##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 FORM 10-Q
 (Mark
One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2006
 OR
 o
    
    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
  
 Ohio
    
    31-1718622(State or other jurisdiction of
    
    (I.R.S. Employer Identification No.)incorporation or organization)465 Cleveland AvenueWesterville, Ohio
    
    43082(Address of principal executive offices)
    
    (Zip Code)
 (614) 895-2000
 
  þ o
  o þ o
  o þ




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##### 



PROCENTURY CORPORATION
 QUARTERLY REPORT ON FORM 10-Q
For the Quarterly Period Ended September 30, 2006
 INDEX
 PagePART I: FINANCIAL INFORMATIONItem 1. Financial Statements

   
    
    3Consolidated Condensed Statements of Operations (unaudited)  For the three and nine months
ended September 30, 2006 and 2005

    
    
    3Consolidated Condensed Balance Sheets  September 30, 2006 (unaudited) and December 31, 2005

    
    
    4Consolidated Condensed Statements of Shareholders Equity and Comprehensive Income
(unaudited)  For the nine months ended September 30, 2006 and 2005

    
    
    5Consolidated Condensed Statements of Cash Flows (unaudited)  For the nine months ended
September 30, 2006 and 2005

    
    
    6Notes to Consolidated Condensed Financial Statements (unaudited)  September 30, 2006


7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations

    
    
    21Item 3. Quantitative and Qualitative Disclosures About Market Risk

    
    
    34Item 4. Controls and Procedures


34PART II: OTHER INFORMATIONItem 1. Legal Proceedings

    
    
    35Item 1A. Risk Factors

    
    
    35Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

    
    
    35Item 3. Defaults Upon Senior Securities

    
    
    35Item 4. Submission of Matters to a Vote of Security Holders

    
    
    35Item 5. Other Information

    
    
    35Item 6. Exhibits

    
    
    35SIGNATURES


36EX-31.1EX-31.2EX-32.1EX-32.2
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##### Table of Contents



PART I: FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 PROCENTURY CORPORATION AND SUBSIDIARIES
 
 
 Three Months
    
    
    Nine MonthsEnded September 30,
    
    
    Ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Premiums earned
    
    $
    55,425
    
    
    
    44,934
    
    
    
    156,992
    
    
    
    129,479Net investment income
    
    
    4,999
    
    
    
    3,866
    
    
    
    14,114
    
    
    
    10,520Net realized investment gains (losses)
    
    
    4
    
    
    
    (66
    )
    
    
    (37
    )
    
    
    (219
    )Total revenues
    
    
    60,428
    
    
    
    48,734
    
    
    
    171,069
    
    
    
    139,780Losses and loss expenses
    
    
    34,393
    
    
    
    36,410
    
    
    
    97,407
    
    
    
    88,724Amortization of deferred policy acquisition costs
    
    
    14,440
    
    
    
    10,941
    
    
    
    39,402
    
    
    
    31,496Other operating expenses
    
    
    3,618
    
    
    
    3,821
    
    
    
    11,616
    
    
    
    10,360Severance expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    793Interest expense
    
    
    608
    
    
    
    483
    
    
    
    1,718
    
    
    
    1,359Total expenses
    
    
    53,059
    
    
    
    51,655
    
    
    
    150,143
    
    
    
    132,732Income (loss) before income tax
    
    
    7,369
    
    
    
    (2,921
    )
    
    
    20,926
    
    
    
    7,048Income tax expense (benefit)
    
    
    2,236
    
    
    
    (1,128
    )
    
    
    6,168
    
    
    
    1,763Net income (loss)
    
    $
    5,133
    
    
    
    (1,793
    )
    
    
    14,758
    
    
    
    5,285Basic net income (loss) per share
    
    $
    0.39
    
    
    
    (0.14
    )
    
    
    1.13
    
    
    
    0.40Diluted net income (loss) per share
    
    $
    0.39
    
    
    
    (0.14
    )
    
    
    1.11
    
    
    
    0.40Weighted average of shares outstanding  basic
    
    
    13,133,711
    
    
    
    13,064,909
    
    
    
    13,116,317
    
    
    
    13,054,764Weighted average of shares outstanding  diluted
    
    
    13,270,589
    
    
    
    13,124,487
    
    
    
    13,239,563
    
    
    
    13,126,632Cash dividend per share
    
    $
    0.04
    
    
    
    0.02
    
    
    
    0.105
    
    
    
    0.06
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##### Table of Contents



PROCENTURY CORPORATION AND SUBSIDIARIES
 
 
 September 30,
    
    
    December 31,2006
    
    
    2005(Unaudited)AssetsInvestmentsFixed maturities:Available-for-sale, at fair value(amortized cost 2006, $343,880; 2005, $306,237)
    
    $
    341,030
    
    
    $
    302,632Held-to-maturity, at amortized cost(fair value 2006, $1,104; 2005, $1,118)
    
    
    1,118
    
    
    
    1,128Equities (available-for-sale):Equity securities, at fair value (cost 2006, $29,878; 2005, $27,521)
    
    
    29,979
    
    
    
    26,941Bond mutual funds, at fair value (cost 2006, $14,583; 2005, $18,516)
    
    
    14,292
    
    
    
    17,852Short-term investments, at amortized cost
    
    
    27,187
    
    
    
    12,229Total investments
    
    
    413,606
    
    
    
    360,782Cash and cash equivalents
    
    
    8,383
    
    
    
    5,628Premiums in course of collection, net
    
    
    18,573
    
    
    
    14,849Deferred policy acquisition costs
    
    
    23,477
    
    
    
    20,649Prepaid reinsurance premiums
    
    
    10,991
    
    
    
    10,989Reinsurance recoverable on paid losses, net
    
    
    8,032
    
    
    
    6,422Reinsurance recoverable on unpaid losses, net
    
    
    37,903
    
    
    
    37,448Deferred federal income tax asset
    
    
    9,869
    
    
    
    9,151Income tax recoverable
    
    
    306
    
    
    
    Other assets
    
    
    9,494
    
    
    
    8,227Total assets
    
    $
    540,634
    
    
    $
    474,145Liabilities and Shareholders EquityLoss and loss expense reserves
    
    $
    240,919
    
    
    $
    211,647Unearned premiums
    
    
    108,226
    
    
    
    95,631Long term debt
    
    
    25,000
    
    
    
    25,000Accrued expenses and other liabilities
    
    
    13,704
    
    
    
    6,893Reinsurance balances payable
    
    
    4,711
    
    
    
    2,572Collateral held
    
    
    11,169
    
    
    
    11,014Income taxes payable
    
    
    
    
    
    
    185Total liabilities
    
    
    403,729
    
    
    
    352,942Shareholders equity:Common stock, without par value:Common shares  Issued and outstanding 13,248,323 and 13,211,019
shares at September 30, 2006 and December 31, 2005, respectively
    
    
    
    
    
    
    Additional paid-in capital
    
    
    100,593
    
    
    
    100,202Retained earnings
    
    
    38,215
    
    
    
    24,846Unearned compensation
    
    
    
    
    
    
    (695
    )Accumulated other comprehensive loss, net of taxes
    
    
    (1,903
    )
    
    
    (3,150
    )Total shareholders equity
    
    
    136,905
    
    
    
    121,203Total liabilities and shareholders equity
    
    $
    540,634
    
    
    $
    474,145
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PROCENTURY CORPORATION AND SUBSIDIARIES
 
 
 Nine Months Ended September 30,2006
    
    
    2005Shareholders EquityCapital stock:Beginning of period
    
    $
    
    
    
    
    Stock issued
    
    
    
    
    
    
    End of period
    
    
    
    
    
    
    Additional paid-in capital:Beginning of period
    
    
    100,202
    
    
    
    100,103Impact of adoption of SFAS 123R
    
    
    (695
    )
    
    
    Shares issued under share compensation plans
    
    
    989
    
    
    
    136Exercise of share options
    
    
    6
    
    
    
    Tax benefit of share compensation plans
    
    
    91
    
    
    
    End of period
    
    
    100,593
    
    
    
