As a result of our acquisition of Midlands in 2007, the combined operating results of PMA Management Corp. and Midlands have been reported in a new reporting segment, Fee-based Business. The results of PMA Management Corp. were previously included with the results of The PMA Insurance Group. For comparative purposes, the financial results of The PMA Insurance Group and PMA Management Corp. have been reclassified in all prior periods to reflect this change. The combined operating results in 2008 for Fee-based Business also include those of PMA Management Corp. of New England, Inc., which we acquired in June 2008.
Total premiums ceded decreased by $14.8 million in 2008 and increased by $46.7 million in 2007, compared to the immediately preceding year. Premiums ceded for workers’ compensation decreased by $20.3 million in 2008, compared to 2007, primarily due to lower premiums ceded under fronting arrangements, which were partially offset by an increase in the amount of workers’ compensation business sold to captive accounts, where a substantial portion of the direct premiums are ceded. Premiums ceded for workers’ compensation increased by $47.0 million in 2007, compared to 2006, primarily due to our agreement with Midwest, under which we ceded $57.3 million in 2007, compared to $14.8 million in 2006. Premiums ceded for Commercial Lines increased by $5.5 million in 2008, compared to 2007, mainly resulting from increased direct premium writings. Premiums ceded for Commercial Lines slightly declined in 2007, compared to 2006, mainly resulting from changes in the contractual terms of our property quota share treaty.
The loss and LAE ratio improved 1.8 points in 2007, compared to 2006. The improved loss and LAE ratio primarily reflected a lower current accident year loss and LAE ratio in 2007, compared to 2006. While our underwriting criteria remained consistent in 2007, our current accident year loss and LAE ratio continued to benefit from changes in the type of workers’ compensation products selected by our insureds and a reduced amount of integrated disability and assumed premiums in 2007. Pricing changes coupled with payroll inflation for rate-sensitive workers’ compensation business were slightly below overall estimated loss trends. We estimated our medical cost inflation to be 7% during 2007, compared to our estimate of 8.5% in 2006.
The PMA Insurance Group, exclusive of fronting business, does not write a significant amount of natural catastrophe exposed business. We actively manage our exposure to catastrophes through our underwriting process, where we generally monitor the accumulation of insurable values in catastrophe-prone regions. Our geographic exposure to loss is principally confined to the Northeast, the Mid-Atlantic States and the Southeast corresponding to the locations of our branch operations. The PMA Insurance Group, exclusive of fronting business, maintains property catastrophe reinsurance protection of 95% of $18.0 million excess of $2.0 million per occurrence.
On October 1, 2007, we acquired all of the stock of Midlands Holding Corporation for $19.8 million. The ultimate purchase price for the stock could range from $22.8 million to $44.5 million based on the future earnings growth of Midlands during the four years following our date of acquisition. In 2008, we paid additional cash of $2.5 million to the former shareholders of Midlands for contractual earn-out and guaranteed payments. We expect to be able to pay most of any future earn-out payments through cash generated from Midlands’ operations. We also used holding company cash of $3.4 million for the return of estimated net worth on the closing date, which was adjusted for an additional payment of $811,000 in April 2008.
We have the right to call our 8.50% Monthly Income Senior Notes due 2018 at any time at 100% of the face amount of the notes, plus accrued interest.
Under the terms of the sale of one of our insurance subsidiaries, PMA Insurance Cayman, Ltd. (renamed Trabaja Reinsurance Company), to London Life and Casualty Reinsurance Corporation in 1998, we have agreed to indemnify the buyer, up to a maximum of $15.0 million, if the actual claim payments in the aggregate exceed the estimated payments upon which the loss reserves of the former subsidiary were established. If the actual claim payments in the aggregate are less than the estimated payments upon which the loss reserves have been established, we will participate in such favorable loss reserve development. Trabaja Reinsurance Company is our largest reinsurer. As of December 31, 2008, we are not aware of any significant changes from our original estimate. See Note 8 to the Consolidated Financial Statements for additional information.
