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 September 30, 2005
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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(State or other jurisdiction of
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31-1718622 |
incorporation or organization)
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(I.R.S. Employer Identification No.) |
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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 an accelerated filer (as defined in Rule
12b-2 of the Exchange Act).
YES o NO þ
Indicate by check mark whether the registrant is a shell company
(as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
As of November 10, 2005, the registrant had 13,211,019 outstanding Common Shares, without par
value.
PROCENTURY CORPORATION
QUARTERLY REPORT ON FORM 10-Q
For the Quarterly Period Ended September 30, 2005
INDEX
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Page |
PART I: FINANCIAL INFORMATION |
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Item 1. Financial Statements |
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3 |
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Consolidated Condensed Statements of Operations For the three and nine months ended
September 30, 2005 and 2004 |
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3 |
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Consolidated Condensed Balance Sheets September 30, 2005 and December 31, 2004 |
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4 |
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Consolidated Condensed Statements of Shareholders Equity and Comprehensive Income For
the nine months ended September 30, 2005 and 2004 |
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5 |
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Consolidated Condensed Statements of Cash Flows For the nine months ended September 30,
2005 and 2004 |
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6 |
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Notes to Consolidated Condensed Financial Statements September 30, 2005 |
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7 |
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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations |
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18 |
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Item 3. Quantitative and Qualitative Disclosures About Market Risk |
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29 |
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Item 4. Controls and Procedures |
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29 |
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PART II: OTHER INFORMATION |
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Item 1. Legal Proceedings |
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30 |
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds |
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30 |
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Item 3. Defaults Upon Senior Securities |
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30 |
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Item 4. Submission of Matters to a Vote of Security Holders |
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30 |
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Item 5. Other Information |
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30 |
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Item 6. Exhibits |
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30 |
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SIGNATURES |
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31 |
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2
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
PROCENTURY CORPORATION AND SUBSIDIARIES
Consolidated Condensed Statements of Operations
(Unaudited)
(Dollars in thousands, except per share data)
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For the Three Months Ended |
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For the Nine Months Ended |
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September 30, |
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September 30, |
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2005 |
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2004 |
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2005 |
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2004 |
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Premiums earned |
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$ |
44,934 |
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39,543 |
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129,479 |
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107,421 |
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Net investment income |
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3,866 |
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2,719 |
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10,520 |
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7,094 |
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Net realized investment (losses) gains |
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(66 |
) |
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(22 |
) |
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(219 |
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122 |
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Total revenues |
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48,734 |
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42,240 |
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139,780 |
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114,637 |
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Losses and loss expenses |
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36,410 |
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24,518 |
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88,724 |
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64,406 |
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Amortization of deferred policy acquisition costs |
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10,941 |
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8,526 |
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31,496 |
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24,019 |
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Other operating expenses |
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3,821 |
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3,385 |
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10,360 |
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10,236 |
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Severance expense |
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793 |
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250 |
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Interest expense |
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483 |
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352 |
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1,359 |
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1,113 |
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Interest expense on the redemption of Class B Shares |
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518 |
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Total expenses |
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51,655 |
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36,781 |
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132,732 |
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100,542 |
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(Loss) income before income tax |
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(2,921 |
) |
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5,459 |
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7,048 |
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14,095 |
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Income tax (benefit) expense |
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(1,128 |
) |
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1,747 |
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1,763 |
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4,510 |
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Net (loss) income |
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$ |
(1,793 |
) |
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3,712 |
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5,285 |
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9,585 |
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Basic net (loss) income per share |
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$ |
(0.14 |
) |
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0.28 |
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0.40 |
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0.98 |
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Diluted net (loss) income per share |
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$ |
(0.14 |
) |
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0.28 |
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0.40 |
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0.98 |
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Weighted average of shares outstanding basic |
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13,064,909 |
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13,135,450 |
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13,054,764 |
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9,779,529 |
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Weighted average of shares outstanding diluted |
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13,124,487 |
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13,179,052 |
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13,126,632 |
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9,803,101 |
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Cash dividend per share |
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$ |
0.02 |
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0.02 |
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0.06 |
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0.02 |
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See accompanying notes to the unaudited consolidated condensed financial statements.
3
PROCENTURY CORPORATION AND SUBSIDIARIES
Consolidated Condensed Balance Sheets
(Unaudited)
(Dollars in thousands)
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September 30, 2005 |
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December 31, 2004 |
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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 2005, $298,444; 2004, $262,470) |
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$ |
296,160 |
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263,401 |
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Held-to-maturity, at amortized cost (fair value 2005, $1,127; 2004, $1,156) |
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1,132 |
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1,142 |
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Equities (available-for-sale): |
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Equity
securities, at
fair value (cost 2005, $25,987; 2004, $17,944) |
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25,676 |
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18,228 |
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Bond mutual
funds, at fair
value (cost 2005, $18,261; 2004, $18,943) |
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17,821 |
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18,921 |
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Short-term investments, at amortized cost |
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4,199 |
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4,026 |
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Total investments |
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344,988 |
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305,718 |
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Cash |
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11,100 |
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6,681 |
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Premiums in course of collection, net |
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13,859 |
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11,747 |
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Deferred policy acquisition costs |
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19,389 |
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17,411 |
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Prepaid reinsurance premiums |
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10,481 |
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|
9,382 |
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Reinsurance recoverable on paid losses, net |
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2,919 |
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3,897 |
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Reinsurance recoverable on unpaid losses, net |
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51,042 |
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29,485 |
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Deferred federal income tax asset |
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8,242 |
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5,442 |
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Federal income taxes recoverable |
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1,700 |
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Other assets |
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6,797 |
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5,164 |
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Total assets |
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$ |
470,517 |
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394,927 |
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Liabilities and Shareholders Equity |
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Loss and loss expense reserves |
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$ |
215,343 |
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|
153,236 |
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Unearned premiums |
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90,179 |
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82,135 |
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Long term debt |
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25,000 |
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25,000 |
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Accrued expenses and other liabilities |
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5,308 |
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6,703 |
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Reinsurance balances payable |
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3,268 |
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2,348 |
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Collateral held |
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13,818 |
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7,008 |
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Federal income taxes payable |
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3,260 |
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Total liabilities |
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352,916 |
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279,690 |
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Shareholders equity: |
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Capital stock, without par value |
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Additional paid-in capital |
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100,239 |
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100,103 |
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Retained earnings |
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20,219 |
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15,727 |
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Unearned share compensation |
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(925 |
) |
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(1,413 |
) |
Accumulated other comprehensive (loss) income, net of taxes |
|
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(1,932 |
) |
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|
820 |
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Total
shareholders
equity |
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117,601 |
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|
115,237 |
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Total liabilities and shareholders equity |
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$ |
470,517 |
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|
394,927 |
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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)
(Dollars in thousands)
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For the Nine Months Ended September 30, |
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2005 |
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2004 |
|
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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|
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Beginning of period |
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100,103 |
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|
26,866 |
|
Issuance of common shares |
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|
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|
77,931 |
|
Issuance cost |
|
|
|
|
|
|
(1,298 |
) |
Redemption of Class B shares |
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|
|
|
(5,000 |
) |
Shares issued under share compensation plans |
|
|
136 |
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|
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|
Vesting of restricted common shares |
|
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|
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|
111 |
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|
|
|
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End of period |
|
|
100,239 |
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|
|
98,610 |
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|
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Retained earnings: |
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Beginning of period |
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15,727 |
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|
|
8,297 |
|
Net income (loss) |
|
|
5,285 |
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|
|
9,585 |
|
Dividend of subsidiary available for sale |
|
|
|
|
|
|
(7,024 |
) |
Dividends |
|
|
(793 |
) |
|
|
(262 |
) |
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|
|
|
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End of period |
|
|
20,219 |
|
|
|
10,596 |
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|
|
|
|
|
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Unearned share compensation: |
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|
|
|
|
|
|
|
Beginning of period |
|
|
(1,413 |
) |
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|
|
|
Vesting of restricted shares |
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|
488 |
|
|
|
|
|
|
|
|
|
|
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|
End of period |
|
|
(925 |
) |
|
|
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive income, net of taxes: |
|
|
|
|
|
|
|
|
Beginning of period |
|
|
820 |
|
|
|
1,234 |
|
Unrealized holding (losses) gains arising during period, net of reclassification adjustment |
|
|
(2,752 |
) |
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|
370 |
|
Dividend of subsidiary available for sale |
|
|
|
|
|
|
(564 |
) |
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|
|
|
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End of period |
|
|
(1,932 |
) |
|
|
1,040 |
|
|
|
|
|
|
|
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Total shareholders equity |
|
$ |
117,601 |
|
|
|
110,246 |
|
|
|
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|
|
|
|
|
|
|
|
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Comprehensive Income |
|
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|
|
|
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Net income |
|
$ |
5,285 |
|
|
|
9,585 |
|
|
|
|
|
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Other comprehensive income: |
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|
|
|
|
|
|
|
Unrealized gains (losses) on securities: |
|
|
|
|
|
|
|
|
Unrealized holding (losses) gains arising during the period: |
|
|
|
|
|
|
|
|
Gross |
|
|
(4,445 |
) |
|
|
708 |
|
Related federal income tax (expense) benefit |
|
|
1,550 |
|
|
|
(259 |
) |
|
|
|
|
|
|
|
Net unrealized gains (losses) |
|
|
(2,895 |
) |
|
|
449 |
|
|
|
|
|
|
|
|
Reclassification adjustment for (losses) gains included in net income: |
|
|
|
|
|
|
|
|
Gross |
|
|
(219 |
) |
|
|
122 |
|
Related federal income tax benefit (expense) |
|
|
77 |
|
|
|
(43 |
) |
|
|
|
|
|
|
|
Net reclassification adjustment |
|
|
(142 |
) |
|
|
79 |
|
|
|
|
|
|
|
|
Other comprehensive (loss) income |
|
|
(2,752 |
) |
|
|
370 |
|
|
|
|
|
|
|
|
Total comprehensive income (loss) |
|
$ |
2,533 |
|
|
|
9,955 |
|
|
|
|
|
|
|
|
See accompanying notes to the unaudited consolidated condensed financial statements.
