number
of Shares
Purchased
–
–
443,450
–
–
396,823
–
–
40,500
249,500
18,300
–
1,148,573
Average
Price Paid
per Share
–
–
$ 42.04
–
–
$ 43.93
–
–
$ 51.12
$ 51.90
$ 52.01
–
$ 45.31
(1) Shown net of authorizations used for repurchase of debt.
Total Number of Shares
Purchased as Part of Publicly
Announced Plans or Programs
Approximate Dollar Value of Shares
that May Yet Be Purchased Under the
Plans or Programs(1)
74,409,144
$
74,409,144
$
55,767,577
$
55,767,577
$
55,767,577
$
38,336,077
$
38,336,077
$
$
38,336,077
$ 129,265,865
$ 116,316,002
$ 115,364,171
$ 115,364,171
–
–
443,450
–
–
396,823
–
–
40,500
249,500
18,300
–
1,148,573
29
ITEM 6. SELECTED FINANCIAL DATA
Selected Financial Data (1)
Gross premiums written (2)
Net premiums written (2)
Premiums earned (2)
Premiums ceded (2)
Net premiums earned (2)
Net investment income (2)
Equity in earnings (loss) of unconsolidated
subsidiaries (2)
Net realized investment gains (losses) (2)
Other revenues
Total revenues (2)
Net losses and loss adjustment expenses (2)
Income (loss) from continuing operations(3)
Net income(3)
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
Total assets
Reserve for losses and loss
adjustment expenses (2)
Long-term debt (2)
Total liabilities from continuing operations
Total capital
Total capital per share of common
stock outstanding
Year Ended December 31
2009
2008
2007
2006
2005
(In thousands except per share data)
553,922
514,043
540,012
(42,469)
497,543
150,945
1,438
12,792
9,965
672,683
231,068
222,026
222,026
$
471,482
$
549,074
$
578,983
$
572,960
429,007
506,397
543,376
521,343
503,579
(44,301)
459,278
158,384
(7,997)
(50,913)
8,410
567,162
211,499
177,725
585,310
(51,797)
533,513
171,308
1,630
(5,939)
5,556
706,068
350,997
168,186
627,166
(44,099)
583,067
147,450
2,339
(1,199)
5,941
737,598
443,329
126,984
596,557
(53,316)
543,241
98,293
900
912
4,604
647,950
438,201
80,026
$
177,725
$
168,186
$
236,425
$
113,457
6.76
6.70
6.76
6.70
$
$
$
$
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
32,848
33,150
32,750
34,362
32,960
35,823
32,044
34,925
30,049
32,908
$
$
$
$
$
$
$
3,838,222
$ 3,575,942
$ 3,639,395
$ 3,492,098
$ 2,614,319
4,440,808
4,440,808
2,559,707
164,158
3,185,738
4,342,853
4,342,853
2,607,148
179,177
3,224,306
3,341,600
3,909,379
2,224,436
167,240
2,806,820
$ 1,423,585
$ 1,255,070
$ 1,118,547
$
765,046
4,647,414
4,647,414
4,280,938
4,280,938
2,422,230
2,379,468
50,203
2,942,819
1,704,595
34,930
2,857,353
$
$
52.59
$
42.69
$
38.69
$
33.61
$
24.59
Common stock outstanding at end of year
32,412
33,346
32,443
33,276
31,109
(1) Includes acquired entities since date of acquisition, only. PICA was acquired on April 1, 2009. PRA Wisconsin was acquired on August 1,
2006. NCRIC Corporation was acquired on August 3, 2005.
(2) Excludes discontinued operations.
(3) Includes a loss on extinguishment of debt of $2.8 million for the year ended December 31, 2009 and a gain on extinguishment of debt of $4.6
million for the year ended December 31, 2008.
30
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with Consolidated Financial Statements
and Notes to those statements which accompany this report. A glossary of insurance terms and phrases is
available on the investor section of our website. Throughout the discussion, references to ProAssurance,
“PRA,” "we," "us" and "our" refer 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. Incurred losses in any period reflect our estimate of losses
incurred related to the premiums earned in that period as well as any changes to our estimates of the
reserve established for losses of prior periods.
The estimation of professional liability losses is inherently difficult. Loss costs, even for claims
with similar characteristics, can 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. Our reserves are established by management after taking into consideration a variety of
factors including premium rates, claims frequency, historical paid and incurred loss development trends,
the effect of inflation, general economic trends, the legal and political environment, and the conclusions
reached by our internal actuaries.
Our internal actuaries perform an in-depth review of our reserve for losses on a semi-annual basis
using the loss and exposure data of our insurance subsidiaries. In addition, we engage external actuaries to
review our data and provide us with their observations regarding our data and the adequacy of our
established reserve. We believe that use of external actuaries provides us with an independent viewpoint
regarding our loss experience and a broader perspective on industry loss trends. We update and review the
data underlying the estimation of our reserve for losses each reporting period and make adjustments to
loss estimation assumptions that we believe best reflect emerging data. Any adjustments are reflected in
the then-current operations. Due to the size of our reserve for losses, even a small percentage adjustment
to these estimates could have a material effect on our results of operations for the period in which the
adjustment is made.
31
There is a significant risk that actual incurred losses will develop differently from our 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 (Paid and Reported) Method
– Paid Development Method
– Reported Development Method
– Average Paid Value Method
– Average Reported Value Method
– Backward Recursive Method
The descriptions require some explanation as to how we and actuaries view our reserves and a
brief description of each method follows. We segment our reserves by accident year, which is the year in
which the claim becomes our liability. As claims are incurred (reported) and 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 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
losses that have been incurred but not reported to us, and future developments on losses that have been
reported to us.
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
32
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 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 amount.
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 net reserve for losses. The high and low end points of the
distributions are as follows:
80% Confidence Level
60% Confidence Level
Low End Point
$1.656 billion
$1.801 billion
Carried Net Reserve High End Point
$2.160 billion
$2.160 billion
$2.725 billion
$2.494 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.
33
The following table presents additional information about net favorable loss development:
(In thousands)
2009
2008
2007
Net favorable loss development recognized
Loss development as % of beginning of year loss reserves
$ 207,300
8.7%
$ 185,251
7.2%
$ 104,985
4.0%
Any change in our estimate of losses 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 2009,
2008 and 2007.
Reinsurance
We use insurance and reinsurance (collectively, "reinsurance") to provide capacity to write larger
limits of liability, to provide protection against losses in excess of policy limits, and to stabilize
underwriting results in years in which higher losses occur. The purchase of reinsurance does not relieve
us from the ultimate risk on our policies, but it does provide reimbursement for certain losses we pay.
We evaluate each of our ceded reinsurance contracts at inception to determine if there is
sufficient risk transfer to allow the contract to be accounted for as reinsurance under current accounting
guidance. At December 31, 2009 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 collectability 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 have engaged an independent pricing service to provide us with the fair value for
approximately 95% of our investments, principally equity securities and fixed income securities. Fair
value is defined 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 pricing service has a larger
and more experienced staff than ours, has access to large quantities of data that would be difficult and
expensive for us to acquire, and many years of valuation experience.
We determine fair value using an exchange traded price if one is available. As of December 31,
2009 we valued approximately 6% of our investments at fair value using an exchange traded price. There
is little judgment involved when fair value is determined using an exchange traded price. In accordance
with GAAP, for disclosure purposes we classify securities valued using an exchange traded price as
Level 1 securities.
34
Approximately 89% of our investments, principally our fixed income securities, are valued at fair
value using available market information. Excluding government bonds, most fixed income securities do
not trade daily and thus exchange traded prices are generally not available for these securities. However,
market information, (such as last reported trade, non-binding broker quotes, bids, benchmark yield curves,
issuer spreads, two sided markets, benchmark securities, offers, and recent data regarding assumed
prepayment speeds, cash flow and loan performance data) often referred to as observable inputs, is
available for most of our fixed income securities. The pricing service provides us a price that has been
determined using pricing models when multiple observable inputs are available but an exchange traded
price is not. Pricing models vary by asset class and utilize the available market data for securities
considered comparable to establish a price for our security. The pricing service discloses the inputs used
for each asset class that it prices and states that all market inputs used are scrutinized for consistency with
other relevant market information before being included in the valuation computation. Determining fair
values using these pricing models requires the use of judgment to identify appropriate comparable
securities and to choose valuation methodology that is appropriate for the asset class and available data.
In accordance with GAAP, for disclosure purposes we classify securities valued using multiple market
observable inputs as Level 2 securities.
The pricing service 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 discuss the
provided valuation with the pricing service and would make adjustments if deemed necessary. To date,
we have not adjusted any prices supplied by the pricing service.
The pricing service provides a fair value only when an exchange traded price is available or when
suitable multiple market observable inputs for a security can be identified. We hold certain non public
investments which are not valued by the pricing service and certain other securities which are valued by
the pricing service in some periods, but not others, depending upon the level of recent market activity for
the securities or comparable securities. If the pricing service does not provide a price, Management
estimates fair value using either a single non-binding broker quote or pricing models that utilize market
based assumptions which have limited observable inputs. The process involves significant judgment in
selecting the appropriate data and modeling techniques to use in the valuation process. We fair value 2%
of our investments in this manner. In accordance with GAAP, for disclosure purposes we classify
securities that are valued using limited observable inputs as Level 3 securities.
We also hold interests in private investment funds (non-public investment partnerships and
limited liability companies) which are accounted for under the cost method and some of which are
accounted for under the equity method, depending on our presumed degree of influence over the
operating and financial policies of the fund. We value our interests in the entities accounted for under the
equity method based on quarterly net asset values provided to us by fund managers. Interests accounted
for using the equity method total $48.5 million at December 31, 2009. Interests accounted for using the
cost method total $36.3 million at December 31, 2009.
Investment Impairments
We evaluate all our investments on at least a quarterly basis for declines in fair value that
represent other-than-temporary impairments (OTTI). In all instances we consider an impairment to be an
other-than-temporary impairment if we intend to sell the security or if we believe we will be required to
sell the security before we fully recover the amortized cost basis of the security. Otherwise, we consider
various factors in our evaluation, depending upon the type of security, as discussed below.
35
For equity securities, we consider the following:
−
−
the length of time for which the fair value of the investment has been less than its
recorded basis;
the financial condition and near-term prospects of the issuer underlying the investment,
taking into consideration the economic prospects of the issuer's industry and geographical
region, to the extent that information is publicly available;
the historical and implied volatility of the fair value of the security;
−
− our ability and intent to hold the investment for a period of time sufficient to allow for
any anticipated recovery in fair value.
For debt securities, we consider the following:
− whether or not we expect to fully recover the amortized cost basis of the security, based
upon consideration of some or all of the following:
−
third party research and credit rating reports;
−
the current credit standing of the issuer, including credit rating downgrades
− extent to which the decline in fair value is attributable to credit risk specifically
associated with an investment or its issuer;
− 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;
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;
failure of the issuer of the security to make scheduled interest or principal payments;
−
− any changes to the rating of the security by a rating agency;
−
recoveries or additional declines in fair value subsequent to the balance sheet date;
and
− our ability and intent to hold the investment for a period of time sufficient to allow
for any anticipated recovery in fair value.
In assessing whether we expect to recover the cost basis of debt securities, particularly asset-
backed securities, we must make a number of assumptions regarding matters that will affect the cash
flows that we expect to receive from the security in future periods. These judgments are subjective in
nature and may subsequently be proved to be inaccurate.
We evaluate our investments in private investment funds for OTTI by considering whether there
has been a decline in fair value below the recorded value. We receive reports from the funds at least
quarterly which provide us a net asset value (NAV) for our interest in the fund. The NAV is based on the
fair values of securities held by the fund as determined by the fund manager. Determining whether there
has been a decline in fair value involves assumptions and estimates. We consider the most recent NAV
provided, the performance of the fund relative to the market, the stated objectives of the fund, and cash
flows expected from the fund and audit results in considering whether an OTTI exists.
We also evaluate our holdings of Federal Home Loan Bank (FHLB) securities for impairment.
We consider the current capital status of the FHLB, whether the FHLB is in compliance with regulatory
minimum capital requirements, and the reported operating results of the current period.
36
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 our future
operations 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 asset 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. We operate in a single operating segment. Our segment components are
economically similar, and we consider ProAssurance to be one reporting unit for the purposes of
evaluating goodwill. We estimate the fair value of our reporting unit on the evaluation date based on
ProAssurance’s market capitalization and an expected premium that would be paid to acquire control of
the company (a control premium). We then perform a sensitivity analysis using a range of historical stock
prices and control premiums. We concluded in 2009, 2008, and 2007 that the fair value of our reporting
unit exceeded the carrying value and no adjustment to impair goodwill was necessary.
ProAssurance Overview
We are an insurance holding company and our operating results are primarily derived from the
operations of our insurance subsidiaries, 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 2008
data, we are the largest publicly traded medical professional liability specialist insurance writer in the
nation. We believe our customer focus combined with our financial strength, strong reputation and proven
ability to manage claims, will enable us, over the long-term, to profitably expand our operations. 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. In addition to
37
prudent risk selection and pricing, we seek to control our underwriting results through effective claims
management, and have fostered a strong culture of defending claims that we believe have no merit. We
manage claims by tailoring claims handling to the legal climate of each state, which we believe
differentiates us from other national writers.
Through our market-based 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 market-based focus 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 price alone. We also believe that our local market knowledge 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 manage our business to protect our financial security.
We measure performance in a number of ways, but particularly focus on our combined ratio and
investment returns, both of which directly affect our return on equity (ROE). We target a long-term
average ROE of 12% to 14%.
We believe that a focus on rate adequacy, selective underwriting and effective claims
management is required if we are to achieve our ROE targets. We closely monitor premium revenues,
losses and loss adjustment costs, and acquisition, underwriting and insurance expenses. Our overall
investment strategy is to focus on maximizing current income from our investment portfolio while
maintaining safety, liquidity, duration and portfolio diversification. We engage in activities that generate
other income; however, such activities, principally fee and agency services, do not constitute a significant
use of our resources or a significant source of revenues or profits.
Growth Opportunities and Outlook
We expect our long-term growth to come through controlled expansion of our existing operations.
We also look to expand through the acquisition of other specialty insurance companies or books of
business; however, such expansion is often opportunistic and cannot be predicted. We continue to review
our distribution channels and will make adjustments as market opportunities change.
We continue to face price-based competition in virtually all of our markets. Some competitors
offer coverage at rates we believe do not allow for an acceptable return for the risk being accepted. One
competitive trend emerging with greater frequency is hospitals purchasing physician practices. In
response to this trend, we have recently introduced a new product designed to provide greater risk sharing
options to hospitals and large physician groups. Another continuing competitive trend is physicians and
hospitals seeking to lower their costs through the use of alternative risk transfer approaches such as self
insurance and risk sharing pools. These alternatives become less attractive as prices soften in the
traditional insurance markets. Our focus on basic fundamentals is providing opportunities in a variety of
markets. In 2009, we strengthened our agency distribution system and improved work flows related to
38
new business submissions. These process improvements allowed us to review additional risks, increasing
our overall new business writings despite continued price and coverage competition.
As a result of our branding campaign, “Treated Fairly”, and improvements in loss cost trends that
have allowed us to reduce rates in certain markets, we were able to grow our organic physician count in
2009 which partially offset the effects of lower rates. We believe our emphasis on fair treatment of our
insureds and other important stakeholders enhanced our market position and differentiation. We will
continue to use “Treated Fairly” in all of our activities, and we believe that as we reach more customers
with this message we will continue to improve retention and add new insureds, both of which will help
offset the effects of lower rates.
Our integration of our three acquisitions in 2009 provides opportunity for continued market
leadership in the podiatry line and expands the markets for allied health and legal professional liability.
The entities now provide for licensure and opportunistic expansion within all states. With each of the
acquired entities we began to cross sell and identify new opportunities for all ProAssurance entities. We
continue to see new opportunities from each of the acquisitions and believe each will provide organic
growth through expansion in their existing markets and relationships.
Accounting Changes Adopted
Consolidation-Accounting and Reporting for Decreases in Ownership of a Subsidiary
Effective for interim and annual reporting periods ending on or after December 15, 2009, the
FASB issued clarification on the scope of the guidance regarding decreases in ownership of consolidated
entities. The guidance also expands disclosure requirements about deconsolidation of a subsidiary or
derecognition of a group of assets. We adopted the revised guidance as of the quarter ended December 31,
2009; adoption had no effect on our results of operations or financial position.
Distributions to Shareholders with Components of Stock and Cash
Effective for interim and annual periods ending on or after December 15, 2009, the FASB revised
GAAP guidance that clarifies the proper accounting treatment for distributions to shareholders that
include both stock and cash. We adopted the revised guidance as of the quarter ended December 31,
2009; adoption had no effect on our results of operations or financial position.
Fair Value Measurements-Investments in Certain Entities that Calculate Net Asset Value per Share (or its
Equivalent)
Effective for interim and annual periods ending after December 15, 2009, the FASB revised
GAAP guidance to permit a reporting entity to measure the fair value of certain investments on the basis
of the net asset value per share of the investment (or its equivalent). The revised guidance also requires
new disclosures, by major category of investments, regarding investments measured on the basis of net
asset value. We adopted the revised guidance as of the quarter ended December 31, 2009; adoption had
no effect on our results of operations or financial position.
Fair Value-Liabilities
In August 2009, the FASB revised GAAP guidance regarding the valuation of liabilities at fair
value; the guidance is effective for the first reporting period that begins after issuance of the guidance.
The updated guidance clarifies that when a quoted price in an active market for an identical liability is not
available, fair value should be determined using quoted prices for identical or similar liabilities traded as
assets or using another valuation technique described in existing GAAP guidance for determining fair
values. Such techniques include present value techniques, and techniques based on the amount that a
reporting entity would pay on the measurement date to transfer or enter into an identical liability. We
39
adopted the revised guidance as of the quarter ended December 31, 2009; adoption had no effect on the
valuation of our liabilities.
FASB Accounting Standards Codification
Effective for interim and annual periods ending after September 15, 2009, the FASB published
the FASB Accounting Standards Codification (the Codification) as the single source of authoritative
nongovernmental GAAP. The Codification is not intended to change current GAAP, but rather to provide
all the authoritative literature related to a particular topic in one place. Upon the effective date, all pre-
existing accounting standard documents were superseded and accounting literature not included in the
Codification became non-authoritative. We adopted use of the Codification as of the quarter ended
September 30, 2009; adoption had no effect on our results of operations or financial position.
Subsequent Events
Effective for interim and annual reporting periods ending on or after June 15, 2009, the FASB
revised GAAP guidance to more clearly set forth the period after the balance sheet date during which
management should evaluate events or transactions for potential recognition or disclosure in the financial
statements, the circumstances under which events or transactions after the balance sheet date should be
recognized and the disclosures that should be made regarding such events. We adopted the revised
guidance as of the quarter ended June 30, 2009; adoption had no effect on our results of operations or
financial position.
Fair Value
Effective for interim and annual reporting periods ending on or after June 15, 2009, the FASB
revised GAAP guidance regarding the valuation of assets or liabilities when the volume and level of
market transactions for those assets or liabilities has significantly decreased. The revised guidance
clarifies factors to be considered in determining whether there has been a significant decrease in market
activity for an asset in relation to normal activity and provides additional guidance on when the use of
multiple (or different) valuation techniques may be warranted and considerations for determining the
weight that should be applied to the various techniques. The revisions also establish a requirement that
conclusions about whether transactions are orderly be based on the weight of the evidence and require
entities to disclose any changes to valuation techniques (and related inputs) that result from a conclusion
that markets are not orderly and the effect of the change, if practicable. The revised guidance also
expanded disclosure requirements regarding the fair value of financial instruments. We adopted the
revised guidance as of the quarter ended June 30, 2009; adoption had no significant effect on our results
of operations or financial position.
Investments—Disclosure Requirements; Other-than-temporary Impairments
Effective for interim and annual reporting periods ending on or after June 15, 2009, the FASB
revised GAAP to require expanded disclosures related to investments in debt and equity securities.
Guidance regarding other-than-temporary impairments was also revised. Previous investment guidance
required that an impairment of a debt security be considered as other-than-temporary unless management
could assert both the intent and the ability to hold the impaired security until recovery of value. The
revised impairment guidance specifies that an impairment be considered as other-than-temporary unless
an entity can assert that it has no intent to sell the security and that it is not more likely than not that the
entity will be required to sell the security before recovery of its anticipated amortized cost basis. The new
guidance also establishes the concept of credit loss. Credit loss is defined as the difference between the
present value of the cash flows expected to be collected from a debt security and the amortized cost basis
of the security. The new guidance states that “in instances in which a determination is made that a credit
loss exists but the entity does not intend to sell the debt security and it is not more likely than not that the
40
entity will be required to sell the debt security before the anticipated recovery of its remaining amortized
cost basis” an impairment is to be separated into (a) the amount of the total impairment related to the
credit loss and (b) the amount of total impairment related to all other factors. The credit loss component
of the impairment is to be recognized in income of the current period. The non-credit component is to be
recognized as a part of other comprehensive income. Transition provisions require a cumulative effect
adjustment to reclassify the noncredit component of a previously recognized other-than-temporary
impairment from retained earnings to accumulated other comprehensive income “if an entity does not
intend to sell and it is not more likely than not that the entity will be required to sell the security before
recovery of its amortized cost basis”. We adopted the revised guidance as of the beginning of the quarter
ended June 30, 2009. As of April 1, 2009, our debt securities included non-credit impairment losses
previously recognized in earnings of approximately $5.4 million. In accordance with the transition
provisions of the revised guidance, we reclassified these non-credit losses, net of tax, from retained
earnings to accumulated comprehensive income as of April 1, 2009 (a $3.5 million increase to retained
earnings; a $3.5 million decrease to accumulated other comprehensive income).
Convertible Debentures
Effective January 1, 2009, the FASB revised GAAP guidance regarding the accounting for
Convertible Debentures. The revised guidance 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, 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. The revised
guidance is applicable to the Convertible Debentures which we converted in July 2008. We adopted the
revised guidance as of its effective date January 1, 2009; adoption had no effect on 2009 operating results
because no convertible debt has been outstanding during 2009. The cumulative effect of adoption, which
would be an increase to additional paid-in capital of $65,000 and an offsetting decrease to retained
earnings of the same amount, has not been recorded because the effect is immaterial and would not
change total stockholders’ equity.
Non-controlling Interests in Subsidiaries
Effective for interim and annual reporting periods beginning on or after December 15, 2008, the
FASB revised GAAP guidance to establish accounting and reporting standards for the noncontrolling
interest in a subsidiary and for the deconsolidation of a subsidiary. We adopted the revised guidance as of
its effective date, January 1, 2009. Adoption did not have an effect on our results of operations or
financial position.
