PROCENTURY CORPORATION 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 |
For the quarterly period ended June 30, 2006
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 |
For the transition period from to .
000-50641
(Commission File Number)
PROCENTURY CORPORATION
(Exact name of Registrant as specified in its charter)
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Ohio
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31-1718622 |
(State or other jurisdiction of
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(I.R.S. Employer Identification No.) |
incorporation or organization) |
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465 Cleveland Avenue |
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Westerville, Ohio
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43082 |
(Address of principal executive offices)
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(Zip Code) |
(614) 895-2000
(Registrants telephone number, including area code)
Indicate by check mark whether 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 report(s)), and (2) has been
subject to such filing requirements for the past 90 days.
YES R NO £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated
filer in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer £ Accelerated filer R Non-accelerated filer £
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Act).
£ Yes R No
As of August 7, 2006, the registrant had 13,211,619 outstanding Common Shares, without par
value.
PROCENTURY CORPORATION
QUARTERLY REPORT ON FORM 10-Q
For the Quarterly Period Ended June 30, 2006
INDEX
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Page |
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3 |
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4 |
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5 |
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6 |
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7 |
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21 |
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33 |
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33 |
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34 |
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34 |
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34 |
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34 |
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34 |
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34 |
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34 |
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36 |
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2
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
PROCENTURY CORPORATION AND SUBSIDIARIES
Consolidated Condensed Statements of Operations
(Unaudited)
(In thousands, except per share data)
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Three Months |
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Six Months |
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Ended June 30, |
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Ended June 30, |
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2006 |
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2005 |
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2006 |
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2005 |
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Premiums earned |
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$ |
52,565 |
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43,025 |
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101,567 |
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84,545 |
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Net investment income |
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4,689 |
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3,495 |
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9,115 |
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6,654 |
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Net realized investment losses |
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(62 |
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(94 |
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(41 |
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(153 |
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Total revenues |
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57,192 |
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46,426 |
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110,641 |
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91,046 |
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Losses and loss expenses |
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32,575 |
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26,587 |
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63,014 |
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52,314 |
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Amortization of deferred policy acquisition costs |
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12,896 |
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10,335 |
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24,962 |
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20,555 |
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Other operating expenses |
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4,075 |
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3,474 |
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7,998 |
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6,539 |
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Severance expense |
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793 |
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Interest expense |
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567 |
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459 |
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1,110 |
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876 |
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Total expenses |
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50,113 |
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40,855 |
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97,084 |
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81,077 |
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Income before income tax |
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7,079 |
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5,571 |
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13,557 |
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9,969 |
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Income tax expense |
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2,054 |
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1,572 |
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3,932 |
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2,891 |
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Net income |
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$ |
5,025 |
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3,999 |
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9,625 |
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7,078 |
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Basic net income per share |
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$ |
0.38 |
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0.31 |
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0.73 |
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0.54 |
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Diluted net income per share |
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$ |
0.38 |
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0.30 |
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0.73 |
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0.54 |
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Weighted average of shares outstanding basic |
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13,114,535 |
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13,052,650 |
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13,107,620 |
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13,049,570 |
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Weighted average of shares outstanding diluted |
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13,247,528 |
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13,121,314 |
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13,224,050 |
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13,127,469 |
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Cash dividend per share |
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$ |
0.035 |
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0.02 |
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0.065 |
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0.04 |
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See accompanying notes to the unaudited consolidated condensed financial statements.
3
PROCENTURY CORPORATION AND SUBSIDIARIES
Consolidated Condensed Balance Sheets
(Unaudited)
(In thousands, except share data)
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June 30, |
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December 31, |
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2006 |
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2005 |
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Assets |
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Investments |
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Fixed maturities: |
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Available-for-sale, at fair value
(amortized cost 2006, $334,972; 2005, $306,237) |
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$ |
325,278 |
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$ |
302,632 |
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Held-to-maturity, at amortized cost
(fair value 2006, $1,091; 2005, $1,118) |
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1,121 |
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1,128 |
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Equities (available-for-sale): |
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Equity securities, at fair value (cost 2006, $29,383; 2005, $27,521) |
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28,447 |
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26,941 |
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Bond mutual funds, at fair value (cost 2006, $14,367; 2005, $18,516) |
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13,797 |
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17,852 |
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Short-term investments, at amortized cost |
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11,621 |
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12,229 |
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Total investments |
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380,264 |
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360,782 |
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Cash and cash equivalents |
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8,892 |
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5,628 |
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Premiums in course of collection, net |
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15,359 |
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14,849 |
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Deferred policy acquisition costs |
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22,906 |
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20,649 |
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Prepaid reinsurance premiums |
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10,282 |
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10,989 |
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Reinsurance recoverable on paid losses, net |
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8,001 |
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6,422 |
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Reinsurance recoverable on unpaid losses, net |
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41,694 |
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37,448 |
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Deferred federal income tax asset |
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12,290 |
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9,151 |
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Income tax recoverable |
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321 |
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Other assets |
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9,706 |
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8,227 |
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Total assets |
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$ |
509,715 |
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$ |
474,145 |
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Liabilities and Shareholders Equity |
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Loss and loss expense reserves |
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$ |
234,951 |
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$ |
211,647 |
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Unearned premiums |
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102,277 |
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95,631 |
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Long term debt |
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25,000 |
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25,000 |
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Accrued expenses and other liabilities |
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6,744 |
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6,893 |
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Reinsurance balances payable |
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3,786 |
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2,572 |
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Collateral held |
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10,453 |
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11,014 |
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Income taxes payable |
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185 |
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Total liabilities |
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383,211 |
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352,942 |
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Shareholders equity: |
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Common stock, without par value: |
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Common shares Issued and outstanding 13,211,619 shares at
June 30, 2006 and 13,211,019 shares at December 31, 2005 |
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Additional paid-in capital |
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100,171 |
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100,202 |
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Retained earnings |
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33,611 |
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24,846 |
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Unearned compensation |
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(695 |
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Accumulated other comprehensive loss, net of taxes |
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(7,278 |
) |
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(3,150 |
) |
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Total shareholders equity |
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126,504 |
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121,203 |
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Total liabilities and shareholders equity |
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$ |
509,715 |
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$ |
474,145 |
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See accompanying notes to the unaudited consolidated condensed financial statements.
4
PROCENTURY CORPORATION AND SUBSIDIARIES
Consolidated Condensed Statements of Shareholders Equity
and Comprehensive Income
(Unaudited)
(In thousands)
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Six Months Ended June 30, |
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2006 |
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2005 |
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Shareholders Equity |
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Capital stock: |
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Beginning of period |
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$ |
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Stock issued |
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End of period |
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Additional paid-in capital: |
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Beginning of period |
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100,202 |
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|
100,103 |
|
Impact of adoption of SFAS 123R |
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(695 |
) |
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Shares issued under share compensation plans |
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613 |
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63 |
|
Exercise of share options |
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6 |
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Tax benefit on share compensation plans |
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45 |
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End of period |
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|
100,171 |
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|
100,166 |
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Retained earnings: |
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Beginning of period |
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|
24,846 |
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|
|
15,727 |
|
Net income |
|
|
9,625 |
|
|
|
7,078 |
|
Dividends declared (2006, $0.065/share and 2005, $0.04/share) |
|
|
(860 |
) |
|
|
(528 |
) |
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End of period |
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|
33,611 |
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|
|
22,277 |
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Unearned share compensation: |
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|
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|
Beginning of period |
|
|
(695 |
) |
|
|
(1,413 |
) |
Impact of adoption of SFAS 123R |
|
|
695 |
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|
|
402 |
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|
|
|
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End of period |
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(1,011 |
) |
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Accumulated other comprehensive (loss) income, net of taxes: |
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|
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Beginning of period |
|
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(3,150 |
) |
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|
820 |
|
Unrealized holding (losses) gains arising during the period,
net of reclassification adjustment |
|
|
(4,128 |
) |
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|
173 |
|
|
|
|
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End of period |
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|
(7,278 |
) |
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|
993 |
|
|
|
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Total shareholders equity |
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$ |
126,504 |
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|
|
122,425 |
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Comprehensive Income |
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Net income |
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$ |
9,625 |
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|
|
7,078 |
|
Other comprehensive (loss) income: |
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Unrealized (losses) gains on securities: |
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Unrealized holding (losses) gains arising during the period: |
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|
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Gross |
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|
(11,238 |
) |
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|
118 |
|
Related federal income tax benefit (expense) |
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|
3,933 |
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|
|
(44 |
) |
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|
|
|
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Net unrealized (losses) gains |
|
|
(7,305 |
) |
|
|
74 |
|
|
|
|
|
|
|
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Reclassification adjustment for losses included in net income
|
|
|
|
|
|
|
|
|
Gross |
|
|
(41 |
) |
|
|
(153 |
) |
Related federal income tax benefit |
|
|
14 |
|
|
|
54 |
|
|
|
|
|
|
|
|
Net reclassification adjustment |
|
|
(27 |
) |
|
|
(99 |
) |
|
|
|
|
|
|
|
Other comprehensive (loss) income |
|
|
(7,278 |
) |
|
|
173 |
|
|
|
|
|
|
|
|
Total comprehensive income |
|
$ |
2,347 |
|
|
|
7,251 |
|
|
|
|
|
|
|
|
See accompanying notes to the unaudited consolidated condensed financial statements.