5
PROCENTURY CORPORATION AND SUBSIDIARIES
Consolidated Condensed Statements of Cash Flows
(Unaudited)
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
For the Nine Months Ended September 30, |
|
|
|
2005 |
|
|
2004 |
|
Cash flows provided by operating activities: |
|
|
|
|
|
|
|
|
Net income |
|
$ |
5,285 |
|
|
|
9,585 |
|
Adjustments: |
|
|
|
|
|
|
|
|
Net realized investment losses (gains) |
|
|
219 |
|
|
|
(122 |
) |
Deferred federal income tax benefit |
|
|
(1,470 |
) |
|
|
(3,413 |
) |
Restricted share compensation |
|
|
624 |
|
|
|
111 |
|
Changes in assets and liabilities: |
|
|
|
|
|
|
|
|
Premiums in course of collection, net |
|
|
(2,112 |
) |
|
|
(780 |
) |
Deferred policy acquisition costs |
|
|
(1,978 |
) |
|
|
(5,365 |
) |
Prepaid reinsurance premiums |
|
|
(1,099 |
) |
|
|
(2,673 |
) |
Reinsurance recoverable on paid and unpaid losses, net |
|
|
(20,579 |
) |
|
|
6,616 |
|
Federal income taxes payable/recoverable |
|
|
(4,960 |
) |
|
|
1,623 |
|
Losses and loss expense reserves |
|
|
62,107 |
|
|
|
17,333 |
|
Unearned premiums |
|
|
8,044 |
|
|
|
18,284 |
|
Reinsurance balances payable |
|
|
920 |
|
|
|
(1,683 |
) |
Collateral held |
|
|
6,810 |
|
|
|
(1,820 |
) |
Receivable from subsidiary available for sale |
|
|
|
|
|
|
26,687 |
|
Other, net |
|
|
(949 |
) |
|
|
(1,328 |
) |
|
|
|
|
|
|
|
Net cash provided by operating activities |
|
|
50,862 |
|
|
|
63,055 |
|
|
|
|
|
|
|
|
Cash flows used in investing activities: |
|
|
|
|
|
|
|
|
Purchases of equity securities |
|
|
(50,594 |
) |
|
|
(50,591 |
) |
Purchases of fixed maturity securities available-for-sale |
|
|
(98,324 |
) |
|
|
(161,417 |
) |
Proceeds from sales of equity securities |
|
|
42,849 |
|
|
|
41,132 |
|
Proceeds from sales and maturities of fixed maturities available-for-sale |
|
|
61,594 |
|
|
|
30,170 |
|
Proceeds from maturities of fixed maturities held-to-maturity |
|
|
|
|
|
|
325 |
|
Acquisition, net of cash acquired |
|
|
(1,002 |
) |
|
|
|
|
Net change in short-term investments |
|
|
(173 |
) |
|
|
14,482 |
|
|
|
|
|
|
|
|
Net cash used in investing activities |
|
|
(45,650 |
) |
|
|
(125,899 |
) |
|
|
|
|
|
|
|
Cash flows (used in) provided by financing activities: |
|
|
|
|
|
|
|
|
Issuance of common shares |
|
|
|
|
|
|
77,931 |
|
Issuance cost |
|
|
|
|
|
|
(1,298 |
) |
Redemption of Class B common shares |
|
|
|
|
|
|
(5,000 |
) |
Principal payment on long term debt |
|
|
|
|
|
|
(9,133 |
) |
Dividend of subsidiary |
|
|
|
|
|
|
(262 |
) |
Draw on line of credit |
|
|
2,300 |
|
|
|
|
|
Principal payment on line of credit |
|
|
(2,300 |
) |
|
|
|
|
Dividend paid to shareholders |
|
|
(793 |
) |
|
|
|
|
|
|
|
|
|
|
|
Net cash (used in) provided by financing activities |
|
|
(793 |
) |
|
|
62,238 |
|
|
|
|
|
|
|
|
Increase (decrease) in cash and cash equivalents |
|
|
4,419 |
|
|
|
(606 |
) |
Cash and equivalents at beginning of year |
|
|
6,681 |
|
|
|
5,814 |
|
|
|
|
|
|
|
|
Cash and equivalents at end of year |
|
$ |
11,100 |
|
|
|
5,208 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information: |
|
|
|
|
|
|
|
|
Interest paid |
|
$ |
1,357 |
|
|
|
1,234 |
|
|
|
|
|
|
|
|
Federal income taxes paid |
|
$ |
8,191 |
|
|
|
6,300 |
|
|
|
|
|
|
|
|
See accompanying notes to the unaudited consolidated condensed financial statements.
6
PROCENTURY CORPORATION AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements
September 30, 2005
(Unaudited)
(1) |
|
Basis of Presentation |
|
|
|
The accompanying interim unaudited consolidated condensed financial statements and notes
include the accounts of ProCentury Corporation , (the Company or ProCentury) and its wholly
owned insurance subsidiary, Century Surety Company (Century). The interim unaudited
consolidated condensed financial statements have been prepared in accordance with U.S.
generally accepted accounting principles (GAAP) for interim financial information and with
the instructions to Article 10 of Regulation S-X. Accordingly, the interim unaudited
consolidated condensed financial statements do not include all of the information and notes
required by GAAP for complete financial statements. In the opinion of management, all
adjustments considered necessary for a fair presentation of results for the interim periods
have been included. These interim unaudited consolidated condensed financial statements and
related notes should be read in conjunction with the consolidated financial statements and
related notes in the Companys audited consolidated financial statements, included in the
Companys annual report on Form 10-K Filing as of December 31, 2004. The Companys results of
operations for interim periods are not necessarily indicative of the results to be expected for
the entire year. |
|
|
|
On April 20, 2004, the common shares of Evergreen National Indemnity Company (Evergreen) and
its wholly owned subsidiary, Continental Heritage Insurance Company (Continental) (formerly
controlled subsidiaries of Century) were distributed as dividends from Century to ProCentury
and then by ProCentury to ProCenturys existing Class A shareholders. Prior to the dividends,
Evergreen was a controlled subsidiary of Century. The operations of Evergreen and Continental
consisted of ProCenturys historical surety and assumed workers compensation lines of
insurance, which were re-classified (net of minority interest and income taxes) as discontinued
operations in the accompanying interim unaudited consolidated condensed financial statements
and notes for 2004. |
|
|
|
On April 26, 2004, the Company issued 8,000,000 common shares at $10.50 per share in the IPO
and received net proceeds (before expenses) of $77.9 million. The following transactions
occurred in connection with the IPO: |
|
|
|
Immediately prior to the completion of the IPO, each outstanding Class A common
share was converted into 500 common shares. After the conversion, but prior to the
completion of the IPO, the Company had 4,999,995 Class A common shares outstanding. The
share conversion is reflected for all periods presented. |
|
|
|
|
Immediately prior to the completion of the IPO, the common shares of Evergreen
National Indemnity Company (Evergreen) and its wholly owned subsidiary, Continental
Heritage Insurance Company (Continental) were distributed as dividends from Century to
ProCentury and then by ProCentury to ProCenturys existing Class A shareholders. Prior
to the dividends, Evergreen was a controlled subsidiary of Century. The operations of
Evergreen and Continental consisted of ProCenturys historical surety and assumed
workers compensation lines of insurance, which were re-classified (net of minority
interest and income taxes) as discontinued operations in the accompanying interim
unaudited consolidated condensed financial statements and notes for all periods
presented. |
|
|
|
|
The Company issued 8,000,000 Class A common shares and received net proceeds
(before expenses) of $77.9 million. |
|
|
|
|
The Company granted 101,200 restricted common shares and 364,000 stock options to
certain employees of ProCentury. |
|
|
|
|
The Company repaid $8.7 million of bank indebtedness outstanding at the closing
of the IPO. |
|
|
|
|
The Company redeemed all of its outstanding Class B common shares for an
aggregate redemption price of $5.0 million and recorded interest expense of $518,000 in
connection with the redemption; and |
|
|
|
|
The Company amended its articles of incorporation to eliminate the authority to
issue Class B and Class C common shares. |
7
On June 1, 2005, Century acquired 100% of the outstanding shares of the Firemans Fund of Texas
(FFTX) for $5.8 million (including direct costs of $100,000). FFTX had statutory surplus of
$5.4 million on the date of acquisition. FFTX is a Texas domiciled property and casualty
company licensed in Texas, Oklahoma and California. The acquisition is part of the Companys
long-term plan to develop business that requires admitted status, as well as its continued
focus on growing its excess and surplus lines business. The total purchase price of the
acquisition was allocated to the assets and the liabilities acquired based upon the respective
fair values as of the date of acquisition. Intangible assets included in the purchase were
valued at $375,000. The excess of the fair value of the net identifiable assets acquired over
the purchase price was $193,000. In accordance with Statement of Financial Accounting
Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, the amortization of
goodwill and indefinite-lived intangible assets is not permitted. Goodwill and indefinite-lived
intangible assets remain on the balance sheet and are tested for impairment on an annual basis,
or when there is reason to suspect that their values may have been diminished or impaired.
In preparing the interim unaudited consolidated condensed financial statements, management was
required to make certain estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities as of the date of the
interim unaudited consolidated condensed financial statements, and the reported amounts of
revenue and expenses for the reporting period. Actual results could differ significantly from
those estimates.
Material estimates that are particularly susceptible to significant change in the near-term
relate to the determination of loss and loss expense reserves, the recoverability of deferred
policy acquisition costs, the determination of federal income taxes, the net realizable value
of reinsurance recoverables and the determination of other-than-temporary declines in the fair
value of investments. Although considerable variability is inherent in these estimates,
management believes that the amounts provided are adequate. These estimates are continually
reviewed and adjusted as necessary. Such adjustments are generally reflected in current
operations.
All significant intercompany balances and transactions have been eliminated.
Share Option Accounting
The Company follows the provisions of Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees (APB 25), the Financial Accounting Standards Board (FASB)
Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation (an
interpretation of APB Opinion No. 25), and other related accounting interpretations for the
Companys share option and restricted common share plans utilizing the intrinsic value
method. The Company also follows the disclosure provisions of SFAS No. 123, Accounting for
Stock-Based Compensation, for the Companys share option grants, as amended by SFAS No. 148,
Accounting for Stock-Based Compensation Transition and Disclosure; an amendment of FASB
Statement No. 123. This disclosure requires pro forma net income and earnings per share
information, which is calculated assuming the Company has accounted for its stock option plans
under the fair value method described in SFAS No. 123 and SFAS No. 148.
If the Company recorded compensation expense for its share option grants based on the fair
value method, the Companys net (loss) income and (loss) earnings per share would have been
adjusted to the pro forma amounts as indicated in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended |
|
|
For the Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
|
|
(Dollars in thousands, except per share data) |
|
Net (loss) income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As reported |
|
$ |
(1,793 |
) |
|
|
3,712 |
|
|
|
5,285 |
|
|
|
9,585 |
|
Add: Share-based employee
compensation expense included in
reported net income, net of related
tax effects |
|
|
97 |
|
|
|
111 |
|
|
|
398 |
|
|
|
111 |
|
Less: Additional share-based employee
compensation expense determined under
fair value-based method for all
awards, net of related tax effects |
|
|
(150 |
) |
|
|
(169 |
) |
|
|
(649 |
) |
|
|
(217 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro Forma |
|
$ |
(1,846 |
) |
|
|
3,654 |
|
|
|
5,034 |
|
|
|
9,479 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic (loss) income per common share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As reported |
|
$ |
(0.14 |
) |
|
|
0.28 |
|
|
|
0.40 |
|
|
|
0.98 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro Forma |
|
$ |
(0.14 |
) |
|
|
0.28 |
|
|
|
0.39 |
|
|
|
0.97 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted (loss) income per common share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As reported |
|
$ |
(0.14 |
) |
|
|
0.28 |
|
|
|
0.40 |
|
|
|
0.98 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro Forma |
|
$ |
(0.14 |
) |
|
|
0.28 |
|
|
|
0.38 |
|
|
|
0.97 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8
|
|
The fair values of the share options are estimated on the dates of grant using the Black
Scholes option pricing model with the following weighted average assumptions: |
|
|
|
|
|
|
|
For the Three and Nine Months |
