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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 March 31, 2005 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(State or other jurisdiction of
    
    31-1718622incorporation or organization)
    
    (I.R.S. Employer Identification No.)465 Cleveland AvenueWesterville, Ohio
    
    43082(Address of principal executive offices)
    
    (Zip Code)
 (614) 895-2000
(Registrants telephone number, including area code) 
  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 As of May 13, 2005, the registrant had 13,211,019 outstanding Common Shares, without par
value.




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PROCENTURY CORPORATION QUARTERLY REPORT ON FORM 10-Q
For the Quarterly Period Ended March 31, 2005 INDEX PagePART I: FINANCIAL INFORMATIONItem 1. Financial Statements
    
    
    3Consolidated Condensed Statements of Operations - For the three months ended March 31, 2005
and 2004
    
    
    3Consolidated Condensed Balance Sheets  March 31, 2005 and December 31, 2004
    
    
    4Consolidated Condensed Statements of Shareholders Equity and Comprehensive Income - For
the three months ended March 31, 2005 and 2004
    
    
    5Consolidated Condensed Statements of Cash Flows - For the three months ended March 31, 2005
and 2004
    
    
    6Notes to Consolidated Condensed Financial Statements  March 31, 2005
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    18Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    29Item 4. Controls and Procedures
    
    
    30PART II: OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    30Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    30Item 3. Defaults Upon Senior Securities
    
    
    30Item 4. Submission of Matters to a Vote of Security Holders
    
    
    30Item 5. Other Information
    
    
    30Item 6. Exhibits
    
    
    31SIGNATURES
    
    
    32Exhibit 10.2Exhibit 10.3Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
 2




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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) For the Three Months Ended March 31,2005
    
    
    2004Premiums earned
    
    $
    41,520
    
    
    
    32,059Net investment income
    
    
    3,159
    
    
    
    1,965Net realized investment (losses) gains
    
    
    (59
    )
    
    
    123Total revenues
    
    
    44,620
    
    
    
    34,147Losses and loss expenses
    
    
    25,727
    
    
    
    18,902Amortization of deferred policy acquisition costs
    
    
    10,220
    
    
    
    6,850Other operating expenses
    
    
    3,065
    
    
    
    3,580Severance expense
    
    
    793
    
    
    
    250Interest expense
    
    
    417
    
    
    
    415Total expenses
    
    
    40,222
    
    
    
    29,997Income before income tax
    
    
    4,398
    
    
    
    4,150Income tax expense
    
    
    1,319
    
    
    
    1,262Net income
    
    $
    3,079
    
    
    
    2,888Basic net income per share
    
    $
    0.24
    
    
    
    0.58Diluted net income per share
    
    $
    0.23
    
    
    
    0.58Weighted average of shares outstanding  basic
    
    
    13,046,339
    
    
    
    5,000,532Weighted average of shares outstanding  diluted
    
    
    13,129,546
    
    
    
    5,000,532
 See accompanying notes to the unaudited consolidated condensed financial statements. 3




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PROCENTURY CORPORATION AND SUBSIDIARIES 
 Consolidated Condensed Balance Sheets
(Unaudited)
(Dollars in thousands, except per share data) December 31,March 31, 2005
    
    
    2004AssetsInvestments:Fixed maturities:Available-for-sale, at fair value (amortized cost 2005, $265,282; 2004,
$262,470)
    
    $
    262,469
    
    
    
    263,401Held-to-maturity, at amortized cost (fair value 2005, $1,132; 2004, $1,156)
    
    
    1,138
    
    
    
    1,142Equities (available-for-sale):Equity securities, at fair value (cost 2005, $21,233; 2004, $17,944)
    
    
    20,847
    
    
    
    18,228Bond mutual funds, at fair value (cost 2005, $27,845; 2004, $18,943)
    
    
    27,414
    
    
    
    18,921Short-term investments, at amortized cost
    
    
    3,000
    
    
    
    4,026Total investments
    
    
    314,868
    
    
    
    305,718Cash
    
    
    3,568
    
    
    
    6,681Premiums in course of collection, net
    
    
    14,823
    
    
    
    11,747Deferred policy acquisition costs
    
    
    17,506
    
    
    
    17,411Prepaid reinsurance premiums
    
    
    9,070
    
    
    
    9,382Reinsurance recoverable on paid losses, net
    
    
    4,220
    
    
    
    3,897Reinsurance recoverable on unpaid losses, net
    
    
    31,555
    
    
    
    29,485Deferred federal income tax asset
    
    
    7,701
    
    
    
    5,442Other assets
    
    
    6,106
    
    
    
    5,164Total assets
    
    $
    409,417
    
    
    
    394,927Liabilities and Shareholders EquityLoss and loss expense reserves
    
    
    165,736
    
    
    
    153,236Unearned premiums
    
    
    82,589
    
    
    
    82,135Long term debt
    
    
    25,000
    
    
    
    25,000Accrued expenses and other liabilities
    
    
    9,123
    
    
    
    9,051Collateral held
    
    
    9,825
    
    
    
    7,008Federal income taxes payable
    
    
    1,870
    
    
    
    3,260Total liabilities
    
    
    294,143
    
    
    
    279,690Shareholders equity:Capital stock, without par value
    
    
    
    
    
    
    Additional paid-in capital
    
    
    100,139
    
    
    
    100,103Retained earnings
    
    
    18,541
    
    
    
    15,727Unearned share compensation
    
    
    (1,091
    )
    
    
    (1,413
    )Accumulated other comprehensive (loss) income, net of taxes
    
    
    (2,315
    )
    
    
    820Total shareholders equity
    
    
    115,274
    
    
    
    115,237Total liabilities and shareholders equity
    
    $
    409,417
    
    
    
    394,927
 See accompanying notes to the unaudited consolidated condensed financial statements. 4




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PROCENTURY CORPORATION AND SUBSIDIARIES
(Formerly ProFinance Holdings Corporation) 
 Consolidated Condensed Statements of Shareholders Equity
and Comprehensive Income (Unaudited) (Dollars in thousands) For the Three Months Ended March 31,2005
    
    
    2004Shareholders EquityCapital stock:Beginning of period
    
    $
    
    
    
    
    Stock issued
    
    
    
    
    
    
    End of period
    
    
    
    
    
    
    Additional paid-in capital:Beginning of period
    
    
    100,103
    
    
    
    26,867Shares issued under share compensation plans
    
    
    36
    
    
    
    End of period
    
    
    100,139
    
    
    
    26,867Retained earnings:Beginning of period
    
    
    15,727
    
    
    
    8,297Net income
    
    
    3,079
    
    
    