We review the securities in our fixed income portfolio on a periodic basis to specifically identify individual securities for any meaningful decline in fair value below amortized cost. Our analysis includes all securities whose fair value is significantly below amortized cost at the time of the analysis, with additional emphasis placed on securities whose fair value has been below amortized cost for an extended period of time. As part of our periodic review process, we utilize information received from our outside professional asset manager to assess each issuer’s current credit situation. This review contemplates recent issuer activities, such as quarterly earnings announcements or other pertinent financial news for the issuer, recent developments in a particular industry, economic outlook for a particular industry and rating agency actions. For structured securities, we analyze the quality of the underlying collateral of the security.
LAE for unpaid claims or our estimates in future periods could exceed or be less than the reasonable range of possible outcomes that we can currently estimate.
In September 2006, the Company entered into an agreement with Midwest Insurance Companies (“Midwest”) under which it underwrote and serviced workers’ compensation policies in California using the Company’s approved forms and guidelines. During the term of the agreement, the Company retained between 0% and 10% of the underwriting results on this business. The Company also earned an administrative fee based upon the actual amount of premiums earned pursuant to the agreement. Total direct premiums written under this agreement were $10.4 million, $59.8 million and $14.8 million in 2008, 2007 and 2006, respectively. The Company’s agreement with Midwest was terminated in March 2008.
The Company used the $20.0 million net proceeds from the junior subordinated debt issued in 2007 to purchase, in the open market, its 6.50% Convertible Debt. In 2007, the Company retired $18.1 million principal amount of its 6.50% Convertible Debt for which it paid $21.2 million, exclusive of accrued interest. As the derivative component of the debt was already reflected in the debt balance, the purchase activity did not result in any significant realized gain or loss.
The Company is frequently involved in numerous lawsuits arising, for the most part, in the ordinary course of business, either as a liability insurer defending third-party claims brought against its insureds, or as an insurer defending coverage claims brought against it by its policyholders or other insurers. While the outcome of all litigation involving the Company, including insurance-related litigation, cannot be determined, such litigation is not expected to result in losses that differ from recorded reserves by amounts that would be material to the Company’s financial condition, results of operations or liquidity. For additional information about our liability for unpaid losses and loss adjustment expenses, see Note 7. In addition, reinsurance recoveries related to claims in litigation, net of the allowance for uncollectible reinsurance, are not expected to result in recoveries that differ from recorded receivables by amounts that would be material to the Company’s financial condition, results of operations or liquidity.
In a 2004 order (the “2004 Order”) approving the transfer of the Pooled Companies from PMACIC to PMA Capital Corporation, the Pennsylvania Insurance Department prohibited PMACIC from declaring or paying any dividends, return of capital or other types of distributions to PMA Capital Corporation prior to 2006. Under the terms of the 2004 Order, PMACIC was permitted to request an “extraordinary” dividend, as defined under Pennsylvania law, in 2006 provided that immediately after giving effect to the dividend or return of capital, PMACIC’s risk-based capital equaled or exceeded 225% of Authorized Control Level Capital, as defined by the National Association of Insurance Commissioners (“NAIC”). In 2006, the Department approved the Company’s request for an “extraordinary” dividend in the amount of $73.5 million from PMACIC. The Company used the proceeds to reduce its debt obligations and to maintain liquidity at the holding company. In 2007, the Department approved the Company’s request for an additional “extraordinary” dividend in the amount of $37.5 million from PMACIC. The Company did not receive any dividends from PMACIC in 2008, and given the pending sale of this operation in 2009, the Company does not expect to receive any dividends from PMACIC prior to the closing of the sale. As of December 31, 2008, the statutory surplus of PMACIC was $34.5 million, which included a $13.0 million capital contribution made by PMA Capital Corporation in the fourth quarter of 2008. The capital contribution included $5.0 million of cash and a promissory note of $8.0 million. As of December 31, 2008, the risk-based capital ratio of PMACIC was 202% of Authorized Control Level Capital.
The carrying amount reported in the balance sheet as of December 31, 2008 for the Senior Notes was $54.9 million. Based upon the quoted market price, the Company determined the fair value of its Senior Notes to be $42.0 million at December 31, 2008.
The Company files income tax returns in the U.S. federal jurisdiction and in various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2005. The Company is currently not under examination by any tax authority. The Company does not anticipate any significant changes to its total unrecognized tax benefits within the next 12 months. The Company will recognize, as applicable, interest and penalties related to unrecognized tax positions as part of income taxes.
The Company’s depreciation and amortization expense by principal business segment were as follows: