UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended SEPTEMBER 30, 2001 or ______ [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ______ to ______. Commission file number 0-16533 ProAssurance Corporation* ------------------------------------------------------ (Exact name of registrant as specified in its charter) Delaware 63-1261433 - ------------------------------- --------------------------------- (State or other jurisdiction of (IRS Employer Identification No.) incorporation of organization) 100 Brookwood Place, Birmingham, AL 35209 - ------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (205) 877-4400 ------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]. As of November 8, there were 25,779,390 shares of the registrant's common stock outstanding. *On June 27, 2001 Medical Assurance, Inc. (Commission file number 001-19439) and Professionals Group, Inc. (Commission file number 001-21223) became wholly owned subsidiaries of ProAssurance as more fully described herein. Page 1 of 24
Table of Contents <TABLE> <S> <C> Part I - Financial Information Item l. Condensed Consolidated Financial Statements (Unaudited) of ProAssurance Corporation and Subsidiaries Condensed Consolidated Balance Sheets.............................................................3 Condensed Consolidated Statements of Changes in Capital...........................................4 Condensed Consolidated Statements of Income.......................................................5 Condensed Consolidated Statements of Cash Flows...................................................6 Notes to Condensed Consolidated Financial Statements..............................................7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....................................................13 Item 3. Quantitative and Qualitative Disclosures about Market Risk.......................................22 Part II - Other Information Item 6. Exhibits and Reports on Form 8-K.................................................................24 Signatures.................................................................................................24 </TABLE>
PROASSURANCE CORPORATION AND SUBSIDIARIES Condensed Consolidated Balance Sheets (Unaudited) (in thousands, except share data) <TABLE> <CAPTION> SEPTEMBER 30 December 31 2001 2000 ----------- ----------- <S> <C> <C> ASSETS Investments: Fixed maturities available for sale, at fair value $ 1,334,429 $ 603,497 Equity securities available for sale, at fair value 104,064 80,872 Real estate, net 12,976 11,237 Short-term investments 70,349 100,920 ----------- ----------- Total investments 1,521,818 796,526 Cash and cash equivalents 58,698 8,550 Premiums receivable 94,074 54,405 Receivable from reinsurers on unpaid losses and loss adjustment expenses 388,085 166,202 Prepaid reinsurance premiums 17,898 2,704 Deferred taxes 87,975 30,757 Other assets 106,266 63,692 ----------- ----------- $ 2,274,814 $ 1,122,836 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Policy liabilities and accruals: Reserve for losses and loss adjustment expenses $ 1,454,856 $ 659,659 Unearned premiums 193,514 78,495 Reinsurance premiums payable 41,316 27,249 ----------- ----------- Total policy liabilities 1,689,686 765,403 Other liabilities 56,840 12,266 Long-term debt 85,000 -- ----------- ----------- Total liabilities 1,831,526 777,669 Minority interests 22,086 -- Commitments and contingencies -- -- Stockholders' equity: Common stock, par value $0.01 and $1 per share in 2001 and 2000, respectively; 100,000,000 shares authorized; 25,899,847 and 25,105,441 shares issued, respectively 259 25,107 Additional paid-in capital 260,853 231,988 Accumulated other comprehensive income (loss), net of deferred taxes (benefit) of $212 and $(460), respectively 15,679 (854) Retained earnings 144,453 136,257 ----------- ----------- 421,244 392,498 Less treasury stock at cost, 120,457 and 2,437,503 shares, respectively (42) (47,331) ----------- ----------- Total stockholders' equity 421,202 345,167 ----------- ----------- Total liabilities and stockholder's equity $ 2,274,814 $ 1,122,836 =========== =========== </TABLE> See accompanying notes. 3
ProAssurance Corporation and Subsidiaries Condensed Consolidated Statements of Changes in Capital (Unaudited) (in thousands) <TABLE> <CAPTION> Accumulated Other Other Comprehensive Retained Capital Total Income Earnings Accounts --------- ------------- --------- -------- <S> <C> <C> <C> <C> Balance at December 31, 2000 $ 345,167 $ (854) $136,257 $ 209,764 Comprehensive income Net income 8,196 -- 8,196 -- Other comprehensive income, net of tax Unrealized gains on securities, net of reclassification adjustment of $1,334 for gains included in net income, and unrealized gains attributable to minority interests of $442 16,533 16,533 -- -- --------- Comprehensive income 24,729 Common stock issued for compensation 19 -- -- 19 Stock options exercised 164 164 Equity issued in consolidation: Common stock issued to Professionals Group shareholders 49,495 -- -- 49,495 Fair value of options assumed 2,952 -- -- 2,952 Purchase of treasury stock (1,324) -- -- (1,324) --------- -------- --------- -------- Balance at September 30, 2001 $ 421,202 $ 15,679 $144,453 $ 261,070 -======== ======== ========= ======== <CAPTION> Accumulated Other Other Comprehensive Retained Capital Total Income Earnings Accounts --------- ------------- --------- -------- <S> <C> <C> <C> <C> Balance at December 31, 1999 $ 325,724 $(5,424) $111,957 $ 219,191 Comprehensive income Net income 19,300 -- 19,300 -- Other comprehensive income, net of tax Unrealized gains on securities, net of reclassification adjustment of $473 for gains included in net income 3,239 3,239 -- -- --------- Comprehensive income 22,539 Common stock issued for compensation 40 -- -- 40 Purchase of treasury stock (8,830) -- -- (8,830) --------- -------- --------- ------- Balance at September 30, 2000 $ 339,462 $(2,185) $131,257 $ 210,401 -======== ======== ========= ======= </TABLE> 4 See accompanying notes.