    100,239Retained earnings:Beginning of period
    
    
    24,846
    
    
    
    15,727Net income
    
    
    14,758
    
    
    
    5,285Dividends declared (2006, $0.105/share and 2005, $0.06/share)
    
    
    (1,389
    )
    
    
    (793
    )End of period
    
    
    38,215
    
    
    
    20,219Unearned share compensation:Beginning of period
    
    
    (695
    )
    
    
    (1,413
    )Impact of adoption of SFAS 123R
    
    
    695
    
    
    
    488End of period
    
    
    
    
    
    
    (925
    )Accumulated other comprehensive (loss) income, net of taxes:Beginning of period
    
    
    (3,150
    )
    
    
    820Unrealized holding gains (losses) arising during the period,
net of reclassification adjustment
    
    
    1,247
    
    
    
    (2,752
    )End of period
    
    
    (1,903
    )
    
    
    (1,932
    )Total shareholders equity
    
    $
    136,905
    
    
    
    117,601Comprehensive IncomeNet income
    
    $
    14,758
    
    
    
    5,285Other comprehensive loss:Unrealized gains (losses) on securities:Unrealized holding gains (losses) arising during the period:Gross
    
    
    1,772
    
    
    
    (4,445
    )Related federal income tax (expense) benefit
    
    
    (549
    )
    
    
    1,550Net unrealized gains (losses)
    
    
    1,223
    
    
    
    (2,895
    )Reclassification adjustment for losses included in net incomeGross
    
    
    (37
    )
    
    
    (219
    )Related federal income tax benefit
    
    
    13
    
    
    
    77Net reclassification adjustment
    
    
    (24
    )
    
    
    (142
    )Other comprehensive income (loss)
    
    
    1,247
    
    
    
    (2,752
    )Total comprehensive income
    
    $
    16,005
    
    
    
    2,533
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PROCENTURY CORPORATION AND SUBSIDIARIES
 
  
 Nine Months Ended September 30,2006
    
    
    2005Cash flows provided by operating activities:Net income
    
    $
    14,758
    
    
    
    5,285Adjustments:Net realized investment losses
    
    
    37
    
    
    
    219Deferred federal income tax benefit
    
    
    (1,280
    )
    
    
    (1,470
    )Share-based compensation expense
    
    
    989
    
    
    
    624Changes in assets and liabilities:Premiums in course of collection, net
    
    
    (3,724
    )
    
    
    (2,167
    )Deferred policy acquisition costs
    
    
    (2,828
    )
    
    
    (1,978
    )Prepaid reinsurance premiums
    
    
    (2
    )
    
    
    (1,099
    )Reinsurance recoverable on paid and unpaid losses, net
    
    
    (2,065
    )
    
    
    (20,579
    )Income taxes payable/receivable
    
    
    (491
    )
    
    
    (4,960
    )Losses and loss expense reserves
    
    
    29,272
    
    
    
    62,107Unearned premiums
    
    
    12,595
    
    
    
    8,044Other, net
    
    
    532
    
    
    
    6,781Net cash provided by operating activities
    
    
    47,793
    
    
    
    50,807Cash flows used in investing activities:Purchases of equity securities
    
    
    (8,829
    )
    
    
    (50,594
    )Purchase of fixed maturity securities available-for-sale
    
    
    (90,998
    )
    
    
    (98,324
    )Proceeds from sales of equity securities
    
    
    10,056
    
    
    
    42,849Proceeds from sales and maturities of fixed maturities available-for-sale
    
    
    52,393
    
    
    
    61,594Acquisition, net of cash acquired
    
    
    
    
    
    
    (1,002
    )Change in short-term investments
    
    
    (14,958
    )
    
    
    (3,398
    )Change in securities receivable/payable
    
    
    8,590
    
    
    
    3,225Net cash used in investing activities
    
    
    (43,746
    )
    
    
    (45,650
    )Cash flows used in financing activities:Dividend paid to shareholders
    
    
    (1,389
    )
    
    
    (793
    )Exercise of share options
    
    
    6
    
    
    
    Tax benefit on share compensation plans
    
    
    91
    
    
    
    Draw on line of credit
    
    
    1,000
    
    
    
    2,300Principal payment on line of credit
    
    
    (1,000
    )
    
    
    (2,300
    )Net cash used in financing activities
    
    
    (1,292
    )
    
    
    (793
    )Increase in cash and cash equivalents
    
    
    2,755
    
    
    
    4,364Cash and equivalents at beginning of period
    
    
    5,628
    
    
    
    7,681Cash and equivalents at end of period
    
    $
    8,383
    
    
    
    12,045Supplemental disclosure of cash flow information:Interest paid
    
    $
    1,734
    
    
    
    1,357Federal income taxes paid
    
    $
    7,850
    
    
    
    8,191
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PROCENTURY CORPORATION AND SUBSIDIARIES
 
 
 (1)
    
    Basis of PresentationThe 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 Companys
audited consolidated financial statements, included in the Companys annual report on Form 10-K
for the year ended December 31, 2005. The Companys results of operations for interim periods
are not necessarily indicative of the results to be expected for the entire year.In preparing the interim unaudited consolidated condensed financial statements, management was
required to make certain estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities as of the date of the
interim unaudited consolidated condensed financial statements, and the reported amounts of
revenue and expenses for the reporting period. Actual results could differ significantly from
those estimates.Material estimates that are particularly susceptible to significant change in the near-term
relate to the determination of loss and loss expense reserves, the recoverability of deferred
policy acquisition costs, the determination of federal income taxes, the net realizable value of
reinsurance recoverables and the determination of other-than-temporary declines in the fair
value of investments. Although considerable variability is inherent in these estimates,
management believes that the amounts provided are reasonable. These estimates are continually
reviewed and adjusted as necessary. Such adjustments are reflected in current operations.All significant intercompany balances and transactions have been eliminated.Share Option AccountingEffective January 1, 2006, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 123(R), Share-Based Payment(SFAS No. 123R), using the modified prospective
application transition method. SFAS No. 123R revises SFAS No. 123, Accounting for Stock-Based
Compensation(SFAS No. 123). The Company previously followed the provisions of Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees(APB 25), the
Financial Accounting Standards Board (FASB) Interpretation No. 44, Accounting for Certain
Transactions involving Stock Compensation (an interpretation of APB Opinion No. 25), and other
related accounting interpretations for the Companys share option and restricted common share
plans utilizing the intrinsic value method. The Company also followed the disclosure
provisions of SFAS No. 123, Accounting for Stock-Based Compensation,for the Companys share
option grants, as amended by SFAS No. 148, Accounting for Stock-Based Compensation  Transition
and Disclosure; an amendment of FASB Statement No. 123.Under the modified prospective method, all unvested employee share options and restricted stock
are being expensed over the remaining vesting period based on the fair value at the date the
options were granted. In addition, SFAS No. 123R requires the Company to estimate forfeitures in
calculating the expense relating to stock-based compensation as opposed to recognizing these
forfeitures and the corresponding reduction in expense as they occur. In addition, SFAS No. 123R
requires the Company to reflect the tax savings resulting from tax deductions in excess of
compensation expense reflected in its financial statements as a cash inflow from financing
activities in its statement of cash flows rather than as an operating cash flow as in prior
periods.
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If the Company recorded compensation expense for its share option grants based on the fair
value method as previously required by SFAS No. 123, the Companys net (loss) income and (loss)
earnings per share for the three and nine months ended September 30, 2005 would have been
adjusted to the pro forma amounts as indicated in the following table:
 Three
    
    
    NineMonths
    
    
    MonthsEnded September
    
    
    Ended September30, 2005
    
    
    30, 2005(In thousands,
    
    
    (In thousands,except per
    
    
    except pershare data)
    
    
    share data)Net (loss) income:As reported
    
    $
    (1,793
    )
    
    $
    5,285Add: Share-based employee compensation expense included in reported
net (loss) income, net of related tax effects
    
    
    97
    
    
    
    398Less: Additional share-based employee compensation expense determined
under fair value-based method for all awards, net of related tax effects
    