Business Combinations
Effective prospectively for business combinations with an acquisition date on or after the
beginning of the first annual reporting period beginning on or after December 15, 2008, the FASB revised
GAAP guidance related to business combinations. The revised guidance retains the previous requirement
that the acquisition method of accounting be used for all business combinations but provides new and
additional guidance 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. We adopted the new
guidance as of its effective date, January 1, 2009 and accounted for our acquisitions of Mid-Continent
General Agency, Inc. (Mid-Continent), Georgia Lawyers Insurance Company (Georgia Lawyers) and
41
Podiatry Insurance Company of America (PICA) during the first and second quarters of 2009 in
accordance with the revised guidance (see Note 3).
Trading Security Cash Flows
Effective for fiscal years beginning after November 15, 2007 the FASB revised GAAP regarding
cash flows from purchases, sales and maturities of trading securities. Under the new guidance, such cash
flows are classified based on the nature and purpose for which the securities were acquired. Under prior
guidance, cash flows from purchases, sales and maturities of trading securities were classified as
operating cash flows. ProAssurance adopted this guidance as of January 1, 2008. Accordingly,
ProAssurance’s statement of cash flows reflects trading security cash flows during 2007 based on the
prior guidance, whereas cash flows during 2008 and 2009 are based on the revised guidance.
Accounting Changes Not Yet Adopted
Fair Value Measurements
Effective for interim and annual reporting periods beginning after December 15, 2009 or
December 15, 2010, as specified, the FASB revised GAAP guidance related to fair value measurement to
require additional disclosures and to clarify certain existing disclosure requirements. The guidance is
intended to improve the disclosures and increase transparency in financial reporting. Adoption of this
guidance is not expected to have an effect on our results of operations or financial position.
Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance
Effective for interim and annual reporting periods beginning on or after December 15, 2009 for
outstanding arrangements and effective otherwise for reporting periods beginning on or after June 15,
2009, the FASB issued guidance related to share-lending arrangements for an entity’s own shares
executed in contemplation of a convertible debt offering or other financing. Adoption of this guidance is
not expected to have an effect on our results of operations or financial position. Early adoption is not
permitted.
Consolidation of Variable Interest Entities
Effective at the start of a reporting entity’s first fiscal year beginning after November 15, 2009,
the FASB revised guidance which changes how a reporting entity determines whether or not to
consolidate its interest in an entity that is insufficiently capitalized or is not controlled through voting (or
similar) rights. The determination of whether a reporting entity is required to consolidate another entity
will now be based on, among other things, the other entity’s purpose and design and the reporting entity’s
ability to direct the activities of the other entity that most significantly impact the other entity’s economic
performance. The revised guidance also requires the reporting entity to provide additional disclosures
about its involvement with variable interest entities and any significant changes in risk exposure due to
that involvement. A reporting entity will be required to disclose how its involvement with a variable
interest entity affects the reporting entity’s financial statements. Adoption of this guidance is not expected
to have a significant effect on our results of operations or financial position. Early adoption is not
permitted.
Transfers and Servicing-Accounting for Transfers of Financial Assets
Effective at the start of a reporting entity’s first fiscal year beginning after November 15, 2009,
the FASB revised guidance that requires additional disclosure regarding transfers of financial assets,
including securitization transactions, where entities have continuing exposure to risks related to the
transferred financial assets. Adoption of this guidance is not expected to have an effect on our results of
operations or financial position. Early adoption is not permitted.
42
Revenue Recognition-Multiple Deliverable Revenue Arrangements
Effective prospectively for revenue arrangements entered into or materially modified in fiscal
years beginning on or after June 15, 2010, the FASB issued guidance addressing the accounting for
multiple-deliverable arrangements. The guidance eliminates the residual method of allocation and
requires that arrangement consideration be allocated at inception using the relative selling price method.
The guidance establishes a selling price hierarchy and also expands required disclosures related to a
vendor’s multiple-deliverable revenue arrangements. Adoption of this guidance is not expected to have an
effect on our results of operations or financial position.
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. Our insurance
subsidiaries, in aggregate, are permitted to pay dividends of approximately $204 million during 2010
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. At December 31,
2009 we held cash and investments of approximately $211.4 million outside of our insurance subsidiaries
that are available for use without regulatory approval.
Acquisitions
In the first quarter of 2009 we acquired 100% of the outstanding shares of Mid-Continent and
Georgia Lawyers as a means of expanding our professional liability business. These acquisitions were not
material to ProAssurance individually or in the aggregate.
On April 1, 2009 we acquired Podiatry Insurance Company of America and subsidiaries (PICA)
through a cash sponsored demutualization as a means of expanding our professional liability insurance
operations. PICA provides professional liability insurance primarily to podiatric physicians, chiropractors
and other healthcare providers throughout the United States. We purchased all of PICA’s outstanding
stock created in the demutualization for $135 million in cash, of which $15 million was a surplus
contribution to be used to provide renewal premium credits to eligible policyholders over a three year
period beginning in 2010.
See Note 3 to the Consolidated Financial Statements for detailed information regarding the PICA
transaction, including a summarized listing of the assets acquired and liabilities assumed.
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 payment of losses associated with the premiums.
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.
43
Our operating activities provided positive cash flows of approximately $75.4 million and $167.9
million for the years ended December 31, 2009 and 2008, respectively. Operating cash flows for 2009 and
2008 compare as follows:
Cash provided by operating activities year ended December 31, 2008
Increase (decrease) in operating cash flows during 2009 exclusive of PICA:
(In millions)
Lower premium receipts (1)
Lower investment receipts
Increase in net premium payments to reinsurers
Decrease in losses paid (2)
Decrease in reinsurance recoveries (3)
2008 commutation receipts (no comparable receipts during 2009)
Increase in Federal income tax payments (4)
Payment of CHW judgment (5)
Other amounts not individually significant, net
PICA operating cash flows
Cash provided by operating activities year ended December 31, 2009
$
Cash Flow
Increase
(Decrease)
168
$
(13)
(14)
(7)
101
(77)
(27)
(39)
(21)
(11)
15
75
(1) Premiums written increased in 2009, but approximately $10 million of the increase relates to two-
year policies for which the second term amount is not due to be received until 2010.
(2) The timing of our loss payments varies from period to period because the process for resolving
claims is complex and occurs at an uneven pace depending upon the circumstances of the
individual claim.
(3) The timing of reinsurance recoveries varies from period to period and can depend upon the nature
of the reinsurance treaty, the nature of the underlying claim and the timing and amount of
underlying losses.
(4) The increase in tax payments reflects timing differences. Our estimated tax payments for the
fourth quarter period are paid in the next fiscal year. Fourth quarter taxable income was
significantly more in 2008 than in 2007, which resulted in a related tax payment in first quarter
2009 that was higher than the payment made in first quarter of 2008.
(5) In 2009 we paid a judgment in favor of Columbia Hospital for Women Medical Center, Inc.
(CHW) entered against our subsidiary, ProAssurance National Capital Insurance Company (PRA
National), prior to our acquisition of PRA National. We established a liability related to the
judgment and accrued post trial interest at the time PRA National was acquired in 2005. See Note
9 to the Consolidated Financial Statements for additional information.
44
Investment Exposures
The following table provides summarized information regarding our investments as of December 31,
(In thousands)
Carrying
Value
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Average
Rating
% Total
Investments
2009:
Fixed Maturities
Government
U.S. Treasury
U.S. Agency
Total government
State and Municipal Bonds
Corporate Bonds
Financial institutions
FDIC insured
Communications
Utilities
Energy
Industrial
Transportation
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 only
Financial
Energy
Consumer cyclical
Consumer non-cyclical
Technology
Industrial
Communications
All Other
Total equities
Short-Term
BOLI
Investment in Unconsolidated Subsidiaries
Private fund–primarily invested in high yield asset-backed securities(3)
Private fund–primarily invested in long/short equities
Private fund–primarily invested in non-public equities
Total investment in unconsolidated subsidiaries
Other Investments
High yield asset-backed securities, held in a private investment fund(4)
Federal Home Loan Bank capital stock
Private fund–primarily invested in distressed debt
Private fund–primarily invested in long/short equities
Other
Total other investments
Total Investments
45
$
$ 153,544
67,026
220,570
$
4,874
2,371
7,245
(1,267)
(182)
(1,449)
AAA
AAA
AAA
1,448,649
51,977
(3,621)
AA
A+
AAA
BBB+
A
BBB+
A
BBB+
A
A
AAA
BBB+
(1)
(2)
AAA
AAA
AAA
AA
AA+
AA+
AA-
286,982
76,907
63,286
80,192
36,005
491,411
17,655
21,574
1,074,012
504,480
36,222
7,231
8,930
92,567
34,045
6,605
9,684
699,764
3,442,995
9,319
7,963
3,647
9,527
4,865
4,158
4,197
3,729
47,405
187,059
65,003
29,930
12,943
5,629
48,502
10,932
5,190
23,073
6,010
2,053
47,258
9,590
818
3,070
3,493
2,591
18,191
624
494
38,871
19,912
1,215
–
1,056
1,074
1,247
89
413
25,006
123,099
117
52
92
206
178
311
24
48
1,028
–
–
–
–
–
–
–
–
–
–
–
–
(1,797)
(13)
(221)
(524)
(178)
(2,857)
(125)
(40)
(5,755)
(368)
(2,961)
(3,494)
(4,184)
(2,448)
(12)
–
(164)
(13,631)
(24,456)
–
–
(14)
(2)
–
–
–
(5)
(21)
–
–
–
–
–
–
(8,485)
–
–
–
–
(8,485)
4%
2%
6%
38%
7%
2%
2%
2%
1%
13%
0%
1%
28%
13%
1%
0%
0%
2%
1%
0%
1%
18%
90%
0%
0%
0%
0%
0%
0%
0%
0%
1%
5%
2%
1%
0%
0%
1%
0%
0%
1%
0%
0%
1%
$ 3,838,222
$ 124,127
$
(32,962)
100%
(1) 3% AAA, 56% AA, 38% A, 3% B or below
(2) 19% are AAA rated, 6% are AA, 5% are A, 70% are B or below
(3) Includes subprime securities with a fair value of $12.7 million
(4) Includes subprime securities with a fair value of $700,000 (recorded cost basis of $4.0 million; average rating of BBB)
A complete listing of our investment holdings as of December 31, 2009 is presented in an
Investor Supplement we make available in the Investor Relations section of our website,
www.proassurance.com or directly at www.proassurance.com/investorrelations/supplemental.aspx.
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. We anticipate that between $50 million and $80 million of our investments will mature (or be
paid down) each quarter of the next year and become available, if needed, to meet our cash flow
requirements. The primary outflow of cash at our insurance subsidiaries 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 $227.7 million at December 31, 2009 as compared to
$445.5 million at December 31, 2008. We utilized $135 million in the PICA acquisition in April 2009.
We also moved funds to longer-term investments during 2009 as credit markets stabilized.
Our investment portfolio continues to be composed of high quality fixed income securities with
approximately 97% of our fixed maturities being either United States government agency or investment
grade securities as determined by national rating agencies. The weighted average effective duration of our
fixed maturity securities at December 31, 2009 is 4.2 years; the weighted average effective duration of
our fixed maturity securities combined with our short-term securities is 4.0 years. The securities acquired
in the PICA transaction were, on average, longer in duration than the securities we already owned, which
caused a small increase in the overall weighted average effective duration.
At December 31, 2009 we held asset-backed securities with a fair value of $699.8 million
(recorded cost basis of $688.4 million). During 2009, we recognized $3.2 million of losses on asset-
backed securities primarily relating to mortgage-backed securities impacted by the deterioration of the
housing market. In performing our OTTI assessment of mortgage-backed securities, management projects
expected cash flows, making assumptions regarding expected default rates and the value of collateral
available to recover losses. If estimated cash flows project a loss, an OTTI is realized for the difference
between the book value and present value of the anticipated cash flows 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 default 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.
We hold five positions in financial institution fixed maturity securities for which the position held
has a fair value that exceeds $20 million. The aggregate fair value of these five positions totals $143.1
million ($140.2 million recorded cost basis), of which $51.2 million is FDIC backed.
At December 31, 2009 we held fixed maturity securities with pretax net unrealized gains of
approximately $99 million as compared to pretax net unrealized losses of $43 million as of December 31,
46
2008. The improvement is primarily due to a reduction in credit spreads, particularly with respect to state
and municipal securities and corporate bonds, offset somewhat by the impact of slightly higher market
interest rates. The fixed maturity securities acquired in the PICA transaction were valued at their fair
value on the date of acquisition, April 1, 2009—see Notes 2 and 3—and overall have appreciated in value
because of lower market interest rates at December 31, 2009.
Losses
The following table, known as the Analysis of Reserve Development, 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. PICA and Georgia Lawyers reserves are included only in
the year 2009.
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 Analysis of Reserve Development:
– 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.
47
Analysis of Reserve Development
(In thousands)
December 31,
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
$
486,279
$
493,457
$
1,009,354
$
1,098,941
$
1,298,458
$
1,544,981
$
1,896,743
$
2,236,385
$
2,232,596
$
2,111,112
$
2,159,571
133,832
239,872
313,993
358,677
387,040
408,079
417,362
430,779
443,854
449,177
486,279
463,779
469,934
488,416
487,366
485,719
489,187
490,200
490,575
487,380
487,935
143,892
251,855
321,957
367,810
402,035
422,005
440,676
457,761
466,109
493,457
507,275
529,698
527,085
534,382
536,875
535,120
531,995
524,837
520,981
245,743
436,729
563,557
656,670
726,661
794,786
836,485
863,018
1,009,354
1,026,354
1,023,582
1,032,571
1,035,832
1,045,063
1,052,050
1,040,376
1,015,217
224,318
393,378
528,774
635,724
749,300
824,761
863,781
1,098,941
1,098,891
1,099,292
1,109,692
1,108,539
1,133,343
1,121,440
1,079,640
200,314
378,036
526,867
680,470
794,870
852,985
199,617
384,050
578,455
728,582
805,270
242,608
503,271
697,349
825,139
331,295
600,500
787,347
312,348
550,042
278,655
1,298,458
1,289,744
1,282,920
1,259,802
1,250,110
1,230,105
1,156,614
1,544,981
1,522,000
1,479,773
1,418,802
1,340,061
1,234,223
1,896,743
1,860,451
1,764,076
1,615,125
1,450,275
2,236,385
2,131,400
1,955,903
1,747,459
2,232,596
2,047,344
1,829,140
2,111,112
1,903,812
Reserve for losses,
undiscounted and net of
reinsurance recoverables
Cumulative net paid, as of:
One Year Later
Two Years Later
Three Years Later
Four Years Later
Five Years Later
Six Years Later
Seven Years Later
Eight Years Later
Nine Years Later
Ten Years Later
Re-estimated Net Liability as of:
End of Year
One Year Later
Two Years Later
Three Years Later
Four Years Later
Five Years Later
Six Years Later
Seven Years Later
Eight Years Later
Nine Years Later
Ten Years Later
Net cumulative redundancy (deficiency)
$
(1,656)
$
(27,524)
$
(5,863)
$
19,301
$
141,844
$
310,758
$
446,468
$
488,926
$
403,456
$
207,300
Original gross liability - end of year
Less: reinsurance recoverables
Original net liability - end of year
Gross re-estimated liability - latest
Re-estimated reinsurance recoverables
Net re-estimated liability - latest
$
665,786
(179,507)
486,279
$
$
659,659
(166,202)
493,457
$
$
$
1,322,871
(313,517)
1,009,354
$
$
1,494,875
(395,934)
1,098,941
$
589,435
(101,500)
487,935
$
$
$
607,163
(86,182)
520,981
$
$
1,245,507
(230,290)
1,015,217
$
$
1,381,076
(301,436)
1,079,640
$
$
1,634,749
(336,291)
1,298,458
$
$
1,467,949
(311,335)
1,156,614
$
$
1,818,635
(273,654)
1,544,981
$
$
2,224,436
(327,693)
1,896,743
$
$
1,538,627
(304,404)
1,234,223
$
$
1,821,354
(371,079)
1,450,275
$
$
2,607,148
(370,763)
2,236,385
$
$
2,186,313
(438,854)
1,747,459
$
$
2,559,707
(327,111)
2,232,596
$
$
2,176,881
(347,741)
1,829,140
$
$
2,379,468
(268,356)
2,111,112
$
$
2,170,605
(266,793)
1,903,812
Gross cumulative redundancy (deficiency)
$
76,351
$
52,496
$
77,364
$
113,799
$
166,800
$
280,008
$
403,082
$
420,835
$
382,826
$
208,863
48
In each year reflected in the table, we have estimated our reserve for losses utilizing the
management and actuarial processes discussed in critical accounting estimates. Factors that have
contributed to the variation in loss development are primarily related to the extended period of time
required to resolve 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 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 2007, 2008 and 2009 we have recognized favorable development related to our
previously established reserves primarily for accident years 2003 through 2007 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 2009, 2008 and 2007 is summarized below:
(In thousands)
Balance, beginning of year
Less receivable from reinsurers
Net balance, beginning of year
Year Ended December 31
2009
$ 2,379,468
268,356
2,111,112
2008
$ 2,559,707
327,111
2,232,596
2007
$ 2,607,148
370,763
2,236,385
Reserves acquired from acquisitions
163,946
–
–
Incurred related to:
Current year
Prior years
Total incurred
Paid related to:
Current year
Prior years
Total paid
438,368
(207,300)
231,068
(67,900)
(278,655)
(346,555)
396,750
(185,251)
211,499
(20,635)
(312,348)
(332,983)
455,982
(104,985)
350,997
(23,492)
(331,294)
(354,786)
Net balance, end of year
Plus receivable from reinsurers
Balance, end of year
2,159,571
262,659
$ 2,422,230
2,111,112
268,356
$ 2,379,468
2,232,596
327,111
$ 2,559,707
At December 31, 2009 our gross reserve for losses included case reserves of approximately
$1.028 billion and IBNR reserves of approximately $1.394 billion. Our consolidated reserve for losses on
a GAAP basis exceeds the combined reserves of our insurance subsidiaries on a statutory basis by
approximately $63.9 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.
49
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, the
professional liability per claim retention level has varied between 90% and 100% of the first $1 million
and between 0% and 5% of claims exceeding those levels depending on the coverage year and the state in
which business was written. We also insure some large professional liability risks that are above the limits
of our 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.
Our primary reinsurance agreement is negotiated annually at October 1. Under our most recent
agreement, effective October 1, 2009, we will not be reimbursed for allocated loss adjustment expenses.
As a result, the minimum and maximum premium due under the agreement have been lowered, which we
believe will compensate for the decrease in recoveries under the treaty. Therefore, we do not expect these
changes to result in a significant overall change in the cost of reinsurance.
Our risk retention level is dependent upon numerous factors including our risk tolerance and the
capital we have to support it, the price and availability of reinsurance, volume of business, level of
experience with a particular set of claims 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.
We utilize a reinsurance broker to assist us in the analysis of the credit quality of our reinsurers. We base
our reinsurance buying decisions on an evaluation of the then-current financial strength, 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.
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, 2009:
(In thousands)
Reinsurer
Hannover Rueckversicherung AG
Transatlantic Reinsurance Company
General Reinsurance Corporation
Aspen Insurance UK, Ltd.
AXA Reassurances SA*
A.M. Best
Company Rating
A
A
A++
A
NR-4
Net Amounts Due
From Reinsurer
$ 25,872
$ 20,818
$ 19,088
$ 16,703
$ 10,018
*NR-4 indicates the reinsurer is not rated by A.M. Best at the request of the reinsurer.
50
Debt
Our long-term debt as of December 31, 2009 is comprised of the following.
(In thousands, except %)
Contractual Rate
Outstanding Principal
2034 Trust Preferred Securities/Debentures
2034 Surplus Notes
2019 Notes Payable(4)
2012 Surplus Note
4.1% (1)
4.1% (1)
6.6% (2)
3.3% (3)
$
22,992
12,000
17,739
517
(1) Adjusted quarterly based on LIBOR.
(2) The related interest rate swap fixes rate at 6.6%. Swap is settled monthly. See Note 10.
(3) Adjusted quarterly based on the U.S. prime rate.
(4) Both the 2019 Note Payable and the related interest rate swap are valued at fair value. See Note 10.
Carrying Value
December 31, 2009
$
$
22,992
12,000
14,740
471
50,203
All of our long-term debt is currently repayable or redeemable, with proper notice, at a date no
later than the next quarterly or semi-annual interest payment date. Insurance department approval is
required for redemption of surplus notes. A detailed description of our debt is provided in Note 10 to the
Consolidated Financial Statements.
Off Balance Sheet Arrangements/Guarantees
As discussed in Note 10 to the Consolidated Financial Statements, our Trust Preferred
Subordinated Debentures (TPS Debentures) are held by, and are the sole assets of a related business trust
(Trust-2). Trust-2 purchased the TPS Debentures with proceeds from related trust preferred stock (TPS)
issued and sold by the trust. The terms and maturities of the TPS Debentures mirror those of the related
TPS. Trust-2 uses the debenture interest and principal payments we pay into the trust to meet Trust-2’s
TPS obligations. Trust-2 is not consolidated because we are not the primary beneficiary of Trust-2.
ProAssurance has issued guarantees that amounts paid to Trust-2 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, 2009 follows:
Payments due by period
Less than
(In thousands)
Loss and loss adjustment expenses
Interest on long-term debt*
Long-term debt obligations
Operating lease obligations
Total
Total
$ 2,422,230
44,552
53,203
9,209
$ 2,529,194
1 year
541,242
2,643
303
2,863
547,051
1-3 years
791,657
5,222
1,141
2,646
800,666
$
$
3-5 years
$ 527,321
5,093
768
1,658
534,840
$
$
$
*Includes projected payments due on interest rate swap associated with our long-term debt.
More than
5 years
$ 562,010
31,594
50,991
2,042
$ 646,637
51
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, 2009. 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 10 to the Consolidated Financial Statements.
Treasury Stock
We repurchased approximately 1.1 million common shares, having a total cost of $52.0 million,
during the year ended December 31, 2009. We reissued 100,533 treasury shares as a part of the
consideration for acquisitions during the first quarter of 2009. Our Board of Directors authorized $150
million in April 2007, an additional $100 million in August 2008, and an additional $100 million in
September 2009 for the repurchase of common shares or the retirement of outstanding debt.
Approximately $115.4 million of the amounts authorized by the Board remains available for use at
December 31, 2009.
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.
In accordance with GAAP for insurance entities, claim-related actions are considered as a part of
our loss reserving process. 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.
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.
For non-claim related actions, we evaluate each case separately and establish what we believe is
an appropriate reserve based on GAAP guidance related to contingent liabilities.
52
Overview of Results–Years Ended December 31, 2009 and 2008
Net income totaled $222.0 million for the year ended December 31, 2009 as compared to $177.7
million for the year ended December 31, 2008. Net income per diluted share was $6.70 and $5.22 for the
years ended December 31, 2009 and 2008, respectively. The increase in diluted earnings per share is
primarily attributable to an increase in net income, but also reflects a decrease in diluted weighted average
shares outstanding.
Results from the years ended December 31, 2009 and 2008, respectively, compare as follows:
Premiums—Exclusive of PICA
Net premiums earned declined in 2009 by approximately $32.0 million (7.0%) for the year. The
decline reflects the effects of a competitive market place and rate reductions resulting from improved loss
trends.
Premiums—PICA
PICA contributed net premiums earned of $70.3 million during 2009.
Net Investment Income; Net Realized Investment Gains (Losses)—Consolidated
Our 2009 net investment results (which include both net investment income and earnings from
unconsolidated subsidiaries) increased by $2.0 million (1.3%) and reflects improved results from our
investments in unconsolidated subsidiaries offset by the decline in net investment income primarily due to
lower yields on short-term securities.
Net realized gains were $12.8 million in 2009 as compared to net realized losses of $50.9 million
for 2008. The improvement is principally the result of a $39.0 million reduction in impairment losses due
to more favorable market conditions during 2009.
Gain/Loss on Extinguishment of Debt—Consolidated
Our 2009 results reflect a $2.8 million ($1.8 million after tax) loss related to the extinguishment
of debt, while our 2008 results reflect a $4.6 million ($2.9 million after tax) gain from the extinguishment
of debt. During 2009 we redeemed at par surplus notes acquired in the PICA acquisition which were
valued below par on the date of acquisition. For additional information regarding the extinguishment of
debt see Note 10 to the Consolidated Financial Statements.
Expenses—Exclusive of PICA
Current accident year net losses decreased by $22.2 million (5.6%) for the year, principally due to
a decline in insured risks. We recognized favorable development in 2009 of $207.3 million (a $22.0
million increase).
Underwriting, acquisition and insurance expenses increased during 2009 by $1.5 million (1.5%)
as compared to 2008, primarily due to additional expenses associated with an increase in non-physician
premiums and higher commission costs for physician premiums.
Interest expense declined by $4.9 million in 2009 because we reduced the outstanding principal
balance of our long-term debt during the latter half of 2008 by $129 million.
53
Expenses—PICA
The following PICA expenses are included in our 2009 operating results:
(In thousands)
Net losses
Underwriting, acquisition and
insurance expenses
Interest expense
Year Ended
December 31, 2009
$
63,757
$
$
15,343
1,521
Ratios
Our net loss ratio exclusive of PICA decreased to 39.2% in 2009 from 46.1% in 2008, primarily
because favorable prior year loss development had a more pronounced effect on the calendar year net loss
ratio in 2009 (because 2009 earned premium was less than 2008 earned premium, and because favorable
loss development was higher in 2009). Our 2009 calendar year net loss ratio when PICA subsidiaries are
included is 46.4%.
Our expense ratio exclusive of PICA increased to 23.2% in 2009 from 21.6% in 2008, primarily
because premiums earned decreased but expenses remained relatively flat. Our 2009 expense ratio is
22.7% when the PICA subsidiaries are included.
Our operating ratio exclusive of PICA decreased to 28.5% in 2009 from 33.3% in 2008, reflecting
the improvement in the net loss ratio, offset by a higher expense ratio and lower investment ratio. Our
operating ratio including PICA is 38.8% for 2009.
Return on equity, which is computed only on a consolidated basis, is 14.2% for 2009.
Non-GAAP Financial Measures
Operating income is a Non-GAAP financial measure that is widely used to evaluate the
performance of insurance entities. Operating income excludes the after-tax effects of realized gains or
losses, guaranty fund assessments and debt retirement gain or loss. We believe operating income presents
a useful view of the performance of our insurance operations, but should be considered in conjunction
with net income computed in accordance with GAAP.
The following table is a reconciliation of Net income to Operating income:
(In thousands, except per share data)
Net income
Items excluded in the calculation of operating income:
(Gain) loss on extinguishment of debt
Net realized investment (gains) losses
Guaranty fund (recoupments) assessments
Pre-tax effect of exclusions
Tax effect, at 35%
Operating income
Per diluted common share:
Net income
Effect of exclusions
Operating income per diluted common share
Year Ended December 31
2008
2009
$
222,026
$
177,725
2,839
(12,792)
(533)
(10,486)
3,670
(4,571)
50,913
(1,334)
45,008
(15,753)
$
215,210
$
206,980
$
$
6.70
(0.21)
6.49
$
$
5.22
0.85
6.07
54
Results of Operations–Year Ended December 31, 2009 Compared to Year Ended December 31,
2008
Selected consolidated financial data for each period is summarized in the table below.
($ in thousands, except share data)
2009
2008
Change
Year Ended December 31
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
Loss on extinguishment of debt
Total expenses
$ 553,922
$ 471,482
$ 514,043
$ 429,007
$ 540,012
(42,469)
497,543
150,945
$ 503,579
(44,301)
459,278
158,384
$
$
$
1,438
12,792
–
9,965
672,683
265,983
(34,915)
231,068
116,537
3,477
2,839
353,921
(7,997)
(50,913)
4,571
3,839
567,162
267,412
(55,913)
211,499
100,385
6,892
–
318,776
82,440
85,036
36,433
1,832
38,265
(7,439)
9,435
63,705
(4,571)
6,126
105,521
(1,429)
20,998
19,569
16,152
(3,415)
2,839
35,145
Income before income taxes
318,762
248,386
70,376
Income taxes
Net income
Earnings per share:
Basic
Diluted
Net loss ratio
Underwriting expense ratio
Combined ratio
Operating ratio
Return on equity
96,736
70,661
26,075
$ 222,026
$ 177,725
$
44,301
$
$
6.76
6.70
$
$
5.43
5.22
$
$
1.33
1.48
46.4%
22.7%
69.1%
38.8%
14.2%
46.1%
21.7%
67.8%
33.3%
13.3%
0.3
1.0
1.3
5.5
0.9
PLEASE NOTE: All variance discussions that follow exclude the effects of the PICA acquisition unless
specifically stated otherwise. In all tables the abbreviation “nm” indicates that the percentage change is
not meaningful, either because the prior year amount is zero or because the percent change exceeds 100%.
55
Premiums
($ in thousands)
Gross premiums written:
PRA all other
PICA Acquisition
Net premiums written:
PRA all other
PICA Acquisition
Premiums earned:
PRA all other
PICA Acquisition
Premiums ceded:
PRA all other
PICA Acquisition
Net premiums earned:
PRA all other
PICA Acquisition
$
$
$
$
$
$
$
$
$
$
Year Ended December 31
2008
Change
2009
477,022
76,900
553,922
439,354
74,689
514,043
$
$
471,482
–
471,482
$
$
429,007
–
429,007
467,269
72,743
540,012
$
$
503,579
–
503,579
39,986
2,483
42,469
$
$
44,301
–
44,301
427,283
70,260
497,543
$
$
459,278
–
459,278
$
$
$
$
$
$
$
$
$
$
5,540
76,900
82,440
10,347
74,689
85,036
(36,310)
72,743
36,433
(4,315)
2,483
(1,832)
(31,995)
70,260
38,265
1.2%
nm
17.5%
2.4%
nm
19.8%
(7.2%)
nm
7.2%
(9.7%)
nm
(4.1%)
(7.0%)
nm
8.3%
Gross Premiums Written
Gross premiums written by component are as follows:
($ in thousands)
2009
2008
Change
Year Ended December 31
Physician(1):
PRA all other
PICA Acquisition
Non-physician(1):
Healthcare providers
PRA all other
PICA Acquisition
Hospital and facility(1)
Other(1)
PRA all other
PICA Acquisition
Non-physician total
Tail premiums(2)
Total Gross Premiums
Written
$
379,348
62,512
441,860
$
389,492
–
389,492
$ (10,144)
62,512
52,368
(2.6%)
nm
13.4%
27,139
9,450
36,589
31,350
19,345
4,397
23,742
91,681
20,381
15,582
–
15,582
31,229
11,659
–
11,659
58,470
23,520
11,557
9,450
21,007
74.2%
nm
134.8%
121
0.4%
7,686
4,397
12,083
33,211
65.9%
nm
103.6%
56.8%
(3,139)
(13.3%)
$
553,922
$
471,482
$
82,440
17.5%
(1) Excludes tail premiums
(2) Includes PICA tail premiums of $0.5 million
56
PRA Exclusive of PICA
Changes in our premium volume are driven by three primary factors: our retention of existing
business, the amount of new business we are able to generate (including business that comes to PRA as a
result of acquisitions), and the premium charged for business that is renewed, which is affected both by
rates charged and by the amount and type of coverage an insured chooses to purchase. The professional
liability market continues to remain competitive with some competitors choosing to compete primarily on
price.
Physician premiums continue to be our primary revenue source and comprise 80% and 83% of
our gross premiums written in 2009 and 2008, respectively. Our physician retention rate is 89% and 88%
for the years ended December 31, 2009 and 2008, respectively. Retention rates are affected by a number
of factors. Insureds may terminate coverage because they are leaving the practice of medicine through
death, disability or retirement. Also, based on our underwriting evaluation, we may choose not to renew
an insured. We may lose business to competitors or to self-insurance mechanisms (often when physicians
join hospital based practice groups) due to pricing or other issues.
New business increased during 2009. We wrote approximately $22 million of new physician
business during the year that was not attributable to acquisitions, as compared to $12 million in 2008.
In the third and fourth quarters of 2008, we began renewing physician policies for a two-year
term in a selected jurisdiction. Written premium for the entire two-year policy term is recorded in the
period the policy is renewed, while earned premium is recorded on a pro rata basis over the two-year
policy term. The gross written premiums attributable to two-year policies for 2009 is $23.0 million as
compared to $2.7 million written in 2008. Also, in 2009, in order to more evenly distribute renewals
throughout the year, we offered early renewal to a number of insureds who would otherwise have had a
first quarter 2010 renewal date. As a result of the shift in renewal dates, there will be approximately $9
million less in business eligible to be renewed.
As favorable loss trends have emerged we have lowered our rates where indicated. For our
physician business, our charged rates on 2009 renewals decreased 4% on average, as compared to an
average decrease of 6% for 2008. Our charged rates include the effects of filed rates, surcharges and
discounts. Despite competitive pressures, we remain committed to a rate structure that will allow us to
fulfill our obligations to our insureds, while generating competitive returns for our stockholders.
Our non-physician healthcare providers are primarily dentists and allied health professionals. The
2009 increase in this business is primarily attributable to business contributed by Mid-Continent. Non-
physician “other” premiums are primarily legal professional liability premiums, but also includes other
types of general liability premiums. The acquisitions of Georgia Lawyers and Mid-Continent contributed
additional non-physician premiums of approximately $18 million in 2009.
We separately report tail premiums because we offer extended reporting endorsement or "tail"
policies to insureds that are discontinuing their claims-made coverage with us, but we do not market such
coverages separately. The amount of tail premium written and earned can vary widely from period to
period.
PICA
Gross premiums written contributed by PICA consist primarily of coverages provided to
podiatrists, who are categorized as physician premiums in the above table, and coverages provided to
chiropractors, who are categorized as non-physician health-care providers in the above table. Our 2009
retention rate for the core PICA business is approximately 93%.
57
Premiums Earned
($ in thousands)
2009
2008
Change
Year Ended December 31
Premiums earned:
PRA all other
PICA Acquisition
$ 467,269
72,743
$ 540,012
$ 503,579
–
$ 503,579
$
$
(36,310)
72,743
36,433
(7.2%)
nm
7.2%
Because premiums are generally earned pro rata over the entire policy period, fluctuations in
premiums earned tend to lag those of premiums written. Generally, our policies carry a term of one year,
but as discussed above, beginning in late 2008 we began to renew some policies with a two-year term.
Tail premiums are 100% earned in the period written because the policies insure only incidents that
occurred in prior periods and are not cancellable.
PRA Exclusive of PICA
Exclusive of the effect of tail premiums and acquisitions, the decline in premiums earned for the
year ended December 31, 2009 as compared to 2008 reflects declines in gross premiums written during
2008 and 2009.
PICA
PICA subsidiaries contributed earned premiums of approximately $73 million during 2009;
approximately $41.6 million of which relates to premiums written prior to the date of acquisition (and
thus never reported in our written premiums). At December 31, 2009 approximately $1.7 million of
premium written prior to the acquisition is yet to be earned and will be added to our earned premium on a
pro rata basis, principally during the first quarter of 2010.
Premiums Ceded
($ in thousands)
2009
2008
Change
Year Ended December 31
Premiums ceded:
PRA all other
PICA Acquisition
$ 39,986
2,483
$ 42,469
$
$
44,301
–
44,301
$
$
(4,315)
2,483
(1,832)
(9.7%)
nm
(4.1%)
Reinsurance expense ratio:*
PRA all other
PICA Acquisition
Consolidated
8.6%
3.4%
7.9%
8.8%
–
8.8%
(points)
(0.2)
nm
(0.9)
*Calculated as premiums ceded as a percentage of premiums earned
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.
58
PRA Exclusive of PICA
Premiums ceded in both 2009 and 2008 include amounts related to changes to our estimates of
reinsurance premiums incurred for prior accident years, as follows.
(In thousands)
Premiums ceded, before estimate changes
Estimate changes, prior accident years
Premiums ceded
Premiums Ceded
Year Ended December 31
2009
$ 45,977
(5,991)
$ 39,986
2008
$ 45,509
(1,208)
$ 44,301
Reinsurance Expense Ratio
Year Ended December 31
2009
9.8%
(1.2%)
8.6%
2008
9.0%
(0.2%)
8.8%
The increase in our reinsurance expense ratio for 2009 is due to an increase in premiums ceded,
along with a decrease in premiums earned, which reflects shifts in the mix of our premiums. The increase
in premiums ceded is principally related to legal professional liability premiums, which are generally
more heavily reinsured than our physician premiums. The decline in premiums earned is principally
attributable to physician policies with lower coverage limits for which we retain all of the risk of loss;
consequently, there is no corresponding decrease to premiums ceded.
The amount of reinsurance premiums incurred for prior accident years is largely determined
based on the losses expected to be recovered, subject to certain minimums and maximums specific to the
reinsurance agreement being adjusted. In both 2009 and 2008, we reduced our estimates of prior accident
year gross losses within our reinsured layers of coverage, as well as the related reinsurance recoveries and
premiums ceded. However, the reductions were more pronounced in 2009.
PICA
The PICA subsidiaries cede only a small portion of the risk on the policies they issue.
Accordingly, the reinsurance expense ratio for these entities is minimal.
Net Investment Income, Equity in Earnings (Loss) of Unconsolidated Subsidiaries, Net Realized
Investment Gains (Losses)
Net Investment Income-Consolidated
($ in thousands)
Net investment income
2009
$ 150,945
2008
$ 158,384
Change
$
(7,439)
(4.7%)
Year Ended December 31
Net investment income is primarily derived from the income earned by our fixed maturity
securities and also includes income from our short-term, 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:
Year Ended December 31
(In thousands)
Fixed maturities
Equities
Short-term investments
Other invested assets
Business owned life insurance
Investment expenses
Net investment income
$
2009
150,122
1,036
1,209
2,802
1,563
(5,787)
2008
$ 150,085
1,231
6,891
2,801
1,932
(4,556)
158,384
$
$
150,945
59
Fixed Maturities. The increase in income in 2009 reflects higher average invested balances, the benefit of
which was offset almost entirely by lower yields. The increase in average invested balances is principally
attributable to the PICA acquisition. Yields declined in 2009 as a result of proceeds from maturities and
sales being reinvested at lower rates. Lower returns from TIPS (Treasury Inflation Protected Securities)
also reduced yields in 2009. We expect average yields to continue to decrease in 2010, unless market
rates improve. Average yields for our available-for-sale fixed maturity securities during 2009 and 2008
are as follows:
Average income yield
Average tax equivalent income yield
Year Ended December 31
2009
4.6%
5.3%
2008
4.8%
5.6%
Short-term Investments. The decrease in earnings from short-term investments during 2009 reflects a
decline in market interest rates (an average of 200 basis points for the year) on lower average balances in
2009 as compared to 2008. In the latter portion of 2008, we increased our short-term holdings because of
the instability in the longer term market and to also provide funds needed for the PICA acquisition. As
markets stabilized in 2009, we reduced our short-term holdings.
Equity in Earnings (Loss) of Unconsolidated Subsidiaries-Consolidated
(In thousands)
Equity in earnings (loss) of
Year Ended December 31
2008
Change
2009
unconsolidated subsidiaries
$
1,438 $
(7,997)
$
9,435
Equity in earnings (loss) of unconsolidated subsidiaries is derived from our investment interests
in three private funds accounted for under 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 all three funds is affected by the volatility of equity and credit markets. No
unconsolidated subsidiaries were acquired in the PICA acquisition.
Net Realized Investment Gains (Losses)-Consolidated
The following table provides detailed information regarding our net realized investment gains
(losses).
(In thousands)
Total other-than-temporary impairment losses:
Residential mortgage-backed securities (1)
Corporate bonds(2)
Equities(3)
Other(4)
Portion recognized in Other Comprehensive Income(5):
Residential mortgage-backed securities
Net impairment losses recognized in earnings
Net gains (losses) from sales
Trading portfolio gains (losses)
Fair value adjustments, net
Net realized investment gains (losses)
Year Ended December 31
2009
2008
$
$
(3,393)
(3,749)
(494)
(536)
199
(7,973)
12,066
9,335
(636)
12,792
$
(9,140)
(25,347)
(10,564)
(1,969)
–
(47,020)
1,533
(5,426)
–
$ (50,913)
(1) Includes unrealized impairment losses of approximately $61,000 that were recognized in earnings in the first
quarter of 2009 but reclassified from retained earnings to other comprehensive income on April 1, 2009
(2) Includes $19.5 million related to Lehman for 2008
(3) Includes $9.5 million related to Fannie Mae and Freddie Mac preferred stock for 2008
(4) 2008 includes $1.0 million related to the Reserve Primary Fund
(5) In accordance with GAAP all OTTI losses prior to April 1, 2009 were recognized in earnings
60
Trading portfolio gains are primarily attributable to improved market prices for equity securities
during 2009. Fair value adjustments are attributable to our election of fair value treatment for both the
2019 Note Payable and related interest rate swap, as discussed in Note 10 to the Consolidated Financial
Statements.
Losses and Loss Adjustment Expenses
The determination of calendar year losses involves the actuarial evaluation of incurred losses for
the current accident year and the actuarial re-evaluation of incurred losses for prior accident years,
including an evaluation of the reserve amounts required for losses in excess of policy limits.
Accident year refers to the accounting period in which the insured event becomes a liability of the
insurer. For occurrence policies the insured event becomes a liability when the event takes place; for
claims-made policies, which represent the majority of the Company's business, the insured event
generally becomes a liability when the event is first reported to the insurer. We believe that measuring
losses on an accident year basis is the most indicative measure of the underlying profitability of the
premiums earned in that period since it associates policy premiums earned with the estimate of the losses
incurred related to those policy premiums. All losses associated with the subsidiaries we acquired from
PICA are considered current accident year losses because the insured event became a ProAssurance
liability in 2009.
The following table summarizes calendar year net losses and net loss ratios for the years ended
December 31, 2009 and 2008, respectively, by separating losses between the current accident year and all
prior accident years.
($ in millions)
Current accident year:
PRA all other
PICA Acquisition
Consolidated
Prior accident years:
PRA all other
PICA Acquisition
Consolidated
Calendar year:
PRA all other
PICA Acquisition
Consolidated
$
$
$
$
$
$
Net Losses
Year Ended December 31
2008
2009
Change
Net Loss Ratios*
Year Ended December 31
2008
Change
2009
374.6
63.8
438.4
$ 396.8
–
$ 396.8
$ (22.2)
63.8
$ 41.6
87.7%
90.7%
88.1%
86.4%
–
86.4%
(207.3)
–
(207.3)
$ (185.3)
–
$ (185.3)
$ (22.0)
–
$ (22.0)
(48.5%)
–
(40.3%)
–
(41.7%)
(40.3%)
167.3
63.8
231.1
$ 211.5
–
$ 211.5
$ (44.2)
63.8
$ 19.6
39.2%
90.7%
46.4%
46.1%
–
46.1%
1.3
90.7
1.7
(8.2)
–
(1.4)
(6.9)
90.7
0.3
*Net losses as specified divided by net premiums earned.
PRA Exclusive of PICA
The current accident year loss ratio increased 1.3 points when compared to the prior year,
approximately 60% of this increase is attributable to an increase to our reserve for the death, disability
and retirement (DDR) provision in our claims-made polices. After a number of coverage years, most of
our insureds qualify for this extended coverage when the insured retires or should the insured die or
become disabled during the policy term. Our strong retention rate has resulted in an increase in the
number of insureds expected to become eligible to receive this extended coverage and we have recorded a
corresponding increase to the related reserve.
61
During the years ended December 31, 2009 and 2008, we recognized favorable loss development
of $207.3 million and $185.3 million, on a net basis, related to reserves established in prior years.
The principal components of development are as follows:
Reserve development by accident year, favorable (unfavorable):
(In millions)
2008 & 2007 accident years
2006 & 2005 accident years
2004 & 2003 accident years
Accident years prior to 2003
Net favorable development recognized
Year Ended December 31
2008
2009
$
(1.1)
94.0
73.6
40.8
$ 207.3
$
9.8
110.5
58.2
6.8
$ 185.3
Substantially all of the development recognized during 2009 and 2008 relates to medical
professional liability claims-made reserves. The favorable development for medical professional claims
made policies in both 2009 and 2008 is based upon observation of actual claims data which indicates that
claims severity (i.e., the expected average cost of claims) is trending below our initial expectations. Given
both the long tailed nature of our business and the past volatility of final claim settlement values, we are
generally cautious in giving credence to the trends that lead to the recognition of favorable net loss
development. As we conclude that sufficient credible data with respect to these trends exists we take
appropriate actions. In the case of the claims severity trends , we believe it is appropriate to recognize the
impact of these trends in our actuarial evaluation of prior period loss estimates while also remaining
attentive to the past volatility of claims severity.
In establishing the rates for our insurance products we consider loss and loss trends over a multi-
year period. To the extent that we experience improvements in claims frequency and claims severity these
improvements are considered in our rate making process and reflected in our established rates. We have
reflected decreased estimates of severity in our rate making process as well as in our loss estimates for
several 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 the 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.
PICA
The current accident year loss ratio was adversely affected by an increase to reserves for the DDR
provision associated with PICA claims-made policies and by unfavorable development of losses
associated with certain other liability coverages. When the effect of these two items is excluded PICA
2009 net loss ratio is approximately 80%. In 2010, we plan to discontinue offering the other liability
coverage that generated the 2009 unfavorable development.
