<PAGE>
As filed with the Securities and Exchange Commission on September 16, 1998
Registration No. 333-
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------
FORM S-3
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
------------------
<TABLE>
<S> <C>
PMC Capital I Pennsylvania Manufacturers Corporation
- -------------------------------------- ------------------------------------------
(Exact name of registrant as specified (Exact name of registrant as specified
in its charter) in its charter)
Delaware Pennsylvania
- --------------------------------- -------------------------------
(State or other jurisdiction of (State or other jurisdiction of
incorporation or organization) incorporation or organization)
Applied For 23-2217932
- -------------------------------------- ----------------------------------------
(I.R.S. Employer Identification No.) (I.R.S. Employer Identification No.)
The PMA Building The PMA Building
380 Sentry Parkway 380 Sentry Parkway
Blue Bell, Pennsylvania 19422-2328 Blue Bell, Pennsylvania 19422-2328
(215) 665-5046 (215) 665-5046
- -------------------------------------- ----------------------------------------
(address, including zip code, and (address, including zip code, and
telephone number, including area telephone number, including area
code, of registrant's principal code, of registrant's principal
executive offices) executive offices)
</TABLE>
--------------------
Francis W. McDonnell
Senior Vice President and Chief Financial Officer
Pennsylvania Manufacturers Corporation
1735 Market Street
Philadelphia, Pennsylvania 19103-7590
(215) 665-5070
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(Name, address, including zip code, and
telephone number, including area code,
of agent for service)
--------------------
Copies to:
Robert L. Pratter, Esquire William D. Torchiana, Esquire
Duane, Morris & Heckscher LLP Sullivan & Cromwell
4200 One Liberty Place 125 Broad Street
Philadelphia, PA 19103-7396 New York, New York 10004
(215) 979-1000 (212) 558-4000
--------------------
Approximate date of commencement of proposed sale to the public: As soon
as practicable after this Registration Statement becomes effective.
<PAGE>
If the only securities being registered on this Form are to be offered
pursuant to dividend or interest reinvestment plans, please check the following
box. [_]
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 of the Securities Act of 1933
other than securities offered only in connection with dividend or interest
reinvestment plans, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration number of the earlier effective
registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act of 1933, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434
under the Securities Act of 1933, please check the following box. [_]
--------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
==================================================================================================
Proposed
Proposed Maximum
Title of each class Maximum Aggregate
of securities to be Amount to be Offering Price Offering Amount of
registered Registered Per Unit(2)(3) Price(2)(3) Registration Fee
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Junior
Subordinated
Debentures of $100,000,000 $ $100,000,000 N/A
Pennsylvania
Manufacturers
Corporation(1)
- --------------------------------------------------------------------------------------------------
Capital Securities $100,000,000 $ $100,000,000 $29,500
of PMC Capital I
- --------------------------------------------------------------------------------------------------
Guarantee of
Capital Securities
of PMC Capital I N/A N/A N/A N/A
by Pennsylvania
Manufacturers
Corporation(4)
- --------------------------------------------------------------------------------------------------
Total ............. $100,000,000 100% $100,000,000 $29,500
==================================================================================================
</TABLE>
(1) Junior Subordinated Debentures of Pennsylvania Manufacturers Corporation
may be issued and sold to PMC Capital I, in which event such Junior
Subordinated Debentures may later be distributed to the holders of Capital
Securities of PMC Capital I upon its dissolution and the distribution of
the assets thereof. The amount registered is in United States dollars or
the equivalent thereof in any other currency, currency unit or units or
composite currency or currencies.
<PAGE>
(2) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457. The aggregate offering price of the Junior
Subordinated Debentures and Capital Securities registered hereby will not
exceed $100,000,000.
(3) Exclusive of accrued interest and distributions, if any.
(4) Includes back-up undertakings, consisting of obligations of Pennsylvania
Manufacturers Corporation to provide certain indemnities in respect of, and
pay and be responsible for certain expenses and debts of PMC Capital I. No
separate consideration will be received for the Guarantee or any back-up
undertakings.
____________________
THE REGISTRANTS HEREBY AMEND THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANTS SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT OF 1933, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
===========================================
<PAGE>
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED SEPTEMBER ___, 1998
$100,000,000
PMC CAPITAL I
___ % CAPITAL SECURITIES, SERIES A
(Liquidation Amount $1,000 Per Capital Security)
Fully and Unconditionally Guaranteed, As Described Herein, By
PENNSYLVANIA MANUFACTURERS CORPORATION
------------------------
The ___% Capital Securities, Series A (the "Capital Securities") offered
hereby (the "Offering") represent undivided beneficial interests in the assets
of PMC Capital I, a statutory business trust formed under the laws of the State
of Delaware (the "Issuer" or the "Trust"). Pennsylvania Manufacturers
Corporation ("PMC"), a Pennsylvania corporation, will be the owner of all of the
beneficial interests represented by common securities (the "Common Securities")
of the Issuer. Bank of New York is the Property Trustee of the Issuer. The
Issuer exists for the sole purpose of issuing the Capital Securities and the
Common Securities and investing the proceeds thereof in ___% Junior Subordinated
Debentures, Series A (the "Junior Subordinated Debentures") to be issued by PMC.
The Junior Subordinated Debentures will mature on _________, 2028 (the "Stated
Maturity"). The Capital Securities will have a preference under certain
circumstances with respect to cash distributions and amounts payable on
liquidation, redemption or otherwise over the Common Securities. See
"Description of the Capital Securities -- Subordination of Common Securities."
Holders of the Capital Securities will be entitled to receive preferential
cumulative cash distributions accruing from the date of original issuance and
payable semi-annually in arrears on and of each year, commencing , 1999, at the
annual rate of ___% of the liquidation amount of $1,000 per Capital Security
("distributions"). PMC has the right to defer payments of interest on the Junior
Subordinated Debentures, so long as no Debenture Event of Default (as defined
herein) has occurred and is continuing, at any time (continued on next page)
See "Risk Factors" beginning on Page 18 hereof for certain information
Relevant to an investment in the Capital Securities.
-----------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION NOR HAS THE SECURITIES AND EXCHANGE
COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY
OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
Initial Public Offering Underwriting Proceeds to the
Price(1) Commissions(2) Issuer(3)(4)
----------------------- --------------------- ---------------------
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Capital Security....... $1,000 (3)
- ------------------------------------------------------------------------------------------------------------------------
Total ..................... $100,000,000 (3)
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Plus accrued distributions, if any, from the date of original issuance.
(2) The Issuer, PMC and PMA Reinsurance Corporation have agreed to indemnify
the several Underwriters against certain liabilities, including liabilities
under the Securities Act of 1933, as amended. See "Underwriting."
(3) In view of the fact that the proceeds of the sale of the Capital Securities
will be used to purchase the Junior Subordinated Debentures, PMC has agreed
to pay to the Underwriters as compensation ("Underwriters' Compensation")
for their arranging the investment therein of such proceeds, $____ per
Capital Security (or $_____ in the aggregate). See "Underwriting."
(4) Other expenses of issuance and distribution, which are payable by PMC, are
estimated to be $500,000.
The Capital Securities offered hereby are offered severally by the
Underwriters, as specified herein, subject to receipt and acceptance by them and
subject to their right to reject any order in whole or in part. It is expected
that the Capital Securities will be ready for delivery in book-entry form only
through the facilities of DTC, on or about ____________, 1998, against payment
therefor in immediately available funds.
Goldman, Sachs & Co.
Merrill Lynch & Co.
First Union Capital Markets
----------------
The date of this Prospectus is _____________, 1998
[Red Herring Legend]
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
- 2 -
<PAGE>
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE CAPITAL
SECURITIES, INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT COVERING
TRANSACTIONS IN SUCH SECURITIES, AND THE IMPOSITION OF A PENALTY BID, DURING AND
AFTER THE OFFERING. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
(Continued from Previous Page)
and from time to time for a period not exceeding 10 consecutive semi-annual
periods with respect to each deferral period (each an "Extension Period"),
provided that no Extension Period may extend beyond the Stated Maturity of the
Junior Subordinated Debentures. Upon the termination of any such Extension
Period and the payment of all interest then accrued and unpaid (together with
interest thereon at the rate of ___% per annum, compounded semi-annually, to the
extent permitted by applicable law), PMC may elect to begin a new Extension
Period subject to the requirements set forth herein. If interest payments are
so deferred, distributions on the Capital Securities will also be deferred and
PMC will not be permitted to declare or pay any distributions with respect to
PMC's capital stock or make any payment on any debt securities of PMC that rank
pari passu with or junior to the Junior Subordinated Debentures or make any
guarantee payments with respect to any guarantee by PMC of the debt securities
of any subsidiary of PMC that rank pari passu with or junior to the Junior
Subordinated Debentures subject to certain exceptions described herein. During
an Extension Period, interest on the Junior Subordinated Debentures will
continue to accrue (and the amount of distributions to which holders of the
Capital Securities are entitled will accumulate) at the rate of ___% per annum,
compounded semi-annually from the relevant payment date for such interest and
holders of Capital Securities will be required to accrue interest income for
United States federal income tax purposes. See "Description of the Junior
Subordinated Debentures--Option to Extend Interest Payment Period" and "United
States Federal Income Taxation--Original Issue Discount."
PMC has, through the Guarantee, the Trust Agreement, the Capital
Securities, the Indenture and the Expense Agreement (each as defined herein),
taken together, fully, irrevocably and unconditionally guaranteed all of the
Issuer's obligations under the Capital Securities. See "Relationship Among the
Capital Securities, the Junior Subordinated Debentures and the Guarantee--Full
and Unconditional Guarantee." The Guarantee of PMC guarantees the payment of
distributions and payments on liquidation or redemption of the Capital
Securities, but only in each case to the extent of funds held by the Issuer, as
described herein (the "Guarantee"). See "Description of the Guarantee." If PMC
does not make interest payments on the Junior Subordinated Debentures held by
the Issuer, the Issuer will have insufficient funds to pay distributions on the
Capital Securities. The Guarantee does not cover payment of distributions when
the Issuer does not have sufficient funds to pay such distributions. In such
event, a holder of Capital Securities may institute a legal proceeding directly
against PMC pursuant to the terms of the Indenture to enforce payment of amounts
equal to such distributions to such holder. See "Description of the Junior
Subordinated Debentures--Debenture Events of Default and Consequent Rights of
Certain Holders--Rights of Holders of Capital Securities to Direct Action."
PMC's obligations under the Guarantee and the Junior Subordinated Debentures are
subordinate and junior in right of payment to all Senior Debt (as defined
herein) of PMC.
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<PAGE>
The Capital Securities are subject to mandatory redemption, in whole or in
part, upon repayment of the Junior Subordinated Debentures at maturity or their
earlier redemption. See "Description of the Capital Securities--Redemption."
The Junior Subordinated Debentures are redeemable prior to their Stated Maturity
at the option of PMC (i) on or after ______________, 2008, in whole at any time
or in part from time to time or (ii) prior to , 2008, in whole (but not in
part), within 90 days following the occurrence of a Special Event (as defined
herein). For a description of redemption prices for the Capital Securities
pursuant to clause (i) or (ii) above, see "Description of the Capital
Securities--Redemption" and "Description of the Junior Subordinated Debentures--
Optional Redemption."
The Junior Subordinated Debentures are unsecured and subordinated and
junior in right of payment to all Senior Debt of PMC. After the completion of
this Offering and the repayment of debt with the proceeds thereof, PMC will have
approximately $104.5 million principal amount of indebtedness for borrowed money
constituting Senior Debt. The terms of the Junior Subordinated Debentures do
not limit PMC's ability to incur additional Senior Debt. PMC is an insurance
holding company and substantially all of the operating assets of PMC are owned
by its subsidiaries. PMC relies primarily on the receipt of sufficient funds
from its subsidiaries in the form of dividends, net payments under a tax-sharing
agreement between PMC and its subsidiaries and loans to meet its obligations for
payment of principal and interest on its outstanding debt obligations and
corporate expenses. Accordingly, the Junior Subordinated Debentures will be
effectively subordinated to all existing and future liabilities of PMC's
subsidiaries, and holders of Junior Subordinated Debentures should look only to
the assets of PMC for payments on the Junior Subordinated Debentures. The
payment of dividends by PMC's insurance subsidiaries is limited under the
insurance laws of their states of domicile (primarily Pennsylvania). PMC's
insurance subsidiaries have the ability to loan funds to PMC subject to certain
regulatory restrictions. See "Description of the Junior Subordinated
Debentures--Subordination."
PMC will have the right at any time to terminate the Issuer and cause the
Junior Subordinated Debentures to be distributed to the holders of the Capital
Securities in liquidation of the Issuer. In the event of the termination of the
Issuer, after satisfaction of liabilities to creditors of the Issuer as required
by applicable law, the holders of the Capital Securities will be entitled to
receive for each Capital Security a Liquidation Amount of $1,000 per Capital
Security, plus accumulated and unpaid distributions thereon to the date of
payment, or a distribution of such Liquidation Amount in Junior Subordinated
Debentures, subject to certain limitations. See "Description of the Capital
Securities--Liquidation Distribution Upon Termination."
The Capital Securities will be represented by global certificates
registered in the name of The Depository Trust Company ("DTC") or its nominee.
Beneficial interests in the Capital Securities will be shown on, and transfers
thereof will be effected only through, records maintained by participants in
DTC. Except as described herein, Capital Securities in certificated form will
not be issued in exchange for the global certificates. See "Description of the
Capital Securities--Book-Entry-Only Issuance--The Depository Trust Company."
FOR NORTH CAROLINA RESIDENTS: THE COMMISSIONER OF INSURANCE OF THE
STATE OF NORTH CAROLINA HAS NOT APPROVED OR DISAPPROVED THIS OFFERING NOR
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<PAGE>
HAS THE COMMISSIONER PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
AVAILABLE INFORMATION
The Trust and PMC have filed with the Securities and Exchange Commission
(the "Commission") a Registration Statement on Form S-3 (together with all
amendments and exhibits thereto, the "Registration Statement") under the
Securities Act of 1933, as amended (the "Securities Act"), with respect to the
Capital Securities, the Junior Subordinated Debentures and the Guarantee. This
Prospectus, which forms a part of the Registration Statement, does not contain
all the information set forth in the Registration Statement, certain parts of
which have been omitted in accordance with the Rules and Regulations of the
Commission. Statements made in this Prospectus as to the contents of any
contract, agreement or other document referred to are not necessarily complete.
With respect to each such contract, agreement or other document filed as an
exhibit to the Registration Statement, reference is made to the exhibit for a
more complete description of the matter involved, and each such statement shall
be deemed qualified in its entirety by such reference.
PMC is subject to the informational requirements of the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), and, in accordance therewith,
files reports and other information with the Commission. In addition, the Trust
and PMC intend to furnish to holders of Capital Securities annual reports
containing consolidated financial statements of PMC certified by an independent
public accounting firm. Such reports and other information and the Registration
Statement, including the exhibits and schedules filed therewith, may be examined
without charge at the public reference facilities maintained by the Commission
at Room 1024, Judiciary Plaza, 450 Fifth Street N.W., Washington, D.C. 20549,
and at the Commission's regional offices at Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661 and 7 World Trade Center, 13th
Floor, New York, New York 10048. Copies of all or any part of the Registration
Statement may be obtained from the Public Reference Section of the Commission at
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed
rates. The Commission maintains a Web Site (http://www.sec.gov) that contains
reports, proxy and information statements and other information regarding
registrants who file electronically with the Commission. The public may obtain
information on the operation of the Public Reference Room by calling the
Commission at 1-800-SEC-0330.
No separate financial statements of the Trust have been included herein.
PMC and the Trust do not consider such financial statements material to holders
of the Capital Securities because the Trust is a newly formed special purpose
entity, has no operating history or independent operations and is not engaged
in, and does not propose to engage in, any activity other than its holding as
trust assets the Junior Subordinated Debentures of PMC and its issuance of the
Capital Securities and the Common Securities. See "The Issuer," "Description of
the Capital Securities," "Description of the Guarantee" and "Description of the
Junior Subordinated Debentures." In addition, PMC does not expect that the
Trust will be filing reports under the Exchange Act with the Commission. The
Trust is a statutory business trust formed under the laws of the State of
Delaware. PMC, as of the date hereof, beneficially owns all of the beneficial
interests in the Trust. PMC's and the Trust's principal executive offices are
located at 380 Sentry Parkway, Blue Bell, Pennsylvania 19422-2328, telephone
number (215) 665-5046.
- 5 -
<PAGE>
FORWARD-LOOKING STATEMENTS
Certain statements made throughout this Prospectus contain forward-looking
statements that involve risks and uncertainties. The Company's actual results
could differ materially from those expected by the Company. The factors that
could cause actual results to vary materially, some of which are described in
the forward-looking statements, include, but are not limited to, changes in
general economic conditions, including the performance of financial markets and
interest rates; regulatory or tax changes, including changes in risk-based
capital or other regulatory standards that affect the ability of the Company to
conduct its business; competitive or regulatory changes that affect the cost of
or demand for the Company's products; the effect of changes in workers'
compensation statutes and the administration thereof; the Company's ability to
predict and effectively manage claims related to insurance and reinsurance
policies; reliance on key management; adequacy of reserves for claims
liabilities; adequacy and collectibility of reinsurance purchased by the
Company; frequency and severity of natural disasters and other catastrophes; and
other factors disclosed from time to time in reports filed by the Company with
the Commission. Investors should not place undue reliance on any such forward-
looking statements.
- 6 -
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by reference to the
detailed information and consolidated financial statements appearing elsewhere
in this Prospectus. Certain insurance terms and other capitalized terms used
herein are defined in "Glossary of Certain Insurance and Other Defined Terms."
Unless the context otherwise requires, all references in this Prospectus to: (i)
"PMC" or the "Company" refers to Pennsylvania Manufacturers Corporation and,
depending on the context, its subsidiaries on a consolidated basis; (ii) "PMA
Re" refers to the Company's property and casualty reinsurance operations,
including PMA Reinsurance Corporation, a Pennsylvania insurance subsidiary of
the Company; (iii) "Property and Casualty Group" refers to the Company's
workers' compensation and standard commercial lines of property and casualty
insurance operations, which are written through the "Pooled Companies"
consisting of three Pennsylvania insurance subsidiaries of the Company,
including Pennsylvania Manufacturers Association Insurance Company ("PMAIC"),
which share underwriting results through an intercompany pooling arrangement;
(iv) "Caliber One" refers to the Company's specialty insurance operation,
including Caliber One Indemnity Company, a Delaware insurance subsidiary of the
Company; (v) "PMA Cayman" refers to PMA Insurance, Cayman Ltd., a Cayman Islands
run-off insurance subsidiary of the Company and (vi) "MASCCO" refers to Mid-
Atlantic States Casualty Company, a Pennsylvania run-off insurance subsidiary of
the Company.
Unless otherwise specified, all financial information is presented in
accordance with United States generally accepted accounting principles ("GAAP").
Statutory data included herein have been derived from the annual and quarterly
statements of PMC's insurance subsidiaries as filed with insurance regulatory
authorities and prepared in accordance with statutory accounting principles
("SAP") prescribed or permitted by such regulatory authorities.
Unless otherwise specified herein, the information contained herein assumes
no exercise of the Underwriters' over-allotment option.
The Company
General
The Company is an insurance holding company, whose subsidiaries operate in
three distinct segments of the property and casualty insurance industry: (i)
reinsurance, through PMA Re, which commenced business in 1980; (ii) standard
commercial lines of insurance, with an emphasis on workers' compensation,
through the Property and Casualty Group, which has been in business since 1915
and (iii) specialty insurance products, focusing on excess and surplus lines,
through the Company's recently-formed operation, Caliber One. PMA Re writes a
broad range of property and casualty reinsurance products with an emphasis on
risk-exposed casualty excess of loss reinsurance and operates in the United
States domestic brokered market. The Property and Casualty Group offers a broad
range of standard commercial lines including commercial general liability,
commercial automobile and commercial multi-peril, with an emphasis on
underwriting of workers' compensation products and services primarily in nine
contiguous jurisdictions in the Mid-Atlantic and Southern regions of the United
States, utilizing the PMA Group trade name. In 1998, Caliber One commenced
writing excess and surplus lines of insurance, including commercial general
liability, automobile and certain
- 7 -
<PAGE>
property exposures on a non-admitted basis. For the six months ended June 30,
1998, the Company's net premiums written of $257.0 million were derived 45.9%
from PMA Re, 53.8% from the Property and Casualty Group and 0.3% from Caliber
One. Net income for the Company for six months ended June 30, 1998 and the year
ended December 31, 1997 was $21.4 million and $15.0 million, respectively. As of
June 30, 1998, the Company had total assets of $3,075.4 million and
shareholders' equity of $496.4 million.
According to data provided by the Reinsurance Association of America
("RAA"), as of June 30, 1998, PMA Reinsurance Corporation was the 24th largest
reinsurer in the United States in terms of statutory surplus and 17th largest in
terms of net premiums written. Management believes that PMA Re competes on the
basis of its ability to offer prompt and responsive service and products
designed to meet clients needs and its excellent long-term relationships in the
broker and ceding company communities. PMA Re's net premiums written grew at a
compound annual rate of 13.2% between 1992 and 1997. As of June 30, 1998,
statutory surplus of PMA Reinsurance Corporation was $279.1 million, and for the
six months ended June 30, 1998, PMA Re's net premiums written were $117.9
million. PMA Re reported pre-tax operating income of $23.0 million and $23.2
million for the six-month periods ended June 30, 1998 and 1997, respectively,
and $46.0 million, $44.8 million and $39.8 million for the years ended December
31, 1997, 1996 and 1995, respectively.
The Property and Casualty Group markets a full range of workers'
compensation products and services, as well as other standard commercial lines
of property and casualty insurance, primarily to middle market accounts
(premiums ranging from $40,000 to $300,000) and smaller accounts (premiums less
than $40,000). The Property and Casualty Group distributes its products
primarily through approximately 240 regional brokers and agents throughout its
marketing territories and also utilizes an internal sales force in Pennsylvania
and Delaware, which accounted for approximately 13% of direct premiums written
in 1997. In 1997, workers' compensation insurance accounted for 60% of the
Property and Casualty Group's direct premiums written, and Pennsylvania workers'
compensation insurance accounted for 50% of the Property and Casualty Group's
workers' compensation direct premiums written. The Property and Casualty Group
offers a variety of workers' compensation products, such as third-party claims
administration services, rent-a-captives and high-deductible plans in addition
to traditional fixed-cost and loss-sensitive workers' compensation products, and
management believes that the Property and Casualty Group competes in workers'
compensation on the basis of its ability to provide prompt and responsive
service.
In 1996, the Company restructured the Property and Casualty Group with the
goal of restoring its profitability after three years of operating losses. The
operating losses resulted primarily from unfavorable underwriting experience and
adverse reserve development related to accident years 1987 through 1991, when
the Property and Casualty Group wrote a much higher volume of business than its
current volume. The principal components of the restructuring were: (i)
strengthening loss reserves; (ii) initiating a commutation program to settle a
significant number of open claims from the 1987 to 1991 period; (iii)
designating PMA Cayman and MASCCO as separate run-off companies to alleviate the
SAP impact on the
- 8 -
<PAGE>
Pooled Companies of the loss reserve strengthening and to manage the capital
deployed in running off pre-1992 workers' compensation claims; (iv) initiating
an expense reduction program and (v) implementing management changes, including
the appointment of a new Chief Operating Officer and the creation of a new
position of Chief Underwriting Officer. In June 1998, the Company entered into a
letter of intent to sell PMA Cayman. Largely as a result of the restructuring,
the Property and Casualty Group recorded pre-tax operating income of $5.4
million for the six months ended June 30, 1998, compared to pre-tax operating
losses of $5.9 million for the six months ended June 30, 1997 and $3.7 million,
$215.7 million (including restructuring and other special charges of $223.1
million) and $3.9 million for the years ended December 31, 1997, 1996 and 1995,
respectively. At June 30, 1998, the Pooled Companies' statutory surplus was
$263.1 million, and for the six months ended June 30, 1998, the Property and
Casualty Group's net premiums written were $138.4 million. See "Business--The
Property and Casualty Group."
In December 1997, the Company acquired an insurance company, which was
renamed Caliber One Indemnity Company, to enter the excess and surplus lines
insurance business. Within the last year, the Company hired several experienced
specialty insurance executives to manage Caliber One, who have substantial
relationships within the wholesale brokerage community, which management
believes will have a favorable impact on Caliber One's ability to obtain market
acceptance. Caliber One distributes its products primarily through national
wholesale brokers, and Caliber One Indemnity Company is approved as a surplus
lines carrier in 38 states, Puerto Rico and the District of Columbia. As of
June 30, 1998, Caliber One Indemnity Company's statutory surplus was $25.5
million, and for the six months ended June 30, 1998, Caliber One's net premiums
written were $917,000.
The Company's insurance subsidiaries have the following ratings from A.M.
Best: PMA Reinsurance Corporation, A+ ("Superior"); the Pooled Companies, A-
("Excellent") and Caliber One Indemnity Company, A ("Excellent"). Management
believes that ratings from A.M. Best are material to its operations and that a
downgrade from the present rating classifications could have an adverse effect
on the Company's ability to market its products. A.M. Best's ratings are based
upon an assessment of an insurance company's perceived financial strength
regarding its ability to pay obligations to its policyholders and are not
directed toward the protection of investors.
The Company maintains its executive offices at 380 Sentry Parkway, Blue
Bell, PA 19422, and its telephone number is (215) 665-5046.
Business Strategy
Management believes that PMC's three insurance businesses are characterized
by the need for specialized expertise and a requirement for strong underwriting
skills. Management also believes that each of the operations targets
sophisticated customers who desire products designed for specific client needs
that require a high level of service. The following discussion sets forth the
main components of the Company's overall operating strategies and the
implementation thereof by the Company's operating units.
Underwriting Discipline
Management believes that risk selection and pricing is critical to the
Company's success. Maintenance of underwriting discipline has become more
difficult and more critical to the achievement of an acceptable level of
profitability for the Company given the present competitive conditions in
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<PAGE>
the property and casualty insurance and reinsurance industries. The Company's
three operations have rejected and non-renewed certain accounts because market
rates and contract terms for such risks did not provide the opportunity to
achieve a rate of return that management considers acceptable.
The Company relies on experienced underwriting management in order to
maintain underwriting discipline. The underwriting management at PMA Re, the
Property and Casualty Group and Caliber One averages 21, 22 and 16 years of
experience, respectively, in the property and casualty insurance industry. In
addition, in 1997 the Property and Casualty Group strengthened its underwriting
management by creating the new position of and appointing a Chief Underwriting
Officer, who has over 22 years of experience in the industry. Also, the Property
and Casualty Group reorganized the reporting structure so that field
underwriting management now reports functionally to the Chief Underwriting
Officer rather than to branch managers with primarily marketing
responsibilities.
For all of the Company's insurance operations, underwriting management is
evaluated and compensated with the emphasis on profit objectives.
Marketing
The Company markets its products on the basis of price, service, product
design and financial security. The Company attempts to price its products in
such a way that the prices charged to its clients are commensurate with the
overall marketplace. The current soft pricing environment has made competition
and marketing solely on the basis of price increasingly difficult. Therefore,
the Company has focused its marketing efforts on providing excellent service and
products designed for specific client needs, as well as maintaining stable and
solid relationships with the Company's distribution system.
Beginning in 1996, PMA Re undertook a target marketing program designed to
increase its business with certain existing accounts and obtain new ceding
company clients from a pre-screened list developed by the Company. Management
believes that PMA Re has been able to write certain business that has been
displaced as a result of the recent consolidation of the United States
reinsurance industry. As a result of these factors and PMA Re's other
competitive attributes, including management's relationships with broker and
ceding company communities, PMA Re's net premiums written grew 8.5% in 1997
compared to 1996 and increased 22.5% for the six months ended June 30, 1998
compared to the six months ended June 30, 1997, notwithstanding the non-renewal
or cancellation of a total of $68.2 million of business since January 1, 1997
primarily for underwriting reasons. The Property and Casualty Group's marketing
strategy is focused on: (i) reestablishing a portion of its historical market
share in its traditional marketing territories on a profitable basis; (ii)
implementing planned geographic expansion into selected territories bordering
its present marketing territories; (iii) increasing its business with national
brokerages and (iv) increasing its business with smaller accounts (less than
$40,000 in annual premium) in certain jurisdictions in response to workers'
compensation reforms which have made such business more attractive. Caliber
One's marketing strategy is based upon management's relationships within the
wholesale brokerage community and responsiveness to marketplace needs through
product design.
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<PAGE>
Products and Services
Management believes that the Company's results depend on its ability to
offer products designed to meet client needs and services that distinguish the
Company from its competitors. The Company's service standards have been designed
to emphasize prompt turn-around time for underwriting submissions, access to
information and claims handling. PMA Re offers a full range of reinsurance
products, including traditional treaty reinsurance, facultative reinsurance,
finite risk and other specialized products. In addition, PMA Re has been at the
forefront of service initiatives within the brokered reinsurance market,
including fastrack claims, electronic data interchange and electronic funds
transfer. Fastrack claims is a process whereby certain claims are pre-approved
for payment as long as the request for payment falls within certain parameters,
thereby accelerating remittance to the client. The Property and Casualty Group
has developed products and services to serve the various segments of its market.
It offers its workers' compensation insureds the enhanced ability to control
medical costs, through its affiliation with First Health Group, Inc., a third
party preferred provider organization. The Property and Casualty Group has also
utilized aggressive claims settlement processes, including commutations, as part
of its strategy to assist clients in reducing the overall cost of their workers'
compensation benefits. The Property and Casualty Group offers alternative market
products, such as large deductible plans, rent-a-captive services and third
party administration of claims to self-insured clients. In addition, in 1998,
the Property and Casualty Group began marketing an integrated disability
product, PMA One, which combines occupational and non-occupational disability
coverages. Caliber One develops products for specialized segments of the market,
including coverages for clinical trials, environmental risks, special events,
toy manufacturers and retroactive liability.
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<PAGE>
PMC Capital I
PMC Capital I is a statutory business trust formed under Delaware law. The
Issuer exists for the exclusive purposes of (i) issuing the Capital Securities
and the Common Securities representing undivided beneficial interests in the
assets of the Issuer, (ii) investing the gross proceeds of the sale of the
Capital Securities and the Common Securities in the Junior Subordinated
Debentures and (iii) engaging in only those other activities necessary,
convenient or incidental thereto. All of the Common Securities, having an
aggregate liquidation amount equal to 3% of the total capital of the Issuer,
will be owned by PMC. The Common Securities will rank pari passu, and payments
will be made thereon pro rata, with the Capital Securities, except that upon the
occurrence and continuance of an event of default under the Amended and Restated
Trust Agreement (the "Trust Agreement"), among PMC as Depositor, Bank of New
York as Property Trustee and Bank of New York (Delaware) as Delaware Trustee,
and the Administrative Trustees named therein, resulting from an event of
default by PMC on the Junior Subordinated Debentures, the rights of the holders
of the Common Securities to payment in respect of distributions and payments
upon liquidation, redemption and otherwise will be subordinated to the rights of
the holders of the Capital Securities. The Property Trustee and the
Administrative Trustees are referred to herein, collectively, as the "Trustees."
Subject to the right of holders of a majority in Liquidation Amount of the
outstanding Capital Securities to appoint a substitute Property Trustee upon the
occurrence of certain events described herein, PMC, as the owner of all of the
Common Securities, has the exclusive right (subject to the provisions of the
Trust Agreement) to appoint, remove or replace the Property Trustee, the duties
and obligations of which will be governed by the Trust Agreement. PMC will pay
all fees and expenses related to the Issuer and the offering of the Capital
Securities.
The Offering
Issuer PMC Capital I
Securities Offered $100,000,000 of ___% Capital Securities
Ownership The ownership interests in the Trust will be
evidenced by (i) a class of Capital Securities
representing approximately 97% of the ownership
interests in the Trust and (ii) a class of Common
Securities (together with the Capital Securities,
the "Trust Securities") representing approximately
3% of the ownership interest in the Trust.
Maturity of the Junior ________, 2028 (the "Stated Maturity"). The Capital
Subordinated Debentures Securities are mandatorily redeemable upon the
maturity or earlier redemption of the Junior
Subordinated Debentures.
Distribution Payment Dates ___________ 1 and __________ 1, commencing _______,
1999.
Extension of Interest PMC will have the right to extend the interest
Payment Period payment period on the Junior Subordinated
Debentures, so long as no Event of Default has
occurred and is continuing, for a period not
exceeding ten consecutive semi-annual periods
(each, an "Extension Period"), and, as a
consequence, during an Extension Period, semi-
annual distributions on the Capital Securities
would be deferred (and the amount of distributions
which holders of the Capital Securities are
entitled to will accumulate additional
distributions thereon at the rate of _____%
thereof, compounded semi-annually from the relevant
payment date for such
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<PAGE>
distributions). During an Extension Period, neither
PMC nor any of its subsidiaries shall (i) declare
or pay any dividends or distributions on, or
redeem, purchase, acquire or make a liquidation
payment with respect to, any of PMC's outstanding
capital stock or (ii) make any payment of
principal, interest or premium, if any, on or
repay, repurchase or redeem any debt securities of
PMC that rank pari passu with or junior to the
Junior Subordinated Debentures or make any
guarantee payments with respect to any guarantee by
PMC of the debt securities of any subsidiaries of
PMC that rank pari passu with or junior to the
Junior Subordinated Debentures (other than (a)
dividends or distributions in Common Stock or Class
A Common Stock of PMC, (b) payments under the
Guarantee and (c) purchases of Common Stock or
Class A Common Stock of PMC related to the issuance
of Common Stock or Class A Common Stock of PMC
under any of PMC's benefit plan for directors,
officers or employees). This deferral feature
cannot be used to extend the maturity of the Junior
Subordinated Debentures.