    2,888Dividends
    
    
    (265
    )
    
    
    End of period
    
    
    18,541
    
    
    
    11,185Unearned share compensation:Beginning of period
    
    
    (1,413
    )
    
    
    Vesting of restricted shares
    
    
    322
    
    
    
    End of period
    
    
    (1,091
    )
    
    
    Accumulated other comprehensive income, net of taxes:Beginning of period
    
    
    820
    
    
    
    1,234Unrealized holding (losses) gains arising during the period, net of
reclassification adjustment
    
    
    (3,135
    )
    
    
    1,264Unrealized holding losses arising during the period, discontinued
operations
    
    
    
    
    
    
    (1
    )End of period
    
    
    (2,315
    )
    
    
    2,497Total shareholders equity
    
    $
    115,274
    
    
    
    40,549Comprehensive (Loss) IncomeNet income
    
    $
    3,079
    
    
    
    2,888Other comprehensive (loss) income:Unrealized (losses) gains on securities:Unrealized holding (losses) gains arising during the period:Gross
    
    
    (4,881
    )
    
    
    2,074Related federal income tax benefit (expense)
    
    
    1,708
    
    
    
    (730
    )Net unrealized (losses) gains
    
    
    (3,173
    )
    
    
    1,344Reclassification adjustment for (losses) gains included in net incomeGross
    
    
    (59
    )
    
    
    123Related federal income tax benefit (expense)
    
    
    21
    
    
    
    (43
    )Net reclassification adjustment
    
    
    (38
    )
    
    
    80Other comprehensive (loss) income
    
    
    (3,135
    )
    
    
    1,264Other comprehensive loss, discontinued operations
    
    
    
    
    
    
    (1
    )Total other comprehensive (loss) income
    
    
    (3,135
    )
    
    
    1,263Total comprehensive (loss) income
    
    $
    (56
    )
    
    
    4,151
 See accompanying notes to the unaudited consolidated condensed financial statements. 5




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PROCENTURY CORPORATION AND SUBSIDIARIES 
 Consolidated Condensed Statements of Cash Flows
(Unaudited)
(Dollars in thousands) For the Three Months Ended March 31,2005
    
    
    2004Cash flows provided by operating activities:Net income
    
    $
    3,079
    
    
    
    2,888Adjustments:Net realized investment losses (gains)
    
    
    59
    
    
    
    (123
    )Deferred federal income tax benefit
    
    
    (572
    )
    
    
    97Restricted share compensation
    
    
    358
    
    
    
    Changes in assets and liabilities:Premiums in course of collection, net
    
    
    (3,076
    )
    
    
    (853
    )Deferred policy acquisition costs
    
    
    (95
    )
    
    
    (2,603
    )Prepaid reinsurance premiums
    
    
    312
    
    
    
    (9,592
    )Reinsurance recoverable on paid and unpaid losses, net
    
    
    (2,393
    )
    
    
    (3,843
    )Federal income taxes payable
    
    
    (1,390
    )
    
    
    2,837Losses and loss expense reserves
    
    
    12,500
    
    
    
    13,405Unearned premiums
    
    
    454
    
    
    
    14,062Receivable from subsidiary available for sale
    
    
    
    
    
    
    2,706Discontinued operations
    
    
    
    
    
    
    (5,612
    )Other, net
    
    
    2,475
    
    
    
    (2,059
    )Net cash provided by operating activities
    
    
    11,711
    
    
    
    11,310Cash flows used in investing activities:Purchases of equity securities
    
    
    (31,159
    )
    
    
    (19,365
    )Purchase of fixed maturity securities available-for-sale
    
    
    (35,034
    )
    
    
    (44,411
    )Proceeds from sales of equity securities
    
    
    18,935
    
    
    
    18,874Proceeds from sales and maturities of fixed maturities available-for-sale
    
    
    31,673
    
    
    
    13,991Net proceeds from sale of short-term investments
    
    
    1,026
    
    
    
    16,292Discontinued operations
    
    
    
    
    
    
    3,899Net cash used in investing activities
    
    
    (14,559
    )
    
    
    (10,720
    )Cash flows used in financing activities:Principal payment on long term debt
    
    
    
    
    
    
    (234
    )Dividend paid to shareholders
    
    
    (265
    )
    
    
    Net cash used in financing activities
    
    
    (265
    )
    
    
    (234
    )(Decrease) increase in cash and cash equivalents
    
    
    (3,113
    )
    
    
    356Cash and equivalents at beginning of year
    
    
    6,681
    
    
    
    5,814Cash and equivalents at end of year
    
    $
    3,568
    
    
    
    6,170Supplemental disclosure of cash flow information:Interest paid
    
    $
    417
    
    
    
    435Federal income taxes paid
    
    $
    3,281
    
    
    
    
 See accompanying notes to the unaudited consolidated condensed financial statements. 6




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PROCENTURY CORPORATION AND SUBSIDIARIES 
 Notes to Consolidated Condensed Financial Statements March 31, 2005 (Unaudited)  (1)
    Basis of PresentationThe accompanying unaudited interim 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 Filing at December 31, 2004. The Companys 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 ProCenturys existing Class A shareholders. Prior to the dividends,
Evergreen was a controlled subsidiary of Century. The operations of Evergreen and Continental
consisted of ProCenturys 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.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 AccountingThe 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
Companys share option and restricted common share 7




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plans utilizing the intrinsic value method. The Company also follows the disclosure
provisions of Statement of Financial Accounting Standards (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. 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 Companys net income and income per share would have been
adjusted to the pro forma amounts as indicated in the following table: For the Three Months EndedMarch
31,2005
    
    

2004(dollars in thousands, except per share data)Net income:As reported
    
    $
    3,079
    
    
    
    2,888Add: Share-based
employee compensation expense included in reported net income, net of
related tax effects
    
    
    232
    
    
    
    Less: Additional share-based employee
compensation expense determined under
fair value-based method for all
awards, net of related tax effects
    
    
    (592
    )
    
    
    Pro Forma
    
    $
    2,719
    
    
    
    2,888Basic income per common share:As reported
    
    $
    0.24
    
    
    
    0.58Pro Forma
    
    $
    0.21
    
    
    
    0.58Diluted income per common share:As reported
    
    $
    0.23
    
    
    
    0.58Pro Forma
    
    $
    0.21
    
    
    
    0.58
  No share
option or restricted common share-based compensation expense is included in reported net income
for  2004, as the Company had no common share equivalents
granted during the first quarter of 2004.The fair values of the share options and restricted common shares are estimated on the dates of
grant using the Black Scholes option pricing model with the following weighted average
assumptions: Three
Months EndedMarch
31, 2005Risk free interest rate
    
