| PROASSURANCE CORP ITEM 1A RISK FACTORS There are a number of factors, many beyond our control, which may cause results to differ significantly from our expectations |
| Some of these factors are described below under “Risk Factors,” while others having to do with operational, liquidity, interest rate and other variables, are described elsewhere in this report (see, for example, Part II, Item 7 |
| Management’s Discussion and Analysis of Financial Condition and Results of Operations, “Liquidity and Capital Resources and Financial Condition” and Part II, Item 7A Quantitative and Qualitative Disclosures about 13 _________________________________________________________________ [47]Table of Contents Market Risk) |
| Any factor described in this report could by itself, or together with one or more factors, have a negative effect on our business, results of operations and/or financial condition |
| There may be factors not described in this report that could also cause results to differ from our expectations |
| Our operating results may be affected if actual insured losses differ from our loss reserves |
| Significant periods of time often elapse between the occurrence of an insured loss, the reporting of the loss by the insured and payment of that loss |
| To recognize liabilities for unpaid losses, we establish reserves as balance sheet liabilities representing estimates of amounts needed to pay reported and unreported losses and the related loss adjustment expense |
| The process of estimating loss reserves is a difficult and complex exercise involving many variables and subjective judgments |
| As part of the reserving process, we review historical data and consider the impact of various factors such as: – trends in claim frequency and severity; – changes in operations; – emerging economic and social trends; – inflation; and – changes in the regulatory and litigation environments |
| This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate, but not necessarily accurate, basis for predicting future events |
| There is no precise method for evaluating the impact of any specific factor on the adequacy of reserves, and actual results are likely to differ from original estimates |
| Our loss reserves also may be affected by court decisions that expand liability on our policies after they have been issued and priced |
| In addition, a significant jury award, or series of awards, against one or more of our insureds could require us to pay large sums of money in excess of our reserved amounts |
| Our policy to aggressively litigate claims against our insureds may increase the risk that we may be required to make such payments |
| To the extent loss reserves prove to be inadequate in the future, we would need to increase our loss reserves and incur a charge to earnings in the period the reserves are increased, which could have a material adverse impact on our financial condition and results of operation and the price of our common stock |
| If we are unable to maintain a favorable financial strength rating, it may be more difficult for us to write new business or renew our existing business |
| Independent rating agencies assess and rate the claims-paying ability of insurers based upon criteria established by the agencies |
| Periodically the rating agencies evaluate us to confirm that we continue to meet the criteria of previously assigned ratings |
| The financial strength ratings assigned by rating agencies to insurance companies represent independent opinions of financial strength and ability to meet policyholder obligations and are not directed toward the protection of investors |
| Ratings by rating agencies are not ratings of securities or recommendations to buy, hold or sell any security |
| Our principal operating subsidiaries hold favorable financial strength ratings with AM Best, Standard & Poor’s, Fitch and other rating agencies |
| Financial strength ratings are used by agents and customers as an important means of assessing the financial strength and quality of insurers |
| If our financial position deteriorates, we may not maintain our favorable financial strength ratings from the rating agencies |
| A downgrade or withdrawal of any such rating could limit or prevent us from writing desirable business |
| 14 _________________________________________________________________ [48]Table of Contents We operate in a highly competitive environment |
| The property and casualty insurance business is highly competitive |
| We compete with large national property and casualty insurance companies, locally-based specialty companies, self-insured entities and alternative risk transfer arrangements (such as captive insurers and risk retention groups) whose activities are directed to limited markets |
| Competitors include companies that have substantially greater financial resources than we do, as well as mutual companies and similar companies not owned by shareholders whose return on equity objectives may be lower than ours |
| Competition in the property and casualty insurance business is based on many factors, including premiums charged and other terms and conditions of coverage, services provided, financial ratings assigned by independent rating agencies, claims services, reputation, perceived financial strength and the experience of the insurance company in the line of insurance to be written |
| Increased competition could adversely affect our ability to attract and retain business at current premium levels and reduce the profits that would otherwise arise from operations |
| Our revenues may fluctuate with insurance market conditions |
| We derive a significant portion of our insurance premium revenue from medical malpractice risks |
