| PHILADELPHIA CONSOLIDATED HOLDING CORP Item 1A RISK FACTORS If our insurance company subsidiaries are unable to pay dividends or make loans to us due to government regulations that apply to insurance companies or for any reason, we may not be able to continue our normal business operations |
| Our principal assets currently consist of all or substantially all of the equity interests of our subsidiaries listed below: • Philadelphia Indemnity Insurance Company; • Philadelphia Insurance Company; • Maguire Insurance Agency, Inc |
| ; • PCHC Investment Corp, a Delaware investment corporation; • Liberty American Insurance Group, Inc, an insurance holding company; • Mobile USA Insurance Company; • Liberty American Insurance Company; • Liberty American Insurance Services, Inc |
| ; and • Liberty American Premium Finance Company |
| Maguire Insurance Agency, Inc |
| is an underwriting manager and Liberty American Insurance Services, Inc |
| is an insurance agency that markets, underwrites and services homeowners insurance and mobile homeowners policies |
| Our primary sources of funds are dividends and payments from our subsidiaries that we receive under tax allocation agreements |
| Government regulations that apply to insurance companies restrict the ability of our insurance company subsidiaries to pay dividends and make loans to us |
| The accumulated profits of these subsidiaries from which dividends may be paid totaled dlra442dtta8 million at December 31, 2005 |
| Of this amount, these insurance company subsidiaries may pay a total of approximately dlra162dtta0 million of dividends in 2006 without obtaining prior approval from the department of insurance for the states in which they are domiciled |
| Further, creditors of any of our subsidiaries will have the right to be paid in full the amounts they are owed if a subsidiary liquidates its 18 _________________________________________________________________ [53]Table of Contents assets or undergoes a reorganization or other similar transaction before we will have the right to receive any distribution of assets from the subsidiary, unless we also are recognized as a creditor of the subsidiary |
| If we are unable to receive distributions from our subsidiaries, we may not be able to continue our normal business operations |
| If AM Best downgrades the ratings of our insurance company subsidiaries, we will not be able to compete as effectively with our competitors and our ability to sell insurance policies could decline, reducing our sales and earnings |
| AM Best Company rates Philadelphia Indemnity Insurance Company and Philadelphia Insurance Company “A+” (Superior) |
| According to AM Best Company, companies rated “A+” (Superior) have, on balance, superior financial strength, operating performance and market profile, when compared to the standards established by the AM Best Company, and have a very strong ability to meet their ongoing obligations to policyholders |
| We believe that the rating assigned by AM Best Company is an important factor in marketing our products |
| If the agency downgrades our ratings in the future, it is likely that: • we would not be able to compete as effectively with our competitors; and • our ability to sell insurance policies could decline |
| If that happens, our sales and earnings would decrease |
| Rating agencies evaluate insurance companies based on financial strength and the ability to pay claims, factors more relevant to policyholders than investors |
| If our reserves for losses and costs related to adjustment of losses are not adequate, we would have to increase our reserves, which would result in reductions in net income and policyholders’ surplus and could result in a downgrading of the rating of our insurance company subsidiaries |
| We establish reserves for losses and costs related to the adjustment of losses under the insurance policies we write |
| We determine the amount of these reserves based on our best estimate and judgment of the losses and costs we will incur on existing insurance policies |
| While we believe that our reserves are adequate, we base these reserves on assumptions about future events |
| The following factors may have a substantial impact on our future loss experience: • the amounts of claims settlements; • legislative activity; and • changes in inflation and economic conditions |
| Actual losses and the costs we incur related to the adjustment of losses under insurance policies may be different from the amount of reserves we establish |
| If the actual amount of losses and costs related to the adjustment of losses under insurance policies exceed the amount we have reserved for these losses and costs related to the adjustment of losses, we would be required to increase our reserves |
| When we increase reserves, our income before income taxes for the period will decrease by a corresponding amount |
| In addition, increasing reserves causes a reduction in policyholders’ surplus and could cause a downgrading of the rating of our insurance company subsidiaries |
| If market conditions cause reinsurance to be more costly or unavailable, we may be required to bear increased risks or reduce the level of our underwriting commitments |
| As part of our overall risk and capacity management strategy, we purchase reinsurance for significant amounts of risk underwritten by our insurance company subsidiaries, especially catastrophe risks |
| Market conditions beyond our control determine the availability and cost of the reinsurance we purchase, which may affect the level of our business and profitability |