62
Underwriting, Acquisition and Insurance Expenses
($ in thousands)
Insurance related:
PRA all other
PICA acquisition(2)
Non-insurance related:
PRA all other
PICA acquisition
Underwriting, Acquisition and Insurance Expenses
Year Ended December 31
2009
2008
Change
$ 99,233
13,656
112,889
1,961
1,687
3,648
$ 116,537
$ 99,182
710
99,892
493
–
493
$ 100,385
$
51
12,946
12,997
1,468
1,687
3,155
$ 16,152
0.1%
nm
13.0%
nm
nm
nm
16.1%
(1) Our expense ratio computations exclude non insurance related expenses.
(2) PICA transaction expenses of $710,000 were paid by ProAssurance during 2008.
Insurance Related Expenses-Exclusive of PICA
Underwriting Expense Ratio (1) (2)
Year Ended December 31
2008
Change
2009
23.2%
19.4%
22.7%
21.6%
0.1%
21.7%
1.6
nm
1.0
Expenses during 2009 reflect a number of cost variations, but changed little on a net basis.
Expenses for commissions, brokerage fees, and underwriting and sales salaries and benefits were higher
in 2009, both because we earned more non-physician premiums which carry higher expenses than
physician premiums and because more of our physician premium was generated by external
(commissioned) agents. Also, guaranty fund recoupments are lower in 2009 than in 2008. Partially
offsetting these higher costs is a $1.5 million reduction in share based compensation costs, due to a
different type of award made in 2009. Costs were also reduced in 2009 by a $1.8 million benefit related to
final settlement of the CHW Judgment (actual costs incurred were less than amounts previously
estimated).
Other Expense Information
Non-insurance related expenses. We operate several insurance agencies and provide benefit management
services on a limited basis through a separate PICA subsidiary. These activities generate commission and
service fee revenues, which are reported as a part of other income. The acquisition of Mid-continent and
PICA increased these expenses in 2009. We have excluded the direct expenses of these activities from
our underwriting expense ratio computations because the activities are not associated with the generation
of premiums revenues.
Guaranty fund assessments. Insurance related expenses in the table above are reduced by net recoupments
from guaranty fund assessments of approximately $533,000 and $1.3 million during 2009 and 2008,
respectively.
Underwriting Expense Ratio-Exclusive of PICA
The 1.6 point increase in our underwriting expense ratio is primarily a result of a 7% decline in
net premiums earned in 2009 as compared to 2008, while expenses remained relatively flat. A non-
recurring expense reduction related to final settlement of the CHW litigation, as discussed above, reduced
our 2009 expenses; excluding this non-recurring item increases the 2009 ratio to 23.6%.
Underwriting Expense Ratio-PICA
PICA 2009 expenses include non-recurring transaction related expenses of approximately $2.5
million recorded during 2009. Excluding this non-recurring item decreases the PICA expense ratio to
15.9%. Almost 60% of PICA 2009 earned premium relates to policies written prior to the acquisition. In
63
accordance with the GAAP guidance for business combinations, we did not recognize any acquisition
expense for these policies. However, in 2010, almost all of our PICA earned premium will relate to
policies written after the acquisition. On average, in 2010 we would expect the PICA expense ratio to
approximate 22%.
Interest Expense
Consolidated
Interest expense decreased in 2009 as compared to 2008 primarily because we reduced
outstanding debt in the latter half of 2008. We converted all our Convertible Debentures in July of 2008
(aggregate principal of $107.6 million) and extinguished approximately $23 million of our 2034 Trust
Preferred Securities/Debentures (TPS/Debentures) in mid-December 2008. Also, rates on our variable
rate debt decreased by approximately 200 basis points in 2009 as compared to 2008. These reductions in
interest expense were partially offset by additional interest expense incurred in the latter half of 2009
related to debt and other liabilities assumed in the PICA acquisition (see Notes 3 and 10).
Interest expense by debt obligation is provided in the following table:
(In thousands)
Debt obligations held prior to PICA acquisition:
Convertible Debentures
Trust Preferred Securities/Debentures due 2034
Surplus Notes due May 2034
Surplus Note due February 2012
Debt assumed in the PICA acquisition:
2033 Surplus Notes
Note Payable due February 2019
Other (including PICA)
Year Ended December 31
2008
2009
Change
$
–
1,160
768
28
$ 2,283
3,463
1,138
–
$
(2,283)
(2,303)
(370)
28
147
900
–
–
147
900
474
$ 3,477
8
$ 6,892
466
(3,415)
$
Taxes
Consolidated
Our effective tax rate for each period is significantly lower than the 35% statutory rate because a
considerable portion of our net investment income is tax-exempt. The effect of tax-exempt income on our
effective tax rate is shown in the table below:
Statutory rate
Tax-exempt income
Other
Effective tax rate
Year Ended December 31
2008
35.0%
(7.0%)
0.4%
28.4%
2009
35.0%
(5.2%)
0.5%
30.3%
Tax exempt income had a less significant effect on our 2009 effective tax rate primarily because
2009 taxable income increased at a greater rate than tax-exempt income. Our 2009 taxable income
reflected impairment losses of $8.0 million, whereas 2008 taxable income reflected impairment losses of
$47.0 million. Also, we recognized more (a $22.0 million increase) favorable loss development in 2009
than in 2008 which also increased 2009 taxable income.
We expect to be able to realize the full benefit of deferred tax assets associated with impairment
losses because capital gains recognized during the statutory carryback period are sufficient to absorb the
impairment losses. A deferred tax asset valuation allowance of approximately $900,000 has been
established related to PICA capital loss carry-forwards.
64
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 $5.1 million primarily because of lower average outstanding
debt during 2008.
Ratios
Our net loss ratio has decreased in 2008 by 19.7 points due to the increased amount of favorable
net loss development as discussed above. Our expense ratio has increased by 1.9 points primarily due to
the decline in premium. Our operating ratio is lower by 20.2 points. Return on equity is 13.3% for 2008 as
compared to 14.2% for 2007.
65
Results of Operations–Year Ended December 31, 2008 Compared to Year Ended December 31,
2007
Selected consolidated financial data for each period is summarized in the table below.
($ 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:
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)
Losses and loss adjustment expenses
Reinsurance recoveries
Net losses and loss adjustment expenses
Underwriting, acquisition and insurance
expenses
Interest expense
Total expenses
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
248,386
236,339
12,047
Income taxes
Net income
Earnings per share:
Basic
Diluted
Net loss ratio
Underwriting expense ratio
Combined ratio
Operating ratio
Return on equity
70,661
68,153
2,508
$ 177,725
$ 168,186
$ 9,539
$
$
5.43
5.22
$
$
5.10
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)
66
Premiums
($ in thousands)
Gross premiums written
2008
$ 471,482
2007
$ 549,074
Change
$ (77,592)
(14.1%)
Year Ended December 31
Premiums earned
Premiums ceded
Net premiums earned
$ 503,579
(44,301)
$ 459,278
$ 585,310
(51,797)
$ 533,513
$ (81,731)
7,496
$ (74,235)
(14.0%)
(14.5%)
(13.9%)
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)
Physician Premiums*
2008
$ 389,492
2007
$ 459,609
Change
$ (70,117)
(15.3%)
Year Ended December 31
*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)
2008
2007
Change
Year Ended December 31
Non-physician Premiums*
Hospital and facility
Other non-physician
$ 31,229 $ 34,237
28,791
$ 58,470 $ 63,028
27,241
$
$
(3,008)
(1,550)
(4,558)
(8.8%)
(5.4%)
(7.2%)
*Exclusive of tail premiums as discussed below
67
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 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)
Premiums earned
2008
$ 503,579
2007
$ 585,310
Change
$ (81,731)
(14.0%)
Year Ended December 31
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)
Premiums ceded
2008
$ 44,301
2007
$ 51,797
Change
$
(7,496)
(14.5%)
Year Ended December 31
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.
68
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.
Net Investment Income, Net Realized Investment Gains (Losses); Equity in Earnings (Loss) of
Unconsolidated Subsidiaries
Net Investment Income
($ in thousands)
Net investment income
2008
$ 158,384
2007
$ 171,308
Change
$ (12,924)
(7.5%)
Year Ended December 31
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
$
2008
$ 150,085
1,231
6,891
2,801
1,932
(4,556)
$ 158,384
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)
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.
69
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.
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
2007
$
1,533
$ 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 $10.9 million
during the fourth quarter.
Losses and Loss Adjustment Expenses
The determination of calendar year losses involves the actuarial evaluation of incurred losses for
the current accident year and the actuarial re-evaluation of incurred losses for prior accident years,
including an evaluation of the reserve amounts required for losses in excess of policy limits.
Accident year refers to the accounting period in which the insured event becomes a liability of the
insurer. For occurrence policies the insured event becomes a liability when the event takes place; for
claims-made policies, which represent the majority of the Company's business, the insured event
generally becomes a liability when the event is first reported to the insurer. We believe that measuring
losses on an accident year basis is the most indicative measure of the underlying profitability of the
premiums earned in that period since it associates policy premiums earned with the estimate of the losses
incurred related to those policy premiums.
70
The following table summarizes calendar year net losses and net loss ratios for the years ended
December 31, 2008 and 2007 by separating losses between the current accident year and all prior accident
years.
($ In millions)
Current accident year
Prior accident years
Calendar year
Net Losses
Year Ended December 31
2007
$ 456.0
(105.0)
$ 351.0
2008
$ 396.8
(185.3)
$ 211.5
Change
$
(59.2)
(80.3)
$ (139.5)
Net Loss Ratios*
Year Ended December 31
2007
85.5%
(19.7%)
65.8%
Change
0.9
(20.6)
(19.7)
2008
86.4%
(40.3%)
46.1%
*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
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
20.0%
Change
1.9
2008
21.9%
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, respectively.
71
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 assessments
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.
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 Notes 10 and 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:
Year Ended December 31
2007
(In thousands)
2008
Change
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 2008 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.
72
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
do not intend to sell and believe we will not be required to sell any of the debt securities held in an
unrealized loss position before its anticipated recovery.
The following table summarizes estimated changes in the fair value of our available-for-sale fixed
maturity securities for specific hypothetical changes in interest rates by asset class for December 31,
2009. There are principally two factors that determine interest rates on a given security: market interest
rates and credit spreads. As different asset classes can be affected in different ways by movements in
those two factors, we have broken out our portfolio by asset class in the following table.
(In millions, except duration)
(200)
December 31, 2009
Interest Rate Shift in Basis Points
Current
(100)
100
Fixed maturities, available for sale:
U.S. Treasury and Agency obligations
Duration
$
230
3.06
$
225
3.22
$
221
3.23
$
216
3.17
$
200
211
3.11
State and municipal bonds
Duration
$ 1,601
4.38
$ 1,528
5.20
$ 1,449
5.29
$ 1,373
5.31
$ 1,301
5.27
Corporate bonds
Duration
Asset-backed securities
Duration
$ 1,152
3.45
$ 1,114
3.69
$ 1,074
3.71
$ 1,035
3.62
$
725
1.65
$
717
1.64
$
699
3.03
$
673
3.91
$
$
999
3.54
645
4.21
Fixed maturities, available for sale total
Duration
$ 3,708
3.44
$ 3,584
3.84
$ 3,443
4.15
$ 3,297
4.30
$ 3,156
4.31
Fixed maturities, available for sale total
Duration
$ 3,137
2.44
$ 3,069
3.19
December 31, 2008
$ 2,962
3.98
$ 2,835
4.18
$ 2,712
4.20
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, 2009 is on a cost basis
which approximates its fair value. This portfolio lacks significant interest rate sensitivity due to its short
duration.
73
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, 2009, 97% of our fixed maturity securities are rated investment grade as
determined by Nationally Recognized Statistical Rating Organizations (NRSROs), such as 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.
We hold $1.45 billion of municipal bonds. These bonds may have enhanced credit ratings as a
result of guarantees by an insurer, but we require the bonds that we purchase to meet our credit criteria on
a stand-alone basis. As of December 31, 2009, on a stand-alone basis, our municipal bonds have a
weighted average rating of AA-.
Equity Price Risk
At December 31, 2009 the fair value of our investment in common stocks was $47.4 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 0.99. 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 9.9% to $52.1 million. Conversely, a 10%
decrease in the S&P 500 Index would imply a decrease of 9.9% in the fair value of these securities to
$42.7 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.
74
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 80. The
Supplementary Financial Information required by Item 302 of Regulation S-K is included in Note 17 to
the Consolidated Financial Statements of ProAssurance and its subsidiaries.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.
Not Applicable.
ITEM 9A. CONTROLS AND PROCEDURES.
Disclosure Controls
Under the supervision and with the participation of management, including the Chief Executive
Officer and Chief Financial Officer, the Company has evaluated the effectiveness of the design and
operation of our disclosure controls and procedures as of the end of the fiscal year ended December 31,
2009. 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, 2009 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, 2009 and that there was no change in the Company's internal controls
during the fiscal quarter then ended that has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting, other than as described below.
Our management excluded PICA’s systems and processes from the scope of our assessment of
internal control over financial reporting as of December 31, 2009 in reliance on the guidance set forth in
Question 3 of a “Frequently Asked questions” interpretive release issued by the staff of the Securities and
Exchange Commission’s Office of the Chief Accountant and the Division of Corporation Finance in June
2004 (and revised on October 6, 2004). We are excluding PICA from that scope because we expect
substantially all of its significant systems and processes to be converted to those of ProAssurance during
2010. At December 31, 2009 PICA represented $396.3 million or 8.5% of total assets, and $88.2 million
or 13.1% of total revenues for the year then ended.
Ernst & Young LLP, an independent registered public accounting firm, has audited the
effectiveness of our internal controls over financial reporting as of December 31, 2009 as stated in their
report which is included elsewhere herein.
ITEM 9B. OTHER INFORMATION.
None
75
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, 2009, 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 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.
As indicated in the accompanying Management’s Report on Internal Control over Financial Reporting,
management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did
not include the internal controls of Podiatry Insurance Company of America, which is included in the 2009
consolidated financial statements of ProAssurance Corporation and subsidiaries and constituted 8.5% and 7.2% of
total and net assets, respectively, as of December 31, 2009, and 13.1% and 2.4% of revenues and net income,
respectively, for the year then ended. Our audit of internal control over financial reporting of ProAssurance
Corporation and subsidiaries also did not include an evaluation of the internal control over financial reporting of
Podiatry Insurance Company of America.
In our opinion, ProAssurance Corporation and subsidiaries maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2009, 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, 2009 and 2008, 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, 2009, of ProAssurance Corporation and subsidiaries and our report dated February 24, 2010
expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Birmingham, Alabama
February 24, 2010
76
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this Item regarding executive officers is included in Part I of the
Form 10K (Pages 27 and 28) in accordance with Instruction 3 of the Instructions to Paragraph (b) of Item
401 of Regulation S-K.
The information required by this Item regarding directors is incorporated by reference pursuant to
General Instruction G (3) of Form 10K from ProAssurance’s definitive proxy statement for the 2010
Annual Meeting of its Stockholders to be filed with the Securities and Exchange Commission pursuant to
Regulation 14A on or before April 8, 2010.
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 2010 Annual
Meeting of its Stockholders to be filed with the Securities and Exchange Commission pursuant to
Regulation 14A on or before April 8, 2010.
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 2010 Annual
Meeting of its Stockholders to be filed with the Securities and Exchange Commission pursuant to
Regulation 14A on or before April 8, 2010.
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 2010 Annual
Meeting of its Stockholders to be filed with the Securities and Exchange Commission pursuant to
Regulation 14A on or before April 8, 2010.
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 2010 Annual
Meeting of its Stockholders to be filed with the Securities and Exchange Commission pursuant to
Regulation 14A on or before April 8, 2010.
77
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 Registered Public Accounting Firm
Consolidated Balance Sheets – December 31, 2009 and 2008
Consolidated Statements of Changes in Capital – years ended December 31,
2009, 2008 and 2007
Consolidated Statements of Income – years ended December 31, 2009, 2008 and
2007
Consolidated Statements of Cash Flow – years ended December 31, 2009, 2008
and 2007
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.
78
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 2010.
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/Jerry D. Brant
Jerry D. Brant
/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/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, 2010
Chief Financial Officer
February 24, 2010
President
February 24, 2010
February 24, 2010
February 24, 2010
February 24, 2010
February 24, 2010
February 24, 2010
February 24, 2010
February 24, 2010
February 24, 2010
February 24, 2010
Director
Director
Director
Director
Director
Director
Director
Director
Director
79
ProAssurance Corporation and Subsidiaries
Consolidated Financial Statements
Years Ended December 31, 2009, 2008 and 2007
Table of Contents
Report of Independent Registered Public Accounting Firm ....................................................................... 81
Audited Consolidated Financial Statements
Consolidated Balance Sheets ...................................................................................................................... 82
Consolidated Statements of Changes in Capital ......................................................................................... 83
Consolidated Statements of Income ............................................................................................................ 84
Consolidated Statements of Cash Flow ...................................................................................................... 85
Notes to Consolidated Financial Statements ............................................................................................... 87
80
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, 2009 and 2008, 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, 2009. 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, 2009
and 2008, and the consolidated results of their operations and their cash flow for each of the three years in
the period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles.
Also, in our opinion, the related financial statement schedules, when considered in relation to the basic
financial statements taken as a whole, present fairly in all material respects the information set forth
therein.
As discussed in Note 1 to the consolidated financial statements, the Company changed its method
of accounting for impairment of debt securities with the adoption of the guidance originally issued in
FASB Staff Position 115-2 and 124-2, Recognition and Presentation of Other-Than-Temporary
Impairments, (codified in FASB ASC Topic 320 Investments – Debt and Equity Securities) effective
April 1, 2009.
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, 2009, 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, 2010 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Birmingham, Alabama
February 24, 2010
81
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
Amortizable intangible assets
Goodwill
Other assets
Total Assets
Liabilities and Stockholders' Equity
Liabilities
Policy liabilities and accruals
December 31
December 31
2009
2008
$ 3,442,995
$ 2,961,568
3,579
43,826
187,059
65,003
48,502
47,258
6,981
11,852
441,996
63,440
44,522
45,583
3,838,222
3,575,942
40,642
116,403
16,778
262,659
11,836
25,493
68,806
44,496
9,973
122,317
89,789
3,459
86,137
17,826
268,356
13,009
19,505
138,034
23,496
–
72,213
62,961
$ 4,647,414
$ 4,280,938
Reserve for losses and loss adjustment expenses
$ 2,422,230
$ 2,379,468
Unearned premiums
Reinsurance premiums payable
Total Policy Liabilities
Other liabilities
Long-term debt, $35,463 and $34,930, at amortized cost, respectively; $14,740 and $0 at
fair value, respectively
Total Liabilities
Stockholders' Equity
Common stock, par value $0.01 per share, 100,000,000 shares authorized, 34,223,346 and
34,109,196 shares issued, respectively
Additional paid-in capital
Accumulated other comprehensive income (loss), net of deferred tax expense (benefit) of
$31,908 and $(19,328) respectively
Retained earnings
Treasury stock, at cost, 1,811,356 shares and 763,316 shares, respectively
Total Stockholders' Equity
244,212
113,994
2,780,436
112,180
50,203
2,942,819
342
526,068
59,254
1,196,428
1,782,092
(77,497)
1,704,595
185,756
127,877
2,693,101
129,322
34,930
2,857,353
341
518,687
(35,898)
970,891
1,454,021
(30,436)
1,423,585
Total Liabilities and Stockholders' Equity
$ 4,647,414
$ 4,280,938
See accompanying notes.
82
ProAssurance Corporation and Subsidiaries
Consolidated Statements of Changes in Capital
(In thousands)
Balance at January 1, 2007
Cumulative effect of accounting change
Purchase of treasury shares
Common shares issued for compensation
Share-based compensation
Net effect of stock options exercised
Comprehensive income:
Other comprehensive income (loss) (see Note 11)
Net income
Total comprehensive income
Balance at December 31, 2007
Purchase of treasury shares
Conversion of convertible debentures
Common shares issued for compensation
Share-based compensation
Net effect of stock options exercised
Comprehensive income:
Other comprehensive income (loss) (see Note 11)
Net income
Total comprehensive income
Balance at December 31, 2008
Cumulative effect of accounting change (see Note 1)
Purchase of treasury shares
Treasury shares issued in acquisition (see Note 3)
Common shares issued for compensation
Share-based compensation
Net effect of stock options exercised
Comprehensive income:
Other comprehensive income (loss) (see Note 11)
Net income
Total comprehensive income
Balance at December 31, 2009
Common
Stock
$ 334
–
–
1
–
1
Additional
Paid-in
Capital
$ 495,848
–
–
3,249
8,326
(1,500)
Accumulated Other
Comprehensive
Income (Loss)
111
$
–
–
–
–
–
Retained
Earnings
$ 622,310
2,670
–
–
–
–
$
–
–
–
336
–
4
1
–
–
–
–
–
341
–
–
–
1
–
–
–
–
–
505,923
–
1,092
3,810
7,763
99
–
–
–
518,687
–
–
177
1,218
6,210
(224)
–
–
–
$ 342
–
–
–
$ 526,068
$
9,791
–
–
9,902
–
–
–
–
–
(45,800)
–
–
(35,898)
(3,511)
–
–
–
–
–
98,663
–
–
59,254
–
168,186
–
793,166
–
–
–
–
–
–
177,725
–
970,891
3,511
–
–
–
–
–
–
222,026
–
$ 1,196,428
$
Treasury
Stock
(56)
–
(54,201)
–
–
–
–
–
–
(54,257)
(87,561)
111,382
–
–
–
–
–
–
(30,436)
–
(52,045)
4,984
–
–
–
–
–
–
(77,497)
Total
$ 1,118,547
2,670
(54,201)
3,250
8,326
(1,499)
177,977
1,255,070
(87,561)
112,478
3,811
7,763
99
131,925
1,423,585
–
(52,045)
5,161
1,219
6,210
(224)
320,689
$ 1,704,595
See accompanying notes.