| Between 2000 and 2004, premium rates increased significantly which has improved our operating results |
| We believe competition has increased in the medical malpractice industry with the recent increases in premium rates |
| Should our competitors become less disciplined in their pricing, or more permissive in their terms, we may lose customers who base their purchasing decisions primarily on price because our policy is to charge adequate premiums on risks that meet our underwriting standards |
| We cannot predict whether, when or how market conditions will change, or the manner in which, or the extent to which any such changes may adversely impact the results of our operations |
| Our revenues may fluctuate with interest rates and investment results |
| We generally rely on the positive performance of our investment portfolio to offset insurance losses and to contribute to our profitability |
| As our investment portfolio is primarily comprised of interest-earning assets, prevailing economic conditions, particularly changes in market interest rates, may significantly affect our operating results |
| Changes in interest rates also can affect the value of our interest-earning assets, which are principally comprised of fixed and adjustable-rate investment securities |
| Generally, the values of fixed-rate investment securities fluctuate inversely with changes in interest rates |
| Interest rate fluctuations could adversely affect our stockholders’ equity, income and/or cash flows |
| Our total investments at December 31, 2005 were dlra2dtta631 billion, of which dlra2dtta403 billion was invested in fixed maturities |
| Unrealized pre-tax net investment losses on investments in fixed maturities were dlra15dtta2 million at December 31, 2005 |
| At December 31, 2005, we held equity investments having a fair value of dlra10dtta0 million in an available-for-sale portfolio and held additional equity securities having a fair value of dlra5dtta2 million in a trading portfolio |
| The fair value of these securities fluctuates depending upon company specific and general market conditions |
| Any decline in the fair value of available-for-sale securities that we determine to be other-than-temporary will reduce our net income |
| Any changes in the fair values of trading securities, whether gains or losses, will be included in net income in the period changed |
| Changes in healthcare could have a material impact on our operations |
| We derive substantially all of our medical professional liability insurance premiums from physicians and other individual healthcare providers, physician groups and smaller healthcare facilities |
| Significant attention has been focused on reforming the healthcare industry at both the federal and state levels which could result in changes to how health care providers insure their medical malpractice risks |
| A broad range of healthcare reform measures has been suggested, and public discussion of such measures will likely continue in the future |
| Proposals have included, among others, spending limits, price controls, limiting increases in insurance premiums, limiting 15 _________________________________________________________________ [49]Table of Contents the liability of doctors and hospitals for tort claims, imposing liability on institutions rather than physicians, and restructuring the healthcare insurance system |
| We cannot predict which, if any, reform proposals will be adopted, when they may be adopted or what impact they may have on us |
| The adoption of certain of these proposals could materially adversely affect our financial condition or results of operations |
| In addition to regulatory and legislative efforts, there have been significant market driven changes in the healthcare environment |
| In recent years, a number of factors related to the emergence of managed care have negatively impacted or threatened to impact the medical practice and economic independence of medical professionals |
| Medical professionals have found it more difficult to conduct a traditional fee-for-service practice and many have been driven to join or contractually affiliate with larger organizations |
| Such change and consolidation may result in the elimination of, or a significant decrease in, the role of the physician in the medical malpractice insurance purchasing decision |
| It could also result in greater emphasis on the role of professional managers, who may seek to purchase insurance on a price competitive basis, and who may favor insurance companies that are larger and more highly rated than we are |
| In addition, such change and consolidation could reduce our medical malpractice premiums as groups of insurance purchasers generally retain more risk or self insure |
| The movement from traditional fee-for-service practice to the managed care environment may also result in an increase in the liability profile of our insureds |
| The majority of our insured physicians practice in primary care specialties such as internal medicine, family practice, general practice and pediatrics |
| In the managed care environment, these primary care physicians are being required to take on the role of “gatekeeper” and restrain the use of specialty care by controlling access to specialists and by performing certain procedures that would customarily be performed by specialists in a fee-for-service setting |
| These practice changes may result in an increase in the claims frequency and severity experienced by primary care physicians and by us as their insurance carrier |
| We are a holding company and are dependent on dividends and other payments from our operating subsidiaries, which are subject to dividend restrictions |