    
    3.69
    %Dividend yield
    
    
    0.76
    %Volatility factor
    
    
    .231Weighted average expected option life
    
    6.1 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 registrants 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 Companys financial statements. 8




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(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.On April 21, 2004, the Companys Class A common shares split on a 500 to 1 basis. Prior
periods share and per share data has been adjusted to reflect this split. On April 26, 2004,
the Company issued 8,000,000 common shares, which are reflected in the Companys basic share
and per share data for all periods after April 26, 2004.On April 26, 2004 and August 5, 2004, the Company issued 101,200 and 54,800 non-performance
based restricted common shares, respectively. These shares are included in the Companys basic
shares and per share data once vested. The non-vested shares are considered dilutive and
included in the diluted share and per share data based on the treasury share method.On April 26, 2004 and March 22, 2005, the Company issued 364,000 and 6,000 qualified and
non-qualified share options to employees and non-employee board members, respectively. During
the three months ended March 31, 2005, the share options are considered dilutive, and therefore
are included in the diluted share and per share data based on the treasury share method.On March 22, 2005, the Company issued 55,024 performance based restricted shares. These shares
are not include in the Companys basic or diluted share calculation as they are contingently
issuable based on the performance criteria in the share agreements.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. For the Three Months Ended March 31, 2005(Dollars in thousands, except per share data)Income
    
    
    Shares
    
    
    Per Share(Numerator)
    
    
    (Denominator)
    
    
    AmountBasic Net Income Per ShareNet income before discontinued operations
    
    $
    3,079
    
    
    
    13,046,339
    
    
    $
    0.24Effect of Dilutive SecuritiesRestricted common shares and
share options
    
    
    
    
    
    
    83,207
    
    
    
    0.01Diluted EPSNet income
    
    $
    3,079
    
    
    
    13,129,546
    
    
    $
    0.23
  Diluted EPS is the same as Basic EPS for the three months ended March 31, 2004 because the
Company had no common share equivalents granted during that period. 9




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(3)
    InvestmentsThe 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: March 31, 2005(dollars in thousands)Gross
    
    
    Gross
    
    
    EstimatedAmortized
    
    
    unrealized
    
    
    unrealized
    
    
    faircost
    
    
    gains
    
    
    losses
    
    
    valueU.S. Treasury securities
    
    $
    89
    
    
    
    12
    
    
    
    
    
    
    
    101Agencies not backed by the full faith and credit of
the U.S. Government
    
    
    1,049
    
    
    
    
    
    
    
    (18
    )
    
    
    1,031Total
    
    $
    1,138
    
    
    
    12
    
    
    
    (18
    )
    
    
    1,132
 December 31, 2004(dollars in thousands)Gross
    
    
    Gross
    
    
    EstimatedAmortized
    
    
    unrealized
    
    
    unrealized
    
    
    faircost
    
    
    gains
    
    
    losses
    
    
    valueU.S. Treasury securities
    
    $
    89
    
    
    
    13
    
    
    
    
    
    
    
    102Agencies not backed by the full faith and credit of
the U.S. Government
    
    
    1,053
    
    
    
    1
    
    
    
    
    
    
    
    1,054Total
    
    $
    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: 10




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March 31, 2005(dollars in thousands)Gross
    
    
    Gross
    
    
    EstimatedAmortized
    
    
    unrealized
    
    
    unrealized
    
    
    faircost
    
    
    gains
    
    
    losses
    
    
    valueFixed maturities:U.S. Treasury securities
    
    $
    3,067
    
    
    
    17
    
    
    
    (32
    )
    
    
    3,052Agencies not backed by the full faith and credit of
the U.S. Government
    
    
    14,319
    
    
    
    
    
    
    
    (223
    )
    
    
    14,096Obligations of states and political subdivisions
    
    
    121,397
    
    
    
    332
    
    
    
    (1,330
    )
    
    
    120,399Corporate securities
    
    
    35,527
    
    
    
    22
    
    
    
    (664
    )
    
    
    34,885Mortgage-backed securities
    
    
    35,282
    
    
    
    107
    
    
    
    (443
    )
    
    
    34,946Collateralized mortgage obligations
    
    
    30,108
    
    
    
    43
    
    
    
    (369
    )
    
    
    29,782Asset-backed securities
    
    
    25,582
    
    
    
    65
    
    
    
    (338
    )
    
    
    25,309Total fixed maturities
    
    
    265,282
    
    
    
    586
    
    
    
    (3,399
    )
    
    
    262,469Equities:Equity securities
    
    
    21,233
    
    
    
    147
    
    
    
    (533
    )
    
    
    20,847Bond mutual funds
    
    
    27,845
    
    
    
    
    
    
    
    (431
    )
    
    
    27,414Total equities
    
    
    49,078
    
    
    
    147
    
    
    
    (964
    )
    
    
    48,261Total
    
    $
    314,360
    
    
    
    733
    
    
    
    (4,363
    )
    
    
    310,730
 December 31, 2004(dollars in thousands)Gross
    
    
    Gross
    
    
    EstimatedAmortized
    
    
    unrealized
    
    
    unrealized
    
    
    faircost
    
    
    gains
    
    
    losses
    
    
    valueFixed maturities:U.S. Treasury securities
    
    $
    4,169
    
    
    
    35
    
    
    
    (32
    )
    
    
    4,172Agencies not backed by the full faith and credit of
the U.S. Government
    
    
    16,805
    
    
    
    98
    
    
    
    (84
    )
    
    
    16,819Obligations of states and political subdivisions
    
    
    119,893
    
    
    
    1,225
    
    
    
    (399
    )
    
    
    120,717Corporate securities
    
    
    46,249
    
    
    
    200
    
    
    
    (300
    )
    
    
    46,149Mortgage-backed securities
    
    
    33,148
    
    
    
    276
    
    
    
    (48
    )
    
    
    33,376Collateralized mortgage obligations
    
    
    23,825
    
    
    
    72
    
    
    
    (120
    )
    
    
    23,777Asset-backed securities
    
    
    18,383
    
    
    
    135
    
    
    
    (127
    )
    
    
    18,391Total fixed maturities
    
    
    262,470
    
    
    
    2,041
    
    
    
    (1,110
    )
    
    
    263,401Equities:Equity securities
    
    
    17,944
    
    
    
    458
    
    
    
    (174
    )
    
    
    18,228Bond mutual funds
    
    
    18,943
    
    
    
    3
    
    
    
    (25
    )
    
    
    18,921Total equities
    
    
    36,887
    
    
    