83
ProAssurance Corporation and Subsidiaries
Consolidated Statements of Income
(In thousands, except per share data)
Revenues
Gross premiums written
Net premiums written
Premiums earned
Premiums ceded
Net premiums earned
Net investment income
Equity in earnings (loss) of unconsolidated subsidiaries
Net realized investment gains (losses):
Other-than-temporary impairment losses (OTTI)
Less: portion of OTTI losses recognized in other
comprehensive income (before taxes)
Net impairment losses recognized in earnings
Other net realized investment gains (losses)
Total 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
Loss on extinguishment of debt
Total expenses
Income before income taxes
Provision for income taxes
Current expense (benefit)
Deferred expense (benefit)
Total income tax expense (benefit)
Net income
Earnings per share:
Basic
Diluted
Weighted average number of common shares outstanding
Basic
Diluted
Year Ended December 31
2008
2009
2007
$ 553,922
$ 471,482
$ 549,074
$ 514,043
$ 429,007
$ 506,397
$ 540,012
(42,469)
497,543
150,945
1,438
$ 503,579
(44,301)
459,278
158,384
(7,997)
$ 585,310
(51,797)
533,513
171,308
1,630
(8,172)
(47,020)
(7,753)
199
(7,973)
20,765
12,792
–
9,965
672,683
265,983
(34,915)
231,068
116,537
3,477
2,839
353,921
–
(47,020)
(3,893)
(50,913)
4,571
3,839
567,162
267,412
(55,913)
211,499
100,385
6,892
–
318,776
–
(7,753)
1,814
(5,939)
–
5,556
706,068
438,527
(87,530)
350,997
106,751
11,981
–
469,729
318,762
248,386
236,339
70,122
26,614
96,736
70,894
(233)
70,661
64,329
3,824
68,153
222,026
$ 177,725
$ 168,186
$
$
6.76
6.70
$
$
5.43
5.22
$
$
5.10
4.78
32,848
33,150
32,750
34,362
32,960
35,823
See accompanying notes.
84
ProAssurance Corporation and Subsidiaries
Consolidated Statements of Cash Flow
(In thousands)
Year Ended December 31
2008
2007
2009
$ 222,026
$
177,725
$
168,186
15,434
4,221
2,839
(1,563)
(12,792)
–
6,210
26,614
(5,988)
(535)
(11,042)
1,088
11,171
2,374
2,758
(126,657)
14,021
(15,153)
(59,617)
75,409
(930,168)
(720)
(33,156)
(292)
(2,542)
808,145
6,362
26,072
2,180
271,043
(124,509)
(1,572)
20,843
(7,000)
(52,045)
–
(24)
(59,069)
37,183
3,459
40,642
$
13,424
3,147
(4,571)
(1,931)
50,913
–
7,763
(233)
2,615
6,511
12,556
21,741
58,755
1,826
13,685
(180,239)
(32,272)
(705)
17,173
167,883
(737,851)
(2,701)
(3,976)
(278)
(25,752)
903,575
956
872
4,238
(212,179)
–
(21,581)
(94,677)
(18,366)
(87,561)
5,807
99
(100,021)
(26,815)
30,274
3,459
12,587
3,500
–
(1,889)
5,939
42,683
8,326
3,824
1,643
(4,837)
14,330
(20,815)
43,652
4,119
(3,952)
(47,441)
(35,745)
22,406
27,592
244,108
(1,407,147)
(948)
–
(551)
(15,806)
1,276,174
270
–
10,443
(37,626)
–
6,858
(168,333)
(15,464)
(54,201)
972
1,956
(66,737)
9,038
21,236
30,274
$
$
Operating Activities
Net income
Adjustments to reconcile income to net cash provided by operating activities
Amortization, net of accretion
Depreciation
Loss (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 (see Note 1)
Share-based compensation
Deferred income taxes
Policy acquisition costs deferred, net of related amortization
Other
Changes in assets and liabilities, excluding effect of business combinations:
Premiums receivable
Receivable from reinsurers on paid losses and loss adjustment expense
Receivable from reinsurers on unpaid losses and loss adjustment expenses
Prepaid reinsurance premiums
Other assets
Reserve for losses and loss adjustment expenses
Unearned premiums
Reinsurance premiums payable
Other liabilities
Net cash provided by operating activities
Investing Activities
Purchases of:
Fixed maturities available for sale
Equity securities available for sale
Equity securities trading (see Note 1)
Other investments
Cash investment in unconsolidated subsidiaries
Proceeds from sale or maturities of:
Fixed maturities available for sale
Equity securities available for sale
Equity securities trading (see Note 1)
Other investments
Net sales or maturities of short-term investments, excluding unsettled redemptions
Cash paid for acquisitions, net of cash received
Other
Net cash provided by (used by) investing activities
Financing Activities
Repayment of long-term debt
Repurchase of common stock
Book overdraft
Other
Net cash provided by (used by) financing activities
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning at period
Cash and cash equivalents at end of period
(continued)
See accompanying notes.
85
ProAssurance Corporation and Subsidiaries
Consolidated Statements of Cash Flow
(In thousands)
Supplemental Disclosure of Cash Flow Information
Net cash paid during the year for income taxes
Cash paid during the year for interest
Significant non-cash transactions
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 10 and 11
Year Ended December 31
2008
2007
2009
$ 89,915
4,277
$
$ 48,479
6,439
$
$ 45,249
$ 10,956
$
$
$
$
–
5,161
3,090
–
–
$
–
$
$
9,427
$ 112,478
$ 34,732
–
$
–
$
–
$
See accompanying notes.
86
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
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 and other professional services. ProAssurance operates in the United States of
America (U.S.) in a single reportable segment.
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 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
Certain items have been reclassified in prior year financial statements to conform to the financial
statement presentation of the current period. Amounts reclassified did not affect net income or equity.
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.
87
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
1. Accounting Policies (continued)
Investments; Investment in Unconsolidated Subsidiaries
Fair Values
Fair value is determined using an exchange traded price, if available, or market information as
provided by an independent pricing service. Fair values for securities not actively traded are estimated
using exchange traded prices for similar assets, when available, or other multiple observable inputs.
Management reviews valuations of securities obtained from the pricing service 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 interests in private investment funds. Management values private placements either using
a single non-binding broker quote or pricing models that utilize market based assumptions that have
limited observable inputs. Management values interests in private investment funds based on the net asset
value of the interest held, as provided by the fund.
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, as described above, 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, as described above, 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 a maturity at purchase 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
88
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
1. Accounting Policies (continued)
influence over the operating and financial policies of an investee are accounted for using the cost method.
Under the cost method, investments are valued at cost, with investment income recognized when
received. The cost basis of the investment is reduced if the investment suffers impairment in value that is
deemed to be other-than-temporary. 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. Under the equity method, the recorded basis of the investment is adjusted each
period for the investor’s pro rata share of the investee’s income or loss.
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, which approximates fair value.
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
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.
If there is intent to sell the security or if it is not more likely than not that the security will be
required to be sold before full recovery of its amortized cost basis, ProAssurance considers a decline in
fair value to be an other-than-temporary impairment. Otherwise, ProAssurance considers the following
factors in determining whether an investment’s decline is other-than-temporary:
For equity securities:
− the length of time for which the fair value of the investment has been less than its
recorded basis;
− the financial condition and near-term prospects of the issuer underlying the investment,
taking into consideration the economic prospects of the issuer's industry and geographical
region, to the extent that information is publicly available;
− the historical and implied volatility of the fair value of the security;
89
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
1. Accounting Policies (continued)
For debt securities, an evaluation is made as to whether the impairment is due to credit loss,
which is defined as the excess of the current amortized cost basis of the security over the present
value of expected future cash flows. Methodologies used to estimate the present value of expected
cash flows to determine if a decline is due to a credit loss are:
− For non-structured fixed maturities (U.S. Treasury securities, obligations of U.S.
Government and government agencies and authorities, obligations of states, municipalities
and political subdivisions, and corporate debt) the estimate of expected cash flows is
determined by projecting a recovery value and a recovery time frame and assessing whether
further principal and interest will be received. ProAssurance considers the following in
projecting recovery values and recover time frames:
− third party research and credit rating reports;
− the current credit standing of the issuer, including credit rating downgrades, whether
before or after the balance sheet date;
− internal assessments and the assessments of external portfolio managers regarding specific
circumstances surrounding an investment, which indicate the investment is more or less
likely to recover its amortized cost than other investments with a similar structure;
− failure of the issuer of the security to make scheduled interest or principal payments;
− For structured securities (primarily asset-backed securities), ProAssurance estimates the
present value of the security’s cash flows using the effective yield of the security at the date
of acquisition (or the most recent implied rate used to accrete the security if the implied rate
has changed as a result of a previous impairment or changes in expected cash flows).
ProAssurance incorporates six month averages of the levels of delinquencies, defaults,
severities, and prepayments in the securitization, for the parameters applied to the assets
underlying the securitization in determining the net present value of the cash flows.
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 equates the carrying
amount of the investment to the present value of the anticipated future cash flows. The recalculated yield is
then used to recognize 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. 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.
The assessment of whether the amortized cost basis of debt securities, particularly asset-backed debt
securities, is expected to be recovered requires management to make assumptions regarding various matters
affecting cash flows to be received in the future. The choice of assumptions is subjective and requires the use
of judgments; actual credit losses experienced in future periods may differ from management’s estimates of
those credit losses.
Investments in private investment funds are also evaluated for impairment. Management considers
the net asset value reported by the fund, the performance of the fund relative to the market, the stated
objectives of the fund, cash flows expected from the fund and the fund’s most recent audit results in
considering whether there has been a decline in the fair value below the recorded value that is other than
temporary.
ProAssurance recognizes other than temporary impairments, including impairments of debt securities
due to credit loss, in earnings as a part of net realized investment gains (losses). In subsequent periods, any
measurement of gain or loss or impairment is based on the revised amortized basis of the security. Declines
in fair value, including impairments of debt securities that are not evaluated as being due to credit loss, not
considered to be other-than-temporary are recognized in other comprehensive income.
90
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
1. Accounting Policies (continued)
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, but also includes land and a building held for sale.
Properties held for sale have a combined carrying value of approximately $4.2 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 $15.9 million and $14.6 million at
December 31, 2009 and 2008, respectively. Real estate depreciation expense for the three years ended
December 31, 2009, 2008 and 2007 is $1.2 million, $1.0 million and $1.1 million, respectively.
Reinsurance
ProAssurance enters into reinsurance agreements whereby other insurance entities agree to assume
a portion of the risk associated with the policies issued by ProAssurance. In return, ProAssurance agrees to
pay a premium to the reinsurer. ProAssurance purchases (cedes) reinsurance to provide for greater
diversification of business and to allow management to control exposure to potential losses arising from
large risks.
Receivable from Reinsurers 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.
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
91
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
1. Accounting Policies (continued)
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
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 indicators such as market capitalization. Management
concluded in 2009, 2008 and 2007 that no adjustment to impair goodwill was necessary. Goodwill
approximated $122.3 million at December 31, 2009 and $72.2 million at December 31, 2008. The 2009
increase of $50.1 million is entirely attributable to acquisitions as described in Note 3.
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.
Amortizable Intangible Assets
Intangible assets with definite lives are amortized over the estimated useful life of the asset.
Intangible assets with an indefinite life are not amortized.
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.
Management establishes the reserve for losses after taking into consideration a variety of factors
including the conclusions reached by internal actuaries, premium rates, claims frequency, historical paid
and incurred loss development trends, the effect of inflation, general economic trends, the legal and
political environment, and the reports received from external actuaries. Internal actuaries perform an in-
depth review of the reserve for losses at least semi-annually using the loss and exposure data of
ProAssurance subsidiaries. Management engages external actuaries to review subsidiary loss and exposure
data and provide reports to Management regarding the adequacy of reserves.
Estimating casualty insurance reserves, and particularly liability reserves, is a complex process.
Claims may be resolved over an extended period of time, often five years or more, and may be subject to
92
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
1. Accounting Policies (continued)
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 2009, 2008 and 2007.
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.
Treasury Stock
Treasury shares are reported at cost, and are reflected on the balance sheets as an unallocated
reduction of total equity.
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,
performance shares and restricted stock units) under GAAP recognition and measurement principles
(modified prospective method). 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. 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, using
the same calculation methodologies, including grant-date fair values, as was used to prepare pro forma
disclosures prior to January 1, 2009.
Subsequent Events
ProAssurance has evaluated subsequent events for disclosure or recognition in its financial
statements through February 24, 2010 which is the date these financial statements were issued.
Accounting Changes Adopted
Consolidation-Accounting and Reporting for Decreases in Ownership of a Subsidiary
Effective for interim and annual reporting periods ending on or after December 15, 2009, the FASB
issued clarification on the scope of the guidance regarding decreases in ownership of consolidated entities.
The guidance also expands disclosure requirements about deconsolidation of a subsidiary or derecognition
of a group of assets. ProAssurance adopted the revised guidance as of the quarter ended December 31,
2009; adoption had no effect on its results of operations or financial position.
93
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
1. Accounting Policies (continued)
Distributions to Shareholders with Components of Stock and Cash
Effective for interim and annual periods ending on or after December 15, 2009, the FASB revised
GAAP guidance that clarifies the proper accounting treatment for distributions to shareholders that include
both stock and cash. ProAssurance adopted the revised guidance as of the quarter ended December 31,
2009; adoption had no effect on its results of operations or financial position.
Fair Value Measurements-Investments in Certain Entities that Calculate Net Asset Value per Share (or its
Equivalent)
Effective for interim and annual periods ending after December 15, 2009, the FASB revised GAAP
guidance to permit a reporting entity to measure the fair value of certain investments on the basis of the net
asset value per share of the investment (or its equivalent). The revised guidance also requires new
disclosures, by major category of investments, regarding investments measured on the basis of net asset
value. ProAssurance adopted the revised guidance as of the quarter ended December 31, 2009; adoption
had no effect on its results of operations or financial position.
Fair Value-Liabilities
In August 2009, the FASB revised GAAP guidance regarding the valuation of liabilities at fair
value; the guidance is effective for the first reporting period that begins after issuance of the guidance. The
updated guidance clarifies that when a quoted price in an active market for an identical liability is not
available, fair value should be determined using quoted prices for identical or similar liabilities traded as
assets or using another valuation technique described in existing GAAP guidance for determining fair
values. Such techniques include present value techniques, and techniques based on the amount that a
reporting entity would pay on the measurement date to transfer or enter into an identical liability.
ProAssurance adopted the revised guidance as of the quarter ended December 31, 2009; adoption had no
effect on the valuation of its liabilities.
FASB Accounting Standards Codification
Effective for interim and annual periods ending after September 15, 2009, the FASB published the
FASB Accounting Standards Codification (the Codification) as the single source of authoritative
nongovernmental GAAP. The Codification is not intended to change current GAAP, but rather to provide
all the authoritative literature related to a particular topic in one place. Upon the effective date, all pre-
existing accounting standard documents were superseded and accounting literature not included in the
Codification became non-authoritative. ProAssurance adopted use of the Codification as of the quarter
ended September 30, 2009; adoption had no effect on its results of operations or financial position.
Subsequent Events
Effective for interim and annual reporting periods ending on or after June 15, 2009, the FASB
revised GAAP guidance to more clearly set forth the period after the balance sheet date during which
management should evaluate events or transactions for potential recognition or disclosure in the financial
statements, the circumstances under which events or transactions after the balance sheet date should be
recognized and the disclosures that should be made regarding such events. ProAssurance adopted the
revised guidance as of the quarter ended June 30, 2009; adoption had no effect on its results of operations
or financial position.
94
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
1. Accounting Policies (continued)
Fair Value
Effective for interim and annual reporting periods ending on or after June 15, 2009, the FASB
revised GAAP guidance regarding the valuation of assets or liabilities when the volume and level of market
transactions for those assets or liabilities has significantly decreased. The revised guidance clarifies factors
to be considered in determining whether there has been a significant decrease in market activity for an asset
in relation to normal activity and provides additional guidance on when the use of multiple (or different)
valuation techniques may be warranted and considerations for determining the weight that should be
applied to the various techniques. The revisions also establish a requirement that conclusions about whether
transactions are orderly be based on the weight of the evidence and require entities to disclose any changes
to valuation techniques (and related inputs) that result from a conclusion that markets are not orderly and
the effect of the change, if practicable. The revised guidance also expanded disclosure requirements
regarding the fair value of financial instruments. ProAssurance adopted the revised guidance as of the
quarter ended June 30, 2009; adoption had no significant effect on its results of operations or financial
position.
Investments—Disclosure Requirements; Other-than-temporary Impairments
Effective for interim and annual reporting periods ending on or after June 15, 2009, the FASB
revised GAAP to require expanded disclosures related to investments in debt and equity securities.
Guidance regarding other-than-temporary impairments was also revised. Previous investment guidance
required that an impairment of a debt security be considered as other-than-temporary unless management
could assert both the intent and the ability to hold the impaired security until recovery of value. The revised
impairment guidance specifies that an impairment be considered as other-than-temporary unless an entity
can assert that it has no intent to sell the security and that it is not more likely than not that the entity will be
required to sell the security before recovery of its anticipated amortized cost basis. The new guidance also
establishes the concept of credit loss. Credit loss is defined as the difference between the present value of
the cash flows expected to be collected from a debt security and the amortized cost basis of the security.
The new guidance states that “in instances in which a determination is made that a credit loss exists but the
entity does not intend to sell the debt security and it is not more likely than not that the entity will be
required to sell the debt security before the anticipated recovery of its remaining amortized cost basis” an
impairment is to be separated into (a) the amount of the total impairment related to the credit loss and (b)
the amount of total impairment related to all other factors. The credit loss component of the impairment is
to be recognized in income of the current period. The non-credit component is to be recognized as a part of
other comprehensive income. Transition provisions require a cumulative effect adjustment to reclassify the
noncredit component of a previously recognized other-than-temporary impairment from retained earnings
to accumulated other comprehensive income “if an entity does not intend to sell and it is not more likely
than not that the entity will be required to sell the security before recovery of its amortized cost basis”.
ProAssurance adopted the revised guidance as of the beginning of the quarter ended June 30, 2009. As of
April 1, 2009, its debt securities included non-credit impairment losses previously recognized in earnings
of approximately $5.4 million. In accordance with the transition provisions of the revised guidance,
ProAssurance reclassified these non-credit losses, net of tax, from retained earnings to accumulated
comprehensive income as of April 1, 2009 (a $3.5 million increase to retained earnings; a $3.5 million
decrease to accumulated other comprehensive income).
95
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
1. Accounting Policies (continued)
Convertible Debentures
Effective January 1, 2009, the FASB revised GAAP guidance regarding the accounting for
Convertible Debentures. The revised guidance 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, 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. The revised guidance is applicable to the
Convertible Debentures which ProAssurance converted in July 2008. ProAssurance adopted the revised
guidance as of its effective date January 1, 2009; adoption had no effect on 2009 operating results because
no convertible debt has been outstanding during 2009. The cumulative effect of adoption, which would be
an increase to additional paid-in capital of $65,000 and an offsetting decrease to retained earnings of the
same amount, has not been recorded because the effect is immaterial and would not change total
stockholders’ equity.
Non-controlling Interests in Subsidiaries
Effective for interim and annual reporting periods beginning on or after December 15, 2008, the
FASB revised GAAP guidance to establish accounting and reporting standards for the noncontrolling
interest in a subsidiary and for the deconsolidation of a subsidiary. ProAssurance adopted the revised
guidance as of its effective date, January 1, 2009. Adoption did not have an effect on its results of
operations or financial position.
Business Combinations
Effective prospectively for business combinations with an acquisition date on or after the beginning
of the first annual reporting period beginning on or after December 15, 2008, the FASB revised GAAP
guidance related to business combinations. The revised guidance retains the previous requirement that the
acquisition method of accounting be used for all business combinations but provides new and additional
guidance 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. ProAssurance adopted the new guidance as
of its effective date, January 1, 2009 and accounted for its acquisitions of Mid-Continent General Agency,
Inc. (Mid-Continent), Georgia Lawyers Insurance Company (Georgia Lawyers) and Podiatry Insurance
Company of America (PICA) during the first and second quarters of 2009 in accordance with the revised
guidance (see Note 3).
Trading Security Cash Flows
Effective for fiscal years beginning after November 15, 2007 the FASB revised GAAP regarding
cash flows from purchases, sales and maturities of trading securities. Under the new guidance, such cash
flows are classified based on the nature and purpose for which the securities were acquired. Under prior
guidance, cash flows from purchases, sales and maturities of trading securities were classified as operating
cash flows. ProAssurance adopted this guidance as of January 1, 2008. Accordingly, ProAssurance’s
statement of cash flows reflects trading security cash flows during 2007 based on the prior guidance,
whereas cash flows during 2008 and 2009 are based on the revised guidance.
96
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
1. Accounting Policies (continued)
Accounting Changes Not Yet Adopted
Fair Value Measurements
Effective for interim and annual reporting periods beginning after December 15, 2009 or December
15, 2010, as specified, the FASB revised GAAP guidance related to fair value measurement to require
additional disclosures and to clarify certain existing disclosure requirements. The guidance is intended to
improve the disclosures and increase transparency in financial reporting. Adoption of this guidance is not
expected to have an effect on our results of operations or financial position.
Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance
Effective for interim and annual reporting periods beginning on or after December 15, 2009 for
outstanding arrangements and effective otherwise for reporting periods beginning on or after June 15, 2009,
the FASB issued guidance related to share-lending arrangements for an entity’s own shares executed in
contemplation of a convertible debt offering or other financing. Adoption of this guidance is not expected
to have an effect on ProAssurance’s results of operations or financial position. Early adoption is not
permitted.
Consolidation of Variable Interest Entities
Effective at the start of a reporting entity’s first fiscal year beginning after November 15, 2009, the
FASB revised guidance which changes how a reporting entity determines whether or not to consolidate its
interest in an entity that is insufficiently capitalized or is not controlled through voting (or similar) rights.
The determination of whether a reporting entity is required to consolidate another entity will now be based
on, among other things, the other entity’s purpose and design and the reporting entity’s ability to direct the
activities of the other entity that most significantly impact the other entity’s economic performance. The
revised guidance also requires the reporting entity to provide additional disclosures about its involvement
with variable interest entities and any significant changes in risk exposure due to that involvement. A
reporting entity will be required to disclose how its involvement with a variable interest entity affects the
reporting entity’s financial statements. Adoption of this guidance is not expected to have a significant effect
on ProAssurance’s results of operations or financial position. Early adoption is not permitted.
Transfers and Servicing-Accounting for Transfers of Financial Assets
Effective at the start of a reporting entity’s first fiscal year beginning after November 15, 2009, the
FASB revised guidance that requires additional disclosure regarding transfers of financial assets, including
securitization transactions, where entities have continuing exposure to risks related to the transferred
financial assets. Adoption of this guidance is not expected to have an effect on ProAssurance’s results of
operations or financial position. Early adoption is not permitted.
Revenue Recognition-Multiple Deliverable Revenue Arrangements
Effective prospectively for revenue arrangements entered into or materially modified in fiscal years
beginning on or after June 15, 2010, the FASB issued guidance addressing the accounting for multiple-
deliverable arrangements. The guidance eliminates the residual method of allocation and requires that
arrangement consideration be allocated at inception using the relative selling price method. The guidance
establishes a selling price hierarchy and also expands required disclosures related to a vendor’s multiple-
deliverable revenue arrangements. Adoption of this guidance is not expected to have an effect on
ProAssurance’s results of operations or financial position.
97
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
2. Fair Value Measurement
Fair value is defined 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. A three level hierarchy has
been established 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 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
(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.