    
    (150
    )
    
    
    (649
    )Pro forma
    
    $
    (1,846
    )
    
    $
    5,034Basic (loss) income per common share:As reported
    
    $
    (0.14
    )
    
    $
    0.40Pro forma
    
    $
    (0.14
    )
    
    $
    0.39Diluted (loss) income per common share:As reported
    
    $
    (0.14
    )
    
    $
    0.40Pro forma
    
    $
    (0.14
    )
    
    $
    0.38
 The fair values of the share options are estimated on the dates of grant using the Black-Scholes
option pricing model with the following weighted average assumptions:
 Three and Nine Months EndedSeptember 30, 2005Risk free interest rate
    
    
    3.97
    %Dividend yield
    
    
    0.76
    %Volatility factor
    
    
    23.15
    %Weighted average expected option term
    
    7 Years
 (2)
    
    Income per Common ShareBasic 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 Companys interim
unaudited consolidated condensed financial statements:
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Three Months Ended September 30, 2006Income
    
    
    Shares
    
    
    Per Share(Numerator)
    
    
    (Denominator)
    
    
    Amount(In thousands, except per share data)Basic Net Income Per ShareNet income
    
    $
    5,133
    
    
    
    13,133,711
    
    
    
    0.39Effect of Dilutive SecuritiesRestricted common shares and share options
    
    
    
    
    
    
    136,878
    
    
    
    Diluted EPSNet income
    
    $
    5,133
    
    
    
    13,270,589
    
    
    
    0.39
 Three Months Ended September 30, 2005Income
    
    
    Shares
    
    
    Per Share(Numerator)
    
    
    (Denominator)
    
    
    Amount(In thousands, except per share data)Basic Net Income Per ShareNet income
    
    $
    (1,793
    )
    
    
    13,064,909
    
    
    
    (0.14
    )Effect of Dilutive SecuritiesRestricted common shares and share options
    
    
    
    
    
    
    59,578
    
    
    
    Diluted EPSNet income
    
    $
    (1,793
    )
    
    
    13,124,487
    
    
    
    (0.14
    )
 Nine Months Ended September 30, 2006Income
    
    
    Shares
    
    
    Per Share(Numerator)
    
    
    (Denominator)
    
    
    Amount(In thousands, except per share data)Basic Net Income Per ShareNet income
    
    $
    14,758
    
    
    
    13,116,317
    
    
    
    1.13Effect of Dilutive SecuritiesRestricted common shares and share options
    
    
    
    
    
    
    123,246
    
    
    
    (0.02
    )Diluted EPSNet income
    
    $
    14,758
    
    
    
    13,239,563
    
    
    
    1.11
 Nine Months Ended September 30, 2005Income
    
    
    Shares
    
    
    Per Share(Numerator)
    
    
    (Denominator)
    
    
    Amount(In thousands, except per share data)Basic Net Income Per ShareNet income
    
    $
    5,285
    
    
    
    13,054,764
    
    
    
    0.40Effect of Dilutive SecuritiesRestricted common shares and share options
    
    
    
    
    
    
    71,868
    
    
    
    Diluted EPSNet income
    
    $
    5,285
    
    
    
    13,126,632
    
    
    
    0.40
 (3)
    
    InvestmentsThe Company invests primarily in investment-grade fixed maturities. The amortized cost, gross
unrealized gains and losses and estimated fair value of fixed maturities classified as
held-to-maturity were as follows:
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September 30, 2006Gross
    
    
    Gross
    
    
    EstimatedAmortized
    
    
    unrealized
    
    
    unrealized
    
    
    faircost
    
    
    gains
    
    
    losses
    
    
    value(In thousands)U.S. Treasury securities
    
    $
    89
    
    
    
    10
    
    
    
    
    
    
    
    99Agencies not backed by the full faith and credit of
the U.S. Government
    
    
    1,029
    
    
    
    
    
    
    
    (24
    )
    
    
    1,005Total
    
    $
    1,118
    
    
    
    10
    
    
    
    (24
    )
    
    
    1,104
 December 31, 2005Gross
    
    
    Gross
    
    
    EstimatedAmortized
    
    
    unrealized
    
    
    unrealized
    
    
    faircost
    
    
    gains
    
    
    losses
    
    
    value(In thousands)U.S. Treasury securities
    
    $
    89
    
    
    
    13
    
    
    
    
    
    
    
    102Agencies not backed by the full faith and credit of
the U.S. Government
    
    
    1,039
    
    
    
    
    
    
    
    (23
    )
    
    
    1,016Total
    
    $
    1,128
    
    
    
    13
    
    
    
    (23
    )
    
    
    1,118
 The amortized cost, gross unrealized gains and losses, and estimated fair value of
fixed-maturity and equity securities classified as available-for-sale were as follows:
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September 30, 2006Gross
    
    
    Gross
    
    
    EstimatedAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    FairCost
    
    
    Gains
    
    
    Losses
    
    
    Value(In thousands)Fixed maturities:U.S. Treasury securities
    
    $
    3,652
    
    
    
    
    
    
    
    (53
    )
    
    
    3,599Agencies not backed by the full faith and
credit of the U.S. Government
    
    
    13,544
    
    
    
    
    
    
    
    (246
    )
    
    
    13,298Obligations of states and political subdivisions
    
    
    148,496
    
    
    
    521
    
    
    
    (628
    )
    
    
    148,389Corporate securities
    
    
    34,487
    
    
    
    41
    
    
    
    (810
    )
    
    
    33,718Mortgage-backed securities
    
    
    51,082
    
    
    
    42
    
    
    
    (1,010
    )
    
    
    50,114Collateralized mortgage obligations
    
    
    43,062
    
    
    
    120
    
    
    
    (683
    )
    
    
    42,499Asset-backed securities
    
    
    49,557
    
    
    
    558
    
    
    
    (702
    )
    
    
    49,413Total fixed maturities
    
    
    343,880
    
    
    
    1,282
    
    
    
    (4,132
    )
    
    
    341,030Equities:Equity securities
    
    
    29,878
    
    
    
    435
    
    
    
    (334
    )
    
    
    29,979Bond mutual funds
    
    
    14,583
    
    
    
    58
    
    
    
    (349
    )
    
    
    14,292Total equities
    
    
    44,461
    
    
    
    493
    
    
    
    (683
    )
    
    
    44,271Total
    
    $
    388,341
    
    
    
    1,775
    
    
    
    (4,815
    )
    
    
    385,301
 December 31, 2005Gross
    
    
    Gross
    
    
    EstimatedAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    FairCost
    
    
    Gains
    
    
    Losses
    
    
    Value(In thousands)Fixed maturities:U.S. Treasury securities
    
    $
    3,688
    
    
    
    1
    
    
    
    (53
    )
    
    
    3,636Agencies not backed by the full faith and
credit of the U.S. Government
    
    
    14,526
    
    
    
    
    
    
    
    (230
    )
    
    
    14,296Obligations of states and political subdivisions
    
    
    142,932
    
    
    
    387
    
    
    
    (1,037
    )
    
    
    142,282Corporate securities
    
    
    36,689
    
    
    
    40
    
    
    
    (876
    )
    
    
    35,853Mortgage-backed securities
    
    
    40,910
    
    
    
    31
    
    
    
    (880
    )
    
    
    40,061Collateralized mortgage obligations
    
    
    27,943
    
    
    
    15
    
    
    
    (606
    )
    
    
    27,352Asset-backed securities
    
    
    39,549
    
    
    
    238
    
    
    
    (635
    )
    
    
    39,152Total fixed maturities
    
    
    306,237
    
    
    
    712
    
    
    
    (4,317
    )
    
    
    302,632Equities:Equity securities
    
    
    27,521
    
    
    
    215
    
    
    
    (795
    )
    
    
    26,941Bond mutual funds
    
    
    18,516
    
    
    
    15
    
    
    
    (679
    )
    
    
    17,852Total equities
    
    
    46,037
    
    
    
    230
    
    
    
    (1,474
    )
    
    
    44,793Total
    
    $
    352,274
    
    
    