|
|
Ended September 30, 2005 |
Risk free interest rate |
|
|
3.97 |
% |
Dividend yield |
|
|
0.76 |
% |
Volatility factor |
|
|
23.15 |
% |
Weighted average expected option life |
|
7.00 Years |
|
|
In December 2004, the FASB revised Statement No. 123 (SFAS 123R), Share-Based Payment, which
requires companies to expense the estimated fair value of employee stock options and similar
awards, for all options vesting, granted, or modified after the effective date of this revised
statement. The accounting provisions of SFAS 123R were to become effective for interim periods
beginning after June 15, 2005. In April 2005, the Securities and Exchange Commission (SEC)
adopted a final rule amending Rule 4-01(a) of Regulation S-X regarding the compliance date for
SFAS 123R. This ruling delays the effective date of SFAS 123R to the first interim or annual
reporting period of the registrants first fiscal year beginning on or after June 15, 2005. As
a result, the accounting provisions of SFAS 123R will become effective beginning in 2006 for
the Companys financial statements. The Company is evaluating the impact of implementing SFAS
123R and anticipates it will be material to the financial statements. |
|
(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. |
9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended September 30, 2005 |
|
|
|
(Dollars in thousands, except per share data) |
|
|
|
Income |
|
|
Shares |
|
|
Per Share |
|
|
|
(Numerator) |
|
|
(Denominator) |
|
|
Amount |
|
Basic Net (Loss) Per Share |
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss) |
|
$ |
(1,793 |
) |
|
|
13,064,909 |
|
|
$ |
(0.14 |
) |
Effect of Dilutive Securities |
|
|
|
|
|
|
|
|
|
|
|
|
Restricted common shares and
share options |
|
|
|
|
|
|
59,578 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted EPS |
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss) |
|
$ |
(1,793 |
) |
|
|
13,124,487 |
|
|
$ |
(0.14 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended September 30, 2004 |
|
|
|
(Dollars in thousands, except per share data) |
|
|
|
Income |
|
|
Shares |
|
|
Per Share |
|
|
|
(Numerator) |
|
|
(Denominator) |
|
|
Amount |
|
Basic Net Income Per Share |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
3,712 |
|
|
|
13,135,450 |
|
|
$ |
0.28 |
|
Effect of Dilutive Securities |
|
|
|
|
|
|
|
|
|
|
|
|
Restricted common shares and
share options |
|
|
|
|
|
|
43,602 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted EPS |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
3,712 |
|
|
|
13,179,052 |
|
|
$ |
0.28 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Nine Months Ended September 30, 2005 |
|
|
|
(Dollars in thousands, except per share data) |
|
|
|
Income |
|
|
Shares |
|
|
Per Share |
|
|
|
(Numerator) |
|
|
(Denominator) |
|
|
Amount |
|
Basic Net Income Per Share |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
5,285 |
|
|
|
13,054,764 |
|
|
$ |
0.40 |
|
Effect of Dilutive Securities |
|
|
|
|
|
|
|
|
|
|
|
|
Restricted common shares and
share options |
|
|
|
|
|
|
71,868 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted EPS |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
5,285 |
|
|
|
13,126,632 |
|
|
$ |
0.40 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Nine Months Ended September 30, 2004 |
|
|
|
(Dollars in thousands, except per share data) |
|
|
|
Income |
|
|
Shares |
|
|
Per Share |
|
|
|
(Numerator) |
|
|
(Denominator) |
|
|
Amount |
|
Basic Net Income Per Share |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
9,585 |
|
|
|
9,779,529 |
|
|
$ |
0.98 |
|
Effect of Dilutive Securities |
|
|
|
|
|
|
|
|
|
|
|
|
Restricted common shares and
share options |
|
|
|
|
|
|
23,572 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted EPS |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
9,585 |
|
|
|
9,803,101 |
|
|
$ |
0.98 |
|
|
|
|
|
|
|
|
|
|
|
10
(3) |
|
Investments |
|
|
|
The Company invests primarily in investment-grade fixed-maturity securities. The amortized
cost, gross unrealized gains and losses and estimated fair value of fixed-maturity securities
classified as held-to-maturity were as follows: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2005 |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
Estimated |
|
|
|
Amortized |
|
|
unrealized |
|
|
unrealized |
|
|
fair |
|
|
|
cost |
|
|
gains |
|
|
losses |
|
|
value |
|
U.S. Treasury securities |
|
$ |
89 |
|
|
|
14 |
|
|
|
|
|
|
|
103 |
|
Agencies not backed by the full faith and credit of
the U.S. Government |
|
|
1,043 |
|
|
|
|
|
|
|
(19 |
) |
|
|
1,024 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,132 |
|
|
|
14 |
|
|
|
(19 |
) |
|
|
1,127 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2004 |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
Estimated |
|
|
|
Amortized |
|
|
unrealized |
|
|
unrealized |
|
|
fair |
|
|
|
cost |
|
|
gains |
|
|
losses |
|
|
value |
|
U.S. Treasury securities |
|
$ |
89 |
|
|
|
13 |
|
|
|
|
|
|
|
102 |
|
Agencies not backed by the full faith and credit of
the U.S. Government |
|
|
1,053 |
|
|
|
1 |
|
|
|
|
|
|
|
1,054 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,142 |
|
|
|
14 |
|
|
|
|
|
|
|
1,156 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2005 |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
Estimated |
|
|
|
Amortized |
|
|
unrealized |
|
|
unrealized |
|
|
fair |
|
|
|
cost |
|
|
gains |
|
|
losses |
|
|
value |
|
Fixed maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities |
|
$ |
3,693 |
|
|
|
1 |
|
|
|
(45 |
) |
|
|
3,649 |
|
Agencies not backed by the full faith and credit of
the U.S. Government |
|
|
14,325 |
|
|
|
13 |
|
|
|
(165 |
) |
|
|
14,173 |
|
Obligations of states and political subdivisions |
|
|
134,464 |
|
|
|
444 |
|
|
|
(819 |
) |
|
|
134,089 |
|
Corporate securities |
|
|
38,207 |
|
|
|
50 |
|
|
|
(694 |
) |
|
|
37,563 |
|
Mortgage-backed securities |
|
|
43,427 |
|
|
|
74 |
|
|
|
(580 |
) |
|
|
42,921 |
|
Collateralized mortgage obligations |
|
|
27,831 |
|
|
|
5 |
|
|
|
(375 |
) |
|
|
27,461 |
|
Asset-backed securities |
|
|
36,497 |
|
|
|
253 |
|
|
|
(446 |
) |
|
|
36,304 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities |
|
|
298,444 |
|
|
|
840 |
|
|
|
(3,124 |
) |
|
|
296,160 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities |
|
|
25,987 |
|
|
|
255 |
|
|
|
(566 |
) |
|
|
25,676 |
|
Bond mutual funds |
|
|
18,261 |
|
|
|
24 |
|
|
|
(464 |
) |
|
|
17,821 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equities |
|
|
44,248 |
|
|
|
279 |
|
|
|
(1,030 |
) |
|
|
43,497 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
342,692 |
|
|
|
1,119 |
|
|
|
(4,154 |
) |
|
|
339,657 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2004 |
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
Gross |
|
|
Gross |
|
|
Estimated |
|
|
|
Amortized |
|
|
unrealized |
|
|
unrealized |
|
|
fair |
|
|
|
cost |
|
|
gains |
|
|
losses |
|
|
value |
|
Fixed maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities |
|
$ |
4,169 |
|
|
|
35 |
|
|
|
(32 |
) |
|
|
4,172 |
|
Agencies not backed by the full faith and credit of
the U.S. Government |
|
|
16,805 |
|
|
|
98 |
|
|
|
(84 |
) |
|
|
16,819 |
|
Obligations of states and political subdivisions |
|
|
119,893 |
|
|
|
1,225 |
|
|
|
(399 |
) |
|
|
120,717 |
|
Corporate securities |
|
|
46,249 |
|
|
|
200 |
|
|
|
(300 |
) |
|
|
46,149 |
|
Mortgage-backed securities |
|
|
33,148 |
|
|
|
276 |
|
|
|
(48 |
) |
|
|
33,376 |
|
Collateralized mortgage obligations |
|
|
23,825 |
|
|
|
72 |
|
|
|
(120 |
) |
|
|
23,777 |
|
Asset-backed securities |
|
|
18,383 |
|
|
|
135 |
|
|
|
(127 |
) |
|
|
18,391 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities |
|
|
262,470 |
|
|
|
2,041 |
|
|
|
(1,110 |
) |
|
|
263,401 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities |
|
|
17,944 |
|
|
|
458 |
|
|
|
(174 |
) |
|
|
18,228 |
|
Bond mutual funds |
|
|
18,943 |
|
|
|
3 |
|
|
|
(25 |
) |
|
|
18,921 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equities |
|
|
36,887 |
|
|
|
461 |
|
|
|
(199 |
) |
|
|
37,149 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
299,358 |
|
|
|
2,501 |
|
|
|
(1,309 |
) |
|
|
300,550 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Under the Companys accounting policy for equity securities and fixed-maturity securities
that can be contractually prepaid or otherwise settled in a way that may limit the Companys
ability to fully recover cost, an impairment is deemed to be other-than-temporary unless the
Company has both the ability and intent to hold the investment for a reasonable period until
the securitys forecasted recovery and evidence exists indicating that recovery will occur
within a reasonable period of time. |
|
|
|
For other fixed-maturity and equity securities, an other-than-temporary impairment charge
is taken when the Company does not have the ability and intent to hold the security until the
forecasted recovery or if it is no longer probable that the Company will recover all amounts
due under the contractual terms of the security. Many criteria are considered during this
process including, but not limited to, the current fair value as compared to amortized cost or
cost, as appropriate, of the security; the amount and length of time a securitys fair value
has been below amortized cost or cost; specific credit issues and financial prospects related
to the issuer; the Companys ability and intent to hold or dispose of the security, and current
economic conditions. |
|
|
|
Other-than-temporary impairment losses result in a permanent reduction to the cost basis
of the underlying investment. Other-than-temporary losses of $79,000 and $114,000 were included
in the investment losses for the three and nine months ended September 30, 2005, respectively.
No other-than-temporary declines were realized in the nine months ended September 30, 2004. |
|
|
|
The estimated fair value, related gross unrealized losses, and the length of time that the
securities have been impaired for held-to-maturity securities that are considered temporarily
impaired are as follows: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2005 |
|
|
|
(Dollars in thousands) |
|
|
|
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 |
|
Agencies not backed by the full faith
and credit of the U.S. Government |
|
$ |
1,024 |
|
|
|
(19 |
) |
|
|
|
|
|
|
|
|
|
|
1,024 |
|
|
|
(19 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,024 |
|
|
|
(19 |
) |
|
|
|
|
|
|
|
|
|
|
1,024 |
|
|
|
(19 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12
|
|
The estimated fair value, related gross unrealized losses, and the length of time that the
securities have been impaired for available-for-sale securities that are considered temporarily
impaired are as follows: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2005 |
|
|
|
(Dollars in thousands) |
|
|
|
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 |
|
Fixed maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities |
|
$ |
3,381 |
|
|
|
(45 |
) |
|
|
|
|
|
|
|
|
|
|
3,381 |
|
|
|
(45 |
) |
Agencies not backed by the full faith
and credit of the U.S. Government |
|
|
6,071 |
|
|
|
(64 |
) |
|
|
5,253 |
|
|
|
(101 |
) |
|
|
11,324 |
|
|
|
(165 |
) |
Obligations of states and political
subdivisions |
|
|
66,787 |
|
|
|
(471 |
) |
|
|
16,667 |
|
|
|
(348 |
) |
|
|
83,454 |
|
|
|
(819 |
) |
Corporate securities |
|
|
24,249 |
|
|
|
(448 |
) |
|
|
7,594 |
|
|
|
(246 |
) |
|
|
31,843 |
|
|
|
(694 |
) |
Mortgage-backed securities |
|
|
36,124 |
|
|
|
(439 |
) |
|
|
5,645 |
|
|
|
(141 |
) |
|
|
41,769 |
|
|
|
(580 |
) |
Collateralized mortgage obligations |
|
|
17,152 |
|
|
|
(242 |
) |
|
|
9,348 |
|
|
|
(133 |
) |
|
|
26,500 |
|
|
|
(375 |
) |
Asset-backed securities |
|
|
15,758 |
|
|
|
(240 |
) |
|
|
7,954 |
|
|
|
(206 |
) |
|
|
23,712 |
|
|
|
(446 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities |
|
|
169,522 |
|
|
|
(1,949 |
) |
|
|
52,461 |
|
|
|
(1,175 |
) |
|
|
221,983 |
|
|
|
(3,124 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity securities |
|
|
10,749 |
|
|
|
(393 |
) |
|
|
2,796 |
|
|
|
(173 |
) |
|
|
13,545 |
|
|
|
(566 |
) |
Bond mutual funds |
|
|
8,298 |
|
|
|
(253 |
) |
|
|
9,060 |
|
|
|
(211 |
) |
|
|
17,358 |
|
|
|
(464 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equities |
|
|
19,047 |
|
|
|
(646 |
) |
|
|
11,856 |
|
|
|
(384 |
) |
|
|
30,903 |
|
|
|
(1,030 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
188,569 |
|
|
|
(2,595 |
) |
|
|
64,317 |
|
|
|
(1,559 |
) |
|
|
252,886 |
|
|
|
(4,154 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At September 30, 2005, the Company had seventy-five fixed income securities and seven
equity securities that have been in an unrealized loss position for one year or longer.