Guarantee Taken together, PMC's obligations under the Junior
Subordinated Debentures, the Indenture, the Trust
Agreement, the Expense Agreement and the Guarantee
provide, in the aggregate, a full, irrevocable and
unconditional guarantee of payments of
distributions and other amounts due on the Capital
Securities. No single document standing alone or
operating in conjunction with fewer than all the
other documents constitutes such guarantee.
Mandatory Redemption The Capital Securities are subject to mandatory
redemption upon repayment of the Junior
Subordinated Debentures at maturity or their
earlier redemption. PMC will have the option at any
time on or after, _________________, 2008, to
redeem, in whole or in part, the Junior
Subordinated Debentures, at par, plus accrued and
unpaid interest, if any, through the redemption
date. PMC will also have the right at any time,
upon the occurrence of a Special Event (as defined
herein), to redeem, in whole but not in part, the
Junior Subordinated Debentures.
Liquidation Amount $1,000.00 per Capital Security (the "Liquidation
Amount").
Subordination of Common Income distributions, payments of redemption prices
Securities and amounts distributed in connection with the
liquidation of the Trust will be made pari passu
among holders of Capital Securities and PMC, as
holder of the common Securities, except that, in
the event of a default by PMC on the Junior
Subordinated Debentures, (i) full income
distributions and payments of redemption prices
will be made on the Capital Securities before
further income distributions or payments of
redemption prices are made on the Common Securities
and (ii) the full liquidation preference will be
paid on the Capital Securities in the event of a
liquidation of the Trust before any liquidating
distribution is made on the Common Securities.
Use of Proceeds All of the proceeds from the sale of Capital
Securities will be invested by the Trust in the
Junior Subordinated Debentures. PMC will use the
proceeds from issuance of the Junior Subordinated
Debentures to repay debt that is outstanding under
the Revolving Credit Facility. See "Use of
Proceeds."
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<PAGE>
SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA
The summary consolidated financial and operating data set forth below as of
December 31, 1997, 1996 and 1995 and for each of the three years in the period
ended December 31, 1997 were derived from the audited consolidated financial
statements of the Company. The summary consolidated financial and operating
data as of June 30, 1998 and 1997 and for the six-month periods ended June 30,
1998 and 1997 were derived from the Company's unaudited consolidated financial
statements. The unaudited consolidated financial statements have been prepared
on the same basis as the Company's audited consolidated financial statements,
and, in the opinion of management, include all adjustments, consisting of only
normal recurring adjustments, necessary for a fair presentation of the Company's
financial position and results of operations for these periods. The results of
operations for the six months ended June 30, 1998 may not be indicative of
results of operations for the full year. All summary consolidated financial and
operating data set forth below should be read in conjunction with the
consolidated financial statements of the Company, together with the notes
thereto, and Management's Discussion and Analysis of Financial Condition and
Results of Operations, both appearing elsewhere in this Prospectus.
<TABLE>
<CAPTION>
(dollar amounts in thousands)
Six Months Ended
June 30, Year Ended December 31,
----------------------- ------------------------------------
1998 1997 1997(1) 1996(1) 1995(1)
---- ---- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Net premiums written $257,038 $253,125 $418,282 $443,475 $489,876
======== ======== ======== ======== ========
Consolidated Revenues:
Net premiums earned $221,576 $222,401 $375,951 $420,575 $484,952
Net investment income 65,200 68,459 136,698 133,936 139,355
Net realized investment gains (losses) 11,263 (1,931) 8,598 2,984 31,923
Service revenues 5,090 5,038 10,311 9,189 5,106
-------- -------- -------- -------- --------
Total consolidated revenues $303,129 $293,967 $531,558 $566,684 $661,336
======== ======== ======== ======== ========
Pre-tax operating income (loss)(2):
PMA Re $ 22,952 $ 23,187 $ 45,957 $ 44,807 $ 39,793
-------- -------- -------- -------- --------
The Property and Casualty Group(3):
Excluding Run-off Operations 4,954 (4,781) (3,607) (215,669) (3,885)
Run-off Operations 428 (1,107) (73) --- ---
-------- -------- -------- -------- --------
Total Property and Casualty Group 5,382 (5,888) (3,680) (215,669) (3,885)
Caliber One (1,070) --- --- --- ---
Corporate operations (5,548) (4,526) (9,954) (6,464) (14,184)
-------- -------- -------- -------- --------
Total pre-tax operating income
(loss) before interest expense 21,716 12,773 32,323 (177,326) 21,724
Interest expense 7,463 8,222 15,768 17,052 18,734
-------- -------- -------- -------- --------
Pre-tax operating income (loss) 14,253 4,551 16,555 (194,378) 2,990
Net realized investment gains (losses) 11,263 (1,931) 8,598 2,984 31,923
-------- -------- -------- -------- --------
Income (loss) before income
taxes and extraordinary item 25,516 2,620 25,153 (191,394) 34,913
Provision (benefit) for income taxes 4,071 (2,657) 5,400 (56,060) 10,783
-------- -------- -------- -------- --------
Income (loss) before extraordinary item 21,445 5,277 19,753 (135,334) 24,130
Extraordinary loss from early
</TABLE>
- 14 -
<PAGE>
<TABLE>
<S> <C> <C> <C> <C> <C>
extinguishment of debt, net
of related tax effect (4) --- (4,734) (4,734) --- ---
-------- ------- -------- --------- --------
Net income (loss) $ 21,445 $ 543 $ 15,019 $(135,334) $ 24,130
======== ======= ======== ========= ========
After-tax operating income (loss)(5) $ 14,124 $ 6,532 $ 14,164 $(137,274) $ 3,380
======== ======= ======== ========= ========
Ratio of earnings to fixed charges:
Including net realized
investment gains (losses) (6) 4.0x 1.3x 2.4x --- 2.7x
Excluding net realized
investment gains (losses) (7) 2.7x 1.5x 1.9x --- 1.1x
GAAP Ratios for Insurance Subsidiaries (8):
PMA Re:
Loss ratio 69.0% 73.1% 69.6% 73.7% 74.6%
Expense ratio 35.2% 29.3% 34.9% 30.2% 29.5%
----- ----- ----- ----- -----
Combined ratio (9) 104.2% 102.4% 104.5% 103.9% 104.1%
===== ===== ===== ===== =====
The Property and Casualty Group,
including Run-off Operations (3):
Loss ratio 85.5% 95.4% 91.1% 158.2% 92.5%
Expense ratio (10) 34.0% 35.0% 45.3% 48.6% 30.6%
Policyholders' dividend ratio 6.7% 4.8% 6.9% 6.1% 4.8%
----- ----- ----- ----- -----
Combined ratio (9) 126.2% 135.2% 143.3% 212.9% 127.9%
===== ===== ===== ===== =====
The Property and Casualty Group,
excluding Run-off Operations (3):
Loss ratio 77.7% 84.9% 83.7% --- ---
Expense ratio (10) 32.8% 33.9% 36.4% --- ---
Policyholders' dividend ratio 6.7% 4.8% 5.6% --- ---
----- ----- ----- ----- -----
Combined ratio (9) 117.2% 123.6% 125.7% --- ---
===== ===== ===== ===== =====
<CAPTION>
June 30, December 31,
----------------------- ------------------------------------
1998 1997 1997 1996 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Consolidated Financial Position:
Total investments $2,159,303 $2,067,828 $2,194,738 $2,261,353 $2,455,949
Total assets 3,075,413 3,085,640 3,057,258 3,117,516 3,258,572
Reserves for unpaid losses and LAE 1,939,568 2,052,791 2,003,187 2,091,072 2,069,986
Long-term debt 203,000 203,049 203,000 204,699 203,848
Shareholders' equity 496,383 415,120 478,347 425,828 609,668
</TABLE>
__________________________
(1) Operating results in 1997, 1996 and 1995 were impacted by approximately
$12,100, $223,100 and $8,400, respectively, of restructuring and other
special charges. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" for further information.
(2) Pre-tax operating income (loss) excludes net realized investment gains
(losses). Pre-tax operating income by business segment for all periods is
unaudited and has been
- 15 -
<PAGE>
presented in accordance with SFAS No. 131, "Disclosures About Segments of
an Enterprise and Related Information," which the Company adopted on
January 1, 1998. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Company's interim financial
statements and notes thereto as of June 30, 1998 and 1997 included
elsewhere in this Prospectus.
(3) Run-off operations ("Run-off Operations") of the Property and Casualty
Group are comprised of MASCCO, PMA Cayman and PMA Life Insurance Company
("PMA Life"), which were established in December 1996 to reinsure certain
obligations primarily associated with workers' compensation claims written
by the Pooled Companies for the accident years 1991 and prior. The Run-off
Operations are separate legal entities and substantially all of the assets
of the Run-off Operations are held in trust for the benefit of the Pooled
Companies. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
(4) In 1997, the Company refinanced substantially all of its long-term debt
that resulted in a $4,734 extraordinary loss, net of tax effect. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
(5) After-tax operating income (loss) represents pre-tax operating income
(loss) less the provision (benefit) for income taxes net of the taxes
attributable to net realized investment gains (losses).
(6) For the purposes of determining this ratio, earnings (loss) consist of
income (loss) before income taxes and extraordinary loss (1997), plus fixed
charges. Fixed charges consist of interest expense on debt, amortization
of debt issuance costs and the portion of operating leases that management
believes is representative of the interest factor. In 1996, earnings were
insufficient to cover fixed charges by $191,394. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
(7) In 1996, earnings were insufficient to cover fixed charges by $194,378.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
(8) The results of operations of Caliber One are not material to the
underwriting ratios of the Company; accordingly, the ratios for Caliber One
have not been presented.
(9) The combined ratio computed on a GAAP basis is equal to losses and loss
adjustment expenses ("LAE") plus amortization of deferred acquisition
costs, operating expenses and policyholders' dividends (where applicable),
all divided by net premiums earned.
(10) The GAAP operating expense ratios exclude $4,718 and $4,506 for the six
months ended June 30, 1998 and 1997, respectively, and $9,316, $8,227 and
$5,300 for the years ended December 31, 1997, 1996 and 1995, respectively,
of PMA Management Corp. direct expenses related to service revenues, which
are not included in premiums earned. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
- 16 -
<PAGE>
RISK FACTORS
Potential investors should carefully consider the following risk factors
and other information in this prospectus prior to making an investment decision
regarding the Capital Securities. In addition, because holders of Capital
Securities may receive Junior Subordinated Debentures in exchange therefor upon
liquidation of the Trust, prospective purchasers of Capital Securities are also
making an investment decision with regard to the Junior Subordinated Debentures
and should carefully review all the information regarding the Junior
Subordinated Debentures and PMC herein.
Risk Factors Relating To the Capital Securities
Subordination of the Guarantee and the Junior Subordinated Debentures
PMC's obligations under the Guarantee and under the Junior Subordinated
Debentures are unsecured and rank subordinate and junior in right of payment to
all present and future Senior Debt of PMC and pari passu with obligations to or
rights of PMC's other general unsecured creditors. Substantially all of PMC's
debt constitutes senior debt. PMC is an insurance holding company and
substantially all of the operating assets of PMC are owned by its consolidated
subsidiaries. PMC relies primarily on the receipt of sufficient funds from its
subsidiaries in the form of dividends, net tax sharing payments and loans to
meet its obligations for payment of principal and interest on its outstanding
debt obligations and corporate expenses. Accordingly, the Junior Subordinated
Debentures will be effectively subordinated to all existing and future
liabilities of PMC's subsidiaries, and holders of the Junior Subordinated
Debentures should look only to the assets of PMC for payments on the Junior
Subordinated Debentures. The payment of dividends by PMC's insurance
subsidiaries is limited under the insurance laws of their states of domicile
(primarily Pennsylvania). At December 31, 1997, PMA Reinsurance Corporation and
the Pooled Companies could pay dividends of approximately $48.7 million to PMC
without regulatory permission. Through September 1, 1998, $18.0 million in
dividends has been declared, of which $10.0 million has been paid. See
"Supervision and Regulation." In addition, the ability of PMC's subsidiaries to
pay dividends is effectively restricted by certain minimum surplus and risk-
based capital requirements contained in the Company's revolving credit
agreement. See "Risk Factors Associated With the Company--Restrictions on
Subsidiary Dividends." None of the Capital Securities, the Junior Subordinated
Debentures or the Guarantee limit PMC's ability to incur additional
indebtedness, including Senior Debt. After the completion of this Offering and
the repayment of debt with the proceeds thereof, PMC will have outstanding
approximately $104.5 million of principal amount of indebtedness constituting
Senior Debt. PMC expects from time to time to incur additional indebtedness
constituting Senior Debt. See "Description of the Guarantee--Status of the
Guarantee" and "Description of the Junior Subordinated Debentures--
Subordination."
The ability of the Issuer to pay amounts due on the Capital Securities is
solely dependent upon PMC making payments on the Junior Subordinated Debentures
as and when required.
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<PAGE>
Limited Rights Under the Guarantee
The Guarantee will be qualified as an indenture under the Trust Indenture
Act of 1939, as amended (the "Trust Indenture Act"). The Property Trustee
(herein sometimes called the "Trustee") will act as indenture trustee under the
Guarantee for the purposes of compliance with the Trust Indenture Act and to
hold the Guarantee for the benefit of the holders of the Capital Securities. The
Guarantee guarantees to the holders of the Capital Securities the following
payments, to the extent not paid by or on behalf of the Issuer: (i) any
accumulated and unpaid distributions that are required to be paid on the Capital
Securities, to the extent the Trust has funds available therefor at such time,
(ii) the redemption price with respect to the Capital Securities called for
redemption by the Trust, to the extent the Trust has funds available therefor at
such time and (iii) upon a voluntary or involuntary dissolution, winding-up or
termination of the Trust (other than in connection with the distribution of
Junior Subordinated Debentures to the holders of the Capital Securities), the
lesser of (a) the aggregate of the Liquidation Amount and all accumulated and
unpaid distributions on the Capital Securities to the date of the payment to the
extent the Trust has funds available therefor at such time and (b) the amount of
assets of the Trust remaining available for distribution to holders of the
Capital Securities in liquidation of the Trust. The holders of not less than a
majority in aggregate Liquidation Amount of the outstanding Capital Securities
have the right to direct the time, method and place of conducting any proceeding
for any remedy available to the Trustee or exercising any trust or power
conferred upon the Trustee under the Guarantee. Any holder of the Capital
Securities may institute a legal proceeding directly against PMC to enforce the
holder's rights under the Guarantee without first instituting a legal proceeding
against the Issuer, the Guarantee Trustee or any other person or entity. If PMC
were to default on its obligation to pay amounts payable under the Junior
Subordinated Debentures, the Issuer would lack funds for the payment of
distributions or amounts payable on redemption of the Capital Securities or
otherwise, and, in such event, holders of the Capital Securities would not be
able to rely upon the Guarantee for payment of such amounts. Instead, in the
event a Debenture Event of Default shall have occurred and be continuing and
such event is attributable to the failure of PMC for 30 days to pay interest on
or the failure of PMC to pay principal on the Junior Subordinated Debentures
when due and payable, then a holder of Capital Securities may, pursuant to the
terms of the Indenture and in addition to its rights under the Guarantee,
institute a legal proceeding directly against PMC for enforcement of payment to
such holder of the principal of and interest on such Junior Subordinated
Debentures having a principal amount equal to the aggregate Liquidation Amount
of the Capital Securities of such holder (a "Direct Action"). In connection with
such a Direct Action, PMC shall have a right of set-off under the Indenture to
the extent of any payment made by PMC to such holder of Capital Securities in
the Direct Action. See "Description of Junior Subordinated Debentures--Set-
Off." Except as set forth herein, holders of Capital Securities will not be
able to exercise directly any other remedy available to the holders of the
Junior Subordinated Debentures or assert directly any other rights in respect of
the Junior Subordinated Debentures. See "Description of the Junior Subordinated
Debentures--Debenture Events of Default and Consequent Rights of Certain
Holders--Rights of Holders of Capital Securities to Direct Action" and
"Description of the Guarantee." The Trust Agreement provides that each holder
of Capital Securities by acceptance thereof agrees to the provisions of the
Guarantee and the Indenture.
- 19 -
<PAGE>
Limited Voting Rights
Holders of Capital Securities will have generally limited voting rights
relating only to the conduct of proceedings for remedies available to the
Debenture Trustee, waiver of certain defaults, rescission of any declaration of
acceleration and certain modifications of the Capital Securities. Holders of
Capital Securities will not be entitled to vote to appoint, remove or replace
the Property Trustee, which voting rights are vested exclusively in the holder
of the Common Securities, except upon the occurrence of certain events described
herein. The Property Trustee, the Administrative Trustees and PMC may amend the
Trust Agreement without the consent of the holders of Capital Securities to
ensure that the Issuer will be classified for United States federal income tax
purposes as a grantor trust or as other than an association taxable as a
corporation to ensure that the Junior Subordinated Debentures will be treated as
indebtedness of PMC or to ensure that the Issuer will not be required to
register as an "investment company" under the Investment Company Act unless such
action adversely and materially affects the interests of such holders. See
"Description of the Capital Securities--Voting Rights."
Option to Defer Interest Payments; Tax Consequences and Market Price
So long as no Debenture Event of Default (as defined herein) has occurred
and is continuing, PMC has the right under the Indenture to defer payments of
interest on the Junior Subordinated Debentures at any time, and from time to
time for a period not exceeding 10 consecutive semi-annual periods with respect
to each deferral period (each, an "Extension Period"), provided that no
Extension Period may extend beyond the Stated Maturity of the Capital
Securities. As a consequence of such a deferral, semi-annual distributions on
the Capital Securities will be deferred by the Trust during any such Extension
Period (and the amount of the distributions to which holders of the Capital
Securities are entitled will accumulate additional distributions thereon at a
rate of ___% per annum, compounded semi-annually from the relevant payment date
for such distributions). During any such Extension Period, PMC shall not, and
shall cause any subsidiary of PMC not to, (a) declare or pay dividends or
distributions on, or redeem, purchase, acquire or make a liquidation payment
with respect to, any of PMC's capital stock or (b) make any payment of interest,
principal or premium, if any, on or repay, repurchase or redeem any debt
securities of PMC that rank pari passu with or junior to the Junior Subordinated
Debentures (other than (a) dividends or distributions in Common Stock or Class A
Common Stock of PMC, (b) payments under the Guarantee and (c) purchases of
Common Stock or Class A Common Stock of PMC related to the issuance of Common
Stock or Class A Common Stock of PMC under any of PMC's benefit plans for its
directors, officers or employees). Prior to the termination of any such
Extension Period, PMC may further defer the payment of interest, provided that
no Extension Period shall exceed 10 consecutive semi-annual periods or extend
beyond the Stated Maturity of the Junior Subordinated Debentures. Upon the
termination of any Extension Period and the payment of all interest then accrued
and unpaid (together with interest thereon at the rate of ___% per annum,
compounded semi-annually, to the extent permitted by applicable law), PMC may
commence a new Extension Period, subject to the above requirements. There is no
limitation on the number of times that PMC may elect to begin an Extension
Period. See "Description of the Capital Securities--Distributions" and
"Description of the Junior Subordinated Debentures--Option to Extend Interest
Payment Period."
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If interest payments are so deferred, each holder of Capital Securities may
be required to recognize income (in the form of original issue discount) in
respect of its pro rata share of the Junior Subordinated Debentures held by the
Issuer for United States federal income tax purposes. As a result, a holder of
Capital Securities may be required to include such income in gross income for
United States federal income tax purposes in advance of the receipt of cash
attributable to such income and will not receive the cash from the Trust related
to such income if such holder disposes of its Capital Securities prior to the
record date for distributions of such amounts. See "United States Federal
Income Taxation -- Original Issue Discount." PMC has no present intention of
exercising its right to defer payments of interest by extending the interest
payment period on the Junior Subordinated Debentures. However, if PMC determines
to exercise such right in the future, the market price of the Capital Securities
is likely to be affected. A holder that disposes of its Capital Securities
during an Extension Period, therefore, might not receive the same return on its
investment as a holder that continues to hold its Capital Securities. In
addition, as a result of the existence of PMC's right to defer interest
payments, the market price of the Capital Securities (which represent an
undivided beneficial interest in the Junior Subordinated Debentures) may be more
volatile than other securities on which original issue discount accrues that are
not subject to such deferrals.
Special Event Redemption or Exchange
Upon the occurrence and continuance of a Special Event (as defined herein),
prior to ___ 1, 2008, PMC shall have the right to redeem the Junior Subordinated
Debentures, in whole but not in part within 90 days following the occurrence of
such Special Event and therefore cause a mandatory redemption of the Capital
Securities. Any such redemption shall be at a price equal to the Make-Whole
Amount (as defined in "Description of the Capital Securities--Redemption")
together with accrued interest to but excluding the date fixed for redemption.
If a Special Event were to occur, there can be no assurance that PMC would have
sufficient funds to effectuate an optional redemption of the Junior Subordinated
Debentures and pay the redemption price. PMC's ability to exercise its option to
redeem the Junior Subordinated Debentures may be limited by the terms of its
then-existing borrowing and other agreements. "Special Event" means either an
Investment Company Event or a Tax Event. An "Investment Company Event" means the
receipt by the Issuer of an opinion of counsel experienced in such matters to
the effect that, as a result of the occurrence of a change in law or regulation
or change in interpretation or application of law or regulation by any
legislative body, court, governmental agency or regulatory authority (a "Change
in 1940 Act Law"), the Issuer is or will be considered an investment company
that is required to be registered under the Investment Company Act of 1940, as
amended, which Change in 1940 Act Law becomes effective on or after the date of
original issuance of the Capital Securities. A "Tax Event" means the receipt by
the Issuer of an opinion of counsel experienced in such matters to the effect
that, as a result of (a) any amendment to, or change (including any announced
prospective change) in, the laws (or any regulations thereunder) of the United
States or any political subdivision or taxing authority thereof or therein
affecting taxation or (b) any official administrative pronouncement or judicial
decision interpreting or applying such laws and regulations, which amendment or
change is effective or such pronouncement or decision is announced on or after
the date of issuance of the Capital Securities under the Trust Agreement, there
is more than an insubstantial risk that (i) the Issuer is, or will be within 90
days of the date of such opinion, subject to United States federal income tax
with respect to
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income received or accrued on the Junior Subordinated Debentures, (ii) interest
payable by PMC on the Junior Subordinated Debentures is not, or within 90 days
of the date of such opinion, will not be, deductible by PMC, in whole or in
part, for United States federal income tax purposes or (iii) the Issuer is, or
will be within 90 days of the date of such opinion, subject to more than a de
minimis amount of other taxes, duties or other governmental charges. See
"Description of the Capital Securities--Redemption--Special Event Redemption or
Distribution of Junior Subordinated Debentures."
At any time, PMC has the right to terminate the Issuer and, after
satisfaction of the liabilities of creditors of the Issuer as provided by
applicable law, cause the Junior Subordinated Debentures to be distributed to
the holders of the Capital Securities in liquidation of the Trust. See
"Description of the Capital Securities--Liquidation Distribution Upon
Termination."
Tax Consequences
The receipt of cash by the holders of the Capital Securities upon a
termination of the Trust would be a taxable event to such holders. Under current
United States federal income tax law, a distribution of Junior Subordinated
Debentures upon the termination of the Trust generally would not be a taxable
event to holders of the Capital Securities. See "United States Federal Income
Taxation--Receipt of Junior Subordinated Debentures or Cash Upon Liquidation of
the Trust."
Effect on Market Prices
There can be no assurance as to the market prices for the Capital
Securities or the Junior Subordinated Debentures that may be distributed in
exchange for the Capital Securities if a termination or liquidation of the Trust
were to occur. Accordingly, the Capital Securities that an investor may
purchase, whether pursuant to the offer made hereby or in the secondary market,
or the Junior Subordinated Debentures that a holder of Capital Securities may
receive on termination and liquidation of the Trust, may trade at a discount to
the price that the investor paid to purchase the Capital Securities offered
hereby.
Corresponding Investment Decision in Junior Subordinated Debentures
Because holders of Capital Securities may receive Junior Subordinated
Debentures in connection with a liquidation of the Trust, prospective purchasers
of the Capital Securities are also making an investment decision with regard to
the Junior Subordinated Debentures and should carefully review all the
information regarding the Junior Subordinated Debentures contained herein. See
"Description of the Capital Securities--Liquidation Distribution upon
Termination" and "Description of the Junior Subordinated Debentures."
Possible Tax Law Changes
Prospective investors should be aware that Enron Corporation has filed a
petition in the United States Tax Court challenging the proposed disallowance by
the Internal Revenue Service (the "IRS") of the deduction of interest expense on
securities issued by Enron Corporation in 1993 and 1994 that are similar to,
although different in a number of respects from, the Junior Subordinated
Debentures. It is
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possible that a decision in that case could give rise to a Tax Event, which
would permit PMC to cause a redemption of the Capital Securities, as described
more fully under "Description of Capital Securities--Redemption--Special Event
Redemption or Distribution of Junior Subordinated Debentures." Prospective
investors also should be aware that legislation has been proposed by the Clinton
Administration in the past that, if enacted, would have denied an interest
deduction to issuers of instruments such as the Junior Subordinated Debentures.
No such legislation is currently pending. There can be no assurance, however,
that similar legislation will not ultimately be enacted into law, or that other
developments will not occur on or after the date hereof that would adversely
affect that tax treatment of the Junior Subordinated Debentures or the Issuer.
Such changes also could give rise to a Tax Event.
Liquidity of Trading; Trading Price of the Capital Securities May Not Fully
Reflect Value of Unpaid Interest:
PMC and the Issuer do not intend to have the Capital Securities listed on
any securities exchange. If the Underwriters do not make a market for the
Capital Securities, the liquidity of the Capital Securities could be adversely
affected.
The Capital Securities may trade at a price that does not fully reflect the
value of accrued but unpaid interest with respect to the underlying Junior
Subordinated Debentures. A holder who disposes of his Capital Securities between
record dates for payments of distributions thereon (and consequently does not
receive a distribution from the Issuer for the period prior to such disposition)
will nevertheless be required to include accrued but unpaid interest on the
Junior Subordinated Debentures through the date of disposition in income as
ordinary income, and to add such amount to his adjusted tax basis in the Capital
Securities disposed of. To the extent that the selling price (which may not
fully reflect the value of accrued but unpaid interest) is less than the
holder's adjusted tax basis (which will include accrued but unpaid interest),
the holder may recognize a capital loss. Subject to certain limited exceptions,
capital losses cannot be applied to offset ordinary income for United States
federal income tax purposes. See "United States Federal Income Taxation--
Original Issue Discount" and "--Sales of Capital Securities."
Risk Factors Associated with the Company
Holding Company Structure
PMC is an insurance holding company and the right of PMC to participate in
any distribution of assets of any subsidiary upon such subsidiary's liquidation
or reorganization or otherwise (and thus the ability of holders of the Junior
Subordinated Debentures and the Capital Securities to benefit indirectly from
such distribution) is subject to the prior claims of creditors of that
subsidiary, except to the extent that the Company may itself be recognized as a
creditor of that subsidiary. Accordingly, the Junior Subordinated Debentures
will be effectively subordinated to all existing and future liabilities of the
subsidiaries of PMC, and the holders of Junior Subordinated Debentures should
look only to the assets of PMC for payments on the Junior Subordinated
Debentures. At June 30, 1998, the subsidiaries of PMC had total liabilities,
excluding liabilities owed to PMC and intercompany transactions, of
approximately $2.4 billion.
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<PAGE>
Restrictions on Subsidiary Dividends and Other Payments
PMC is an insurance holding company whose assets consist principally of all
of the outstanding common stock of its insurance subsidiaries. PMC's ongoing
ability to pay dividends to its shareholders and meet its other obligations,
including operating expenses and any principal and interest on debt (including
the Junior Subordinated Debentures), is primarily dependent on the receipt of
sufficient funds from its insurance subsidiaries in the form of dividends, net
payments under a tax-sharing agreement between PMC and its subsidiaries and
loans. The payment of dividends by PMC's subsidiaries to PMC is regulated under
the insurance laws of Pennsylvania and Delaware (such laws are substantially
similar). In addition, to the extent tax-sharing payments and loans exceed
certain threshold amounts, notice to and non-disapproval by the Pennsylvania
Insurance Commissioner would be required. Under Pennsylvania law, PMC's
Pennsylvania-domiciled subsidiaries (PMA Reinsurance Corporation and the Pooled
Companies) may pay dividends only from unassigned surplus and future earnings
arising from their businesses and must receive prior approval of the
Pennsylvania Insurance Commissioner to pay a dividend if such dividend would
exceed the greater of (i) 10% of the insurer's policyholders' surplus, as shown
on its last annual statement on file with the Pennsylvania Insurance
Commissioner or (ii) the insurer's statutory net income for the previous
calendar year. Pennsylvania law gives the Pennsylvania Insurance Commissioner
broad discretion to disapprove requests for dividends in excess of these limits.
Based upon this limitation and the 1997 statutory results of PMA Reinsurance
Corporation and the Pooled Companies, PMA Reinsurance Corporation and the Pooled
Companies have the legal capacity to pay approximately $48.7 million in
dividends in the aggregate to PMC in 1998 without obtaining the approval of the
Pennsylvania Insurance Commissioner. Through September 1, 1998, $18.0 million in
dividends had been declared, of which $10.0 million has been paid. Pennsylvania
law also provides that following the payment of any dividend, the insurer's
policyholders' surplus must be reasonable in relation to its outstanding
liabilities and adequate for its financial needs, and permits the Pennsylvania
Insurance Commissioner to bring an action to rescind a dividend which violates
these standards.
Caliber One Indemnity Corporation is a Delaware-domiciled insurance
subsidiary of PMA Reinsurance Corporation. As a subsidiary of PMA Reinsurance
Corporation, Caliber One Indemnity Corporation's dividends are not directly
available to PMC.
In the event that the ability of either the Pooled Companies or PMA
Reinsurance Corporation to pay dividends or make other payments to PMC in the
future is reduced or eliminated, PMC's ability to pay principal and interest on,
and/or redeem, the Junior Subordinated Debentures could be materially and
adversely affected, depending upon the extent of such reduction. See
"Supervision and Regulation."
In March 1997, the Company refinanced substantially all of its existing
debt facility with a $235.0 million revolving credit facility (the "Revolving
Credit Facility"). In addition to the Revolving Credit Facility, the Company
maintains a committed facility of $50.0 million for letters of credit (the
"Letter of Credit Facility"). The Revolving Credit Facility and the Letter of
Credit Facility are sometimes referred to herein as the "Credit Facilities." In
addition to the foregoing regulatory restrictions, the Credit Facilities also
impose restrictions on the ability of the Company's subsidiaries to pay
dividends. Under these restrictions, the statutory surplus of PMC's insurance
subsidiaries (as measured each calendar quarter) must not be less than $450
million and such subsidiaries
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must annually maintain certain minimum ratios of adjusted surplus to risk-based
capital (300% for PMA Reinsurance Corporation and 230% for the Pooled Companies
in 1998, increasing to 240% thereafter). As of June 30, 1998, the Company's
insurance subsidiaries reported combined statutory surplus of $561.1 million,
and as of December 31, 1997, PMA Reinsurance Corporation's risk-based capital
ratio was 355% and the Pooled Companies' risk-based capital ratios ranged from
293% to 324%.
Certain Risks Affecting the Property and Casualty Insurance Industry
The Company's operating results may be impacted by several factors that
broadly impact the property and casualty insurance industry. Such factors
include weather-related and other catastrophic losses, general economic
conditions, including interest rate changes and trends in inflation of claims
costs, legislative and regulatory initiatives, frequency of litigation and
trends in the size of awards, as well as competitive conditions.
In writing property and casualty insurance, the Company's insurance
subsidiaries are subject to the possibility of losses from catastrophic events.
In order to reduce risk and increase its underwriting capacity, the Company
actively manages its exposure to such events through the underwriting process
and through the purchase of reinsurance coverages; as a result, the Company's
historical underwriting results have not been significantly impacted by
catastrophes. However, catastrophic events could exceed the Company's
reinsurance and/or retrocessional protection, and materially and adversely
impact the Company's financial position. See "Business--The Company's
Reinsurance Ceded."
Overall economic trends, as well as legislative, regulatory and judicial
trends may impact the operations of the Company's insurance subsidiaries. In
addition, because the Company's earnings are substantially dependent on
investment income and capital gains, changes in interest rates or other factors
affecting the Company's investment portfolio and the credit quality and
performance thereof may reduce the Company's investment results and have a
material adverse effect on its results of operations. An economic downturn may
reduce the overall demand for the Company's insurance products. Also, management
believes that, in times of less favorable economic conditions, workers'
compensation claims (particularly indemnity claims) have a tendency to be more
severe. Legislative, regulatory and judicial issues that could adversely affect
the Company include (i) an environment of more frequent and severe claims, (ii)
increases in the overall cost of doing business, through increased capital
requirements, higher taxes and assessments, residual market charges or higher
overall costs of regulatory compliance, (iii) restrictions on premium rates and
policy terms and (iv) reduced demand for the Company's products. The impact of
these factors can dramatically impact the demand for the Company's products,
insurance capacity, pricing and claims experience and, ultimately, have a
material adverse effect on the Company's business, results of operations and
financial condition. See "--Certain Concentrations" below, "Business--Regulatory
Matters," "Business--The Property and Casualty Group--Workers' Compensation
Insurance" and "Supervision and Regulation."
Adequacy of Loss Reserves
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 the insurer and the insurer's payment of that loss. Liabilities for
reinsurers generally become known more slowly than for primary insurers and are
generally subject to more unforeseen development.