5
PROCENTURY CORPORATION AND SUBSIDIARIES
Consolidated Condensed Statements of Cash Flows
(Unaudited)
(In thousands)
|
|
|
|
|
|
|
|
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|
|
Six Months Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
Cash flows provided by operating activities: |
|
|
|
|
|
|
|
|
Net income |
|
$ |
9,625 |
|
|
|
7,078 |
|
Adjustments: |
|
|
|
|
|
|
|
|
Net realized investment losses |
|
|
41 |
|
|
|
153 |
|
Deferred federal income tax benefit |
|
|
(916 |
) |
|
|
(1,188 |
) |
Share-based compensation expense |
|
|
613 |
|
|
|
465 |
|
Changes in assets and liabilities: |
|
|
|
|
|
|
|
|
Premiums in course of collection, net |
|
|
(510 |
) |
|
|
(5,305 |
) |
Deferred policy acquisition costs |
|
|
(2,257 |
) |
|
|
(1,508 |
) |
Prepaid reinsurance premiums |
|
|
707 |
|
|
|
(512 |
) |
Reinsurance recoverable on paid and unpaid losses, net |
|
|
(5,825 |
) |
|
|
(7,135 |
) |
Income taxes payable/receivable |
|
|
(506 |
) |
|
|
(2,912 |
) |
Losses and loss expense reserves |
|
|
23,304 |
|
|
|
30,076 |
|
Unearned premiums |
|
|
6,646 |
|
|
|
6,610 |
|
Other, net |
|
|
(491 |
) |
|
|
2,383 |
|
|
|
|
|
|
|
|
Net cash provided by operating activities |
|
|
30,431 |
|
|
|
28,205 |
|
|
|
|
|
|
|
|
Cash flows used in investing activities: |
|
|
|
|
|
|
|
|
Purchases of equity securities |
|
|
(6,664 |
) |
|
|
(46,712 |
) |
Purchase of fixed maturity securities available-for-sale |
|
|
(47,435 |
) |
|
|
(62,864 |
) |
Proceeds from sales of equity securities |
|
|
8,697 |
|
|
|
39,141 |
|
Proceeds from sales and maturities of fixed maturities available-for-sale |
|
|
17,981 |
|
|
|
48,154 |
|
Acquisition, net of cash acquired |
|
|
|
|
|
|
(1,002 |
) |
Change in short-term investments |
|
|
608 |
|
|
|
533 |
|
|
|
|
|
|
|
|
Net cash used in investing activities |
|
|
(26,813 |
) |
|
|
(22,750 |
) |
|
|
|
|
|
|
|
Cash flows used in financing activities: |
|
|
|
|
|
|
|
|
Dividend paid to shareholders |
|
|
(860 |
) |
|
|
(528 |
) |
Exercise of share options |
|
|
6 |
|
|
|
|
|
Draw on line of credit |
|
|
500 |
|
|
|
2,300 |
|
Principal payment on line of credit |
|
|
|
|
|
|
(2,300 |
) |
|
|
|
|
|
|
|
Net cash used in financing activities |
|
|
(354 |
) |
|
|
(528 |
) |
|
|
|
|
|
|
|
Increase in cash and cash equivalents |
|
|
3,264 |
|
|
|
4,927 |
|
Cash and equivalents at beginning of period |
|
|
5,628 |
|
|
|
7,681 |
|
|
|
|
|
|
|
|
Cash and equivalents at end of period |
|
$ |
8,892 |
|
|
|
12,608 |
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information: |
|
|
|
|
|
|
|
|
Interest paid |
|
$ |
1,123 |
|
|
|
872 |
|
|
|
|
|
|
|
|
Federal income taxes paid |
|
$ |
5,300 |
|
|
|
6,991 |
|
|
|
|
|
|
|
|
See accompanying notes to the unaudited consolidated condensed financial statements.
6
PROCENTURY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements
June 30, 2006
(Unaudited)
(1) |
|
Basis of Presentation |
|
|
|
The accompanying interim unaudited consolidated condensed financial statements and notes include
the accounts of ProCentury Corporation (the Company or ProCentury), and its wholly owned
insurance subsidiary, Century Surety Company (Century). The interim unaudited consolidated
condensed financial statements have been prepared in accordance with U.S. generally accepted
accounting principles (GAAP), for interim financial information and with the instructions to
Article 10 of Regulation S-X. Accordingly, the interim unaudited consolidated condensed
financial statements do not include all of the information and notes required by GAAP for
complete financial statements. In the opinion of management, all adjustments considered
necessary for a fair presentation of results for the interim periods have been included. These
interim unaudited consolidated condensed financial statements and related notes should be read
in conjunction with the consolidated financial statements and related notes in the Companys
audited consolidated financial statements, included in the Companys annual report on Form 10-K
for the year ended December 31, 2005. The Companys results of operations for interim periods
are not necessarily indicative of the results to be expected for the entire year. |
|
|
|
In preparing the interim unaudited consolidated condensed financial statements, management was
required to make certain estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities as of the date of the
interim unaudited consolidated condensed financial statements, and the reported amounts of
revenue and expenses for the reporting period. Actual results could differ significantly from
those estimates. |
|
|
|
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. |
|
|
|
All significant intercompany balances and transactions have been eliminated. |
|
|
|
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 us 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. |
7
|
|
If the Company recorded compensation expense for its share option grants based on the fair
value method as previously required by SFAS No. 123, the Companys net income and earnings per
share for the three and six months ended June 30, 2005 would have been adjusted to the pro forma
amounts as indicated in the following table: |
|
|
|
|
|
|
|
|
|
|
|
Three |
|
|
Six |
|
|
|
Months |
|
|
Months |
|
|
|
Ended June 30, |
|
|
Ended June 30, |
|
|
|
2005 |
|
|
2005 |
|
|
|
(In thousands, |
|
|
(In thousands, |
|
|
|
except per |
|
|
except per |
|
|
|
share data) |
|
|
share data) |
|
Net income: |
|
|
|
|
|
|
|
|
As reported |
|
$ |
3,999 |
|
|
$ |
7,078 |
|
Add: Share-based employee compensation expense included in reported
net income, net of related tax effects |
|
|
84 |
|
|
|
302 |
|
Less: Additional share-based employee compensation expense determined
under fair value-based method for all awards, net of related tax effects |
|
|
(150 |
) |
|
|
(502 |
) |
|
|
|
|
|
|
|
Pro forma |
|
$ |
3,933 |
|
|
$ |
6,878 |
|
|
|
|
|
|
|
|
Basic income per common share: |
|
|
|
|
|
|
|
|
As reported |
|
$ |
0.31 |
|
|
$ |
0.54 |
|
|
|
|
|
|
|
|
Pro forma |
|
$ |
0.30 |
|
|
$ |
0.53 |
|
|
|
|
|
|
|
|
Diluted income per common share: |
|
|
|
|
|
|
|
|
As reported |
|
$ |
0.30 |
|
|
$ |
0.54 |
|
|
|
|
|
|
|
|
Pro forma |
|
$ |
0.30 |
|
|
$ |
0.52 |
|
|
|
|
|
|
|
|
|
|
The fair values of the share options are estimated on the dates of grant using the Black-Scholes
option pricing model with the following weighted average assumptions: |
|
|
|
|
|
|
|
Three and Six Months Ended |
|
|
June 30, 2005 |
Risk free interest rate |
|
|
3.97 |
% |
Dividend yield |
|
|
0.76 |
% |
Volatility factor |
|
|
23.14 |
% |
Weighted average expected option life |
|
7 Years |
(2) |
|
Income per Common Share |
|
|
|
Basic income per share (EPS) 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 or net loss per share is computed
excluding the common share equivalents. |
|
|
|
Based on the above and 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 interim
unaudited consolidated condensed financial statements. |
8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, 2006 |
|
|
|
Income |
|
|
Shares |
|
|
Per Share |
|
|
|
(Numerator) |
|
|
(Denominator) |
|
|
Amount |
|
|
|
(In thousands, except per share data) |
|
Basic Net Income Per Share |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
5,025 |
|
|
|
13,114,535 |
|
|
|
0.38 |
|
Effect of Dilutive Securities |
|
|
|
|
|
|
|
|
|
|
|
|
Restricted common shares and share options |
|
|
|
|
|
|
132,993 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted EPS |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
5,025 |
|
|
|
13,247,528 |
|
|
|
0.38 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, 2005 |
|
|
|
Income |
|
|
Shares |
|
|
Per Share |
|
|
|
(Numerator) |
|
|
(Denominator) |
|
|
Amount |
|
|
|
(In thousands, except per share data) |
|
Basic Net Income Per Share |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
3,999 |
|
|
|
13,052,650 |
|
|
|
0.31 |
|
Effect of Dilutive Securities |
|
|
|
|
|
|
|
|
|
|
|
|
Restricted common shares and share options |
|
|
|
|
|
|
68,664 |
|
|
|
(0.01 |
) |
|
|
|
|
|
|
|
|
|
|
Diluted EPS |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
3,999 |
|
|
|
13,121,314 |
|
|
|
0.30 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2006 |
|
|
|
Income |
|
|
Shares |
|
|
Per Share |
|
|
|
(Numerator) |
|
|
(Denominator) |
|
|
Amount |
|
|
|
(In thousands, except per share data) |
|
Basic Net Income Per Share |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
9,625 |
|
|
|
13,107,620 |
|
|
|
0.73 |
|
Effect of Dilutive Securities |
|
|
|
|
|
|
|
|
|
|
|
|
Restricted common shares and share options |
|
|
|
|
|
|
116,430 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted EPS |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
9,625 |
|
|
|
13,224,050 |
|
|
|
0.73 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2005 |
|
|
|
Income |
|
|
Shares |
|
|
Per Share |
|
|
|
(Numerator) |
|
|
(Denominator) |
|
|
Amount |
|
|
|
(In thousands, except per share data) |
|
Basic Net Income Per Share |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
7,078 |
|
|
|
13,049,570 |
|
|
|
0.54 |
|
Effect of Dilutive Securities |
|
|
|
|
|
|
|
|
|
|
|
|
Restricted common shares and share options |
|
|
|
|
|
|
77,899 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted EPS |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
7,078 |