Seventy-three of the fixed income securities are investment grade, of which seventy-one of
these securities are rated A1/A or better (including fifty-three securities which are rated
AAA). The two remaining non-investment grade fixed income securities are rated BB and BB- and
have a fair value equal to 99.9% of their book value as of September 30, 2005. Two of the
equity securities that have been in an unrealized loss position for one year or longer relate
to closed end bond or preferred stock funds, each of which continues to pay its regular
dividend on a monthly basis and also has an underlying net asset value per share that exceeds
its price per share as of September 30, 2005. One of the equity securities relates to an
investment in an open end high quality short duration bond fund, of which the underlying assets
are all rated AAA. Finally, the four remaining equity securities that have been in an
unrealized loss position for one year or longer relate to preferred share investments in
issuers each of which has shown an improved financial performance during 2005. In addition,
these seven equity securities have an aggregate fair market value equal to 96.8% of their book
value as of September 30, 2005. All seventy-five of the fixed income securities are current on
interest and principal and all seven of the equity securities continue to pay dividends at a
level consistent with the prior year. Management believes the declines are temporary and are
not indicative of other-than-temporary impairments. |
|
(4) |
|
Loss and Loss Expense Reserves |
|
|
|
Liability for losses and loss expenses represents the Companys best estimate of the ultimate
amounts needed to pay both reported and unreported claims. These estimates are based on
quarterly internal actuarial studies and certified on an annual basis by an independent
actuary. The Company continually reviews these estimates and, based on new developments and
information, the Company includes adjustments of the probable ultimate liability in the
operating results for the periods in which the adjustments are made. |
|
|
|
Net loss and loss expenses incurred were $36.4 million for the quarter ended September 30,
2005, compared to $24.5 million for the quarter ended September 30, 2004. In the third quarter
of 2005, the Company recorded $35.4 million of incurred losses and loss expenses attributable
to the 2005 accident year and $978,000 attributable to events of prior years. In the third
quarter of 2004, the Company recorded $20.6 million of incurred losses and loss expenses
attributable to the 2004 accident year and $3.9 million attributable to events of prior years. |
|
|
|
Net loss and loss expenses incurred were $88.7 million for the nine months ended September 30,
2005, compared to $64.4 million for the nine months ended September 30, 2004. For the nine
months ended September 30, 2005, the Company recorded $84.1 million of incurred losses and loss
expenses attributable to the 2005 accident year and $4.6 million attributable to events of
prior years. For the nine months ended September 30, 2004, the Company recorded $56.4 million
of incurred losses and loss expenses attributable to the 2004 accident year and $8.0 million
attributable to events of prior years. |
|
|
|
During the quarter ended September 30, 2005, the Company incurred $8.8 million of incurred net loss
and loss expenses and $18.3 million of gross loss and loss expenses related to Hurricanes Katrina
and Rita. The Company did not incur a significant amount of hurricane losses in 2004. |
13
|
|
The prior year increase for the quarter ended September 30, 2005 resulted principally from the
non-construction defect casualty line of business in the property and casualty segment. This
increase resulted from unexpected increases in claims severities that caused reassessments of
the claim reporting and settlement patterns, which resulted in $944,000 of
additional incurred loss and loss expenses. In addition, the most significant components of
the prior year increases for the quarter ended September 30, 2005 included $454,000 of
favorable development in the Companys property line as a result of actual reported losses
below expectations and $363,000 of prior year increases related to construction defect claims
within the other liability line of the property and casualty segment. The development with
construction defect claims primarily resulted in anticipated increase in litigation expenses
related to the contribution actions which were slightly offset by favorable claim count
development. Construction defect claim severities continue to be within the Companys
expectations. The $978,000 prior year increases in the quarter ended September 30, 2005
compares to $3.9 million of prior year increases for the same period in 2004, which primarily
resulted from the construction defect line. |
|
|
|
The prior year increase for the nine months ended September 30, 2005 included $3.5 million
increases related to construction defect, $2.0 million related to the non-construction defect
casualty line and $463,000 of increases related to the exited commercial auto line from adverse
new claim information on two claims. The increases were offset by
approximately $989,000 of favorable development in the property line of business. The
increases related to construction defect primarily relate to reserves established for several
contribution action settlements that are anticipated to be paid within the year and increased
estimate of litigation reserves related to the contribution actions. The increases related to
the non-construction defect casualty line primarily relate to claim severities exceeding the
Companys expectations resulting in reassessments of the initial loss ratio expectations and
the claim reporting and settlement patterns. The favorable development for property resulted
from actual reported losses below expectations. The prior year increases for the nine months
ended September 30, 2005 of $4.6 million compares to $8.0 million during the same period of
2004. |
|
|
|
A significant portion of the nine months ended September 30, 2004 prior year increases resulted
principally from construction defect claims in the other liability line in the property and
casualty segment. During the first nine months of 2004, new construction defect claim counts
exceeded expectations. Based on the claim count experience that emerged, the Companys
actuaries revised the factors used in the estimation of ultimate construction defect claim
counts. This re-estimation of claim count projection factors produced an increase in the
estimated ultimate cost of construction defect claims, causing adverse development on prior
accident years during the nine month periods ended September 30, 2004. In addition, in the nine
months ended September 30, 2004, increases in incurred amounts on four claims also increased
the amount of incurred development. |
|
|
|
Additionally, during the second quarter of 2004, the Company experienced development related to
19 new contractors claims. The 19 new claims were higher than recent experience and the
development on pending claims exceeded the Companys expectations. |
|
|
|
During the first quarter of 2004, the Company recorded increases in paid and incurred losses
and loss expenses on seven commercial auto liability claims. The net incurred increases on
these claims totaled $778,000. The increases were related to one significant, unanticipated new
claim ($155,000), reserve increases related to coverage disputes on three claims ($297,000),
and unfavorable changes in conditions relating to three other claims ($326,000). |
|
(5) |
|
Reinsurance |
|
|
|
In the ordinary course of business, Century assumes and cedes reinsurance with other insurers
and reinsurers. These arrangements provide greater diversification of business and limit the
maximum net loss potential on large risks. There have been no significant changes in the
Companys reinsurance program. The amounts of ceded loss and loss expense reserves and ceded
unearned premiums would represent a liability of the Company in the event that its reinsurers
would be unable to meet existing obligations under reinsurance agreements. |
14
|
|
|
The effects of assumed and ceded reinsurance on premiums written, premiums earned and loss and
loss expenses incurred were as follows: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months |
|
|
For the Nine Months |
|
|
|
Ended September 30, |
|
|
Ended September 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
|
|
(Dollars in thousands) |
|
Premiums written: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct |
|
$ |
52,491 |
|
|
|
49,963 |
|
|
|
154,444 |
|
|
|
141,939 |
|
Assumed |
|
|
993 |
|
|
|
38 |
|
|
|
1,945 |
|
|
|
135 |
|
Ceded |
|
|
(7,703 |
) |
|
|
(6,535 |
) |
|
|
(19,965 |
) |
|
|
(19,042 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums written |
|
$ |
45,781 |
|
|
|
43,466 |
|
|
|
136,424 |
|
|
|
123,032 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums earned: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct |
|
$ |
51,575 |
|
|
|
45,768 |
|
|
|
147,457 |
|
|
|
124,235 |
|
Assumed |
|
|
475 |
|
|
|
95 |
|
|
|
888 |
|
|
|
375 |
|
Ceded |
|
|
(7,116 |
) |
|
|
(6,320 |
) |
|
|
(18,866 |
) |
|
|
(17,189 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums earned |
|
$ |
44,934 |
|
|
|
39,543 |
|
|
|
129,479 |
|
|
|
107,421 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses and loss expenses incurred: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct |
|
$ |
50,850 |
|
|
|
29,397 |
|
|
|
114,521 |
|
|
|
76,612 |
|
Assumed |
|
|
(229 |
) |
|
|
575 |
|
|
|
(641 |
) |
|
|
2,521 |
|
Ceded |
|
|
(14,211 |
) |
|
|
(5,453 |
) |
|
|
(25,156 |
) |
|
|
(14,727 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net losses and loss expenses incurred |
|
$ |
36,410 |
|
|
|
24,518 |
|
|
|
88,724 |
|
|
|
64,406 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6) |
|
Deferred Policy Acquisition Costs |
|
|
|
The following table reflects the amounts of policy acquisition costs deferred and amortized: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
|
|
(Dollars in thousands) |
|
Balance at beginning of period |
|
$ |
18,919 |
|
|
|
15,616 |
|
|
|
17,411 |
|
|
|
11,714 |
|
Policy acquisition costs deferred |
|
|
11,411 |
|
|
|
9,989 |
|
|
|
33,474 |
|
|
|
29,384 |
|
Amortization of deferred policy acquisition costs |
|
|
(10,941 |
) |
|
|
(8,526 |
) |
|
|
(31,496 |
) |
|
|
(24,019 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period |
|
$ |
19,389 |
|
|
|
17,079 |
|
|
|
19,389 |
|
|
|
17,079 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of deferred policy acquisition costs for the nine months ended September 30,
2004 included a reduction of amortization expense of $2.5 million relating to the transfer of
capitalized acquisition costs from Evergreen and Continental for the property and casualty
segment, which was partially offset by $1.9 million of capitalized acquisition costs for the
surety segment that was transferred from Century to Evergreen and Continental. These
transactions occurred in conjunction with the termination of the intercompany pooling agreement
and the implementation of the loss portfolio agreements among Century, Evergreen and
Continental, as disclosed in the Companys Form 10-K filing for the year ended December 31,
2004. |
|
(7) |
|
Federal Income Taxes |
|
|
|
The income tax provision for the nine months ended September 30, 2005 and 2004, has been
computed based on our estimated annual effective tax rate of 25.0% and 32.0%, respectively,
which differ from the federal income tax rate of 35% principally because of tax-exempt
investment income. The income tax provision for the quarter ended September 30, 2005 was
38.6% primarily due to the pretax loss recorded for the quarter and the effect of tax-exempt
investment income. The income tax provision for the quarter ended September 30, 2004 was 32.0%
primarily due to the effect of tax-exempt investment income. |
|
(8) |
|
Commitments and Contingencies |
|
|
|
The Company is a defendant in various lawsuits in the ordinary course of its business. In the
opinion of management, the effects, if any, of such lawsuits are not expected to be material to
the Companys consolidated financial position or results from operations. |
15
(9) |
|
Segment Reporting Disclosures |
|
|
|
The Company operates in the Property and Casualty Lines (P/C) (including general liability,
multi-peril, and commercial property) segment of the specialty insurance market. |
|
|
|
All investment activities are included in the Investing segment. Exited programs (including
workers compensation and commercial auto) are included in Other (including Exited Lines) for
purposes of segment reporting. |
|
|
|
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 segment
is measured by net investment income and net realized gains or losses. |
|
|
|
The Company does not allocate assets to the P/C and Other (including exited lines) segments for
management reporting purposes. The total investment portfolio and cash are allocated to the
Investment operating segment. |
|
|
|
The following is a summary of segment disclosures: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
|
|
(Dollars in thousands) |
|
|
(Dollars in thousands) |
|
Segment revenue: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
P/ C |
|
$ |
44,625 |
|
|
|
39,550 |
|
|
|
129,065 |
|
|
|
107,427 |
|
Investing |
|
|
3,800 |
|
|
|
2,697 |
|
|
|
10,301 |
|
|
|
7,216 |
|
Other (including exited lines) |
|
|
309 |
|
|
|
(7 |
) |
|
|
414 |
|
|
|
(6 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment revenue |
|
$ |
48,734 |
|
|
|
42,240 |
|
|
|
139,780 |
|
|
|
114,637 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment (loss) profit: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
P/ C |
|
$ |
(5,602 |
) |
|
|
2,895 |
|
|
|
(389 |
) |
|
|
8,469 |
|
Investing |
|
|
3,800 |
|
|
|
2,697 |
|
|
|
10,301 |
|
|
|
7,216 |
|
Other (including exited lines) |
|
|
(100 |
) |
|
|
(4 |
) |
|
|
(180 |
) |
|
|
(1,119 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment (loss) profit |
|
$ |
(1,902 |
) |
|
|
5,588 |
|
|
|
9,732 |
|
|
|
14,566 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investing |
|
$ |
344,988 |
|
|
|
290,981 |
|
|
|
344,988 |
|
|
|
290,981 |
|
Assets not allocated |
|
|
125,529 |
|
|
|
87,958 |
|
|
|
125,529 |
|
|
|
87,958 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total consolidated assets |
|
$ |
470,517 |
|
|
|
378,939 |
|
|
|
470,517 |
|
|
|
378,939 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16
|
|
The following summary reconciles significant segment items to the Companys interim
unaudited consolidated condensed financial statements: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Nine Months |
|
|
|
Ended September 30, |
|
|
Ended September 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
|
|
(Dollars in thousands) |
|
(Loss) income before income taxes: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment (loss) profit |
|
$ |
(1,902 |
) |
|
|
5,588 |
|
|
|
9,732 |
|
|
|
14,566 |
|
Unallocated amounts: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate expenses |
