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, 2007
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 þ NO o
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 o Accelerated filer þ Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Act).
o Yes þ No
As of August 3, 2007, the registrant had 13,358,867 outstanding Common Shares, without par
value.
PROCENTURY CORPORATION
QUARTERLY REPORT ON FORM 10-Q
For the Quarterly Period Ended June 30, 2007
INDEX
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 Ended June 30, |
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Six Months Ended June 30, |
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2007 |
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2006 |
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2007 |
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2006 |
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Premiums earned |
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$ |
56,697 |
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52,565 |
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111,085 |
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101,567 |
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Net investment income |
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5,493 |
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4,689 |
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10,926 |
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9,115 |
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Net realized investment losses |
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(37 |
) |
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(62 |
) |
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(238 |
) |
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(41 |
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Other income |
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97 |
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118 |
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220 |
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252 |
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Total revenues |
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62,250 |
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57,310 |
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121,993 |
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110,893 |
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Losses and loss expenses |
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33,124 |
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32,575 |
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67,001 |
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63,014 |
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Amortization of deferred policy acquisition costs |
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14,689 |
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12,896 |
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28,388 |
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24,962 |
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Other operating expenses |
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4,353 |
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4,193 |
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8,204 |
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8,250 |
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Interest expense |
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668 |
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567 |
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1,354 |
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1,110 |
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Total expenses |
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52,834 |
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50,231 |
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104,947 |
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97,336 |
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Income before income tax expense |
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9,416 |
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7,079 |
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17,046 |
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13,557 |
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Income tax expense |
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2,948 |
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2,054 |
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5,199 |
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3,932 |
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Net income |
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$ |
6,468 |
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5,025 |
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11,847 |
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9,625 |
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Basic net income per share |
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$ |
0.49 |
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0.38 |
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0.90 |
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0.73 |
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Diluted net income per share |
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$ |
0.48 |
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0.38 |
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0.88 |
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0.73 |
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Weighted average of shares outstanding basic |
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13,232,156 |
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13,114,535 |
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13,229,792 |
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13,107,620 |
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Weighted average of shares outstanding diluted |
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13,419,481 |
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13,247,528 |
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13,420,544 |
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13,224,050 |
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See accompanying notes to the unaudited consolidated condensed financial statements.
3
PROCENTURY CORPORATION AND SUBSIDIARIES
Consolidated Condensed Balance Sheets
(In thousands, except share data)
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June 30, |
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2007 |
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December 31, |
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(Unaudited) |
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2006 |
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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 2007, $392,944; 2006, $362,066) |
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$ |
380,703 |
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358,422 |
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Held-to-maturity, at amortized cost
(fair value 2007, $1,095; 2006, $1,101) |
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1,107 |
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1,114 |
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Equities (available-for-sale): |
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Equity securities, at fair value (cost 2007, $31,455; 2006, $28,112) |
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30,479 |
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28,188 |
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Bond mutual funds, at fair value (cost 2007, $14,737; 2006, $14,876) |
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14,507 |
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14,755 |
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Short-term investments, at amortized cost |
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18,944 |
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25,623 |
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Total investments |
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445,740 |
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428,102 |
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Cash and equivalents |
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10,709 |
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7,960 |
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Premiums in course of collection, net |
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39,937 |
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37,428 |
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Deferred policy acquisition costs |
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26,782 |
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26,915 |
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Prepaid reinsurance premiums |
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15,038 |
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14,051 |
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Reinsurance recoverable on paid losses, net |
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6,662 |
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7,524 |
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Reinsurance recoverable on unpaid losses, net |
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36,491 |
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36,104 |
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Deferred federal income tax asset |
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15,490 |
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11,561 |
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Other assets |
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11,109 |
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9,403 |
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Total assets |
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$ |
607,958 |
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579,048 |
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Liabilities and Shareholders Equity |
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Loss and loss expense reserves |
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$ |
266,132 |
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250,672 |
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Unearned premiums |
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126,166 |
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127,620 |
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Long term debt |
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25,000 |
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25,000 |
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Line of credit |
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4,650 |
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4,000 |
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Accrued expenses and other liabilities |
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21,227 |
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9,778 |
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Reinsurance balances payable |
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5,715 |
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7,706 |
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Collateral held |
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10,366 |
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10,370 |
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Income taxes payable |
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162 |
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1,514 |
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Total liabilities |
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459,418 |
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436,660 |
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Shareholders equity: |
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Common stock, without par value: |
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Common shares Issued and outstanding 13,358,867 shares at
June 30, 2007 and 13,248,323 shares issued and
outstanding at December 31, 2006 |
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Additional paid-in capital |
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102,674 |
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100,954 |
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Retained earnings |
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54,608 |
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43,830 |
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Accumulated other comprehensive loss, net of taxes |
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|
(8,742 |
) |
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(2,396 |
) |
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Total shareholders equity |
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|
148,540 |
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|
142,388 |
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Total liabilities and shareholders equity |
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$ |
607,958 |
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579,048 |
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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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2007 |
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2006 |
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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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100,954 |
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|
100,202 |
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Impact of adoption of SFAS 123R |
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(695 |
) |
Shares issued under share compensation plans |
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|
704 |
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|
613 |
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Tax benefit on share compensation plans |
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|
319 |
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45 |
|
Exercise of share options |
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|
697 |
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6 |
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End of period |
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102,674 |
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|
100,171 |
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Retained earnings: |
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Beginning of period |
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43,830 |
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|
24,846 |
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Net income |
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|
11,847 |
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|
9,625 |
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Dividend declared (2007, $0.08/share and 2006, $0.065/share) |
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(1,069 |
) |
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|
(860 |
) |
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End of period |
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54,608 |
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33,611 |
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Unearned share compensation: |
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Beginning of period |
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(695 |
) |
Impact of adoption of SFAS 123R |
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|
695 |
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|
|
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End of period |
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Accumulated other comprehensive loss, net of taxes: |
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Beginning of period |
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(2,396 |
) |
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|
(3,150 |
) |
Unrealized holding losses arising during the period,
net of reclassification adjustment |
|
|
(6,346 |
) |
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|
(4,128 |
) |
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|
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|
End of period |
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|
(8,742 |
) |
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|
(7,278 |
) |
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Total shareholders equity |
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$ |
148,540 |
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|
|
126,504 |
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Comprehensive Income |
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Net income |
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$ |
11,847 |
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|
9,625 |
|
Other comprehensive loss: |
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Unrealized losses on securities: |
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Unrealized holding losses arising during the period: |
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Gross |
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|
(9,995 |
) |
|
|
(6,392 |
) |
Related federal income tax benefit |
|
|
3,494 |
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|
|
2,237 |
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|
|
|
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Net unrealized losses |
|
|
(6,501 |
) |
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|
(4,155 |
) |
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Reclassification adjustment for losses included in net income |
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|
|
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Gross |
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|
(238 |
) |
|
|
(41 |
) |
Related federal income tax benefit |
|
|
83 |
|
|
|
14 |
|
|
|
|
|
|
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|
Net reclassification adjustment |
|
|
(155 |
) |
|
|
(27 |
) |
|
|
|
|
|
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Other comprehensive loss |
|
|
(6,346 |
) |
|
|
(4,128 |
) |
|
|
|
|
|
|
|
Total comprehensive income |
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$ |
5,501 |
|
|
|
5,497 |
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|
|
|
|
|
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|
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, |
|
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2007 |
|
|
2006 |
|
Cash flows provided by operating activities: |
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|
|
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|
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|
Net income |
|
$ |
11,847 |
|
|
|
9,625 |
|
Adjustments: |
|
|
|
|
|
|
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|
Net realized investment losses |
|
|
238 |
|
|
|
41 |
|
Deferred federal income tax benefit |
|
|
(518 |
) |
|
|
(916 |
) |
Share-based compensation expense |
|
|
704 |
|
|
|
613 |
|
Changes in assets and liabilities: |
|
|
|
|
|
|
|
|
Premiums in course of collection, net |
|
|
(2,509 |
) |
|
|
(510 |
) |
Deferred policy acquisition costs |
|
|
133 |
|
|
|
(2,257 |
) |
Prepaid reinsurance premiums |
|
|
(987 |
) |
|
|
707 |
|
Reinsurance recoverable on paid and unpaid losses, net |
|
|
475 |
|
|
|
(5,825 |
) |
Income taxes payable/receivable |
|
|
(1,352 |
) |
|
|
(506 |
) |
Losses and loss expense reserves |
|
|
15,460 |
|
|
|
23,304 |
|
Collateral held |
|
|
(4 |
) |
|
|
(561 |
) |
Unearned premiums |
|
|
(1,454 |
) |
|
|
6,646 |
|
Other, net |
|
|
(3,043 |
) |
|
|
(550 |
) |
|
|
|
|
|
|
|
Net cash provided by operating activities |
|
|
18,990 |
|
|
|
29,811 |
|
|
|
|
|
|
|
|
Cash flows used in investing activities: |
|
|
|
|
|
|
|
|
Purchases of equity securities |
|
|
(10,600 |
) |
|
|
(6,664 |
) |
Purchases of fixed maturity securities available-for-sale |
|
|
(86,783 |
) |
|
|
(47,435 |
) |
Proceeds from sales of equity securities |
|
|
7,628 |
|
|
|
8,697 |
|
Proceeds from sales and maturities of fixed maturities available-for-sale |
|
|
54,908 |
|
|
|
17,981 |
|
Change in short-term investments |
|
|
6,679 |
|
|
|
608 |
|
Change in securities receivable/payable |
|
|
11,330 |
|
|
|
620 |
|
|
|
|
|
|
|
|
Net cash used in investing activities |
|
|
(16,838 |
) |
|
|
(26,193 |
) |
|
|
|
|
|
|
|
Cash flows provided by (used in) financing activities: |
|
|
|
|
|
|
|
|
Dividend paid to shareholders |
|
|
(1,069 |
) |
|
|
(860 |
) |
Tax benefit on share compensation plans |
|
|
319 |
|
|
|
|
|
Draw on line of credit |
|
|
650 |
|
|
|
500 |
|
Exercise of share options |
|
|
697 |
|
|
|
6 |
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities |
|
|
597 |
|
|
|
(354 |
) |
|
|
|
|
|
|
|
Increase in cash and equivalents |
|
|
2,749 |
|
|
|
3,264 |
|
Cash and equivalents at beginning of period |
|
|
7,960 |
|
|
|
5,628 |
|
|
|
|
|
|
|
|
Cash and equivalents at end of period |
|
$ |
10,709 |
|
|
|
8,892 |
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information: |
|
|
|
|
|
|
|
|
Interest paid |
|
$ |
1,624 |
|
|
|
1,123 |
|
|
|
|
|
|
|
|
Federal income taxes paid |
|
$ |
6,750 |
|
|
|
5,300 |
|
|
|
|
|
|
|
|
See accompanying notes to the unaudited consolidated condensed financial statements.
