Effective at the close of business April 24, 2000, all shares of Common Stock were reclassified as Class A Common stock. Accordingly, all dividends subsequent to April 24, 2000 are for the Class A Common stock.
(5) The expense ratio equals the sum of acquisition and insurance-related operating expenses divided by net premiums earned. Acquisition and insurance-related expenses for The PMA Insurance Group were $129.7 million, $142.7 million, $108.6 million, $92.3 million and $72.5 million for 2004, 2003, 2002, 2001 and 2000.
(6) The combined ratio computed on a GAAP basis is equal to losses and loss adjustment expenses plus acquisition expenses and policyholders' dividends (where applicable), all divided by net premiums earned.
The following is a discussion of the financial condition of PMA Capital Corporation and its consolidated subsidiaries (“PMA Capital” or the “Company” which also may be referred to as “we” or “us”) as of December 31, 2004, compared with December 31, 2003, and the results of operations of PMA Capital for 2004 and 2003, compared with the immediately preceding year. The balance sheet information presented below is as of December 31 for each respective year. The statement of operations information is for the year ended December 31 for each respective year.
We are a property and casualty insurance holding company, which offers through our subsidiaries workers’ compensation, integrated disability and, to a lesser extent, other standard lines of commercial insurance, primarily in the eastern part of the United States. These products are written through The PMA Insurance Group business segment. Our Run-off Operations include our prior reinsurance and excess and surplus lines operations.
Our business profile changed significantly in 2003 and 2004. On November 4, 2003, we announced a third quarter pre-tax charge of $150 million to increase the loss reserves for our reinsurance business for prior accident years. Following this announcement, A.M. Best Company, Inc. (“A.M. Best”) reduced the financial strength ratings of PMA Capital Insurance Company (“PMACIC”), our reinsurance subsidiary, and The PMA Insurance Group companies, our primary insurance business, to B++ (Very Good). On November 6, 2003, we announced our decision to cease writing reinsurance business and to run off our existing reinsurance business. We also decided to suspend payment of dividends on our Class A common stock. The B++ financial strength rating constrained The PMA Insurance Group’s ability to attract and retain business during 2004.
considered “extraordinary” under Pennsylvania insurance law. At December 31, 2004, PMACIC’s risk-based capital is 379% of Authorized Control Level Capital.
On November 15, 2004, we exchanged $84.1 million aggregate principal amount of 6.50% Senior Secured Convertible Debt due 2022 (“6.50% Convertible Debt”) for $84.1 million aggregate principal amount of 4.25% Senior Convertible Debt due 2022 (“4.25% Convertible Debt”). We did not receive any proceeds as a result of the exchange offer. The exchange allowed us to extend the first put date associated with our convertible debt from September 2006 to June 2009. We also raised an additional $15 million of capital from the sale of 6.50% Convertible Debt on November 15, 2004. We expect to be able to receive capital distributions from our principal operating subsidiaries sufficient to repurchase the new debt on the put date of June 30, 2009.
acquisition and operating expenses, which are direct and indirect costs of acquiring both new and renewal business, including commissions paid to agents and brokers, and the internal expenses to operate the business segment; and
Including the increase in the fair value of the derivative component of the 6.50% Convertible Debt, after-tax net realized investment gains were $4.2 million for 2004, primarily reflecting sales reducing our per issuer exposure and general duration management trades. After-tax net realized gains were $9.0 million in 2003, compared to after-tax losses of $10.5 million in 2002. Net realized investment gains in 2003 were primarily attributable to sales intended to change the duration of our investment portfolio in order to better match our cash flows with our liability payouts. Net realized investment losses for 2002 primarily reflect impairment losses of $15.4 million after-tax ($23.8 million pre-tax) on fixed income securities, primarily corporate bonds issued by telecommunications and energy companies.
Results for 2002 were reduced by approximately $76 million after-tax ($116 million pre-tax: $64 million for our reinsurance business and $52 million for our excess and surplus lines business) due to unfavorable prior year loss development at the Run-off Operations. Additionally, results for 2002 included a charge of $28 million after-tax for non-reserve charges ($43 million pre-tax) associated with our decision to exit and run off our excess and surplus lines business.
In this MD&A, in addition to providing consolidated net income (loss), we also provide segment operating income (loss) because we believe that it is a meaningful measure of the profit or loss generated by our operating segments. Operating income (loss), which is GAAP net income (loss) excluding net realized investment gains and losses, is the financial performance measure used by our management and Board of Directors to evaluate and assess the results of our insurance businesses. Accordingly, we report operating income by segment in Note 15 to the Consolidated Financial Statements as required by SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information." Our management and Board of Directors use operating income as the measure of financial performance because (i) net realized investment gains and losses are unpredictable and not necessarily indicative of current operating fundamentals or future performance of the business segments and (ii) in many instances, decisions to buy and sell securities are made at the holding company level, and such decisions result in net realized gains and losses that do not relate to the operations of the individual segments. Operating income (loss) does not replace net income (loss) as the GAAP measure of our consolidated results of operations.
We also provide combined ratios and operating ratios for The PMA Insurance Group on page 38. The “combined ratio” is a measure of property and casualty underwriting performance. The combined ratio computed using GAAP-basis numbers is equal to losses and LAE, plus acquisition expenses, insurance-related operating expenses and policyholders’ dividends, where applicable, all divided by net premiums earned. A combined ratio of less than 100% reflects an underwriting profit. Because time normally elapses between the receipt of premiums and the payment of claims and certain related expenses, we invest the available premiums. Underwriting results do not include investment income from these funds. Given the long-tail
nature of our liabilities, we believe that the operating ratios are also important in evaluating our business. The operating ratio is the combined ratio less the net investment income ratio, which is net investment income divided by net premiums earned.
Direct workers’ compensation and integrated disability premiums written were $341.2 million in 2004, compared to $546.1 million in 2003, primarily reflecting the impact of the B++ A.M. Best financial strength rating between November 2003 and November 2004. This rating constrained our ability to write new business and to retain existing business in 2004. In 2003, direct workers' compensation and integrated disability premiums written increased by 37%, compared to 2002, primarily due to an increase in the volume of risks underwritten, and to a lesser extent, pricing increases. In addition, direct workers' compensation premiums written for 2003 included $35 million of retrospectively rated premiums recorded in the fourth quarter under loss-sensitive policies that are attributable to the higher than expected losses from accident years 2001 and 2002. See “Losses and Expenses” beginning on page 40 for additional information. Our renewal retention rate on existing workers’ compensation accounts was 62% for 2004, compared to 84% for 2003 and 82% for 2002. New workers’ compensation and integrated disability business was $42.1 million for 2004, compared to $133.3 million and $123.3 million for 2003 and 2002, respectively. We obtained price increases of approximately 6% in 2004, 10% in 2003 and 17% in 2002 on workers’ compensation business.