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<PAGE>
In addition, the reserving for workers' compensation insurance is more difficult
than many other lines of insurance. The Company has recorded favorable (adverse)
development of $86.0 million, ($156.1) million and ($51.5) million in 1997, 1996
and 1995, respectively, of which $44.1 million, ($110.0) million and ($54.7)
million in 1997, 1996 and 1995, respectively, were associated with workers'
compensation. See "Business--Loss Reserves" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
Estimating reserves for workers' compensation claims can be more difficult
than for many other lines of property and casualty insurance for several
reasons, including (i) the long payment "tail" associated with the business,
(ii) the impact of social, political and regulatory trends on benefit levels for
both medical and indemnity payments, (iii) the impact of economic trends and
(iv) the impact of changes in the mix of business. At various times, one or a
combination of such factors can make the interpretation of actuarial data
associated with workers' compensation loss development more difficult, and it
can take additional time to recognize changes in loss development patterns.
Under such circumstances, reserve adjustments will be made as loss patterns
develop and new information becomes available, and such adjustments may be
material.
As is common practice in the property and casualty insurance industry, the
Company discounts its workers' compensation unpaid losses; the average discount
rate presently utilized is approximately 5.0%. As such, future operating results
of the Company will be impacted by accretion of loss reserve discount. For the
six-month periods ended June 30, 1998 and 1997, respectively, accretion of
discount increased losses incurred by $14.4 million and $23.8 million, and for
the years ended December 31, 1997, 1996 and 1995, respectively, accretion
increased losses incurred by $51.4 million, $57.5 million and $13.3 million (net
of $35.0 million related to the change in discount rate from approximately 4.0%
to 5.0%). At June 30, 1998, the Company had loss reserve discount of $437.0
million, comprised as follows: the Pooled Companies, $114.6 million; MASCCO,
$55.4 million, PMA Cayman, $226.2 million; other Property and Casualty Group
entities, $6.5 million and PMA Re, $34.3 million. See "Business--Loss Reserves."
Estimation of obligations for asbestos and environmental exposures
continues to be more difficult than for other loss reserves because of several
factors, including (i) evolving methodologies for the estimation of liabilities;
(ii) lack of reliable historical claim data; (iii) uncertainties with respect to
insurance and reinsurance coverage related to these obligations; (iv) changing
judicial interpretations and (v) changing government standards. The Company
recorded incurred losses for asbestos and environmental exposures of $1.0
million, $60.4 million and $25.3 million in 1997, 1996 and 1995, respectively,
and at December 31, 1997, the Company maintained loss reserves of $48.6 million
($76.7 million gross of reinsurance) for asbestos-related losses (of which $41.9
million was IBNR) and loss reserves of $31.7 million ($45.1 million gross of
reinsurance) for environmental-related losses (of which, $20.5 million was
IBNR). Management believes that its reserves for asbestos and environmental
claims are appropriately established based upon known facts, existing case law
and generally accepted actuarial methodologies. However, due to changing
interpretations by courts involving coverage issues, the potential for changes
in federal and state standards for clean-up liability and other factors, the
ultimate exposure to the Property and Casualty Group for these claims may vary
significantly from the reserves currently recorded, resulting in a potential
future
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<PAGE>
adjustment in the claims reserves recorded. See "Business--Loss Reserves" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Estimating the Company's ultimate claims liability is necessarily a complex
and judgmental process as the amounts are based upon management's informed
estimates and judgments using data currently available. As additional
experience and data become available regarding claims payment and reporting
patterns, legislative developments and economic conditions, the estimates are
revised accordingly. If the Company's ultimate net losses prove to be
substantially greater than the reserves recorded, the related adjustments could
have a material adverse impact on the Company's financial condition and results
of operations.
Competitive Conditions
The domestic property and casualty insurance and reinsurance industries are
very competitive and consist of many companies, with no one company dominating
the market. Competitive conditions may vary from state to state and market to
market for a variety of reasons, including the regulatory climate, the number of
market participants and similar factors. In addition to other insurance
companies, the Company's insurance subsidiaries compete with certain alternative
market arrangements, such as captive insurers, risk-sharing pools and
associations, risk-retention groups and self-insurance programs. Many of the
Company's competitors are larger and have greater financial resources than the
Company and offer a broader range of products than the Company. Historically,
the financial performance of the property and casualty insurance industry has
tended to fluctuate in cyclical patterns of very competitive (soft) markets
followed by less competitive (hard) markets. Although an individual insurance
company's financial performance depends in part upon its own specific business
characteristics; the profitability of most property and casualty insurance
companies tends to follow this cyclical market pattern. At present, the
property and casualty insurance industry is experiencing a prolonged soft
market, and the extension of the current market conditions could have an adverse
effect on the Company's business, results of operations and financial condition.
There can be no assurance that market conditions will improve or, if they do
improve that they will have a favorable impact on the Company. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
One of the bases of competition in the insurance industry, particularly in
the reinsurance segment, is size of capitalization. While management believes
that PMA Re's present level of capitalization is appropriate and has not
materially adversely affected its participation in business opportunities or
resulted in any significant erosion of its client base, PMA Re could be affected
by (i) changes in market perception of appropriate levels of capitalization or
(ii) the need to increase capitalization in response to market opportunities.
While the purpose of the Offering is to increase the Company's flexibility to
respond to such situations, there can be no assurance that PMC will have the
ability to increase PMA Re's capitalization to satisfy state insurance
regulators or to maintain the current A.M. Best ratings of PMC's insurance
subsidiaries. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations," "Business--Competition" and "Use of Proceeds."
The Property and Casualty Group must attract and retain productive agents
to sell its insurance products and services. Strong competition exists among
insurance companies for agents with demonstrated abilities. Competition among
insurance companies for such agents
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is based upon, among other things, the services provided to, and relationships
developed with, these agents in addition to compensation and product structure.
If the Property and Casualty Group is not able to continue to attract and retain
productive agents, there could be a material adverse effect on the Company.
The surplus lines of insurance offered by Caliber One are generally placed
by wholesale brokers and managing general agents who specialize in particular
lines of coverage or classes of insureds. These insureds tend to be
sophisticated and price-conscious insurance purchasers. As a result, surplus
lines insurers may experience increased premium rate competition in soft
markets. This could result in a material adverse effect on the Company.
Collectibility of Reinsurance
The Company follows the customary insurance practice of reinsuring with
other insurance companies a portion of the risks underwritten by its insurance
subsidiaries. This reinsurance is maintained to protect the Company against the
severity of losses on individual claims and unusually serious occurrences in
which a number of claims produces an aggregate extraordinary loss. Reinsurance
does not discharge the Company's insurance subsidiaries from their obligations
to their policyholders; however, it does make the assuming reinsurers liable to
the Company's insurance subsidiaries for the reinsured portion of the risk. At
June 30, 1998, the Company had $211.2 million in reinsurance receivables which
are not directly secured by letters of credit, trust arrangements, funds held or
other collateral. Although management believes that the Company's reinsurance
protection is placed with financially sound companies, there can be no assurance
that such reinsurers will pay reinsurance claims on a timely basis, if at all.
Further, although the Company has reinsurance it believes to be adequate, there
can be no assurance that the Company will continue to be able to obtain
reinsurance on acceptable terms and that the Company's reinsurance protection
will be adequate in the event of a catastrophe. See "Certain Risks Affecting the
Property and Casualty Insurance Industry" above and "Business--The Company's
Reinsurance Ceded."
Certain Concentrations
In 1997, the Property and Casualty Group derived 49% of its direct written
premiums from Pennsylvania, 61% of which was workers' compensation. Also in
1997, the Property and Casualty Group derived 60% of its direct written premiums
from workers' compensation in all of the states in which it conducts business.
This concentration exposes the Company to changes affecting the Pennsylvania
economy, as well as changes impacting benefit and/or rate levels for workers'
compensation in Pennsylvania and the other states in which it conducts business.
Since 1993, two major benefit reform laws have been passed in Pennsylvania,
which have had a favorable impact on workers' compensation loss costs. In 1993,
Act 44 introduced medical cost containment measures and improved the Property
and Casualty Group's ability to utilize managed care techniques. Specifically,
Act 44 introduced medical cost containment measures to the Pennsylvania workers'
compensation benefit system and increased the length of time in which an insurer
may require an employee to accept medical treatment from the employer's list of
designated health care providers from 14 days to 30 days. In addition, the law
reduced the minimum wage replacement benefit to injured workers, introduced a
credit for unemployment compensation benefits, restored the right of subrogation
against tort
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recoveries in work-related automobile accidents and created new anti-fraud
measures. In 1996, Act 57 introduced measures that primarily reduce indemnity
loss costs. Among its provisions, Act 57: (i) imposes application of American
Medical Association Impairment Guidelines for the assessment of permanent and
total claims after the first two years of total disability compensation payments
and limits indemnity benefits to an additional 500 weeks for workers who are not
at least 50% disabled (as measured by those guidelines); (ii) contains certain
Social Security and pension benefits offsets; (iii) further increases the time
frame for directed medical treatment; (iv) addresses certain inequities in the
average weekly wage calculation; (v) increases the ability of employers to
demonstrate that injured workers have earning capacity and (vi) facilitates the
use of full and final settlements of employers' workers' compensation
obligations on particular claims. As a result of these Acts, as well as reforms
in several other states in which the Property and Casualty Group operates, the
frequency and severity of workers' compensation claims have been decreasing,
which has contributed to the decreased accident year workers' compensation loss
ratios of the Property and Casualty Group since 1993. In conjunction with these
benefit reforms, manual rate levels in Pennsylvania decreased approximately 10%
in 1994, 25% in 1997 and 27% in the first six months of 1998 (although
management expects such rate of change to be a 19% decrease for the year ending
December 31, 1998) when compared to the respective preceding year. Management
believes the projected savings derived from the reforms will offset these manual
rate decreases. However, the ultimate cost of workers' compensation claims can
be difficult to predict and there can be no assurance that rates will remain
adequate. While management believes that the Company has benefited from workers'
compensation reform in Pennsylvania and elsewhere, as well as a generally good
economic climate in the states in which it conducts business, there can be no
assurance that: (i) there will not be initiatives, legislative or otherwise, to
reverse the effects of workers' compensation reforms; (ii) workers' compensation
rates will remain adequate or (iii) economic conditions will remain favorable.
See "Business--The Property and Casualty Group" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
PMA Re distributes its products through reinsurance intermediaries, known
as brokers. In 1997, three brokers each accounted for more than 10% of PMA Re's
gross premiums in force: Aon Reinsurance (35.7%); Guy Carpenter & Company
(23.3%); and E.W. Blanch (13.6%). PMA Re's top five brokers accounted for 90.8%
of its gross premiums in force in 1997. While management believes that these
relationships with these brokers are generally excellent, if relations with any
of its major brokers were to deteriorate, resulting in reduced premium flow, it
could have a material adverse effect on PMA Re and the Company. See "Business--
PMA Re--Marketing and Distribution."
Importance of Ratings
As insurers and reinsurers tend to compete on the basis of financial
stability, among other things, management believes that the ratings of the
Company's insurance subsidiaries by the major rating agencies are material to
its operations. Presently, A.M. Best has rated PMA Reinsurance Corporation, A+
("Superior"), the Pooled Companies, A- ("Excellent") and Caliber One Indemnity
Company, A ("Excellent"). The Company is also presently seeking ratings of its
insurance subsidiaries from Standard & Poor's and Moody's. The ratings of the
insurance subsidiaries from these rating agencies are based upon an analysis of
the insurance company's perceived financial strength regarding its ability to
pay obligations to its
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<PAGE>
policyholders and are not directed toward the protection of investors. Such
ratings are subject to changes and do not constitute recommendations to buy,
sell or hold securities. There can be no assurance that such ratings or future
changes therein will not affect the Company's competitive position. There can be
no assurance that PMA Reinsurance Corporation, the Pooled Companies or Caliber
One Indemnity Company will maintain their ratings, and any downgrade could have
a material adverse effect on their respective businesses. In addition, there can
be no assurance that ratings to be received from Standard & Poor's and/or
Moody's will not have a detrimental effect on the Company's competitive
position. See "Business--Competition."
Regulation
The Company is subject to regulation under applicable insurance statutes,
including the insurance holding company statutes of Pennsylvania. In addition,
the Company's insurance subsidiaries are subject to regulation in each of the
states in which they transact business. Insurance regulation is intended to
protect policyholders rather than to protect investors in insurance companies or
their holding companies. The extent of regulation by the states varies, but in
general, most jurisdictions have laws and regulations governing standards of
solvency, adequacy of reserves, reinsurance, capital adequacy and standards of
business conduct. In addition, statutes and regulations usually require the
licensing of insurers and their agents, the approval of policy forms for
admitted insurers and, for certain lines of insurance, including all of the
lines written by the Property and Casualty Group, approval of rates. In
supervising and regulating insurance companies, including reinsurers, state
insurance departments enjoy broad authority and discretion in applying
applicable insurance laws and regulations for the protection of policyholders
and the public. Inasmuch as they are subject to regulatory approval, the rates
that the Property and Casualty Group can charge for workers' compensation and
standard commercial lines of property and casualty insurance might not keep pace
with the underlying claim costs. In addition, any changes in these laws and
regulations or the failure of the Company to comply with such laws and
regulations could materially adversely affect the Company's operations. See
"Supervision and Regulation."
Workers' compensation insurers doing business in certain states are
required to provide insurance for risks which are not otherwise written on a
voluntary basis by the private market ("residual market business"). This system
exists in all of the Property and Casualty Group's current marketing
territories, except Pennsylvania and Maryland, in which separate governmental
entities write all of the workers' compensation residual market business.
Because residual market business consists of difficult to insure risks and
entities and classes with poor experience, the underwriting results of residual
market business tend to be worse than those of voluntary business. In 1997, the
Property and Casualty Group wrote $5.2 million of residual market business,
which constituted approximately 3% of its voluntary market volume. While
management believes that the Property and Casualty Group has a lesser exposure
to residual market business than many other companies writing workers'
compensation business, based upon the volume of residual market business
written, the Company is exposed to the possibility that its underwriting results
will be adversely affected by increases in the size of the residual market and
worsening experience in the residual market. See "Business--the Property and
Casualty Group--Workers' Compensation Residual Market Business."
- 30 -
<PAGE>
In recent years, various proposals have been introduced in Congress, which
call for the federal government to assume some role in the regulation of
insurance. To date, none of these proposals has been enacted, and the Company
cannot predict what form such future proposals might take or what effect, if
any, such proposals might have on PMC or its subsidiaries if enacted into law.
Year 2000 Issue
As a consequence of the programming convention which utilized a two-digit
date field rather than a four-digit date field, most computers require
relatively costly reprogramming to enable them to perform correctly date
operations involving year 2000 ("Year 2000") or later (the "Year 2000 Issue").
Many anticipate that the Year 2000 Issue will have substantial
repercussions on the business world, since computer operations involving date
calculations are pervasive.
With the assistance of outside consulting groups, the Company began
evaluating and reprogramming its own computer systems to address the Year 2000
Issue in late 1995. Management anticipates that by year-end 1998, it will have
substantially completed all necessary programming work. Accordingly, management
believes that Year 2000 Issues related to the Company's hardware and internal
software programs are not likely to result in any material adverse disruptions
in the Company's computer systems or its internal business operations. The cost
of this work through June 30, 1998 has been approximately $5.3 million,
including approximately $1.5 million incurred during the first six months of
1998. The Company estimates that the total remaining cost will be approximately
$175,000, which will be expensed throughout the remainder of 1998.
The Company is currently in the process of evaluating its relationships
with third parties with which the Company has a direct and material relationship
to determine whether they are Year 2000 compliant, such as banks, brokers,
reinsurers, third party service providers, software and other service vendors,
insureds and agents and other intermediaries. The responses by such third
parties to inquiries made by the Company as have been received to date indicate
that these third parties either are or expect to be compliant by the Year 2000.
Even assuming that all material third parties provide a timely
representation affirming such Year 2000 compliance, however, it is not possible
to state with certainty that such representations will turn out to have been
accurate, or that the operations of such third parties will not be materially
impacted in turn by other parties with whom they themselves have a material
relationship, and who fail to timely become Year 2000 compliant. Consequently,
it is not possible to predict whether or to what extent the Year 2000 Issues may
have an adverse material impact on the Company as a result of their impact on
the operations of third parties with whom the Company has a material
relationship. The failure of one or more third parties with whom the Company has
a material relationship to be Year 2000 compliant could cause significant
disruptions in the Company's ability to pay claims, receive and deposit funds
and make investments, which could have a material adverse effect on the
Company's financial condition and results of operations. The Company's
contingency plans in the event of failure of such third parties to be Year 2000
compliant include replacing the third party, performing directly the services
performed by the third party and maintaining liquidity under the Company's
Revolving Credit Facility, which may have a material impact on the Company.
Many experts now believe that Year 2000 Issues may have a material adverse
effect on the national and global economy generally. In addition, it seems
likely that if businesses are materially damaged as a result of Year 2000
Issues, at least some such businesses may attempt to recoup their losses by
claiming coverage under various types of insurance policies. Management
of the Property and Casualty Group and Caliber One believe that under a fair
reading of the various policies issued by them, no coverage for Year 2000 Issues
should exist. Management of PMA Re also believes that the policies of its ceding
company clients which are reinsured by PMA Re do not provide coverage for Year
2000 issues. However, in the event that claims for Year 2000 Issues are asserted
against the Property and Casualty Group, Caliber One or PMA Re, it is not
possible to predict whether or to what extent any such coverage could ultimately
be found to exist by courts in various jurisdictions, or, if found, the effect
thereof on any of such companies or the Company. In addition, to the extent that
the Property and Casualty Group, Caliber One or PMA Re contest the assertion of
Year 2000 coverage claims, it is likely that the costs of litigation could be
material, even if they are able to prevail in their coverage positions as to
which no assurance can be given.
- 31 -
<PAGE>
Dependence Upon Key Personnel
The Company depends upon its executive management, including the executive
management of its insurance subsidiaries, to execute its business strategy. The
loss of any of these individuals or a reduction in the time devoted by such
persons to the Company's business could have a material adverse effect on the
Company's business. The Company's future success will depend, in part, upon its
ability to attract and retain highly qualified personnel. The Company faces
competition for such personnel from other companies, many of which have
significantly greater resources than the Company. There can be no assurance
that the Company will be able to attract and retain the necessary personnel on
acceptable terms. See "Business" and "Management."
- 32 -
<PAGE>
THE COMPANY
The Company is an insurance holding company, whose subsidiaries operate in
three distinct segments of the property and casualty insurance industry: (i)
reinsurance, through PMA Re, which commenced business in 1980; (ii) standard
commercial lines of insurance, with an emphasis on workers' compensation through
the Property and Casualty Group, which has been in business since 1915 and (iii)
specialty insurance products, focusing on excess and surplus lines, through the
Company's recently-formed operation, Caliber One. PMA Re writes a broad range of
property and casualty reinsurance products with an emphasis on risk-exposed
casualty excess of loss reinsurance and operates in the United States domestic
brokered market. The Property and Casualty Group offers a broad range of
standard commercial lines products including commercial general liability,
commercial automobile and commercial multi-peril, with an emphasis on
underwriting of workers' compensation products and services primarily in nine
contiguous jurisdictions in the Mid-Atlantic and Southern regions of the United
States, utilizing the PMA Group trade name. In 1998, Caliber One commenced
writing excess and surplus lines of property and casualty insurance, including
commercial general liability, automobile and certain property exposures on a
non-admitted basis. For the six months ended June 30, 1998, the Company's net
premiums written of $257.0 million were derived 45.9% from PMA Re, 53.8% from
the Property and Casualty Group and 0.3% from Caliber One. Net income for the
Company for the six months ended June 30, 1998 and the year ended December 31,
1997 was $21.4 million and $15.0 million, respectively. As of June 30, 1998, the
Company had total assets of $3,075.4 million and shareholders' equity of $496.4
million.
According to data provided by the RAA, as of June 30, 1998, PMA Reinsurance
Corporation was the 24th largest reinsurer in the United States in terms of
statutory surplus and 17th largest in terms of net premiums written. Management
believes that PMA Re competes on the basis of its ability to offer prompt and
responsive service and products designed to meet client needs and its excellent
long-term relationships in the broker and ceding company communities. PMA Re's
net premiums written grew at a compound annual rate of 13.2% between 1992 and
1997. As of June 30, 1998, statutory surplus of PMA Reinsurance Corporation was
$279.1 million, and for the six months ended June 30, 1998, PMA Re's net
premiums written were $117.9 million. PMA Re reported pre-tax operating income
of $23.0 million and $23.2 million for the six-month periods ended June 30, 1998
and 1997, respectively, and $46.0 million, $44.8 million and $39.8 million for
the years ended December 31, 1997, 1996 and 1995, respectively.
The Property and Casualty Group markets a full range of workers'
compensation products and services, as well as other standard commercial lines
of property and casualty insurance, primarily to middle market accounts
(premiums ranging from $40,000 to $300,000) and smaller accounts (premiums less
than $40,000). The Property and Casualty Group distributes its products
primarily through approximately 240 regional brokers and agents throughout its
marketing territories and also utilizes an internal sales force in Pennsylvania
and Delaware, which accounted for approximately 13% of direct premiums written
in 1997. In 1997, workers' compensation insurance accounted for 60% of the
Property and Casualty Group's direct premiums written, and Pennsylvania workers'
compensation insurance accounted for 50% of
- 33 -
<PAGE>
the Property and Casualty Group's workers' compensation direct premiums written.
The Property and Casualty Group offers a variety of workers' compensation
products, such as third-party claims administration services, rent-a-captives
and high-deductible plans in addition to traditional fixed-cost and loss-
sensitive workers' compensation products, and management believes that the
Property and Casualty Group competes in workers' compensation on the basis of
its ability to provide prompt and responsive service.
In 1996, the Company restructured the Property and Casualty Group with the
goal of restoring its profitability after three years of operating losses. The
losses resulted primarily from unfavorable underwriting experience and adverse
reserve development related to accident years 1987 through 1991, when the
Property and Casualty Group wrote a much higher volume of business than its
current volume. The principal components of the restructuring were: (i)
strengthening loss reserves; (ii) initiating a commutation program to settle a
significant number of open claims from the 1987 to 1991 period; (iii)
designating PMA Cayman and MASCCO as separate run-off companies to alleviate the
SAP impact on the Pooled Companies of the loss reserve strengthening and to
manage the capital deployed in running off pre-1992 workers' compensation
claims; (iv) initiating an expense reduction program and (v) implementing
management changes, including the appointment of a new Chief Operating Officer
and the creation of the position of Chief Underwriting Officer. In June 1998,
the Company entered into a letter of intent to sell PMA Cayman. Largely as a
result of the restructuring, the Property and Casualty Group recorded pre-tax
operating income of $5.4 million for the six months ended June 30, 1998,
compared to pre-tax operating losses of $5.9 million for the six months ended
June 30, 1997 and $3.7 million, $215.7 million (including restructuring and
other special charges of $223.1 million) and $3.9 million for the years ended
December 31, 1997, 1996 and 1995, respectively. At June 30, 1998, the Pooled
Companies' statutory surplus was $263.1 million, and for the six months ended
June 30, 1998, the Property and Casualty Group's net premiums written were
$138.4 million. See "Business--The Property and Casualty Group."
In December 1997, the Company acquired an insurance company, which was
renamed Caliber One Indemnity Company, to enter the excess and surplus lines
insurance business. Within the last year, the Company hired several experienced
specialty insurance executives to manage Caliber One, who have substantial
relationships within the wholesale brokerage community, which management
believes will have a favorable impact on Caliber One's ability to obtain market
acceptance. Caliber One distributes its products primarily through national
wholesale brokers, and Caliber One Indemnity Company is approved as a surplus
lines carrier in 38 states, Puerto Rico and the District of Columbia. As of
June 30, 1998, Caliber One Indemnity Company's statutory surplus was $25.5
million, and for the six months ended June 30, 1998, Caliber One's net premiums
written were $917,000.
The Company's insurance subsidiaries have the following ratings from A.M.
Best: PMA Reinsurance Corporation, A+ ("Superior"); the Pooled Companies, A-
("Excellent") and Caliber One Indemnity Company, A ("Excellent"). Management
believes that ratings from A.M. Best are material to its operations and that a
downgrade from the present rating classifications could have an adverse effect
on the Company's ability to market its products. A.M. Best's ratings are based
upon an assessment of an insurance company's perceived financial strength
regarding its ability to pay obligations to its policyholders and are not
directed toward the protection of investors.
- 34 -
<PAGE>
The Company maintains its executive offices at 380 Sentry Parkway, Blue
Bell, PA 19422, and its telephone number is (215) 665-5046.
THE ISSUER
The Issuer is a statutory business trust formed under Delaware law pursuant
to (i) a trust agreement executed by PMC as Depositor, Bank of New York, as the
Property Trustee of the Issuer, and Bank of New York (Delaware), as Delaware
Trustee, and (ii) a certificate of trust filed with the Delaware Secretary of
State. The trust agreement will be amended and restated in its entirety (as so
amended and restated, the "Trust Agreement") substantially in the form filed as
an exhibit to the Registration Statement of which this Prospectus forms a part.
The Trust Agreement will be qualified as an indenture under the Trust Indenture
Act. The Issuer exists for exclusive purposes of (i) issuing and selling the
Capital Securities and the Common Securities, (ii) using the proceeds from the
sale of the Capital Securities and the Common Securities to acquire the Junior
Subordinated Debentures issued by PMC and (iii) engaging in only those other
activities necessary, convenient or incidental thereto. Accordingly, the Junior
Subordinated Debentures, the rights of the Property Trustee under the Guarantee
and the right to reimbursement of expenses under the Expense Agreement will be
the sole assets of the Issuer, and payments under the Junior Subordinated
Debentures and the Expense Agreement will be the sole revenue of the Issuer.
All of the Common Securities of the Issuer will be owned by PMC. The
Common Securities will rank pari passu, and payments will be made thereon pro
rata, with the Capital Securities, except that upon the occurrence and
continuance of an Event of Default under the Trust Agreement (as defined
therein) resulting from a Debenture Event of Default, the rights of PMC as
holder of the Common Securities to payment in respect of distributions and
payments upon liquidation, redemption or otherwise will be subordinated to the
rights of the holders of the Capital Securities. See "Description of the
Capital Securities -- Subordination of Common Securities." PMC will acquire
Common Securities in an aggregate liquidation amount equal to approximately 3%
of the total capital of the Issuer.
The Issuer has a term of approximately 55 years, but may terminate earlier
as provided in the Trust Agreement. The Issuer's business and affairs are
conducted by its trustees, each appointed by PMC as holder of the Common
Securities. The trustees for the Issuer will be Bank of New York, as the
Property Trustee, Bank of New York (Delaware), as Delaware Trustee, and three
individual Administrative Trustees who are employees or officers of or
affiliated with PMC. Bank of New York, as Property Trustee, will act as sole
indenture trustee under the Trust Agreement for purposes of compliance with the
Trust Indenture Act. Bank of New York will also act as trustee under the
Guarantee and the Indenture (each as defined herein). See "Description of the
Guarantee" and "Description of the Junior Subordinated Debentures." The holder
of the Common Securities of the Issuer, or the holders of a majority in
Liquidation Amount of the Capital Securities if a Debenture Event of Default has
occurred and is continuing, will be entitled to appoint, remove or replace the
Property Trustee. In no event will the holders of the Capital Securities have
the right to vote to appoint, remove or replace the Administrative Trustees;
such voting rights are vested exclusively in the holder of the Common
Securities. The duties and obligations of the Property Trustee are governed by
the Trust Agreement. PMC will pay all fees and expenses related to the Issuer
and the
- 35 -
<PAGE>
offering of the Capital Securities and will pay, directly or indirectly, all
ongoing costs, expenses and liabilities of the Issuer.
The principal executive office of the Issuer is located at 380 Sentry
Parkway, Blue Bell, Pennsylvania 19422, and its telephone number is (215) 665-
5046.
RATIO OF EARNINGS TO FIXED CHARGES
The following table sets forth the Company's ratio of earnings to fixed
charges for the six months ended June 30, 1998 and 1997 and the years ended
December 31, 1997, 1996, 1995, 1994 and 1993.
<TABLE>
<CAPTION>
Six Months
Ended Year ended December 31,
June 30,
----------- -------------------------------
1998 1997 1997 1996 1995 1994 1993
----- ---- ---- ------- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
Ratio of Earnings to
Fixed Charges(1):
Including net realized
investment gains (losses) 4.0x 1.3x 2.4x --(2) 2.7x 5.5x 7.7x
Excluding net realized
investment gains (losses) 2.7x 1.5x 1.9x --(3) 1.1x 2.2x 2.5x
</TABLE>
(1) For the purposes of determining this ratio, earnings (loss) consist of
income (loss) before income taxes and extraordinary loss (1997), plus fixed
charges. Fixed charges consist of interest expense on debt, amortization of
debt issuance costs and the portion of operating leases that management
believes is representative of the interest factor.
(2) In 1996, earnings were insufficient to cover fixed charges by $191.4
million. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
(3) In 1996, earnings were insufficient to cover fixed charges by $194.4
million. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
- 36 -
<PAGE>
CAPITALIZATION
The following table sets forth the unaudited consolidated capitalization of
the Company at June 30, 1998 on an actual basis and as adjusted to reflect the
issuance of the Junior Subordinated Debentures in connection with the Offering
as if the Offering had occurred on June 30, 1998, after deducting the estimated
underwriting discount and expenses of the Offering. This table should be read
in conjunction with the consolidated financial statements, including the notes
thereto, appearing elsewhere in this Prospectus.
<TABLE>
<CAPTION>
(dollar amounts in thousands, except per share data)
At June 30, 1998
(Unaudited)
Actual As Adjusted
------ -----------
Long-term debt:
<S> <C> <C>
Revolving Credit Facility(1) $203,000 $104,500
-------- --------
Company-obligated mandatorily
redeemable Capital Securities of
subsidiary trust holding solely Junior
Subordinated Debentures of the
Company(2) -- 100,000
-------- --------
Shareholders' equity:
Common stock, $5.00 par value, 40,000,000
shares authorized, 14,765,020 shares
issued and 14,329,013 shares
outstanding 73,825 73,825
Class A common stock, $5.00 par value,
40,000,000 shares authorized,
9,677,925 shares issued and 9,356,995
shares outstanding 48,389 48,389
Additional paid-in capital-Class A common
stock 339 339
Retained earnings 359,486 359,486
Unrealized gain on investments available
for sale 26,297 26,297
Notes receivable from officers (198) (198)
Treasury stock, at cost (436,007 shares-
common stock and 320,930 shares-
Class A common stock) (11,755) (11,755)
-------- --------
Total shareholders' equity 496,383 496,383
-------- --------
Total capitalization $699,383 $700,883
======== ========
</TABLE>
(1) At June 30, 1998, $32,000 was available for borrowing under the Company's
Revolving Credit Facility. As adjusted, at June 30, 1998, available
borrowings under the Company's Revolving Credit Facility are $130,500.
(2) Represents the issuance of the Capital Securities by the Trust (net of
related issuance costs). One hundred percent of the assets of the Trust
will consist of approximately $98.5 million of Junior Subordinated
Debentures of PMC. The financial statements of the Trust will be reflected
in the consolidated financial statements of the Company with the Capital
Securities reflected as Company-obligated mandatorily redeemable Capital
Securities of subsidiary trust holding solely Junior Subordinated Debentures
of the Company. See "Accounting Treatment."
- 37 -
<PAGE>
USE OF PROCEEDS
PMC currently estimates the net proceeds to be received from the Offering
will be $98.5 million, after giving effect to estimated underwriting discounts
and estimated offering expenses. All of the net proceeds from the sale of the
Capital Securities will be invested in the Junior Subordinated Debentures. PMC
intends to use the proceeds from the sale of such Junior Subordinated Debentures
to repay indebtedness under the Revolving Credit Facility, which will
increase the availability under the Revolving Credit Facility from $32 million
to $130.5 million. The final maturity of the Revolving Credit Facility is
December 31, 2002, with reductions in availability of $47.5 million on December
31, 1999 and level reductions in availability of $62.5 million each December 31
thereafter, commencing in 2000. The Revolving Credit Facility bears interest at
a variable interest rate of LIBOR plus .70% on the drawn amount (with such
spread adjustable downward based upon reductions in the Company's ratio of debt
to total capitalization), or 6.4% at June 30, 1998, and carries a .275% facility
fee on the undrawn portion (also adjustable downward based upon reductions in
the Company's ratio of debt to total capitalization). It is the Company's
intention to utilize availability under the Revolving Credit Facility, from time
to time in the future, to capitalize subsidiaries and make other strategic
investments as business opportunities arise, subject to the maintenance of
appropriate financial leverage ratios. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and Capital
Resources."
ACCOUNTING TREATMENT
For financial reporting purposes, the Issuer will be treated as a
subsidiary of the Company, and, accordingly, the accounts of the Issuer will be
included in the consolidated financial statements of the Company. The Capital
Securities will be presented as a separate line item in the consolidated balance
sheets of the Company, entitled "Company-obligated mandatorily redeemable
Capital Securities of subsidiary trust holding solely Junior Subordinated
Debentures of the Company" and the audited notes to the consolidated financial
statements will contain disclosure that (a) the Common Securities of the Trust
are wholly owned by PMC, (b) the sole asset of the Trust is the ___% Junior
Subordinated Debentures of PMC in the approximate principal amount of $98.5
million, having a stated maturity of ___, 2028, and (c) PMC fully and
unconditionally guarantees the Trust's obligations under the Capital Securities.
For financial reporting purposes, the Company will record distributions payable
on the Capital Securities as an expense in its consolidated statements of
operations.