6
PROCENTURY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements
June 30, 2007
(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 subsidiaries, Century Surety Company (Century) and ProCentury Insurance Company
(PIC). 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 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, 2006. 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,
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. |
|
|
|
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. |
|
(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: |
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, 2007 |
|
|
|
(In thousands, except per share data) |
|
|
|
Income |
|
|
Shares |
|
|
Per Share |
|
|
|
(Numerator) |
|
|
(Denominator) |
|
|
Amount |
|
Basic Net Income Per Share |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
6,468 |
|
|
|
13,232,156 |
|
|
$ |
0.49 |
|
Effect of Dilutive Securities |
|
|
|
|
|
|
|
|
|
|
|
|
Restricted common shares and share options |
|
|
|
|
|
|
187,325 |
|
|
|
(0.01 |
) |
|
|
|
|
|
|
|
|
|
|
Diluted EPS |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
6,468 |
|
|
|
13,419,481 |
|
|
$ |
0.48 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, 2006 |
|
|
|
(In thousands, except per share data) |
|
|
|
Income |
|
|
Shares |
|
|
Per Share |
|
|
|
(Numerator) |
|
|
(Denominator) |
|
|
Amount |
|
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 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2007 |
|
|
|
(In thousands, except per share data) |
|
|
|
Income |
|
|
Shares |
|
|
Per Share |
|
|
|
(Numerator) |
|
|
(Denominator) |
|
|
Amount |
|
Basic Net Income Per Share |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
11,847 |
|
|
|
13,229,792 |
|
|
$ |
0.90 |
|
Effect of Dilutive Securities |
|
|
|
|
|
|
|
|
|
|
|
|
Restricted common shares and share options |
|
|
|
|
|
|
190,752 |
|
|
|
(0.02 |
) |
|
|
|
|
|
|
|
|
|
|
Diluted EPS |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
11,847 |
|
|
|
13,420,544 |
|
|
$ |
0.88 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2006 |
|
|
|
(In thousands, except per share data) |
|
|
|
Income |
|
|
Shares |
|
|
Per Share |
|
|
|
(Numerator) |
|
|
(Denominator) |
|
|
Amount |
|
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 |
|
|
|
|
|
|
|
|
|
|
|
(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: |
8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2007 |
|
|
|
(In thousands) |
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
Estimated |
|
|
|
Amortized |
|
|
unrealized |
|
|
unrealized |
|
|
fair |
|
|
|
cost |
|
|
gains |
|
|
losses |
|
|
value |
|
U.S. Treasury securities |
|
$ |
88 |
|
|
|
7 |
|
|
|
|
|
|
|
95 |
|
Agencies not backed by the full faith and credit of
the U.S. Government |
|
|
1,019 |
|
|
|
|
|
|
|
(19 |
) |
|
|
1,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,107 |
|
|
|
7 |
|
|
|
(19 |
) |
|
|
1,095 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2006 |
|
|
|
(In thousands) |
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
Estimated |
|
|
|
Amortized |
|
|
unrealized |
|
|
unrealized |
|
|
fair |
|
|
|
cost |
|
|
gains |
|
|
losses |
|
|
value |
|
U.S. Treasury securities |
|
$ |
88 |
|
|
|
10 |
|
|
|
|
|
|
|
98 |
|
Agencies not backed by the full faith and credit of
the U.S. Government |
|
|
1,026 |
|
|
|
|
|
|
|
(23 |
) |
|
|
1,003 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,114 |
|
|
|
10 |
|
|
|
(23 |
) |
|
|
1,101 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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:
9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2007 |
|
|
|
(In thousands) |
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
|
|
|
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Estimated |
|
|
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Fair Value |
|
Fixed maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities |
|
$ |
2,128 |
|
|
|
|
|
|
|
(47 |
) |
|
|
2,081 |
|
Agencies not backed by the full faith and
credit of the U.S. Government |
|
|
14,555 |
|
|
|
|
|
|
|
(380 |
) |
|
|
14,175 |
|
Obligations of states and political subdivisions |
|
|
133,897 |
|
|
|
28 |
|
|
|
(2,780 |
) |
|
|
131,145 |
|
Corporate securities |
|
|
35,856 |
|
|
|
38 |
|
|
|
(726 |
) |
|
|
35,168 |
|
Mortgage-backed securities |
|
|
106,437 |
|
|
|
63 |
|
|
|
(2,936 |
) |
|
|
103,564 |
|
Collateralized mortgage obligations |
|
|
59,098 |
|
|
|
38 |
|
|
|
(1,225 |
) |
|
|
57,911 |
|
Asset-backed securities |
|
|
40,973 |
|
|
|
72 |
|
|
|
(4,386 |
) |
|
|
36,659 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities |
|
|
392,944 |
|
|
|
239 |
|
|
|
(12,480 |
) |
|
|
380,703 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities |
|
|
31,455 |
|
|
|
99 |
|
|
|
(1,075 |
) |
|
|
30,479 |
|
Bond mutual funds |
|
|
14,737 |
|
|
|
12 |
|
|
|
(242 |
) |
|
|
14,507 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equities |
|
|
46,192 |
|
|
|
111 |
|
|
|
(1,317 |
) |
|
|
44,986 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
439,136 |
|
|
|
350 |
|
|
|
(13,797 |
) |
|
|
425,689 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2006 |
|
|
|
(In thousands) |
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
|
|
|
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Estimated |
|
|
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Fair Value |
|
Fixed maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities |
|
$ |
3,636 |
|
|
|
|
|
|
|
(49 |
) |
|
|
3,587 |
|
Agencies not backed by the full faith and
credit of the U.S. Government |
|
|
13,793 |
|
|
|
|
|
|
|
(258 |
) |
|
|
13,535 |
|
Obligations of states and political subdivisions |
|
|
150,981 |
|
|
|
445 |
|
|
|
(795 |
) |
|
|
150,631 |
|
Corporate securities |
|
|
35,058 |
|
|
|
125 |
|
|
|
(730 |
) |
|
|
34,453 |
|
Mortgage-backed securities |
|
|
59,599 |
|
|
|
34 |
|
|
|
(1,108 |
) |
|
|
58,525 |
|
Collateralized mortgage obligations |
|
|
49,486 |
|
|
|
152 |
|
|
|
(622 |
) |
|
|
49,016 |
|
Asset-backed securities |
|
|
49,513 |
|
|
|
316 |
|
|
|
(1,154 |
) |
|
|
48,675 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities |
|
|
362,066 |
|
|
|
1,072 |
|
|
|
(4,716 |
) |
|
|
358,422 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities |
|
|
28,112 |
|
|
|
346 |
|
|
|
(270 |
) |
|
|
28,188 |
|
Bond mutual funds |
|
|
14,876 |
|
|
|
62 |
|
|
|
(183 |
) |
|
|
14,755 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equities |
|
|
42,988 |
|
|
|
408 |
|
|
|
(453 |
) |
|
|
42,943 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
405,054 |
|
|
|
1,480 |
|
|
|
(5,169 |
) |
|
|
401,365 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other-than-temporary impairment losses result in permanent reductions to the cost basis of
the underlying investments and are recorded as realized losses in the interim unaudited
consolidated condensed statements of operations. Other-than-temporary losses of $266,000 and
$882,000 were realized during the three and six months ended June 30, 2007. These losses
related to seven and eighteen asset-backed securities that were written down in accordance with
EITF 99-20 in the three and six months ended June 30, 2007, respectively. No
other-than-temporary impairments were realized during the three or six months ended June 30,
2006.
The estimated fair value, related gross unrealized loss, and the length of time that the
securities have been impaired for held-to-maturity securities that are considered temporarily
impaired at June 30, 2007 are as follows:
10
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2007 |
|
|
|
Less than 12 months |
|
|
12 months or longer |
|
|
Total |
|
|
|
Estimated |
|
|
Gross |
|
|
Estimated |
|
|
Gross |
|
|
Estimated |
|
|
Gross |
|
|
|
fair |
|
|
unrealized |
|
|
fair |
|
|
unrealized |
|
|
fair |
|
|
unrealized |
|
|
|
value |
|
|
loss |
|
|
value |
|
|
loss |
|
|
value |
|
|
loss |
|
|
|
(In thousands) |
|
Fixed Maturity Securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury Securities |
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agencies not backed by the full faith and
credit of the U.S. Government |
|
|
|
|
|
|
|
|
|
|
1,000 |
|
|
|
(19 |
) |
|
|
1,000 |
|
|
|
(19 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
|
|
|
|
|
|
|
|
1,000 |
|
|
|
(19 |
) |
|
|
1,000 |
|
|
|
(19 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 at June 30, 2007 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less Than 12 Months |
|
|
12 Months or Longer |
|
|
Total |
|
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
Gross |
|
|
|
Estimated |
|
|
Unrealized |
|
|
Estimated |
|
|
Unrealized |
|
|
Estimated |
|
|
Unrealized |
|
|
|
Fair Value |
|
|
Loss |
|
|
Fair Value |
|
|
Loss |
|
|
Fair Value |
|
|
Loss |
|
|
|
(In thousands) |
|
Fixed maturity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities |
|
$ |
483 |
|
|
|
(9 |
) |
|
|
1,598 |
|
|
|
(38 |
) |
|
|
2,081 |
|
|
|
(47 |
) |
Obligations of U.S. government
corporations and agencies |
|
|
7,579 |
|
|
|
(185 |
) |
|
|
6,596 |
|
|
|
(195 |
) |
|
|
14,175 |
|
|
|
(380 |
) |
Obligations of states and political
subdivisions |
|
|
88,098 |
|
|
|
(1,828 |
) |
|
|
39,640 |
|
|
|
(952 |
) |
|
|
127,738 |
|
|
|
(2,780 |
) |
Corporate securities |
|
|
4,406 |
|
|
|
(54 |
) |
|
|
26,428 |
|
|
|
(672 |
) |
|
|
30,834 |
|
|
|
(726 |
) |
Mortgage-backed securities |
|
|
58,280 |
|
|
|
(1,562 |
) |
|
|
30,484 |
|
|
|
(1,374 |
) |
|
|
88,764 |
|
|
|
(2,936 |
) |
Collateralized mortgage obligations |
|
|
30,952 |
|
|
|
(713 |
) |
|
|
20,576 |
|
|
|
(512 |
) |
|
|
51,528 |
|
|
|
(1,225 |
) |
Asset-backed securities |
|
|
17,186 |
|
|
|
(2,500 |
) |
|
|
11,111 |
|
|
|
(1,886 |
) |
|
|
28,297 |
|
|
|
(4,386 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
206,984 |
|
|
|
(6,851 |
) |
|
|
136,433 |
|
|
|
(5,629 |
) |
|
|
343,417 |
|
|
|
(12,480 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities |
|
|
21,392 |
|
|
|
(761 |
) |
|
|
4,271 |
|
|
|
(314 |
) |
|
|
25,663 |
|
|
|
(1,075 |
) |
Bond mutual funds |
|
|
486 |
|
|
|
(15 |
) |
|
|
5,131 |
|
|
|
(227 |
) |
|
|
5,617 |
|
|
|
(242 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
21,878 |
|
|
|
(776 |
) |
|
|
9,402 |
|
|
|
(541 |
) |
|
|
31,280 |
|
|
|
(1,317 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Grand Total |
|
$ |
228,862 |
|
|
|
(7,627 |
) |
|
|
145,835 |
|
|
|
(6,170 |
) |
|
|
374,697 |
|
|
|
(13,797 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At June 30, 2007, the Company had 187 fixed income securities and 15 equity securities that
have been in an unrealized loss position for one year or longer. Of the fixed income
securities, 166 are investment grade, of which 155 of these securities are rated A1/A or better
(including 112 securities which are rated AAA). The 21 remaining non-investment grade fixed
income securities have an aggregate fair value equal to 84.6% of their book value as of June 30,
2007. Of the equity securities, four that have been in an unrealized loss position for one year
or longer relate to investments in closed or open ended bond or preferred stock funds. Each of
these investments continues to pay its regularly scheduled monthly dividend and there have been
no material changes in credit quality for any of these funds over the past twelve months.
Finally, the 11 remaining equity securities that have been in an unrealized loss position for
one year or longer relate to preferred share investments in issuers each of which has shown an
improved or stable financial performance during the past twelve months. In addition, these 11
equity securities have an aggregate fair market value equal to 94.2% of their book value as of
June 30, 2007. All 187 of the fixed income securities are current on interest and principal and
all 15 of the equity securities continue to pay dividends at a level consistent with the prior
year. Management believes that it is probable that all contract terms of each security will be
satisfied. The unrealized loss position for all investments, including equity securities, is
due to the changes in interest rate environment and current capital market conditions and the
Company has the positive intent and ability to hold these securities until they mature or
recover in value.
11
(4) |
|
Loss and Loss Expense Reserves |
|
|
|
Loss and loss expense reserves represent our best estimate of ultimate amounts for losses and
related expenses from claims that have been reported but not paid, and those losses that have
occurred but have not yet been reported to us. Loss reserves do not represent an exact
calculation of liability, but instead represent our estimates, generally utilizing individual
claim estimates and actuarial expertise and estimation techniques at a given accounting date.