Premiums ceded decreased $29.6 million in 2004 and increased $11.8 million in 2003, compared to the immediately preceding years. Premiums ceded for workers’ compensation and integrated disability decreased by $24.4 million in 2004, compared to 2003, as a result of lower direct premiums written for those lines and because The PMA Insurance Group increased its aggregate annual deductible for losses in excess of $250,000 to $18.8 million from $5.0 million on its workers’ compensation reinsurance program. Premiums ceded for workers’ compensation and integrated disability increased by $21.1 million in 2003, compared to 2002, as a result of the increase in direct premiums written as well as higher rates being charged by reinsurers. Premiums ceded for Commercial Lines were lower by $5.2 million and $9.3 million in 2004 and 2003, respectively, compared to the immediately preceding years, primarily reflecting the decrease in direct premiums written for commercial lines in 2004 and the increase in our net retentions in Commercial Lines from $500,000 in 2002 to $1.5 million in 2003.
The loss and LAE ratio improved 2.7 points in 2004, compared to 2003. The lower loss and LAE ratio in 2004, compared to 2003, primarily reflects the effects on the 2003 loss and LAE ratio of the higher than expected losses and LAE for workers’ compensation business written for accident years 2001 and 2002 as discussed below, partially offset by a higher current accident year loss and LAE ratio in 2004. Overall loss trends in workers’ compensation are rising modestly ahead of price increases. Medical cost inflation, which has contributed to increased severity of workers’ compensation losses, was the primary reason for the increasing accident year loss costs in 2004. We estimate our medical cost inflation for 2004 to be 11%, which is the same as our estimate for 2003. We expect medical cost inflation to remain a significant component of loss costs in 2005.
Overall, the loss and LAE ratio increased by 2.6 points in 2003, compared to 2002, reflecting the effects of prior year loss development described above, partially offset by an improved current accident year loss and LAE ratio. Our current accident year loss and LAE ratio improved 5.3 points in 2003, compared to 2002, including 4.5 points due to the premium adjustment of $35 million recorded in the fourth quarter for policies of loss-sensitive plans. The remainder of the improvement is primarily due to price increases that outpaced increasing loss costs. Medical cost inflation was the primary reason for the increasing loss costs in 2003.
In November 2003, we announced our decision to withdraw from the reinsurance business previously served by our PMA Re operating segment. We are no longer writing new reinsurance business. As a result of this decision, the results of PMA Re are reported as Run-off Operations. Run-off Operations also includes the results of our former excess and surplus lines business, which we placed in run-off in May 2002.
exit from the reinsurance business. Results for the Run-off Operations for 2004 will not be indicative of future results due to our expectation that earned premiums and related losses and expenses will decrease significantly and due to the unpredictability of the impact of future commutations, if any. Results for 2003 reflected the third quarter $150 million charge to increase loss reserves for our reinsurance business associated mainly with accident years 1997 to 2000. Results for 2002 were reduced by approximately $116 million ($64 million for our reinsurance business and $52 million for our excess and surplus lines business) due to unfavorable prior year loss development. Additionally, the Run-off Operations recorded a charge of $43 million pre-tax as a result of our decision to exit the excess and surplus line business in 2002.
Generally, trends in net premiums earned follow patterns similar to net premiums written. In periods of decreasing premium writings, the decrease in net premiums written will typically be greater than the decrease in net premiums earned, as was the case in 2004 and 2003. Premiums are earned principally on a pro rata basis over the coverage periods of the underlying policies. However, with respect to policies that provide for premium adjustments, such as experience-rated or exposure-based adjustments, such premium adjustments may be made subsequent to the end of the policy’s coverage period and will be recorded as earned premiums in the period in which the adjustment is made.
The Corporate and Other segment primarily includes corporate expenses, including debt service. This segment recorded pre-tax operating losses of $21.2 million, $22.7 million and $14.2 million in 2004, 2003 and 2002, respectively. During 2004, we sold a real estate partnership interest resulting in a pre-tax gain of $6.6 million, which is included in other revenues. Partially offsetting this gain was a pre-tax loss of $6.0 million related to the convertible debt exchange, including $4.7 million to record the 6.50% Convertible Debt at fair value and $1.3 million to write off the unamortized issuance costs on the 4.25% Convertible Debt. Results for 2004 also reflect lower operating expenses, partially offset by higher interest expense. Operating expenses for 2003 included approximately $3 million of accrued costs associated primarily with the remaining salary obligations under
employment contracts with certain of our former executive officers. Interest expense increased by $2.5 million in 2004 and $6.6 million in 2003, compared to the immediately preceding years, primarily due to a higher average amount of debt outstanding.
During 2004, our actuaries conducted their periodic reserve reviews of The PMA Insurance Group and the Run-off Operations. Based on the actuarial work performed, which included analyzing recent trends in the levels of the reported and paid claims, an updated selection of actuarially determined loss reserve estimates was developed by accident year for each major line of business. The information derived during these reviews indicated that general liability and professional liability lines written by the Run-off Operations continued to exhibit volatility. While the conclusion of the reviews indicated that no adjustments to reserves were necessary and that our carried reserves were reasonable, continued volatility could require adjustments in future periods.
Estimating reserves for asbestos and environmental exposures continues to be difficult because of several factors, including: (i) evolving methodologies for the estimation of the liabilities; (ii) lack of reliable historical claim data; (iii) uncertainties with respect to insurance and reinsurance coverage related to these obligations; (iv) changing judicial interpretations; and (v) changing government standards. Management believes that its reserves for asbestos and environmental claims are appropriately established based upon known facts, existing case law and generally accepted
actuarial methodologies. However, due to changing interpretations by courts involving coverage issues, the potential for changes in Federal and state standards for clean-up and liability, as well as issues involving policy provisions, allocation of liability and damages among participating insurers, and proof of coverage, our ultimate exposure for these claims may vary significantly from the amounts currently recorded, resulting in a potential future adjustment that could be material to our financial condition and results of operations.