- 38 -
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
The selected consolidated financial and operating data set forth below as
of December 31, 1997, 1996, 1995, 1994, and 1993 and for each of the five years
in the period ended December 31, 1997 were derived from the audited consolidated
financial statements of the Company. The selected consolidated financial and
operating data as of June 30, 1998 and 1997 and for the six-month periods ended
June 30, 1998 and 1997 were derived from the Company's unaudited consolidated
financial statements. The unaudited consolidated financial statements have been
prepared on the same basis as the Company's audited consolidated financial
statements, and, in the opinion of management, include all adjustments,
consisting of only normal recurring adjustments, necessary for a fair
presentation of the Company's financial position and results of operations for
these periods. The results of operations for the six months ended June 30, 1998
may not be indicative of results of operations for the full year. All selected
consolidated financial and operating data set forth below should be read in
conjunction with the consolidated financial statements of the Company, together
with the notes thereto, and Management's Discussion and Analysis of Financial
Condition and Results of Operations, both appearing elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
(dollar amounts in thousands, except per share data)
Six Months Ended
June 30, Year Ended December 31,
------------------------ --------------------------------------------------------------------
1998 1997 1997(1) 1996(1) 1995(1) 1994(1) 1993
----------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Net premiums written $ 257,038 $ 253,125 $ 418,282 $ 443,475 $ 489,876 $ 466,502 $ 536,987
=========== =========== =========== =========== =========== =========== ===========
Consolidated Revenues:
Net premiums earned $ 221,576 $ 222,401 $ 375,951 $ 420,575 $ 484,952 $ 466,534 $ 547,407
Net investment income 65,200 68,459 136,698 133,936 139,355 138,719 153,842
Net realized investment
gains (losses) 11,263 (1,931) 8,598 2,984 31,923 47,521 69,798
Service revenues 5,090 5,038 10,311 9,189 5,106 3,380 1,321
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total consolidated revenues $ 303,129 $ 293,967 $ 531,558 $ 566,684 $ 661,336 $ 656,154 $ 772,368
=========== =========== =========== =========== =========== =========== ===========
Pre-tax operating income
(loss)(2):
PMA Re $ 22,952 $ 23,187 $ 45,957 $ 44,807 $ 39,793 $ 33,703 $ 33,511
----------- ----------- ----------- ----------- ----------- ----------- -----------
The Property and Casualty
Group (3):
Excluding Run-off
Operations 4,954 (4,781) (3,607) (215,669) (3,885) 3,893 (1,153)
Run-off Operations 428 (1,107) (73) --- --- --- ---
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total Property and Casualty
Group 5,382 (5,888) (3,680) (215,669) (3,885) 3,893 (1,153)
Caliber One (1,070) --- --- --- --- --- ---
Corporate operations (5,548) (4,526) (9,954) (6,464) (14,184) (6,686) (885)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total pre-tax operating
income (loss) before
interest expense 21,716 12,773 32,323 (177,326) 21,724 30,910 31,473
Interest expense 7,463 8,222 15,768 17,052 18,734 13,051 11,650
----------- ----------- ----------- ----------- ----------- ----------- -----------
Pre-tax operating income
(loss) 14,253 4,551 16,555 (194,378) 2,990 17,859 19,823
Net realized investment
gains (losses) 11,263 (1,931) 8,598 2,984 31,923 47,521 69,798
----------- ----------- ----------- ----------- ----------- ----------- -----------
Income (loss) before income
taxes and extraordinary
item 25,516 2,620 25,153 (191,394) 34,913 65,380 89,621
Provision (benefit) for
income taxes 4,071 (2,657) 5,400 (56,060) 10,783 8,130 21,324
----------- ----------- ----------- ----------- ----------- ----------- -----------
Income (loss) before
cumulative effect of
accounting changes and
extraordinary item 21,445 5,277 19,753 (135,334) 24,130 57,250 68,297
Cumulative effect of
accounting changes, net of
related tax effects (4) --- --- --- --- --- --- 14,119
Extraordinary loss from
early extinguishment of
debt, net of related tax
effect (5) --- (4,734) (4,734) --- --- --- ---
----------- ----------- ----------- ----------- ----------- ----------- -----------
Net income (loss) $ 21,445 $ 543 $ 15,019 $ (135,334) $ 24,130 $ 57,250 $ 82,416
=========== =========== =========== =========== =========== =========== ===========
After tax operating income
(loss) (6) $ 14,124 $ 6,532 $ 14,164 $ (137,274) $ 3,380 $ 26,361 $ 22,928
=========== =========== =========== =========== =========== =========== ===========
</TABLE>
- 39 -
<PAGE>
<TABLE>
<CAPTION>
(dollar amounts in thousands, except per share data)
Six Months Ended
June 30, Year Ended December 31,
------------------------ --------------------------------------------------------------------
1998 1997 1997(1) 1996(1) 1995(1) 1994(1) 1993
----------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Per Share Data:
Weighted average shares:
Basic (7) 23,770,912 23,855,031 23,855,031 23,800,791 23,816,088 23,897,263 24,231,071
Diluted (7), (8) 24,658,911 24,567,378 24,567,378 23,800,791 24,781,949 24,650,741 24,470,024
Income (loss) before
cumulative effect of
accounting changes and
extraordinary item per
share:
Basic (7) $ .90 $ .22 $ .83 $ (5.68) $ 1.01 $ 2.40 2.82
Diluted (7), (8) .87 .21 .80 (5.68) .97 2.32 2.79
Net income (loss) per share:
Basic (7) .90 .02 .63 (5.68) 1.01 2.40 3.40
Diluted (7), (8) .87 .02 .61 (5.68) .97 2.32 3.37
After tax operating income
(loss) per share:
Basic (7) .59 .27 .59 (5.77) .14 1.10 .95
Diluted (7), (8) .57 .27 .58 (5.77) .14 1.07 .94
Dividends paid per common
share .16 .16 .32 .32 .32 .32 .28
Dividends paid per Class A
common share .18 .18 .36 .36 .36 .36 32
Shareholders' equity per
share 20.96 17.40 19.96 17.86 25.53 22.10 22.23
Ratio of earnings to fixed
charges:
Including net realized
investment gains (losses)
(10) 4.0x 1.3x 2.4x -- 2.7x 5.5x 7.7x
Excluding net realized
investment gains (losses)
(11) 2.7x 1.5x 1.9x -- 1.1x 2.2x 2.5x
GAAP Ratios for Insurance
Subsidiaries (12):
PMA Re:
Loss ratio 69.0% 73.1% 69.6% 73.7% 74.6% 74.7% 80.6%
Expense ratio 35.2% 29.3% 34.9% 30.2% 29.5% 33.3% 29.4%
----------- ----------- ----------- ----------- ----------- ----------- -----------
Combined ratio (13) 104.2% 102.4% 104.5% 103.9% 104.1% 108.0% 110.0%
=========== =========== =========== =========== =========== =========== ===========
The Property and Casualty
Group, including Run-off
Operations (3):
Loss ratio 85.5% 95.4% 91.1% 158.2% 92.5% 90.1% 96.3%
Expense ratio (14) 34.0% 35.0% 45.3% 48.6% 30.6% 31.4% 25.0%
Policyholders' dividend
ratio 6.7% 4.8% 6.9% 6.1% 4.8% 4.6% 3.5%
----------- ----------- ----------- ----------- ----------- ----------- -----------
Combined ratio (13) 126.2% 135.2% 143.3% 212.9% 127.9% 126.1% 124.8%
=========== =========== =========== =========== =========== =========== ===========
The Property and Casualty
Group, excluding Run-off
Operations (3):
Loss ratio 77.7% 84.9% 83.7% -- -- -- --
Expense ratio (14) 32.8% 33.9% 36.4% -- -- -- --
Policyholders' dividend
ratio 6.7% 4.8% 5.6% -- -- -- --
----------- ----------- ----------- ----------- ----------- ----------- -----------
Combined ratio (13) 117.2% 123.6% 125.7% -- -- -- --
=========== =========== =========== =========== =========== =========== ===========
June 30, December 31,
----------------- -------------------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
---- ---- ---- ---- ---- ---- ----
Consolidated Financial Position:
Total investments $ 2,159,303 $ 2,067,828 $ 2,194,738 $ 2,261,353 $ 2,455,949 $ 2,313,261 $ 2,374,208
Total assets 3,075,413 3,085,640 3,057,258 3,117,516 3,258,572 3,181,979 3,197,909
Reserves for unpaid losses
and LAE 1,939,568 2,052,791 2,003,187 2,091,072 2,069,986 2,103,714 2,150,665
Long-term debt 203,000 203,049 203,000 204,699 203,848 203,975 194,836
Shareholders' equity (9) 496,383 415,120 478,347 425,828 609,668 524,862 534,383
- ---------------------------
</TABLE>
___________________________
(1) Operating results in 1997, 1996 and 1995 were impacted by approximately
$12,100, $223,100 and $8,400, respectively, of restructuring and other
special charges. See "Management's Discussion and Analysis of Financial
Condition and Results of
- 40 -
<PAGE>
Operations" for further information. In addition,
1994 operating results included a charge of approximately $4,908 to write
down the value of the Company's former headquarters building.
(2) Pre-tax operating income (loss) excludes net realized investment gains
(losses). Pre-tax operating income by business segment for all periods is
unaudited and has been presented in accordance with SFAS No.131,
"Disclosures about segments of an Enterprise and Related Information",
which the Company adopted on January 1, 1998. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and the
Company's interim financial statements and notes thereto as of June 30,
1998 and 1997 included elsewhere in this Prospectus.
(3) Run-off Operations of the Property and Casualty Group are comprised of
MASCCO, PMA Cayman and PMA Life, which were established
in December 1996 to reinsure certain obligations primarily associated with
workers' compensation claims written by the Pooled Companies for the
accident years 1991 and prior. The Run-off Operations are separate legal
entities and substantially all of the assets of the Run-off Operations are
held in trust for the benefit of the Pooled Companies. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
(4) In 1993, the Company recognized an after-tax net benefit of $14,119
resulting from the adoption of SFAS No. 109, "Accounting for Income Taxes,"
($21,500 benefit), and SFAS No. 106, "Employers' Accounting for Post-
retirement Benefits Other Than Pensions," ($7,381 after-tax charge).
(5) In 1997, the Company refinanced substantially all of its long-term debt
that resulted in a $4,734 extraordinary loss, net of tax effect. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
(6) After-tax operating income (loss) represents pre-tax operating income
(loss) less the provision (benefit) for income taxes net of taxes
attributable to net realized investment gains (losses).
(7) In 1997, the Company adopted SFAS No. 128, "Earnings Per Share," which
requires the presentation of basic and diluted earnings per share (see
Notes 1-I and 16 to the audited consolidated financial statements appearing
elsewhere in this Prospectus). All prior periods' presentation of earnings
per share data has been restated to conform to SFAS No. 128.
(8) For the year ended December 31, 1996, common stock equivalents were not
taken into consideration in the computation of weighted-average diluted
shares as these common stock equivalents would have an anti-dilutive effect
on the net loss per share.
(9) In 1994, shareholders' equity increased $45,343 related to the adoption of
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities."
- 41 -
<PAGE>
(10) For the purposes of determining this ratio, earnings (loss) consist of
income (loss) before income taxes and extraordinary loss (1997), plus fixed
charges. Fixed charges consist of interest expense on debt, amortization of
debt issuance costs and the portion of operating leases that management
believes is representative of the interest factor. In 1996, earnings were
insufficient to cover fixed charges by $191,394. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
(11) In 1996, earnings were insufficient to cover fixed charges by $194,378.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
(12) The results of operations of Caliber One are not material to the
underwriting ratios of the Company; accordingly, the ratios for Caliber One
have not been presented.
(13) The combined ratio computed on a GAAP basis is equal to losses and LAE,
plus amortization of deferred acquisition costs, operating expenses and
policyholders' dividends (where applicable), all divided by net premiums
earned.
(14) The GAAP operating expense ratios exclude $4,718 and $4,506 for the six
months ended June 30, 1998 and 1997, respectively, and $9,316, $8,227 and
$5,300, for the years ended December 31, 1997, 1996 and 1995, respectively,
of PMA Management Corp. direct expenses related to service revenues, which
are not included in premiums earned. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
- 42 -
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion of the Company's results of operations and its
liquidity and capital resources should be read in connection with the Selected
Consolidated Financial and Operating Data of the Company and the consolidated
financial statements of the Company and notes thereto, and the unaudited
financial statements and notes thereto included elsewhere in this Prospectus.
Results of Operations for the Six Months Ended June 30, 1998 Compared to the Six
Months Ended June 30, 1997
The table below presents the major components of net income for the Company
for the six months ended June 30, 1998 and 1997:
(dollar amounts in thousands, except per share data)
Six Months Ended
June 30,
----------------
1998 1997
---- ----
Pre-tax operating income(1) $14,253 $ 4,551
Net realized investment gains (losses) 11,263 (1,931)
------- -------
Income before income taxes and
extraordinary loss 25,516 2,620
Provision (benefit) for income taxes 4,071 (2,657)
------- -------
Income before extraordinary loss 21,445 5,277
Extraordinary loss, net of related taxes -- (4,734)
------- -------
Net income $21,445 $ 543
======= =======
After-tax operating income(2) $14,124 $ 6,532
======= =======
Per Basic Share:
Income before extraordinary loss $ .90 $ .22
Extraordinary loss -- (.20)
------- -------
Net income $ .90 $ .02
======= =======
After-tax operating income(2) $ .59 $ .27
======= =======
- 43 -
<PAGE>
Per Diluted Share:
Income before extraordinary loss $ .87 $ .21
Extraordinary loss -- $ (.19)
------- -------
Net income $ .87 $ .02
======= =======
After-tax operating income(2) $ .57 $ .27
======= =======
- -------------------------
(1) Pre-tax operating income is defined as income from continuing operations
before income taxes, but excluding net realized investment gains (losses).
(2) After-tax operating income is defined as pre-tax operating income less a
provision for income tax adjusted for the taxes attributable to net realized
investment gains (losses).
The following table indicates the Company's pre-tax operating income (loss)
by business segment for the six months ended June 30, 1998 and 1997:
(dollar amounts in thousands)
Six Months Ended
June 30,
---------------------
1998 1997(1)
---- -------
PMA Re $22,952 $23,187
The Property and Casualty Group 5,382 (5,888)
Caliber One (1,070) --
Corporate and Other (5,548) (4,526)
------- -------
Pre-tax operating income before
interest expense 21,716 12,773
Interest expense 7,463 8,222
------- -------
Pre-tax operating income $14,253 $ 4,551
======= =======
At June 30, 1998, the Company's total assets by business segment were as
follows:
(dollar amounts in thousands)
PMA Re $1,188,852
The Property and Casualty Group 1,822,760
Caliber One 62,465
Corporate and Other 1,336
----------
Total assets(1) $3,075,413
==========
- ----------------------
(1) Pre-tax operating income (loss) by business segment has been reclassified
for 1997 to reflect the changes related to the implementation of SFAS No.
131 (see Note 3 to the interim consolidated financial statements included
elsewhere in this Prospectus for further discussion).
On a consolidated basis, the Company reported pre-tax operating income of
$14.3 million for the six months ended June 30, 1998 compared to $4.6 million
for the six months ended June 30, 1997. The increase in pre-tax operating
income was primarily due to increased
- 44 -
<PAGE>
operating income at the Property and Casualty Group partially offset by the
Caliber One pre-tax operating loss of $1.1 million related to the commencement
of its operations. Pre-tax operating income for PMA Re for the first half of
1998 was flat relative to the first half of 1997, as higher premium volumes,
lower loss ratios and higher investment income were offset by increases in
acquisition costs as well as timing issues related to certain operating expenses
in the first six months of 1998. The increase in pre-tax operating income for
the Property and Casualty Group was due to lower losses and expenses recorded in
the first half of 1998 compared to 1997 as a result of the restructuring efforts
initiated during 1997. The pre-tax operating loss at Corporate and Other was
$1.0 million higher than the comparable 1997 period, related to certain
compensation programs, which were not adopted until the second half of 1997,
partially offset by costs incurred in the first six months of 1997 related to
certain corporate properties that were disposed of in the third quarter of 1997.
Interest expense decreased $759,000 for the six months ended June 30, 1998
compared to the same period in 1997 due to the March 1997 refinancing of the
Company's debt facility.
Net realized investment gains were $11.3 million in the six months ended
June 30, 1998 compared to net realized investment losses of $1.9 million in the
1997 period due primarily to lower interest rates in the 1998 period.
Net income on a consolidated basis before extraordinary item was $21.4
million, or $0.90 per basic share and $0.87 per diluted share, for the six
months ended June 30, 1998 compared to $5.3 million, or $0.22 per basic share
and $0.21 per diluted share, for the six months ended June 30, 1997. On March
14, 1997, the Company refinanced substantially all of its outstanding credit
agreements not already maturing in 1997. In connection with this refinancing,
the Company recognized an extraordinary loss in the first six months of 1997
from the early extinguishment of debt of $4.7 million, or $0.20 per basic share
and $0.19 per diluted share, net of tax.
PMA Re Results of Operations
Summarized financial results of PMA Re for the six months ended June 30,
1998 and 1997 are as follows:
(dollar amounts in thousands)
Six Months Ended
June 30,
-------------------
1998 1997
---- ----
Net premiums written $117,908 $ 96,279
======== ========
Net premiums earned $100,967 $ 85,087
Net investment income 27,171 25,288
-------- --------
Operating revenues 128,138 110,375
-------- --------
Losses and LAE incurred 69,678 62,231
- 45 -
<PAGE>
Acquisition and operating expenses 35,508 24,957
-------- --------
Total losses and expenses 105,186 87,188
-------- --------
Pre-tax operating income $ 22,952 $ 23,187
======== ========
GAAP loss ratio 69.0% 73.1%
GAAP combined ratio 104.2% 102.4%
SAP loss ratio 68.4% 73.1%
SAP combined ratio 104.5% 103.5%
Premium Revenues
The following table indicates PMA Re's gross and net premiums written by
major category of business for the six months ended June 30, 1998 and 1997:
(dollar amounts in thousands)
Six Months Ended
June 30,
-----------------
1998 1997
---- ----
Gross premiums written:
Casualty lines $102,608 $83,289
Property lines 41,313 36,916
Other lines 501 501
-------- -------
Total $144,422 $120,706
======== ========
Net premiums written:
Casualty lines $ 83,535 $ 68,286
Property lines 33,849 27,501
Other lines 524 492
-------- --------
Total $117,908 $ 96,279
======== ========
Gross premiums written increased $23.7 million, or 19.6%, for the six
months ended June 30, 1998 compared to the same period in 1997. For the six
months ended June 30, 1998, gross premiums written increased 23.2% for casualty
lines and 11.9% for property lines compared to the same period in 1997. The
main reasons for these increases in gross premiums written were increased
participations on reinsurance treaties and new programs with existing clients,
as well as contracts with new clients. These increases were partially offset by
the trend toward large ceding companies increasing their retentions, which
decreases PMA Re's subject premium. In addition, highly competitive conditions
in the United States reinsurance market caused PMA Re to non-renew certain
accounts due to inadequate rates and/or other underwriting concerns.
Net premiums written increased $21.6 million, or 22.5%, for the six months
ended June 30, 1998 compared to the same period in 1997. PMA Re made changes to
its retrocessional program in the second half of 1997 and in 1998, which reduced
the percentage of premiums ceded to retrocessionaires in 1998. Net premiums
earned for PMA Re also increased $15.9 million, or 18.7%, for the six months
ended June 30, 1998, respectively, compared to the same period in 1997. Net
premiums earned generally follow growth patterns similar to net premiums written
after giving effect to a lag in premium earnings.
- 46 -
<PAGE>
Losses and Expenses
The following table reflects the components of PMA Re's combined ratios,
computed in accordance with GAAP for the six months ended June 30, 1998 and
1997:
Six Months Ended
June 30,
------------------
1998 1997
---- ----
Loss ratio 69.0% 73.1%
---- ----
Expense ratio:
Amortization of deferred
acquisition costs 28.5% 23.8%
Operating expenses 6.7% 5.5%
---- ----
Total expense ratio 35.2% 29.3%
---- ----
Combined ratio - GAAP (1) 104.2% 102.4%
===== =====
- ---------------------
(1) The combined ratio computed on a GAAP basis is equal to losses and LAE, plus
amortization of deferred acquisition costs, operating expenses and
policyholders' dividends (where applicable), all divided by net premiums
earned.
For the six-month period ended June 30, 1998, PMA Re posted lower loss
ratios, reflecting higher levels of favorable loss reserve development and the
effects of more treaties written with ceding commissions, which increased the
proportion of the subject premium assumed by PMA Re. The six-month period in
1998 was also impacted by higher acquisition costs, which reflected the
aforementioned increase in the number of treaties written with ceding
commissions, as well as competitive conditions.
The ratio of operating expenses to net premiums earned (the "Operating
Expense Ratio") increased 1.2 points for the six months ended June 30, 1998
compared to the same period in 1997. The increase in the Operating Expense
Ratio relates to increases in staff relating to higher activity levels, as well
as the timing of certain expenses in 1997, such as costs relating to the
restructuring of PMA Re's compensation plans. In addition, the increase is
partially due to the Year 2000 compliance program, for which the majority of
expenses incurred began in the second half of 1997. PMA Re has incurred costs
of approximately $425,000 during 1998 related to the Year 2000 compliance
program. Management expects that PMA Re will incur approximately $175,000 of
additional expenses in 1998 related to the Year 2000 compliance program and that
such project will be completed in 1998. See "Liquidity and Capital Resources"
for further discussion.
Net Investment Income
Higher levels of investment income, which reflected higher levels of
invested assets, also impacted PMA Re's operating income. For the six months
ended June 30, 1998, net investment income increased $1.9 million versus the
comparable 1997 period.
- 47 -
<PAGE>
The Property and Casualty Group Results of Operations
Net premiums written for the Property and Casualty Group were adjusted to
include $6.5 million for the six months ended June 30, 1998 and $4.9 million for
the six months ended June 30, 1997 representing estimated retrospective policy
adjustments related to the current accident year and retrospective policy
adjustments paid. These adjustments were made for presentation purposes only
and do not impact the Property and Casualty Group's reported revenues, financial
position or results of operations because these adjustments have no effect on
net premiums earned. Summarized financial results of the Property and Casualty
Group for the six months ended June 30, 1998 and 1997 are as follows:
(dollar amounts in thousands)
Six Months Ended
June 30,
----------------
1998 1997
---- ----
Net premiums written:
Workers' compensation $106,952 $104,464
Commercial lines 31,432 52,382
------- --------
Total $138,384 $156,846
======== ========
Net premiums earned:
Workers' compensation $ 87,011 $ 95,616
Commercial lines 33,578 41,698
-------- --------
Total 120,589 137,314
-------- --------
Net investment income:
Excluding Run-off Operations 25,367 26,930
Run-off Operations 11,303 14,972
-------- --------
Total 36,670 41,902
-------- --------
Service revenues 5,090 5,038
-------- --------
Operating revenues 162,349 184,254
-------- --------
Losses and LAE incurred:
Excluding Run-off Operations 93,684 115,873
Run-off Operations 9,401 15,097
-------- --------
Total 103,085 130,970
-------- --------
Acquisition and operating expenses:
Excluding Run-off Operations 44,278 50,759
Run-off Operations 1,474 1,796
-------- --------
Total 45,752 52,555
-------- --------
Policyholders' dividends 8,130 6,617
-------- --------
Total losses and expenses 156,967 190,142
-------- --------
Pre-tax operating income (loss) $ 5,382 $ (5,888)
======== ========
GAAP loss ratio 85.5% 95.4%
GAAP combined ratio 126.2% 135.2%
SAP loss ratio(1) 77.9% 85.3%
SAP combined ratio(1) 113.4% 118.9%
- --------------------------
(1) The SAP loss and combined ratios above relate to the Pooled Companies only.
- 48 -
<PAGE>
The Property and Casualty Group Excluding Run-off Operations
Premium Revenues
Direct premiums written for the Property and Casualty Group decreased $19.9
million for six months ended June 30, 1998 compared to the same period in 1997.
Direct premiums written for commercial lines of business other than workers'
compensation, such as commercial auto, general liability, umbrella, multi-peril
and commercial property lines (collectively, "Commercial Lines") decreased $19.6
million for the six months ended June 30, 1998 compared to the same period in
1997. Direct premiums written for workers' compensation decreased $298,000 for
the six months ended June 30, 1998 compared to the same period in 1997. For the
six months ended June 30, 1998, reinsurance premiums assumed decreased $73,000
compared to the same period in 1997. Reinsurance premiums ceded decreased $1.5
million for the six months ended June 30, 1998 compared to the same period in
1997. The percentage of net workers' compensation premiums written to total net
premiums written increased to 77% for the six months ended June 30, 1998 from
67% during the same period in 1997. This increase was primarily due to a
planned reduction in Commercial Lines business, as described below, and
continued competitive conditions.
For the six months ended June 30, 1998, net premiums written decreased
$18.5 million compared to the same period in 1997. Earned premiums decreased by
$16.7 million for the six months ended June 30, 1998 compared to the same period
in 1997. Net premiums earned generally follow growth patterns similar to net
premiums written after giving effect to a lag in premium earnings, absent any
significant adjustments to accrued retrospective premiums. Such adjustments did
not fluctuate materially between periods.
The decrease in direct premiums written for workers' compensation was
primarily due to continued intense price competition in the workers'
compensation market as well as the impact of rate changes associated with
workers' compensation benefit reforms in Pennsylvania. Workers' compensation
reform laws adopted in Pennsylvania ("Act 57") resulted in a reduction in manual
workers' compensation rates in excess of 25%, effective February 1997 for new
and renewal business. Management does not expect manual rate decreases to be as
significant for the 1998 policy year as compared to the 1997 policy year,
although manual rate levels in all of the Group's principal marketing states
continue to decrease.
The Property and Casualty Group has continued its marketing of alternative
market workers' compensation products for larger accounts, including large-
deductible policies and providing excess coverage to self-insured groups.
Typically, the Property and Casualty Group receives a lower up-front premium for
these types of alternative market product plans. However, under this type of
business, the insured retains a greater share of the underwriting risk than
under rate-sensitive or loss-sensitive products, which reduces the potential for
unfavorable claims activity on the accounts and encourages loss control on the
part of the insured. A substantial portion of related revenues are recorded as
service revenues. Such service revenues increased $52,000 for the six months
ended June 30, 1998 compared to the same period in 1997.
- 49 -
<PAGE>
Direct workers' compensation premiums written were also impacted by changes
in the level of premium adjustments, primarily related to audit premiums. For
the six months ended June 30, 1998, such adjustments increased premiums written
by $8.1 million compared to increases of $8.3 million in the comparable 1997
period.
The decreases in Commercial Lines direct writings for the six months ended
June 30, 1998 compared to 1997 were primarily due to a planned reduction in net
Commercial Lines business as well as continued competitive conditions in
Commercial Lines pricing in 1998. Rather than lower prices to what it believes
are unacceptable levels, the Property and Casualty Group has chosen not to renew
some of its Commercial Lines business. In addition, the Property and Casualty
Group has reduced its writings of new Commercial Lines accounts in the first six
months of 1998 compared to the same period in 1997 because management believes
that market rates and contract terms for many of these accounts did not provide
the opportunity to achieve what management considers to be an acceptable return.
Losses and Expenses
The following table reflects the components of the Property and Casualty
Group's combined ratios, computed in accordance with GAAP for the six months
ended June 30, 1998 and 1997:
Six Months Ended
June 30,
-----------------
1998 1997
---- ----
Loss ratio 77.7% 84.9%
----- -----
Expense ratio:
Amortization of deferred acquisition costs 19.2% 19.2%
Operating expenses(1) 13.6% 14.7%
----- -----
Total expense ratio 32.8% 33.9%
----- -----
Policyholders' dividend ratio 6.7% 4.8%
----- -----
Combined - GAAP(2) 117.2% 123.6%
===== =====
- ------------------------------
(1) The GAAP Operating Expense Ratio excludes $4.7 million and $4.5 million for
the six months ended June 30, 1998 and 1997, respectively, of PMA Management
Corp. direct expenses related to service revenues, which are not included in
premiums earned.
(2) The GAAP combined ratios for the Property and Casualty Group including the
Run-off Operations were 126.2% for the six months ended June 30, 1998
compared to 135.2% for the six months ended June 30, 1997. See "Run-off
Operations."
For the six months ended June 30, 1998, the GAAP loss ratio improved by 7.2
points compared to the same period in 1997. This improvement was primarily due
to an improved loss and LAE ratio in Commercial Lines and an improvement in
medical costs and in LAE in the workers' compensation line and a lower amount of
discount accretion on workers' compensation loss reserves.
- 50 -
<PAGE>
The improvement in the loss and LAE ratio in Commercial Lines favorably
impacted the overall loss ratio by 1.4 points for the six months ended June 30,
1998 compared to the same period in 1997. This improvement in the Commercial
Lines loss and LAE ratio was primarily due to a reduction in exposures
underwritten by the Property and Casualty Group in 1998 compared to the same
period in 1997. The Property and Casualty Group believes that reduced
exposures, which have occurred primarily as a result of price competition and
more stringent underwriting, have improved the overall loss ratio on its
remaining Commercial Lines business.
Measures to control medical costs and LAE in workers' compensation improved
the overall loss and LAE ratio by 2.5 points in the six months ended June 30,
1998 compared to the same period in 1997. Medical costs improved primarily due
to the Property and Casualty Group's affiliation with a national preferred
provider organization, which became effective January 1998. This affiliation
enabled the Property and Casualty Group to lower its cost in providing medical
benefits to injured workers. LAE decreased primarily due to continued use of
certain claims resolution practices. By using techniques such as managed care
and commutations, the Property and Casualty Group has reduced the amount and
number of outstanding claims and the amount of time that a claim remains open.
These techniques have lowered costs associated with managing open claims.
In July 1997, the Property and Casualty Group completed a formal program
under which it commuted a large number of workers' compensation claims from
accident years 1991 and prior. The commutation program resulted in current
payments, which were less than the carried reserves. As substantially all of
these reserves were carried on a discounted basis, the ultimate level of
discount on the Property and Casualty Group's carried reserves decreased as
well. As the level of discount has decreased, the loss ratio has benefited from
lower amounts of discount accretion.
During the past five years, direct premiums written for workers'
compensation have declined significantly and the Property and Casualty Group has
underwritten less exposures in more recent years. As a result, loss reserve
levels have declined and the level of discount has declined as well. These
reductions have decreased the amount of discount accretion related to the
established loss reserves. As a result, this lower amount of discount accretion
improved the overall loss and LAE ratio by 2.6 points in the first six months of
1998 compared to the same period in 1997. The Property and Casualty Group has
initiated another commutation program, which is currently underway and expected
to continue through 1998. This program is expected to focus on claims from
accident years 1992 to 1996.
The increase in the percentage of net workers' compensation premiums
written and earned to total net premiums written and earned had a favorable
impact on the loss and LAE ratio, as workers' compensation business has had
better loss experience than other Commercial Lines in the Property and Casualty
Group's marketing territory. This mix of business caused a 0.7 point reduction
in the loss and LAE ratio for the six months ended June 30, 1998 compared to the
same period in 1997.
The GAAP expense ratio decreased by 1.1 points for the six months ended
June 30, 1998 compared to the same period in 1997 related to a corresponding
reduction in the operating expense ratio. Such reduction was due to decreases
in operating expenses of $3.7
- 51 -
<PAGE>
million during the six months ended June 30, 1998 compared to the same period in
1997 as a result of the continuation of cost reduction measures initiated during
1997.
The Property and Casualty Group incurred approximately $498,000 of
severance and other restructuring costs for the six months ended June 30, 1998
compared with $1.7 million for the same period in 1997. In addition,
approximately $1.0 million of costs related to addressing the Year 2000 Issue
were incurred during the six months ended June 30, 1998 compared with $438,000
for the same period in 1997. The remaining Year 2000 costs are not expected to
be material and management anticipates that such project will be completed in
1998. See "Liquidity and Capital Resources" for further discussion.
The policyholders' dividend ratio was 6.7% for the six months ended June
30, 1998 compared to 4.8% for the same period in 1997. The increase in the
dividend ratio is primarily due to improved loss experience in the workers'
compensation line of business and increased writings of participating business.
Net Investment Income
Net investment income was $25.4 million for the six months ended June 30,
1998 compared to $26.9 million for the same period in 1997. Net investment
income decreased for the first six months of 1998 compared to the same period in
1997, primarily as a result of lower fixed income yields, partially offset by
slightly higher average invested assets.
The Run-off Operations
----------------------
As a part of the Property and Casualty Group's 1996 restructuring plan, the
Property and Casualty Group established the Run-off Operations principally to
manage the capital supporting workers' compensation loss reserves from accident
years 1992 and prior. Such reserves primarily relate to the period of time from
1987 to 1991 when the Property and Casualty Group wrote a much higher volume of
business and experienced poor underwriting results. The reserves are mainly
indemnity related and relate to the pre-1992 periods. The Run-off Operations
consist of PMA Cayman, MASCCO and PMA Life.
PMA Cayman was incorporated in Grand Cayman, and had no material operations
until 1996. In 1996, the Pooled Companies ceded to PMA Cayman substantially all
of the Pooled Companies' remaining liability for workers' compensation claims
for accident years 1991 and prior other than the policies ceded to MASCCO. In
1997, the Pooled Companies also ceded to PMA Cayman a portion of the Pooled
Companies' workers compensation reserves from accident years 1992 to 1996. At
June 30, 1998, PMA Cayman had $233.0 million in total assets and $215.5 million
in total reserves. Substantially all of PMA Cayman's assets are held in trust
for the benefit of the Pooled Companies. The Company entered into a letter of
intent dated June 26, 1998, to sell PMA Cayman. The transaction is subject to
customary closing conditions, including regulatory approvals, and is expected to
be completed in the third quarter of 1998. In connection with the proposed
sale, the Company recorded a $2.4 million pre-tax loss in the second quarter of
1998, which is included in "Net Realized Investment Gains."
