PMACIC, our reinsurance subsidiary which is in run-off, owned the primary insurance subsidiaries that comprise The PMA Insurance Group, or the Pooled Companies, until June 2004. In its Order approving the transfer of the Pooled Companies from PMACIC to PMA Capital, the Pennsylvania Insurance Department prohibited PMACIC from declaring or paying any dividends, return of capital or any other types of distributions to PMA Capital in 2004 and 2005. In 2006, the Pennsylvania Insurance Department approved our request for an extraordinary dividend in the amount of $73.5 million from PMACIC. We used the proceeds to reduce our debt obligations and to maintain liquidity at the holding company. In 2007, PMACIC may declare and pay ordinary dividends without the prior approval of the Pennsylvania Insurance Department and is
We provide combined ratios and operating ratios for The PMA Insurance Group below. The “combined ratio” is a measure of property and casualty underwriting performance. The combined ratio computed on a GAAP basis is equal to losses and loss adjustment expenses, plus acquisition and insurance-related operating expenses and policyholders’ dividends, 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 equal to the combined ratio less the net investment income ratio, which is computed by dividing net investment income by net premiums earned.
Pre-tax operating income for The PMA Insurance Group was $28.9 million in 2006, compared to $22.0 million in 2005 and $13.2 million in 2004. The increased pre-tax operating income in 2006, compared to 2005, is due to both improved underwriting results and increased investment income. The increased pre-tax operating income in 2005, compared to 2004, primarily reflects improved underwriting results.
in 2006, compared to 2005. Our renewal retention rate on existing accounts in 2006 was 84% and new business premium was $6.9 million. Direct writings of commercial lines premiums increased by $4.4 million in 2005, compared to 2004. Our renewal retention rate on existing accounts in 2005 was 80% and new business premium was $15.8 million, compared to 40% and $4.3 million, respectively, in 2004. Overall pricing on other commercial lines increased modestly in 2006, compared to prior year. In 2005 and 2004, we obtained overall price increases on other commercial lines averaging approximately 4% and 19%, respectively.
The PMA Insurance Group, exclusive of the business written by MGIA, 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 the business written by MGIA, maintains property catastrophe reinsurance protection of 95% of $18.0 million excess of $2.0 million per occurrence.
MGIA underwrites and services workers’ compensation policies in California, which is exposed to the earthquake peril. This business is 100% ceded to non-affiliated reinsurers. Included as part of the reinsurance program is property catastrophe protection of up to a limit of $50.0 million.
The 6.50% Convertible Debt is secured equally and ratably with our $54.9 million 8.50% Senior Notes by a first lien on 20% of the capital stock of our principal operating subsidiaries. This lien is released if the 6.50% Convertible Debt is no longer outstanding. However, execution of any lien by the holders of the 6.50% Convertible Debt is subject to approval by the Pennsylvania Insurance Department. The 6.50% Convertible Debt is convertible at the rate of 61.0948 shares per $1,000 principal amount, equivalent to a conversion price of $16.368 per share of Class A Common Stock for $18.4 million principal amount and 62.9287 shares per $1,000 principal amount, equivalent to a conversion price of $15.891 per share for $941,000 principal amount. 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 our assets.
We did not make a contribution to our qualified pension plan in 2006 or 2005. Our accumulated benefit obligation was greater than the fair value of plan assets by approximately $11 million and $17 million at December 31, 2006 and December 31, 2005, respectively. The funded status of our qualified pension plan improved in 2006, due primarily to the increase in interest rates and higher than expected return on our plan assets. In 2006 and 2005, we were not required to make any contribution to the pension plan under the minimum funding requirements of the Employee Retirement Income Security Act (“ERISA”) of 1974. In August 2006, the Pension Protection Act of 2006 (“PPA”) became law. Although we are not required to make any minimum funding contributions to our pension plan in 2007, we believe that the PPA will accelerate the timing of our future contributions. Our plan assets are composed of 25% fixed maturities and 75% equities at December 31, 2006. We currently estimate that the pension plan’s assets will generate a long-term rate of return of 8.25%, which we believe is a reasonable long-term rate of return, in part because of the historical performance of the broad financial markets. We also maintain non-qualified pension plans with respect to which we pay benefits from the general assets of the Company. We expect benefit payments related to these non-qualified plans to be less than $500,000 in 2007. Pension expense in 2006, 2005 and 2004 was $600,000, $5.4 million and $4.9 million, respectively.