Under our reinsurance and retrocessional coverages in place during 2004, 2003 and 2002, we ceded premiums totaling $78.9 million, $228.6 million and $300.6 million, and we ceded losses and LAE of $99.8 million, $243.1 million and $223.2 million to reinsurers and retrocessionaires.
At December 31, 2004, we had reinsurance receivables due from the following unaffiliated reinsurers in excess of 5% of our shareholders’ equity:
The PMA Insurance Group has recorded reinsurance receivables of $13.9 million at December 31, 2004, related to certain umbrella policies covering years prior to 1977. The reinsurer has disputed the extent of coverage under these policies. The ultimate resolution of this dispute cannot be determined at this time. An unfavorable resolution of the dispute could have a material adverse effect on our financial condition and results of operations. See “Critical Accounting Estimates - Reinsurance Receivables” beginning on page 57 and Note 5 to our Consolidated Financial Statements for additional information.
In 2004, the Run-off Operations purchased reinsurance to protect its statutory capital from adverse loss development of its loss and LAE reserves. Under the agreement, we ceded $100 million in carried loss and LAE reserves and paid $146.5 million in cash. During 2004, the Run-off Operations incurred $6.0 million in ceded premiums for this agreement. In addition, the contract requires additional premiums of $2.5 million if it is not commuted by December 2007. At December 31, 2004, the Run-off Operations had $105 million of available coverage under this agreement for future adverse loss development. Any future cession of losses may require the Company to cede additional premiums of up to $35 million on a pro rata basis, at the following contractually determined levels:
The additional premiums have been prepaid and are included in other assets on the Balance Sheet. Because the coverage is retroactive, we will not record the benefit of this reinsurance in our consolidated Statements of Operations until we receive the related recoveries. See Run-off Operations beginning on page 41 for additional information regarding this reinsurance coverage.
See Note 5 to our Consolidated Financial Statements for additional discussion.
Workers’ compensation insurers were not permitted to exclude terrorism from coverage prior to the enactment of TRIA, and continue to be subject to this prohibition. When underwriting existing and new commercial insurance business, The PMA Insurance Group considers the added potential risk of loss due to terrorist activity, and this may lead it to decline to write or non-renew certain business. Additional rates may be charged for terrorism coverage, and as of January 1, 2004, The PMA Insurance Group had adopted premium charges for workers’ compensation insurance in all states. The PMA Insurance Group has also refined its underwriting procedures in consideration of terrorism risks.
However, because of the unpredictable nature of terrorism, TRIA’s uncertain application and the amount of terrorism losses that The PMA Insurance Group must retain under TRIA, if future terrorist attacks occur, they may result in losses that could have a material adverse effect on our financial condition, results of operations and liquidity. For additional information regarding the underwriting criteria of our operating segments, see “Item 1 - Business - The PMA Insurance Group, Underwriting.”
At the holding company level, our primary sources of liquidity are dividends and net tax payments received from subsidiaries, and capital raising activities. We utilize cash to pay debt obligations, including interest costs; taxes to the Federal government; corporate expenses; and dividends to shareholders.
In 2004, the Pennsylvania Insurance Department approved our application for the Pooled Companies, previously subsidiaries of PMACIC, to become direct, wholly owned subsidiaries of PMA Capital Corporation. However, in its Order approving the transfer of the Pooled Companies from PMACIC to PMA Capital Corporation, the Pennsylvania Insurance Department prohibited PMACIC, our reinsurance subsidiary which is currently in run-off, from any declaration or payment of dividends, return of capital or any other types of distributions in 2004 and 2005 to PMA Capital Corporation. In 2006, PMACIC may declare and pay ordinary dividends or returns of capital without the prior approval of the Pennsylvania Insurance Department if, immediately after giving effect to the dividend or returns of capital, PMACIC’s risk-based capital equals or exceeds 225% of Authorized Control Level Capital as defined by the National Association of Insurance Commissioners. In 2007 and beyond, PMACIC may make dividend payments, as long as such dividends are not considered “extraordinary” under Pennsylvania insurance law. At December 31, 2004, PMACIC’s risk-based capital is 379% of Authorized Control Level Capital.
convertible at the rate of 61.0948 shares, equivalent to a conversion price of $16.368 per share of Class A common stock. The indenture governing the 6.50% Convertible Debt contains restrictive covenants with respect to limitations on our ability to incur indebtedness, enter into transactions with affiliates or engage in a merger or sale of all or substantially all of the Company's assets.
At December 31, 2004, we had $31.3 million of cash and short-term investments at the holding company and its non-regulated subsidiaries, which, we believe combined with our other capital sources, will continue to provide us with sufficient funds to meet our foreseeable ongoing expenses and interest payments.
See discussion below for the variable interest rates on the Trust Preferred Debt. The obligations related to the Trust Preferred Debt have been calculated using the interest rates in effect at December 31, 2004.
The operating lease obligations referred to in the table above are primarily obligations of our insurance subsidiaries and are net of sublease payments of $1.5 million in 2005, $3.1 million in 2006-2007, $4.9 million in 2008-2010 and $6.2 million thereafter.
In 2003, we issued $43.8 million of 30-year floating rate subordinated debentures to three wholly owned statutory trust subsidiaries. We used all of the $41.2 million of net proceeds to pay down a portion of our then outstanding bank credit facility and for general corporate purposes. The trust preferred debt matures in 2033 and is redeemable, in whole or in part, in 2008 at its stated liquidation amount plus accrued and unpaid interest. The interest rates on the trust preferred debt equals the three-month London InterBank Offered Rate ("LIBOR") plus 4.10%, 4.20% and 4.05% and is payable on a quarterly basis. At December 31, 2004, the weighted average interest rate on the trust preferred securities was 6.51%.
We have the right to defer interest payments on the trust preferred securities for up to twenty consecutive quarters but, if so deferred, we may not declare or pay cash dividends or distributions on our Class A common stock. The obligations of the
We did not repurchase any shares during 2004 or 2003. We repurchased 90,000 shares of our Class A Common stock at a cost of $1.7 million in 2002. Decisions regarding share repurchases are subject to prevailing market conditions and an evaluation of the costs and benefits associated with alternative uses of capital.
We had an interest in a real estate partnership for which we had provided a guaranty of $7.0 million related to loans on properties of the partnership. We sold our interest in the partnership in 2004, and as such, this guaranty terminated at the time of the sale.
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. See Note 5 to the Consolidated Financial Statements for additional information.
Our investment portfolio includes only fixed maturities, short-term investments and cash. The portfolio is diversified and does not contain any significant concentrations in single issuers other than U.S. Treasury and agency obligations. Our largest exposure to a single corporate issuer is $17.2 million, or 1% of total invested assets. In addition, we do not have a significant concentration of our investments in any single industry segment other than finance companies, which comprise 10% of invested assets at December 31, 2004. Included in this industry segment are diverse financial institutions, including the financing subsidiaries of automotive manufacturers. Substantially all of our investments are dollar denominated as of December 31, 2004.
Mortgage-backed and other asset-backed securities in the table above include collateralized mortgage obligations (“CMOs”) of $170.1 million and $209.2 million carried at fair value as of December 31, 2004 and 2003. CMO holdings are concentrated in securities with limited prepayment, extension and default risk, such as planned amortization class bonds.
The net unrealized gain on our investments at December 31, 2004 was $20.8 million, or 1.5% of the amortized cost basis. The net unrealized gain included gross unrealized gains of $33.1 million and gross unrealized losses of $12.3 million.
For all but two securities, which were carried at a fair value of $16.9 million at December 31, 2004, we determine the market value of each fixed income security using prices obtained in the public markets. For these two securities, whose fair values are not reliably determined from these public market sources, we utilize the services of our outside professional investment asset managers to determine the fair value. The asset managers determine the fair value of the securities by using a discounted present value of the estimated future cash flows (interest and principal repayment).
We review the securities in our fixed income portfolio on a periodic basis to specifically review individual securities for any meaningful decline in market value below amortized cost. Our analysis addresses 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 the expertise of our outside professional asset managers who provide us with an updated assessment of each issuer’s current credit situation based on recent issuer activities, such as quarterly earnings announcements or other pertinent financial news for the company, recent developments in a particular industry, economic outlook for a particular industry and rating agency actions.
For all securities that are in an unrealized loss position for an extended period of time, we perform an evaluation of the specific events attributable to the market decline of the security. We consider the length of time and extent to which the security’s market value has been below cost as well as the general market conditions, industry characteristics and the fundamental operating results of the issuer to determine if the decline is due to changes in interest rates, changes relating to a decline in credit quality of the issuer, or general market conditions. We also consider as part of the evaluation our intent and ability to hold the security until its market value has recovered to a level at least equal to the amortized cost. Where we determine that a security’s unrealized loss is other than temporary, a realized loss is recognized in the period in which the decline in value is determined to be other than temporary.
At December 31, 2004, 99% of our fixed income investments were publicly traded and all were rated by at least one nationally recognized credit rating agency. In addition, at December 31, 2004, $12.4 million, or 0.9%, of our total investments were below investment grade. Of these below investment grade investments, $2.9 million were in an unrealized loss position, which totaled $195,000.
During 2003, we recorded other than temporary impairment charges for securities issued by four companies, resulting in impairment losses of $2.6 million in 2003, primarily related to securities issued by airline companies and one asset-backed security. During 2002, we impaired securities issued by 11 companies, resulting in impairment charges of $23.8 million during 2002, including $14.2 million for WorldCom. See Critical Accounting Estimates - Investments on page 56 for additional information.
We had pre-tax net realized investment gains of $6.5 million in 2004, compared to $13.8 million in 2003 and net realized investment losses of $16.1 million in 2002. During 2004, there were gross realized investment gains and losses of $20.1 million and $4.9 million, respectively. Also included in 2004 net realized investment gains were realized losses of $3.8 million related to the increase in the fair value of the derivative component of our 6.50% Convertible Debt and $4.9 million of foreign exchange losses. Gross realized losses in 2004 reflected sales reducing our per issuer exposure and general duration management trades, impairment losses of $334,000 on fixed income securities and realized losses of $380,000 on sales of securities where we reduced and/or eliminated our positions in certain issuers due to credit concerns.
See “Item 1 - Business - Investments” and Notes 2B and 3 to our Consolidated Financial Statements for additional discussion about our investment portfolio.
In December 2003, the Financial Accounting Standards Board (“FASB”) revised Statement of Financial Accounting Standards (“SFAS”) No. 132, “Employers’ Disclosures About Pensions and Other Postretirement Benefits,” to require additional disclosures regarding defined benefit pension plans and other defined benefit postretirement plans. We have applied the disclosure provisions of SFAS No. 132, as revised, to our Consolidated Financial Statements.
In March 2004, the EITF reached a consensus regarding EITF 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The consensus provides guidance for evaluating whether an investment is other-than-temporarily impaired. The disclosure provisions of EITF 03-1 were effective for year-end 2003, with the recognition and measurement provisions scheduled to be effective for the third quarter of 2004. However, in September 2004, the FASB issued Staff Position EITF 03-1-1, which delays the effective date of the application of the recognition and measurement provisions of EITF 03-1. The delay of the recognition and measurement provisions is expected to be superseded concurrently with the issuance of a FASB Staff Position which will provide additional implementation guidance. We will assess whether this guidance will have a material impact on our financial condition or results of operations once the new guidance is released.
At December 31, 2004, we estimated that under all insurance policies and reinsurance contracts issued by our insurance businesses, our liability for all events that occurred as of December 31, 2004 is $2,111.6 million. This amount includes estimated losses from claims plus estimated expenses to settle claims. Our estimate also includes amounts for losses occurring prior to December 31, 2004 whether or not these claims have been reported to us.
In arriving at the estimate of unpaid claims, our actuaries performed detailed studies of historical data for customer mix, incurred claims, reported claims and paid claims for each major line of business and by accident year. The review of this data results in patterns and trends that are analyzed using various actuarial models that assume that historical development patterns will be predictive of future patterns. Along with this historical data, our actuaries consider the impact of legal and legislative developments, regulatory trends, changes in social attitudes and economic conditions. From this assessment, we develop various sets of assumptions that we believe are reasonable, valid and can be used to help us predict future claim trends. These assumptions are then applied to various actuarially accepted methods and techniques, which provide us with a range of possible outcomes of the ultimate claims to be paid by us in the future. Management uses its judgment to select the
best estimate of the amounts needed to pay all future claims and related expenses from this range of possible outcomes. Under GAAP, we record a liability on our balance sheet equal to our best estimate of the ultimate claims liability.
