ProCentury Corporation 10-K
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549
Form 10-K
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þ
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the fiscal year ended
December 31, 2007
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or
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o
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
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For the transition period
from to
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Commission File Number 0-6612
ProCentury
Corporation
(Exact name of registrant as
specified in its charter)
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Ohio
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31-1718622
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(State or other jurisdiction
of
incorporation or organization)
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(I.R.S. Employer
Identification No.)
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465 Cleveland Ave. Westerville, Ohio
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43082
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(Address of principal executive
offices)
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(Zip Code)
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Registrants telephone number, including area code
(614) 895-2000
Securities registered pursuant to Section 12(b) of the
Act:
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Title of Each Class
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Name of Each Exchange on Which Registered
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Common Shares, without par value
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NASDAQ
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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 o No þ
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Act. Yes o No þ
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 þ No o
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 registrants 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. o
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):
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Large accelerated
filer o
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Accelerated
filer þ
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Non-accelerated
filer o
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Smaller reporting
company o
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(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
Act). Yes o No þ
The aggregate market value of the voting stock held by
non-affiliates of the Registrant as of June 30, 2007, based
upon the closing sale price of the Common Shares on
June 30, 2007 as reported on the NASDAQ National Market,
was $223,894,611.
The number of shares outstanding of the Registrants Common
Shares, without par value, on March 17, 2008 was 13,421,032
DOCUMENTS
INCORPORATED BY REFERENCE
None.
PART I
General
ProCentury Corporation, or ProCentury, is a property and
casualty insurance holding company that writes specialty
insurance products for small and mid-sized businesses through
Century Surety Company, or Century, and ProCentury Insurance
Company, or PIC, our operating insurance subsidiaries.
References to Company, we,
us, and our refer to ProCentury and its
subsidiaries, unless the context requires otherwise. Century and
PIC are both rated A− by the A.M. Best
Company or A.M. Best. We primarily write general liability,
commercial property, commercial multi-peril, commercial auto and
marine insurance in the excess and surplus lines market through
a select group of general agents. The excess and surplus lines
market provides an alternative market for customers with
hard-to-place risks that insurance companies licensed by the
state in which the insurance policy is sold, also referred to as
standard insurers or admitted insurers, typically do not cover.
Our strategy is to generate an underwriting profit by being
selective in the classes of business and the coverages we write
and by providing superior service to our agents. Our goal is to
be selective in the classes of business and the coverages we
write within the excess and surplus lines market. We seek to
combine profitable underwriting, investment returns and
efficient capital management to deliver consistent long-term
growth in shareholder value.
As a specialty company, we offer insurance products designed to
meet specific insurance needs of targeted insured markets. These
targeted insured markets are often not served or are underserved
by standard companies and, as a specialty insurer, we seek to
compete more on the basis of service and availability of
coverage than price. We focus on serving the insurance needs of
small and mid-sized businesses, including apartment buildings,
hospitality businesses, garages, non-franchised auto dealers,
condominium associations, retail and wholesale stores, artisan
contractors, marinas, daycare facilities, fitness centers and
special event providers. The insurance needs of these targeted
insured markets are serviced by retail insurance brokers who
maintain relationships with the general agents with whom we do
business. We develop specialty insurance products through our
own experience or knowledge or through proposals brought to us
by agents with special expertise in specific classes of
business. We underwrite all of our applicants for insurance
coverages on an individual basis. For each class we insure, we
employ a number of customized endorsements, rating tools and
decreased limits to align our product offerings with the risk
profile of the class and the specific insured being underwritten.
We are either approved as an excess and surplus lines insurer or
authorized as an admitted insurer by the state insurance
regulators in 49 states plus the District of Columbia. In
the excess and surplus lines market, we serve businesses that
are unable to obtain coverage from standard lines carriers for a
variety of reasons, including the following:
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the non-standard nature of the insured is outside
the risk profile of most standard lines carriers;
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the risk associated with an insured is higher than the risk
anticipated by a standard lines carrier when it filed its rates
and forms for regulatory approval, which prevents it from
charging a premium that is appropriate for the heightened risk;
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many geographic regions are considered to be adverse markets in
which to operate due to legal, regulatory or claims issues or
because they are too remote to warrant a marketing effort and,
as a result, agents in theses areas have a limited choice of
admitted insurers; and
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small agent organizations do not generate enough premium volume
to qualify for direct relationships with standard lines carriers.
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We generally target shorter tail classes of casualty
business focusing on owner landlord and tenants classes of
business. Tail is the term used to describe the
period of time from the occurrence giving rise to a claim to the
time that the actual cost of the occurrence to the insurance
carrier is known. We believe these shorter tail owner landloard
and tenants classes of business present less rating and
reserving risk to us compared to longer tail casualty lines,
such as manufacturing and contractors casualty lines. Although
we tend to focus on writing shorter tail classes of business,
there are benefits to writing some longer tail casualty lines,
such as in the manufacturing and
3
contractors classes of business. We currently write longer tail
casualty lines in selective classes and geographic regions when
opportunities would appear to support our core strategy of
profitable underwriting.
Consistent with our general approach to casualty lines, we
believe that the inherent short tail of the property business
presents less pricing and reserving risk compared to longer tail
classes of business. These classes include apartment buildings,
commercial buildings and low value dwellings. We also write
commercial multi-peril policies that provide our insureds with
commercial property and general liability coverages bundled
together as a package. The targeted classes, limits and pricing
on these policies are the same as the policies we write
separately.
We offer garage liability, professional liability, commercial
excess and umbrella policies to supplement our commercial
multi-peril and commercial general liability writings.
Commercial umbrella insurance policies provide excess liability
coverage above the limits of standard liability policies and may
also provide coverage for risks not covered under standard
liability policies. Our customers typically include small
business, retail stores and non-residential service contractors.
In addition, we have developed customized products and coverages
for other small commercial insureds such as daycare facilities,
fitness centers and special event providers.
We also have a program unit that focuses on the development of
specialty programs as well as alternative risk transfer
programs, which require the insured to fund all or part of the
insurance risk with cash or a letter of credit. Our specialty
programs focus on specific risks for a targeted group of
insureds, such as oil and gas contractors, pet sitters and
assisted care facilities.
In June 2006, we created a unit to write ocean marine business,
which targets small and medium sized ocean cargo, marine
liability, and hull exposures. We focus more on shorter tail
marine exposures and typically do not write high hazard marine
manufacturing and contracting exposures. We typically exclude
workers compensation coverages from our protection and
indemnity coverage for the ocean marine business. Our marine
products are distributed through our existing agents and brokers
as well as specialized ocean marine brokers. In addition, in
April 2007, we began marketing a product that serves the
environmental contractors and consultant market as well as a
product that offers mono-line contractors pollution
liability for non-environmental contracting risks.
In addition, in August 2007, we began to underwrite surety
business. We seek construction accounts with an underwriting
focus on financial condition and work experience. We also write
non-contract surety bonds such as license-permit, public
official, court, probate and other miscellaneous surety products.
Our principal executive offices are located at 465 Cleveland
Ave., Westerville, Ohio 43082, and the telephone number at that
address is
(614) 895-2000.
We file annual, quarterly, and current reports and proxy
statements with the Securities and Exchange Commission, or SEC.
These filings are available to the public over the Internet on
the SECs Web site at
http://www.sec.gov
and on our Web site at
http://www.procentury.com
as soon as reasonably practicable after we file such information
with the SEC.
Pursuant to
Rule 12b-23
under the Securities and Exchange Act of 1934, as amended, the
industry segment information included in Item 8,
note 13 of Notes to Consolidated Financial Statements, is
incorporated by reference in partial response to this
Item 1.
On February 20, 2008, pursuant to unanimous approval of our
board of directors, we entered into an Agreement and Plan of
Merger (the Merger Agreement) with Meadowbrook
Insurance Group, Inc. (Meadowbrook) and MBKPC Corp.,
a wholly-owned subsidiary of Meadowbrook (Merger
Sub), whereby we will be merged with and into Merger Sub
(the Merger). At the effective time of the Merger,
our shareholders will be entitled to receive, for each common
share, either $20.00 in cash or Meadowbrook common stock having
a value of $20.00, subject to adjustment as described below.
Each of our shareholders will have the option to elect to
receive cash or Meadowbrook stock, subject to proration so that
the maximum total cash consideration will not exceed 45% of the
total consideration paid in order to preserve the tax-free
exchange of the stock consideration.
If the
30-day
volume-weighted average price of the Meadowbrook common stock
preceding the election date, which will be at least five days
before the closing of the transaction, is between $8.00 and
$10.50, the exchange ratio will result in stock consideration
having a value of $20.00 per ProCenturys common share
based on such
30-day
volume-weighted average price. Above or below this range for
Meadowbrooks stock price, the exchange ratio will be fixed
as if the
30-day
volume-weighted average price preceding the election date
equaled $10.50 or $8.00, as
4
applicable. Outstanding options to purchase our common shares
will become fully vested and option holders can either exercise
such options and, in connection with the closing, elect to
receive the form of merger consideration described above for the
ProCentury shares acquired on exercise or agree to have their
options cancelled in exchange for a per share cash payment equal
to the difference between $20.00 and the exercise price of their
options.
The Merger is subject to customary closing conditions, including
the approval of Meadowbrook and our shareholders, regulatory
approvals, the absence of any law or order prohibiting the
closing, the effectiveness of the
Form S-4
registration statement relating to the Meadowbrook common stock
to be issued in the Merger, the accuracy of the representations
and warranties of the other party (subject to the standards set
forth in the Merger Agreement), compliance of the other party
with its covenants in all material respects and the delivery of
opinions relating to the U.S. federal income tax code
treatment of the Merger. If the merger is not consummated as a
result of certain events, we will be required to pay a
termination fee of $9.5 million to Meadowbrook.
Company
History
Century Surety Company, or Century, our primary insurance
subsidiary, was formed in 1978 as a specialty insurance carrier
for inland marine, surety and fidelity coverages for the surface
mining industry. In 1984, Century expanded its original focus
and initiated a business strategy centered on hard to place
property and casualty risks. In 1992, Century acquired
Continental Heritage Insurance Company, which wrote bail bond
business. In 1993, Century acquired Evergreen National Indemnity
Company, which wrote landfill and specialty surety business. In
1996, Century was acquired by Century Business Services, Inc.
ProCentury was formed as an Ohio corporation in July 2000 by
certain of our shareholders and members of management. In
October 2000, pursuant to a management-led buyout, ProCentury
acquired Century and its subsidiaries, including Evergreen and
Continental, from Century Business Services, Inc. Following this
transaction, the strategic direction of ProCentury focused
primarily on the excess and surplus lines and involved exiting
certain unprofitable businesses, such as commercial automobile
beginning in May 2000 and workers compensation in January
2002.
On April 26, 2004, we issued 8,000,000 common shares at
$10.50 per share in an initial public offering, or the IPO, and
received proceeds (before expenses) of $77.9 million.
Immediately prior to the IPO, Evergreen and Continental were
spun-off to ProCenturys then-existing Class A
shareholders. The operations of Evergreen and Continental
consisted of ProCenturys historical surety and assumed
excess workers compensation lines of insurance, which were
re-classified (net of minority interest and income taxes) as
discontinued operations in the accompanying financial
information for the years ended December 31, 2004 and 2003.
On June 1, 2005, Century acquired 100% of the outstanding
shares of the Firemans Fund Insurance Company of
Texas for $5.9 million. Firemans Fund of Texas was a
Texas domiciled property and casualty company licensed in Texas,
Oklahoma and California. The acquisition was part of our
long-term plan to develop business that requires admitted
status, as well as our continued focus on growing our excess and
surplus lines business. On August 16, 2005, Firemans
Fund of Texas was renamed ProCentury Insurance Company. Since
the acquisition, PIC has obtained 25 additional admitted
licenses. PIC is also approved as an excess and surplus lines
insurer in Ohio.
Industry
Overview
The excess and surplus lines insurance market differs
significantly from the standard market. In the standard market,
insurance products and coverages are largely uniform with broad
coverage grants due to highly regulated rates and forms.
Standard market companies tend to compete for customers
primarily on the basis of rate, retain close relationships with
retail insurance agents and make accommodations to the insureds
to maintain the marketability of their product for their
contracted direct agent.
In contrast, the excess and surplus lines market provides
coverage for risks that either do not fit the underwriting
criteria of standard carriers with which the retail agent has a
direct relationship, or they are of a class or risk that the
standard market generally avoids since the regulated nature of
that market does not allow for customized terms or rates.
Non-standard risks can be underwritten profitably, however, by
the excess and surplus market, by using highly specific coverage
forms with terms based on individual risk assessment, rather
than the risk
5
profile of the most desirable members of the class. When a
certain risk has been excluded from the standard market, the
retail agents need quick placement with the excess and surplus
lines market in order to maintain coverage for the insured. As a
result, the primary basis for competition within the excess and
surplus lines industry can be focused more on service and
availability than rate.
The insurance industry has historically been cyclical. During
the past five years, many admitted insurers returned to more
risk-based underwriting disciplines in the standard market,
resulting in higher premium rates, less flexible terms and, in
some cases, an unavailability of adequate insurance coverage in
the standard market in some classes. We, along with other excess
and surplus lines insurers, benefited from this increase in
rates and volume. During 2006, however, the excess and surplus
lines industry began to experience softer market conditions
primarily attributed to intensified competition from admitted
and surplus lines insurers, resulting in volume and rate
decreases. This increased competition continued in 2007 and is
expected to continue in 2008. We will continue to monitor our
rates and control our costs in an effort to maximize profits
during softening market conditions.
Lines of
Business
The following table sets forth an analysis of gross and net
written premiums by segment and major product groupings during
the periods indicated:
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Years Ended December 31,
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2007
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2006
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2005
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(In thousands)
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Gross written premiums:
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Property and casualty
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$
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233,238
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277,733
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212,127
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Other (including exited lines)
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5,108
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5,303
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4,037
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Total gross written premiums
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238,346
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283,036
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216,164
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Ceded written premiums
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34,542
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35,117
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26,645
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Net written premiums
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$
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203,804
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247,919
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189,519
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Property
and Casualty
Casualty Business. For the year ended
December 31, 2007, 65.2% of our total property and casualty
gross written premiums were generated by our casualty business.
The majority of our casualty business is related to typically
shorter tail owner landlords and tenants (OL&T)
classes of business. The manufacturing and contracting
(M&C) classes of business tend to be longer
tail due to their products and completed operations exposure. We
believe that, with some exception, OL&T classes of business
present lower reserving risk compared to M&C classes. We
continue to write M&C classes of business with particular
attention to our experience and the current direction of loss
trends, and discipline in policy construction, underwriting,
pricing and reserving. For the year ended December 31,
2007, 70.5% of our casualty gross written premiums were shorter
tail classes. With respect to the M&C classes of business
we continue to write, we focus on controlling the reserving and
pricing risk through the use of policy forms, including claims
made and reported forms, disciplined pricing and reserving, and
in the case of manufacturing risks, emphasizing consumable
products with low risk of mass tort claims.
Our primary casualty insurance policies provide coverage limits
generally ranging from $25,000 to $1.0 million per
occurrence, with the majority of our policies having limits
between $500,000 and $1.0 million. We retain the first
$500,000 of an individual casualty loss as well as 50% of the
loss amount that exceeds $500,000 but is less than
$1.0 million and reinsure the remainder of the loss. Our
general liability policies usually provide coverage for defense
and related expenses in addition to per occurrence and aggregate
policy limits. For certain products, defense expenses are
included in the policy limits. In the event that one or more of
our reinsurers become incapable of reimbursing us for a loss,
our liabilities will increase.
Other Casualty Business. We offer garage
liability, professional liability, commercial excess and
umbrella policies to supplement our commercial multi-peril and
commercial general liability writings. On garage and
professional liability, we write up to a maximum of
$1.0 million per occurrence or accident. Commercial excess
policies provide excess liability coverage above the limits of
standard liability policies and may also provide
6
coverage for risks not covered under standard liability
policies. Our limited umbrella form policy may also provide
coverage for risks not covered under standard liability policies
after the insured satisfies a self-insured retention. We write
commercial umbrella and excess insurance for limits up to a
total aggregate of $5.0 million above the minimum
underlying limits of $1.0 million per occurrence and
$2.0 million in the aggregate. Although most of our
umbrella and excess business is written to support our primary
policies, we will accept other carriers as the primary insurers,
provided they are rated A-V or better by
A.M. Best.
In June 2006, we created a unit to write ocean marine business.
Within the marine unit, we target small and medium sized ocean
cargo, marine liability, and hull exposures. As is consistent
with our property and casualty strategy, we tend to focus on
shorter tail exposures and typically do not write high hazard
marine manufacturing and contracting exposures. We typically
exclude workers compensation coverages from our Protection
and Indemnity coverage. Distribution of marine products is
through our existing agents and brokers as well as specialized
ocean marine brokers. In addition, in April 2007, we started
marketing a product that serves the environmental contractors
and consultant market as well as a product that offers mono-line
contractors pollution liability for non-environmental
contracting risks.
The program unit we formed in 2003 to focus on the development
of specialty programs and alternative risk transfer programs has
since grown to over fifteen individual programs with an average
annual premium production in 2007 of $1.8 million per
program. Our program unit writes specialty programs and
alternative risk transfer programs, which require the insured to
fund all or part of the insurance risk with cash or a letter of
credit. Examples of specialty programs we write in this unit are
oil and gas contractors, pet sitters and assisted care
facilities. We expect the program unit will become a more
significant factor in our growth strategy.
Our program unit seeks to write the better risks in a class with
strict information gathering, loss control and underwriting
guidelines and rules. We typically require more underwriting
information on each account than is required in our usual
surplus lines business in order to help us determine which
individual risks in the group that we will write. In combination
with our increased class and individual risk underwriting
guidelines, this business is expected to produce more profitable
results versus business written on the same class but with less
intensive underwriting and submission requirements.
The fully or partially funded alternative risk business we write
in our program unit is generally for insureds with risks for
which traditional insurance is not cost effective for the first
$1.0 to $5.0 million of coverage. In these situations, the
insured pays us a premium that is calculated to include the
limit of insurance that is exposed. Additionally, the insured
pays us a fee to cover overhead and profit, which is included in
Other income on the Consolidated Statements of
Operations.
In addition, in 2005, we began to establish segregated cell
captives arrangements in which our agents can use their own
funds to establish a cell. This allows agents to assume part of
the risk and the related results of the business that they write
by acting as a quota share reinsurer of Century. The segregated
cell captive arrangements are designed to produce more
profitable long-term results by aligning the agents
interests with the profitability of the business that they write.
Property Business. For the year ended
December 31, 2007, 34.8% of our total property and casualty
gross written premiums comprised property business. Consistent
with our focus on shorter tail casualty lines, we believe that
the inherent short tail property business presents less rating
and reserving risk.
Our commercial property lines generally provide coverage limits
of up to $30.0 million, but the majority of our written
premiums in 2007 were written at limits of less than
$2.0 million. Through the use of treaty, automatic
facultative and certificate facultative reinsurance, we retain
the first $500,000 of each individual loss for the current
accident year.
Package Business. We write commercial
multi-peril policies that provide our insureds with commercial
property and general liability coverages bundled together as a
package. The targeted classes, limits and pricing on these
policies are the same as if written separately.
7
Other (Including Exited Lines) We write a
limited amount of landfill and specialty surety bond business on
a direct and assumed basis. Our exited lines include commercial
automobile/trucking that was exited in May 2000 and
workers compensation that was exited in January 2002.
In addition, in August 2007, we began to underwrite surety
business. We seek construction accounts with an underwriting
focus on financial condition and work experience. We also write
non-contract surety bonds such as license-permit, public
official, court, probate and other miscellaneous surety.
Geographic
Distribution
The following table sets forth the geographic distribution of
our gross written premiums for the periods indicated:
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Years Ended December 31,
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2007
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2006
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2005
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(In thousands)
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Midwest
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$
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32,615
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13.7
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%
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$
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44,171
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15.6
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%
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$
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36,826
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17.0
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%
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Southeast
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78,349
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32.9
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84,310
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29.8
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56,348
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26.1
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Southwest
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42,775
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17.9
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47,071
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16.6
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34,650
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16.0
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West
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64,405
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27.0
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87,935
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31.1
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76,196
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35.2
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Northeast
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14,803
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6.2
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14,973
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5.3
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8,933
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4.1
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Assumed Reinsurance
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5,399
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2.3
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4,576
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1.6
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3,211
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1.6
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Total
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$
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238,346
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100.0
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%
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$
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283,036
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100.0
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%
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$
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216,164
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We attempt to minimize catastrophic risk by diversifying in
different geographical regions. Our primary catastrophic risk is
structural property exposures as a result of fire following an
earthquake, hurricanes, tornados, hail storms, winter storms and
freezing. We maintain property catastrophe coverage by
evaluating the probable maximum loss using a catastrophe
exposure model developed by independent experts. Historically,
we have not written wind coverage on fixed properties in Florida
or within two counties of the Gulf of Mexico and the eastern
seaboard states; however, we continue to evaluate this market
for profitable opportunities.
Underwriting
and Pricing
We underwrite our commercial property and casualty business on a
binding authority and brokerage basis.
Binding Authority. Binding authority business
represents risks that may be quoted and bound with a policy
subsequently issued on our behalf by our general agents. This
business is produced in accordance with specific and detailed
rules set forth in our Electronic Underwriting Manual that is
provided to our general agents. In addition to our Electronic
Underwriting Manual, in April of 2006, we released Century
Online, a web based rating and quoting tool. This tool gives
agents the ability to rate, quote and bind a policy using the
same rates that are in our Electronic Underwriting Manual. We
monitor the classes of business subject to agents limited
binding authority, considering market conditions, competition,
underwriting results and other factors and we frequently change
these guidelines by amending our Electronic Underwriting Manual
and Century Online products.
Our Electronic Underwriting Manual requires that some
prospective insureds must be submitted to our underwriters for
specific approval prior to the agent quoting or binding the
risk. The most frequent reason for this specific approval
requirement is the size of the risk involved. For a majority of
our agents, any prospective property risk with a total insured
value over $1.0 million is automatically required to be
submitted for approval prior to binding. However, a limited
number of agents have authority up to $2.5 million.
Similarly, any prospective casualty risk with a premium of
$35,000 or greater is required to be submitted for approval
prior to binding.
The economics of the binding business are generally different
than those of the brokerage business. The binding business is
characterized by small, independently owned, single location
businesses that have been denied coverage by the standard
market. Due to their size, retail agents find it difficult for a
standard carrier to accept the account on an exception basis,
often nearly running out of time to provide the insured with
coverage before the current policy expires. For this reason, it
is important to provide limited binding authority, for the less
difficult
8
classes of business, in order to take full advantage in terms of
rate and form that also allows fast and reliable service that
the insured demands. Further, because the binding business is
less likely than the brokerage business to be
shopped at renewal, it is more persistent from year
to year and, accordingly, somewhat resistant to a softening
market. Commissions on binding contracts are generally higher
than commissions on brokerage policies.
Binding authority business accounted for 63.6% of our total core
property and casualty gross written premiums for the year ended
December 31, 2007. Our Electronic Underwriting Manual and
Century Online outline our risk eligibility, pricing,
underwriting guidelines and policy issuance instructions. We
monitor the underwriting quality of our business by
re-underwriting each piece of business produced by our general
agents in accordance with their underwriting authority. Our
Electronic Underwriting Manual and Century Online provide
numerous benefits, including the ability to easily and
efficiently update our underwriting policies through web based
updates, instead of asking agents to replace specific pages in a
paper manual. Additionally, our Electronic Underwriting Manual
and Century Online allows our agents to enter class codes or
descriptions and to automatically receive the appropriate forms
so that submissions to Century generally are complete and
properly submitted. Our Century Agency Automation Team is
comprised of the information technology professionals at some of
our larger agents who meet with us regularly to enhance our
performance in the critical area of agency relations and
efficiency. In addition, investments in our data warehouse gives
us improved analytical capabilities in the areas of agency and
program growth and class profitability.
Brokerage Business. Brokerage business
represents risks that exceed the limits of underwriting
authority that we are willing to grant to our general agents.
Many of our brokerage accounts are classes of insurance that are
not permitted to be written at all by our general agents
pursuant to their binding authority. However, most of our
brokerage business is produced on risks that produce individual
total insured value or premium above levels we believe prudent
to allow for agency binding and issuance authority. Generally,
any property risk with a total insured value over
$1.5 million is automatically classified as a brokerage
account. For casualty business, the threshold is $35,000 in
premium. If there is a package policy where either the property
or casualty portion is indicated as a brokerage account, the
entire account is classified as brokerage business. Commissions
on brokerage policies are generally five percentage points lower
than on binding contracts. Brokerage business accounted for
36.4% of our total core property and casualty gross written
premiums for the year ended December 31, 2007.
Pricing. In the commercial property and
casualty market, the rates and terms of coverage provided by
property and casualty insurance carriers are frequently based on
benchmarks and forms promulgated by the Insurance Services
Office, also known as ISO. ISO makes available to its members
advisory rating, statistical and actuarial services, policy
language and other related services. ISO currently provides
these services to more than 1,500 property and casualty
insurance companies in the United States. One of the services
that ISO provides is an actuarial-based estimate of the expected
loss cost for risks in each of approximately 1,000 risk
classifications. These benchmark loss costs reflect an analysis
of the loss and allocated loss expenses on claims reported to
ISO. ISO statistics, however, include only claims and policy
information reported to ISO, and therefore do not reflect all of
the loss experience for each class.
We primarily use ISO loss costs as the foundation for
establishing our rates for all casualty lines of business. We
then develop loss cost multipliers, which are
designed to support our operating expenses, acquisition expenses
and targeted return on equity. We multiply our loss cost
multipliers by ISO loss costs to produce our final rates. On our
property business, we employ a proprietary class rating matrix
that employs a series of ISO commercial fire rating
schedule-based charges determined by construction, occupancy,
protection and geographical concerns. We also employ minimum
premiums based on the limit and coverage provided that can only
increase the effective rate. Our final rates are regionalized to
incorporate variables such as historic loss experience, the
types and lines of business written, competition and state
regulatory considerations. Any rates that are not ISO based
require approval from our actuarial department. For business
that we write on an admitted, or licensed basis, we must obtain
advance regulatory approval of rates in a number of states. For
our non-program business, all agency underwritten business is
re-underwritten by our binding unit to check for mistakes or
other results that may be inconsistent with the rates set forth
in our Electronic Underwriting Manual and Century Online. Our
program business is either re-underwritten or audited and
monitored by the program manager on a regular basis.
9
Marketing
and Distribution
As of December 31, 2007, we marketed our insurance products
through 149 agents, including 118 agents with binding authority.
These agents maintain 246 offices in 41 states. This
wholesale general agency force makes our products available to
licensed retail agencies throughout the United States. We
believe that our distribution network enables us to efficiently
access, at a relatively low fixed cost, the numerous small
markets our product offerings target. These general agents and
their retail insurance agents and brokers have local market
knowledge and expertise that enable us to more effectively
access these markets. We generally confine our general agents
marketing territory to three or fewer states.
Our surety products are marketed through direct retail agency
appointments. As of December 31, 2007, we had forty agents
who were contracted for surety only.
We strive to preserve each general agents franchise value
with us in that general agents marketing territory. We
seek to increase our written premiums with these general agents
and to develop long-term, profitable relationships by providing
a high level of service and support. For example, we try to
respond to our general agents requests for quotes on their
proposals within 48 hours. We believe that the performance
of the business that we ultimately write is measurably improved
when produced by general agents who have increased familiarity
and experience with our underwriting requirements.
Claims
Management and Administration
Our claims management objectives are to:
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control loss and expenses through prompt investigation, accurate
coverage determination, early evaluation, close supervision of
outside service providers and early resolution of all reported
claims;
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provide a high level of service and support to general agents
and insureds throughout the claims process; and
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provide information and intelligence to our underwriters and
actuaries about changes in individual risk exposures and trends
in claims and the law that affect our overall risk exposure.
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Our claims staff handles almost all claims under our policies.
Outside service providers, like independent adjusters, third
party administrators and law firms, are utilized to provide
specific claims related services under the direction of our
claims staff. With rare exception, our general agents have no
authority to settle claims or otherwise exercise control over
the claims process. Our claims managers and staff oversee and
provide appropriate controls on all claims. Claims adjusters
have reserving authority based upon their skill levels and
experience. We have a regular, formal claims review process. All
changes in loss and loss expense reserves on all claims valued
greater than $25,000 are reviewed on a weekly basis by senior
claims and underwriting management and, often, the President of
Century.
Loss and
Loss Expense Reserves
We are liable for covered losses and incurred loss expenses
under the terms of the insurance policies that we write. In many
cases, several years may elapse between the occurrence of an
insured loss, the reporting of the loss to us and our settlement
of that loss. We reflect our liability for the ultimate payment
of all incurred losses and loss expenses by establishing loss
and loss expense reserves as balance sheet liabilities for both
reported and unreported claims. We do not use discounting
(recognition of the time value of money) in reporting our
estimated reserves for losses and loss expenses.
Loss and loss expense reserves represent our best estimate of
ultimate amounts for losses and related expenses from claims
that have been reported but not paid, and those losses that have
occurred but have not yet been reported to us. Loss reserves do
not represent an exact calculation of liability, but instead
represent our estimates, generally utilizing individual claim
estimates and actuarial analysis and estimation techniques at a
given accounting date. The loss reserve estimates are
expectations of what ultimate settlement and administration of
claims will cost upon final resolution. These estimates are
based on facts and circumstances then known to us, a review of
historical settlement patterns, estimates of trends in claims
frequency and severity, projections of loss costs, expected
interpretations of legal theories of liability, and many other
factors. In establishing reserves, we also take into account
estimated
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recoveries, reinsurance, salvage and subrogation. The reserves
are reviewed regularly by our internal actuarial staff and
annually reviewed by an outside independent actuarial firm
primarily for the purpose of obtaining an opinion on our
reserves for our statutory financial statements and for
regulatory purposes.
Our actuarial department included two credentialed actuaries as
of year end 2007. Each of these actuaries is a Fellow of the
Casualty Actuarial Society and Member of the American Academy of
Actuaries. The duties of the Actuarial Unit include:
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performing an actuarial analysis of loss and loss expense
reserves on a quarterly basis;
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assisting our Underwriting Department in evaluating pricing
adequacy;
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assisting our Loss Reserve Committee, which includes our Senior
Vice President and Chief Actuary, President and Chief Executive
Officer of ProCentury, Senior Vice President of Operations,
Senior Underwriting Officer, Chief Financial Officer and
Treasurer, and President of Century, in establishing
managements best estimate of loss and loss expense
reserves; and
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working with our independent external actuary in the year-end
loss and loss expense reserves statement of actuarial opinion
process.
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Our actuaries engage in discussions with senior management,
underwriting, and the claims department on a regular basis to
gain information regarding any substantial changes in operations
or other assumptions that are necessary to consider in the
reserving analysis.
The process of estimating loss reserves involves a high degree
of judgment and is subject to a number of variables. These
variables can be affected by both internal and external events,
such as changes in claims handling procedures, claim personnel,
economic inflation, legal trends, and legislative changes, among
others. The impact of many of these items on ultimate costs for
loss and loss expense is difficult to estimate. Loss reserve
estimations also differ significantly by coverage due to
differences in claim complexity, the volume of claims, the
policy limits written, the terms and conditions of the
underlying policies, the potential severity of individual
claims, the determination of occurrence date for a claim, and
reporting lags (the time between the occurrence of the
policyholder events and when it is actually reported to us). We
attempt to consider all significant facts and circumstances
known at the time loss reserves are established. In addition, we
continually refine our loss reserve estimates as historical loss
experience develops and additional claims are reported and
settled.
We exercise a considerable degree of judgment in evaluating the
numerous factors involved in the estimation of reserves.
Different actuaries will choose different assumptions when faced
with such uncertainty, based on their individual backgrounds,
professional experiences and areas of focus. Hence, the estimate
selected by various actuaries may differ materially. We consider
this uncertainty by examining our historic reserve accuracy.
Given the significant impact of the reserve estimates on our
financial statements, we subject the reserving process to
significant diagnostic testing. We have incorporated data
validity checks and balances into our front-end processes.
Leading indicators such as actual versus expected emergence and
other diagnostics are also incorporated into the reserving
processes.
Due to the inherent uncertainty underlying loss reserve
estimates, including but not limited to the future settlement
environment, final resolution of the estimated liability for a
claim or category of claims will be different from that
anticipated at the reporting date. Therefore, actual paid losses
in the future may yield a materially higher or lower amount than
currently reserved.
The amount by which estimated losses differ from those
originally recorded for a period is known as
development. Development is unfavorable when the
losses ultimately settle for more than the levels at which they
were reserved or subsequent estimates indicate a basis for
increasing loss reserves on unresolved claims. Development is
favorable when losses ultimately settle for less than the amount
reserved or subsequent estimates indicate a basis for reducing
loss reserves on unresolved claims. We reflect favorable or
unfavorable developments of loss reserves in the results of
operations for the period in which the estimates are changed.
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Process
for Establishing Loss and Loss Expense Reserves
We record two categories of loss and loss expense
reserves case-specific reserves and incurred but not
reported (IBNR) reserves.
When a claim is reported, our claim department establishes a
case reserve for the estimated probable ultimate cost to resolve
a claim as soon as sufficient information is available to
evaluate a claim. We open most claim files with a formula
reserve (a nominal fixed amount) for the type of claim
involved. The Companys formula reserve amounts are
regularly reviewed but have not been changed during the three
years ended December 31, 2007 in order to maintain
stability in this aspect of the claim reserving process. We
adjust the formula reserve to the probable ultimate cost for
that claim as soon as sufficient information is available. It is
our goal to reserve each claim at its probable ultimate cost no
later than 30 days after the claim file is opened on
property claims or 90 days following receipt of the claim
on casualty claims. During the life cycle of a particular claim,
more information may materialize that causes us to increase or
decrease the estimate of the ultimate value of the claim. We may
determine that it is appropriate to pay portions of the reserve
to the claimant or related settlement expenses before final
resolution of the claim. The amount of the individual claim
reserve is then adjusted accordingly based on the most recent
information available.
We establish IBNR reserves to estimate the amount we will have
to pay for claims that have occurred, but have not yet been
reported to us; claims that have been reported to us that may
ultimately be paid out differently than expected by our
case-specific reserves; and claims that have been paid and
closed, but may reopen and require future payment. Case reserves
and IBNR reserves comprise the total loss and loss expense
reserves.
Methods
for Claims Other than Construction Defect
Our internal actuaries apply multiple traditional actuarial
techniques to compute loss and loss expense reserve estimates
for claim liabilities other than construction defect. Each
individual technique produces a unique loss and loss expense
reserve estimate for the line being analyzed. The set of
techniques applied together produces a range of loss and loss
expense reserve estimates (range). From these
estimates, the actuaries form a best estimate which considers
the assumptions and factors discussed below that influence
ultimate claim costs.
The selected ultimate losses and loss expenses minus the
payments made to date minus case reserves equal the best
estimate IBNR for each reserving segment. The actuarial methods
and a brief discussion of their strengths and weaknesses are
discussed below. In this discussion, we use the terms
loss and loss and loss expenses
interchangeably.
The actuarial techniques for claims other than construction
defect include the following:
Paid Loss Development. Historical
payment patterns are analyzed to estimate payment patterns
applicable to pending claims and unreported claims. The expected
payment patterns are applied to payments made to date by
accident year to produce an estimate of ultimate losses.
Strengths: The method is based on paid losses
and is, therefore, not dependent upon changes in case reserve
levels or changes in case reserving practices.
Weaknesses: As paid losses can be slow to
develop in certain lines, this method does not make full use of
relevant information which is present in case reserve levels.
Changes in claim settlement practices over time can be difficult
to quantify and reflect in establishing the expected payment
pattern for future payments. This method can be unstable for
immature accident years due to the relatively small proportion
of ultimate losses paid.
Incurred Loss Development. Historical
case incurred (payments plus case reserves) patterns are
analyzed to estimate case incurred patterns applicable to
pending claims and unreported claims. The expected case incurred
patterns are applied to case incurred losses to date by accident
year to produce an estimate of ultimate losses.
Strengths: Case incurred losses develop, or
are reported, more quickly than paid losses, thereby making use
of more available information. Case incurred loss development
estimates tend to fluctuate less than paid loss development
estimates.
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Weaknesses: Changes in claim settlement and
case reserving practices over time can be difficult to quantify
and reflect in establishing the expected case incurred pattern
for future case incurred losses. This method can also be
unstable for immature accident years due to the relatively small
proportion of ultimate losses reported.
Expected Loss Ratio Method. Historical
accident year estimated ultimate loss ratios, adjusted for loss
trends as well as exposure trends and pricing changes across
years, are analyzed to produce an estimate of the expected loss
ratio for each accident year. In certain instances, where
previous claims experience is not fully credible, it is
necessary to apply judgment to develop expected loss ratio
estimates. The expected loss ratio multiplied by the applicable
earned premium for each accident year produces an estimate of
the ultimate losses.
Strengths: The expected loss ratio for a given
accident year depends on claims experience from numerous
previous accident years on a combined basis rather than merely
the experience for the given year. As a result, the method tends
to be very stable. The method is not significantly impacted by
changes in claim settlement case reserving practices.
Weaknesses: Because the method does not depend
significantly upon claims experience, the results are slow to
respond to favorable and unfavorable emergence or changes in
trends.
Paid Bornhuetter-Ferguson (Paid BF) Method and
Incurred Bornhuetter-Ferguson (Incurred BF)
Method. There are two types of
Bornhuetter-Ferguson (BF) methods. The Paid BF
method is a combination of the paid loss development method and
the expected loss ratio method. For each accident year, the Paid
BF estimate is a weighted average of the paid development
estimate and the expected loss ratio method. The weight assigned
to the paid development method is the expected percentage of
losses paid, based on the payment pattern from the paid loss
development method. For example, if the paid development method
indicated that 30% of ultimate losses are expected to have been
paid for a given accident year, the Paid BF method would assign
30% weight to the paid loss development indication and 70%
weight to the expected loss ratio method.
The Incurred BF method is a combination of the incurred loss
development method and the expected loss ratio method. For each
accident year, the Incurred BF estimate is a weighted average of
the incurred development estimate and the expected loss ratio
method. The weight assigned to the incurred development method
is the expected percentage of losses reported based on the case
incurred pattern from the case incurred loss development method.
For example, if the incurred development method indicated that
60% of ultimate losses are expected to have been reported for a
given accident year, the Incurred BF method would assign 60%
weight to the incurred loss development indication and 40%
weight to the expected loss ratio method.
Strengths: The BF methods reflect actual loss
emergence that is favorable or unfavorable, however, the methods
assume that future emergence will follow the initial
expectations of ultimate losses and payment or reporting
patterns. The BF methods are less sensitive to deviations from
expectations than the development methods.
Weaknesses: As the methods assign weight to
the expected loss ratio, differences between the expected loss
ratio and the actual loss ratio could impact the accuracy of the
estimate.
Paid Stanard Buhlman (Paid SB) Method and
Incurred Stanard Buhlman (Incurred SB)
Method. There are two types of Stanard
Buhlman (SB) methods. The Paid SB method is very
similar to the Paid BF method, the only difference being the
means by which the expected loss ratios are computed for each
accident year. In the Paid SB method, as applied by our
actuaries, the expected loss ratio is computed by comparing
actual paid losses to earned premiums, adjusted for payment
patterns, loss and exposure trends and pricing changes. In the
Paid BF method as applied by our actuaries, the expected loss
ratio is computed by comparing paid losses adjusted by loss
trend and payment patterns to earned premium, adjusted by rate
change and exposure trends. The difference between the expected
loss ratios in these two methods is very subtle.
The Incurred SB method is very similar to the Incurred BF
method, the only difference being the means by which the
expected loss ratios are computed for each accident year. In the
Incurred SB method, as applied by our actuaries, the expected
loss ratio is computed by comparing actual case incurred losses
to earned premiums, adjusted for case incurred patterns, loss
and exposure trends and pricing changes. In the Incurred BF
method, as applied by our actuaries, the expected loss ratio is
computed by comparing incurred losses, adjusted by loss trend
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and incurred loss patterns, to earned premium, adjusted by rate
change and exposure trends. The difference between the expected
loss ratios in these two methods is very subtle.
Strengths: The SB methods have many of the
same strengths as the BF methods. The SB methods reflect actual
loss emergence that is favorable or unfavorable; however, the
methods assume that future emergence will follow the initial
expectations of ultimate losses and payment or reporting
patterns. The SB methods are less sensitive to deviations from
expectations than the development methods.
Weaknesses: The SB methods have many of the
same weaknesses as the BF methods. As the methods assign weight
to the expected loss ratio, differences between the expected
loss ratio and the actual loss ratio could impact the accuracy
of the estimate.
The methods described above produce estimates which have
different strengths and weaknesses. Our actuaries consider these
strengths and weaknesses when forming their best estimates. In
general, for immature loss experience, the actuaries tend to
assign greater weight to the Bornhuetter-Ferguson and Expected
Loss Ratio methods. This is based on the stability and accuracy
of these methods. As experience matures, greater weight is
assigned to the development methods.
In most cases, multiple estimation methods will be valid for the
particular facts and circumstances of the claim liabilities
being evaluated. Each estimation method has its own set of
assumption variables and its own advantages and disadvantages,
with no single estimation method being better than the others in
all situations and no one set of assumed variables being
meaningful for all product line components. The relative
strengths and weaknesses of the particular estimation methods,
when applied to a particular group of claims, can also change
over time; therefore, the weight given to each estimation method
will likely change by accident year and with each evaluation.
The actuarial point estimates typically follow a progression
that places significant weight on the Expected Loss Ratio and BF
method when accident years are younger and claims emergence is
immature. As accident years mature and claims emerge over time,
increasing weight is placed on the other methods. For product
lines with faster loss emergence, the progression from Expected
Loss Ratio and BF to other methods occurs more quickly.
For our long- and medium-tail products, the Expected Loss Ratio
and BF methods are typically given the most weight for the first
36 months of evaluation. These methods are also predominant
for the first 12 months of evaluation for short-tail lines.
Beyond these time periods, our actuaries apply their
professional judgment when weighting the estimates from the
various methods deployed.
Judgment can supersede this natural progression if risk factors
and assumptions change or if a situation occurs that amplifies a
particular strength or weakness of a methodology. Extreme
projections are critically analyzed and may be adjusted, given
less credence, or discarded all together. The actuaries monitor
any substantial changes in methods or assumptions from one loss
reserve study to another.
Our estimates of ultimate loss and loss expense reserves are
subject to change as additional data emerge. This could occur as
a result of change in loss development patterns; a revision in
expected loss ratios; the emergence of exceptional loss
activity; a change in weightings between actuarial methods; the
addition of new actuarial methodologies or new information that
merits inclusion; or the emergence of internal variables or
external factors that would alter their view.
The above actuarial techniques for computing loss and loss
expense reserve estimates use the following factors, among
others:
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our experience and the industrys experience;
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historical trends in reserving patterns and loss payments;
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the impact of claim inflation;
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the pending level of unpaid claims;
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the cost of claim settlements;
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the line of business mix; and
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the environment in which property and casualty insurance
companies operate.
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Although many factors influence the actual cost of claims and
our corresponding reserve estimates, we do not measure and
estimate values for all of these variables individually. This is
due to the fact that many of the factors that are known to
impact the cost of claims cannot be measured directly, such as
the impact on claim costs due to economic inflation, coverage
interpretations and jury determinations. In most instances, we
rely on our historical experience or industry information to
estimate values for the variables that are explicitly used in
our reserve analysis. We assume that the historical effect of
these unmeasured factors, which is embedded in our experience or
industry experience, is representative of future effects of
these factors. Where we have reason to expect a change in the
effect of one of these factors, we perform analysis to quantify
the necessary adjustments.
The above methods produce various reserve indications for each
accident year within each reserving grouping. From these
indications a best estimate is selected for each accident year
within each reserving grouping. Based on the results of the
methods and knowledge of the Companys business, the
actuaries use their best professional judgment to select one
figure from the various indications that they believe is the
most accurate reserve estimate. The indications and the selected
best estimates for each method and accident year are aggregated
across reserving groupings to produce a low estimate, a best
estimate and a high estimate for each line of business. As of
December 31, 2007, the range for casualty lines was 20.9%
below to 4.0% above the selected best estimate; for property
lines the range was 19.0% below to 5.7% above the selected best
estimate. The range presented herein represents neither the full
range of reasonably likely outcomes nor the full range of
possible outcomes.
For property and casualty lines, the ranges were a direct result
of the methods applied to the Companys experience; they
did not depend on any assumptions or additional factors outside
the various reserving methods.
Method
for Construction Defect Claims
For construction defect claim liabilities, with loss dates prior
to 2005, our internal actuaries apply one actuarial technique,
under various sets of assumptions, which considers the factors
that influence ultimate claim costs as discussed above.
Construction defect claim liabilities with loss dates after 2005
are included in casualty.
The actuarial technique for construction defect claims includes
several variables relating to the number of IBNR claims and the
average cost per IBNR claim. In addition to computing best
estimate parameter values for the actuarial projection, the
actuaries also consider the impact on resulting IBNR related to
reasonably foreseeable fluctuations in these variables.
The actuarial technique used to estimate construction defect
reserves is as follows:
Frequency Severity Method for Construction
Defect Claims. For the construction defect
reserving grouping, ultimate losses are based on an estimated
number of unreported claims that will close with payment
multiplied by an average cost per claim. Historical claim
reporting patterns are analyzed to establish claim reporting
patterns applicable to future claims. Expected claim reporting
patterns are applied to claims received to date by accident year
to produce an estimate of ultimate claim counts. Ultimate claim
counts minus claims received to date equal IBNR claim counts.
Historical claim closure data is analyzed to estimate the
percentage of future construction defect claims that will close
with payment by accident year. In addition, historical closed
claim severities and reported incurred claim severities are
analyzed to develop a selected claim severity for unreported
construction defect claims that will close with payment.
Strengths: The parameters for this model are
based on the Companys historical claim experience.
Weaknesses: Construction defect claim
severities are highly variable. Variations in close with payment
ratios could produce significant changes in estimated ultimate
costs.
For the construction defect reserving grouping, the actuaries
use one method to estimate IBNR reserves. This method is
comprised of estimated IBNR claims by accident year based on an
estimated number of unreported claims that will close with
payment multiplied by an average cost per claim. The actuaries
evaluate the impact of fluctuations above and below the expected
levels for each of these three components of the calculation on
estimated
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IBNR. As of December 31, 2007, the range for construction
defect claims was 12.8% below to 17.4% above the selected best
estimate. The range presented herein represents neither the full
range of reasonably likely outcomes nor the full range of
possible outcomes.
At the low end of the range, the parameters of the IBNR estimate
were varied as follows:
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claim reporting patterns were reduced by amounts ranging from
10% to 1%;
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close with payment ratios by accident year were not
varied; and
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average claim severities were reduced by 14.3%.
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These factors produced IBNR estimates that, when added to case
reserves, were 12.8% below the best estimate reserves.
At the high end of the range, the parameters of the IBNR
estimate were varied as follows:
|
|
|
|
|
claim reporting patterns were increased by amounts ranging from
10% to 1%;
|
|
|
|
close with payment ratios by accident year were not
varied; and
|
|
|
|
average claim severities were increased by 15.2%.
|
These factors produced IBNR estimates that, when added to case
reserves, were 17.4% above the best estimate reserves. It is
important to note that we do not believe that the fluctuations
considered in these calculations represent the full range of
reasonably likely outcomes. We believe the likely range extends
beyond this range, particularly on the high end. The range
presented herein represents neither the full range of reasonably
likely outcomes nor the full range of possible outcomes.
Impact of
Available Data and Company Experience
All actuarial techniques or methods require a significant amount
of professional judgment. When claim experience is insufficient
or unavailable for a reserving segment, we tend to apply the
expected loss ratio method. We typically refer to industry or
competitor loss ratio data that we believe is representative of
our segment when selecting an expected loss ratio. As of
December 31, 2007, except for the run-off workers
compensation line, we had no meaningful reserving segments for
which reserves were based significantly or completely upon
industry or competitor information.
In addition, there are numerous factors, both identified and
unidentified, that we believe affect claim liabilities. In most
instances, we cannot measure the impact of these variables
individually. Therefore we cannot identify changes in these
factors and adjust loss estimates accordingly. We assume that
our historical claim experience is representative of the future.
As circumstances warrant, we will attempt to quantify
significant changes in underlying factors and adjust loss
estimates accordingly.
In all of our significant lines, payment patterns and reporting
patterns are primarily based upon our experience. For run-off of
workers compensation, we base such patterns on industry
information from the National Council on Compensation Insurance.
In our most significant segments, expected loss ratios are based
on the Companys historical loss ratios, adjusted for loss
trends and pricing changes. The actuaries judgmentally select
loss trends based on knowledge of the Companys business
and industry loss trends available from Insurance Services
Offices and pricing changes are based on the Companys
experience.
Each of our reserving techniques is based heavily upon the
premise that historical Company data for each factor is
representative of future behavior for that factor. Our reserving
groupings were defined to achieve the greatest level of
homogeneity (similarity of risks, coverages and claim costs) and
credibility, which should reduce volatility of measured
statistics. Our key assumptions are identified below:
|
|
|
|
|
historical payment patterns are representative of payment
patterns for pending and future claims;
|
|
|
|
historical case incurred patterns are representative of case
incurred patterns for pending and future claims;
|
16
|
|
|
|
|
expected loss ratios estimated from historical results, trends
and pricing changes will be reasonably accurate and methods
utilizing expected loss ratios will produce reasonable reserve
indications;
|
|
|
|
loss trends based on industry experience will be applicable to
Company results; and
|
|
|
|
future construction defect claims will behave similarly to
historical construction defect claims in terms of costs, rate of
reporting and percentage which will be covered by Centurys
policies.
|
For factors such as payment patterns, case incurred patterns,
loss trends and pricing changes, we establish selected values
but we do not consider the range of possible values. As such, we
do not quantify the effects on ultimate losses or IBNR which
would result from fluctuations of these factors from our
expectations.
For the parameters in the construction defect reserving method,
we have considered the impact of fluctuations in parameter
values from the values we expected. It is important to note that
we do not believe that the fluctuations considered in these
calculations represent the full range of reasonably likely
outcomes. We believe the likely range extends beyond this range,
particularly on the high end.
Activity
in Loss and Loss Expense Reserves for the Three Years Ended
December 31, 2007
We review our reserves for loss and loss expenses every quarter,
and based on new developments and information, we include
adjustments of the probable ultimate liability in operating
results for the periods in which the adjustments are made. In
general, our initial reserves are based upon the actuarial and
underwriting data utilized to set pricing levels and are
reviewed as additional information, including claims experience,
becomes available. The establishment of loss and loss expense
reserves makes no provision for the broadening of coverage by
legislative action or judicial interpretation or for the
extraordinary future emergence of new types of losses not
sufficiently represented in our historical experience or which
cannot yet be quantified. We regularly analyze our reserves and
review our pricing and reserving methodologies so that future
adjustments to prior year reserves can be minimized. However,
given the complexity of this process, reserves require continual
updates and the ultimate liability may be higher or lower than
previously indicated.
Due to the inherent uncertainty in estimating reserves for
losses and loss expenses, there can be no assurance that the
ultimate liability will not materially exceed amounts reserved,
with a resulting adverse effect on our results of operations and
financial condition. Based on the current assumptions used in
calculating reserves, management believes our overall reserve
levels at December 31, 2007 make a reasonable provision for
our future obligations.
17
Activity in the liability for loss and loss expense reserves is
summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
|
Loss and loss expense reserves at beginning of year, as reported
|
|
$
|
250,672
|
|
|
|
211,647
|
|
|
|
153,236
|
|
Less reinsurance recoverables on unpaid losses at beginning of
year
|
|
|
36,104
|
|
|
|
37,448
|
|
|
|
29,485
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss and loss expense reserves at beginning of year
|
|
|
214,568
|
|
|
|
174,199
|
|
|
|
123,751
|
|
Provision for loss and loss expense incurred for claims related
to:
|
|
|
|
|
|
|
|
|
|
|
|
|
Current year
|
|
|
134,981
|
|
|
|
136,583
|
|
|
|
112,946
|
|
Prior years:
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and casualty
|
|
|
|
|
|
|
|
|
|
|
|
|
Casualty
|
|
|
(6,049
|
)
|
|
|
6,164
|
|
|
|
7,384
|
|
Property
|
|
|
(2,661
|
)
|
|
|
(9,250
|
)
|
|
|
(2,388
|
)
|
Other (including exited lines):
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial automobile
|
|
|
(9
|
)
|
|
|
73
|
|
|
|
439
|
|
Workers compensation
|
|
|
142
|
|
|
|
2,056
|
|
|
|
(35
|
)
|
Other
|
|
|
(487
|
)
|
|
|
(146
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total prior years
|
|
|
(9,064
|
)
|
|
|
(1,103
|
)
|
|
|
5,400
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total incurred
|
|
|
125,917
|
|
|
|
135,480
|
|
|
|
118,346
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss and loss expense payments for claims related to:
|
|
|
|
|
|
|
|
|
|
|
|
|
Current year
|
|
|
38,064
|
|
|
|
38,781
|
|
|
|
24,548
|
|
Prior years
|
|
|
64,031
|
|
|
|
56,330
|
|
|
|
43,350
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total paid
|
|
|
102,095
|
|
|
|
95,111
|
|
|
|
67,898
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss and loss expense reserves at end of year
|
|
|
238,390
|
|
|
|
214,568
|
|
|
|
174,199
|
|
Plus reinsurance recoverables on unpaid losses at end of year
|
|
|
40,863
|
|
|
|
36,104
|
|
|
|
37,448
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss and loss expense reserves at end of year, as reported
|
|
$
|
279,253
|
|
|
|
250,672
|
|
|
|
211,647
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
An explanation of significant components of loss and loss
expense reserve development by segment (net of reinsurance,
unless otherwise indicated) follows.
Property
and Casualty
Casualty. Our changes in the reserve estimates
related to prior accident years for the year ended
December 31, 2007 for the casualty lines resulted in a
decrease in incurred losses and loss expenses of
$6.1 million. The favorable development during the year
ended December 31, 2007 primarily relates to the 2004
through 2006 accident years. At the beginning of 2005, we began
writing certain contractors liability business on a claims
made form, replacing the occurrence form which had previously
been utilized through 2004. We wrote a significant volume of
claims made contractor business in both 2005 and 2006. We
reduced carried reserves related to the 2005 and 2006 casualty
business based on our internal actuarial reserve
recommendations. The 2005 and 2006 casualty books have performed
better than expected, and previously carried reserves exceeded
the current indications for each of the estimation methods
applied in our internal actuarial analysis. We continue to write
contractors liability business on an occurrence form, in
certain jurisdictions and for certain classes of business.
In addition, during the year ended December 31, 2007,
management reduced its long-term loss ratio expectations and
loss development factors for other casualty business based on
loss experience that emerged during the year that was more
favorable than our initial expectations. Due to the reduction of
these long-term loss ratio expectations and loss development
factors, the indicated ultimate loss ratios produced by certain
actuarial methods were lower as of December 31, 2007 than
they were as of December 31, 2006. As a result, for the
year ended December 31, 2007. management reduced the
selected ultimate loss ratios for casualty business for accident
18
years 2004 through 2006. The reduction in losses for casualty
business discussed above was partially offset by increases in
legal costs and settlement costs related to litigation on
construction defect claims.
Our changes in the reserve estimates related to prior accident
years for the years ended December 31, 2006 and 2005 for
the casualty lines resulted in increases in incurred losses and
loss expenses of $6.2 million and $7.4 million,
respectively. A significant portion of our casualty reserve
development relates to construction defect claims in certain
states. Reserves and claim frequency on this business have been
impacted by court decisions in California and other states
affecting insurance law and tort law and by legislation enacted
in California, which generally provides consumers who experience
construction defects a method other than litigation to obtain
reimbursement for construction defect repairs. These legal
developments impact claim severity, frequency and time to
settlement assumptions underlying our reserves. Starting with
California in December 2000, we began to exit contractors
liability business written on an occurrence form. By the end of
the first quarter of 2001, we had significantly reduced our
contractors liability written on an occurrence form
underwriting in all states, and completely eliminated
contractors liability written on an occurrence form in
Arizona, California, Colorado, Hawaii, Louisiana, Nevada, New
Jersey, North Carolina, Oregon, South Carolina and Washington.
Although we reduced our exposure to construction defect claims
and, accordingly, the magnitude of our adverse development in
this business has declined since 2000, our ultimate liability
may exceed or be less than current estimates due to these legal
actions, among other variables.
In addition, we incurred increased legal expenses and internal
restructuring costs to address related claims, which contributed
to our continued adverse development in this area. During 2004,
as a result of court decisions that further defined the legal
environment in California, we decided to enhance our defense
strategy for certain types of construction defect claims. As a
result, the Company revised its construction defect defense team
by retaining appellate and new trial counsel and restaffing the
in-house team responsible for management of the litigation. Once
the new legal teams were established late in 2004 and into 2005,
it was determined that there were certain cases that should be
settled and the defense budgets for the remaining cases had to
be revised to reflect the added resources, resulting in higher
than expected loss and defense costs in 2005. This strategy
continued in 2006 and we incurred additional legal expenses when
litigation discovery procedures yielded new information about
the underlying claims. This new information required a
reassessment of expected settlements or judgments and expenses
on many suits that had been received in prior years.