|
|
|
13,127,469 |
|
|
|
0.54 |
|
|
|
|
|
|
|
|
|
|
|
(3) |
|
Investments |
|
|
|
The Company invests primarily in investment-grade fixed maturities. The amortized cost, gross
unrealized gains and losses and estimated fair value of fixed maturities classified as
held-to-maturity were as follows: |
9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2006 |
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
Estimated |
|
|
|
Amortized |
|
|
unrealized |
|
|
unrealized |
|
|
fair |
|
|
|
cost |
|
|
gains |
|
|
losses |
|
|
value |
|
|
|
(In thousands) |
|
U.S. Treasury securities |
|
$ |
88 |
|
|
|
7 |
|
|
|
|
|
|
|
95 |
|
Agencies not backed by the full faith and credit of
the U.S. Government |
|
|
1,033 |
|
|
|
|
|
|
|
(37 |
) |
|
|
996 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,121 |
|
|
|
7 |
|
|
|
(37 |
) |
|
|
1,091 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2005 |
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
Estimated |
|
|
|
Amortized |
|
|
unrealized |
|
|
unrealized |
|
|
fair |
|
|
|
cost |
|
|
gains |
|
|
losses |
|
|
value |
|
|
|
(In thousands) |
|
U.S. Treasury securities |
|
$ |
89 |
|
|
|
13 |
|
|
|
|
|
|
|
102 |
|
Agencies not backed by the full faith and credit of
the U.S. Government |
|
|
1,039 |
|
|
|
|
|
|
|
(23 |
) |
|
|
1,016 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,128 |
|
|
|
13 |
|
|
|
(23 |
) |
|
|
1,118 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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: |
10
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2006 |
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
Estimated |
|
|
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Fair |
|
|
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Value |
|
|
|
(In thousands) |
|
Fixed maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities |
|
$ |
3,658 |
|
|
|
|
|
|
|
(91 |
) |
|
|
3,567 |
|
Agencies not backed by the full faith and
credit of the U.S. Government |
|
|
14,538 |
|
|
|
|
|
|
|
(612 |
) |
|
|
13,926 |
|
Obligations of states and political subdivisions |
|
|
153,058 |
|
|
|
51 |
|
|
|
(3,961 |
) |
|
|
149,148 |
|
Corporate securities |
|
|
35,440 |
|
|
|
7 |
|
|
|
(1,345 |
) |
|
|
34,102 |
|
Mortgage-backed securities |
|
|
38,177 |
|
|
|
18 |
|
|
|
(1,809 |
) |
|
|
36,386 |
|
Collateralized mortgage obligations |
|
|
39,546 |
|
|
|
22 |
|
|
|
(1,122 |
) |
|
|
38,446 |
|
Asset-backed securities |
|
|
50,555 |
|
|
|
229 |
|
|
|
(1,081 |
) |
|
|
49,703 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities |
|
|
334,972 |
|
|
|
327 |
|
|
|
(10,021 |
) |
|
|
325,278 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities |
|
|
29,383 |
|
|
|
143 |
|
|
|
(1,079 |
) |
|
|
28,447 |
|
Bond mutual funds |
|
|
14,367 |
|
|
|
29 |
|
|
|
(599 |
) |
|
|
13,797 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equities |
|
|
43,750 |
|
|
|
172 |
|
|
|
(1,678 |
) |
|
|
42,244 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
378,722 |
|
|
|
499 |
|
|
|
(11,699 |
) |
|
|
367,522 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2005 |
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
Estimated |
|
|
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Fair |
|
|
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Value |
|
|
|
(In thousands) |
|
Fixed maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities |
|
$ |
3,688 |
|
|
|
1 |
|
|
|
(53 |
) |
|
|
3,636 |
|
Agencies not backed by the full faith and
credit of the U.S. Government |
|
|
14,526 |
|
|
|
|
|
|
|
(230 |
) |
|
|
14,296 |
|
Obligations of states and political subdivisions |
|
|
142,932 |
|
|
|
387 |
|
|
|
(1,037 |
) |
|
|
142,282 |
|
Corporate securities |
|
|
36,689 |
|
|
|
40 |
|
|
|
(876 |
) |
|
|
35,853 |
|
Mortgage-backed securities |
|
|
40,910 |
|
|
|
31 |
|
|
|
(880 |
) |
|
|
40,061 |
|
Collateralized mortgage obligations |
|
|
27,943 |
|
|
|
15 |
|
|
|
(606 |
) |
|
|
27,352 |
|
Asset-backed securities |
|
|
39,549 |
|
|
|
238 |
|
|
|
(635 |
) |
|
|
39,152 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities |
|
|
306,237 |
|
|
|
712 |
|
|
|
(4,317 |
) |
|
|
302,632 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities |
|
|
27,521 |
|
|
|
215 |
|
|
|
(795 |
) |
|
|
26,941 |
|
Bond mutual funds |
|
|
18,516 |
|
|
|
15 |
|
|
|
(679 |
) |
|
|
17,852 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equities |
|
|
46,037 |
|
|
|
230 |
|
|
|
(1,474 |
) |
|
|
44,793 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
352,274 |
|
|
|
942 |
|
|
|
(5,791 |
) |
|
|
347,425 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other-than-temporary impairment losses result in a permanent reduction to the cost basis of
the underlying investment and are recorded as a realized loss in the interim unaudited
consolidated condensed statements of operations. No other-than-temporary declines were realized
during the three or six months ended June 30, 2006. No other-than-temporary declines were
realized during the three months ended June 30, 2005. Other-than-temporary losses of $35,000
were included in the net realized investment losses for the six months ended June 30, 2005. |
|
|
The fair values and gross unrealized losses for securities classified as held-to-maturity by the
Company and assessed as temporarily impaired by management, categorized by the length of time
that the individual securities have been in a continuous unrealized loss position, as of June
30, 2006 are as follows: |
11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2006 |
|
|
|
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) |
|
Agencies not backed by the full faith
and credit of the U.S. Government |
|
$ |
|
|
|
|
|
|
|
|
(996 |
) |
|
|
(37 |
) |
|
|
(996 |
) |
|
|
(37 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
|
|
|
|
|
|
|
|
(996 |
) |
|
|
(37 |
) |
|
|
(996 |
) |
|
|
(37 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2006 |
|
|
|
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 |
|
$ |
1,821 |
|
|
|
(32 |
) |
|
|
1,746 |
|
|
|
(59 |
) |
|
|
3,567 |
|
|
|
(91 |
) |
Agencies not backed by the full faith
and credit of the U.S. Government |
|
|
7,849 |
|
|
|
(341 |
) |
|
|
6,077 |
|
|
|
(271 |
) |
|
|
13,926 |
|
|
|
(612 |
) |
Obligations of states and political
subdivisions |
|
|
123,492 |
|
|
|
(3,136 |
) |
|
|
22,447 |
|
|
|
(825 |
) |
|
|
145,939 |
|
|
|
(3,961 |
) |
Corporate securities |
|
|
11,364 |
|
|
|
(463 |
) |
|
|
20,763 |
|
|
|
(882 |
) |
|
|
32,127 |
|
|
|
(1,345 |
) |
Mortgage-backed securities |
|
|
20,629 |
|
|
|
(988 |
) |
|
|
15,319 |
|
|
|
(821 |
) |
|
|
35,948 |
|
|
|
(1,809 |
) |
Collateralized mortgage obligations |
|
|
23,425 |
|
|
|
(596 |
) |
|
|
13,220 |
|
|
|
(526 |
) |
|
|
36,645 |
|
|
|
(1,122 |
) |
Asset-backed securities |
|
|
30,580 |
|
|
|
(800 |
) |
|
|
6,567 |
|
|
|
(281 |
) |
|
|
37,147 |
|
|
|
(1,081 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
219,160 |
|
|
|
(6,356 |
) |
|
|
86,139 |
|
|
|
(3,665 |
) |
|
|
305,299 |
|
|
|
(10,021 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities |
|
|
21,140 |
|
|
|
(813 |
) |
|
|
3,774 |
|
|
|
(266 |
) |
|
|
24,914 |
|
|
|
(1,079 |
) |
Bond mutual funds |
|
|
8,158 |
|
|
|
(321 |
) |
|
|
5,174 |
|
|
|
(278 |
) |
|
|
13,332 |
|
|
|
(599 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
29,298 |
|
|
|
(1,134 |
) |
|
|
8,948 |
|
|
|
(544 |
) |
|
|
38,246 |
|
|
|
(1,678 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Grand Total |
|
$ |
248,458 |
|
|
|
(7,490 |
) |
|
|
95,087 |
|
|
|
(4,209 |
) |
|
|
343,545 |
|
|
|
(11,699 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At June 30, 2006, the Company had 121 fixed income securities and 13 equity securities that
have been in an unrealized loss position for one year or longer. Of the fixed income securities,
117 are investment grade, of which 115 of these securities are rated A1/A or better (including 77
securities which are rated AAA). The four remaining non-investment grade fixed income securities
have an aggregate fair value equal to 95.6% of their book value as of June 30, 2006. One of the
equity securities that has been in an unrealized loss position for one year or longer relates to a
closed end preferred stock fund and one of the equity securities relates to a closed end bond fund,
each of which continues to pay its regular dividend on a monthly basis and also has an underlying
net asset value per share that exceeds its respective price per share as of June 30, 2006. Two of
the equity securities relate to investments in open end high quality short duration bond funds,
both of which the underlying assets are all rated AAA. Finally, the nine 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 financial performance during the
past twelve months. In addition, these nine equity securities have an aggregate fair market value
equal to 95.0% of their book value as of June 30, 2006. All 121 of the fixed income securities are
current on interest and principal and all 13 of the equity securities continue to pay dividends at
a level consistent with the prior year. Management
12
believes that it is probable that all contract terms of the security will be satisfied. The
unrealized loss position is due to the changes in the interest rate environment and the Company has
positive intent and the ability to hold the securities until they mature or recover in value.