For additional information about our liability for unpaid losses and loss adjustment expenses, see Notes 2-D and 4 to the Consolidated Financial Statements as well as “Item 1 - Business - Loss Reserves.”
We follow the customary insurance industry practice of reinsuring with other insurance and reinsurance companies a portion of the risks under the policies written by our insurance and reinsurance subsidiaries. Our reinsurance receivables total $1,142.6 million at December 31, 2004. We have estimated that $9.0 million of our total reinsurance receivables will be uncollectible, and we have provided a valuation allowance for that amount.
Based on our evaluation of reinsurance receivables at December 31, 2004, we have established an allowance for amounts that we have concluded are uncollectible at the balance sheet date. In evaluating collectibility, we considered historical payment performance of our reinsurers, the fact that our reinsurers are current on their obligations to our insurance subsidiaries, and any known disputes or collection issues as of the balance sheet date. To these factors, we applied our informed judgment in ascertaining the appropriate level of allowance for uncollectible amounts. At December 31, 2004, approximately $17.6 million of uncollateralized reinsurance receivables, including $6.5 million due for ceded IBNR, are due from reinsurers who have ratings that declined to below “Adequate,” defined as B++ or below by A.M. Best, in 2004 or who were under regulatory supervision or in liquidation in 2004.
For additional information about reinsurance receivables, see Note 5 to the Consolidated Financial Statements as well as “Reinsurance” beginning on page 45.
We record deferred tax assets and liabilities to the extent of the tax effect of differences between the financial statement carrying values and tax bases of assets and liabilities. The recoverability of deferred tax assets is evaluated based upon management’s estimates of the future profitability of our taxable entities based on current forecasts. We establish a valuation allowance for deferred tax assets where it appears more likely than not that we will not be able to recover the deferred tax asset. At December 31, 2004, PMA Capital has a net deferred tax asset of $86.5 million, resulting from $170.9 million of gross deferred tax assets reduced by a deferred tax asset valuation allowance of $57.0 million and by $27.4 million of deferred tax liabilities. In establishing the appropriate value of this asset, management must make judgments about our ability to utilize the net tax benefit from the reversal of temporary differences and the utilization of operating loss carryforwards that expire mainly from 2018 through 2024.
In 2003, a valuation allowance in the amount of $49 million was established. In the fourth quarter of 2004, we reassessed the valuation allowance previously established against our net deferred tax assets and determined that it needed to be increased by $8 million. Included in management’s reassessment were such factors as the recent losses and revised projections of future earnings at the Run-off Operations. Accordingly, we have estimated at December 31, 2004 that our insurance operations will generate sufficient future taxable income to utilize the net deferred tax asset, net of the $57.0 million valuation allowance, over a period of time not exceeding the expiration of our operating loss carryforwards. As a result, we determined that it is more likely than not that we will be able to realize the future tax benefit of our net deferred tax asset. In making this determination, we have made reasonable estimates of our future taxable income. If our estimates of future income were to be revised downward and we determined that it was then more likely than not that we would not be able to realize the value of our net deferred tax asset, then this could have a material adverse effect on our results of operations. For additional information see Note 12 to our Consolidated Financial Statements.
Premiums, including estimates of additional premiums resulting from audits of insureds’ records, and premiums from ceding companies which are typically reported on a delayed basis, are earned principally on a pro rata basis over the terms of the policies. As discussed in “PMA Insurance Group - Premiums” beginning on page 39, in the fourth quarter of 2003, The PMA Insurance Group recorded $35 million of retrospectively rated premiums under loss sensitive policies that were attributable to higher than expected losses from accident years 2001 and 2002. Under The PMA Insurance Group’s loss-sensitive rating plans, we adjust the amount of the insured’s premiums after the policy period expires based, to a large extent, upon the insured’s actual loss experience during the policy period. Retrospectively rated premium adjustments and audit premium adjustments are recorded as earned in the period in which the adjustment is made.
adverse property and casualty loss development for events that we insured in prior years, including unforeseen increases in medical costs;
Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2004, 2003 and
Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2004, 2003 and 2002
Premiums receivable (net of valuation allowance: 2004 - $7,049; 2003 - $7,972)
Reinsurance receivables (net of valuation allowance: 2004 - $9,002; 2003 - $6,769)
The PMA Insurance Group - The PMA Insurance Group writes workers’ compensation, integrated disability and, to a lesser extent, other standard lines of commercial insurance, primarily in the eastern part of the United States. Approximately 87% of The PMA Insurance Group’s business for 2004 was produced through independent agents and brokers.
C. Premiums - Premiums, including estimates of additional premiums resulting from audits of insureds’ records, and premiums from ceding companies which are typically reported on a delayed basis, are earned principally on a pro rata basis over the terms of the policies. For reinsurance premiums assumed, management must estimate the subject premiums associated with the treaties in order to determine the level of written and earned premiums for a reporting period. Such estimates are based on information from brokers and ceding companies, which can be subject to change as new information becomes available. Any changes occurring or reported to the Company after the policy term are recorded as earned premiums in the period in which the adjustment is made. See Note 4 for additional information. With respect to policies that provide for premium adjustments, such as experience-rated or exposure-based adjustments, such premium adjustments may be made subsequent to the end of the policy’s coverage period and will be recorded as earned premiums in the period in which the adjustment is made. Premiums applicable to the unexpired terms of policies in force are reported as unearned premiums. The estimated premiums receivable on retrospectively rated policies are reported as a component of premiums receivable.
D. Unpaid Losses and Loss Adjustment Expenses - Unpaid losses and loss adjustment expenses (“LAE”), which are stated net of estimated salvage and subrogation, are estimates of losses and LAE on known claims and estimates of losses and LAE incurred but not reported (“IBNR”). IBNR reserves are calculated utilizing various actuarial methods. Unpaid losses on certain workers’ compensation claims are discounted to present value using the Company’s payment experience and mortality and interest assumptions in accordance with statutory accounting practices prescribed by the Pennsylvania Insurance Department. The Company also discounts unpaid losses and LAE for certain other claims at rates permitted by domiciliary regulators or if the timing and amount of such claims are fixed and determinable. The methods of making such estimates and establishing the resulting reserves are continually reviewed and updated and any adjustments resulting there from are reflected in earnings in the period identified. See Note 4 for additional information.
anticipated investment income. To the extent that acquisition costs are not recoverable, the deficiency is charged to income in the period identified.