The loss reserve estimates are expectations of what ultimate settlement and administration of
claims will cost upon final resolution. These estimates are based on facts and circumstances
then known to us, a review of historical settlement patterns, estimates of trends in claims
frequency and severity,
projections of loss costs, expected interpretations of legal theories of liability, and many
other factors. In establishing reserves, we also take into account estimated recoveries,
reinsurance, salvage and subrogation. The reserves are reviewed regularly by a team of actuaries
we employ. |
|
|
|
Net loss and loss expenses incurred were $33.1 million for the quarter ended June 30, 2007,
compared to $32.6 million for the quarter ended June 30, 2006. In the second quarter of 2007,
the Company recorded $35.6 million of incurred losses and loss expenses attributable to the 2007
accident year, which was partially offset by favorable development of $2.5 million attributable
to events of prior years. 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. |
|
|
|
Net loss and loss expenses incurred were $67.0 million for the six months ended June 30, 2007,
compared to $63.0 million for the six months ended June 30, 2006. In the first six months of
2007, the Company recorded $70.5 million of incurred losses and loss expenses attributable to the
2007 accident year, which were partially offset by favorable development of $3.5 million
attributable to events of prior years, as discussed below. For the six months ended June 30,
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. |
|
|
|
The favorable development during the three and six months ended June 30, 2007 resulted primarily
from reductions in the ultimate loss ratios for accident years 2005 and 2006 on the claims made
contractor liability business included in our property and casualty segment. The Company reduced
carried reserves related to the 2005 and 2006 casualty business based on the Companys internal
actuarial reserve recommendations. The 2005 and 2006 casualty reserves have performed better
than expected to date, and previously carried reserves exceeded the current indications for each
of the estimation methods applied in the Companys internal actuarial analysis. At the beginning
of 2005, the Company began writing certain contractors liability business on a claims made form,
replacing the occurrence form which had previously been utilized through 2004. The Company wrote
a significant volume of claims made contractor business in both 2005 and 2006, and this business
has continued to perform better than expected. The Company continues to monitor loss emergence
on this book and adjusts assumptions and estimates as needed. The Company continues to write
contractor business on an occurrence form on a limited basis, in certain jurisdictions and for
certain classes of business. |
|
|
|
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 the 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 the 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 amounts expected to be paid for
legal expenses or settlements of claims in litigation 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 potential
reinsurance collection issues on two separate casualty claims. |
|
|
|
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. |
12
(5) |
|
Reinsurance |
|
|
|
In the ordinary course of business, Century and PIC assume and cede 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, since December 31, 2006. The amounts of ceded loss and loss
expense reserves and ceded unearned premiums would represent a liability of the Company in the
event that its reinsurers would be unable to meet existing obligations under reinsurance
agreements. |
|
|
|
The effects of assumed and ceded reinsurance on premiums written, premiums earned and loss and
loss expenses incurred were as follows: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
For the Six Months |
|
|
|
Ended June 30, |
|
|
Ended June 30, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Premiums written: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct |
|
$ |
65,588 |
|
|
|
64,488 |
|
|
|
123,016 |
|
|
|
121,763 |
|
Assumed |
|
|
2,196 |
|
|
|
1,192 |
|
|
|
3,223 |
|
|
|
1,946 |
|
Ceded |
|
|
(9,200 |
) |
|
|
(7,191 |
) |
|
|
(17,595 |
) |
|
|
(14,788 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums written |
|
$ |
58,584 |
|
|
|
58,489 |
|
|
|
108,644 |
|
|
|
108,921 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums earned: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct |
|
|
63,091 |
|
|
|
59,061 |
|
|
|
124,187 |
|
|
|
115,146 |
|
Assumed |
|
|
2,224 |
|
|
|
1,105 |
|
|
|
3,505 |
|
|
|
1,917 |
|
Ceded |
|
|
(8,618 |
) |
|
|
(7,601 |
) |
|
|
(16,607 |
) |
|
|
(15,496 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums earned |
|
$ |
56,697 |
|
|
|
52,565 |
|
|
|
111,085 |
|
|
|
101,567 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses and loss expenses incurred: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct |
|
$ |
34,784 |
|
|
|
38,566 |
|
|
|
71,514 |
|
|
|
72,860 |
|
Assumed |
|
|
638 |
|
|
|
253 |
|
|
|
761 |
|
|
|
357 |
|
Ceded |
|
|
(2,298 |
) |
|
|
(6,244 |
) |
|
|
(5,274 |
) |
|
|
(10,203 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net losses and loss expenses incurred |
|
$ |
33,124 |
|
|
|
32,575 |
|
|
|
67,001 |
|
|
|
63,014 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Companys allowance for uncollectible reinsurance at June 30, 2007 was $4.1 million, which
had not changed since December 31, 2006. |
|
|
|
Management believes that the reserves for uncollectible reinsurance constitute a reasonable
provision for expected costs and recoveries related to the collection of the recoverables on
these claims, however, actual legal costs and settlements of these claims could vary
significantly from the current estimates recorded. |
|
(6) |
|
Deferred Policy Acquisition Costs |
|
|
|
The following reflects the amounts of policy acquisition costs deferred and amortized: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
For the Six Months |
|
|
|
Ended June 30, |
|
|
Ended June 30, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
Balance at beginning of period |
|
$ |
25,996 |
|
|
|
21,418 |
|
|
|
26,915 |
|
|
|
20,649 |
|
Policy acquisition costs deferred |
|
|
15,475 |
|
|
|
14,384 |
|
|
|
28,255 |
|
|
|
27,219 |
|
Amortization of deferred policy acquisition costs |
|
|
(14,689 |
) |
|
|
(12,896 |
) |
|
|
(28,388 |
) |
|
|
(24,962 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period |
|
$ |
26,782 |
|
|
|
22,906 |
|
|
|
26,782 |
|
|
|
22,906 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, 2007, the Company expensed $214,000 of unamortized deferred policy
acquisition costs related to the auto physical damage program. This expense was a result of the
fact that the programs loss and loss expense ratio exceeded our expectations causing the program
to fall below the profitability levels required for continued deferral of the additional policy
acquisition costs. There were no such expenses during the three or six months ended June 30,
2006. |
13
(7) |
|
Federal Income Taxes |
|
|
|
The income tax provision for the three and six months ended June 30, 2007 has been computed based
on our estimated annual effective tax rate of 30.5% which differs from the federal income tax
rate of 35% principally because of tax-exempt investment income. The income tax provision for
the three and six months ended June 30, 2006 was 29.0% primarily due to the effect of tax-exempt
investment income. |
|
(8) |
|
Commitments and Contingencies |
|
|
|
We are party to lawsuits, arbitrations and other proceedings that arise in the normal course of
our business. Certain of the lawsuits, arbitrations and other proceedings involve claims under
policies that we underwrite as an insurer, the liabilities for which we believe have been
adequately included in our loss and loss adjustment expense reserves. Also, from time to time, we
are party to lawsuits, arbitrations and other proceedings that relate to disputes over
contractual relationships with third parties or that involve alleged errors and omissions on the
part of our insurance subsidiaries. We provide accruals for these items to the extent we deem the
losses probable and reasonably estimable. |
|
|
|
The outcome of litigation is subject to numerous uncertainties. Although the ultimate outcome of
pending matters cannot be determined at this time, based on present information, we believe the
resolution of these matters will not have a material adverse effect on our financial position,
results of operations or cash flows. |
|
(9) |
|
Employee Benefits |
|
|
|
During 2004, the Company adopted and the shareholders approved a stock option plan that provided
for tax-favored incentive share options (qualified options), non-qualified share options to
employees and 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,
restricted shares that vest based on achieved performance metrics and non-restricted shares that
are issued in conjunction with the Companys annual bonus plan. The Company accounts for this
plan in accordance with FAS 123R. Any compensation cost recorded in accordance with FAS 123R is
recorded in the same captions as the salary expense of the employee (i.e. the compensation cost
for the Chief Investment Officer is recorded in net investment income). The Company will issue
authorized but unissued shares or treasury shares to satisfy restricted share awards or the
exercise of share options. |
|
|
|
With respect to qualified options, an employee may be granted an option to purchase shares at the
grant date fair market value, payable as determined by the Companys board of directors. An
optionee must exercise an option within 10 years from the grant date. Full vesting of options
granted occurs at the end of four years. |
|
|
|
With respect to non-qualified options, an employee or a board member may be granted an option to
purchase shares at the grant date fair market value, payable as determined by the Companys board
of directors. An optionee must exercise an option within 10 years from the grant date. Full
vesting of options granted occurs at the end of three years. |
|
|
|
For both non-qualified and qualified options, the option exercise price equals the stocks fair
market value on the date of the grant. Compensation expense is measured on the grant date fair
value using a Black Scholes model. The compensation cost is recognized over the respective
service period, which typically matches the vesting period. |
|
|
|
The time-based restricted shares are granted to key executives and vest in equal installments
upon the lapse of a period of time, typically over four-and five-year periods and include both
monthly and annual vesting periods. Compensation expense for time-based restricted shares is
measured on the grant date fair 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. Compensation expense for
performance-based restricted share awards is recognized based on the fair value of the awards on
the date of grant. |
|
|
|
The non-restricted shares are granted to key executives pursuant to the stock option plan in
conjunction with the Companys annual bonus plan and are fully vested on the date of grant.
These shares are granted to the executive when the annual bonus plan calculation exceeds the
employees target bonus. Under the annual bonus plan the portion of the bonus that is less than
or equal to |
14
|
|
the executives target bonus is paid in cash and any amount greater than the target
bonus is paid in non-restricted shares. Compensation expense for non-restricted shares is
recognized based on the grant date fair value. |
|
|
|
The Company may grant awards for up to 1.2 million shares under the plan. Through June 30, 2007,
the Company had granted 311,000 non-qualified options, 292,500 qualified options, 156,000
time-based restricted shares, 127,353 performance based restricted shares, and 8,661
non-restricted shares under the share plan. |
|
|
|
During the second quarter of 2007, the Company granted an additional 12,000 non-qualified options
to its board of directors which vest monthly over a three-year period. During the quarter ended
March 31, 2007, the Company awarded certain employees 85,000 share options which vest monthly
over a four-year period. The weighted average fair value of options granted during the three and
six months ended June 30, 2007 was $6.62 and $6.46, respectively. A summary of the status of the
option plan at June 30, 2007 and changes during the three and six months then ended is presented
in the following table: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended |
|
|
For the Six Months Ended |
|
|
|
June 30, 2007 |
|
|
June 30, 2007 |
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
Weighted- |
|
|
|
Number of |
|
|
Average |
|
|
Number of |
|
|
Average |
|
|
|
Shares |
|
|
Exercise Price |
|
|
Shares |
|
|
Exercise Price |
|
Outstanding at beginning of period |
|
|
524,642 |
|
|
$ |
12.11 |
|
|
|
505,900 |
|
|
$ |
10.58 |
|
Changes during the period: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted |
|
|
12,000 |
|
|
|
18.70 |
|
|
|
97,000 |
|
|
|
19.81 |
|
Exercised |
|
|
|
|
|
|
|
|
|
|
(66,258 |
) |
|
|
10.51 |
|
Forfeited |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expired |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at end of period |
|
|
536,642 |
|
|
$ |
12.26 |
|
|
|
536,642 |
|
|
$ |
12.26 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at end of period |
|
|
347,513 |
|
|
$ |
10.69 |
|
|
|
347,513 |
|
|
$ |
10.69 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 issued during the three and six months ended June 30, 2007: |
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
Six Months |
|
|
Ended June 30, |
|
Ended June 30, |
|
|
2007 |
|
2007 |
Risk-free interest rate |
|
|
4.92 |
% |
|
|
4.51 |
% |
Expected dividends |
|
|
0.95 |
% |
|
|
0.74 |
% |
Expected volatility |
|
|
28.15 |
% |
|
|
25.45 |
% |
Weighted average expected term |
|
6.50 |
Years |
|
6.28 |
Years |
|
|
Information on the range of exercise prices for options outstanding at June 30, 2007, is as
follows: |
15
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding |
|
|
Options Excercisable |
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average |
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
|
|
Remaining |
|
|
Average |
|
|
Aggregate |
|
|
|
|
|
|
Average |
|
|
Aggregate |
|
|
|
|
|
Outstanding |
|
|
Contractual |
|
|
Exercise |
|
|
Intrinsic |
|
|
Exercisable |
|
|
Exercise |
|
|
Intrinsic |
|
Price Range |
|
|
Options |
|
|
Term |
|
|
Price |
|
|
Value |
|
|
Options |
|
|
Price |
|
|
Value |
|
$ |
10.20 |
|
|
|
12,000 |
|
|
|
7.9 |
|
|
$ |
10.20 |
|
|
$ |
78,720 |
|
|
|
8,316 |
|
|
$ |
10.20 |
|
|
$ |
54,553 |
|
$ |
10.50 |
|
|
|
309,600 |
|
|
|
6.8 |
|
|
$ |
10.50 |
|
|
$ |
1,938,096 |
|
|
|
290,381 |
|
|
$ |
10.50 |
|
|
$ |
1,817,787 |
|
$ |
10.64 |
|
|
|
106,042 |
|
|
|
8.5 |
|
|
$ |
10.64 |
|
|
$ |
648,977 |
|
|
|
38,848 |
|
|
$ |
10.64 |
|
|
$ |
237,747 |
|
$ |
13.04 |
|
|
|
12,000 |
|
|
|
8.9 |
|
|
$ |
13.04 |
|
|
$ |
44,640 |
|
|
|
4,326 |
|
|
$ |
13.04 |
|
|
$ |
16,093 |
|
$ |
18.70 |
|
|
|
12,000 |
|
|
|
9.9 |
|
|
$ |
18.70 |
|
|
$ |
(23,280 |
) |
|
|
336 |
|
|
$ |
18.70 |
|
|
$ |
(652 |
) |
$ |
19.97 |
|
|
|
85,000 |
|
|
|
9.7 |
|
|
$ |
19.97 |
|
|
$ |
(272,850 |
) |
|
|
5,306 |
|
|
$ |
19.97 |
|
|
$ |
(17,032 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
2,414,303 |
|
|
|
|
|
|
|
|
|
|
$ |
2,108,496 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
A summary of all employee time-based restricted share activity during the three and six
months ended June 30, 2007 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
For the Six Months |
|
|
|
Ended June 30, 2007 |
|
|
Ended June 30, 2007 |
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
Weighted |
|
|
|
Number of |
|
|
Average |
|
|
Number of |
|
|
Average |
|
|
|
Shares |
|
|
Grant Price |
|
|
Shares |
|
|
Grant Price |
|
Outstanding at beginning of period |
|
|
40,428 |
|
|
$ |
10.17 |
|
|
|
45,156 |
|
|
$ |
10.19 |
|
Changes during the period: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested |
|
|
(4,729 |
) |
|
|
10.33 |
|
|
|
(9,457 |
) |
|
|
10.33 |
|
Cancelled |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at end of period |
|
|
35,699 |
|
|
$ |
10.15 |
|
|
|
35,699 |
|
|
$ |
10.15 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In March 2007, the Company granted 35,625 of performance-based restricted shares to certain
executives that vest annually over a four-year period subject to the achievement of certain
performance metrics. The Company accounts for these awards as fixed awards that are recorded
at fair value on the date of grant. A summary of all employee performance-based restricted
share activity during the three and six months ended June 30, 2007 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
For the Six Months |
|
|
|
Ended June 30, 2007 |
|
|
Ended June 30, 2007 |
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
Weighted |
|
|
|
Number of |
|
|
Average |
|
|
Number of |
|
|
Average |
|
|
|
Shares |
|
|
Grant Price |
|
|
Shares |
|
|
Grant Price |
|
Outstanding at beginning of period |
|
|
91,012 |
|
|
$ |
15.82 |
|
|
|
64,728 |
|
|
$ |
12.76 |
|
Changes during the period: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted |
|
|
|
|
|
|
|
|
|
|
35,625 |
|
|
|
19.97 |
|
Vested |
|
|
|
|
|
|
|
|
|
|
(9,341 |
) |
|
|
10.50 |
|
Cancelled |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at end of period |
|
|
91,012 |
|
|
$ |
15.82 |
|
|
|
91,012 |
|
|
$ |
15.82 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
of June 30, 2007, total compensation cost related to nonvested share options or restricted shares was $2.6 million, which is expected be recorded over 2.0 years. Total compensation cost
for share-based awards was $290,000 and $311,000 for the three months ended June 30, 2007 and
2006, respectively. For the six months ended June 30, 2007 and 2006, total compensation cost
was $704,000 and $613,000, respectively. The tax benefit included in the accompany statements
of operations related to the compensation cost was $14,000 and $13,000 for the three months
ended June 30, 2007 and 2006, respectively. For the six months ended June 30, 2007 and 2006
the tax benefit included in the accompany statements of operations related to the
16
compensation
cost was $319,000 and $45,000, respectively. For the three and six months ended June 30, 2007,
the Company had $49,000 and $118,000 of compensation cost for share-based awards capitalized
with deferred policy acquisition costs.