    461
    
    
    
    (199
    )
    
    
    37,149Total
    
    $
    299,358
    
    
    
    2,501
    
    
    
    (1,309
    )
    
    
    300,550
  Under the Companys accounting policy for equity securities and fixed-maturity securities that
can be contractually prepaid or otherwise settled in a way that may limit the Companys 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
securitys forecasted recovery and evidence exists indicating that recovery will occur within a
reasonable period of time. 11




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##### Table of Contents



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 securitys fair value
has been below amortized cost or cost; specific credit issues and financial prospects related
to the issuer; the Companys 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. No other-than-temporary declines were realized in the three months ended
March 31, 2005 or March 31, 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: March 31, 2005(dollars in thousands)Less than 12 months
    
    
    12 months or longer
    
    
    TotalEstimated
    
    
    Gross
    
    
    Estimated
    
    
    Gross
    
    
    Estimated
    
    
    Grossfair
    
    
    unrealized
    
    
    fair
    
    
    unrealized
    
    
    fair
    
    
    unrealizedvalue
    
    
    loss
    
    
    value
    
    
    loss
    
    
    value
    
    
    lossAgencies not backed by the full faith
and credit of the U.S. Government
    
    $
    1,031
    
    
    
    (18
    )
    
    
    
    
    
    
    
    
    
    
    1,031
    
    
    
    (18
    )Total
    
    $
    1,031
    
    
    
    (18
    )
    
    
    
    
    
    
    
    
    
    
    1,031
    
    
    
    (18
    )
  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: March 31, 2005(dollars in thousands)Less than 12 months
    
    
    12 months or longer
    
    
    TotalEstimated
    
    
    Gross
    
    
    Estimated
    
    
    Gross
    
    
    Estimated
    
    
    Grossfair
    
    
    unrealized
    
    
    fair
    
    
    unrealized
    
    
    fair
    
    
    unrealizedvalue
    
    
    loss
    
    
    value
    
    
    loss
    
    
    value
    
    
    lossFixed maturities:U.S. Treasury securities
    
    $
    1,540
    
    
    
    (32
    )
    
    
    
    
    
    
    
    
    
    
    1,540
    
    
    
    (32
    )Agencies not backed by the full faith
and credit of the U.S. Government
    
    
    12,152
    
    
    
    (167
    )
    
    
    1,944
    
    
    
    (56
    )
    
    
    14,096
    
    
    
    (223
    )Obligations of states and political
subdivisions
    
    
    73,053
    
    
    
    (833
    )
    
    
    15,614
    
    
    
    (497
    )
    
    
    88,667
    
    
    
    (1,330
    )Corporate securities
    
    
    29,356
    
    
    
    (656
    )
    
    
    400
    
    
    
    (8
    )
    
    
    29,756
    
    
    
    (664
    )Mortgage-backed securities
    
    
    30,538
    
    
    
    (437
    )
    
    
    150
    
    
    
    (6
    )
    
    
    30,688
    
    
    
    (443
    )Collateralized mortgage obligations
    
    
    21,409
    
    
    
    (310
    )
    
    
    2,261
    
    
    
    (59
    )
    
    
    23,670
    
    
    
    (369
    )Asset-backed securities
    
    
    13,349
    
    
    
    (272
    )
    
    
    2,757
    
    
    
    (66
    )
    
    
    16,106
    
    
    
    (338
    )Total fixed maturities
    
    
    181,397
    
    
    
    (2,707
    )
    
    
    23,126
    
    
    
    (692
    )
    
    
    204,523
    
    
    
    (3,399
    )Equities:Equity securities
    
    
    12,667
    
    
    
    (485
    )
    
    
    899
    
    
    
    (48
    )
    
    
    13,566
    
    
    
    (533
    )Bond mutual funds
    
    
    21,852
    
    
    
    (431
    )
    
    
    
    
    
    
    
    
    
    
    21,852
    
    
    
    (431
    )Total equities
    
    
    34,519
    
    
    
    (916
    )
    
    
    899
    
    
    
    (48
    )
    
    
    35,418
    
    
    
    (964
    )Total
    
    $
    215,916
    
    
    
    (3,623
    )
    
    
    24,025
    
    
    
    (740
    )
    
    
    239,941
    
    
    
    (4,363
    )
  At March 31, 2005, the Company had thirty fixed income securities and three equity
securities that have been in an unrealized loss position for one year or longer. Twenty-nine of
the fixed income securities are investment 12




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##### Table of Contents



grade, of which twenty-eight securities are rated A1/A or better (including twenty-three securities which are rated AAA). The one remaining
investment grade fixed income security is rated BB+ and has a fair value equal to 98.8% of its
book value as of March 31, 2005. The three equity securities that have been in an unrealized
loss position for one year or longer relate to three issuers each of which has shown an
improved financial performance during 2004. In addition, these three equity securities have an
aggregate fair market value equal to 94.9% of their book value as of March 31, 2005. All
thirty of the fixed income securities are current on interest and principal and the three
equity securities continue to pay dividends at a level consistent with or higher than the prior
year . Management believes the declines are temporary and are not indicative of
other-than-temporary impairments.  (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 $25.7 million for the quarter ended March 31, 2005
compared to $18.9 million for the quarter ended March 31, 2004. In the first quarter of 2005,
the Company recorded $23.8 million of incurred losses and loss expenses attributable to the
2005 accident year and $1.9 million attributable to events of prior years. In the first quarter
of 2004, the Company recorded $16.7 million of incurred losses and loss expenses attributable
to the 2004 accident year and $2.2 million attributable to events of prior years.The prior year increases for the first quarter of 2005 resulted principally from construction
defect claims within the other liability line of the property and casualty segment. During the
first three months of 2005, the Company established reserves for two contribution action
settlements that are anticipated to be paid within the year. This development was slightly
offset by favorable claim count development, while claim severities continued to be within the
Companys expectation. Prior year development for construction defect claims was $1.4 million
for the three months ended March 31, 2005.At March 31, 2005, the Company had 519 open claims relating to construction defect compared to
566 open claims as of December 31, 2004. During the first quarter of 2005, 175 new claims were
reported and 222 existing claims were settled or dismissed. Our net loss and loss expense
reserves for construction defect claims at March 31, 2005 were $19.4 million compared to $19.0
million at December 31, 2004.During the first quarter of 2004, new construction defect claim counts exceeded expectations.
Based on the claim count experience that emerged, the Companys 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. The prior year development recognized during the quarter for
construction defect was substantially due to adverse claim count experience. The claim
severities for the first quarter of 2004 were in line with the Companys recent experience and
expectations. Additionally, during the quarter, development on pending claims was favorable
and the amount of claims closed continued to exceed the amount of new claims reported. As of
March 31, 2004 the Company had 572 open claims relating to construction defect compared to 597
open claims as of December 31, 2003. During the first quarter of 2004, 262 new claims were
reported and 287 existing claims were settled or dismissed. Our net loss and loss expense
reserves for construction defect claims at March 31, 2004 were $17.9.During the first quarter of 2005, the Company recorded $355,000 of prior year development for
property. This primarily resulted from adverse development on two December 2004 fire claims.
All other lines performed as expected in the first quarter of 2005.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 13