    942
    
    
    
    (5,791
    )
    
    
    347,425
 Other-than-temporary impairment losses result in permanent reductions to the cost basis of the
underlying investments and are recorded as realized losses in the interim unaudited consolidated
condensed statements of operations. An other-than-temporary loss of $202,000 was realized during
the three and nine months ended September 30, 2006. Other-than-temporary losses of $79,000 and
$114,000 were realized during the three and nine months ended September 30, 2005, respectively.The fair values and gross unrealized losses for securities classified as held-to-maturity by the
Company and assessed as temporarily impaired by management, categorized by the length of time
that the individual securities have been in a continuous unrealized loss position, as of
September 30, 2006, are as follows:
 11




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September 30, 2006Less than 12 months
    
    
    12 months or longer
    
    
    TotalEstimated
    
    
    Gross
    
    
    Estimated
    
    
    Gross
    
    
    Estimated
    
    
    Grossfair
    
    
    unrealized
    
    
    fair
    
    
    unrealized
    
    
    fair
    
    
    unrealizedvalue
    
    
    loss
    
    
    value
    
    
    loss
    
    
    value
    
    
    loss(In thousands)Agencies not backed by the full faith
and credit of the U.S. Government
    
    $
    
    
    
    
    
    
    
    
    1,005
    
    
    
    (24
    )
    
    
    1,005
    
    
    
    (24
    )Total
    
    $
    
    
    
    
    
    
    
    
    1,005
    
    
    
    (24
    )
    
    
    1,005
    
    
    
    (24
    )
 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, 2006Less Than 12 Months
    
    
    12 Months or Longer
    
    
    TotalEstimated
    
    
    Gross
    
    
    Estimated
    
    
    Gross
    
    
    Estimated
    
    
    GrossFair
    
    
    Unrealized
    
    
    Fair
    
    
    Unrealized
    
    
    Fair
    
    
    UnrealizedValue
    
    
    Loss
    
    
    Value
    
    
    Loss
    
    
    Value
    
    
    Loss(In thousands)Fixed maturity securities:U.S. Treasury securities
    
    $
    484
    
    
    
    (2
    )
    
    
    3,114
    
    
    
    (51
    )
    
    
    3,598
    
    
    
    (53
    )Agencies not backed by the full faith
and credit of the
U.S. Government
    
    
    3,019
    
    
    
    (30
    )
    
    
    10,279
    
    
    
    (216
    )
    
    
    13,298
    
    
    
    (246
    )Obligations of states and political
subdivisions
    
    
    17,393
    
    
    
    (59
    )
    
    
    53,525
    
    
    
    (569
    )
    
    
    70,918
    
    
    
    (628
    )Corporate securities
    
    
    4,521
    
    
    
    (79
    )
    
    
    24,945
    
    
    
    (731
    )
    
    
    29,466
    
    
    
    (810
    )Mortgage-backed securities
    
    
    28
    
    
    
    0
    
    
    
    35,051
    
    
    
    (1,010
    )
    
    
    35,079
    
    
    
    (1,010
    )Collateralized mortgage obligations
    
    
    6,140
    
    
    
    (114
    )
    
    
    21,243
    
    
    
    (569
    )
    
    
    27,383
    
    
    
    (683
    )Asset-backed securities
    
    
    12,806
    
    
    
    (379
    )
    
    
    11,953
    
    
    
    (323
    )
    
    
    24,759
    
    
    
    (702
    )Total
    
    
    44,391
    
    
    
    (663
    )
    
    
    160,110
    
    
    
    (3,469
    )
    
    
    204,501
    
    
    
    (4,132
    )Equities:Equity securities
    
    
    8,141
    
    
    
    (131
    )
    
    
    4,889
    
    
    
    (203
    )
    
    
    13,030
    
    
    
    (334
    )Bond mutual funds
    
    
    0
    
    
    
    0
    
    
    
    13,215
    
    
    
    (349
    )
    
    
    13,215
    
    
    
    (349
    )Total
    
    
    8,141
    
    
    
    (131
    )
    
    
    18,104
    
    
    
    (552
    )
    
    
    26,245
    
    
    
    (683
    )Grand Total
    
    $
    52,532
    
    
    
    (794
    )
    
    
    178,214
    
    
    
    (4,021
    )
    
    
    230,746
    
    
    
    (4,815
    )
 At September 30, 2006, the Company had 204 fixed income securities and 18 equity securities that
have been in an unrealized loss position for one year or longer. Of the fixed income securities,
183 are investment grade, of which 177 of these securities are rated A1/A or better (including 132
securities which are rated AAA). The 21 remaining non-investment grade fixed income securities
have an aggregate fair value equal to 94.7% of their book value as of September 30, 2006. Of the
equity securities, six that have been in an unrealized loss position for one year or longer relate
to investments in closed or open ended bond or preferred stock funds. Each of these investments
continues to pay its regularly scheduled monthly dividend and there have been no material changes
in credit quality for any of these funds over the past twelve months. Finally, the 12 remaining
equity securities that have been in an unrealized loss position for one year or longer relate to
preferred share investments in issuers each of which has shown an improved or stable financial
performance during the past twelve months. In addition, these 12 equity securities have an
aggregate fair market value equal to 96.3% of their book value as of September 30, 2006. All 204
of the fixed income securities are current on interest and principal and all 18 of the equity
securities continue to pay dividends at a level consistent with the prior year. Management
believes all contract terms of each security will be satisfied. The unrealized loss position is
due to the changes in the interest rate environment and the Company has positive intent and the
ability to hold the securities until they mature or recover in value.
 12




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(4)
    
    Loss and Loss Expense ReservesLiability for losses and loss expenses represents the Companys 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 $34.4 million for the quarter ended September 30, 2006,
compared to $36.4 million for the quarter ended September 30, 2005. In the third quarter of 2006,
the Company recorded $35.6 million of incurred losses and loss expenses attributable to the 2006
accident year and $1.2 million of favorable prior year development. 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 of adverse prior year development.Net loss and loss expenses incurred were $97.4 million for the nine months ended September 30,
2006, compared to $88.7 million for the nine months ended September 30, 2005. In the first nine
months of 2006, the Company recorded $97.0 million of incurred losses and loss expenses
attributable to the 2006 accident year and $353,000 of adverse prior year development. In the
first nine months of 2005, the Company recorded $84.1 million of incurred losses and loss
expenses attributable to the 2005 accident year and $4.6 million of adverse prior year
development.For the three months ended September 30, 2006, within the property line, the Company experienced
favorable non-catastrophe case reserve development producing a reduction in ultimate loss and
loss expenses by $3.3 million primarily for the 2004 and 2005 accident years. This favorable
development was offset by an increase of $200,000 in casualty reserves during the three month
period as a result of a small amount of adverse development in the casualty line related to one
specific claim. Additionally, the Company recorded approximately $1.9 million of unfavorable
development during the three months ended September 30, 2006 primarily related to estimated costs
associated with possible reinsurance collection issues on the 1998 through 1999 workers
compensation reinsurance treaties.For the nine months ended September 30, 2006, within the property line, the Company experienced
favorable non-catastrophe case reserve development producing a reduction in ultimate loss and
loss expenses by $7.0 million primarily for the 2004 and 2005 accident years. The Company also
changed its estimates during such nine month period on catastrophe losses by reducing its
estimates on Hurricane Wilma by $1.2 million due to actual incurred losses being lower than
original estimates. This favorable development was offset by an increase of $4.3 million in
casualty reserves during such nine month period as a result of a small amount of adverse
development in the casualty line and a result of a refinement to the internal actuarial reserving
technique concerning the weighting of reserve indications and supplemental information concerning
claims severities. The Companys
reserves moved to a higher point on the range of loss and loss expense reserve estimate, despite
the fact that overall, the Companys casualty book of business performed within the range of
expectations for the quarter and nine months ended September 30, 2006. The Company also incurred
approximately $1.4 million of adverse development during the nine months ended September 30, 2006
due to an increase in legal severities on construction defect claims. Additionally, the Company
recorded approximately $2.9 million of unfavorable development during the nine months ended
September 30, 2006 related to estimated costs associated with possible reinsurance collection
issues on two separate casualty claims and the 1998 and 1999 workers compensation reinsurance
treaties.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 prior year increase for the three months ended September 30, 2005 included increases of $1.1
million related increases in the non-construction defect casualty line, $200,000 related to
construction defect reserves and $133,000 related to the exited commercial auto line from adverse
new claim information. The increases were offset by approximately $454,000 of favorable
development in the property line of business. The increases related to the non-construction
defect casualty line primarily relate to claim severities exceeding the Companys expectations
resulting in reassessments of the initial loss ratio expectations and the claim reporting and
settlement patterns. The increases related to construction defect primarily relate to increased
estimates of litigation reserves. The favorable development for property resulted from actual
reported losses below expectations.
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##### Table of Contents