(10) |
|
Segment Reporting Disclosures |
The Company operates in the Property and Casualty Lines (including general liability,
multi-peril, commercial property, garage liability and auto physical damage).
The Companys Other (including exited lines) includes the surety business and the Companys
exited lines, such as workers compensation and commercial auto/trucking. A limited amount of
surety business is written in order to maintain Centurys U.S. Treasury listing.
All investment activities are included in the Investing operating segment.
The Company considers many factors, including economic similarity, the nature of the underwriting
units insurance products, production sources, distribution strategies and regulatory environment
in determining how to aggregate operating segments.
Segment profit or loss for each of the Companys segments is measured by underwriting profit or
loss. The property and casualty insurance industry commonly defines underwriting profit or loss
as earned premium net of loss and loss expenses and underwriting, acquisition and insurance
expenses. Underwriting profit or loss does not replace operating income or net income computed in
accordance with GAAP as a measure of profitability. Segment profit for the Investing operating
segment is measured by net investment income and net realized gains or losses. The Company does
not allocate assets, including goodwill, to the Property and Casualty and Other operating
segments for management reporting purposes. The total investment portfolio and cash are allocated
to the Investing operating segment.
Following is a summary of segment disclosures:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
For the Six Months |
|
|
|
Ended June 30, |
|
|
Ended June 30, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
|
|
(In thousands) |
|
|
(In thousands) |
|
Segment revenue: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and Casualty |
|
$ |
54,659 |
|
|
|
51,618 |
|
|
|
108,027 |
|
|
|
99,961 |
|
Investing |
|
|
5,456 |
|
|
|
4,627 |
|
|
|
10,688 |
|
|
|
9,074 |
|
Other (including exited lines) |
|
|
2,038 |
|
|
|
947 |
|
|
|
3,058 |
|
|
|
1,606 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment revenue |
|
$ |
62,153 |
|
|
|
57,192 |
|
|
|
121,773 |
|
|
|
110,641 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment profit: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and Casualty |
|
$ |
4,814 |
|
|
|
2,726 |
|
|
|
7,718 |
|
|
|
4,880 |
|
Investing |
|
|
5,456 |
|
|
|
4,627 |
|
|
|
10,688 |
|
|
|
9,074 |
|
Other (including exited lines) |
|
|
344 |
|
|
|
341 |
|
|
|
534 |
|
|
|
718 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment profit |
|
$ |
10,614 |
|
|
|
7,694 |
|
|
|
18,940 |
|
|
|
14,672 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investing |
|
$ |
445,740 |
|
|
|
380,264 |
|
|
|
445,740 |
|
|
|
380,264 |
|
Assets not allocated |
|
|
162,218 |
|
|
|
129,451 |
|
|
|
162,218 |
|
|
|
129,451 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total consolidated assets |
|
$ |
607,958 |
|
|
|
509,715 |
|
|
|
607,958 |
|
|
|
509,715 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following summary reconciles significant segment items to the Companys interim unaudited
consolidated condensed financial statements:
17
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
For the Six Months |
|
|
|
Ended March 31, |
|
|
Ended June 30, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
|
|
(In thousands) |
|
|
(In thousands) |
|
Total revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment revenues |
|
$ |
62,153 |
|
|
|
57,192 |
|
|
|
121,773 |
|
|
|
110,641 |
|
Other |
|
|
97 |
|
|
|
118 |
|
|
|
220 |
|
|
|
252 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total consolidated revenues |
|
$ |
62,250 |
|
|
|
57,310 |
|
|
|
121,993 |
|
|
|
110,893 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income tax expense: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment profit |
|
$ |
10,614 |
|
|
|
7,694 |
|
|
|
18,940 |
|
|
|
14,672 |
|
Unallocated amounts: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income |
|
|
97 |
|
|
|
118 |
|
|
|
220 |
|
|
|
252 |
|
Corporate expenses |
|
|
(627 |
) |
|
|
(166 |
) |
|
|
(760 |
) |
|
|
(257 |
) |
Interest expense |
|
|
(668 |
) |
|
|
(567 |
) |
|
|
(1,354 |
) |
|
|
(1,110 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income tax expense |
|
$ |
9,416 |
|
|
|
7,079 |
|
|
|
17,046 |
|
|
|
13,557 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
18
The following is a summary of segment earned premium by group of products:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property |
|
|
Casualty |
|
|
Other |
|
|
Consolidated |
|
|
|
(In thousands) |
|
Three Months Ended June 30, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and Casualty |
|
$ |
19,402 |
|
|
|
35,257 |
|
|
|
|
|
|
|
54,659 |
|
Other (including exited lines) |
|
|
|
|
|
|
|
|
|
|
2,038 |
|
|
|
2,038 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
$ |
19,402 |
|
|
|
35,257 |
|
|
|
2,038 |
|
|
|
56,697 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and Casualty |
|
$ |
15,039 |
|
|
|
36,579 |
|
|
|
|
|
|
|
51,618 |
|
Other (including exited lines) |
|
|
|
|
|
|
|
|
|
|
947 |
|
|
|
947 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
$ |
15,039 |
|
|
|
36,579 |
|
|
|
947 |
|
|
|
52,565 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property |
|
|
Casualty |
|
|
Other |
|
|
Consolidated |
|
|
|
(In thousands) |
|
Six Months Ended June 30, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and Casualty |
|
$ |
38,372 |
|
|
|
69,655 |
|
|
|
|
|
|
|
108,027 |
|
Other (including exited lines) |
|
|
|
|
|
|
|
|
|
|
3,058 |
|
|
|
3,058 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
$ |
38,372 |
|
|
|
69,655 |
|
|
|
3,058 |
|
|
|
111,085 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and Casualty |
|
$ |
29,472 |
|
|
|
70,489 |
|
|
|
|
|
|
|
99,961 |
|
Other (including exited lines) |
|
|
|
|
|
|
|
|
|
|
1,606 |
|
|
|
1,606 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
$ |
29,472 |
|
|
|
70,489 |
|
|
|
1,606 |
|
|
|
101,567 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company does not manage property and casualty products at this level of detail.
(11) |
|
Dividends to Common Shareholders |
|
|
|
On March 8, 2007, the Board of Directors declared a dividend of $0.04 per common share that was
paid on April 18, 2007 to shareholders of record as of March 27, 2007. The dividends were
accrued on the March 31, 2007 interim unaudited consolidated condensed balance sheet in the
caption accrued expenses and other liabilities. In addition, on May 17, 2007, the Board of
Directors declared a dividend of $0.04 per common share that was paid on June 6, 2007 to
shareholders of record as of May 24, 2007. |
|
|
|
On March 12, 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. The dividends were
accrued on the March 31, 2006 interim unaudited consolidated condensed balance sheet in the
caption accrued expenses and other liabilities. In addition, 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 $10.0 million line of credit with a maturity date of September 30, 2009, and
interest only payments due quarterly based on LIBOR plus 1.2% of the outstanding balance. All of
the outstanding shares of Century are pledged as collateral. The Company did not make any draws
on the line of credit during the second quarter of 2007. During the first six months of 2007,
the Company made draws totaling $650,000 on the line of credit for general corporate purposes.
At June 30, 2007, there was $4.7 million outstanding under the line of credit. Interest expense
for the three and six months ended June 30, 2007 was approximately $93,000 and $169,000,
respectively. The outstanding balance at June 30, 2006 was $500,000 and interest expense for the
six months then ended was $1,800. |
19
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 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, except as required by law. 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, 2006, and elsewhere in this report, and include, but are not
limited to, the following factors:
|
|
|
our business is cyclical in nature and our industry is currently experiencing softening
market conditions which may affect our financial performance, our ability to grow and the price of our common shares; |
|
|
|
|
our success depends on our ability to appropriately price the risks we underwrite; |
|
|
|
|
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; |
|
|
|
|
severe weather conditions and other catastrophes may result in an increase in the number and
amount of claims experienced by our insureds; |
|
|
|
|
a decline in our financial rating assigned by A.M. Best & Company may result in
a reduction of new or renewal business; |
|
|
|
|
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; |
|
|
|
|
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; |
|
|
|
|
we may not be successful in developing our new specialty lines or new classes of insureds through our
program unit that could cause us to experience losses; |
|
|
|
|
we may not find suitable acquisition candidates or new insurance ventures and even if
we do, we may not successfully integrate any such acquired companies or successfully invest in such ventures; |
|
|
|
|
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 capital market
conditions, all of which impact interest rates; |
|
|
|
|
our investment performance may suffer as a result of adverse capital market developments
or other factors, which may affect our financial results and ability to conduct business; |
|
|
|
|
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 reinsurers may not pay claims made by us on losses in a timely fashion or may not
pay some or all of these claims, in each case causing our costs to increase and our revenues to decline; |
|
|
|
|
we 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 such regulations, we may be subject to penalties, including fines and suspensions, which
may adversely affect our financial condition and results of operations;
|
20
|
|
|
as a holding company, we are dependent on the results of operations of our insurance
subsidiaries and the regulatory and contractual capacity of our subsidiaries to pay dividends to us.
Some states limit the aggregate amount of dividends our subsidiaries may pay to us in any twelve-month
period, thereby limiting our funds to pay expenses and dividends; |
|
|
|
|
although we have paid cash dividends in the past, we may not pay cash dividends in the future; |
|
|
|
|
if we lose key personnel or are unable to recruit qualified personnel, our ability to implement
our business strategies could be delayed or hindered; |
|
|
|
|
managing technology initiatives and meeting new data security requirements present significant challenges to us; |
|
|
|
|
our general agents may exceed their authority and bind us to policies outside our underwriting
guidelines, and until we effect a cancellation of a policy, we may incur loss and loss expenses related to that policy; |
|
|
|
|
our reliance on our agents subjects us to credit risk; and |
|
|
|
|
we are exposed to risks relating to evaluations of controls required by Section 404 of the Sarbanes-Oxley Act of 2002. |
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 Century Insurance Group®. As a specialty
insurer, we offer insurance products designed to meet specific insurance needs of targeted insured
groups. The excess and surplus lines market provides an alternative market for customers with
hard-to-place risks and risks that insurance companies licensed by the state in which the insurance
policy is sold, which are also referred to as admitted insurers, typically do not cover. As an
underwriter within the excess and surplus lines market, we are selective in the lines of business
and types of risks we choose to write. We develop these specialty insurance products through our
own experience or knowledge or through proposals brought to us by agents with special expertise in
specific classes of business.