| We are a holding company whose principal source of funds is cash dividends and other permitted payments from operating subsidiaries |
| If our subsidiaries are unable to make payments to us, or are able to pay only limited amounts, we may be unable to make payments on our indebtedness |
| The payment of dividends by these operating subsidiaries is subject to restrictions set forth in the insurance laws and regulations of their respective states of domicile, as discussed under Item 1, “Insurance Regulatory Matters” on page 10 |
| 16 _________________________________________________________________ [50]Table of Contents Regulatory requirements could have a material impact on our operations |
| Our insurance businesses are subject to extensive regulation by state insurance authorities in each state in which they operate |
| Regulation is intended for the benefit of policyholders rather than shareholders |
| In addition to the amount of dividends and other payments that can be made to a holding company by insurance subsidiaries, these regulatory authorities have broad administrative and supervisory power relating to: – licensing requirements; – trade practices; – capital and surplus requirements; – investment practices; and – rates charged to insurance customers |
| These regulations may impede or impose burdensome conditions on rate increases or other actions that we may want to take to enhance our operating results |
| In addition, we may incur significant costs in the course of complying with regulatory requirements |
| Most states also regulate insurance holding companies like us in a variety of matters such as acquisitions, changes of control and the terms of affiliated transactions |
| Future legislative or regulatory changes may also adversely affect our business operations |
| The unpredictability of court decisions could have a material impact on our operations |
| The financial position of our insurance subsidiaries may also be affected by court decisions that expand insurance coverage beyond the intention of the insurer at the time it originally issued an insurance policy |
| In addition, a significant jury award, or series of awards, against one or more of our insureds could require us to pay large sums of money in excess of our reserve amounts |
| The passage of tort reform or other legislation, and the subsequent review of such laws by the courts could have a material impact on our operations |
| Tort reforms generally restrict the ability of a plaintiff to recover damages by, among other limitations, eliminating certain claims that may be heard in a court, limiting the amount or types of damages, changing statutes of limitation or the period of time to make a claim, and limiting venue or court selection |
| A number of states in which we do business have enacted, or are considering, tort reform legislation |
| Proposed federal tort reform legislation has failed to win Congressional approval to date |
| While the effects of tort reform would appear to be beneficial to our business generally, there can be no assurance that such reforms will be effective or ultimately upheld by the courts in the various states |
| Further, if tort reforms are effective, the business of providing professional liability insurance may become more attractive, thereby causing an increase in competition for us |
| In addition, there can be no assurance that the benefits of tort reform will not be accompanied by legislation or regulatory actions that may be detrimental to our business |
| For example, various states have established or are evaluating their intention to establish state sponsored malpractice insurance for their resident physicians that may eliminate targeted physicians from the private insurance market |
| Furthermore, insurance regulatory authorities may require premium rate limitations and expanded coverage requirements as well as other requirements in anticipation of the expected benefits of tort reform which may or may not be actually realized |
| Our geographic concentration ties our performance to the economic, regulatory and demographic conditions of the mid-Atlantic, Midwest and Southeast states |
| Our revenues and profitability are subject to prevailing economic, regulatory, demographic and other conditions in the states in which we write insurance |
| We currently write professional liability insurance in 22 states and the District of Columbia, with approximately 68prca of gross premiums written in Alabama, Florida, Indiana, Michigan and Ohio in 2005 |
| Because our business currently is concentrated in a limited number of markets, adverse developments that are 17 _________________________________________________________________ [51]Table of Contents limited to a geographic area in which we do business may have a disproportionately greater affect on us than they would have if we did business in markets outside that particular geographic area |
| Our business could be adversely affected by the loss of independent agents |
| We depend in part on the services of independent agents and brokers in the marketing of our insurance products |
| We face competition from other insurance companies for the services and allegiance of independent agents and brokers |
| These agents and brokers may choose to direct business to competing insurance companies or may direct less desirable risks to us |
| 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 |
| Market conditions beyond our control determine the availability and cost of the reinsurance, which may affect the level of our business and profitability |
| We may be unable to maintain current reinsurance coverage or to obtain other reinsurance coverage in adequate amounts and at favorable rates |