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##### Table of Contents



coverage disputes on three claims ($297,000), and unfavorable changes in conditions relating to three other claims ($326,000).(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. The amounts of ceded loss and loss expense reserves and ceded
unearned premiums would represent a liability of the Company in the event that its reinsurers
would be unable to meet existing obligations under reinsurance agreements.The effects of assumed and ceded reinsurance on premiums written, premiums earned and loss and
loss expenses incurred were as follows: For the Three MonthsEnded March 31,2005
    
    
    2004(Dollars in thousands)Premiums written:Direct
    
    $
    47,318
    
    
    
    42,865Assumed
    
    
    314
    
    
    
    (29
    )Ceded
    
    
    (5,346
    )
    
    
    (6,192
    )Net premiums written
    
    $
    42,286
    
    
    
    36,644Premiums earned:Direct
    
    $
    46,963
    
    
    
    36,923Assumed
    
    
    215
    
    
    
    10Ceded
    
    
    (5,658
    )
    
    
    (4,874
    )Net premiums earned
    
    $
    41,520
    
    
    
    32,059Losses and loss expenses incurred:Direct
    
    $
    31,894
    
    
    
    24,705Assumed
    
    
    (270
    )
    
    
    409Ceded
    
    
    (5,897
    )
    
    
    (6,212
    )Net losses and loss expenses incurred
    
    $
    25,727
    
    
    
    18,902
  (6)
    Deferred Policy Acquisition CostsThe following table reflects the amounts of policy acquisition costs deferred and amortized: Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Balance at beginning of year
    
    $
    17,411
    
    
    
    11,714Policy acquisition costs deferred
    
    
    10,315
    
    
    
    9,453Amortization of deferred policy acquisition costs
    
    
    (10,220
    )
    
    
    (6,850
    )Balance at end of year
    
    $
    17,506
    
    
    
    14,317
  Amortization of deferred policy acquisition costs for the three months ended March 31, 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 14




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##### Table of Contents



agreement and the implementation of the loss portfolio agreements among Century, Evergreen and
Continental, as disclosed in the December 31, 2004 Form 10-K filing.(7)
    Federal Income TaxesThe income tax provision for the quarters ended March 31, 2005 and 2004 has been computed based
on the Companys estimated annual effective tax rate of 30.0% and 31.1%, respectively, which differ from the
federal income tax rate of 35% principally because of tax-exempt investment income.(8)
    Commitments and ContingenciesThe 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 Companys consolidated financial position or results from operations.(9)
    Segment Reporting DisclosuresThe 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 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 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. 15




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##### Table of Contents



The following is a summary of segment disclosures: Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Segment revenue:P/ C
    
    $
    41,513
    
    
    
    32,054Investing
    
    
    3,100
    
    
    
    2,088Other (including exited lines)
    
    
    7
    
    
    
    5Segment revenue
    
    $
    44,620
    
    
    
    34,147Segment profit (loss):P/ C
    
    $
    2,938
    
    
    
    2,686Investing
    
    
    3,100
    
    
    
    2,088Other (including exited lines)
    
    
    (561
    )
    
    
    (743
    )Segment profit
    
    $
    5,477
    
    
    
    4,031Segment assets:Investing
    
    $
    318,436
    
    
    
    181,915Assets not allocated
    
    
    90,981
    
    
    
    125,508Total consolidatd assets
    
    $
    409,417
    
    
    
    307,423
  The following summary reconciles significant segment items to the Companys interim unaudited
consolidated condensed financial statements: Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Income before income taxes:Segment profit
    
    $
    5,477
    
    
    
    4,031Unallocated amounts:Corporate expenses
    
    
    (662
    )
    
    
    534Interest expense
    
    
    (417
    )
    
    
    (415
    )Income before income taxes
    
    $
    4,398
    
    
    
    4,150
  The following is a summary of segment earned premium by group of products: Property
    
    
    Casualty
    
    
    Other
    
    
    Consolidated(Dollars in thousands)Three Months Ended March 31, 2005P/ C
    
    $
    14,416
    
    
    
    27,097
    
    
    
    
    
    
    
    41,513Other (including exited lines)
    
    
    
    
    
    
    
    
    
    
    7
    
    
    
    7Earned premiums
    
    $
    14,416
    
    
    
    27,097
    
    
    
    7
    
    
    
    41,520Three Months Ended March 31, 2004P/ C
    
    $
    13,255
    
    
    
    18,799
    
    
    
    
    
    
    
    32,054Other (including exited lines)
    
    
    
    
    
    
    
    
    
    
    5
    
    
    
    5Earned premiums
    
    $
    13,255
    
    
    
    18,799
    
    
    
    5
    
    
    
    32,059
  The Company does not manage property and casualty products at this level of detail. 16




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##### Table of Contents



(10)
    Dividend to Common ShareholdersOn 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. The dividends were
accrued in the accompanying March 31, 2005 unaudited interim balance sheet in the caption
accrued expenses and other liabilities.(11)
    Line of CreditThe 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. There was no outstanding
balance at March 31, 2005; however, in April 2005, the Company made a $2.3 million draw on the
line of credit for general corporate purposes. 17




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##### Table of Contents



Item 2. Managements 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 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 18




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##### Table of Contents




    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. 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 companys 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 companys 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. 19




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##### Table of Contents



Critical Accounting Policies It is important to understand our accounting policies in order to understand our financial
statements. Management considers certain of these policies to be critical to the presentation of
our financial results, since they require management to make estimates and assumptions. These
estimates and assumptions affect the reported amounts of assets, liabilities, revenues, expenses
and related disclosures at the financial reporting date and throughout the period being reported
upon. Certain of the estimates result from judgments that can be subjective and complex and
consequently actual results may differ from these estimates, which would be reflected in future
periods. Our most critical accounting policies involve the reporting of loss and loss expense reserves
(including losses that have occurred but were not reported to us by the financial reporting date),
reinsurance recoverables, the impairment of investments, deferred policy acquisition costs and
federal income taxes. Loss and Loss Expense Reserves.Loss and loss expense reserves represent an estimate of the
expected cost of the ultimate settlement and administration of losses, based on facts and
circumstances then known. We use actuarial methodologies to assist us in establishing these
estimates, including judgments relative to estimates of future claims severity and frequency,
length of time to develop to ultimate resolution, 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 periods 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
Companys accounting policy for equity securities and fixed-maturity securities that can be
contractually prepaid or otherwise settled in a way that may limit the Companys 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 securitys 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 securitys fair value has been below
amortized cost or cost; specific credit issues and financial prospects related to the issuer; the
Companys 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 March 31, 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 20