With this continued development related to our construction
defect claims in 2006 as well as a small amount of adverse
development on our non-construction defect casualty claims, our
internal actuaries continued to refine their actuarial reserving
techniques concerning the weighting of reserve indications and
supplemental information concerning claims severities. As a
result, our casualty reserves moved to a higher point in the
range of loss and loss expense reserve estimates. We also
recorded $2.9 million of unfavorable development during the
year ended December 31, 2006 related to estimated costs
associated with possible reinsurance collection issues on two
separate casualty claims.
Property. Our changes in reserve estimates for
the years ended December 31, 2007, 2006 and 2005 for the
property lines resulted in decreases in reserves of
$2.7 million, $9.3 million and $2.4 million,
respectively. When establishing our December 31, 2005 loss
and loss expense reserves, we believed the accident year 2005
property loss ratio would be significantly impacted by claims
activity resulting from Hurricanes Katrina, Rita and Wilma. In
addition, due to the significantly higher claims per adjuster
levels at the end of 2005 caused by the hurricane activity, we
believed that there was a potential risk that case reserves
would not be set as quickly as they would be with normal case
loads. Accordingly, we considered this potential risk in setting
our expected payment pattern and case incurred pattern for
property business resulting in a higher reserve estimate than
would have been normally set absent this risk. At the end of
2005, we held property IBNR for loss and loss expense reserves
of $13.8 million. We expected $8.6 million of reported
incurred losses and loss expenses for the year 2006. During
2006, actual reported incurred losses and loss expenses were
$3.4 million. As a result of the significantly better than
expected loss emergence during 2006, the selected payment
patterns and case incurred patterns were revised downward. As a
result of the better than expected loss emergence and the
revision to payment and case incurred patterns, the IBNR reserve
for accident years 2005 and prior as of December 31, 2006
decreased to $1.8 million. These results, coupled with a
corresponding reduction in claim handling costs yielded the
overall reduction of $9.3 million in losses and loss
expenses in 2006. For 2007 and 2005, the changes in reserves
primarily relate to changes in the development
19
patterns on multiple accident years, as the number of claims and
claim severity were below expectations at December 31, 2007
and 2005.
Other
(Including Exited Lines)
We began writing commercial automobile/trucking coverage for
commercial vehicles and trucks in 1997. In 2000, we exited the
commercial automobile line of business due to unsatisfactory
underwriting results. Our net loss and loss expense reserves for
commercial automobile as of December 31, 2007 and 2006 were
$101,000 and $147,000, respectively.
We offered workers compensation coverage from 1997 through
January 2002. We exited this line of business beginning
January 1, 2002 due to unsatisfactory underwriting results
and the lack of availability of acceptable reinsurance. Until
July 2000, we purchased 100% quota share reinsurance on this
line of business. Beginning in 2000, we started to retain some
risk. No new policies have been written since the first quarter
of 2002. In 2006, we recorded $2.9 million of unfavorable
development related to estimated costs associated with
reinsurance collection issues on our 1997 through 1999
workers compensation reinsurance treaties. Our net loss
and loss expense reserves for workers compensation as of
December 31, 2007 and 2006 were $3.0 million and
$3.2 million, respectively.
The table provided on the following pages presents the
development of reserves, net of reinsurance, from 1997 through
2006. The top line of the table presents the reserves at the
balance sheet date for each of the periods indicated. This
represents the estimated amounts of loss and loss expenses that
were unpaid at the balance sheet date, including losses that had
been incurred but not yet reported to us. The upper portion of
the table presents the re-estimated amount of the previously
recorded reserves based on experience as of the end of each
succeeding period, including cumulative payments made since the
end of the respective period. The estimate changes as more
information becomes known about the payments, as well as the
frequency and severity of claims for individual periods.
Favorable loss development, shown as a cumulative redundancy in
the table, exists when the original reserve estimate is greater
than the re-estimated reserves. The lower portion of the table
presents the cumulative amounts paid as of the end of each
successive period with respect to those claims. Information with
respect to the cumulative development of gross reserves (that
is, without deduction for reinsurance ceded) also appears at the
bottom portion of the table.
20
In evaluating the information in the table provided below, note
that each amount entered incorporates the cumulative effects of
all changes in amounts entered for prior periods. The table does
not present accident or policy year development data. In
addition, conditions and trends that have affected the
development of liability in the past may not necessarily recur
in the future.
Analysis
of Loss and Loss Adjustment Expense Development
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1998
|
|
|
1999
|
|
|
2000
|
|
|
2001
|
|
|
2002
|
|
|
|
(In thousands)
|
|
|
Net liability for losses and loss expenses
|
|
$
|
42,262
|
|
|
|
46,649
|
|
|
|
44,915
|
|
|
|
48,944
|
|
|
|
59,002
|
|
Liability re-estimated as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One year later
|
|
|
44,269
|
|
|
|
49,382
|
|
|
|
50,265
|
|
|
|
64,818
|
|
|
|
86,045
|
|
Two years later
|
|
|
45,006
|
|
|
|
52,390
|
|
|
|
66,745
|
|
|
|
86,480
|
|
|
|
101,553
|
|
Three years later
|
|
|
47,237
|
|
|
|
66,299
|
|
|
|
84,178
|
|
|
|
98,983
|
|
|
|
109,802
|
|
Four years later
|
|
|
58,059
|
|
|
|
77,477
|
|
|
|
94,930
|
|
|
|
104,975
|
|
|
|
119,978
|
|
Five years later
|
|
|
65,977
|
|
|
|
84,861
|
|
|
|
100,422
|
|
|
|
113,125
|
|
|
|
125,428
|
|
Six years later
|
|
|
72,691
|
|
|
|
88,590
|
|
|
|
107,588
|
|
|
|
118,857
|
|
|
|
|
|
Seven years later
|
|
|
76,396
|
|
|
|
94,235
|
|
|
|
113,683
|
|
|
|
|
|
|
|
|
|
Eight years later
|
|
|
81,945
|
|
|
|
99,914
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine years later
|
|
|
87,929
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cumulative redundancy (deficiency)
|
|
|
(45,667
|
)
|
|
|
(53,265
|
)
|
|
|
(68,768
|
)
|
|
|
(69,913
|
)
|
|
|
(66,426
|
)
|
Cumulative amount of net liability paid as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One year later
|
|
|
14,221
|
|
|
|
18,741
|
|
|
|
19,047
|
|
|
|
24,805
|
|
|
|
30,585
|
|
Two years later
|
|
|
25,237
|
|
|
|
31,444
|
|
|
|
37,562
|
|
|
|
46,413
|
|
|
|
56,457
|
|
Three years later
|
|
|
33,559
|
|
|
|
45,199
|
|
|
|
54,598
|
|
|
|
65,472
|
|
|
|
76,414
|
|
Four years later
|
|
|
42,754
|
|
|
|
55,536
|
|
|
|
68,806
|
|
|
|
78,143
|
|
|
|
90,995
|
|
Five years later
|
|
|
49,406
|
|
|
|
65,559
|
|
|
|
78,743
|
|
|
|
89,339
|
|
|
|
101,484
|
|
Six years later
|
|
|
57,133
|
|
|
|
72,538
|
|
|
|
89,005
|
|
|
|
98,524
|
|
|
|
|
|
Seven years later
|
|
|
63,589
|
|
|
|
79,311
|
|
|
|
97,154
|
|
|
|
|
|
|
|
|
|
Eight years later
|
|
|
69,792
|
|
|
|
86,466
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine years later
|
|
|
76,018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross liability end of year
|
|
|
55,844
|
|
|
|
76,357
|
|
|
|
84,974
|
|
|
|
94,146
|
|
|
|
91,011
|
|
Reinsurance recoverable on unpaid losses
|
|
|
13,582
|
|
|
|
29,708
|
|
|
|
40,059
|
|
|
|
45,202
|
|
|
|
32,009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net liability end of year
|
|
|
42,262
|
|
|
|
46,649
|
|
|
|
44,915
|
|
|
|
48,944
|
|
|
|
59,002
|
|
Gross liability re-estimated latest
|
|
|
99,221
|
|
|
|
138,690
|
|
|
|
159,315
|
|
|
|
156,589
|
|
|
|
160,042
|
|
Reinsurance recoverable on unpaid losses
re-estimated latest
|
|
|
11,292
|
|
|
|
38,776
|
|
|
|
45,632
|
|
|
|
37,732
|
|
|
|
34,614
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net liability re-estimated latest
|
|
|
87,929
|
|
|
|
99,914
|
|
|
|
113,683
|
|
|
|
118,857
|
|
|
|
125,428
|
|
Gross cumulative redundancy (deficiency)
|
|
$
|
(43,377
|
)
|
|
|
(62,333
|
)
|
|
|
(74,341
|
)
|
|
|
(62,443
|
)
|
|
|
(69,031
|
)
|
21
Analysis
of Loss and Loss Adjustment Expense Development
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2003
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
2007
|
|
|
|
(In thousands)
|
|
|
Net liability for losses and loss expenses
|
|
$
|
92,497
|
|
|
|
123,763
|
|
|
|
174,199
|
|
|
|
214,568
|
|
|
|
238,390
|
|
Liability re-estimated as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One year later
|
|
|
103,548
|
|
|
|
129,163
|
|
|
|
173,096
|
|
|
|
205,504
|
|
|
|
|
|
Two years later
|
|
|
111,189
|
|
|
|
137,927
|
|
|
|
172,192
|
|
|
|
|
|
|
|
|
|
Three years later
|
|
|
122,467
|
|
|
|
140,351
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Four years later
|
|
|
127,860
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Five years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cumulative redundancy (deficiency)
|
|
|
(35,363
|
)
|
|
|
(16,588
|
)
|
|
|
2,007
|
|
|
|
9,064
|
|
|
|
|
|
Cumulative amount of net liability paid as of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One year later
|
|
|
35,717
|
|
|
|
43,363
|
|
|
|
56,330
|
|
|
|
64,031
|
|
|
|
|
|
Two years later
|
|
|
62,569
|
|
|
|
75,106
|
|
|
|
95,370
|
|
|
|
|
|
|
|
|
|
Three years later
|
|
|
84,190
|
|
|
|
96,089
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Four years later
|
|
|
98,167
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Five years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine years later
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross liability end of year
|
|
|
129,558
|
|
|
|
153,236
|
|
|
|
211,647
|
|
|
|
250,672
|
|
|
|
279,253
|
|
Reinsurance recoverable on unpaid losses
|
|
|
37,061
|
|
|
|
29,485
|
|
|
|
37,448
|
|
|
|
36,104
|
|
|
|
40,863
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net liability end of year
|
|
|
92,497
|
|
|
|
123,751
|
|
|
|
174,199
|
|
|
|
214,568
|
|
|
|
238,390
|
|
Gross liability re-estimated latest
|
|
|
153,414
|
|
|
|
172,393
|
|
|
|
205,187
|
|
|
|
239,402
|
|
|
|
|
|
Reinsurance recoverable on unpaid losses
re-estimated latest
|
|
|
25,554
|
|
|
|
32,042
|
|
|
|
32,995
|
|
|
|
33,898
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net liability re-estimated latest
|
|
|
127,860
|
|
|
|
140,351
|
|
|
|
172,192
|
|
|
|
205,504
|
|
|
|
|
|
Gross cumulative redundancy (deficiency)
|
|
$
|
(23,856
|
)
|
|
|
(19,157
|
)
|
|
|
6,460
|
|
|
|
11,270
|
|
|
|
|
|
|
|
|
(1) |
|
For calendar years and diagonals between 1997 and 2003, the
amounts do not include the net effects of the discontinued
operations. |
|
(2) |
|
In 2004, we entered in a loss portfolio transfer agreement with
Evergreen and Continental whereby we assumed all of Evergreen
and Continentals business excluding surety and assumed
workers compensation. Evergreen and Continental were
spun-off to our class A shareholders in 2004 and are,
therefore, no longer our subsidiaries. Therefore, for years
prior to 2004 gross reserves include our gross reserves for
all lines excluding surety (including the gross reserves for
Evergreen and Continental) and the 2004 year and the gross
liability re-estimated latest excludes the gross
reserves for Evergreen and Continental and includes the
assumption of the net business of Evergreen and Continental. In
addition, due to the above transactions in 2004, the gross
cumulative redundancy (deficiency) includes the effects of
eliminating Evergreen and Continentals gross reserves and
the assumption of Evergreen and Continentals net reserves
(excluding surety). Therefore, while the trend of the gross
cumulative redundancy (deficiency) remains, the results may not
represent the actual redundancy or deficiency of our gross
reserves. |
22
Reinsurance
We purchase reinsurance to reduce our exposure to liability on
individual risks and claims and to protect against catastrophic
losses. Reinsurance involves an insurance company transferring,
or ceding, a portion of its exposure on a risk to
another insurer, the reinsurer. The reinsurer assumes the
exposure in return for a portion of the premium. The ceding of
liability to a reinsurer does not legally discharge the primary
insurer from its liability for the full amount of the policies
on which it obtains reinsurance. The primary insurer remains
liable for the entire loss if the reinsurer fails to meet its
obligations under the reinsurance agreement.
In formulating our reinsurance programs, we are selective in our
choice of reinsurers and consider numerous factors, the most
important of which are the financial stability of the reinsurer,
its history of responding to claims and its overall reputation.
In an effort to minimize our exposure to the insolvency of our
reinsurers, we evaluate the acceptability and review the
financial condition of each reinsurer annually. Generally we use
only those reinsurers that have an A.M. Best rating of
A− (excellent) or better and that have at
least $500 million in policyholders surplus, or
Lloyds of London syndicates that have an A.M. Best rating
of A− (excellent) or better. In the event that
a reinsurers policyholders surplus falls below
$500 million or the A.M. Best rating falls below an
A-, we will attempt to replace the reinsurer with a
reinsurer that fits our criteria, or we will try to commute the
contract. Retention levels are reviewed each year to maintain a
balance between the growth in surplus and the cost of
reinsurance.
Our reinsurance strategy has remained consistent for several
years. We believe we maintain appropriate conservative per risk
and per occurrence retention levels and purchase sufficient
reinsurance coverage on a per risk and per occurrence, and
catastrophic basis.
The majority of our reinsurance agreements are subject to annual
review. If a contract period experiences high severity losses or
high frequency losses, there is a risk that we will not be able
to renew our existing reinsurance facilities or that we could
exhaust our existing treaty limits. This could result in
increased exposure to loss, or if we are unwilling to bear an
increase in net exposure, a reduction in revenue due to higher
reinsurance cost
and/or lower
volume of insurance written.
We are also subject to changes in reinsurance market conditions
which are beyond our control. Reduced capacity or increased
costs could impact our ability to purchase sufficient
reinsurance which may lead to lower revenue.
23
The following is a summary of our 2008 and 2007 multiple-line
excess of loss reinsurance treaty:
|
|
|
|
|
Line of Business
|
|
Company Policy Limit
|
|
Reinsurance Coverage/Company Retention
|
|
Property
|
|
Up to $12.5 million per risk
|
|
We retain the first $500,000 per risk and reinsure all losses in
excess of $500,000 up to $12.5 million per risk through treaty
and automatic facultative agreements. Additional certificate
facultative coverage is available for risks exceeding $12.5
million. In addition, effective January 1, 2008, we participate
on a 18% quota share basis in the $500,000 per risk excess.
|
Casualty primary
|
|
$1.0 million per occurrence
|
|
We retain the first $500,000 per occurrence. In addition, we
share on a quota share basis 50% of any per occurrence loss
greater than $500,000 but less than $1.0 million.
|
Casualty excess and umbrella
|
|
Up to $5.0 million per occurrence in excess of the $1.0 million
primary policy
|
|
We retain 10% of the first $1.0 million per occurrence and we
reinsure 100% of any per occurrence loss greater than $1.0
million but less than $4.0 million.
|
Terrorism aggregate excess of loss
|
|
Insurer deductible as defined in Section 102 for the Terrorism
Risk Insurance Act of 2002 and amended by the Terrorism Risk
Insurance Extension Act of 2005
|
|
For 2007, we retain the first $8.0 million per occurrence and
reinsure any per occurrence loss greater than $8.0 million but
less than $28 million. For 2008, we retain the first $8.0
million per occurrence and reinsure any per occurrence loss
greater than $8.0 million but less than $16.5 million.
|
The Company maintains variable quota share reinsurance on its
ocean marine, surety and environmental business which allows for
a proportionate sharing of premium and losses. Generally, the
percentage of ceded reinsurance increases as the limit of the
policies issued increases, which allows the Company to maintain
an acceptable retention level.
Since 2004, we have maintained casualty clash
coverage of $19.0 million in excess of $1.0 million to
cover exposures such as punitive damages and other
extra-contractual obligations, losses in excess of policy limits
and exposure to a larger single loss than intended due to losses
incurred under two or more coverages or policies for the same
event.
We maintain property catastrophe coverage of $16.0 million
above $4.0 million of cumulative net property retentions.
We annually evaluate the probable maximum loss using a
catastrophe exposure model developed by independent experts. The
most recent model suggests we are insured for a
500-year
catastrophic event. Our primary catastrophic risk is structural
property exposures because of fire following an earthquake,
hurricanes, tornados, hailstorms, winter storms, and freezing.
Historically, we have not written wind coverage on fixed
properties in Florida or within two counties of the Gulf of
Mexico and the eastern seaboard states; however, we continue to
evaluate this market for profitable opportunities.
We purchased Terrorism Aggregate Excess of Loss reinsurance
coverage effective February 1, 2006 to reduce our retention
under the Insurer Deductible as defined in
Section 102 of the Terrorism Risk Insurance Act of 2002 and
as amended by the Terrorism Risk Insurance Extension Act of 2005
(collectively called the Act). In 2007, we
24
retained and are liable for $8.0 million of our aggregate
ultimate net loss arising out of all insured losses, as defined
by the Act, for the term of the contract. The reinsurer is then
liable for the amount by which such aggregate ultimate net loss
exceeds our retention, but the liability of the reinsurer will
not exceed $20.0 million for the term of the contract. In
2008, we will retain and be liable for $8.0 million of our
aggregate ultimate net loss arising out of all insured losses,
as defined by the Act, for the term of the contract. The
reinsurer will then be liable for the amount by which such
aggregate ultimate net loss exceeds our retention, but the
liability of the reinsurer will not exceed $8.5 million for
the term of the contract.
The following table is a summary of our top ten reinsurers,
based on net amount recoverable, as of December 31, 2007.
These amounts include reinsurance recoverable on paid losses,
reinsurance recoverable on unpaid losses, prepaid reinsurance
premiums and reinsurance balances payable.
|
|
|
|
|
|
|
|
|
A.M. Best
|
|
Net Amount
|
|
Reinsurer
|
|
Rating
|
|
Recoverable
|
|
|
|
As of December 31, 2007
|
|
|
|
(In thousands)
|
|
|
Ace Property and Casualty
|
|
A+
|
|
$
|
18,152,000
|
|
Swiss Reinsurance America Corporation
|
|
A+
|
|
|
10,330,000
|
|
Munich Reinsurance America
|
|
A+
|
|
|
6,353,000
|
|
Hannover Ruckvesicherungs-Aktiengeselischaft
|
|
A
|
|
|
3,396,000
|
|
General Reinsurance Corporation
|
|
A++
|
|
|
3,115,000
|
|
Berkley Insurance Company
|
|
A+
|
|
|
2,107,000
|
|
Axis Reinsurance Company
|
|
A
|
|
|
1,840,000
|
|
Gerling Global Reinsurance Corporation(1)
|
|
NR3
|
|
|
1,664,000
|
|
Evergreen National Indemnity Company
|
|
A−
|
|
|
1,339,000
|
|
Lloyds Syndicate Number 2003
|
|
A
|
|
|
618,000
|
|
|
|
|
(1) |
|
We are closely monitoring the financial status of Gerling Global
Reinsurance Corporation (which is not rated as it is no longer
accepting new or renewal business). We are currently in
arbitration with Gerling over a disputed claim. |
The reinsurance market has changed dramatically over the past
few years as a result of inadequate pricing, poor underwriting
and the significant losses incurred in conjunction with the
terrorist attacks on September 11, 2001 and the
2004/2005
hurricane seasons. As a result, reinsurers have exited some
lines of business, reduced available capacity and implemented
provisions in their contracts designed to reduce their exposure
to loss. The market improved throughout 2006 due to a moderate
hurricane season and continued in 2007 and 2008.
Investment
Portfolio
Our investment strategy is designed to capitalize on our ability
to generate positive cash flow from our underwriting activities.
Preservation of capital is our first priority, with a secondary
focus on maximizing appropriate risk adjusted returns. We seek
to maintain sufficient liquidity from operations, investing and
financing activities to meet our anticipated insurance
obligations and operating and capital expenditure needs. The
majority of our fixed maturity portfolio is rated investment
grade to mitigate our exposure to credit risk. Our investment
portfolio is managed by two outside independent investment
managers and one related party investment manager, which all
operate under investment guidelines approved by our investment
committee. Our investment committee meets at least quarterly and
reports to our board of directors. In addition, we employ
stringent diversification rules and balance our investment
credit risk and related underwriting risks to minimize total
potential exposure to any one security. In limited
circumstances, we will invest in non-investment grade fixed
maturity securities that have an appropriate risk adjusted
return, subject to satisfactory credit analysis performed by us
and our investment managers.
25
Our cash and investment portfolio totaled $467.3 million as
of December 31, 2007 and is summarized by type of
investment as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percent of
|
|
|
|
Amount
|
|
|
Portfolio
|
|
|
|
(Dollars in thousands)
|
|
|
Fixed-maturity:
|
|
|
|
|
|
|
|
|
U.S. Treasury securities
|
|
$
|
2,663
|
|
|
|
0.6
|
%
|
Agencies not backed by the full faith and credit by the U.S.
Government
|
|
|
6,101
|
|
|
|
1.3
|
|
Corporate securities
|
|
|
34,366
|
|
|
|
7.4
|
|
Mortgage-backed securities (GSEs)
|
|
|
77,200
|
|
|
|
16.5
|
|
Asset-backed securities
|
|
|
27,802
|
|
|
|
6.0
|
|
Collateralized mortgage obligations
|
|
|
49,671
|
|
|
|
10.6
|
|
Obligations of states and political subdivisions
|
|
|
209,735
|
|
|
|
44.9
|
|
|
|
|
|
|
|
|
|
|
Total fixed-maturity
|
|
|
407,538
|
|
|
|
87.3
|
|
|
|
|
|
|
|
|
|
|
Cash and short-term investments
|
|
|
16,496
|
|
|
|
3.5
|
|
|
|
|
|
|
|
|
|
|
Equity securities:
|
|
|
|
|
|
|
|
|
Bond mutual funds
|
|
|
14,244
|
|
|
|
3.0
|
|
Preferred shares
|
|
|
26,338
|
|
|
|
5.6
|
|
Common shares
|
|
|
2,660
|
|
|
|
0.6
|
|
|
|
|
|
|
|
|
|
|
Total equity securities
|
|
|
43,242
|
|
|
|
9.2
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
467,276
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
Competition
The property and casualty insurance industry is highly
competitive. We compete with domestic and international
insurers, many of which have greater financial, marketing and
management resources and experience than we do. We also may
compete with new market entrants in the future. Competition is
based on many factors, including the perceived market strength
of the insurer, pricing and other terms and conditions, services
provided, the speed of claims payment, the reputation and
experience of the insurer and ratings assigned by independent
rating organizations such as A.M. Best. Century and PIC
have a pooled rating from A.M. Best of A−
(excellent). Ratings for an insurance company are based on its
ability to pay policyholder obligations and are not directed
toward the protection of investors.
Today our primary competitors are Nationwide Mutual Insurance
Company (Scottsdale Insurance), Markel Corporation (Essex
Insurance Company), IFG Companies (Burlington Insurance Group),
W.R. Berkley Corporation (Nautilus Insurance Company), Argo
Group International Holdings, Ltd. (Colony Insurance Company),
United American Indemnity, LTD
(Penn-America
Insurance Company), Franklin Holdings, Ltd. (James River Group),
RLI Corporation, Philadelphia Consolidated Holdings Corporation,
American Safety Insurance Holdings, Ltd. (American Safety
Holdings Corporation ) and First Mercury Financial Corporation
(First Mercury Insurance Company). We generally compete on the
basis of service, as most market competitors have maintained
both pricing and underwriting discipline. Additionally, we
continue to experience increased competition in the excess and
surplus market from standard carriers that are trying to gain
additional market share.
Ratings
A.M. Best, which rates insurance companies based on factors
of concern to policyholders, issued a pooled rating of
A− (excellent) as its 2007 annual rating of
our property and casualty insurance subsidiaries. A.M. Best
assigns 16 ratings to insurance companies, which currently range
from A++ (superior) to F (in
liquidation). In evaluating a companys financial and
operating performance, A.M. Best reviews the companys
profitability, leverage and liquidity, as well as its book of
business, the adequacy and soundness of its reinsurance, the
quality and
26
estimated market value of its assets, the adequacy of its loss
and loss expense reserves, the adequacy of its surplus, its
capital structure, the experience and competence of its
management and its market presence. A.M. Bests
ratings reflect its opinion of an insurance companys
financial strength, operating performance and ability to meet
its obligations to policyholders and are not evaluations
directed to purchasers of an insurance companys securities.
Regulatory
Environment
Insurance Regulation. We are regulated by
insurance regulatory agencies in the states in which we conduct
business. State insurance regulations generally are designed to
protect the interests of policyholders, state insurance
consumers or claimants rather than shareholders or other
investors. The nature and extent of state regulation varies by
jurisdiction, and state insurance regulators generally have
broad administrative power relating to, among other matters,
setting capital and surplus requirements, licensing of insurers
and agents, establishing standards for reserve adequacy,
prescribing statutory accounting methods and the form and
content of statutory financial reports, regulating certain
transactions with affiliates, and prescribing the types and
amounts of investments.
The National Association of Insurance Commissioners is a group
formed by state insurance commissioners to discuss issues and
formulate policy with respect to regulation, reporting and
accounting of insurance companies. Although the National
Association of Insurance Commissioners has no legislative
authority and insurance companies are at all times subject to
the laws of their respective domiciliary states and, to a lesser
extent, other states in which they conduct business, the
National Association of Insurance Commissioners is influential
in determining the form in which such laws are enacted. Model
Insurance Laws, Regulations and Guidelines have been promulgated
by the National Association of Insurance Commissioners as a
minimum standard by which state regulatory systems and
regulations are measured. Adoption of state laws which provide
for substantially similar regulations to those described in
certain of the model laws is a requirement for accreditation by
the National Association of Insurance Commissioners. The
National Association of Insurance Commissioners provides
authoritative guidance to insurance regulators on current
statutory accounting issues by promulgating and updating a
codified set of statutory accounting practices in its Accounting
Practices and Procedures Manual.
Regulation of insurance companies constantly changes as the
National Association of Insurance Commissioners, governmental
agencies and legislatures react to real or perceived issues. In
recent years, the state insurance regulatory framework has come
under increased federal scrutiny, and some state legislatures
have considered or enacted laws that alter and, in many cases,
increase state authority to regulate insurance companies and
insurance holding company systems. Further, the National
Association of Insurance Commissioners and some state insurance
regulators are re-examining existing laws and regulations
specifically focusing on issues relating to the solvency of
insurance companies, interpretations of existing laws and the
development of new laws. Although the federal government does
not directly regulate the business of insurance, federal
initiatives often affect the insurance industry in a variety of
ways.
Required Licensing. In Ohio, Arizona, Indiana,
West Virginia and Wisconsin, Century operates on an admitted, or
licensed, basis. In addition, PIC is admitted in Texas, its
state of domicile, and Alaska, Arizona, Arkansas, California,
Georgia, Indiana, Kansas, Louisiana, Massachusetts, Michigan,
Minnesota, Missouri, Montana, Nebraska, Nevada, New Jersey, New
Mexico, New York, North Dakota, Oklahoma, Oregon, Pennsylvania,
South Carolina, Utah, West Virginia and Wisconsin. Each of
Centurys and PICs licenses in these states are in
good standing as of December 31, 2007. Insurance licenses
are issued by state insurance regulators upon application and
may be of perpetual duration or may require periodic renewal. We
must apply for and obtain appropriate new licenses before we can
expand into a new state on an admitted basis or offer new lines
of insurance that require separate or additional licensing. PIC
is also admitted in the District of Columbia.
In most states, Century operates on a surplus lines basis. While
Century does not have to apply for and maintain a license in
those states, it is subject to maintaining suitability standards
or approval under each particular states surplus lines
laws to be included as an approved carrier. Century maintains
surplus lines approvals in all states except where it is
admitted, as identified above, and Massachusetts and Rhode
Island. In states in which it operates on a surplus lines basis,
Century has freedom of rate and form on the majority of its
business. This means that Century can implement a change in
policy form, underwriting guidelines, or rates for a product on
an immediate basis. PIC is authorized to operate on a surplus
line basis in Ohio.
27
Insurers operating on an admitted basis must file premium rate
schedules and policy or coverage forms for review and approval
by the insurance regulators. In many states, rates and policy
forms must be approved prior to use, and insurance regulators
have broad discretion in judging whether an insurers rates
are adequate, not excessive and not unfairly discriminatory.
Insurance Holding Company Regulation. We
operate as an insurance holding company system and are subject
to regulation in the jurisdictions in which we conduct business.
These regulations require that each insurance company in the
system register with the insurance department of its state of
domicile and furnish information concerning the operations of
companies within the holding company system that may materially
affect the operations, management or financial condition of the
insurers within the system domiciled in that state. The
insurance laws similarly provide that all transactions among
members of a holding company system must be fair and reasonable.
Transactions between insurance subsidiaries and their parents
and affiliates generally must be disclosed to the state
regulators, and prior approval of the applicable state insurance
regulator generally is required for any material or
extraordinary transaction. In addition, a change of control of a
domestic insurer or of any controlling person requires the prior
approval of the state insurance regulator. Generally, any person
who acquires 10% or more of the outstanding voting securities of
the insurer or its parent company is presumed to have acquired
control of the domestic insurer. Since August 2005, one investor
beneficially has owned more than 10% of our outstanding common
shares. According to the Schedule 13G filed by the investor
with the U.S. Securities and Exchange Commission, the
ProCentury common shares are held in the ordinary course of
business and were not acquired and are not held for the purpose
of or with the effect of changing or influencing the control of
the issuer of the securities. Based on the information contained
in the Schedule 13G, a change of control was deemed not to
have occurred and a disclaimer of affiliation was filed, as
contemplated under applicable state statutes, with the
appropriate state insurance regulators to disclose the
information about the shares being held and the basis for
disclaiming the affiliation. In early 2007, such investor group
reduced its investment to less than 10%.
Restrictions on Paying Dividends. ProCentury
is a holding company with no business operations of its own.
Consequently, our ability to pay dividends to shareholders and
meet debt payment obligations is largely dependent on dividends
and other distributions from Century. State insurance law
restricts the ability of Century to declare shareholder
dividends. State insurance regulators require insurance
companies to maintain specified levels of statutory capital and
surplus. The amount of an insurers surplus following
payment of any dividends must be reasonable in relation to the
insurers outstanding liabilities and adequate to meet its
financial needs. Further, prior approval from the Ohio
Department of Insurance generally is required in order for
Century to declare and pay extraordinary dividends.
An extraordinary dividend is defined as any dividend or
distribution that, together with other distributions made within
the preceding 12 months, exceeds the greater of 10% of the
insurers surplus as of the preceding December 31, or
the insurers net income for the 12 month period
ending the preceding December 31, in each case determined
in accordance with statutory accounting practices. Using these
criteria, the available ordinary dividend available to be paid
from Century to ProCentury during 2008 is $27.4 million.
The ordinary dividend available to be paid from PIC to Century
during 2008 is $2.9 million. State insurance regulatory
authorities that have jurisdiction over the payment of dividends
by our insurance subsidiaries may in the future adopt statutory
provisions more restrictive than those currently in effect.
Guaranty Funds. Under state insurance guaranty
fund laws, insurers doing business on an admitted basis in a
state can be assessed for certain obligations of insolvent
insurance companies to policyholders and claimants. Maximum
contributions required by law in any one year vary between 1%
and 2% of annual premiums written in that state. In most states,
guaranty fund assessments are recoverable either through future
policy surcharges or offsets to state premium tax liability.
Except for New Jersey, the business that is written on a surplus
line basis is not subject to state guaranty fund assessments.
Investment Regulation. Our insurance
subsidiaries are subject to state law which requires
diversification of its investment portfolio and limits the
amount of investments in certain categories. Failure to comply
with these laws and regulations would cause non-conforming
investments to be treated as non-admitted assets in the states
in which we are licensed to sell insurance policies for purposes
of measuring statutory surplus and, in some instances, would
require us to sell those investments.
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Restrictions on Cancellation, Non-Renewal or
Withdrawal. Many states have laws and regulations
that limit the ability of an insurance company licensed by that
state to exit a market. For example, certain states limit an
automobile insurers ability to cancel or not renew
policies. Some states prohibit an insurer from withdrawing one
or more lines of business from the state, except pursuant to a
plan approved by the state insurance regulator, which may
disapprove a plan that may lead to market disruption.
Increasingly, state statutes, explicitly or by interpretation,
apply these restrictions to insurers operating on a surplus line
basis.
Licensing of Our Employees and Adjustors. In
certain states in which we operate, insurance claims adjusters
are required to be licensed and some must fulfill annual
continuing education requirements. In most instances, our
employees who are negotiating coverage terms are underwriters
and employees of the company and are not required to be licensed
agents. Approximately thirty of our employees currently maintain
requisite licenses for these activities in most states in which
we conduct business.
Privacy Regulations. In 1999, the United
States Congress enacted the Gramm-Leach-Bliley Act, which, among
other things, protects consumers from the unauthorized
dissemination of certain personal information. Subsequently, a
majority of states have implemented additional regulations to
address privacy issues. These laws and regulations apply to all
financial institutions, including insurance and finance
companies, and require us to maintain appropriate procedures for
managing and protecting certain personal information of our
customers and to fully disclose our privacy practices to our
customers. We may also be exposed to future privacy laws and
regulations, which could impose additional costs and impact our
results of operations or financial condition. A National
Association of Insurance Commissioners initiative that impacted
the insurance industry in 2001 was the adoption in 2000 of the
Privacy of Consumer Financial and Health Information Model
Regulation, which assisted states in promulgating regulations to
comply with the Gramm-Leach-Bliley Act. In 2002, to further
facilitate the implementation of the Gramm-Leach-Bliley Act, the
National Association of Insurance Commissioners adopted the
Standards for Safeguarding Customer Information Model
Regulation. Several states have now adopted similar provisions
regarding the safeguarding of customer information. We have
established procedures for safeguarding customer information and
our insurance subsidiaries follow procedures pertaining to
applicable customers to comply with the Gramm-Leach-Bliley
related privacy requirements.
Trade Practices. The manner in which insurance
companies and insurance agents conduct the business of insurance
is regulated by state statutes in an effort to prohibit
practices that constitute unfair methods of competition or
unfair or deceptive acts or practices. Prohibited practices
include, but are not limited to, disseminating false information
or advertising; unfair discrimination, rebating, and false
statements. We set business conduct policies and provide regular
training to make our employee-agents and other sales personnel
aware of these prohibitions, and we require them to conduct
their activities in compliance with these statutes.
Unfair Claims Practices. Generally, insurance
companies, adjusting companies and individual claims adjusters
are prohibited by state statutes from engaging in unfair claims
practices. Unfair claims practices include, but are not limited
to, knowingly misrepresenting pertinent facts or insurance
policy provisions; failing to acknowledge and act reasonably
promptly upon communications with respect to claims arising
under insurance policies; and failing to attempt in good faith
to effectuate fair and equitable settlement of claims submitted
in which liability has become reasonably clear. We set business
conduct policies and conduct regular training to make our
employee-adjusters and other claims personnel aware of these
prohibitions, and we require them to conduct their activities in
compliance with these statutes.
Quarterly and Annual Financial Reporting. We
are required to file quarterly and annual financial reports with
state insurance regulators utilizing statutory accounting
practices (SAP) rather than generally accepted
accounting principles (GAAP). In keeping with the
intent to assure policyholder protection, SAP financial reports
generally are based on a liquidation concept. For a summary of
the significant differences for our insurance subsidiaries
between statutory accounting practices and GAAP, see
Note 12 to our audited consolidated financial statements
included in this report.
Periodic Financial and Market Conduct
Examinations. The Ohio Department of Insurance
and Texas Department of Insurance conduct
on-site
visits and examinations our insurance subsidiaries
affairs, including their financial condition and their
relationships and transactions with affiliates, every three to
five years, and may conduct special or target examinations to
address particular concerns or issues at any time. Insurance
regulators of other
29
states in which we do business may also conduct examinations.
The results of these examinations can give rise to regulatory
orders requiring remedial, injunctive or other corrective action.
Risk-Based Capital. Risk-Based Capital
(RBC) requirements laws are designed to assess the
minimum amount of capital that an insurance company needs to
support its overall business operations and to ensure that it
has an acceptably low expectation of becoming financially
impaired. Regulators use RBC to set capital requirements
considering the size and degree of risk taken by the insurer and
taking into account various risk factors including asset risk,
credit risk, underwriting risk and interest rate risk. As the
ratio of an insurers total adjusted capital and surplus
decreases relative to its risk-based capital, the RBC laws
provide for increasing levels of regulatory intervention
culminating with mandatory control of the operations of the
insurer by the domiciliary insurance department at the so-called
mandatory control level.
At December 31, 2007, both Century and PIC maintained an
RBC level in excess of an amount that would require any
corrective actions on our part.
IRIS Ratios. The National Association of
Insurance Commissioners Insurance Regulatory Information System,
or IRIS, is part of a collection of analytical tools designed to
provide state insurance regulators with an integrated approach
to screening and analyzing the financial condition of insurance
companies operating in their respective states. IRIS is intended
to assist state insurance regulators in targeting resources to
those insurers in greatest need of regulatory attention. IRIS
consists of two phases: statistical and analytical. In the
statistical phase, the National Association of Insurance
Commissioners database generates key financial ratio results
based on financial information obtained from insurers
annual statutory statements. The analytical phase is a review of
the annual statements, financial ratios and other automated
solvency tools. The primary goal of the analytical phase is to
identify companies that appear to require immediate regulatory
attention. A ratio result falling outside the usual range of
IRIS ratios is not considered a failing result; rather, unusual
values are viewed as part of the regulatory early monitoring
system. Furthermore, in some years, it may not be unusual for
financially sound companies to have several ratios with results
outside the usual ranges. An insurance company may fall out of
the usual range for one or more ratios because of specific
transactions that are in themselves immaterial.
As of December 31, 2007, Century had no IRIS ratios outside
the usual range and PIC had two IRIS ratios outside the usual
range, as set forth in the following table:
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Company
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Ratio
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Usual Range
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Our Ratio
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PIC
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Change in Net Premiums Written
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33.0 - (33.0
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(38.0
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PIC
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Gross Change in Policyholders Surplus
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50.0 - (10.0
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89.0
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The ratio for Change in Net Premiums Written were outside the
IRIS usual range because of the implementation of the
intercompany pooling agreement which became effective on
January 1, 2006. The ratio for Gross Change in
Policyholders Surplus was outside the IRIS usual ranges
because of a $12.0 million capital contribution received
from Century.
We are monitoring the following:
Broker Contingent Commission. The New York
attorney general investigations into insurance broker activities
connected with contingent commission agreements have led to
lawsuits and prompted other attorneys general and state
insurance departments to conduct further investigations. We have
not received any formal inquiries from state attorneys general
and insurance departments. However, we have conducted internal
reviews of our contingent commission arrangements and related
underwriting practices and we believe we are in full compliance
with the NAIC Model Act. Some state regulatory agencies have
adopted or proposed the adoption of guidelines for the
regulation of agreements for agents and brokers. We continue to
closely monitor all such guidelines and proposals.
Federal Insurance Legislation. Several
legislative measures have been introduced in the
U.S. Congress, which, if enacted, may introduce a new level
of federal, rather than state, regulation, streamline the
regulation of nonadmitted insurance and reinsurance, and to
repeal the federal antitrust exemption afforded to the business
of insurance. Any proposed legislation could have a significant
impact on the insurance industry. We monitor all proposals in
the legislative process.
30
Terrorism Exclusion Regulatory Activity. After
the events of September 11, 2001, the National Association
of Insurance Commissioners urged states to grant conditional
approval to commercial lines endorsements that excluded coverage
for acts of terrorism consistent with language developed by ISO.
The ISO endorsement included certain coverage limitations. Many
states have allowed the endorsements for commercial lines, but
rejected such exclusions for personal exposures.
As a result, Congress enacted and the President signed into law
in November 2002, the Terrorism Risk Insurance Act of 2002 (TRIA
or the Act). TRIA provided a federal backstop for defined acts
of terrorism and imposed certain obligations on insurers. TRIA
was extended in 2005 for a two-year period covering program
years 2006 and 2007, and some changes to the original Act were
made at that time. The Act has been extended for an additional
seven years through December 31, 2014 with the enactment of
the Terrorism Risk Insurance Program Reauthorization Act of 2007
(the 2007 extension).
Several provisions of the Act have changed in the 2007
extension. These include:
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revising the definition of a certified act of terrorism to
eliminate the requirement that an individual is acting on behalf
of any foreign person or foreign interest;
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extending the program through December 31, 2014;
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requiring clear and conspicuous notice to policyholders of the
existence of the $100,000,000,000 cap;
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fixing the insurer deductible at 20 percent of an
insurers direct earned premium and the federal share of
compensation at 85 percent of insured losses that exceed
insurer deductibles;
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fixing the program trigger at $100,000,000 for all additional
program years;
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requiring the U.S. Treasury to promulgate regulations for
determining pro-rata shares of insured losses under the program
when insured losses exceed $100,000,000,000; and,
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accelerating the timing of the mandatory recoupment of the
federal share through policyholder surcharges.
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Other terms of the Act, as amended by the Terrorism Risk
Insurance Extension Act of 2005, remain unchanged. We have
maintained compliance with the TRIA requirements, as extended,
and will continue to comply with such requirements to make the
mandatory terrorism coverage available to policyholders.
Mold Contamination. The property and casualty
insurance industry experienced an increase in claim activity
beginning in 2001 pertaining to mold contamination. Significant
plaintiffs verdicts and increased media attention to the
subject have caused insurers to develop
and/or
refine relevant insurance policy language that excludes mold
coverage. We anticipate increased state legislative activity
pertaining to mold contamination. We will closely monitor
regulatory and litigation trends and continue to review relevant
insurance policy exclusion language.
OFAC. The Treasury Departments Office of
Foreign Asset Control (OFAC) maintains a list of
Specifically Designated Nationals and Blocked
Persons (the SDN List). The SDN List
identifies persons and entities that the government believes are
associated with terrorists, rogue nations
and/or drug
traffickers. OFACs regulations prohibit insurers, among
others, from doing business with persons or entities on the SDN
List. If the insurer finds and confirms a match, the insurer
must take steps to block or reject the transaction, notify the
affected person and file a report with OFAC. The focus on
insurers responsibilities with respect to the SDN List has
increased significantly since September 11. We have
implemented procedures to comply with OFACs SDN List
regulations.
Class Action Reform. Legislation was
enacted by Congress that curtailed forum shopping and allows
defendants to move large national class action cases to federal
courts. The legislation also includes provisions to protect
consumer class members on matters such as non-cash settlements
and written settlement information. We view this as favorable
legislation to us and the industry.
Employees
We employ 323 people as of March 7, 2008. Our
employees are not covered by any collective bargaining
agreements, and we believe our relationship with our employees
is satisfactory.
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Forward
Looking Statements
Forward looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934 appear
throughout this report. Forward looking statements, which
generally include words such as anticipate,
expect, believe, intend,
estimate and similar expressions and include those
statements regarding our expectations, hopes, beliefs,
intentions, goals or strategies regarding the future and are
based on certain underlying assumptions by us. Such assumptions
are, in turn, based on information available and internal
estimates and analyses of general economic conditions,
competitive factors, conditions specific to the property and
casualty insurance industry, claims development and the impact
thereof on our loss reserves, the adequacy of our reinsurance
programs, developments in the securities market and the impact
on our investment portfolio, regulatory changes and conditions,
and other factors. Actual results could differ materially from
those in forward looking statements. We assume no obligation to
update any such statements. You should review the various risks,
uncertainties and other factors listed under Risk
Factors below and elsewhere in this annual report on
Form 10-K
and in our other Securities and Exchange Commission filings.
Our
business is cyclical in nature and our industry is currently
experiencing softening market conditions which may affect our
financial performance, our ability to grow and the price of our
common shares.
Historically, the financial performance of the property and
casualty insurance industry has tended to fluctuate in cyclical
patterns. Although an individual insurance companys
financial performance is dependent on its own specific business
characteristics, the profitability of most property and casualty
insurance companies tends to follow this cyclical market
pattern. This cyclicality is due in large part to the actions of
industry participants, such as inadequate pricing and
increasingly broad policy terms, general economic factors, such
as low interest rates, the impact of terrorist attacks and
severe weather, none of which is within our control. These
cyclical patterns cause our revenues and net income to
fluctuate, which may cause the price of our common shares to be
volatile.
During the past five years, many admitted insurers returned to
more risk-based underwriting disciplines in the standard market,
resulting in higher premium rates, less flexible terms and, in
some cases, an unavailability of adequate insurance coverage in
the standard market in some classes. We, along with other excess
and surplus lines insurers, benefited from this increase in
rates and volume. During 2006, however, the excess and surplus
lines industry began to experience softer market conditions
primarily attributed to intensified competition from admitted
and surplus lines insurers, resulting in slight rate decreases.
Because these market conditions are due in large part to the
actions of our competitors and general economic factors, we
cannot predict the timing or duration of these conditions. This
increased competition intensified in 2007 and is continuing in
2008.
Our
success depends on our ability to appropriately price the risks
we underwrite.
Our financial condition depends on our ability to underwrite and
set premium rates accurately for a wide variety of risks. Rate
adequacy is necessary to generate sufficient premiums to pay
losses, loss expenses and underwriting expenses and to earn a
profit. In order to price our products accurately, we must
collect and properly analyze a substantial amount of data,
develop, test and apply appropriate rating formulas, closely
monitor and timely recognize changes in trends and project both
severity and frequency of losses with reasonable accuracy. Our
ability to undertake these efforts successfully and price our
products accurately is subject to a number of risks and
uncertainties, some of which are outside our control, including:
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the availability of sufficient reliable data and our ability to
properly analyze available data;
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the uncertainties that inherently characterize estimates and
assumptions;
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our selection and application of appropriate rating and pricing
techniques; and
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changes in legal standards, claim settlement practices, medical
care expenses and restoration costs.
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Consequently, we could under-price risks, which would negatively
affect our profit margins, or we could overprice risks, which
could reduce our sales volume and competitiveness. In either
event, our profitability could be materially and adversely
affected.
32
Our
actual incurred losses may be greater than our loss and loss
expense reserves, which could cause our future earnings,
liquidity and financial rating to decline.
We are liable for loss and loss expenses under the terms of the
insurance policies we write. In many cases, several years may
elapse between the occurrence of an insured loss, the reporting
of the loss to us and our payment of the loss. We establish loss
and loss expense reserves for our estimate of the ultimate
payment of all loss and loss expenses incurred. If any of our
reserves prove to be inadequate, we will be required to increase
reserves resulting in a reduction in our net income in the
period in which the inadequacy is identified. Future loss
experience substantially in excess of established reserves could
also cause our future earnings, liquidity and financial rating
to decline. These reserves are based on historical data and
estimates of future events and by their nature are imprecise.
Our ultimate loss and loss expenses may vary from established
reserves.
Furthermore, several factors may have a substantial impact on
our future loss experience. These factors may include:
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inflation in the size of claims;
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claims development patterns;
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legislative and judicial activity;
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social and economic patterns; and
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litigation and regulatory trends.
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Additionally, we have established loss and loss expense reserves
for certain lines of business we have exited, but circumstances
could develop that would make these reserves insufficient. As of
December 31, 2007, unpaid loss and loss expense reserves
(net of reserves ceded to our reinsurers) were
$238.4 million, consisting of case loss and loss expense
reserves of $70.0 million and incurred but not reported
loss and loss expense reserves of $168.4 million.
We have re-estimated our loss and loss expense reserves
attributable to insured events in prior years. These
reestimations resulted in a (decrease) increase in reserves of
$(9.1) million, $(1.1) million and $5.4 million
for the years ended December 31, 2007, 2006 and 2005,
respectively.
Severe
weather conditions and other catastrophes may result in an
increase in the number and amount of claims experienced by our
insureds.
Most of our property business is exposed to the risk of severe
weather conditions and other catastrophes. Catastrophes can be
caused by various events, including natural events such as
severe hurricanes, winter weather, tornadoes, windstorms,
earthquakes, hailstorms, severe thunderstorms and fires, and
other events such as explosions, terrorist attacks and riots.
The incidence and severity of catastrophes and severe weather
conditions are inherently unpredictable. Severe weather
conditions and catastrophes can cause losses in all of our
property lines and generally result in an increase in the number
of claims incurred as well as the amount of compensation sought
by claimants because every geographic location in which we
provide insurance policies is subject to the risk of severe
weather conditions. In 2005, we recorded $5.4 million of
after tax losses related to the hurricane season. Throughout
2007, 2006 and prior to December 31, 2004, we have not been
materially impacted by catastrophic events. We use a model that
is commonly used throughout the industry to help us ensure that
we are purchasing sufficient catastrophe reinsurance limits.
Currently, we purchase catastrophe reinsurance to cover a
potential catastrophe that is modeled to only occur once every
500 years. There can be no assurance that this modeled
information will accurately predict catastrophic losses. It is
possible that a catastrophic event or multiple catastrophic
events could cause our loss and loss expense reserves to
increase and our liquidity and financial condition to decline.
A
decline in our financial rating assigned by A.M. Best may
result in a reduction of new or renewal business.
A.M. Best, an insurance rating agency, assigns ratings that
generally are based on an insurance companys ability to
pay policyholder obligations. The A.M. Best ratings
criteria focus on capital adequacy, loss and loss
33
expense reserve adequacy and operating performance. A reduction
in our performance in these criteria could result in a downgrade
of an insurance companys rating. Our insurance
subsidiaries received an A− (excellent) pooled
annual rating in 2007 from A.M. Best. A downgrade of our
rating below A− (excellent) could cause our
current and future general agents, retail brokers and insureds
to choose other, more highly rated competitors which would have
an adverse impact on our financial results.
We may
incur increased costs in competing for underwriting revenue. If
we are unable to compete effectively with the large number of
companies in the insurance industry for underwriting revenues,
our underwriting revenues and net income may
decline.
We compete with a large number of other companies in our
selected lines of business. We face competition from specialty
insurance companies, underwriting agencies and intermediaries,
as well as from diversified financial services companies that
are significantly larger than we are and that have significantly
greater financial, marketing, management and other resources
than we do. Some of these competitors also have significantly
greater experience and market recognition than we do.
In its annual U.S. Surplus Lines Market Review Special
Report, published in October 2007, A.M. Best stated
that the large, well established insurance carriers continue to
dominate the excess and surplus lines market, with the top 25
insurance groups commanding an 81% share of the market. While we
believe opportunities are available in this market, the leading
insurance carriers have a firm stronghold. We are not one of the
25 largest insurance carriers in the excess and surplus lines
market. Competition in this market is generally based on many
factors, including
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the perceived market strength of the insurer in a particular
line;
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pricing and other terms and conditions;
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service;
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promptness of claims payment;
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the reputation and experience of the insurer; and
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ratings assigned by independent ratings organizations, such as
A.M. Best.
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We compete primarily on the basis of service.
We may incur increased costs in competing for premiums. If we
are unable to compete effectively in the markets in which we
operate or to expand our operations into new markets, our
underwriting revenues and net income may decline.
A number of new, proposed or potential legislative and industry
developments could further increase competition in our industry.
These developments include:
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an increase in capital-raising by companies in our lines of
business, which could result in new entrants to our markets and
an excess of capital in the industry;
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the implementation of commercial lines deregulation in several
states, which could increase competition from standard carriers
for our excess and surplus lines of insurance business;
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programs in which state-sponsored entities provide property
insurance in catastrophe prone areas; and
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changing practices caused by the Internet, which may lead to
greater competition in the insurance business.
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New competition from these developments could cause the supply
and/or
demand for insurance or reinsurance to change, which could
affect our ability to price our products at attractive rates and
thereby affect our underwriting results. Ultimately, this
competition could affect our ability to attract business at
premium rates that are likely to generate underwriting profits.
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We
distribute our products through a select group of general
agents, ten of which account for a significant part of our
business, and such relationships could be discontinued or cease
to be profitable.
We distribute our products through a select group of general
agents. Of our gross written premiums for the year ended
December 31, 2007, 52.1% were distributed through ten
general agents. In 2007, our largest agency group, with
locations in seven states, accounted for $43.3 million
(18.2%) of our total gross written premiums. A loss of all or
substantially all the business produced by one or more of these
general agents could have a negative impact on our revenues.
We may
not be successful in developing our new specialty lines or new
classes of insureds through our program unit that could cause us
to experience losses.
Since 2003, we have entered into several new specialty lines of
business and more than ten new offerings through our program
unit, including commercial auto physical damage, garage
liability and ocean marine. We continue to look for appropriate
opportunities to diversify our business portfolio by offering
new lines of insurance in which we believe we have sufficient
underwriting and claim expertise. However, because of our
limited history in these new lines, there is limited financial
information available to help us evaluate whether we will be
able to successfully develop these new lines or the likely
ultimate losses and expenses associated with these new lines. We
also may have less experience managing their development and
growth than some of our competitors. Additionally, there is a
risk that the lines of business into which we expand will not
perform at the levels we anticipate.
We may
not find suitable acquisition candidates or new insurance
ventures and even if we do, we may not successfully integrate
any such acquired companies or successfully invest in such
ventures.
As part of our present strategy, we continue to evaluate
possible acquisition transactions and the
start-up of
complementary business ventures on an ongoing basis, and at any
given time, we may be engaged in discussions with respect to
possible acquisitions and new ventures. We cannot assure you
that we will be able to identify suitable acquisition
transactions or insurance ventures, that such transactions will
be financed and completed on acceptable terms or that our future
acquisitions or ventures will be successful. The process of
integrating any company involves a number of special risks,
including the possibility that management may be distracted from
regular business concerns by the need to integrate operations,
unforeseen difficulties in integrating operations and systems,
problems concerning assimilating and retaining the employees of
the acquired company, challenges in retaining customers and
potential adverse short-term effects on operating results. In
addition, we may incur debt to finance future acquisitions and
we may issue securities in connection with future acquisitions
which may dilute the holdings of our current and future
shareholders. If we are unable to successfully complete and
integrate strategic acquisitions in a timely manner, our growth
strategy could be adversely affected. Furthermore, our current
acquisition strategy may include the evaluation of potential
acquisitions of privately-held companies. Because privately-held
companies are generally not subject to Section 404 of the
Sarbanes-Oxley Act of 2002, such companies may not have adequate
internal control procedures, which may, during our integration
with any such company, have an adverse affect on our internal
controls.
Our
investment results and, therefore, our financial condition may
be impacted by changes in the business, financial condition or
operating results of the entities in which we invest, illiquid
credit markets, as well as changes in government monetary
policies, general economic conditions and overall capital market
conditions, all of which impact interest rates.
Our results of operations depend, in part, on the performance of
our investments. Interest rates are highly sensitive to many
factors, including governmental monetary policies and domestic
and international economic and political conditions.
Fluctuations in interest rates affect our returns on and the
fair value of our fixed-maturity securities and equity
securities. In addition, market volatility can make it difficult
to value certain of our securities if trading becomes less
frequent. Unrealized gains and losses on available-for-sale
fixed-maturity securities and equity securities are recognized
in Accumulated other comprehensive income, net of
taxes and increase or decrease our shareholders
equity as reflected in our Consolidated Balance Sheet. Interest
rates in the United States are currently low relative to
historical levels. Our available-for-sale fixed-maturity
securities and equity securities are currently in a net
unrealized loss position, and an increase in interest rates
would further reduce the fair value of
35
our investments in available-for-sale fixed-maturity securities
and equity securities. In addition, defaults by third parties
who fail to pay or perform obligations could reduce our
investment income and could result in investment losses in our
portfolio.
We had fixed-maturity and equity investments with a fair value
of $450.8 million as of December 31, 2007 that are
subject to:
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credit risk, which is the risk that our investments will
decrease in value due to unfavorable changes in the financial
prospects or a downgrade in the credit rating of an entity in
which we have invested;
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equity price risk, which is the risk that we will incur economic
loss due to a decline in common or preferred stock or bond
mutual fund share prices; and
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interest rate risk, which is the risk that our investments may
decrease in value due to changes in interest rates.
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Our fixed-maturity investment portfolio had a fair value of
$407.6 million as of December 31, 2007 and includes
mortgage-backed and other asset-backed securities. As of
December 31, 2007, the fair value of mortgage-backed
securities, asset-backed securities and collateralized mortgage
obligations totaled $154.7 million and constituted 33.1% of
our cash and investment portfolio. As with other fixed-maturity
investments, the fair value of these securities fluctuates
depending on market and other general economic conditions and
the interest rate environment. Changes in interest rates can
expose us to prepayment risks on these investments. In periods
of declining interest rates, mortgage prepayments generally
increase and mortgage-backed securities and other asset-backed
securities are paid more quickly, requiring us to reinvest the
proceeds at the then prevailing market rates.