Level 3: the reporting entity's own assumptions about market participant assumptions
based on the best information available in the circumstances (non-observable
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 and liabilities measured at
fair value on a recurring basis as of December 31, 2009, and indicate the fair value hierarchy of the
valuation techniques utilized to determine such value. 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
based on the level of the most significant input to the fair value measurement. ProAssurance's assessment
of the significance of a particular input to the fair value measurement requires judgment, and considers
factors specific to the assets being valued.
98
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
2. Fair Value Measurement (continued)
Assets and liabilities measured at fair value on a recurring basis as of December 31, 2009,
including financial instruments for which ProAssurance has elected fair value accounting, are as follows:
December 31, 2009
Fair Value Measurements Using
Level 2
Level 3
Level 1
(In thousands)
Assets:
Fixed maturities, available for sale
U.S. Treasury and Agency obligations
State and municipal bonds
Corporate bonds
Residential mortgage-backed securities
Commercial mortgage-backed securities
Other asset-backed securities
Equity securities, available for sale
Equity securities, trading
Short-term investments(1)
Investment in unconsolidated subsidiaries
Other investments(2)
Total assets
Liabilities:
2019 Note Payable
Interest rate swap agreement
Total liabilities
$
$
$
$
–
–
–
–
–
–
3,579
43,826
168,060
–
–
215,465
–
–
–
$
$
$
$
220,570
1,439,154
1,049,677
556,863
91,627
50,334
–
–
18,999
–
–
3,427,224
–
–
–
$
$
$
$
Total
Fair Value
$
220,570
1,448,649
1,074,012
556,863
92,567
50,334
3,579
43,826
187,059
48,502
10,932
$ 3,736,893
–
9,495
24,335
–
940
–
–
–
–
48,502
10,932
94,204
14,740
2,937
17,677
$
$
14,740
2,937
17,677
(1) Short-term investments are reported at amortized cost, which approximates fair value.
(2) Other investments also includes $36.3 million of investments accounted for using the cost method that are not included in the
table above.
Level 3 assets in the table consist primarily of auction rate municipal bonds (included in State and
municipal bonds), private placement senior notes (included in Corporate bonds), an asset-backed bond
(included in Other asset-backed securities) and a beneficial interest in asset-backed securities held in a
private investment fund (included in Other investments) and interests in private investment funds accounted
for under the equity method (included in Investment in unconsolidated subsidiaries).
The auction rate municipal bonds are rated A or better. The private placement senior notes are
unconditionally guaranteed by large regional banks rated A+ or better. The asset-backed bond is rated AA
and is collateralized by a timber trust. The fair values of these three types of assets are primarily derived
using pricing models, which may require multiple market input parameters, considered appropriate for the
asset being valued.
The asset-backed securities held in a private investment fund are primarily backed by manufactured
housing, recreational vehicle receivables, and subprime securities. These securities have an average rating
of BBB, and are valued using a broker dealer quote.
The interests in private investment funds accounted for under the equity method are valued using
the net asset value provided by each fund. The following table provides additional information regarding
these investments:
(In thousands)
Private fund primarily invested in high yield asset-backed securities
Private fund primarily invested in long/short equities
Private fund primarily invested in non-public equities, including other
private funds
Fair Value
$
29,930
12,943
5,629
48,502
$
Unfunded
Commitments
None
None
Fund Description
(1)
(2)
$3,500
(3)
99
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
2. Fair Value Measurement (continued)
(1) The fund primarily holds high yield asset-backed debt securities but also holds other investments
expected to offer high yields, including equities and derivatives. Redemptions, unless subject to
restriction, are allowed as of the first business day of each quarter with 90 days prior notice.
Redemption is currently allowed for approximately $9.0 million of the fund, but restricted until
after March 31, 2010 for $18.3 million of the fund, and restricted later than June 30, 2010 for the
remaining $2.6 million of the fund. Redemptions are paid at 75% within 30 days, with the
remainder paid within 90 days of the redemption date.
(2) The fund holds both long and short U.S. and North American equities, and targets absolute returns
using a strategy designed to take advantage of event-driven market opportunities. Redemptions are
allowed with a notice requirement of up to 45 days and are paid within 30 days of the redemption
date, unless the redemption request is for 90% or more of the requestor’s capital balance.
Redemptions at the 90% and above level will be paid at 90% with the remainder paid after the
fund’s annual audit.
(3) The fund is structured to provide capital appreciation through diversified investments in private
equity, including investments in buyout, venture capital, mezzanine, distressed debt and other
private equity-oriented funds. Redemptions are not allowed, except by special permission of the
fund. Fund proceeds are periodically distributed at the discretion of the fund over an anticipated
time frame that spans 3 to 5 years.
The following tables present additional information about assets and liabilities measured at fair
value using Level 3 inputs, including financial instruments for which ProAssurance has elected fair value
accounting, for the year ended December 31, 2009:
(In thousands)
State and
Municipal
Bonds
Corporate
Bonds
Level 3 Fair Value Measurements - Assets
Investment in
Unconsolidated
Subsidiaries
Asset-
backed
Securities
Equity
Securities
Other
Investments
Total
Balance January 1, 2009
$
–
$ 36,472
$
1,327
$
357 $
–
$ 14,576 $
52,732
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, 2009
The amount of total gains (losses) for the year
ended December 31, 2009 included in
earnings attributable to the change in
unrealized gains (losses) relating to assets
still held at December 31, 2009
–
(330)
(200)
10,025
–
9,495
$
(7)
371
(11,337)
5,092
(6,256)
$ 24,335
$
–
149
(21)
–
(515)
940
$
(357)
–
–
–
–
–
$
–
–
–
48,502
–
48,502
(536)
2,516
(434)
–
(5,190)
$ 10,932 $
(900)
2,706
(11,992)
63,619
(11,961)
94,204
$
–
$
(7)
$
–
$
(357) $
–
$
(536) $
(900)
100
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
2. Fair Value Measurement (continued)
(In thousands)
2019 Note Payable
Interest rate
swap
agreement
Total
Level 3 Fair Value Measurements—Liabilities
Balance January 1, 2009
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, 2009
The amount of total (gains) losses for the year
ended December 31, 2009 included in earnings
attributable to the change in unrealized (gains)
losses relating to liabilities still held at
December 31, 2009
$
–
$
–
$
–
2,389
–
12,351
–
–
14,740
(1,753)
–
4,690
–
–
2,937
$
$
636
–
17,041
–
–
17,677
$
$
2,389
$
(1,753)
$
636
Transfers into Level 3 include:
− Corporate bonds having a combined value of $5 million were valued using multiple observable
inputs at December 31, 2008, but such information was not available at December 31, 2009. At
December 31, 2009, the bonds were valued using a single broker dealer quote.
− Municipal bonds totaling $10 million were valued using multiple observable inputs at December
31, 2008. Such inputs were unavailable in 2009 and the bonds were valued using a pricing model at
December 31, 2009.
− The interests in private investment funds accounted for under the equity method are valued at both
December 31, 2009 and 2008 at the net asset value provided by fund management ($48.5 million at
December 31, 2009). These interests were not included in the fair value table at December 31,
2008, but were included at December 31, 2009 after GAAP guidance was issued in 2009 that
specified such valuation constituted valuation at fair value.
We transferred a number of securities from Level 3 to Level 2. There was no active market for the
securities or nearly identical securities during the latter portion of 2008. Market activity increased in 2009,
which provided multiple observable inputs that could be used to value the securities. Securities transferred
are:
− Asset-backed securities valued at $515,000.
− A private placement bond (included in Corporate bonds) valued at $4 million that was a new issue
during 2008.
− Two corporate bonds, having a combined value of $2.2 million.
− FHLB investments of $5.2 million are valued at cost and, as such, have been exluded from the
table at December 31, 2009.
Fair Value Option Elections
ProAssurance elected to account for a liability assumed in the acquisition of PICA at fair value on a
recurring basis, specifically the 2019 Note Payable bearing a floating interest rate discussed further in Note
10. The 2019 Note Payable has a related interest rate swap intended to mitigate the market risk of future
interest rate changes on the 2019 Note Payable. The interest rate swap is carried at fair value with
101
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
2. Fair Value Measurement (continued)
changes in fair value recorded in net realized gains (losses). Electing the fair value option allows
ProAssurance to account for the note payable at fair value, which is more consistent with management’s
view of the underlying economics and reduces the accounting inconsistency that would otherwise result
from carrying the note payable on an amortized cost basis and the interest rate swap at fair value. As of
December 31, 2009, the 2019 Note Payable had a fair value of $14.7 million recorded in Long-term Debt
and an outstanding principal balance of $17.7 million. Since the date of acquisition, the fair value of the
interest rate swap liability decreased by $1.8 million and the fair value of the 2019 Note Payable increased
by $2.4 million; on a net basis, a loss of $636,000 was recognized related to the changes in fair value.
Gains or losses from changes in the fair value of the 2019 Note Payable and related interest rate swap are
included in net realized investments gains (losses) on the ProAssurance income statement.
3. Acquisitions
All entities acquired in 2009 have been accounted for in accordance with GAAP relating to
business combinations and are considered to be a part of ProAssurance’s sole reporting segment, the
professional liability segment. No entities were acquired in 2008 or 2007.
ProAssurance acquired 100% of the outstanding shares of Mid-Continent and Georgia Lawyers
during the first quarter of 2009 as a means of expanding its professional liability business. Assets acquired
and liabilities assumed were recorded based on estimated fair values as of the date of acquisition. The
excess of the purchase price over the fair values of the identifiable net assets acquired was recognized as
goodwill totaling $13.4 million for the two acquisitions. Approximately $12 million of the goodwill is
expected to be tax deductible. The consideration for these acquisitions included 100,533 ProAssurance
common shares, which were reissued from treasury stock. The shares, which had a cost basis of
approximately $5.0 million, were valued at $5.2 million, based on the market value of ProAssurance
common shares on the date of closing. ProAssurance’s preliminary estimate of goodwill relating to the
Mid-Continent acquisition was reduced by $4.6 million during the fourth quarter of 2009 based on a final
determination of the purchase price.
On April 1, 2009 ProAssurance acquired Podiatry Insurance Company of America and
subsidiaries (PICA) through a cash sponsored demutualization as a means of expanding its professional
liability insurance operations. PICA provides professional liability insurance primarily to podiatric
physicians, chiropractors and other healthcare providers throughout the United States. ProAssurance
purchased all of PICA’s outstanding stock created in the demutualization for $120 million in cash and
$15 million in premium credits to eligible policyholders to be paid over a three year period beginning
in 2010. Total purchase consideration transferred had a fair value of $133.8 million on the acquisition
date, April 1, 2009. As summarized in the table below, the purchase consideration was allocated to the
assets acquired and liabilities assumed based on their estimated fair values on the acquisition date.
Goodwill of $36.7 million was recognized equal to the excess of the purchase price over the net fair
value of the identifiable assets acquired and liabilities assumed. None of the goodwill is expected to be
tax deductible. ProAssurance incurred expenses related to the purchase of approximately $2.5 million
during 2009, primarily in the second quarter, and $710,000 during 2008, primarily in the fourth quarter.
These expenses have been included as a part of insurance expenses in the period incurred.
102
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
3. Acquisitions (continued)
The purchase consideration was allocated to assets acquired and liabilities assumed based on
estimated fair values as of April 1, 2009 as follows:
(In thousands)
Fixed maturities, available for sale
Equity securities, available for sale
Equity securities, trading
Short-term investments
Premiums receivable
Reinsurance recoverable
Intangible assets:
Goodwill
Other intangibles
Real estate
Deferred tax assets
Other assets
Reserve for losses and loss adjustment expenses
Unearned premiums
Long-term debt
Other liabilities
Fair value of net assets acquired
$
$
218,766
1,193
15,628
14,114
19,426
3,998
36,673
23,200
20,178
9,746
15,635
(163,616)
(41,851)
(16,803)
(22,487)
133,800
ProAssurance believes that all contractual cash flows related to acquired receivables will be
collected. The fair value of net assets acquired includes fair value adjustments to record real estate
assets at appraised market values. Certain liabilities were also adjusted including long-term debt fair
valued using average spreads for financial instruments with similar credit ratings and maturities and an
interest rate swap valued by determining the present value of the future cash flows. The fair value of
reserves for losses and loss adjustment expenses and related reinsurance recoverables were estimated
based on the present value of the expected underlying net cash flows including a profit margin and a
risk premium and were determined to be materially the same as the recorded cost basis acquired.
Actuarial reviews performed in connection with the finalization of ProAssurance's purchase
accounting for PICA indicated that initial estimates of the acquisition date fair value of PICA’s reserve
for losses were understated. The allocation of the PICA purchase price has been adjusted, in
accordance with GAAP related to business combinations, to reflect the revised estimate. The estimate
of deferred tax assets and current taxes payable associated with loss reserves has also been revised.
Additionally, initial estimates of the fair value of the net deferred tax asset acquired and current tax
liabilities assumed have also been revised as additional analysis has concluded for several matters for
which the initial estimates were considered provisional. The above summary of assets (liabilities)
acquired reflects the revised estimates. The combined effect of the revisions reduced the initial
estimates of the fair value of net assets acquired by $7.6 million and increased goodwill by a like
amount.
Intangible assets acquired include the following:
(In millions)
Trade names
Renewal rights
Non-compete agreements
Internally developed software
State license agreements
April 1, 2009
Estimated Fair
Value
$ 2.0
$ 5.2
$ 0.7
$ 1.7
$ 13.6
Estimated
Useful Life
7 years
15 years
2 years
5 years
Indefinite
103
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
3. Acquisitions (continued)
The following table discloses the amount of PICA revenues and earnings since the acquisition
on April 1, 2009 that are included in ProAssurance consolidated results for the year ended December
31, 2009. The table also includes supplemental pro forma information reflecting the combined results
of ProAssurance and PICA as if the acquisition had occurred at the beginning of the current and prior
year annual reporting periods (on January 1, 2009 and January 1, 2008, respectively), adjusted to
exclude transaction costs and include pro forma amortization of certain intangibles recognized in the
purchase price allocation.
Actual PICA Results Included in
ProAssurance Consolidated Results
2009
88,152
5,396
$
$
Supplemental Pro forma
Combined Results
2009
697,608
227,529
$
$
2008
672,569
185,661
$
$
(In thousands)
Revenue
Earnings
4. Investments
The amortized cost and estimated fair value of available-for-sale fixed maturities and equity
securities are as follows:
(In thousands)
Fixed maturities
U.S. Treasury and Agency obligations
State and municipal bonds
Corporate bonds
Residential mortgage-backed securities
Commercial mortgage-backed securities
Other asset-backed securities
Equity securities
(In thousands)
Fixed maturities
U.S. Treasury and Agency obligations
State and municipal bonds
Corporate bonds
Residential mortgage-backed securities
Commercial mortgage-backed securities
Other asset-backed securities
Equity securities
December 31, 2009
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair
Value
$
7,245
51,977
38,871
22,183
1,074
1,749
123,099
1,028
$ 124,127
$
$
(1,449)
(3,621)
(5,755)
(11,007)
(2,448)
(176)
(24,456)
(21)
(24,477)
$
220,570
1,448,649
1,074,012
556,863
92,567
50,334
3,442,995
3,579
$ 3,446,574
December 31, 2008
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair
Value
$
$
6,992
26,268
6,823
17,932
–
120
58,135
558
58,693
$
$
(2,477)
(19,492)
(40,852)
(10,082)
(22,878)
(5,607)
(101,388)
(1,526)
(102,914)
$
177,168
1,356,206
593,782
584,387
170,859
79,166
2,961,568
6,981
$ 2,968,549
Amortized
Cost
$
214,774
1,400,293
1,040,896
545,687
93,941
48,761
3,344,352
2,572
$ 3,346,924
Amortized
Cost
$
172,653
1,349,430
627,811
576,537
193,737
84,653
3,004,821
7,949
$ 3,012,770
104
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
4. Investments (continued)
The following table provides summarized information with respect to available-for-sale securities
held in an unrealized loss position at December 31, 2009, including the length of time the securities have
been held in a continuous unrealized loss position.
(In thousands)
Fixed maturities, available for sale
U.S. Treasury and Agency obligations
State and municipal bonds
Corporate bonds
Residential mortgage-backed securities
Commercial mortgage-backed securities
Other asset-backed securities
Common and preferred stocks
Total
Fair
Value
Unrealized
Loss
December 31, 2009
Less than 12 months
Fair
Value
Unrealized
Loss
More than 12 months
Fair
Value
Unrealized
Loss
$
55,556
177,643
183,995
64,882
53,155
4,823
540,054
230
$ 540,284
$
$
(1,449) $
(3,621)
(5,755)
(11,007)
(2,448)
(176)
(24,456)
(21)
55,556
152,783
140,344
44,086
24,940
1,903
419,612
121
(24,477) $ 419,733
$
$
(1,449) $
(2,399)
(2,284)
(4,262)
(92)
(12)
(10,498)
(2)
(10,500) $
–
24,860
43,651
20,796
28,215
2,920
120,442
109
120,551
$
$
–
(1,222)
(3,471)
(6,745)
(2,356)
(164)
(13,958)
(19)
(13,977)
Management does not intend to sell and believes ProAssurance will not be required to sell any of the
debt or equity securities held in an unrealized loss position before its anticipated recovery.
As of December 31, 2009, there are 344 debt securities (14% of all debt securities held) in an
unrealized loss position representing 287 issuers. After an evaluation of each debt security, management
concluded that these securities have not suffered an other-than-temporary impairment in value. The single
greatest unrealized loss position is approximately $2.1 million; the second greatest unrealized loss position
is an unrealized loss of approximately $1.3 million. The unrealized losses shown in the table are primarily
attributable to higher market yields relative to the book yields of the securities. Each fixed maturity security
has paid all scheduled contractual payments and was assessed as to whether it would continue to do so.
Asset-backed securities were modeled to determine if they would maintain assumed cash flows using six-
month historical performance data from the collateral (loans) underlying the security, if available, or sector
based assumptions if not. 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.
The following table presents a roll forward of cumulative credit losses recorded in earnings related
to impaired debt securities for which the non-credit portion of the other-than-temporary impairment is
recorded in Other Comprehensive Income.
Balance January 1, 2009
$
–
(In thousands)
Credit losses recognized related to impaired securities held at April 1, 2009 for which a portion of the
impairment is recorded in Other Comprehensive Income (see Note 1 regarding impairments)
Additional credit losses recognized during the period, related to securities for which:
No OTTI has been previously recognized
OTTI has been previously recognized
Reductions due to:
Securities sold during the period (realized)
Securities which will be sold in coming periods
Securities for which it has become more likely than not that the security will be required to be sold prior to
anticipated recovery of amortized cost basis
Accretion recognized during the period related to cash flows that are expected to exceed the amortized cost
basis of the security
Balance December 31, 2009
1,329
610
129
–
–
–
–
$ 2,068
105
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
4. Investments (continued)
Credit losses recognized in 2009 included residential mortgage-backed securities and corporate
bonds. ProAssurance estimates the portion of loss attributable to credit using a discounted cash flow model
that relies on actual collateral performance measures (default rate, voluntary prepayment rate, and loss
severity), if available, or sector based assumptions if not. These assumptions are applied throughout the
remaining term of the security, based upon the underlying transactions’ structure, including payment
priorities and performance triggers.
The recorded cost basis and estimated fair value of available-for-sale securities at December 31,
2009, 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)
Fixed maturities, available for sale
U.S. Treasury and Agency obligations
State and municipal bonds
Corporate bonds
Residential mortgage-backed securities
Commercial mortgage-backed securities
Other asset-backed securities
Common and preferred stocks
Amortized
Cost
Due in one
year or less
Due after
one year
through
five years
Due after
five years
through ten
years
Due after
ten years
Total Fair
Value
$
214,774 $
1,400,293
1,040,896
545,687
93,941
48,761
3,344,352
2,572
3,346,924
$
33,824
56,674
96,810
$
81,252
328,400
627,939
$
5,258
373,235
16,363
$
100,236 $
690,340
332,900
220,570
1,448,649
1,074,012
556,863
92,567
50,334
3,442,995
3,579
$ 3,446,574
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 entity or its affiliates exceeded 10% of stockholders’ equity at December 31, 2009.
At December 31, 2009, ProAssurance has available-for-sale securities with a fair value of $24.7
million on deposit with various state insurance departments to meet regulatory requirements. ProAssurance
also has available-for-sale securities with a fair value of $26.2 million that are pledged as collateral security
for the 2019 Note Payable (see Note 10).
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.
106
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
4. Investments (continued)
Other Investments
ProAssurance has Other Investments comprised of the following:
(In millions)
Equity interests in private investment funds, at cost
Federal Home Loan Bank (FHLB) capital stock, at cost
Other, at cost
High yield asset-backed securities, at fair value (amortized cost of $19.4 and $20.5 at
December 31, 2009 and 2008, respectively)
Other Investments
2009
2008
$
$
29.1
5.2
2.1
10.9
47.3
$
$
29.1
5.1
1.9
9.5
45.6
FHLB capital stock is not marketable, but may be liquidated by terminating membership in the
FHLB. The liquidation process can take up to five years.
The high yield asset-backed securities were originally directly owned by ProAssurance but have
since been transferred to a private investment fund specializing in managing such securities. ProAssurance
retains a direct beneficial interest in the securities. Management evaluated the securities for impairment as
of December 31, 2009 and determined that the present value of expected future cash flows from each
security equaled or exceeded the amortized cost basis of the security.
Net Investment Income
Net investment income by investment category is as follows:
(In thousands)
2009
2008
2007
Fixed maturities
Equities
Short-term investments
Other invested assets
Business owned life insurance
Investment expenses
Net investment income
$ 150,122
1,036
1,209
2,802
1,563
156,732
(5,787)
$ 150,945
$ 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
Net realized investment gains (losses) are comprised of the following:
(In thousands)
2009
2008
2007
Total other-than-temporary impairment losses:
Residential mortgage-backed securities (1)
Corporate bonds(2)
Equities(3)
Other(4)
Other invested assets, asset-backed securities
Portion recognized in Other Comprehensive Income(5):
Residential mortgage-backed securities
Gross realized gains, available-for-sale and short-term securities
Gross realized (losses), available-for-sale and short-term securities
Net realized gains (losses), trading securities
Change in unrealized holding gains (losses), trading securities
Fair value adjustments, net
Net realized investment gains (losses)
$
$
(3,393)
(3,749)
(494)
(536)
–
199
17,217
(5,151)
(956)
10,291
(636)
12,792
$
$
(9,140)
(25,347)
(10,564)
(1,969)
–
–
8,038
(6,505)
(890)
(4,536)
–
$ (50,913)
(2,286)
(185)
–
(1,108)
(4,174)
–
2,944
(1,143)
(284)
297
–
(5,939)
(1) Includes unrealized impairment losses of approximately $61,000 that were recognized in earnings in the first
quarter of 2009 but reclassified from retained earnings to other comprehensive income on April 1, 2009
(2) 2008 includes $19.5 million related to Lehman
(3) 2008 includes $9.5 million related to Fannie Mae and Freddie Mac preferred stock
(4) 2008 includes $1.0 million related to the Reserve Primary Fund
(5) In accordance with GAAP all OTTI losses prior to April 1, 2009 were recognized in earnings
107
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
4. Investments (continued)
Net gains (losses) related to fixed maturities included in the above table are $4.5 million, ($32.0)
million and ($483,000) during 2009, 2008, and 2007, respectively.