The prior year increase for the nine months ended September 30, 2005 included increases of $3.3
million related to construction defect, $2.0 million related to the non-construction defect
casualty line, and $463,000 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 pertaining to construction defect
primarily relate to reserves established for several contribution action settlements and
increased estimates 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 Companys 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.Management believes the loss and loss expense reserves make a reasonable provision for expected
losses, however, ultimate settlement of these amounts could vary significantly from the amounts
recorded.(5)
    
    ReinsuranceIn 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
Companys reinsurance program except for the fact that the Company is now retaining 50% of the
$500,000 excess of $500,000 layer of the 2006 casualty treaty. This layer was ceded 100% to
reinsurers in 2005. The amounts of ceded loss and loss expense reserves and ceded unearned
premiums would represent a liability of the Company in the event that its reinsurers would be
unable to meet existing obligations under reinsurance agreements.
 14




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##### Table of Contents



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 MonthsEnded September 30,
    
    
    Ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(In thousands)Premiums written:Direct
    
    $
    68,849
    
    
    
    52,491
    
    
    
    190,612
    
    
    
    154,444Assumed
    
    
    454
    
    
    
    993
    
    
    
    2,400
    
    
    
    1,945Ceded
    
    
    (8,638
    )
    
    
    (7,703
    )
    
    
    (23,426
    )
    
    
    (19,965
    )Net premiums written
    
    $
    60,665
    
    
    
    45,781
    
    
    
    169,586
    
    
    
    136,424Premiums earned:Direct
    
    
    62,831
    
    
    
    51,575
    
    
    
    177,977
    
    
    
    147,457Assumed
    
    
    523
    
    
    
    475
    
    
    
    2,440
    
    
    
    888Ceded
    
    
    (7,929
    )
    
    
    (7,116
    )
    
    
    (23,425
    )
    
    
    (18,866
    )Net premiums earned
    
    $
    55,425
    
    
    
    44,934
    
    
    
    156,992
    
    
    
    129,479Losses and loss expenses incurred:Direct
    
    
    34,133
    
    
    
    50,850
    
    
    
    106,993
    
    
    
    114,521Assumed
    
    
    481
    
    
    
    (229
    )
    
    
    838
    
    
    
    (641
    )Ceded
    
    
    (221
    )
    
    
    (14,211
    )
    
    
    (10,424
    )
    
    
    (25,156
    )Net losses and loss expenses incurred
    
    $
    34,393
    
    
    
    36,410
    
    
    
    97,407
    
    
    
    88,724
 In 1998 and 1999, the Company had quota share and excess of loss reinsurance agreements with
three reinsurance companies for the workers compensation line of business. These agreements were
entered into through an intermediary, which was ordered into liquidation in 2000. Since that
time, the Company attempted to collect the losses directly from one of the reinsurers. On March
22, 2006, the Companys effort to vacate an adverse award received in arbitration related to this
reinsurer proved unsuccessful. As a result, the Company began the process of turning the claims
over to the liquidator of the intermediary. As of September 30, 2006, the Company had
approximately $2.9 million of recoverables related to these reinsurance agreements, of which $1.1
million related to the quota share agreements and $1.8 million related to the excess of loss
agreements. In the third quarter of 2006, the Company received communication from the
liquidator of the intermediary that caused the Company to believe that the Company would not be
able to recover a significant amount from the liquidator. As a result, the Company increased the
reserve for uncollectible reinsurance from the $1.5 million that was recorded at June 30, 2006 to
$2.9 million at September 30, 2006.In addition, in the second quarter of 2006, the Company increased its reserves for uncollectible
reinsurance to $1.4 million from $250,000 related to disputes with three reinsurers on 1997 and
2000 accident year casualty claims. The total amount in dispute is approximately $4.0 million.
During the second quarter of 2006, the Company was unsuccessful on appeal of a 1997 accident year
claim for which it is anticipated one of the reinsures may deny indemnification. In addition,
the Company has filed a notice of arbitration against one of its reinsurers related to a 2000
accident year claim for which a $250,000 provision for arbitration costs was established in the
first quarter of 2006. In the second quarter of 2006, the Company recorded an additional
provision of $220,000 for arbitration costs for the 2000 accident year claim as the Company will
file for arbitration if current negotiations are not successful. No new information was obtained
during the third quarter that indicated a change in the reserve was warranted. As of September
30, 2006, the Company had $1.4 million of reserves for uncollectible reinsurance for these
amounts in dispute.Management believes that the reserves for uncollectible reinsurance constitute a reasonable
provision for expected costs and recoveries related to the collection of the recoverables on
these claims, however, actual legal costs and settlements of these claims could vary
significantly from the current estimates recorded.(6)
    
    Deferred Policy Acquisition CostsThe following reflects the amounts of policy acquisition costs deferred and amortized:
 15




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For the Three Months
    
    
    For the Nine MonthsEnded September 30,
    
    
    Ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(In thousands)Balance at beginning of period
    
    $
    22,906
    
    
    
    18,919
    
    
    
    20,649
    
    
    
    17,411Policy acquisition costs deferred
    
    
    15,011
    
    
    
    11,411
    
    
    
    42,230
    
    
    
    33,474Amortization of deferred policy acquisition
costs
    
    
    (14,440
    )
    
    
    (10,941
    )
    
    
    (39,402
    )
    
    
    (31,496
    )Balance at end of period
    
    $
    23,477
    
    
    
    19,389
    
    
    
    23,477
    
    
    
    19,389
 For the three and nine months ended
September 30, 2006, the Company expensed $766,000 of unamortized deferred policy acquisition
costs related to the auto physical damage program.  This expense was a result of the fact
that the programs loss and loss expense ratio exceeded our expectations causing the
program to fall below the profitability levels required for continued deferral of the
additional policy acquisition costs.  There were no such expenses during the three and
nine months ended September 30, 2005.(7)
    
    Federal Income TaxesThe income tax provision for the three and nine months ended September 30, 2006 of 30.3% and
29.5%, respectively has been computed based on our estimated annual effective tax rate of 29.5%
which differs from the federal income tax rate of 35% principally because of tax-exempt
investment income. The income tax provision for the nine months ended September 30, 2005 was
computed based on our estimated annual effective tax rate of 25.0%, which also differed 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.(8)
    
    Commitments and ContingenciesThe Company is party to lawsuits, arbitrations and other proceedings that arise in the normal
course of its business. Many of such lawsuits, arbitrations and other proceedings involve claims
under policies that the Company underwrites as an insurer, the liabilities for which the Company
believes have been adequately included in its loss and loss adjustment expense (LAE) reserves.
Also, from time to time, the Company is party to lawsuits, arbitrations and other proceedings
that relate to disputes over contractual relationships with third parties, or that involve
alleged errors and omissions on the part of our insurance subsidiaries. The Company provides
accruals for these items to the extent it deems the losses are probable and reasonably estimable.The outcome of litigation is subject to numerous uncertainties. Although the ultimate outcome of
pending matters cannot be determined at this time, based on present information, the Company
believes the resolution of these matters will not have a material adverse effect on its financial
position, results of operations or cash flows.(9)
    
    Employee BenefitsDuring 2004, the Company adopted and the shareholders approved a stock option plan (the plan)
that provided tax-favored incentive stock options (qualified options), non-qualified share
options to employees and qualified board members that do not qualify as tax-favored incentive
share options (non-qualified options), time-based restricted shares that vest solely on service
provided and restricted shares that vest based on achieved performance metrics. Compensation cost
is recorded in the same financial statement caption as the salary expense of the employee (i.e.
the compensation cost for the Chief Investment Officer is recorded as an offset to net investment
income).With respect to qualified options, an employee may be granted an option to purchase shares at the
grant date fair market value, payable as determined by the Companys compensation committee. An
optionee must exercise an option within 10 years from the grant date. Full vesting of qualified
options occurs at the end of four years.With respect to non-qualified options, an employee or a board member may be granted an option to
purchase shares at the grant date fair market value, payable as determined by the Companys
compensation committee. An optionee must exercise an option within 10 years from the grant date.
Full vesting of non-qualified options occurs at the end of three years.For both non-qualified and qualified options, the option exercise price equals the stocks fair
market value on the date of the grant. In accordance with SFAS No. 123R, compensation expense is
recorded over the service period based on the grant date fair market value of the options. The
fair market value is determined by the Company using the Black-Scholes option pricing model.
Prior to the adoption of SFAS 123R, in accordance with APB No. 25, no compensation expense was
recorded for the qualified and non-qualified share options as the market value on the grant dates
equaled the exercise price.
 16




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##### Table of Contents



The time-based restricted shares are granted to key executives and vest in equal installments
upon the lapse of a period of time, typically over four and five-year periods and include both
monthly and annual vesting periods. Compensation expense for time-based restricted shares is
measured on the grant date at the current market value and then recognized over the respective
service period, which typically matches the vesting period.The performance-based restricted shares are granted to key executives and vest annually over a
four-year period based on achieved specified performance metrics. In accordance with SFAS 123R,
compensation cost is measured on the grant date at the grant date market value and recorded over
the service period, unless it becomes unlikely that the performance criteria will be met. Prior
to the adoption of SFAS 123R, compensation expense for performance-based restricted share awards
was recognized based on the fair value of the awards at the end of the period.The Company may grant options for up to 1.2 million shares under the plan. Through December 31,
2005, the Company had granted 287,000 non-qualified options, 95,000 qualified options, 156,000
time-based restricted shares and 55,024 performance-based restricted shares under the share plan.
On January 3, 2006 and June 1, 2006, the Company granted an additional 112,500 qualified options
and an additional 12,000 non-qualified options. In addition, on September 1, 2006, the Company
granted 36,704 performance-based restricted shares. Total compensation cost for
share-based payment arrangements included in net income was approximately $376,000 and $989,000
for the three and nine months ended September 30, 2006. In 2005, the compensation cost included
in net income was $159,000 and $624,000 for the three and nine months ended September 30, 2005.
The tax benefit related to these arrangements were $46,000 and $91,000 for the three and nine
months ended September 30, 2006. During 2005, there were no tax
related benefits. At September 30, 2006 the Company had $1.8 million
of future compensation cost related to unvested shares awarded.A summary of the status of the option plan for the nine months ended September 30, 2006 is
presented in the following table:
 September 30, 2006Weighted-Number of
    
    
    AverageShares
    
    
    Exercise PriceOutstanding at beginning of period
    
    
    382,000
    
    
    $
    10.49Changes during the period:Granted
    
    
    124,500
    
    
    
    10.87Exercised
    
    
    (600
    )
    
    
    10.50Forfeited
    
    
    
    
    
    
    Expired
    
    
    
    
    
    
    Outstanding at end of period
    
    
    505,900
    
    
    $
    10.58Exercisable at end of period
    
    
    328,108
    
    
    $
    10.52
 17




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##### Table of Contents



The fair market value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average assumptions used for
grants in 2006:
 Three and Nine MonthsEndedSeptember 30,2006Risk-free interest rate
    
    
    4.07
    %Expected Dividends
    
    
    0.93
    %Expected Volatility
    
    
    23.11
    %Weighted average expected term
    
    7 Years
 Information on the range of exercise prices for options outstanding as of September 30, 2006, is
as follows:
 Options Outstanding
    
    Options ExcercisableWeightedAverage
    
    Weighted
    
    
    
    
    
    WeightedRemaining
    
    Average
    
    
    
    
    
    AverageOutstanding
    
    Contractual
    
    Exercise
    
    Exercisable
    
    ExercisePrice Range
    
    Options
    
    Term
    
    Price
    
    Options
    
    Price$
    10.20
    
    
    
    12,000
    
    
    
    8.7
    
    
    $
    10.20
    
    
    
    5,328
    
    
    $
    10.20$
    10.50
    
    
    
    369,400
    
    
    
    7.6
    
    
    $
    10.50
    
    
    
    297,925
    
    
    $
    10.50$
    10.64
    
    
    
    112,500
    
    
    
    9.3
    
    
    $
    10.64
    
    
    
    23,523
    
    
    $
    10.64$
    13.04
    
    
    
    12,000
    
    
    
    9.7
    
    
    $
    13.04
    
    
    
    1,332
    
    
    $
    13.04
 A summary of all employee time-based restricted share activity during the nine months ended
September 30, 2006 is as follows:
 2006WeightedNumber of
    
    
    AverageShares
    
    
    Grant PriceOutstanding at beginning of period
    
    
    68,033
    
    
    $
    10.22Changes during the period:Granted
    
    
    
    
    
    
    Vested
    
    
    (18,149
    )
    
    
    10.26Cancelled
    
    
    
    
    
    
    Outstanding at end of period
    
    
    49,884
    
    
    $
    10.20
 In January 2005 and October 2005, the Company modified two executives time-based restricted
share awards in connection with the termination of their employment to accelerate the vesting
period. As such, the Company accounted for the modifications as cancellations of a fixed award
and a grant of a variable award, which are valued at the fair market value on the monthly vesting
date. During 2005, the Company recorded $231,924 of compensation expense related to the January
modification and $42,617 related to the October modification. During the nine months ended
September 30, 2006, the Company recorded no compensation expense related to the January
modification as all related shares were vested as of December 31, 2005. The Company recorded
$165,343 of compensation expense related to the October 2005 modification and as of September 30,
2006, all related shares have vested.A summary of all employee performance-based restricted share activity for the nine months ended
September 30, 2006 is as follows:
 18




---



##### Table of Contents



2006WeightedNumber of
    
    
    AverageShares
    
    
    Grant PriceOutstanding at beginning of period
    
    
    37,365
    
    
    $
    10.50Changes during the period:Granted
    
    
    36,704
    
    
    
    14.49Vested
    
    
    (9,341
    )
    
    
    10.50Cancelled
    
    
    
    
    
    
    Outstanding at end of period
    
    
    64,728
    
    
    $
    12.76
 Of the performance-based restricted share awards granted in March of 2005, an award for 17,659
shares was modified in accordance with the agreement entered into in connection with the
termination of an executive officers employment in October 2005. As such, the award was treated
as cancelled on October 1, 2005 due to a modification of the award to accelerate the vesting of
the shares, change the vesting from annual vesting to monthly vesting and remove the performance
based restrictions. As such, the award is treated as a variable award which is valued at the fair
market value on the monthly vesting date. During 2005, the Company recorded $46,058 compensation
expense related to the restricted shares. During the nine months ended September 30, 2006, the
Company recorded $178,686 compensation expense related to the restricted shares and all related
shares vested at September 30, 2006.(10)
    