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<PAGE>
MASCCO is a Pennsylvania insurance company and a wholly owned subsidiary of
the Company. Prior to December 31, 1996, MASCCO was a party to a pooling
agreement with the Pooled Companies. Effective December 31, 1996, and with the
approval of the Pennsylvania Commissioner, MASCCO withdrew from the pooling
agreement and ceased writing any new business. The Pooled Companies also ceded
to MASCCO the indemnity portion of Pennsylvania workers' compensation claims for
accident years 1991 and prior. At June 30, 1998, MASCCO had $97.0 million in
total assets and $80.1 million in total reserves. Substantially all of MASCCO's
assets are held in trust for the benefit of the Pooled Companies.
PMA Life is a Pennsylvania life insurance company that derives all of its
insurance revenues from intercompany transactions with the Pooled Companies. In
1997, the Property and Casualty Group reinsured substantially all of PMA Life's
insurance liabilities with a third party reinsurer and no longer places
insurance business with PMA Life. At June 30, 1998, PMA Life had assets of
$22.9 million and $17.7 million in total reserves.
The following table reflects the components of the Property and Casualty
Group - Run-off Operations' operating results for the six months ended June 30,
1998 and 1997:
(dollar amounts in thousands)
Six Months Ended
June 30,
--------------------
1998 1997
------- -------
Net investment income $11,303 $14,972
Net premiums earned(1) -- 814
------- -------
Total operating revenues 11,303 15,786
------- -------
Losses and LAE incurred 9,401 15,097
Operating expenses 1,474 1,796
------- -------
Total expenses 10,875 16,893
------- -------
Pre-tax operating income (loss) $ 428 $(1,107)
======= =======
- -----------------------
(1) Amount represents net premiums earned during the first six months of 1997
for PMA Life prior to the reinsurance transaction mentioned above, after
which PMA Life was placed into run-off.
Investment income for the Run-off Operations decreased by $3.6 million in
the six months ended June 30, 1998 compared to the same period in 1997 primarily
due to lower average invested balances as the Run-off Operations paid claims
aggregating $160.7 million in 1997 and $58.4 million in the first six months of
1998. The aforementioned commutation program initiated by the Property and
Casualty Group in late 1996 and completed in July 1997 accelerated payments to
claimants, and a portion of such payments were funded by the Run-off Operations.
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<PAGE>
Losses and LAE of the Run-off Operations are comprised of discount
accretion on established loss reserves of the Run-off Operations. The decrease
in loss reserve discount accretion was primarily due to the payments made for
the underlying claims in 1997.
Caliber One Results of Operations
Summarized financial results of Caliber One for the six months ended June
30, 1998 are as follows:
(dollar amounts in thousands)
Six Months Ended
June 30, 1998
----------------
Net premiums written $ 917
======
Net premiums earned $ 191
Net investment income 714
------
Operating revenues 905
------
Losses and LAE incurred 153
Acquisition and operating expenses 1,822
------
Total losses and expenses 1,975
------
Pre-tax operating loss $(1,070)
========
Due to the start-up nature of the business, the financial ratios for
Caliber One do not provide meaningful representation of its operating results
and, therefore, have been excluded from the table above. Gross premiums written
and net premiums written for Caliber One in the second quarter of 1998 were $1.3
million and $705,000, respectively, representing a 345% increase in gross
premiums written and a 233% increase in net premiums written compared to the
first quarter of 1998. The loss ratio for the first six months of 1998 was
80.1%. As expected, operating expenses, which include start-up costs, in the
first half of 1998 were high relative to the premium volume, which distorts the
expense ratio. Management expects operating expenses to be more commensurate
with premium volume over time as premium volume continues to grow. Net
investment income was $714,000 for the first half of 1998.
Corporate and Other Results of Operations
Corporate and Other is primarily comprised of corporate overhead and the
operations of the Company's properties. For the six months ended June 30, 1998,
Corporate and Other recorded a pre-tax operating loss before interest expense of
$5.5 million compared to $4.5 million for the six months ended June 30, 1997.
The higher operating loss in 1998 compared to the same period in 1997 relates to
increased corporate operating costs, primarily related to compensation as the
Company implemented a new management incentive compensation plan in the second
quarter of 1997 that increased expenses for 1998 relative to the first half of
1997, partially offset by operating costs associated with certain corporate
properties disposed of in the third quarter of 1997.
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<PAGE>
Net Realized Investment Gains
The Company recorded net realized investment gains of $11.3 million for the
six months ended June 30, 1998 compared to net realized investment losses of
$1.9 million for the comparable 1997 period. Gains and losses on the sale of
investments are recognized as a component of net income, but the timing and
recognition of such gains and losses are unpredictable and are not indicative of
future results. In addition, the $2.4 million pre-tax loss related to the
pending sale of PMA Cayman was included in net realized investment gains for
the six months ended June 30, 1998.
Interest Expense and Income Taxes
Interest expense decreased $759,000 for the six months ended June 30, 1998
compared to the similar 1997 period due to the refinancing of the Company's debt
in March 1997. The Company's effective tax rate was 16.0% for the six months
ended June 30, 1998, compared to a benefit of 101.4% for the six months ended
June 30, 1997. The Company recorded a net deferred tax asset of $63.0 million
as of June 30, 1998 compared to $70.4 million as of December 31, 1997.
Liquidity and Capital Resources
Liquidity
Liquidity is a measure of an entity's ability to secure enough cash to meet
its contractual obligations and operating needs. At the holding company level,
the Company requires cash to pay debt obligations and dividends to shareholders,
pay taxes to the federal government and capitalize subsidiaries from time to
time. The Company's primary sources of liquidity are dividends from
subsidiaries, net tax payments received from subsidiaries, and borrowings.
The Company paid interest of $7.5 million for the six months ended June 30,
1998 compared to $12.2 million for the six months ended June 30, 1997. The
decrease in interest paid for the first half of 1998 relates to the fact that
the March 1997 refinancing of PMC's debt obligations accelerated certain
interest payments to the first quarter of 1997. The Company paid $4.1 million
of dividends to shareholders in the six-month period ended June 30, 1998
compared to $4.0 million for the comparable period in 1997.
Dividends received from subsidiaries were $10.0 million for the six months
ended June 30, 1998 compared to $8.0 million for the comparable 1997 period.
Net tax cash flows from subsidiaries were $14.7 million for the six months ended
June 30, 1998 compared to $8.4 million for the comparable 1997 period.
The Company's domestic insurance subsidiaries' ability to pay dividends to
the holding company is limited by the insurance laws and regulations of
Pennsylvania and also by the Credit Facilities. Under such laws and regulations,
dividends may not be paid without prior approval of the Pennsylvania Insurance
Commissioner in excess of the greater of (i) 10% of surplus as regards to
policyholders as of the end of the preceding year or (ii) statutory net income
for the preceding year, but in no event to exceed unassigned
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<PAGE>
funds. Under this standard, the Pooled Companies and PMA Reinsurance Corporation
can pay an aggregate of $48.7 million of dividends, without the prior approval
of the Pennsylvania Insurance Commissioner, during 1998. Caliber One Indemnity
Company is a direct subsidiary of PMA Reinsurance Corporation, and as such, its
dividends may not be paid directly to PMC.
PMC's dividends to shareholders are restricted by its debt agreements.
Based upon the terms of the Company's Credit Facilities, under the most
restrictive debt covenant, PMC would be able to pay dividends to shareholders of
approximately $14.5 million in 1998.
Management believes that the Company's sources of funds will provide
sufficient liquidity to meet its short-term and long-term obligations.
Capital Resources
The Company's total assets increased $18.1 million to $3,075.4 million at
June 30, 1998 compared to $3,057.3 million at December 31, 1997. Total
investments decreased $35.4 million to $2,159.3 million at June 30, 1998. This
decrease was primarily attributable to the Property and Casualty Group's pay-
down of loss reserves from prior accident years. All other assets increased
$53.6 million, primarily due to increases in uncollected premiums of $40.9
million and reinsurance receivables of $15.4 million in comparison to December
31, 1997. The increase in uncollected premiums compared to December 31, 1997
was primarily related to the cyclical nature of the premium volume and
collection patterns throughout the year. The uncollected premiums are more
comparable to the balances at June 30, 1997. The increase in reinsurance
receivables compared to December 31, 1997 primarily relates to the Property and
Casualty Group's new reinsurance treaty for Commercial Lines entered into during
1997. Additional increases in other assets and deferred acquisition costs of
$24.9 million and $8.1 million, respectively, were offset by a decrease in cash
of $24.6 million related to settlement timing of investment transactions at
December 31, 1997. The increase in other assets at June 30, 1998 compared to
December 31, 1997 primarily relates to timing differences in prepaid expenses
and miscellaneous assets at the operating companies. The increase in deferred
acquisition costs at June 30, 1998 compared to December 31, 1997 is primarily
due to the higher acquisition costs at PMA Re (see "PMA Re Results of
Operations") as well as the cyclical nature of the premium writings which
increases acquisition costs in the beginning of the year.
Consolidated shareholders' equity at June 30, 1998 totaled $496.4 million,
or $20.96 per share, compared to $478.3 million, or $19.96 per share, at
December 31, 1997. As a result of changes in market interest rates, the
unrealized appreciation of investments, net of tax, was $26.3 million at June
30, 1998 compared to $18.8 million at December 31, 1997, resulting in an
increase in shareholders' equity of $7.5 million, or $0.32 per share.
At June 30, 1998, the Company had $203.0 million outstanding under its
existing credit facility, with $32.0 million available for additional
borrowings. Management also entered into an interest rate swap agreement which
is intended to manage the impact of the potential volatility of the interest
rate associated with the floating rates on the credit facility. The interest
rate swap covers a notional principal amount of $150.0 million and effectively
converts the floating rate on such portion of the credit facility to a fixed
rate of 7.24%. At June 30, 1998, the Company had $47.0 million of outstanding
letters of credit under the Letter of Credit Facility. See "Liquidity and
Capital Resources December 31, 1997 and 1996."
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<PAGE>
The Company's interest rate swap agreement involves the exchange of
interest payment obligations without the exchange of underlying principal. The
differential to be paid or received is recognized as an adjustment of interest
expense. In the event that a counterparty fails to meet the terms of the
agreement, the Company's exposure is limited to the interest rate differential
on the notional principal amount ($150.0 million). Management believes such
credit risk is minimal and any loss would not be significant.
Year 2000 Issue
With the assistance of outside consulting groups, the Company began
evaluating and reprogramming its own computer systems to address the Year 2000
Issue in late 1995. Management anticipates that by year-end 1998, it will have
substantially completed all necessary programming work. Accordingly, management
believes that Year 2000 Issues related to the Company's hardware and internal
software programs are not likely to result in any material adverse disruptions
in the Company's computer systems or its internal business operations. The cost
of this work through June 30, 1998 has been approximately $5.3 million,
including approximately $1.5 million incurred during the first six months of
1998. The Company estimates that the total remaining cost will be approximately
$175,000, which will be expensed throughout the remainder of 1998.
The Company is currently in the process of evaluating its relationships
with third parties with which the Company has a direct and material relationship
to determine whether they are Year 2000 compliant, such as banks, brokers,
reinsurers, third party service providers, software and other service vendors,
insureds and agents and other intermediaries. The responses by such third
parties to inquiries made by the Company as have been received to date indicate
that these third parties either are or expect to be compliant by the Year 2000.
Even assuming that all material third parties provide a timely
representation affirming such Year 2000 compliance, however, it is not possible
to state with certainty that such representations will turn out to have been
accurate, or that the operations of such third parties will not be materially
impacted in turn by other parties with whom they themselves have a material
relationship, and who fail to timely become Year 2000 compliant. Consequently,
it is not possible to predict whether or to what extent the Year 2000 Issues may
have an adverse material impact on the Company as a result of their impact on
the operations of third parties with whom the Company has a material
relationship. The failure of one or more third parties with whom the Company has
a material relationship to be Year 2000 compliant could cause significant
disruptions in the Company's ability to pay claims, receive and deposit funds
and make investments, which could have a material adverse effect on the
Company's financial condition and results of operations. The Company's
contingency plans in the event of failure of such third parties to be Year 2000
compliant include replacing the third party, performing directly the services
performed by the third party and maintaining liquidity under the Company's
Revolving Credit Facility, which may have a material impact on the Company.
Many experts now believe that Year 2000 Issues may have a material adverse
effect on the national and global economy generally. In addition, it seems
likely that if businesses are materially damaged as a result of Year 2000
Issues, at least some such businesses may attempt to recoup their losses by
claiming coverage under various types of insurance policies. Management of the
Property and Casualty Group and Caliber One believe that under a fair reading of
the various policies issued by them, no coverage for Year 2000 Issues should
exist. Management of PMA Re also believes that the policies of its ceding
company clients which are reinsured by PMA Re do not provide coverage for Year
2000 issues. However, in the event that claims for Year 2000 issues are asserted
against the Property and Casualty Group, Caliber One or PMA Re, it is not
possible to predict whether or to what extent any such coverage could ultimately
be found to exist by courts in various jurisdictions, or, if found, the effect
thereof on any of such companies or the Company. In addition, to the extent that
the Property and Casualty Group, Caliber One or PMA Re contest the assertion of
Year 2000 coverage claims, it is likely that the costs of litigation could be
material, even if they are able to prevail in their coverage positions as to
which no assurance can be given.
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<PAGE>
New Accounting Pronouncements
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Comprehensive Income" ("SFAS No. 130"), which
establishes standards for the reporting and disclosure of comprehensive income
and its components (revenues, expenses, gains and losses). SFAS No. 130
requires that all items required to be recognized under accounting standards as
components of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements. Comprehensive
income includes a reclassification adjustment for net realized investment gains
included in net income of $8.9 million (after income taxes of $4.8 million) for
the six months ended June 30, 1998 and net realized investment losses of
$950,000 (after income taxes of $512,000) for the six months ended June 30,
1997. The new standard requires only additional disclosures in the consolidated
financial statements; it does not affect the Company's financial position or
results of operations.
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and
Related Information" ("SFAS No. 131"), which establishes standards for the way
that public business enterprises report information about operating segments in
annual financial statements and interim financial reports issued to
shareholders. SFAS No. 131 also establishes standards for related disclosures
about products and services, geographic areas and major customers. In
connection with the adoption of SFAS No. 131, the Company has identified four
reportable segments: (i) PMA Re, which provides reinsurance products and
services; (ii) the Property and Casualty Group, which writes workers'
compensation and other standard lines of commercial insurance and includes run-
off operations; (iii) Caliber One, which writes specialty insurance focusing on
excess and surplus lines and (iv) Corporate and Other, which is primarily
comprised of corporate overhead and the operations of the Company's properties.
Pursuant to the adoption of SFAS No. 131, the Company has restated the
information for the six-month period ended June 30, 1997 for comparability,
primarily related to certain corporate expenses that were previously allocated
to the operating segments. SFAS No. 131 requires only additional disclosures in
the consolidated financial statements; it does not affect the Company's
financial position or results of operations.
Supplemental financial information for annual periods prior to the date of
adoption of SFAS No. 131 are as follows:
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<PAGE>
(dollar amounts in thousands)
Year ended December 31,
--------------------------------
1997 1996 1995
---- ---- ----
Pre-tax operating income (loss):
PMA Re $45,957 $ 44,807 $ 39,793
The Property and Casualty Group:
Excluding Run-off Operations (3,607) (215,669) (3,885)
Run-off Operations (73) -- --
------- --------- --------
Total (3,680) (215,669) (3,885)
Corporate (9,954) (6,464) (14,184)
------- --------- --------
Total pre-tax operating income (loss) $32,323 ($177,326) $ 21,724
======= ========= ========
The difference between this supplemental information and the information in
the Company's audited financial statements and year end Management's Discussion
and Analysis of Financial Condition and Results of Operations included elsewhere
in this Prospectus is primarily related to certain corporate expenses that were
previously allocated to the operating segments. The amount of this adjustment
was $6.5 million ($1.2 million allocated to PMA Re and $5.3 million to the
Property and Casualty Group), $6.0 million ($2.0 million allocated to PMA Re and
$4.0 million to the Property and Casualty Group) and $770,000 ($350,000
allocated to PMA Re and $420,000 to the Property and Casualty Group) for the
years ended December 31, 1997, 1996 and 1995, respectively. Amounts for previous
years were not material; accordingly no adjustment has been made.
In January 1998, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of Position
97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related
Assessments" ("SOP 97-3"). SOP 97-3, which is effective for fiscal years
beginning after December 31, 1998, and provides guidance for determining when an
insurance company should recognize a liability for guaranty-fund and other
insurance related assessments and how to measure that liability. While the
Company is presently evaluating the impact of SOP 97-3, the adoption of SOP 97-3
is likely to result in an increase in the Company's liabilities for such
assessments, although such increase is not expected to exceed $5.0 million. The
impact of adopting SOP 97-3 will be reflected as a cumulative effect of an
accounting change in the first quarter of 1999.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS No. 133"), which establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities. SFAS No. 133 requires that entities
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. If certain
conditions are met, a derivative may be specifically designated as (i) a hedge
of the exposure to changes in the fair value of a recognized asset or liability
or an unrecognized firm commitment, (ii) a hedge of the exposure to variable
cash flows of a forecasted transaction or (iii) a hedge of the foreign currency
exposure of a net investment in a foreign operation, an unrecognized firm
commitment, an available-for-sale security or a foreign-currency-denominated
forecasted transaction. The accounting for changes in the fair value of a
derivative (that is, gains and losses) depends on
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<PAGE>
the intended use of the derivative and the resulting designation. SFAS No. 133
is effective for all fiscal quarters of fiscal years beginning after June 15,
1999. While the Company is presently evaluating the impact of SFAS No. 133, the
adoption of SFAS No. 133 is not expected to have a material impact on the
Company's financial condition or results of operations.
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<PAGE>
Results of Operations for the Years Ended December 31, 1997, 1996, and 1995
The table below presents the major components of net income (loss) for the
years ended December 31, 1997, 1996 and 1995:
(dollar amounts in thousands, except per share data)
1997 1996 1995
-------- ---------- -------
Pre-tax operating income (loss) (1)........ $16,555 $(194,378) $ 2,990
Net realized investment gains.............. 8,598 2,984 31,923
------- --------- -------
Income (loss) before income taxes.......... 25,153 (191,394) 34,913
Provision (benefit) for income taxes....... 5,400 (56,060) 10,783
------- --------- -------
Income (loss) before extraordinary loss.... 19,753 (135,334) 24,130
Extraordinary loss, net of related taxes... (4,734) --- ---
------- --------- -------
Net income (loss).......................... $15,019 $(135,334) $24,130
======= ========= =======
Per basic share:
Income (loss) before extraordinary loss.. $ .83 $ (5.68) $ 1.01
Extraordinary loss....................... (.20) -- --
------- --------- -------
Net income (loss)........................ $ .63 $ (5.68) $ 1.01
======= ========= =======
Per diluted share:
Income (loss) before extraordinary loss.. $ .80 $ (5.68) $ .97
Extraordinary loss....................... (.19) -- --
------- --------- -------
Net income (loss)........................ $ .61 $ (5.68) $ .97
======= ========= =======
- --------------
(1) Pre-tax operating income (loss) is defined as income (loss) from continuing
operations before income taxes, but excluding net realized investment
gains.
The following table indicates the Company's pre-tax operating income (loss)
by principal business segment for the years ended December 31, 1997, 1996 and
1995:
(dollar amounts in thousands)
1997 1996 1995
-------- ---------- ---------
PMA Re.................................. $44,802 $ 42,783 $ 39,443
The Property and Casualty Group......... (9,038) (219,619) (4,305)
Corporate and Other..................... (3,441) (490) (13,414)
------- --------- --------
Pre-tax operating income (loss) before
interest expense...................... 32,323 (177,326) 21,724
Interest expense........................ 15,768 17,052 18,734
------- --------- --------
Pre-tax operating income (loss)......... $16,555 $(194,378) $ 2,990
======= ========= ========
In 1997, the Company reported consolidated pre-tax operating income of
$16.6 million, or $0.69 and $0.67 per basic and diluted share, respectively,
compared to a pre-tax operating loss of $194.4 million, or $8.17 per basic and
diluted share, in 1996. After-tax operating income for 1997 was $14.2 million,
or $0.59 and $0.58 per basic and diluted share, respectively, compared to an
after-tax operating loss of $137.3 million, or $5.77 per basic and diluted
share,
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<PAGE>
in 1996. The improvement in the 1997 results was due primarily to special
charges recorded in 1996, increased pre-tax operating income generated by PMA Re
and improved underwriting results by the Property and Casualty Group. The
increase in PMA Re's pre-tax operating income to $44.8 million in 1997 compared
to $42.8 million in 1996, was due to higher premium volume, improved
underwriting results and higher investment income. The pre-tax operating loss of
the Property and Casualty Group decreased in 1997 to $9.0 million compared to
$219.6 million in 1996, due primarily to special charges recorded in 1996, as
well as the impact of cost savings initiatives implemented in late 1996 and in
1997. Corporate and Other operations reported a pre-tax operating loss of $3.4
million in 1997 compared to a pre-tax operating loss of $500,000 in 1996. The
higher operating loss for Corporate and Other operations was due primarily to
increased operating costs related to certain corporate properties disposed of
during the third quarter of 1997. Interest expense decreased in 1997 by $1.3
million due to the refinancing of the Company's debt with the Revolving Credit
Facility. See "Liquidity and Capital Resources" herein for further discussion.
On a consolidated basis, the Company reported pre-tax operating income of
$3.0 million, or $0.13 and $0.12 per basic and diluted share, respectively, in
1995 compared to the $194.4 million pre-tax operating loss discussed above for
1996. After-tax operating income was $3.4 million, or $0.14 per basic and
diluted share, in 1995 compared to the $137.3 million after-tax operating loss
in 1996 mentioned above. The decrease from 1995 to 1996 was due primarily to
special charges recorded in 1996 at the Property and Casualty Group. In 1995,
PMA Re reported pre-tax operating income of $39.4 million, the Property and
Casualty Group had a pre-tax operating loss of $4.3 million and Corporate and
Other operations recorded a pre-tax operating loss of $13.4 million. The
improvement in the operating results of Corporate and Other from 1995 to 1996
was due primarily to an $8.4 million write-down in 1995 of certain real estate
properties owned by the Company as well as higher overhead expenses. Interest
expense decreased in 1996 by approximately $1.7 million as compared to 1995,
primarily reflecting lower average debt balances and the pay-down of higher
coupon debt.
Net income on a consolidated basis, before extraordinary items, was $19.8
million, or $0.83 per basic share and $0.80 per diluted share, respectively, in
1997 compared to a net loss of $135.3 million, or $5.68 per basic and diluted
share, in 1996. On March 14, 1997, the Company refinanced substantially all of
its outstanding credit agreements not already maturing in 1997 with the
Revolving Credit Facility. In connection with this refinancing, the Company
recognized an extraordinary loss from the early extinguishment of debt of $4.7
million, or $0.20 and $0.19 per basic and diluted share, respectively, net of
tax.
Over the past three years, restructuring charges and other special items
have impacted the Company's operating results. During 1997, the Company
recorded $7.0 million of severance and other restructuring charges, primarily
related to the Property and Casualty Group and Corporate and Other operations.
In addition, the Company recorded $2.2 million of operating costs for certain
corporate properties which were disposed of during 1997 (see "Corporate and
Other") and $2.0 million of Year 2000 expenses. See "Liquidity and Capital
Resources" for further discussion. In 1996, the Company's operating results
included a pre-tax charge of $221.3 million ($143.8 million after tax) recorded
by the Property and Casualty Group in order to strengthen its loss and LAE
reserves, to recognize restructuring costs in connection with staff reductions
and to write off certain accounts receivable. In addition, pre-tax Year 2000
costs in 1996 were $1.8 million. In 1995, the Company recorded a charge of $8.4
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<PAGE>
million to write down the Company's former headquarters building and certain
adjacent properties to their fair market values less costs to carry and sell the
properties. The charges over the three-year period consisted of the following:
(dollar amounts in millions)
1997 1996 1995
----- ------ -----
Severance and other restructuring charges.. $ 7.0 $ 7.6 $ --
Year 2000 costs............................ 2.0 1.8 --
Costs related to corporate properties...... 2.2 -- --
Write-down of corporate properties......... -- -- 8.4
Caliber One pre-opening costs.............. 0.9 -- --
Loss reserve strengthening................. -- 191.4 --
Receivables write-down..................... -- 17.5 --
Equipment write-down....................... -- 4.8 --
----- ------ ----
Total pre-tax charge....................... $12.1 $223.1 $8.4
===== ====== ====
PMA Re Results of Operations
Summarized financial results of PMA Re for the years ended December 31,
1997, 1996 and 1995 are as follows:
(dollar amounts in thousands)
1997 1996 1995
-------- -------- --------
Net premiums written................ $177,934 $164,053 $152,760
======== ======== ========
Net premiums earned................. $163,603 $151,974 $139,345
Net investment income............... 52,270 48,676 45,166
-------- -------- --------
Operating revenues.................. 215,873 200,650 184,511
-------- -------- --------
Losses and LAE incurred............. 113,931 111,937 103,947
Acquisition and operating expenses.. 57,140 45,930 41,121
-------- -------- --------
Total losses and expenses........... 171,071 157,867 145,068
-------- -------- --------
Pre-tax operating income............ $ 44,802 $ 42,783 $ 39,443
======== ======== ========
GAAP loss ratio..................... 69.6% 73.7% 74.6%
GAAP combined ratio................. 104.5% 103.9% 104.1%
SAP loss ratio...................... 69.5% 73.7% 74.6%
SAP combined ratio.................. 103.8% 104.4% 105.5%
Premium Revenues
In 1997 and 1996, net premiums written increased 8.5% and 7.4%,
respectively. The increases in 1997 and 1996 were primarily the result of
increased participation in reinsurance treaties and the writing of additional
layers and programs with existing clients. An increased number of programs
added for property lines during the second half of 1996 and during 1997 also
contributed to the aforementioned increases in net premiums written. These
increases were partially offset by the trend toward large ceding companies
increasing their retentions, which decreased PMA Re's subject premium. In
addition, highly competitive pricing
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<PAGE>
conditions in the United States reinsurance market caused PMA Re to non-renew
certain existing business and to decline certain new business opportunities.
The following table indicates PMA Re's gross and net premiums written by
major category of business for the years ended December 31, 1997, 1996 and 1995:
(dollar amounts in thousands)
% Change % Change
1997 1996
to to
1997 1996 1995 1996 1995
-------- -------- --------- -------- --------
Gross premiums written:
Casualty lines.......... $151,901 $143,991 $128,736 5.5 % 11.9 %
Property lines.......... 72,625 63,325 63,693 14.7 % (0.6)%
Other lines............. 795 842 (63) (5.6)% --
-------- -------- -------- ----- -----
Total.................... $225,321 $208,158 $192,366 8.2 % 8.2 %
======== ======== ======== ===== =====
Net premiums written:
Casualty lines.......... $118,889 $122,008 $107,383 (2.6)% 13.6 %
Property lines.......... 58,257 41,240 45,440 41.3 % (9.2)%
Other lines............. 788 805 (63) (2.1)% --
-------- -------- -------- ----- -----
Total.................... $177,934 $164,053 $152,760 8.5 % 7.4 %
======== ======== ======== ===== =====
PMA Re's net casualty premiums written decreased 2.6% in 1997 and increased
13.6% in 1996. The decrease in 1997 was primarily attributable to the purchase
of increased retrocessional protection, which offset increases in gross casualty
premiums relating to new business with existing clients and larger lines taken
on existing programs. The growth in 1996 was attributable to the expansion of
several programs covering specialty business, which included professional
liability, directors' and officers' liability and other coverages written on a
surplus lines basis.
PMA Re's net property business increased 41.3% during 1997 and decreased
9.2% during 1996. The increase in net property premiums written in 1997 was
primarily the result of additional property underwriting expertise that PMA Re
added to its underwriting staff in late 1996 to broaden its product offerings.
Such expertise enabled PMA Re to increase cross-selling opportunities with its
existing treaty reinsurance clients by offering additional and expanded property
coverages. In addition, property premiums ceded decreased primarily related to
changes in PMA Re's property retrocessional coverages in terms of premiums and
ceding commissions. The decrease in net premiums written in 1996 was primarily
attributable to higher ceding company retentions, competitive pricing conditions
and higher ceded property premiums.
The property programs written by PMA Re generally contain per occurrence
limits or are not considered significantly catastrophe exposed, either because
of the locations of the insured values or the nature of the underlying
properties insured. However, as is common in property reinsurance, PMA Re is
exposed to the possibility of loss from catastrophic events due to the
aggregation of per occurrence limits and similar issues. PMA Re actively
manages this exposure through aggregate management, minimizing the writing of
catastrophe business and retrocessional protection. See "Liquidity and Capital
Resources -- Capital Resources."
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<PAGE>
In 1997, PMA Re recorded $2.5 million of net facultative reinsurance
premiums, which represented 1.4% of total net premiums written for the year,
compared to $1.0 million, or 0.6%, in 1996. PMA Re commenced writing
facultative reinsurance in November 1995.
Net premiums earned increased 7.7% and 9.1% in 1997 and 1996, respectively.
These increases both correspond to the increases in net premiums written, as net
premiums earned generally follow growth patterns similar to net premiums written
adjusted for the customary lag related to the timing of premium writings within
the year.
Losses and Expenses
PMA Re's combined ratios have remained relatively stable from 1995 through
1997, ranging from 103.9% to 104.5% during the three-year period. This relative
stability is attributable to (i) consistently favorable development of unpaid
losses and LAE; (ii) prudent management of catastrophe exposures and (iii) lower
loss ratios offsetting generally increased acquisition costs related to writing
more business with ceding commissions.
The following table indicates the components of PMA Re's combined ratios
computed in accordance with GAAP for the years ended December 31, 1997, 1996 and
1995(1):
1997 1996 1995
------ ------ ------
Loss ratio................................... 69.6% 73.7% 74.6%
----- ----- -----
Expense ratio:
Amortization of deferred acquisition costs.. 27.6% 24.7% 24.2%
Operating expenses.......................... 7.3% 5.5% 5.3%
----- ----- -----
Total expense ratio.......................... 34.9% 30.2% 29.5%
----- ----- -----
Combined ratio-GAAP.......................... 104.5% 103.9% 104.1%
===== ===== =====
- ------------
(1) The combined ratio computed in accordance with GAAP is equal to the sum of
losses and LAE, amortization of deferred acquisition costs, operating
expenses and policyholders' dividends (where applicable), all divided by
net premiums earned.
For the three years ended December 31, 1997, PMA Re's loss ratios have
declined primarily as a result of increased ceding commissions and favorable
loss reserve development. PMA Re's loss ratio decreased to 69.6% in 1997 from
73.7% and 74.6% in 1996 and 1995, respectively. For contracts written on a pro
rata basis and other contracts containing ceding commissions, premiums tend to
be higher relative to the losses when compared to contracts that do not contain
ceding commissions. In the three years ended December 31, 1997, PMA Re has
written more contracts containing ceding commissions which has contributed to
the decreases in loss ratios. For such contracts, PMA Re pays the ceding
company a commission, but in return, PMA Re receives a higher proportion of the
subject premium. In addition, net favorable development on prior years' unpaid
losses and LAE was $23.3 million, $28.6 million and $15.0 million in 1997, 1996
and 1995, respectively.
The ratio of amortization of deferred acquisition costs to net premiums
earned ("Acquisition Expense Ratio") increased 2.9 points to 27.6% in 1997
compared to 1996 and 0.5 points in 1996 compared to 1995. These increases
predominantly relate to the fact that PMA
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<PAGE>
Re continues to write more contracts with ceding commissions. In addition, the
ceding commissions that PMA Re received related to its retrocessional
catastrophe cover were higher in 1996 than in 1997, which contributed to the
lower Acquisition Expense Ratio in 1996.
The ratio of operating expenses to net premiums earned (the "Operating
Expense Ratio") increased 1.8 points to 7.3% in 1997 compared to 5.5% in 1996.
This increase was attributable to increases in certain expenses, such as salary
and facility expenses, in connection with the addition of staff and expansion of
office facilities during 1997. During the three-year period ended December 31,
1997, PMA Re has continued to add staff in response to increased premium volume
and to increase the level of specialized services provided to customers.
Accordingly, the Operating Expense Ratio increased from 5.3% in 1995 to 7.3% in
1997.
The Company is presently undertaking a project to upgrade all of its
computer systems to be able to process records with dates beyond December 31,
1999. During 1997, PMA Re incurred costs amounting to approximately $400,000
related to the Year 2000 compliance program. Management expects that PMA Re
will incur approximately $600,000 in 1998 related to the Year 2000 compliance
program. Management expects that such project will be completed in 1998. See
"Liquidity and Capital Resources."
Net Investment Income
Net investment income increased 7.4% to $52.3 million in 1997 from $48.7
million in 1996, which represented a 7.8% increase from $45.2 million in 1995.
Such increases were primarily attributable to the overall increase in PMA Re's
invested assets, as well as changes in portfolio holdings. During 1997, PMA Re
shifted some of its holdings from government securities to high-quality
corporate securities, which generally yield higher levels of investment income.
In addition, the 1996 increase was due to a decrease in holdings of tax-exempt
securities for which pre-tax yields tend to be lower than other investment
vehicles. At amortized cost, PMA Re's cash and invested assets increased $49.0
million, or 5.9%, and $34.9 million, or 4.4%, during 1997 and 1996,
respectively.
Comparison of SAP and GAAP Results
The difference between the combined ratios presented in accordance with
GAAP compared to SAP is primarily attributable to the different accounting
treatment of acquisition costs. As PMA Re's premium volume has grown during
1997 and 1996, PMA Re has incurred additional acquisition costs, which are
deferred for GAAP. For SAP purposes, PMA Re is required to expense such costs
as incurred, resulting in an incremental expense recorded on a SAP basis
compared to GAAP.