G. Derivatives - The derivative component of the Company’s 6.50% Senior Secured Convertible Debt due 2022 (“6.50% Convertible Debt”) is bifurcated and recorded at fair value in long-term debt on the Balance Sheet. Changes in fair value are recorded in net realized investment gains (losses). See Note 6 for additional information.
In December 2004, the Company adopted Emerging Issues Task Force (“EITF”) Consensus 04-8, “The Effect of Contingently Convertible Debt on Diluted Earnings Per Share,” which requires the inclusion of the dilutive effect of contingently convertible debt instruments in the computation of diluted income (loss) per share regardless of whether the contingency triggering convertibility has been met. The Company’s earnings per share calculation for the first and second quarters of 2003 did not include the effects of potential conversion because the conditions for convertibility had not yet occurred. Adoption of EITF 04-8 resulted in a reduction in the Company’s first and second quarter 2003 diluted income per share by three and four cents, respectively, but has no effect for full year 2003, because the effect of conversion would have been anti-dilutive. Beginning in the third quarter of 2003, the conversion requirements were met on the Company’s convertible debt. See unaudited “Quarterly Financial Information” for additional information.
In March 2004, the EITF reached a consensus regarding EITF 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The consensus provides guidance for evaluating whether an investment is other-than-temporarily impaired. The disclosure provisions of EITF 03-1 were effective for year-end 2003, with the recognition and measurement provisions scheduled to be effective for the third quarter of 2004. However, in September 2004, the FASB issued Staff Position EITF 03-1-1, which delays the effective date of the application of the recognition and measurement provisions of EITF 03-1. The delay of the recognition and measurement provisions is expected to be superseded concurrently with the issuance of a FASB Staff Position which will provide additional implementation guidance. The Company will assess whether this guidance will have a material impact on its financial condition or results of operations once the new guidance is released.
In December 2004, the FASB revised SFAS No. 123, “Share-Based Payment” to require the recognition of expenses relating to share-based payment transactions, including employee stock option grants, based on the fair value of the equity instruments issued. The Company is required to adopt the revised SFAS No. 123 in the third quarter of 2005. Effective with the third quarter of 2005, the Company will recognize an expense over the required service period for any stock options granted, modified, cancelled, or repurchased after that date and for the portion of grants for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards. In December 2002, the Company adopted the disclosure provisions of SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure,” which required prominent disclosures in financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. See Note 2-J for the effect on net income (loss) if the fair value based method had been applied.
The Company’s investment portfolio is diversified and does not contain any significant concentrations in single issuers other than U.S. Treasury and agency obligations. In addition, the Company does not have a significant concentration of investments in any single industry segment other than finance companies, which comprise 10% of invested assets at December 31, 2004. Included in this industry segment are diverse financial institutions, including the financing subsidiaries of automotive manufacturers.
The amortized cost and fair value of fixed maturities at December 31, 2004, by contractual maturity, are as follows:
The following table summarizes the effect on the Company’s underwriting assets and liabilities of the commutation and novation of certain reinsurance and retrocessional contracts by the Run-off Operations segment occurring in 2004. The commutations and novations did not have a material effect on the Company’s results of operations for 2004.
During 2004, the favorable prior year loss development at the Run-off Operations related primarily to reinsurance contracts that were novated or commuted. This favorable prior year loss development was substantially offset by net premiums earned and acquisition expenses.
During 2002, the Run-off Operations also recorded unfavorable prior year development of $107 million for the reinsurance business. During the fourth quarter, the Company’s actuaries observed a higher than expected increase in the frequency and, to a lesser extent, severity of reported claims by ceding companies. Management’s selection of the ultimate losses indicated that net loss and LAE reserves for prior accident years needed to be increased by $64 million in the fourth quarter of 2002, primarily for excess of loss and pro rata general liability occurrence contracts and, to a lesser extent, excess of loss general liability claims-made contracts, from accident years 1998, 1999 and 2000.
Management believes that its unpaid losses and LAE are fairly stated at December 31, 2004. However, estimating the ultimate claims liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management’s informed estimates, assumptions and judgments using data currently available. As additional experience and data become available regarding claims payment and reporting patterns, legal and legislative developments, judicial theories of liability, the impact of regulatory trends on benefit levels for both medical and indemnity payments, changes in social attitudes and economic conditions, the estimates are revised accordingly. If the Company’s ultimate losses, net of reinsurance, prove to differ substantially from the amounts recorded at December 31, 2004, the related adjustments could have a material adverse effect on the Company’s financial condition, results of operations and liquidity.
At December 31, 2004, 2003 and 2002, gross reserves for asbestos-related losses were $27.9 million, $37.8 million and $42.1 million, respectively ($14.0 million, $17.8 million and $25.8 million, net of reinsurance, respectively). Of the net asbestos reserves, approximately $10.3 million, $14.9 million and $22.9 million related to IBNR losses at December 31, 2004, 2003 and 2002, respectively.
At December 31, 2004, 2003 and 2002, gross reserves for environmental-related losses were $16.1 million, $14.2 million and $18.2 million, respectively ($6.4 million, $8.8 million and $14.3 million, net of reinsurance, respectively). Of the net environmental reserves, approximately $3.0 million, $3.7 million, and $7.9 million related to IBNR losses at December 31, 2004, 2003 and 2002, respectively. All incurred asbestos and environmental losses were for accident years 1986 and prior.
Estimating reserves for asbestos and environmental exposures continues to be difficult because of several factors, including: (i) evolving methodologies for the estimation of the liabilities; (ii) lack of reliable historical claim data; (iii) uncertainties with respect to insurance and reinsurance coverage related to these obligations; (iv) changing judicial interpretations; and (v) changing government standards. Management believes that its reserves for asbestos and environmental claims are appropriately established based upon known facts, existing case law and generally accepted actuarial methodologies. However, due to changing interpretations by courts involving coverage issues, the potential for changes in Federal and state standards for clean-up and liability, as well as issues involving policy provisions, allocation of liability and damages among participating insurers, and proof of coverage, the Company’s ultimate exposure for these claims may vary significantly from the amounts currently recorded, resulting in a potential future adjustment that could be material to the Company’s financial condition, results of operations and liquidity.