PROASSURANCE CORPORATION AND SUBSIDIARIES Condensed Consolidated Statements of Income (Unaudited) (in thousands, except per share data) <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30 September 30 ------------------------ ------------------------- 2001 2000 2001 2000 --------- -------- --------- --------- <S> <C> <C> <C> <C> Revenues: Gross premiums written $ 132,177 $ 62,371 $ 262,605 $ 167,849 ========= ======== ========= ========= Premiums earned $ 127,033 $ 56,901 $ 250,178 $ 157,472 Premiums ceded (21,541) (12,338) (48,464) (31,795) --------- -------- --------- --------- Net premiums earned 105,492 44,563 201,714 125,677 Net investment income 20,226 10,072 40,164 29,679 Other income 2,487 810 4,727 2,679 --------- -------- --------- --------- Total revenues 128,205 55,445 246,605 158,035 Expenses: Losses and loss adjustment expenses 124,764 49,105 240,192 132,147 Reinsurance recoveries (23,425) (8,620) (48,064) (25,826) --------- -------- --------- --------- Net losses and loss adjustment expenses 101,339 40,485 192,128 106,321 Underwriting, acquisition and insurance expenses 22,812 9,145 46,058 28,857 Interest expense 1,533 -- 1,616 -- --------- -------- --------- --------- Total expenses 125,684 49,630 239,802 135,178 --------- -------- --------- --------- Income before income taxes and minority interest 2,521 5,815 6,803 22,857 Provision for income taxes: Current expense (benefit) 1,065 1,528 (320) 3,243 Deferred expense (2,291) (913) (1,884) 314 --------- -------- --------- --------- (1,226) 615 (2,204) 3,557 --------- -------- --------- --------- Income before minority interest 3,747 5,200 9,007 19,300 --------- -------- --------- --------- Minority interest (811) -- (811) -- --------- -------- --------- --------- Net income $ 2,936 $ 5,200 $ 8,196 $ 19,300 ========= ======== ========= ========= Earnings per share: Net income--basic and diluted $ 0.11 $ 0.22 $ 0.35 $ 0.83 ========= ======== ========= ========= Weighted average number of common shares outstanding--basic and diluted 25,791 23,405 23,745 23,329 ========= ======== ========= ========= </TABLE> See accompanying notes. 5
PROASSURANCE CORPORATION AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (Unaudited) (in thousands) <TABLE> <CAPTION> Nine Months Ended September 30 ------------------------ 2001 2000 --------- -------- <S> <C> <C> OPERATING ACTIVITIES Net cash provided by operating activities $ 49,760 $ 24,863 INVESTING ACTIVITIES Purchases of fixed maturities available for sale (462,767) (83,289) Purchases of equity securities available for sale (4,924) (33,923) Proceeds from sale or maturities of fixed maturities available for sale 448,035 93,273 Proceeds from sale of equity securities available for sale 12,562 8,913 Net decrease in short-term investments 49,863 4,569 Cash used in consolidation (196,304) -- Cash acquired in consolidation 72,245 -- Other (2,003) (6,533) --------- -------- Net cash used by investing activities (83,293) (16,990) FINANCING ACTIVITIES Proceeds from long term debt 110,000 -- Repayment of debt (25,000) -- Purchase of treasury stock (1,319) (8,770) --------- -------- Net cash provided by financing activities 83,681 (8,770) Increase (decrease) in cash and cash equivalents 50,148 (897) Cash and cash equivalents at beginning of period 8,550 19,409 --------- -------- Cash and cash equivalents at end of period $ 58,698 $ 18,512 ========= ======== </TABLE> See accompanying notes. 6
PROASSURANCE CORPORATION AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements include the accounts of ProAssurance Corporation ("ProAssurance") and its subsidiaries (collectively the "Company"). ProAssurance is a holding company formed for the purpose of consolidating Medical Assurance, Inc. ("Medical Assurance") and Professionals Group, Inc. ("Professionals Group") as its wholly owned subsidiaries. Additional information about the consolidation is provided in Note 2. The financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2001 are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. 2. CONSOLIDATION OF MEDICAL ASSURANCE AND PROFESSIONALS GROUP ProAssurance Corporation was formed on June 27, 2001 in a transaction referred to hereafter as the consolidation ("consolidation"). The consolidation of Medical Assurance into ProAssurance was in the form of a corporate reorganization and was treated in a manner similar to a pooling of interests. Upon consummation of the consolidation, each outstanding share of Medical Assurance common stock, par value $1.00 per share, was converted into one share of ProAssurance common stock, par value $0.01 per share. Additionally, approximately 469,000 outstanding Medical Assurance options were converted into a like number of outstanding ProAssurance options. The consolidation of Professionals Group into ProAssurance was treated as a purchase transaction. Each outstanding share of Professionals Group common stock was converted into the right to receive, at the holder's election, either (i) 0.897 of a share of ProAssurance common stock plus $13.47 in cash, or (ii) $27.47 in cash. Approximately 22.6 million ProAssurance shares were issued to Medical Assurance shareholders. Aggregate consideration paid to the Professionals Group shareholders consisted of approximately $196 million in cash and 3.2 million shares of ProAssurance common stock, valued at approximately $50 million. The fair value of the ProAssurance shares issued was $15.59 per share based on the average Medical Assurance common stock price for a few days prior to June 27, 2001. Additionally, outstanding options of approximately 274,000 Professionals Group common shares were converted to outstanding options of approximately 482,000 ProAssurance common shares. The estimated fair value of the options issued was approximately $3 million. 7