The Property and Casualty Group Results of Operations
Summarized financial results of the Property and Casualty Group for the
years ended December 31, 1997, 1996 and 1995 are as follows:
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<PAGE>
(dollar amounts in thousands)
1997 1996 1995
-------- --------- --------
Net premiums written:
Workers' compensation............. $175,301 $ 189,338 $233,145
Commercial Lines.................. 65,047 90,084 103,971
-------- --------- --------
Total............................. $240,348 $ 279,422 $337,116
======== ========= ========
Net premiums earned:
Workers' compensation............. $152,773 $ 176,380 $243,175
Commercial Lines.................. 59,575 92,221 102,432
-------- --------- --------
Total............................. 212,348 268,601 345,607
Net investment income............... 82,098 82,455 92,275
Service revenues.................... 10,311 9,189 5,106
-------- --------- --------
Operating revenues.................. 304,757 360,245 442,988
-------- --------- --------
Losses and LAE incurred............. 193,530 424,900 319,644
Acquisition and operating expenses.. 105,549 138,709 110,906
Policyholder dividends.............. 14,716 16,255 16,743
-------- --------- --------
Total losses and expenses........... 313,795 579,864 447,293
-------- --------- --------
Pre-tax operating loss.............. $ (9,038) $(219,619) $ (4,305)
======== ========= ========
GAAP loss ratio..................... 91.1% 158.2% 92.5%
GAAP combined ratio................. 143.3% 212.9% 127.9%
SAP loss ratio(1)................... 84.0% 125.7% 77.3%
SAP combined ratio(1)............... 119.0% 175.6% 115.1%
- ----------------
(1) The SAP loss and combined ratios above relate to the operations of the
Pooled Companies only and do not include the results of other statutory
entities within the Property and Casualty Group.
Premium Revenues
Premiums for the Property and Casualty Group have decreased in the three-
year period ended December 31, 1997. Between 1997 and 1996, net premiums
written decreased 14.0%, and between 1996 and 1995, net premiums written
decreased 17.1%. Direct premiums written for workers' compensation decreased
$20.6 million and $36.5 million in 1997 and 1996, respectively. Direct premiums
written for Commercial Lines increased $11.7 million in 1997 compared to 1996,
and decreased $11.6 million in 1996 compared to 1995. Reinsurance premiums
assumed decreased $4.4 million between 1997 and 1996 and increased $0.8 million
between 1996 and 1995. Reinsurance premiums ceded increased $25.8 million in
1997 compared to 1996 and $10.4 million in 1996 compared to 1995. Net premiums
earned decreased $56.3 million between 1997 and 1996 and $77.0 million between
1996 and 1995.
The decline in premiums from 1995 to 1997 is due to a number of factors
discussed below, including the Property and Casualty Group's underwriting
decisions, competition and the impact of workers' compensation benefit reform
laws.
During the three years ended December 31, 1997, competition and manual rate
levels affected workers' compensation premium volume. During this period, the
Property and Casualty Group did not renew certain accounts due to inadequate
profit potential. Intense competition caused rates for certain accounts to be
unattractive relative to the risks assumed.
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<PAGE>
Rather than match the price merely to retain the volume, the Property and
Casualty Group declined to write the accounts. Average manual rate levels
declined 25.0%, 7.0% and 3.0% in 1997, 1996, and 1995, respectively. The rate
decreases had a substantially lower proportional impact on premiums written
during 1996 and 1995, because the Property and Casualty Group had reduced its
dependence on rate-sensitive business. The Property and Casualty Group increased
its focus on rate sensitive small account business in 1997 because it believes
that the impact of recently passed legislation in its principal marketing
states, including Act 57 in Pennsylvania, may make loss experience on such
business more predictable than it has been in recent years.
Workers' compensation premiums also declined during the three-year period
ended December 31, 1997 as a result of the enactment of workers' compensation
benefit reform laws. The decline in workers' compensation premiums has been
concentrated primarily in Pennsylvania. Direct workers' compensation premiums
for all other jurisdictions increased in 1997 compared to 1996, including an
increase of $3.8 million from new jurisdictions in 1997. The number of workers'
compensation policies increased to 3,184 in 1997 compared to 2,757 in 1996.
However, the increase in policies was offset by the rate decreases related to
the benefit reform laws. These benefit reform laws also have had a favorable
impact on loss and LAE reserves for business written on policies subject to such
reform laws. See "Losses and Expenses" below. The changes in workers'
compensation benefits that were promulgated under Act 57 in Pennsylvania were
accompanied by a change in the basic premium rate structure for workers'
compensation insurance, which lowered the rates charged to insureds by
approximately 25% effective February 1997. This change in rate structure was
reviewed by an independent actuarial firm on behalf of the Commonwealth of
Pennsylvania in connection with the approval of rates under Act 57. In
addition, the Company's actuaries reviewed the effect that the reforms would
have on workers' compensation benefits paid in relation to the changes in
premiums charged. It was the opinion of both groups of actuaries that the rate
changes mandated by Act 57 were consistent with the changes in benefits allowed
under Act 57, and the effect of the rate changes would be minimal with respect
to the profitability of the business. The premium charged on a fixed-cost
policy is based upon the manual rates filed with and approved by the state
insurance department and does not increase or decrease based upon the losses
incurred during the policy period. Under policies that are subject to dividend
plans, the customer may receive a dividend based upon loss experience during the
policy period. Since the late 1980's, the Property and Casualty Group has
reduced its proportion of rate-sensitive products from over 70% to approximately
62%. As a result of the enactment of regulatory reform in several jurisdictions
in the Property and Casualty Group's marketing territory, the Property and
Casualty Group may write more rate-sensitive accounts in such jurisdictions in
the future.
Direct workers' compensation premiums were also impacted by changes in the
level of premium adjustments, primarily related to audit premiums and
retrospective policies. In 1997, such adjustments decreased premiums written by
$4.4 million ($15.8 million in audit premiums billed and $20.2 million in
retrospective premiums returned), while in 1996, such adjustments reduced
premiums written by $6.1 million ($17.1 million in audit premiums billed and
$23.2 million in retrospective premiums returned) and in 1995, such adjustments
increased premiums written by $13.1 million ($26.9 million in audit premiums
billed and $13.8 million in retrospective premiums returned). The slightly
lower impact of premium adjustments in 1997 compared to 1996 was due primarily
to a decrease in retrospectively rated premiums
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<PAGE>
returned to insureds, resulting from a lower volume of workers' compensation
business written during the three years ended December 31, 1997. The decrease in
1996 compared to 1995 was due primarily to two factors: the lower amount of
billed audit premiums, which is attributable to better estimating of the
ultimate exposure base (generally, payroll) on such risks by the Property and
Casualty Group's underwriters and the increase in retrospectively rated premiums
returned to insureds, resulting from the favorable loss experience in more
recent accident years in workers' compensation. As the Property and Casualty
Group has expanded retrospectively rated business since 1989, proportionately
more policies had mature loss data, resulting in more premium adjustments.
Changes in actuarial estimates of future premium adjustments on retrospective
policies are recorded directly in net premiums earned (see below for further
discussion), and, therefore, such retrospective adjustments returned to insureds
do not impact net premiums earned.
Under retrospectively rated policies, the Property and Casualty Group
receives an up-front provisional premium that is adjusted based upon loss
experience of the insured. If losses are lower than expected, the insured
receives a refund, subject to a minimum premium and, if losses are higher than
expected, the insured owes additional premium, subject to a maximum premium.
Between the minimum and maximum premiums, the net impact on the Company's
operating results is negligible, because changes in loss estimates pertaining to
retrospectively rated contracts are offset by changes in premium estimates, net
of changes in estimates for accrued premium taxes and other loss-based costs.
While the premium is adjusted based upon loss experience, the Company's profit
load (or margin) portion of the premium is fixed at the policy's inception and
is not adjusted based upon loss experience, although the margin would be
impaired in the event losses exceed the maximum premium amount. Approximately
$50.1 million, $59.0 million and $85.0 million of the Property and Casualty
Group's workers' compensation premiums were derived from loss-sensitive products
in 1997, 1996 and 1995, respectively. The audit premiums referred to above were
derived from the Company's workers' compensation insurance policies. An
insured's workers' compensation premiums are determined by two factors:
aggregate payroll and employer business classification. The Company determines
its initial estimate of annual premium based on payroll records and business
classification data submitted to it by the insured. An audit of this data is
performed after the policy year ends, and an adjustment to the premium is then
made and billed to the insured.
Also reducing net premiums written is the fact that, since 1992, the
Property and Casualty Group has been increasing its focus on alternative market
workers' compensation products. These products include large-deductible
policies, offshore rent-a-captive programs and individual self-insurance
programs. Typically, the Property and Casualty Group receives a lower net
premium for these types of plans. However, under this type of business, the
insured retains a greater share of the underwriting risk than under rate-
sensitive or loss-sensitive products, which reduces the potential for
unfavorable claim activity on the accounts and encourages loss control on the
part of the insured. A substantial portion of related revenues are recorded as
service revenues rather than premiums. Such service revenues increased $1.1
million in 1997 compared to 1996 and $4.1 million in 1996 compared to 1995.
Companies writing workers' compensation in certain states generally must
share in the risk of insuring entities that cannot obtain insurance in the
voluntary market. Typically, an insurer's share of this residual market is
dependent upon its market share of direct premiums
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<PAGE>
in the voluntary market, and the assignments are accomplished either by direct
assignment or by assumption from pools. In 1997, the Property and Casualty
Group's direct assignments, which are included in direct written premiums,
decreased $3.1 million compared to 1996 and decreased $15.3 million in 1996
compared to 1995. These decreases reflect generally lower premium volume in
workers' compensation for the Property and Casualty Group, as well as
increasingly competitive conditions in the voluntary workers' compensation
market which has led to lower amounts of residual market business.
During 1997 compared to 1996, direct writings of Commercial Lines increased
$11.7 million assumed Commercial Lines premiums decreased $8.5 million and ceded
Commercial Lines premiums increased $28.2 million. The growth in direct
writings for Commercial Lines in 1997 was due primarily to rate increases on
existing business as well as additional companion commercial business associated
with new workers' compensation customers. The Property and Casualty Group is
continuing to review the profitability of these lines, and the net growth in
such lines has been limited as a result of this review and the new reinsurance
treaty discussed below. Also, market conditions have been extremely competitive
in these lines, and management has refused to compromise underwriting standards
merely to increase volume. During 1996 compared to 1995, direct writings of
Commercial Lines decreased $11.6 million assumed Commercial Lines premiums
increased $0.8 million and ceded Commercial Lines premiums increased $3.1
million.
In 1997, the Property and Casualty Group entered into a new reinsurance
treaty that covers substantially all of the Commercial Lines casualty business
at a $175,000 per risk attachment point, compared to a $500,000 per risk
attachment point in 1996 which accounted for the increase in ceded Commercial
Lines premiums.
Ceded premiums increased $25.8 million in 1997 compared to 1996, and
increased $10.4 million in 1996 compared to 1995. The increase in 1997 compared
to 1996 was due primarily to a reinsurance treaty effected at December 31, 1997,
ceding $15.4 million of annuity reserves held by PMA Life to a third party (the
"PMA Life transaction"). Ceded premiums also increased approximately $6.6
million due to the aforementioned lower attachment point of the Commercial Lines
casualty reinsurance treaty the Property and Casualty Group entered into
effective January 1, 1997. Finally, ceded reinsurance premiums increased an
additional $6.2 million, due to the increased direct writings of Commercial
Lines business in 1997 compared to 1996. In 1996 compared to 1995, ceded
premiums decreased, although the rate of decrease was less than the rate of
decrease in direct premiums due to the increased use of facultative reinsurance
for specific risks in Commercial Lines.
Fluctuations in net premiums earned were primarily attributable to changes
in net premiums written. In addition to the impact of fluctuations in premiums
written, premiums earned were also impacted by the change in accrued
retrospective premiums. Accrued retrospective premiums, which are a component
of uncollected premiums, are based upon actuarial estimates of expected ultimate
losses and resulting estimated premium adjustments relating to retrospectively
rated policies. The estimated ultimate premium adjustments under
retrospectively rated policies are recorded in the initial policy year based
upon estimated loss experience on the underlying policies and adjusted in
subsequent periods in conjunction with revisions of the estimated underlying
losses on such policies. In addition, accrued retrospective premiums are
increased or decreased based upon retrospective policy
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<PAGE>
adjustments paid or billed. Such adjustments actually billed or paid do not
impact premium revenues because the Company records an offsetting amount through
net premiums written. The following table sets forth the components of the
change in accrued retrospective premiums for each of the three years in the
period ended December 31, 1997:
(dollar amounts in thousands)
1997 1996 1995
--------- --------- ---------
Estimated retrospective policy
adjustments related to the current
accident year........................ ($12,460) ($18,767) ($12,941)
Revision of estimate of retrospective
policy adjustments related to
prior accident years................. (44,719) (9,888) (4,845)
Retrospective policy adjustments paid.. 20,179 23,155 13,786
Uncollectible write-off................ --- (5,000) ---
-------- -------- --------
Total.................................. ($37,000) ($10,500) ($4,000)
======== ======== ========
In 1997, 1996 and 1995, the Property and Casualty Group reduced accrued
retrospective premiums by $37.0 million, $10.5 million and $4.0 million,
respectively. The primary reason for the additional reduction in 1997 compared
to 1996 was a $44.7 million revision of estimate of accrued retrospective
premiums, primarily due to the favorable development of claims liabilities for
more recent accident years ($35.7 million) and the commutation of claims for
accident years 1991 and prior in 1997 ($9.0 million). The reduction for policy
years 1991 and prior primarily relates to the commutation program for such years
initiated in late 1996. In July 1997, the Property and Casualty Group completed
a formal program under which it commuted a large number of claims associated
with workers' compensation claims from accident years 1991 and prior, including
loss reserves associated with retrospective policies. The commutation program
resulted in current payments to claimants that were less than the carried
reserves. As a result of the differences between the current commutation
payments to claimants and carried reserves on such claims, management reduced
its estimate of amounts recoverable under retrospectively rated policies and the
Property and Casualty Group also recognized a reduction in losses and LAE
associated with such policies. See "Losses and Expenses." The reduction for
the 1992 through 1996 policy years was related primarily to a corresponding
amount of favorable development on underlying loss reserves for such years. The
effects of the commutations on these prior loss reserves, as well as the intent
of the Property and Casualty Group to continue utilizing early intervention
techniques such as commutations on claims from more recent accident years, have
led to a re-estimation of policy liabilities for these more recent accident
years, and a re-estimation of amounts due under retrospectively rated policies
for these more recent accident years. The reduction in amounts due under
retrospectively rated policies and the corresponding reduction in loss reserves
resulting from commutation of the carried loss reserves and re-estimation of
more recent accident years resulted in a reduction of the GAAP loss ratio for
1997 compared to 1996 and 1995. See "Losses and Expenses." In addition, the
reduction of earned premiums caused both the GAAP expense ratio and the
policyholder dividend ratio to increase for 1997 compared to 1996 and 1995.
However, the impact of the reduction of the accrued
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<PAGE>
retrospective premiums (net of the adjustment to underlying loss reserves) on
the Company's results of operations was negligible.
The increased adjustment to prior accident years recorded in 1996 compared
to 1995 reflects additional favorable loss reserve development in the prior
three accident years.
Management believes that it has made a reasonable estimate of the Company's
accrued retrospective premiums. While the eventual ultimate receivable may
differ from the current estimates, management does not believe that the
difference will have a material effect, either adversely or favorably, on the
Company's financial position or results of operations.
Losses and Expenses
The following table reflects the components of the Property and Casualty
Group's combined ratios, computed in accordance with GAAP for the years ended
December 31, 1997, 1996 and 1995:
1997 1996 1995
------ ------ ------
Loss ratio................................... 91.1% 158.2% 92.5%
----- ----- -----
Expense ratio:
Amortization of deferred acquisition costs.. 22.7% 19.7% 15.5%
Operating expenses(1)....................... 22.6% 28.9% 15.1%
----- ----- -----
Total expense ratio.......................... 45.3% 48.6% 30.6%
----- ----- -----
Policyholders' dividend ratio................ 6.9% 6.1% 4.8%
----- ----- -----
Combined ratio-GAAP.......................... 143.3% 212.9% 127.9%
===== ===== =====
- ----------
(1) The GAAP Operating Expense Ratio excludes $9.3 million, $8.2 million and
$5.3 million in 1997, 1996 and 1995, respectively, of PMA Management Corp.
direct expenses related to service revenues which are not included in
premiums earned.
The components of the loss and LAE ratio for the Property and Casualty
Group for the years ended December 31, 1997, 1996 and 1995 are as follows:
1997 1996 1995
------ ------ ------
Current accident year - undiscounted............ 81.3% 81.4% 83.8%
Accretion of discount for prior accident years
and discounting of current accident year....... 12.0% 5.5% (0.7%)
Adjustments to retrospectively rated business
and net effect of PMA Life transaction......... (1.5%) -- --
Change in discount rate......................... -- -- (9.8%)
Reserve (release) strengthening................. (0.7%) 71.3% 19.2%
---- ----- ----
Loss and LAE ratio.............................. 91.1% 158.2% 92.5%
==== ===== ====
In 1997, the calendar year loss ratio was impacted by a $31.7 million net
charge, which represented the accretion of discount on workers' compensation
loss reserves for prior accident years, partially offset by discounting of
current accident year reserves, while the 1996 calendar year loss ratio was
impacted by a $15.0 million net charge for accretion of discount
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<PAGE>
on prior accident year workers' compensation loss reserves and discounting of
current accident year reserves. The increase in the net charge for discount
accretion is due primarily to higher overall reserve levels in 1997 and lower
levels of current accident year reserves being discounted in 1997 compared to
1996. The Property and Casualty Group expects lower levels of discount
associated with current accident year reserves to continue due to benefit
reforms which have been enacted in many of the states in which it does business
that reduce claims duration. Management also expects that the net charge
associated with accretion of discount of prior years' reserves will decrease in
1998 and forward because the accelerated payment of claims due to commutations
is expected to lower the level of discount in the Property and Casualty Group's
loss reserves. The increase in the loss ratio in 1996 compared to 1995 from the
accretion of discount was due primarily to higher overall reserves in 1996 and
to lower levels of earned premium in 1996 compared to 1995. Discounting of
reserves for workers' compensation claims is established in accordance with
applicable state laws, which permit discounting the estimated claim payments on
certain claims at various rates. The Property and Casualty Group uses a discount
rate of approximately 5% per year, which is within the range of permitted rates
in the states in which it does business. Loss reserves on other lines of
business as well as loss adjustment expense reserves for all lines of business
are not discounted.
In 1997, the Property and Casualty Group recorded a reserve release of
approximately $53.9 million on prior year losses and LAE, excluding the
accretion of discount. The release primarily relates to favorable reserve
development of $9.0 million for retrospectively rated policies for accident
years 1991 and prior and favorable development of $28.0 million related to
retrospectively rated policies pertaining to accident years 1992 through 1996.
The Property and Casualty Group also recorded favorable development on
guaranteed cost workers' compensation reserves for accident years 1991 and prior
of $7.1 million, partially offset by reserve strengthening of $5.0 million in
commercial multi-peril business for accident year 1996. Furthermore, incurred
losses on prior accident years were also affected by the cession of prior year
reserves included in the PMA Life transaction of $14.8 million. In 1996 and
1995, the loss ratio included $191.4 million and $66.5 million, respectively, of
strengthening of unpaid losses and LAE of prior accident years. The loss reserve
(release) strengthening, net of retrospectively rated policies and the PMA Life
Insurance Company transaction, was associated with the following lines of
business:
(dollar amounts in millions)
1997 1996 1995
------ ------ -------
Pre-1992 workers' compensation......... $(7.1) $110.0 $ 54.7
Asbestos and environmental............. -- 60.4 23.4
Other lines of business................ 5.0 21.0 (11.6)
----- ------ ------
Total reserve (release) strengthening.. $(2.1) $191.4 $ 66.5
===== ====== ======
The 1996 aggregate workers' compensation adverse development was allocated
$102.0 million to Pennsylvania and $8.0 million to all other states in which the
Property and Casualty Group does business. Of the $102.0 million, the
allocation by year is as follows: prior to 1987: $16.0 million; 1987 to 1991:
$101.0 million and 1992 and subsequent years: ($15.0 million). In 1995,
substantially all of the workers compensation adverse development related to
accident years 1987 to 1991 in Pennsylvania. For accident years prior to 1992,
the traditional paid loss development schedules for workers' compensation had
begun to exhibit an increasing trend
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<PAGE>
in loss development factors by 1993. This trend was initially attributed to an
increase in commutation activity. In 1995, management began to question whether
loss data was developing in a manner that was consistent with the conclusion
that the loss development trends were impacted solely by commutation activity.
As a result, management began to accumulate additional data in order to
determine whether there were additional causes for the increase in the paid loss
development data and management obtained claim count data that was far more
detailed than had been historically utilized in the reserve setting process.
This data indicated that the paid loss development factors were not only
impacted by commutation activity, but also by a decline in the claims closure
rate in Pennsylvania. Management believes that the decline in the closure rates
was due to several interrelated factors. One factor related to the fact that
efforts to rehabilitate claimants and return them to work were not as successful
as anticipated. For accident years 1987 to 1991, in particular, extensive
efforts were made by the Company to rehabilitate claimants and return them to
work at either full or modified duty. By late 1995 and into 1996, it was
recognized, by a review of a slow down in the claims closure pattern, that these
rehabilitation efforts were not impacting the closure rates as expected. Another
factor negatively impacting claims closure rates related to the economic
conditions in Pennsylvania in the early 1990's. During the period from 1990 to
1994, economic conditions in Pennsylvania were considered to be depressed in the
Company's major industry niches for workers' compensation insurance
(construction and heavy manufacturing). Payrolls in these industries were
stagnant, and in many cases, employment was flat or declining. The Company
believes that in periods of declining employment opportunities, there is a
tendency for indemnity periods to increase, which occurred for workers who
suffered injuries in these industries.
The above factors, when considered with the fact that the benefits period
in Pennsylvania was unlimited, caused the Company to believe that a substantial
portion of claimants from the pre-1992 period, who had already been out of work
five to nine years, would not return to work in any capacity. In late 1995 and
during 1996, management undertook an effort to quantify the impact of the
declining closure rates compared to the increase in commutation activity.
During the fourth quarter of 1995, the Property and Casualty Group strengthened
its workers' compensation reserves by $54.7 million; however, the quantification
of the effect of the claims closure rate was an extremely complex process, and
as such, the data was not fully understood at that time. As the data under
analysis was more mature and refined in 1996, management determined that the
workers' compensation loss reserves for Pennsylvania for pre-1992 accident years
needed to be increased substantially; therefore, the Property and Casualty Group
increased its workers' compensation reserves by $110.0 million.
Benefit reforms enacted by states in which the Property and Casualty Group
transacts business, most significantly Pennsylvania, have had a beneficial
impact on more recent accident year loss ratios. Prior to 1996, the principal
revisions to the Pennsylvania system included medical cost containment measures
and an expansion of the period of time during which the insurer may require an
employee to accept medical treatment from the employer's list of designated
healthcare providers. In July 1996, Pennsylvania enacted Act 57, a workers'
compensation reform bill that is expected to reduce substantially indemnity
benefit periods in Pennsylvania. In addition to regulatory reforms, the loss
ratios have been favorably impacted by the conversion to loss sensitive and
alternative market products. Such a trend is evidenced by the fact that
accident year loss ratios (losses recorded for the year in which
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the event occurred expressed as a percentage of the earned premiums for that
year) for workers' compensation have been generally lower in more recent
accident years, as the following chart indicates:
Property and Casualty Group Workers' Compensation Undiscounted
--------------------------------------------------------------
Accident Year Pure Loss Ratios at December 31, 1997
---------------------------------------------------
Accident Year Loss Ratio
------------- ----------
1990 100%
1991 86%
1992 80%
1993 64%
1994 64%
1995 63%
1996 63%
1997 66%
In addition, management took several steps to reduce the outstanding claims
associated with the Pennsylvania workers' compensation business written through
1991. A formal commutation program was initiated in the fourth quarter 1996 and
continued into late 1997. Commutations are agreements with claimants whereby the
claimants, in exchange for a lump sum payment, will forego their rights to
future indemnity payments from the Property and Casualty Group. Under
Pennsylvania workers' compensation laws, the claimant and the Pennsylvania
Workers' Compensation Board must approve all such commutation arrangements. The
Property and Casualty Group paid $101.1 million and $17.8 million in 1997 and
the fourth quarter of 1996, respectively, to commute workers' compensation
indemnity claims. Savings associated with these claims were consistent with
management's expectations. The number of open claims for accident years 1991
and prior was substantially reduced as a result of the commutation program.
This reduction in open claims is expected to reduce the possibility of further
adverse development on such reserves, although there can be no assurance that
the level of commutations will have a significant impact on the future
development of such reserves.
Estimating reserves for workers' compensation claims can be more difficult
than for many other lines of property and casualty insurance for several
reasons, including (i) the long payment "tail" associated with the business;
(ii) the impact of social, political and regulatory trends on benefit levels for
both medical and indemnity payments; (iii) the impact of economic trends and
(iv) the impact of changes in the mix of business. At various times, one or a
combination of such factors can make the interpretation of actuarial data
associated with workers' compensation loss development more difficult, and it
can take additional time to recognize changes in loss development patterns.
Under such circumstances, adjustments will be made to such reserves as loss
patterns develop and new information becomes available and such adjustments may
be material.
The adverse development in reserves associated with asbestos and
environmental claims is the result of a detailed analysis completed in 1996 of
loss and LAE reserves associated with asbestos and environmental liability
claims. The reserving for asbestos and environmental claims has undergone
change at both the Company and in the insurance
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industry in general. For environmental and asbestos liability claims, reserving
methodology has been evolving in the recent past into accepted industry
practice. The Company has applied these methods to its asbestos and
environmental loss reserves in 1997 and 1996. To reserve for environmental
claims, the Company currently utilizes a calendar year development technique
known as aggregate loss development. This technique focuses on the aggregate
losses paid as of a particular date and aggregate payment patterns associated
with such claims. Several elements including remediation studies, remediation,
defense, declaratory judgment and third party bodily injury claims were
considered in estimating the costs and payment patterns of the environmental and
toxic tort losses. Prior to the development of these techniques, there was a
substantial range in estimating reserves for environmental and toxic tort
liabilities. The methods employed by the Company prior to the review completed
in 1996 included a review of aggregate loss and LAE paid and case incurred data
along with resulting "survival ratios" to establish IBNR for environmental and
toxic tort claims. For asbestos claims, the Company had previously reserved
costs to defend, and any indemnification payments anticipated on, claims for
which it had received notice that it was a responsible party, plus a bulk factor
applied to the estimated case reserves to provide for potential development of
indemnification and defense cost related to such claims. In 1996, the Company
performed a ground up analysis of asbestos loss reserves using an actuarially
accepted modeling technique. Using historical information as a base and
information obtained from a review of open claims files, assumptions were made
about future claims activity in order to estimate ultimate losses. For each
individual major account, projections were made regarding new plaintiffs per
year, the number of years new claims will be reported, the average loss severity
per plaintiff and the ratio of LAE to loss. In many cases involving larger
asbestos claims, the Company reserved up to the policy limits for the applicable
loss coverage parts for the affected accounts. Policy terms and reinsurance
treaties were applied in the modeling of future losses. Estimation of
obligations for asbestos and environmental exposures continues to be more
difficult than for other loss reserves because of several factors, including:
(i) evolving methodologies for the estimation of the liabilities; (ii) lack of
reliable historical claim data; (iii) uncertainties with respect to insurance
and reinsurance coverage related to these obligations; (iv) changing judicial
interpretations and (v) changing government standards.
The Company's asbestos-related loss reserves as of December 31, 1997, 1996
and 1995 which include reserves for PMA Re of $0.3 million, $0.3 million and
$0.6 million, gross and net, at December 31, 1997, 1996 and 1995, respectively:
(dollar amounts in thousands)
1997 1996 1995
-------- --------- --------
Gross of reinsurance:
Beginning reserves......................... $80,055 $ 27,611 $13,969
Incurred losses and LAE.................... 2,435 62,854 22,482
Calendar year payments for losses and LAE.. (5,764) (10,410) (8,840)
------- -------- -------
Ending reserves............................ $76,726 $ 80,055 $27,611
======= ======== =======
Net of reinsurance:
Beginning reserves......................... $53,300 $ 23,443 $ 8,168
Incurred losses and LAE.................... (36) 39,427 21,826
Calendar year payments for losses
and LAE.................................. (4,686) (9,570) (6,551)
------- -------- -------
Ending reserves............................ $48,578 $ 53,300 $23,443
======= ======== =======
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The Company's environmental-related loss reserves as of December 31, 1997,
1996 and 1995, which include reserves for PMA Re of $3.8 million, $2.9 million
and $2.6 million, gross and net, at December 31, 1997, 1996 and 1995,
respectively, and $13.1 million gross and zero net for Caliber One Indemnity
Company at December 31, 1997 were as follows:
(dollar amounts in thousands)
1997 1996 1995
-------- -------- --------
Gross of reinsurance:
Beginning reserves..................... $35,626 $20,134 $20,952
Incurred losses and LAE................ 1,130 22,143 3,516
Reserves acquired through purchase of
Caliber One Indemnity Company(1)..... 13,060 --- ---
Calendar year payments for losses
and LAE.............................. (4,708) (6,651) (4,334)
------- ------- -------
Ending reserves........................ $45,108 $35,626 $20,134
======= ======= =======
Net of reinsurance:
Beginning reserves..................... $34,592 $20,134 $20,952
Incurred losses and LAE................ 1,068 21,109 3,516
Calendar year payments for losses
and LAE.............................. (3,965) (6,651) (4,334)
------- ------- -------
Ending reserves........................ $31,695 $34,592 $20,134
======= ======= =======
- ---------------
(1) Such acquired reserves have been reinsured by an affiliate of the former
parent. See "Liquidity and Capital Resources."
Of the total net asbestos reserves, $6.7 million, $6.8 million and $6.7
million related to established claims reserves at December 31, 1997, 1996 and
1995, respectively, and $41.9 million, $46.5 million and $16.7 million related
to IBNR at December 31, 1997, 1996 and 1995, respectively. Of the total net
environmental reserves, $11.2 million, $12.5 million and $10.3 million related
to established claims reserves at December 31, 1997, 1996 and 1995,
respectively, and $20.5 million, $22.1 million and $9.8 million related to
incurred but not reported losses at December 31, 1997, 1996 and 1995,
respectively. All incurred asbestos and environmental losses were for accident
years 1986 and prior.
Management believes that the Property and Casualty Group's reserves for
asbestos and environmental claims are appropriately established based upon known
facts, existing case law and generally accepted actuarial methodologies.
However, due to changing interpretations by courts involving coverage issues,
the potential for changes in federal and state standards for clean-up and
liability and other factors, the ultimate exposure to the Property and Casualty
Group for these claims may vary significantly from the amounts currently
recorded, resulting in a potential future adjustment in the claims reserves
recorded. In addition, issues involving policy provisions, allocation of
liability among participating insurers, proof of coverage and other factors make
quantification of liabilities exceptionally difficult and subject to adjustment
based upon newly available data.
In 1996, Commercial Lines experienced reserve strengthening of $21.0
million compared to a reserve release of $11.6 million in 1995. The reserve
strengthening in 1996 was principally
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due to a re-estimation of loss adjustment costs associated with general
liability claims. Through 1991, the Property and Casualty Group's mix of general
liability insurance policies was weighted towards the manufacturing classes of
business. Subsequent to 1991, the Property and Casualty Group's mix of business
became more heavily weighted towards the construction and contracting classes of
business. These particular classes of business have experienced losses due to
alleged construction defects and similar matters that have taken longer to
emerge than the classes of business previously written by the Property and
Casualty Group. Defense costs associated with these claims have also exceeded
the original estimate of the Property and Casualty Group's management, which was
based on the patterns of indemnification payments associated with the earlier
classes of business written. When this issue was discovered, the Property and
Casualty Group factored the increased defense costs and the emergence pattern in
determining a more appropriate reserve amount for loss handling costs. The
release of reserves in 1995 was due primarily to favorable loss experience in
commercial automobile business.
The 1997 expense ratio declined by 3.3 points compared to the 1996 expense
ratio. The 1997 Acquisition Expense Ratio increased by 3.0 points compared to
1996, primarily due to a 4.2 point increase related to the aforementioned
adjustment to accrued retrospective premiums in 1997 ($37.0 million) and by the
1997 cession of premiums associated with the PMA Life transaction ($15.4
million), offset by the write-off in 1996 of $5.0 million in retrospectively
rated premiums. These actions reduced earned premiums without a commensurate
decrease in acquisition expenses. Such increase was partially offset by ceding
commissions received by the Property and Casualty Group on its reinsurance
arrangement for Commercial Lines casualty losses. Such commissions are recorded
as a reduction of acquisition expenses. In 1996, the Acquisition Expense Ratio
increased 4.2 points compared to 1995 primarily due to a change in the mix of
business to a greater proportion of alternative market products and self-insured
services, which have much lower, if any, net premium which caused acquisition
expenses to represent a larger proportion of net premiums earned.
The 1997 Operating Expense Ratio was 22.6%, a decrease of 6.3 points as
compared to 28.9% in 1996. After adjusting for the reduction in accrued
retrospective premiums and the PMA Life transaction, the adjusted Operating
Expense Ratio would have been 18.1% in 1997. The lower adjusted Operating
Expense Ratio is primarily attributable to expense containment programs begun at
the Property and Casualty Group, and the higher levels of restructuring charges
and valuation adjustments in 1996. Operating expenses in 1997 decreased by
$31.0 million compared to 1996, despite an increase of $1.1 million in expenses
associated with the Property and Casualty Group's service revenues. The 1996
Operating Expense Ratio was adversely impacted by several factors, including an
accrual of $7.6 million for a voluntary early retirement program ("VERIP"), a
$4.8 million charge associated with a change in depreciable lives of computer
equipment and a $10.1 million increase in premium balances written off. In
1997, the Property and Casualty Group recorded $5.2 million for severance and
related costs associated with the continued restructuring and cost reduction
initiatives. These initiatives lowered payroll and related expenses in 1997 by
$4.9 million. The 1996 Operating Expense Ratio increased 13.8 points in
comparison to 1995 primarily related to the aforementioned factors that
adversely impacted the 1996 ratio.