At December 31, 2004, the Company had reinsurance receivables due from the following unaffiliated reinsurers in excess of 5% of shareholders’ equity:
The Company performs credit reviews of its reinsurers focusing on, among other things, financial capacity, stability, trends and commitment to the reinsurance business. Reinsurers failing to meet the Company’s standards are excluded from the Company’s reinsurance programs. In addition, the Company requires collateral, typically assets in trust, letters of credit or funds withheld, to support balances due from certain reinsurers, generally those not authorized to transact business in the applicable jurisdictions. At December 31, 2004 and 2003, the Company’s reinsurance receivables of $1,142.6 million and $1,220.3 million were supported by $507.2 million and $644.1 million of collateral. Of the uncollateralized reinsurance receivables as of December 31, 2004, approximately 94% were from reinsurers rated “A-” or better by A.M. Best.
The PMA Insurance Group has recorded reinsurance receivables of $13.9 million at December 31, 2004, related to certain umbrella policies covering years prior to 1977. The reinsurer has disputed the extent of coverage under these policies. The ultimate resolution of this dispute cannot be determined at this time. An unfavorable resolution of the dispute could have a material adverse effect on the Company’s financial condition and results of operations.
The Company's largest reinsurer is Trabaja Reinsurance Company (“Trabaja”). Reinsurance receivables from Trabaja were $264.1 million at December 31, 2004, of which 95% were collateralized.
On June 30, 2009, holders of the 6.50% Convertible Debt will have the right to require the Company to repurchase for cash any amounts outstanding for 114% of the principal amount of the debt plus accrued and unpaid interest, if any, to the settlement date. In 2006, in the event PMA Capital Corporation receives any extraordinary dividends from its subsidiaries, the Company will be required to use 50% of those dividends to redeem up to $35 million principal amount of the 6.50% Convertible Debt at 110% of the original principal amount. Holders may elect to receive any premium over the principal amount (“Put Premium”) in either cash or Class A common stock, with the number of shares determined based on a value of $8.00 per share.
In October 2002, the Company issued $86.25 million of 4.25% Convertible Debt from which the Company received net proceeds of $83.7 million. The Company used the proceeds from this offering primarily to increase the capital of its insurance and reinsurance subsidiaries. As discussed above, the Company exchanged $84.1 million of this debt in November 2004. The Company also retired $1.2 million of this debt in December 2004 through open market purchases. As of December 31, 2004, $925,000 remained outstanding. This debt is convertible at a conversion price of $16.368 per share, subject to adjustment upon certain events. Further, holders of this debt, at their option, may require the Company to repurchase all or a portion of the debt on September 30, 2006, 2008, 2010, 2012 and 2017, or subject to specified exceptions, upon a change in control. The Company may choose to pay the repurchase price in cash or shares of Class A common stock. The Convertible Debt is redeemable in cash, in whole or in part, at the Company’s option at any time on or after September 30, 2006.
Under the terms of the sale of PMA Cayman in 1998, the Company has 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, the Company will participate in such favorable loss reserve development.
At December 31, 2004, The PMA Insurance Group is guarantor of $2.2 million principal amount on certain premium finance loans made by unaffiliated premium finance companies to insureds.
In 2004, the Company issued 262,600 shares of restricted Class A common stock to employees under the Company’s 2002 Equity Incentive Plan and 79,326 shares of restricted Class A common stock to its Directors under the 2004 Directors Plan. The restricted stock vests (restrictions lapse) between one and three years. The Company also issued 16,422 shares of Class A Common stock to Directors in 2004 in lieu of a portion of their retainer under the 2004 Directors Plan.
The Company repurchased 90,185 shares of its Class A Common stock at a cost of $1.7 million in 2002. No shares were repurchased in 2004 or 2003. The Company’s remaining share repurchase authorization at December 31, 2004 is $15.4 million. Decisions regarding share repurchases are subject to prevailing market conditions and an evaluation of the costs and benefits associated with alternative uses of capital.
The Company declared dividends on its Class A Common stock of $0.315 and $0.42 per share in 2003 and 2002, respectively. In November 2003, the Company’s Board of Directors suspended dividends on the Company’s Class A Common stock.
In 2000, the Company’s Board of Directors adopted a shareholder rights plan that will expire on May 22, 2010. The rights automatically attached to each share of Class A Common stock. Generally, the rights become exercisable after the acquisition of 15% or more of the Company’s Class A Common stock and permit rights-holders to purchase the Company’s Class A Common stock or that of an acquirer at a substantial discount. The Company may redeem the rights for $0.001 per right at any time prior to an acquisition.
In June 2004, the Pennsylvania Insurance Department approved the application for the Pooled Companies, previously subsidiaries of PMACIC, to become direct, wholly owned subsidiaries of PMA Capital Corporation. However, in its Order approving the transfer of the Pooled Companies from PMACIC to PMA Capital Corporation, the Pennsylvania Insurance Department prohibited PMACIC, the Company’s reinsurance subsidiary which is currently in run-off, from any declaration or payment of dividends, return of capital or any other types of distributions in 2004 and 2005 to PMA Capital Corporation.
Dividends received from subsidiaries were $24.0 million and $28.0 million in 2003 and 2002, respectively.
The Company currently has stock option plans in place for stock options granted to officers and other key employees for the purchase of the Company’s Class A Common stock, under which 4,800,314 Class A Common shares were reserved for issuance at December 31, 2004. The stock options were granted under terms and conditions determined by the Compensation Committee of the Board of Directors. Stock options granted have a maximum term of ten years, generally vest over periods ranging between one and four years, and are typically granted with an exercise price at least equal to the fair market value of the Class A Common stock on the date the options are granted. Information regarding these option plans is as follows:
Stock options outstanding and options exercisable at December 31, 2004 were as follows:
Shares used as the denominator of the basic and diluted earnings per share were computed as follows:
At December 31, 2004, the Company had a net operating loss ("NOL") carryforward of $221.9 million, which will expire in years 2018 through 2024, and an $8.5 million alternative minimum tax ("AMT") credit carryforward, which does not expire. The NOL carryforward, which produces a gross deferred tax asset of $77.6 million, will be applied to reduce taxable income of the Company.