|
|
(536 |
) |
|
|
223 |
|
|
|
(1,325 |
) |
|
|
1,160 |
|
Interest expense |
|
|
(483 |
) |
|
|
(352 |
) |
|
|
(1,359 |
) |
|
|
(1,113 |
) |
Interest expense on redemption of Class B shares |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(518 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss) income before income tax |
|
$ |
(2,921 |
) |
|
|
5,459 |
|
|
|
7,048 |
|
|
|
14,095 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following is a summary of segment earned premium by group of products: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property |
|
|
Casualty |
|
|
Other |
|
|
Consolidated |
|
|
|
(Dollars in thousands) |
|
Three Months Ended September 30, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
P/ C |
|
$ |
13,983 |
|
|
|
30,642 |
|
|
|
|
|
|
|
44,625 |
|
Other (including exited lines) |
|
|
|
|
|
|
|
|
|
|
309 |
|
|
|
309 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
$ |
13,983 |
|
|
|
30,642 |
|
|
|
309 |
|
|
|
44,934 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
P/ C |
|
$ |
14,858 |
|
|
|
24,692 |
|
|
|
|
|
|
|
39,550 |
|
Other (including exited lines) |
|
|
|
|
|
|
|
|
|
|
(7 |
) |
|
|
(7 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
$ |
14,858 |
|
|
|
24,692 |
|
|
|
(7 |
) |
|
|
39,543 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
P/ C |
|
$ |
42,329 |
|
|
|
86,736 |
|
|
|
|
|
|
|
129,065 |
|
Other (including exited lines) |
|
|
|
|
|
|
|
|
|
|
414 |
|
|
|
414 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
$ |
42,329 |
|
|
|
86,736 |
|
|
|
414 |
|
|
|
129,479 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2004 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
P/ C |
|
$ |
42,152 |
|
|
|
65,275 |
|
|
|
|
|
|
|
107,427 |
|
Other (including exited lines) |
|
|
|
|
|
|
|
|
|
|
(6 |
) |
|
|
(6 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
$ |
42,152 |
|
|
|
65,275 |
|
|
|
(6 |
) |
|
|
107,421 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company does not manage property and casualty products at this level of detail. |
|
(10) |
|
Dividend to Common Shareholders |
|
|
|
On March 24, 2005, the Board of Directors declared a dividend of $0.02 per common share that
was paid on April 28, 2005 to shareholders of record as of April 7, 2005. On May 19, 2005, the
Board of Directors declared a dividend of $0.02 per common share that was paid on June 22, 2005
to shareholders of record as of June 1, 2005. On August 17, 2005, the Board of Directors
declared a dividend of $0.02 per common share that was paid on September 21, 2005 to
shareholders of record as of August 31, 2005. |
|
(11) |
|
Line of Credit |
|
|
|
The Company has a $5.0 million line of credit with a maturity date of September 8, 2006, and
interest only payments due quarterly based on LIBOR plus 2.5% of the outstanding balance. All
of the outstanding shares of Century are pledged as collateral. In April 2005, the Company made
a $2.3 million draw on the line of credit for general corporate purposes. The $2.3 million
draw was paid off on May 17, 2005. Interest paid on the line of credit was $5,000. Due to the
late filing of the Companys Quarterly Report on Form 10-Q for the quarter ended June 30, 2005,
the Company became non-compliant with the debt covenants for the line of credit. On September
7, 2005, the Company received a waiver from the bank and now has the ability to draw on the
line of credit. The Company does not have any borrowings outstanding under the line of credit
at September 30, 2005. |
17
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. 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, 2004, and elsewhere in this report, and include, but are not limited to, the following factors:
|
|
|
our actual incurred losses and loss expenses, including those related to recent hurricanes,
may be greater than our loss and loss expense reserves, which could have a material adverse
effect on our financial condition and results of operations; |
|
|
|
|
a decline in our financial rating may result in a reduction of new or renewal business; |
|
|
|
|
we are subject to extensive regulation, which may adversely affect our ability to achieve
our business objectives, and if we fail to comply with these regulations, we may be subject
to penalties, including fines and suspensions, which may adversely affect our financial
condition and results of operations; |
|
|
|
|
changes in our operating environment may adversely affect our performance; |
|
|
|
|
our general agents may exceed their authority and could bind us to business outside our underwriting guidelines; |
|
|
|
|
if we lose key personnel or are unable to recruit qualified personnel, our ability to
implement our business strategies could be delayed or hindered; |
|
|
|
|
our investment results and, therefore, our financial condition may be impacted by changes
in the business, financial condition or operating results of the entities in which we
invest, as well as changes in interest rates, government monetary policies, general economic
conditions and overall market conditions; |
|
|
|
|
we distribute our products through a select group of general agents, and there can be no
assurance that such relationships will continue, or if they do continue, that they will
remain profitable for us; |
|
|
|
|
we rely on our information technology and telecommunication systems, and the failure of
these systems could materially and adversely affect our business; |
|
|
|
|
our reinsurers may not pay claims made by us on losses in a timely fashion; |
|
|
|
|
if we are not able to renew our existing reinsurance or obtain new reinsurance, either
our net exposure would increase or we would have to reduce the level of our underwriting
commitment; |
|
|
|
|
our business is cyclical in nature, which may affect our financial performance; |
|
|
|
|
we compete with a large number of companies in the insurance industry for underwriting revenues; |
|
|
|
|
severe weather conditions and other catastrophes may result in an increase in the number
and amount of claims filed against us; and |
|
|
|
|
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. |
You are cautioned not to place undue reliance on forward-looking statements, which speak only
as of their respective dates.
18
Overview
ProCentury is a holding company that underwrites selected property and casualty and surety
insurance through its subsidiaries collectively known as the Century Insurance Group®. As a niche
company, we offer specialty insurance products designed to meet specific insurance needs of
targeted insured groups. The excess and surplus lines market provides an alternative market for
customers with hard-to-place risks and risks that insurance companies licensed by the state in
which the insurance policy is sold, which are also referred to as admitted insurers, specifically
refuse to write. When we underwrite within the excess and surplus lines market, we are selective in
the lines of business and types of risks we choose to write. Typically, the development of these
specialty insurance products is generated through proposals brought to us by an agent or broker
seeking coverage for a specific group of clients.
We evaluate our insurance operations by monitoring key measures of growth and profitability.
We measure our growth by examining gross written premiums. We generally measure our operating
results by examining our net income, return on equity and loss, expense and combined ratios. The
following provides further explanation of the key measures that we use to evaluate our results:
Gross Written Premiums. Gross written premiums is the sum of direct written premiums and
assumed written premiums. We use gross written premiums, which excludes the impact of premiums
ceded to reinsurers, as a measure of the underlying growth of our insurance business from period to
period.
Net Written Premiums. Net written premiums is the sum of direct written premiums and assumed
written premiums less ceded written premiums. We use net written premiums, primarily in relation to
gross written premiums, to measure the amount of business retained after cessions to reinsurers.
Loss Ratio. Loss ratio is the ratio (expressed as a percentage) of losses and loss expenses
incurred to premiums earned. Loss ratio generally is measured on both a gross (direct and assumed)
and net (gross less ceded) basis. We use the gross loss ratio as a measure of the overall
underwriting profitability of the insurance business we write and to assess the adequacy of our
pricing. Our net loss ratio is meaningful in evaluating our financial results, which are net of
ceded reinsurance, as reflected in our consolidated financial statements.
Expense Ratio. Expense ratio is the ratio (expressed as a percentage) of net operating
expenses to premiums earned and measures a companys operational efficiency in producing,
underwriting and administering its insurance business. We reduce our operating expenses by
ancillary income (excluding net investment income and realized gains (losses) on securities) to
calculate our net operating expenses. Due to our historically high levels of reinsurance, we
calculate our expense ratio on both a gross basis (before the effect of ceded reinsurance) and a
net basis (after the effect of ceded reinsurance). Although the net basis is meaningful in
evaluating our financial results that are net of ceded reinsurance, as reflected in our
consolidated financial statements, we believe that the gross expense ratio better reflects the
operational efficiency of the underlying business and is a better measure of future trends.
Interest expense is not included in the calculation of the expense ratio.
Combined Ratio. Combined ratio is the sum of the loss ratio and the expense ratio and measures
a companys overall underwriting profit. If the combined ratio is at or above 100, an insurance
company cannot be profitable without investment income (and may not be profitable if investment
income is insufficient). We use the combined ratio in evaluating our overall underwriting
profitability and as a measure for comparing our profitability relative to the profitability of our
competitors.
Critical Accounting Policies
It is important to understand our accounting policies in order to understand our financial
statements. Management considers certain of these policies to be critical to the presentation of
our financial results, since they require management to make estimates and assumptions. These
estimates and assumptions affect the reported amounts of assets, liabilities, revenues, expenses
and related disclosures at the financial reporting date and throughout the period being reported
upon. Certain of the estimates result from judgments that can be subjective and complex and
consequently actual results may differ from these estimates, which would be reflected in future
periods.
Our most critical accounting policies involve the reporting of loss and loss expense reserves
(including losses that have occurred but were not reported to us by the financial reporting date),
reinsurance recoverables, the impairment of investments, deferred policy acquisition costs and
federal income taxes.
19
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, judicial theories of liability and other
third-party factors that are often beyond our control. Due to the inherent uncertainty associated
with the cost of unsettled and unreported claims, the ultimate liability may be different from the
original estimate. Such estimates are regularly reviewed and updated and any resulting adjustments
are included in the current periods results. See Note 4 to our unaudited consolidated condensed
financial statements included in this Form 10-Q.
Reinsurance Recoverables. Reinsurance recoverables on paid and unpaid losses, net, are
established for the portion of our loss and loss expense reserves that are ceded to reinsurers.
Reinsurance recoverables are determined based in part on the terms and conditions of reinsurance
contracts which could be subject to interpretations that differ from our own based on judicial
theories of liability. In addition, we bear credit risk with respect to our reinsurers which can be
significant considering that certain of the reserves remain outstanding for an extended period of
time. We are required to pay losses even if a reinsurer fails to meet its obligations under the
applicable reinsurance agreement. See Note 5 to our unaudited consolidated condensed financial
statements included in this Form 10-Q.
Impairment of Investments. Impairment of investment securities results in a charge to
operations when a market decline below cost is deemed to be other-than-temporary. Under the
Companys accounting policy for equity securities and fixed-maturity securities that can be
contractually prepaid or otherwise settled in a way that may limit the Companys ability to fully
recover cost, an impairment is deemed to be other-than-temporary unless the Company has both the
ability and intent to hold the investment for a reasonable period until the securitys forecasted
recovery and evidence exists indicating that recovery will occur in a reasonable period of time.
For other fixed-maturity and equity securities, an other-than-temporary impairment charge is
taken when the Company does not have the ability and intent to hold the security until the
forecasted recovery or if it is no longer probable that the Company will recover all amounts due
under the contractual terms of the security. Many criteria are considered during this process
including, but not limited to, the current fair value as compared to amortized cost or cost, as
appropriate, of the security; the amount and length of time a securitys fair value has been below
amortized cost or cost; specific credit issues and financial prospects related to the issuer; the
Companys ability and intent to hold or dispose of the security; and current economic conditions.
Other-than-temporary impairment losses result in a permanent reduction to the cost basis of the
underlying investment. For additional detail regarding our investment portfolio at September 30,
2005 and December 31, 2004, including disclosures regarding other-than-temporary declines in
investment value, see Note 3 to our unaudited consolidated condensed financial statements included
in this Form 10-Q.
Deferred Policy Acquisition Costs. We defer commissions, premium taxes and certain other costs
that vary with and are primarily related to the acquisition of insurance contracts. These costs are
capitalized and charged to expense in proportion to premium revenue recognized. The method followed
in computing deferred policy acquisition costs limits the amount of such deferred costs to their
estimated realizable value, which gives effect to the premium to be earned, related investment
income, anticipated losses and settlement expenses and certain other costs expected to be incurred
as the premium is earned. Judgments as to ultimate recoverability of such deferred costs are highly
dependent upon estimated future loss costs associated with the
written premiums. See Note 6 to our unaudited consolidated condensed financial statements
included in this Form 10-Q.