Our equity portfolio totaled $43.2 million as of
December 31, 2007. This total includes $29.0 million
of investments in preferred and common securities of individual
companies, which are subject to economic loss from the decline
in preferred and common share prices. As a result, the value of
these investments are driven by the specific financial prospects
of these individual companies, as well as the equity markets in
general. The remaining $14.2 million of our equity
portfolio is invested in bond mutual funds.
The book value of our sub-prime residential mortgage backed
securities as of December 31, 2007 was $8.4 million.
Sub-prime mortgage lending is the origination of residential
mortgage loans to customers with weak credit profiles. We are
not an originator of below-prime mortgages. The slowing
U.S. housing market, greater use of affordability mortgage
products, and relaxed underwriting standards for some
originators of below-prime loans has recently led to higher
delinquency and loss rates, especially within the 2006 and 2007
vintage years. We do not own any sub-prime securities that are
backed by mortgage loans made in either 2006 or 2007. These
factors have caused a pull-back in market liquidity and
repricing of risk, which has led to an increase in unrealized
losses from December 31, 2006 to December 31, 2007. We
expect delinquency and loss rates in the sub-prime mortgage
sector to be volatile in the near term. In accordance with
EITF 99-20,
we have performed cash flow analysis on our sub-prime holdings
stressing multiple variables, including prepayment speeds,
default rates, and loss severity. Based on this analysis and our
expectation of future loan performance, other than certain
credit-related impairments recorded in the current year, future
payments are expected to be received in accordance with the
contractual terms of the securities. For a discussion on
credit-related impairments, see Other-Than-Temporary Impairments
section included under Managements Discussion and
Analysis of Financial Condition and Results of
Operations Investment Results below.
During 2007, the U.S. financial markets have experienced a
significant level of volatility in the value of the equity
markets and a spread widening in the fixed-maturity markets. In
addition, certain sectors of fixed-maturity securities,
primarily asset backed securities, experienced a significant
level of illiquidity and price dislocation, each of which also
affect the value of our fixed-maturity securities. As of
December 31, 2007, our fixed-maturity securities, equity
securities, preferred shares and bond mutual funds, had a fair
value of $450.8 million, which represents 96.5% of our
total cash and investment portfolio, these securities are
subject to changes in fair value based on fluctuations in
interest rates. As of December 31, 2007, a 200 basis
point decline in interest rates would result in a
$42.3 million, or 9.5% increase in fair value of our
portfolio and a 200 basis point increase would result in a
$45.0 million, or 10.0%, decrease in fair value of our
portfolio. As of December 31, 2007, our investment
portfolio had a net unrealized investment loss, after the effect
of income taxes of $8.7 million. However, these unrealized
36
losses may not persist in the current economic environment or
may not be realized or the ultimate loss may be greater.
Our
investment performance may suffer as a result of adverse capital
market developments or other factors, which may affect our
financial results and ability to conduct business.
We invest the premiums we receive from policyholders until it is
needed to pay policyholder claims or other expenses. Our
investment portfolio is managed by three outside independent
investment managers, all of which operate under investment
guidelines approved by our investment committee. Although we
seek to maintain sufficient liquidity from operations, investing
and financing activities to meet our anticipated insurance
obligations and operating and capital expenditure needs, our
investments are subject to a variety of risks, including risks
relating to general economic conditions, market volatility,
interest rate fluctuations, liquidity risk and credit and
default risk. In particular, the volatility of our claims may
force us to liquidate securities, which may cause us to incur
capital losses. If we do not structure our investment portfolio
so that it is appropriately matched with our insurance
liabilities, we may be forced to liquidate investments prior to
maturity at a significant loss to cover such liabilities.
Investment losses could significantly decrease our asset base
and statutory surplus, thereby affecting our ability to conduct
business.
If we
are not able to renew our existing reinsurance or obtain new
reinsurance, either our net exposure would increase or we would
have to reduce the level of our underwriting
commitment.
In 2008, for our property business, we retain the first $500,000
of a loss and share on a quota share basis 18% of the loss
amount that exceeds $500,000 up to $1.0 million. For
example, if we have a casualty policy that has a $600,000 loss,
the reinsurer will be liable to us for $82,000 of the loss. For
our casualty business, we retain the first $500,000 of a loss
and share on a quota share basis 50% of the loss amount that
exceeds $500,000 up to $1.0 million. For example, if we
have a casualty policy that has a $600,000 loss, the reinsurer
will be liable to us for $50,000 of the loss.
In 2007, we purchased property excess of loss reinsurance to
limit our loss from a single occurrence on any one coverage part
from any one policy to $500,000. For example, if we have a
property policy that has a $600,000 loss, the reinsurer will be
liable to us for $100,000 of the loss. For our casualty
business, we retain the first $500,000 of a loss and share on a
quota share basis 50% of the loss amount that exceeds $500,000
up to $1.0 million. For example, if we have a casualty
policy that has a $600,000 loss, the reinsurer will be liable to
us for $50,000 of the loss.
Further, we purchase catastrophe reinsurance to limit losses
arising from any single occurrence, to $4.0 million up to
$15.2 million, regardless of how many policyholders are
involved or the extent of their loss,. We purchase casualty
clash coverage for the loss amount above $1.0 million up to
$19.0 million for any single occurrence, regardless of the
number of policyholders involved. However, we may choose in the
future to re-evaluate the use of reinsurance to increase or
decrease the amount of liability we cede to reinsurers,
depending upon the cost and availability of reinsurance.
Market conditions beyond our control determine the availability
and cost of the reinsurance protection that we purchase. The
reinsurance market has changed dramatically over the past few
years as a result of inadequate pricing, poor underwriting and
the significant losses incurred in conjunction with the
terrorist attacks on September 11, 2001 and the 2004 and
2005 hurricane storm seasons. As a result, reinsurers have
exited some lines of business, reduced available capacity and
implemented provisions in their contracts designed to reduce
their exposure to loss. In addition, the historical results of
reinsurance programs and the availability of capital also affect
the availability of reinsurance. The reinsurance market improved
throughout 2006, 2007 and 2008 due to a moderate hurricane
season.
Our reinsurance facilities generally are subject to annual
renewal. If we are unable to renew our expiring facilities or to
obtain new reinsurance facilities, either our net exposures
would increase, which could increase our exposure to loss, or,
if we were unwilling to bear an increase in net exposures, we
would have to reduce the level of our underwriting commitments,
especially catastrophe exposed risks, which would reduce our
revenues. To the extent that we are forced to pay more for
reinsurance or retain more liability than we do currently, we
may need to reduce the volume of insurance we write. Due to the
underwriting profile of our business, we have not been
37
significantly impacted by the changes in the reinsurance market
described above either in claims or reinsurance terms and
pricing.
Our
reinsurers may not pay claims made by us on losses in a timely
fashion or may not pay some or all of these claims, in each case
causing our costs to increase and our revenues to
decline.
We purchase reinsurance by transferring part of the risk we have
assumed (known as ceding) to a reinsurance company in exchange
for part of the premium we receive in connection with the risk.
Although reinsurance makes the reinsurer liable to us to the
extent the risk is transferred or ceded to the reinsurer, it
does not relieve us (the reinsured) of our liability to our
policyholders. Accordingly, we bear credit risk with respect to
our reinsurers. That is, our reinsurers may not pay claims made
by us on a timely basis, or they may not pay some or all of
these claims. Either of these events would increase our costs.
As of December 31, 2007, we had $44.8 million of
amounts recoverable from our reinsurers that we would be
obligated to pay if our reinsurers failed to pay. We have
recorded a provision for uncollectible amounts of
$3.4 million at December 31, 2007 and
$4.1 million at December 31, 2006, which relates to
balances due from reinsurers that are in dispute.
We are
subject to extensive regulation, which may adversely affect our
ability to achieve our business objectives. In addition, if we
fail to comply with these regulations, we may be subject to
penalties, including fines and suspensions, which may adversely
affect our financial condition and results of
operations.
General. Our insurance subsidiaries are
subject to regulations, administered primarily by Ohio and
Texas, our domiciliary states, and to a lesser degree, the other
states in which we are licensed or admitted to sell insurance.
Most insurance regulations are designed to protect the interests
of insurance policyholders, as opposed to the interests of
shareholders. These regulations are generally administered by a
department of insurance in each state and relate to, among other
things, excess and surplus lines of business authorizations,
capital and surplus requirements, rate and form approvals,
investment parameter restrictions, underwriting limitations,
affiliate transactions, dividend limitations, changes in control
and a variety of other financial and non-financial components of
our business. In addition, we are subject to privacy regulations
and restrictions on our ability to cancel or not renew a policy
or to withdraw from one or more lines of business within a
state. Significant changes in these laws and regulations could
limit our discretion or make it more expensive to conduct our
business. State insurance departments also conduct periodic
examinations of the affairs of insurance companies and require
the filing of annual and other reports relating to financial
condition, holding company issues and other matters. These
regulatory requirements may adversely affect or inhibit our
ability to achieve some or all of our business objectives.
Required Licensing. Regulatory authorities
have broad discretion to deny or revoke licenses for various
reasons, including the violation of regulations. In some
instances, where there is uncertainty as to applicability, we
follow practices based on our interpretations of regulations or
practices that we believe generally to be followed by the
industry. These practices may ultimately be different from the
interpretations of regulatory authorities. If we do not have the
requisite licenses and approvals or do not comply with
applicable regulatory requirements, insurance regulatory
authorities could preclude or temporarily suspend us from
carrying on some or all of our activities or otherwise penalize
us. This could adversely affect our ability to operate our
business. Further, changes in the level of regulation of the
insurance industry or changes in laws or regulations themselves
or interpretations by regulatory authorities could adversely
affect our ability to operate our business.
Risk-Based Capital. The National Association
of Insurance Commissioners has adopted a system to test the
adequacy of statutory capital, known as risk-based
capital. This system establishes the minimum amount of
riskbased capital necessary for a company to support its overall
business operations. It identifies property and casualty
insurers that may be inadequately capitalized by evaluating
certain inherent risks of each insurers assets and
liabilities and its mix of net written premiums. Insurers
falling below a calculated threshold may be subject to varying
degrees of regulatory action, including supervision,
rehabilitation or liquidation. Failure to maintain our riskbased
capital at the required levels could cause our insurance
subsidiary to lose its regulatory authority to conduct its
business. See Managements Discussion and Analysis of
Financial Condition and Results of Operations
Liquidity and Capital Resources for a discussion of our
risk-based capital as of December 31, 2007.
38
IRIS Ratios. The Insurance Regulatory
Information System, or IRIS, is part of a collection of
analytical tools designed to provide state insurance regulators
with an integrated approach to screening and analyzing the
financial condition of insurance companies. IRIS has two phases
of screening: statistical and analytical. In the statistical
phase, the National Association of Insurance Commissioners
database generates financial ratios based on financial
information obtained from insurance companies annual
statutory statements. The analytical phase is a review of the
annual statements, financial ratios and other automated solvency
tools. A ratio result falling outside the usual range of IRIS
ratios is viewed as part of the regulatory early monitoring
system. As of December 31, 2007, Century had no IRIS ratios
outside the usual range and PIC had two IRIS ratios outside the
usual range, as described in Our Business
Regulatory Environment IRIS
Ratios, which could result in possible regulatory
attention.
We are
subject to judicial decisions affecting insurance and tort law,
which may adversely affect our ability to achieve our business
objectives.
State courts may render decisions impacting our liability for
losses under insurance and tort law. This case law, as well as
any legislation enacted in response, can impact the claim
severity and frequency assumptions underlying our reserves.
Accordingly, our ultimate liability may exceed our estimates due
to this variable, among others.
As a
holding company, we are dependent on the results of operations
of our insurance subsidiaries and the regulatory and contractual
capacity of our subsidiaries to pay dividends to us. Some states
limit the aggregate amount of dividends our subsidiaries may pay
to us in any twelve-month period, thereby limiting our funds to
pay expenses and dividends.
We are an insurance holding company and our principal asset is
the shares we hold in Century. Dividends and other payments from
this company are our primary source of funds to pay expenses and
dividends to our shareholders. The payment of dividends by
Century to us is limited by statute. In general, these
restrictions limit the aggregate amount of dividends or other
distributions that Century may declare or pay within any
twelve-month period without advance regulatory approval.
Generally, this limitation is the greater of statutory net
income for the preceding calendar year or 10% of the statutory
surplus at the end of the preceding calendar year. In addition,
insurance regulators have broad powers to prevent reduction of
statutory surplus to inadequate levels and could refuse to
permit the payment of dividends of the maximum amounts
calculated under any applicable formula. As a result, we may not
be able to receive dividends from our subsidiary at times and in
amounts necessary to meet our debt service obligations or to pay
dividends to our shareholders or corporate expenses. The amount
of dividends that can be paid to us from Century in 2008 without
regulatory approval is $27.4 million.
Although
we have paid cash dividends in the past, we may not pay cash
dividends in the future.
The declaration and payment of dividends is subject to the
discretion of our board of directors and will depend on our
financial condition, results of operations, cash requirements,
future prospects, regulatory and contractual restrictions on the
payment of dividends by our subsidiaries and other factors
deemed relevant by our board of directors. There is no
requirement that we must, and we cannot assure you that we will,
declare and pay any dividends in the future. Our board of
directors may determine to retain such capital for general
corporate or other purposes.
If we
lose key personnel or are unable to recruit qualified personnel,
our ability to implement our business strategies could be
delayed or hindered.
Our future success will depend, in large part, upon the efforts
of our executive officers and other key personnel. We rely
substantially upon the services of Edward F. Feighan, our
Chairman of the Board, President and Chief Executive Officer,
Erin E. West, our Vice President, Chief Financial Officer and
Treasurer and Christopher J. Timm, our Executive Vice President
and Director. Messrs. Feighan and Timm and Ms. West
each have an employment agreement with us. The loss of any of
these officers or other key personnel could cause our ability to
implement our business strategies to be delayed or hindered. We
do not have key person insurance on the lives of any of our key
management personnel, except one officer. As we continue to
grow, we will need to recruit and retain additional qualified
personnel, but we may not be able to do so. As we have grown, we
have generally been successful in filling key positions, but our
ability to continue to recruit and retain such personnel will
depend upon a number of factors,
39
such as our results of operations, prospects and the level of
competition then prevailing in the market for qualified
personnel.
Managing
technology initiatives and meeting new data security
requirements present significant risks for us, which could lead
to increased costs or business disruptions.
While technological developments can streamline many business
processes and ultimately reduce the cost of operations,
technology initiatives can present short-term cost and
implementation risks. In addition, projections of expenses,
implementation schedules and utility of results my be inaccurate
and can escalate over time. We rely on these systems to process
new and renewal business, provide customer service, make claims
payments and facilitate collections and cancellations, as well
as to perform actuarial and other analytical functions necessary
for pricing and product development. Failure to implement or
maintain adequate systems could significantly increase our costs
or cause us to lose business, each of which could adversely
affect our results of operations.
Data security is subject to increasing regulation. We face
rising costs and competing time constraints in meeting
compliance requirements of new and proposed regulations. The
expanding volume and sophistication of computer viruses, hackers
and other external hazards may increase the vulnerability of our
data systems to security breaches. These increased risks and
expanding regulatory requirement expose us to potential data
loss and damages and significant increases in compliance and
litigation costs.
Our
general agents may exceed their authority and bind us to
policies outside our underwriting guidelines, and until we
effect a cancellation, we may incur loss and loss expenses
related to that policy.
As of December 31, 2007, we underwrote 63.6% of our
property and casualty premiums on a limited binding authority
basis. Binding authority business represents risks that may be
quoted and bound by our general agents prior to our underwriting
review. If a general agent exceeds this authority by binding us
to a risk that does not comply with our underwriting guidelines,
we are at risk for claims under that policy that occur during
the period from its issue date until we receive the policy and
cancel it. To cancel a policy for exceeding underwriting
authority, we must receive and cancel the policy within
statutorily prescribed time limits that are dependent on the
jurisdiction but are typically 60 days. Our general agents
are required by contract to have bound policies issued and a
copy sent to our office within 30 days of the effective
date of coverage. Our policy review generally takes two to four
weeks, depending on the time of year. Upon review of a policy,
we issue instructions to cure any material errors we discover.
If cancellation of the policy is the only cure, we order the
cancellation of the policy at that time pursuant to state law.
As a result, we may be bound by a policy that does not comply
with our underwriting guidelines, and until we can effect a
cancellation, we may incur loss and loss expenses related to
that policy.
Our
reliance on our agents subjects us to credit risk.
Our agents collect premiums from policyholders and forward them
to us. In certain jurisdictions, when the insured pays premiums
for these policies to agents for payment over to us, the
premiums might be considered to have been paid under applicable
insurance laws and regulations, and the insured will no longer
be liable to us for these amounts, whether or not we actually
receive the premiums from the agent. Consequently, we assume a
degree of credit risk associated with our agents. Although
agents failures to remit premiums to us have not caused a
material adverse impact on us to date, there have been instances
where agents collected premiums and did not remit it to us and
we were nonetheless required under applicable law to provide the
coverage set forth in the policy despite the absence of premium.
Because the possibility of these events is dependent in large
part upon the financial condition of our agents, which is not
publicly available, we are not able to quantify the exposure
presented by this risk. If we are unable to collect premiums
from our agents in the future, our financial condition and
results of operations could be materially and adversely affected.
We are
exposed to risks relating to evaluations of controls required by
Section 404 of the Sarbanes-Oxley Act of 2002.
We continue to evaluate our internal controls systems to allow
management to report on, and our independent registered public
accounting firm to audit, our internal controls over financial
reporting and to perform the system
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and process evaluation and testing (and any necessary
remediation) required to comply with the management
certification and auditor attestation requirements of
Section 404 of the Sarbanes-Oxley Act of 2002. In the
course of this evaluation, we may identify control deficiencies
of varying degrees of severity under applicable SEC and Public
Company Accounting Oversight Board rules and regulations that
remain unremediated. As a public company, we are required to
report, among other things, control deficiencies that constitute
a material weakness or changes in internal controls
that, or are reasonably likely to, materially affect internal
controls over financial reporting. A material
weakness is a significant deficiency, or combination of
significant deficiencies that results in more than a remote
likelihood that a material misstatement of the annual or interim
financial statements will not be prevented or detected. If we
cease to comply with the requirements of Section 404
manner, we might be subject to sanctions or investigation by
regulatory authorities such as the SEC or NASDAQ. Additionally,
failure to comply with Section 404 or the report by us of a
material weakness may cause investors to lose confidence in our
financial statements and our stock price may be adversely
affected. If we fail to remedy any material weakness, our
financial statements may be inaccurate, we may face restricted
access to the capital markets, and your share price may be
adversely affected.
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Item 1B.
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Unresolved
Staff Comments
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None
Our corporate headquarters is a 44,000 square foot office
building located in Westerville, Ohio. We lease this building
pursuant to a lease agreement with an initial term of ten years,
which expires in 2013. In addition, we have an option to renew
the lease agreement for two five-year terms. In July 2006, we
leased 11,000 additional square feet of office space in the same
complex as our corporate headquarters. This space was leased
with an initial term of five years and an option to terminate
the lease after two years with one-month advance notice and
payment of any unamortized leasehold improvements and brokerage
cost.
We also lease an aggregate of 20,000 square feet of office
space in Phoenix, Arizona. Our lease of this space has an
initial term that expires in 2009. We also lease
1,200 square feet of office space in Conrad, Texas which
has a three-year lease term, ending in April 30, 2010.
Beginning in February 2008, we also lease 1,181 square feet
of office space in Naples, Florida. This lease expires in 2011.
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Item 3.
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Legal
Proceedings
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We are party to lawsuits, arbitrations and other proceedings
that arise in the normal course of our business. Many of such
lawsuits, arbitrations and other proceedings involve claims
under policies that we underwrite as an insurer, the liabilities
for which we believe have been adequately included in our loss
and loss expense reserves. Also, from time to time, we are party
to lawsuits, arbitrations and other proceedings that relate to
disputes over contractual relationships with third parties, or
that involve alleged errors and omissions on the part of our
insurance subsidiaries. We provide accruals for these items to
the extent we deem the losses probable and reasonably estimable.
The outcome of litigation is subject to numerous uncertainties.
Although the ultimate outcome of pending matters cannot be
determined at this time, based on present information, we
believe the resolution of these matters will not have a material
adverse effect on our financial position, results of operations
or cash flows.
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Item 4.
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Submission
of Matters to a Vote of the Security Holders
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There were no matters submitted to a vote of security holders in
the fourth quarter of 2007.
41
Executive
Officers of the Registrant
The following table sets forth certain information concerning
our executive officers as of March 17, 2008:
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Name
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Age
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Position with ProCentury
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Edward F. Feighan
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60
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Chairman of the Board, President, Chief Executive Officer
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Erin E. West
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32
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Chief Financial Officer and Treasurer
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Christopher J. Timm
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51
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Executive Vice President and Director
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Greg D. Ewald
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54
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Senior Vice President of Underwriting
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James P. Flood
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57
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Senior Vice President of Operations
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Edward F. Feighan has been our Chairman, President and Chief
Executive Officer since October 2003. Mr. Feighan was
President of Avalon National Corporation, a holding company for
a workers compensation insurance agency, from 1998 until
2000. From September 1998 until May 2003, Mr. Feighan was
Managing Partner of Alliance Financial, Ltd., a merchant banking
firm specializing in mergers and acquisitions. He has served as
a director of our company and our insurance company subsidiaries
from 1993 to 1996 and from 2000 to the present. Mr. Feighan
has served at times as our Special Counsel.
Erin E. West was named Chief Financial Officer and Treasurer in
October 2005. Ms. West served under our former Chief
Financial Officer, Mr. Charles D. Hamm, Jr., as Chief
Financial Officer of Century since July 2004 and Vice President
of Century since December 2003. Ms. West also serves as
director, Secretary and Treasurer of both Century and ProCentury
Insurance Company. Ms. West is a certified public
accountant and was formerly a Supervising Senior with KPMG LLP
from 1997 to 2001.
Christopher J. Timm was named Executive Vice President and
President of Century in May 2003. Since 2000, he has served as a
Director and Vice President of ProCentury and a senior officer
and director of most companies within the Century Insurance
Group®.
From 1998 until 2000, following the sale of
Environmental & Commercial Insurance Agency, Inc.,
Mr. Timm complied with the terms of a non-compete agreement
and pursued non-insurance business ventures. From 1990 through
1998, Mr. Timm was an owner and President of
Environmental & Commercial Insurance Agency, Inc., a
managing underwriting agency.
Greg D. Ewald has served as Senior Vice President of
Underwriting for Century since 2000. Mr. Ewald serves as a
director of both Century and ProCentury Insurance Company and is
a director and President of ProCentury Risk Partners Insurance
Company, a D.C. captive insurer subsidiary of ProCentury
Corporation. Previously, Mr. Ewald was Senior Vice
President for Acceptance Insurance Company from 1990 to 2000 and
for Underwriters Reinsurance Company (now Swiss Re) from 1979 to
1990.
James P. Flood was named Senior Vice President of Operations in
November of 2007. Since October 2003, Mr. Flood has served
as Senior Vice President of Claims for Century. Mr. Flood
also serves as a Director of both Century and ProCentury
Insurance Company. From 2002 to 2003, Mr. Flood was a
management and claims consultant and, from 1995 to 2002, served
as Claims Senior Vice President, Group Vice President and Chief
Claims Officer for CNA. From 1988 to 1995, Mr. Flood was
Senior Vice President of Claims for Continental Insurance
Company. From 1977 to 1987, Mr. Flood was a trial attorney
for Buckeye Union Insurance Company. He was admitted to the Ohio
Bar in 1977.
42
PART II
|
|
Item 5.
|
Market
for the Registrants Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities
|
ProCentury Corporation (symbol: PROS) common shares are listed
on the NASDAQ National Market. As of March 7, 2008, there
were 89 holders of record of the 13,421,032 outstanding common
shares of the Company. The high, low and closing sale prices of
our common shares for each quarter in 2007, 2006, and 2005 are
listed below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter of 2007
|
|
|
|
1st
|
|
|
2nd
|
|
|
3rd
|
|
|
4th
|
|
|
High
|
|
$
|
23.30
|
|
|
|
24.00
|
|
|
|
16.84
|
|
|
|
15.54
|
|
Low
|
|
|
17.75
|
|
|
|
16.50
|
|
|
|
11.90
|
|
|
|
13.60
|
|
Close
|
|
|
23.20
|
|
|
|
16.76
|
|
|
|
14.63
|
|
|
|
15.35
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter of 2006
|
|
|
|
1st
|
|
|
2nd
|
|
|
3rd
|
|
|
4th
|
|
|
High
|
|
$
|
13.64
|
|
|
|
14.29
|
|
|
|
15.74
|
|
|
|
18.92
|
|
Low
|
|
|
10.50
|
|
|
|
12.50
|
|
|
|
12.89
|
|
|
|
14.29
|
|
Close
|
|
|
13.64
|
|
|
|
13.71
|
|
|
|
15.00
|
|
|
|
18.50
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter of 2005
|
|
|
|
1st
|
|
|
2nd
|
|
|
3rd
|
|
|
4th
|
|
|
High
|
|
$
|
12.50
|
|
|
|
11.05
|
|
|
|
10.75
|
|
|
|
11.45
|
|
Low
|
|
|
10.11
|
|
|
|
9.75
|
|
|
|
9.81
|
|
|
|
9.96
|
|
Close
|
|
|
10.49
|
|
|
|
10.20
|
|
|
|
10.22
|
|
|
|
10.73
|
|
The Company declared a $0.04 per share cash dividend in each
quarter of 2007. The Company declared a $0.03, $0.035, $0.04 and
$0.04 per share cash dividend in the first, second, third and
fourth quarters of 2006, respectively. The Company declared a
$0.02 per share cash dividend in the first three quarters of
2005 and $0.025 in the fourth quarter of 2005. As an insurance
holding company, our principal asset is the shares we hold in
Century. The dividends and other payments from Century are our
primary source of funds; however, the payment of dividends by
Century to us is limited by statute. As a result, we may not be
able to receive funds at times and in amounts necessary to meet
our debt service obligations or to pay dividends to our
shareholders or corporate expenses.
43
The chart below reflects the Companys total return
performance for the years ended December 31, 2007, 2006,
2005 and 2004.
Total
Return Performance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Period Ending
|
Index
|
|
04/21/04
|
|
12/31/04
|
|
12/31/05
|
|
12/31/06
|
|
12/31/07
|
ProCentury Corporation
|
|
$
|
100.00
|
|
|
|
118.57
|
|
|
|
103.45
|
|
|
|
180.15
|
|
|
|
150.92
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
S&P 500
|
|
|
100.00
|
|
|
|
109.18
|
|
|
|
114.54
|
|
|
|
132.63
|
|
|
|
139.91
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
S&P Property & Casualty Insurance Index
|
|
|
100.00
|
|
|
|
104.74
|
|
|
|
120.57
|
|
|
|
136.09
|
|
|
|
118.26
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SNL Insurance P&C Index
|
|
|
100.00
|
|
|
|
102.25
|
|
|
|
111.78
|
|
|
|
130.29
|
|
|
|
140.68
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NASDAQ Composite
|
|
|
100.00
|
|
|
|
109.81
|
|
|
|
110.51
|
|
|
|
121.03
|
|
|
|
132.90
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Source: Standard & Poors and SNL Financial.
We have added the NASDAQ Composite and SNL Insurance P&C
indexes this year with the intent of discontinuing the use of
the S&P 500 and the S&P Property and Casualty
Insurance Index next year. The Company believes that the NASDAQ
composite and SNL Insurance P&C indexes provide closer
representation of the broad and peer indexes for ProCentury.
44
|
|
Item 6.
|
Selected
Financial Data
|
SELECTED
CONSOLIDATED FINANCIAL DATA
The following table summarizes selected consolidated financial
information for the periods ended and as of the dates indicated.
The selected data presented below under the captions
Operating Data and Balance Sheet Data
for, and as of the end of, each of the periods in the five-year
period ended December 31, 2007 are derived from our
consolidated financial statements, which financial statements
have been audited by KPMG LLP, an independent registered public
accounting firm. The consolidated financial statements as of
December 31, 2007 and 2006 and for each of the periods in
the three-year period ended December 31, 2007, and KPMG
LLPs report thereon, are included elsewhere in this
10-K filing.
These historical results are not necessarily indicative of
results to be expected from any future period. You should read
this selected consolidated financial information together with
our consolidated financial statements and related notes and the
section of this report entitled Managements
Discussion and Analysis of Financial Condition and Results of
Operations.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
|
(In thousands)
|
|
|
Operating Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums earned
|
|
$
|
217,562
|
|
|
|
218,992
|
|
|
|
177,630
|
|
|
|
148,702
|
|
|
|
108,294
|
|
Net investment income
|
|
|
22,081
|
|
|
|
19,372
|
|
|
|
14,487
|
|
|
|
10,048
|
|
|
|
6,499
|
|
Net realized investment (losses) gains
|
|
|
(1,982
|
)
|
|
|
80
|
|
|
|
(326
|
)
|
|
|
50
|
|
|
|
1,932
|
|
Other income
|
|
|
489
|
|
|
|
437
|
|
|
|
198
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
|
238,150
|
|
|
|
238,881
|
|
|
|
191,989
|
|
|
|
158,800
|
|
|
|
116,725
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Discontinued operations(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,259
|
|
|
|
1,548
|
|
Net income
|
|
|
24,756
|
|
|
|
20,901
|
|
|
|
10,241
|
|
|
|
14,980
|
|
|
|
314
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income (loss)
|
|
|
18,442
|
|
|
|
21,655
|
|
|
|
6,271
|
|
|
|
14,566
|
|
|
|
(405
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) from continuing operations before discontinued
operations
|
|
$
|
1.87
|
|
|
|
1.59
|
|
|
|
0.78
|
|
|
|
1.29
|
|
|
|
(0.25
|
)
|
Discontinued operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0.12
|
|
|
|
0.31
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
1.87
|
|
|
|
1.59
|
|
|
|
0.78
|
|
|
|
1.41
|
|
|
|
0.06
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted net income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) from continuing operations before discontinued
operations
|
|
$
|
1.85
|
|
|
|
1.58
|
|
|
|
0.78
|
|
|
|
1.29
|
|
|
|
(0.25
|
)
|
Discontinued operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0.12
|
|
|
|
0.31
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
1.85
|
|
|
|
1.58
|
|
|
|
0.78
|
|
|
|
1.41
|
|
|
|
0.06
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average of shares outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
basic
|
|
|
13,242,083
|
|
|
|
13,121,848
|
|
|
|
13,060,509
|
|
|
|
10,623,645
|
|
|
|
5,000,532
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
diluted
|
|
|
13,392,949
|
|
|
|
13,256,419
|
|
|
|
13,129,425
|
|
|
|
10,653,316
|
|
|
|
5,000,532
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance Performance Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(for the periods ended)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross written premiums(2)
|
|
$
|
238,346
|
|
|
|
283,036
|
|
|
|
216,164
|
|
|
|
191,405
|
|
|
|
149,708
|
|
Net written premiums(3)
|
|
|
203,804
|
|
|
|
247,919
|
|
|
|
189,519
|
|
|
|
166,024
|
|
|
|
131,839
|
|
45
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
|
|
(In thousands)
|
|
|
GAAP Underwriting Ratios: (for the periods ended)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss ratio(4)
|
|
|
57.9
|
%
|
|
|
61.9
|
%
|
|
|
66.6
|
%
|
|
|
59.9
|
%
|
|
|
74.8
|
%
|
Expense ratio(5)
|
|
|
33.8
|
%
|
|
|
32.6
|
%
|
|
|
32.8
|
%
|
|
|
31.9
|
%
|
|
|
34.2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined ratio(6)
|
|
|
91.7
|
%
|
|
|
94.5
|
%
|
|
|
99.4
|
%
|
|
|
91.8
|
%
|
|
|
109.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance Sheet Data: (at the end of the period)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and investments
|
|
$
|
467,276
|
|
|
|
436,062
|
|
|
|
366,410
|
|
|
|
315,008
|
|
|
|
171,201
|
|
Reinsurance recoverables on paid and unpaid losses, net
|
|
|
44,777
|
|
|
|
43,628
|
|
|
|
43,870
|
|
|
|
33,382
|
|
|
|
42,042
|
|
Assets available for sale
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
59,018
|
|
Total assets
|
|
|
607,054
|
|
|
|
579,048
|
|
|
|
474,145
|
|
|
|
394,927
|
|
|
|
332,113
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss and loss expense reserves
|
|
|
279,253
|
|
|
|
250,672
|
|
|
|
211,647
|
|
|
|
153,236
|
|
|
|
129,236
|
|
Liabilities available for sale
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
51,431
|
|
Long term debt
|
|
|
25,000
|
|
|
|
25,000
|
|
|
|
25,000
|
|
|
|
25,000
|
|
|
|
34,133
|
|
Total shareholders equity
|
|
|
161,021
|
|
|
|
142,388
|
|
|
|
121,203
|
|
|
|
115,237
|
|
|
|
36,397
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net writings ratio, including discontinued operations(7)
|
|
|
1.3
|
|
|
|
1.8
|
|
|
|
1.6
|
|
|
|
1.4
|
|
|
|
1.7
|
|
Return on average equity(8)
|
|
|
16.3
|
%
|
|
|
15.9
|
%
|
|
|
8.7
|
%
|
|
|
18.5
|
%
|
|
|
0.9
|
%
|
|
|
|
(1) |
|
Immediately prior to the completion of the IPO, the common
shares of Evergreen and its wholly owned subsidiary, Continental
were distributed as dividends from Century to ProCentury and
then by ProCentury to ProCenturys existing Class A
shareholders. Prior to the dividends, Evergreen was a controlled
subsidiary of Century. The operations of Evergreen and
Continental consisted of ProCenturys historical surety and
assumed excess workers compensation lines of insurance,
which were re-classified (net of minority interest and income
taxes) as discontinued operations in the above selected
consolidated financial data. |
|
(2) |
|
The amount received or to be received for insurance policies
written by us during a specific period of time without reduction
for acquisition costs, reinsurance costs or other deductions. |
|
(3) |
|
Gross written premiums less the portion of such premiums ceded
to (reinsured by) other insurers during a specific period of
time. |
|
(4) |
|
The ratio of losses and loss expenses to premiums earned, net of
the effects of reinsurance. |
|
(5) |
|
The ratio of amortization of deferred policy acquisition costs
and other underwriting expenses to premiums earned, net of the
effects of reinsurance. |
|
(6) |
|
The sum of the loss and loss expense ratio, net of the effects
of reinsurance. |
|
(7) |
|
The ratio of net written premiums to our insurance
subsidiaries combined statutory surplus. Management
believes this measure is useful in gauging our exposure to
pricing errors in our current book of business. It may not be
comparable to the definition of net writings ratio used by other
companies. For periods prior to 2004, this ratio includes
discontinued operations, as the insurance subsidiaries
combined statutory surplus is not allocated by line of business.
Therefore, in computing the ratio of net written premiums to our
insurance subsidiaries combined statutory surplus we did
not restate the net written premium for discontinued operations
to be consistent with that of the subsidiaries combined
statutory surplus. |
|
(8) |
|
Return on average equity consists of the ratio of net income to
the average of the beginning of period and end of period total
shareholders equity. For 2004, return on average equity
consists of the ratio of net income to the average equity, which
is based on the average of the beginning of period and the end
of each quarters total shareholders equity. |
46
|
|
Item 7.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations
|
MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion of our financial condition and
results of operations should be read in conjunction with our
consolidated financial statements and the notes to those
statements included in this annual report on
Form 10-K.
This discussion and analysis includes forward-looking statements
that are subject to risks, uncertainties and other factors
described in Risk Factors and elsewhere that could
cause our actual growth, results of operations, performance and
business prospects and opportunities in 2008 and beyond to
differ materially from those expressed in, or implied by, those
forward-looking statements. See Forward-Looking
Statements.
Overview
ProCentury is a holding company that underwrites selected
property and casualty and surety insurance through its
subsidiaries collectively known as Century Insurance
Group®.
As a specialty company, we offer insurance products designed to
meet specific insurance needs of targeted insured groups. The
excess and surplus lines market provides an alternative market
for customers with hard-to-place risks and risks that insurance
companies licensed by the state in which the insurance policy is
sold, which are also referred to as admitted
insurers, typically do not cover. As an underwriter within
the excess and surplus lines market, we are selective in the
lines of business and types of risks we choose to write. We
develop these specialty insurance products through our own
experience or knowledge or through proposals brought to us by
agents with special expertise in specific classes of business.
We evaluate our insurance operations by monitoring key measures
of growth and profitability. The following provides further
explanation of the key financial measures that we use to
evaluate our results:
Written and Unearned Premium. Written premium
is recorded based on the insurance policies that have been
reported to us and, beginning in the fourth quarter of 2006, the
policies that have been written by agents but not yet reported
to us. We must estimate the amount of written premium not yet
reported based on judgments relative to current and historical
trends of the business being written. Such estimates are
regularly reviewed and updated and any resulting adjustments are
included in the current periods results. An unearned
premium reserve is established to reflect the unexpired portion
of each policy at the financial reporting date. For additional
information regarding our written and unearned premium refer to
Note 4 to our audited consolidated financial statements
included in this report.
Loss and Loss Expense Ratio. Loss and loss
expense ratio is the ratio (expressed as a percentage) of losses
and loss expenses incurred to premiums earned. Our net loss and
loss expense is meaningful in evaluating our financial results,
which are net of ceded reinsurance, as reflected in our audited
consolidated financial statements.
Expense Ratio. Expense ratio is the ratio
(expressed as a percentage) of net operating expenses to
premiums earned and measures a companys operational
efficiency in producing, underwriting and administering its
insurance business. Interest expense is not included in the
calculation of the expense ratio.
Combined Ratio. Combined ratio is the sum of
the loss and loss expense ratio and the expense ratio and
measures a companys overall underwriting profit. If the
combined ratio is at or above 100, an insurance company cannot
be profitable without investment income (and may not be
profitable if investment income is insufficient). We use the
combined ratio in evaluating our overall underwriting
profitability and as a measure for comparing our profitability
relative to the profitability of our competitors.
Critical
Accounting Policies
It is important to understand our accounting policies in order
to understand our financial statements. Management considers
certain of these policies to be critical to the presentation of
our financial results, since they require management to make
estimates and assumptions. These estimates and assumptions
affect the reported amounts of assets, liabilities, revenues,
expenses and related disclosures at the financial reporting date
and throughout the period being reported upon. Certain of the
estimates result from judgments that can be subjective and
47
complex and consequently actual results may differ from these
estimates, which would be reflected in future periods.
Material estimates that are particularly susceptible to
significant change in the near-term relate to the determination
of other-than-temporary declines in the fair value of
investments, the determination of loss and loss expense
reserves, the net realizable value of reinsurance recoverables,
the recoverability of deferred policy acquisition costs, and the
determination of federal income taxes. Although considerable
variability is inherent in these estimates, management believes
that the amounts provided are reasonable. These estimates are
continually reviewed and adjusted as necessary. Such adjustments
are reflected in current operations.
Loss and Loss Expense Reserves. Loss and loss
expense reserves represent an estimate of the expected cost of
the ultimate settlement and administration of losses based on
facts and circumstances then known. We use actuarial
methodologies to assist us in establishing these estimates,
including judgments relative to estimates of future claims
severity and frequency, length of time to develop to ultimate
resolution, and consideration of new judicial decisions in tort
and insurance law, emerging theories or liabilities and other
factors beyond our control. Due to the inherent uncertainty
associated with the cost of unsettled and unreported claims, the
ultimate liability may be different from the original estimate.
Such estimates are regularly reviewed and updated and any
resulting adjustments are included in the current periods
results. Additional information regarding our loss and loss
expense reserves can be found in Note 3 to our audited
consolidated financial statements included in this report.
Reinsurance Recoverables. Reinsurance
recoverables on paid and unpaid losses, net, are established for
the portion of our loss and loss expense reserves that are ceded
to reinsurers. Reinsurance recoverables are determined based in
part on the terms and conditions of reinsurance contracts which
could be subject to interpretations that differ from our own
based on judicial theories of liability. In addition, we bear
credit risk with respect to our reinsurers that can be
significant considering that certain of the reserves remain
outstanding for an extended period of time. We are required to
pay losses even if a reinsurer fails to meet its obligations
under the applicable reinsurance agreement. See Note 4 to
our audited consolidated financial statements included in this
report.
Impairment of Investments. Impairment of
investment securities results in a charge to income when a
market decline below cost is deemed to be other-than-temporary.
Under our accounting policy for equity securities and
fixed-maturity securities that can be contractually prepaid or
otherwise settled in a way that may limit our ability to fully
recover cost, an impairment is deemed to be other-than-temporary
unless we have both the ability and intent to hold the
investment until the securitys forecasted recovery and
evidence exists indicating that recovery will occur in a
reasonable period of time.
For fixed-maturity and equity securities that can not be
contractually prepaid or otherwise settled, an
other-than-temporary impairment charge is taken when we do not
have the ability and intent to hold the security until the
forecasted recovery or if it is no longer probable that we will
recover all amounts due under the contractual terms of the
security. Many criteria are considered during this process
including, but not limited to, the current fair value as
compared to amortized cost or cost, as appropriate, of the
security; the amount and length of time a securitys fair
value has been below amortized cost or cost; specific credit
issues and financial prospects related to the issuer; our intent
to hold or dispose of the security; and current economic
conditions. Other-than-temporary impairment losses result in a
permanent reduction to the cost basis of the underlying
investment.
During 2007, credit markets experienced reduced liquidity,
higher volatility and widening credit spreads across asset
classes mainly as a result of marketplace uncertainty arising
from higher defaults in sub-prime and
Alt-A
residential mortgage loans. In connection with this uncertainty,
we believe investors and lenders have retreated from many
investments in asset-backed securities including those
associated with sub-prime and Alt-A residential mortgage loans,
as well as types of debt investments with weak lender
protections or those with limited transparency
and/or
complex features which hindered investor understanding. At the
same time, investors shifted emphasis towards safety pushing up
the demand for U.S. Treasury instruments. The current credit
market conditions resulted in an unfavorable liquidity
environment for issuers of financial instruments including
commercial paper, long-term debt and asset-backed securities.
Valuation of Investments. The Companys
investments in fixed maturities, which include bonds and
redeemable preferred stock and certain equity securities, which
include common and non-redeemable preferred
48
stocks, are classified as available-for-sale and
accordingly, are carried at fair value with the after-tax
difference from cost or amortized cost, reflected in
shareholders equity as a component of accumulated other
comprehensive income, net of valuation allowances on deferred
tax assets. Short-term investments are carried at amortized
cost, which approximates fair value. The fair value for fixed
maturity securities is largely determined by one of two primary
pricing methods: third party pricing service market prices or
independent broker quotations. Prices from third party pricing
services are often unavailable for securities that are rarely
traded or are traded only in privately negotiated transactions
and as a result, certain of the Companys securities are
priced via broker quotations.
Additionally, for certain securitized financial assets with
contractual cash flows (including asset-backed securities), FASB
Emerging Task Force (EITF)
99-20,
Recognition of Interest Income and Impairment on
Purchased and Retained Beneficial Interests in Securitized
Financial Assets, requires us to periodically update
our best estimate of cash flows over the life of the security.
If management determines that the fair value of a securitized
financial asset is less than its carrying amount and there has
been a decrease in the present value of the estimated cash flows
since the last revised estimate, considering both timing and
amount, then an other-than-temporary impairment is recognized.
For additional detail regarding our investment portfolio at
December 31, 2007 and December 31, 2006, including
disclosures regarding other-than-temporary declines in
investment value, see Investment Portfolio below and
Note 2 to our audited consolidated financial statements
included in this report.
Deferred Policy Acquisition Costs. We defer
commissions, premium taxes and certain other costs that vary
with and are primarily related to the acquisition of insurance
contracts. The acquisition costs are reduced by ceding
commission income. The costs are capitalized and charged to
expense in proportion to premium revenue recognized. The method
followed in computing deferred policy acquisition costs limits
the amount of such deferred costs to their estimated realizable
value, which gives effect to the premium to be earned, related
investment income, anticipated losses and settlement expenses
and certain other costs expected to be incurred as the premium
is earned. Judgments as to ultimate recoverability of such
deferred costs are highly dependent upon estimated future loss
costs associated with the written premiums. See Note 5 to
our audited consolidated financial statements included in this
report.
Federal Income Taxes. We provide for federal
income taxes based on amounts we believe we ultimately will owe.
Inherent in the provision for federal income taxes are estimates
regarding the deductibility of certain items and the realization
of certain tax credits. In the event the ultimate deductibility
of certain items or the realization of certain tax credits
differs from estimates, we may be required to significantly
change the provision for federal income taxes recorded in the
consolidated financial statements. Any such change could
significantly affect the amounts reported in the consolidated
statements of income.
We utilize the asset and liability method of accounting for
income tax. Under this method, deferred tax assets and
liabilities are recognized for the future tax consequences
attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit
carry-forwards. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in
the years in which those temporary differences are expected to
be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in
the period that includes the enactment date. Valuation
allowances are established when necessary to reduce the deferred
tax assets to the amounts more likely than not to be realized.
See Note 7 to our audited consolidated financial statements
included in this report.
49
Results
of Operations
The table below summarizes certain operating results and key
measures we use in monitoring and evaluating our operations. The
information is intended to summarize and supplement information
contained in our consolidated financial statements and to assist
the reader in gaining a better understanding of our results of
operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
|
Selected Financial Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross written premiums
|
|
$
|
238,346
|
|
|
|
283,036
|
|
|
|
216,164
|
|
Net premiums earned
|
|
|
217,562
|
|
|
|
218,992
|
|
|
|
177,630
|
|
Net investment income
|
|
|
22,081
|
|
|
|
19,372
|
|
|
|
14,487
|
|
Net realized investment (losses) gains
|
|
|
(1,982
|
)
|
|
|
80
|
|
|
|
(326
|
)
|
Other income
|
|
|
489
|
|
|
|
437
|
|
|
|
198
|
|
Total revenues
|
|
|
238,150
|
|
|
|
238,881
|
|
|
|
191,989
|
|
Total expenses
|
|
|
202,108
|
|
|
|
209,245
|
|
|
|
178,410
|
|
Net income
|
|
$
|
24,756
|
|
|
|
20,901
|
|
|
|
10,241
|
|
Key Financial Ratios:
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss and loss expense ratio
|
|
|
57.9
|
%
|
|
|
61.9
|
%
|
|
|
66.6
|
%
|
Expense ratio
|
|
|
33.8
|
|
|
|
32.6
|
|
|
|
32.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined ratio
|
|
|
91.7
|
%
|
|
|
94.5
|
%
|
|
|
99.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Overview
of Operating Results
The insurance industry has historically been cyclical. During
the past five years, many admitted insurers returned to more
risk-based underwriting disciplines in the standard market,
resulting in higher premium rates, less flexible terms and, in
some cases, an unavailability of adequate insurance coverage in
the standard market in some classes. We, along with other excess
and surplus lines insurers, benefited from this increase in
rates and volume. During 2006, however, the excess and surplus
lines industry began to experience softer market conditions
primarily attributed to intensified competition from admitted
and surplus lines insurers, resulting in volume and rate
decreases. This increased competition intensified in 2007 and is
continuing in 2008. We will continue to monitor our rates and
control our costs in an effort to maximize profits during
softening market conditions.
Year Ended December 31, 2007 Compared to Year Ended
December 31, 2006. Net income was
$24.8 million for the year ended December 31, 2007
compared to net income of $20.9 million for the year ended
December 31, 2006. The increase in net income for the year
ended December 31, 2007 was primarily attributable to an
increase in net investment income, coupled with a lower combined
ratio as a result of a reduction of the loss and loss expense
ratio. The reduction in the loss and loss expense ratio was
driven by a favorable decrease in the current accident year loss
and loss expense ratio compared to the 2006 current accident
year that decreased loss and loss expenses by $653,000 and a
favorable decrease in the prior accident years loss and
loss expense ratio that decreased loss and loss expenses by
$9.1 million.
Our gross written premiums decreased 15.8% to
$238.3 million for the year ended December 31, 2007
compared to $283.0 million for the same period in 2006. The
decrease resulted from a 7.4% decline due to the impact of the
change in the timing of recording gross written premiums in 2006
that increased our 2006 gross written premium by
$20.9 million (discussed in more detail below), a 3.2%
decline due to the termination of the auto physical damage
program that began in 2006 and a 5.2% decline due to increased
market competition. During 2007, we continued to experience
increased competition across our product lines with indications
of other carriers continuing to lower their rates and expand
their risk profile. Despite this increase in competition, we
maintained our underwriting discipline. We had moderate rate
decreases in our core property and casualty lines during the
year ended December 31, 2007. However, we experienced
premium volume growth from our garage and ocean marine business
during that period.
50
Net investment income increased by 14.0% for the year ended
December 31, 2007 compared to the same period in 2006. This
is due to continued positive cash flows from operations. Our tax
equivalent yield for the year ended December 31, 2007 was
5.7%, compared to 5.8% 2006.
Total expenses decreased by $7.1 million to $202.1 for the
year ended December 31, 2007 compared to
$209.3 million for the year ended December 31, 2006.
The combined ratio for the year ended December 31, 2007 was
91.7% compared to 94.5% for the same period in 2006. The loss
and loss expense ratio was 57.9% and 61.9%, for the years ended
December 31, 2007 and 2006, respectively. For the year
ended December 31, 2007, total loss and loss expenses
related to the 2007 accident year was $135.0 million, which
was partially offset by $9.1 million of favorable reserve
development on prior accident years. This compares to
$136.6 million of current accident year loss and loss
expenses and $1.1 million of favorable reserve development
on prior accident years for the year ended December 31,
2006. The decrease in loss and loss expenses for the year ended
December 31, 2007 for the current accident year is
primarily due to the decline in earned premium, which was
supplemented with a decline in the current accident year loss
and loss expense ratio. The favorable development on prior
accident years for the year ended December 31, 2007
primarily related to our claims made contractors casualty
business written in 2005 and 2006 and our property business
written in 2005 and 2006. This business continued to perform
better than our original estimates.
The expense ratio for the years ended December 31, 2007 and
for 2006 was 33.8% and 32.6%, respectively. The increase in the
expense ratio in 2007 compared to 2006 is directly attributable
to higher contingent commissions due to the favorable loss
experience, lower growth in earned premium and $300,000 of
professional fees and other costs incurred in the second quarter
of 2007 related primarily to an aborted public equity offering.
In addition, we incurred a higher blended commission rate due to
a greater percentage of binding business that has a higher
commission rate than that of brokerage business for the year
ended December 31, 2007.
Year Ended December 31, 2006 Compared to Year Ended
December 31, 2005. Net income was $20.9 for
the year ended December 31, 2006, compared to net income of
$10.2 for the year ended December 31, 2005. The increase in
net income for the year ended December 31, 2006 was
primarily attributable to a 24.4% increase in total revenue in
2006 as a result of higher net earned premium and net investment
income. The impact of the increase in revenue on net income was
also supplemented by a 4.9 percentage points decrease in
the total combined ratio in 2006 as compared to 2005. The lower
combined ratio is primarily due to a decrease in losses that
were incurred related to prior years and hurricanes when
comparing 2006 to 2005.
Of our total revenue growth, 88.2% was due to a 23.3% increase
in net earned premium because of an increase in the volume of
business that was partially offset by slight rate declines in
the property line of business and supported by relatively flat
rates in our casualty business. While our core property and
casualty business continued to grow in 2006, the most
significant areas of growth were a result of higher volume of
program business and the continued growth in contractors
business written on a claims-made form.
In addition to our net earned premium growth, our net investment
income grew by 33.7% in 2006 compared to the same period in
2005. This growth was due to continued favorable cash flows from
operations during the year ended December 31, 2006 and
higher investment yields which on a tax equivalent basis
increased to 5.8% for the year ended December 31, 2006 from
5.2% for the same period in 2005.
Higher expenses that resulted from an increase in net loss and
loss expenses and amortization of deferred acquisition costs
partially offset the increase in total revenue. This increase in
overall expenses is a direct result of the growth in the volume
of business produced in 2006 and is partially offset by an
increase in the profitability of the business written as seen in
an overall decrease in the 2006 combined ratio as compared to
the combined ratio in 2005. This decrease in the overall
combined ratio is a direct result of a 4.7 percentage point
decrease in the loss and loss expense ratio that decreased to
61.9% for the year ended December 31, 2006 from 66.6% for
the same period in 2005. As previously stated, the decrease in
the loss and loss expense ratio for year ended December 31,
2006 compared to the same periods in 2005 resulted from higher
net incurred loss and loss expenses in 2005 due to
$5.4 million of unfavorable development in 2005 related to
prior accident years and a significantly worse hurricane season
in 2005 than in 2006 that resulted in $8.3 million of
additional losses. We recorded $1.1 million favorable prior
year development in 2006.
51
The expense ratio for year ended December 31, 2006 and 2005
was 32.6% and 32.8%, respectively. The decrease in the expense
ratio for the year ended December 31, 2006 is directly
attributable the fact that the 2005 expense ratio was impacted
by 0.4% of expense related to the severance agreement with our
former Chief Operating Officer which was recorded in the first
quarter of 2005. No severance expense was incurred in 2006. In
addition, the overall expense ratio was impacted by slightly
higher acquisition costs included in the amortization of
deferred acquisition costs which was offset by a decrease in the
other expense ratio due to expense efficiencies gained as a
result of the fact that our fixed costs have not increased at
the same rate as our earned premium.
In addition, On September 13, 2006, the SEC staff released
Staff Accounting Bulletin 108 (SAB 108) regarding
the process of quantifying financial statement misstatements
that were uncorrected in prior years. Following the release of
SAB 108, we reviewed all of our accounting practices and
did not identify any items that were considered to be a material
misstatement of prior year financial statements. We did,
however, make immaterial adjustments, one of which changed the
timing of recording gross written premiums. In the past, we
recorded premiums on a received and processed basis, which did
not take into account premiums written by agents but not yet
submitted to us. Under our revised accounting policy, which was
implemented in the fourth quarter of 2006, we recorded an
estimate of the policies that have been written by agents but
not yet reported to us. These adjustments had the following
impacts on the results for both the quarter and year ended
December 31, 2006:
|
|
|
|
|
Premiums in the course of collection, deferred policy
acquisition costs, loss and loss expense reserves and unearned
premiums were higher by $16.7 million, $2.7 million,
$2.6 million, and $16.2 million, respectively.
|
|
|
|
Gross written premiums, net written premiums and premiums earned
were $20.9 million higher, $18.2 million higher and
$4.1 million higher, respectively.
|
|
|
|
Losses and loss expenses, the amortization of deferred policy
acquisition costs and other operating expenses were higher by
$2.6 million $784,000, and $396,000, respectively.
|
|
|
|
Net income was higher by $216,000 or $0.02 per diluted share.
|
Revenues
Premiums
Premiums include insurance premiums underwritten by our
insurance subsidiaries (which are referred to as direct
premiums) and insurance premiums assumed from other insurers
(which are referred to as assumed premiums). We refer to direct
and assumed premiums together as gross premiums.
Written premiums are the total amount of premiums billed to the
policyholder less the amount of premiums returned, generally
because of cancellations, during a given period. Written
premiums become premiums earned as the policy ages. Barring
premium changes, if an insurance company writes the same mix of
business each year, written premiums and premiums earned will be
equal, and the unearned premium reserve will remain constant.
During periods of growth, the unearned premium reserve will
increase, causing premiums earned to be less than written
premiums. Conversely, during periods of decline, the unearned
premium reserve will decrease, causing premiums earned to be
greater than written premiums.
Written premium is recorded based on the insurance policies that
have been reported to us and beginning in the fourth quarter of
2006, the policies that have been written by agents but not yet
reported to us. We must estimate the amount of written premium
not yet reported based on judgments relative to current and
historical trends of the business being written. Such estimates
will be regularly reviewed and updated and any resulting
adjustments will be included in the current years results.
An unearned premium reserve is established to reflect the
unexpired portion of each policy at the financial reporting date.
We have historically relied on quota share, excess of loss, and
catastrophe reinsurance primarily to manage our regulatory
capital requirements and to limit our exposure to loss.
Generally, we have ceded a significant portion of our premiums
to unaffiliated reinsurers in order to maintain net written
premiums to statutory surplus ratio of less than 2-to-1.
52
Our underwriting business is currently divided into two primary
segments:
|
|
|
|
|
property and casualty; and
|
|
|
|
other (including exited lines).
|
Our property and casualty segment primarily includes general
liability, commercial property and multi-peril insurance for
small and mid-sized businesses. The other (including exited
lines) segment primarily includes our surety business.
The following table presents our gross written premiums in our
primary segments and provides a summary of gross, ceded and net
written premiums and net premiums earned for the periods
indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
|
Gross written premiums:
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and casualty
|
|
$
|
233,238
|
|
|
|
277,733
|
|
|
|
212,127
|
|
Other (including exited lines)
|
|
|
5,108
|
|
|
|
5,303
|
|
|
|
4,037
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross written premiums
|
|
|
238,346
|
|
|
|
283,036
|
|
|
|
216,164
|
|
Ceded written premiums
|
|
|
34,542
|
|
|
|
35,117
|
|
|
|
26,645
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net written premiums
|
|
$
|
203,804
|
|
|
|
247,919
|
|
|
|
189,519
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums earned
|
|
$
|
217,562
|
|
|
|
218,992
|
|
|
|
177,630
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net written premiums to gross written premiums
|
|
|
85.5
|
%
|
|
|
87.6
|
%
|
|
|
87.7
|
%
|
Net premiums earned to net written premiums
|
|
|
106.8
|
%
|
|
|
88.3
|
%
|
|
|
93.7
|
%
|
Net writings ratio(1)
|
|
|
1.3
|
|
|
|
1.8
|
|
|
|
1.6
|
|
|
|
|
(1) |
|
The ratio of net written premiums to our insurance
subsidiaries combined statutory surplus. Management
believes this measure is useful in gauging our exposure to
pricing errors in the current book of business. It may not be
comparable to the definition of net writings ratio used by other
companies. |
Gross
Written Premiums
Year Ended December 31, 2007 Compared to Year Ended
December 31, 2006. Gross written premiums
decreased by $44.7 million to $238.3 million for the
year ended December 31, 2007 from $283.0 million for
the same period in 2006. As noted above, following the release
of SAB 108 in 2006, we reviewed all of our accounting
practices and did not identify any items that were considered to
be a material misstatement of prior year financial statements.