We evaluate our insurance operations by monitoring key measures of growth and profitability.
The following provides further explanation of the key financial measures that we use to evaluate
our results:
Written and Unearned Premium. Written premium is recorded based on the insurance policies
that have been reported to us and, beginning in the fourth quarter of 2006, the policies that have
been written by agents but not yet reported to us. We must estimate the amount of written premium
not yet reported based on judgments relative to current and historical trends of the business being
written. Such estimates are regularly reviewed and updated and any resulting adjustments are
included in the current periods results. An unearned premium reserve is established to reflect the
unexpired portion of each policy at the financial reporting date. For additional information
regarding our written and unearned premium refer to Note 5 to our interim unaudited consolidated
condensed financial statements included in this Form 10-Q.
Loss and Loss Expense Ratio. Loss and loss expense ratio is the ratio (expressed as a
percentage) of losses and loss expenses incurred to premiums earned. Our net loss and loss expense
is meaningful in evaluating our financial results, which are net of ceded reinsurance, as reflected
in our interim unaudited consolidated condensed financial statements included in this Form 10-Q.
Expense Ratio. Expense ratio is the ratio (expressed as a percentage) of net operating
expenses to premiums earned and measures a companys operational efficiency in producing,
underwriting and administering its insurance business. Interest expense is not included in the
calculation of the expense ratio.
Combined Ratio. Combined ratio is the sum of the loss and loss expense 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.
21
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.
Material estimates that are particularly susceptible to significant change in the near-term
relate to the determination of other-than-temporary declines in the fair value of investments, the
determination of loss and loss expense reserves, the net realizable value of reinsurance
recoverables, the recoverability of deferred policy acquisition costs, and the determination of
federal income taxes. Although considerable variability is inherent in these estimates, management
believes that the amounts provided are reasonable. These estimates are continually reviewed and
adjusted as necessary. Such adjustments are reflected in current operations.
Loss and Loss Expense Reserves. Loss and loss expense reserves represent an estimate of the
expected cost of the ultimate settlement and administration of losses based on facts and
circumstances then known. We use actuarial methodologies to assist us in establishing these
estimates, including judgments relative to estimates of future claims severity and frequency,
length of time to develop to ultimate resolution, consideration of new judicial decisions in tort
and insurance law, emerging theories or liabilities and other factors beyond our control. Due to
the inherent uncertainty associated with the cost of unsettled and unreported claims, the ultimate
liability may be different from the original estimate. Such estimates are regularly reviewed and
updated and any resulting adjustments are included in the current periods results. Additional
information regarding our loss and loss expense reserves can be found in Results of Operations
Expenses Losses and Loss Expenses and 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 that can be
significant considering that certain of the reserves remain outstanding for an extended period of
time. We are required to pay losses even if a reinsurer fails to meet its obligations under the
applicable reinsurance agreement. See Note 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 our
accounting policy for equity securities and fixed-maturity securities that can be contractually
prepaid or otherwise settled in a way that may limit our ability to fully recover cost, an
impairment is deemed to be other-than-temporary unless we have both the ability and intent to hold
the investment until the securitys forecasted recovery and evidence exists indicating that
recovery will occur in a reasonable period of time.
For other fixed-maturity and equity securities, an other-than-temporary impairment charge is
taken when we do not have the ability and intent to hold the security until the forecasted recovery
or if it is no longer probable that we will recover all amounts due under the contractual terms of
the security. Many criteria are considered during this process including, but not limited to, the
current fair value as compared to amortized cost or cost, as appropriate, of the security; the
amount and length of time a securitys fair value has been below amortized cost or cost; specific
credit issues and financial prospects related to the issuer; our intent to hold or dispose of the
security; and current economic conditions. Other-than-temporary impairment losses result in a
permanent reduction to the cost basis of the underlying investment.
Additionally, for certain securitized financial assets with contractual cash flows (including
asset-backed securities), FASB Emerging Task Force (EITF) 99-20, Recognition of Interest Income
and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets,
requires us to periodically update 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, 2007 and December 31,
2006, including disclosures regarding other-than-temporary declines in investment value, see
Investment Portfolio below and Note 3 to our interim unaudited consolidated
22
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. Acquisition
costs are reduced by ceding commission income. These costs, net of ceded commission income, 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. We provide for federal income taxes based on amounts we believe we
ultimately will owe. Inherent in the provision for federal income taxes are estimates regarding the
deductibility of certain items and the realization of certain tax credits. In the event the
ultimate deductibility of certain items or the realization of certain tax credits differs from
estimates, we may be required to significantly change the provision for federal income taxes
recorded in the consolidated financial statements. Any such change could significantly affect the
amounts reported in the consolidated statements of income.
We utilize the asset and liability method of accounting for income tax. Under this method,
deferred tax assets and liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in income in the period
that includes the enactment date. Valuation allowances are established when necessary to reduce the
deferred tax assets to the amounts more likely than not to be realized. See Note 7 to our interim
unaudited consolidated condensed financial statements included in this Form 10-Q.
Results of Operations
The table below summarizes our operating results and key measures we use in monitoring and
evaluating our operations. The information is intended to summarize and supplement information
contained in our consolidated financial statements and to assist the reader in gaining a better
understanding of our results of operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
For the Six Months |
|
|
|
Ended June 30, |
|
|
Ended June 30, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
|
|
(In thousands) |
|
|
(In thousands) |
|
Selected Financial Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross written premiums |
|
$ |
67,784 |
|
|
|
65,680 |
|
|
|
126,239 |
|
|
|
123,709 |
|
Premiums earned |
|
|
56,697 |
|
|
|
52,565 |
|
|
|
111,085 |
|
|
|
101,567 |
|
Net investment income |
|
|
5,493 |
|
|
|
4,689 |
|
|
|
10,926 |
|
|
|
9,115 |
|
Net realized investment losses |
|
|
(37 |
) |
|
|
(62 |
) |
|
|
(238 |
) |
|
|
(41 |
) |
Total revenues |
|
|
62,250 |
|
|
|
57,310 |
|
|
|
121,993 |
|
|
|
110,893 |
|
Total expenses |
|
|
52,834 |
|
|
|
50,231 |
|
|
|
104,947 |
|
|
|
97,336 |
|
Net income |
|
|
6,468 |
|
|
|
5,025 |
|
|
|
11,847 |
|
|
|
9,625 |
|
Key Financial Ratios: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss and loss expense ratio |
|
|
58.4 |
% |
|
|
62.0 |
% |
|
|
60.3 |
% |
|
|
62.0 |
% |
Expense ratio |
|
|
33.6 |
% |
|
|
32.5 |
% |
|
|
32.9 |
% |
|
|
32.7 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined ratio |
|
|
92.0 |
% |
|
|
94.5 |
% |
|
|
93.2 |
% |
|
|
94.7 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
23
Overview of Operating Results
Net income was $6.5 million for the three months ended June 30, 2007 compared to net income of
$5.0 million for the three months ended June 30, 2006. For the six months ended June 30, 2007, net
income was $11.8 million compared to net income of $9.6 million for the six months ended June 30,
2006.
The increase in net income for the three and six months ended June 30, 2007 was primarily
attributable to an increase in earned premium and net investment income, coupled with a lower
combined ratio. The increase in net earned premium resulted from our growth in gross written
premiums in 2006 and was supported by higher gross written premiums for the second quarter of 2007
when compared to the second quarter of 2006. During the second quarter, we continued to experience
increased competition across our product lines with indications of other carriers continuing to
lower their rates and expand their risk profile. Despite this increase in competition, we
maintained our underwriting discipline and our gross written premiums increased 3.2% for the second
quarter of 2007 and 2.0% for the six months ended June 30, 2007 compared to the same periods in
2006. This increase in earned premium was supplemented by a 17.1% and 19.9% increase in net
investment income for the three and six months ended June 30, 2007, respectively, compared to the
same periods in 2006. This is due to continued positive cash flows from operations. Our tax
equivalent yield for the three and six months ended June 30, 2007 was 5.7% and 5.8%, respectively,
consistent with the same periods in 2006..
Total expenses increased to $52.8 million for the three months ended June 30, 2007 from $50.2
million for the same period in 2006. For the six months ended June 30, 2007, expenses increased to
$104.9 million from $97.3 million for the same period in 2006. The increase can be primarily
attributed to the growth in our underwriting business. The combined ratio for the three months
ended June 30, 2007 was 92.0% compared to 94.5% for the same period in 2006. For the first six
months of 2007, the combined ratio was 93.2% compared to 94.7% for the same period of 2006. For
the quarter ended June 30, 2007, the loss and loss expense ratio was 58.4% compared to 62.0% and
for the six months ended June 30, 2007, our loss and loss expense ratio was 60.3% compared to
62.0%. For the three and six months ended June 30, 2007, total loss and loss expenses related to
the 2007 accident year was $35.6 million and $70.5 million respectively, which was partially offset
by $2.5 million and $3.5 million, respectively of favorable reserve development on prior accident
years. This compares to $31.7 million and $61.4 million of current accident year loss and loss
expenses and $886,000 and $1.6 million of unfavorable reserve development on prior accident years
for the three and six months ended June 30, 2006, respectively. The increase in loss and loss
expenses related to the current accident year is primarily due to the growth in business as well as
increases in losses primarily from the auto physical damage program, weather related property
losses and higher property claims severity. The favorable development primarily relates to our
claims made contractors casualty business written in 2005 and 2006. This business continued to
perform better than our original estimates.
The expense ratio for the three months ended June 30, 2007 and 2006 was 33.6% and 32.5%,
respectively. For the six months ended June 30, 2007, our expense ratio was 32.9% compared to
32.7% for the same period in 2006. The increase in the expense ratio is directly attributable to
approximately $300,000 of professional fees and other costs incurred in the second quarter of 2007
related primarily to an aborted public equity offering. These expenses increased our expense ratio
for the three months ended June 30, 2007 by one half of a percentage point and by three tenths of a
percentage point for the six months ended June 30, 2007. In addition, we incurred a higher blended
commission rate due to the mix of business in the second quarter of 2007 and for the six months
ended June 30, 2007.
Revenues
Premiums
Premiums include insurance premiums underwritten by our insurance subsidiaries (which are
referred to as direct premiums) and insurance premiums assumed from other insurers (which are
referred to as assumed premiums). We refer to direct and assumed premiums together as gross
premiums.
Written premium is recorded based on the insurance policies that have been reported to us and,
beginning in the fourth quarter of 2006, the policies that have been written by agents but not yet
reported to us. We estimate the amount of written premium not yet reported based on judgments
relative to current and historical trends of the business being written. Such estimates are
regularly reviewed and updated and any resulting adjustments will be included in the current years
results. Written premiums are the total amount of premiums billed to the policyholder less the
amount of premiums returned, generally because of cancellations, during a given period.
We have historically relied on quota share, excess of loss, and catastrophe reinsurance
primarily to manage our regulatory capital
24
requirements and to limit our exposure to loss. We record the cost of reinsurance (ceded
premium) as an offset to our gross written premiums. We refer to our gross written premiums less
our ceded premiums as net written premiums. Generally, we have ceded a significant portion of our
premiums to unaffiliated reinsurers in order to maintain net written premiums to statutory surplus
ratio of less than 2-to-1.
Net written premiums become premiums earned as the policy ages. An unearned premium reserve is
established to reflect the unexpired portion of each policy at the financial reporting date.
Barring premium changes, if an insurance company writes the same mix of business each year, written
premiums and premiums earned will be equal, and the unearned premium reserve will remain constant.
During periods of growth, the unearned premium reserve will increase, causing premiums earned to be
less than written premiums. Conversely, during periods of decline, the unearned premium reserve
will decrease, causing premiums earned to be greater than written premiums.
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 and
multi-peril 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.
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, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
|
|
(In thousands) |
|
|
(In thousands) |
|
Gross written premiums |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property/casualty |
|
$ |
65,596 |
|
|
|
64,790 |
|
|
|
123,299 |
|
|
|
121,880 |
|
Other (including exited lines) |
|
|
2,188 |
|
|
|
890 |
|
|
|
2,940 |
|
|
|
1,829 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross written premiums |
|
|
67,784 |
|
|
|
65,680 |
|
|
|
126,239 |
|
|
|
123,709 |
|
Ceded written premiums |
|
|
9,200 |
|
|
|
7,191 |
|
|
|
17,595 |
|
|
|
14,788 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net written premiums |
|
$ |
58,584 |
|
|
|
58,489 |
|
|
|
108,644 |
|
|
|
108,921 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums earned |
|
$ |
56,697 |
|
|
|
52,565 |
|
|
|
111,085 |
|
|
|
101,567 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net written premiums to gross written premiums |
|
|
86.4 |
% |
|
|
89.1 |
% |
|
|
86.1 |
% |
|
|
88.0 |
% |
Net premiums earned to net written premiums |
|
|
96.8 |
% |
|
|
89.9 |
% |
|
|
102.2 |
% |
|
|
93.2 |
% |
Net writings ratio (1) |
|
|
1.6 |
|
|
|
1.8 |
|
|
|
1.5 |
|
|
|
1.7 |
|
|
|
|
(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 to $67.8 million for the three months ended June 30, 2007
from $65.7 million for the same period in 2006. For the six months ended June 30, 2007, gross
written premiums increased $2.5 million to $126.2 million compared
to $123.7 million for the comparable period in 2006. During the second quarter of 2007 and
first six months of 2007, we continued to experience an increase in competition with indications
that we believe show other carriers are striving to increase their market share
25
by reducing prices
and providing broader coverage forms. These softening market conditions were the most prevalent in
our casualty market where we saw a decrease in premiums from our casualty book resulting from other
carriers offering broader coverages at a lower price on certain classes of business. In addition,
due to the unfavorable underwriting results from our auto physical damage book written in 2006, we
significantly decreased the amount of business written in the program for the second quarter of
2007 compared to the second quarter of 2006.