In 2003, the Company recorded a valuation allowance in the amount of $49 million. In the fourth quarter of 2004, the Company reassessed the valuation allowance previously established against its net deferred tax assets and determined that it needed to be increased by $8 million, considering a number of factors, including the recent losses and revised projections of future earnings at the Run-off Operations. Accordingly, management has estimated at December 31, 2004 that the insurance operations will generate sufficient future taxable income to utilize the net deferred tax asset, net of the $57.0 million valuation allowance, over a period of time not exceeding the expiration of the operating loss carryforwards. The valuation allowance of $57.0 million reserves against $46.3 million of gross deferred tax assets related to the NOL carryforward and all of the projected deferred tax asset related to the AMT credit carryforward because it is more likely than not that this portion of the benefit will not be realized. The Company will continue to periodically assess the realizability of its net deferred tax asset.
The Company's Federal income tax returns are subject to audit by the Internal Revenue Service ("IRS"). No tax years are currently under audit by the IRS. In the fourth quarter of 2004, the Company reversed $8.1 million of certain tax contingency reserves recorded in prior years, due primarily to closed examination years.
The Company also maintains non-qualified unfunded supplemental defined benefit pension plans (the "Non-qualified Pension Plans") for the benefit of certain key employees. The projected benefit obligation and accumulated benefit obligation for the Non-qualified Pension Plans were $7.6 million and $7.3 million, respectively, as of December 31, 2004.
Other Postretirement Benefits - In addition to providing pension benefits, the Company provides certain health care benefits for retired employees and their spouses. Substantially all of the Company’s employees may become eligible for those benefits if they meet the requirements for early retirement under the Qualified Pension Plan and have a minimum of 10 years employment with the Company. For employees who retired on or subsequent to January 1, 1993, the Company will pay a fixed portion of medical insurance premiums, including Medicare Part B. Retirees will absorb future increases in medical premiums.
The decline in Qualified Pension Plan asset performance in 2000 to 2002, combined with historically low interest rates (which are the key assumption in estimating plan liabilities) caused the Company to record a $24.0 million increase in its accrued Qualified Pension Plan liability and to take a $15.6 million non-cash charge to equity in the fourth quarter of 2003. In 2004, the Company increased its Qualified Pension Plan liability by an additional $1.2 million and recorded a non-cash charge to equity of $806,000. These charges did not impact earnings or cash flow, and could reverse in future periods if either interest rates increase or market performance and plan asset returns improve.
The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for the Qualified Pension Plan were $78.2 million, $73.2 million and $65.0 million, respectively, at December 31, 2004 and $70.5 million, $65.3 million and $62.4 million, respectively, at December 31, 2003.
The asset allocation for the Company’s Qualified Pension Plan at the end of 2004 and 2003, and the target allocation for 2005, by asset category, are as follows:
Qualified Pension Plan benefits will be paid from the pension trust assets which have a fair value of $65.0 million at December 31, 2004. Non-qualified Pension Plan benefits will be paid from the general assets of the Company.
As a result of the decision to exit from and run off this business, 2002 results for the Run-off Operations include a charge of $43 million pre-tax. Components of the charge include approximately $16 million to write-down assets to their estimated net realizable value, including non-cash charges of approximately $6 million for leasehold improvements and other fixed assets and $1.3 million for goodwill. During 2003, the Company recognized an additional $2.5 million write-down of assets, including approximately $2 million for reinsurance receivables and $500,000 for premiums receivable, reflecting an updated assessment of their estimated net realizable value. The write-down is included in operating expenses in the Statement of Operations for 2003.
During 2002, approximately 80 Caliber One employees, primarily in the underwriting area, were terminated in accordance with the Company’s exit plan. Approximately 6 positions, primarily claims staff, remain as of December 31, 2004. Involuntary employee termination benefits of $38,000, $730,000 and $1.9 million were paid during 2004, 2003 and 2002, respectively.
Corporate and Other includes the effects of eliminating transactions between the various insurance segments.
The PMA Insurance Group’s operations are concentrated in ten contiguous states in the eastern part of the U.S. As such, economic trends in individual states may not be independent of one another. Also, The PMA Insurance Group’s products are highly regulated by each of these states. For many of The PMA Insurance Group’s products, the insurance departments of the states in which it conducts business must approve rates and policy forms. In addition, workers’ compensation benefits are determined by statutes and regulations in each of these states. While The PMA Insurance Group considers factors such as rate adequacy, regulatory climate and economic factors in its underwriting process, unfavorable developments in these factors could have an adverse impact on the Company’s financial condition and results of operations. The PMA Insurance Group is the Company’s sole remaining ongoing insurance segment. In 2004, workers’ compensation net premiums written represented 85% of The PMA Insurance Group’s net premiums written. In 2003 and 2002, workers’ compensation net premiums written by The PMA Insurance Group represented 41% and 32%, respectively, of the Company’s net premiums written.
The Company actively manages its exposure to catastrophes through its underwriting process, where the Company generally monitors the accumulation of insurable values in catastrophe-prone regions. The PMA Insurance Group maintains catastrophe reinsurance protection of 95% of $18.0 million excess of $2.0 million.
Although the Company believes that it has adequate reinsurance to protect against the estimated probable maximum gross loss from a catastrophe, an especially severe catastrophe or series of catastrophes, or terrorist event, could exceed the Company’s reinsurance and/or retrocessional protection and may have a material adverse impact on the Company’s financial condition, results of operations and liquidity. In 2004, 2003 and 2002, the Company’s loss and LAE ratios were not significantly impacted by catastrophes.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedules as of and for the year ended December 31, 2004 of the Company and our report dated March 16, 2005, expressed an unqualified opinion on those financial statements and financial statement schedules.
Includes a reduction of $.03 and $.04 for the first and second quarters of 2003, respectively, from previously filed Forms 10-Q due to the December 2004 adoption of EITF 04-8, “The Effect of Contingently Convertible Debt on Diluted Earnings Per Share,” which requires retroactive restatement of all periods presented. See Note 2-L to the Consolidated Financial Statements for additional information.