We did, however, make immaterial adjustments, one of which
changed the timing of recording gross written premiums. In the
past, we recorded premiums on a received and processed basis,
which did not take into account premiums written by agents but
not yet submitted to us. Under our revised accounting policy,
which was implemented in the fourth quarter of 2006, we recorded
a $20.9 million increase in gross written premiums to
estimate policies that had been written by agents but not yet
reported to us. In addition, due to the unfavorable underwriting
results from our auto physical damage book written in 2006,
gross written premiums for the program decreased by
$9.0 million for year ended December 31, 2007 compared
to the same period in 2006. The remainder of the decline in
gross written premiums is due to the continued increase in
competition with indications that we believe show other carriers
are striving to increase their market share by reducing prices
and providing broader coverage forms. These softening market
conditions were most prevalent in our casualty market where we
saw a decrease in premiums from our casualty book resulting from
other carriers offering broader coverages at a lower price on
certain classes of business.
Year Ended December 31, 2006 Compared to Year Ended
December 31, 2005. Gross written premiums
increased 30.9% for the year ended December 31, 2006
compared to the same period in 2005. This fluctuation for the
2006 year was the result of growth in the property and
casualty segment from all of our product lines, but primarily
from an increase in volume from our specialty program unit and
an increase in our casualty book of
53
business from growth in our contractor business written on a
claims-made form. Our program unit introduced an auto physical
damage program in mid-2005 that has increased our property
business by $10.9 million throughout 2006. In addition, in
January 2005, we stopped writing contractors business written on
an occurrence form and began to offer contractors liability
coverage on a claims-made form. The claims-made
contractors coverage has a significantly shorter claim
reporting period, which should result in less reserve
variability and more predictable results. The initial impact of
ceasing to write contractors on an occurrence form caused a
decrease in premium writings on our contractors book in 2005.
The market for contractors written on a claims-made form did,
however, begin to improve late in 2005 and into 2006 causing an
increase in our casualty premiums of $8.4 million during
2006. The growth in our property and casualty segment was
slightly offset by minimal rate decline in property business
while casualty rates remained stable. In addition, our gross
written premiums for the year ended December 31, 2006,
includes an adjustment of $20.9 million related to the
initial booking of policies that have been written by agents but
not yet reported to us, as discussed above.
Gross written premium for the other (including exited lines)
segment increased $1.3 million for the year ended
December 31, 2006 compared to the year ended
December 31, 2005. This increase represents surety business
written in order to maintain our U.S. Treasury listing.
Net
Written and Earned Premiums
Year Ended December 31, 2007 Compared to Year Ended
December 31, 2006. Net written premiums
decreased by $44.1 million to $203.8 million for the
year ended December 31, 2007 compared to the year ended
December 31, 2006. The decrease was due to lower gross
written premiums and a higher percentage of ceded premium to
gross written premium. The additional ceded premium in the year
ended December 31, 2007 compared to the same period in 2006
is due to a change in the mix of business, specifically ocean
marine, to the total business, which has a higher ceding rate
than our other lines.
Net written premiums represented 85.5% of gross written premiums
for year ended December 31, 2007, compared to 87.6% for the
same period in 2006. The lower relationship of net written
premiums to gross written premiums for the year ended
December 31, 2007 reflects an increase in ceded premiums in
the current year, as noted above.
The ratio of premiums earned to net written premiums for the
year ended December 31, 2007 and 2006 was 106.8% and 88.3%,
respectively. The relationship of premiums earned to net written
premiums during the year ended December 31, 2007 was higher
compared to the same period in 2006, reflecting a decrease in
the growth rate of premiums in 2007 compared to the same period
in 2006.
Year Ended December 31, 2006 Compared to Year Ended
December 31, 2005. Net written premiums
increased by 30.8% for the year ended December 31, 2006,
respectively, compared to the same period in 2005 due to the
growth in gross written premiums. Net written premiums
represented 87.6% of gross written premiums for the year ended
December 31, 2006, which is relatively the same as the
relationship of net written premiums to gross written premiums
for the year ended December 31, 2005. Our net written
premiums for the year ended December 31, 2006, includes an
adjustment of $18.2 million related to the initial booking
of policies that have been written by agents but not yet
reported to us, as discussed above.
Premiums earned increased by 23.3% to $219.0 million for
the year ended December 31, 2006, compared to
$177.6 million in 2005. Premiums earned as a percentage of
net written premiums was 88.3% and 93.7% for the years ended
December 31, 2006 and 2005, respectively. The relationship
of premiums earned to net written premiums during the year ended
December 31, 2006 was lower compared to the same period in
2005 as a result of the fact that beginning in 2006, we include
an estimate of the premiums not yet received from our agents in
our total gross and net written premium. As the majority of this
premium was expected to have effective dates in December, the
premiums were estimated to be less than a month earned,
resulting in a lower overall relationship of premiums earned to
net written premiums.
54
Net
Investment Income
Our investment portfolio generally consists of liquid, readily
marketable and investment-grade fixed-maturity and equity
securities. Net investment income is primarily comprised of
interest and dividend earned on these securities, net of related
investment expenses.
Year Ended December 31, 2007 Compared to Year Ended
December 31, 2006. Net investment income was
$22.1 million for the year ended December 31, 2007,
compared to $19.4 million for the same period in 2006. The
increase was primarily due to an increase in assets available
for investment, including cash. Invested assets, including cash,
increased by $31.2 million to $467.3 million as of
December 31, 2007 from $436.1 million as of
December 31, 2006. The pre-tax investment yield for the
years ended December 31, 2007 and 2006 was 5.1%. Our
taxable equivalent yield for the year ended December 31,
2007 was 5.7% compared to 5.8% for the same period in 2006.
Year Ended December 31, 2006 Compared to Year Ended
December 31, 2005. Net investment income was
$19.4 million for the year ended December 31, 2006,
compared to $14.5 million for the same period in 2005. The
increase was due to an increase in invested assets, including
cash, and higher investment yields. Invested assets, including
cash, increased by $69.7 million to $436.1 million as
of December 31, 2006 from $366.4 million as of
December 31, 2005. The pre-tax investment yield for the
year ended December 31, 2006 was 5.1%, compared to 4.6% for
the same period in 2005. For the year ended December 31,
2006 and 2005, the taxable equivalent yield was 5.8% and 5.2%,
respectively.
Realized
Gains (Losses) on Securities
Realized gains and losses on securities are principally affected
by changes in interest rates, the timing of sales of investments
and changes in credit quality of the securities we hold as
investments.
Year Ended December 31, 2007 Compared to Year Ended
December 31, 2006. We realized net
investment losses of $2.0 million for the year ended
December 31, 2007 compared to net investment gains of
$80,000 for the year ended December 31, 2006.
Other-than-temporary losses of $4.5 million were realized
during the year ended December 31, 2007. These losses
related to 38 asset-backed securities that were written down in
accordance with
EITF 99-20
and six preferred stocks for the year ended December 31,
2007. Other-than-temporary losses of $1.4 million were
realized during the year ended December 31, 2006.
Year Ended December 31, 2006 Compared to Year Ended
December 31, 2005. We realized net
investment gains of $80,000 on the sale and write down of
securities for the year ended December 31, 2006 compared to
$326,000 of net realized losses for the year ended
December 31, 2005. Other-than-temporary losses of
$1.4 million were recorded during the year ended
December 31, 2006. Other-than-temporary losses of $150,000
were included in the net realized investment losses for the year
ended December 31, 2005.
Expenses
Losses
and Loss Expenses
We are liable for covered losses and incurred loss expenses
under the terms of the insurance policies that we write. In many
cases, several years may elapse between the occurrence of an
insured loss, the reporting of the loss to us and our settlement
of that loss We reflect our liability for the ultimate payment
of all incurred losses and loss expenses by establishing loss
and loss expense reserves as balance sheet liabilities for both
reported and unreported claims. Loss and loss expenses represent
our largest expense item and include (1) payments made to
settle claims, (2) estimates for future claim payments and
changes in those estimates for current and prior periods, and
(3) costs associated with settling claims.
Loss and loss expense reserves represent our best estimate of
ultimate amounts for losses and related expenses from claims
that have been reported but not paid, and those losses that have
occurred but have not yet been reported to us. Loss reserves do
not represent an exact calculation of liability, but instead
represent our estimates, generally utilizing individual claim
estimates and actuarial analysis and estimation techniques at a
given accounting date. The loss reserve estimates are
expectations of what ultimate settlement and administration of
claims will cost upon final
55
resolution. These estimates are based on facts and circumstances
then known to us, a review of historical settlement patterns,
estimates of trends in claims frequency and severity,
projections of loss costs, expected interpretations of legal
theories of liability, and many other factors. In establishing
reserves, we also take into account estimated recoveries,
reinsurance, salvage and subrogation. The reserves are reviewed
regularly by our internal actuarial staff and annually reviewed
by an outside independent actuarial firm primarily for the
purpose of obtaining an opinion on our reserves for our
statutory financial statements and for regulatory purposes.
Our reinsurance program significantly influences our net
retained losses. In exchange for premiums ceded to reinsurers
under quota share and excess of loss reinsurance agreements, our
reinsurers assume a portion of the losses and loss expenses
incurred. See Business Reinsurance. We
remain obligated for amounts ceded in the event that the
reinsurers do not meet their obligations under the agreements
(due to, for example, disputes with the reinsurer or the
reinsurers insolvency).
The process of estimating loss reserves involves a high degree
of judgment and is subject to a number of variables. These
variables can be affected by both internal and external events,
such as changes in claims handling procedures, claim personnel,
economic inflation, legal trends, and legislative changes, among
others. The impact of many of these items on ultimate costs for
loss and loss expense is difficult to estimate. Loss reserve
estimations also differ significantly by coverage due to
differences in claim complexity, the volume of claims, the
policy limits written, the terms and conditions of the
underlying policies, the potential severity of individual
claims, the determination of occurrence date for a claim, and
reporting lags (the time between the occurrence of the policy
holder events and when it is actually reported to us). We
attempt to consider all significant facts and circumstances
known at the time loss reserves are established. In addition, we
continually refine our loss reserve estimates as historical loss
experience develops and additional claims are reported and
settled.
We exercise a considerable degree of judgment in evaluating the
numerous factors involved in the estimation of reserves.
Different actuaries will choose different assumptions when faced
with such uncertainty, based on their individual backgrounds,
professional experiences and areas of focus. Hence, the estimate
selected by various actuaries may differ materially. We consider
this uncertainty by examining our historic reserve accuracy.
Given the significant impact of the reserve estimates on our
financial statements, we subject the reserving process to
significant diagnostic testing. We have incorporated data
validity checks and balances into our front-end processes.
Leading indicators such as actual versus expected emergence and
other diagnostics are also incorporated into the reserving
processes.
Due to the inherent uncertainty underlying loss reserve
estimates, including but not limited to the future settlement
environment, final resolution of the estimated liability for a
claim or category of claims will be different from that
anticipated at the reporting date. Therefore, actual paid losses
in the future may yield a materially higher or lower amount than
currently reserved.
The amount by which estimated losses differ from those
originally recorded for a period is known as
development. Development is unfavorable when the
losses ultimately settle for more than the levels at which they
were reserved or subsequent estimates indicate a basis for
increasing loss reserves on unresolved claims. Development is
favorable when losses ultimately settle for less than the amount
reserved or subsequent estimates indicate a basis for reducing
loss reserves on unresolved claims. We reflect favorable or
unfavorable developments of loss reserves in the results of
operations for the period in which the estimates are changed.
We record two categories of loss and loss expense
reserves case-specific reserves and incurred but not
reported (IBNR) reserves.
When a claim is reported, our claim department establishes a
case reserve for the estimated probable ultimate cost to resolve
a claim as soon as sufficient information is available to
evaluate a claim. We open most claim files with a formula
reserve (a nominal fixed amount) for the type of claim
involved. Our formula reserve amounts are regularly reviewed but
have not been changed during the three years ended
December 31, 2007 in order to maintain stability in this
aspect of the claim reserving process. We adjust the formula
reserve to the probable ultimate cost for that claim as soon as
sufficient information is available. It is our goal to reserve
each claim at its probable ultimate cost no later than
30 days after the claim file is opened on property claims
or 90 days following receipt of the claim on casualty
claims. During the life cycle of a particular claim, more
information may materialize that causes us to
56
increase or decrease the estimate of the ultimate value of the
claim. We may determine that it is appropriate to pay portions
of the reserve to the claimant or related settlement expenses
before final resolution of the claim. The amount of the
individual claim reserve would then be adjusted accordingly
based on the most recent information available.
We establish IBNR reserves to estimate the amount we will have
to pay for claims that have occurred, but have not yet been
reported to us; claims that have been reported to us that may
ultimately be paid out differently than expected by our
case-specific reserves; and claims that have been paid and
closed, but may reopen and require future payment. Case reserves
and IBNR reserves comprise the total loss and loss expense
reserves.
We periodically review our reserves for loss and loss expenses,
and based on new developments and information, we include
adjustments of the probable ultimate liability in operating
results for the periods in which the adjustments are made. In
general, our initial reserves are based upon the actuarial and
underwriting data utilized to set pricing levels and are
reviewed as additional information, including claims experience,
becomes available. The establishment of loss and loss expense
reserves makes no provision for the broadening of coverage by
legislative action or judicial interpretation or for the
extraordinary future emergence of new types of losses not
sufficiently represented in our historical experience or which
cannot yet be quantified. We regularly analyze our reserves and
review our pricing and reserving methodologies so that future
adjustments to prior year reserves can be minimized. However,
given the complexity of this process, reserves require continual
updates and the ultimate liability may be higher or lower than
previously indicated.
Due to the inherent uncertainty in estimating reserves for
losses and loss expenses, there can be no assurance that the
ultimate liability will not materially exceed amounts reserved,
with a resulting adverse effect on our results of operations and
financial condition. Based on the current assumptions used in
calculating reserves, management believes our overall reserve
levels at December 31, 2007 make a reasonable provision for
our future obligations.
The following table presents our case reserves and IBNR reserves
for loss and loss expenses (net of the effects of reinsurance)
by segment and the effects of reinsurance for the periods
included:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2007
|
|
|
December 31, 2006
|
|
|
December 31, 2005
|
|
|
|
Case
|
|
|
IBNR
|
|
|
Total
|
|
|
Case
|
|
|
IBNR
|
|
|
Total
|
|
|
Case
|
|
|
IBNR
|
|
|
Total
|
|
|
Property and casualty:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Casualty
|
|
$
|
57,035
|
|
|
|
152,790
|
|
|
|
209,825
|
|
|
|
59,801
|
|
|
|
128,569
|
|
|
|
188,370
|
|
|
|
46,581
|
|
|
|
95,870
|
|
|
|
142,451
|
|
Property
|
|
|
11,427
|
|
|
|
13,564
|
|
|
|
24,991
|
|
|
|
13,506
|
|
|
|
8,796
|
|
|
|
22,302
|
|
|
|
12,801
|
|
|
|
15,171
|
|
|
|
27,972
|
|
Other (including exited lines):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial auto
|
|
|
97
|
|
|
|
4
|
|
|
|
101
|
|
|
|
|
|
|
|
147
|
|
|
|
147
|
|
|
|
534
|
|
|
|
402
|
|
|
|
936
|
|
Workers compensation
|
|
|
1,428
|
|
|
|
1,602
|
|
|
|
3,030
|
|
|
|
1,164
|
|
|
|
2,056
|
|
|
|
3,220
|
|
|
|
1,097
|
|
|
|
1,560
|
|
|
|
2,657
|
|
Surety
|
|
|
|
|
|
|
443
|
|
|
|
443
|
|
|
|
|
|
|
|
529
|
|
|
|
529
|
|
|
|
|
|
|
|
183
|
|
|
|
183
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net reserves for losses and loss expenses
|
|
|
69,987
|
|
|
|
168,403
|
|
|
|
238,390
|
|
|
|
74,471
|
|
|
|
140,097
|
|
|
|
214,568
|
|
|
|
61,013
|
|
|
|
113,186
|
|
|
|
174,199
|
|
Plus reinsurance recoverables on unpaid losses at end of period
|
|
|
12,865
|
|
|
|
27,998
|
|
|
|
40,863
|
|
|
|
11,723
|
|
|
|
24,381
|
|
|
|
36,104
|
|
|
|
14,063
|
|
|
|
23,385
|
|
|
|
37,448
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross reserves for losses and loss expenses
|
|
$
|
82,852
|
|
|
|
196,401
|
|
|
|
279,253
|
|
|
|
86,194
|
|
|
|
164,478
|
|
|
|
250,672
|
|
|
|
75,076
|
|
|
|
136,571
|
|
|
|
211,647
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
57
The following table presents our incurred losses and loss
expenses (net of the effects of reinsurance) from the most
current accident year and from re-estimation of ultimate losses
on prior accident years and provides a summary of losses
incurred to premiums earned (loss and loss expense ratio) for
the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
|
Net incurred losses and loss expenses attributable to insured
events of:
|
|
|
|
|
|
|
|
|
|
|
|
|
Current year
|
|
$
|
134,981
|
|
|
|
136,583
|
|
|
|
112,946
|
|
Prior years:
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and casualty
|
|
|
|
|
|
|
|
|
|
|
|
|
Casualty
|
|
|
(6,049
|
)
|
|
|
6,164
|
|
|
|
7,384
|
|
Property
|
|
|
(2,661
|
)
|
|
|
(9,250
|
)
|
|
|
(2,388
|
)
|
Other (including exited lines):
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial automobile
|
|
|
(9
|
)
|
|
|
73
|
|
|
|
439
|
|
Workers compensation
|
|
|
142
|
|
|
|
2,056
|
|
|
|
(35
|
)
|
Other
|
|
|
(487
|
)
|
|
|
(146
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total prior years
|
|
|
(9,064
|
)
|
|
|
(1,103
|
)
|
|
|
5,400
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net incurred
|
|
$
|
125,917
|
|
|
|
135,480
|
|
|
|
118,346
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss and loss expense ratio:
|
|
|
|
|
|
|
|
|
|
|
|
|
Current year
|
|
|
62.1
|
%
|
|
|
62.4
|
%
|
|
|
63.6
|
%
|
Prior years
|
|
|
(4.2
|
)
|
|
|
(0.5
|
)
|
|
|
3.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss and loss expense ratio:
|
|
|
57.9
|
%
|
|
|
61.9
|
%
|
|
|
66.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
An overall and by segment explanation of our reserves and
development on those reserves (net of reinsurance unless
otherwise indicated) for the years ended December 31, 2007,
2006 and 2005 is as follows:
Overall
Year Ended December 31, 2007 Compared to Year Ended
December 31, 2006. Our gross reserves for
loss and loss expenses were $279.3 million (before the
effects of reinsurance) and $238.4 million (after the
effects of reinsurance) at December 31, 2007, as estimated
through our actuarial analysis. At December 31, 2006, our
gross reserves for loss and loss expenses were
$250.7 million (before the effects of reinsurance) and
$214.6 million (after the effects of reinsurance), as
estimated through our actuarial analysis. In 2007, we concluded
through our actuarial analysis that the December 31, 2006
reserve for losses and loss expenses of $214.6 million
(after the effects of reinsurance) was redundant by
$9.1 million, primarily due to favorable development in our
casualty reserves.
Net loss and loss expenses incurred were $125.9 million for
the year ended December 31, 2007, compared to
$135.5 million for the year ended December 31, 2006.
In 2007, we recorded $135.0 million of incurred losses and
loss expenses attributable to the 2007 accident year, which were
partially offset by favorable development of $9.1 million
attributable to events of prior years. In 2006, we recorded
$136.6 million of incurred losses and loss expenses
attributable to the 2006 accident year and $1.1 million of
favorable prior year development. Net loss and loss expense
ratios were 57.9% and 61.9% for the years ended
December 31, 2007 and 2006, respectively.
The favorable development during the year ended
December 31, 2007 primarily relates to the 2004 through
2006 accident years. At the beginning of 2005, we began writing
certain contractors liability business on a claims made
form, replacing the occurrence form which had previously been
utilized through 2004. We wrote a significant volume of claims
made contractor liability business in both 2005 and 2006, and
this business has continued to perform better than expected. We
continue to write contractors liability business on an
occurrence form, in certain jurisdictions and for certain
classes of business. The ultimate loss ratios for the 2005 and
2006 accident years were reduced during 2007 due in part to the
continued favorable experience on the claims made contractor
liability business. In addition, management reduced its
long-term loss ratio expectations and loss development factors
for
58
other casualty business based on loss experience that emerged
during the year. Due to the reduction of these long-term loss
ratio expectations and loss development factors, the indicated
ultimate loss ratios produced by certain actuarial methods were
lower as of December 31, 2007 than they were as of
December 31, 2006. As a result, during the year, management
reduced the selected ultimate loss ratios for casualty business
for accident years 2004 through 2006. The reduction in losses
for casualty business discussed above was partially offset by
increases in legal and settlement costs related to litigation on
construction defect claims. In total, this resulted in favorable
development of $6.1 million for the year ended
December 31, 2007. In addition, 2007 we experienced
favorable case reserve development in the property line for
accident years 2005 and 2006, resulting in a reduction in losses
of $2.7 million during 2007.
Year Ended December 31, 2006 Compared to Year Ended
December 31, 2005. Our gross reserves for
loss and loss expenses were $250.7 million (before the
effects of reinsurance) and $214.6 million (after the
effects of reinsurance), as estimated through our actuarial
analysis at December 31, 2006. At December 31, 2005,
our gross reserves for loss and loss expenses were
$211.7 million (before the effects of reinsurance) and
$174.2 million (after the effects of reinsurance), as
estimated through our actuarial analysis. In 2006, we determined
that the December 31, 2005 net reserve for losses and
loss expenses of $174.2 (after the effects of reinsurance) was
redundant by $1.1 million. This favorable development is
detailed in the chart above and further discussed in the segment
information below.
Net loss and loss expenses incurred were $135.5 million for
the year ended December 31, 2006, compared to
$118.3 million for the year ended December 31, 2005.
In 2006, we recorded $136.6 million of incurred losses and
loss expenses attributable to the 2006 accident year and
$1.1 million of favorable prior year development. In 2005,
we recorded $112.9 million of incurred losses and loss
expense attributable to the 2005 accident year and
$5.4 million of unfavorable prior year development. Net
loss and loss expense ratios were 61.9% and 66.6% for the years
ended December 31, 2006 and 2005, respectively.
Segment
Property
and Casualty
Casualty. Our changes in the reserve estimates
related to prior accident years for the years ended
December 31, 2007, 2006 and 2005 for the casualty lines
resulted in a decrease in incurred losses and loss expenses of
$6.1 million and an increase in incurred losses and loss
expenses of $6.2 million and $7.4 million,
respectively. The favorable development during the year ended
December 31, 2007 primarily relates to the 2004 through
2006 accident years. At the beginning of 2005, we began writing
certain contractors liability business on a claims made
form, replacing the occurrence form which had previously been
utilized through 2004. We wrote a significant volume of claims
made contractor business in both 2005 and 2006. Casualty
reserves for accident years 2005 and 2006 were particularly
difficult to initially estimate due to the magnitude and very
limited experience for claims made contractor business. The
ultimate loss ratios for the 2005 and 2006 accident years were
reduced during the year due in part to the continued favorable
experience on the claims made contractor liability business. We
continue to write contractors liability business on an
occurrence form, in certain jurisdictions and for certain
classes of business.
In addition, during the year ended December 31, 2007,
management reduced its long-term loss ratio expectations and
loss development factors for other casualty business based on
loss experience that emerged during the year that was more
favorable than our initial expectations. Due to the reduction of
these long-term loss ratio expectations and loss development
factors, the indicated ultimate loss ratios produced by certain
actuarial methods were lower as of December 31, 2007 than
they were as of December 31, 2006. As a result, during the
year, management reduced the selected ultimate loss ratios for
casualty business for accident years 2004 through 2006. The
reduction in losses for casualty business discussed above was
partially offset by increases in legal costs and settlement
costs related to litigation on construction defect claims.
Our changes in the reserve estimates related to prior accident
years for the years ended December 31, 2006 and 2005 for
the casualty lines resulted in reserve increases of
$6.2 million and $7.4 million, respectively. A
significant portion of our casualty reserve development relates
to construction defect claims with loss dates prior to 2001 in
certain states. Reserves and claim frequency on this business
have been impacted by decisions by courts in
59
California and other states affecting insurance law and tort law
and by legislation enacted in California, which generally
provides consumers who experience construction defects a method
other than litigation to obtain reimbursement for construction
defect repairs. These legal developments impact claim severity,
frequency and time to settlement assumptions underlying our
reserves. Starting with California in December 2000, we began to
exit contractors liability business written on an
occurrence form. By the end of the first quarter of 2001, we had
significantly reduced our contractors liability written on
an occurrence form in Arizona, California, Colorado, Hawaii,
Louisiana, Nevada, New Jersey, North Carolina, Oregon, South
Carolina and Washington. Although we reduced our exposure to
construction defect claims and, accordingly, the magnitude of
our adverse development in this business has declined since
2000, our ultimate liability may exceed or be less than current
estimates due to these legal actions among other variables.
In addition, we incurred increased legal expenses and internal
restructuring costs to address related claims, which contributed
to our continued adverse development in this area. During 2004,
as a result of court decisions that further defined the legal
environment in California, we decided to enhance our defense
strategy for certain types of construction defect claims. As a
result, the Company revised its construction defect defense team
by retaining appellate and new trial counsel and restaffing the
in-house team responsible for management of the litigation. Once
the new legal teams were established late in 2004 and into 2005,
it was determined that there were certain cases that should be
settled and the defense budgets for the remaining cased had to
be revised to reflect the added resources, resulting in higher
than expected loss and defense costs in 2005. This strategy
continued in 2006 and we incurred additional legal expenses when
litigation discovery procedures yielded new information about
the underlying claims. This new information required a
reassessment of expected settlements or judgments and expenses
on many suits that had been received in prior years.
With this continued development related to our construction
defect claims in 2006 as well as a small amount of adverse
development on our non-construction defect casualty claims, our
internal actuaries continued to refine their actuarial reserving
techniques concerning the weighting of reserve indications and
supplemental information concerning claims severities. As a
result, our casualty reserves moved to a higher point on the
range of loss and loss expense reserve estimates. We also
recorded $2.9 million of unfavorable development during the
year ended December 31, 2006 related to estimated costs
associated with possible reinsurance collection issues on two
separate casualty claims.
Our net loss and loss expense reserves for construction defects
as of December 31, 2007, 2006 and 2005 were
$15.6 million, $16.5 million and $17.7 million,
respectively. The re-estimation of construction defect reserves
for the years ended December 31, 2007, 2006 and 2005
primarily affected the 1996 and 1997 accident years and the 1999
to 2001 accident years.
As of December 31, 2007, the projected loss and loss
expense ratios, after the effects of reinsurance, for the
casualty lines were 60.8%, 56.0% and 54.2% for accident periods
2007, 2006 and 2005.
Our internal actuaries apply multiple traditional actuarial
techniques to calculate loss and loss expense reserve estimates
that use the following factors, among others:
|
|
|
|
|
our experience and the industrys experience;
|
|
|
|
historical trends in reserving patterns and loss payments;
|
|
|
|
the impact of claim inflation;
|
|
|
|
the pending level of unpaid claims;
|
|
|
|
the cost of claim settlements;
|
|
|
|
the line of business mix; and
|
|
|
|
the environment in which property and casualty insurance
companies operate.
|
Although many factors influence the actual cost of claims and
our corresponding reserve estimates, we do not measure and
estimate values for all of these variables individually. This is
due to the fact that many of the factors that are known to
impact the cost of claims cannot be measured directly, such as
the impact on claim costs due to
60
economic inflation, coverage interpretations and jury
determinations. In most instances, we rely on our historical
experience or industry information to estimate values for the
variables that are explicitly used in our reserve analyses. We
assume that our historical experience reflects the effect of
these unmeasured factors and is indicative of future effects of
these factors. Where we have reason to expect a change in the
effect of one of these factors, we perform analysis to quantify
the necessary adjustments.
For claim liabilities other than construction defect, our
internal actuaries apply multiple traditional actuarial
techniques to determine loss and loss expense reserve estimates.
Each technique produces a unique loss and loss expense reserve
estimate for the line being analyzed. The set of techniques
applied produces a range of loss and loss expense reserve
estimates. From these estimates, the actuaries form a best
estimate which considers the assumptions and factors that
influence ultimate claim costs, including but not limited to
those identified above as of December 31, 2007 for casualty
lines, other than construction defect claims, the low end of the
range of techniques was 20.9% below the actuarial best estimate,
and the high end of the range of techniques was 4.0% above the
actuarial best estimate. These low and high loss and loss
expense reserve estimates reflect the fact that the
methodologies applied do not produce identical estimates, and
these estimates do not constitute the range of all possible
outcomes. It is important to note that actual claim costs will
vary from the selected estimate, perhaps by substantial amounts,
due to the inherent variability of the business written, the
potentially significant claim settlement lags and the fact that
not all events affecting future claim costs can be estimated at
this time period. The range presented herein represents neither
the full range of reasonably likely outcomes nor the full range
of possible outcomes.
For the construction defect reserving segment, the actuaries use
one method to estimate IBNR reserves. The method is comprised of
estimated IBNR claims by accident year, the percentage of claims
expected to close with payment by accident year, and an expected
average claim cost per claim closed with payment. The actuaries
evaluate the impact of fluctuations above and below the expected
levels for each of three components of the calculation on
estimated IBNR. As of December 31, 2007, the range for
construction defect claims was 12.8% below to 17.4% above the
selected best estimate. The range presented herein represents
neither the full range of reasonably likely outcomes nor the
full range of possible outcomes.
At the low end of the range, the parameters of the IBNR estimate
were varied as follows:
|
|
|
|
|
claim reporting patterns were reduced by amounts ranging from
10% to 1%;
|
|
|
|
close with payment ratios by accident year were not
varied; and
|
|
|
|
average claim severities were reduced by 14.3%.
|
These factors produced IBNR estimates that, when added to case
reserves, were 12.8% below the best estimate reserves.
At the high end of the range, the parameters of the IBNR
estimate were varied as follows:
|
|
|
|
|
claim reporting patterns were increased by amounts ranging from
10% to 1%
|
|
|
|
close with payment ratios by accident year were not
varied; and
|
|
|
|
average claim severities were increased by 15.2%.
|
These factors produced IBNR estimates that, when added to case
reserves, were 17.4% above the best estimate reserves. It is
important to note that we do not believe that the fluctuations
considered in these calculations represent the full range of
reasonably likely outcomes. We believe the likely range extends
beyond this range, particularly on the high end. The range
presented herein represents neither the full range of reasonably
likely outcomes nor the full range of possible outcomes.
Property. Our changes in estimates for the
years ended December 31, 2007, 2006 and 2005 for the
property lines resulted in decreases of $2.7 million,
$9.3 million and $2.4 million, respectively.
When establishing our December 31, 2005 loss and loss
expense reserves, we believed the accident year 2005 property
loss ratio would be significantly impacted by claims activity
resulting from Hurricanes Katrina, Rita and Wilma. In addition,
due to the significantly higher claims per adjuster levels at
the end of 2005 caused by the
61
hurricane activity, we believed that there was a potential risk
that case reserves would not be set as quickly as they would be
with normal case loads. Accordingly, we considered this
potential risk in setting our expected payment pattern and case
incurred pattern for property business resulting in a higher
reserve estimate than would have been normally set absent this
risk. At the end of 2005, we held property IBNR for loss and
loss expenses of $13.8 million. We expected
$8.6 million of reported incurred losses and loss expenses
for the year 2006. During 2006, actual reported incurred loss
and loss expense reserves were $3.4 million. As a result of
the significantly better than expected loss emergence during
2006, the selected payment patterns and case incurred patterns
were revised downward. As a result of the better than expected
loss emergence and the revision to payment and case incurred
patterns, the IBNR reserve for accident years 2005 and prior as
of December 31, 2006 decreased to $1.8 million. These
results, coupled with a corresponding reduction in claim
handling costs yielded the overall reduction of
$9.3 million in losses and loss expense in 2006. For 2007
and 2005, the changes in reserves primarily relate to changes in
the selected development patterns on multiple accident years, as
the number of claims and claim severity were below expectations
at December 31, 2007 and 2005.
As of December 31, 2007, the projected loss and loss
expense ratios, after the effects of reinsurance, for the
property lines were 68.0%, 66.0% and 61.2% for accident periods
2007, 2006 and 2005.
Our internal actuaries apply multiple actuarial techniques
utilizing the same factors discussed above under
Casualty to determine loss and loss expense reserve
estimates for property claim liabilities. Each technique
produces a unique loss and loss expense reserve estimate for the
line being analyzed. The set of techniques applied produces a
range of loss and loss expense reserve estimates. From these
estimates, the actuaries form a best estimate that considers
assumptions and factors, as discussed above, that influence
ultimate claim costs. As of December 31, 2007, for property
lines the low end of the range of techniques was 19.0% below the
actuarial best estimate and the high end of the range of
techniques was 5.7% above the actuarial best estimate. These low
and high loss and loss expense reserve estimates reflect the
fact that the methodologies applied do not produce identical
estimates, and these estimates do not constitute the range of
all possible outcomes. It is important to note that actual claim
costs will vary from the selected estimate, perhaps by
substantial amounts, due to the inherent variability of the
business written, the potentially significant claim settlement
lags and the fact that not all events affecting future claim
costs can be estimated at this time. The range presented herein
represents neither the full range of reasonably likely outcomes
nor the full range of possible outcomes.
Other
(Including Exited Lines)
We began writing commercial automobile/trucking coverage for
commercial vehicles and trucks in 1997. In 2000, we exited the
commercial automobile line of business due to unsatisfactory
underwriting results. Our net loss and loss expense reserves for
commercial automobile as of December 31, 2007 and 2006 were
$101,000 and $147,000, respectively.
We offered workers compensation coverage from 1997 through
January 2002. We exited this line of business beginning
January 1, 2002 due to unsatisfactory underwriting results
and the lack of availability of acceptable reinsurance. Until
July 2000, we purchased 100% quota share reinsurance on this
book of business. Beginning in 2000, we started to retain some
risk. No new policies have been written since the first quarter
of 2002. In 2006, we recorded $2.9 million of unfavorable
development related to estimated costs associated with
reinsurance collection issues on our 1997 through 1999
workers compensation reinsurance treaties. Our net loss
and loss expense reserves for workers compensation as of
December 31, 2007 and 2006 were $3.0 million and
$3.2 million, respectively.
Operating
Expenses
Operating expenses include the costs to acquire a policy
(included in amortization of deferred policy acquisition costs),
other operating expenses (including corporate expenses) and
interest expense. The following
62
table presents our amortization of deferred policy acquisition
costs, other operating expenses and related ratios and interest
expense for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
|
Amortization of deferred policy acquisition costs
(ADAC)
|
|
$
|
55,230
|
|
|
|
54,404
|
|
|
|
42,935
|
|
Other operating expenses
|
|
|
18,280
|
|
|
|
17,043
|
|
|
|
14,463
|
|
Severance expense
|
|
|
|
|
|
|
|
|
|
|
793
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ADAC and other operating expenses
|
|
|
73,510
|
|
|
|
71,447
|
|
|
|
58,191
|
|
Interest expense
|
|
|
2,681
|
|
|
|
2,318
|
|
|
|
1,873
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
$
|
76,191
|
|
|
|
73,765
|
|
|
|
60,064
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expense ratio:
|
|
|
|
|
|
|
|
|
|
|
|
|
ADAC
|
|
|
25.4
|
%
|
|
|
24.8
|
%
|
|
|
24.2
|
%
|
Other operating expenses
|
|
|
8.4
|
%
|
|
|
7.8
|
%
|
|
|
8.2
|
%
|
Severance expense
|
|
|
|
|
|
|
|
|
|
|
0.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expense ratio(1)
|
|
|
33.8
|
%
|
|
|
32.6
|
%
|
|
|
32.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Interest expense is not included in the calculation of the
expense ratio. |
Year Ended December 31, 2007 Compared to Year Ended
December 31, 2006. Other operating expenses
increased by 7.3% for the year ended December 31, 2007,
respectively compared to the same period in 2006. The overall
expense ratio for year ended December 31, 2007 was 33.8%
compared to 32.6% for the year ended December 31, 2006. The
increase in other operating expenses for the year ended
December 31, 2007 compared to the same period in 2006, is
due to higher agent contingent commissions, resulting from the
favorable loss experience that we experienced during 2007 and
higher amortization of deferred policy acquisition costs with an
increase of binding.
For the year ended December 31, 2007, we experienced an
increase in our ADAC portion of the expense ratio because of a
higher amount of binding business, which has higher acquisition
costs relative to brokerage business.
The increase in other operating expenses for the year ended
December 31, 2007 is due to higher costs related to our
agent contingent commission program and $300,000 of professional
and other fees expensed, which related primarily to an aborted
public equity offering. The increases were partially offset by
recoveries received from our corporate insurance policy.
Interest expense increased on our variable rate
Trust Preferred securities due to the increase in LIBOR
during 2007. In addition, we incurred $324,000 of interest
expense related to our line of credit for the year ended
December 31, 2007, compared to $6,000 for the year ended
December 31, 2006.
Year Ended December 31, 2006 Compared to Year Ended
December 31, 2005. For the year ended
December 31, 2006, we experienced an increase in our ADAC
portion of the expense ratio due to a lower amount of
acquisition expenses that were able to be deferred related to
the auto physical damage program. During the third quarter of
2006, the loss and loss expense ratio related to this program
exceeded our expectations causing the program to fall below the
profitability levels required for continued deferral of the
additional policy acquisition costs. This resulted in $648,000
of additional amortization expense for the year ended
December 31, 2006. There were no such expenses during the
year ended December 30, 2005. The increase in the ADAC
portion of the expense ratio for the year ended
December 31, 2006 was offset by the commutation of certain
2005 and prior contingent commission contracts that lowered the
other operating expense portion of the expense ratio. There were
no commutations of contingent commission contracts in 2005.
In response to the lower than expected performance of the auto
physical damage program, we tightened the underwriting selection
guidelines, and increased premium rates to yield a decrease in
the loss and loss expense ratio.
63
We also decreased the commissions paid to the agent from 21% to
17%. These changes were designed to increase the profitability
of this program to meet our expectations.
Interest expense continues to increase based on the increase in
interest rates on our variable rate Trust Preferred
securities, due to the current interest rate environment.
Income
Taxes
We have historically filed a consolidated federal income tax
return that has included all of our subsidiaries. The statutory
rate used in calculating our tax provision was 35.0% in 2007,
2006 and 2005. Income tax expense differed from the amounts
computed at the statutory rate as demonstrated in the following
table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
Federal income tax expense at statutory rate
|
|
|
35.00
|
%
|
|
|
35.00
|
%
|
|
|
35.00
|
%
|
(Decrease) increase attributable to:
|
|
|
|
|
|
|
|
|
|
|
|
|
Nontaxable interest income net of proration
|
|
|
(4.71
|
)
|
|
|
(5.59
|
)
|
|
|
(9.77
|
)
|
Deferred tax asset valuation allowance
|
|
|
1.21
|
|
|
|
|
|
|
|
|
|
Dividend received deduction net of proration
|
|
|
(0.52
|
)
|
|
|
(0.48
|
)
|
|
|
(0.33
|
)
|
Other
|
|
|
0.33
|
|
|
|
0.54
|
|
|
|
(0.32
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
31.31
|
%
|
|
|
29.47
|
%
|
|
|
24.58
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liquidity
and Capital Resources
ProCentury is a holding company, the principal asset of which is
the common shares of Century. Although we have the capacity to
generate cash through loans from banks and issuances of equity
securities, our primary source of funds to meet our short-term
liquidity needs, including the payment of dividends to our
shareholders and corporate expenses, is dividends from Century.
Centurys principal sources of funds are underwriting
operations, investment income, proceeds from sales and
maturities of investments and dividends from PIC. Centurys
primary use of funds is to pay claims and operating expenses, to
purchase investments and to make dividend payments to us.
ProCenturys future liquidity is dependent on the ability
of Century to pay dividends.
Our insurance subsidiaries are restricted by statute as to the
amount of dividends it may pay without the prior approval of
regulatory authorities. Century and PIC may pay dividends
without advance regulatory approval only from unassigned surplus
and only to the extent that all dividends in the current twelve
months do not exceed the greater of 10% of total statutory
surplus as of the end of the prior fiscal year or statutory net
income for the prior year. Using these criteria, the available
ordinary dividend available to be paid from Century to
ProCentury during 2008 is $27.4 million. The ordinary
dividend available to be paid from PIC to Century during 2008 is
$2.9 million.
Century paid ordinary dividends of $5.0 million in 2007,
$2.5 million in 2006 and $2.5 million in 2005. PIC has
not paid any dividends to Century in 2007, 2006 or 2005.
Centurys ability to pay future dividends to ProCentury
without advance regulatory approval is dependent upon
maintaining a positive level of unassigned surplus, which in
turn, is dependent upon Century generating net income in excess
of dividends to ProCentury.
Our insurance subsidiaries are required by law to maintain a
certain minimum level of surplus on a statutory basis. Surplus
is calculated by subtracting total liabilities from total
admitted assets. The National Association of Insurance
Commissioners (NAIC) has a risk-based capital
standard designed to identify property and casualty insurers
that may be inadequately capitalized based on inherent risks of
each insurers assets and liabilities and its mix of net
written premiums. Insurers falling below a calculated threshold
may be subject to varying degrees of regulatory action. As of
December 31, 2007, the statutory surplus of Century (which
includes Centurys investment in PIC) was in excess of the
prescribed risk-based capital requirements that correspond to
any level of regulatory action. Centurys statutory surplus
(including PICs surplus) at December 31, 2007 was
$153.5 million and the authorized control level was
$31.1 million.
64
Year Ended December 31, 2007 Compared to Year Ended
December 31, 2006. Consolidated net cash
provided by operating activities was $45.4 million for the
year ended December 31 2007, compared to $64.0 million for
the same period in 2006. The majority of the decrease is due to
the lower amount of growth in premiums for the year ended
December 31, 2007 compared to the year ended
December 31, 2006.
Consolidated net cash used in investing activities was
$41.2 million for the year ended December 31, 2007,
compared to $63.9 million for the same period in 2006. The
decrease resulted from a lower amount of operational cash
available for investing during 2007 compared to 2006.
Consolidated net cash used in financing activities was $453,000
for the year ended December 31, 2007, compared to net cash
provided by financing activities of $2.2 million for the
same period in 2006. This decrease is primarily the result of
lower net draws on the line of credit and higher dividends paid
to shareholders, which were partially offset by $697,000 of
proceeds from the exercise of share options during the year
ended December 31, 2007 compared to the same period in 2006.
Interest on our debt issued to a related party trust is variable
and resets quarterly based on a spread over three-month London
Interbank Offered Rates (LIBOR). As part of our
asset/liability matching program, we have short-term
investments, investments in bond mutual funds, as well as
available cash balances from operations and investment
maturities, that are available for reinvestment during periods
of rising or falling interest rates.
Line of Credit. We have a $10.0 million
line of credit with a maturity date of September 30, 2009,
and interest only payments due quarterly based on LIBOR plus
1.2% of the outstanding balance. All of the outstanding shares
of Century are pledged as collateral. At December 31, 2007,
the outstanding borrowings on the line of credit were
$4.7 million. During the year ended 2007, the Company made
draws totaling $650,000 on the line of credit for general
corporate purposes. Interest expense for the year ended
December 31, 2007 was $324,000. The Company had borrowings
outstanding under the line of credit at December 31, 2006
of $4.0 million. Interest expense for the year ended
December 31, 2006 was $6,000.
Given our historical cash flow, we believe cash flow from
operating activities in 2007 will provide sufficient liquidity
for our operations, as well as to satisfy debt service
obligations and to pay other operating expenses. Although we
anticipate that we will be able to meet our cash requirements,
we can give no assurance in this regard.
Year ended December 31, 2006 compared to Year ended
December 31, 2005. Consolidated net cash
provided by operating activities was $64.0 million for the
year ended December 31, 2006, compared to
$63.7 million for the year ended December 31, 2005.
The increase is due to our growth of gross written premiums and
investment income, which was partially offset by an increase in
the amount of claim payments as a result of the 2005 hurricane
season and quicker claim payouts related to the auto physical
damage program, as it has a much shorter tail than our other
property and casualty business.
Consolidated net cash used by investing activities was
$63.9 million for the year ended December 31, 2006,
compared to $64.6 million for the year ended
December 31, 2005. This decrease is a result of a larger
amount of cash at the end of 2006 that had not yet been invested.
Consolidated net cash provided by financing activities was
$2.2 million for the year ended December 31, 2006,
compared to net cash used by financing activities of
$1.1 million for the same period in 2005. This increase is
primarily the result of additional draws on the line of credit
in 2006 compared to 2005, which was contributed to Century to
supplement Centurys capital base in response to the
significant growth in gross written premium. The increase in net
cash provided by financing activities was partially offset by an
increase in dividends to $0.145 per share during year ended
December 31, 2006 compared to $0.085 per share during the
year ended December 31, 2005.
65
The following table summarizes information about our contractual
obligations and commercial commitments. The minimum payments
under these agreements as of December 31, 2007 were as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Years
|
|
|
|
2008
|
|
|
2009
|
|
|
2010
|
|
|
2011
|
|
|
2012
|
|
|
Thereafter
|
|
|
Total
|
|
|
|
(In thousands)
|
|
|
Long Term Debt:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt issues to a related party trust(1)(2)
|
|
$
|
2,302
|
|
|
|
2,302
|
|
|
|
2,302
|
|
|
|
2,302
|
|
|
|
2,302
|
|
|
|
71,493
|
|
|
|
83,003
|
|
Loss and loss expense payments,(3)
|
|
|
99,181
|
|
|
|
67,459
|
|
|
|
45,232
|
|
|
|
26,194
|
|
|
|
13,674
|
|
|
|
27,513
|
|
|
|
279,253
|
|
Operating leases on facilities
|
|
|
1,545
|
|
|
|
1,258
|
|
|
|
1,106
|
|
|
|
1,019
|
|
|
|
932
|
|
|
|
776
|
|
|
|
6,636
|
|
Other operating leases
|
|
|
279
|
|
|
|
70
|
|
|
|
58
|
|
|
|
27
|
|
|
|
|
|
|
|
|
|
|
|
434
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total contractual obligations
|
|
$
|
103,307
|
|
|
|
71,089
|
|
|
|
48,698
|
|
|
|
29,542
|
|
|
|
16,908
|
|
|
|
99,782
|
|
|
|
369,326
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Amounts include interest payments associated with these
obligations using applicable interest rates as of
December 31, 2007. |
|
(2) |
|
In connection with the adoption of FASB Interpretation Number
46R, Consolidation of Variable Interest Entities (as
amended) ProCentury has deconsolidated the trusts
established in connection with the issuance of trust preferred
securities effective December 31, 2003. As a result,
ProCentury reports as a component of long term debt the junior
subordinated debentures payable by ProCentury to the trusts. See
Note 6(a) to our audited consolidated financial statements
included in this report. |
|
(3) |
|
The timing for payment of our estimated losses is determined by
our actuaries, using periods based on our historical claims
payment experience. Due to the uncertainty in estimating the
timing of such payments, there is a risk that the amounts paid
in any period can be significantly different than the amounts
disclosed above. |
Interest on our debt issued to a related party trust is variable
and resets quarterly based on a spread over three-month London
Interbank Offered Rates (LIBOR). As part of our
asset/liability matching program, we have short-term
investments, investments in bond mutual funds, as well as
available cash balances from operations and investment
maturities, that are available for reinvestment during periods
of rising or falling interest rates.
Investment
Portfolio
Our investment strategy is designed to capitalize on our ability
to generate positive cash flow from our underwriting activities.
Preservation of capital is our first priority, with a secondary
focus on maximizing appropriate risk adjusted return. We seek to
maintain sufficient liquidity from operations, investing and
financing activities to meet our anticipated insurance
obligations and operating and capital expenditure needs. The
majority of our fixed-maturity portfolio is rated investment
grade to protect investments. Our investment portfolio is
managed by two outside independent investment managers and one
related party investment manager, all which operate under
investment guidelines approved by our investment committee. Our
investment committee meets at least quarterly and reports to our
board of directors. In addition, we employ stringent
diversification rules and balance our investment credit risk and
related underwriting risks to minimize total potential exposure
to any one security. In limited circumstances, we will invest in
non-investment grade fixed maturity securities that have an
appropriate risk adjusted return, subject to satisfactory credit
analysis performed by us and our investment managers. Our cash
and
66
investment portfolio totaled $467.3 million as of
December 31, 2007 and is summarized by type of investment
as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percent of
|
|
|
|
Amount
|
|
|
Portfolio
|
|
|
|
(Dollars in thousands)
|
|
|
Fixed-maturity:
|
|
|
|
|
|
|
|
|
U.S. Treasury securities
|
|
$
|
2,663
|
|
|
|
0.6
|
%
|
Agencies not backed by the full faith and credit by the U.S.
Government
|
|
|
6,101
|
|
|
|
1.3
|
|
Corporate securities
|
|
|
34,366
|
|
|
|
7.4
|
|
Mortgage-backed securities (GSEs)
|
|
|
77,200
|
|
|
|
16.5
|
|
Asset-backed securities
|
|
|
27,802
|
|
|
|
6.0
|
|
Collateralized mortgage obligations
|
|
|
49,671
|
|
|
|
10.6
|
|
Obligations of states and political subdivisions
|
|
|
209,735
|
|
|
|
44.9
|
|
|
|
|
|
|
|
|
|
|
Total fixed-maturity
|
|
|
407,538
|
|
|
|
87.3
|
|
|
|
|
|
|
|
|
|
|
Cash and short-term investments
|
|
|
16,496
|
|
|
|
3.5
|
|
|
|
|
|
|
|
|
|
|
Equity securities:
|
|
|
|
|
|
|
|
|
Bond mutual funds
|
|
|
14,244
|
|
|
|
3.0
|
|
Preferred shares
|
|
|
26,338
|
|
|
|
5.6
|
|
Common shares
|
|
|
2,660
|
|
|
|
0.6
|
|
|
|
|
|
|
|
|
|
|
Total equity securities
|
|
|
43,242
|
|
|
|
9.2
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
467,276
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
At December 31, 2007, our fixed-maturity portfolio of
$407.5 million represented 87.3% of the carrying value of
our total of cash and investments. Standard &
Poors Rating Services (Standard &
Poors) or Moodys Investors Service, Inc.
(Moodys) rated 95.3% of these securities
A or better. Equity securities, which consist of
preferred and common shares and bond mutual funds, totaled
$43.2 million or 9.2% of total cash and investments. The
following is a summary of the credit quality of the
fixed-maturity portfolio at December 31, 2007:
|
|
|
|
|
AAA
|
|
|
80.2
|
%
|
AA
|
|
|
12.3
|
|
A
|
|
|
2.8
|
|
BBB
|
|
|
1.2
|
|
Below BBB
|
|
|
3.5
|
|
|
|
|
|
|
Total
|
|
|
100.0
|
%
|
|
|
|
|
|
67
At December 31, 2007, our investment portfolio contained
corporate fixed-maturity and corporate preferred equity
securities with a fair value of $60.7 million. The
following is a summary of these securities by industry segment
at December 31, 2007:
|
|
|
|
|
Financial
|
|
|
47.9
|
%
|
Consumer, non-cyclical
|
|
|
10.2
|
|
Industrial
|
|
|
7.0
|
|
Utilities
|
|
|
7.3
|
|
Government
|
|
|
12.9
|
|
Communications
|
|
|
4.9
|
|
Consumer, cyclical
|
|
|
4.1
|
|
Energy
|
|
|
4.1
|
|
Basic materials
|
|
|
1.4
|
|
Technology
|
|
|
0.2
|
|
|
|
|
|
|
Total
|
|
|
100.0
|
%
|
|
|
|
|
|
At December 31, 2007, the investment portfolio contained
$154.7 million of mortgage-backed, asset-backed and
collateralized mortgage obligations. Of these securities, 96.2%
were rated AA or better and 95.3% were rated
AAA by Standard & Poors or the
equivalent rating by Moodys. These securities are publicly
registered and had fair values obtained from brokers. Changes in
estimated cash flows due to changes in prepayment assumptions
from the original purchase assumptions are revised based on
current interest rates and the economic environment. We had no
derivative financial instruments, real estate or mortgages in
the investment portfolio at December 31, 2007.
Under our accounting policy for equity securities and
fixed-maturity securities that can be contractually prepaid or
otherwise settled in a way that may limit our ability to fully
recover cost, an impairment is deemed to be other-than-temporary
unless we have both the ability and intent to hold the
investment for a reasonable period until the securitys
forecasted recovery and evidence exists indicating that recovery
will occur within a reasonable period of time.
For fixed-maturity and equity securities, an
other-than-temporary impairment charge is taken when we do not
have the ability and intent to hold the security until the
forecasted recovery or if it is no longer probable that we will
recover all amounts due under the contractual terms of the
security. Many criteria are considered during this process
including, but not limited to, the current fair value as
compared to amortized cost or cost, as appropriate, of the
security; the amount and length of time a securitys fair
value has been below amortized cost or cost; specific credit
issues and financial prospects related to the issuer; our intent
to hold or dispose of the security; and current economic
conditions. Other-than-temporary impairment losses result in a
permanent reduction to the cost basis of the underlying
investment.
Additionally, for certain securitized financial assets with
contractual cash flows (including asset-backed securities), FASB
Emerging Task Force (EITF)
99-20,
Recognition of Interest Income and Impairment on
Purchased and Retained Beneficial Interests in Securitized
Financial Assets, requires us to periodically update
its best estimate of cash flows over the life of the security.
If management determines that the fair value of a securitized
financial asset is less than its carrying amount and there has
been a decrease in the present value of the estimated cash flows
since the last revised estimate, considering both timing and
amount, then an other-than-temporary impairment is recognized.
Other-than-temporary impairment losses result in a permanent
reduction to the cost basis of the underlying investment and are
included in the net realized investment gains (losses) in the
consolidated statements of operations. For the year ended
December 31, 2007, 38 asset-backed securities were written
down in accordance with
EITF 99-20
and six preferred stocks were written down in the aggregate
amount of $4.5 million. For the year ended
December 31, 2006, eleven asset-backed securities were
written down in accordance with
EITF 99-20
in the aggregate amount of $1.4 million, which was included
in net realized investment gains (losses) in the consolidated
statements of operations. For the year ended December 31,
2005, two fixed maturity securities were written down in
68
the total of $150,000, which was included in net realized
investment gains (losses) in the consolidated statements of
operations.
The estimated fair value, related gross unrealized losses, and
the length of time that the securities have been impaired for
available-for-sale securities that are considered temporarily
impaired are as follows.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2007
|
|
|
|
|
|
|
Less Than 12 Months
|
|
|
12 Months or Longer
|
|
|
Total
|
|
|
|
|
|
|
Estimated
|
|
|
Gross
|
|
|
Estimated
|
|
|
Gross
|
|
|
Estimated
|
|
|
Gross
|
|
|
|
|
|
|
Fair
|
|
|
Unrealized
|
|
|
Fair
|
|
|
Unrealized
|
|
|
Fair
|
|
|
Unrealized
|
|
|
|
|
|
|
Value
|
|
|
Loss
|
|
|
Value
|
|
|
Loss
|
|
|
Value
|
|
|
Loss
|
|
|
|
|
|
|
(In thousands)
|
|
|
|
|
|
Fixed maturity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities
|
|
$
|
135
|
|
|
|
|
|
|
|
100
|
|
|
|
|
|
|
|
235
|
|
|
|
|
|
|
|
|
|
Obligations of U.S. government corporations and agencies
|
|
|
|
|
|
|
|
|
|
|
1,328
|
|
|
|
(8
|
)
|
|
|
1,328
|
|
|
|
(8
|
)
|
|
|
|
|
Obligations of states and political subdivisions
|
|
|
50,308
|
|
|
|
(591
|
)
|
|
|
22,742
|
|
|
|
(149
|
)
|
|
|
73,050
|
|
|
|
(740
|
)
|
|
|
|
|
Corporate securities
|
|
|
7,045
|
|
|
|
(240
|
)
|
|
|
20,101
|
|
|
|
(278
|
)
|
|
|
27,146
|
|
|
|
(518
|
)
|
|
|
|
|
Mortgage-backed securities (GSEs)
|
|
|
35,940
|
|
|
|
(86
|
)
|
|
|
26,912
|
|
|
|
(277
|
)
|
|
|
62,852
|
|
|
|
(363
|
)
|
|
|
|
|
Collateralized mortgage obligations
|
|
|
8,353
|
|
|
|
(401
|
)
|
|
|
10,660
|
|
|
|
(231
|
)
|
|
|
19,013
|
|
|
|
(632
|
)
|
|
|
|
|
Asset-backed securities
|
|
|
5,053
|
|
|
|
(2,058
|
)
|
|
|
11,690
|
|
|
|
(1,841
|
)
|
|
|
16,743
|
|
|
|
(3,899
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
106,834
|
|
|
|
(3,376
|
)
|
|
|
93,533
|
|
|
|
(2,784
|
)
|
|
|
200,367
|
|
|
|
(6,160
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities
|
|
|
22,946
|
|
|
|
(5,615
|
)
|
|
|
958
|
|
|
|
(148
|
)
|
|
|
23,904
|
|
|
|
(5,763
|
)
|
|
|
|
|
Bond mutual funds
|
|
|
9,514
|
|
|
|
(683
|
)
|
|
|
5,391
|
|
|
|
(102
|
)
|
|
|
14,905
|
|
|
|
(785
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
32,460
|
|
|
|
(6,298
|
)
|
|
|
6,349
|
|
|
|
(250
|
)
|
|
|
38,809
|
|
|
|
(6,548
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Grand Total
|
|
$
|
139,294
|
|
|
|
(9,674
|
)
|
|
|
99,882
|
|
|
|
(3,034
|
)
|
|
|
239,176
|
|
|
|
(12,708
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2007, the Company had 141 fixed-maturity
securities and seven equity securities that have been in an
unrealized loss position for one year or longer. Of the
fixed-maturity securities, 121 are investment grade, and 116 of
these securities are rated A1/A or better (including 84
securities which are rated AAA). The 20 remaining non-investment
grade fixed-maturity securities have an aggregate fair value
equal to 65.2% of their book value as of December 31, 2007.