Despite the increase in competition and the lower amount of business written in the auto
physical damage program, our overall business is stable with growth from our garage and ocean
marine business. We have experienced moderate rate decreases in our core property and casualty
business thus far in 2007. The increase in other, including exited lines, is due to higher assumed
bonding business.
Net Written and Earned Premiums
Net written premiums increased by $95,000 to $58.6 for the first quarter 2007 compared to the
same period in 2006. This increase was due to higher gross written premiums, which was partially
offset by higher ceded premium. For the six months ended June 30, 2007, net written premiums
decreased by $277,000, compared to the same period in 2006. This decrease is due to an increase in
ceded premium. The additional ceded premium in the three and six months ended June 30, 2007
compared to the same periods in 2006 is due to an increase in the percent of property business to
the total business, which has a higher ceding rate than our casualty line.
Net written premiums represented 86.4% and 86.1% of gross written premiums for the three and
six months ended June 30, 2007, respectively, compared to 89.1% and 88.0% for the same periods,
respectively in 2006. The lower relationship of net written premiums to gross written premiums for
the three and six months ended June 30, 2007 reflects an increase in ceded premiums in the current
year, as noted above.
The ratio of premiums earned to net written premiums for the first quarter of 2007 and 2006
was 96.8% and 89.9%, respectively. Premiums earned represent 102.2% of net written premiums for
the six months ended June 30, 2007 compared to 93.2% for the first six months ended June 30, 2006.
The relationship of premiums earned to net written premiums during the second quarter and first six
months of 2007 was higher compared to the same period in 2006, reflecting a decrease in the growth
rate of premiums in 2007 compared to the same periods in 2006.
Net Investment Income
Our investment portfolio generally consists of liquid, readily marketable and investment-grade
fixed-maturity and equity securities. Net investment income is primarily comprised of interest and
dividend earned on these securities, net of related investment expenses.
Net investment income was $5.5 million and $10.9 million for the three and six months ended
June 30, 2007, compared to $4.7 million and $9.1 million for the same periods in 2006. The
increase was partially due to an increase in assets available for investment, including cash.
Invested assets, including cash, increased by $67.2 million to $456.4 million as of June 30, 2007
from $389.2 million as of June 30, 2006. The pre-tax investment yield for the three and six months
ended June 30, 2007 was 5.1% and 5.1%, compared to 5.1% and 5.0% for the same periods in 2006. Our
taxable equivalent yield for the three and six months ended June 30, 2007 was 5.7% and 5.8%,
respectively, consistent with the same periods in 2006..
Realized Gains (Losses) on Securities
Realized gains and losses on securities are principally affected by changes in interest rates,
the timing of sales of investments and changes in credit quality of the securities we hold as
investments.
We realized net investment losses of $37,000 and $238,000 on the sale of securities for the
three and six months ended June 30, 2007, respectively, compared to $62,000 and $41,000 for the
same periods in 2006. Other-than-temporary losses of $266,000 and $882,000 were realized during
the three and six months ended June 30, 2007. These losses related to seven and eighteen
asset-backed securities that were written down in accordance with EITF 99-20 for the three and six
months ended June 30, 2007, respectively. No other-than-temporary impairments were realized during
the three or six months ended June 30, 2006.
26
Expenses
Losses and Loss Expenses
We are liable for covered losses and incurred loss expenses under the terms of the insurance
policies that we write. In many cases, several years may elapse between the occurrence of an
insured loss, the reporting of the loss to us and our settlement of that loss. We reflect our
liability for the ultimate payment of all incurred losses and loss expenses by establishing loss
and loss expense reserves as balance sheet liabilities for both reported and unreported claims.
Loss and loss expenses represent our largest expense item and include (1) payments made to settle
claims, (2) estimates for future claim payments and changes in those estimates for current and
prior periods and (3) costs associated with settling claims.
Loss and loss expense reserves represent our best estimate of ultimate amounts for losses and
related expenses from claims that have been reported but not paid, and those losses that have
occurred but have not yet been reported to us. Loss reserves do not represent an exact calculation
of liability, but instead represent our estimates, generally utilizing individual claim estimates
and actuarial expertise and estimation techniques at a given accounting date. The loss reserve
estimates are expectations of what ultimate settlement and administration of claims will cost upon
final resolution. These estimates are based on facts and circumstances then known to us, a review
of historical settlement patterns, estimates of trends in claims frequency and severity,
projections of loss costs, expected interpretations of legal theories of liability, and many other
factors. In establishing reserves, we also take into account estimated recoveries, reinsurance,
salvage and subrogation. The reserves are reviewed regularly by a
team of actuaries we employ.
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 we incur under the policies we write.
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 of the
reinsurers insolvency).
The process of estimating loss reserves involves a high degree of judgment and is subject to a
number of variables. These variables can be affected by both internal and external events, such as
changes in claims handling procedures, claim personnel, economic inflation, legal trends, and
legislative changes, among others. The impact of many of these items on ultimate costs for loss
and loss expense is difficult to estimate. Loss reserve estimations also differ significantly by
coverage due to differences in claim complexity, the volume of claims, the policy limits written,
the terms and conditions of the underlying policies, the potential severity of individual claims,
the determination of occurrence date for a claim, and reporting lags (the time between the
occurrence of the policyholder events and when it is actually reported to us). We attempt to
consider all significant facts and circumstances known at the time loss reserves are established.
In addition, we continually refine our loss reserve estimates as historical loss experience
develops and additional claims are reported and settled.
We exercise a considerable degree of judgment in evaluating the numerous factors involved in
the estimation of reserves. Different actuaries will choose different assumptions when faced with
such uncertainty, based on their individual backgrounds, professional experiences and areas of
focus. Hence, the estimate selected by various actuaries may differ materially. We consider this
uncertainty by examining our historical reserve accuracy.
Given the significant impact of the reserve estimates on our financial statements, we subject
the reserving process to significant diagnostic testing. We have incorporated data validity checks
and balances into our front-end processes. Leading indicators such as actual versus expected
emergence and other diagnostics are also incorporated into the reserving processes.
Due to the inherent uncertainty underlying loss reserve estimates, including but not limited
to the future settlement environment, final resolution of the estimated liability for a claim or
category of claims will be different from that anticipated at the reporting date. Therefore,
actual paid losses in the future may yield a materially higher or lower amount than currently
reserved.
The amount by which estimated losses differ from those originally recorded for a period is
known as development. Development is unfavorable when the losses ultimately settle for more than
the levels at which they were reserved or subsequent estimates indicate a basis for increasing loss
reserves on unresolved claims. Development is favorable when losses ultimately settle for less
than the amount reserved or subsequent estimates indicate a basis for reducing loss reserves on
unresolved claims. We reflect favorable or unfavorable developments of loss reserves in the
results of operations for the period in which the estimates are changed.
27
We record two categories of loss and loss expense reserves case-specific reserves and
incurred but not reported (IBNR) reserves.
When a claim is reported, our claim department establishes a case reserve for the estimated
probable ultimate cost to resolve a claim as soon as sufficient information is available to
evaluate a claim. We open most claim files with a formula reserve (a normal fixed amount) for
the type of claim involved. The Companys formula reserve amounts are regularly reviewed but have
not been changed during the three years ended December 31, 2006 in order to maintain stability in
this aspect of the claim reserving process. We adjust the formula reserve to the probable ultimate
cost for that claim as soon as sufficient information is available. It is our goal to reserve each
claim at its probable ultimate cost no later than 30 days after the claim file is opened on
property claims or 90 days following receipt of the claim on casualty claims. During the life
cycle of a particular claim, more information may materialize that causes us to increase or
decrease the estimate of the ultimate value of the claim. We may determine that it is appropriate
to pay portions of the reserve to the claimant or related settlement expenses before final
resolution of the claim. The amount of the individual claim reserve would then be adjusted
accordingly based on the most recent information available.
We establish IBNR reserves to estimate the amount we will have to pay for claims that have
occurred, but have not yet been reported to us; claims that have been reported to us that may
ultimately be paid out differently than expected by our case-specific reserves; and claims that
have been paid and closed, but may reopen and require future payment. Case reserves and IBNR
reserves comprise the total loss and loss expense reserves.
We periodically review our reserves for loss and loss expenses, and based on new developments
and information, we include adjustments of the probable ultimate liability in operating results for
the periods in which the adjustments are made. In general, our initial reserves are based upon the
actuarial and underwriting data utilized to set pricing levels and are reviewed as additional
information, including claims experience, becomes available. The establishment of loss and loss
expense reserves makes no provision for the broadening of coverage by legislative action or
judicial interpretation or for the extraordinary future emergence of new types of losses not
sufficiently represented in our historical experience or which cannot yet be quantified. We
regularly analyze our reserves and review our pricing and reserving methodologies so that future
adjustments to prior year reserves can be minimized. However, given the complexity of this
process, reserves require continual updates and the ultimate liability may be higher or lower than
previously indicated.
Due to the inherent uncertainty in estimating reserves for losses and loss expenses, there can
be no assurance that the ultimate liability will not materially exceed amounts reserved, with a
resulting adverse effect on our results of operations and financial condition. Based on the
current assumptions used in calculating reserves, management believes our overall recorded reserves
at June 30, 2007 make a reasonable provision for our future obligations.
Our reserve for losses and loss expenses at June 30, 2007 was $266.1 million (before the
effects of reinsurance) and $229.6 million (after the effects of reinsurance), as estimated through
our actuarial analysis. During the first six months of 2007, we concluded through our actuarial
analysis that the December 31, 2006 reserve for losses and loss expenses of $214.6 million (after
the effects of reinsurance) was redundant by $3.5 million, primarily due to favorable development
in our casualty reserves. Our case and IBNR reserve for losses and loss expenses (net of the
effects of reinsurance) and the effects of reinsurance at June 30, 2007 and December 31, 2006 by
line is summarized as follows:
28
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2007 |
|
|
|
|
|
|
December 31, 2006 |
|
|
|
Case |
|
|
IBNR |
|
|
Total |
|
|
Case |
|
|
IBNR |
|
|
Total |
|
Property and Casualty: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Casualty |
|
$ |
55,288 |
|
|
|
145,250 |
|
|
|
200,538 |
|
|
|
59,801 |
|
|
|
128,569 |
|
|
|
188,370 |
|
Property |
|
|
13,961 |
|
|
|
11,271 |
|
|
|
25,232 |
|
|
|
13,506 |
|
|
|
8,796 |
|
|
|
22,302 |
|
Other (including exited lines): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial auto |
|
|
103 |
|
|
|
|
|
|
|
103 |
|
|
|
147 |
|
|
|
|
|
|
|
147 |
|
Workers compensation |
|
|
1,067 |
|
|
|
2,065 |
|
|
|
3,132 |
|
|
|
1,164 |
|
|
|
2,056 |
|
|
|
3,220 |
|
Surety |
|
|
|
|
|
|
636 |
|
|
|
636 |
|
|
|
|
|
|
|
529 |
|
|
|
529 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net reserves for losses and loss expenses |
|
|
70,419 |
|
|
|
159,222 |
|
|
|
229,641 |
|
|
|
74,618 |
|
|
|
139,950 |
|
|
|
214,568 |
|
Plus reinsurance recoverables on unpaid
losses at end of period |
|
|
10,883 |
|
|
|
25,608 |
|
|
|
36,491 |
|
|
|
11,723 |
|
|
|
24,381 |
|
|
|
36,104 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross reserves for losses and loss expenses |
|
$ |
81,302 |
|
|
|
184,830 |
|
|
|
266,132 |
|
|
|
86,341 |
|
|
|
164,331 |
|
|
|
250,672 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss and loss expenses incurred were $33.1 million for the quarter ended June 30, 2007,
compared to $32.6 million for the quarter ended June 30, 2006. In the second quarter of 2007, the
Company recorded $35.6 million of incurred losses and loss expenses attributable to the 2007
accident year, which was partially offset by favorable development of $2.5 million attributable to
events of prior years. 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.