| If we are unable to renew our expiring coverage or to obtain new reinsurance coverage, 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 our underwritten risk |
| 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 our risks 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 to the extent the risk is transferred, it does not relieve us of our liability to our policyholders |
| If reinsurers fail to pay us or fail to pay on a timely basis, our financial results would be adversely affected |
| At December 31, 2005, we had reinsurance recoverables on paid and unpaid losses and loss adjustment expenses of approximately dlra327dtta7 million |
| The guaranty fund assessments that we are required to pay to state guaranty associations may increase and results of operations and financial condition could suffer as a result |
| Each state in which we operate has separate insurance guaranty fund laws requiring admitted property and casualty insurance companies doing business within their respective jurisdictions to be members of their guaranty associations |
| These associations are organized to pay covered claims (as defined and limited by the various guaranty association statutes) under insurance policies issued by insolvent insurance companies |
| Most guaranty association laws enable the associations to make assessments against member insurers to obtain funds to pay covered claims after a member insurer becomes insolvent |
| These associations levy assessments (up to prescribed limits) on all member insurers in a particular state on the basis of the proportionate share of the premiums written by member insurers in the covered lines of business in that state |
| Maximum assessments permitted by law in any one year generally vary between 1prca and 2prca of annual premiums written by a member in that state |
| Some states permit member insurers to recover assessments paid through surcharges on policyholders or through full or partial premium tax offsets, while other states permit recovery of assessments through the rate filing process |
| Property and casualty guaranty fund assessments incurred by us totaled dlra226cmam000 and dlra396cmam000 for 2005 and 2004, respectively |
| Our policy is to accrue the insurance insolvencies when notified of assessments |
| We are not able to reasonably estimate the liabilities of an insolvent insurer or develop a meaningful range of the insolvent insurer’s liabilities because of inadequate financial data with respect to the estate of the insolvent company as supplied by the guaranty funds |
| 18 _________________________________________________________________ [52]Table of Contents Our business could be adversely affected by the loss of one or more key employees |
| We are heavily dependent upon our senior management and the loss of services of our senior executives could adversely affect our business |
| Our success has been, and will continue to be, dependent on our ability to retain the services of existing key employees and to attract and retain additional qualified personnel in the future |
| The loss of the services of key employees or senior managers, or the inability to identify, hire and retain other highly qualified personnel in the future, could adversely affect the quality and profitability of our business operations |
| Our board of directors is in the process of considering succession planning relating to our Chief Executive Officer |
| Crowe, our current Chairman and Chief Executive Officer, has indicated to the board that he has no immediate plans for retirement |
| Provisions in our charter documents, Delaware law and state insurance law may impede attempts to replace or remove management or impede a takeover, which could adversely affect the value of our common stock |
| Our certificate of incorporation, bylaws and Delaware law contain provisions that may have the effect of inhibiting a non-negotiated merger or other business combination |
| Additionally, the board of directors may issue preferred stock, which could be used as an anti-takeover device, without a further vote of our stockholders |
| We currently have no preferred stock outstanding, and no present intention to issue any shares of preferred stock |
| However, because the rights and preferences of any series of preferred stock may be set by the board of directors in its sole discretion, the rights and preferences of any such preferred stock may be superior to those of our common stock and thus may adversely affect the rights of the holders of common stock |
| The voting structure of common stock and other provisions of our certificate of incorporation are intended to encourage a person interested in acquiring us to negotiate with, and to obtain the approval of, the board of directors in connection with a transaction |
| However, certain of these provisions may discourage our future acquisition, including an acquisition in which stockholders might otherwise receive a premium for their shares |
| As a result, stockholders who might desire to participate in such a transaction may not have the opportunity to do so |
| In addition, state insurance laws provide that no person or entity may directly or indirectly acquire control of an insurance company unless that person or entity has received approval from the insurance regulator |
| An acquisition of control of our insurance operating subsidiaries generally would be presumed if any person or entity acquires 10prca (5prca in Alabama) or more of its outstanding common stock, unless the applicable insurance regulator determines otherwise |
| These provisions apply even if the offer may be considered beneficial by stockholders |
| If a change in management or a change of control is delayed or prevented, the market price of our common stock could decline |