Federal Income Taxes The Company provides for federal income taxes based on amounts the
Company believes it ultimately will owe. Inherent in the provision for federal income taxes are
estimates regarding the deductibility of certain items and the realization of certain tax credits.
In the event the ultimate deductibility of certain items or the realization of certain tax credits
differs from estimates, the Company may be required to significantly change the provision for
federal income taxes recorded in the consolidated financial statements. Any such change could
significantly affect the amounts reported in the consolidated statements of 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 unaudited
consolidated condensed financial statements included in this Form 10-Q.
20
Results of Operations
The table below summarizes certain operating results and key measures used in monitoring and
evaluating operations. The information is intended to summarize and supplement information
contained in the interim unaudited consolidated condensed financial statements and to assist the
reader in gaining a better understanding of results of operations.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
|
|
(Dollars in thousands) |
|
|
(Dollars in thousands) |
|
Selected Financial Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross written premiums |
|
$ |
53,484 |
|
|
|
50,001 |
|
|
|
156,389 |
|
|
|
142,074 |
|
Premiums earned |
|
|
44,934 |
|
|
|
39,543 |
|
|
|
129,479 |
|
|
|
107,421 |
|
Net investment income |
|
|
3,866 |
|
|
|
2,719 |
|
|
|
10,520 |
|
|
|
7,094 |
|
Net realized investment (losses) gains |
|
|
(66 |
) |
|
|
(22 |
) |
|
|
(219 |
) |
|
|
122 |
|
Total revenues |
|
|
48,734 |
|
|
|
42,240 |
|
|
|
139,780 |
|
|
|
114,637 |
|
Total expenses |
|
|
51,655 |
|
|
|
36,781 |
|
|
|
132,732 |
|
|
|
100,542 |
|
Net (loss) income |
|
|
(1,793 |
) |
|
|
3,712 |
|
|
|
5,285 |
|
|
|
9,585 |
|
Key Financial Ratios: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss and loss expense ratio |
|
|
81.0 |
% |
|
|
62.0 |
% |
|
|
68.5 |
% |
|
|
60.0 |
% |
Expense ratio |
|
|
32.9 |
% |
|
|
30.1 |
% |
|
|
32.9 |
% |
|
|
32.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined ratio |
|
|
113.9 |
% |
|
|
92.1 |
% |
|
|
101.4 |
% |
|
|
92.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Overview of Operating Results
For the three months ended September 30, 2005, net loss was $1.8 million compared to net
income of $3.7 million for the three months ended September 30, 2004. Net income decreased to $5.3
million, for the nine months ended September 30, 2005, from $9.6 million for the nine months ended
September 30, 2004.
The decrease in net income for the three and nine months ended September 30, 2005 was
primarily attributable to an increase in loss and loss expenses related to Hurricanes Katrina and
Rita, which were partially offset by an increase in net earned premium and net investment income.
During the quarter ended September 30, 2005, we incurred $6.0 million after-tax ($9.3 million,
pre-tax) of losses and reinstatement premium related to the hurricanes. We did not incur a
significant amount of hurricane losses in 2004. The increase in net earned premium resulted principally from an increase in the volume of business
which was offset by slight rate declines in both the property and casualty lines of business. Net
investment income for the nine months ended September 30, 2005 increased due to higher invested
assets as a result of the proceeds from the Companys initial public offering that occurred in
April of 2004, the operational cash flows that occurred during the first nine months of 2005, as
well as higher yield on invested assets as our tax equivalent yield increased to 5.46% at September
30, 2005 from 4.65% at September 30, 2004.
The increase in total revenue was offset by an increase in total expenses that resulted from
an increase in net loss and loss expenses, and amortization of deferred acquisition costs and the
$793,000 severance expense associated with the departure of our former Chief Operating Officer that
occurred in the first quarter in 2005. The loss and loss expense ratios for the three months ended
September 30, 2005 and 2004 were 81.0% and 62.0%, respectively. The loss and loss expense ratios
for the nine months ended September 30, 2005 and 2004 were 68.5% and 60.0%, respectively. The loss
and loss expense ratio for the first nine months of 2005 includes 7.1% related to the loss
estimates for hurricane Katrina and Rita and higher current accident year ultimate loss and loss
expense ratios driven by the decreasing rate environment throughout 2004 and into 2005. The loss
and loss expense ratio for the first nine months of 2005 also reflects a decreasing amount of
increases related to prior accident years, compared to the same period during 2004. The expense
ratios for the three months ended September 30, 2005 and 2004 were 32.9% and 30.1%, respectively.
The expense ratios for the nine months ended September 30, 2005 and 2004 were 32.9% and 32.1%,
respectively. The increase in the expense ratio for the quarter and the year is directly
attributable to higher costs related to our efforts to become Sarbanes-Oxley compliant and the
severance payment associated with the departure of our former Chief Operating Officer.
21
Revenues
Premiums
Premiums include insurance premiums underwritten by Century (which are referred to as direct
premiums) and insurance premiums assumed from other insurers generally in states where Century is
not licensed (which are referred to as assumed premiums). We refer to direct and assumed premiums
together as gross premiums.
Written premiums are the total amount of premiums billed to the policyholder less the amount
of premiums returned, generally as a result of cancellations, during a given period. Written
premiums become premiums earned as the policy ages. Barring premium changes, if an insurance
company writes the same mix of business each year, written premiums and premiums earned will be
equal, and the unearned premium reserve will remain constant. During periods of growth, the
unearned premium reserve will increase, causing premiums earned to be less than written premiums.
Conversely, during periods of decline, the unearned premium reserve will decrease, causing premiums
earned to be greater than written premiums.
We have historically relied on quota share, excess of loss, and catastrophe reinsurance
primarily to manage our regulatory capital requirements and also to limit our exposure to loss.
Generally, we have ceded a significant portion of our premiums to unaffiliated reinsurers in order
to maintain a net written premiums to statutory surplus ratio of less than 2-to-1.
Our underwriting business is currently divided into two primary segments:
|
|
|
property/casualty; and |
|
|
|
|
other (including exited lines). |
Our property/casualty segment primarily includes general liability, commercial property 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, workers compensation, which was
exited in January 2002, and commercial auto, which was exited in May 2000.
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.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
|
|
(Dollars in thousands) |
|
|
(Dollars in thousands) |
|
Gross written premiums: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property/casualty |
|
$ |
52,015 |
|
|
|
50,001 |
|
|
|
154,154 |
|
|
|
142,074 |
|
Other (including exited lines) |
|
|
1,469 |
|
|
|
|
|
|
|
2,235 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross written premiums |
|
|
53,484 |
|
|
|
50,001 |
|
|
|
156,389 |
|
|
|
142,074 |
|
Ceded written premiums |
|
|
(7,703 |
) |
|
|
(6,535 |
) |
|
|
(19,965 |
) |
|
|
(19,042 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net written premiums |
|
$ |
45,781 |
|
|
|
43,466 |
|
|
|
136,424 |
|
|
|
123,032 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums earned |
|
$ |
44,934 |
|
|
|
39,543 |
|
|
|
129,479 |
|
|
|
107,421 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net written premiums to gross
written premiums |
|
|
85.6 |
% |
|
|
86.9 |
% |
|
|
87.2 |
% |
|
|
86.6 |
% |
Net premiums earned to net
written premiums |
|
|
98.1 |
% |
|
|
91.0 |
% |
|
|
94.9 |
% |
|
|
87.3 |
% |
Net writings ratio (1) |
|
|
1.5 |
|
|
|
1.6 |
|
|
|
1.5 |
|
|
|
1.5 |
|
|
|
|
(1) |
|
The ratio of net written premiums to our insurance subsidiaries combined statutory
surplus. This ratio is not restated to exclude discontinued operations as the insurance
subsidiaries combined statutory surplus is not allocated by line of business. Therefore, in
computing the ratio of net written premiums to our insurance subsidiaries combined statutory
surplus we do not restate the net written premium for discontinued operations to be consistent
with that of the 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. |
22
Gross Written Premiums
Gross written premiums increased to $53.5 million for the quarter ended September 30, 2005, an
increase of 7.0% from $50.0 million for the same period in 2004. Gross written premiums increased
to $156.4 million for the nine months ended September 30, 2005, an increase of 10.1% from $142.1
million for the same period in 2004. This increase was primarily due to an increase in volume of
our property/casualty segment which was slightly offset by overall rate declines across our book of
business. While our casualty line of business continued to grow with an increase of gross written
premiums of $3.1 million in the third quarter of 2005 and $15.5 million for the nine months ended
September 30, 2005, we experienced a decline in our overall casualty growth rate due to rate
declines and increased market competition. Although, we expect these rate declines and increased
market competition to continue throughout 2005, we believe that there are still opportunities for
profitable growth in our casualty lines. Gross written premiums for our property lines decreased
in the third quarter by $1.3 million and in the nine months ended September 30, 2005 by $3.1
million. This decrease is a result of declining rates across our property book of business,
causing the loss of some of our individually significant property accounts. We continue to assess
the property market to ensure that it will deliver the appropriate profitability.
Net Written Premiums and Premiums Earned
Net written premiums for the three months ended September 30, 2005 were $45.8 million,
representing an increase of 5.3% compared to the same period in 2004. Net written premiums for the
nine months ended September 30, 2005 were $136.4 million, representing an increase of 10.9%
compared to the same period in 2004. Net written premiums represented 85.6% and 87.2% of gross
written premiums for the three and nine months ended September 30, 2005. For the quarter ended
September 30, 2005, the relationship of net written premiums to gross written premiums remained relatively stable
compared to the same period of 2004. The increase in the relationship of net written premiums to gross written
premiums for the nine months ended September 30, 2005 compared to the same period in 2004 reflects
lower retention of business with effective dates of 2003 that was not recorded until the first
quarter of 2004.
Premiums earned, a function of net written premiums, were $44.9 million for the three months
ended September 30, 2005, or 98.1% of net written premiums. Premiums earned were $129.5 million for
the nine months ended September 30, 2005, or 94.9% of net written premiums. The relationship of
premiums earned to net written premiums during the same periods in 2004 is higher, reflecting the
slower growth rate at the end of 2004 and into the first three quarters of 2005.
Net Investment Income
Our investment portfolio generally consists of liquid, readily marketable and investment-grade
fixed-maturity and equity securities. Net investment income is comprised of interest and dividends
earned on these securities, net of related investment expenses.
Net investment income increased to $3.9 million for the three months ended September 30, 2005,
compared to $2.7 million for the same period in 2004. For the nine months ended September 30, 2005,
net investment income increased to $10.5 million compared to $7.1 million for the same period in
2004. The increase was primarily due to an increase in invested assets, including cash, as a
result of higher invested assets due to the proceeds from the Companys initial public offering in
April 2004, an increase in operating cash flows throughout 2004 and into 2005 and higher investment
yields. Invested assets, including cash, increased by $59.9 million to $356.1 million as of
September 30, 2005 and from $296.2 million as of September 30, 2004. Pre-tax investment yield for
the three months ended September 30, 2005 was 4.75%, compared to 4.12% for the same period in 2004.
For the nine months ended September 30, 2005, pre-tax investment yield was 4.54%, compared to
3.93% for the same period in 2004.
In addition, as part of our effort to increase our tax equivalent yield, we raised our
allocation to tax-exempt municipals throughout 2004 and into 2005, which contributed to an increase
in our tax equivalent yield to 5.47% as of September 30, 2005 from 4.65% as of September 30, 2004.
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 held as
investments.
We realized net investment losses of $66,000 and $22,000 on the sale of securities for the
three months ended September 30, 2005 and 2004, respectively. For the nine months ended September
30, 2005 and 2004, we realized net investment losses of $219,000 and net investment gains of
$122,000, respectively, on the sale of securities. Other-than-temporary losses of $79,000 and
$114,000 were included in net realized investment losses for the three and nine months ended
September 30, 2005, respectively. No other-than-temporary declines were realized in 2004.