In 1997 and 1996, respectively, the Property and Casualty Group incurred
approximately $1.6 million and $1.8 million associated with the Year 2000 Issue.
Management
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anticipates that the Property and Casualty Group will incur approximately
$700,000 in 1998 as a result of this conversion; it is expected that this
conversion will be completed by the end of 1998. See "Liquidity and Capital
Resources."
The policyholders' dividend ratios were 6.9%, 6.1% and 4.8% for the years
ended December 31, 1997, 1996 and 1995, respectively. The policyholders'
dividend ratio increased by 1.3 points in 1997 as a result of the adjustment to
retrospectively rated premiums and the PMA Life transaction. The ratios have
generally increased over the three-year period ended December 31, 1997 primarily
because of sliding-scale dividend plans. Under such plans, the insured receives
a dividend based upon the collective loss experience of the plan. As the loss
experience for the three underwriting years ended December 31, 1997 has improved
relative to the years prior to this period, the Property and Casualty Group has
incurred higher policyholders' dividends.
Net Investment Income
Net investment income was relatively flat in 1997 compared to 1996, as
lower average investment balances resulting from the pay-down of loss reserves
from prior accident years primarily related to the commutation program and
decreasing premium volume were offset by higher yields associated with the
purchase of high grade corporate bonds and asset-backed securities. Net
investment income decreased 10.6% in 1996 compared to 1995, primarily due to
lower average investment balances.
Comparison of SAP and GAAP Results
The results presented under SAP are those of the Pooled Companies. Prior
to December 31, 1996, the Pooled Companies were comprised of four domestic
insurance companies: PMAIC, Manufacturers Alliance Insurance Company,
Pennsylvania Manufacturers Indemnity Company and MASCCO. As part of a plan to
reduce the amount of indemnity reserves from accident years 1991 and prior in
the Pooled Companies, MASCCO was removed from the pooling arrangement effective
December 31, 1996, and indemnity reserves from accident years 1991 and prior
were transferred to MASCCO. The other significant difference relates to various
reinsurance agreements between the Pooled Companies and certain foreign
insurance subsidiaries. Prior to December 31, 1996, Chestnut Insurance Company,
Ltd. was the reinsurer under these agreements. At December 31, 1996, these
reinsurance arrangements were novated, and the assets and liabilities associated
with such contracts were sold to PMA Cayman, a foreign affiliate. At December
31, 1997, the Pooled Companies had reinsurance recoverables from MASCCO and PMA
Cayman of $96.2 million and $284.9 million, respectively.
In addition to the above and the different accounting treatment of
acquisition costs (see "PMA Re Results of Operations" for further discussion of
SAP to GAAP differences related to acquisition costs), the GAAP results for the
Property and Casualty Group include the results of other entities within the
Property and Casualty Group, but excluded from the aforementioned pooling
agreement, including PMA Life and other affiliated reinsurers and non-insurance
companies utilized in providing certain products and services to the Property
and Casualty Group's clients. The exclusion of such entities tends to decrease
the SAP combined ratio relative to the GAAP combined ratio.
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Corporate and Other
The Corporate and Other segment is primarily comprised of corporate
overhead and the operations of the Company's properties. Corporate and Other
operations reported a pre-tax operating loss of $3.4 million in 1997 compared to
a pre-tax operating loss of $500,000 in 1996. The decline in the operating
results of Corporate and Other was due primarily to a $2.2 million increase in
operating costs related to certain corporate properties disposed of during the
third quarter of 1997. No material gain or loss was recorded in connection with
the disposal of such properties.
In 1995, management determined that the fair market values of the Company's
former headquarters building, which was disposed of in 1997, and certain
adjacent properties were less than the carrying values plus the costs to carry
and sell the properties. The Company recorded a charge of $8.4 million in 1995
to write down these properties to their fair market values less costs to carry
and sell the properties. No such charge was recorded during 1996.
During 1997, the Company incurred pre-operating charges of approximately
$900,000 in establishing Caliber One. The Corporate and Other segment also
incurred $1.8 million of severance and related restructuring costs in 1997.
Net Realized Investment Gains
Net realized investment gains amounted to $8.6 million, $3.0 million and
$31.9 million in 1997, 1996 and 1995, respectively. During the three-year
period ended December 31, 1997, the Company realized gains from investment sales
related to the following: (i) transactions to move holdings between taxable and
tax-exempt fixed-maturity investments in order to maximize after-tax yields;
(ii) transactions to expand the asset classes in which the Company invests to
capitalize on favorable yield spreads between such instruments and U.S. Treasury
securities; (iii) transactions based upon an assessment of the interest rate
environment and the shape of the yield curve and (iv) sales of equity
securities, as the Company has substantially reduced its holdings of this asset
class over the last three years. Gains and losses on the sale of investments
are recognized as a component of net income, but the timing and recognition of
such gains and losses are unpredictable and are not indicative of future
results.
In 1997, the Company repositioned its investment portfolio to improve its
pre-tax investment yield, while maintaining the maturity matching structure
between investments and liability cash flow projections. As interest rates
declined in the latter part of the year, these transactions resulted in a net
$8.6 million gain for 1997.
During 1996 and 1995, most of the investment sales activity resulted from
reducing the Company's holdings of tax-advantaged securities. Based upon an
assessment of the Company's position with respect to the alternative minimum tax
("AMT"), the Company reduced its tax-advantaged securities positions beginning
in late 1995 and throughout 1996. In 1996, these sales resulted in a net loss of
$900,000, compared to 1995 when such transactions resulted in a net gain of
$12.1 million. In addition to gains and losses arising from the sales of fixed
maturity investments, sales of equity securities generated net realized gains of
$3.9 million and $900,000 in 1996 and 1995, respectively.
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Interest Expense and Income Taxes
Interest expense decreased $1.3 million in 1997 to $15.8 million from $17.1
million in 1996 due to the refinancing of the Company's debt with the Revolving
Credit Facility. See "Liquidity and Capital Resources" below. In 1996, interest
expense decreased to $17.1 million from $18.7 million in 1995. Such reduction
related to slightly lower average debt balances in 1996. In addition, principal
payments on the Company's higher coupon senior notes for which average coupon
rate of amounts paid was 9.49% were funded with drawdowns on the Company's
Revolving Credit Facility which had an average interest rate of 6.08% in 1996.
The Company's effective tax rates were 21.5%, (29.3)% and 30.9% in 1997,
1996 and 1995, respectively. The Company recorded a net deferred tax asset of
$70.4 million and $101.6 million in 1997 and 1996, respectively. See "Liquidity
and Capital Resources -- Capital Resources." In the normal course of business
the Company is examined by various taxing authorities, including the Internal
Revenue Service. Federal tax return examinations have been completed for the
years 1992 and 1993. The examinations for years 1994 and 1995 are currently in
progress. In management's opinion, the ultimate resolution of these matters will
not have an adverse impact on the Company's financial position or results of
operations .
Liquidity and Capital Resources
Liquidity
Liquidity is a measure of an entity's ability to secure enough cash to meet
its contractual obligations and operating needs. At the holding company level,
the Company requires cash to pay debt obligations, dividends to shareholders and
taxes to the federal government, as well as to capitalize subsidiaries from time
to time. PMC's primary sources of liquidity are dividends from subsidiaries, net
tax payments received from subsidiaries and borrowings.
The Company paid interest of $19.8 million, $16.6 million and $15.1 million
in 1997, 1996 and 1995, respectively. The Company made scheduled debt
repayments in 1997, 1996 and 1995 of $7.3 million, $25.1 million and $125.1
million, respectively, and paid dividends to shareholders of $8.0 million in
1997 and $7.9 million in 1996 and 1995. PMC also made cash capital
contributions to its subsidiaries totaling $11.0 million, $50.0 million and
$61.0 million in 1997, 1996 and 1995, respectively. In 1995, PMC also utilized
cash to settle intercompany balances with its domestic insurance subsidiaries.
Dividends from subsidiaries were $22.5 million, $53.6 million and $103.2
million in 1997, 1996 and 1995, respectively. Net tax cash flows were $20.0
million, $12.0 million and $11.4 million in 1997, 1996 and 1995, respectively.
In addition to dividends and tax payments from subsidiaries, the Company
utilized the following sources to generate liquidity for the above needs. During
the first quarter of 1997, the Company made debt repayments of $8.0 million on
the revolving credit agreement before refinancing all of its credit agreements
not already maturing in 1997 with the Revolving Credit Facility. See "Capital
Resources." During 1996, the Company financed scheduled repayments on its senior
note facilities of $25.0 million through drawdowns on its revolving credit
agreement.
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In 1995, the Company repaid its expiring revolving credit agreement by issuing
$107.0 million of 7.62% privately placed senior notes. In addition, in 1995, the
Company funded the scheduled debt repayments on its existing senior notes by
drawing down $18.0 million on a new $50.0 million revolving credit agreement
with a banking syndicate. At December 31, 1997, the Company had $32.0 million
available on the Revolving Credit Facility. In addition to the Revolving Credit
Facility, the Company maintains a committed facility of $50 million for letters
of credit. The Letter of Credit Facility is utilized primarily for securing
reinsurance obligations of the Company's insurance subsidiaries. As of December
31, 1997, the Company had $46.9 million outstanding in letters of credit under
the Letter of Credit Facility.
The Company's domestic insurance subsidiaries' ability to pay dividends to
the Company is limited by the insurance laws and regulations of Pennsylvania.
Under such laws and regulations, dividends may not be paid without prior
approval of the Pennsylvania Insurance Commissioner in excess of the greater of
(i) 10% of surplus as regards policyholders as of the end of the preceding year
or (ii) SAP net income for the preceding year, but in no event to exceed
unassigned funds.
Under this standard, the Pooled Companies and PMA Reinsurance Corporation
can pay an aggregate of $48.7 million of dividends during 1998 without the prior
approval of the Pennsylvania Insurance Commissioner. Caliber One Indemnity
Company had an unassigned deficit of $6.4 million as of December 31, 1997, and,
therefore, cannot pay non-extraordinary dividends; also, PMA Reinsurance
Corportion owns Caliber One Indemnity Company, and, as such, its dividends may
not be paid directly to PMC. Under its plan of operation filed with the
Pennsylvania Insurance Department, MASCCO must maintain a ratio of unpaid losses
and LAE to surplus of no more than eight to one; as of December 31, 1997, MASCCO
was in compliance with such requirement. The Credit Facilities also contain
limitations on the ability of the Company's insurance subsidiaries to pay
dividends. The Credit Facilities require the Company's insurance subsidiaries to
maintain combined statutory capital and surplus of $450.0 million. At December
31, 1997, the Company's insurance subsidiaries had combined statutory capital
and surplus of $552.2 million. In addition, the Credit Facilities require that
the Pooled Companies maintain an adjusted surplus to authorized control level
ratio, as calculated under risk-based capital rules, of not less than 220% as of
December 31, 1997, 230% as of December 31, 1998 and 240% as of December 31, 1999
and thereafter, and requires that PMA Reinsurance Corportion maintain such ratio
at 300%. At December 31, 1997, the ratios of the Pooled Companies ranged from
293% to 324%, PMA Reinsurance Corportion's ratio was 355% and Caliber One
Indemnity Company's ratio was 1,922%.
In December 1997, PMA Reinsurance Corportion acquired 100% of the
outstanding common stock of Caliber One Indemnity Company (formerly known as
Lincoln Insurance Company) for approximately $16.0 million and made a capital
contribution of $11.3 million to Caliber One Indemnity Company. In conjunction
with this purchase, all of Caliber One Indemnity Company's acquired loss
reserves were reinsured by an affiliate of Caliber One Indemnity Company's
former parent for adverse development and uncollectible reinsurance in the
amount of the stated reserves plus $68.5 million. See Note 1 to the consolidated
financial statements. Management believes that the reinsurance obtained as part
of the purchase will be adequate to cover any future adverse reserve development
or uncollectible reinsurance on the acquired
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reserves. PMA Re intends to maintain Caliber One Indemnity Company's surplus at
not less than $25.0 million, the minimum capital and surplus required by many
states in order to be an eligible surplus lines carrier.
PMC's dividends to shareholders are restricted by its debt agreements.
Based upon the terms of the Revolving Credit Facility, on a pro forma basis,
under the most restrictive debt covenant, PMC would be able to pay dividends of
approximately $14.5 million in 1998. See "Liquidity and Capital Resources --
Capital Resources."
Management believes that the Company's sources of funds will provide
sufficient liquidity to meet short-term and long-term obligations.
Capital Resources
The Company's total assets decreased to $3,057.3 million at December 31,
1997 from $3,117.5 million at December 31, 1996. Total investments decreased
$66.6 million to $2,194.7 million at December 31, 1997. The decrease in
investments is primarily attributable to the Property and Casualty Group's pay-
down of loss reserves from prior accident years as part of the formal
commutation program that was initiated in the fourth quarter of 1996 and
continued into late 1997. All other assets increased $6.4 million in 1997,
mainly due to increases in reinsurance recoverables of $74.4 million and cash of
$25.0 million. The reinsurance recoverables increase primarily relates to the
purchase of Caliber One Indemnity Company during 1997 and the PMA Life
transaction, which included approximately $32.7 million and $15.4 million,
respectively, of ceded loss reserves. The increase in cash relates to
investment security purchases that did not settle until January 1, 1998, causing
a large cash balance at year-end. The above asset increases were partially
offset by a $33.6 million decrease in uncollected premiums primarily related to
the reduction in accrued retrospective premiums by the Property and Casualty
Group, a $31.2 million decrease in deferred income taxes and a $12.2 million
decrease in fixed assets primarily related to the disposal of certain corporate
properties during the third quarter of 1997. No material gain or loss was
recorded in connection with the disposal of such properties.
The Company's deferred income tax asset decreased to $70.4 million at
December 31, 1997 from $101.6 million at December 31, 1996. The $31.2 million
decrease from 1996 to 1997 resulted primarily from the $23.5 million charge
related to the fair value of Company's investments that is recorded as a
component of the deferred tax asset. The net deferred tax asset of $70.4
million reflects management's estimate of the amounts that the Company expects
to recover in future years primarily through the utilization of net operating
losses and AMT credit carryforwards. Under SFAS No. 109, a valuation allowance
should be provided to offset the effects of a deferred tax asset if management
believes that it is more likely than not that the benefit of a deferred tax item
will not be realized. Management believes that the benefit of its deferred tax
asset will be fully realized, and therefore has not provided for a valuation
allowance. At December 31, 1997, the Company had approximately $109.6 million of
net operating carryforwards (expiring in 2011), approximately $7.5 million of
AMT credit carryforwards (which do not expire) and approximately $188,000 of
general business credit carryforwards (expiring in 2010 and 2011).
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Unpaid losses and LAE decreased $87.9 million to $2,003.2 million at
December 31, 1997. This decrease reflects the Property and Casualty Group's
pay-down of loss reserves from prior accident years as part of the formal
commutation program which was initiated in the fourth quarter of 1996 and
continued into late 1997, partially offset by loss reserves acquired in
connection with the purchase of Caliber One Indemnity Company.
Estimating future claims costs is necessarily a complex and judgmental
process inasmuch as reserve amounts are based on management's informed estimates
and judgments using data currently available. As such, management reviews a
variety of information, and uses a number of actuarial methods applied to
historical claims data, which often produces a range of possible results. As
additional experience and other data are reviewed, these estimates and judgments
are revised, at which point reserves may be increased or decreased accordingly.
Such increases or decreases are reflected in operating results for the time
period in which the adjustments are made. While the estimate for unpaid losses
and LAE is subject to many uncertainties, management believes that it has made
adequate provision for the Company's claims liabilities. However, if actual
losses exceed the amounts recorded in the Company's financial statements, the
Company's financial condition and results of operations could be adversely
affected.
At December 31, 1997, the Company's loss reserves were stated net of $59.9
million of salvage and subrogation. $50.8 million of salvage and subrogation
related to the Property and Casualty Group, $46.0 million of which related to
workers' compensation and $4.8 million related to Commercial Lines. The
anticipated salvage and subrogation was $9.1 million for PMA Re. Incurred
salvage and subrogation (increased) reduced losses and LAE by ($18.5) million,
($0.6) million and $9.5 million in 1997, 1996 and 1995, respectively. The
Company's policy with respect to estimating the amounts and realizability of
salvage and subrogation is to develop accident year schedules of historic paid
salvage and subrogation by line of business, which are then projected to an
ultimate basis using actuarial projection techniques. The anticipated salvage
and subrogation is the estimated ultimate salvage and subrogation less any
amounts received by the Company. The realizability of anticipated salvage and
subrogation is reflected in the historical data that is used to complete the
projection, as historic paid data implicitly considers realization and
collectibility.
The Company actively manages its exposure to catastrophic events. In the
underwriting process, the Company generally minimizes the writing of insurable
values in catastrophe prone regions. Also, in writing property reinsurance
coverages, PMA Re typically requires per occurrence loss limitations for
contracts that could have catastrophe exposure. Through per risk reinsurance,
the Company also manages its net retention in each exposure. In addition, PMA Re
maintains retrocessional protection of $46.0 million excess of $2.0 million per
occurrence, and the Property and Casualty Group maintains catastrophe
reinsurance protection of $27.7 million excess of $850,000. As a result, the
Company's loss ratios have not been significantly impacted by catastrophes, and
management believes that the Company has adequate reinsurance to protect against
the estimated probable maximum gross loss from a catastrophic event; however,
although management believes it is unlikely, an especially severe catastrophic
event could exceed the Company's reinsurance and retrocessional protection, and
materially adversely impact the Company's financial position.
- 84 -
<PAGE>
The Company also maintains reinsurance and retrocessional protection for
other lines of business at December 31, 1997 as follows:
Retention Limits
---------------- --------------
The Property and Casualty Group:
Per Occurrence:
Workers' compensation......... $ 1.5 million $ 103.5 million
Per Risk:
Property lines................ $ 0.5 million(1) $ 19.5 million
Auto physical damage.......... $ 0.5 million $ 2.0 million
Other casualty lines.......... $ 0.2 million(2) $ 4.8 million
PMA Re:...........................
Per Occurrence:
Casualty lines................ $ 2.8 million $ 12.5 million
Workers' compensation......... $ 2.0 million $ 53.0 million
Property lines................ $ 2.0 million $ 46.0 million
Per Risk:
Property lines................ $ 0.8 million $ 4.2 million
Casualty lines................ $ 1.5 million $ 6.0 million
- ----------------
(1) This coverage also provides protection of $48.5 million per occurrence over
its combined net retention of $0.5 million.
(2) This coverage also provides protection of $49.8 million per occurrence over
its combined net retention of $0.2 million.
PMA Re also maintains aggregate protection up to $22.3 million in excess of
$178.0 million for the current accident year. Effective January 1, 1998, PMA Re
added a new workers' compensation program which includes coverage of $98.0
million excess of $2.0 million per occurrence, $98.5 million excess of $1.5
million per program per occurrence and $18.5 million excess of $1.5 million per
person per occurrence.
The Company performs extensive credit reviews on its reinsurers, focusing
on, among other things, financial capacity, stability, trends and commitment to
the reinsurance business. Prospective and existing reinsurers failing to meet
the Company's standards are excluded from the Company's reinsurance programs.
In addition, the Company requires letters of credit to support balances due from
reinsurers not authorized to transact business in the applicable jurisdictions.
At December 31, 1997, the Company had reinsurance recoverables due from the
following unaffiliated single reinsurers in excess of 3% of shareholders'
equity:
(dollar amounts in thousands)
Gross amount A.M. Best
due to the Company Rating
------------------- ---------
Reinsurer
- ---------
United States Fidelity and Guaranty Company..... $74,041 A
Essex Insurance Company......................... $36,807 A
American Re-Insurance Corporation............... $35,411 A+
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<PAGE>
Kemper Reinsurance Corporation.................. $21,853 A
London Life International Reinsurance
Corporation.................................... $16,212 A+
Continental Casualty Company.................... $15,209 A
The Company maintained funds held to collateralize the above balances in
the amount of $66.2 million at December 31, 1997. The Company believes that it
would have the right to offset the funds withheld from a reinsurer against the
balances due from such reinsurer in the event of insolvency. Funds held under
reinsurance treaties decreased $17.3 million in 1997, primarily due to the
commutation of a prior underwriting year for one of the reinsurance covers at
the Property and Casualty Group as well as one of the retrocessional covers at
PMA Re, partially offset by retrocessional activity at PMA Re for the current
underwriting year.
Long-term debt remained essentially constant between 1997 and 1996. As
noted previously, management refinanced the Company's existing credit agreements
on March 14, 1997 under the Revolving Credit Facility, replacing the following
debt that was outstanding at that time:
(dollar amounts in thousands)
Senior notes 9.60%, due 2001.................. $ 46,428
Senior notes 7.62%, due 2001, Series A........ 71,000
Senior notes 7.62%, due 2000, Series B........ 36,000
Revolving credit agreement, expiring in 1998.. 36,000
--------
Total......................................... $189,428
========
The early extinguishment of the senior note agreements resulted in an
extraordinary loss of $4.7 million ($7.3 million pre-tax) which was recorded in
the first quarter of 1997. The Revolving Credit Facility bears interest at
LIBOR plus 0.70% on the utilized portion and carries a 0.275% facility fee on
the unutilized portion. The margin over LIBOR is adjustable downward based upon
future reductions in the Company's debt to capitalization ratio. As of December
31, 1997, the interest rate on the Revolving Credit Facility was 6.61% on the
utilized portion. The final expiration of the Revolving Credit Facility will be
December 31, 2002, maturing in an installment of $15.5 million in 1999 and
annual installments of $62.5 million commencing in 2000 through 2002. Management
also entered into an interest rate swap agreement that manages the impact of the
potential volatility of the interest rate associated with the floating rates on
the Revolving Credit Facility. The interest rate swap covers a notional
principal amount of $150.0 million and effectively converts the floating rate on
such portion of the Revolving Credit Facility to a fixed 7.24%.
Other liabilities, including taxes, licenses and fees, decreased $9.1
million in 1997 to $81.5 million compared to 1996 primarily due to lower
operating expenses at the Property and Casualty Group during 1997.
Consolidated shareholders' equity at December 31, 1997 totaled $478.3
million, or $19.96 per share, compared to $425.8 million, or $17.86 per share,
at December 31, 1996. As a result of changes in market interest rates, the
unrealized appreciation of investments, net of tax, was $18.8 million at
December 31, 1997 compared to an unrealized depreciation of investments, net of
tax, of $24.9 million at December 31, 1996, resulting in an increase in
shareholders'
- 86 -
<PAGE>
equity of $43.7 million, or $1.82 per share. Consolidated shareholders' equity
decreased to $425.8 million, or $17.86 per share, at December 31, 1996, from
$609.7 million, or $25.53 per share, at December 31, 1995. This decrease was due
primarily to the net loss of $135.3 million in 1996, a decrease in shareholders'
equity of $42.4 million, net of tax, or $1.78 per share, related to unrealized
depreciation of investments and dividends declared of $7.9 million.
At December 31, 1997, the Company's capital structure consisted of $203.0
million of long-term debt and $478.3 million of shareholders' equity. The
Company utilizes long-term debt in its capital structure to fund internal
expansion through capital contributions to subsidiaries, to pursue investment
opportunities and to refinance existing debt. Due to the inherent risks
associated with the insurance industry, management strives to maintain a
relatively conservative capital structure. Management believes that a certain
amount of debt is necessary in order to enhance returns on shareholders' equity;
however, the level of debt must be appropriate in terms of the availability of
dividends from subsidiaries, operating income and the overall capital structure.
In determining the appropriate level of long-term debt, management focuses on
the following statistics: statutory dividends to interest expense, earnings
(loss) before interest and taxes to interest expense, pre-tax operating income
(loss) before interest to interest expenses and debt to capitalization ratio.
The following table indicates the Company's status with respect to these
statistics:
1997 1996 1995
----- ------ -----
Statutory dividends to interest expense (times)........ 1.4 3.1 3.8
Earnings (loss) before interest and taxes to interest
expense (times)...................................... 2.6 (10.2)(1) 2.9
Pre-tax operating income (loss) before interest to
interest expense (times)............................. 2.0 (10.4)(1) 1.2
Debt to total capitalization (excluding SFAS No. 115
adjustment).......................................... 30.6% 31.2% 25.6%
(1) Relates to the loss before interest and taxes and the pre-tax operating
loss of $191.4 million and $194.4 million, respectively, in 1996.
Investments
The Company's investment policy objectives are to (i) seek competitive
after-tax income and total return, (ii) maintain very high-grade asset quality
and marketability, (iii) maintain maturity distribution commensurate with the
Company's business objectives, (iv) provide portfolio flexibility for changing
business and investment climates and (v) provide liquidity to meet operating
objectives. The Company has established strategies, asset quality standards,
asset allocations and other relevant criteria for its fixed maturity and equity
portfolios. In addition, maturities are structured after projecting liability
cash flows with actuarial models. The Company also does not invest in various
types of investments, including speculative derivatives. The Company's
portfolio does not contain any significant concentrations in single issuers
(other than U.S. treasury and agency obligations), industry segments or
geographic regions.
The Company's Board of Directors is responsible for the Company's
investment policy objectives. The Company retains outside investment advisers
to provide investment advice and guidance, supervise the Company's portfolio and
arrange securities transactions through brokers and dealers. The Executive and
Finance Committees of the Company's Board of Directors meet periodically with
the investment advisers to review the performance of the
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<PAGE>
investment portfolio and to determine what actions should be taken with respect
to the Company's investments. Investments by the Pooled Companies, MASCCO and
PMA Re must comply with the insurance laws and regulations of the Commonwealth
of Pennsylvania and investments for Caliber One Indemnity Company must comply
with the insurance laws and regulations of the State of Delaware. The Company's
capital not allocated to the Pooled Companies, MASCCO, PMA Re and Caliber One
Indemnity Company may be invested in securities and other investments that are
not subject to such insurance laws, but nonetheless conform to the Company's
investment policy.
The following table summarizes the Company's investments by carrying value
as of June 30, 1998 and as of December 31, 1997 and 1996:
(dollar amounts in millions)
<TABLE>
<CAPTION>
June 30, December 31,
------------------ ---------------------------------------
1998 1997 1996
------------------ ------------------ ------------------
Carrying Carrying Carrying
Value(1) Percent Value(1) Percent Value(1) Percent
-------- ------- -------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
Investment
- ----------
U.S. Treasury securities and
obligations of U.S. Government
agencies........................... $1,007.4 46.7% $1,119.5 51.0% $1,602.8 70.8%
Obligations of states and political
subdivisions....................... 16.5 0.8% --- -- 76.5 3.4%
Corporate debt securities............ 805.4 37.3% 687.7 31.3% 372.8 16.5%
Mortgage backed securities........... 166.4 7.7% 122.3 5.6% 74.0 3.3%
Equity securities.................... --- -- --- -- 0.3 --
Short-term investments............... 163.6 7.5% 265.2 12.1% 135.0 6.0%
-------- ----- -------- ----- -------- -----
Total................................ $2,159.3 100.0% $2,194.7 100.0% $2,261.4 100.0%
======== ===== ======== ===== ======== =====
- ------------
</TABLE>
(1) Carrying value is equal to market value for all periods presented.
The Company has no investments which are not dollar denominated as of June
30, 1998.
The following table indicates the composition of the Company's fixed
maturities portfolio at carrying value, excluding short-term investments, by
rating as of June 30, 1998 and as of December 31, 1997 and 1996:
- 88 -
<PAGE>
(dollar amounts in millions)
<TABLE>
<CAPTION>
June 30, December 31,
------------------ ----------------------------------------
1998 1997 1996
------------------ ------------------- -------------------
Carrying Carrying Carrying
Value(2) Percent Value(2) Percent Value(2) Percent
-------- -------- -------- -------- ------- ----------
<S> <C> <C> <C> <C> <C> <C>
Ratings(1)
- ----------
U.S. Treasury securities and AAA.. $1,480.6 74.2% $1,449.0 75.1 $1,882.4 88.5%
AA................................ 147.5 7.4% 150.0 7.8% 95.8 4.5%
A................................. 224.7 11.2% 282.2 14.6% 147.9 7.0%
BBB............................... 142.9 7.2% 48.3 2.5% --- --
-------- ----- -------- ----- -------- -----
Total............................. $1,995.7 100.0% $1,929.5 100.0% $2,126.1 100.0%
======== ===== ======== ===== ======== =====
- -----------
</TABLE>
(1) Ratings as assigned by Standard & Poor's. Such ratings are generally
assigned at the issuance of the securities, subject to revision on the
basis of ongoing evaluations. Ratings in the table are as of December 31 of
the years indicated.
(2) Carrying value is equal to market value.
The following table sets forth scheduled maturities for the Company's
investments in fixed maturities, excluding short-term investments, based on
stated maturity dates as of June 30, 1998. Expected maturities will differ from
contractual maturities because the issuers may have the right to call or prepay
obligations with or without call or prepayment penalties:
(dollar amounts in millions)
Carrying Value(1) Percent
-------------- --------
1 year or less $ 140.9 7.0%
Over 1 year through 5 years 659.6 33.1%
Over 5 years through 10 years 323.1 16.2%
Over 10 years through 20 years 209.5 10.5%
Over 20 years 496.1 24.9%
Mortgage backed securities 166.5 8.3%
-------- -----
Total $1,995.7 100.0%
======== =====
______________
(1) Carrying value is equal to market value.
The following table reflects the Company's investment results for the six
months ended June 30, 1998 and for each year in the three-year period ended
December 31, 1997:
(dollar amounts in millions)
Six Months
Ended Year Ended December 31,
June 30, -------------------------------------
1998 1997 1996 1995
---------- ---------- ------------ -----------
Average invested assets(1).. $2,177.0 $2,247.7 $2,366.8 $2,395.8
Net investment income(2).... $ 65.2 $ 136.7 $ 133.9 $ 139.4
Net effective yield(3)...... 5.99% 6.09% 5.66% 5.82%
Net realized investment
gains(4)................... $ 13.7 $ 8.6 $ 3.0 $ 31.9
- -------------
- 89 -
<PAGE>
(1) Average of beginning and ending amounts of cash and investments for the
period at carrying value (market value).
(2) After investment expenses, excluding net realized investment gains.
(3) Net investment income for the period divided by average invested assets for
the same period. The net effective yield for the six months ended June 30,
1998 has been annualized.
(4) Excludes loss on sale of PMA Cayman of $2.4 million. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
As of June 30, 1998 and December 31, 1997, respectively, the effective
duration of the Company's investments was approximately 5.4 years and 5.3 years
and the effective duration of its liabilities was approximately 4.9 years and
5.1 years.
During 1997, the Company established a securities lending program through
which securities are loaned from the Company's portfolio to qualifying third
parties, subject to certain limits, via a lending agent for short periods of
time. Borrowers of these securities must provide collateral equal to a minimum
of 102% of the market value and accrued interest of the loaned securities.
Acceptable collateral may be in the form of either cash or securities. Cash
received as collateral is invested in short-term investments, and all securities
received as collateral are of similar quality to those securities lent by the
Company. In addition, the Company limits securities lending to 40% of statutory
admitted assets of its insurance subsidiaries, with a 2% limit on statutory
admitted assets to any individual borrower. The Company receives either a fee
from the borrower or retains a portion of the income earned on the collateral.
Under the terms of the securities lending program, the Company is indemnified
against borrower default, with the lending agent responsible to the Company for
any deficiency between the cost of replacing a security that was not returned
and the amount of collateral held by the Company. In the six-month period ended
June 30, 1998 and the year ended December 31, 1997, respectively, the Company
recognized income from securities lending transactions of approximately $406,000
and $524,000, net of lending fees, which was included in investment income. The
Company had approximately $632.9 million and $175.0 million, respectively, of
securities on loan as of June 30, 1998 and December 31, 1997.
- 90 -
<PAGE>
BUSINESS
Company Overview
The Company is an insurance holding company, whose subsidiaries operate in
three distinct segments of the property and casualty insurance industry: (i)
reinsurance, through PMA Re, which commenced business in 1980; (ii) standard
commercial lines of insurance, with an emphasis on workers' compensation through
the Property and Casualty Group, which has been in business since 1915 and (iii)
specialty insurance products, focusing on excess and surplus lines, through the
Company's recently-formed operation, Caliber One. PMA Re writes a broad range of
property and casualty reinsurance products with an emphasis on risk-exposed
casualty excess of loss reinsurance and operates in the United States domestic
brokered market. The Property and Casualty Group offers a broad range of
standard commercial lines, including commercial general liability, commercial
automobile and commercial multi-peril, with an emphasis on workers' compensation
products and services primarily in nine contiguous jurisdictions in the Mid-
Atlantic and Southern regions of the United States, utilizing the PMA Group
trade name. In 1998, Caliber One commenced writing excess and surplus lines of
property and casualty insurance, including commercial general liability,
automobile and certain property exposures on a non-admitted basis. For the six
months ended June 30, 1998, the Company's net premiums written of 257.0 million
were derived 45,9% from PMA Re, 53.8% from the Property and Casualty Group and
0.3 from Caliber One. Net income for the Company for the six months ended June
30, 1998 and the year ended December 31, 1997 was $21.4 million and $15.0
million, respectively. As of June 30, 1998, the Company had total assets of
$3,075.4 million and shareholders' equity of $496.4 million.
The Company's insurance subsidiaries have the following ratings from A.M.