| Our reinsurance facilities are generally subject to annual renewal |
| We may be unable to maintain our current reinsurance facilities or to obtain other reinsurance facilities in adequate amounts and at favorable rates |
| If we are unable to renew our expiring facilities or to obtain new reinsurance facilities, either our net exposure to risk would increase or, if we are unwilling to bear an increase in net risk exposures, we would have to reduce the amount of risk we underwrite, especially risks related to catastrophes |
| 19 _________________________________________________________________ [54]Table of Contents We cannot guarantee that our reinsurers will pay in a timely fashion, if at all, and, as a result, we could experience losses |
| We transfer some of the risk we have assumed to reinsurance companies in exchange for part of the premium we receive in connection with the risk |
| Although reinsurance makes the reinsurer liable to us, it does not relieve us of our liability to our policyholders |
| Our reinsurers may not pay the reinsurance recoverables that they owe to us or they may not pay such recoverables on a timely basis |
| If our reinsurers fail to pay us or fail to pay us on a timely basis, our financial results would be adversely affected |
| Claims related to catastrophic events could result in catastrophe losses |
| It is possible that a catastrophic event could greatly increase claims under the insurance policies we write |
| This, in turn, could result in losses for one or more of our insurance company subsidiaries |
| Catastrophes may result from a variety of events or conditions, including hurricanes, windstorms, earthquakes, hail and other severe weather conditions and may include terrorist events |
| We generally try to reduce our exposure to catastrophe losses through underwriting and the purchase of catastrophe reinsurance |
| But, reinsurance may not be sufficient to cover our actual losses |
| In addition, a number of states from time to time have passed legislation that has had the effect of limiting the ability of insurers to manage risk, such as legislation prohibiting an insurer from withdrawing from catastrophe-prone areas |
| If we are unable to maintain adequate reinsurance or to withdraw from areas where we experience or expect significant catastrophe-related claims, we could experience significant losses |
| We are subject to possible assessments from state insurance facilities and state guaranty funds |
| We are subject to assessments from various state guaranty funds and state insurance facilities, including Florida Citizens Property Insurance Corporation, the Mississippi Windstorm Underwriting Association, the Alabama Insurance Underwriting Association, and the Texas Windstorm Insurance Association |
| The ultimate impact of Hurricanes Katrina, Rita and Wilma on these facilities is currently uncertain, but could result in the facilities recognizing a financial deficit or a financial deficit greater than the level currently estimated by these facilities |
| They may, in turn, have the ability to assess participating insurers when financial deficits occur, adversely affecting our results of operations |
| These facilities are generally designed so that the ultimate cost is borne by policyholders |
| We and other insurance companies writing residential property policies in Florida must participate in the Florida Hurricane Catastrophe Fund, which potentially reimburses companies for their qualifying losses at various participating percentages above required retention levels subject to maximum reimbursement amounts |
| We currently have reimbursement recoverable balances from the Florida Hurricane Catastrophe Fund for the 2004 and 2005 hurricane losses in Florida |
| If the Florida Hurricane Catastrophe Fund does not have sufficient funds to pay its ultimate reimbursement obligations to us and other participating insurance companies, it has the authority to issue bonds |
| Such bonds are funded by assessments on generally all property and casualty premiums in Florida |
| By law, these assessments are the obligation of insurance policyholders which insurance companies must collect |
| Companies are required to collect the Florida Hurricane Catastrophe Fund assessments directly from residential property policyholders and remit them to the Florida Hurricane Catastrophe Fund as they are collected |
| Our exposure to assessments and the availability of policyholder recoupments or premium rate increases related to these assessments may not offset each other in our financial statements |
| Moreover, even if they do offset each other, they may not offset each other in our financial statements for the same fiscal period due to the ultimate timing of when the assessments are accrued and when the related recoupments are accrued or when related premium rate increases are earned, as well as the possibility of policies not being renewed in subsequent years |
| Our results may fluctuate as a result of many factors, including cyclical changes in the insurance industry |
| The results of companies in the property and casualty insurance industry historically have been subject to significant fluctuations and uncertainties |
| The industry’s profitability can be affected significantly by: • rising levels of actual costs that are not known by companies at the time they price their products; • volatile and unpredictable developments, including man-made, weather-related and other natural catastrophes or terrorist attacks; • changes in loss reserves resulting from the general claims and legal environments as different types of claims arise and judicial interpretations relating to the scope of insurer’s liability develop; and 20 _________________________________________________________________ [55]Table of Contents • fluctuations in interest rates, inflationary pressures and other changes in the investment environment, which affect returns on invested assets and may impact the ultimate payout of losses |