23
Expenses
Losses and Loss Expenses
Losses and loss expenses represent our largest expense item and include (1) payments made to
settle claims, (2) estimates for future claim payments and changes in those estimates for current
and prior periods, and (3) costs associated with settling claims. The items that influence the
incurred losses and loss expenses for a given period include, but are not limited to, the
following:
|
|
|
the number of exposures covered in the current year; |
|
|
|
|
trends in claim frequency and claim severity; |
|
|
|
|
changes in the cost of adjusting claims; |
|
|
|
|
changes in the legal environment relating to coverage interpretation, theories of liability and jury determinations; and |
|
|
|
|
the re-estimation of prior years reserves in the current year. |
We continue to perform an internal quarterly actuarial analysis and establish or adjust (for
prior accident quarters) our best estimate of the ultimate incurred losses and loss expenses to
reflect loss development information and trends that have been updated for the most recent
quarters activity. As of December 31 of each year, an independent actuary performs an analysis of
the adequacy of our reserves. Our estimate of ultimate loss and loss expenses is evaluated and
re-evaluated by accident year and by major coverage grouping. Changes in estimates are reflected in
the period the additional information becomes known.
Our reinsurance program significantly influences our net retained losses. In exchange for
premiums ceded to reinsurers under quota share and excess of loss reinsurance agreements, our
reinsurers assume a portion of the losses and loss expenses incurred. We remain obligated for
amounts ceded in the event that the reinsurers do not meet their obligations under the agreements
(due to, for example, disputes with the reinsurer or the reinsurers insolvency).
Net losses and loss expenses increased to $36.4 million for the three months ended September
30, 2005 from $24.5 million for the same period in 2004. Net losses and loss expense ratios for the
three months ended September 30, 2005 and 2004 were 81.0% and 62.0%, respectively. Hurricanes Katrina and Rita
impacted the third quarter 2005 loss ratio by 20.2 percentage points. For the nine months ended September 30, 2005, net losses and loss expenses increased to $88.7 from $64.4 million
for the same period in 2004. Net losses and loss expense ratios for the nine months ended September
30, 2005 and 2004 were 68.5% and 60.0%, respectively. The net losses and loss expense ratio for the nine months ended September 30, 2005
was impacted by Hurricanes Katrina and Rita by 7.0 percentage points.
Our reserve for losses and loss expenses at September 30, 2005 was $215.3 million (before the
effects of reinsurance) and $164.3 million (after the effects of reinsurance), as estimated through
our actuarial analysis. For the third quarter of 2005 and the first nine months of 2005, we
concluded through our actuarial analysis that the December 31, 2004 reserve for losses and loss
expenses of $123.8 million (after the effects of reinsurance) was deficient by $978,000 and $4.6
million, respectively, primarily in our construction defect and non-construction defect casualty,
offset by favorable development in our property reserves.
Our reserve for losses and loss expenses (net of the effects of reinsurance) at September 30,
2005 and December 31, 2004 by line was as follows:
|
|
|
|
|
|
|
|
|
|
|
September 30, 2005 |
|
|
December 31, 2004 |
|
|
|
(Dollars in thousands) |
|
Property/casualty: |
|
|
|
|
|
|
|
|
Casualty |
|
$ |
131,693 |
|
|
|
102,430 |
|
Property |
|
|
28,766 |
|
|
|
16,115 |
|
Other (including exited lines): |
|
|
|
|
|
|
|
|
Commercial auto |
|
|
1,082 |
|
|
|
1,780 |
|
Workers compensation |
|
|
2,718 |
|
|
|
3,426 |
|
Other |
|
|
42 |
|
|
|
|
|
|
|
|
|
|
|
|
Net reserves for losses and loss expenses |
|
|
164,301 |
|
|
|
123,751 |
|
Plus reinsurance recoverables on unpaid losses at end
of period |
|
|
51,042 |
|
|
|
29,485 |
|
|
|
|
|
|
|
|
Gross reserves for losses and loss expenses |
|
$ |
215,343 |
|
|
|
153,236 |
|
|
|
|
|
|
|
|
24
Net loss and loss expenses incurred was $36.4 million for the quarter ended September 30,
2005, compared to $24.5 million for the quarter ended September 30, 2004. In the third quarter of
2005, we recorded $35.4 million of incurred losses and loss expenses attributable to the 2005
accident year and $978,000 attributable to events of prior years. In the third quarter of 2004, we
recorded $20.6 million of incurred losses and loss expenses attributable to the 2004 accident year
and $3.9 million attributable to events of prior years.
Net loss and loss expenses incurred was $88.7 million for the nine months ended September 30,
2005, compared to $64.4 million for the nine months ended September 30, 2004. For the nine months
ended September 30, 2005, we recorded $84.1 million of incurred losses and loss expenses
attributable to the 2005 accident year and $4.6 million attributable to events of prior years. For
the nine months ended September 30, 2004, we recorded $56.4 million of incurred losses and loss
expenses attributable to the 2004 accident year and $8.0 million attributable to events of prior
years. The accident year losses and loss expense ratios for the property and casualty segment for
accident years 2005 and 2004 were 65.1% and 51.7%, respectively.
The prior year increase for the quarter ended September 30, 2005 resulted principally from the
non-construction defect casualty line of business in the property and casualty segment. This
increase resulted from unexpected increases in claims severity trends that caused reassessments of
the initial loss ratio expectations and the claim reporting and settlement patterns, which resulted in $944,000 of additional incurred loss and loss expenses. In addition, the
most significant components of the prior year increases for the quarter ended September 31, 2005
included $454,000 of favorable development in our property line as a result of actual reported
losses below expectations and $363,000 of prior year increases related to construction defect
claims within the other liability line of the property and casualty segment. This development
with construction defect claims primarily resulted in anticipated increase in litigation expenses
related to the contribution actions which were slightly offset by favorable claim count
development. Construction defect claim severities continue to be within our expectations. The
$978,000 prior year increases in the quarter ended September 30, 2005 compares to $3.9 million of
prior year increases for the same period in 2004, which primarily resulted from the construction
defect line.
The prior year increase for the nine months ended September 30, 2005 included $3.5 million
increases related to construction defect, $2.0 million related to the non-construction defect
casualty line and $463,000 of increases related to the exited commercial auto line from adverse new
claim information on two claims. The increases were offset by $989,000 of favorable development in
the property line of business. The increases related to construction defect primarily relate to
reserves established for several contribution action settlements that are anticipated to be paid
within the year and increased estimate of litigation reserves related to the contribution actions.
The increases related to the non-construction defect casualty line primarily relate to claim
severities exceeding our expectations resulting in reassessments of the initial loss ratio
expectations and the claim reporting and settlement patterns. The favorable development for
property resulted from actual reported losses below expectations. The prior year increases for the
nine months ended September 30, 2005 of $4.6 million compares to $8.0 million during the same
period of 2004.
A significant portion of the nine months ended September 30, 2004 prior year increases
resulted principally from construction defect claims in the other liability line in the property
and casualty segment. During the first nine months of 2004, new construction defect claim counts
exceeded expectations. Based on the claim count experience that emerged, our actuaries revised the
factors used in the estimation of ultimate construction defect claim counts. This re-estimation of
claim count projection factors produced an increase in the estimated ultimate cost of construction
defect claims, causing adverse development on prior accident years during the nine month periods
ended September 30, 2004. In addition, in the nine months ended September 30, 2004, increases in
incurred amounts on four claims also increased the amount of incurred development.
Additionally, during the second quarter of 2004, the Company experienced development related
to 19 new contractors claims. The 19 new claims were higher than recent experience and the
development on pending claims exceeded our expectations.
During the first quarter of 2004, we recorded increases in paid and incurred losses and loss
expenses on seven commercial auto liability claims. The net incurred increases on these claims
totaled $778,000. The increases were related to one significant, unanticipated new claim
($155,000), reserve increases related to coverage disputes on three claims ($297,000), and
unfavorable changes in conditions relating to three other claims ($326,000).
At September 30, 2005 we had 493 open claims relating to construction defect compared to 566
open claims as of December 31, 2004. During the third quarter of 2005, 195 new claims were reported
and 278 existing claims were settled or dismissed. During the nine months ended September 30, 2005,
634 new claims were reported and 707 existing claims were settled or dismissed. Our net loss and
loss expense reserves for construction defect claims at September 30, 2005 were $17.1million
compared to $19.0 million at December 31, 2004.
25
At September 30, 2004 we had 575 open claims relating to construction defect compared to 597
open claims as of December 31, 2003. During the third quarter of 2004, 269 new claims were reported
and 272 existing claims were settled or dismissed. During the nine months ended September 30, 2004,
773 new claims were reported and 795 existing claims were settled or dismissed. Our net loss and
loss expense reserves for construction defect claims at September 30, 2004 were $18.8 million
compared to $18.6 million at December 31, 2003.
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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
|
|
(Dollars in thousands) |
|
Amortization of deferred policy acquisition costs (ADAC) |
|
$ |
10,941 |
|
|
|
8,526 |
|
|
|
31,496 |
|
|
|
24,019 |
|
Other operating expenses |
|
|
3,821 |
|
|
|
3,385 |
|
|
|
10,360 |
|
|
|
10,236 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ADAC and other operating expenses |
|
|
14,762 |
|
|
|
11,911 |
|
|
|
41,856 |
|
|
|
34,255 |
|
Severance expense |
|
|
|
|
|
|
|
|
|
|
793 |
|
|
|
250 |
|
Interest expense |
|
|
483 |
|
|
|
352 |
|
|
|
1,359 |
|
|
|
1,113 |
|
Interest expense on the redemption of the Class B shares |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
518 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
$ |
15,245 |
|
|
|
12,263 |
|
|
|
44,008 |
|
|
|
36,136 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expense ratio: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ADAC |
|
|
24.3 |
% |
|
|
21.5 |
% |
|
|
24.3 |
% |
|
|
22.4 |
% |
Other operating expenses |
|
|
8.6 |
% |
|
|
8.6 |
% |
|
|
8.0 |
% |
|
|
9.5 |
% |
Severence |
|
|
0.0 |
% |
|
|
0.0 |
% |
|
|
0.6 |
% |
|
|
0.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expense ratio (1) |
|
|
32.9 |
% |
|
|
30.1 |
% |
|
|
32.9 |
% |
|
|
32.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Interest expense is not included in the calculation of the expense ratio. |
Operating expenses increased $3.0 million, or 24.3%, to $15.2 million for the three month
period ended September 30, 2005 from the same period in 2004. For the nine months ended September
30, 2005, operating expenses increased $7.9 million, or 21.8%, to $44.0 million compared to the
nine months ended September 30, 2004. The increase is primarily attributable to an increase in
ADAC as a result of an increase in the volume of insurance written. The increase in the ADAC ratio
to 24.3% for the nine months ended September 30, 2005 from 21.5% in the same period in 2004, is
directly related to the fact that the 2004 expense includes a reduction of amortization expense of
$2.5 million relating to the transfer of capitalized acquisition costs from Evergreen and
Continental for the property and casualty segment, which was partially offset by $1.9 million of
capitalized acquisition costs for the surety segment that was transferred from Century to Evergreen
and Continental. These
transactions occurred in the first quarter of 2004 in conjunction with the termination of the
intercompany pooling agreement and the implementation of the loss portfolio transfer agreements.
The increase in other operating expenses for the three months ended September 30, 2005
compared to the three months ended September 30, 2004 is primarily due to higher costs related to
Sarbanes-Oxley compliance. The overall expense ratio for the three months ended September 30, 2005
was 32.9%, which is 2.8 percentage points higher than that of the same period in 2004. Other
operating expenses remained relatively stable in the nine months ended September 30, 2005, compared
to the same periods in 2004.
The increase in the expense ratio for the nine month period ended September 30, 2005 is also a
result of an increase in ADAC as noted above. In addition, the expense ratio for the nine months
ended September 30, 2005 includes the impact of the severance agreement with our former Chief Operating
Officer.
Interest expense continues to increase throughout 2005 with the increase in interest rates on
our Trust Preferred securities due to the increasing interest rate environment.
26
Income Taxes
The income tax provision for the nine months ended September 30, 2005 and 2004, has been
computed based on our estimated annual effective tax rate of 25.0% and 32.0%, respectively, which
differ from the federal income tax rate of 35% principally because of tax-exempt investment income.
The income tax provision for the quarter ended September 30, 2005 was 38.6% primarily due to the
pretax loss recorded for the quarter and the effect of tax-exempt investment income. The income
tax provision for the quarter ended September 30, 2004 was 32.0% primarily due to the effect 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.