PROASSURANCE CORPORATION AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) The total cost of the purchase transaction of approximately $252 million has been allocated to the assets acquired and the liabilities assumed based on estimates of their respective fair values. The estimated fair value of identifiable assets acquired totaled $1,165 million and the estimated fair value of the liabilities assumed totaled $931 million. The estimated excess of the total cost of the acquisition over the fair value of net assets acquired of approximately $18 million was recorded as goodwill. The preliminary fair value of Professionals Group's reserves for losses and loss adjustment expenses and related reinsurance recoverables was estimated based on the present value of the expected underlying cash flows of the loss reserves and reinsurance recoverables and includes a risk premium and a profit margin. In determining the preliminary fair value estimate, management discounted Professionals Group's historical GAAP undiscounted net loss reserves to present value assuming a 5% discount rate, which approximated the current U.S. Treasury rate at the date of consolidation. The discounting pattern was actuarially developed from Professionals Group's historical loss data. An expected profit margin of 5% was applied to the discounted loss reserves, which is consistent with management's understanding of the returns anticipated by the reinsurance market (the reinsurance market representing a willing party in the purchase of loss reserves). Additionally, for the professional liability loss reserves of Professionals Group, an estimated risk premium of 5% was applied to the discounted reserves, which is deemed to be reasonable and consistent with expectations in the marketplace given the long-tail nature and the related high degree of uncertainty of such reserves. For the personal lines loss reserves (homeowners and automobile) of Professionals Group, an estimated risk premium of 2% was applied to discounted loss reserves as such reserves develop over a much shorter period of time and, generally, are less volatile than professional liability reserves. ProAssurance funded the cash requirements of the consolidation with the proceeds of a $110 million term loan facility (see Note 8) and with internal funds generated from dividends paid to ProAssurance by Medical Assurance and Professionals Group at the time of closing. 8
PROASSURANCE CORPORATION AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) The Company is required to incorporate Professionals Group's activity commencing upon the effective date of the acquisition. The unaudited pro forma information below presents combined results of operations as if the acquisition had occurred at the beginning of the respective periods presented after giving effect to certain adjustments, including amortization of goodwill, increased interest expense on debt related to the acquisition and lower investment income due to cash used to fund a portion of the consolidation, and related tax effects. Professional Group's nonrecurring and transaction related expenses were also excluded from the pro forma financial information. The unaudited pro forma information is not necessarily indicative of the results of operations of the combined company had the acquisition occurred at the beginning of the periods presented, nor is it necessarily indicative of future results (in thousands, except per share data). <TABLE> <CAPTION> ProForma Results Nine Months Ended September 30 ------------------------------ 2001 2000 --------- -------- <S> <C> <C> Revenues $ 393,374 $359,004 ========= ======== Net income (loss) $ (11,643) $ 22,384 ========= ======== Net income (loss) per share Basic and Diluted $ (0.46) $ .84 ========= ======== </TABLE> 3. SEGMENT INFORMATION The Company operates in the United States of America and, prior to the consolidation, operated in only one reportable industry segment, which is providing professional liability insurance for physicians and surgeons, dentists, hospitals, and others engaged in the delivery of health care. The Company owns all the stock of The Medical Assurance Company, Inc., Medical Assurance of West Virginia, Inc., and ProNational Insurance Company ("ProNational"), which was acquired in the consolidation. These subsidiaries are property and casualty insurance companies that primarily provide professional liability insurance coverages and services to health care providers (the professional liability segment). As a result of the consolidation, the Company is now engaged in an additional segment, which is providing personal property and casualty insurance to individuals (the personal lines segment). At September 30, 2001, the Company owns 84.05% of the stock of MEEMIC Holdings, Inc. ("MEEMIC Holdings"), a publicly traded insurance holding company that provides personal auto, homeowners, boat and umbrella coverages primarily to educational employees and their families through its wholly-owned subsidiary, MEEMIC Insurance Company. 9
PROASSURANCE CORPORATION AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) The accounting policies are consistent with those described in the basis of presentation footnote of the Company's consolidated financial statements. Identifiable assets of the Company are primarily cash and marketable securities. Other than cash and marketable securities owned directly by the parent company, the identifiable assets of the Company are allocated to the reportable operating segments. Other than investment income earned directly by the parent company and interest expense related to long-term debt held by the parent, all revenues and expenses of the Company are allocated to the operating segments for purposes of Statement of Financial Accounting Standard No. 131, Disclosures about Segments of an Enterprise and Related Information. Revenue is primarily from unaffiliated customers. The table below provides a reconciliation of segment information to total consolidated information (in millions). <TABLE> <CAPTION> Three months ended Nine months ended September 30 September 30 ----------------------------- ----------------------------- 2001 2000 2001 2000 --------- --------- --------- --------- <S> <C> <C> <C> <C> Revenues: Professional liability lines $ 90.1 $ 55.4 $ 208.5 $ 158.0 Personal lines 37.7 -- 37.7 -- Corporate and other 0.4 -- 0.4 -- --------- --------- --------- --------- Total revenues $ 128.2 $ 55.4 $ 246.6 $ 158.0 ========= ========= ========= ========= Net Income (Loss): Professional liability lines $ (0.3) $ 5.2 $ 4.9 $ 19.3 Personal lines 4.0 -- 4.0 -- Corporate and other (0.8) -- (0.7) -- --------- --------- --------- --------- Total net income (loss) $ 2.9 $ 5.2 $ 8.2 $ 19.3 ========= ========= ========= ========= <CAPTION> September 30 --------------------------- 2001 2000 --------- --------- <S> <C> <C> Identifiable Assets: Professional liability lines $ 2,013.8 $ 1,150.4 Personal lines 261.0 -- Corporate and other -- -- --------- --------- Total assets $ 2,274.8 $ 1,150.4 ========= ========= </TABLE> 10