| The demand for property and casualty insurance can also vary significantly, rising as the overall level of economic activity increases and falling as that activity decreases |
| The property casualty insurance industry historically is cyclical in nature |
| These fluctuations in demand and competition could produce underwriting results that would have a negative impact on our results of operations and financial condition |
| We face significant competitive pressures in our business that could cause demand for our products to fall and adversely affect our profitability |
| We compete with a large number of other companies in our selected lines of business |
| We compete, and will continue to compete, with major US and non-US insurers and other regional companies, as well as mutual companies, specialty insurance companies, underwriting agencies and diversified financial services companies |
| Some of our competitors have greater financial and marketing resources than we do |
| Our profitability could be adversely affected if we lose business to competitors offering similar or better products at or below our prices |
| In addition, a number of new, proposed or potential legislative or industry developments could further increase competition in our industry |
| New competition from these developments could cause the demand for our products to fall, which could adversely affect our profitability |
| Because we are heavily regulated by the states in which we operate, we may be limited in the way we operate |
| We are subject to extensive supervision and regulation in the states in which we operate |
| The supervision and regulation relate to numerous aspects of our business and financial condition |
| The primary purpose of the supervision and regulation is the protection of our insurance policyholders and not our investors |
| The extent of regulation varies, but generally is governed by state statutes |
| These statutes delegate regulatory, supervisory and administrative authority to state insurance departments |
| This system of regulation covers, among other things: • standards of solvency, including risk-based capital measurements; • restrictions on the nature, quality and concentration of investments; • restrictions on the types of terms that we can include in the insurance policies we offer; • certain required methods of accounting; • reserves for unearned premiums, losses and other purposes; and • potential assessments for the provision of funds necessary for the settlement of covered claims under certain insurance policies provided by impaired, insolvent or failed insurance companies |
| The regulations or the state insurance departments may affect the cost or demand for our products and may impede us from obtaining rate increases or taking other actions we might wish to take to increase our profitability |
| Further, we may be unable to maintain all required licenses and approvals and our business may not fully comply with the wide variety of applicable laws and regulations or the relevant authority’s interpretation of the laws and regulations |
| Also, regulatory authorities have relatively broad discretion to grant, renew or revoke licenses and approvals |
| If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, the insurance regulatory authorities could stop or temporarily suspend us from carrying on some or all of our activities or monetarily penalize us |
| The outcome of industry-wide investigations into finite risk reinsurance products and contingent commission arrangements could adversely affect our business and results of operations Various regulatory authorities, including the SEC and a number of state attorneys-general, have initiated investigations and lawsuits relating to finite risk reinsurance arrangements entered into by insurance companies with reinsurers and the payment of so-called “contingent commissions” by insurance companies |
| Finite-risk reinsurance is a form of reinsurance in which, among other things, there is limited risk transferred to the reinsurer |
| See below for a description of contingent commission arrangements |
| 21 _________________________________________________________________ [56]Table of Contents As previously reported in the Form 8-K we filed with the SEC on June 17, 2005, we received a subpoena on June 15, 2005 from the SEC requesting documents and other information regarding any non-traditional insurance arrangements, including finite risk reinsurance, we entered into with General Re Corporation and its affiliates |
| We supplied the requested documents to the SEC in response to the subpoena in August 2005 |
| Various regulatory agencies, including the office of the New York Attorney General, have conducted investigations and initiated lawsuits concerning contingent commission arrangements and the extent to which these arrangements have been disclosed to purchasers of insurance |
| These arrangements involve payments by insurance companies to brokers and agents of additional incentive commissions if they place business with the insurance company exceeding certain levels of profitability and/or volume |
| Some of these regulators have indicated that the brokers and agents should have disclosed these arrangements to their customers |