(4) |
|
Loss and Loss Expense Reserves |
|
|
|
Liability for losses and loss expenses represents the Companys best estimate of the ultimate
amounts needed to pay both reported and unreported claims. These estimates are based on quarterly
internal actuarial studies and certified on an annual basis by an independent actuary. The
Company continually reviews these estimates and, based on new developments and information, the
Company includes adjustments of the probable ultimate liability in the operating results for the
periods in which the adjustments are made. |
|
|
|
Net loss and loss expenses incurred were $32.6 million for the quarter ended June 30, 2006,
compared to $26.6 million for the quarter ended June 30, 2005. In the second quarter of 2006, the
Company recorded $31.7 million of incurred losses and loss expenses attributable to the 2006
accident year and $886,000 attributable to events of prior years. In the second quarter of 2005,
the Company recorded $24.9 million of incurred losses and loss expenses attributable to the 2005
accident year and $1.7 million attributable to events of prior years. |
|
|
|
Net loss and loss expenses incurred were $63.0 million for the six months ended June 30, 2006,
compared to $52.3 million for the six months ended June 30, 2005. In the first six months of
2006, the Company recorded $61.4 million of incurred losses and loss expenses attributable to the
2006 accident year and $1.6 million attributable to events of prior years. In the first six
months of 2005, the Company recorded $48.7 million of incurred losses and loss expenses
attributable to the 2005 accident year and $3.6 million attributable to events of prior years. |
|
|
|
In the aggregate, the Company recorded $886,000 and $1.6 million of unfavorable reserve
development related to prior accident years for the three and six months ended June 30, 2006,
respectively. For the six months ended June 30, 2006, within the property line, the Company
experienced favorable non-catastrophe case reserve development producing a reduction in ultimate
loss and loss expenses for the 2004 and 2005 accident years by $4.0 million. The Company also
changed its estimates during such six month period on catastrophe losses by reducing its
estimates on Hurricane Wilma by $1.1 million due to actual incurred losses being lower than
original estimates. This favorable development was offset by an increase of $4.1 million in
casualty reserves during such six month period as a result of a refinement to the internal
actuarial reserving technique concerning the weighting of reserve indications and supplemental
information concerning claims severities. The Companys reserves moved to a higher point on the
range of loss and loss expense reserve estimate, despite the fact that overall, the Companys
casualty book of business performed within the range of expectations for the quarter and six
months ended June 30, 2006. The Company also incurred approximately
$1.2 million of adverse development during the six months ended June 30, 2006 due to an increase
in legal severities on construction defect claims. Additionally, the Company recorded
approximately $1.4 million of unfavorable development during the six months ended June 30, 2006
related to estimated costs associated with possible reinsurance collection issues on two separate
casualty claims. |
|
|
|
The prior year development increases for the quarter and six months ended June 30, 2005 resulted
principally from construction defect claims within the other liability line of the property and
casualty segment. During the first and second quarter of 2005, the Company established reserves
for several contribution action settlements. This development was slightly offset by favorable
claim count development, while claim severities continued to be within the Companys
expectations. Prior year development for construction defect claims was $1.7 million and $3.1
million for the three and six months ended June 30, 2005, respectively. The prior year increases
related to construction defect claims was partially offset by positive development in the
Companys property line and supplemented by additional development in the casualty line. |
|
|
|
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. |
13
(5) |
|
Reinsurance |
|
|
|
In the ordinary course of business, Century 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. There have been no significant changes in the
Companys reinsurance program except for the fact that the Company is now retaining 50% of the
$500,000 excess of $500,000 layer of the 2006 casualty treaty. This layer was ceded 100% to
reinsurers in 2005. 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. |
14
|
|
The effects of assumed and ceded reinsurance on premiums written, premiums earned and loss and
loss expenses incurred were as follows: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
For the Six Months |
|
|
|
Ended June 30, |
|
|
Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
|
|
(In thousands) |
|
Premiums written: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct |
|
$ |
64,488 |
|
|
|
54,635 |
|
|
|
121,763 |
|
|
|
101,953 |
|
Assumed |
|
|
1,192 |
|
|
|
638 |
|
|
|
1,946 |
|
|
|
952 |
|
Ceded |
|
|
(7,191 |
) |
|
|
(6,916 |
) |
|
|
(14,788 |
) |
|
|
(12,262 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums written |
|
$ |
58,489 |
|
|
|
48,357 |
|
|
|
108,921 |
|
|
|
90,643 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums earned: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct |
|
|
59,061 |
|
|
|
48,919 |
|
|
|
115,146 |
|
|
|
95,882 |
|
Assumed |
|
|
1,105 |
|
|
|
198 |
|
|
|
1,917 |
|
|
|
413 |
|
Ceded |
|
|
(7,601 |
) |
|
|
(6,092 |
) |
|
|
(15,496 |
) |
|
|
(11,750 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums earned |
|
$ |
52,565 |
|
|
|
43,025 |
|
|
|
101,567 |
|
|
|
84,545 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses and loss expenses incurred: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct |
|
|
38,566 |
|
|
|
31,777 |
|
|
|
72,860 |
|
|
|
63,671 |
|
Assumed |
|
|
253 |
|
|
|
(142 |
) |
|
|
357 |
|
|
|
(412 |
) |
Ceded |
|
|
(6,244 |
) |
|
|
(5,048 |
) |
|
|
(10,203 |
) |
|
|
(10,945 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net losses and loss expenses incurred |
|
$ |
32,575 |
|
|
|
26,587 |
|
|
|
63,014 |
|
|
|
52,314 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In 1998 and 1999, the Company had quota share and excess of loss reinsurance agreements with
three reinsurance companies for the workers compensation line of business. These agreements were
entered into through an intermediary, which was ordered into liquidation in 2000. Since that
time, the Company attempted to collect the losses directly from one of the reinsurers. On March
22, 2006, the Companys effort to vacate an adverse award received in arbitration related to this
reinsurer proved unsuccessful. As such, the Company is currently in the process of turning the
claims over to the liquidator of the intermediary. At June 30, 2006, the Company has a reserve
of $1.5 million in the event it is unable to fully collect the amounts due. As of June 30, 2006,
the Company had approximately $2.9 million of recoverables related to these reinsurance
agreements, of which $1.1 million related to the quota share agreements and $1.8 million related
to the excess of loss agreements. |
|
|
|
In addition, in the second quarter of 2006, the Company increased its reserves for uncollectible
reinsurance to $1.4 million from $250,000 related to disputes with three reinsurers on 1997 and
2000 accident year casualty claims. The total amount in dispute is approximately $4.0 million.
During the second quarter of 2006, the Company was unsuccessful on appeal on the 1997 accident
year claim for which it is anticipated that one of the reinsures may deny indemnification. In
addition, the Company has filed a notice of arbitration against one of its reinsurers related to
the 2000 accident year claim for which a $250,000 provision was established in the first quarter
of 2006. In the second quarter of 2006, the Company recorded an additional provision of $220,000
for the 2000 accident year claim as the Company may file for arbitration if current negotiations
are not successful. |
|
|
|
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 settlement of these claims could vary significantly
from the current estimates recorded. |
|
(6) |
|
Deferred Policy Acquisition Costs |
|
|
|
The following reflects the amounts of policy acquisition costs deferred and amortized: |
15
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
For the Six Months |
|
|
|
Ended June 30, |
|
|
Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
|
|
|
|
|
|
(In thousands) |
|
|
|
|
|
Balance at beginning of period |
|
$ |
21,418 |
|
|
|
17,506 |
|
|
|
20,649 |
|
|
|
17,411 |
|
Policy acquisition costs deferred |
|
|
14,384 |
|
|
|
11,748 |
|
|
|
27,219 |
|
|
|
22,063 |
|
Amortization of deferred policy acquisition costs |
|
|
(12,896 |
) |
|
|
(10,335 |
) |
|
|
(24,962 |
) |
|
|
(20,555 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period |
|
$ |
22,906 |
|
|
|
18,919 |
|
|
|
22,906 |
|
|
|
18,919 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(7) |
|
Federal Income Taxes |
|
|
|
The income tax provision for the three and six months ended June 30, 2006 and 2005 has been
computed based on our estimated annual effective tax rate of 29.0%, which differs from the
federal income tax rate of 35% principally because of tax-exempt investment income. |
|
(8) |
|
Commitments and Contingencies |
|
|
|
The Company is party to lawsuits, arbitration 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 the Company underwrites as an insurer, the liabilities for which the Company
believes have been adequately included in its loss and loss adjustment expense (LAE) reserves.
Also, from time to time, the Company is 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. The Company provides
accruals for these items to the extent it deems 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, the Company
believes the resolution of these matters will not have a material adverse effect on its financial
position, results of operations or cash flows. |
|
(9) |
|
Employee Benefits |
|
|
|
During 2004, the Company adopted and the shareholders approved a stock option plan (the 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. Compensation cost
is recorded in the same
financial statement caption as the salary expense of the employee (i.e. the compensation cost for
the Chief Investment Officer is recorded in net investment income). |
|
|
|
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. In accordance with SFAS No. 123R, compensation expense is
recorded over the service period based on the grant date fair market value of the options. The
fair market value is determined by the Company using the Black-Scholes option pricing model.
Prior to the adoption of SFAS 123R, in accordance with APB No. 25, no compensation expense was
recorded for the qualified and non-qualified share options as the market value on the grant dates
equaled the exercise price. |
|
|
|
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- |
16
|
|
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. |
|
|
|
The performance-based restricted shares are granted to key executives and vest annually over a
four-year period based on achieved specified performance metrics. In accordance with SFAS 123R,
compensation cost is measured on the grant date at the grant date market value and recorded over
the service period. Prior to the adoption of SFAS 123R, compensation expense for
performance-based restricted share awards was recognized based on the fair value of the awards at
the end of the period. |
|
|
|
The Company may grant options for up to 1.2 million shares under the plan. Through December 31,
2005, the Company had granted 287,000 non-qualified options, 95,000 qualified options, 156,000
time-based restricted shares and 55,024 performance-based restricted shares under the share plan.
On January 3, 2006 and June 1, 2006, the Company granted an additional 112,500 qualified options
and an additional 12,000 non-qualified options. |
|
|
|
A summary of the status of the option plan for the six months ended June 30, 2006 and for the
year ended December 31, 2005 are presented in the following table: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2006 |
|
|
December 31, 2005 |
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
Weighted- |
|
|
|
Number of |
|
|
Average |
|
|
Number of |
|
|
Average |
|
|
|
Shares |
|
|
Exercise Price |
|
|
Shares |
|
|
Exercise Price |
|
Outstanding at beginning of period |
|
|
382,000 |
|
|
$ |
10.49 |
|
|
|
364,000 |
|
|
$ |
10.50 |
|
Granted |
|
|
124,500 |
|
|
|
10.87 |
|
|
|
18,000 |
|
|
|
10.30 |
|
Exercised |
|
|
(600 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at end of period |
|
|
505,900 |
|
|
$ |
10.58 |
|
|
|
382,000 |
|
|
$ |
10.49 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at end of period |
|
|
290,259 |
|
|
$ |
10.53 |
|
|
|
217,393 |
|
|
$ |
10.50 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average fair value of
options granted during year |
|
|
|
|
|
$ |
3.18 |
|
|
|
|
|
|
$ |
2.99 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17
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 2006 and 2005:
|
|
|
|
|
|
|
|
|
|
|
Six Months |
|
|
|
|
Ended |
|
Year Ended |
|
|
June 30, |
|
December 31 |
|
|
2006 |
|
2005 |
Risk free interest rate |
|
|
4.07 |
% |
|
|
4.03 |
% |
Dividend yield |
|
|
0.93 |
% |
|
|
0.76 |
% |
Volatility factor |
|
|
23.11 |
% |
|
|
23.14 |
% |
Weighted average expected option life |
|
7 Years |
|
7 Years |
Information on the range of exercise prices for options outstanding as of June 30, 2006, is as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding |
|
Options Excercisable |
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average |
|
Weighted |
|
|
|
|
|
Weighted |
|
|
|
|
|
|
Remaining |
|
Average |
|
Exercisable |
|
Average |
|
|
Outstanding |
|
Contract |
|
Exercise |
|
as of |
|
Exercise |
Price Range |
|
Options |
|
Life |
|
Price |
|
June 30, 2006 |
|
Price |
$10.20 |
|
|
12,000 |
|
|
|
8.9 |
|
|
$ |
10.20 |
|
|
|
4,332 |
|
|
$ |
10.20 |
|
$10.50 |
|
|
369,400 |
|
|
|
7.8 |
|
|
$ |
10.50 |
|
|
|
270,619 |
|
|
$ |
10.50 |
|
$10.64 |
|
|
112,500 |
|
|
|
9.5 |
|
|
$ |
10.64 |
|
|
|
15,572 |
|
|
$ |
10.64 |
|
$13.04 |
|
|
12,000 |
|
|
|
9.9 |
|
|
$ |
13.04 |
|
|
|
336 |
|
|
$ |
13.04 |
|
A summary of all employee time-based restricted share activity during the six months ended
June 30, 2006 and the year ended December 31, 2005 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006 |
|
|
2005 |
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
Weighted |
|
|
|
Number of |
|
|
Average |
|
|
Number of |
|
|
Average |
|
|
|
Shares |
|
|
Grant Price |
|
|
Shares |
|
|
Grant Price |
|
Beginning of year |
|
|
68,033 |
|
|
$ |
10.22 |
|
|
|
137,049 |
|
|
$ |
10.31 |
|
Add (deduct): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested |
|
|
(7,472 |
) |
|
|
10.58 |
|
|
|
(31,593 |
) |
|
|
10.28 |
|
Cancelled |
|
|
|
|
|
|
|
|
|
|
(37,423 |
) |
|
|
10.50 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
End of year |
|
|
60,561 |
|
|
$ |
10.20 |
|
|
|
68,033 |
|
|
$ |
10.22 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In January 2005 and September 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 September modification. During the six months
ended June 30, 2006, the Company recorded no compensation expense related to the January
modification and $163,579 related to the September modification, as all shares related to the
January modification have vested as of December 31, 2005 and 4,085 shares related to the
September modification remain unvested at June 30, 2006.