Other information regarding sales and purchases of available-for-sale securities:
2007
(In millions)
2008
2009
Proceeds from sales (exclusive of maturities and paydowns):
Adjustable rate, short duration fixed maturity securities
Other available-for-sale securities
Total
Purchases of:
Adjustable rate, short duration fixed maturity securities
Other available-for-sale securities
Total
$
$
$
$
7.0
485.6
492.6
–
930.9
930.9
$
$
$
$
148.1
400.3
548.4
106.7
633.9
740.6
$
$
$
$
691.5
360.6
1,052.1
576.7
831.4
1,408.1
5. Reinsurance
ProAssurance has various excess of loss, quota share, and cession reinsurance agreements.
Historically, the professional liability per claim retention level has varied between 90% and 100% of the
first $1 million and between 0% and 5% 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):
2009 Premiums
2008 Premiums
2007 Premiums
Written
Earned
Written
Earned
Written
Earned
Direct
Assumed
Ceded
Net premiums
$ 553,777
145
(39,879)
$ 514,043
$ 539,922
90
(42,469)
$ 497,543
$ 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
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, 2009, all reinsurance recoverables are considered collectible. Reinsurance
recoverables totaling approximately $24.8 million are collateralized by letters of credit or funds withheld.
At December 31, 2009 no amounts due from individual reinsurers exceed 5% of stockholders’ equity.
There were no significant reinsurance commutations in 2009.
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.
108
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
6. Income Taxes
Deferred income taxes reflect the net tax effects of temporary differences between the amount of
assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.
Significant components of ProAssurance's deferred tax assets and liabilities are as follows:
(In thousands)
2009
2008
Deferred tax assets
Unpaid loss discount
Unearned premium adjustment
CHW and other contingencies (see Note 9)
Loss and credit carryovers
Basis differences–investments
Compensation related
Unrealized losses on investments, net
Other
Total deferred tax assets
Deferred tax liabilities
Deferred acquisition costs
Unrealized gains on investments, net
Other
Total deferred tax liabilities
Net deferred tax assets
$
71,562
19,971
–
360
7,311
12,512
–
3,166
114,882
$ 76,351
14,528
7,868
1,276
18,217
7,725
20,555
2,859
149,379
8,922
34,282
2,872
46,076
68,806
6,827
–
4,518
11,345
$ 138,034
$
A valuation allowance of $920,000 was established in 2009 related to deferred tax assets acquired
in the PICA transaction. No other valuation allowances related to deferred tax assets have been
established.
At December 31, 2009 ProAssurance has available net operating loss (NOL) carryforwards of
$284,000 and Alternative Minimum Tax (AMT) credit carryforwards of $231,000. 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 2006.
A reconciliation of the beginning and ending amounts of unrecognized tax benefits for 2009 is, as
follows:
(In thousands)
Balance at January 1
Additions for tax positions taken during the current year
Interest
Balance at December 31
2009
$ 3,755
3,056
345
$ 7,156
2008
$
–
3,755
–
$ 3,755
The unrecognized tax benefits at December 31, 2009, 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.
109
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
6. Income Taxes (continued)
A reconciliation of “expected” income tax expense (35% of income before income taxes) to
actual income tax expense in the accompanying financial statements follows:
(In thousands)
2008
2009
2007
Computed “expected” tax expense
$ 111,567
$ 86,935
$ 82,719
Tax-exempt income
Other
Total
(16,548)
(17,270)
(15,827)
1,717
996
1,261
$ 96,736
$ 70,661
$ 68,153
No significant interest or penalties were accrued or paid during the year ended December 31,
2009 nor was there any significant liability for such amounts at December 31, 2009.
7. Deferred Policy Acquisition Costs
Policy acquisition costs, most significantly commissions, premium taxes, and underwriting
salaries, that are primarily and directly related to the production of new and renewal premiums are
capitalized as policy acquisition costs and amortized to expense as the related premium revenues are
earned.
Amortization of deferred policy acquisition costs are $49.7 million, $47.3 million, and $52.3
million for years ended December 31, 2009, 2008, and 2007, respectively.
8. Reserve for Losses and Loss Adjustment Expenses
The reserve for losses is established based on estimates of individual claims and actuarially
determined estimates of future losses based on ProAssurance’s past loss experience, available industry
data and projections as to future claims frequency, severity, inflationary trends and settlement patterns.
Estimating reserves, and particularly liability reserves, is a complex process. Claims may be resolved over
an extended period of time, often five years or more, and may be subject to litigation. Estimating losses
for liability claims requires ProAssurance to make and revise judgments and assessments regarding
multiple uncertainties over an extended period of time. As a result, reserve estimates may vary
significantly from the eventual outcome. The assumptions used in establishing ProAssurance’s reserves
are regularly reviewed and updated by management as new data becomes available. Changes to estimates
of previously established reserves are included in earnings in the period in which the estimate is changed.
ProAssurance believes that the methods it uses to establish reserves are reasonable and
appropriate. Each year, ProAssurance uses internal actuaries to review the reserve for losses of each
insurance subsidiary. ProAssurance also engages external actuaries to review ProAssurance claims data
and provide observations regarding cost trends, rate adequacy and ultimate loss costs. 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 external actuary’s certification as to their respective reserves in
accordance with the requirements of the National Association of Insurance Commissioners (NAIC).
110
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
8. Reserve for Losses and Loss Adjustment Expenses (continued)
Activity in the reserve for losses and loss adjustment expenses is summarized as follows:
(In thousands)
Balance, beginning of year
Less reinsurance recoverables
Net balance, beginning of year
Net reserves acquired from acquisitions
Net losses:
Current year
Favorable development of reserves
established in prior years
Total
Paid related to:
Current year
Prior years
Total paid
Net balance, end of year
Plus reinsurance recoverables
Balance, end of year
$
2009
2,379,468
268,356
2,111,112
163,946
2008
2007
$ 2,559,707
327,111
2,232,596
$ 2,607,148
370,763
2,236,385
–
–
438,368
396,750
455,982
(207,300)
231,068
(185,251)
211,499
(104,985)
350,997
(67,900)
(278,655)
(346,555)
(20,635)
(312,348)
(332,983)
(23,492)
(331,294)
(354,786)
2,159,571
262,659
2,422,230
$
2,111,112
268,356
$ 2,379,468
2,232,596
327,111
$ 2,559,707
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 2009 reflects reductions in the Company’s estimates of
claim severity principally for the 2003 through 2007 accident years. 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. Actuarial evaluations of both
internal and industry actual claims data in 2009, 2008 and 2007 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.
9. Commitments and Contingencies
As a result of the acquisition in 2005 of ProAssurance National Capital Insurance Company (PRA
National), formerly known as NCRIC, Inc., ProAssurance assumed the risk of loss for a judgment (the
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). 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 purchase price allocation in 2005, and accrued post trial interest thereafter. In
April 2009, PRA National paid approximately $20.8 million to CHW which represents a full settlement of
the Judgment, except with regard to a pending settlement setoff of less than $250,000.
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
111
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
9. Commitments and Contingencies (continued)
undertaken may be unsuccessful; ProAssurance may be unsuccessful in legal efforts to limit the scope of
coverage available to its insureds, and ProAssurance may become a party to bad faith litigation over the
amount of the judgment above an insured's policy limits. ProAssurance's management is of the opinion,
based on consultation with legal counsel, that the resolution of these actions will not have a material
adverse effect on ProAssurance's financial position. However, the ultimate cost of resolving these legal
actions may differ from the reserves established; the resulting difference could have a material effect on
ProAssurance's results of operations for the period in which any such action is resolved.
ProAssurance is involved in a number of operating leases primarily for office space 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, 2009.
Operating Leases
(In thousands)
2010
2011
2012
2013
Thereafter
Total minimum lease payments
$ 2,862
1,707
1,014
888
2,737
$ 9,208
ProAssurance incurred rent expense of $3.5million, $2.8 million and $2.9 million in the years
ended December 31, 2009, 2008 and 2007, respectively.
10. Long-term Debt
ProAssurance’s outstanding long-term debt consists of the following as of December 31, 2009
and December 31, 2008.
Trust Preferred Securities/ Trust Preferred Subordinated Debentures due 2034, unsecured,
bearing interest at a variable rate of LIBOR plus 3.85%, adjusted quarterly (4.1% at
December 31, 2009). Estimated fair value at December 31, 2009 is $23.0 million*.
(In thousands)
2009
2008
$
22,992
$ 22,992
Surplus Notes due May 2034, unsecured, principal of $12 million, bearing interest at a
variable rate of LIBOR plus 3.85%, adjusted quarterly (4.1% at December 31, 2009).
Estimated fair value at December 31, 2009 is $12.0 million*.
12,000
11,938
Note Payable due February 2019, carried at fair value, principal of $17.7 million. Bearing a
variable rate of LIBOR plus 0.7%, see information below regarding the associated interest
rate swap, secured by available-for-sale securities having a fair value at December 31,
2009 of approximately $26.2 million.
Surplus Note due February 2012, unsecured, principal of $517,000, at December 31, 2009,
bearing interest at the U.S. prime rate, paid and adjusted quarterly (3.3% at December 31,
2009). Estimated fair value at December 31, 2009 is $513,000*.
14,740
471
─
─
$ 50,203
$ 34,930
*Fair values given are based on the present value of expected underlying cash flows of the debt, discounted at rates available at December
31, 2009 for similar debt issued by entities with a similar credit standing to ProAssurance or, if issued by an insurance subsidiary, the
subsidiary issuing the debt.
112
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
10. Long-term Debt (continued)
Trust Preferred Securities/Trust Preferred Subordinated Debentures due 2034 (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 (Trust-1) and a portion of
the outstanding TPS of the other trust (Trust-2), 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.
Trust-1 was liquidated in 2009.
ProAssurance owns all voting securities of Trust-2 and the TPS Debentures are the sole assets of
Trust-2. Trust-2 meets the obligations of its TPS with the interest and principal paid on the TPS
Debentures. ProAssurance is not the primary beneficiary of Trust-2 and, in accordance with GAAP
guidance for the consolidation of variable interest entities, does not consolidate Trust-2. ProAssurance
consolidated Trust-1 prior to its liquidation.
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 has been
allowed since May 2009. Interest is payable quarterly at LIBOR plus 3.85%, set and paid quarterly.
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.
Surplus Notes Due 2034 (the Surplus Notes)
The Surplus Notes are the unsecured obligations of ProAssurance Wisconsin Insurance Company
(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. The
Surplus Notes became redeemable, for cash, in whole or in part, beginning in May 2009.
The Surplus Notes bear interest at LIBOR plus 3.85%; prior to May 2009 the rate on the notes
was fixed at 7.7%. 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 acquired at a discount of $420,000 which was accreted (through interest
expense) from the date the debt was assumed until May 2009, the first redemption date.
Note Payable due February 2019 and related Interest Rate Swap
The Note Payable due February 2019 (the 2019 Note Payable) was assumed in ProAssurance’s
acquisition of PICA and is a secured obligation of PICA. Principal and interest payable are paid monthly
with the principal amortizing over the life of the loan. The entire remaining principal shall be due and
payable on February 1, 2019. PICA is required to maintain collateral security for the loan in an amount at
least equal to the outstanding principal balance. The 2019 Note Payable is not guaranteed by
ProAssurance or any of its subsidiaries other than PICA. In accordance with GAAP guidance regarding
the valuation of liabilities assumed in a business combination, the 2019 Note Payable was recorded at its
fair value on the PICA acquisition date, April 1, 2009. Additionally, ProAssurance elected to account for
the 2019 Note Payable at fair value on a recurring basis and, accordingly, no accretion of the fair value
purchase adjustment is being recorded.
113
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
10. Long-term Debt (continued)
Future maturities of the 2019 Note Payable as of December 31, 2009 are as follows:
2010
$303,100
2011
$ 324,600
2012
$ 344,000
2013
$ 370,900
2014
$397,400
Thereafter
$ 15,999,300
PICA is subject to certain debt covenants related to the 2019 Note Payable. The covenants are of
the nature routinely associated with loans of this type and include the following:
− a requirement that PICA maintain a debt service coverage ratio of 1:1, measured annually. The
ratio is computed as net income (as defined by GAAP) plus depreciation, interest, amortization
and income taxes divided by aggregate principal and interest payments on all of PICA’s debt.
− a requirement that PICA maintain a A.M. Best insurance rating of B++ “Good” or better.
− a restriction on the sale, lease or transfer of a substantial, material portion of PICA’s assets
without the approval of the bank
PICA is currently in compliance with all covenants.
PICA is party to an interest rate swap agreement (the swap) with the 2019 Note Payable issuing
bank, the purpose of which is to reduce the market risk from changes in future interest rates relative to the
2019 Note Payable. The swap fixes the interest rate related to the Note Payable at 6.6%. The swap will
terminate February 1, 2019. The notional amount of the swap corresponds directly to the unamortized
portion of the debt being hedged each month. Under the swap agreement, PICA agrees to exchange, at
monthly intervals, the difference between the fixed-rate and LIBOR variable rate by reference to the
notional principal amount. The fair value of the interest rate swap at December 31, 2009 is $2.9 million
and is classified within Other Liabilities.
Surplus Note due February 2012
In connection with the acquisition of Georgia Lawyers, ProAssurance issued a surplus note (the
2012 Surplus Note) due February 2012. The 2012 Surplus Note is the unsecured obligation of
ProAssurance Casualty Company (PRA Casualty). The 2012 Surplus Note may be repaid, plus any
accrued and unpaid interest, at any time without penalty or fee. The 2012 Surplus Note has been recorded
at fair value on the acquisition date as required by GAAP. The resulting discount to the 2012 Surplus
Note is being accreted over the remaining life of the debt using the effective interest method.
Debt Extinguished
As a part of the PICA acquisition, ProAssurance assumed liability for PICA’s Surplus Notes due
May 2033 (the 2033 Surplus Notes) which had an outstanding principal balance of $7.0 million.
ProAssurance redeemed the 2033 Surplus Notes at par, for cash, on August 24, 2009. Because the 2033
Surplus Notes were valued at fair value on the date of acquisition, but were redeemed at par, a pre-tax
loss of approximately $2.8 million ($1.8 million, net of tax) was incurred in the third quarter of 2009
related to the redemption.
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.
114
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
10. Long-term Debt (continued)
Credit Facility
ProAssurance’s PICA subsidiary has a revolving credit facility with a bank in the amount of $3.0
million. The expiration date of the line of credit is August 1, 2010 and the line bears an interest rate of
LIBOR plus 1.25%. Outstanding balances under the facility must be collateralized by securities of an
equal or greater value. There was no outstanding balance as of December 31, 2009.
Debt Guarantees
ProAssurance has guaranteed that amounts paid to Trust-2 pursuant to its 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, (including obligations to pay related trust costs, fees, expenses,
debt and other obligations for Trust-2 other than with respect to the common and trust preferred securities
of the Trust-2), the Indentures pursuant to which those debentures were issued, and the related trust
agreements provide a full and unconditional guarantee of amounts due on the TPS.
11. Stockholders’ Equity
At December 31, 2009 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, 2009, the Board of Directors has not approved
the issuance of preferred stock.
At December 31, 2009 approximately 1.8 million of ProAssurance’s authorized common shares
are reserved by the Board of Directors of ProAssurance for award or issuance under incentive
compensation plans as described in Note 12. Additionally, approximately 1.2 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 available-for-sale securities for the years ended December
31, 2009, 2008 and 2007 are as follows:
(In thousands)
Net realized investment gains (losses) included in the calculation
of net income
Tax effect (at 35%)
Net realized investment gains (losses) reclassified from other
2009
2008
2007
$
3,704
(1,296)
$
(44,485)
15,570
$ (5,940)
2,079
comprehensive income
$
2,408
$
(28,915)
$ (3,861)
As of April 1, 2009 in conjunction with adoption of new GAAP guidance regarding impairment
of debt securities, ProAssurance reclassified previously recognized non-credit impairment losses, net of
tax, from retained earnings to accumulated comprehensive income (a $3.5 million increase to retained
earnings; a $3.5 million decrease to accumulated other comprehensive income). As of January 1, 2007,
ProAssurance increased retained earnings by $2.7 million for the cumulative effect of adopting the new
GAAP guidance regarding uncertain tax treatments (See Note 1 for the full discussions regarding new
GAAP guidance adopted by ProAssurance).
115
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
11. Stockholders’ Equity (continued)
The Board of Directors of ProAssurance authorized $150 million in April 2007, an additional
$100 million in August 2008 and an additional $100 million in September 2009, for the repurchase of
common shares or the retirement of outstanding debt. As of December 31, 2009, the repurchase
authorization remaining available for use is approximately $115.4 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 $7.0 million, $18.4 million and $15.5 million of the
authorization to redeem debt during the years ended December 31, 2009, 2008 and 2007, respectively (see
Note 10). ProAssurance repurchased approximately 1.1 million, 1.8 million and 1.0 million common
shares, having a total cost of $52.0 million, $87.6 million and $54.2 million during the years ended
December 31, 2009, 2008 and 2007, respectively. ProAssurance reissued 100,533 treasury shares, having
a cost basis of approximately $5.0 million, during the first quarter of 2009 as part of the consideration for
acquisitions in the quarter.
As discussed in Note 10, 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.
12. Stock Options and Share-Based Payments
ProAssurance recognized share-based compensation cost of $6.2 million, $7.8 million and $8.3
million and a related tax benefit of $2.2 million, $2.6 million and $2.8 million during the years ended
December 31, 2009, 2008, and 2007, respectively. Share-based compensation costs are primarily
classified as underwriting, acquisition and insurance expenses.
ProAssurance provided performance-based stock compensation to employees during 2009 under
the ProAssurance Corporation 2008 Equity Incentive Plan, which was adopted in May 2008 and will be
used for all future awards. ProAssurance primarily provided performance-based stock compensation to
employees during 2008 and 2007 under the ProAssurance Corporation 2004 Equity Incentive Plan. 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.
ProAssurance has provided share based compensation to employees through a combination of
restricted stock units, performance share units and stock option awards, as follows (in millions):
Restricted stock units
Performance shares
Stock options
Share-Based Compensation
Expense by Award Type
Year Ended December 31
2008
–
4.7
3.1
$ 7.8
2007
–
2.4
5.9
$ 8.3
2009
$ 0.6
4.4
1.2
$ 6.2
$
$
Unrecognized
Compensation Cost by
Award Type at
December 31, 2009
$ 0.8
4.6
0.6
$ 6.0
All awards are charged to expense as an increase to equity over relevant service period of the
award, which is generally three years for restricted stock units and performance shares and 54 months for
stock option awards.
116
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
12. Stock Options and Share-Based Payments (continued)
Stock Options
The following table provides information regarding ProAssurance option activity:
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
2009
2008
2007
Weighted
Average
Exercise
Price
$ 42.49
–
32.23
53.48
42.66
40.66
Options
1,013,658
–
(34,131)
(18,777)
960,750
803,750
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
957,060
42.62
999,044
42.36
959,049
40.46
ProAssurance’s 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.
At December 31, 2009, unrecognized compensation cost related to non-vested options granted
under ProAssurance's stock compensation plans approximated $618,000. That cost is expected to be
recognized over a weighted average period of 2.1 years.
The fair value of options vested during the years ended December 31, 2009, 2008 and 2007 is
$2.2 million, $11.8 million and $17.0 million, respectively. The aggregate intrinsic value of options
exercised during 2009, 2008 and 2007 is $695,000, $1.4 million and $8.0 million, respectively.
Additional information regarding ProAssurance options as of December 31, 2009:
Weighted Average
Remaining Contractual Term
(In years)
Aggregate Intrinsic
Value
(In millions)
Options outstanding
Options outstanding, vested or expected to vest
Options exercisable
$ 10.9
$ 10.9
$ 10.8
5.7
5.7
5.3
There were no cash proceeds from options exercised during the year ended December 31, 2009 or
2008. Cash proceeds from options exercised during the year ended December 31, 2007 totaled $128,000.
No stock options were granted during 2009. The weighted average fair values of options granted
during 2008 and 2007 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
3.1%
0.23
0.0%
6
4.6%
0.22
0.0%
5
117
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
12. Stock Options and Share-Based Payments (continued)
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.
Restricted Stock Units
On February 26, 2009, ProAssurance granted approximately 29,000 shares of restricted stock
units to certain employees under the ProAssurance 2008 Equity Incentive Plan. The awards 100% vest on
February 26, 2012 based on a service requirement. The fair value of each restricted share was estimated at
$47.70, equal to the market value of a ProAssurance common share on the date of grant. The
unrecognized compensation cost at December 31, 2009 related to Restricted Stock is approximately
$780,000 and is expected to be recognized over a weighted average period of 2.2 years. No restricted
stock was forfeited during 2009.
Performance Shares
The following table provides information regarding ProAssurance's Performance Shares:
100% vesting date
Shares awarded (target)
Grant date fair value
2009
12/31/2011
71,135
$ 47.70
Performance Shares
2008
12/31/2010
73,000
$ 54.28
2007
12/31/2009
58,000
$ 51.48
At December 31, 2009, based on current achievement of the Performance Measures, it is
estimated that approximately 265,000 Performance Shares, having an estimated grant date fair value of
approximately $13.6 million, will ultimately vest. At December 31, 2009 the unrecognized compensation
cost related to Performance Shares is estimated as $4.6 million and is expected to be recognized over a
weighted average period of 1.6 years. Performance Share forfeitures have not been significant.
ProAssurance granted Performance Share awards to employees in 2009 under the ProAssurance
2008 Equity Incentive Plan, as well as in 2008 and 2007 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 based upon requirements for
continued service and achievement of specified performance goals. 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 goals 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.
In February 2009, ProAssurance awarded participants approximately 44,000 shares for
performance shares granted in 2006. The awards were issued at the maximum level (125% of the target)
based on performance levels achieved. Cash was given in lieu of shares sufficient to satisfy required tax
withholdings.