Net loss and loss expenses incurred were $67.0 million for the six months ended June 30, 2007,
compared to $63.0 million for the six months ended June 30, 2006. In the first six months of 2007,
the Company recorded $70.5 million of incurred losses and loss expenses attributable to the 2007
accident year, which were partially offset by favorable development of $3.5 million attributable to
events of prior years, as noted above. For the six months ended June 30, 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.
The increase in net loss and loss expense reserves during the three and six months of 2007 is
primarily attributable to our continued growth and higher current accident year loss and loss
expense ratios primarily related to our property business. The higher loss and loss expense ratios
related to our property business is a direct result of an increase in weather related claims
together with increased claim severity. These higher losses together with an increase in losses
related to the auto physical damage program, adversely affected the property line results but were
offset by $2.5 million and $3.5 million of favorable prior year development for the three and six
months ended June 30, 2007. The favorable development during the three and six months ended June
30, 2007 resulted primarily from reductions in the ultimate loss ratios for accident years 2005 and
2006 on the claims made contractor liability business included in our property and casualty
segment. The Company reduced carried reserves related to the 2005 and 2006 casualty business based
on the Companys internal actuarial reserve recommendations. The 2005 and 2006 casualty books have
performed better than expected to date, and previously carried reserves exceeded the current
indications for each of the estimation methods applied in the Companys internal actuarial
analysis. At the beginning of 2005, the Company began writing certain contractors liability
business on a claims made form, replacing the occurrence form which had previously been utilized
through 2004. The Company wrote a significant volume of claims made contractor business in both
2005 and 2006, and this business has continued to perform better than expected. The Company
continues to monitor loss emergence on this book and adjusts assumptions and estimates as needed.
The Company continues to write contractors on an occurrence form on a limited basis, in certain
jurisdictions, and for certain classes of business.
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 the 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 the 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 amounts expected to be paid for legal expenses or
settlements of
29
claims in litigation 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 potential reinsurance collection issues on two
separate casualty claims.
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, |
|
|
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
|
|
(In thousands) |
|
|
(In thousands) |
|
Amortization of deferred policy acquisition costs (ADAC) |
|
$ |
14,689 |
|
|
|
12,896 |
|
|
|
28,388 |
|
|
|
24,962 |
|
Other operating expenses |
|
|
4,353 |
|
|
|
4,193 |
|
|
|
8,204 |
|
|
|
8,250 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ADAC and other operating expenses |
|
|
19,042 |
|
|
|
17,089 |
|
|
|
36,592 |
|
|
|
33,212 |
|
Interest expense |
|
|
668 |
|
|
|
567 |
|
|
|
1,354 |
|
|
|
1,110 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
$ |
19,710 |
|
|
|
17,656 |
|
|
|
37,946 |
|
|
|
34,322 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expense ratio: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ADAC |
|
|
25.9 |
% |
|
|
24.5 |
% |
|
|
25.5 |
% |
|
|
24.6 |
% |
Other operating expenses |
|
|
7.7 |
% |
|
|
8.0 |
% |
|
|
7.4 |
% |
|
|
8.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expense ratio (1) |
|
|
33.6 |
% |
|
|
32.5 |
% |
|
|
32.9 |
% |
|
|
32.7 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Interest expense is not included in the calculation of the expense ratio. |
Operating expenses increased by 11.6% and 10.6% for the three and six months ended June 30,
2007, respectively compared to the same periods in 2007. The overall expense ratio for the three
and six months ended June 30, 2007 was 33.6% and 32.9%, respectively, compared to 32.5% and 32.7%
for the same periods in 2006. The increase in expenses for the three and six months ended June 30,
2007 compared to the same periods in 2006, is due to an increase in ADAC as a result of an increase
in the volume of insurance written. In addition, for the six months ended June 30, 2007, we
experienced an increase in our ADAC portion of the expense ratio as a result of a higher amount of
binding business which has higher acquisition costs relative to brokerage business, a higher amount
of assumed bonding business that has higher acquisition costs relative to our direct business and a
lower amount of acquisition expenses that were able to be deferred related to the auto physical
damage program. During the third quarter of 2006, the loss and loss expense ratio related to this
program exceeded our expectations causing the program to fall below the profitability levels
required for continued deferral of the additional policy acquisition costs. This resulted in
$214000 of additional expense for the six months ended June 30, 2007. There were no such expenses
during the three and six months ended June 30, 2006.
The increase in other operating expenses in the second quarter of 2007 is due to $300,000 of
professional and other fees expensed, which related primarily to an aborted public equity offering.
The increase in ADAC for the six months ended June 30, 2007 was offset by slight decreases in the
other operating expenses portion of the expense ratio. The decreases were related to recoveries
received from our corporate insurance policy. These recoveries were partially offset by higher
than expected costs related to our 2006 contingent commission program.
Interest expense continues to increase on our variable rate Trust Preferred securities due to
increases in the interest rate environment throughout 2006. In addition, we incurred $169,000 of
interest related to our line of credit for the six months ended June 30, 2007 compared to $1,800
for the same period in 2006.
Income Taxes
We have historically filed a consolidated federal income tax return that has included all of
our subsidiaries. The income tax provision for the three and six months ended June 30, 2007 and
2006 has been computed based on our estimated annual effective tax
30
rate of 30.5% and 29.0%,
respectively, which differ from the federal income tax rate of 35% principally because of
tax-exempt investment income.
Liquidity and Capital Resources
ProCentury is a holding company, the principal asset of which is the common shares of Century
Surety Company or Century. Although we have the capacity to generate cash through loans from banks
and issuances of debt and equity securities, our primary source of funds to meet our short-term
liquidity needs, including the payment of dividends to our shareholders and corporate expenses,
is dividends from Century. Centurys principal sources of funds are underwriting operations,
investment income, proceeds from sales and maturities of investments and dividends from ProCentury
Insurance Company or PIC. Centurys primary use of funds is to pay claims and operating expenses,
to purchase investments and to make dividend payments to us. ProCenturys future liquidity is
dependent on the ability of Century to pay dividends.
Our insurance subsidiaries are restricted by statute as to the amount of dividends it may pay
without the prior approval of regulatory authorities. Century and PIC may pay dividends without
advance regulatory approval only from unassigned surplus and only to the extent that all dividends
in the trailing 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
total ordinary dividend available to be paid from Century to ProCentury during 2007 is $18.4
million. The ordinary dividend available to be paid from PIC to Century during 2007 is $1.6
million.
Century paid ordinary dividends of $1.3 million for both the three months ended June 30, 2007
and 2006. For both the six months ended June 30, 2007 and 2006, ordinary dividends of $2.6 million
were paid. PIC did not pay dividends to Century in 2007 or 2006. Centurys ability to pay future
dividends to ProCentury without advance regulatory approval is dependent upon maintaining a
positive level of unassigned surplus, which in turn, is dependent upon Century generating net
income in excess of dividends to ProCentury.
Our insurance subsidiaries are required by law to maintain a certain minimum level of surplus
on a statutory basis. Surplus is calculated by subtracting total liabilities from total admitted
assets. The National Association of Insurance Commissioners (NAIC) has a risk-based capital
standard designed to identify property and casualty insurers that may be inadequately capitalized
based on inherent risks of each insurers assets and liabilities and its mix of net written
premiums. Insurers falling below a calculated threshold may be subject to varying degrees of
regulatory action. As of December 31, 2006, Centurys and PICs statutory surplus was in excess of
the prescribed risk-based capital requirements that correspond to any level of regulatory action.
Centurys statutory surplus at December 31, 2006 was $137.5 million and the authorized control
level was $36.3 million. As of June 30, 2007, Centurys statutory surplus was $149.1 million.
Six Months Ended June 30, 2007 Compared to Six Months Ended June 30, 2006. Consolidated net
cash provided by operating activities was $19.0 million for the first six months of 2007, compared
to $29.8 million for the same period in 2006. The majority of the decrease is due to the lower
amount of growth in premiums for the six months ended June 30, 2007 compared to the six months
ended June 30, 2006.
Consolidated net cash used in investing activities was $16.8 million for the first six months
of 2007, compared to $26.2 million for the same period in 2006. The decrease resulted from a lower
amount of operational cash available for investing at June 30, 2007 compared to the same period in
2006.
Consolidated net cash provided by financing activities was $597,000 for the first six months
of 2007, compared to net cash used in financing activities of approximately $354,000 for the same
period in 2006. This increase is primarily the result of $697,000 of proceeds from the exercise of
share options. This increase from the exercise of share options was partially offset by higher
dividends paid to shareholders during the six months ended June 30, 2007 compared to the same
period in 2006.
Interest on our debt issued to a related party trust is variable and resets quarterly based on
a spread over three-month London Interbank Offered Rates (LIBOR). As part of our asset/liability
matching program, we have short-term investments, investments in bond mutual funds, as well as
available cash balances from operations and investment maturities, that are available for
reinvestment during periods of rising or falling interest rates.
Line of Credit. The Company has a $10.0 million line of credit with a maturity date of
September 30, 2009, and interest only payments due quarterly based on LIBOR plus 1.2% of the
outstanding balance. All of the outstanding shares of Century are pledged as collateral. During
the first quarter of 2007, we made draws totaling $650,000 on the line of credit for general
corporate purposes.
31
We did not make any draws on the line of credit during the second quarter of
2007. At June 30, 2007, there is $4.7 million outstanding under the line of credit. Interest
expense for the three and six months ended June 30, 2007 was $76,000 and $169,000, respectively.
The outstanding balance at June 30, 2006 was $500,000 and interest expense for the six months then
ended was $1,800.
The following table summarized information about our contractual obligations and commercial
commitments. The minimum payments under these agreements as of June 30, 2007 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Years |
|
|
|
2007 |
|
|
2008 |
|
|
2009 |
|
|
2010 |
|
|
2011 |
|
|
Thereafter |
|
|
Total |
|
|
|
(In thousands) |
|
Long Term Debt: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt issues to a related
party trust (1) (2) |
|
$ |
1,201 |
|
|
|
2,402 |
|
|
|
2,402 |
|
|
|
2,402 |
|
|
|
2,402 |
|
|
|
77,131 |
|
|
|
87,940 |
|
Loss and loss expense payments (3) |
|
|
56,571 |
|
|
|
76,385 |
|
|
|
53,126 |
|
|
|
33,354 |
|
|
|
19,330 |
|
|
|
27,366 |
|
|
|
266,132 |
|
Operating leases on facilities |
|
|
565 |
|
|
|
1,150 |
|
|
|
867 |
|
|
|
714 |
|
|
|
673 |
|
|
|
1,129 |
|
|
|
5,098 |
|
Other operating leases |
|
|
152 |
|
|
|
235 |
|
|
|
70 |
|
|
|
59 |
|
|
|
32 |
|
|
|
|
|
|
|
548 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total contractual obligations |
|
$ |
58,489 |
|
|
|
80,172 |
|
|
|
56,465 |
|
|
|
36,529 |
|
|
|
22,437 |
|
|
|
105,626 |
|
|
|
359,718 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Amounts include interest payments associated with these obligations using applicable interest
rates as of June 30, 2007. |
|
(2) |
|
In connection with the adoption of FIN 46R, ProCentury has deconsolidated the trusts
established in connection with the issuance of trust preferred securities effective December 31,
2003. As a result, ProCentury reports as a component of long term debt the junior subordinated
debentures payable by ProCentury to the trusts. |
|
(3) |
|
The timing for payment of our estimated losses is determined by periods based on our historical
claims payment experience. Due to the uncertainty in estimating the timing of such payments, there
is a risk that the amounts paid in any period can be significantly different than the amounts
disclosed above. |
Given our historical cash flow, we believe cash flow from operating activities in 2007 will
provide sufficient liquidity for our operations, as well as to satisfy debt service obligations and
to pay other operating expenses. Although we anticipate that we will be able to meet our cash
requirements, we can give no assurance in this regard.
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 $456.4 million at June 30, 2007 from $436.1
million at December 31, 2006 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 was 5.8% for both the six months ended June 30, 2007 and the year
ended December 31, 2006. The fair value of our fixed maturities at June 30, 2007
increased to $381.5 million from $359.5 million at December 31, 2006. The fair value of our equity
securities increased to $45.0 million at June 30, 2007 from $42.9 million at December 31, 2006. As
of June 30, 2007, the duration of the fixed income portfolio was 4.3 years, slightly longer than
the duration of 4.1 years at December 31, 2006. The average credit quality of the portfolio
remained investment grade.
32
Accounting Standards
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No.