A summary of all employee performance-based restricted share activity for the six months ended
June 30, 2006 and 2005 is as follows:
18
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006 |
|
|
2005 |
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
Weighted |
|
|
|
Number of |
|
|
Average |
|
|
Number of |
|
|
Average |
|
|
|
Shares |
|
|
Grant Price |
|
|
Shares |
|
|
Grant Price |
|
Beginning of year |
|
|
37,365 |
|
|
$ |
10.50 |
|
|
|
|
|
|
$ |
|
|
Add (deduct): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted |
|
|
|
|
|
|
|
|
|
|
55,024 |
|
|
|
10.50 |
|
Vested |
|
|
(9,341 |
) |
|
|
10.50 |
|
|
|
|
|
|
|
|
|
Cancelled |
|
|
|
|
|
|
|
|
|
|
(17,659 |
) |
|
|
10.50 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
End of year |
|
|
28,024 |
|
|
$ |
10.50 |
|
|
|
37,365 |
|
|
$ |
10.50 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 September 2005. As such, the award was
treated as cancelled on September 30, 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 six months ended June 30, 2006,
the Company recorded $74,234 compensation expense related to the restricted shares and 4,414
shares remain unvested at June 30, 2006. |
|
(10) |
|
Segment Reporting Disclosures |
|
|
|
The Company operates in the Property and Casualty Lines (P/C) (including general liability,
multi-peril, commercial property and garage liability). |
|
|
|
The Companys Other (including exited lines) include 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 P/C 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: |
19
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
For the Six Months |
|
|
|
Ended June 30, |
|
|
Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
|
|
|
|
|
|
(In thousands) |
|
|
|
|
|
Segment revenue: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
P/C |
|
$ |
51,618 |
|
|
|
42,927 |
|
|
|
99,961 |
|
|
|
84,440 |
|
Investing |
|
|
4,627 |
|
|
|
3,401 |
|
|
|
9,074 |
|
|
|
6,501 |
|
Other (including exited lines) |
|
|
947 |
|
|
|
98 |
|
|
|
1,606 |
|
|
|
105 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment revenue |
|
$ |
57,192 |
|
|
|
46,426 |
|
|
|
110,641 |
|
|
|
91,046 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment profit: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
P/C |
|
|
2,844 |
|
|
|
2,275 |
|
|
|
5,132 |
|
|
|
5,213 |
|
Investing |
|
|
4,627 |
|
|
|
3,401 |
|
|
|
9,074 |
|
|
|
6,501 |
|
Other (including exited lines) |
|
|
341 |
|
|
|
481 |
|
|
|
718 |
|
|
|
(80 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment profit |
|
$ |
7,812 |
|
|
|
6,157 |
|
|
|
14,924 |
|
|
|
11,634 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investing |
|
|
380,264 |
|
|
|
328,727 |
|
|
|
380,264 |
|
|
|
328,727 |
|
Assets not allocated |
|
|
129,451 |
|
|
|
111,109 |
|
|
|
129,451 |
|
|
|
111,109 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total consolidated assets |
|
$ |
509,715 |
|
|
|
439,836 |
|
|
|
509,715 |
|
|
|
439,836 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following summary reconciles significant segment items to the Companys interim
unaudited consolidated condensed financial statements:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
For the Six Months |
|
|
|
Ended June 30, |
|
|
Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
|
|
(In thousands) |
|
Income before income taxes: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment profit |
|
$ |
7,812 |
|
|
|
6,157 |
|
|
|
14,924 |
|
|
|
11,634 |
|
Unallocated amounts: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate expenses |
|
|
(166 |
) |
|
|
(127 |
) |
|
|
(257 |
) |
|
|
(789 |
) |
Interest expense |
|
|
(567 |
) |
|
|
(459 |
) |
|
|
(1,110 |
) |
|
|
(876 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
$ |
7,079 |
|
|
|
5,571 |
|
|
|
13,557 |
|
|
|
9,969 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20
|
|
The following is a summary of segment earned premium by group of products: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property |
|
|
Casualty |
|
|
Other |
|
|
Consolidated |
|
|
|
|
|
|
|
(In thousands) |
|
|
|
|
|
Three Months Ended June 30, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
P/C |
|
$ |
15,039 |
|
|
|
36,579 |
|
|
|
|
|
|
|
51,618 |
|
Other (including exited lines) |
|
|
|
|
|
|
|
|
|
|
947 |
|
|
|
947 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
$ |
15,039 |
|
|
|
36,579 |
|
|
|
947 |
|
|
|
52,565 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
P/C |
|
$ |
13,930 |
|
|
|
28,997 |
|
|
|
|
|
|
|
42,927 |
|
Other (including exited lines) |
|
|
|
|
|
|
|
|
|
|
98 |
|
|
|
98 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
$ |
13,930 |
|
|
|
28,997 |
|
|
|
98 |
|
|
|
43,025 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
P/C |
|
$ |
29,472 |
|
|
|
70,489 |
|
|
|
|
|
|
|
99,961 |
|
Other (including exited lines) |
|
|
|
|
|
|
|
|
|
|
1,606 |
|
|
|
1,606 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
$ |
29,472 |
|
|
|
70,489 |
|
|
|
1,606 |
|
|
|
101,567 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
P/C |
|
$ |
28,346 |
|
|
|
56,094 |
|
|
|
|
|
|
|
84,440 |
|
Other (including exited lines) |
|
|
|
|
|
|
|
|
|
|
105 |
|
|
|
105 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
$ |
28,346 |
|
|
|
56,094 |
|
|
|
105 |
|
|
|
84,545 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company does not manage property and casualty products at this level of detail. |
|
(11) |
|
Dividends to Common Shareholders |
|
|
|
On March 13, 2006, the Board of Directors declared a dividend of $0.03 per common share that was
paid on April 17, 2006 to shareholders of record as of March 27, 2006. On May 15, 2006, the Board
of Directors declared a dividend of $0.035 per common share that was paid on June 7, 2006 to
shareholders of record as of May 24, 2006. |
|
(12) |
|
Line of Credit |
|
|
|
The Company has a $5.0 million line of credit with a maturity date of September 8, 2006, and
interest only payments due quarterly based on LIBOR plus 2.5% of the outstanding balance. All of
the outstanding shares of Century are pledged as collateral. In June 2006, the Company made a
$500,000 draw on the line of credit for general corporate purposes. Interest expense on the line
of credit for the quarter ended June 30, 2006 was approximately $1,800. The outstanding balance
at June 30, 2006 of $500,000 is included in the caption accrued expenses and other liabilities in
the accompanying unaudited consolidated condensed balance sheets The Company also made an
additional draw of $500,000 on the line of credit in July 2006. |
|
|
|
There was no outstanding balance at June 30, 2005; however, in April 2005, the Company made a
$2.3 million draw on the line of credit for general corporate purposes. The $2.3 million draw
was paid off on May 17, 2005. Interest paid on the line of credit for the period which the draw
was outstanding was $5,000 for the quarter ended June 30, 2005. |
Item 2. 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 interim unaudited consolidated condensed financial statements and the notes
to those statements included in this Form 10-Q. Some of the statements in this report, including
those set forth in the discussion and analysis below, are forward-looking statements as defined
in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are derived
from information that we currently have and assumptions that we make and may be identified by words
such as believes, anticipates, expects, plans, should, estimates and similar
expressions. We cannot assure you that anticipated results will be achieved, since actual results
may differ
21
materially because of both known and unknown risks and uncertainties we face. We
undertake no obligation to publicly update or revise any forward-looking statements, whether as a
result of new information, future events or otherwise. Factors that could cause actual results to
differ materially from our forward-looking statements are described under the heading Risks Related to
Our Business and Industry in our Annual Report on Form 10-K for the year ended December 31, 2005,
and elsewhere in this report, and include, but are not limited to, the following factors:
|
|
|
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; |
|
|
|
|
a decline in our financial rating assigned by A.M. Best may result in a reduction of new
or renewal business; |
|
|
|
|
we are subject to extensive regulation and judicial decisions affecting insurance and
tort law, which may adversely affect our ability to achieve our business objectives. In
addition, if we fail to comply with certain regulations, we may be subject to penalties,
including fines and suspensions, which may adversely affect our financial condition and
results of operations; |
|
|
|
|
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 those policies; |
|
|
|
|
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 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, as well as changes in government monetary policies, general economic conditions
and overall market conditions, all of which impact interest rates; |
|
|
|
|
we distribute our products through a select group of general agents, five of which
account for a significant part of our business, and such relationships could be
discontinued or cease to be profitable; |
|
|
|
|
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; |
|
|
|
|
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; |
|
|
|
|
our business is cyclical in nature, which will affect our financial performance and may
affect the price of our common shares; |
|
|
|
|
if we are unable to compete effectively with the large number of companies in the
insurance industry for underwriting revenues, we may incur increased costs and our
underwriting revenues and net income may decline; |
|
|
|
|
severe weather conditions and other catastrophes may result in an increase in the number
and amount of claims experienced by our insureds; and |
|
|
|
|
as a holding company, we are dependent on the results of operations of our insurance
subsidiary and the regulatory and contractual capacity of our subsidiary to pay dividends
to us. Some states limit the aggregate amount of dividends our subsidiary may pay to us in
any twelve-month period, thereby limiting our funds to pay expenses and dividends. |
You are cautioned not to place undue reliance on forward-looking statements, which speak only
as of their respective dates.