In 2005, we recorded impairment losses for securities issued by two auto manufacturers and one retail department store, resulting in a pre-tax impairment charge of $1.0 million. Pre-tax impairment charges for the year ended December 31, 2004 were $334,000 and related to one asset-backed security and a security issued by an airline. The write-downs were measured based on public market prices at the time we determined the decline in value was other than temporary.
In general, our businesses are subject to a changing social, economic, legal, legislative and regulatory environment that could materially affect them. Some of the changes include initiatives to restrict insurance pricing and the application of underwriting standards and reinterpretations of insurance contracts long after the policies were written in an effort to provide coverage unanticipated by us. The eventual effect on us of the changing environment in which we operate remains uncertain.
In February 2006, the FASB issued Statement of Financial Accounting Standards No. 155, “Accounting for Certain Hybrid Financial Instruments - an Amendment of FASB Statements No. 133 and 140” (“SFAS 155”). SFAS 155 is intended to simplify the accounting for certain hybrid financial instruments by permitting fair value remeasurement for any hybrid instrument that contains an embedded derivative that previously would have required bifurcation. The statement is effective for all financial instruments acquired, issued, or subject to a remeasurement event in fiscal years that begin after September 15, 2006. We do not expect that the adoption of SFAS 155 will have a material impact on our consolidated financial statements.
Prior to 2004, we established a valuation allowance in the amount of $49 million. This was based upon our assessment that it was more likely than not that a portion of the gross deferred tax assets related to the NOL carryforward and all of the deferred tax asset related to the AMT credit carryforward would not be realized. We periodically reassess the valuation allowance previously established against the net deferred tax assets. Factors considered in our reassessment included historical earnings, scheduled reversal of deferred tax liabilities and revised projections of future earnings. Based upon our consideration of these factors in conjunction with the current level of valuation allowance recorded, we increased the
Motion to Dismiss the Amended Complaint, dismissing all allegations with respect to The PMA Insurance Group, and otherwise denied the Motion to Dismiss. By virtue of the Order, the alleged class period was reduced to November 6, 2003. The lawsuit is in its earliest stages; therefore, it is not possible at this time to reasonably estimate the impact on the Company. However, the lawsuit may have a material adverse effect on the Company’s financial condition, results of operations and liquidity.
In 2006, the Company completed the redemption of $35 million principal amount of its 6.50% Convertible Debt. Under the original terms of this debt, the Company was required to pay a premium to the holders of the debt. The premium was due in cash, or at the election of the holder, in shares of the Company’s Class A Common Stock. As a result of this redemption, the Company issued 307,990 shares of Class A Common Stock. This issuance of shares in lieu of cash resulted in an increase in Shareholders’ equity of $3.1 million. See Note 6 for additional information regarding this redemption.
The Company recognizes compensation expense for restricted stock awards over the vested period of the award. Compensation expense recognized for restricted stock was $1.3 million in 2006, $841,000 in 2005 and $1.3 million in 2004. At December 31, 2006, unrecognized compensation expense for non-vested restricted stock was $465,000, which is expected to be recognized over a weighted average period of 6 months.
The Company was required to adopt SFAS 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” in 2006. SFAS 158 requires that an employer recognize the overfunded or underfunded status of each defined benefit postretirement plan as an asset or liability in the statement of financial position. Changes in the funded status during any given period of time shall be recognized as a change in comprehensive income. The statement has no impact on the recognition of benefit costs. The Company’s 2006 adoption of this statement resulted in a $13.5 million decrease in Other assets, a $15.2 million decrease in Accounts payable, accrued expenses and other liabilities, and a $1.1 million increase in Accumulated other comprehensive income.