108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current
Year Financial Statements (SAB 108). SAB 108 provides interpretive guidance on how the effects
of prior-year uncorrected misstatements should be considered when quantifying misstatements in the
current year financial statements. SAB 108 requires registrants to quantify misstatements using
both an income statement (rollover) and balance sheet (iron curtain) approach and evaluate
whether either approach results in a misstatement that,
when all relevant quantitative and qualitative factors are considered, is material. If prior
year errors that had been previously considered immaterial now are considered material based on
either approach, no restatement is required so long as management properly applied its previous
approach and all relevant facts and circumstances were considered. If prior years are not restated,
the cumulative effect adjustment is recorded in opening accumulated earnings as of the beginning of
the fiscal year of adoption. SAB 108 is effective for fiscal years ending on or after November 15,
2006, with earlier adoption encouraged. We adopted SAB 108 in the fourth quarter of 2006 and it did
not have a material effect on our consolidated financial condition or results of operations.
In July 2006, the Financial Accounting Standards Board (FASB) released FASB Interpretation
No. (FIN) 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No.
109. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in the financial
statements in accordance with SFAS 109, Accounting for Income Taxes. The Interpretation
prescribes a recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a tax return. It
also provides guidance on derecognition, classification, interest and penalties, accounting for
interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after
December 15, 2006. We adopted FIN 48 effective January 1, 2007 and it did not have a material
impact on our consolidated financial condition or results of operations.
In September 2005, the Accounting Standards Executive Committee of the American Institute of
Certified Public Accountants (AICPA) issued Statement of Position (SOP) 05-1, Accounting by
Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges
of Insurance Contracts (SOP 05-1). SOP 05-1 provides guidance on accounting by insurance
enterprises for deferred acquisition costs on internal replacements of insurance and investment
contracts other than those specifically described in SFAS No. 97, Accounting and Reporting by
Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from
the Sale of Investments, issued by the FASB. SOP 05-1 defines an internal replacement as a
modification in product benefits, features, rights or coverages that occurs as a result of the
exchange of a contract for a new contract, or by amendment, endorsement or rider to a contract, or
by the election of a new feature or coverage within a contract. SOP 05-1 is effective for internal
replacements occurring in fiscal years beginning after December 15, 2006, with earlier adoption
encouraged. Retrospective application of SOP 05-1 to previously issued financial statements is not
permitted. Initial application of SOP 05-1 is required as of the beginning of an entitys fiscal
year. We adopted SOP 05-1 effective January 1, 2007 and it did not have a material effect on our
consolidated financial condition or results of operations.
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
adopted SFAS No. 155 and it did not have a material effect on our consolidated financial condition
or results of operations.
In September 2006, the FASB issued Statement No. 157, Fair Value Measurements (SFAS No.
157), which clarifies that the term fair value is intended to mean a market-based measure, not an
entity-specific measure and gives the highest priority to quoted prices in active markets in
determining fair value. SFAS No. 157 requires disclosures about (1) the extent to which companies
measure assets and liabilities at fair value, (2) the methods and assumptions used to measure fair
value, and (3) the effect of fair value measures on earnings. SFAS No. 157 is effective for fiscal
years beginning after November 15, 2007. We are currently evaluating the impact of adopting SFAS
No. 157; however, we do not expect it will have a material effect on our consolidated financial
condition or results of operations.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets
and Financial Liabilities, Including an Amendment of FASB Statement No. 115 (SFAS 159). The
objective of SFAS 159 is to improve financial reporting by providing entities with the opportunity
to mitigate volatility in reported net income caused by measuring related assets and liabilities
differently. This statement permits entities to choose, at specified election dates, to measure
eligible items at fair value (i.e., the fair value option). Items eligible for the fair value
option include certain recognized financial assets and liabilities, rights and
33
obligations under
certain insurance contracts that are not financial instruments, host financial instruments
resulting from the separation of an embedded nonfinancial derivative instrument from a nonfinancial
hybrid instrument, and certain commitments. Business entities shall report unrealized gains and
losses on items for which the fair value option has been elected in net income. The fair value
option (a) may be applied instrument by instrument, with certain exceptions; (b) is irrevocable
(unless a new election date occurs); and (c) is applied only to entire instruments and not to
portions of instruments. SFAS 159 is effective as of the beginning of an entitys first fiscal year
that begins after November 15, 2007, although early adoption is permitted under certain conditions.
Companies must report
the effect of the first remeasurement to fair value as a cumulative-effect adjustment to the
opening balance of retained earnings. We are currently evaluating the impact of adopting SFAS 159.
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, 2007, 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, 2006.
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 and Treasurer
(CFO), 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 March 31, 2007,
management concluded that the Companys Disclosure Controls were effective as of such date.
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.
34
PART II: OTHER INFORMATION
Item 1. Legal Proceedings
We are party to lawsuits, arbitrations and other proceedings that arise in the normal course
of our business. Certain of the lawsuits, arbitrations and other proceedings involve claims under
policies that we underwrite as an insurer, the liabilities for which we believe have been
adequately included in our loss and loss adjustment expense reserves. Also, from time to time, we
are party to lawsuits, arbitrations and other proceedings that relate to disputes over contractual
relationships with third parties, or that involve alleged errors and omissions on the part of our
insurance subsidiaries. We provide accruals for these items to the extent we deem the losses
probable and reasonably estimable.
The outcome of litigation is subject to numerous uncertainties. Although the ultimate outcome
of pending matters cannot be determined at this time, based on present information, we believe the
resolution of these matters will not have a material adverse effect on our financial position,
results of operations or cash flows.
Item 1A. Risk Factors
The risks below related to our business and industry have been identified since and are in
addition to those identified in the Companys annual report on Form 10-K for the year ended
December 31, 2006.
Our success depends on our ability to appropriately price the risks we underwrite.
Our financial condition depends on our ability to underwrite and set premium rates accurately
for a wide variety of risks. Rate adequacy is necessary to generate sufficient premiums to pay
losses, loss expenses and underwriting expenses and to earn a profit. In order to price our
products accurately, we must collect and properly analyze a substantial amount of data, develop,
test and apply appropriate rating formulas, closely monitor and timely recognize changes in trends
and project both severity and frequency of losses with reasonable accuracy. Our ability to
undertake these efforts successfully and price our products accurately is subject to a number of
risks and uncertainties, some of which are outside our control, including:
|
|
|
the availability of sufficient reliable data and our ability to properly analyze available data; |
|
|
|
|
the uncertainties that inherently characterize estimates and assumptions; |
|
|
|
|
our selection and application of appropriate rating and pricing techniques; and |
|
|
|
|
changes in legal standards, claim settlement practices, medical care expenses and restoration costs. |
Consequently, we could under-price risks, which would negatively affect our profit margins, or
we could over-price risks, which could reduce our sales volume and competitiveness. In either
event, our profitability could be materially and adversely affected.
We may not find suitable acquisition candidates or new insurance ventures and even if we do, we may
not successfully integrate any such acquired companies or successfully invest in such ventures.
As part of our present strategy, we continue to evaluate possible acquisition transactions and
the start-up of complementary business ventures on an ongoing basis, and at any given time, we may
be engaged in discussions with respect to possible acquisitions and new ventures. We cannot assure
you that we will be able to identify suitable acquisition transactions or insurance ventures, that
such transactions will be financed and completed on acceptable terms or that our future
acquisitions or ventures will be successful. The process of integrating any company involves a
number of special risks, including the possibility that management may be distracted from regular
business concerns by the need to integrate operations, unforeseen difficulties in integrating
operations and systems, problems concerning assimilating and retaining the employees of the
acquired company, challenges in retaining customers and potential adverse short-term effects on
operating results. In addition, we may incur debt to finance future acquisitions and we may issue
securities in connection with future acquisitions which may dilute the holdings of our current and
future shareholders. If we are unable to successfully complete and integrate strategic
acquisitions in a timely manner, our growth strategy could be adversely affected. Furthermore, our
current acquisition strategy may include the evaluation of potential acquisitions of privately-held
companies. Because privately-held companies are generally not subject to Section 404 of the
Sarbanes-Oxley Act of 2002, such companies may not have adequate internal control procedures, which
may, during our integration with any such company, have an adverse affect on our internal controls.
35
Our investment performance may suffer as a result of adverse capital market developments or other
factors, which may affect our financial results and ability to conduct business.
We invest the premiums we receive from policyholders until it is needed to pay policyholder
claims or other expenses. Our investment portfolio is managed by two outside independent
investment managers and one related party investment manager, all of which operate under investment
guidelines approved by our investment committee. Although we seek to maintain sufficient liquidity
from operations, investing and financing activities to meet our anticipated insurance obligations
and operating and capital expenditure needs, our investments are subject to a variety of risks,
including risks relating to general economic conditions, market volatility, interest rate
fluctuations, liquidity risk and credit and default risk. In particular, the volatility of our
claims may force us to liquidate securities, which may cause us to incur capital losses. If we do
not structure our investment portfolio so that it is appropriately matched with our insurance
liabilities, we may be forced to liquidate investments prior to maturity at a significant loss to
cover such liabilities. Investment losses could significantly decrease our asset base and
statutory surplus, thereby affecting our ability to conduct business.
We are subject to judicial decisions affecting insurance and tort law, which may adversely affect
our ability to achieve our business objectives.
State courts may render decisions impacting our liability for losses under insurance and tort
law. This case law, as well as any legislation enacted in response, can impact the claim severity
and frequency assumptions underlying our reserves. Accordingly, our ultimate liability may exceed
our estimates due to this variable, among others.
Although we have paid cash dividends in the past, we may not pay cash dividends in the future.
The declaration and payment of dividends is subject to the discretion of our board of
directors and will depend on our financial condition, results of operations, cash requirements,
future prospects, regulatory and contractual restrictions on the payment of dividends by our
subsidiaries and other factors deemed relevant by our board of directors. There is no requirement
that we must, and we cannot assure you that we will, declare and pay any dividends in the future.
Our board of directions may determine to retain such capital for general corporate or other
purposes.
Our reliance on our agents subjects us to credit risk.
Our agents collect premiums from policyholders and forward them to us. In certain
jurisdictions, when the insured pays premiums for these policies to agents for payment over to us,
the premiums might be considered to have been paid under applicable insurance laws and regulations,
and the insured will no longer be liable to us for these amounts, whether or not we actually
receive the premiums from the agent. Consequently, we assume a degree of credit risk associated
with our agents. Although agents failures to remit premiums to us have not caused a material
adverse impact on us to date, there have been instances where agents collected premiums and did not
remit it to us and we were nonetheless required under applicable law to provide the coverage set
forth in the policy despite the absence of premium. Because the possibility of these events is
dependent in large part upon the financial condition of our agents, which is not publicly
available, we are not able to quantify the exposure presented by this risk. If we are unable to
collect premiums from our agents in the future, our financial condition and results of operations
could be materially and adversely affected.
We are exposed to risks relating to evaluations of controls required by Section 404 of the
Sarbanes-Oxley Act of 2002.
We continue to evaluate our internal controls systems to allow management to report on, and
our independent registered public accounting firm to audit, our internal controls over financial
reporting and to perform the system and process evaluation and testing (and any necessary
remediation) required to comply with the management certification and auditor attestation
requirements of Section 404 of the Sarbanes-Oxley Act of 2002. In the course of this evaluation,
we may identify control deficiencies of varying degrees of severity under applicable SEC and Public
Company Accounting Oversight board rules and regulations that remain unremediated. As a public
company, we are required to report, among other things, control deficiencies that constitute a
material weakness or changes in internal controls that, or are reasonably likely to, materially
affect internal controls over financial reporting. A material weakness is a significant
deficiency, or combination of significant deficiencies that results in more than a remote
likelihood that a material misstatement of the annual or interim financial statements will not be
prevented or detected. If we cease to comply with the requirements of Section 404, we might be
subject to sanctions or investigation by regulatory authorities such as the SEC or Nasdaq.
Additionally, failure to comply with Section 404 or the report by us of a material weakness may
cause investors to lose confidence in
36
our financial statements and our stock price may be adversely affected. If we fail to remedy any
material weakness, our financial statements may be inaccurate, we may face restricted access to the
capital markets, and your share price may be adversely affected.
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 16, 2007. The matters brought
before the shareholders for vote at this meeting and the resulting vote were as follows:
|
1. |
|
The election of the following three Class III Directors, each to serve until the 2010
annual meeting of shareholders and until a successor has been duly elected and qualified: |
|
|
|
|
|
|
|
|
|
|
|
For |
|
Against/Withheld |
Edward F. Feighan |
|
|
11,956,602 |
|
|
|
356,984 |
|
Jeffrey A. Maffett |
|
|
11,429,026 |
|
|
|
884,560 |
|
Press C. Southworth III |
|
|
11,998,342 |
|
|
|
315,244 |
|
|
2. |
|
The ratification of the selection of KPMG LLP as the Companys independent registered
public accounting firm for the Companys fiscal year ending December 31, 2007: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For |
|
Against |
|
Abstain |
|
|
|
12,299,476 |
|
|
|
9,051 |
|
|
|
5,058 |
|
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 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
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 3, 2007 |
By: |
/s/ Erin E. West
|
|
|
|
Erin E. West |
|
|
|
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer) |
|
38
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. |
39