PROASSURANCE CORPORATION AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) 4. INVESTMENTS Proceeds from sales of investments in fixed maturities and equity securities available for sale were approximately $362.5 million and $64.8 million for the nine month periods ended September 30, 2001 and 2000, respectively. Gross realized gains on such sales were approximately $3.7 million and $2.6 million for the nine month periods ended September 30, 2001 and 2000, respectively; gross realized losses on such sales were approximately $2.1 million and $1.9 million for the nine month periods ended September 30, 2001 and 2000, respectively. Realized gains and losses are included as a component of other income. The amortized cost of fixed maturities and equity securities available for sale was $1,413.7 million and $685.7 million at September 30, 2001 and December 31, 2000, respectively. 5. RESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES The reserves were evaluated and reflect consideration of prior loss experience and changes in the frequency and severity of claims. Actual incurred losses may vary from estimated amounts due to the inherent difficulty in estimating development of long-tailed lines of business. Because of the increasing trends in severity and frequency of professional liability claims recognized by the Company, the average ultimate payment of indemnity and loss adjustment expenses for recent accident years appears likely to exceed comparable averages for previous years per exposure unit. Although such average remains within the level contemplated by the previously established reserves, the Company did not recognize any favorable prior year development during the three and nine months ended September 30, 2001 versus $5.0 million and $22.5 million recognized during the comparable periods of 2000. The Company's management believes the unearned premiums under contracts, together with the related anticipated investment income to be earned, is adequate to discharge the related contract liabilities. 6. DEFERRED POLICY ACQUISITION COSTS Costs that vary with and are directly related to the production of new and renewal premiums (primarily premium taxes, commissions and underwriting salaries) are deferred to the extent they are recoverable against unearned premiums and are amortized as related premiums are earned. Amortization of deferred acquisition costs, net of ceding commissions earned, amounted to approximately $25.2 million and $15.5 million for the nine months ended September 30, 2001 and 2000, respectively. 11
PROASSURANCE CORPORATION AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) 7. INCOME TAXES The provision for income taxes is different from that which would be obtained by applying the statutory Federal income tax rate to income (loss) before taxes because much of the Company's investment income is tax-exempt. 8. LONG-TERM DEBT On June 27, 2001, the Company borrowed $110 million under a term loan facility in order to fund the consolidation. The debt bears interest at a variable rate based on the London Interbank Offered Rate (LIBOR) or the bank's base rate as elected from time to time by the Company. At September 30, 2001 the interest rate was 4.35%. The debt requires quarterly principal repayments of $2.5 million. Beginning in 2003, the Company must also repay an annual installment equal to the lesser of $15 million or the amount by which 50% of the adjusted parent-only annual cash flow of the Company exceeds the minimum quarterly payments for such year. On September 30, 2001 the Company made a $25 million payment, including a $22.5 million prepayment, on the debt thereby reducing the principal balance to $85 million. Excluding annual cash flow repayments, the remaining aggregate amounts of maturities of long-term debt for the next five years are as follows: 2001, $5 million; 2002 through 2004, $10 million each year; and 2005 the remaining balance becomes due on September 30. The term loan is part of a credit facility provided to the Company by a bank syndicate under the terms of a credit agreement that also provides for a line of credit in the amount of $40 million. Borrowings under the line of credit are repayable in full in two years, subject to renewal. The Company has not borrowed any funds under the line of credit. The credit agreement, as is customary for credit agreements of this size and nature, requires the Company to maintain certain financial standards, otherwise known as loan covenants, of which the Company was in compliance with as of September 30, 2001. 9. STOCKHOLDERS' EQUITY AND EARNINGS PER SHARE ProAssurance Corporation has 100 million shares of authorized common stock and 50 million shares of authorized preferred stock. The Board of Directors has the authorization to determine the provisions for the issuance of shares of the preferred stock, including the number of shares to be issued and the designations, powers, preferences and rights and the qualifications, limitations or restrictions of such shares. At September 30, 2001, the Board of Directors had not authorized the issuance of any preferred stock nor determined any provisions for the preferred stock. 12
PROASSURANCE CORPORATION AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) 10. COMMITMENTS AND CONTINGENCIES The Company is involved in various legal actions arising primarily from claims related to insurance policies. At other times legal actions may arise from claims asserted by policyholders. The legal actions arising from these claims have been considered by the Company in establishing its reserves. While the outcome of all legal actions is not presently determinable, the Company's management is of the opinion, based on consultation with legal counsel, that the settlement of these actions will not have a material adverse effect on the Company's financial position or results of operations. 