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. 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, as was the case in 2005.
Unpaid losses and LAE reflect management’s best estimate of future amounts needed to pay claims and related settlement costs with respect to insured events which have occurred, including events that have not been reported to us. Due to the “long-tail” nature of a significant portion of our business, in many cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured loss, the reporting of the loss to us and our payment of that loss. This business is subject to more unforeseen development than shorter tailed lines of business would be. Our major long-tail lines include our workers’ compensation and casualty reinsurance business.
We perform credit reviews of our reinsurers focusing on, among other things, financial capacity, stability, trends and commitment to the reinsurance business. Reinsurers failing to meet our standards are excluded from our reinsurance programs. In addition, we require 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, 2005 and 2004, our reinsurance receivables were supported by $444.2 million and $507.2 million of collateral, respectively. Of the uncollateralized reinsurance receivables at December 31, 2005, 93% were due from reinsurers rated “A-” or better by A.M. Best and is broken down as follows: “A++” - 5%; “A+” - 41%; “A” - 36% and “A-” - 11%. We believe that our reinsurance receivables, net of the valuation allowance, are fully collectible. In 2003, we wrote off reinsurance receivables of $3.0 million, all from the Run-off Operations.
In 2003, we issued $43.8 million of 30-year floating rate junior subordinated debentures to three wholly-owned statutory trusts. We used 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 junior subordinated 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 junior subordinated debt equals the three-month LIBOR plus 4.10%, 4.20% and 4.05% and is payable on a quarterly basis. At December 31, 2005, the weighted average interest rate on the junior subordinated securities was 8.53%.
The net unrealized loss on our investments at December 31, 2005 was $4.3 million, or 0.4% of the amortized cost basis. The net unrealized loss included gross unrealized gains of $15.2 million and gross unrealized losses of $19.5 million. For all but two securities, which were carried at a fair value of $16.9 million at December 31, 2005, we determine the market value of fixed income securities 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).
In addition to company-specific financial information and general economic data, we also consider our ability and intent to hold a particular security to maturity or until the fair value of the security recovers to a level at least equal to the amortized cost. Our ability and intent to hold securities to such time is evidenced by our strategy and process to match the cash flow characteristics of the invested asset portfolio, both interest income and principal repayment, to the actuarially determined estimated liability pay-out patterns of each insurance company’s claims liabilities. 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.
development is increased at our former reinsurance business because of the nature of the reinsurance business itself and because of the fact it is in run-off. Reinsurers rely on their ceding companies to provide them with information regarding incurred losses. Therefore, reported claims for reinsurers become known more slowly than for primary insurers and are more subject to unforeseen development and uncertainty. Additionally, the potential for adverse reserve development in our former reinsurance operation has increased because it has ceased ongoing business relationships with most of its ceding companies. As a result, to the extent that there are disputes with its ceding companies over claims coverage or other issues, we believe that it will more likely be required to arbitrate these disputes.
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.
Premiums receivable (net of valuation allowance: 2005 - $8,342; 2004 - $9,349)
In 2004, the Company purchased reinsurance covering potential adverse loss development of the loss and LAE reserves of the Run-off Operations. Upon entering into the agreement, the Company ceded $100 million in carried loss and LAE reserves and paid $146.5 million in cash. During 2004, the Company incurred $6.0 million in ceded premiums for this agreement. During the first quarter of 2005, the Run-off Operations ceded $30 million in losses and LAE under this agreement. See Note 4 for additional information about prior year loss reserve development at the Run-off Operations recorded in 2005. Because the coverage is retroactive, the Run-off Operations deferred the initial benefit of this cession, which will be amortized over the estimated settlement period of the losses using the interest method. Accordingly, the Company has a deferred gain on retroactive reinsurance of $27.2 million at December 31, 2005, which is included in accounts payable, accrued expenses and other liabilities on the Balance Sheet. Amortization of the deferred gain for the year ended December 31, 2005, reduced net loss and loss adjustment expenses by $2.8 million. At December 31, 2005, the Run-off Operations have $75 million of available coverage under this agreement for future adverse loss development.
Trabaja, formerly PMA Insurance Cayman, Ltd. (“PMA Cayman”), is a wholly-owned subsidiary of London Life and Casualty Reinsurance Corporation (“London Reinsurance Group”). The Company sold PMA Cayman to London Reinsurance Group for $1.8 million, and transferred approximately $230 million of cash and invested assets as well as loss reserves to the buyer in 1998. Under the terms of the sale of PMA Cayman to London Reinsurance Group in 1998, the Company has agreed to indemnify London Reinsurance Group, up to a maximum of $15 million if the actual claim payments in the aggregate exceed the estimated payments upon which the loss reserves of PMA Cayman were established. If the actual claim payments in the aggregate are less than the estimated payments upon which the loss reserves have been established, then the Company will participate in such favorable loss reserve development.
cession of losses under these contracts may require the Company to cede additional premiums ranging from 40% to 50% of ceded losses depending on the level of such losses.
In September 2005, the Company issued, through one of its insurance subsidiaries, $10.0 million of Floating Rate Surplus Notes due 2035 (“Surplus Notes”). The Surplus Notes may be redeemed in whole or in part on or after November 2, 2010. The Surplus Notes bear interest at an annual rate equal to the three-month London InterBank Offered Rate (“LIBOR”) plus 4.5%. At December 31, 2005, the interest rate on the Surplus Notes was 8.76%. All payments of interest and principal on these notes are subject to the prior approval of the Pennsylvania Insurance Department. The Company used the $9.7 million net proceeds and a portion of the Run-off Operations’ assets to purchase, in the open market, $25.7 million principal amount of its outstanding 6.50% Convertible Debt. The Company paid $27.9 million for these bond purchases, exclusive of accrued interest. As the derivative component of the bonds was already reflected in the debt balance, the purchase activity did not result in any significant realized gain or loss.
Stock options outstanding and options exercisable at December 31, 2005 were as follows:
Diluted shares for 2005, 2004 and 2003 do not assume the conversion of the Company’s Convertible Debt into 5.8 million, 6.1 million and 5.3 million shares of Class A Common stock, respectively, because it would have been anti-dilutive. The dilutive effect of the Convertible Debt for 2004 represents the impact of the Put Premium feature on the 6.50% Convertible Debt. See Note 6 for additional information.
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 2004, the Company reversed $8.1 million of certain tax contingency reserves recorded in prior years, due primarily to closed examination years.
The Company's total assets by principal business segment were as follows:
The Company’s statutory financial statements are presented on the basis of accounting practices prescribed or permitted by the Pennsylvania Insurance Department (for PMA Capital Insurance Company and The PMA Insurance Group) and the Delaware Insurance Department (for Caliber One Indemnity Company). Pennsylvania and Delaware have adopted Codification as the basis of their statutory accounting practices. However, Pennsylvania has retained the prescribed practice of non-tabular discounting of unpaid losses and LAE for workers’ compensation, which was not permitted under Codification. This prescribed accounting practice increased statutory capital and surplus by $101,000 and $435,000 at December 31, 2004 and 2003, respectively, over what it would have been had the prescribed practice not been allowed. As of December 31, 2005, the Company no longer utilizes non-tabular discounting for its net unpaid losses and LAE for workers’ compensation.