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##### Table of Contents



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 TaxesThe 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. 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 interim unaudited consolidated condensed financial statements and to assist the reader
in gaining a better understanding of results of operations. Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Selected Financial Data:Gross written premiums
    
    $
    47,632
    
    
    
    42,836Premiums earned
    
    
    41,520
    
    
    
    32,059Net investment income
    
    
    3,159
    
    
    
    1,965Net realized investment (losses) gains
    
    
    (59
    )
    
    
    123Total revenues
    
    
    44,620
    
    
    
    34,147Total expenses
    
    
    40,222
    
    
    
    29,997Net income
    
    
    3,079
    
    
    
    2,887Key Financial Ratios:Loss and loss expense ratio
    
    
    62.0
    %
    
    
    59.0
    %Expense ratio
    
    
    33.9
    %
    
    
    33.3
    %Combined ratio
    
    
    95.9
    %
    
    
    92.3
    %
 Overview of Operating Results Net income increased from $2.9 million for the three months ended March 31, 2004 to $3.1
million for the three months ended March 31, 2005. The increase in net income was primarily attributable to an increase in total revenue, which
was directly related to an increase in net earned premium and net investment income. The increase
in net earned premium resulted 21




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##### Table of Contents



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 increased in the first quarter of 2005 due to higher invested assets as a result of the
proceeds from the Companys initial public offering that occurred in April of 2004 and the
operational cash flows that occurred throughout 2004 and into the first quarter of 2005. This increase in total revenue was offset by an increase in total expenses that resulted from
an increase in net loss and loss expenses and the $793,000 severance expense with our former Chief
Operating Officer. The loss and loss expense ratios for the three months ended March 31, 2005 and
2004 were 62.0% and 59.0%, respectively, which reflects higher current accident year ultimate loss
and loss expense ratios driven by the decreasing rate environment throughout 2004 and into 2005.
The expense ratios for the three months ended March 31, 2005 and 2004 were 33.9% and 33.3%,
respectively. The increase in the expense ratio is directly attributable to the severance expense
recorded in the first quarter of 2005 as mentioned above. 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 Centurys U.S. Treasury listing, workers compensation, which was
exited in January 2002, and commercial auto, which was exited in May 2000. 22




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##### Table of Contents



The following table presents our gross written premiums in our primary segments and provides a
summary of gross, ceded and net written premiums and net premiums earned for the periods indicated. For the Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Gross written premiums:Property/casualty
    
    $
    47,575
    
    
    
    42,865Other (including exited lines)
    
    
    57
    
    
    
    (29
    )Total gross written premiums
    
    
    47,632
    
    
    
    42,836Ceded written premiums
    
    
    5,346
    
    
    
    6,192Net written premiums
    
    $
    42,286
    
    
    
    36,644Premiums earned
    
    $
    41,520
    
    
    
    32,059Net written premiums to gross
written premiums
    
    
    88.8
    %
    
    
    85.5
    %Premiums earned to net
written premiums
    
    
    98.2
    %
    
    
    87.5
    %Net writings ratio (1)
    
    
    1.4
    
    
    
    1.9
   (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. Gross Written Premiums Gross written premiums increased to $47.6 million for the quarter ended March 31, 2005, an
increase of 11.2% from $42.8 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 $5.4 million of gross written premiums, we experienced a decline in our overall
casualty growth rate due to rate softening and increased market competition. Although, we expect
this rate softening and increased market competition to continue throughout 2005, we believe that
there are still opportunities for profitable growth in our casualty lines. Our property lines
decreased in the first quarter of 2005 by $737,000. This decrease is a result of softened rates
across our property book of business, causing the loss of some of our individually significant
property accounts. Net Written Premiums and Premiums Earned Net written premiums for the three months ended March 31, 2005 were $42.3 million,
representing an increase of 15.4% compared to the same period in 2004. Net written premiums
represented 88.8% of gross written premiums for the three months ended March 31, 2005. This is
higher than the relationship of net written premiums to gross
written premiums during the same period in 2004, reflecting an increase in retention for the
current year resulting from the decreased use of facultative reinsurance from a lower number of
property accounts that have been historically ceded under the facultative treaty. Premiums earned, a function of net written premiums, were $41.5 million for the three months
ended March 31, 2005, or 98.2% of net written premiums. This is higher than the relationship of
premiums earned to net written premiums during the same period in 2004, reflecting the slower
growth rate at the end of 2004 and into the first quarter of 2005. 23




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##### Table of Contents



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 $3.2 million for the three months ended March 31, 2005,
compared to $2.0 million for the same period in 2004. The increase was primarily due to an increase
in invested assets, including cash as a result of the proceeds from the IPO and an increase in
operation cash flows throughout 2004 and into 2005. Invested assets, including cash, increased by
$130.3 million to $318.4 million as of March 31, 2005 from $188.1 million as of March 31, 2004.
Pre-tax investment yield for the first three months ended March 31, 2005 was 4.5%, compared to 4.3%
for the same period in 2004. In addition, in an effort to increase our tax equivalent yield we
increased our allocation to tax-exempt municipals throughout 2004 and into 2005. Based on the
increase in our allocation, we increased our tax equivalent yield to 5.1% as of March 31, 2005 from
4.6% as of March 31, 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 $59,000 and net investment gains of $123,000 on the sale
of securities for the three months ended March 31, 2005 and 2004, respectively. No
other-than-temporary declines were realized in the first quarter of 2005 or 2004. 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
quarters activity. As of December 31 of each year, we have
an independent actuarial analysis performed of the adequacy of our reserves. Our estimate of
ultimate loss and loss expenses is evaluated and re-evaluated by accident year and by major
coverage grouping. 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 reinsurers insolvency). 24