11. NEW ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets, which supersedes Opinion 17, Intangible Assets. Both statements are effective for fiscal years beginning after December 15, 2001. The new rules address how goodwill and other intangible assets should be accounted for in financial statements upon acquisition and how these items should be accounted for subsequent to acquisition. Contrary to Opinion 17, SFAS No. 142 does not presume that goodwill and all other intangible assets are wasting assets requiring amortization. Instead, goodwill and intangible assets that have indefinite useful lives will be tested at least annually for impairment. If goodwill and intangible assets are deemed to be impaired, the change will be charged through the Statement of Income. SFAS No. 142 requires additional disclosure of information about goodwill and other intangible assets in the years subsequent to their acquisition. Intangible assets affected by this pronouncement totaled $23 million at September 30, 2001, including $18 million of goodwill resulting from the consolidation. The Company has determined there are no impaired intangible assets as of September 30, 2001. Thus, adopting these pronouncements would not affect the current results of operations with any additional charges for impairment, but would eliminate amortization expense recorded related to such intangibles. For the three and nine months ended September 30, 2001 the related amortization expense totaled $0.2 million and $0.5 million, respectively. 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS LIQUIDITY AND CAPITAL RESOURCES The payment of losses, loss adjustment expenses (LAE), and operating expenses in the ordinary course of business and debt service are currently the Company's principal need for liquid funds. Cash provided from the ordinary course of business was sufficient during the first nine months of 2001 to meet those needs, and the Company believes those sources will be sufficient to meet its cash needs for at least the next twelve months. The Company believes that its reserves for losses and LAE are adequate to discharge outstanding contractual liabilities. On June 27, 2001, Medical Assurance and Professionals Group became wholly owned subsidiaries of ProAssurance, a newly formed holding company. On June 28, 2001, ProAssurance common stock began trading on the New York Stock Exchange under the symbol "PRA" and the common stock of Medical Assurance and Professionals Group was delisted from the New York Stock Exchange and NASDAQ National Market, respectively. See Note 2 of the Notes to Condensed Consolidated Financial Statements for more information concerning the consolidation. ProAssurance funded the cash requirements of the consolidation with the proceeds of a $110.0 million term loan and with internal funds generated from dividends paid by Medical Assurance and Professionals Group at the time of closing. See Note 8 of the Notes to Condensed Consolidated Financial Statements for more information regarding the term loan. The term loan was made pursuant to a credit agreement with the lending banks, a copy of which was filed as an exhibit to the ProAssurance Form 8-K/A dated May 18, 2001. The cash requirements of the consolidation were less than originally anticipated by management because fewer Professionals Group shareholders elected to receive an all-cash distribution. On September 30, 2001 the Company made a $22.5 million prepayment against the term loan as well as the required quarterly repayment of $2.5 million. As a result, the Company anticipates that both interest expense and investment income will be reduced in future periods as compared to the third quarter of 2001. The Company's long-term debt is held and serviced by the parent holding company, ProAssurance, substantially all of whose cash flow is derived from the dividends of its operating insurance subsidiaries. The Company anticipates being able to meet debt service requirements over the next twelve months without additional regulatory approval for dividends. The Company did not repurchase any of its shares during the third quarter but has a total of 1.03 million shares remaining from stock repurchase authorizations granted to Medical Assurance prior to the consolidation. These authorizations will be used to repurchase ProAssurance shares. 14
RESULTS OF OPERATIONS--OVERVIEW The Company operates in the United States of America in two reportable insurance industry segments: professional liability and personal lines. The Company's professional liability insurance segment provides professional liability insurance for physicians and surgeons, dentists, hospitals, and others engaged in the delivery of health care. This segment is principally made up of its three operating insurance subsidiaries: The Medical Assurance Company, Inc., ProNational Insurance Company and Medical Assurance of West Virginia, Inc. ProNational was acquired on June 27, 2001 as a result of the Company's consolidation. The professional liability segment also includes accident and health, workers compensation and multi-line insurance. The Company has curtailed its participation in these lines of business and expects substantial reductions in premiums written over the next twelve months. Earned premiums will taper off more slowly, reflecting the written premium volumes of earlier periods. The Company's personal lines insurance segment provides personal property and casualty insurance to individuals. The Company's personal lines segment includes the operations of a single insurance company, MEEMIC Insurance Company, acquired on June 27, 2001 as a result of the Company's consolidation. All revenues and expenses of the Company are allocated to the operating segments, other than investment income earned directly by the parent company and interest expense related to long-term debt held by the parent. All of the interest expense is attributable to the long-term debt incurred by the parent corporation in the consolidation. 15
