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.
It is important to understand our accounting policies in order to understand our consolidated 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.
Federal Income Taxes. We provide for federal income taxes based on amounts we believe the ultimately will owe. Inherent in the provision for federal income taxes are estimates regarding the deductibility of certain items. In the event the ultimate deductibility of certain items or the realization of certain tax credits differs from estimates, we may be required to significantly change the provision for federal income taxes recorded in the consolidated financial statements. Any such change could significantly affect the amounts reported in the consolidated statements of income.
We utilize the asset and liability method of accounting for income tax. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce the deferred tax assets to the amounts more likely than not to be realized. See Note 9 to our audited consolidated financial statements included in this report.
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002. We realized net gains of $1.9 million on the sale of securities for the year ended December 31, 2003 and $2.4 million for the same period in 2002. These gains included a realized loss of $87,000 attributable to adjustments for other-than-temporary impairment of securities for the year ended December 31, 2003 and $38,000 for the same period in 2002.
As of December 31, 2004, the projected loss and loss expense ratios, after the effects of reinsurance, for the casualty lines were 48.9%, 44.0% and 57.8% for accident periods 2004, 2003 and 2002, respectively.
Century markets and underwrites general liability, commercial property, multi-peril, and limited bonding coverages to commercial and individual customers through independent and affiliated agents throughout the United States. The Company writes business on both an admitted and nonadmitted basis in 48 states and the District of Columbia, on an admitted basis only in six states and on a nonadmitted basis only in 42 states and the District of Columbia. Century competes with other property and casualty insurance companies and is subject to the regulations of certain state and federal agencies and undergoes periodic financial examinations by those regulatory authorities.
The consolidated financial statements include the accounts of ProCentury and its wholly owned subsidiaries.
In the ordinary course of business, Century reinsures certain risks, generally on an excess-of-loss basis, with other insurance companies which primarily are rated “A-” or higher by A.M. Best on the date that the agreement is entered into. Such reinsurance arrangements serve to limit the Company’s maximum loss.
The Company’s stock option grants are considered anti-dilutive at December 31, 2004 as the average market price was less than the exercise price. Diluted EPS is the same as Basic EPS for the year ended December 31, 2003 and 2002 because the Company had no common share equivalents granted during those periods.
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 year ended December 31, 2004. For the year ended December 31, 2003 and 2002, one fixed maturity security was written down in the amount of $87,000 and one fixed maturity security was written down in the amount of $38,000, respectively, which were included as a realized loss in the accompanying consolidated condensed statements of operations.
In 2002 and through March of 2003, ProCentury sold a total of 49.8% of Evergreen (25.0% of the voting shares) in three transactions in order to raise capital to support current operations. The intent at the time of these transactions was to retain a controlling interest in Evergreen. In May of 2003, management of the Company began initial discussions and contemplation concerning adopting a formal plan of reorganization, that would be contingent on the successful completion of an initial public offering (IPO), that included the disposition of the remaining shares of Evergreen (see further discussion below).
The components of the income tax (benefit) expense are as follows:
If the Company recorded compensation expense for its share option grants based on the “fair value method,” the Company’s net income (loss) would have been adjusted to the pro forma amounts as indicated in the following table: