See "Item 1 - Business-Ratings" for additional information regarding our ratings.
Net investment income was $2.7 million lower in 2003 and $3.8 million lower in 2002, compared to the immediately preceding year. The lower net investment income in 2003, compared to 2002, primarily reflects a reduction in invested asset yields of approximately 90 basis points, partially offset by a higher invested asset base that increased approximately 12%. The decline in 2002, compared to 2001, primarily reflects a reduction in invested asset yields of approximately 50 basis points.
In 2001, gross and net premiums written included approximately $25 million of premiums (mainly property premiums in the Finite Risk and Financial Products unit) due under contractual provisions of certain of PMA Re’s assumed business where additional premiums were due to us because of the cession of World Trade Center losses to us by our reinsureds. These additional premiums were more than offset by approximately $30 million of ceded premiums payable by PMA Re to its retrocessionaires because PMA Re ceded a portion of its World Trade Center gross losses to these retrocessionaires.
Ceded premiums were $155.8 million, $137.7 million and $116.0 million in 2003, 2002 and 2001, respectively. Ceded premiums for 2003 include approximately $103.6 million from our Finite Risk and Financial Products unit that were due under a quota share retrocessional cover that ceded one-third of this unit’s 2003 premiums and losses. Ceded premiums increased by $21.7 million in 2002, compared to 2001, reflecting the increase in gross premiums written and an increase in premiums charged by retrocessionaires, partially offset by the additional ceded premiums in 2001 resulting from the terrorist attack on the World Trade Center.
The PMA Insurance Group retains the first $5 million of losses.
The PMA Insurance Group 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. The PMA Insurance Group maintains catastrophe reinsurance protection of 95% of $18.0 million excess of $2.0 million. PMA Re did not write a significant amount of catastrophe exposed business in its traditional underwriting units. Excluding PMA Re’s Finite Risk and Financial Products writings, less than 1% of gross written premiums was for property catastrophe coverage in 2003. The Finite Risk and Financial Products unit wrote $36.5 million in premiums for property catastrophe coverage in 2003. However, these contracts generally provided for additional premiums payable to PMA Re to mitigate the severity of the catastrophic loss. Also, in writing property reinsurance coverages, PMA Re typically required per occurrence loss limitations for contracts that could have had catastrophe exposure. Through per risk reinsurance, we manage our net retention in each exposure. PMA Re’s property per occurrence reinsurance provides catastrophe protection of $40.0 million in excess of $10.0 million on its traditional property book. PMA Re can also recover an additional $20.0 million of Traditional and/or Finite Risk and Financial Products occurrence losses under certain industry loss scenarios. Certain of these contracts require that we cede additional premiums of up to 20% of ceded losses depending on the level of such losses.
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. Appropriate 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 refined its underwriting procedures to take into account terrorism risks.
Our investment objectives are to (i) seek competitive after-tax income and total return as appropriate, (ii) maintain medium to high investment grade asset quality and high marketability, (iii) maintain maturity distribution commensurate with our business objectives, (iv) provide portfolio flexibility for changing business and investment climates and (v) provide liquidity to meet operating objectives. Our investment strategy includes guidelines for asset quality standards, asset allocations among investment types and issuers, and other relevant criteria for our portfolio. In addition, invested asset cash flows, both current income and investment maturities, are structured after considering projected liability cash flows of loss reserve payouts using actuarial models. Property and casualty claim demands are somewhat unpredictable in nature and require liquidity from the underlying invested assets, which are structured to emphasize current investment income to the extent consistent with maintaining appropriate portfolio quality and diversity. The liquidity requirements are met primarily through publicly traded fixed maturities as well as operating cash flows and short-term investments.
In evaluating the recoverability of our net deferred tax asset, management has considered the recent performance of its business, which generated pre-tax losses of $67.7 million and $79.2 million in 2003 and 2002 due primarily to losses from PMA Re and the Run-off Operations. As a result of these losses, we have reduced our deferred tax asset at December 31, 2003 by $49.0 million to establish a valuation allowance. We believe that our future results will improve due to the profitability of more recent accident year business and due to our exit from the business segments that generated the substantial portion of our net losses in 2002 and 2003. Accordingly, despite our recent earnings history, we have estimated at December 31, 2003 that our insurance operations will generate sufficient future taxable income to utilize the net deferred tax asset, net of the $49.0 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 13 to our Consolidated Financial Statements.
• adverse property and casualty loss development for events that we insured in prior years;
Basic - pro forma $ (3.02 ) $ (1.58 ) $ 0.28
Adoption of FIN 46 and its current interpretations did not have a material impact on the Company’s financial condition, results of operations or liquidity. At December 31, 2003, the Company applied the provisions of FIN 46 and its current interpretations to its reporting for three wholly owned statutory trusts, which issued $42.5 million of trust preferred securities in 2003. As a result of application of the provisions of FIN 46, the Company deconsolidated these wholly owned statutory trusts, resulting in an increase of $1.3 million in other assets and debt on the Balance Sheet. See Note 7 for additional information about the trust preferred debt.
The amortized cost and fair value of fixed maturities at December 31, 2003, by contractual maturity, are as follows:
Reserves transferred in 2002 reflect the assumption of PMA Re’s and The PMA Insurance Group’s losses by an unaffiliated third party. Cash and short-term investments of $50 million were transferred to support the payment of the transferred reserves.
Several purported class action lawsuits captioned Newman v. PMA Capital Corporation, John W. Smithson, William E. Hitselberger and Francis W. McDonnell, (initiated November 7, 2003), Appel v. PMA Capital Corporation, John W. Smithson, William E. Hitselberger and Francis W. McDonnell (initiated November 10, 2003), Boyd v. PMA Capital Corporation, John W. Smithson, William E. Hitselberger and Francis W. McDonnell (initiated November 20, 2003), Waller v. PMA Capital Corporation, John W. Smithson, Francis W. McDonnell and William E. Hitselberger (initiated November 12, 2003), Bauer v. PMA Capital Corporation, John W. Smithson, William E. Hitselberger and Francis W. McDonnell (initiated November 21, 2003), and Frey v. PMA Capital Corporation, John W. Smithson, William E. Hitselberger and Francis W. McDonnell (initiated December 11, 2003) were filed in the Eastern District of Pennsylvania by alleged shareholders of PMA Capital who seek to represent a class of purchasers of PMA Capital securities from November 13, 1998 to November 3, 2003. The complaints allege, among other things, that the defendants violated Rule 10b-5 of the Securities Exchange Act of 1934, as amended, by making materially false and misleading public statements and material omissions during the class period regarding the Company's loss reserves.
In 2002, the Company received refunds from the IRS of $10.6 million, resulting primarily from an AMT net operating loss, which was generated in 2001 and carried back to 1998 and 1999.
The surplus of The PMA Insurance Group’s domestic insurance subsidiaries and Caliber One Indemnity Company are eliminated as they are included in the statutory surplus of PMA Capital Insurance Company, the parent company of these insurance companies.