RESULTS OF OPERATIONS - PROFESSIONAL LIABILITY INSURANCE SEGMENT Unaudited financial data for the Company's professional liability insurance segment for the three and nine months ended September 30, 2001 and 2000 are summarized in the table below (in thousands). <TABLE> <CAPTION> THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 ------------------------------------ -------------------------------------- INCREASE INCREASE 2001 2000 (DECREASE) 2001 2000 (DECREASE) -------- -------- -------- --------- --------- --------- <S> <C> <C> <C> <C> <C> <C> Gross premiums written $ 95,458 $ 62,371 $ 33,087 $ 225,886 $ 167,849 $ 58,037 ======== ======== ======== ========= ========= ======== Revenues: Premiums earned $ 91,757 56,901 $ 34,856 $ 214,902 157,472 $ 57,430 Premiums ceded (21,125) (12,338) (8,787) (48,048) (31,795) (16,253) -------- ------ -------- --------- ------- -------- Net premiums earned 70,632 44,563 26,069 166,854 125,677 41,177 Net investment income 17,344 10,072 7,272 37,226 29,679 7,547 Other income 2,134 810 1,324 4,376 2,679 1,697 -------- ------ -------- --------- ------- -------- Total revenues 90,110 55,445 34,665 208,456 158,035 50,421 Expenses: Net losses and loss adjustment expenses 78,208 40,485 37,723 168,997 106,321 62,676 Underwriting, acquisition and insurance expenses 14,749 9,145 5,604 37,995 28,857 9,138 -------- ------ -------- --------- ------- -------- Total expenses 92,957 49,630 43,327 206,992 135,178 71,814 -------- ------ -------- --------- ------- -------- Income (loss) before income taxes (2,847) 5,815 (8,662) 1,464 22,857 (21,393) ======== ====== ======== ========= ======= ======== </TABLE> Premiums Premiums written: Two factors have a pervasive impact on the results of operations for the three and nine month periods ended September 30, 2001, as compared to the same periods of 2000. First, Professionals Group's operating results have been included in Company results since the effective date of the consolidation (accounted for as a purchase transaction) on June 27, 2001. Substantially all of the increase in premiums written for the three month period is attributable to this consolidation. 16
Second, the Company has continued to implement rate increases based on current loss trends (see discussion under "Losses"); additional rate increases are planned. However, the higher rates may result in a greater loss of insureds in future periods. To date, premiums renewed at the higher rates coupled with new business have substantially offset the effect of premiums lost due to higher rates. Rate increases implemented after October 1, 2000 have not yet been fully reflected in earned premiums since premiums are earned over the entire policy period (usually one-year) after the policy is written. The additional increase in premiums written for the nine month period ending September 30, 2001 is principally attributable to the effect of rate increases. Net premiums earned: As with written premiums, the increase in earned premiums for the three month period ended September 30, 2001 is primarily attributable to the consolidation. The increase for the nine month period ended September 30, 2001 beyond the consolidation increase is due to new business and to premiums earned at higher rates, offset by premiums not renewed. The Company purchases reinsurance to provide for greater diversification of business, allow management to control exposure to potential losses arising from large risks and provide capacity for additional growth. Premiums ceded are estimated based on the terms of the respective reinsurance agreements. The estimated expense is continually reviewed and any adjustments that become necessary are included in current operations. Approximately 50% and 30% of the increase in ceded premiums earned for the three and nine month periods ended September 30, 2001, respectively, is due to the consolidation. The remaining increase for both the three and nine month periods is due to higher cessions of Medical Assurance premiums. Beginning with the fourth quarter of 2000, Medical Assurance increased its cessions to reinsurers in certain states, i.e. decreased its retention. Additionally, in the third quarter of 2001 there was a shift such that a higher proportion of the Company's earned premiums were subject to reinsurance. Thus Medical Assurance ceded premiums earned have increased throughout the nine month period with a more pronounced effect occurring in the third quarter. Included in net earned premiums for the nine month periods ended September 30, 2001, and 2000 are accident and health, workers compensation and multi-line premiums of approximately $30.8 million and $23.0 million, respectively. The Company has previously disclosed its commitment to discontinue writing most of these premiums and expects substantially decreased premiums from this source in future periods. The increase primarily reflects higher rates charged on this business. 17
Losses Consolidated losses and loss adjustment expenses (losses) and the related current accident year loss ratio are summarized in the following table (dollars in thousands). The current accident year loss ratio is calculated by dividing current accident year incurred losses by net premiums earned. <TABLE> <CAPTION> Three months ended Nine months ended September 30 September 30 ------------------------ -------------------------- 2001 2000 2001 2000 --------- -------- --------- --------- <S> <C> <C> <C> <C> Incurred loss related to: Current accident year $ 78,208 $ 45,485 $ 168,997 $ 128,821 Prior accident years -- (5,000) -- (22,500) --------- -------- --------- --------- Net incurred loss $ 78,208 $ 40,485 $ 168,997 $ 106,321 ========= ======== ========= ========= Current accident year net loss ratio 111% 102% 101% 103% ========= ======== ========= ========= </TABLE> Losses incurred include two components: a) actuarial evaluation of incurred loss levels for the current accident year and b) actuarial re-evaluation of incurred loss levels for prior accident years. These components take into consideration prior loss experience, loss trends and changes in the frequency and severity of claims. Any adjustments related to previously established amounts are included in current operations. The increase in current year net losses for both the three and nine month periods is primarily due to the losses incurred related to the additional premiums earned as a result of the Professionals Group consolidation. Company losses for the nine months ended September 30, 2001 only include Professionals Group losses since the consolidation date of June 27, 2001 and thus are not indicative of the results that would have been obtained had the consolidation occurred January 1, 2001. The increase in the current year net loss ratio for the comparative three month period is principally due to the consolidation. The Company implemented rate increases based on current loss trends (see below); additional rate increases are planned. Rate increases implemented after October 1, 2000 have not yet been fully reflected in earned premiums since premiums are earned over the entire policy period (usually one-year) after the policy is written. The Company expects its loss ratio to decrease as these historical and prospective rate increases are earned, provided the loss costs do not exceed those projected in the rate filings. 18