The majority of this unrealized loss related to sub prime bonds,
a sector which has experienced significant illiquidity and price
dislocation. Each of these sub prime bonds was tested under the
application of
EITF 99-20
and it was determined none of these bonds was other than
temporarily impaired. Three of the equity securities that have
been in an unrealized loss position for one year or longer
relate to investments in open ended bond funds. Each of these
investments continues to pay its regularly scheduled monthly
dividend and there have been no material changes in credit
quality of any of these funds over the past twelve months.
Finally, the four remaining equity securities that have been in
an unrealized loss position for one year or longer relate to
preferred share investments in issuers each of which has shown
an improved or stable financial performance during the past
twelve months. In addition, these four equity securities have an
aggregate fair market value equal to 83.7% of their book value
as of December 31, 2007. All 141 of the fixed income
securities are current on interest and principal and all seven
of the equity securities continue to pay dividends at a level
consistent with the prior year. Management believes that it is
probable that all contract terms of each fixed-maturity security
will be satisfied. The unrealized loss position of the
fixed-maturity securities is due to the changes in interest rate
environment and the Company has the positive intent and ability
to hold these securities until they mature or recover in value.
The unrealized loss position in the equity securities is due to
current market conditions and the Company has the positive
intent and ability to hold these securities until they recover
in value within a reasonable period of time.
69
Quantitative
and Qualitative Disclosures about Market Risk
Market risk is the potential economic loss principally arising
from adverse changes in the fair value of financial instruments.
The major components of market risk affecting us are credit
risk, equity price risk and interest rate risk.
Credit Risk. Credit risk is the potential
economic loss principally arising from adverse changes in the
financial condition of a specific debt issuer. We attempt to
address this risk by investing in fixed-maturity securities that
are either investment grade, which are those bonds rated
BBB- or higher by Standard & Poors,
or securities that although not investment grade, meet our
credit requirements and targeted risk adjusted return. We also
independently and through our outside independent investment
managers, monitor the financial condition of all of the issuers
of fixed-maturity securities in our portfolio. We utilize a
rating change report, a rating watch report and a focus list as
part of this process. Finally, we employ stringent
diversification rules that limit our credit exposure to any
single issuer.
Equity Price Risk. Equity price risk is the
potential that we will incur economic loss due to decline in
common stock prices. We attempt to manage this risk by focusing
on a long-term, conservative, value oriented, dividend driven
investment philosophy for our equity portfolio. The equity
securities in our portfolio are primarily mid-to-large
capitalization issues with strong dividend performance. Our
strategy remains one of value investing, with security selection
taking precedence over market timing. We also employ stringent
diversification rules that limit our exposure to any individual
stock.
Interest Rate Risk. We had fixed-maturity,
preferred shares and bond mutual fund investments with a fair
value of $448.1 million at December 31, 2007 that are
subject to interest rate risk. We attempt to manage our exposure
to interest rate risk through a disciplined asset/liability
matching and capital management process. In the management of
this risk, the characteristics of duration, credit and
variability of cash flows are critical elements. These risks are
assessed regularly and balanced within the context of our
liability and capital position.
The table below summarizes our interest rate risk. It
illustrates the sensitivity of the fair value of fixed-maturity,
preferred share and bond mutual fund investments to selected
hypothetical changes in interest rates at December 31,
2007. The selected scenarios are not predictions of future
events, but rather illustrate the effect that such events may
have on the fair value of the fixed-maturity, preferred share
and bond mutual fund portfolio and shareholders equity.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Hypothetical
|
|
|
|
|
|
|
|
|
|
Percentage
|
|
|
|
|
|
|
|
|
|
Increase
|
|
|
|
|
|
|
Estimated
|
|
|
(Decrease) in
|
|
|
|
Estimated
|
|
|
Change in
|
|
|
Fair
|
|
|
Shareholders
|
|
Hypothetical Change in Interest Rates
|
|
Fair Value
|
|
|
Fair Value
|
|
|
Value
|
|
|
Equity
|
|
|
200 basis point increase
|
|
$
|
403,142
|
|
|
|
(44,989
|
)
|
|
|
(10.0
|
)%
|
|
|
(27.9
|
)%
|
100 basis point increase
|
|
|
425,834
|
|
|
|
(22,297
|
)
|
|
|
(5.0
|
)%
|
|
|
(13.8
|
)%
|
No change
|
|
|
448,131
|
|
|
|
|
|
|
|
|
|
|
|
|
|
100 basis point decrease
|
|
|
469,639
|
|
|
|
21,508
|
|
|
|
4.8
|
%
|
|
|
13.4
|
%
|
200 basis point decrease
|
|
|
490,474
|
|
|
|
42,343
|
|
|
|
9.5
|
%
|
|
|
26.3
|
%
|
Accounting
Standards
See Note 1 to our audited consolidated financial statements
included in this report for a discussion of recently issued
accounting pronouncements.
|
|
Item 7A.
|
Quantitative
and Qualitative Disclosures about Market Risk
|
The information required by Item 7A is included in
Item 7 on page 70 of this report.
70
|
|
Item 8.
|
Financial
Statements and Supplementary Data
|
INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS
|
|
|
|
|
|
|
Page
|
|
|
Financial Statements:
|
|
|
|
|
|
|
|
73
|
|
|
|
|
74
|
|
|
|
|
75
|
|
|
|
|
76
|
|
|
|
|
77
|
|
|
|
|
78
|
|
Financial Statement Schedules:
|
|
|
|
|
|
|
|
110
|
|
|
|
|
111
|
|
|
|
|
114
|
|
|
|
|
115
|
|
|
|
|
116
|
|
|
|
|
117
|
|
71
Report of
Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
ProCentury Corporation:
We have audited the accompanying consolidated balance sheets of
ProCentury Corporation and subsidiaries (the Company) as of
December 31, 2007 and 2006, and the related consolidated
statements of operations, shareholders equity and
comprehensive income, and cash flows for each of the years in
the three-year period ended December 31, 2007. In
connection with our audits of the consolidated financial
statements, we also have audited financial statement schedules I
to VI. These consolidated financial statements and financial
statement schedules are the responsibility of the Companys
management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement
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 consolidated financial statements referred
to above present fairly, in all material respects, the financial
position of the Company as of December 31, 2007 and 2006,
and the results of its operations and its cash flows for each of
the years in the three-year period ended December 31, 2007,
in conformity with U.S. generally accepted accounting
principles. Also in our opinion, the related financial statement
schedules, when considered in relation to the basic consolidated
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, effective January 1, 2006, the Company adopted
Statement of Financial Accounting Standards No. 123(R),
Share-Based Payment.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
Companys internal control over financial reporting as of
December 31, 2007, based on criteria established in
Internal Control Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), and our report dated March 17, 2008
expressed an adverse opinion on the effectiveness of the
Companys internal control over financial reporting.
/s/ KPMG LLP
Columbus, Ohio
March 17, 2008
72
Report of
Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
ProCentury Corporation:
We have audited ProCentury Corporation and subsidiaries
(the Company) internal control over financial reporting as of
December 31, 2007, based on criteria established in
Internal Control Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO). The Companys 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 Managements Report on Internal Control Over
Financial Reporting contained in Item 9A(b). Our
responsibility is to express an opinion on the Companys
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, and testing and evaluating the
design and operating effectiveness of internal control based on
the assessed risk. Our audit also included performing such other
procedures as we considered necessary in the circumstances. We
believe that our audit provides a reasonable basis for our
opinion.
A companys 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 companys
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
companys 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.
A material weakness is a deficiency, or a combination of
deficiencies, in internal control over financial reporting, such
that there is a reasonable possibility that a material
misstatement of the companys annual or interim financial
statements will not be prevented or detected on a timely basis.
A material weakness related to determining the assumptions for
projected cash flows for asset-backed securities in connection
with managements assessment of other-than-temporary
impairment has been identified and included in Managements
Report on Internal Control over Financial Reporting. We also
have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the
consolidated balance sheets of the Company as of
December 31, 2007 and 2006, and the related consolidated
statements of operations, shareholders equity and
comprehensive income, and cash flows for each of the years in
the three-year period ended December 31, 2007. This
material weakness was considered in determining the nature,
timing, and extent of audit tests applied in our audit of the
2007 consolidated financial statements, and this report does not
affect our report dated March 17, 2008, which expressed an
unqualified opinion on those consolidated financial statements.
In our opinion, because of the effect of the aforementioned
material weakness on the achievement of the objectives of the
control criteria, the Company has not maintained effective
internal control over financial reporting as of
December 31, 2007, based on criteria established in
Internal Control Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway
Commission.
/s/ KPMG LLP
Columbus, Ohio
March 17, 2008
73
PROCENTURY
CORPORATION AND SUBSIDIARIES
December 31,
2007 and 2006
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
ASSETS
|
Investments
|
|
|
|
|
|
|
|
|
Fixed maturities:
|
|
|
|
|
|
|
|
|
Available-for-sale, at fair value
|
|
$
|
406,439
|
|
|
|
358,422
|
|
(amortized cost 2007, $411,015; 2006, $362,066)
|
|
|
|
|
|
|
|
|
Held-to-maturity, at amortized cost
|
|
|
1,099
|
|
|
|
1,114
|
|
(fair value 2007, $1,110; 2006, $1,101)
|
|
|
|
|
|
|
|
|
Equities (available-for-sale):
|
|
|
|
|
|
|
|
|
Equity securities, at fair value (cost 2007, $34,686; 2006,
$28,112)
|
|
|
28,998
|
|
|
|
28,188
|
|
Bond mutual funds, at fair value (cost 2007, $15,029; 2006,
$14,876)
|
|
|
14,244
|
|
|
|
14,755
|
|
Short-term investments, at amortized cost
|
|
|
4,730
|
|
|
|
25,623
|
|
|
|
|
|
|
|
|
|
|
Total investments
|
|
|
455,510
|
|
|
|
428,102
|
|
Cash and equivalents
|
|
|
11,766
|
|
|
|
7,960
|
|
Premiums in course of collection, net
|
|
|
31,805
|
|
|
|
37,428
|
|
Deferred policy acquisition costs
|
|
|
24,336
|
|
|
|
26,915
|
|
Prepaid reinsurance premiums
|
|
|
14,834
|
|
|
|
14,051
|
|
Reinsurance recoverable on paid losses, net
|
|
|
3,914
|
|
|
|
7,524
|
|
Reinsurance recoverable on unpaid losses, net
|
|
|
40,863
|
|
|
|
36,104
|
|
Deferred federal income tax asset
|
|
|
13,584
|
|
|
|
11,561
|
|
Other assets
|
|
|
10,442
|
|
|
|
9,403
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
607,054
|
|
|
|
579,048
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS EQUITY
|
Loss and loss expense reserves
|
|
$
|
279,253
|
|
|
|
250,672
|
|
Unearned premiums
|
|
|
114,645
|
|
|
|
127,620
|
|
Long term debt
|
|
|
25,000
|
|
|
|
25,000
|
|
Line of credit
|
|
|
4,650
|
|
|
|
4,000
|
|
Accrued expenses and other liabilities
|
|
|
6,690
|
|
|
|
9,778
|
|
Reinsurance balances payable
|
|
|
5,193
|
|
|
|
7,706
|
|
Collateral held
|
|
|
9,889
|
|
|
|
10,370
|
|
Income taxes payable
|
|
|
713
|
|
|
|
1,514
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
446,033
|
|
|
|
436,660
|
|
|
|
|
|
|
|
|
|
|
Shareholders equity:
|
|
|
|
|
|
|
|
|
Common stock, without par value:
|
|
|
|
|
|
|
|
|
Common shares Issued and outstanding
13,363,867 shares at December 31, 2007 and
13,248,323 shares issued and outstanding at
December 31, 2006
|
|
|
|
|
|
|
|
|
Additional paid-in capital
|
|
|
103,283
|
|
|
|
100,954
|
|
Retained earnings
|
|
|
66,448
|
|
|
|
43,830
|
|
Accumulated other comprehensive loss, net of taxes
|
|
|
(8,710
|
)
|
|
|
(2,396
|
)
|
|
|
|
|
|
|
|
|
|
Total shareholders equity
|
|
|
161,021
|
|
|
|
142,388
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders equity
|
|
$
|
607,054
|
|
|
|
579,048
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
74
PROCENTURY
CORPORATION AND SUBSIDIARIES
Years
ended December 31, 2007, 2006 and 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
Premiums earned
|
|
$
|
217,562
|
|
|
|
218,992
|
|
|
|
177,630
|
|
Net investment income
|
|
|
22,081
|
|
|
|
19,372
|
|
|
|
14,487
|
|
Net realized investment (losses) gains
|
|
|
(1,982
|
)
|
|
|
80
|
|
|
|
(326
|
)
|
Other income
|
|
|
489
|
|
|
|
437
|
|
|
|
198
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
|
238,150
|
|
|
|
238,881
|
|
|
|
191,989
|
|
Losses and loss expenses
|
|
|
125,917
|
|
|
|
135,480
|
|
|
|
118,346
|
|
Amortization of deferred policy acquisition costs
|
|
|
55,230
|
|
|
|
54,404
|
|
|
|
42,935
|
|
Other operating expenses
|
|
|
18,280
|
|
|
|
17,043
|
|
|
|
14,463
|
|
Severance expense
|
|
|
|
|
|
|
|
|
|
|
793
|
|
Interest expense
|
|
|
2,681
|
|
|
|
2,318
|
|
|
|
1,873
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expenses
|
|
|
202,108
|
|
|
|
209,245
|
|
|
|
178,410
|
|
Income before income tax expense
|
|
|
36,042
|
|
|
|
29,636
|
|
|
|
13,579
|
|
Income tax expense
|
|
|
11,286
|
|
|
|
8,735
|
|
|
|
3,338
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
24,756
|
|
|
|
20,901
|
|
|
|
10,241
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net income per share
|
|
$
|
1.87
|
|
|
|
1.59
|
|
|
|
0.78
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted net income per share
|
|
$
|
1.85
|
|
|
|
1.58
|
|
|
|
0.78
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average of shares outstanding basic
|
|
|
13,242,083
|
|
|
|
13,121,848
|
|
|
|
13,060,509
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average of shares outstanding diluted
|
|
|
13,392,949
|
|
|
|
13,256,419
|
|
|
|
13,129,425
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
75
PROCENTURY
CORPORATION AND SUBSIDIARIES
Years
ended December 31, 2007, 2006 and 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
SHAREHOLDERS EQUITY
|
Capital stock:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of period
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock issued
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
End of period
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional paid-in capital:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of period
|
|
|
100,954
|
|
|
|
100,202
|
|
|
|
100,110
|
|
|
|
|
|
Impact of adoption of SFAS 123R
|
|
|
|
|
|
|
(695
|
)
|
|
|
|
|
|
|
|
|
Shares issued under share compensation plans
|
|
|
1,294
|
|
|
|
1,320
|
|
|
|
92
|
|
|
|
|
|
Tax benefit on share compensation plans
|
|
|
338
|
|
|
|
121
|
|
|
|
|
|
|
|
|
|
Exercise of share options
|
|
|
697
|
|
|
|
6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
End of period
|
|
|
103,283
|
|
|
|
100,954
|
|
|
|
100,202
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retained earnings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of period
|
|
|
43,830
|
|
|
|
24,846
|
|
|
|
15,727
|
|
|
|
|
|
Net income
|
|
|
24,756
|
|
|
|
20,901
|
|
|
|
10,241
|
|
|
|
|
|
Dividends declared ($0.16/share for 2007, $0.145/share for 2006
and $0.85/share for 2005)
|
|
|
(2,138
|
)
|
|
|
(1,917
|
)
|
|
|
(1,122
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
End of period
|
|
|
66,448
|
|
|
|
43,830
|
|
|
|
24,846
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unearned share compensation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of period
|
|
|
|
|
|
|
(695
|
)
|
|
|
(1,420
|
)
|
|
|
|
|
Impact of adoption of SFAS 123R
|
|
|
|
|
|
|
695
|
|
|
|
|
|
|
|
|
|
Vesting of restricted shares
|
|
|
|
|
|
|
|
|
|
|
324
|
|
|
|
|
|
Shares forfeited under share compensation plans
|
|
|
|
|
|
|
|
|
|
|
401
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
End of period
|
|
|
|
|
|
|
|
|
|
|
(695
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive loss, net of taxes:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of period
|
|
|
(2,396
|
)
|
|
|
(3,150
|
)
|
|
|
820
|
|
|
|
|
|
Unrealized holding (losses) gains arising during the period, net
of reclassification adjustment
|
|
|
(6,314
|
)
|
|
|
754
|
|
|
|
(3,970
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
End of period
|
|
|
(8,710
|
)
|
|
|
(2,396
|
)
|
|
|
(3,150
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total shareholders equity
|
|
$
|
161,021
|
|
|
|
142,388
|
|
|
|
121,203
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COMPREHENSIVE INCOME
|
Net income
|
|
$
|
24,756
|
|
|
|
20,901
|
|
|
|
10,241
|
|
|
|
|
|
Other comprehensive (loss) income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized (losses) gains on securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized holding (losses) gains arising during the period:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
|
|
|
(9,342
|
)
|
|
|
1,240
|
|
|
|
(6,368
|
)
|
|
|
|
|
Related federal income tax benefit (expense)
|
|
|
1,304
|
|
|
|
(434
|
)
|
|
|
2,186
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net unrealized (losses) gains
|
|
|
(8,038
|
)
|
|
|
806
|
|
|
|
(4,182
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reclassification adjustment for (losses) gains included in net
income Gross
|
|
|
(1,982
|
)
|
|
|
80
|
|
|
|
(326
|
)
|
|
|
|
|
Related federal income tax benefit (expense)
|
|
|
258
|
|
|
|
(28
|
)
|
|
|
114
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net reclassification adjustment
|
|
|
(1,724
|
)
|
|
|
52
|
|
|
|
(212
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive (loss) income
|
|
|
(6,314
|
)
|
|
|
754
|
|
|
|
(3,970
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income
|
|
$
|
18,442
|
|
|
|
21,655
|
|
|
|
6,271
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
76
PROCENTURY
CORPORATION AND SUBSIDIARIES
Years
ended December 31, 2007, 2006 and 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
Cash flows provided by operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
24,756
|
|
|
|
20,901
|
|
|
|
10,241
|
|
Adjustments:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized investment losses
|
|
|
1,982
|
|
|
|
(80
|
)
|
|
|
326
|
|
Deferred federal income tax benefit
|
|
|
(976
|
)
|
|
|
(2,817
|
)
|
|
|
(1,781
|
)
|
Share-based compensation expense
|
|
|
1,294
|
|
|
|
1,320
|
|
|
|
817
|
|
Changes in assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums in course of collection, net
|
|
|
5,623
|
|
|
|
(22,579
|
)
|
|
|
(4,153
|
)
|
Deferred policy acquisition costs
|
|
|
2,579
|
|
|
|
(6,266
|
)
|
|
|
(3,238
|
)
|
Prepaid reinsurance premiums
|
|
|
(783
|
)
|
|
|
(3,062
|
)
|
|
|
(1,607
|
)
|
Reinsurance recoverable on paid and unpaid losses, net
|
|
|
(1,149
|
)
|
|
|
242
|
|
|
|
(10,488
|
)
|
Income taxes payable/receivable
|
|
|
(801
|
)
|
|
|
1,329
|
|
|
|
(3,075
|
)
|
Losses and loss expense reserves
|
|
|
28,581
|
|
|
|
39,025
|
|
|
|
58,411
|
|
Collateral held
|
|
|
(481
|
)
|
|
|
(644
|
)
|
|
|
4,006
|
|
Unearned premiums
|
|
|
(12,975
|
)
|
|
|
31,989
|
|
|
|
13,496
|
|
Other, net
|
|
|
(2,217
|
)
|
|
|
4,691
|
|
|
|
702
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
|
45,433
|
|
|
|
64,049
|
|
|
|
63,657
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows used in investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of equity securities
|
|
|
(18,466
|
)
|
|
|
(14,040
|
)
|
|
|
(55,903
|
)
|
Purchases of fixed maturity securities available-for-sale
|
|
|
(294,851
|
)
|
|
|
(158,391
|
)
|
|
|
(120,162
|
)
|
Proceeds from sales of equity securities
|
|
|
11,587
|
|
|
|
17,189
|
|
|
|
46,246
|
|
Proceeds from sales and maturities of fixed maturities
available-for-sale
|
|
|
242,765
|
|
|
|
101,001
|
|
|
|
75,139
|
|
Acquisition, net of cash acquired
|
|
|
|
|
|
|
|
|
|
|
(1,041
|
)
|
Change in short-term investments
|
|
|
20,893
|
|
|
|
(13,394
|
)
|
|
|
(6,645
|
)
|
Change in securities receivable/payable
|
|
|
(3,102
|
)
|
|
|
3,708
|
|
|
|
(2,273
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(41,174
|
)
|
|
|
(63,927
|
)
|
|
|
(64,639
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows (used in) provided by financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividend paid to shareholders
|
|
|
(2,138
|
)
|
|
|
(1,917
|
)
|
|
|
(1,122
|
)
|
Exercise of share options
|
|
|
697
|
|
|
|
6
|
|
|
|
|
|
Tax benefit on share compensation plans
|
|
|
338
|
|
|
|
121
|
|
|
|
|
|
Draw on line of credit
|
|
|
650
|
|
|
|
5,000
|
|
|
|
2,300
|
|
Principal payment on line of credit
|
|
|
|
|
|
|
(1,000
|
)
|
|
|
(2,300
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash (used in) provided by financing activities
|
|
|
(453
|
)
|
|
|
2,210
|
|
|
|
(1,122
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase in cash and equivalents
|
|
|
3,806
|
|
|
|
2,332
|
|
|
|
(2,104
|
)
|
Cash and equivalents at beginning of period
|
|
|
7,960
|
|
|
|
5,628
|
|
|
|
7,732
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and equivalents at end of period
|
|
$
|
11,766
|
|
|
|
7,960
|
|
|
|
5,628
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information:
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest paid
|
|
$
|
3,048
|
|
|
|
2,358
|
|
|
|
1,873
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal income taxes paid
|
|
$
|
12,725
|
|
|
|
10,100
|
|
|
|
8,194
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
77
|
|
(1)
|
Basis of
Presentation
|
ProCentury Corporation is a property and casualty insurance
holding company that writes specialty insurance products for
small and mid-sized businesses through Century Surety Company,
or Century, and ProCentury Insurance Company, or PIC, our
operating insurance subsidiaries. Century and PIC are both rated
A− by the A.M. Best Company, or
A.M. Best.
Following is a description of the significant risks facing the
Company:
|
|
|
|
|
Legal/ Regulatory Risk is the risk that changes in the
legal or regulatory environment in which an insurer operates
will occur and create additional loss costs or expenses not
anticipated by the insurer in pricing its products. That is,
regulatory initiatives designed to reduce insurer profits or new
legal theories may create costs for the insurer beyond those
recorded in the consolidated financial statements.
|
|
|
|
Credit Risk is the risk that issuers of securities owned
by the Company will default or other parties, including
reinsurers that owe the Company money, will not pay. In
addition, the Company may be likely to experience realized
investment losses to the extent its liquidity needs require the
disposition of fixed-maturity securities in unfavorable
liquidity or credit spread environments.
|
|
|
|
Interest Rate Risk is the risk that interest rates will
change and cause a change in the value of an insurers
investments.
|
|
|
|
Ratings Risk is the risk that rating agencies change
their outlook or group rating of Century and PIC. The rating
agencies generally utilize proprietary capital adequacy models
in the process of establishing group ratings for Century and
PIC. Century and PIC are at risk to changes in these models and
the impact that changes in the underlying business that it is
engaged in can have on such models.
|
|
|
|
Significant Business Concentrations: As of
December 31, 2007, the Company did not have a material
concentration of financial instruments in a single investee or
geographic location. Also, the Company did not have a
concentration of business transactions with a particular
distribution source, a market or geographic area in which
business is conducted that makes it overly vulnerable to a
single event which could cause a severe impact to the
Companys financial position. The Company did, however,
have a concentration of business transactions with a particular
customer. See Note 11(c).
|
|
|
|
Reinsurance: The Company has entered into
reinsurance contracts to cede a portion of its business. Total
amounts recoverable under these reinsurance contracts include
ceded reserves, paid and unpaid claims, and certain other
amounts, which totaled $54.4 million as of
December 31, 2007. The ceding of risk does not discharge
the original insurer from its primary obligation to the contract
holder. See Note 4.
|
|
|
|
Catastrophe Exposures: Certain insurance
coverages that the Company writes include exposure to
catastrophic events such as fire following an earthquake,
hurricanes, tornados, hail storms, winter storms and freezing.
As a result, a single catastrophe occurrence or destructive
weather pattern could materially adversely affect the results of
operations and surplus of our insurance subsidiaries.
|
|
|
(b)
|
Basis
of Accounting and Estimates
|
The accompanying consolidated financial statements have been
prepared in accordance with U.S. generally accepted
accounting principles (GAAP).
In preparing the consolidated financial statements, management
is required to make certain estimates and assumptions that
affect the reported amounts of assets, liabilities, revenues,
expenses and related disclosures at the financial reporting date
and throughout the period being reported upon. Certain of the
estimates result from
78
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
judgments that can be subjective and complex and consequently
actual results may differ from these estimates, which would be
reflected in future periods.
Material estimates that are particularly susceptible to
significant change in the near-term relate to the determination
of loss and loss expense reserves, the recoverability of
deferred policy acquisition costs, the determination of federal
income taxes, the net realizable value of reinsurance
recoverables and the determination of other-than-temporary
declines in the fair value of investments. Although considerable
variability is inherent in these estimates, management believes
that the amounts provided are reasonable. These estimates are
continually reviewed and adjusted as necessary. Such adjustments
are reflected in current operations.
The consolidated financial statements include the accounts of
ProCentury and its wholly owned subsidiaries. All significant
intercompany balances and transactions have been eliminated.
|
|
(d)
|
Investment
Securities
|
The Company classifies its fixed maturity and equity securities
into one of two categories: held-to-maturity or
available-for-sale. Held-to-maturity securities are those
securities that the Company has the ability and intent to hold
until maturity. All securities not classified as
held-to-maturity are classified as available-for-sale.
Held-to-maturity fixed maturity securities are recorded at
amortized cost, adjusted for the amortization or accretion of
premiums or discounts to maturity date using the effective
interest method. Available-for-sale securities are recorded at
fair value. Unrealized gains and losses, net of the related tax
effect, on available-for-sale securities are excluded from
earnings and are reported as a component of accumulated other
comprehensive income within shareholders equity, until
realized.
For mortgage-backed securities, the Company recognizes income
using a constant effective yield method based on prepayment
assumptions and the estimated economic life of the securities.
When estimated prepayments differ significantly from anticipated
prepayments, the effective yield is recalculated to reflect
actual payments to date and anticipated future payments. Any
resulting adjustment is included in net investment income. All
other investment income is recorded using the interest-method
without anticipating the impact of prepayments.
Realized gains or losses represent the difference between the
amortized cost of securities sold and the proceeds realized upon
sale, and are recorded on the trade date. The Company uses the
specific identification method to determine the cost of
securities sold.
Under the Companys accounting policy for equity securities
and fixed-maturity securities that can be contractually prepaid
or otherwise settled in a way that may limit the Companys
ability to fully recover cost, an impairment is deemed to be
other-than-temporary unless the Company has both the ability and
intent to hold the investment for a reasonable period until the
securitys forecasted recovery and evidence exists
indicating that recovery will occur in a reasonable period of
time.
For fixed-maturity and equity securities, an
other-than-temporary impairment charge is taken when the Company
does not have the ability and intent to hold the security until
the forecasted recovery or if it is no longer probable that the
Company will recover all amounts due under the contractual terms
of the security. Many criteria are considered during this
process including, but not limited to, the current fair value as
compared to amortized cost or cost, as appropriate, of the
security; the amount and length of time a securitys fair
value has been below amortized cost or cost; specific credit
issues and financial prospects related to the issuer;
managements intent to hold or dispose of the security; and
current economic conditions. Other-than-temporary impairment
losses result in a permanent reduction to the cost basis of the
underlying investment.
79
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
Additionally, for certain securitized financial assets with
contractual cash flows (including asset-backed securities), FASB
Emerging Task Force (EITF)
99-20,
Recognition of Interest Income and Impairment on
Purchased and Retained Beneficial Interests in Securitized
Financial Assets, requires the Company to periodically
update its best estimate of cash flows over the life of the
security. If management determines that the fair value of a
securitized financial asset is less than its carrying amount and
there has been a decrease in the present value of the estimated
cash flows since the last revised estimate, considering timing
and amount, then an other than-temporary impairment
is recognized.
Other-than-temporary impairment losses result in a permanent
reduction to the cost basis of the underlying investment and are
included in realized gains (losses) in the accompanying
Consolidated Statements of Operations.
Premiums and discounts are amortized or accreted over the life
of the related held-to-maturity or available-for-sale security
as an adjustment to yield using the effective interest method.
Dividend and interest income is recognized when earned.
|
|
(e)
|
Premiums
in Course of Collection
|
Premiums in course of collection include amounts due from
agents, and beginning in 2006, including an estimate of the
policies that have been written by agents but not yet reported
to us, and amounts relating to assumed reinsurance. These
balances are stated net of certain commission payable amounts,
prepaid agents balances, and allowance for uncollectible
premiums in course of collection. The Company evaluates the
collectibility of premiums in course of collection based on a
combination of factors. In circumstances in which the Company is
aware of a specific customers inability to meet its
financial obligations to the Company, a specific allowance for
bad debt against amounts due is recorded to reduce the net
receivable to the amount believed to be collectible. For all
remaining balances, allowances are recognized for bad debts
based on the length of time the receivables are past due using
the Companys historical experience of write-offs. The
allowance for uncollectible premiums in course of collection was
$142,000 and $156,000, at December 31, 2007 and 2006,
respectively.
|
|
(f)
|
Loss
and Loss Expense Reserves
|
Loss and loss expense reserves represent an estimate of the
expected cost of the ultimate settlement and administration of
losses, based on facts and circumstances then known. The Company
uses actuarial methodologies to assist in establishing these
estimates, including judgments relative to estimates of future
claims severity and frequency, length of time to develop to
ultimate resolution, and consideration of new judicial
discussions in tort and insurance law, emerging theories or
liabilities and other factors beyond our control. Due to the
inherent uncertainty associated with the cost of unsettled and
unreported claims, the ultimate liability may be different from
the original estimate. Such estimates are regularly reviewed and
updated and any resulting adjustments are included in the
current periods results. The loss and loss expense
reserves are not discounted.
|
|
(g)
|
Premium
Written, Earned and Unearned
|
Insurance premiums are recognized as revenue ratably over the
period of the insurance contract or over the period of risk if
the period of risk differs significantly from the contract
period. Written premium is recorded based on the insurance
policies that have been reported to the Company and beginning in
2006, the policies that have been written by the agents but not
yet reported to the Company. The Company must estimate the
amount of written premium not yet reported based on judgments
relative to current and historical trends of the business being
written. Such estimates are regularly reviewed and updated and
any resulting adjustments are included in the current
years results. An unearned premium reserve is established
to reflect the unexpired portion of each policy at the financial
reporting date.
80
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
The Company records policies that have fully funded limits on a
deposit basis as they are not considered to transfer insurance
risk.
|
|
(i)
|
Deferred
Policy Acquisition Costs
|
The Company defers commissions, premium taxes and certain other
costs that vary with and are primarily related to the
acquisition of insurance contracts. The acquisition costs are
reduced by ceding commission income. The costs are capitalized
and charged to expense in proportion to premium revenue
recognized. The method followed in computing deferred policy
acquisition costs limits the amount of such deferred costs to
their estimated realizable value, which gives effect to the
premium to be earned, related investment income, anticipated
losses and settlement expenses and certain other costs expected
to be incurred as the premium is earned. Judgments as to
ultimate recoverability of such deferred costs are highly
dependent upon estimated future loss costs associated with the
written premiums. The amounts that are not considered realizable
are charged as an expense through amortization of deferred
policy acquisition costs.
In the ordinary course of business, our insurance subsidiaries
reinsure certain risks, generally on an excess-of-loss basis,
with other insurance companies which primarily are rated
A or higher by A.M. Best. Such reinsurance
arrangements serve to limit the Companys maximum loss.
Reinsurance does not discharge the Company from its primary
liability to policyholders, and to the extent that a reinsurer
is unable to meet its obligations, the Company would be liable.
Reinsurance recoverables are determined based in part on the
terms and conditions of reinsurance contracts. Reinsurance
recoverables on paid and unpaid losses, net, are established for
the portion of our loss and loss expense payments and reserves,
respectively, that are ceded to reinsurers and are reported
separately as assets, net of any valuation allowance. Ceded
premiums payable are reported separately as liabilities.
Reinsurance premiums paid and reinsurance recoveries on claims
incurred are deducted from the respective revenue and expense
accounts. The estimated valuation allowance on reinsurance
recoverables on paid losses at December 31, 2007 and 2006
was $3.4 million and $4.1 million, respectively.
|
|
(k)
|
Intangibles
and Goodwill
|
On June 1, 2005, Century acquired 100% of the outstanding
shares of the Firemans Fund of Texas (FFTX) for
$5.9 million. FFTX is a Texas domiciled property and
casualty company licensed in Texas, Oklahoma and California,
Arizona, Arkansas, Indiana, Kansas, Louisiana, Michigan,
Missouri, Nevada, New Mexico, North Dakota, Oregon, South
Carolina, Utah and West Virginia. The acquisition is part of the
Companys long-term plan to develop business that requires
admitted status, as well as its continued focus on growing its
excess and surplus lines business. On August 16, 2005, FFTX
was renamed ProCentury Insurance Company. The total purchase
price of the acquisition was allocated to the assets and the
liabilities acquired based upon the respective fair values as of
the date of acquisition. Intangible assets included in the
purchase were valued at $375,000. The excess of the fair value
of the net identifiable assets acquired over the purchase price
was $240,000 and was recorded as non-deductible goodwill. In
accordance with Statement of Financial Accounting Standards
(SFAS) No. 142, Goodwill and Other
Intangible Assets, the amortization of goodwill and
indefinite-lived intangible assets is not permitted. Goodwill
and indefinite-lived intangible assets remain on the balance
sheet and are tested for impairment on an annual basis, or when
there is reason to suspect that their values may have been
diminished or
81
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
impaired. During our annual analysis in 2007, we determined
these assets had not been impaired. The indefinite-life
intangible assets and goodwill are included in other assets in
the Consolidated Balance Sheets.
ProCentury and its subsidiaries file a consolidated federal
income tax return in accordance with a tax sharing agreement.
The entities utilize a consolidated approach to the allocation
of federal income taxes, whereas ProCenturys tax sharing
agreement with its subsidiaries allowed it to make certain code
elections in its consolidated federal tax return. In the event
such code elections are made, any benefit or liability is the
responsibility of ProCentury and is not accrued or paid by the
subsidiaries.
The Company provides for federal income taxes based on amounts
the Company believes it ultimately will owe. Inherent in the
provision for federal income taxes are estimates regarding the
deductibility of certain items and the realization of certain
tax credits. In the event the ultimate deductibility of certain
items or the realization of certain tax credits differs from
estimates, the Company may be required to significantly change
the provision for federal income taxes recorded in the
consolidated financial statements. Any such change could
significantly affect the amounts reported in the consolidated
statements of income.
The Company utilizes the asset and liability method of
accounting for income tax. Under this method, deferred tax
assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities
and their respective tax bases and operating loss and tax credit
carry-forwards. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in
the years in which those temporary differences are expected to
be recovered or settled. Under this method, the effect on
deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment
date. Valuation allowances are established when necessary to
reduce the deferred tax assets to the amounts which are more
likely than not to be realized.
Basic net income per share excludes dilution and is calculated
by dividing income available to common shareholders by the
weighted-average number of common shares outstanding for the
period. Diluted EPS reflects the dilution that could occur if
securities or other contracts to issue common shares (common
share equivalents) were exercised. When inclusion of common
share equivalents increases the EPS or reduces the loss per
share, the effect on earnings is antidilutive. Under these
circumstances, diluted net income per share is computed
excluding the common share equivalents.
Pursuant to disclosure requirements contained in
SFAS No. 128, Earnings per Share, the following
information represents a reconciliation of the numerator and
denominator of the basic and diluted EPS computations contained
in the Companys consolidated financial statements.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For lhe Year Ended December 31, 2007
|
|
|
|
Income
|
|
|
Shares
|
|
|
Per Share
|
|
|
|
(Numerator)
|
|
|
(Denominator)
|
|
|
Amount
|
|
|
|
(Dollars in thousands, except per share data)
|
|
|
Basic Net Income Per Share
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
24,756
|
|
|
|
13,242,083
|
|
|
$
|
1.87
|
|
Effect of Dilutive Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted common shares and share options
|
|
|
|
|
|
|
150,866
|
|
|
|
(0.02
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted EPS
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
24,756
|
|
|
|
13,392,949
|
|
|
$
|
1.85
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
82
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31, 2006
|
|
|
|
Income
|
|
|
Shares
|
|
|
Per Share
|
|
|
|
(Numerator)
|
|
|
(Denominator)
|
|
|
Amount
|
|
|
|
(Dollars in thousands, except per share data)
|
|
|
Basic Net Income Per Share
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
20,901
|
|
|
|
13,121,848
|
|
|
$
|
1.59
|
|
Effect of Dilutive Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted common shares and share options
|
|
|
|
|
|
|
134,571
|
|
|
|
(0.01
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted EPS
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
20,901
|
|
|
|
13,256,419
|
|
|
$
|
1.58
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31, 2005
|
|
|
|
Income
|
|
|
Shares
|
|
|
Per Share
|
|
|
|
(Numerator)
|
|
|
(Denominator)
|
|
|
Amount
|
|
|
|
(Dollars in thousands, except per share data)
|
|
|
Basic Net Income Per Share
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
10,241
|
|
|
|
13,060,509
|
|
|
$
|
0.78
|
|
Effect of Dilutive Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted common shares and share options
|
|
|
|
|
|
|
68,916
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted EPS
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
10,241
|
|
|
|
13,129,425
|
|
|
$
|
0.78
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income encompasses all changes in
shareholders equity (except those arising from
transactions with shareholders) and includes net income and
changes in net unrealized investment gains and losses on fixed
maturity investments classified as available-for-sale and equity
securities, net of taxes.
|
|
(o)
|
Fair
Value Disclosures
|
The Company, in estimating its fair value disclosures for
financial instruments, uses the following methods and
assumptions:
|
|
|
|
|
Cash and short-term investments The carrying
amounts reported approximate their fair value.
|
|
|
|
Investment securities Fair values for fixed
maturity securities are based on quoted market prices, where
available. For fixed maturity securities not actively traded,
fair values are estimated using values obtained from
brokers quotes. Fair values for equity securities,
consisting of preferred and common stocks and bond mutual funds,
are based on quoted market prices or pricing services. Fair
value disclosures for investments are included in Note 2.
|
|
|
|
Other The carrying amounts reported for
premiums in the course of collection, reinsurance recoverables,
accrued investment income, and other assets approximate their
fair value. The Companys long term debt, line of credit,
accrued expenses and other liabilities, collateral held, and
reinsurance balances payable are either short term in nature or
based on current market prices, which also approximates fair
value.
|
83
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
|
|
(p)
|
Share
Option Accounting
|
Effective January 1, 2006, the Company adopted Statement of
Financial Accounting Standards (SFAS)
No. 123(R), Share-Based Payment (SFAS No.
123R), using the modified prospective application
transition method. SFAS No. 123R revises
SFAS No. 123, Accounting for Stock-Based
Compensation (SFAS No. 123). The
Company previously followed the provisions of Accounting
Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB 25), the Financial
Accounting Standards Board (FASB) Interpretation
No. 44, Accounting for Certain Transactions involving
Stock Compensation (an interpretation of APB Opinion
No. 25), and other related accounting interpretations
for the Companys share option and restricted common share
plans utilizing the intrinsic value method. The
Company also followed the disclosure provisions of
SFAS No. 123, Accounting for Stock-Based
Compensation, for the Companys share option grants, as
amended by SFAS No. 148, Accounting for Stock-Based
Compensation Transition and Disclosure; an amendment
of FASB Statement No. 123.
Under the modified prospective method, all unvested employee
share options and restricted stock are being expensed over the
remaining vesting period based on the fair value at the date the
options were granted. In addition, SFAS No. 123R
requires the Company to estimate forfeitures in calculating the
expense relating to stock-based compensation as opposed to
recognizing these forfeitures and the corresponding reduction in
expense as they occur. In addition, SFAS No. 123R
requires the Company to reflect the tax savings resulting from
tax deductions in excess of compensation expense reflected in
its financial statements as a cash inflow from financing
activities in its statement of cash flows rather than as an
operating cash flow as in prior periods.
If the Company recorded compensation expense for its share
option grants based on the fair value method, the
Companys net income and earnings per share for the year
ended December 31, 2005 would have been adjusted to the pro
forma amounts as indicated in the following table:
|
|
|
|
|
|
|
2005
|
|
|
|
(In thousands, except
|
|
|
|
for per share data)
|
|
|
Net income:
|
|
|
|
|
As reported
|
|
$
|
10,241
|
|
Add: Share-based employee compensation expense included in
reported net income, net of related tax effects
|
|
|
530
|
|
Less: Additional share-based employee compensation expense
determined under fair value-based method for all awards, net of
related tax effects
|
|
|
(824
|
)
|
|
|
|
|
|
Pro Forma
|
|
$
|
9,947
|
|
|
|
|
|
|
Basic income per common share:
|
|
|
|
|
As reported
|
|
$
|
0.78
|
|
|
|
|
|
|
Pro Forma
|
|
$
|
0.76
|
|
|
|
|
|
|
Diluted income per common share:
|
|
|
|
|
As reported
|
|
$
|
0.78
|
|
|
|
|
|
|
Pro Forma
|
|
$
|
0.76
|
|
|
|
|
|
|
84
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
The fair values of the share options are estimated on the date
of grant using the Black Scholes option pricing model with the
following weighted average assumptions:
|
|
|
|
|
|
|
Year Ended
|
|
|
|
December 31, 2005
|
|
|
Risk-free interest rate
|
|
|
3.97
|
%
|
Expected dividends
|
|
|
0.76
|
%
|
Expected volatility
|
|
|
23.14
|
%
|
Weighted average expected term
|
|
|
7.00
|
Years
|
|
|
(q)
|
Recently
Issued Accounting Standards
|
In February 2007, the FASB issued SFAS No. 159,
The Fair Value Option for Financial Assets and Financial
Liabilities, Including an Amendment of FASB Statement
No. 115 (SFAS 159). The objective of
SFAS 159 is to improve financial reporting by providing
entities with the opportunity to mitigate volatility in reported
net income caused by measuring related assets and liabilities
differently. This statement permits entities to choose, at
specified election dates, to measure eligible items at fair
value (i.e., the fair value option). Items eligible for the fair
value option include certain recognized financial assets and
liabilities, rights and obligations under certain insurance
contracts that are not financial instruments, host financial
instruments resulting from the separation of an embedded
nonfinancial derivative instrument from a nonfinancial hybrid
instrument, and certain commitments. Business entities shall
report unrealized gains and losses on items for which the fair
value option has been elected in net income. The fair value
option (a) may be applied instrument by instrument, with
certain exceptions; (b) is irrevocable (unless a new
election date occurs); and (c) is applied only to entire
instruments and not to portions of instruments. SFAS 159 is
effective as of the beginning of an entitys first fiscal
year that begins after November 15, 2007, although early
adoption is permitted under certain conditions. Companies must
report the effect of the first remeasurement to fair value as a
cumulative-effect adjustment to the opening balance of retained
earnings. We are currently evaluating the impact of adopting
SFAS 159.
In September 2006, the Securities and Exchange Commission issued
Staff Accounting Bulletin No. 108, Considering
the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements
(SAB 108). SAB 108 provides interpretive
guidance on how the effects of prior-year uncorrected
misstatements should be considered when quantifying
misstatements in the current year financial statements.
SAB 108 requires registrants to quantify misstatements
using both an income statement (rollover) and
balance sheet (iron curtain) approach and evaluate
whether either approach results in a misstatement that, when all
relevant quantitative and qualitative factors are considered, is
material. If prior year errors that had been previously
considered immaterial now are considered material based on
either approach, no restatement is required so long as
management properly applied its previous approach and all
relevant facts and circumstances were considered. If prior years
are not restated, the cumulative effect adjustment is recorded
in opening accumulated earnings as of the beginning of the
fiscal year of adoption. SAB 108 is effective for fiscal
years ending on or after November 15, 2006, with earlier
adoption encouraged. We adopted SAB 108 in the fourth
quarter of 2006 and it did not have a material effect on our
consolidated financial condition or results of operations.
In September 2006, the FASB issued Statement No. 157,
Fair Value Measurements
(SFAS No. 157), which clarifies that the
term fair value is intended to mean a market-based measure, not
an entity-specific measure and gives the highest priority to
quoted prices in active markets in determining fair value.
SFAS No. 157 requires disclosures about (1) the
extent to which companies measure assets and liabilities at fair
value, (2) the methods and assumptions used to measure fair
value, and (3) the effect of fair value measures on
earnings. SFAS No. 157 is effective for fiscal years
beginning after November 15, 2007. We are currently
evaluating the impact of adopting
85
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
SFAS No. 157; however, we do not expect it will have a
material effect on our consolidated financial condition or
results of operations.
In July 2006, the Financial Accounting Standards Board
(FASB) released FASB Interpretation No. (FIN) 48,
Accounting for Uncertainty in Income Taxes, an
interpretation of FASB Statement No. 109. FIN 48
clarifies the accounting for uncertainty in income taxes
recognized in the financial statements in accordance with
SFAS 109, Accounting for Income Taxes. The
Interpretation prescribes a recognition threshold and
measurement attribute for the financial statement recognition
and measurement of a tax position taken or expected to be taken
in a tax return. It also provides guidance on derecognition,
classification, interest and penalties, accounting for interim
periods, disclosure and transition. FIN 48 is effective for
fiscal years beginning after December 15, 2006. We adopted
FIN 48 effective January 1, 2007 and it did not have a
material impact on our consolidated financial condition or
results of operations.
In February 2006, the FASB issued Statement No. 155,
Accounting for Certain Hybrid Financial Instruments
(SFAS No. 155). Under current generally
accepted accounting principles an entity that holds a financial
instrument with an embedded derivative must bifurcate the
financial instrument, resulting in the host and the embedded
derivative being accounted for separately.
SFAS No. 155 permits, but does not require, entities
to account for financial instruments with an embedded derivative
at fair value thus negating the need to bifurcate the instrument
between its host and the embedded derivative.
SFAS No. 155 is effective as of the beginning of the
first annual reporting period that begins after
September 15, 2006. We adopted SFAS No. 155
effective January 1, 2007 and it did not have a material
effect on our consolidated financial condition or results of
operations.
In September 2005, the Accounting Standards Executive Committee
of the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP)
05-1,
Accounting by Insurance Enterprises for Deferred
Acquisition Costs in Connection with Modifications or Exchanges
of Insurance Contracts
(SOP 05-1).
SOP 05-1
provides guidance on accounting by insurance enterprises for
deferred acquisition costs on internal replacements of insurance
and investment contracts other than those specifically described
in SFAS No. 97, Accounting and Reporting by
Insurance Enterprises for Certain Long-Duration Contracts and
for Realized Gains and Losses from the Sale of
Investments, issued by the FASB.
SOP 05-1
defines an internal replacement as a modification in product
benefits, features, rights or coverages that occurs as a result
of the exchange of a contract for a new contract, or by
amendment, endorsement or rider to a contract, or by the
election of a new feature or coverage within a contract.
SOP 05-1
is effective for internal replacements occurring in fiscal years
beginning after December 15, 2006, with earlier adoption
encouraged. Retrospective application of
SOP 05-1
to previously issued financial statements is not permitted.
Initial application of
SOP 05-1
is required as of the beginning of an entitys fiscal year.
We adopted
SOP 05-1
effective January 1, 2007 and it did not have a material
effect on our consolidated financial condition or results of
operations.
86
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
The Company invests primarily in investment-grade fixed
maturities. The amortized cost, gross unrealized gains and
losses and estimated fair value of fixed maturity securities
classified as held-to-maturity were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2007
|
|
|
|
|
|
|
Gross
|
|
|
Gross
|
|
|
Estimated
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Unrealized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Gains
|
|
|
Losses
|
|
|
Value
|
|
|
|
(In thousands)
|
|
|
U.S. Treasury securities
|
|
$
|
87
|
|
|
|
14
|
|
|
|
|
|
|
|
101
|
|
Agencies not backed by the full faith and credit of the U.S.
Government
|
|
|
1,012
|
|
|
|
|
|
|
|
(3
|
)
|
|
|
1,009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,099
|
|
|
|
14
|
|
|
|
(3
|
)
|
|
|
1,110
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2006
|
|
|
|
|
|
|
Gross
|
|
|
Gross
|
|
|
Estimated
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Unrealized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Gains
|
|
|
Losses
|
|
|
Value
|
|
|
|
(In thousands)
|
|
|
U.S. Treasury securities
|
|
$
|
88
|
|
|
|
10
|
|
|
|
|
|
|
|
98
|
|
Agencies not backed by the full faith and credit of the U.S.
Government
|
|
|
1,026
|
|
|
|
|
|
|
|
(23
|
)
|
|
|
1,003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,114
|
|
|
|
10
|
|
|
|
(23
|
)
|
|
|
1,101
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
87
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
The amortized cost, gross unrealized gains and losses, and
estimated fair value of fixed maturity and equity securities
classified as available-for-sale were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2007
|
|
|
|
|
|
|
Gross
|
|
|
Gross
|
|
|
Value
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Unrealized
|
|
|
Estimated
|
|
|
|
Cost
|
|
|
Gains
|
|
|
Losses
|
|
|
Fair
|
|
|
|
(In thousands)
|
|
|
Fixed maturities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities
|
|
$
|
2,515
|
|
|
|
61
|
|
|
|
|
|
|
|
2,576
|
|
Agencies not backed by the full faith and credit of the U.S.
Government
|
|
|
5,084
|
|
|
|
13
|
|
|
|
(8
|
)
|
|
|
5,089
|
|
Obligations of states and political subdivisions
|
|
|
209,564
|
|
|
|
911
|
|
|
|
(740
|
)
|
|
|
209,735
|
|
Corporate securities
|
|
|
34,837
|
|
|
|
47
|
|
|
|
(518
|
)
|
|
|
34,366
|
|
Mortgage-backed securities (GSEs)
|
|
|
77,527
|
|
|
|
36
|
|
|
|
(363
|
)
|
|
|
77,200
|
|
Collateralized mortgage obligations
|
|
|
49,895
|
|
|
|
408
|
|
|
|
(632
|
)
|
|
|
49,671
|
|
Asset-backed securities
|
|
|
31,593
|
|
|
|
108
|
|
|
|
(3,899
|
)
|
|
|
27,802
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities
|
|
|
411,015
|
|
|
|
1,584
|
|
|
|
(6,160
|
)
|
|
|
406,439
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities
|
|
|
34,686
|
|
|
|
75
|
|
|
|
(5,763
|
)
|
|
|
28,998
|
|
Bond mutual funds
|
|
|
15,029
|
|
|
|
|
|
|
|
(785
|
)
|
|
|
14,244
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equities
|
|
|
49,715
|
|
|
|
75
|
|
|
|
(6,548
|
)
|
|
|
43,242
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
460,730
|
|
|
|
1,659
|
|
|
|
(12,708
|
)
|
|
|
449,681
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2006
|
|
|
|
|
|
|
Gross
|
|
|
Gross
|
|
|
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Unrealized
|
|
|
Estimated
|
|
|
|
Cost
|
|
|
Gains
|
|
|
Losses
|
|
|
Fair Value
|
|
|
|
(In thousands)
|
|
|
Fixed maturities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities
|
|
$
|
3,636
|
|
|
|
|
|
|
|
(49
|
)
|
|
|
3,587
|
|
Agencies not backed by the full faith and credit of the U.S.
Government
|
|
|
13,793
|
|
|
|
|
|
|
|
(258
|
)
|
|
|
13,535
|
|
Obligations of states and political subdivisions
|
|
|
150,981
|
|
|
|
445
|
|
|
|
(795
|
)
|
|
|
150,631
|
|
Corporate securities
|
|
|
35,058
|
|
|
|
125
|
|
|
|
(730
|
)
|
|
|
34,453
|
|
Mortgage-backed securities
|
|
|
59,599
|
|
|
|
34
|
|
|
|
(1,108
|
)
|
|
|
58,525
|
|
Collateralized mortgage obligations
|
|
|
49,486
|
|
|
|
152
|
|
|
|
(622
|
)
|
|
|
49,016
|
|
Asset-backed securities
|
|
|
49,513
|
|
|
|
316
|
|
|
|
(1,154
|
)
|
|
|
48,675
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities
|
|
|
362,066
|
|
|
|
1,072
|
|
|
|
(4,716
|
)
|
|
|
358,422
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities
|
|
|
28,112
|
|
|
|
346
|
|
|
|
(270
|
)
|
|
|
28,188
|
|
Bond mutual funds
|
|
|
14,876
|
|
|
|
62
|
|
|
|
(183
|
)
|
|
|
14,755
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equities
|
|
|
42,988
|
|
|
|
408
|
|
|
|
(453
|
)
|
|
|
42,943
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
405,054
|
|
|
|
1,480
|
|
|
|
(5,169
|
)
|
|
|
401,365
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
88
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
Other-than-temporary impairment losses result in a permanent
reduction to the cost basis of the underlying investment and are
included in the net realized investment gains (losses) in the
consolidated statements of operations. For the year ended
December 31, 2007, 38 asset back securities were written
down in accordance with
EITF 99-20
and six preferred stocks were written down in the aggregate
amount of $4.5 million. For the year ended
December 31, 2006, eleven of the asset-backed securities
were written down in accordance with
EITF 99-20
in the amount of $1.4 million. For the year ended
December 31, 2005, the Company determined that two of the
fixed maturity securities were other than temporarily impaired
and were written down in the aggregate of $150,000, which were
included as realized losses in the consolidated statements of
operations.