    Segment Reporting DisclosuresThe Company operates in the Property and Casualty Lines (P/C) (including general liability,
multi-peril, commercial property, garage liability and auto physical damage).The Companys Other (including exited lines) includes the surety business and the Companys
exited lines, such as workers compensation and commercial auto/trucking. A limited amount of
surety business is written in order to maintain Centurys U.S. Treasury listing.All investment activities are included in the Investing operating segment.The Company considers many factors, including economic similarity, the nature of the underwriting
units insurance products, production sources, distribution strategies and regulatory environment
in determining how to aggregate operating segments.Segment profit or loss for each of the Companys segments is measured by underwriting profit or
loss. The property and casualty insurance industry commonly defines underwriting profit or loss
as earned premium net of loss and loss expenses and underwriting, acquisition and insurance
expenses. Underwriting profit or loss does not replace operating income or net income computed in
accordance with GAAP as a measure of profitability. Segment profit for the Investing operating
segment is measured by net investment income and net realized gains or losses. The Company does
not allocate assets, including goodwill, to the P/C and Other operating segments for management
reporting purposes. The total investment portfolio and cash are allocated to the Investing
operating segment.Following is a summary of segment disclosures:
 19




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##### Table of Contents



For the Three Months
    
    
    For the Nine MonthsEnded September 30,
    
    
    Ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(In thousands)Segment revenue:P/C
    
    $
    55,044
    
    
    
    44,625
    
    
    
    155,005
    
    
    
    129,065Investing
    
    
    5,003
    
    
    
    3,800
    
    
    
    14,077
    
    
    
    10,301Other (including exited lines)
    
    
    381
    
    
    
    309
    
    
    
    1,987
    
    
    
    414Segment revenue
    
    $
    60,428
    
    
    
    48,734
    
    
    
    171,069
    
    
    
    139,780Segment profit (loss):P/C
    
    
    4,309
    
    
    
    (5,602
    )
    
    
    9,441
    
    
    
    (389
    )Investing
    
    
    5,003
    
    
    
    3,800
    
    
    
    14,077
    
    
    
    10,301Other (including exited lines)
    
    
    (994
    )
    
    
    (100
    )
    
    
    (276
    )
    
    
    (180
    )Segment profit (loss)
    
    $
    8,318
    
    
    
    (1,902
    )
    
    
    23,242
    
    
    
    9,732Segment assets:Investing
    
    
    413,606
    
    
    
    344,988
    
    
    
    413,606
    
    
    
    344,988Assets not allocated
    
    
    127,028
    
    
    
    125,529
    
    
    
    127,028
    
    
    
    125,529Total consolidated assets
    
    $
    540,634
    
    
    
    470,517
    
    
    
    540,634
    
    
    
    470,517
 The following summary reconciles significant segment items to the Companys interim unaudited
consolidated condensed financial statements:
 For the Three Months
    
    
    For the Nine MonthsEnded September 30,
    
    
    Ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(In thousands)Income (loss) before income taxes:Segment profit (loss)
    
    $
    8,318
    
    
    
    (1,902
    )
    
    
    23,242
    
    
    
    9,732Unallocated amounts:Corporate expenses
    
    
    (341
    )
    
    
    (536
    )
    
    
    (598
    )
    
    
    (1,325
    )Interest expense
    
    
    (608
    )
    
    
    (483
    )
    
    
    (1,718
    )
    
    
    (1,359
    )Income (loss)
before income taxes
    
    $
    7,369
    
    
    
    (2,921
    )
    
    
    20,926
    
    
    
    7,048
 20




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##### Table of Contents



The following is a summary of segment earned premium by group of products:
 Property
    
    
    Casualty
    
    
    Other
    
    
    Consolidated(In thousands)Three Months Ended September 30, 2006P/C
    
    $
    15,779
    
    
    
    39,265
    
    
    
    
    
    
    
    55,044Other (including exited lines)
    
    
    
    
    
    
    
    
    
    
    381
    
    
    
    381Earned premiums
    
    $
    15,779
    
    
    
    39,265
    
    
    
    381
    
    
    
    55,425Three Months Ended September 30, 2005P/C
    
    $
    13,983
    
    
    
    30,642
    
    
    
    
    
    
    
    44,625Other (including exited lines)
    
    
    
    
    
    
    
    
    
    
    309
    
    
    
    309Earned premiums
    
    $
    13,983
    
    
    
    30,642
    
    
    
    309
    
    
    
    44,934Nine Months Ended September 30, 2006P/C
    
    $
    45,251
    
    
    
    109,754
    
    
    
    
    
    
    
    155,005Other (including exited lines)
    
    
    
    
    
    
    
    
    
    
    1,987
    
    
    
    1,987Earned premiums
    
    $
    45,251
    
    
    
    109,754
    
    
    
    1,987
    
    
    
    156,992Nine Months Ended September 30, 2005P/C
    
    $
    42,329
    
    
    
    86,736
    
    
    
    
    
    
    
    129,065Other (including exited lines)
    
    
    
    
    
    
    
    
    
    
    414
    
    
    
    414Earned premiums
    
    $
    42,329
    
    
    
    86,736
    
    
    
    414
    
    
    
    129,479
 The Company does not manage property and casualty products at this level of detail.(11)
    
    Dividends to Common ShareholdersOn March 13, 2006, the Board of Directors declared a dividend of $0.03 per common share that was
paid on April 17, 2006 to shareholders of record as of March 27, 2006. On May 15, 2006, the Board
of Directors declared a dividend of $0.035 per common share that was paid on June 7, 2006 to
shareholders of record as of May 24, 2006. In addition, on August 16, 2006, the Board of
Directors declared a dividend of $0.04 per common share that was paid on September 20, 2006 to
shareholders of record as of August 30, 2006.(12)
    
    Line of CreditDuring the third quarter of 2006, the Company amended its line of credit agreement. The amended
agreement provides for a $10.0 million line of credit with a maturity date of September 30, 2009,
and interest only payments due quarterly based on LIBOR plus 1.2% of the outstanding balance.
All of the outstanding shares of Century are pledged as collateral. In both June and July 2006,
the Company made a $500,000 draw on the line of credit for general corporate purposes. A payment
of approximately $1,006,000 was paid on the line of credit in August 2006, including $1,000,000
of principal and approximately $6,000 of interest. The Company does not have any borrowings
outstanding under the line of credit at September 30, 2006 or 2005.
 
 Item 2. Managements Discussion And Analysis Of Financial Condition And Results Of Operations
  21




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##### Table of Contents




    
    our actual incurred losses may be greater than our loss and loss expense reserves, which
could cause our future earnings, liquidity and financial rating to decline;
    
    a decline in our financial rating assigned by A.M. Best may result in a reduction of new
or renewal business;
    
    we are subject to extensive regulation and judicial decisions affecting insurance and
tort law, which may adversely affect our ability to achieve our business objectives. In
addition, if we fail to comply with certain regulations, we may be subject to penalties,
including fines and suspensions, which may adversely affect our financial condition and
results of operations;
    
    our general agents may exceed their authority and bind us to policies outside our
underwriting guidelines, and until we effect a cancellation, we may incur loss and loss
expenses related to those policies;
    
    if we lose key personnel or are unable to recruit qualified personnel, our ability to
implement our business strategies could be delayed or hindered;
    
    our investment results and, therefore, our financial condition may be impacted by
changes in the business, financial condition or operating results of the entities in which
we invest, as well as changes in government monetary policies, general economic conditions
and overall market conditions, all of which impact interest rates;
    
    we distribute our products through a select group of general agents, five of which
account for a significant part of our business, and such relationships could be
discontinued or cease to be profitable;
    
    our reinsurers may not pay claims made by us on losses in a timely fashion or may not
pay some or all of these claims, in each case causing our costs to increase and our
revenues to decline;
    
    if we are not able to renew our existing reinsurance or obtain new reinsurance, either
our net exposure would increase or we would have to reduce the level of our underwriting
commitment;
    
    our business is cyclical in nature, which will affect our financial performance and may
affect the price of our common shares;
    
    if we are unable to compete effectively with the large number of companies in the
insurance industry for underwriting revenues, we may incur increased costs and our
underwriting revenues and net income may decline;
    
    severe weather conditions and other catastrophes may result in an increase in the number
and amount of claims experienced by our insureds; and
    
    as a holding company, we are dependent on the results of operations of our insurance
subsidiaries and the regulatory and contractual capacity thereof 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.
  Overview
 ®
 22




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##### Table of Contents



Gross Written Premiums.
 Net Written Premiums.
 Earned Premiums.
 Loss Ratio.
 Expense Ratio.
 Combined Ratio.
 Critical Accounting Policies
   Loss and Loss Expense Reserves.
 23