Although we have the capacity to generate cash through loans from banks and issuances of equity
securities, our primary source of funds to meet our short-term liquidity needs, including the
payment of dividends to our shareholders and corporate expenses, is dividends from Century.
Centurys principal sources of funds are underwriting operations, investment income and proceeds
from sales and maturities of investments. Centurys primary use of funds is to pay claims and
operating expenses, to purchase investments and to make dividend payments to ProCentury.
ProCenturys future liquidity is dependent on the ability of Century to pay dividends.
Century is restricted by statute as to the amount of dividends it may pay without the prior
approval of regulatory authorities. Century may pay dividends to ProCentury without advance
regulatory approval only from unassigned surplus and only to the extent that all dividends in the
current twelve months do not exceed the greater of 10% of total statutory surplus as of the end of
the prior fiscal year or statutory net income for the prior year. Using these criteria, the
available ordinary dividend payable by Century to ProCentury in 2005 is $13.8 million. Century
distributed ordinary dividends of $1.3 million for the nine months ended September 30, 2005.
Century distributed ordinary dividends of $3.7 million and $5.4 million of extraordinary dividends
for the nine months ended September 30, 2004. Of the total dividends in 2004, $7.6 million
consisted of the dividend of Centurys interest in Evergreen. 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.
Century is required by law to maintain a certain minimum level of surplus on a statutory
basis. The National Association of Insurance Commissioners (NAIC) has a risk-based capital
standard designed to identify property and casualty insurers that may be inadequately capitalized
based on inherent risks of each insurers assets and liabilities and its mix of net written
premiums. Insurers falling below a calculated threshold may be subject to varying degrees of
regulatory action. At December 31, 2004, the statutory surplus of Century was in excess of the
prescribed risk-based capital requirements that correspond to any level of regulatory action.
Centurys statutory surplus at December 31, 2004 was $115.8 million and the regulatory action level
was $29.3 million. Centurys statutory surplus at September 30, 2005 was $118.9 million.
Consolidated net cash provided by operating activities was $50.9 million for the first nine
months of 2005, compared to $63.1 million for the same period in 2004. Of the total decrease, $26.7
is a direct result of the settlement we received in 2004 from Evergreen and Continental related to
the termination of the intercompany pooling arrangement, which was primarily offset by our positive
net income and overall profitable growth.
Consolidated net cash used by investing activities was $45.7 million for the first nine months
of 2005, compared to $125.9 million for the same period in 2004. This decrease is directly due to
the efforts in 2004 to invest the IPO proceeds, the proceeds from the settlement from Evergreen and
Continental and to invest our operational cash float into higher yielding fixed-maturity
securities. In 2005, we have continued our effort to minimize idle operational cash float by
investing our operating cash flows into higher yielding fixed-maturity securities.
Consolidated net cash used in financing activities was $0.8 million for the first nine months
of 2005, compared to net cash provided by financing activities of $62.2 million for the same period
in 2004. The $0.8 million in the first nine months of 2005 were dividends paid. The $62.2 million
in the first nine months of 2004 relate to activities that occurred in conjunction with our IPO
that occurred in April of 2004.
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.
27
Line of Credit. ProCentury has a $5.0 million line of credit. Interest on the note is
payable quarterly and is based on a floating rate of LIBOR plus 2.5%. The note matures on
September 8, 2006. Under the terms of the line of credit, 100% of the common shares of Century are
pledged as collateral. In April 2005, we made a $2.3 million draw on the line of credit for
general corporate purposes. The $2.3 million draw was paid off on May 17, 2005. Interest paid on
the line of credit was $5,000. Due to the late filing of the Quarterly Report on Form 10-Q for the
quarter ended June 30, 2005, we became non-compliant with the debt covenants in its line of credit.
On September 7, 2005, we received a waiver from the bank and now have the ability to draw on the
line of credit. We do not have any borrowings outstanding under the line of credit at September
30, 2005.
The following table summarizes information about contractual obligations and commercial
commitments. The minimum payments under these agreements at September 30, 2005 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Year |
|
|
|
2005 |
|
|
2006 |
|
|
2007 |
|
|
2008 |
|
|
2009 |
|
|
Thereafter |
|
|
Total |
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Long Term Debt: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt issued to a related party trust (1)(2) |
|
$ |
515 |
|
|
|
2,060 |
|
|
|
2,060 |
|
|
|
2,060 |
|
|
|
2,060 |
|
|
|
72,790 |
|
|
|
81,545 |
|
Loss and loss expense payments, net of the
effects of reinsurance (3) |
|
|
16,966 |
|
|
|
56,242 |
|
|
|
37,376 |
|
|
|
24,703 |
|
|
|
11,831 |
|
|
|
17,183 |
|
|
|
164,301 |
|
Operating lease on facilities |
|
|
239 |
|
|
|
978 |
|
|
|
998 |
|
|
|
1,018 |
|
|
|
734 |
|
|
|
2,339 |
|
|
|
6,306 |
|
Other operating leases |
|
|
60 |
|
|
|
212 |
|
|
|
212 |
|
|
|
152 |
|
|
|
|
|
|
|
|
|
|
|
636 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total contractual obligations |
|
$ |
17,780 |
|
|
|
59,492 |
|
|
|
40,646 |
|
|
|
27,933 |
|
|
|
14,625 |
|
|
|
92,312 |
|
|
|
252,788 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Amounts include interest payments associated with these obligations using applicable
interest rates as of September 30, 2005. |
|
(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. See Note 8(b) to our 2004
audited consolidated financial statements included in the Form 10-K. |
|
(3) |
|
The timing for payment of our estimated losses, net of the effects of reinsurance 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 2005 will
provide sufficient liquidity for our operations, as well as to satisfy debt service obligations and
to pay other operating expenses. Although we anticipate that we will be able to meet our cash
requirements, we cannot give assurances in this regard.
Investment Portfolio
Our investment strategy is designed to capitalize on our ability to generate positive cash
flow from our underwriting activities. Preservation of capital is our first priority, with a
secondary focus on maximizing appropriate risk adjusted return. We seek to maintain sufficient
liquidity from operations, investing and financing activities to meet our anticipated insurance
obligations and operating and capital expenditure needs. The majority of our fixed-maturity
portfolio is rated investment grade to protect investments. Our investment portfolio is managed by
two outside independent investment managers that operate under investment guidelines approved by
Centurys investment committee. Centurys investment committee meets at least quarterly and reports
to Centurys board of directors. In addition, we employ stringent diversification rules and balance
our investment credit risk and related underwriting risks to minimize total potential exposure to
any one security. In limited circumstances, we will invest in non-investment grade fixed-maturity
securities that have an appropriate risk adjusted return, subject to satisfactory credit analysis
performed by us and our investment managers.
Our cash and investment portfolio increased to $356.1 million at September 30, 2005 from
$312.4 million at December 31, 2004 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.
The Companys taxable equivalent yield increased from 4.65% at December 31, 2004 to 5.47% at
September 30, 2005. The increase in the taxable equivalent yield during the first nine months of
2005 was a result of the investment of proceeds from maturities and operating cash flows at higher
interest rates, which were partially driven by the overall rise in market interest rates. The fair
value of our fixed-maturity securities at September 30, 2005 increased to $297.3 million from
$264.6 million at December 31, 2004. The fair value of our equity securities increased from $37.1
million at December 31, 2004 to $43.5 million at September 30, 2005. During the nine months ended
September 30, 2005, the duration of the fixed income portfolio remained constant at 4.5 years at
both December 31, 2004 and at September 30, 2005. The overall credit quality of the portfolio
remained investment grade.
28
Accounting Standards
In December 2004, the FASB revised Statement No. 123 (SFAS 123R), Share-Based Payment, which
requires companies to expense the estimated fair value of employee stock options and similar
awards, for all options vesting, granted, or modified after the effective date of this revised
statement. The accounting provisions of SFAS 123R were to become effective for interim periods
beginning after June 15, 2005. In April 2005, the Securities and Exchange Commission (SEC) adopted
a final rule amending Rule 4-01(a) of Regulation S-X regarding the compliance date for SFAS 123R.
This ruling delays the effective date of SFAS 123R to the first interim or annual reporting period
of the registrants first fiscal year beginning on or after June 15, 2005. As a result, the
accounting provisions of SFAS 123R will become effective beginning in 2006 for our financial
statements. In December 2004, the FASB revised Statement No. 123 (SFAS 123R), Share-Based
Payment, which requires companies to expense the estimated fair value of employee stock options
and similar awards, for all options vesting, granted, or modified after the effective date of this
revised statement. The accounting provisions of SFAS 123R were to become effective for interim
periods beginning after June 15, 2005. In April 2005, the Securities and Exchange Commission (SEC)
adopted a final rule amending Rule 4-01(a) of Regulation S-X regarding the compliance date for SFAS
123R. The effect of this ruling is to delay the effective date of SFAS 123R to the first interim
or annual reporting period of the registrants first fiscal year beginning on or after June 15,
2005. As a result, the accounting provisions of SFAS 123R will become effective for our financial
statements beginning in 2006. The Company is evaluating the impact of implementing SFAS 123R and
anticipates it will be material to the financial statements.
In March 2004, the FASB approved the consensus reached on the EITF Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments. The objective of this
consensus is to provide guidance for identifying impaired investments. EITF 03-1 also provides new
disclosure requirements for investments that are deemed to be temporarily impaired. Originally, the
accounting provisions of EITF 03-1 were effective for all reporting periods beginning after June
15, 2004, while the disclosure requirements are effective only for annual periods ending after June
15, 2004. In September 2004, the FASB issued two FASB Staff Positions (FSP), FSP EITF 03-1-a and
FSP EITF 03-1-1, which delayed the measurement and recognition paragraphs of the consensus for
further discussion. The disclosure requirements remain effective as originally issued under EITF
03-1. In June 2005, the FASB issued a final FSP EITF 03-1-a (retitled FSP FAS 115-1, The Meaning
of Other-Than-Temporary Impairment and Its Application to Certain Investments) which will replace
the guidance set forth in paragraphs 10-18 of Issue 03-1 and clarifies when an investor should
recognize an impairment loss. The provisions of FSP FAS 115-1 are effective for
other-than-temporary impairment analysis conducted in periods beginning after December 15, 2005.
The Company has evaluated the provisions of FSP FAS 115-1 and believes the impact will be
immaterial on its overall results of operations or financial position.
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 September 30, 2005, 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, 2004.
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 Executive Vice President and Chief
Financial Officer (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 error 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.
In
August, 2005,
management concluded a significant deficiency existed in the Companys Disclosure
Controls. Subsequently, management implemented corrective actions to enhance the Companys
Disclosure Controls. Based on managements evaluation of the Companys Disclosure Controls as of
September 30, 2005, management concluded that they provide reasonable assurance that information
required to be disclosed by the Company in its periodic reports is accumulated and communicated to
management, including the CEO and CFO, as appropriate to allow timely decisions regarding
disclosure and is recorded, processed, summarized and reported within the time periods specified in
the Securities and Exchange Commissions rules and forms.
There were no changes in the Companys internal control over financial reporting during the
Companys most recent fiscal quarter that materially affected, or are reasonably likely to
materially affect, the Companys internal control over financial reporting.
29
PART II: OTHER INFORMATION
Item 1. Legal Proceedings
The Companys subsidiaries are regularly engaged in the defense of claims arising out of the
conduct of the insurance business. The Company does not believe that such litigation, individually
or in the aggregate, will have a material effect on its consolidated financial condition or results
of operations.
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
Not applicable.
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.) |
|
|
|
10.1
|
|
Consulting Agreement, dated September 20, 2005, between the
ProCentury Corporation and Charles D. Hamm, Jr. |
|
|
|
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.
30
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: November 10, 2005 |
By: |
/s/ Erin E. West
|
|
|
|
Erin E. West |
|
|
|
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer) |
|
|
31
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.) |
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10.1
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Consulting Agreement, dated September 20, 2005, between the
ProCentury Corporation and Charles D. Hamm, Jr. |
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31.1
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Certification of Principal Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act |
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31.2
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Certification of Principal Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act |
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32.1
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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) |
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32.2
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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.