The estimated fair value, related gross unrealized loss, and the
length of time that the securities have been impaired for
available-for-sale securities that are considered temporarily
impaired are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2007
|
|
|
|
Less Than 12 Months
|
|
|
12 Months or Longer
|
|
|
Total
|
|
|
|
Estimated
|
|
|
Gross
|
|
|
Estimated
|
|
|
Gross
|
|
|
Estimated
|
|
|
Gross
|
|
|
|
Fair
|
|
|
Unrealized
|
|
|
Fair
|
|
|
Unrealized
|
|
|
Fair
|
|
|
Unrealized
|
|
|
|
Value
|
|
|
Loss
|
|
|
Value
|
|
|
Loss
|
|
|
Value
|
|
|
Loss
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
Fixed maturity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities
|
|
$
|
135
|
|
|
|
|
|
|
|
100
|
|
|
|
|
|
|
|
235
|
|
|
|
|
|
Obligations of U.S. government corporations and agencies
|
|
|
|
|
|
|
|
|
|
|
1,328
|
|
|
|
(8
|
)
|
|
|
1,328
|
|
|
|
(8
|
)
|
Obligations of states and political subdivisions
|
|
|
50,308
|
|
|
|
(591
|
)
|
|
|
22,742
|
|
|
|
(149
|
)
|
|
|
73,050
|
|
|
|
(740
|
)
|
Corporate securities
|
|
|
7,045
|
|
|
|
(240
|
)
|
|
|
20,101
|
|
|
|
(278
|
)
|
|
|
27,146
|
|
|
|
(518
|
)
|
Mortgage-backed securities (GSEs)
|
|
|
35,940
|
|
|
|
(86
|
)
|
|
|
26,912
|
|
|
|
(277
|
)
|
|
|
62,852
|
|
|
|
(363
|
)
|
Collateralized mortgage obligations
|
|
|
8,353
|
|
|
|
(401
|
)
|
|
|
10,660
|
|
|
|
(231
|
)
|
|
|
19,013
|
|
|
|
(632
|
)
|
Asset-backed securities
|
|
|
5,053
|
|
|
|
(2,058
|
)
|
|
|
11,690
|
|
|
|
(1,841
|
)
|
|
|
16,743
|
|
|
|
(3,899
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
106,834
|
|
|
|
(3,376
|
)
|
|
|
93,533
|
|
|
|
(2,784
|
)
|
|
|
200,367
|
|
|
|
(6,160
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities
|
|
|
22,946
|
|
|
|
(5,615
|
)
|
|
|
958
|
|
|
|
(148
|
)
|
|
|
23,904
|
|
|
|
(5,763
|
)
|
Bond mutual funds
|
|
|
9,514
|
|
|
|
(683
|
)
|
|
|
5,391
|
|
|
|
(102
|
)
|
|
|
14,905
|
|
|
|
(785
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
32,460
|
|
|
|
(6,298
|
)
|
|
|
6,349
|
|
|
|
(250
|
)
|
|
|
38,809
|
|
|
|
(6,548
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Grand Total
|
|
$
|
139,294
|
|
|
|
(9,674
|
)
|
|
|
99,882
|
|
|
|
(3,034
|
)
|
|
|
239,176
|
|
|
|
(12,708
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2007, the Company had 141 fixed-maturity
securities and seven equity securities that have been in an
unrealized loss position for one year or longer. Of the
fixed-maturity securities, 121 are investment grade, and 116 of
these securities are rated A1/A or better (including 84
securities which are rated AAA). The 20 remaining non-investment
grade fixed-maturity securities have an aggregate fair value
equal to 65.2% of their book value as of December 31, 2007.
The majority of this unrealized loss related to sub prime bonds,
a sector which has experienced significant illiquidity and price
dislocation. Each of these sub prime bonds was tested under the
application of
EITF 99-20
and it was determined none of these bonds was other than
temporarily impaired. Three of the equity securities that have
been in an unrealized loss position for one year or longer
relate to investments in open ended bond funds. Each of these
investments continues to pay its regularly scheduled monthly
dividend and there have been no material changes in credit
quality of any of these funds over the past twelve months.
Finally, the four
89
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
remaining equity securities that have been in an unrealized loss
position for one year or longer relate to preferred share
investments in issuers each of which has shown an improved or
stable financial performance during the past twelve months. In
addition, these four equity securities have an aggregate fair
market value equal to 83.7% of their book value as of
December 31, 2007. All 141 of the fixed-maturity securities
are current on interest and principal and all seven of the
equity securities continue to pay dividends at a level
consistent with the prior year. Management believes that it is
probable that all contract terms of each fixed-maturity security
will be satisfied. The unrealized loss position of the
fixed-maturity securities is due to the changes in interest rate
environment and the Company has the positive intent and ability
to hold these securities until they mature or recover in value.
The unrealized loss position in the equity securities is due to
current market conditions and the Company has the positive
intent and ability to hold these securities until they recover
in value within a reasonable period of time.
The estimated fair value, related gross unrealized loss, and the
length of time that the securities have been impaired for
available-for-sale securities that were considered temporarily
impaired at December 31, 2007 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2006
|
|
|
|
Less Than 12 Months
|
|
|
12 Months or Longer
|
|
|
Total
|
|
|
|
|
|
|
Gross
|
|
|
Estimated
|
|
|
Gross
|
|
|
|
|
|
Gross
|
|
|
|
Estimated
|
|
|
Unrealized
|
|
|
Fair
|
|
|
Unrealized
|
|
|
Estimated
|
|
|
Unrealized
|
|
|
|
Fair Value
|
|
|
Loss
|
|
|
Value
|
|
|
Loss
|
|
|
Fair Value
|
|
|
Loss
|
|
|
|
(In thousands)
|
|
|
Fixed maturity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities
|
|
$
|
207
|
|
|
|
(2
|
)
|
|
|
3,381
|
|
|
|
(47
|
)
|
|
|
3,588
|
|
|
|
(49
|
)
|
Obligations of U.S. government corporations and agencies
|
|
|
6,925
|
|
|
|
(75
|
)
|
|
|
6,610
|
|
|
|
(183
|
)
|
|
|
13,535
|
|
|
|
(258
|
)
|
Obligations of states and political subdivisions
|
|
|
44,635
|
|
|
|
(187
|
)
|
|
|
42,079
|
|
|
|
(608
|
)
|
|
|
86,714
|
|
|
|
(795
|
)
|
Corporate securities
|
|
|
2,718
|
|
|
|
(28
|
)
|
|
|
25,175
|
|
|
|
(702
|
)
|
|
|
27,893
|
|
|
|
(730
|
)
|
Mortgage-backed securities
|
|
|
20,139
|
|
|
|
(142
|
)
|
|
|
33,598
|
|
|
|
(966
|
)
|
|
|
53,737
|
|
|
|
(1,108
|
)
|
Collateralized mortgage obligations
|
|
|
11,124
|
|
|
|
(131
|
)
|
|
|
20,504
|
|
|
|
(491
|
)
|
|
|
31,628
|
|
|
|
(622
|
)
|
Asset-backed securities
|
|
|
21,040
|
|
|
|
(747
|
)
|
|
|
12,298
|
|
|
|
(407
|
)
|
|
|
33,338
|
|
|
|
(1,154
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
106,788
|
|
|
|
(1,312
|
)
|
|
|
143,645
|
|
|
|
(3,404
|
)
|
|
|
250,433
|
|
|
|
(4,716
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities
|
|
|
8,555
|
|
|
|
(101
|
)
|
|
|
4,365
|
|
|
|
(169
|
)
|
|
|
12,920
|
|
|
|
(270
|
)
|
Bond mutual funds
|
|
|
498
|
|
|
|
(3
|
)
|
|
|
13,181
|
|
|
|
(180
|
)
|
|
|
13,679
|
|
|
|
(183
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
9,053
|
|
|
|
(104
|
)
|
|
|
17,546
|
|
|
|
(349
|
)
|
|
|
26,599
|
|
|
|
(453
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Grand Total
|
|
$
|
115,841
|
|
|
|
(1,416
|
)
|
|
|
161,191
|
|
|
|
(3,753
|
)
|
|
|
277,032
|
|
|
|
(5,169
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
90
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
Fixed maturities, by contractual maturity, are shown below.
Expected maturities will differ from contractual maturities
because borrowers may have the right to call or to prepay
obligations with or without call or prepayment penalties.
|
|
|
|
|
|
|
|
|
|
|
December 31, 2007
|
|
|
|
Amortized
|
|
|
Estimated
|
|
|
|
Cost
|
|
|
Fair Value
|
|
|
|
(In thousands)
|
|
|
Held-to-maturity:
|
|
|
|
|
|
|
|
|
Due in one year or less
|
|
$
|
1,012
|
|
|
|
1,009
|
|
Due after one year through five years
|
|
|
|
|
|
|
|
|
Due after five years through ten years
|
|
|
|
|
|
|
|
|
Due after ten years
|
|
|
87
|
|
|
|
101
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,099
|
|
|
|
1,110
|
|
|
|
|
|
|
|
|
|
|
Available-for-sale:
|
|
|
|
|
|
|
|
|
Due in one year or less
|
|
$
|
11,298
|
|
|
|
11,253
|
|
Due after one year through five years
|
|
|
38,930
|
|
|
|
38,763
|
|
Due after five years through ten years
|
|
|
86,213
|
|
|
|
86,348
|
|
Due after ten years
|
|
|
115,559
|
|
|
|
115,403
|
|
Mortgage-backed, collateralized obligations and asset backed
|
|
|
159,015
|
|
|
|
154,672
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
411,015
|
|
|
|
406,439
|
|
|
|
|
|
|
|
|
|
|
The components of net investment income in 2007, 2006 and 2005
were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
|
Interest on fixed maturities
|
|
$
|
18,424
|
|
|
|
16,342
|
|
|
|
12,393
|
|
Dividends on equity securities
|
|
|
3,239
|
|
|
|
3,166
|
|
|
|
2,832
|
|
Interest on cash and short-term investments
|
|
|
1,791
|
|
|
|
1,354
|
|
|
|
486
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
23,454
|
|
|
|
20,862
|
|
|
|
15,711
|
|
Less investment expenses
|
|
|
1,373
|
|
|
|
1,490
|
|
|
|
1,224
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
22,081
|
|
|
|
19,372
|
|
|
|
14,487
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
91
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
All investments in fixed-maturity securities were income
producing during 2007, 2006 and 2005. Net realized investment
gains (losses), including other-than-temporary impairments, were
as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
|
Realized (losses) gains:
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross realized gains
|
|
$
|
2,455
|
|
|
|
1,589
|
|
|
|
590
|
|
Gross realized losses
|
|
|
(4,285
|
)
|
|
|
(1,610
|
)
|
|
|
(417
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities
|
|
|
(1,830
|
)
|
|
|
(21
|
)
|
|
|
173
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross realized gains
|
|
|
357
|
|
|
|
595
|
|
|
|
116
|
|
Gross realized losses
|
|
|
(509
|
)
|
|
|
(494
|
)
|
|
|
(615
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equity securities
|
|
|
(152
|
)
|
|
|
101
|
|
|
|
(499
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized investment (losses) gains:
|
|
$
|
(1,982
|
)
|
|
|
80
|
|
|
|
(326
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31, 2007, 2006 and 2005, net
income tax (benefit) expense on net realized investment (losses)
gains was $(258,000), $28,000, and $(114,000), respectively.
Proceeds from the sale of fixed maturity securities
available-for-sale were $201.8 million, $71.6 million,
and $48.3 million for the years ended December 31,
2007, 2006 and 2005, respectively.
The change in unrealized appreciation on investments recorded in
shareholders equity and in other comprehensive income is
as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
|
Fixed maturities securities
|
|
$
|
(932
|
)
|
|
|
(39
|
)
|
|
|
(4,536
|
)
|
Equity securities
|
|
|
(6,428
|
)
|
|
|
1,199
|
|
|
|
(1,506
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in unrealized (depreciation) appreciation on investments
before adjustment to taxes
|
|
|
(7,360
|
)
|
|
|
1,160
|
|
|
|
(6,042
|
)
|
Change in deferred income tax expense (benefit)
|
|
|
1,046
|
|
|
|
406
|
|
|
|
(2,072
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in net unrealized appreciation on investments, net of tax
|
|
$
|
(6,314
|
)
|
|
|
754
|
|
|
|
(3,970
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Century and PIC held fixed maturity securities with a carrying
value of $9.9 million and $9.4 million on deposit with
regulatory authorities as required by law at December 31,
2007 and 2006, respectively.
At December 31, 2007 and 2006, Century maintained a trust
fund (consisting of cash and investments) with a combined
carrying value of $260,000 and $247,000, respectively. The
assets of the trust are recorded as cash and investments and are
held as security for unearned premiums and outstanding loss
reserves under an assumed reinsurance contract.
92
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
|
|
(3)
|
Loss and
Loss Expense Reserves
|
The rollforward of loss and loss expense reserves are summarized
as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
|
Loss and loss expense reserves at beginning of year, as reported
|
|
$
|
250,672
|
|
|
|
211,647
|
|
|
|
153,236
|
|
Less reinsurance recoverables on unpaid losses at beginning of
year
|
|
|
36,104
|
|
|
|
37,448
|
|
|
|
29,485
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss and loss expense reserves at beginning of year
|
|
|
214,568
|
|
|
|
174,199
|
|
|
|
123,751
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for loss and loss expenses incurred for claims related
to:
|
|
|
|
|
|
|
|
|
|
|
|
|
Current year
|
|
|
134,981
|
|
|
|
136,583
|
|
|
|
112,946
|
|
Prior years
|
|
|
(9,064
|
)
|
|
|
(1,103
|
)
|
|
|
5,400
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total incurred
|
|
|
125,917
|
|
|
|
135,480
|
|
|
|
118,346
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses and loss expense payments for claims related to:
|
|
|
|
|
|
|
|
|
|
|
|
|
Current year
|
|
|
38,064
|
|
|
|
38,781
|
|
|
|
24,548
|
|
Prior years
|
|
|
64,031
|
|
|
|
56,330
|
|
|
|
43,350
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total paid
|
|
|
102,095
|
|
|
|
95,111
|
|
|
|
67,898
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss and loss expense reserves at end of year
|
|
|
238,390
|
|
|
|
214,568
|
|
|
|
174,199
|
|
Plus reinsurance recoverables on unpaid losses at end of year
|
|
|
40,863
|
|
|
|
36,104
|
|
|
|
37,448
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss and loss expense reserves at end of year, as reported
|
|
$
|
279,253
|
|
|
|
250,672
|
|
|
|
211,647
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss and loss expense reserves represent our best estimate of
ultimate amounts for losses and related expenses from claims
that have been reported but not paid, and those losses that have
occurred but have not yet been reported to us. Loss reserves do
not represent an exact calculation of liability, but instead
represent our estimates, generally utilizing individual claim
estimates, actuarial expertise and estimation techniques at a
given accounting date. The loss reserve estimates are
expectations of what ultimate settlement and administration of
claims will cost upon final resolution. These estimates are
based on facts and circumstances then known to us, a review of
historical settlement patterns, estimates of trends in claims
frequency and severity, projections of loss costs, expected
interpretations of legal theories of liability, and many other
factors. In establishing reserves, we also take into account
estimated recoveries, reinsurance, salvage and subrogation. The
reserves are reviewed regularly by our internal actuarial staff.
The favorable development during the year ended
December 31, 2007 primarily relates to the 2004 through
2006 accident years. At the beginning of 2005, the Company began
writing certain contractors liability business on a claims
made form, replacing the occurrence form which had previously
been utilized through 2004. The Company wrote a significant
volume of claims made contractor liability business in both 2005
and 2006, and this business has continued to perform better than
expected. The Company continues to write contractors
liability business on an occurrence form, in certain
jurisdictions and for certain classes of business. The ultimate
loss ratios for the 2005 and 2006 accident years were reduced
during 2007 due in part to the continued favorable experience on
the claims made contractor liability business. In addition,
management reduced its long-term loss ratio expectations and
loss development factors for other casualty business based on
loss experience that emerged during the year that was more
favorable than our initial expectations. Due to the reduction of
these long-term loss ratio expectations and loss development
factors, the indicated ultimate loss ratios produced by certain
actuarial methods were lower as of
93
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
December 31, 2007 than they were as of December 31,
2006. As a result, during the year, management reduced the
selected ultimate loss ratios for casualty business for accident
years 2004 through 2006. The reduction in losses for casualty
business discussed above was partially offset by increases in
legal and settlement costs related to litigation on construction
defect claims. In total, this resulted in favorable development
of $6.1 million for the year ended December 31, 2007.
In addition, during the year the Company experienced favorable
case reserve development in the property line for accident years
2005 and 2006, resulting in a reduction in losses of
$2.7 million during the year.
For the year ended December 31, 2006, the Company
experienced favorable non-catastrophe property case reserve
development producing a reduction in ultimate loss and loss
expenses by $7.8 million primarily for the 2004 and 2005
accident years. The Company also changed its estimates during
2006 on catastrophe losses by reducing its estimates on
Hurricane Wilma by $1.5 million due to actual incurred
losses being lower than original estimates. This favorable
development was offset by an increase of $2.5 million in
casualty reserves during 2006 as a result of a small amount of
adverse development in the casualty line and a result of a
refinement to the internal actuarial reserving technique
concerning the weighting of reserve indications and supplemental
information concerning claims severities. The Company also
incurred $2.8 million of adverse development during the
year ended December 31, 2006 due to an increase in legal
severities on construction defect claims that occurred when
litigation discovery procedures yielded new information about
underlying claims that enabled evaluation of expected
settlements or judgment and expenses on suits that had been
received in prior years. Additionally, the Company recorded
$2.9 million of unfavorable development during the year
ended December 31, 2006 related to estimated costs
associated with possible reinsurance collection issues on two
separate casualty claims and the 1998 and 1999 workers
compensation reinsurance treaties.
For the year ended December 31, 2005, the Company
experienced unfavorable casualty development. A significant
portion of the loss and loss expenses attributable to insured
events of prior periods for 2005 resulted from construction
defect claims in the other liability line. As a result of court
decisions that further defined the legal environment in
California, the Company decided to enhance its defense strategy
for certain types of construction defect claims. As a result,
the Company revised the construction defect defense team by
retaining appellate and new trial counsel and restaffing the
in-house team responsible for management of the litigation. Once
the new legal teams were established late in 2004 and into 2005,
it was determined that there were certain cases that should be
settled and the defense budgets for the remaining cases had to
be revised to reflect the added resources, resulting in higher
than expected loss and defense costs in 2005.
Management believes the loss and loss expense reserves make a
reasonable provision for expected losses; however, ultimate
settlement of these amounts could vary significantly from the
amounts recorded.
In the ordinary course of business, Century and PIC assumes and
cedes reinsurance with other insurers and reinsurers. These
arrangements provide greater diversification of business and
limit the maximum net loss potential on large risks. Excess of
loss contracts in effect through December 31, 2007
generally protect against individual property and casualty
losses over $500,000. In addition, beginning in 2006, for
casualty losses over $500,000 and under $1.0 million, the
Company participates on a quota share basis on 50% of the
$500,000 in excess of the $500,000 layer. This layer was ceded
100% to reinsurers in 2005. Excess of loss contracts in effect
for workers compensation losses protect against individual
losses over $200,000. Additionally, from January 1, 2001
through June 30, 2001, and from July 1, 2001 through
December 31, 2002 the first $200,000 in workers
compensation losses were 80% and 60% ceded on a quota share
basis, respectively. Catastrophe and clash coverage is also
maintained. In addition, effective January 1, 2004, Century
entered into a loss portfolio transfer and quota share
arrangement with Evergreen and Continental whereby Century
assumed all of Evergreen and Continentals
94
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
property and casualty, workers compensation, and
commercial automobile lines of business and Evergreen assumed
all of Centurys traditional surety lines of business.
Of the total reinsurance recoverable on paid and unpaid losses
at December 31, 2007, 64.4% was with reinsurance companies,
which had an A. M. Best rating of A or higher at
December 31, 2007. The amounts of ceded loss and loss
expense reserves and ceded unearned premiums would represent a
liability of the Company in the event that its reinsurers would
be unable to meet existing obligations under reinsurance
agreements.
The effects of assumed and ceded reinsurance on premiums
written, premiums earned and loss and loss expenses incurred
were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
Premiums written:
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct
|
|
$
|
232,947
|
|
|
|
278,460
|
|
|
|
212,953
|
|
Assumed
|
|
|
5,399
|
|
|
|
4,576
|
|
|
|
3,211
|
|
Ceded
|
|
|
(34,542
|
)
|
|
|
(35,117
|
)
|
|
|
(26,645
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums written
|
|
$
|
203,804
|
|
|
|
247,919
|
|
|
|
189,519
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums earned:
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct
|
|
|
245,355
|
|
|
|
246,976
|
|
|
|
200,805
|
|
Assumed
|
|
|
5,966
|
|
|
|
4,071
|
|
|
|
1,863
|
|
Ceded
|
|
|
(33,759
|
)
|
|
|
(32,055
|
)
|
|
|
(25,038
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums earned
|
|
$
|
217,562
|
|
|
|
218,992
|
|
|
|
177,630
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses and loss expenses incurred:
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct
|
|
$
|
135,513
|
|
|
|
145,907
|
|
|
|
136,406
|
|
Assumed
|
|
|
1,470
|
|
|
|
2,003
|
|
|
|
(721
|
)
|
Ceded
|
|
|
(11,066
|
)
|
|
|
(12,430
|
)
|
|
|
(17,339
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net losses and loss expenses incurred
|
|
$
|
125,917
|
|
|
|
135,480
|
|
|
|
118,346
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2007 and 2006, the Companys allowance
for uncollectible reinsurance was $3.4 million and
$4.1 million, respectively. Management believes that the
reserves for uncollectible reinsurance constitute a reasonable
provision for expected costs and recoveries related to the
collection of the recoverables on these claims; however, actual
legal costs and settlements of these claims could vary
significantly from the current estimates recorded.
95
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
The following table displays net reinsurance balances
recoverable, from our top ten reinsurers, as of
December 31, 2007. All other reinsurance balances
recoverable, when considered by individual reinsurer, are less
than 3 percent of shareholders equity.
|
|
|
|
|
|
|
|
|
A.M. Best
|
|
Net Amount
|
|
Reinsurer
|
|
Rating
|
|
Recoverable
|
|
|
|
As of December 31, 2007
|
|
|
|
(In thousands)
|
|
|
Ace Property and Casualty
|
|
A+
|
|
$
|
18,152,000
|
|
Swiss Reinsurance America Corporation
|
|
A+
|
|
|
10,330,000
|
|
Munich Reinsurance America
|
|
A+
|
|
|
6,353,000
|
|
Hannover Ruckvesicherungs-Aktiengeselischaft
|
|
A
|
|
|
3,396,000
|
|
General Reinsurance Corporation
|
|
A++
|
|
|
3,115,000
|
|
Berkley Insurance Company
|
|
A+
|
|
|
2,107,000
|
|
Axis Reinsurance Company
|
|
A
|
|
|
1,840,000
|
|
Gerling Global Reinsurance Corporation(1)
|
|
NR3
|
|
|
1,664,000
|
|
Evergreen National Indemnity Company
|
|
A−
|
|
|
1,339,000
|
|
Lloyds Syndicate Number 2003
|
|
A
|
|
|
618,000
|
|
|
|
|
(1) |
|
We are closely monitoring the financial status of Gerling Global
Reinsurance Corporation (which is not rated as it is no longer
accepting new or renewal business). We are currently in
arbitration with Gerling over a disputed claim. |
|
|
(5)
|
Deferred
Policy Acquisition Costs
|
The following reflects the amounts of policy acquisitions costs
deferred and amortized:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
Balance at beginning of period
|
|
$
|
26,915
|
|
|
|
20,649
|
|
|
|
17,411
|
|
Policy acquisition costs deferred
|
|
|
52,651
|
|
|
|
60,670
|
|
|
|
46,173
|
|
Amortization of deferred policy acquisition costs
|
|
|
(55,230
|
)
|
|
|
(54,404
|
)
|
|
|
(42,935
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period
|
|
$
|
24,336
|
|
|
|
26,915
|
|
|
|
20,649
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a)
|
Company
Obligated Mandatorily Redeemable Preferred Securities of
Subsidiary Trust Holding Solely Junior Subordinated
Debentures
|
On December 4, 2002, ProFinance Statutory Trust I (the
Trust), a Connecticut statutory business trust
formed by the Company, issued 15,000 floating rate capital
securities (Trust Preferred Securities)
generating gross proceeds of $15.0 million. Net proceeds
were $14.5 million, after deducting offering costs of
$454,000. In addition, on May 16, 2003, ProFinance
Statutory Trust II (the Trust), a Connecticut
statutory business trust formed by the Company, issued 10,000
floating rate capital securities (Trust Preferred
Securities) generating gross proceeds of
$10.0 million. Net proceeds were $9.7 million, after
deducting offering costs of $300,000.
The Trust Preferred Securities have a 30 year maturity
and are redeemable by the Company at par on or after
December 15, 2007 and May 16, 2008, respectively.
Holders of the Trust Preferred Securities are entitled to
receive
96
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
cumulative cash distributions accruing from the date of issuance
and payable quarterly in arrears at a rate of 400 and
410 basis points, respectively, over the three-month London
Interbank Offered Rates (LIBOR). The maximum
distribution rate is 12.5% through December 4, 2007 and
May 16, 2008, respectively. Under certain circumstances,
the Company has the right to defer distributions and interest on
the Trust Preferred Securities for up to five years. The
obligations of the Trust are guaranteed by the Company with
respect to distributions and payments of the
Trust Preferred Securities. These distributions are
recorded as interest expense in the accompanying consolidated
statements of operations, as the Trust Preferred Securities
are considered a debt instrument. Interest paid totaled
$2.4 million, $2.4 million and $1.9 million in
2007, 2006, and 2005, respectively.
Proceeds from the sale of the Trust Preferred Securities
were used to purchase the Companys Floating Rate Junior
Subordinated Deferrable Interest Debentures (the
Debentures). The Debentures, which are the sole
asset of the Trust, have the same terms with respect to
maturity, payments and distributions as the Trust Preferred
Securities. The Company has the right to defer payments of
interest on the Debentures for up to five years.
The Company has a $10.0 million line of credit with a
maturity date of September 30, 2009, and interest only
payments due quarterly based on LIBOR plus 1.2% of the
outstanding balance. All of the outstanding shares of Century
are pledged as collateral. At December 31, 2007, the
outstanding borrowings on the line of credit were
$4.7 million. During the year ended 2007, the Company made
draws totaling $650,000 on the line of credit for general
corporate purposes. Interest expense for the year ended
December 31, 2007 was $324,000. The Company had borrowings
outstanding under the line of credit at December 31, 2006
of $4.0 million. Interest expense for the year ended
December 31, 2006 was $6,000.
The components of the income tax expense are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
|
Federal current tax expense
|
|
$
|
12,262
|
|
|
|
11,552
|
|
|
|
5,119
|
|
Federal deferred tax benefit
|
|
|
(976
|
)
|
|
|
(2,817
|
)
|
|
|
(1,781
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total federal income tax expense
|
|
$
|
11,286
|
|
|
|
8,735
|
|
|
|
3,338
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The income tax expense differed from the amounts computed by
applying the U.S. federal income tax rate of 35% in 2007,
2006 and 2005 to income before income taxes as a result of the
following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
Federal income tax expense at statutory rate
|
|
|
35.00
|
%
|
|
|
35.00
|
%
|
|
|
35.00
|
%
|
(Decrease) increase attributable to:
|
|
|
|
|
|
|
|
|
|
|
|
|
Nontaxable interest income net of proration
|
|
|
(4.71
|
)
|
|
|
(5.59
|
)
|
|
|
(9.77
|
)
|
Deferred tax asset valuation allowance
|
|
|
1.21
|
|
|
|
|
|
|
|
|
|
Dividend received deduction net of proration
|
|
|
(0.52
|
)
|
|
|
(0.48
|
)
|
|
|
(0.33
|
)
|
Other
|
|
|
0.33
|
|
|
|
0.54
|
|
|
|
(0.32
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
31.31
|
%
|
|
|
29.47
|
%
|
|
|
24.58
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
97
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
The tax effects of temporary differences that give rise to
significant portions of the net deferred federal income tax
asset/liability were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
|
Unearned premiums
|
|
$
|
6,987
|
|
|
|
7,950
|
|
|
|
5,925
|
|
Loss and loss expense reserves discounting
|
|
|
10,017
|
|
|
|
9,664
|
|
|
|
8,303
|
|
Unrealized loss on investments
|
|
|
3,866
|
|
|
|
1,294
|
|
|
|
1,700
|
|
Other than temporary losses on investments
|
|
|
1,845
|
|
|
|
518
|
|
|
|
40
|
|
Reinsurance allowance
|
|
|
1,180
|
|
|
|
1,426
|
|
|
|
450
|
|
Other, net
|
|
|
989
|
|
|
|
747
|
|
|
|
(40
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross deferred tax assets
|
|
|
24,884
|
|
|
|
21,599
|
|
|
|
16,378
|
|
Less valuation allowance
|
|
|
(1,961
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets
|
|
|
22,923
|
|
|
|
21,599
|
|
|
|
16,378
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred policy acquisition costs
|
|
|
(8,518
|
)
|
|
|
(9,420
|
)
|
|
|
(7,227
|
)
|
Other, net
|
|
|
(821
|
)
|
|
|
(618
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross deferred tax liabilities
|
|
|
(9,339
|
)
|
|
|
(10,038
|
)
|
|
|
(7,227
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net deferred federal income tax asset
|
|
$
|
13,584
|
|
|
|
11,561
|
|
|
|
9,151
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effective January 1, 2007, the Company FIN 48, which
clarifies the accounting for uncertainty in income taxes
recognized in a companys financial statements. FIN 48
requires companies to determine whether it is more likely
than not that a tax position will be sustained upon
examination by the appropriate taxing authorities before any
pare to the benefit can be recorded in the financial statements.
It also provides guidance on the recognition, measurement and
classification of income tax uncertainties, along with any
related interest and penalties. Previously recorded income tax
benefits that no longer meet this standard are required to be
charged to earnings in the period that such determination is
made. There was no change in the liability for unrecognized tax
benefits resulting from the implementation of FIN 48 and ,
therefore, the Company did not recognize a cumulative effect
adjustment to the balance of retained earnings as of
January 1, 2007. The Company does not have a liability for
tax exposure reserves as of December 31, 2007 and 2006, and
does not anticipate any material change in the total amount of
unrecognized tax benefits over the subsequent
12-month
period. The adoption did not have an initial impact on the
Companys consolidated financial statements.
The Company has recorded deferred tax assets and liabilities
that result from temporary differences between the time income
or expense items are recognized for financial statement purposes
and for tax reporting. Such amounts are calculated using the
enacted tax rates and laws that are expected to be in effect
when the differences are expected to reverse. The determination
of current and deferred income taxis is based on complex
analyses of many factors including interpretation of Federal and
state income tax laws, the difference between tax and financial
reporting basis of assets and liabilities (temporary
differences), estimates of amounts due or owed such as the
timing of reversals of temporary differences and current
financial accounting standards. A valuation allowance is
established if, based upon the relevant facts and circumstances,
management believes that some or all of certain tax assets will
not be realized. The Company has open tax years that may in the
future be subject to examination by federal and state taxing
authorities. At December 31, 2007, the Company established
a valuation allowance of $2.0 million related to unrealized
losses on equity securities and other-than-temporary impairments
that, upon realization, could not be offset by past or future
capital gains. A portion of this valuation allowance,
$1.5 million was recorded through other comprehensive
income and the remainder was recorded through the statement of
98
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
operations. There was no valuation allowance at
December 31, 2006. Management periodically evaluates the
adequacy of related valuation allowances, taking into account
our open tax return positions, tax assessments received and tax
law changes. The process of evaluating allowance accounts
involves the use of estimates and a high degree of management
judgment. Actual results could differ significantly from the
estimates and interpretations used in determining the current
and deferred income tax liabilities and reserves.
The Companys estimates are reviewed continuously to ensure
reasonableness. However, the amounts the Company may ultimately
realize could differ from such estimated amounts.
|
|
(8)
|
Commitments
and Contingencies
|
We are party to lawsuits, arbitrations and other proceedings
that arise in the normal course of our business. Certain of the
lawsuits, arbitrations and other proceedings involve claims
under policies that we underwrite as an insurer, the liabilities
for which we believe have been adequately included in our loss
and loss adjustment expense reserves. Also, from time to time,
we are party to lawsuits, arbitrations and other proceedings
that relate to disputes over contractual relationships with
third parties or that involve alleged errors and omissions on
the part of our insurance subsidiaries. We provide accruals for
these items to the extent we deem the losses probable and
reasonably estimable.
The outcome of litigation is subject to numerous uncertainties.
Although the ultimate outcome of pending matters cannot be
determined at this time, based on present information, we
believe the resolution of these matters will not have a material
adverse effect on our financial position, results of operations
or cash flows.
During 2004, the Company adopted and the shareholders approved a
stock option plan that provided tax-favored incentive stock
options (qualified options), non-qualified share options to
employees and qualified board members that do not qualify as
tax-favored incentive share options (non-qualified options),
time-based restricted shares that vest solely on service
provided and restricted shares that vest based on achieved
performance metrics. The Company accounts for this plan in
accordance with FAS 123R. Any compensation cost recorded in
accordance with FAS 123R is recorded in the same captions
as the salary expense of the employee (i.e. the compensation
cost for the Chief Investment Officer is recorded in net
investment income). The Company will issue authorized but
unissued shares or treasury shares to satisfy restricted share
awards or the exercise of share options.
With respect to qualified options, an employee may be granted an
option to purchase shares at the grant date fair market value,
payable as determined by the Companys board of directors.
An optionee must exercise an option within 10 years from
the grant date. Full vesting of options granted occurs at the
end of four years.
With respect to non-qualified options, an employee or a board
member may be granted an option to purchase shares at the grant
date fair market value, payable as determined by the
Companys board of directors. An optionee must exercise an
option within 10 years from the grant date. Full vesting of
options granted occurs at the end of three years.
For both non-qualified and qualified options, the option
exercise price equals the stocks fair market value on the
date of the grant. Compensation expense is measured on the grant
date at fair value using a Black Scholes model. The compensation
cost is recognized over the respective service period, which
typically matches the vesting period.
The time-based restricted shares are granted to key executives
and vest in equal installments upon the lapse of a period of
time, typically over four and five year periods and include both
monthly and annual vesting periods. Compensation expense for
time-based restricted shares is measured on the grant date at
the current market value and then recognized over the respective
service period, which typically matches the vesting period.
99
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
The performance based restricted shares are granted to key
executives and vest annually over a four year period based on
achieved specified performance metrics. Compensation expense for
performance based restricted share awards is recognized based on
the fair value of the awards on the date of grant.
The Company may grant awards for up to 1.2 million shares
under the plan. Through December 31, 2007, the Company had
granted 311,000 non-qualified options, 292,500 qualified
options, 156,000 time-based restricted shares, 132,353
performance-based restricted shares, and 8,661 non-restricted
shares under the share plan.
A summary of the status of the option plan at December 31,
2007 and changes during the year then ended is presented in the
following table:
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended
|
|
|
|
December 31, 2007
|
|
|
|
|
|
|
Weighted-
|
|
|
|
Number of
|
|
|
Average
|
|
|
|
Shares
|
|
|
Exercise Price
|
|
|
Outstanding at beginning of period
|
|
|
505,900
|
|
|
$
|
10.58
|
|
Changes during the period:
|
|
|
|
|
|
|
|
|
Granted
|
|
|
97,000
|
|
|
|
19.81
|
|
Exercised
|
|
|
(66,258
|
)
|
|
|
10.51
|
|
Forfeited
|
|
|
(4,088
|
)
|
|
|
15.15
|
|
Expired
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at end of period
|
|
|
532,554
|
|
|
$
|
12.24
|
|
|
|
|
|
|
|
|
|
|
Exercisable at end of period
|
|
|
388,045
|
|
|
$
|
10.98
|
|
|
|
|
|
|
|
|
|
|
The weighted average fair value of options granted during the
years ended December 31, 2007, 2006 and 2005 were $6.46,
$3.18 and $2.99, respectively.
The fair market value of each option grant is estimated on the
date of grant using the Black-Scholes option pricing model with
the following weighted-average assumptions used for grants in
2007, 2006 and 2005:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
Year Ended
|
|
|
Year Ended
|
|
|
|
December 31,
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
Risk-free interest rate
|
|
|
4.51
|
%
|
|
|
4.07
|
%
|
|
|
3.97
|
%
|
Expected dividends
|
|
|
0.74
|
%
|
|
|
0.93
|
%
|
|
|
0.76
|
%
|
Expected volatility
|
|
|
25.45
|
%
|
|
|
23.11
|
%
|
|
|
23.14
|
%
|
Weighted average expected term
|
|
|
6.28 Years
|
|
|
|
7.00 Years
|
|
|
|
7.00 Years
|
|
100
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
Information on the range of exercise prices for options
outstanding as of December 31, 2007, is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding
|
|
|
Options Excercisable
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
Remaining
|
|
|
Average
|
|
|
Aggregate
|
|
|
|
|
|
Average
|
|
|
Aggregate
|
|
|
|
Outstanding
|
|
|
Contractual
|
|
|
Exercise
|
|
|
Intrinsic
|
|
|
Exercisable
|
|
|
Exercise
|
|
|
Intrinsic
|
|
Price
|
|
Options
|
|
|
Term
|
|
|
Price
|
|
|
Value
|
|
|
Options
|
|
|
Price
|
|
|
Value
|
|
|
$10.20
|
|
|
11,386
|
|
|
|
7.4
|
|
|
$
|
10.20
|
|
|
$
|
58,638
|
|
|
|
9,986
|
|
|
$
|
10.20
|
|
|
$
|
51,428
|
|
$10.50
|
|
|
309,349
|
|
|
|
6.3
|
|
|
$
|
10.50
|
|
|
$
|
1,500,343
|
|
|
|
301,841
|
|
|
$
|
10.50
|
|
|
$
|
1,463,930
|
|
$10.64
|
|
|
106,042
|
|
|
|
8.0
|
|
|
$
|
10.64
|
|
|
$
|
499,458
|
|
|
|
52,285
|
|
|
$
|
10.64
|
|
|
$
|
246,262
|
|
$13.04
|
|
|
10,721
|
|
|
|
8.4
|
|
|
$
|
13.04
|
|
|
$
|
24,766
|
|
|
|
5,996
|
|
|
$
|
13.04
|
|
|
$
|
13,851
|
|
$18.70
|
|
|
10,056
|
|
|
|
9.4
|
|
|
$
|
18.70
|
|
|
|
(33,688
|
)
|
|
|
2,006
|
|
|
$
|
18.70
|
|
|
|
(6,720
|
)
|
$19.97
|
|
|
85,000
|
|
|
|
9.2
|
|
|
$
|
19.97
|
|
|
|
(392,700
|
)
|
|
|
15,931
|
|
|
$
|
19.97
|
|
|
|
(73,601
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,656,817
|
|
|
|
|
|
|
|
|
|
|
$
|
1,695,150
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
A summary of all employee time-based restricted share activity
during the year ended December 31, 2007 is as follows:
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended
|
|
|
|
December 31, 2007
|
|
|
|
|
|
|
Weighted
|
|
|
|
Number of
|
|
|
Average
|
|
|
|
Shares
|
|
|
Grant Price
|
|
|
Outstanding at beginning of period
|
|
|
45,156
|
|
|
$
|
10.19
|
|
Changes during the period:
|
|
|
|
|
|
|
|
|
Granted
|
|
|
|
|
|
|
|
|
Vested
|
|
|
(24,862
|
)
|
|
|
10.25
|
|
Cancelled
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at end of period
|
|
|
20,294
|
|
|
$
|
10.10
|
|
|
|
|
|
|
|
|
|
|
In January 2005 and October 2005, the Company modified two
executives time-based restricted share awards in connection with
the termination of their employment to accelerate the vesting
period. As such, the Company accounted for the modifications as
cancellations of a fixed award and a grant of a variable award,
which are valued at the fair market value on the monthly vesting
date. During 2005, the Company recorded $231,924 of compensation
expense related to the January modification and $42,617 related
to the October modification. At December 31, 2005, all
shares related to the January modification were vested. The
Company recorded $165,343 of compensation expense related to the
October 2005 modification for the year ended December 31,
2006. As of December 31, 2006, all related shares were
vested.
101
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
A summary of all employee performance-based restricted share
activity during the year ended December 31, 2007 is as
follows:
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended
|
|
|
|
December 31, 2007
|
|
|
|
|
|
|
Weighted
|
|
|
|
Number of
|
|
|
Average
|
|
|
|
Shares
|
|
|
Grant Price
|
|
|
Outstanding at beginning of period
|
|
|
64,728
|
|
|
$
|
12.76
|
|
Changes during the period:
|
|
|
|
|
|
|
|
|
Granted
|
|
|
40,625
|
|
|
|
19.38
|
|
Vested
|
|
|
(18,517
|
)
|
|
|
12.48
|
|
Cancelled
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at end of period
|
|
|
86,836
|
|
|
$
|
15.92
|
|
|
|
|
|
|
|
|
|
|
In September of 2006 and March of 2005, the Company granted
36,704 and 37,365, respectively of performance based restricted
shares to certain executives that vest annually over a four-year
period subject to the achievement of certain performance
metrics. The Company accounted for these awards as fixed awards
that were recorded at fair value on the date of grant.
Of the performance-based restricted share awards granted in
March of 2005, an award for 17,659 shares was modified in
accordance with the agreement entered into in connection with
the termination of an executive officers employment in
October 2005. As such, the award was treated as cancelled on
October 1, 2005 due to a modification of the award to
accelerate the vesting of the shares, change the vesting from
annual vesting to monthly vesting and remove the performance
based restrictions. As such, the award is treated as a variable
award which is valued at the fair market value on the monthly
vesting date. During 2005, the Company recorded $46,058
compensation expense related to the restricted shares. During
the year ended December 31, 2006, the Company recorded
$178,686 of compensation expense related to the restricted
shares and all related shares were vested by September 30,
2006.
As of December 31, 2007, total compensation cost related to
nonvested share options or restricted shares is
$1.5 million, which is expected be recorded over
1.7 years. Total compensation cost for share based awards
was $1.3 million, $1.3 million and $817,000 for the
years ended December 31, 2007, 2006 and 2005, respectively.
The tax benefit included in the accompany statements of
operations related to the compensation cost was $338,000,
$121,000, and $286,000 for the years ended December 31,
2007, 2006, and 2005, respectively. At December 31, 2007,
the Company had $212,000 of compensation cost for share based
awards capitalized with deferred policy acquisition costs.
|
|
(10)
|
Transactions
with Related Parties
|
Evergreen
National Indemnity Company and Continental Heritage Insurance
Company
In connection with the Companys IPO in April 2004, the
Company spun-off its subsidiaries, Evergreen and Continental, to
the Companys Class A shareholders. In connection with
the spin-off, the Company entered into several agreements with
Evergreen which facilitated the Evergreen and Continental
transactions. The Companys board of directors believes
that these agreements were fair to the Company and its
shareholders.
Transitional Administrative Agreement. Prior
to the Evergreen and Continental dispositions, the Company
provided Evergreen and Continental with all executive,
managerial, supervisory, administrative, technical, claims
handling, investment management, regulatory affairs, legal,
accounting, financial reporting, professional and clerical
services necessary to operate their respective businesses. In
order to provide Evergreen and Continental
102
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
with a transition period before the cessation of these services,
the Company entered into a Transitional Administrative Agreement
with Evergreen and Continental pursuant to which the Company
continued to provide these services to Evergreen and Continental
for an initial term of 18 months in exchange for an annual
fee of $900,000. This agreement was renewed for one six-month
term to expire on December 31, 2005, without any changes in
the terms thereof. On December 29, 2005, the agreement was
amended to extend the term thereof to June 30, 2006, reduce
the administrative fee to $75,000 per calendar quarter payable
during the first month of each quarter and providing for
termination upon not less than thirty (30) days advance
written notice to the Company. On October 13, 2006, the
agreement was amended retroactively to July 1, 2006 to
extend the term thereof to March 31, 2007 and reduce the
administrative fee to $10,000 per calendar quarter. On
April 25, 2007, the agreement was amended retroactively to
April 1, 2007 to extend the term thereof to June 30,
2007 and reduce the administrative fee to $5,000 per calendar
quarter. In all other respects the agreement remained unchanged.
The agreement was terminated as of June 30, 2007. For the
year ended December 31, 2007, 2006, and 2005, the Company
received $15,000, $170,000, and $690,000 under this agreement,
respectively.
Reinsurance Agreements. The Company entered
into loss portfolio transfer reinsurance contracts that provided
for Century to reinsure Evergreen and Continental for business
that was written in Centurys name prior to
December 31, 2003 and transferred to one of the other
companies in connection with the termination of an intercompany
pooling agreement among the parties and for Evergreen to
reinsure Century in the same manner. For example, Century will
reinsure property business transferred to it in connection with
the termination of the intercompany pooling agreement that had
been written for it in Evergreens name. These contracts
will remain in force until all outstanding loss and assignable
loss adjustment expense covered has been settled or commuted in
accordance with the provisions of the applicable contract. The
Company ceded $435,000 of reserves and assumed $2.8 million
of reserves under this contract in 2007. During the year ended
December 31, 2006, the Company ceded $362,000 of reserves
and assumed $3.1 million of reserves under the contract.
Quota Share Reinsurance Agreements. The
Company entered into 100% quota share reinsurance contracts that
provided for Century to reinsure Evergreen and Continental for
property and casualty business that was written on Evergreen or
Continentals paper for Century in states that Century was
not licensed and for Evergreen to reinsure Century in the same
manner for bonding business. Under these contracts, the ceding
company is entitled to receive a 5% commission and reimbursement
of any premium taxes or other direct costs such as boards and
bureaus fees. These fronting contracts were in force until
December 31, 2007. During 2007, the Company assumed
$905,000 of premiums and ceded $302,000 of premiums under this
contract. The Company assumed $535,000 of premiums and ceded
$406,000 of premiums under this contract during the year ended
December 31, 2006.
Software License Agreement and Software Support and
Maintenance Agreement. Century has entered into a
software license agreement with Evergreen and Continental
pursuant to which Century granted to Evergreen and Continental a
fully
paid-up,
royalty free, non-exclusive perpetual license to use certain of
Centurys proprietary software that relates to underwriting
and claims processing and that has been developed for the mutual
benefit of the Company, Evergreen and Continental. In addition,
Century has entered into a software support and maintenance
agreement with Evergreen and Continental, pursuant to which
Century provides certain technical support and maintenance
services for the software in return for an annual support and
maintenance fee of $100,000. Evergreen and Continental may
terminate the software support and maintenance agreement by
providing 90 days prior written notice, and Century may
terminate the agreement by providing twelve months prior
written notice. On December 29, 2005, the software support
and maintenance agreement was amended to adjust the Annual Fee
effective January 1, 2006, to be at the rate of $50,000 per
calendar quarter payable during the first month of each quarter.
On October 18, 2006, the agreement was amended to adjust
the Annual Fee retroactively to July 1, 2006 to $15,000 per
calendar quarter. On April 25, 2007, the agreement was
amended to adjust the Annual Fee retroactively to April 1,
2007 to $5,000 per calendar quarter. In all other respects, the
agreement continues unchanged. The
103
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
Company received $30,000, $130,000, and $100,000 in Annual Fees
respectively for the years ended December 31, 2007, 2006
and 2005, respectively.
In addition, the Company has entered into the following
agreements with Evergreen. The Companys board of directors
believes that these agreements are fair to the Company and its
shareholders.
Quota
Share Reinsurance Agreements
|
|
|
|
|
In 2005, the Company entered into a 50% quota share agreement
with Evergreen whereby, the Company would assume certain special
surety bonds (including landfill). During 2006 and 2005, the
Company recorded $2.6 million and $2.4 million of
assumed bonds, respectively. This agreement was terminated on
August 15, 2006.
|
|
|
|
On August 1, 2006, the Company became a participant on
Evergreens Landfill Variable Quota Share Treaty. The
Company will assume 10% of all landfill bonds written by
Evergreen and Continental which have exposures in excess of
$1,200,000. The Company recorded assumed premium of
$1.9 million in 2007. The Company recorded assumed premium
of $390,000 in 2006. In addition, the Company assumed a 10%
share, or $677,000, of unearned premium rolled forward from the
previous treaty which was terminated on July 31, 2006.
|
|
|
|
On August 15, 2006, the Company became a participant on
Evergreens Contract Bond Quota Share Treaty. The Company
will assume 25% of all contract bonds written by Evergreen and
Continental. The Company recorded assumed premium of $700,000 in
2007. The Company recorded assumed premium of $102,000 in 2006.
|
|
|
|
On October 1, 2007, the Company entered into 100% quota
share reinsurance contract that provided for Century to reinsure
Evergreen for contract surety business underwritten by Century
employees that was written on Evergreens paper for Century
in states that Century was not licensed. Under these contracts,
the ceding company is entitled to receive a 10% commission. This
fronting contract will remain in force until December 31,
2009. During 2007, the Company assumed $3,000 of premiums.
|
|
|
(11)
|
Commitments,
Contingencies and Concentration
|
The following table summarizes information about contractual
obligations and commercial commitments. The minimum payments
under these agreements as of December 31, 2007 were as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Years
|
|
|
|
2008
|
|
|
2009
|
|
|
2010
|
|
|
2011
|
|
|
2012
|
|
|
Thereafter
|
|
|
Total
|
|
|
|
(In thousands)
|
|
|
Operating leases on facilities
|
|
$
|
1,545
|
|
|
|
1,258
|
|
|
|
1,106
|
|
|
|
1,019
|
|
|
|
932
|
|
|
|
776
|
|
|
|
6,636
|
|
Other operating leases
|
|
|
279
|
|
|
|
70
|
|
|
|
58
|
|
|
|
27
|
|
|
|
|
|
|
|
|
|
|
|
434
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total contractual obligations
|
|
$
|
1,824
|
|
|
|
1,328
|
|
|
|
1,164
|
|
|
|
1,046
|
|
|
|
932
|
|
|
|
776
|
|
|
|
7,070
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rental expense on the operating leases on facilities for the
years ended December 31, 2007, 2006 and 2005 was
$1.5 million, $1.3 million, and $1.3 million,
respectively.
The Company is named from time to time as defendants in various
legal actions that are incidental to our business and arise out
of or are related to claims made in connection with our
insurance policies, claims handling,
104
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
premium finance agreements and other contracts and employment
related disputes. The plaintiffs in some of these lawsuits have
alleged bad faith or extra contractual damages and some have
claimed punitive damages. The resolution of these legal actions
is expected not to have a material adverse effect on the
Companys financial position or results of operations.
|
|
(c)
|
Concentration
of Revenues
|
Ten of the Companys 149 agents contributed, on a combined
basis, 52.1% of the Companys 2007 consolidated direct and
assumed premiums written. One of the Companys agents
individually contributed an amount greater than 10% of the
Companys direct and assumed premiums written and
represented 18.2% of the Companys 2007 consolidated direct
and assumed premiums written. There was no concentration of
revenue with respect to geographic area as of December 31,
2007.
|
|
(12)
|
Dividends
from Subsidiaries and Statutory Information
|
Our insurance subsidiaries are regulated by their states of
domicile, Ohio and Texas, and the states in which they do
business. Such regulations, among other things, limit the
payment of dividends without prior regulatory approval.
ProCentury is dependent on dividends from Century for operating
expenses and interest and principal on long term debt and the
Debentures. The maximum dividend that may be paid without prior
approval of the Director of Insurance is limited to the extent
that all dividends in the past 12 months do not exceed the
greater of the statutory income of the preceding calendar year
or 10% of total statutory surplus as of the prior
December 31. As a result, the maximum dividend Century may
pay to ProCentury in 2008 without prior approval is
$27.4 million. Dividends paid to ProCentury from Century
were $5.0 million, $2.5 million, and $2.5 million
in 2007, 2006, and 2005, respectively.
The Company does not expect such regulatory requirements to
impair its ability to pay operating expenses and interest and
principal during 2008.
ProCentury did not make any contributions to Century in 2007.
ProCentury contributed $2.5 million to Century in 2006.
There were no such contributions in 2005.
The National Association of Insurance Commissioners (NAIC) has
developed property and casualty risked based capital (RBC)
standards that relate an insurers reported statutory
surplus to the risks inherent in overall operations. The RBC
formula uses the statutory annual statement to calculate the
minimum indicated capital level required to support asset and
underwriting risk. The NAIC calls for various levels of
regulatory action based on the magnitude of an indicated RBC
capital deficiency, if any. The Company regularly monitors
capital requirements along with the NAICs RBC
developments. The Company has determined that the capital levels
of its insurance subsidiaries are in excess of the minimum
capital requirements for all RBC action levels as of
December 31, 2007.
Our insurance subsidiaries maintain their accounts in conformity
with accounting practices prescribed or permitted by the Ohio
Department of Insurance and Texas Department of Insurance that
vary in certain respects from GAAP. In converting from statutory
to GAAP, typical adjustments include deferral of policy
acquisition costs, the inclusion of statutory nonadmitted
assets, and the inclusion of net unrealized holdings gains or
losses in shareholders equity relating to fixed maturity
securities. The statutory capital and surplus of Century as of
December 31, 2007, 2006 and 2005 was $153.5 million,
$137.5 million and $121.8 million, respectively. The
statutory net income of Century for the years ended
December 31, 2007, 2006 and 2005, was $27.4 million,
$18.4 million and $7.8 million, respectively.
|
|
(13)
|
Segment
Reporting Disclosures
|
The Company operates in the Property and Casualty Segment
(including general liability, multi-peril, commercial property,
garage liability and auto physical damage).
105
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
The Companys Other Segment (including exited lines)
includes the surety business and the Companys exited
lines, such as workers compensation and commercial
auto/trucking. A limited amount of surety business is written in
order to maintain Centurys U.S. Treasury listing.
All investment activities are included in the Investing
operating segment.
The Company considers many factors, including economic
similarity, the nature of the underwriting units insurance
products, production sources, distribution strategies and
regulatory environment in determining how to aggregate operating
segments.
Segment profit or loss for each of the Companys segments
is measured by underwriting profit or loss. The property and
casualty insurance industry commonly defines underwriting profit
or loss as earned premium net of loss and loss expenses and
underwriting, acquisition and insurance expenses. Underwriting
profit or loss does not replace operating income or net income
computed in accordance with GAAP as a measure of profitability.
Segment profit for the Investing operating segment is measured
by net investment income and net realized gains or losses. The
Company does not allocate assets, including goodwill, to the
Property and Casualty and Other operating segments for
management reporting purposes. The total investment portfolio
and cash are allocated to the Investing operating segment.
Following is a summary of segment disclosures:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
|
Segment revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and casualty
|
|
$
|
212,458
|
|
|
|
215,510
|
|
|
|
176,404
|
|
Investing
|
|
|
20,099
|
|
|
|
19,452
|
|
|
|
14,161
|
|
Other (including exited lines)
|
|
|
5,104
|
|
|
|
3,482
|
|
|
|
1,226
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment revenue
|
|
$
|
237,661
|
|
|
|
238,444
|
|
|
|
191,791
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment profit:
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and casualty
|
|
$
|
18,150
|
|
|
|
14,092
|
|
|
|
2,002
|
|
Investing
|
|
|
20,099
|
|
|
|
19,452
|
|
|
|
14,161
|
|
Other (including exited lines)
|
|
|
1,266
|
|
|
|
(1,152
|
)
|
|
|
121
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment profit
|
|
$
|
39,515
|
|
|
|
32,392
|
|
|
|
16,284
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Investing
|
|
$
|
467,276
|
|
|
|
436,062
|
|
|
|
366,410
|
|
Assets not allocated
|
|
|
139,778
|
|
|
|
142,986
|
|
|
|
107,735
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total consolidated assets
|
|
$
|
607,054
|
|
|
|
579,048
|
|
|
|
474,145
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
106
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
The following summary reconciles significant segment items to
the Companys consolidated financial statements:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
|
Total revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment revenues
|
|
$
|
237,661
|
|
|
|
238,444
|
|
|
|
191,791
|
|
Other
|
|
|
489
|
|
|
|
437
|
|
|
|
198
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total consolidated revenues
|
|
$
|
238,150
|
|
|
|
238,881
|
|
|
|
191,989
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income tax expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment profit
|
|
$
|
39,515
|
|
|
|
32,392
|
|
|
|
16,284
|
|
Unallocated amounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income
|
|
|
489
|
|
|
|
437
|
|
|
|
198
|
|
Corporate expenses
|
|
|
(1,281
|
)
|
|
|
(875
|
)
|
|
|
(1,030
|
)
|
Interest expense
|
|
|
(2,681
|
)
|
|
|
(2,318
|
)
|
|
|
(1,873
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income tax expense
|
|
$
|
36,042
|
|
|
|
29,636
|
|
|
|
13,579
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following is a summary of segment earned premium by group of
products:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property
|
|
|
Casualty
|
|
|
Other
|
|
|
Consolidated
|
|
|
|
(In thousands)
|
|
|
Year ended December 31, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and casualty
|
|
$
|
74,005
|
|
|
|
138,453
|
|
|
|
|
|
|
|
212,458
|
|
Other (including exited lines)
|
|
|
|
|
|
|
|
|
|
|
5,104
|
|
|
|
5,104
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums
|
|
$
|
74,005
|
|
|
|
138,453
|
|
|
|
5,104
|
|
|
|
217,562
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and casualty
|
|
$
|
75,465
|
|
|
|
140,045
|
|
|
|
|
|
|
|
215,510
|
|
Other (including exited lines)
|
|
|
|
|
|
|
|
|
|
|
3,482
|
|
|
|
3,482
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums
|
|
$
|
75,465
|
|
|
|
140,045
|
|
|
|
3,482
|
|
|
|
218,992
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and casualty
|
|
$
|
56,224
|
|
|
|
120,180
|
|
|
|
|
|
|
|
176,404
|
|
Other (including exited lines)
|
|
|
|
|
|
|
|
|
|
|
1,226
|
|
|
|
1,226
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums
|
|
$
|
56,224
|
|
|
|
120,180
|
|
|
|
1,226
|
|
|
|
177,630
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company does not manage property and casualty products at
this level of detail.