Because of increasing trends in severity and frequency of claims, the average ultimate payment of indemnity and loss adjustment expenses for recent accident years appears likely to exceed comparable averages for previous years per exposure unit. Although such average remains within the level contemplated by the previously established reserves, the Company did not recognize any favorable prior year development during the three and nine months ended September 30, 2001. Claims are resolved over an extended number of years and a number of these claims are litigated. Management uses its best estimate in establishing its loss reserves, but during the extended period in which claims are resolved, the legal environment and other factors may change. Consequently, ultimate losses are inherently difficult to estimate and actual results may vary from the estimated amounts. Given the large volume of loss reserves at any balance sheet date, a small change in the estimate of those reserves can have a significant effect on current operations. Investment Income The increase in investment income for both the three and the nine month periods ended September 30, 2001 as compared to the same periods of 2000 is due to the increase in invested assets that resulted from the consolidation of Professionals Group. The weighted average investment yield for the fixed maturity portfolio at September 30, 2001 was approximately 5.8%. The composition of the portfolio is continually reviewed to achieve a high level of after-tax return while minimizing risk. Underwriting, Acquisition and Insurance Expenses The increase in underwriting, acquisition and insurance expenses for the three month period is primarily due to the consolidation. The Company is required by most states to be a member of its insolvency or guaranty fund association and, as such, must make payments to the association when so assessed by the state. Third quarter expenses also include approximately $500,000 of state guarantee fund assessments that have no counterpart in the third quarter of 2000. The increase in underwriting, acquisition and insurance expenses shown for the nine month period is due both to the Professionals Group consolidation, as discussed, and to higher acquisition expenses incurred during the first two quarters of 2001 related to accident and health and multi-line premiums. The Company has previously disclosed its commitment to discontinue writing most of these policies and expects substantially decreased premiums and expenses from this source in future periods. 19
RESULTS OF OPERATIONS - PERSONAL LINES INSURANCE OPERATIONS SEGMENT Unaudited financial data for the Company's personal lines insurance segment for the three months ended September 30, 2001 are summarized in the table below (in thousands). <TABLE> <S> <C> Gross premiums written $ 36,719 ======== Revenues: Premiums earned $ 35,276 Premiums ceded (416) -------- Net premiums earned 34,860 Net investment income 2,498 Other income 352 -------- Total revenues 37,710 Expenses: Net losses and loss adjustment expenses 23,131 Underwriting, acquisition and insurance expenses 8,063 -------- Total expenses 31,194 -------- Income before income taxes and minority interest $ 6,516 ======== </TABLE> The Company's personal lines segment is comprised of the operations of a single insurance company, MEEMIC Insurance Company, acquired on June 27, 2001 as a result of the Company's consolidation. MEEMIC is a property casualty insurance company that writes private passenger automobile, homeowner, boat and umbrella insurance products for individuals. MEEMIC Insurance Company is a wholly-owned subsidiary of MEEMIC Holdings, Inc., which in turn is an 84.05% owned subsidiary of Professionals Group and the Company. MEEMIC Holdings, Inc. is publicly traded on the NASDAQ National Market (symbol "MEMH"). For additional information about MEEMIC and comparative analysis to periods prior to the Company's consolidation, see the MEEMIC Holdings, Inc. September 30, 2001 quarterly report on Form 10Q filed with the Securities and Exchange Commission. 20
Net premiums written and net premiums earned for MEEMIC are as follows: <TABLE> <CAPTION> THREE MONTHS ENDED SEPTEMBER 30 2001 ------------------- <S> <C> Net premiums written: Personal automobile $30,702 Homeowners 5,464 Boat 128 Umbrella 1 ------- Total $36,295 ======= Net premiums earned: Personal automobile $30,639 Homeowners 4,137 Boat 83 Umbrella 1 ------- Total $34,860 ======= </TABLE> Net losses and LAE for MEEMIC are as follows: <TABLE> <CAPTION> THREE MONTHS ENDED SEPTEMBER 30 2001 ------------------------------- Losses % of Earned and LAE Premiums --------- ------------ <S> <C> <C> Net Losses: Personal automobile $17,765 58.0% Homeowners 2,944 71.2% Boat 48 57.8% ------- Total net losses $20,757 59.5% Loss adjustment expenses (LAE) 2,374 6.8% ------- Total net losses and LAE $23,131 66.4% ======= </TABLE> Investment income for the three months ended September 30, 2001 was attributable primarily to interest income. The weighted average investment yield for the three month period ended September 30, 2001 was 5.0%. 