Overview
ProCentury is a holding company that underwrites selected property and casualty and surety
insurance through its subsidiaries collectively known as the Century Insurance Group®. As a niche
company, we offer specialty 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, specifically
refuse to write. When we underwrite within the excess and surplus lines market, we are
22
selective in
the lines of business and types of risks we choose to write. Typically, the development of these
specialty insurance products is generated through proposals brought to us by an agent or broker
seeking coverage for a specific group of clients.
We evaluate our insurance operations by monitoring key measures of growth and profitability.
We measure our growth by examining gross written premiums. We generally measure our operating
results by examining our net income, return on equity and loss, expense and combined ratios. The
following provides further explanation of the key measures that we use to evaluate our results:
Gross Written Premiums. Gross written premiums are the sum of direct written premiums and
assumed written premiums. We use gross written premiums, which excludes the impact of premiums
ceded to reinsurers, as a measure of the underlying growth of our insurance business from period to
period.
Net Written Premiums. Net written premiums are the sum of direct written premiums and assumed
written premiums less ceded written premiums. We use net written premiums, primarily in relation to
gross written premiums, to measure the amount of business retained after cessions to reinsurers.
Earned Premiums. Earned premiums are the portion of a premium paid by an insured that has been
allocated to our revenue, loss experience, expenses, and year to date profit.
Loss Ratio. Loss ratio is the ratio (expressed as a percentage) of losses and loss expenses
incurred to premiums earned. Loss ratio generally is measured on both a gross (direct and assumed)
and net (gross less ceded) basis. We use the gross loss ratio as a measure of the overall
underwriting profitability of the insurance business we write and to assess the adequacy of our
pricing. Our net loss ratio, which is net of ceded reinsurance, is meaningful in evaluating our
financial results, as reflected in our 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. We reduce our operating expenses by
ancillary income (excluding net investment income and realized gains (losses) on securities) to
calculate our net operating expenses. Due to our historically high levels of reinsurance, we
calculate our expense ratio on both a gross basis (before the effect of ceded reinsurance) and a
net basis (after the effect of ceded reinsurance). Although the net basis is meaningful in
evaluating our financial results that are net of ceded reinsurance, as reflected in our
consolidated financial statements, we believe the gross expense ratio better reflects the
operational efficiency of the underlying business and is a better measure of future trends.
Interest expense is not included in the calculation of the expense ratio.
Combined Ratio. Combined ratio is the sum of the loss 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 complex and
consequently actual results may differ from these estimates, which would be reflected in future
periods.
Our most critical accounting policies involve the reporting of loss and loss expense reserves
(including losses that have occurred but were not reported to us by the financial reporting date),
reinsurance recoverables, the impairment of investments, deferred policy acquisition costs and
federal income taxes.
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, the effect of changes in the law or unexpected
judicial and other third-party factors that are often beyond our control. Due to the inherent
uncertainty associated with the cost of unsettled and unreported claims, the ultimate liability
23
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. See Note 4 to our interim
unaudited consolidated condensed financial statements included in this Form 10-Q.
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 which 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 5 to our interim unaudited consolidated condensed
financial statements included in this Form 10-Q.
Impairment of Investments. Impairment of investment securities results in a charge to
operations when a market decline below cost is deemed to be other-than-temporary. Under the
Companys accounting policy for equity securities and fixed-maturity securities, 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 other 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; the
Companys ability and 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 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 June 30, 2006 and December 31,
2005, including disclosures regarding other-than-temporary declines in investment value, see Note 3
to our interim unaudited consolidated condensed financial statements included in this Form 10-Q.
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. These 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 6 to our
interim unaudited consolidated condensed financial statements included in this Form 10-Q.
Federal Income Taxes. 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 operations.
We utilize the asset and liability method of accounting for income taxes. 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
24
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 interim unaudited consolidated condensed financial statements included in this Form 10-Q.
Results of Operations
The table below summarizes certain operating results and key measures we use in monitoring and
evaluating operations. The information is intended to summarize and supplement information
contained in the interim unaudited consolidated condensed financial statements and to assist the
reader in gaining a better understanding of results of operations.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
For the Six Months |
|
|
|
Ended June 30, |
|
|
Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
|
|
(In thousands) |
|
|
(In thousands) |
|
Selected Financial Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross written premiums |
|
$ |
65,680 |
|
|
|
55,273 |
|
|
|
123,709 |
|
|
|
102,905 |
|
Premiums earned |
|
|
52,565 |
|
|
|
43,025 |
|
|
|
101,567 |
|
|
|
84,545 |
|
Net investment income |
|
|
4,689 |
|
|
|
3,495 |
|
|
|
9,115 |
|
|
|
6,654 |
|
Net realized investment losses |
|
|
(62 |
) |
|
|
(94 |
) |
|
|
(41 |
) |
|
|
(153 |
) |
Total revenues |
|
|
57,192 |
|
|
|
46,426 |
|
|
|
110,641 |
|
|
|
91,046 |
|
Total expenses |
|
|
50,113 |
|
|
|
40,855 |
|
|
|
97,084 |
|
|
|
81,077 |
|
Net income |
|
|
5,025 |
|
|
|
3,999 |
|
|
|
9,625 |
|
|
|
7,078 |
|
Key Financial Ratios: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss and loss expense ratio |
|
|
62.0 |
% |
|
|
61.8 |
% |
|
|
62.0 |
% |
|
|
61.9 |
% |
Expense ratio |
|
|
32.3 |
% |
|
|
32.1 |
% |
|
|
32.5 |
% |
|
|
33.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined ratio |
|
|
94.3 |
% |
|
|
93.9 |
% |
|
|
94.5 |
% |
|
|
94.9 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
25
Overview of Operating Results
Net income increased to $5.0 million for the three months ended June 30, 2006 from $4.0
million for the three months ended June 30, 2005. For the six months ended June 30, 2006, net
income increased to $9.6 million from $7.1 million for the six months ended June 30, 2005.
The increase in net income for the three and six months ended June 30, 2006 was primarily
attributable to an increase in total revenue, which was directly related to an increase in net
earned premium and net investment income. The increase in net earned premium resulted principally
from an increase in the volume of business which was offset by slight rate declines in both the
property and casualty lines of business. The increase in the volume of business is a result of
growth from our program division and continued growth in contractors business that is written on a
claims made form. In addition, due to continued favorable cash flows from operations during the
six months ended June 30, 2006 and higher investment yields, our net investment income increased
37.0% over the same period in 2005. Our taxable equivalent yield for the six months ended June 30,
2006 and 2005 was 5.70% and 5.13%, respectively.
The increase in total revenue was offset by higher expenses that resulted from an increase in
net loss and loss expenses and amortization of deferred acquisition costs. For the quarters ended
June 30, 2006 and 2005, the loss and loss expense ratio was 62.0% and 61.8%, respectively. The
loss and loss expense ratio for the six months ended June 30, 2006 and 2005 was 62.0% and 61.9%,
respectively. The increase in the loss and loss expense ratio for the three and six months ended
June 30, 2006 reflects higher current accident year ultimate loss and loss expense ratios driven by
the decreasing premium rate environment throughout 2005 and into 2006. The expense ratio for the
three months ended June 30, 2006 and 2005 was 32.3% and 32.1%, respectively. The increase in the
expense ratio for the quarter is directly attributable to an increase in amortization of deferred
acquisition costs as a result of a higher mix of binding premium compared to brokerage premium that
has a higher commission rate. The expense ratio for the six months ended June 30, 2006 and 2005
was 32.5% and 33.0%, respectively. In addition, the decrease in the expense ratio for the year is
a direct result of $793,000 of severance expense that was recorded in the first quarter of 2005.
No severance expense was recorded in 2006.
Revenues
Premiums
Premiums include insurance premiums underwritten by Century (which are referred to as direct
premiums) and insurance premiums assumed from other insurers generally in states where Century is
not licensed (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 as a result of cancellations, during a given period. Written
premiums become premiums earned over the policy period. 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 in written premiums, the unearned premium reserve will
decrease, causing premiums earned to be greater than written premiums.
We have historically relied on quota share, excess of loss, and catastrophe reinsurance
primarily to manage our regulatory capital requirements and also to limit our exposure to loss.
Generally, we have ceded a significant portion of our premiums to unaffiliated reinsurers in order
to maintain a net written premiums to statutory surplus ratio of less than 2-to-1.
Our underwriting business is currently divided into two primary segments:
|
|
|
property/casualty; and |
|
|
|
|
other (including exited lines). |
Our property/casualty segment primarily includes general liability, commercial property,
multi-peril and garage liability insurance for small and mid-sized businesses. The other (including
exited lines) segment primarily includes our surety business, including landfill and specialty
surety that is written in order to maintain Centurys U.S. Treasury listing, workers compensation,
which was exited in January 2002, and commercial auto/trucking, which was exited in May 2000.