| We have approximately 150 preferred agents to which we pay additional commissions based on the profitability and volume of business they place with us |
| Our preferred agent arrangements, and similar arrangements which have been entered into by many other insurance companies, have been in place for many years |
| We and many other property and casualty insurance companies domiciled in Pennsylvania received a request in November 2004 from the Pennsylvania Insurance Department to supply the Department with information concerning contingent commission arrangements |
| We supplied the requested information to the Department in December 2004 |
| We cannot predict the effect, if any, of these investigations, or any proceedings which may result from these investigations, on our future operations, the insurance industry in general, or changes, if any, which may be made to any laws or regulations |
| The outcome of these matters could adversely affect our business and results of operations |
| Because our investment portfolio is made up of primarily fixed income securities, our investment income could suffer as a result of fluctuations in interest rates |
| We currently maintain and intend to continue to maintain an investment portfolio made up of primarily fixed income securities |
| The fair value of these securities can fluctuate depending on changes in interest rates |
| Generally, the fair market value of these investments increases or decreases in an inverse relationship with changes in interest rates, while net investment income earned by us from future investments in fixed income securities will generally increase or decrease with interest rates |
| Changes in interest rates may result in fluctuations in the income derived from, and the valuation of, our fixed income investments, which could have an adverse effect on our results of operations and financial condition |
| Provisions of the Pennsylvania business corporation law, our articles of incorporation and the insurance laws of Pennsylvania, Florida and other states may discourage takeover attempts |
| The Pennsylvania Business Corporation Law contains “anti-takeover” provisions |
| However, Subchapter F of Chapter 25 of the Business Corporation Law applies to us and may have an anti-takeover effect and may delay, defer or prevent a tender offer or takeover attempt that a shareholder might consider in his or her best interest, including those attempts that might result in shareholders receiving a premium over market price for their shares |
| Subchapter F of the Business Corporation Law prohibits certain “business combinations” between an “interested shareholder” and a corporation, unless the corporation’s board of directors gives prior approval and certain other conditions are satisfied, or there is an available exemption |
| The term “business combination” is defined broadly to include various merger, consolidation, division, exchange or sale transactions, including transactions using our assets for purchase price amortization or refinancing purposes |
| An “interested shareholder,” in general, is a beneficial owner of shares entitling that person to cast at least 20prca of the votes that all shareholders would be entitled to cast in an election of directors |
| In addition, our Articles of Incorporation allow the Board of Directors to issue one or more classes or series of preferred stock with voting rights, preferences and other privileges as the Board may determine |
| The issuance of preferred shares could adversely affect the holders of our common stock and could prevent, delay or defer a change of control |
| We are also subject to the laws of various states, like Pennsylvania and Florida, governing insurance holding companies |
| Under these laws, a person generally must obtain the applicable Insurance Department’s approval to acquire, directly or indirectly, 5prca to 10prca or more of the outstanding voting securities of Philadelphia Consolidated or our insurance subsidiaries |
| An Insurance Department’s determination of whether to approve an acquisition would be based on a variety of factors, including an evaluation of the acquirer’s financial stability, the competence of its management and whether competition in that state would be reduced |
| These laws may delay or prevent a takeover of Philadelphia Consolidated or our insurance company subsidiaries |
| 22 _________________________________________________________________ [57]Table of Contents We have a large shareholder whose interests may diverge from those of our other shareholders |
| James J Maguire, the Chairman of our Board of Directors, and his wife beneficially own approximately 21prca of our issued and outstanding common stock |
| Maguire’s immediate family beneficially own approximately an additional 2prca of our issued and outstanding common stock (the immediate family beneficial ownership for this purpose excludes beneficial ownership which is attributable to both Mr |
| James J Maguire and his wife and immediate family members) |
| Such beneficial ownership is calculated pursuant to Rule 13d-3 under the Securities Exchange Act of 1934, as amended |
| Consequently, Mr |
| Maguire will be in a position to strongly influence the outcome of substantially all corporate actions requiring shareholder approval, including mergers involving us, sales of all or substantially all of our assets, and the adoption of certain amendments to our Articles of Incorporation |
| Maguire may have interests different than, or adverse to, those of the rest of our shareholders |