107
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
|
|
(14)
|
Unaudited
Interim Financial Information
|
Selected quarterly financial information is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First
|
|
|
Second
|
|
|
Third
|
|
|
Fourth
|
|
|
|
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Year-to-Date
|
|
|
|
(In thousands)
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums earned
|
|
$
|
54,388
|
|
|
|
56,697
|
|
|
|
55,873
|
|
|
|
50,604
|
|
|
|
217,562
|
|
Net investment income
|
|
|
5,433
|
|
|
|
5,493
|
|
|
|
5,571
|
|
|
|
5,584
|
|
|
|
22,081
|
|
Net realized investment losses
|
|
|
(201
|
)
|
|
|
(37
|
)
|
|
|
(355
|
)
|
|
|
(1,389
|
)
|
|
|
(1,982
|
)
|
Other income
|
|
|
123
|
|
|
|
97
|
|
|
|
159
|
|
|
|
110
|
|
|
|
489
|
|
Income before income tax
|
|
|
7,630
|
|
|
|
9,416
|
|
|
|
8,269
|
|
|
|
10,727
|
|
|
|
36,042
|
|
Net income
|
|
|
5,379
|
|
|
|
6,468
|
|
|
|
5,759
|
|
|
|
7,150
|
|
|
|
24,756
|
|
Basic earnings per share(1)
|
|
$
|
0.41
|
|
|
|
0.49
|
|
|
|
0.43
|
|
|
|
0.54
|
|
|
|
1.87
|
|
Diluted earning per share(1)
|
|
$
|
0.40
|
|
|
|
0.48
|
|
|
|
0.43
|
|
|
|
0.53
|
|
|
|
1.85
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums earned
|
|
$
|
49,002
|
|
|
|
52,565
|
|
|
|
55,425
|
|
|
|
62,000
|
|
|
|
218,992
|
|
Net investment income
|
|
|
4,426
|
|
|
|
4,689
|
|
|
|
4,999
|
|
|
|
5,258
|
|
|
|
19,372
|
|
Net realized investment gains (losses)
|
|
|
21
|
|
|
|
(62
|
)
|
|
|
4
|
|
|
|
117
|
|
|
|
80
|
|
Other income
|
|
|
134
|
|
|
|
118
|
|
|
|
101
|
|
|
|
84
|
|
|
|
437
|
|
Income before income tax
|
|
|
6,478
|
|
|
|
7,079
|
|
|
|
7,369
|
|
|
|
8,710
|
|
|
|
29,636
|
|
Net income
|
|
|
4,600
|
|
|
|
5,025
|
|
|
|
5,133
|
|
|
|
6,143
|
|
|
|
20,901
|
|
Basic earnings per share(1)
|
|
$
|
0.35
|
|
|
|
0.38
|
|
|
|
0.39
|
|
|
|
0.47
|
|
|
|
1.59
|
|
Diluted earning per share(1)
|
|
$
|
0.35
|
|
|
|
0.38
|
|
|
|
0.39
|
|
|
|
0.46
|
|
|
|
1.58
|
|
|
|
|
(1) |
|
Since the weighted-average shares for the quarters are
calculated independently of the weighted-average shares for the
year, quarterly income per share may not total to annual income
per share. |
On February 20, 2008, ProCentury Corporation (parent),
pursuant to unanimous approval of its board of directors,
entered into an Agreement and Plan of Merger (the Merger
Agreement) with Meadowbrook Insurance Group, Inc.
(Meadowbrook) and MBKPC Corp., a wholly-owned
subsidiary of Meadowbrook (Merger Sub), whereby
ProCentury will be merged with and into Merger Sub (the
Merger). At the effective time of the Merger,
shareholders of ProCentury will be entitled to receive, for each
ProCentury common share, either $20.00 in cash or Meadowbrook
common stock having a value of $20.00, subject to adjustment as
described below. Each ProCentury shareholder will have the
option to elect to receive cash or Meadowbrook stock, subject to
proration so that the maximum total cash consideration will not
exceed 45% of the total consideration paid in order to preserve
the tax-free exchange of the stock consideration.
If the
30-day
volume-weighted average price of the Meadowbrook common stock
preceding the election date, which will be at least five days
before the closing of the transaction, is between $8.00 and
$10.50, the exchange ratio will result in stock consideration
having a value of $20.00 per ProCentury common share based on
such 30-day
volume-weighted average price. Above or below this range for
Meadowbrooks stock price, the exchange ratio will be fixed
as if the
30-day
volume-weighted average price preceding the election date
equaled $10.50 or $8.00, as applicable. Outstanding options to
purchase ProCentury common shares will become fully vested and
option
108
PROCENTURY
CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Continued)
December 31, 2007, 2006, 2005
(dollars in thousands)
holders can either exercise such options and, in connection with
the closing, elect to receive the form of merger consideration
described above for the ProCentury shares acquired on exercise
or agree to have their options cancelled in exchange for a per
share cash payment equal to the difference between $20.00 and
the exercise price of their options.
The Merger is subject to customary closing conditions, including
the approval of Meadowbrook and ProCentury shareholders,
regulatory approvals, the absence of any law or order
prohibiting the closing, the effectiveness of the
Form S-4
registration statement relating to the Meadowbrook common stock
to be issued in the Merger, the accuracy of the representations
and warranties of the other party (subject to the standards set
forth in the Merger Agreement), compliance of the other party
with its covenants in all material respects and the delivery of
opinions relating to the U.S. federal income tax code
treatment of the Merger. If the merger is not consummated as a
result of certain events, we will be required to pay a
termination fee of $9.5 million to Meadowbrook.
109
PROCENTURY
CORPORATION AND SUBSIDIARIES
Other
than Investments in Related Parties
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2007
|
|
|
|
|
|
|
|
|
|
Amount
|
|
|
|
|
|
|
|
|
|
Shown on
|
|
|
|
Amortized
|
|
|
|
|
|
Balance
|
|
|
|
Cost
|
|
|
Fair Value
|
|
|
Sheet
|
|
|
|
(In thousands)
|
|
|
Fixed maturities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Available-for-sale
|
|
|
|
|
|
|
|
|
|
|
|
|
Bonds:
|
|
|
|
|
|
|
|
|
|
|
|
|
United States Government
|
|
$
|
2,515
|
|
|
|
2,576
|
|
|
|
2,576
|
|
Agencies not backed by the full faith and credit of the U.S.
Government
|
|
|
5,084
|
|
|
|
5,090
|
|
|
|
5,090
|
|
States, municipals and political subdivisions
|
|
|
209,564
|
|
|
|
209,735
|
|
|
|
209,735
|
|
Convertibles and bonds with warrants attached
|
|
|
1,000
|
|
|
|
1,000
|
|
|
|
1,000
|
|
All other corporate bonds
|
|
|
192,852
|
|
|
|
188,038
|
|
|
|
188,038
|
|
Redeemable preferred stocks
|
|
|
2,847
|
|
|
|
2,312
|
|
|
|
2,312
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
available-for-sale
|
|
|
413,862
|
|
|
|
408,751
|
|
|
|
408,751
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Held-to-maturity
|
|
|
|
|
|
|
|
|
|
|
|
|
Bonds:
|
|
|
|
|
|
|
|
|
|
|
|
|
United States Government
|
|
|
|
|
|
|
|
|
|
|
|
|
Agencies not backed by the full faith and credit of the U.S.
Government
|
|
|
1,099
|
|
|
|
1,110
|
|
|
|
1,099
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
held-to-maturity
|
|
|
1,099
|
|
|
|
1,110
|
|
|
|
1,099
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed-maturities
|
|
|
414,961
|
|
|
|
409,861
|
|
|
|
409,850
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stocks
|
|
|
|
|
|
|
|
|
|
|
|
|
Banks, trust and insurance companies
|
|
|
82
|
|
|
|
82
|
|
|
|
82
|
|
Industrial, miscellaneous and all other
|
|
|
18,501
|
|
|
|
16,822
|
|
|
|
16,822
|
|
Nonredeemable preferred stocks
|
|
|
28,285
|
|
|
|
24,026
|
|
|
|
24,026
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equity securities
|
|
|
46,868
|
|
|
|
40,930
|
|
|
|
40,930
|
|
Short-term investments
|
|
|
4,730
|
|
|
|
XXXX
|
|
|
|
4,730
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investments
|
|
$
|
466,559
|
|
|
|
XXXX
|
|
|
|
455,510
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying report of independent registered public
accounting firm.
110
PROCENTURY
CORPORATION AND SUBSIDIARIES
Condensed
Balance Sheets
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
|
(In thousands)
|
|
|
Assets
|
Investments
|
|
|
|
|
|
|
|
|
Fixed maturities:
|
|
|
|
|
|
|
|
|
Available-for-sale,
at fair value (cost 2007, $1,000; 2006, $1,000)
|
|
$
|
1,000
|
|
|
|
1,000
|
|
Equities
(available-for-sale):
|
|
|
|
|
|
|
|
|
Bond mutual funds, at fair value (cost 2007, $261; 2006, $248)
|
|
|
256
|
|
|
|
241
|
|
|
|
|
|
|
|
|
|
|
Total investments
|
|
|
1,256
|
|
|
|
1,241
|
|
Cash
|
|
|
546
|
|
|
|
458
|
|
Investment in consolidated subsidiaries, equity method
|
|
|
186,039
|
|
|
|
167,631
|
|
Receivable from consolidated subsidiaries
|
|
|
1,303
|
|
|
|
1,303
|
|
Federal income taxes receivable
|
|
|
1,409
|
|
|
|
778
|
|
Other assets
|
|
|
686
|
|
|
|
677
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
191,239
|
|
|
|
172,088
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Shareholders Equity
|
Liabilities:
|
|
|
|
|
|
|
|
|
Long term debt
|
|
$
|
25,000
|
|
|
|
25,000
|
|
Accrued expenses and other liabilities
|
|
|
568
|
|
|
|
680
|
|
Deferred federal income tax liability
|
|
|
|
|
|
|
20
|
|
Line of credit
|
|
|
4,650
|
|
|
|
4,000
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
30,218
|
|
|
|
29,700
|
|
Shareholders equity:
|
|
|
161,021
|
|
|
|
142,388
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders equity
|
|
$
|
191,239
|
|
|
|
172,088
|
|
|
|
|
|
|
|
|
|
|
See notes to Consolidated Financial Statements and accompanying
report of independent registered public accounting firm.
111
PROCENTURY
CORPORATION AND SUBSIDIARIES
Schedule II
Condensed Financial Information of Parent Company
Condensed
Statements of Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
|
Net investment income
|
|
$
|
102
|
|
|
|
111
|
|
|
|
153
|
|
Net realized loss
|
|
|
|
|
|
|
|
|
|
|
(46
|
)
|
Cash dividends on common stock of consolidated subsidiaries
|
|
|
5,000
|
|
|
|
2,500
|
|
|
|
2,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
5,102
|
|
|
|
2,611
|
|
|
|
2,607
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other operating expenses
|
|
|
1,493
|
|
|
|
1,646
|
|
|
|
2,312
|
|
Interest expense
|
|
|
2,681
|
|
|
|
2,318
|
|
|
|
1,873
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expenses
|
|
|
4,174
|
|
|
|
3,964
|
|
|
|
4,185
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before equity in undistributed earnings of
consolidated subsidiaries and income taxes
|
|
|
928
|
|
|
|
(1,353
|
)
|
|
|
(1,578
|
)
|
Equity in undistributed earnings of consolidated subsidiaries
|
|
|
22,395
|
|
|
|
20,906
|
|
|
|
10,391
|
|
Income tax benefit
|
|
|
(1,433
|
)
|
|
|
(1,348
|
)
|
|
|
(1,428
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
24,756
|
|
|
|
20,901
|
|
|
|
10,241
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See notes to Consolidated Financial Statements and accompanying
report of independent registered public accounting firm.
112
PROCENTURY
CORPORATION AND SUBSIDIARIES
Schedule II
Condensed Financial Information of Parent Company
Condensed
Statements of Cash Flows
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
(In thousands)
|
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
24,756
|
|
|
|
20,901
|
|
|
|
10,241
|
|
Adjustments to reconcile net income to net cash provided by
operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity in undistributed net income of subsidiaries
|
|
|
(22,395
|
)
|
|
|
(20,906
|
)
|
|
|
(10,391
|
)
|
Other, net
|
|
|
(770
|
)
|
|
|
21
|
|
|
|
(4,126
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) operating activities
|
|
|
1,591
|
|
|
|
16
|
|
|
|
(4,276
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase of investments
|
|
|
(15
|
)
|
|
|
(11
|
)
|
|
|
(5,069
|
)
|
Sale of investments
|
|
|
|
|
|
|
|
|
|
|
11,327
|
|
Capital contributions to subsidiaries
|
|
|
|
|
|
|
(2,500
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash (used in) provided by investing activities
|
|
|
(15
|
)
|
|
|
(2,511
|
)
|
|
|
6,258
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividend paid to shareholders
|
|
|
(2,138
|
)
|
|
|
(1,917
|
)
|
|
|
(1,122
|
)
|
Draw on line of credit
|
|
|
650
|
|
|
|
5,000
|
|
|
|
2,300
|
|
Principal payment on line of credit
|
|
|
|
|
|
|
(1,000
|
)
|
|
|
(2,300
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities
|
|
|
(1,488
|
)
|
|
|
2,083
|
|
|
|
(1,122
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase (decrease) in cash
|
|
|
88
|
|
|
|
(412
|
)
|
|
|
860
|
|
Cash at beginning of year
|
|
|
458
|
|
|
|
870
|
|
|
|
10
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash at end of year
|
|
$
|
546
|
|
|
|
458
|
|
|
|
870
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information:
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest paid
|
|
$
|
3,048
|
|
|
|
2,358
|
|
|
|
1,873
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal income taxes paid
|
|
$
|
12,725
|
|
|
|
10,100
|
|
|
|
8,194
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See notes to Consolidated Financial Statements and accompanying
report of independent registered public accounting firm.
113
PROCENTURY
CORPORATION AND SUBSIDIARIES
Schedule III
Supplementary Insurance Information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liability for
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unpaid
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization
|
|
|
|
|
|
|
|
|
|
Deferred
|
|
|
Losses and
|
|
|
|
|
|
|
|
|
|
|
|
Losses and
|
|
|
of Deferred
|
|
|
|
|
|
|
|
|
|
Policy
|
|
|
Loss
|
|
|
|
|
|
|
|
|
Net
|
|
|
Loss
|
|
|
Policy
|
|
|
Other
|
|
|
Net
|
|
|
|
Acquisition
|
|
|
Adjustment
|
|
|
Unearned
|
|
|
Earned
|
|
|
Investment
|
|
|
Adjustment
|
|
|
Acquisition
|
|
|
Underwriting
|
|
|
Premiums
|
|
|
|
Costs
|
|
|
Expenses
|
|
|
Premiums
|
|
|
Premiums
|
|
|
Income
|
|
|
Expenses
|
|
|
Costs
|
|
|
Expenses
|
|
|
Written
|
|
|
|
(In thousands)
|
|
|
Year ended December 31, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and casualty
|
|
$
|
23,821
|
|
|
|
269,739
|
|
|
|
113,314
|
|
|
|
212,458
|
|
|
|
|
|
|
|
125,568
|
|
|
|
53,366
|
|
|
|
15,373
|
|
|
|
199,512
|
|
Investing
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other (including Exited Lines)
|
|
|
515
|
|
|
|
9,514
|
|
|
|
1,331
|
|
|
|
5,104
|
|
|
|
22,081
|
|
|
|
349
|
|
|
|
1,864
|
|
|
|
1,625
|
|
|
|
4,292
|
|
Unallocated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,282
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
24,336
|
|
|
|
279,253
|
|
|
|
114,645
|
|
|
|
217,562
|
|
|
|
22,081
|
|
|
|
125,917
|
|
|
|
55,230
|
|
|
|
18,280
|
|
|
|
203,804
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and casualty
|
|
$
|
25,911
|
|
|
|
241,511
|
|
|
|
125,012
|
|
|
|
215,510
|
|
|
|
|
|
|
|
132,564
|
|
|
|
52,623
|
|
|
|
16,231
|
|
|
|
243,850
|
|
Investing
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
19,372
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other (including Exited Lines)
|
|
|
1,004
|
|
|
|
9,161
|
|
|
|
2,608
|
|
|
|
3,482
|
|
|
|
|
|
|
|
2,916
|
|
|
|
1,781
|
|
|
|
(63
|
)
|
|
|
4,069
|
|
Unallocated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
875
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
26,915
|
|
|
|
250,672
|
|
|
|
127,620
|
|
|
|
218,992
|
|
|
|
19,372
|
|
|
|
135,480
|
|
|
|
54,404
|
|
|
|
17,043
|
|
|
|
247,919
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and casualty
|
|
$
|
20,021
|
|
|
|
199,633
|
|
|
|
93,467
|
|
|
|
176,404
|
|
|
|
|
|
|
|
117,864
|
|
|
|
42,326
|
|
|
|
14,212
|
|
|
|
187,033
|
|
Investing
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
14,487
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other (including Exited Lines)
|
|
|
628
|
|
|
|
12,014
|
|
|
|
2,164
|
|
|
|
1,226
|
|
|
|
|
|
|
|
482
|
|
|
|
609
|
|
|
|
14
|
|
|
|
2,486
|
|
Unallocated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
237
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
20,649
|
|
|
|
211,647
|
|
|
|
95,631
|
|
|
|
177,630
|
|
|
|
14,487
|
|
|
|
118,346
|
|
|
|
42,935
|
|
|
|
14,463
|
|
|
|
189,519
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying report of independent registered public
accounting firm.
114
PROCENTURY
CORPORATION AND SUBSIDIARIES
Schedule IV
Reinsurance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ceded to
|
|
|
Assumed from
|
|
|
|
|
|
Percentage of
|
|
|
|
|
|
|
Other
|
|
|
Other
|
|
|
Net Premium
|
|
|
Assumed to
|
|
|
|
Direct
|
|
|
Companies
|
|
|
Companies
|
|
|
Written
|
|
|
Net
|
|
|
|
(In thousands)
|
|
|
Year ended December 31, 2007
|
|
$
|
232,947
|
|
|
|
(34,542
|
)
|
|
|
5,399
|
|
|
|
203,804
|
|
|
|
2.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2006
|
|
$
|
278,460
|
|
|
|
(35,117
|
)
|
|
|
4,576
|
|
|
|
247,919
|
|
|
|
1.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2005
|
|
$
|
212,953
|
|
|
|
(26,645
|
)
|
|
|
3,211
|
|
|
|
189,519
|
|
|
|
1.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying report of independent registered public
accounting firm.
115
PROCENTURY
CORPORATION AND SUBSIDIARIES
Schedule V
Valuation and Qualifying Accounts
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Charged/
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at
|
|
|
(Credited) to
|
|
|
Charged to
|
|
|
|
|
|
Balance at
|
|
|
|
Beginning of
|
|
|
Costs and
|
|
|
Other
|
|
|
Deductions
|
|
|
End of
|
|
|
|
Period
|
|
|
Expenses
|
|
|
Accounts
|
|
|
(1)
|
|
|
Period
|
|
|
Year ended December 31, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for uncollectible:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums in course of collection
|
|
$
|
156
|
|
|
|
(9
|
)
|
|
|
|
|
|
|
5
|
|
|
|
142
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reinsurance
|
|
$
|
4,141
|
|
|
|
17
|
|
|
|
|
|
|
|
787
|
|
|
|
3,371
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for uncollectible:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums in course of collection
|
|
$
|
58
|
|
|
|
98
|
|
|
|
|
|
|
|
|
|
|
|
156
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reinsurance
|
|
$
|
1,285
|
|
|
|
2,856
|
|
|
|
|
|
|
|
|
|
|
|
4,141
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for uncollectible:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums in course of collection
|
|
$
|
79
|
|
|
|
(10
|
)
|
|
|
|
|
|
|
11
|
|
|
|
58
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reinsurance
|
|
$
|
1,285
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,285
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Deductions include write-offs of amounts determined to be
uncollectible. |
See accompanying report of independent registered public
accounting firm.
116
PROCENTURY
CORPORATION AND SUBSIDIARIES
Casualty
Insurance Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liability for
|
|
|
Discount,
|
|
|
Loss and Loss Adjustment
|
|
|
|
|
|
|
Unpaid Losses
|
|
|
if Any,
|
|
|
Expenses (Benefits) Incurred
|
|
|
Paid Losses and
|
|
|
|
and Loss
|
|
|
Deducted
|
|
|
Related to
|
|
|
Loss
|
|
|
|
Adjustment
|
|
|
from
|
|
|
Current
|
|
|
Prior
|
|
|
Adjustment
|
|
|
|
Expenses
|
|
|
Reserves
|
|
|
Period
|
|
|
Periods
|
|
|
Expenses
|
|
|
Year ended December 31, 2007
|
|
$
|
279,253
|
|
|
|
|
|
|
|
134,981
|
|
|
|
(9,064
|
)
|
|
|
102,095
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2006
|
|
$
|
250,672
|
|
|
|
|
|
|
|
136,583
|
|
|
|
(1,103
|
)
|
|
|
95,111
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2005
|
|
$
|
211,647
|
|
|
|
|
|
|
|
112,946
|
|
|
|
5,400
|
|
|
|
67,898
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying report of independent registered public
accounting firm.
117
|
|
Item 9.
|
Changes
in and Disagreements with Accountants on Accounting and
Financial Disclosure
|
No disagreements occurred with accountants on any accounting or
financial disclosure or auditing scope or procedure during 2007.
|
|
Item 9A.
|
Controls
and Procedures
|
|
|
(a)
|
Disclosure
Controls and Procedures
|
As of the end of the period covered by this report, ProCentury
carried out an evaluation, under the supervision and with the
participation of our management, including the Chairman and
Chief Executive Officer (CEO) and the Chief
Financial Officer (CFO) and Treasurer, of the
effectiveness of the design and operation of our disclosure
controls and procedures pursuant to Securities Exchange Act
Rule 13a-15
(Disclosure Controls).
Our management, including the CEO and CFO, does not expect that
its Disclosure Controls will prevent all errors and all fraud. A
control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Further, the design of
a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations in
all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of
fraud, if any, within ProCentury have been detected. These
inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur
because of simple errors or mistake. The design of any system of
controls also is based in part upon certain assumptions about
the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under
all potential future conditions.
Based upon ProCenturys controls evaluation, the CEO and
CFO have concluded that as of December 31, 2007, which is
the end of the period covered by this Annual Report on
Form 10-K,
our disclosure controls and procedures were not effective due to
the material weakness described below.
|
|
(b)
|
Managements
Report on Internal Control over Financial Reporting
|
Our management is responsible for establishing and maintaining
adequate internal controls over financial reporting as defined
in
Rules 13a-15(f)
and
15d-15(f)
under the Securities Exchange Act of 1934. Our internal control
over financial reporting is 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 (GAAP).
Our internal control over financial reporting includes those
policies and procedures that:
(i) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of ProCentury;
(ii) 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 ProCentury are
being made only in accordance with authorization of management
and directors of ProCentury; and
(iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition use, or disposition
of our 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.
Management assessed the effectiveness of our internal control
over financial reporting as of December 31, 2007 using the
criteria described in the Internal Control-Integrated
Framework set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
118
Based on that assessment and those criteria, management has
concluded that ProCenturys internal control over financial
reporting was not effective as of December 31, 2007 due to
the material weakness described below.
Our monitoring and review controls for determining our
assumptions for projected cash flows for asset-backed securities
in connection with our assessment of other than temporary
impairment did not operate effectively. As a result, these
controls failed to detect that insufficient consideration was
given to current information and events that a market
participant would use in determining the fair value of the
investments. This material weakness resulted in a material
adjustment to the net realized investment losses in our
preliminary 2007 annual consolidated financial statements which
was corrected prior to issuance.
The effectiveness of the Companys internal control over
financial reporting as of December 31, 2007, has been
audited by the Companys independent registered public
accounting firm, whose report is included in this Annual Report
on
Form 10-K.
|
|
(c)
|
Additional
Information on Controls over the Valuation of
Investments
|
Our internal control over financial reporting resulted in the
appropriate identification of those securities that had
characteristics of a security that needed to be evaluated as
other than temporarily impaired. Once these securities were
appropriately identified, management analyzed the securities by
updating the cash flow models applicable to the securities to
determine whether the security was projected to meet the future
cash flow projections relating to its principal and interest
payment obligations. Using consistent methodology and
assumptions that had been used in the past, management
consistently assessed impairments resulting from adverse changes
in cash flows and from our ability and intent to hold these
securities. After the foregoing steps were completed, it was
then determined that, in light of the current turmoil in the
credit markets, management should have used more current data
when analyzing securities backed by subprime mortgage assets
(subprime bonds). An evaluation of this type is
highly subjective and was especially difficult to support in
light of the current turmoil and uncertainty in the capital
markets. This weakness in controls over financial reporting only
pertained to securities in our portfolio backed by subprime
bonds, which had an aggregate fair market value at
December 31, 2007 of $4.9 million, representing 1.1%
of our total invested assets.
|
|
(d)
|
Changes
in Internal Control over Financial Reporting
|
There have been no changes in our internal control over
financial reporting in the quarter ended December 31, 2007
that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
To address the material weakness described above, management
completed additional analysis using more current data and will
implement these enhancements in our internal control over
financial reporting that are designed to ensure that we continue
to perform such analysis on a quarterly basis. Management
believes that these steps will remediate the material weakness.
|
|
Item 9B.
|
Other
Information
|
None
PART III
|
|
Item 10.
|
Directors,
Executive Officers and Corporate Governance
|
Information
Regarding Directors
Board of
Directors
Our board of directors currently consists of seven members,
Messrs. Feighan, Fix, Maffett, Southworth, Timm, Weiler and
Woodward. Until July 2007, Michael J. Endres also served as a
member of our board of directors.
119
Edward F. Feighan, age 60, has been our Chairman,
President and Chief Executive Officer since October 2003. From
September 1998 until May 2003, Mr. Feighan was Managing
Partner of Alliance Financial, Ltd., a merchant banking firm
specializing in mergers and acquisitions. He has served as a
director of ProCentury and its insurance company subsidiaries
from 1993 to 1996 and from 2000 to the present. Mr. Feighan
has served as our Special Counsel at times during the past five
years.
Robert F. Fix, age 61, has served as our director
since October 2000. Mr. Fix has served as Vice Chairman of
the Richmond Mutual Bancorporation, Inc. and the Vice Chairman
of its primary subsidiary, First Bank Richmond NA since 2002.
Mr. Fix serves as Chairman of the Board of American
Trust FSB, also a subsidiary of the Richmond Mutual
Bancorporation. He served as President and Chief Executive
Officer of the holding company from 1998 to 2006, and served as
President and Chief Executive Officer of First Bank Richmond
from 1989 to 2002.
Jeffrey A. Maffett, age 59, has served as our
director since October 2000. Mr. Maffett has been Chairman,
President and Chief Executive Officer of Oculina Bank, a
subsidiary of Colonial Banc Corp. of Eaton, Ohio, since November
2003. He has also has been Chairman of Colonial Banc Corp. since
2002. He was President and Chief Executive Officer of Eaton
National Bank & Trust Co., a subsidiary of
Colonial Banc Corp., from 1989 to 2003.
Press C. Southworth III, age 60, has served as our
director since April 2004. Mr. Southworth has served as
Executive Director of Opera Columbus since July 2006 and he was
a partner of PricewaterhouseCoopers LLP from 1998 until he
retired in 2001.
On September 19, 2007, the U.S. Securities and
Exchange Commission (the SEC), issued an Order
Instituting Public Administrative Proceedings Pursuant to
Rule 102(e) of the SECs Rules of Practice, Making
Findings and Imposing Remedial Sanctions (the
Order), against Press C. Southworth III. The Order
finds that Mr. Southworth, a retired partner at
PricewaterhouseCoopers LLP, engaged in improper professional
conduct in connection with the 1998 audit of National Century
Financial Enterprises, Inc. (NCFE), a healthcare
financing company. Although Mr. Southworth is no longer a
certified public accountant and does not practice before the
SEC, the order denies him the privilege of appearing or
practicing before the SEC as an accountant, with a right to
apply for reinstatement after two years. Mr. Southworth
consented to the issuance of the Order without admitting or
denying any of the SECs findings.
Christopher J. Timm, age 51, has served as Executive
Vice President and President of Century since May 2003. Since
March 2000, he has served as our director and Vice President and
a senior officer and director of most companies within the
Century Insurance Group.
Alan R. Weiler, age 74, has served as our director
since April 2004. Mr. Weiler is a Vice President of Sky
Insurance and previously served as Chairman of
Archer-Meek-Weiler Agency, Inc., an insurance agency
specializing in commercial and personal insurance, bonding, risk
management and risk financing alternatives from 1999 until 2007.
He also served as President of Archer-Meek-Weiler Agency, Inc.
from 1970 until 1999. Mr. Weiler serves as a director of
Glimcher Realty Trust.
Robert J. Woodward, Jr., age 66, has served as
our director since April 2004. Mr. Woodward served as
Executive Vice President and Chief Investment Officer of
Nationwide Mutual Insurance Company from 1995 until his
retirement in 2002. Mr. Woodward is a director of Duke
Realty Co.
Committees
of the Board of Directors
The board of directors has a standing audit committee,
compensation committee and nominating and corporate governance
committee, each of which operates under a written charter.
Current copies of these charters are available to shareholders
on our website, www.procentury.com, under Governance
Documents. Each director serving as a member on a board
committee is, or was, in the case of Mr. Endres, an
independent director within the meaning of the
NASDAQs listing standards applicable to such members and
under each committees charter.
Audit Committee. The audit committee assists
the board of directors in fulfilling its oversight
responsibilities for the integrity of our accounting, reporting
and financial control practices. The audit committee:
|
|
|
|
|
reviews the qualifications of the independent registered public
accounting firm;
|
|
|
|
selects and engages the independent registered public accounting
firm;
|
120
|
|
|
|
|
reviews and approves the plan, fees and results of audits;
|
|
|
|
reviews our internal controls; and
|
|
|
|
considers and pre-approves any non-audit services proposed to be
performed by the independent registered public accounting firm.
|
The members of the audit committee are Messrs. Southworth
(chairman), Fix and Woodward. In October 2007,
Mr. Weiler discontinued his service on the audit committee,
and Mr. Fix joined the audit committee. Our board of
directors has determined that Mr. Southworth meets the
requirements for an audit committee financial expert under
Item 401 of
Regulation S-K
promulgated under the Securities Act of 1933.
Code of
Business Conduct and Ethics
We have a Code of Business Conduct and Ethics that addresses our
commitment to honesty, integrity and the ethical behavior of our
employees, officers and directors. This code governs the actions
and working relationships of our employees, officers and
directors, including the chief executive officer, chief
financial officer, controllers, treasurer and chief internal
auditor, if any, of ProCentury, with current and potential
customers, consumers, fellow employees, competitors, government
and self-regulatory agencies, investors, the public, the media,
and anyone else with whom we have or may have contact. Only the
board of directors or one of its committees may waive any
provision of the code with respect to an executive officer or
director. This code is posted on our website,
www.procentury.com, under Governance Documents, and
any amendment of the code or waiver of its provisions with
respect to an executive officer or director will be promptly
disclosed on the website and as otherwise may be required by
rule or regulation.
Section 16(a)
Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934
requires our directors and executive officers, and owners of
more than 10% of a registered class of our equity securities, to
file with the SEC initial reports of ownership and reports of
changes in ownership of common shares and other equity
securities of ProCentury. Executive officers, directors and
owners of more than 10% of the common shares are required by SEC
regulations to furnish us with copies of all forms they file
pursuant to Section 16(a).
To our knowledge, based solely on review of the copies of such
reports furnished to us and written representations that no
other reports were required, during the fiscal year ended
December 31, 2007, all Section 16(a) filing
requirements applicable to its executive officers, directors and
greater than 10% beneficial owners were complied with, except
that a Form 4 was filed on July 3, 2007 by each of
Messrs. Endres, Fix, Maffett, Southworth, Weiler and
Woodward to report the receipt of an option to purchase 2,000
common shares on June 1, 2007 due to an administrative
error.
|
|
Item 11.
|
Executive
Compensation
|
Compensation
Discussion and Analysis
Overview
The following discussion and analysis should be read in
conjunction with the information presented in the compensation
tables, the footnotes to those tables and the related
disclosures appearing elsewhere in this document.
The compensation and benefits payable to the Companys
executive officers are established by or under the supervision
of the compensation committee of the Companys board of
directors (the Committee). The Committee consists of
three members, each of whom is an independent director within
the meaning of the NASDAQs listing standards, a
disinterested director within the meaning of
Rule 16b-3
under the Securities Exchange Act of 1934, and a
non-employee director within the meaning of
Section 162(m) of the Internal Revenue Code.
The Committee has established a compensation philosophy for the
Company and its subsidiaries designed to attract, retain,
motivate and reward the Companys associates in relation to
their achievements. The Committees
121
goal is to provide compensation opportunities within a median
market range for similarly sized, specialty insurance companies
that support the Companys operational plan and strategy.
The Committee endeavors to structure compensation that will
(i) enable the Company to attract and retain candidates
with appropriate skill levels and work ethic and
(ii) differentiate salary levels and incentive awards based
on individual and Company performance.(1) There is no
pre-established policy or target for the allocation between
either cash and non-cash or short-term or long-term
compensation. Rather, the Committee reviews information provided
by its compensation consultant to determine the appropriate
level and mix of compensation.
The Committee strives to establish total executive compensation
that is commensurate with a peer group of companies established
by the Committee with advice from a compensation consultant
retained by the Committee. The Committee also looks to the peer
group comparison and consultant recommendations with respect to
the amount of each element of compensation that is paid to each
executive. The peer group, consisting of 16 companies,
includes some, but not all of the companies in the S&P
Property & Casualty Index, some, but not all of the
companies in the SNL Insurance Property and Casualty Index, a
mix of excess and surplus lines insurance companies, other
specialty lines insurance companies of approximately the same
size as the Company, measured by market capitalization, and
companies with similar performance as the Company, measured by
return on equity. The Committee believes that including a peer
group with this mix of attributes appropriately captures the
kinds of companies that the Company must compete with in the
hiring and retaining of executive employees.
The executive compensation setting process generally begins with
the Committees compensation consultant advising senior
management and the Committee of any recommended changes to the
peer group. Generally, Edward F. Feighan, the Companys
Chairman of the Board, President and Chief Executive Officer,
then makes recommendations to the Committee regarding all
elements of suggested compensation for the Companys
executive officers, other than himself and Christopher J. Timm,
the Companys Executive Vice President. These
recommendations are based on guidance from the Committee to the
effect that the Companys executive compensation should be
in the median range of companies in the peer group, and such
individuals responsibilities and individual and Company
performance. In establishing executive compensation for
Mr. Feighan and Mr. Timm, the Committee has treated
the two executives on a combined basis. In addition to assessing
Company and individual performance, the Committee measures their
combined compensation relative to the combined compensation of
the top two executives at the peer companies, instead of
comparing Mr. Feighans compensation to the peer
companys CEO compensation and Mr. Timms
compensation to the peer companies COO compensation.
Elements
of Compensation
The elements of the Companys executive compensation
consist of base salary, cash incentives, long-term executive
compensation in the form of stock options, restricted shares,
retirement benefits in the form of a qualified defined
contribution plan, and life insurance, health insurance and
other customary fringe benefits.
Base
Salary
As noted above, in establishing base salaries for the
Companys executive officers, the Committee considers the
ranges of salaries offered by companies in the peer group
established by the Committee and obtains recommendations of the
Committees compensation consultant and management in order
to set base salary amounts in the median range of the peer group
companies.(2) Each of the Companys executive officers has
an employment agreement with the Company that provides that base
salary may not be an amount less than that specified in the
agreement. For 2007, the base salaries were established as
follows:
|
|
|
|
|
|
|
2007
|
|
Name
|
|
Base Salary
|
|
|
Edward F. Feighan
|
|
$
|
384,000
|
|
Erin E. West
|
|
$
|
243,000
|
|
Christopher J. Timm
|
|
$
|
364,000
|
|
Greg D. Ewald
|
|
$
|
295,000
|
|
James P. Flood
|
|
$
|
275,000
|
|
122
The base salaries actually paid to the named executive officers
in 2007 increased over their 2006 base salaries as illustrated
in the following table.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
Salaries
|
|
|
Salaries
|
|
|
|
|
Name
|
|
Paid ($)
|
|
|
Paid ($)
|
|
|
% Increase
|
|
|
Edward F. Feighan
|
|
|
384,000
|
|
|
|
313,231
|
|
|
|
23
|
%
|
Erin E. West
|
|
|
239,054
|
|
|
|
227,783
|
|
|
|
5
|
%
|
Christopher J. Timm
|
|
|
364,000
|
|
|
|
293,231
|
|
|
|
24
|
%
|
Greg D. Ewald
|
|
|
293,081
|
|
|
|
245,100
|
|
|
|
20
|
%
|
James P. Flood
|
|
|
258,318
|
|
|
|
230,209
|
|
|
|
12
|
%
|
In 2006, at the request of the executives, the Committee
directed its compensation consultant to evaluate the
competitiveness of the compensation of Messrs. Feighan and
Timm and determined that the total compensation opportunity for
them was meaningfully below the middle of the range of the
appropriate peer group. If the two executives were to be viewed
individually, both Messrs. Feighans and Timms
total compensation would fall below the median of the peer
group. Accordingly, their annualized base salaries were each
increased by $100,000 in September 2006. The increase in 2007
base salary compared to 2006 base salary reflected in the
Summary Compensation Table is a result of their salary increases
being in effect for the last four months of 2006 compared to the
full twelve months in 2007. The base salary for James P. Flood
has been set by the Committee at $275,000, effective
September 1, 2007 based on his promotion from Senior Vice
President of Claims to Senior Vice President of Operations. The
Committee believes that the base salaries of the Companys
executives, measured against the range of base salaries paid by
the peer group, are reasonable in light of the Companys
performance in 2007 relative to return on average equity, growth
in net income and growth in book value.
Annual
Cash Incentives
In connection with the Companys Initial Public Offering in
2004, the Company established the ProCentury Corporation Annual
Incentive Plan. The purpose of the Plan is to advance the
Companys interests and its shareholders interest by
providing certain corporate officers and key employees with
annual incentive compensation that is tied to the achievement of
pre-established and objective performance goals. Under the
Annual Incentive Plan, each executive is provided a target
award, which represents a percentage of the executives
base salary. The bonus targets are 50% of base salary for
Mr. Feighan and Mr. Timm and 40% of base salary for
Ms. West, Mr. Ewald and Mr. Flood. Generally,
executives are entitled to receive the target amount if they
achieve a pre-established return on average equity objective
established by the Committee. The Committee has selected return
on average equity as the appropriate objective in order to
encourage executives to manage and allocate the Companys
capital to products that generate competitive returns on equity
thereby enhancing the potential for appreciation in shareholder
value. In addition, achievement of return on average equity in
excess of the threshold can permit the executive to receive an
award equal to up to 150% of the bonus target.
In 2007, each executive had the opportunity to earn 100% of his
or her bonus target by achieving a 13% return on average equity.
In order to receive any performance based incentive
compensation, the Company must achieve at least a 6% return on
average equity. The actual bonus payouts for 2007 represented
136% of the executives bonus targets based on a
determination that the Companys achievement of a 16.3%
return on average equity was Outstanding Performance as defined
in the Annual Incentive Plan.
Equity
Compensation
Under the Companys 2004 Stock Option and Award Plan, the
Company may grant incentive stock options, nonqualified stock
options and restricted share awards to the Companys
executive officers. The Committee believes that nonqualified
stock options and restricted shares, with performance vesting
elements, are the most appropriate means of rewarding the
Companys executives based on increases in the price of the
Companys common shares. In 2007, the Company made the
restricted share grants set forth in the Grants of Plan-Based
Awards for Fiscal Year 2007 Table. The restricted share awards
have a combination of time and performance-based vesting. The
grants are subject to a four-year vesting schedule if certain
performance metrics are satisfied; 25% of the shares
123
will vest on each anniversary of the date of grant if an average
target return on average equity of 10% for the two fiscal years
preceding the vesting date has been achieved. As with the target
bonuses, the Committee has selected return on average equity as
the appropriate performance objective in order to encourage
executives to manage and allocate the Companys capital to
products that generate competitive returns on equity thereby
enhancing the potential for appreciation in shareholder value,
in this case, over a longer term of two years to trigger
vesting. In addition, because the value of the award increases
as the Companys common shares gain value, these awards
provide further motivation to executives to increase shareholder
value. The Company achieved an average return on average equity
for 2006 and 2007 in excess of 10%; accordingly, 25% of the
restricted shares granted in 2007 will vest on the anniversary
of the grant date in 2008.
In determining the number of shares to be subject to the equity
award for each executive officer, the Committee considered peer
group data for equity awards to officers in similar positions,
the aggregate percentage of ownership of the Companys
common shares held by such executive as a result of equity
awards granted in prior years and individual performance and
responsibility levels. The Committees consideration of the
peer group data included both the relative value of equity
awards made to peer group executives and the percentage of such
companys equity represented by the award. The Committee
also considered, on an individual basis, the extent to which the
size of the award would provide a sufficient incentive to the
executive to strive for Company performance that would cause the
award to vest.
The Committee believes that the structure, number of shares
subject to the equity awards, and relative proportion of the
equity awards to each executives total compensation
granted in 2007 provide appropriate incentive to its executives
to achieve the Companys long-term performance goals and
increased returns to shareholders, and to retain such employees
over the vesting period.
Prior to 2007, the Committee approved equity awards with a grant
date of the first business day of the next succeeding month in
order to facilitate and simplify the administration of and
accounting for the awards. Beginning in 2007, the Company has
implemented a practice of granting equity awards at a Committee
meeting shortly after the announcement of year-end earnings,
with the grants effective on the day they are approved (using
the closing stock price on that date as the exercise price for
options).
Other
Benefits
The Company has established a 401(k) plan for its employees
pursuant to which the Company makes, discretionary matching
contributions equal to 50% of each participants
contribution of up to 6% of base salary, not to exceed 3% of the
participants salary. In addition, the employment
agreements for each of the Companys executive officers
provides for participation in health, disability and other
insurance plans, whole life insurance in the case of
Messrs. Feighan, Timm, Flood and Ms. West, sick leave,
reasonable vacation time and other customary fringe benefits.
The Company does not provide a company car or car allowance,
reimbursement for club dues or other perquisites.
The company has a deferred compensation plan, however no
contributions have been made to it since the plans
adoption in 2003. The purpose of the plan is to allow the
Companys key employees and directors to elect to defer
portions of their compensation and to allow discretionary
contributions by the Company on behalf of selected participants
for future payment to the participants or their beneficiaries.
The board of directors or the compensation committee determines
the participation and benefits of key employees.
124
Summary
Compensation Table
The following table sets forth information concerning the total
compensation received for services rendered to the Company
during 2007 by the Companys chief executive officer, chief
financial officer and its three other executive officers, all of
whom are referred to as named executive officers.
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(h)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(g)
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-
|
|
|
in Pension
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(e)
|
|
|
(f)
|
|
|
Equity
|
|
|
Value and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
|
|
|
Option
|
|
|
Incentive
|
|
|
Nonqualified
|
|
|
(i)
|
|
|
|
|
|
|
|
|
|
(c)
|
|
|
(d)
|
|
|
Awards
|
|
|
Awards
|
|
|
Plan
|
|
|
Deferred
|
|
|
All Other
|
|
|
(j)
|
|
(a)
|
|
(b)
|
|
|
Salary
|
|
|
Bonus
|
|
|
($)
|
|
|
($)
|
|
|
Compensation
|
|
|
Compensation
|
|
|
Compensation
|
|
|
Total
|
|
Name and Principal Position
|
|
Year
|
|
|
($)
|
|
|
($)
|
|
|
(1)
|
|
|
(1)
|
|
|
($) (2)
|
|
|
Earnings ($)
|
|
|
($) (3)
|
|
|
($)
|
|
|
Edward F. Feighan
|
|
|
2007
|
|
|
|
384,000
|
|
|
|
|
|
|
|
243,996
|
|
|
|
15,700
|
|
|
|
261,120
|
|
|
|
|
|
|
|
12,724
|
|
|
|
917,540
|
|
Chairman of the Board, President and Chief Executive Officer
|
|
|
2006
|
|
|
|
313,231
|
|
|
|
|
|
|
|
180,994
|
|
|
|
48,735
|
|
|
|
206,732
|
|
|
|
|
|
|
|
32,985
|
|
|
|
782,677
|
|
Erin E. West
|
|
|
2007
|
|
|
|
239,054
|
|
|
|
|
|
|
|
70,656
|
|
|
|
14,079
|
|
|
|
134,878
|
|
|
|
|
|
|
|
12,451
|
|
|
|
471,118
|
|
Chief Financial Officer and Treasurer
|
|
|
2006
|
|
|
|
227,783
|
|
|
|
|
|
|
|
21,735
|
|
|
|
14,755
|
|
|
|
116,600
|
|
|
|
|
|
|
|
10,473
|
|
|
|
391,346
|
|
Christopher J. Timm
|
|
|
2007
|
|
|
|
364,000
|
|
|
|
|
|
|
|
216,376
|
|
|
|
15,700
|
|
|
|
247,520
|
|
|
|
|
|
|
|
24,863
|
|
|
|
868,459
|
|
Executive Vice President, Secretary and Director
|
|
|
2006
|
|
|
|
293,231
|
|
|
|
|
|
|
|
162,414
|
|
|
|
48,735
|
|
|
|
193,532
|
|
|
|
|
|
|
|
21,885
|
|
|
|
719,797
|
|
Greg D. Ewald
|
|
|
2007
|
|
|
|
293,081
|
|
|
|
|
|
|
|
92,712
|
|
|
|
13,411
|
|
|
|
160,480
|
|
|
|
|
|
|
|
10,130
|
|
|
|
569,814
|
|
Senior Vice President of Underwriting of Century Surety Company
|
|
|
2006
|
|
|
|
245,100
|
|
|
|
|
|
|
|
81,235
|
|
|
|
26,988
|
|
|
|
129,413
|
|
|
|
|
|
|
|
9,922
|
|
|
|
492,658
|
|
James P. Flood
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior Vice President of Operations(4)
|
|
|
2007
|
|
|
|
258,318
|
|
|
|
|
|
|
|
61,712
|
|
|
|
17,560
|
|
|
|
139,424
|
|
|
|
|
|
|
|
7,950
|
|
|
|
484,964
|
|
|
|
|
(1) |
|
The amounts in columns (e) and (f) reflect the dollar
amount recognized for financial statement reporting purposes for
the year ended December 31, 2007, in accordance with
FAS 123(R) of restricted share and stock option awards,
respectively, granted pursuant to the Companys 2004 Stock
Option and Award Plan, and thus include amounts from awards
granted in and prior to 2007. Assumptions used in the
calculation of these amounts are included in footnote
(9) Employee Benefits to the Companys
audited financial statements for the fiscal year ended
December 31, 2007. |
|
(2) |
|
The amounts in column (g) reflect the cash awards to the
named individuals under the ProCentury Corporation Annual
Incentive Plan. Of these amounts, $69,120, $35,703, $65,520 ,
$42,480 and $36,906 was paid to each of Mr. Feighan,
Ms. West, Mr. Timm, Mr. Ewald and Mr. Flood,
respectively, on March 6, 2008 in the form of common shares
issued under the Stock Option and Award Plan based on the per
share price on such date of $18.16. See Footnote (2) of the
Grants of Plan-Based Awards for Fiscal Year 2007
Table.) |
|
(3) |
|
Amounts in column (i) include matching contributions to the
companys 401(k) plan, the value of life insurance premiums
and dividends on shares of unvested restricted stock. Matching
contributions to the companys 401(k) plan were $6,750,
$7,172, $5,670, $6,750, and $6,750 for Mr. Feighan,
Ms. West, Mr. Timm, Mr. Ewald and Mr. Flood,
respectively. In 2007 whole life insurance was available to
Mr. Feighan, Ms. West and Mr. Timm. Pursuant to
terms of their employment contracts, they may elect to have the
Company pay the insurance premiums on their behalf, or they may
elect to receive an amount equal to the premium in cash. For
Ms. West and Mr. Feighan, the other compensation
amounts also include cash amounts equal to the premiums on whole
life insurance; Mr. Timm elected to receive a term
insurance policy having a premium amount of $14,043. In 2007,
Mr. Feighan, Ms. West, Mr. Timm, Mr. Ewald
and Mr. Flood received $5,974, $1,800, $5,150, $3,380 and
$1,200, respectively, from dividends on shares of restricted
stock that have not yet vested. |
|
(4) |
|
Mr. Flood became an executive officer in November 2007. |
125
Executive
Agreements
The Company entered into employment agreements with each of
Messrs. Feighan and Timm in December 2003, with
Ms. West in February 2006 and with Mr. Flood in
November 2007. The Companys subsidiary, Century Surety
Company (Century), entered into an employment
agreement with Mr. Ewald in August 2004. Minimum base
salaries under the agreements are currently $384,000, $243,000,
$364,000, $295,000 and $275,000 for Mr. Feighan,
Ms. West, Mr. Timm, Mr. Ewald and Mr. Flood,
respectively. The agreements also provide for other customary
executive benefits, including:
|
|
|
|
|
participation in retirement or welfare benefit plans, if any;
|
|
|
|
health, disability and other insurance plans;
|
|
|
|
whole life insurance, in the case of Messrs. Feighan, Timm
and Flood, and Ms. West;
|
|
|
|
sick leave;
|
|
|
|
reasonable vacation time; and
|
|
|
|
other benefits as may be approved by the Companys board of
directors or compensation committee on a
case-by-case
basis for proper business purposes.
|
The agreements with Mr. Feighan, Ms. West,
Mr. Timm, Mr. Ewald and Mr. Flood also provide
for annual performance based cash incentive bonuses of up to
50%, 40%, 50%, 40% and 40% of their respective base salaries in
accordance with the Companys Annual Incentive Plan
described below.
Pursuant to the employment agreements, the Company granted to
each of Messrs. Feighan and Timm 25,300 restricted common
shares and nonqualified stock options to purchase 49,800 common
shares at the time of closing the Companys initial public
offering of its common shares (the IPO). Pursuant to
Mr. Ewalds agreement, he received 29,750 restricted
common shares and nonqualified stock options to purchase 20,000
common shares. Ms. West was granted a nonqualified stock
option to purchase 10,000 common shares at the time of the IPO.
Mr. Flood was granted a nonqualified stock option to
purchase 15,000 common shares at the time of the IPO. Each of
the above mentioned restricted share and stock option grants are
subject to service-based vesting.
The options have an exercise price equal to the initial public
offering price of $10.50 and for Messrs. Feighan, Timm and
Ewald, vest as to
1/36
of the shares subject to the option. For Ms. West and
Mr. Flood
1/48
of the shares subject to the option vest each month following
the grant date during which the executive officer has provided
service to the Company. All options will become fully
exercisable for a period of not less than 30 days, and all
unvested shares available pursuant to the options, if any, will
become fully vested, upon the termination of employment by
reason of death, discharge by the Company other than for cause,
or, in the case of Messrs. Feighan, Timm and Flood and
Ms. West, the officers resignation for good reason.
The restricted shares held by Messrs. Feighan and Timm vest
as to
1/48
of the total shares awarded each month following the grant date
during which the executive officer has provided service to the
Company. The restricted shares held by Mr. Ewald vest as to
1/5
of the total shares awarded each year following the grant date
during which the executive officer has provided service to
Century.
The employment agreements may be terminated at any time upon the
mutual agreement of the Company (Century in the case of
Mr. Ewald) and the officer, and will automatically
terminate upon his or her death. The Company (or Century) may
terminate the employment agreements at any time, without cause,
upon 30 days prior written notice to the officer or for
cause immediately upon written notice of termination to the
officer. Each officer may terminate his or her employment
agreement at any time without good reason upon 30 days
prior written notice to the Company (or Century) or, in the case
of Messrs. Feighan, Timm and Flood and Ms. West, for
good reason upon 15 days prior written notice, provided
that each officer will not resign if, prior to the expiration of
the 15 day
126
notice period, the Company causes the facts or events giving
rise to the good reason to no longer exist. If the
officers employment agreement is terminated:
|
|
|
|
|
by the Company (or Century) for cause, by the resignation of the
officer, other than for good reason, or if the officers
employment is terminated by death, he or she or his or her
estate will be entitled to receive:
|
|
|
|
|
|
any earned but unpaid base salary through the effective date of
termination;
|
|
|
|
any award under the Companys annual incentive plan which
was awarded prior to the effective date of termination;
|
|
|
|
in the case of Mr. Ewald, a pro-rata portion of his
service-based, IPO restricted shares based on the number of
months from the date of grant through the termination date
divided by 60, and
|
|
|
|
if the officers employment is terminated by death, his or
her estate will be entitled to receive:
|
|
|
|
|
|
continued payment of his or her base salary for 90 days
following his or her death;
|
|
|
|
an amount equal to the maximum bonus that he or she could have
been awarded under the Companys annual incentive plan for
the current performance year divided by the number of days in
the current performance year occurring prior to and including
the date of his death; and
|
|
|
|
continued benefits for 90 days following his or her
death; or
|
|
|
|
|
|
by the Company (or Century) other than for cause or, in the case
of Messrs. Feighan, Timm, and Flood or Ms. West, if he
or she resigns for good reason, he or she will be entitled to
receive:
|
|
|
|
|
|
any earned but unpaid base salary through the date of such
termination;
|
|
|
|
any award under the Companys annual incentive plan that
was awarded prior to the effective date of termination;
|
|
|
|
continued payment of his or her base salary for 12 months
following the date of termination;
|
|
|
|
in the case of Messrs. Feighan, Timm, and Flood and
Ms. West, the maximum bonus that he or she could have been
awarded under the Companys annual incentive plan for the
current performance year; and
|
|
|
|
continued benefits for 12 months following the date of
termination.
|
Under the agreements for Messrs. Feighan, Timm and Flood
and Ms. West, if a change in control occurs, as defined in
the agreement, and within the 12 months following a change
of control, the Company discharges the officer other than for
cause or if the officer resigns for good reason, he or she will
be entitled to receive within 30 days of his or her
termination of employment:
|
|
|
|
|
any earned but unpaid base salary through the date of
termination;
|
|
|
|
any award under the Companys annual incentive plan that
was awarded prior to the effective date of termination;
|
|
|
|
the product of two times, or one times in the case of
Ms. West and Mr. Flood, his or her then current base
salary at the date of termination;
|
|
|
|
the product of two times the maximum bonus that he or she could
have been awarded under the Companys annual incentive
plan; and
|
|
|
|
the officer will be entitled to continued benefits for
24 months, or 12 months in the case of Ms. West
and Mr. Flood, following the date of termination.
|
Each officer has agreed not to compete with the Company (or
Century) or solicit its employees during the term of his or her
employment agreement and for a period of 12 months
following termination of the employment agreement or, if longer,
the entire period for which the officer is entitled to payments
of base salary, bonus or other incentive awards or other
benefits, other than payments and benefits the officer would be
entitled to receive in the event of a change in control.
127
Annual
Incentive Plan
In December 2003, the Companys board of directors adopted
and its shareholders approved the Companys Annual
Incentive Plan, which was amended and restated in November 2007
to incorporate certain changes to comply with recent changes in
applicable tax laws. The purpose of the Annual Incentive Plan is
to advance the Companys interests and its
shareholders interest by providing certain corporate
officers and key employees with annual incentive compensation
that is tied to the achievement of pre-established and objective
performance goals. Prior to each performance period, the
compensation committee designates, subject to approval by the
Companys board of directors, the employees who will be
participants of the plan for the performance period and the
target incentive award for each participant.
Payment of incentive awards is made in a cash lump sum payment,
or at the discretion of the compensation committee, in common
shares equal to the fair market value of the amount of the
incentive award, provided that a participants incentive
award determined for any performance period may not exceed
150.0% of the participants target award without board
approval. Payment of any amount of incentive award in excess of
150.0% of the target award will be made in common shares or
other property unless the board determines otherwise.
2004
Stock Option and Award Plan
In December 2003, the Companys board of directors adopted
and its shareholders approved the Companys 2004 Stock
Option and Award Plan. The purpose of this plan is to promote
the commonality of the interests of the Companys
employees, directors and consultants with the interest of its
shareholders for the Companys increased growth, value and
profitability and to attract, retain and reward its employees
and consultants. The plan provides for a variety of awards,
including incentive or nonqualified stock options, restricted
shares, restricted share units, performance units, appreciation
rights or any combination of the foregoing. The plan is
administered by the Companys board of directors, or the
compensation committee, which have the authority to determine
the terms, conditions and restrictions applicable to each award.
In the event of a change in control, the acquiring corporation
may either assume the Companys rights and obligations
under outstanding awards or substitute substantially equivalent
options for the acquiring corporations shares. In the
event the acquiring corporation does not assume or substitute
for the outstanding awards, the unexercisable portion of any
outstanding awards will be immediately exercisable in full as of
the date ten days prior to the effective date of the change in
control. Any award that is neither (1) assumed, nor
substituted for, by the acquiring corporation, nor
(2) exercised as of the date of the change in control will
terminate and cease to be outstanding effective as of the date
of the change in control.
401(k)
Plan and Trust
The Company has established a 401(k) plan for its employees that
is intended to qualify under Sections 401(a) and 401(k) of
the Internal Revenue Code of 1986, as amended. Generally, all
employees are eligible to participate in the 401(k) plan on the
first day of the month following completion of three months of
service. Employer matching and discretionary profit-sharing
contributions vest after three years of service. Eligible
employees electing to participate in the 401(k) plan may defer
from one percent of their compensation up to the statutorily
prescribed limit, on a pre-tax basis, by making a contribution
to the plan. The Company currently makes discretionary matching
contributions equal to 50% of each participants
contribution of up to 6% of the participants salary, not
to exceed 3% of the participants compensation.