26
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.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
For the Six Months |
|
|
|
Ended June 30, |
|
|
Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
|
|
(In thousands) |
|
|
(In thousands) |
|
Gross written premiums |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property/casualty |
|
$ |
64,790 |
|
|
|
54,564 |
|
|
|
121,880 |
|
|
|
102,139 |
|
Other (including exited lines) |
|
|
890 |
|
|
|
709 |
|
|
|
1,829 |
|
|
|
766 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross written premiums |
|
$ |
65,680 |
|
|
|
55,273 |
|
|
|
123,709 |
|
|
|
102,905 |
|
Ceded written premiums |
|
|
7,191 |
|
|
|
6,916 |
|
|
|
14,788 |
|
|
|
12,262 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net written premiums |
|
$ |
58,489 |
|
|
|
48,357 |
|
|
|
108,921 |
|
|
|
90,643 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums earned |
|
$ |
52,565 |
|
|
|
43,025 |
|
|
|
101,567 |
|
|
|
84,545 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net to gross written premiums |
|
|
89.1 |
% |
|
|
87.5 |
% |
|
|
88.0 |
% |
|
|
88.1 |
% |
Earned to net written premiums |
|
|
89.9 |
% |
|
|
89.0 |
% |
|
|
93.2 |
% |
|
|
93.3 |
% |
Net writings ratio (1) |
|
|
1.8 |
|
|
|
1.6 |
|
|
|
1.7 |
|
|
|
1.5 |
|
|
|
|
(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
Gross written premiums increased 18.8% and 20.2% for the quarter and six months ended June 30,
2006, respectively compared to the same periods in 2005. This fluctuation for the quarter and
year-to-date was primarily due to an increase in volume from our specialty program unit and an
increase in our casualty book of business as a result of growth in contractor business written on a
claims made form. Our program unit introduced an auto physical damage program in mid-2005 which
has increased our property business by $6.2 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 basis. 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 book of $5.0 million during 2006. The growth in our property/casualty
segment was slightly offset by minimal rate declines across our book of business. Our property
gross written premiums for the quarter ended June 30, 2006 increased 35.4% over the quarter ended
June 30, 2005. The increase in property gross written premiums for the six months ended 2006
compared to 2005 was 35.3%. Gross written premiums for our casualty line of business increased
11.8% and 12.3%, respectively for the quarter and six months ended June 30, 2006 compared to the
same periods in 2005.
Net Written Premiums and Premiums Earned
Net written premiums increased by 21.0% and 20.2% for the three months and six months ended
June 30, 2006, respectively, compared to the same period in 2005 due to the growth in gross written
premiums. Net written premiums represented 89.1% of gross written premiums for the three months
ended June 30, 2006. This is higher than the relationship of net written premiums to gross written
premiums for the three months ended June 30, 2005, reflecting a decrease in ceded premium rate in
the current year resulting from the fact that effective January 1, 2006 we began to retain 50% of
the $500,000 in excess of $500,000 layer of our casualty reinsurance treaty. In 2005, we ceded the
entire $500,000 in excess of $500,000 layer of our casualty reinsurance treaty to outside
reinsurers.
Premiums earned increased by 22.2% and 20.1% for the three and six months ended June 30, 2006,
respectively compared to the same period of 2005. This represents 89.9% and 93.2% of net written
premiums for the three and six months ended June 30, 2006,
respectively. The relationship of premiums earned to net written premiums during the quarter
ended June 30, 2006 was lower, reflecting an increase in the growth rate of premiums in the second
quarter of 2006 compared to the second of 2005.
27
Net Investment Income
Our investment portfolio generally consists of liquid, readily marketable and investment-grade
fixed-maturity and equity securities. Net investment income is comprised of interest and dividends
earned on these securities, net of related investment expenses.
Net investment income was $4.7 million for the three months ended June 30, 2006, compared to
$3.5 million for the same period in 2005. For the six months ended June 30, 2006, net investment
income increased to $9.1 million compared to $6.7 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 $22.8 million to $389.2 million as of June 30, 2006
from $366.4 million as of December 31, 2005. The pre-tax investment yield for the three months
ended June 30, 2006 was 5.1%, compared to 4.7% for the same period in 2005. For the six months
ended June 30, 2006 and 2005, the pre-tax investment yield was 5.0% and 4.5%, respectively. Our
taxable equivalent yield for the second quarter of 2006 increased to 5.8% from 5.3% for the same
quarter in 2005. For the six months ended June 30, 2006 and 2005, the taxable equivalent yield was
5.7% and 5.1%, respectively.
Net Realized Investment Losses
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.
We realized net investment losses of $62,000 on the sale of securities for the quarter ended
June 30, 2006 compared to $94,000 of net investment losses for the quarter ended June 30, 2005. For
the six months ended June 30, 2006 and 2005, we realized net investment losses of $41,000 and
$153,000 on the sale of securities, respectively. No other-than-temporary declines were realized
during the three or six months ended June 30, 2006. No other-than-temporary declines were realized
during the three months ended June 30, 2005. Other-than-temporary losses of $35,000 were included
in the net realized investment losses for the six months ended June 30, 2005.
Expenses
Losses and Loss Expenses
Losses 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. The items that influence the
incurred losses and loss expenses for a given period include, but are not limited to, the
following:
|
|
|
the number of exposures covered in the current year; |
|
|
|
|
trends in claim frequency and claim severity; |
|
|
|
|
changes in the cost of adjusting claims; |
|
|
|
|
changes in the legal environment relating to coverage interpretation, theories of liability and jury determinations; and |
|
|
|
|
the re-estimation of prior years reserves in the current year. |
We establish or adjust (for prior accident quarters) our best estimate of the ultimate
incurred losses and loss expenses to reflect loss development information and trends that have been
updated for the most recent quarters activity through quarterly internal actuarial analysis. As of
December 31 of each year, we have an independent actuarial analysis performed of the adequacy of
our reserves. Our estimate of ultimate loss and loss expenses is evaluated and re-evaluated by
accident year and by major coverage grouping and changes in estimates are reflected in the period
the additional information becomes known.
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. 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).
28
Net loss and loss expenses incurred were $32.6 million for the quarter ended June 30, 2006,
compared to $26.6 million for the quarter ended June 30, 2005. In the second quarter of 2006, we
recorded $31.7 million of incurred losses and loss expenses attributable to the 2006 accident year
and $886,000 attributable to events of prior years. In the second quarter of 2005, we recorded
$24.9 million of incurred losses and loss expenses attributable to the 2005 accident year and $1.7
million attributable to events of prior years.
Net loss and loss expenses incurred were $63.0 million for the six months ended June 30, 2006,
compared to $52.3 million for the six months ended June 30, 2005. In the first six months of 2006,
we recorded $61.4 million of incurred losses and loss expenses attributable to the 2006 accident
year and $1.6 million, respectively attributable to events of prior years. In the first six months
of 2005, we recorded $48.7 million of incurred losses and loss expenses attributable to the 2005
accident year and $3.6 million attributable to events of prior years.
Our reserve for losses and loss expenses at June 30, 2006 was $235.0 million (before the
effects of reinsurance) and $193.3 million (after the effects of reinsurance), as estimated through
our actuarial analysis. For the second quarter of 2006 and the first six months of 2006, we
concluded through our actuarial analysis that the December 31, 2005 reserve for losses and loss
expenses of $174.2 million (after the effects of reinsurance) was deficient by $886,000 and $1.6
million, respectively, primarily in our casualty business, which was partially offset by favorable
development in our property reserves.
Our reserve for losses and loss expenses (net of the effects of reinsurance) at June 30, 2006
and December 31, 2005 by line is summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2006 |
|
|
2005 |
|
|
|
(In thousands) |
|
Property/casualty: |
|
|
|
|
|
|
|
|
Casualty |
|
$ |
167,197 |
|
|
|
142,451 |
|
Property |
|
|
22,423 |
|
|
|
27,972 |
|
Other (including exited lines): |
|
|
|
|
|
|
|
|
Commercial auto |
|
|
588 |
|
|
|
936 |
|
Workers compensation |
|
|
2,635 |
|
|
|
2,657 |
|
Other |
|
|
414 |
|
|
|
183 |
|
|
|
|
|
|
|
|
Net reserves for losses and loss expenses |
|
|
193,257 |
|
|
|
174,199 |
|
Plus reinsurance recoverables on unpaid
losses at end of period |
|
|
41,694 |
|
|
|
37,448 |
|
|
|
|
|
|
|
|
Gross reserves for losses and loss expenses |
|
$ |
234,951 |
|
|
|
211,647 |
|
|
|
|
|
|
|
|
The increase in net loss and loss expense reserves during the first six months of 2006 is
primarily attributable to our continued growth, and an increase in the cost to settle claims
experienced throughout 2005 and into 2006.
In the aggregate, we recorded $886,000 and $1.6 million of unfavorable reserve development
related to prior accident years for the three and six months ended June 30, 2006, respectively.
For the six months ended June 30, 2006, within the property line, we experienced favorable
non-catastrophe case reserve development producing a reduction in ultimate loss and loss expenses
for the 2004 and 2005 accident years by $4.0 million. We also changed our estimates during such
six month period on catastrophe losses by reducing our estimates on Hurricane Wilma by $1.1 million
due to actual incurred losses being lower than original estimates. This favorable development was
offset by an increase of $4.1 million in casualty reserves during such six month period as a result
of a refinement to the internal actuarial reserving technique concerning the weighting of reserve
indications and supplemental information concerning claims severities. Our reserves moved to a
higher point on the range of loss and loss expense reserve estimate, despite the fact that overall,
our casualty book of business performed within the range of expectations for the quarter and six
months ended June 30, 2006. We also incurred approximately $1.2 million of adverse development
during the six months ended June 30, 2006 due to an increase in legal severities on construction
defect claims. Additionally, we recorded approximately $1.4 million of unfavorable development
during the six months ended June 30, 2006 related to estimated costs associated with possible
reinsurance collection issues on two separate casualty claims.
The prior year development increases for the quarter and six months ended June 30, 2005
resulted principally from construction defect claims within the other liability line of the
property and casualty segment. During the first and second quarter of 2005, we
29
established
reserves for several contribution action settlements. This development was slightly offset by
favorable claim count development, while claim severities continued to be within our expectations.
Prior year development for construction defect claims was $1.7 million and $3.1 million for the
three and six months ended June 30, 2005, respectively. The prior year increases related to
construction defect claims was partially offset by positive development in our property line and
supplemented by additional development in the casualty line.