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##### Table of Contents



Net losses and loss expenses increased to $25.7 million for the three months ended March 31,
2005 from $18.9 million for the same period in 2004. Net losses and loss expense ratios for the
three months ended March 31, 2005 and 2004 were 62.0% and 59.0%, respectively. Our reserve for losses and loss expenses at March 31, 2005 was $165.7 million (before the
effects of reinsurance) and $134.2 million (after the effects of reinsurance), as estimated through
our internal actuarial analysis. During the first quarter 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 $1.9 million primarily on our
construction defect and property reserves. Our reserve for losses and loss expenses (net of the effects of reinsurance) at March 31, 2005
and December 31, 2004 by line was as follows: March 31, 2005
    
    
    December 31, 2004(Dollars in thousands)Property/casualty:Casualty
    
    $
    111,820
    
    
    
    102,430Property
    
    
    17,521
    
    
    
    16,115Other (including exited lines):Commercial auto
    
    
    1,725
    
    
    
    1,780Workers compensation
    
    
    3,115
    
    
    
    3,426Net reserves for losses and loss expenses
    
    
    134,181
    
    
    
    123,751Plus reinsurance recoverables on unpaid losses at end
of period
    
    
    31,555
    
    
    
    29,485Gross reserves for losses and loss expenses
    
    $
    165,736
    
    
    
    153,236
 Based on the first quarter 2005 internal actuarial review, the Company recorded $23.8 million
of incurred losses and loss expenses attributable to the 2005 accident year and $1.9 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, 2004 and 2003 were 57.4%, 52.8% and 45.6%,
respectively. In the first quarter of 2004, the Company recorded $16.7 million of incurred losses
and loss expenses attributable to the 2004 accident year and $2.2 million attributable to events of
prior years. The prior year increases for the first quarter of 2005 resulted principally from construction
defect claims within the other liability line of the property and casualty segment. During the
first three months of 2005, the Company established reserves for two contribution action
settlements that are anticipated to be paid within the year. This development was slightly offset
by favorable claim count development, while claim severities continued to be within the Companys
expectation. Prior year development for construction defect claims was $1.4 million for the three
months ended March 31, 2005. At March 31, 2005 the Company had 519 open claims relating to construction defect compared to
566 open claims as of December 31, 2004. During the first quarter of 2005, 175 new claims were
reported and 222 existing
claims were settled or dismissed. Our net loss and loss expense reserves for construction
defect claims at March 31, 2005 were $19.4 million compared to $19.0 million at December 31, 2004. During the first quarter of 2004, new construction defect claim counts exceeded expectations.
Based on the claim count experience that emerged, the Companys 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. The prior year development recognized during the quarter for construction defect was
substantially due to adverse claim count experience. The claim severities for the quarter of 2004
were in line with the Companys recent experience and expectations. Additionally, during the
quarter, 25




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##### Table of Contents



development on pending claims was favorable and the amount of claims closed continued to
exceed the amount of new claims reported. As of March 31, 2004 the Company had 572 open claims
relating to construction defect compared to 597 open claims as of December 31, 2003. During the
first quarter of 2004, 262 new claims were reported and 287 existing claims were settled or
dismissed. Our net loss and loss expense reserves for construction defect claims at March 31, 2004
were $17.9 million. During the first quarter of 2005, the Company recorded $355,000 of prior year development for
property. This primarily resulted from adverse development on two December 2004 fire claims. All
other lines performed as expected in the first quarter of 2005. 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). Our other (exited lines) performed as expected in the first quarter of 2005. For commercial
automobile, the Company had 29 open claims at March 31, 2005 compared to 38 open claims at December
31, 2004. During the first quarter of 2005, there were no new claims reported and nine existing
claims were settled or dismissed. Our net loss and loss expense reserves for commercial automobile
at March 31, 2005 were $1.7 million compared to $1.8 million as of December 31, 2004. In addition,
for workers compensation, at March 31, 2005, the Company had 235 open claims at March 31, 3005
compared to 257 open claims at December 31, 2004. During the first quarter of 2005, there were
three new claims reported and 25 existing claims were settled or dismissed. Our net loss and loss
expense reserves for workers compensation at March 31, 2005 were $3.1 million compared to $3.4
million as of December 31, 2004. 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 EndedMarch 31,2005
    
    
    2004(Dollars in thousands)Amortization of deferred policy acquisition costs (ADAC)
    
    $
    10,220
    
    
    
    6,850Other operating expenses
    
    
    3,065
    
    
    
    3,580ADAC and other operating expenses
    
    
    13,285
    
    
    
    10,430Severance expense
    
    
    793
    
    
    
    250Interest expense
    
    
    417
    
    
    
    415Total operating expenses
    
    $
    14,495
    
    
    
    11,095Expense ratio:ADAC
    
    
    24.6
    %
    
    
    21.4
    %Other operating expenses
    
    
    7.4
    %
    
    
    11.2
    %Severence
    
    
    1.9
    %
    
    
    0.8
    %Total expense ratio (1)
    
    
    33.9
    %
    
    
    33.3
    %
   (1)
    
    Interest expense is not included in the calculation of the expense ratio. 26




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##### Table of Contents



Operating expenses increased $3.4 million, or 30.6%, to $14.5 million for the three month
period ended March 31, 2005 from $11.1 million for the same period in 2004. The increase is
primarily attributable to an increase in ADAC, including commission expenses. This increase
resulted from an increase in the volume of insurance written. The increase in the ADAC ratio to
24.6% in 2005 from 21.4% 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 conjunction
with the termination of the intercompany pooling agreement and the implementation of the loss
portfolio agreements. Other operating expenses decreased slightly to $3.1 million for the first quarter 2005
compared to $3.6 million for the first quarter 2004. This decrease is a direct result of the
Companys focus on expense management that occurred throughout 2004 and into 2005. The overall expense ratio for the three months ended March 31, 2005 was 33.9%, which is 0.6
percentage points higher than that of the same period in 2004. The increase in the expense ratio
for the three month period ended March 31, 2005 is primarily due to the severance agreement with
the Companys former Chief Operating Officer recorded in 2005, the one time ADAC adjustment that
lowered overall expenses in 2004, all of which were offset by an increase in operational
efficiencies achieved through a focus on expense management as seen in the overall decline in the
other operating expense ratio. Interest expense remained consistent for the three months ended March 31, 2005 and 2004 at
$417,000 and $415,000, respectively. Income Taxes The 2005 income tax provision for the quarter ended March 31, 2005 has been computed based on
our estimated annual effective tax rate of 30.0%, which differs from the federal income tax rate of
35% principally because of tax-exempt investment income. The effective tax rate of 30.0% in 2005
is lower than the 32.4% reported in 2004 primarily due to the increase in tax exempt municipal
bonds that occurred throughout 2004 and into 2005. 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.
Centurys principal sources of funds are underwriting operations, investment income and proceeds
from sales and maturities of investments. Centurys primary use of funds is to pay claims and
operating expenses, to purchase investments and to make dividend payments to us. ProCenturys
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 for 2005 is $13.8 million. Century did
not pay ProCentury any dividends in the first quarter of 2005. Century paid ordinary dividends of
$1.5 million for the three months ended March 31, 2004. Centurys 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. Surplus is calculated by subtracting total liabilities from total admitted assets. The
National Association of Insurance Commissioners (NAIC) has a risk-based capital standard designed
to identify property and casualty insurers that may be inadequately capitalized based on inherent
risks of each insurers assets and liabilities and its mix of net 27