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##### Table of Contents



Reinsurance Recoverables.
 Impairment of Investments.
  Recognition of Interest Income
and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets,
  Deferred Policy Acquisition Costs.
 Federal Income Taxes.
  24




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##### Table of Contents



Results of Operations
  For the Three Months
    
    
    For the Nine MonthsEnded September 30,
    
    
    Ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(In thousands)
    
    
    (In thousands)Selected Financial Data:Gross written premiums
    
    $
    69,303
    
    
    
    53,484
    
    
    
    193,012
    
    
    
    156,389Premiums earned
    
    
    55,425
    
    
    
    44,934
    
    
    
    156,992
    
    
    
    129,479Net investment income
    
    
    4,999
    
    
    
    3,866
    
    
    
    14,114
    
    
    
    10,520Net realized investment
gains (losses)
    
    
    4
    
    
    
    (66
    )
    
    
    (37
    )
    
    
    (219
    )Total revenues
    
    
    60,428
    
    
    
    48,734
    
    
    
    171,069
    
    
    
    139,780Total expenses
    
    
    53,059
    
    
    
    51,655
    
    
    
    150,143
    
    
    
    132,732Net income (loss)
    
    
    5,133
    
    
    
    (1,793
    )
    
    
    14,758
    
    
    
    5,285Key Financial Ratios:Loss and loss expense ratio
    
    
    62.1
    %
    
    
    81.0
    %
    
    
    62.0
    %
    
    
    68.5
    %Expense ratio
    
    
    32.6
    %
    
    
    32.9
    %
    
    
    32.5
    %
    
    
    32.9
    %Combined ratio
    
    
    94.7
    %
    
    
    113.9
    %
    
    
    94.5
    %
    
    
    101.4
    %
 25




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##### Table of Contents



Overview of Operating Results
    Revenues
 Premiums
     
    
    property/casualty; and
    
    other (including exited lines).
  26




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##### Table of Contents



For the Three Months
    
    
    For the Nine MonthsEnded September 30,
    
    
    Ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(In thousands)
    
    
    (In thousands)Gross written premiumsProperty/casualty
    
    $
    68,442
    
    
    
    52,015
    
    
    
    190,322
    
    
    
    154,154Other (including exited lines)
    
    
    861
    
    
    
    1,469
    
    
    
    2,690
    
    
    
    2,235Total gross written
premiums
    
    $
    69,303
    
    
    
    53,484
    
    
    
    193,012
    
    
    
    156,389Ceded written premiums
    
    
    8,638
    
    
    
    7,703
    
    
    
    23,426
    
    
    
    19,965Net written premiums
    
    $
    60,665
    
    
    
    45,781
    
    
    
    169,586
    
    
    
    136,424Premiums earned
    
    $
    55,425
    
    
    
    44,934
    
    
    
    156,992
    
    
    
    129,479Net to gross written premiums
    
    
    87.5
    %
    
    
    85.6
    %
    
    
    87.9
    %
    
    
    87.2
    %Earned to net written premiums
    
    
    91.4
    %
    
    
    98.1
    %
    
    
    92.6
    %
    
    
    94.9
    %Net writings ratio (1)
    
    
    1.8
    
    
    
    1.5
    
    
    
    1.7
    
    
    
    1.5
 
 (1)
    
    The ratio of net written premiums to our insurance subsidiaries combined statutory surplus.
Management believes this measure is useful in gauging our exposure to pricing errors in the
current book of business. It may not be comparable to the definition of net writings ratio
used by other companies. Gross Written Premiums
  Net Written Premiums and Premiums Earned
   27




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##### Table of Contents



Net Investment Income
   Net Realized Investment Losses
   Expenses
 Losses and Loss Expenses
  
    
    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.
    28




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##### Table of Contents



September 30,
    
    
    December 31,2006
    
    
    2005(In thousands)Property/casualty:Casualty
    
    $
    177,436
    
    
    
    142,451Property
    
    
    21,580
    
    
    
    27,972Other (including exited lines):Commercial auto
    
    
    533
    
    
    
    936Workers compensation
    
    
    2,924
    
    
    
    2,657Other
    
    
    543
    
    
    
    183Net reserves for losses and loss expenses
    
    
    203,016
    
    
    
    174,199Plus reinsurance recoverables on unpaid
losses at end of period
    
    
    37,903
    
    
    
    37,448Gross reserves for losses and loss expenses
    
    $
    240,919
    
    
    
    211,647
     29




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##### Table of Contents



Operating Expenses
  For the Three Months
    
    
    For the Nine MonthsEnded September 30,
    
    
    Ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(In thousands)Amortization of deferred policy acquisition costs
(ADAC)
    
    $
    14,440
    
    
    
    10,941
    
    
    
    39,402
    
    
    
    31,496Other operating expenses
    
    
    3,618
    
    
    
    3,821
    
    
    
    11,616
    
    
    
    10,360Severance expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    793ADAC and other operating expenses
    
    
    18,058
    
    
    
    14,762
    
    
    
    51,018
    
    
    
    42,649Interest expense
    
    
    608
    
    
    
    483
    
    
    
    1,718
    
    
    
    1,359Total operating expenses
    
    $
    18,666
    
    
    
    15,245
    
    
    
    52,736
    
    
    
    44,008Expense ratio:ADAC
    
    
    26.1
    %
    
    
    24.3
    %
    
    
    25.1
    %
    
    
    24.3
    %Other operating expenses
    
    
    6.5
    %
    
    
    8.6
    %
    
    
    7.4
    %
    
    
    8.0
    %Severance
    
    
    
    %
    
    
    
    %
    
    
    
    %
    
    
    0.6
    %Total expense ratio (1)
    
    
    32.6
    %
    
    
    32.9
    %
    
    
    32.5
    %
    
    
    32.9
    %
 
 (1)
    
    Interest expense is not included in the calculation of the expense ratio. 30




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##### Table of Contents



Income Taxes
  Liquidity and Capital Resources
     31




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Investment Portfolio
   Accounting Standards
  32




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
   
 33




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##### Table of Contents



Item 3. Quantitative And Qualitative Disclosures About Market Risk
   
 Item 4. Controls And Procedures
     34




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PART II: OTHER INFORMATION
 
 Item 1. Legal Proceedings
   
 Item 1A. Risk Factors
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 Item 3. Defaults Upon Senior Securities
  
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information
  
 Item 6. Exhibits
 3.1
    
    
    Amended and Restated Articles of Incorporation of ProCentury (Incorporated by reference
from the Companys 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
Companys Quarterly Report on Form 10-Q for the period ended March 31, 2004, filed with
the SEC on September 4, 2004.)31.1
    
    
    Certification of Principal Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act31.2
    
    
    Certification of Principal Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act32.1
    
    
    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. 35




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##### Table of Contents



SIGNATURE
  PROCENTURY CORPORATIONDate November 8, 2006
    By:
    /s/ Erin E. WestErin E. WestChief Financial Officer and Treasurer
(Principal Financial and Accounting Officer) 36




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##### Table of Contents



EXHIBIT INDEX
 3.1
    
    
    Amended and Restated Articles of Incorporation of ProCentury (Incorporated by reference
from the Companys 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
Companys Quarterly Report on Form 10-Q for the period ended March 31, 2004, filed with
the SEC on September 4, 2004.)31.1
    
    
    Certification of Principal Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act31.2
    
    
    Certification of Principal Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act32.1
    
    
    Certification of Principal Executive Officer pursuant to Rule 13a-14(b) of the Exchange
Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 (1)32.2
    
    
    Certification of Principal Financial Officer pursuant to Rule 13a-14(b) of the Exchange
Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 (1)
 
 (1)
    
    These certifications are not deemed to be filed for purposes of Section 18 of the Exchange
Act, or otherwise subject to the liability of that section. These certifications will not be
deemed to be incorporated by reference into any filing under the Securities Act or the
Exchange Act, except to the extent that the registrant specifically incorporates them by
reference. 37