118
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
13. 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)
2009
2008
2007
Basic earnings per share calculation:
Numerator:
Net income
$ 222,026
$ 177,725
$ 168,186
Denominator:
Weighted average number of common shares outstanding
32,848
32,750
32,960
Basic earnings per share
$
6.76
$
5.43
$
5.10
Diluted earnings per share calculation:
Numerator:
Net income
Effect of assumed conversion of contingently convertible
debt instruments
Net income–diluted computation
Denominator:
Weighted average number of common shares outstanding
Assumed exercise of dilutive stock options and issuance of
performance shares
Assumed conversion of contingently convertible debt
Instruments
Diluted weighted average equivalent shares
$ 222,026
$ 177,725
$ 168,186
–
$ 222,026
1,484
$ 179,209
2,967
$ 171,153
32,848
32,750
32,960
302
–
33,150
319
291
1,293
34,362
2,572
35,823
Diluted earnings per share
$
6.70
$
5.22
$
4.78
In accordance with GAAP guidance regarding the computation of 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
exercise of the options, using the treasury stock method, produces an increased number of shares. The
average number of ProAssurance’s outstanding options that were not considered to be dilutive
approximated 423,000 during 2009, 389,000 during 2008, and 211,000 during 2007.
119
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
14. Benefit Plans
ProAssurance currently maintains a defined contribution savings and retirement plan that is
intended to provide retirement income to eligible employees. ProAssurance also maintains a non-
qualified deferred compensation plan which allows participating management employees to defer a
portion of their current salary. PICA maintained similar plans which were assumed by ProAssurance
on the date of acquisition. The PICA savings and retirement plan has since been merged into the
ProAssurance savings and retirement plan, and the PICA non-qualified deferred compensation plan
became inactive as of the acquisition date.
ProAssurance’s contribution to the savings and retirement plans was $4.5 million ($484,000
attributable to PICA), $3.5 million and $3.3 million during the years ended December 31, 2009, 2008
and 2007, respectively. ProAssurance's contribution to the deferred compensation plan was
approximately $340,000 for the year ended December 31, 2009, $288,000 for the year ended
December 31, 2008, and $125,000 during year ended December 31, 2007. ProAssurance's liability
related to the deferred compensation plans consists primarily of employee salary deferrals and
approximated $6.6 million at December 31, 2009 and $3.5 million at December 31, 2008. We
acquired a deferred compensation liability of $3.0 million in the PICA acquisition.
15. 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 and (b) certain
deferred income taxes which are recorded under GAAP but not for statutory purposes.
The NAIC specifies risk-based capital requirements for property and casualty insurance
providers. At December 31, 2009 statutory capital for each of ProAssurance’s insurance subsidiaries
was sufficient to satisfy regulatory requirements. The table includes the statutory earnings of PICA 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
PICA only for the periods following acquisition (April 2009).
(In millions)
Net Earnings
2008
2007
2009
Surplus
2009
2008
$239
$ 191
$171
$1,265
$ 1,084
ProAssurance’s insurance subsidiaries, in aggregate, are permitted to pay dividends of
approximately $204 million during 2010 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.
120
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
16. Variable Interest Entities
ProAssurance holds passive interests in seven limited partnerships/limited liability companies
that are considered to be Variable Interest Entities (VIEs) under GAAP guidance. ProAssurance is not
the primary beneficiary relative to these entities and is not required to consolidate the entities. 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 four 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 $31.1 million
at December 31, 2009 and $31.0 million at December 31, 2008.
ProAssurance's investment in three of the entities represents an ownership interest of between
10% and 30%. 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 $48.5 million and $44.5 million at December 31, 2009 and 2008, 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.
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 ($10.9
million and $9.5 million at December 31, 2009 and 2008, respectively). See Note 4.
As discussed in Note 10, ProAssurance owns all voting securities in a trust (Trust-2)
associated with its TPS/TPS Debentures, but is not the primary beneficiary of Trust-2.
ProAssurance’s equity investment in Trust-2 totals $992,000 and is included in Other Assets.
121
ProAssurance Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2009
17. Quarterly Results of Operations (unaudited)
The following is a summary of unaudited quarterly results of operations for 2009 and 2008:
(In thousands, except per share data)
1st
2nd
3rd
4th
2009
Net premiums earned
Net losses and loss adjustment expenses:
Current year
Prior year
Net income
Basic earnings per share
Diluted earnings per share
$ 103,891
$ 127,744
$ 131,956
$ 133,952
87,617
(18,500)
28,366
0.85
0.84
104,025
(37,000)
53,881
1.64
1.62
112,066
(42,500)
55,201
1.69
1.67
134,659
(109,300)
84,577
2.61
2.58
(In thousands, except per share data)
1st
2nd
3rd
4th
2008
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
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.
122
ProAssurance Corporation and Subsidiaries
Schedule I – Summary of Investments – Other than Investments in Related Parties
December 31, 2009
Type of Investment
Fixed Maturities
Bonds:
(In thousands)
Recorded
Cost
Basis
Fair
Value
Amount
Which is
Presented
in the
Balance Sheet
U.S. Government or government agencies and authorities
States, municipalities and political subdivisions
Public utilities
All other corporate bonds
Certificates of deposit
Mortgage-backed securities
Total Fixed Maturities
$ 214,774
1,189,824
289,412
1,010,414
300
639,628
3,344,352
$ 220,570
1,230,980
299,447
1,042,268
300
649,430
3,442,995
$ 220,570
1,230,980
299,447
1,042,268
300
649,430
3,442,995
Equity Securities, available-for-sale
Common Stocks:
Public utilities
Banks, trusts and insurance companies
Industrial, miscellaneous and all other
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
107
371
2,094
2,572
1,614
8,087
27,340
37,041
120
488
2,971
3,579
1,897
8,831
33,098
43,826
120
488
2,971
3,579
1,897
8,831
33,098
43,826
169,248
187,059
$ 3,740,272
158,728
187,059
$ 3,836,187
160,763
187,059
$ 3,838,222
(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.
123
ProAssurance Corporation and Subsidiaries
Schedule II – Condensed Financial Information of Registrant
Years Ended December 31, 2009, 2008 and 2007
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
December 31
2009
2008
$ 1,558,390
82,501
–
11,751
34,269
17,372
11,780
19,979
13,784
$ 1,749,826
$ 1,265,452
12,101
412
5,629
131,647
17,159
3
33,613
17,475
$ 1,483,491
$
22,239
22,992
45,231
$
36,914
22,992
59,906
Stockholders’ Equity:
Common stock
Other stockholders’ equity, including unrealized gains (losses) on
securities of subsidiaries
Total Stockholders’ Equity
342
341
1,704,253
1,704,595
1,423,244
1,423,585
Total Liabilities and Stockholders’ Equity
$ 1,749,826
$ 1,483,491
124
ProAssurance Corporation and Subsidiaries
Schedule II – Condensed Financial Information of Registrant
Years Ended December 31, 2009, 2008 and 2007
ProAssurance Corporation – Registrant Only
Condensed Statements of Income
(In thousands)
Revenues:
Investment income including net realized investment
gains (losses) of $1,487, ($3,379) and ($405),
respectively
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
Equity in net income of subsidiaries
Year Ended December 31
2008
2009
2007
$ 6,047
$
(34)
$ 8,281
–
389
6,436
4,571
(2,734)
1,803
–
131
8,412
2,235
8,801
11,036
5,815
5,157
10,972
9,204
4,269
13,473
(4,600)
(840)
(3,760)
(9,169)
(3,325)
(5,844)
(5,061)
(2,911)
(2,150)
225,786
183,569
170,336
Net income
$ 222,026
$ 177,725
$ 168,186
125
ProAssurance Corporation and Subsidiaries
Schedule II – Condensed Financial Information of Registrant
Years Ended December 31, 2009, 2008 and 2007
ProAssurance Corporation – Registrant Only
Condensed Statements of Cash Flow
(In thousands)
Year Ended December 31
2008
2007
2009
Cash provided (used) by operating activities
$
(5,755)
$ 11,915
$ (15,698)
Investing activities
Purchases of:
Fixed maturities, available for sale
Equity securities, available for sale
Equity securities trading
Cash investment in unconsolidated subsidiaries
Proceeds from sale or maturities of:
Fixed maturities, available for sale
Equity securities, available for sale
Equity securities trading
Net decrease (increase) in short-term investments
Dividends from subsidiaries
Contribution of capital to subsidiaries
Cash paid for acquisitions, net of cash received
Other
Financing activities
Repurchase of treasury stock
Subsidiary payments for common shares and share-based
compensation awarded to subsidiary employees
Book overdraft
Principle repayment of debt
Other
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period
Significant non-cash transactions:
Extinguishment of debt as a result of Trust Preferred
Securities reacquired by wholly owned subsidiaries–
See Note 3
Equity increase due to conversion of debt–see Notes 10
and 11 of the ProAssurance Consolidated Financial
Statements
Securities transferred at fair value as dividends from
subsidiaries
Common shares issued in acquisition
(1,299)
–
(13,657)
–
34,822
410
9,122
126,011
65,712
(35,000)
(128,582)
(745)
56,794
(28,881)
(354)
(3,338)
(20,000)
78,961
–
1,026
(64,717)
104,800
(450)
–
(3,608)
63,439
(270,449)
(291)
(5,477)
–
411,996
–
–
(45,228)
7,000
(41,202)
–
3,731
60,080
(32,866)
(87,561)
(54,201)
6,770
–
(13,403)
237
(39,262)
11,777
3
$ 11,780
8,023
315
–
192
(79,031)
(3,677)
3,680
3
$
11,175
–
–
1,958
(41,068)
3,314
366
$ 3,680
$
–
$ 23,403
$
$
–
$ 112,478
$
$ 155,818
$ 5,161
$
$
–
–
$
$
–
–
–
–
126
ProAssurance Corporation and Subsidiaries
Schedule II – Condensed Financial Information of Registrant
Years Ended December 31, 2009, 2008 and 2007
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 Parent) consolidated financial statements. At December
31, 2009 and 2008, PRA Parent’s investment in subsidiaries is stated at the initial
consolidation value plus equity in the undistributed earnings of subsidiaries since the date of
acquisition.
2. Acquisitions/Dispositions
On April 1, 2009 ProAssurance acquired Podiatry Insurance Company of America
and subsidiaries (PICA) through a cash sponsored demutualization. ProAssurance purchased
all of PICA’s outstanding stock created in the demutualization for $120 million in cash and
$15 million in premium credits. The acquisition is described in Note 3 to the Consolidated
Financial Statements.
3. Long-term Debt
Outstanding long-term debt, as of December 31, 2009 and December 31, 2008,
consisted of the following:
Trust Preferred Securities/Trust Preferred Subordinated Debentures due 2034, unsecured,
bearing interest at a variable rate of LIBOR plus 3.85%, adjusted quarterly (4.1% at
December 31, 2009) (see below).
$ 22,992
$ 22,992
(In thousands)
2009
2008
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 Parent. Trust Preferred amounts shown in
the above table are shown net of the reacquired Trust Preferred Securities held by PRA
Parent’s subsidiaries. A gain of $4.6 million was recognized on the extinguishment of the
debt.
In 2009, PRA Parent retired $13.4 million of the Trust Preferred Securities held by its
subsidiaries.
See Note 10 of the Notes to the Consolidated Financial Statements included herein
for a detailed description of the terms of the long-term debt.
4. Related Party Transactions
PRA Parent received dividends from its subsidiaries of $221.5 million, $104.8
million and $7.0 million during the years ended December 31, 2009, 2008 and 2007. PRA
Parent contributed capital to its subsidiaries of $35.0 million, $450,000 and $41.2 million
during the years ended December 31, 2009, 2008 and 2007.
5. Income Taxes
Under terms of PRA Parent’s tax sharing agreement with its subsidiaries, income tax
provisions for individual companies are allocated on a separate company basis.
127
ProAssurance Corporation and Subsidiaries
Schedule III – Supplementary Insurance Information
Years Ended December 31, 2009, 2008 and 2007
(In thousands)
2009
2008
2007
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
$
25,493
2,422,230
244,212
497,543
150,945
$
19,505
2,379,468
185,756
459,278
158,384
$
22,120
2,559,707
218,028
533,513
171,308
current year, net of reinsurance
438,368
396,750
455,982
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
(207,300)
(346,555)
(185,251)
(332,983)
(104,985)
(354,786)
49,694
66,843
47,339
53,046
52,358
54,423
514,043
429,007
506,397
Note: all amounts above are derived entirely from consolidated property and casualty entities.
128
ProAssurance Corporation and Subsidiaries
Schedule IV – Reinsurance
Years Ended December 31, 2009, 2008 and 2007
(In thousands)
2009
2008
2007
Property and Liability(1)
Premiums earned
Premiums ceded
Premiums assumed
Net premiums earned
$ 539,922
(42,469)
90
$ 497,543
$ 503,607
(44,301)
(28)
$ 459,278
$ 585,267
(51,797)
43
$ 533,513
Percentage of amount assumed to net
0.02%
(0.01%)
0.01%
(1) All of ProAssurance's premiums are related to property and liability coverages.
129
EXHIBIT INDEX
Exhibit
Number
Description
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)
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 PIC 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 (10) *
10.3(b)
First amendment to 2004 Equity Incentive Plan (11) *
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 (12): *
Edward L. Rand, Jr.
Howard H. Friedman
Jeffrey P. Lisenby
Darryl K. Thomas
Frank B. O'Neil
130
10.5
10.6(a)
10.6(b)
10.7
10.8
10.9
Release and Severance Compensation Agreement effective as of January 1, 2008,
between ProAssurance and Victor T. Adamo (12) *
Employment Agreement between ProAssurance and W. Stancil Starnes dated as of
May 1, 2007 (13) *
Amendment to Employment Agreement with W. Stancil Starnes (May 1, 2007),
effective as of January 1, 2008 (12) *
Consulting Agreement between ProAssurance and William J. Listwan (14) *
Employment Agreement between ProAssurance and Jerry D. Brant dated as of April
2, 2009 *
Form of Indemnification Agreement between ProAssurance and each of the
following named executive officers and directors of ProAssurance (15)*
Victor T. Adamo
Lucian F. Bloodworth
Jerry D. Brant
Robert E. Flowers
Howard H. Friedman
Jeffrey P. Lisenby
William J. Listwan
John J. McMahon
Drayton Nabers
Frank B. O'Neil
Ann F. Putallaz
Edward L. Rand, Jr.
W. Stancil Starnes
Darryl K. Thomas
William H. Woodhams
Wilfred W. Yeargan, Jr.
10.10
10.11
10.12
10.13
10.14
21.1
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 (12) *
Amendment and Restatement of Director Deferred Compensation Plan effective
January 1, 2008 (12) *
ProAssurance Corporation 2008 Equity Incentive Plan (16) *
ProAssurance Corporation 2008 Annual Incentive Compensation Plan (17) *
Subsidiaries of ProAssurance Corporation
131
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, contract or arrangement
required to be filed as an exhibit to this report.
23.1
31.1
31.2
32.1
32.2
*
Footnotes
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
Filed as an Exhibit to ProAssurance’s Registration Statement on Form S-4 (File No. 333-
124156) and incorporated herein by reference pursuant to SEC Rule 12b-32.
Filed as an Exhibit to ProAssurance’s Current Report on Form 8-K for event occurring
November 4, 2005 (File No. 001-16533) and incorporated herein by reference pursuant to
SEC Rule 12b-32.
Filed as an Exhibit to ProAssurance’s Registration Statement on Form S-4 (File No. 333-
131874) and incorporated by reference pursuant to SEC Rule 12b-32.
Filed as an Exhibit to ProAssurance's 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
Filed as an Exhibit to ProAssurance’s Registration Statement on Form S-4 (File No. 333-
49378) and incorporated herein by reference pursuant to Rule 12b-32 of the Securities
and Exchange Commission (SEC).
Filed as an Exhibit to ProAssurance’s Annual Report on Form 10-K for the year ended
December 31, 2001 (File No. 001-16533) and incorporated herein by reference pursuant
to SEC Rule 12b-32.
Filed as an Exhibit to ProAssurance's 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.
Filed as an Exhibit to MAIC Holding’s Registration Statement on Form S-4 (File No. 33-
91508) and incorporated herein by reference pursuant to SEC Rule 12b-32.
Filed as an Exhibit to MAIC Holding’s Proxy Statement for the 1996 Annual Meeting
(File No. 0-19439) is incorporated herein by reference pursuant to SEC Rule 12b-32.
Filed as an Exhibit to ProAssurance’s Definitive Proxy Statement (File No. 001-165333)
on April 16, 2004 and incorporated herein by reference pursuant to SEC Rule 12b-32.
Filed as an Exhibit to ProAssurance's 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.
132
(12)
(13)
(14)
(15)
(16)
(17)
Filed as an Exhibit to ProAssurance's Annual Report on Form 10-K for the year ended
December 31, 2007 (File No. 001-16533) and incorporated herein by this reference
pursuant to SEC Rule 12b-32.
Filed as an Exhibit to ProAssurance’s Current Report on Form 8-K for the event
occurring May 13, 2007 (File No. 001-16533) and incorporated herein by reference
pursuant to SEC Rule 12b-32.
Filed as an Exhibit to ProAssurance's Current Report on Form 8-K for event occurring on
September 13, 2006 (File No. 001-16533) and incorporated herein by reference pursuant
to SEC Rule 12b-32.
Filed as an Exhibit to ProAssurance's Annual Report on Form 10-K for the year ended
December 31, 2002 (File No. 001-16533) and incorporated herein by this reference
pursuant to SEC Rule 12b-32.
Filed as an Exhibit to ProAssurance’s Registration Statement on Form S-8 (File No. 333-
156645) and incorporated by reference pursuant to SEC Rule 12b-32.
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.
133
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, 2010
/s/ W. Stancil Starnes
W. Stancil Starnes
Chief Executive Officer
134
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, 2010
/s/ Edward L. Rand, Jr.
Edward L. Rand, Jr.
Chief Financial Officer
135
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, 2009 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, 2010
/s/ W. Stancil Starnes
W. Stancil Starnes
Chief Executive Officer
136
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, 2009 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, 2010
/s/ Edward L. Rand, Jr.
Edward L. Rand, Jr.
Chief Financial Officer
137
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 net realized gains
or losses, guaranty fund assessments or recoupments and debt retirement gains or losses, and we believe it
presents a useful 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 gains or losses,
guaranty fund assessments or recoupments and debt retirement gains or losses incurred during the years
presented below. The following table reconciles Income from Continuing Operations to Operating Income:
Reconciliation of Income from Continuing Operations to Operating Income:
(in thousands, except per share amounts)
2009
Year Ended December 31,
2007
2006
2008
2005
Income from Continuing Operations
$
222,026
$
177,725
$
168,186
$
126,984
$
80,026
Items excluded in the calculation
of operating income:
(Gain) loss on the extinguishment of debt
Net realized investment (gains) losses
Guaranty Fund (recoupments) assessments
Pre-tax effect of exclusions
Tax effect at 35%
Operating Income
Per diluted common share:
Income from Continuing Operations
Effect of exclusions
Operating Income per diluted common share
$
$
$
$
$
$
$
$
$
2,839
$
(4,571)
$
–
$
–
$
–
(12,792)
$
50,913
$
5,939
$
1,199
$
(912)
(533)
$
(1,334)
$
553
$
2,609
$
226
(10,486)
$
45,008
$
6,492
$
3,808
$
(686)
3,670
$
(15,753)
$
(2,272)
$
(1,333)
$
240
215,210
$
206,980
$
172,406
$
129,459
$
79,580
6.70
$
5.22
$
4.78
$
3.72
$
2.52
(0.21)
$
0.85
$
0.12
$
0.07
$
(0.01)
6.49
$
6.07
$
4.90
$
3.79
$
2.51
This page is not a part of ProAssurance’s Annual Report on Form 10K, and was not filed with the
Securities & Exchange Commission.
138
Our filings with the Securities and Exchange Commission (SEC)
are available in the Investor Relations section of our website
(www.ProAssurance.com/investorrelations/sec_ filings.aspx).
Our SEC filings are also available in the EDGAR section of the
SEC’s website (www.sec.gov/edgar.shtml).
W. Stancil Starnes, our Chief Executive Officer, submitted the
required Section 12(a) CEO Certification to the New York Stock
Exchange in a timely manner on May 20, 2009. Additionally,
we have been timely in the filing of CEO/CFO certifications as
required in Section 302 of the Sarbanes-Oxley Act. These certi-
fications are published as exhibits in our Form 10-K filed with
the SEC on February 25, 2010.
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 mate-
rials. 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 of the contact methods below:
By E-mail:
Investor@ProAssurance.com
By U. S. Postal Service:
ProAssurance Corporation
Investor Relations & Communications
P.O. Box 590009
Birmingham, AL 35259-0009
By Phone or Fax:
Phone: (205) 877-4400 • (800) 282-6242
Fax: (205) 802-4799
Annual Meeting
The 2010 Annual Meeting is scheduled for 10:00 AM CDT on
Wednesday, May 19, 2010 at the headquarters of ProAssurance
Corporation, 100 Brookwood Place, Birmingham, Alabama 35209.
I N V E S T O R I N F O R M AT I O N
There were 32,504,784 shares of ProAssurance Corporation
common stock outstanding at March 15, 2010. On that date,
we had 3,721 shareholders of record. Our common stock
trades on The New York Stock Exchange under the symbol PRA.
Our stock is listed as ProAsr in the stock section of USA Today
and many major newspapers, and as ProAssurance in the
Wall Street Journal. We also post the price of our stock on our
website, www.ProAssurance.com.
Your Shares
If you hold your shares through a brokerage account, your broker
or a customer service representative at that firm should be
able to answer questions about your holdings.
If you hold your shares in certificate form, or have shares held
in direct registration (DRS), you may contact our transfer agent,
BNY Mellon Shareowner Services, for address changes, transfer
of certificates, and replacement of share certificates that have
been lost or stolen.
You may reach BNY Mellon Shareowner Services in a variety
of ways:
By Phone
(800) 851-9677
(201) 680-6578
(Hearing Impaired)
(800) 231-5469
(201) 680-6610
By Internet
www.bnymellon.com/Shareowner/isd/
Internet information about your account
www.bnymellon.com
General information about BNY Mellon
By Mail
BNY Mellon Shareowner Services, LLC
P.O. Box 358015
Pittsburgh, PA 15252-8015
BNY Mellon Shareowner Services, LLC
480 Washington Boulevard
Jersey City, NJ 07310-1900
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 depart-
ment at (800) 282-6242.
Corporate Governance and Compliance with Regulatory and
New York Stock Exchange Requirements
We invite you to visit the Investor Relations and Corporate
Governance sections of our website, www.ProAssurance.com,
where you will find important information about our Company,
including our Corporate Governance Principles and Code of
Ethics and Conduct, which were developed and adopted by
our Board of Directors. The Governance section of our website
(www.ProAssurance.com/investorrelations/governance.aspx)
also provides copies of the Board-adopted charters for our
Audit, Compensation, and Nominating/Corporate Governance
Committees, along with information such as stock ownership
guidelines, committee composition and leadership, and director
independence, including categorical standards to assist in
determining independence.
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100 Brookwood Place
Birmingham, Alabama 35209
(205) 877-4400
(800) 282-6242
www.ProAssurance.com