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##### Table of Contents



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. Centurys statutory surplus
at December 31, 2004 was $115.8 million and the regulatory action level was $29.3 million.
Centurys statutory surplus at March 31, 2005 was
$118.7 million. Consolidated net cash provided by operating activities was $11.7 million for the first quarter
of 2005, compared to $11.3 million for the same period in 2004. This improvement was primarily
attributable to the increase in net written premiums partially offset by an increase in paid
losses. Consolidated net cash used by investing activities was $14.6 million for the first quarter of
2005, compared to net cash used by investing activities of $10.7 million for the same period in
2004. This increase was primarily attributable to the increased level of purchases of fixed
maturity securities. Consolidated net cash used in financing activities was $265,000 for the first quarter of 2005,
compared to net cash used in financing activities of $234,000 for the same period in 2004. The
$265,000 in the first quarter of 2005 related to dividends declared and accrued on March 24, 2005.
The dividend was paid on April 28, 2005 to shareholders of record as of April 7, 2005. The
$234,000 in the first quarter of 2004 related to principal payments on our long term bank debt that
was subsequently paid off 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. 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
pledge as collateral. There was no outstanding balance at March 31, 2005; however, in April 2005,
the Company made a $2.3 million draw on the line of credit. The following table summarizes information about contractual obligations and commercial
commitments. The minimum payments under these agreements at March 31, 2005 were as follows: Payments Due by Year2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    Thereafter
    
    
    Total(Dollars in thousands)Long Term Debt:Debt issued to a related party trust (1)(2)
    
    $
    1,350
    
    
    
    1,800
    
    
    
    1,800
    
    
    
    1,800
    
    
    
    1,800
    
    
    
    66,751
    
    
    
    75,301Loss and loss expense payments, net of the
effects of reinsurance (3)
    
    
    40,471
    
    
    
    34,984
    
    
    
    24,280
    
    
    
    14,251
    
    
    
    7,689
    
    
    
    12,506
    
    
    
    134,181Operating lease on facilities
    
    
    718
    
    
    
    978
    
    
    
    998
    
    
    
    1,018
    
    
    
    734
    
    
    
    2,339
    
    
    
    6,785Other operating leases
    
    
    180
    
    
    
    212
    
    
    
    212
    
    
    
    152
    
    
    
    
    
    
    
    
    
    
    
    756Total contractual obligations
    
    $
    42,719
    
    
    
    37,974
    
    
    
    27,290
    
    
    
    17,221
    
    
    
    10,223
    
    
    
    81,596
    
    
    
    217,023
   (1)
    
    Amounts include interest payments associated with these obligations using applicable interest
rates as of March 31, 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. 28




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(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 can give no assurance in this regard. Investment Portfolio Our investment strategy is designed to capitalize on our ability to generate positive cash
flow from our underwriting activities. Preservation of capital is our first priority, with a
secondary focus on maximizing appropriate risk adjusted return. We seek to maintain sufficient
liquidity from operations, investing and financing activities to meet our anticipated insurance
obligations and operating and capital expenditure needs. The majority of our fixed-maturity
portfolio is rated investment grade to protect investments. Our investment portfolio is managed by
two outside independent investment managers that operate under investment guidelines approved by
Centurys investment committee. Centurys investment committee meets at least quarterly and reports
to Centurys 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 $318.4 million at March 31, 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
Companys taxable equivalent yield increased from 4.8% at December 31, 2004 to 5.1% at March 31,
2005. The increase in the taxable equivalent yield during the first quarter 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. Our fixed maturity
securities at March 31, 2005 remained fairly consistent with the balance at December 31, 2004.
Equity securities increased from $37.1 million at December 31, 2004 to $48.3 million at March 31,
2005. During the three months ended March 31, 2005, the duration of the fixed income portfolio
decreased slightly from 4.5 years at December 31, 2004 to 4.3 years at March 31, 2005. The overall
credit quality of the portfolio remained investment grade. 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 registrants 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. 
 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 March 31, 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. 29




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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 Companys 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 Companys
disclosure controls and procedures pursuant to Securities Exchange Act Rule 13a-15 (Disclosure
Controls). The Companys 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. Based upon the Companys controls evaluation, the CEO and CFO have concluded that the
Companys Disclosure Controls provide reasonable assurance that the 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 Commissions rules and forms. There were no changes in the Companys internal control over financial reporting during the
Companys most recent fiscal quarter that materially affected, or are reasonably likely to
materially affect, the Companys internal control over financial reporting. 
 PART II: OTHER INFORMATION 
 Item 1. Legal Proceedings The Companys 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. 30




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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.)10.1
    
    Separation Agreement by and between the Company and John A. Marazza, dated January 21,
2005 (Incorporated by reference from the Companys Current Report on Form 8-K filed with
the SEC on January 21, 2005.)10.2
    
    Form of Restricted Stock Award Agreement for Performance Vesting Restricted Stock under
the ProCentury Corporation 2004 Stock Option and Award Plan.10.3
    
    Form of Stock Option Agreement for Non-Qualified Stock Options Granted to Non-Employee
Directors under the ProCentury Corporation 2004 Stock Option and Award Plan.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. 31




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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 CORPORATIONDate: May 13, 2005
    
    By:
    
    /s/ Charles D. HammCharles D. HammChief Financial Officer and Treasurer(Principal Financial and Accounting Officer)
 32




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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.)10.1
    
    Separation Agreement by and between the Company and John A. Marazza, dated January 21,
2005 (Incorporated by reference from the Companys Current Report on Form 8-K filed with
the SEC on January 21, 2005.)10.2
    
    Form of Restricted Stock Award Agreement for Performance Vesting Restricted Stock under
the ProCentury Corporation 2004 Stock Option and Award Plan.10.3
    
    Form of Stock Option Agreement for Non-Qualified Stock Options Granted to Non-Employee
Directors under the ProCentury Corporation 2004 Stock Option and Award Plan.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.