21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to various market risks, including both interest rate risk and equity price risk. Interest rate risk represents the risk of changes in value of a financial instrument caused by fluctuations in market interest rates. The Company handles market risks in accordance with its established investment policies. The goal of these policies is to implement a strategic asset allocation that maximizes the long-term rate of return at a minimum level of risk given a set of asset classes and restrictions. Market risk control relates principally to ratings of issuers and length to maturity. The Company does not enter into derivative transactions. At September 30, 2001, fixed maturity securities totaling $1,334 million, at fair value, including unrealized gains of $33.2 million, comprised 88% of the Company's invested assets of $1,522 million. Thus, the most significant market risk to the Company is interest rate risk related to the fixed maturity portfolio. The Company generally believes it is in a position to keep these investments until final maturity and does not invest in fixed maturity securities for trading purposes. Nevertheless, fluctuations in market interest rates may significantly impact the fair value of this portfolio. Modified duration is one common measure of the interest-sensitivity of fixed-maturity securities. Stated simply, modified duration is a calculation that takes stated maturity, yields and call features into consideration to predict an average age of expected cash flows related to a security. The Company estimates that the fair value of its fixed maturity portfolio and the weighted average modified duration would respond to fluctuations in market interest rates as follows: <TABLE> <CAPTION> Portfolio Change in Modified Interest Value Value Duration Rates $ Millions $ Millions Years ---------- ---------- -------- <S> <C> <C> <C> +2% $1,216 -$118 4.31 +1% $1,273 -$ 61 4.26 Current rate* $1,334 $ 0 4.09 -1% $1,390 $ 56 3.94 -2% $1,453 $119 3.95 </TABLE> *Current rates are as of September 30, 2001. At September 30, 2001 the fair value of the Company's investment in common stocks, excluding preferred stocks as discussed in the following paragraph, was $44.9 million, which included net unrealized losses of $10.6 million. These securities are subject to equity price risk. A hypothetical 10% increase in the market prices as of September 30, 2001 would increase the fair value of these securities to $49.4 million; a hypothetical 10% decrease would reduce the fair value to $40.4 million. The selected hypothetical change does not reflect what could be considered the best or worst scenarios. 22
At September 30, 2001 the Company had investments in preferred stocks carried at fair value of $59.1 million, which included net unrealized gains of $2.2 million. These securities carry fixed rates of return and thus, like fixed maturities, are primarily subject to interest rate risk. The fixed maturities table above does not include preferred stocks. The Company's cash and short-term investment portfolio at September 30, 2001 was on a cost basis which approximates its fair value. This portfolio lacks significant market rate sensitivity due to its short duration. FORWARD LOOKING STATEMENTS The U.S. securities laws, including the Private Securities Litigation Reform Act of 1995, provide a "safe harbor" for certain forward-looking statements. This report contains forward-looking statements (identified by words such as, but not limited to, "believe", "expect", "intend", "anticipate", "estimate" "project" and other analogous expressions) including statements concerning: liquidity and capital requirements, losses and loss reserves, premium rates and retention of current business, competition, the expansion of product lines, the development or acquisition of business in new areas, the consolidation with Medical Assurance and Professionals Group and other matters. These forward-looking statements are based upon the Company's estimates and anticipation of future events that are subject to certain risks and uncertainties that could cause actual results to vary materially from the expected results described in the forward-looking statements. Due to such risks and uncertainties, readers are urged not to place undue reliance on forward-looking statements. All forward-looking statements included in this document are based upon information available to the Company on the date hereof and the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Risks which could adversely affect the Company's operations and/or cause actual results to differ materially from anticipated results include, but are not limited to, the following: - underwriting losses on the risks the Company insures are higher or lower than expected; - unexpected changes in loss trends which might require the reevaluation of the liability for loss and loss adjustment expenses, thus resulting in an increase or decrease in the liability and a corresponding adjustment to earnings; - the Company's ability to retain current business, acquire new business, expand product lines and a variety of other factors affecting daily operations such as, but not limited to, economic, legal, competitive and market conditions which may be beyond the Company's control and are thus difficult or impossible to predict; - changes in the interest rate environment and/or the securities markets that adversely impact the fair value of the Company's investments or operations; - inability of the Company to achieve continued growth through expansion into other states or through acquisitions or business combinations; - general economic conditions that are worse than anticipated; - inability to obtain regulatory approval of, or to implement, premium rate increases; 23
- changes in the legal system that affect the frequency and severity of claims; - significantly increased competition among insurance providers and related pricing weaknesses in some markets; - changes in the availability, cost, quality, or collectibility of reinsurance; and - regulatory and legislative actions or decisions that adversely affect the Company. For every forward-looking statement, the Company claims the protection of the safe harbor for forward-looking statements under the Private Securities Litigation Reform Act of 1995. PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits. Release and Severance Compensation Agreement between Lynn M. Kalinowski and MEEMIC Holdings, Inc. dated July 1, 2001. Release and Severance Compensation Agreement between William P. Sabados and MEEMIC Holdings, Inc dated July 1, 2001. (b) Reports on 8-K. Report on Form 8-K dated July 12, 2001 reporting the completion of the consolidation of Medical Assurance, Inc. and Professionals Group by ProAssurance Corporation. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant had duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ProAssurance Corporation November 12, 2001 By: /s/ Howard H. Friedman ----------------------------- Howard H. Friedman, Chief Financial Officer (Duly authorized officer and principal financial officer) 24