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 table presents our amortization of deferred policy acquisition costs, other
operating expenses and related ratios and interest expense for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
For the Six Months |
|
|
|
Ended June 30, |
|
|
Ended June 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
|
|
|
|
|
|
(In thousands) |
|
|
|
|
|
Amortization of deferred
policy acquisition costs
(ADAC) |
|
$ |
12,896 |
|
|
|
10,335 |
|
|
|
24,962 |
|
|
|
20,555 |
|
Other operating expenses |
|
|
4,075 |
|
|
|
3,474 |
|
|
|
7,998 |
|
|
|
6,539 |
|
Severance expense |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
793 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ADAC and other operating expenses |
|
|
16,971 |
|
|
|
13,809 |
|
|
|
32,960 |
|
|
|
27,887 |
|
Interest expense |
|
|
567 |
|
|
|
459 |
|
|
|
1,110 |
|
|
|
876 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
$ |
17,538 |
|
|
|
14,268 |
|
|
|
34,070 |
|
|
|
28,763 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expense ratio: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ADAC |
|
|
24.5 |
% |
|
|
24.0 |
% |
|
|
24.6 |
% |
|
|
24.3 |
% |
Other operating expenses |
|
|
7.8 |
% |
|
|
8.1 |
% |
|
|
7.9 |
% |
|
|
7.7 |
% |
Severance |
|
|
|
% |
|
|
|
% |
|
|
|
% |
|
|
1.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expense ratio (1) |
|
|
32.3 |
% |
|
|
32.1 |
% |
|
|
32.5 |
% |
|
|
33.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Interest expense is not included in the calculation of the expense ratio. |
Operating expenses increased compared to the same periods in 2005 by 22.9% and 18.5% for the
three and six months ended June 30, 2006, respectively. The overall expense ratio for the three
months ended June 30, 2006 and 2005 was 32.3%, and 32.1%. The overall expense ratio was 32.5% for
the six months ended June 30, 2006 and 33.0% for the six months ended June 30, 2005, respectively.
The increase in expenses and the expense ratio for the three months ended June 30, 2006 and the
increase in expenses for the six months ended June 30, 2006 compared to the same periods of 2005,
is primarily due to an increase in ADAC as a result of an increase in the volume of insurance
written. In addition, we have experienced a slight increase in our ADAC portion of the expense
ratio due to an increase in the volume of our binding premium, which has a higher commission rate
compared to our brokerage business. The other operating expense ratio for the three and six months
ended June 30, 2006 compared to the three and six months ended June 30, 2005 remained relatively
stable. The decrease in the expense ratio for the six months ended June 30, 2006 when compared to
the six months ended June 30, 2005 primarily resulted from the severance expense recorded in the
first quarter of 2005.
Interest expense continues to increase based on the increase in interest rates on our Trust
Preferred securities, due to the increasing interest rate environment.
Income Taxes
The income tax provision for the three and six months ended June 30, 2006 and 2005, has been
computed based on our estimated annual effective tax rate of 29%, which differs from the federal
income tax rate of 35% principally because of tax-exempt investment income.
30
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 and proceeds
from sales and maturities of investments. 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.
Century is restricted by statute as to the amount of dividends it may pay without the prior
approval of regulatory authorities. Century may pay dividends to ProCentury 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 payable by Century to ProCentury in 2006 is $12.1 million. Century paid
ordinary dividends for the three and six months ended June 30, 2006 of $1.3 million and $2.6
million, respectively. Century did not pay ProCentury any dividends in the first six months of
2005.
Century is required by law to maintain a certain minimum level of surplus on a statutory
basis. Surplus is calculated by subtracting total liabilities form 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. At
December 31, 2005, the statutory surplus of Century was in excess of the prescribed risk-based
capital requirements that correspond to any level of regulatory action. Centurys statutory surplus
at December 31, 2005 was $121.8 million and the authorized control level was $33.6 million.
Centurys statutory surplus at June 30, 2006 was $126.8 million.
Consolidated net cash provided by operating activities was $30.4 million for the first six
months of 2006, compared to $28.2 million for the same period in 2005. The increase is a direct
result of the current year growth in premiums, partially offset by the related expenses.
Consolidated net cash used by investing activities was $26.8 million for the first six months
of 2006, compared to $22.8 million for the same period in 2005. The increase resulted from our
ability to invest the continued increase in net cash provided by operating activities.
Consolidated net cash used in financing activities was $354,000 for the first six months of
2006, compared to net cash used in financing activities of $528,000 for the same period in 2005.
This decrease is the result of an increase in dividends of $0.065 per share during the six months
ended June 30, 2006 compared to $0.04 per share during the six months ended June 30, 2005,
partially offset by a $500,000 cash draw on the line of credit.
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.
We have a $5.0 million line of credit with a maturity date of September 8, 2006, and interest
only payments due quarterly based on LIBOR plus 2.5% of the outstanding balance. All of the
outstanding shares of Century are pledged as collateral. In June 2006, the Company made a $500,000
draw on the line of credit for general corporate purposes. Interest expense on the line of credit
for the quarter ended June 30, 2006 was approximately $1,800. We also made an additional draw of
$500,000 on the line of credit in July 2006.
There was no outstanding balance at June 30, 2005; however, in April 2005, we made a $2.3
million draw on the line of credit for general corporate purposes. The $2.3 million draw was paid
off on May 17, 2005. Interest paid on the line of credit for the period during which the draw was
outstanding was $5,000 for the quarter ended June 30, 2005.
Our contractual obligations and commercial commitments have not materially changed from that
reported in our most recent Form 10-K.
31
Given our historical cash flow, we believe cash flow from operating activities in 2006 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 cannot give assurances in this regard.
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
three outside independent investment managers that operate under investment guidelines approved by
Centurys investment committee. Centurys investment committee meets at least quarterly and reports
to ProCenturys 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 or type of 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 investment portfolio increased to $389.2 million at June 30, 2006 from $366.4
million at December 31, 2005 and is summarized by type of investment in Note 3 to the interim
unaudited consolidated condensed financial statements included in this Form 10-Q filing. Our
taxable equivalent yield increased to 5.8% at June 30, 2006 from 5.2% at December 31, 2005. The
increase in the taxable equivalent yield during the first six months of 2006 was a result of the
investment of proceeds from maturities and operating cash flows at higher interest rates, which
were partially driven by the overall rise in market interest rates. The fair value of our fixed
maturities at June 30, 2006 increased to $326.4 million from $303.7 million at December 31, 2005.
The fair value of our equity securities decreased to $42.2 million at June 30, 2006 from $44.8
million at December 31, 2005. As of June 30, 2006, the duration of the fixed income portfolio was
4.3 years, slightly shorter than at December 31, 2005. The overall credit quality of the portfolio
remained investment grade.
Accounting Standards
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 are currently evaluating the impact of this Interpretation.
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 will adopt SOP 05-1 effective January 1, 2007. We are currently evaluating the impact of
the SOP.
32
In February 2006, the Financial Accounting Standards Board (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
expect that SFAS No. 155 will not have a material effect on our consolidated financial condition or
results of operations.
In March 2006, the FASB issued statement No. 156, Accounting for Servicing of Financial
Assets (SFAS No. 156). SFAS No. 156 amends FASB Statement No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, to require that all separately
recognized servicing assets and servicing liabilities be initially measured at fair value, if
practicable. SFAS No. 156 permits, but does not require, the subsequent measurement of separately
recognized servicing assets and servicing liabilities at fair value. An entity that uses derivative
instruments to mitigate the risks inherent in servicing assets and servicing liabilities is
required to account for those derivative instruments at fair value. SFAS No. 156 is effective as of
the beginning of the first annual reporting period that begins after September 15, 2006. We expect
that SFAS No. 156 will not have a material effect on our financial condition or results of
operations.
Item 3. Quantitative And Qualitative Disclosures About Market Risk
The Company is exposed to market risk, which 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.
As of June 30, 2006, there had not been a material change in any of the market risk
information disclosed by the Company under Item 7A. Quantitative and Qualitative Disclosures About
Market Risk in its Annual Report on Form 10-K for the year ended December 31, 2005.
Item 4. Controls And Procedures
As of the end of the period covered by this quarterly report, the Company carried out an
evaluation, under the supervision and with the participation of the Companys 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 the Companys disclosure controls
and procedures pursuant to Securities Exchange Act Rule 13a-15 (Disclosure Controls).
The Companys 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 the Company 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 error 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 on managements evaluation of the Companys Disclosure Controls as of June 30, 2006,
management concluded that they provide reasonable assurance that information required to be
disclosed by the Company in its periodic reports is accumulated and communicated to management,
including the CEO and CFO, as appropriate to allow timely decisions regarding disclosure and is
recorded, processed, summarized and reported within the time periods specified in the Securities
and Exchange Commissions rules and forms.
There were no changes in the Companys internal control over financial reporting during the
Companys most recent fiscal quarter that materially affected, or are reasonably likely to
materially affect, the Companys internal control over financial reporting.
33
PART II: OTHER INFORMATION
Item 1. Legal Proceedings
We are party to lawsuits, arbitration 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 LAE 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.
Item 1A. Risk Factors
The risks related to our business and industry have not materially changed from those
identified in the Companys annual report on Form 10-K for the year ended December 31, 2005.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
The Companys annual meeting of shareholders was held on May 15, 2006. The following matter
was brought before the shareholders for vote at this meeting:
The election of the following three Class II Directors, each to serve until the 2009 annual
meeting of shareholders and until a successor has been duly elected and qualified:
|
|
|
|
|
|
|
For |
|
Against/Withheld |
Robert F. Fix |
|
12,266,104 |
|
322,419 |
Christopher J. Timm |
|
12,433,208 |
|
155,315 |
Robert J. Woodward, Jr. |
|
12,216,460 |
|
372,063 |
Item 5. Other Information
Not applicable.
Item 6. Exhibits
|
|
|
3.1
|
|
Amended and Restated Articles of Incorporation of ProCentury (Incorporated by reference
from the Companys Quarterly Report on Form 10-Q for the period ended March 31, 2004,
filed with the Securities and Exchange Commission SEC on September 4, 2004.) |
|
|
|
3.2
|
|
Amended and Restated Code of Regulations of ProCentury (Incorporated by reference from the
Companys Quarterly Report on Form 10-Q for the period ended March 31, 2004, filed with
the SEC on September 4, 2004.) |
|
|
|
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 |
34
|
|
|
|
|
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 (1) |
|
|
|
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 (1) |
|
|
|
(1) |
|
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. |
35
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf of the undersigned thereunto duly authorized.
|
|
|
|
|
|
PROCENTURY CORPORATION
|
|
Date August 7, 2006 |
By: |
/s/ Erin E. West
|
|
|
|
Erin E. West |
|
|
|
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer) |
|
36
EXHIBIT INDEX
|
|
|
3.1
|
|
Amended and Restated Articles of Incorporation of ProCentury (Incorporated by reference
from the Companys Quarterly Report on Form 10-Q for the period ended March 31, 2004,
filed with the Securities and Exchange Commission (SEC) on September 4, 2004.) |
|
|
|
3.2
|
|
Amended and Restated Code of Regulations of ProCentury (Incorporated by reference from the
Companys Quarterly Report on Form 10-Q for the period ended March 31, 2004, filed with
the SEC on September 4, 2004.) |
|
|
|
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 (1) |
|
|
|
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 (1) |
|
|
|
(1) |
|
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. |
37