128
Grants of
Plan-Based Awards for Fiscal Year 2007
The following table sets forth information with respect to the
grants of plan-based awards to the named executive officers
during the year ended December 31, 2007.
|
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|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
All
|
|
|
All
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
|
|
|
Other
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
|
|
|
Option
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Awards:
|
|
|
Awards:
|
|
|
Exercise
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number
|
|
|
Number of
|
|
|
or Base
|
|
|
Grant
|
|
|
|
|
|
|
|
|
|
Estimated Future Payouts Under
|
|
|
Estimated Future Payouts Under Equity Incentive Plan
Awards
|
|
|
of Shares
|
|
|
Securities
|
|
|
Price of
|
|
|
Date
|
|
|
|
|
|
|
|
|
|
Non-Equity Incentive Plan Awards(1)
|
|
|
|
|
|
|
|
|
Maximum
|
|
|
of Stock
|
|
|
Underlying
|
|
|
Option
|
|
|
Fair
|
|
|
|
Approval
|
|
|
Grant
|
|
|
Threshold
|
|
|
Target
|
|
|
Maximum
|
|
|
Threshold
|
|
|
Target
|
|
|
(# Shares)
|
|
|
or Units
|
|
|
Options
|
|
|
Awards
|
|
|
Value
|
|
Name
|
|
Date
|
|
|
Date
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
(# Shares)
|
|
|
(# Shares)
|
|
|
(2)
|
|
|
(#)
|
|
|
(#)
|
|
|
($/Sh)
|
|
|
($)
|
|
|
Edward F. Feighan
|
|
|
03/07/07
|
|
|
|
03/07/07
|
|
|
|
28,800
|
|
|
|
192,000
|
|
|
|
288,000
|
|
|
|
|
|
|
|
|
|
|
|
11,250
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
224,663
|
|
Erin E. West
|
|
|
03/07/07
|
|
|
|
03/07/07
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
149,775
|
|
|
|
|
|
|
|
|
|
|
|
|
14,343
|
|
|
|
95,622
|
|
|
|
143,432
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Christopher J. Timm
|
|
|
03/07/07
|
|
|
|
03/07/07
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,375
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
187,219
|
|
|
|
|
|
|
|
|
|
|
|
|
27,300
|
|
|
|
182,000
|
|
|
|
273,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Greg D. Ewald
|
|
|
03/07/07
|
|
|
|
03/07/07
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
49,925
|
|
|
|
|
|
|
|
|
|
|
|
|
17,585
|
|
|
|
117,232
|
|
|
|
175,848
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
James P. Flood
|
|
|
03/07/07
|
|
|
|
03/07/07
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
49,925
|
|
|
|
|
11/14/07
|
|
|
|
11/14/07
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
76,000
|
|
|
|
|
|
|
|
|
|
|
|
|
14,915
|
|
|
|
99,435
|
|
|
|
149,152
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
For the fiscal year ended December 31, 2007,
Mr. Feighan, Ms. West, Mr. Timm, Mr. Ewald
and Mr. Flood had the opportunity to receive target
incentive compensation payments of up to 50%, 40%, 50%, 40% and
40% of their respective base salaries under the Companys
Annual Incentive Plan and the terms of the executives
employment agreement. Executives are entitled to receive the
target amount if the Company achieves a pre-established return
on average equity objective established by the compensation
committee. Achievement of return on average equity in excess of
the threshold can permit the executive to receive an award equal
to up to 150% of the bonus target. In 2007, each executive had
the opportunity to earn 100% of his or her bonus target by
achieving a 13% return on average equity. In order to receive
any performance based incentive compensation, the Company must
achieve at least a 6% return on average equity. The actual bonus
payouts for 2007 represented 136% of the executives bonus
targets based on a determination that the Companys
achievement of a 16.3% return on average equity was Excellent
Performance as defined in the Annual Incentive Plan. Payment of
incentive awards is made in a cash lump sum payment, or at the
discretion of the compensation committee, in common shares equal
to the fair market value of the amount of the incentive award.
Of these amounts, $69,120, $35,703, $65,520 , $42,480 and
$36,906 was paid to each of Mr. Feighan, Ms. West,
Mr. Timm, Mr. Ewald and Mr. Flood, respectively,
on March 6, 2008 in the form of common shares issued under
the Stock Option and Award Plan based on the per share price on
such date of $18.16. |
|
(2) |
|
On March 3, 2007 Mr. Feighan, Ms. West,
Mr. Timm, Mr. Ewald and Mr. Flood were awarded
11,250, 7,500, 9,375, 2,500 and 2,500 performance-based
restricted shares, respectively, under the 2004 Stock Option and
Award Plan. The shares are subject to a four-year vesting
schedule in which 25% of the shares will vest on each
anniversary of the date of grant if a target return on equity
for the two fiscal years preceding the vesting date is achieved.
The closing stock price on the grant date was $19.97.
Additionally, because of his promotion to Senior Vice President,
Operations, Mr. Flood was awarded 5,000 performance-based
restricted shares on November 14, 2007. These restricted
shares are subject to the same performance vesting criteria
described above. The closing stock price on the date of the
grant was $15.20. |
129
Outstanding
Equity Awards at Fiscal Year-End for Fiscal Year 2007
The following table sets forth information with respect to the
value of options and restricted stock held by the named
executive officers on December 31, 2007.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Option Awards
|
|
|
Stock Awards
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Incentive
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity
|
|
|
Plan Awards:
|
|
|
|
|
|
|
|
|
|
|
|
|
Incentive
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Incentive
|
|
|
Market
|
|
|
|
|
|
|
|
|
|
|
|
|
Plan
|
|
|
|
|
|
|
|
|
|
|
|
Market
|
|
|
Plan Awards:
|
|
|
or Payout
|
|
|
|
|
|
|
|
|
|
|
|
|
Awards:
|
|
|
|
|
|
|
|
|
|
|
|
Value of
|
|
|
Number of
|
|
|
Value of
|
|
|
|
|
|
|
Number
|
|
|
Number of
|
|
|
Number
|
|
|
|
|
|
|
|
|
Number of
|
|
|
Shares or
|
|
|
Unearned
|
|
|
Unearned
|
|
|
|
|
|
|
of
|
|
|
Securities
|
|
|
of Securities
|
|
|
|
|
|
|
|
|
Shares or
|
|
|
Units of
|
|
|
Shares,
|
|
|
Shares,
|
|
|
|
|
|
|
Securities
|
|
|
Underlying
|
|
|
Underlying
|
|
|
|
|
|
|
|
|
Units of
|
|
|
Stock
|
|
|
Units or
|
|
|
Units or
|
|
|
|
|
|
|
Underlying
|
|
|
Unexercised
|
|
|
Unexercised
|
|
|
Option
|
|
|
|
|
|
Stock That
|
|
|
That
|
|
|
Other Rights
|
|
|
Other Rights
|
|
|
|
|
|
|
Unexercised
|
|
|
Options (#)
|
|
|
Unearned
|
|
|
Exercise
|
|
|
Option
|
|
|
Have Not
|
|
|
Have Not
|
|
|
That Have
|
|
|
That Have
|
|
|
|
|
|
|
Options (#)
|
|
|
Unexercisable
|
|
|
Options
|
|
|
Price
|
|
|
Expiration
|
|
|
Vested
|
|
|
Vested
|
|
|
Not Vested
|
|
|
Not Vested
|
|
Name
|
|
Grant Date
|
|
|
Exercisable
|
|
|
(1)
|
|
|
(#)
|
|
|
($)
|
|
|
Date
|
|
|
(#)(2)
|
|
|
($)(3)
|
|
|
(#)(4)
|
|
|
($)(3)
|
|
|
Edward F. Feighan
|
|
|
4/20/2004
|
|
|
|
49,800
|
|
|
|
0
|
|
|
|
|
|
|
$
|
10.50
|
|
|
|
4/20/2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4/20/2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,109
|
|
|
|
32,363
|
|
|
|
|
|
|
|
|
|
|
|
|
3/22/2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,683
|
|
|
|
148,626
|
|
|
|
|
9/1/2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,799
|
|
|
|
135,065
|
|
|
|
|
3/7/2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11,250
|
|
|
|
172,688
|
|
Erin E. West
|
|
|
4/20/2004
|
|
|
|
10,000
|
|
|
|
0
|
|
|
|
|
|
|
$
|
10.50
|
|
|
|
4/20/2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1/3/2006
|
|
|
|
5,000
|
|
|
|
5,000
|
|
|
|
|
|
|
|
10.64
|
|
|
|
1/3/2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9/1/2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,000
|
|
|
|
46,050
|
|
|
|
|
3/7/2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7,500
|
|
|
|
115,125
|
|
Christopher J. Timm
|
|
|
4/20/2004
|
|
|
|
49,800
|
|
|
|
0
|
|
|
|
|
|
|
$
|
10.50
|
|
|
|
4/20/2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4/20/2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,109
|
|
|
|
32,363
|
|
|
|
|
|
|
|
|
|
|
|
|
3/22/2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,000
|
|
|
|
138,150
|
|
|
|
|
9/1/2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,729
|
|
|
|
103,290
|
|
|
|
|
3/7/2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,375
|
|
|
|
143,906
|
|
Greg D. Ewald
|
|
|
4/20/2004
|
|
|
|
20,000
|
|
|
|
0
|
|
|
|
|
|
|
$
|
10.50
|
|
|
|
4/20/2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8/5/2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11,900
|
|
|
|
182,665
|
|
|
|
|
|
|
|
|
|
|
|
|
1/3/2006
|
|
|
|
5,000
|
|
|
|
5,000
|
|
|
|
|
|
|
|
10.64
|
|
|
|
1/3/2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9/1/2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,000
|
|
|
|
46,050
|
|
|
|
|
3/7/2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,500
|
|
|
|
38,375
|
|
James P. Flood
|
|
|
4/20/2004
|
|
|
|
15,000
|
|
|
|
0
|
|
|
|
|
|
|
$
|
10.50
|
|
|
|
4/20/2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1/3/2006
|
|
|
|
5,000
|
|
|
|
5,000
|
|
|
|
|
|
|
|
10.64
|
|
|
|
1/3/2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9/1/2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,000
|
|
|
|
46,050
|
|
|
|
|
3/7/2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,500
|
|
|
|
38,375
|
|
|
|
|
11/14/2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,000
|
|
|
|
76,750
|
|
|
|
|
(1) |
|
Of the unvested options for Ms. West, Mr. Ewald and
Mr. Flood, 1/48 vest each month following the grant date
during which the executive officer has provided service to the
Company. |
|
(2) |
|
Represents unvested service-based restricted shares granted at
the time of the IPO in 2004. Messrs. Feighan and Timm were
granted 25,300 service-based restricted shares and
Mr. Ewald was granted 29,750 service-based restricted
shares at the time of the IPO. Of the unvested shares for
Messrs. Feighan and Timm, 1/48 vest each month following
the grant date during which the executive officer has provided
service to the Company. Of the unvested shares for
Mr. Ewald, 1/5 vest annually on August 5. |
|
(3) |
|
The market value of the shares that have not vested is based on
the Companys closing stock price of $15.35 on
December 31, 2007. |
|
(4) |
|
Represents unvested performance-based restricted shares, which
vest as to
1/4
of the shares subject to the award on the anniversary of the
grant date only if the Companys return on average equity
target is met during the two fiscal years preceding the
applicable vesting date. Because the return on average equity
performance targets were met in 2005 and 2006,
1/4
of the unvested shares granted in each 2005 and 2006 vested on
the anniversary of their grant date in 2007. Accordingly,
because the Company met its return on average equity target in
2007, another
1/4
of the unvested shares granted in 2005 and 2006 will vest on the
anniversary of their grant date in 2008. As of December 31,
2007, no portion of the grants awarded in 2007 had vested;
however, because the |
130
|
|
|
|
|
2006 and 2007 return on average equity performance objectives
were met, the awards granted in 2007 will vest as to
1/4
of the shares on the anniversary of their grant date. |
Option
Exercises and Stock Vested for Fiscal Year 2007
The following table sets forth information with respect to the
value to the named executive officers of restricted shares that
vested during 2007. In 2007, none of the named executive
officers exercised any options.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Option Awards
|
|
|
|
|
|
Stock Awards
|
|
|
|
|
|
|
Number of
|
|
|
|
|
|
Number of
|
|
|
|
|
|
|
Shares
|
|
|
Value
|
|
|
Shares
|
|
|
Value
|
|
|
|
Acquired on
|
|
|
Realized on
|
|
|
Acquired on
|
|
|
Realized on
|
|
Name
|
|
Exercise (#)
|
|
|
Exercise ($)
|
|
|
Vesting (#)
|
|
|
Vesting ($)
|
|
|
Edward F. Feighan
|
|
|
|
|
|
$
|
|
|
|
|
14,099
|
(1)
|
|
$
|
259,557
|
(4)(5)
|
Erin E. West
|
|
|
|
|
|
$
|
|
|
|
|
1,000
|
(2)
|
|
|
14,295
|
(5)
|
Christopher J. Timm
|
|
|
|
|
|
$
|
|
|
|
|
13,068
|
(1)
|
|
|
242,074
|
(4)(5)
|
Greg D. Ewald
|
|
|
|
|
|
$
|
|
|
|
|
6,950
|
(3)
|
|
|
88,581
|
(5)
|
James P. Flood
|
|
|
|
|
|
$
|
|
|
|
|
1,000
|
(2)
|
|
|
14,295
|
(5)
|
|
|
|
(1) |
|
For Messrs. Feighan and Timm, the number of shares acquired
on vesting includes the monthly vesting of service based
restricted stock originally granted in 2004, and annual vesting
of performance-based restricted shares originally granted in
2005 and 2006. |
|
(2) |
|
The number of shares acquired on vesting for Ms. West and
Mr. Flood includes the annual vesting of performance-based
restricted shares originally granted in 2006. |
|
(3) |
|
For Mr. Ewald, the number of shares acquired on vesting
includes the annual vesting of service based restricted shares
originally granted in 2004 and the annual vesting of
performance-based restricted shares originally granted in 2006. |
|
(4) |
|
The value realized on vesting for the service-based restricted
shares granted to Messrs. Feighan and Timm is based on the
average of the daily high and low stock price on the last
trading day of the month in which the shares vested multiplied
by the number of shares that vested in each month. |
|
(5) |
|
The value realized on vesting is based on the average of the
daily high and low stock price on the day that a portion of the
restricted stock vests. |
|
|
|
|
|
The service-based restricted shares granted to
Messrs. Feighan and Timm vest on the last day of each month; |
|
|
|
The service-based restricted shares granted to Mr. Ewald
vest annually on the anniversary date of the grant; and |
|
|
|
The performance-based restricted shares granted to each of the
executives vest annually on the anniversary date of the grant. |
Post-Employment
Compensation
Pension
Benefits for Fiscal Year 2007
The Company does not offer a pension plan.
Nonqualified
Deferred Compensation for Fiscal Year 2007
No contributions have been made to the deferred compensation
plan in any fiscal year since the plans adoption in 2003.
131
Summary
of Termination and Change in Control
The following table sets forth information with respect to
potential payments that would have been made by the Company to
the named executive officers if such officers employment
was terminated due to certain hypothetical termination events or
a hypothetical change in control of the Company as of
December 31, 2007. The termination and change in control
events triggering such payments are set forth in each
executives employment agreement, as described above, and
in the Annual Incentive Plan and the 2004 Stock Option and Award
Plan described in the sections that follow.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Triggering Event
|
|
Edward F. Feighan
|
|
|
Erin E. West
|
|
|
Christopher J. Timm
|
|
|
Greg D. Ewald
|
|
|
James P. Flood
|
|
|
Resignation for other than good reason(1)
|
|
$
|
261,120
|
|
|
$
|
134,878
|
|
|
$
|
247,520
|
|
|
$
|
198,535
|
|
|
$
|
139,424
|
|
Company discharges executive for cause(2)
|
|
$
|
261,120
|
|
|
$
|
134,878
|
|
|
$
|
247,520
|
|
|
$
|
198,535
|
|
|
$
|
139,424
|
|
Termination other than for cause or resignation for good
reason(3)
|
|
$
|
1,422,088
|
|
|
$
|
689,263
|
|
|
$
|
1,307,477
|
|
|
$
|
894,215
|
|
|
$
|
728,645
|
|
Change in control(4)
|
|
$
|
2,094,294
|
|
|
$
|
824,140
|
|
|
$
|
1,949,713
|
|
|
|
N/A
|
|
|
$
|
868,068
|
|
Death(5)
|
|
$
|
358,440
|
|
|
$
|
198,088
|
|
|
$
|
1,252,063
|
|
|
$
|
274,468
|
|
|
$
|
210,973
|
|
|
|
|
(1) |
|
Represents bonus amounts earned during 2007 but unpaid as of
December 31, 2007. |
|
(2) |
|
Represents bonus amounts earned but unpaid as of
December 31, 2007. For Mr. Ewald, the amount also
includes the value of the automatic vesting of a pro rata number
of restricted shares equal to the difference of
41/60 of the
entire IPO restricted share award and the number of shares
vested as of December 31, 2007, multiplied by the closing
stock price of $15.35 on December 31, 2007. |
|
(3) |
|
Amounts include bonus amounts earned during 2007 but unpaid as
of December 31, 2007; the product of the 2007 base salary
amount multiplied by one; the product of the most current
incentive award multiplied by one; the value of continued health
insurance benefits for one year; the value of one year of life
insurance premiums for Mr. Feighan, Ms. West and
Mr. Timm; and the value of all unvested restricted shares
for each executive, which will automatically vest, based on a
closing stock price of $15.35 on December 31, 2007. |
|
(4) |
|
Amounts include bonus amounts earned during 2007 but unpaid as
of December 31, 2007; the product of the 2007 base salary
amount multiplied by two for Messrs. Feighan and Timm, and
multiplied by one for Ms. West and Mr. Flood; the
product of the most current incentive award multiplied by two
for Messrs. Feighan and Timm, and multiplied by one for
Ms. West and Mr. Flood; the value of continued health
insurance benefits for twenty-four months for
Messrs. Feighan and Timm, and twelve months for
Ms. West and Mr. Flood; the value of two years worth
of life insurance premiums for Messrs. Feighan and Timm,
and one year for Ms. West and Mr. Flood; and the value
of all unvested restricted shares for Mr. Feighan,
Ms. West, Mr. Timm and Mr. Flood, which will
automatically vest, based on a closing stock price of $15.35 on
December 31, 2007. |
|
(5) |
|
If employment terminates on death, the executives estates
or personal representatives are eligible to receive bonus
amounts earned during 2007 but unpaid as of December 31,
2007; an amount equal to the executives current base
salary for 90 days; and continued benefits under the health
insurance plan coverage for 90 days. The amount for
Mr. Timm includes the life insurance benefit payable to his
estate or personal representative and the amount for
Mr. Ewald includes the amount equal to the value of the
automatic vesting of a pro rata number of restricted shares
equal to the difference of 41/60 of the entire IPO restricted
share award and the number of shares vested as of
December 31, 2007, multiplied by the closing stock price of
$15.35 on December 31, 2007. |
In consideration for the receipt of payments described above,
each executive must abide by his or her covenant not to compete
or solicit. The covenant not to compete or solicit covers a
period of twelve months or the entire period he or she is
entitled to payments or benefits, other than payments or
benefits he or she is entitled to following a change in control,
as applicable.
132
Compensation
Committee Report
In accordance with its written charter adopted by the board of
directors, the compensation committee oversees the
Companys compensation and employee benefit plans. The
compensation committee reviewed and discussed the compensation
discussion and analysis for the year ended December 31,
2007 with the Companys management. Based on discussions
with management, the compensation committee recommended to the
board of directors that the compensation discussion and analysis
be included in this annual report.
Compensation Committee
Robert J. Woodward, Jr., Chairman
Jeffrey A. Maffett
Alan R. Weiler
Compensation
of Directors
Directors who are also employees receive no compensation for
serving as directors, and, during 2007, non-employee directors
received a $20,000 annual retainer. Non-employee directors also
received $1,000 for each board meeting they attended in person
and $500 for each telephonic meeting they attended. The lead
director received an additional $5,000 annually.
Non-employee directors serving on the compensation and
nominating and corporate governance committees received $750 for
each meeting they attended in person and $500 for each
telephonic meeting they attended. Audit committee members
received $1,500 for each committee meeting they attended in
person and $1,000 for each telephonic meeting they attended. The
chairman of the audit committee received $5,000 annually. The
Company also reimburses all directors for reasonable travel
expenses incurred in connection with their service as directors.
The Companys directors are also eligible to receive
additional stock options and awards when, as and if determined
by the compensation committee, pursuant to the terms of the 2004
Stock Option and Award Plan. Non-employee directors will receive
an option to purchase 1,000 common shares upon initial election
to the board of directors and an option to purchase
2,000 shares following each annual shareholder meeting,
provided that such non-employee director continues to serve as a
director following such meeting. The options will have an
exercise price equal to the fair market value on the date of
grant and vest as to
1/36
of the total shares awarded at the end of each full month
following the grant date during which the director continues as
a member of the board of directors.
The following table and footnotes provide information regarding
the compensation paid to the Companys non-employee members
of the board of directors in fiscal year 2007.
Summary
Compensation Table for Directors for Fiscal Year 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Committee
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Chairman
|
|
|
|
|
|
Fees
|
|
|
|
|
|
|
|
|
|
|
|
|
Annual
|
|
|
and Lead
|
|
|
Committee
|
|
|
Earned or
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
|
Director
|
|
|
Meeting
|
|
|
Paid in
|
|
|
Option
|
|
|
All Other
|
|
|
|
|
|
|
Retainer
|
|
|
Retainer
|
|
|
Fees
|
|
|
Cash
|
|
|
Awards
|
|
|
Compensation
|
|
|
Total
|
|
Name
|
|
(S)
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
($)
|
|
|
Robert F. Fix
|
|
|
20,000
|
|
|
|
5,000
|
|
|
|
8,000
|
|
|
|
33,000
|
|
|
|
7,995
|
|
|
|
0
|
|
|
|
40,995
|
|
Jeffrey A. Maffett
|
|
|
20,000
|
|
|
|
0
|
|
|
|
8,500
|
|
|
|
28,500
|
|
|
|
7,995
|
|
|
|
0
|
|
|
|
36,495
|
|
Press C. Southworth III
|
|
|
20,000
|
|
|
|
5,000
|
|
|
|
18,500
|
|
|
|
43,500
|
|
|
|
7,995
|
|
|
|
0
|
|
|
|
51,495
|
|
Alan R. Weiler
|
|
|
20,000
|
|
|
|
0
|
|
|
|
20,000
|
|
|
|
40,000
|
|
|
|
7,995
|
|
|
|
0
|
|
|
|
47,995
|
|
Robert J. Woodward, Jr.
|
|
|
20,000
|
|
|
|
0
|
|
|
|
19,750
|
|
|
|
39,750
|
|
|
|
7,995
|
|
|
|
0
|
|
|
|
47,745
|
|
Michael J. Endres
|
|
|
20,000
|
|
|
|
0
|
|
|
|
3,750
|
|
|
|
23,750
|
|
|
|
3,099
|
|
|
|
0
|
|
|
|
31,745
|
|
|
|
|
(1) |
|
On June 1, 2007, each non-employee director was granted an
option to purchase 2,000 shares which vest as to
1/36 of the
total shares awarded at the end of each full month following the
grant date during which the director continues as a member of
the board of directors. The values of the options granted to
each director are based on a Black-Scholes option pricing model
but exclude a forfeiture estimate, based on the assumption that
each of |
133
|
|
|
|
|
the directors will perform the requisite service for the awards
to vest. The exercise price of the options is $18.70, which was
the fair market value of the shares on the date of grant. The
full grant-date fair value of each current directors
option is $12,245 and the full grant-date fair value of
Mr. Endres option is $2,515, since a portion was
forfeited due to his resignation from the board of directors in
July 2007. |
|
(2) |
|
Since 2005, each director has been granted the option to
purchase 7,000 shares with exercise prices ranging from
$10.20 per share to $18.70 per share. As of December 31,
2007 each current director has 4,081 vested options and 2,919
unvested options to purchase common stock and Mr. Endres
has 2,912 vested options and forfeited 4,088 unvested options
upon his resignation in July 2007. |
Changes
to the compensation of directors in 2008
In January 2008, the compensation committee evaluated the level
of compensation paid to the members of its board of directors,
with assistance from its compensation consultant. After
considering peer group data and the trend in corporate
governance practice to eliminate meeting fees and entirely
compensate directors with an annual retainer, the compensation
committee determined that, beginning in 2008, all non-employee
directors will receive a $40,000 annual retainer and the lead
director, chairman of the audit committee and chairman of the
compensation committee will each receive an additional annual
retainer of $5,000. Additionally, following each annual
shareholder meeting, each non-employee director will receive an
option to purchase 3,000 of the Companys common shares,
which will vest in full on the first anniversary of the grant
date. Beginning in 2008, the per-meeting compensation structure
that had been in place previously is no longer applicable.
|
|
Item 12.
|
Security
Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
|
The following table sets forth certain information regarding the
beneficial ownership of common shares of the Company as of
March 9, 2008, except as otherwise disclosed in the notes
below, by:
|
|
|
|
|
each person who is known by the Company to own beneficially more
than 5% of the outstanding common shares based on a review of
filings with the Securities and Exchange Commission
(SEC);
|
|
|
|
the Companys Chief Executive Officer and the
Companys other executive officers named in the Summary
Compensation Table;
|
|
|
|
the Companys directors; and
|
|
|
|
the Companys current executive officers and directors as a
group.
|
134
Except as otherwise described in the notes below, the following
beneficial owners have sole voting power and sole investment
power with respect to all common shares set forth opposite their
respective names:
|
|
|
|
|
|
|
|
|
|
|
Number of Common
|
|
|
|
|
|
|
Shares Beneficially
|
|
|
Percentage
|
|
|
|
Owned
|
|
|
Ownership
|
|
|
T. Rowe Price Associates, Inc. and T. Rowe Price Small-Cap Value
Fund
|
|
|
1,332,900
|
(1)
|
|
|
9.9
|
|
100 East Pratt Street
Baltimore, Maryland 21202
|
|
|
|
|
|
|
|
|
Goldman Sachs Asset Management, L.P.
|
|
|
1,237,825
|
(2)
|
|
|
9.3
|
|
32 Old Slip
New York, New York 10005
|
|
|
|
|
|
|
|
|
Wells Fargo & Company
|
|
|
1,181,408
|
(3)
|
|
|
8.8
|
|
420 Montgomery Street
San Francisco, California 94104
|
|
|
|
|
|
|
|
|
Dimensional Fund Advisors LP
|
|
|
929,556
|
(4)
|
|
|
7.0
|
|
1299 Ocean Avenue
Santa Monica, California 90401
|
|
|
|
|
|
|
|
|
Stonehenge Opportunity Fund, LLC
|
|
|
878,571
|
(5)(10)
|
|
|
6.7
|
|
191 W. Nationwide Boulevard, Suite 600
Columbus, Ohio 43215
|
|
|
|
|
|
|
|
|
Michael J. Endres
|
|
|
52,912
|
(6)
|
|
|
|
|
Greg D. Ewald
|
|
|
68,054
|
(7)
|
|
|
*
|
|
Edward F. Feighan
|
|
|
252,193
|
(8)
|
|
|
1.8
|
|
James P. Flood
|
|
|
36,573
|
(9)
|
|
|
*
|
|
Christopher J. Timm
|
|
|
291,374
|
(10)
|
|
|
2.1
|
|
Erin E. West
|
|
|
36,240
|
(11)
|
|
|
*
|
|
Robert F. Fix
|
|
|
23,001
|
(12)
|
|
|
*
|
|
Jeffrey A. Maffett
|
|
|
7,501
|
(12)
|
|
|
|
|
Press C. Southworth III
|
|
|
8,001
|
(12)(13)
|
|
|
|
|
Alan R. Weiler
|
|
|
20,001
|
(12)(14)
|
|
|
|
|
Robert J. Woodward, Jr.
|
|
|
7,001
|
(12)
|
|
|
|
|
All Current Executive Officers and Directors as a Group
(10 persons)
|
|
|
749,939
|
(15)
|
|
|
5.3
|
|
|
|
|
* |
|
Less than 1% |
|
(1) |
|
Information is as of December 31, 2007 and is based on a
report on Schedule 13G filed with the SEC on
February 14, 2008 by T. Rowe Price Associates, Inc. and T.
Rowe Price Small-Cap Value Fund, Inc. According to the
Schedule 13G/A, T. Rowe Price Associates, Inc. has sole
dispositive power with respect to 1,332,900 shares and sole
voting power with respect to 195,400 shares. These
securities are owned by various individual and institutional
investors including T. Rowe Price Small-Cap Value Fund, Inc.
(which owns 1,133,200 shares, representing 8.4% of the
shares outstanding), which T. Rowe Price Associates, Inc. (Price
Associates) serves as investment adviser with power to direct
investments and/or sole power to vote the securities. For
purposes of the reporting requirements of the Securities
Exchange Act of 1934, Price Associates is deemed to be a
beneficial owner of such securities; however, Price Associates
expressly disclaims that it is, in fact, the beneficial owner of
such securities. |
|
(2) |
|
Information is as of December 31, 2007 and is based on a
report on Schedule 13G/A filed with the SEC on
February 1, 2008 by Goldman Sachs Asset Management, L.P.
(GSAM LP). According to the
Schedule 13G/A,
GSAM LP has sole voting power with respect to 1,120,906 common
shares and sole dispositive power with respect to 1,237,825
common shares and GSAM LP disclaims ownership of any securities
managed on its behalf by third parties. |
135
|
|
|
(3) |
|
Information is as of December 31, 2007 and is based on a
report on Schedule 13G filed with the SEC on
January 25, 2008 by Wells Fargo & Company and its
subsidiaries, Wells Capital Management Incorporated, Wells Fargo
Funds Management, LLC and Wells Fargo Bank, National
Association. According to the Schedule 13G/A, Wells
Fargo & Company has sole power to dispose or direct
the disposition of 1,134,408 common shares and Wells Capital
Management Incorporated has sole power to dispose or direct the
disposition of 1,134,286 common shares. Wells Fargo &
Company has sole power to vote or to direct the vote of
1,178,908 common shares, and Wells Capital Management
Incorporated has sole power to vote or direct the vote of
1,063,786 common shares. |
|
(4) |
|
Information is as of December 31, 2007 and is based on a
report on Schedule 13G filed with the SEC on
February 6, 2008 by Dimensional Fund Advisors LP
(Dimensional). According to the Schedule 13G,
Dimensional is an investment advisor and furnishes advice to
four investment companies and serves as investment manager to
certain other commingled group trusts and separate accounts.
These investment companies, trusts and accounts are known as the
Funds. In its role as investment advisor and
manager, Dimensional has sole voting and dispositive power with
respect to 929,556 common shares, and it may be deemed to be the
beneficial owner of the shares held by the Funds. However, all
of the securities reported on the Schedule 13G are owned by
the Funds. Dimensional disclaims beneficial ownership of such
securities. |
|
(5) |
|
Information is based on a Schedule 13G filed with the SEC
on February 14, 2005 by Stonehenge Opportunity Fund, LLC
(Stonehenge Opportunity Fund). Bluestone Investors,
L.P. is the managing member of Stonehenge Opportunity Fund and
Stonehenge Financial Holdings, Inc. is the general partner of
Bluestone Investors, L.P., each of which may also be deemed to
have sole voting and dispositive power with respect to the
common shares held by Stonehenge Opportunity Fund. No change in
such ownership was reported by Stonehenge Opportunity Fund, LLC
as of December 31, 2007. Pursuant to Stonehenge Opportunity
Funds limited partnership agreement, it has certain rights
to the compensation provided to its principals who serve on the
boards of directors of companies in which it invests.
Accordingly, Stonehenge Opportunity Fund may also be deemed to
beneficially own 2,912 common shares subject to options issued
to Michael J. Endres while he was a director of ProCentury
Corporation. |
|
(6) |
|
The shares held by Mr. Endres, who was a director of the
Company until July 2007, include 2,912 common shares subject to
options currently exercisable or exercisable within
60 days. Mr. Endres is a principal of Stonehenge
Financial Holdings, Inc., an affiliate of Stonehenge Opportunity
Fund, and has an ownership interest in Stonehenge Opportunity
Fund. |
|
(7) |
|
Mr. Ewalds shares include 26,041 common shares
subject to options currently exercisable or exercisable within
60 days. |
|
(8) |
|
Mr. Feighans shares include 49,800 common shares
subject to options currently exercisable or exercisable within
60 days. |
|
(9) |
|
Mr. Floods shares include 21,041 common shares
subject to options currently exercisable or exercisable within
60 days. |
|
(10) |
|
Mr. Timms shares include 49,800 common shares subject
to options currently exercisable or exercisable within
60 days. |
|
(11) |
|
Ms. Wests shares include 16,041 common shares subject
to options currently exercisable or exercisable within
60 days. |
|
(12) |
|
The number of shares for each current non-employee director
includes 5,001 common shares subject to options currently
exercisable or exercisable within 60 days. |
|
(13) |
|
Mr. Southworths shares include 1,000 common shares
held by Mr. Southworths spouse. |
|
(14) |
|
Mr. Weilers shares include 5,000 common shares held
by the ABW Family Limited Partnership. |
|
(15) |
|
Includes an aggregate of 187,728 common shares subject to
options currently exercisable or exercisable within 60 days
owned by the Companys executive officers and directors as
a group. |
136
Equity
Compensation Plans
The following table shows certain information as of
December 31, 2007 with respect to compensation plans under
which our common shares are authorized for issuance:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Common
|
|
|
|
|
|
Number of Common
|
|
|
|
Shares to be Issued
|
|
|
Weighted Average
|
|
|
Shares Remaining
|
|
|
|
Upon Exercise of
|
|
|
Exercise Price of
|
|
|
Available for
|
|
Plan Category
|
|
Outstanding Options
|
|
|
Outstanding Options
|
|
|
Future Issuance(1)
|
|
|
Equity compensation plans approved by shareholders
|
|
|
532,554
|
|
|
$
|
12.24
|
|
|
|
315,442
|
|
Equity compensation plans not approved by shareholders
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
532,554
|
|
|
$
|
12.24
|
|
|
|
315,442
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Shares may be issued upon exercise of options or in the form of
appreciation rights, performance units, restricted stock or
restricted stock units. |
|
|
Item 13.
|
Certain
Relationships and Related Transactions, and Director
Independence
|
Transactions
with Related Parties
Diamond
Hill Capital Investment Management Agreement
In December 2002, the Company entered into an investment
management agreement with Diamond Hill Capital Management, Inc.,
pursuant to which Diamond Hill manages certain of the
Companys securities, which had an aggregate fair market
value of $35.1 million as of December 31, 2007. In
return for these services, the Company pays Diamond Hill a
management fee of 35 basis points of the fair market value
of the portfolio, which is calculated at various points during
the year, and, for the year ended December 31, 2007,
totaled $136,114. The Company expects to pay management fees in
2007 on the same basis. Mr. Endres, a member of the
Companys board of directors, owns an equity interest in
Diamond Hill Capital Management, Inc. of 1.6%.
Agreements
Relating to the Evergreen and Continental Transactions
In connection with the Companys IPO in April 2004, the
Company spun-off its subsidiaries, Evergreen and Continental, to
the Companys Class A shareholders. In connection with
the spin-off, the Company entered into several agreements with
Evergreen which facilitated the Evergreen and Continental
transactions. The Companys board of directors believes
that these agreements were fair to the Company and its
shareholders.
Transitional Administrative Agreement. Prior
to the Evergreen and Continental dispositions, the Company
provided Evergreen and Continental with all executive,
managerial, supervisory, administrative, technical, claims
handling, investment management, regulatory affairs, legal,
accounting, financial reporting, professional and clerical
services necessary to operate their respective businesses. In
order to provide Evergreen and Continental with a transition
period before the cessation of these services, the Company
entered into a Transitional Administrative Agreement with
Evergreen and Continental pursuant to which the Company
continued to provide these services to Evergreen and Continental
for an initial term of 18 months in exchange for an annual
fee of $900,000. This agreement was renewed for one six-month
term to expire on December 31, 2005, without any changes in
the terms thereof. On December 29, 2005, the agreement was
amended to extend the term thereof to June 30, 2006, reduce
the administrative fee to $75,000 per calendar quarter payable
during the first month of each quarter and providing for
termination upon not less than thirty (30) days advance
written notice to the Company. On October 13, 2006, the
agreement was amended retroactively to July 1, 2006 to
extend the term thereof to March 31, 2007 and reduce the
administrative fee to $10,000 per calendar quarter. On
April 25, 2007, the agreement was amended retroactively to
April 1, 2007 to extend the term thereof to June 30,
2007 and reduce the administrative fee to $5,000 per calendar
quarter. In all other respects the agreement remained unchanged.
The agreement was terminated as of June 30, 2007. For the
year ended December 31, 2007, 2006, and 2005, the Company
received $15,000, $170,000, and $690,000 under this agreement,
respectively.
137
Reinsurance Agreements. The Company entered
into loss portfolio transfer reinsurance contracts that provided
for Century to reinsure Evergreen and Continental for business
that was written in Centurys name prior to
December 31, 2003 and transferred to one of the other
companies in connection with the termination of an intercompany
pooling agreement among the parties and for Evergreen to
reinsure Century in the same manner. For example, Century will
reinsure property business transferred to it in connection with
the termination of the intercompany pooling agreement that had
been written for it in Evergreens name. These contracts
will remain in force until all outstanding loss and assignable
loss adjustment expense covered has been settled or commuted in
accordance with the provisions of the applicable contract. The
Company ceded $435,000 reserves and assumed $2.8 million
reserves under this contract in 2007. During the year ended
December 31, 2006, the Company ceded $362,000 reserves and
assumed $3.1 million reserves under the contract.
Quota Share Reinsurance Agreements. The
Company entered into 100% quota share reinsurance contracts that
provided for Century to reinsure Evergreen and Continental for
property and casualty business that was written on Evergreen or
Continentals paper for Century in states that Century was
not licensed and for Evergreen to reinsure Century in the same
manner for bonding business. Under these contracts, the ceding
company is entitled to receive a 5% commission and reimbursement
of any premium taxes or other direct costs such as boards and
bureaus fees. These fronting contracts will remain in force
until December 31, 2007. During 2007, the Company assumed
$905,000 of premiums and ceded $302,000 of premiums under this
contract. The Company assumed $535,000 of premiums and ceded
$406,000 of premiums under this contract during the year ended
December 31, 2006.
Software License Agreement and Software Support and
Maintenance Agreement. Century has entered into a
software license agreement with Evergreen and Continental
pursuant to which Century granted to Evergreen and Continental a
fully
paid-up,
royalty free, non-exclusive perpetual license to use certain of
Centurys proprietary software that relates to underwriting
and claims processing and that has been developed for the mutual
benefit of the Company, Evergreen and Continental. In addition,
Century has entered into a software support and maintenance
agreement with Evergreen and Continental, pursuant to which
Century provides certain technical support and maintenance
services for the software in return for an annual support and
maintenance fee of $100,000. Evergreen and Continental may
terminate the software support and maintenance agreement by
providing 90 days prior written notice, and Century may
terminate the agreement by providing twelve months prior
written notice. On December 29, 2005, the software support
and maintenance agreement was amended to adjust the Annual Fee
effective January 1, 2006, to be at the rate of $50,000 per
calendar quarter payable during the first month of each quarter.
On October 18, 2006, the agreement was amended to adjust
the Annual Fee retroactively to July 1, 2006 to $15,000 per
calendar quarter. On April 25, 2007, the agreement was
amended to adjust the Annual Fee retroactively to April 1,
2007 to $5,000 per calendar quarter. In all other respects, the
agreement continues unchanged. The Company received $30,000,
$130,000, and $100,000 in Annual Fees respectively for the years
ended December 31, 2007, 2006 and 2005, respectively.
In addition, the Company has entered into the following
agreements with Evergreen. The Companys board of directors
believes that these agreements are fair to the Company and its
shareholders.
Quota
Share Reinsurance Agreements
|
|
|
|
|
In 2005, the Company entered into 50% quota share agreement with
Evergreen whereby, the Company would assume certain special
surety bonds (including landfill). During 2006 and 2005, the
Company recorded $2.6 million and $2.4 million of
assumed bonds, respectively. This agreement was terminated on
August 15, 2006.
|
|
|
|
On August 1, 2006, the Company became a participant on
Evergreens Landfill Variable Quota Share Treaty. The
Company will assume 10% of all landfill bonds written by
Evergreen and Continental which have exposures in excess of
$1,200,000. The Company recorded assumed premium of
$1.9 million in 2007. The Company recorded assumed premium
of $390,000 in 2006. In addition, the Company assumed a 10%
share, or $677,000, of unearned premium rolled forward from the
previous treaty which was terminated on July 31, 2006.
|
|
|
|
On August 15, 2006, the Company became a participant on
Evergreens Contract Bond Quota Share Treaty. The Company
will assume 25% of all contract bonds written by Evergreen and
Continental. The Company
|
138
|
|
|
|
|
recorded assumed premium of $700,000 in 2007. The Company
recorded assumed premium of $102,000 in 2006.
|
|
|
|
|
|
On October 1, 2007, the Company entered into 100% quota
share reinsurance contract that provided for Century to reinsure
Evergreen for contract surety business underwritten by Century
employees that was written on Evergreens paper for Century
in states that Century was not licensed. Under these contracts,
the ceding company is entitled to receive a 10% commission. This
fronting contract will remain in force until December 31,
2009. During 2007, the Company assumed $3,000 of premiums.
|
Director
Independence
The board of directors has affirmatively determined that each of
the directors, except Messrs. Feighan and Timm, is, or was,
in the case of Mr. Endres, an independent
director within the meaning of the NASDAQs listing
standards. In making such determination, the board of directors
considered the following categories of relationships:
|
|
|
|
|
the provision of agency services to the Company by an entity of
which a director previously served as chairman and in which his
family members hold an ownership interest;
|
|
|
|
the purchase of an insurance policy from the Company for
coverage of an LLC owned by a director; and
|
|
|
|
two directors service on the board of ProAlliance, which
owns Evergreen National Indemnity Company, a former subsidiary
of the Company prior to the Companys IPO, and with which
the Company has various agreements as described above.
|
|
|
Item 14.
|
Principal
Accounting Fees and Services
|
During 2007 and 2006, the Company engaged KPMG LLP as its
independent registered public accountants. The Company paid KMPG
LLP fees aggregating $803,000 and $660,000 in 2007 and 2006,
respectively, as described in more detail below. None of the
time devoted by KPMG LLP on its engagement to audit the
Companys financial statements for the year ended
December 31, 2007 was attributable to work performed by
persons other than full-time KPMG LLP partners and employees.
Audit Fees. The aggregate fees billed for
professional services rendered by KPMG LLP for the audit of the
Companys annual consolidated financial statements for the
years ended December 31, 2007 and 2006, were $803,000 and
$660,000, respectively.
Audit-Related Fees. No fees were billed by
KPMG LLP for assurance or other services reasonably related to
the performance of the audit or review of the Companys
financial statements that are not reported under Audit
Fees above for the years ended December 31, 2007 and
2006.
Tax Fees. No fees were billed by KPMG LLP for
professional services for tax compliance and tax consulting
services for the years ended December 31, 2007 and 2006.
All Other Fees. No fees were billed by KPMG
LLP for other products and services provided by KPMG LLP for the
years ended December 31, 2007 and 2006.
Policy on Audit Committee Pre-Approval of Audit and
Permissible Non-Audit Services. The audit
committee pre-approves, on an individual basis, all audit and
permissible non-audit services provided by the independent
registered public accountants. These services may include audit
services, audit-related services, tax services and other
services.
PART IV
|
|
Item 15.
|
Exhibits,
Financial Statement Schedules
|
(a)(1) Financial Statements
Reports of independent registered public accounting firm
139
Consolidated Balance Sheets at December 31, 2007 and 2006
Consolidated Statements of Operations for the three years ended
December 31, 2007
Consolidated Statements of Shareholders Equity and
Comprehensive Income for the three years ended December 31,
2007
Consolidated Statements of Cash Flows for the three years ended
December 31, 2007
Notes to Consolidated Financial Statements
(a)(2) Financial Statement Schedules
Schedule I Summary of Investments
Other than Investments in Related Parties
Schedule II Condensed Financial Information of
Parent Company
Schedule III Supplementary Insurance Information
Schedule IV Reinsurance
Schedule V Valuation and Qualifying Accounts
Schedule VI Supplemental Information Concerning
Property Casualty Insurance Operations
(a)(3) Exhibits
See Exhibit Index immediately following the
signature page hereto.
(b) Exhibits.
See Exhibit Index immediately following the
signature page hereto.
(c) Financial Statement Schedules
Schedules required to be filed in response to this portion are
listed above in Item 15(a)(2).
140
SIGNATURES
Pursuant to the requirements of Section 13 or 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.
PROCENTURY CORPORATION
|
|
|
|
By:
|
/s/ Edward
F. Feighan
|
Edward F. Feighan,
Chairman, President and Chief
Executive Officer
Date: March 17, 2008
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 on the date
indicated.
|
|
|
|
|
|
|
Signature
|
|
Title
|
|
Date
|
|
|
|
|
|
|
/s/ Edward
F. Feighan
Edward
F. Feighan
|
|
Chairman of the Board of Directors, President and Chief
Executive Officer (Principal Executive Officer)
|
|
March 17, 2008
|
|
|
|
|
|
/s/ Erin
E. West
Erin
E. West
|
|
Chief Financial Officer and Treasurer Principal Financial and
Accounting Officer)
|
|
March 17, 2008
|
|
|
|
|
|
/s/ Robert
F. Fix
Robert
F. Fix
|
|
Director
|
|
March 17, 2008
|
|
|
|
|
|
/s/ Jeffrey
A. Maffett
Jeffrey
A. Maffett
|
|
Director
|
|
March 17, 2008
|
|
|
|
|
|
/s/ Press
C. Southworth III
Press
C. Southworth III
|
|
Director
|
|
March 17, 2008
|
|
|
|
|
|
/s/ Christopher
J. Timm
Christopher
J. Timm
|
|
Director
|
|
March 17, 2008
|
|
|
|
|
|
/s/ Alan
R. Weiler
Alan
R. Weiler
|
|
Director
|
|
March 17, 2008
|
|
|
|
|
|
/s/ Robert
J. Woodward, Jr.
Robert
J. Woodward, Jr.
|
|
Director
|
|
March 17, 2008
|
141
EXHIBIT INDEX
|
|
|
|
|
Exhibit
|
|
|
Number
|
|
Description
|
|
|
3
|
.1
|
|
Amended and Restated Articles of Incorporation of ProCentury
Corporation (incorporated herein by reference to ProCentury
Corporations Quarterly Report on
Form 10-Q
for the period ended March 31, 2004 (File
No. 000-50641))
|
|
3
|
.2
|
|
Amended and Restated Code of Regulations of ProCentury
Corporation (incorporated herein by reference to ProCentury
Corporations Quarterly Report on
Form 10-Q
for the period ended March 31, 2004 (File
No. 000-50641))
|
|
4
|
.1
|
|
Specimen Certificate for common shares, without par value, of
ProCentury Corporation (incorporated herein by reference to
ProCentury Corporations Registration Statement on
Form S-1
(File
No. 333-111294),
as amended)
|
|
4
|
.2
|
|
Indenture, dated as of December 4, 2002, by and between
ProFinance Holdings Corporation and State Street Bank and
Trust Company of Connecticut (incorporated herein by
reference to ProCentury Corporations Registration
Statement on
Form S-1
(File
No. 333-111294),
as amended)
|
|
4
|
.3
|
|
Amended and Restated Declaration of Trust, dated as of
December 4, 2002, by and among State Street Bank and
Trust Company of Connecticut, ProFinance Holdings
Corporation and Steven R. Young and John Marazza, as
Administrators (incorporated herein by reference to ProCentury
Corporations Registration Statement on
Form S-1
(File
No. 333-111294),
as amended)
|
|
4
|
.4
|
|
Guarantee Agreement, dated as of December 4, 2002, by and
between ProFinance Holdings Corporation and State Street Bank
and Trust Company of Connecticut (incorporated herein by
reference to ProCentury Corporations Registration
Statement on
Form S-1
(File
No. 333-111294),
as amended)
|
|
4
|
.5
|
|
Indenture, dated as of May 16, 2003, by and between
ProFinance Holdings Corporation and U.S. Bank National
Association (incorporated herein by reference to ProCentury
Corporations Registration Statement on
Form S-1
(File
No. 333-111294),
as amended)
|
|
4
|
.6
|
|
Amended and Restated Declaration of Trust, dated as of
May 16, 2003, by and among U.S. Bank National Association,
ProFinance Holdings Corporation and Steven R. Young and John
Marazza, as Administrators (incorporated herein by reference to
ProCentury Corporations Registration Statement on
Form S-1
(File
No. 333-111294),
as amended)
|
|
4
|
.7
|
|
Guarantee Agreement, dated as of May 16, 2003, by and
between ProFinance Holdings Corporation and U.S. Bank National
Association (incorporated herein by reference to ProCentury
Corporations Registration Statement on
Form S-1
(File
No. 333-111294),
as amended)
|
|
10
|
.1
|
|
Employment Agreement, dated as of December 15, 2003, by and
between ProCentury Corporation and Edward F. Feighan
(incorporated herein by reference to ProCentury
Corporations Registration Statement on
Form S-1
(File
No. 333-111294),
as amended)(1)
|
|
10
|
.2
|
|
Employment Agreement, dated as of December 15, 2003, by and
between ProCentury Corporation and Christopher J. Timm
(incorporated herein by reference to ProCentury
Corporations Registration Statement on
Form S-1
(File
No. 333-111294),
as amended)(1)
|
|
10
|
.3
|
|
Employment Agreement, dated as of February 22, 2006, by and
between ProCentury Corporation and Erin E. West (incorporated
herein by reference to ProCentury Corporations Annual
Report on
Form 10-K
for the fiscal year ended 2005 (File
No. 000-50641))(1)
|
|
10
|
.4
|
|
Form of ProCentury Corporation Indemnification Agreement by and
between ProCentury Corporation and each member of its Board of
Directors (incorporated herein by reference to ProCentury
Corporations Registration Statement on
Form S-1
(File
No. 333-111294),
as amended)(1)
|
|
10
|
.5
|
|
ProCentury Corporation 2004 Stock Option and Award Plan
(incorporated herein by reference to ProCentury
Corporations Registration Statement on
Form S-1
(File
No. 333-111294),
as amended)(1)
|
|
10
|
.6
|
|
Amended and Restated ProCentury Corporation Deferred
Compensation Plan (incorporated herein by reference to
ProCentury Corporations Current Report on
Form 8-K
(File
No. 000-50641)(1)
|
|
10
|
.7
|
|
Non-Qualified Plan Trust Agreement, dated January 1,
2008, by and between ProCentury Corporation and Merrill Lynch
Bank and Trust Co., FSB, with respect to a trust forming
part of the ProCentury Corporation Deferred Compensation Plan
|
142
|
|
|
|
|
Exhibit
|
|
|
Number
|
|
Description
|
|
|
10
|
.8
|
|
Amended and Restated ProCentury Corporation Annual Incentive
Plan (incorporated herein by reference to ProCentury
Corporations Current Report on
Form 8-K
(File
No. 000-50641)(1)
|
|
10
|
.9
|
|
Form of Restricted Stock Award Agreement for Restricted Stock
under the ProCentury Corporation 2004 Stock Option and Award
Plan (incorporated herein by reference to ProCentury
Corporations Annual Report on
Form 10-K
for the fiscal year ended 2004 (File
No. 000-50641))(1)
|
|
10
|
.10
|
|
Form of Stock Option Agreement for Non-Qualified Stock Options
under the ProCentury Corporation 2004 Stock Option and Award
Plan (incorporated herein by reference to ProCentury
Corporations Annual Report on
Form 10-K
for the fiscal year ended 2004 (File
No. 000-50641))(1)
|
|
10
|
.11
|
|
Form of Stock Option Agreement for Incentive Stock Options under
the ProCentury Corporation 2004 Stock Option and Award Plan
(incorporated herein by reference to ProCentury
Corporations Annual Report on
Form 10-K
for the fiscal year ended 2004 (File
No. 000-50641))(1)
|
|
10
|
.12
|
|
Form of Restricted Stock Award Agreement for Restricted Stock
for Executive Officers under the ProCentury Corporation 2004
Stock Option and Award Plan (incorporated herein by reference to
ProCentury Corporations Annual Report on
Form 10-K
for the fiscal year ended 2004 (File
No. 000-50641))(1)
|
|
10
|
.13
|
|
Form of Stock Option Agreement for Non-Qualified Stock Options
for Executive Officers under the ProCentury Corporation 2004
Stock Option and Award Plan (incorporated herein by reference to
ProCentury Corporations Annual Report on
Form 10-K
for the fiscal year ended 2004 (File
No. 000-50641))(1)
|
|
10
|
.14
|
|
Form of Restricted Stock Award Agreement for Performance Vesting
Restricted Stock under the ProCentury Corporation 2004 Stock
Option and Award Plan (incorporated herein by reference to
ProCentury Corporations Quarterly Report on
Form 10-Q
for the period ended March 31, 2005 (File
No. 000-50641))(1)
|
|
10
|
.15
|
|
Form of Stock Option Agreement for Non-Qualified Stock Options
Granted to Non-Employee Directors under the ProCentury
Corporation 2004 Stock Option and Award Plan (incorporated
herein by reference to ProCentury Corporations Quarterly
Report on
Form 10-Q
for the period ended March 31, 2005 (File
No. 000-50641))(1)
|
|
10
|
.16
|
|
Transitional Administrative Agreement, effective as of
January 1, 2004, by and among ProCentury Corporation,
Evergreen National Indemnity Corporation and Continental
Heritage Insurance Company (incorporated herein by reference to
ProCentury Corporations Registration Statement on
Form S-1
(File
No. 333-111294),
as amended)
|
|
10
|
.17
|
|
Loss Portfolio Transfer Reinsurance Contract, effective as of
January 1, 2004, issued to Century Surety Company by
Evergreen National Indemnity Company (incorporated herein by
reference to ProCentury Corporations Registration
Statement on
Form S-1
(File
No. 333-111294),
as amended)
|
|
10
|
.18
|
|
Loss Portfolio Transfer Reinsurance Contract, effective as of
January 1, 2004, issued to Continental Heritage Insurance
Company by Century Surety Company (incorporated herein by
reference to ProCentury Corporations Registration
Statement on
Form S-1
(File
No. 333-111294),
as amended)
|
|
10
|
.19
|
|
Loss Portfolio Transfer Reinsurance Contract, effective as of
January 1, 2004, issued to Evergreen National Indemnity
Company by Century Surety Company (incorporated herein by
reference to ProCentury Corporations Registration
Statement on
Form S-1
(File
No. 333-111294),
as amended)
|
|
10
|
.20
|
|
Quota Share Reinsurance Contract, effective as of
January 1, 2004, issued to Evergreen National Indemnity
Company by Century Surety Company (incorporated herein by
reference to ProCentury Corporations Registration
Statement on
Form S-1
(File
No. 333-111294),
as amended)
|
|
10
|
.21
|
|
Quota Share Reinsurance Contract, effective as of
January 1, 2004, issued to Continental Heritage Insurance
Company by Century Surety Company (incorporated herein by
reference to ProCentury Corporations Registration
Statement on
Form S-1
(File
No. 333-111294),
as amended)
|
|
10
|
.22
|
|
Quota Share Reinsurance Contract, effective as of
January 1, 2004, issued to Century Surety Company by
Evergreen National Indemnity Company (incorporated herein by
reference to ProCentury Corporations Registration
Statement on
Form S-1
(File
No. 333-111294),
as amended)
|
143
|
|
|
|
|
Exhibit
|
|
|
Number
|
|
Description
|
|
|
10
|
.23
|
|
Software License Agreement, effective as of January 1,
2004, by and among Century Surety Company, Evergreen National
Indemnity Company and Continental Heritage Insurance Company
(incorporated herein by reference to ProCentury
Corporations Registration Statement on
Form S-1
(File
No. 333-111294),
as amended)
|
|
10
|
.24
|
|
Software Support and Maintenance Agreement, effective as of
January 1, 2004, by and among Century Surety Company,
Evergreen National Indemnity Company and Continental Heritage
Insurance Company (incorporated herein by reference to
ProCentury Corporations Registration Statement on
Form S-1
(File
No. 333-111294),
as amended)
|
|
10
|
.25
|
|
Employment Agreement, dated as of November 14, 2007, by and
between ProCentury Corporation and James P. Flood
|
|
21
|
|
|
Subsidiaries of ProCentury Corporation
|
|
23
|
|
|
Consent of KPMG LLP
|
|
31
|
.1
|
|
Certification of Principal Executive Officer pursuant to
Rule 13a-14(a)
of the Exchange Act
|
|
31
|
.2
|
|
Certification of Principal Financial Officer pursuant to
Rule 13a-14(a)
of the Exchange Act
|
|
32
|
.1
|
|
Certification of Principal Executive Officer pursuant to
Rule 13a-14(b)
of the Exchange Act and 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002(2)
|
|
32
|
.2
|
|
Certification of Principal Financial Officer pursuant to
Rule 13a-14(b)
of the Exchange Act and 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002(2)
|
|
|
|
(1) |
|
Management contracts and compensatory plans or arrangements
required to be filed as an exhibit pursuant to Item 15(b)
of
Form 10-K. |
|
(2) |
|
These certifications are not deemed to be filed for
purposes of Section 18 of the Exchange Act, or otherwise
subject to the liability of that section. These certifications
will not be deemed to be incorporated by reference into any
filing under the Securities Act or the Exchange Act, except to
the extent that the registrant specifically incorporates them by
reference. |
144