Best: PMA Reinsurance Corporation, A+ ("Superior"); the Pooled Companies, A-
("Excellent") and Caliber One Indemnity Company, A ("Excellent"). Management
believes that ratings from A.M. Best are material to its operations and that a
downgrade from the present rating classifications could have an adverse effect
on the Company's ability to market its products. A.M. Best's ratings are based
upon an assessment of an insurance company's perceived financial strength
regarding its ability to pay obligations to its policyholders and are not
directed toward the protection of investors.
After a period of rapid growth in the late 1980's, the Company's
consolidated total net premiums written declined from $552.0 million in 1992 to
$418.3 million in 1997. Since 1993, PMA Re's premium volume expanded as a
result of the increased demand for reinsurance in the markets in which PMA Re
participates as well as trends towards ceding companies restricting the number
of reinsurers with which they will do business. PMA Re has also obtained
additional business as a result of a target marketing program commenced in 1996
as well as from business displaced in the recent consolidation of the United
States reinsurance industry. Those trends have facilitated PMA Re's increased
participation on reinsurance treaties with its existing clients, the writing of
additional layers and programs with existing clients, and to a lesser extent,
the addition of business from new ceding companies. During this period, the
market for the products written by the Property and Casualty Group was very
competitive. The Property and Casualty Group restricted its premium volume,
rather than write business at rates that were not commensurate with the risks
assumed, and introduced loss-sensitive coverages and large-deductible programs,
under which insureds pay less
- 91 -
<PAGE>
premium but bear a greater portion of loss exposure. Beginning in 1992, premiums
written were also reduced as a result of the Property and Casualty Group's re-
underwriting of its book of business and, commencing in 1993, rate reductions
associated with workers' compensation benefit reform laws. Management believes
that recent initiatives undertaken and workers' compensation reforms enacted in
recent years, including the restructuring and the loss reserve strengthening of
$257.9 million in 1995 and 1996, afford the Property and Casualty Group an
opportunity to increase its core business, workers' compensation insurance, on
terms acceptable to it. See "The Property and Casualty Group--Background and
Recent Developments" below.
In 1996, the Company restructured the Property and Casualty Group with the
goal of restoring its profitability after three years of operating losses. The
losses resulted primarily from unfavorable underwriting experience and adverse
reserve development related to accident years 1987 through 1991, when the
Property and Casualty Group wrote a much higher volume of business than its
current volume. The principal components of the restructuring were: (i)
strengthening loss reserves; (ii) initiating a commutation program to settle a
significant number of open claims from the 1987 to 1991 period; (iii)
designating PMA Cayman and MASCCO as separate run-off companies to alleviate the
SAP impact on the Pooled Companies of the loss reserve strengthening and to
manage the capital deployed in running off pre-1992 workers' compensation
claims; (iv) initiating an expense reduction program and (v) implementing
management changes, including the appointment of a new Chief Operating Officer
and the creation of the position of Chief Underwriting Officer. In June 1998,
the Company entered into a letter of intent to sell PMA Cayman. Largely as a
result of the restructuring, the Property and Casualty Group recorded pre-tax
operating income of $5.4 million for the six months ended June 30, 1998,
compared to pre-tax operating losses of $5.9 million for the six months ended
June 30, 1997 and $3.7 million, $215.7 million (including restructuring and
other special charges of $223.1 million) and $3.9 million for the years ended
December 31, 1997, 1996 and 1995, respectively.
The composition of the Company's net premiums written for the six months
ended June 30, 1998 and the year ended December 31, 1997 was as follows:
(dollar amounts in thousands)
Six Months Ended Year Ended
June 30, 1998 December 31, 1997
----------------------- -------------------------
Net Net
premiums % of premiums % of
written total written total
------- ----- ------- -----
PMA Re..................... $117,908 45.9% $177,934 42.5%
The Property and Casualty
Group:
Workers' compensation.... 106,952 41.6% 175,301 41.9%
Other commercial lines... 31,432 12.2% 65,047 15.6%
-------- ----- -------- -----
Total.................... 138,384 53.8% 240,348 57.5%
-------- ----- -------- -----
Caliber One................ 917 0.3% -- --
Eliminations............... (171) -- -- --
-------- ----- -------- -----
Total...................... $257,038 100.0% $418,282 100.0%
======== ===== ======== =====
- 92 -
<PAGE>
PMA Re
Background
According to data provided by the RAA, as of June 30, 1998, PMA Reinsurance
Corporation was the 24th largest reinsurer in the United States in terms of
statutory capital and surplus and 17th largest in terms of net premiums written.
PMA Re writes a broad range of property and casualty reinsurance products with
an emphasis on risk-exposed casualty excess of loss reinsurance within the
United States domestic brokered market. Management believes that PMA Re
competes on the basis of its ability to offer prompt and responsive service and
specialized products to its clients and its excellent long-term relationships in
the broker and ceding company communities.
In the brokered reinsurance market, the products (reinsurance coverages)
are distributed to the ultimate customer (ceding companies) through reinsurance
intermediaries, known as brokers. In exchange for providing such distribution
services, the brokers are paid commissions, known as brokerage, which is
typically based upon a percentage of the premiums ceded under a particular
contract. The brokered reinsurance market differs from the direct reinsurance
market in which reinsurers maintain their own sales forces and distribute their
products directly to their ceding company clients.
During the five-year period ended December 31, 1997, PMA Re has expanded
its premium base without changing its underwriting standards. From 1992 to
1997, PMA Re reported premium volume growth that exceeded that of the overall
reinsurance industry. During such period, PMA Re's compound annual growth rate
for net premiums written was 13.2%, while it is estimated that the reinsurance
industry's compound annual growth rate was 8.2% for the same period based upon
information published by the RAA. PMA Re's premium volume increases have
largely taken the form of increased participation levels on clients' existing
programs, as well as writing of additional layers and programs with current
clients. To a lesser extent, volume growth has been attributable to business
written with new ceding company clients. Management believes that the expansion
of PMA Re's premium base has been attributable to several factors. First, PMA
Re's volume was impacted by industry trends between 1992 and 1995 that tended to
increase the demand for reinsurance. Specifically, much of the growth that
occurred in the primary insurance market in those years was attributable to
regional and niche companies. Typically, these companies demand more
reinsurance than their larger counterparts. Second, management believes that PMA
Re has benefited from the greater selectivity of ceding companies that have
restricted the number of reinsurers with which they will transact business. In
addition, commencing in 1996, PMA Re initiated a target marketing program, under
which certain existing accounts and new accounts identified as having certain
desirable characteristics (such as quality management and underwriting) were
pursued for additional or new business. Finally, PMA Re has been able to write
business for customers that was formerly written by reinsurers in the brokered
market that have been acquired by other reinsurers. These factors have more
than offset the recent trends in 1996 and 1997 of ceding companies retaining
more of their business and highly competitive conditions, which caused PMA Re to
non-renew certain accounts amounting to $68.2 million of in-
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<PAGE>
force premium in the 18 months ended June 30, 1998 and not accept certain new
business opportunities for underwriting or pricing reasons.
Reinsurance Products
The following table indicates PMA Re's gross and net premiums written by
major category of business:
<TABLE>
<CAPTION>
(dollar amounts in thousands)
Six Months Ended
June 30, Year Ended December 31,
------------------ ----------------------------------------------
1998 1997 1997 1996 1995 1994 1993
---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
Gross premiums written(1)
Casualty................. $102,608 $ 83,289 $151,901 $143,991 $128,736 $107,001 $ 94,482
Property................. 41,313 36,916 72,625 63,325 63,693 36,592 28,217
Other.................... 501 501 795 842 (63) 837 1,854
-------- -------- -------- -------- -------- -------- --------
Total.................... $144,422 $120,706 $225,321 $208,158 $192,366 $144,430 $124,553
======== ======== ======== ======== ======== ======== ========
Net premiums written(2)
Casualty................. $ 83,535 $ 68,286 $118,889 $122,008 $107,383 $ 88,585 $ 82,016
Property................. 33,849 27,501 58,257 41,240 45,440 23,929 18,407
Other.................... 524 492 788 805 (63) 837 1,854
-------- -------- -------- -------- -------- -------- --------
Total...................... $117,908 $ 96,279 $177,934 $164,053 $152,760 $113,351 $102,277
======== ======== ======== ======== ======== ======== ========
- --------------------
</TABLE>
(1) For the six months ended June 30, 1998, gross premiums written include $3.4
million of facultative reinsurance comprised of $1.5 million of property and
$1.9 million of casualty. For the six months ended June 30, 1997, gross
premiums written include $2.7 million of facultative reinsurance comprised
of $1.1 million of property and $1.6 million of casualty. For the years
ended December 31, 1997 and 1996, gross premiums written include $5.8
million and $3.5 million of facultative reinsurance, respectively, comprised
of the following: property, $2.4 million and $1.1 million, respectively;
casualty, $3.4 million and $2.3 million, respectively, and other lines,
$100,000 in 1996.
(2) For the six months ended June 30, 1998, net premiums written include $1.2
million of facultative reinsurance comprised of $700,000 of property and
$500,000 of casualty. For the six months ended June 30, 1997, net premiums
written include $700,000 of facultative reinsurance comprised of $300,000 of
property and $400,000 of casualty. In 1997 and 1996, net premiums written
include $2.5 million and $1.0 million of facultative reinsurance,
respectively, comprised of the following: property, $1.7 million and
$500,000, respectively; casualty, $800,000 and $500,000, respectively, and
other lines, less than $0.1 million in 1996.
Casualty Business
Casualty business accounted for 70.8% and 66.8% of net premiums written for
the six months ended June 30, 1998 and the year ended December 31, 1997,
respectively. In the five-year period ended December 31, 1997, casualty
business has increased at a compound
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<PAGE>
annual growth rate of 7.2%. The following table indicates the mix of casualty
business by class on the basis of net premiums written:
(dollar amounts in thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30, Year Ended December 31,
---------------- -----------------------------------------------
1998 1997 1997 1996 1995 1994 1993
---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
Umbrella.................. $13,777 $21,692 $ 30,967 $ 40,307 $ 51,558 $38,743 $34,189
Errors and Omissions...... 11,781 10,557 13,813 19,866 7,149 7,281 4,033
General Liability......... 12,072 5,597 15,174 11,702 7,460 8,936 8,665
Medical Malpractice....... 6,369 3,899 7,373 7,411 6,835 6,355 6,657
Directors' and Officers'.. 3,385 3,363 5,897 6,210 4,586 4,156 1,815
Miscellaneous Liability... 15,441 7,019 16,431 12,811 10,350 6,006 3,690
Auto Liability............ 16,992 11,313 22,268 17,056 13,032 10,134 12,616
Workers' Compensation..... 3,718 4,846 6,966 6,645 6,412 6,974 10,351
------- ------- -------- -------- -------- ------- -------
Total..................... $83,535 $68,286 $118,889 $122,008 $107,382 $88,585 $82,016
======= ======= ======== ======== ======== ======= =======
</TABLE>
Due to the competitive conditions in the casualty market, management has
maintained a relatively conservative growth posture for casualty business in the
five-year period. PMA Re has generally focused on other liability coverages
(which include general liability, products liability, professional liability and
other more specialized liability coverages), while maintaining a relatively
stable level of auto liability premiums and de-emphasizing workers' compensation
coverages. In 1998, casualty premiums increased primarily as a result of the
addition of certain large general liability and auto liability programs. The
decrease in 1997 casualty net premiums was primarily attributable to increased
retrocessional protection purchased which offset increases in gross casualty
premiums relating to new business with existing clients and larger lines taken
on existing programs. In 1998, 1997, 1996 and 1995, PMA Re decreased the amount
of its excess and umbrella business as rates and terms for this type of business
were no longer as attractive as they had been. Much of the growth in 1995 and
1996 related to the expansion and addition of several programs covering
specialty business (which includes professional liability, directors' and
officers' liability, environmental impairment liability, employment practices
liability and other miscellaneous specialized coverages). Such specialty
business now accounts for approximately 53.1% of in-force casualty treaty
business. In 1994, the growth in other liability was primarily attributable to
excess and umbrella business as PMA Re added several significant programs.
Property Business
Property business accounted for 28.7% and 32.7% of net premiums written for
the six months ended June 30, 1998 and the year ended December 31, 1997,
respectively. In the five-year period ended December 31, 1997, property
business has increased at a compound annual growth rate of 40.4%. The increases
in net property premiums written have been primarily the result of additional
property underwriting expertise that PMA Re added to its underwriting staff in
late 1996 to broaden its product offerings. Such expertise enabled PMA Re to
increase cross-selling opportunities with its existing treaty reinsurance
clients by offering additional and expanded property coverages. In addition,
property premiums ceded decreased primarily related to changes in PMA Re's
property retrocessional coverages in terms of premiums and ceding commissions.
The decrease in net premiums written in 1996 was primarily attributable to
higher ceding company retentions, competitive
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<PAGE>
pricing conditions and higher ceded property premiums. The growth in net
property business in 1995 and 1994, of 89.9% and 30.0%, respectively, was
attributable to the expansion of several programs covering auto physical damage,
inland marine risks and certain specialty property coverages written on a
surplus lines basis.
PMA Re has generally de-emphasized catastrophe coverages. As of June 30,
1998 and December 31, 1997, catastrophe business accounted for approximately
4.7% and 4.0%, respectively, of property premiums in force. The property
programs written by PMA Re generally contain per occurrence limits or are not
considered significantly catastrophe exposed, either because of the locations of
the insured values or the nature of the underlying properties insured. However,
as is common in property reinsurance, PMA Re is exposed to the possibility of
loss from catastrophic events due to the aggregation of per occurrence limits
and similar issues. PMA Re actively manages this exposure through aggregate
management, minimizing writings of catastrophe business and retrocessional
protection. As of June 30, 1998, PMA Re maintained catastrophe retrocessional
protection of $48 million excess of $2 million. Management believes that PMA
Re's catastrophe retrocessional coverage is adequate to protect PMA Re against
its probable maximum loss from a significant catastrophe; however, an especially
severe catastrophic event could exceed PMA Re's retrocessional protection and
materially and adversely affect the Company's financial position and results of
operations. See "Risk Factors--Certain Risks Affecting the Property and
Casualty Industry", "Underwriting" and "The Company's Reinsurance Ceded."
Facultative Reinsurance
Facultative reinsurance is a form of reinsurance coverage that is placed on
a risk-by-risk basis, and the reinsurer retains the right to accept or reject
each individual risk submitted by the ceding company.
Facultative reinsurance differs from treaty reinsurance in that treaty
reinsurance typically covers multiple risks within a particular classification,
the reinsurer does not retain the right to accept or reject individual risks as
long as such risks conform to the contract stipulations, and the ceding company
is obligated to cede the risks to the reinsurer. Companies typically purchase
facultative reinsurance for several reasons, including to (i) cover unusual
risks; (ii) cover high hazard risks; (iii) protect a ceding company's net
retention and treaty reinsurers; (iv) obtain additional capacity beyond that
provided by a company's treaty reinsurers; (v) cover risks excluded under a
company's treaties and (vi) cover risks under a company's new line of business.
There are some facultative products that are variations of the above
general concept, such as automatic and semi-automatic facultative contracts.
Under automatic facultative arrangements (sometimes known as facultative
obligatory treaties), the cession is not obligatory from the ceding company's
point of view, but the acceptance of the risk is automatic from the reinsurer's
standpoint. For semi-automatic facultative contracts, the cession is not
obligatory, but the acceptance of the risk is obligatory, unless the risk falls
outside certain stipulated criteria. If the risk falls outside such criteria,
the reinsurer has the option of either: (i) accepting the risk, (ii) declining
the risk or (iii) repricing the risk.
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<PAGE>
For the six months ended June 30, 1998, PMA Re recorded $1.2 million of net
facultative reinsurance premiums that represented 1.0% of total net premiums
written. For the year ended December 31, 1997, PMA Re recorded $2.5 million of
net facultative reinsurance premiums which represented 1.4% of total net
premiums written for the year, compared to $1.0 million, or 0.6%, for the year
ended December 31, 1996. PMA Re offers facultative products as a complement to
existing treaty business, as well as offering such products to companies with
whom PMA Re does not presently have a relationship. The products offered
include traditional facultative certificates and automatic or semi-automatic
programs for both property and casualty exposures.
Marketing and Distribution
PMA Re operates primarily through the domestic brokered reinsurance market
in which it has developed relationships with major reinsurance brokers enabling
it to gain access to a wide range of ceding companies with varying reinsurance
and related service needs. Brokers that accounted for more than 7% of PMA Re's
gross premiums in force were as follows:
(dollar amounts in thousands)
June 30, 1998 December 31, 1997
--------------------- --------------------
Gross Gross
Premiums Percentage Premiums Percentage
in Force of Total in Force of Total
-------- -------- -------- --------
Aon Reinsurance.......... $107,855 38.6% $99,151 35.7%
Guy Carpenter & Company.. 62,660 22.4% 64,803 23.3%
E. W. Blanch............. 38,121 13.6% 38,267 13.8%
Sedgwick Payne Company... 29,285 10.5% 27,322 9.8%
Towers Perrin Re......... 20,029 7.2% 22,669 8.2%
The above brokers are among the largest brokers in the reinsurance
industry.
Beginning in 1996, PMA Re began a target marketing program designed to
identify companies in the smaller and medium company segments with whom PMA Re
presently has either no or an insignificant relationship, but meet desired risk
profiles. After such identification, marketing and underwriting personnel work
with the ceding company's broker to enable PMA Re to have an opportunity to
participate in the reinsurance coverage.
As of June 30, 1998, PMA Re had approximately 212 clients, with no
individual client accounting for more than 6.5% of gross premiums in force .
Underwriting
In reinsurance, underwriting involves the selection of risks and
determining whether the market pricing is adequate given expected losses and
estimated volatility of such losses. Given the present soft-pricing environment,
maintaining underwriting discipline is more difficult and more critical to the
maintenance of acceptable results of operations. PMA Re's underwriting
management averages 21 years in the property and casualty industry.
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<PAGE>
PMA Re's underwriting process has two principal aspects: underwriting the
specific program to be reinsured and underwriting the ceding company.
Underwriting the specific program to be reinsured involves, in addition to
pricing, a review of the type of program, the total risk and the ceding
company's policy forms. Underwriting the ceding company involves an evaluation
of the expected future performance of the ceding company through an examination
of that company's management, financial strength, claims handling and
underwriting abilities. PMA Re generally conducts underwriting and claim
reviews at the offices of prospective ceding companies before entering into a
major treaty, as well as throughout the life of the reinsurance contract.
In underwriting excess-of-loss business, PMA Re has typically sought to
write treaties that are exposed to loss on a per occurrence basis within the
original policy limits of the ceding company. Management believes these layers
in general lend themselves more effectively to actuarial pricing techniques.
PMA Re's underwriters and actuaries work closely together to evaluate the
particular reinsurance program. Using the information provided by the broker,
the actuaries employ pricing models to estimate the ultimate exposure to the
treaty. The pricing models that are utilized employ various experience rating
and exposure rating techniques and are tailored in each case to the risk
exposures underlying each treaty. The underwriters then weigh the results of
the pricing models with the terms and conditions being offered to determine PMA
Re's selected price.
As noted above, PMA Re typically requires per occurrence limits for
property coverages and requires that the underlying insured values not be
catastrophe exposed. Also, PMA Re minimizes catastrophe reinsurance coverages
and has historically maintained sufficient retrocessional protection. Recent
natural catastrophes did not have a significant adverse impact on PMA Re's
combined ratio and earnings inasmuch as PMA Re has minimized assuming
catastrophe reinsurance business or catastrophe-exposed coverages and it has had
sufficient retrocessional arrangements.
The following table indicates PMA Re's gross, ceded and net losses from
recent catastrophes as of December 31, 1997:
(dollar amounts in thousands)
<TABLE>
<CAPTION>
Industry
Incurred PMA Re PMA Re PMA Re
Catastrophe Year Loss(1) Gross Loss Ceded Loss Net Loss
- ----------- ---- -------- ---------- ---------- --------
<S> <C> <C> <C> <C> <C>
Hurricane Hugo............. 1989 $ 4,200,000 $13,200 $11,400 $1,800
San Francisco Earthquake... 1989 1,000,000 2,300 1,000 1,300
Oakland Fires.............. 1991 1,700,000 2,700 1,400 1,300
Hurricane Andrew........... 1992 15,500,000 22,800 20,700 2,100
Hurricane Iniki............ 1992 1,600,000 4,100 2,900 1,200
Northridge, CA Earthquake.. 1994 12,500,000 17,600 11,700 5,900
Hurricane Fran............. 1996 1,500,000 1,300 900 400
- --------------------
</TABLE>
(1) Source: Property Claims Services.
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<PAGE>
PMA Re has no significant obligations to its reinsurers as a result of the
above catastrophes.
Claims Administration
PMA Re's claims department evaluates loss exposures, establishes individual
claim reserves, pays claims, provides claims-related services to PMA Re's
clients, audits the claims activities of current clients and assists in the
underwriting process by evaluating the claims departments of prospective
clients. PMA Re's claims department's evaluation of loss exposure includes
reviewing loss reports received from ceding companies to confirm that claims are
covered under the terms of the relevant reinsurance contract, establishing
reserves on an individual case basis and monitoring the adequacy of those
reserves. The claims department monitors the progress and ultimate outcome of
the claims to determine that subrogation, salvage and other cost recovery
opportunities have been adequately explored. The claims department performs
these functions in coordination with PMA Re's actuarial and underwriting
departments.
In addition to evaluating and adjusting claims, the claims department
conducts claims audits at the offices of prospective ceding companies.
Satisfactory audit results are required in order for reinsurance coverage to be
written by PMA Re. Also, the claims department conducts annual claims audits
for many current and former client ceding companies.
Management believes that PMA Re has been at the forefront of several
service initiatives in the brokered reinsurance market, involving improved
timeliness of claims remittances, including fastrack claims and electronic data
interchange. Fastrack claims involve the pre-approval of payment of certain
claims provided the claims meet predetermined criteria and electronically
disbursing funds to the clients. Electronic data interchange involves the
electronic transmission of data associated with transactions between PMA Re and
the client.
The Property and Casualty Group
Background
The Property and Casualty Group provides workers' compensation insurance,
other commercial property and casualty insurance coverages and related services
to entities located primarily in nine contiguous jurisdictions in the Mid-
Atlantic and Southern regions of the United States, utilizing the PMA Group
trade name. As a result primarily of the Property and Casualty Group's
underwriting decisions, the introduction of loss-sensitive coverages and large
deductible programs, competition and the impact of workers' compensation benefit
reform laws, the Property and Casualty Group's statutory net premiums written
declined from $434.7 million in 1993 to $240.3 million in 1997. For the six
months ended June 30, 1998, net written premiums were $138.4 million compared to
$156.8 million for the six months ended June 30, 1997.
The operating results of the Property and Casualty Group improved in 1997
compared to 1996, primarily as a result of reserve strengthening that the
Property and Casualty Group effectuated in 1996 and expense initiatives
instituted by the Property and Casualty Group in 1997. This improvement has
continued through the first six months of 1998. In 1996, the Property and
Casualty Group strengthened its loss reserves by $191.4 million. Of this amount,
$110.0 million related to workers' compensation, $60.4 million related to
asbestos and environmental claims and $21.0 million related to other lines and
LAE. The adverse development arising from workers' compensation had reduced the
Property and Casualty Group's earnings by a cumulative $251.6 million between
1992 and 1995. The reform legislation enacted in Pennsylvania, the Property and
Casualty Group's principal marketing territory, in 1993 and 1996 has introduced
various controls and limitations on disability and medical benefits. Management
believes that the reforms and more stringent underwriting standards adopted by
the Property and Casualty Group since 1991 have had and continue to have a
beneficial effect on the Property and Casualty Group's accident year loss
ratios. The strengthening recorded for asbestos and environmental claims was
based upon a detailed loss analysis that examined data on an account-by-account
and site-by-site basis for asbestos, and an actuarial calendar year aggregate
loss development technique for environmental claims. The Property and Casualty
Group's net survival ratio was 7.4 years at December 31, 1997 (8.2 years at
December 31, 1996). At June 30, 1998, the Property and Casualty Group's net
survival ratio was 8.2 years. In 1997 and through the first six months of 1998,
the Property and Casualty Group did not record any adverse loss reserve
development (see "Loss Reserves"), and, in addition, the impact of a lower
expense base has contributed to improved operating results for the Property and
Casualty Group. See "Loss Reserves."
In 1997, the Property and Casualty Group completed a formal commutation
program in which it paid approximately $118.9 million, of which $17.8 million
was paid in the fourth quarter of 1996, to injured workers in exchange for a
release from any future indemnity
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<PAGE>
payments. Commutations are agreements with claimants whereby the claimants, in
exchange for a lump sum payment, release their rights to future indemnity
payments from the Property and Casualty Group. Under Pennsylvania workers'
compensation law, the claimant, who is generally represented by legal counsel
and the Pennsylvania Workers' Compensation Board, must approve all such
commutation agreements. Savings associated with these claims were consistent
with management's expectations. The number of open claims for accident years
1991 and prior was substantially reduced as a result of the commutation program.
This reduction in open claims is expected to reduce the possibility of further
adverse development on such reserves, although there can be no assurance that
the level of commutations will have a significant impact on the future
development of such reserves. As a result of the success of this formal
commutation program, the Property and Casualty Group has continued its efforts
to commute additional claims from accident years 1991 and prior and also has
started to commute claims for accident years 1992 through 1996. During the six
months ended June 30, 1998, the Property and Casualty Group paid approximately
$60.1 million to injured workers in exchange for a release from any future
indemnity payments.
The Property and Casualty Group continues to emphasize its traditional core
business, workers' compensation. Management believes that it can capitalize on
the recent regulatory reforms, attract additional business based upon the
Property and Casualty Group's expertise in workers' compensation and reduce
acquisition expenses, because acquisition costs are lower for workers'
compensation than for other lines of commercial insurance. In addition, the
Property and Casualty Group has aligned itself with network health care
providers in order to offer medical cost containment practices to its insureds.
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<PAGE>
In Pennsylvania, the Property and Casualty Group will seek to expand and retain
more of its premium base in territories that meet the Property and Casualty
Group's underwriting and actuarial criteria. Recent regulatory reforms in
Pennsylvania (Acts 44 and 57) have made workers' compensation business more
attractive from an underwriting perspective than it had been in the early
1990's. The workers' compensation system in certain other states in which the
Property and Casualty Group does business (specifically, New Jersey, North
Carolina and Virginia) has also improved in recent years. It is management's
intention to seek to recapture a portion of the workers' compensation market
share in those states where the Property and Casualty Group has lost market
share since the early 1990's.
In addition, the Property and Casualty Group intends to expand into certain
new territories. In 1997, the Property and Casualty Group began writing business
in Georgia, and, in 1996, in New York and South Carolina. In all new
territories, the Property and Casualty Group will undertake a target marketing
effort by identifying profiles of entities that it desires to insure. These
profiles will be communicated to the key producers in these states. It is also
contemplated that the Property and Casualty Group will seek to expand its
relationships with larger national and regional brokerage operations in both its
existing and new states. However, no assurance can be given that the Property
and Casualty Group will be able to accomplish these marketing objectives.
The Property and Casualty Group intends to continue writing other lines of
property and casualty insurance, but generally only if such writings are
supported by its core workers' compensation business. Effective January 1,
1997, the Property and Casualty Group reduced its retention on commercial
casualty lines of business to $175,000 per risk from $500,000 per risk.
Business Written
The following table sets forth net premiums written for the Property and
Casualty Group for the periods indicated:
<TABLE>
<CAPTION>
(dollar amounts in thousands)
Six Months ended
June 30, Year Ended December 31,
------------------- -----------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
Workers' Compensation........... $106,952 $104,464 $186,605 $205,532 $236,742 $267,033 $342,184
Commercial Auto................. 13,002 16,918 28,938 35,224 39,834 38,984 48,108
Commercial Multi-Peril.......... 15,420 25,438 41,713 35,108 40,659 31,123 27,306
General Liability and Umbrella.. 1,903 6,550 8,751 8,204 11,370 12,691 16,788
Other........................... 1,107 3,476 (14,355) 6,245 8,511 3,320 324
-------- -------- -------- -------- -------- -------- --------
Total........................... $138,384 $156,846 $251,652 $290,313 $337,116 $353,151 $434,710
======== ======== ======== ======== ======== ======== ========
</TABLE>
Workers' Compensation Insurance
Workers' compensation is a statutory system that requires employers to
provide workers' compensation benefits to their employees and their employees'
dependents for
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<PAGE>
injuries and occupational diseases arising out of employment, regardless of
whether such injuries result from the employer's or the employee's negligence.
Employers may insure their workers' compensation obligations or, subject to
regulatory approval, self-insure such liabilities. State workers' compensation
statutes require that a policy cover three types of benefits: medical expenses,
disability (indemnity) benefits and death benefits. The amounts of disability
and death benefits payable for various types of claims are established by
statute, but no maximum dollar limitation exists for medical benefits.
Workers' compensation benefits vary among states, and insurance rates are
subject to differing forms of state regulation. Based upon direct written
premium information published by A.M. Best for the most recently available year
(1997), the Property and Casualty Group is the fourth largest private writer of
workers' compensation insurance in Pennsylvania and between the 2nd and 11th
largest writer of workers' compensation insurance in the other jurisdictions
listed in the table below (except for North Carolina). The Property and Casualty
Group has focused on these jurisdictions based upon its knowledge of their
workers' compensation systems and the Property and Casualty Group's assessment
of their business, economic and regulatory climates. Rate adequacy, regulatory
climate, economic conditions and other factors in each state are closely
monitored and taken into consideration in the underwriting process. Management
intends to employ similar analyses in determining whether and to what extent the
Property and Casualty Group will sell its products in additional jurisdictions.
See "Underwriting." The following table sets forth statutory direct workers'
compensation business written by jurisdiction for the five years ended December
31, 1997 and for the six months ended June 30, 1998 and 1997.
(dollar amounts in thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30, Year Ended December 31,
-------------------- ---------------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
Pennsylvania $ 43,820 $ 53,348 $ 91,126 $134,171 $142,234 $169,448 $224,067
New Jersey 21,857 15,486 26,327 17,995 24,388 31,287 47,745
Virginia 12,538 13,077 19,552 17,449 26,395 29,938 31,545
Maryland 7,726 7,750 16,538 11,406 17,993 14,391 15,318
North Carolina 4,966 5,420 9,501 8,195 14,035 11,649 21,216
Delaware 4,024 3,463 7,041 7,545 5,763 4,831 4,274
Other 8,630 6,946 11,470 5,403 7,889 4,864 7,165
-------- -------- -------- -------- -------- -------- --------
Total $103,561 $105,490 $181,555 $202,164 $238,697 $266,408 $351,330
======== ======== ======== ======== ======== ======== ========
</TABLE>
Management of the Property and Casualty Group believes that conditions in
the workers' compensation market have been improving in the last several years.
In addition, several states, including Pennsylvania, have enacted reforms to the
workers' compensation benefit system.
In 1993, Pennsylvania enacted Act 44, which introduced medical cost
containment measures to the workers' compensation benefit system and expanded
the period of time during which the insurer may require an employee to accept
medical treatment from the employer's list of designated health care providers
from 14 to 30 days. Act 44 also reduced the minimum wage replacement benefit to
injured workers, introduced a credit for unemployment compensation
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<PAGE>
benefits, restored the right of subrogation against tort recoveries in work-
related automobile accidents and created new anti-fraud measures. In June 1996,
Pennsylvania enacted Act 57, which further reformed the workers' compensation
system in the state. Among other provisions, Act 57: (i) imposes application of
American Medical Association Impairment Guidelines for the assessment of
permanent and total claims after the first two years of total disability
compensation payments and limits indemnity benefits to an additional 500 weeks
for workers who are not at least 50% disabled (as measured by those guidelines);
(ii) contains certain Social Security and pension benefit offsets; (iii) further
increases the time frame for directed medical treatment; (iv) addresses certain
inequities in the average weekly wage calculation; (v) increases the ability
of employers to demonstrate that injured workers have earning capacity and (vi)
facilitates the use of full and final settlements of employers' workers'
compensation obligations on particular claims.
To date, Act 44 has had a favorable impact on medical loss costs in
Pennsylvania and Act 57 has had a favorable impact on indemnity loss costs. In
recognition of these developments, in the respective first years following the
enactments of Act 44 and Act 57, the average manual rate level in Pennsylvania
decreased approximately 10% in 1994 and approximately 25% in 1997. The benefit
reforms, management's re-underwriting of the Property and Casualty Group's book
of business and the use of loss-sensitive and alternative market products have
had a favorable impact on the Property and Casualty Group's accident year loss
ratios, as evidenced by the table below:
Property and Casualty Group's Workers' Compensation Undiscounted Accident Year
------------------------------------------------------------------------------
Pure Loss Ratios as of December 31, 1997
----------------------------------------
Accident
Year Loss Ratio
---- ----------
1990 100%
1991 86%
1992 80%
1993 64%
1994 64%
1995 63%
1996 63%
1997 66%
Workers' Compensation Products
The Property and Casualty Group offers a variety of workers' compensation
products to its customers. Certain of these products are based on rates filed
and approved by state insurance departments ("rate-sensitive products"), while
others are priced to a certain extent on the basis of the insured's own loss
experience ("loss-sensitive products"). In the last five years, the Property
and Casualty Group has also developed and sold large deductible products and
other programs and services to customers who agree to assume an even greater
exposure to loss than under more traditional loss-sensitive products
("alternative market products"). The Property and Casualty Group decides which
type of product to offer a customer based upon the customer's needs and the
underwriting review. See "Underwriting." Set forth below is percentage
information on the voluntary workers' compensation direct premiums written by
product type for the policy years indicated:
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<PAGE>
<TABLE>
<CAPTION>
1998(1) 1997 1996 1995 1994 1993 1992 1991 1990
------- ----- ----- ----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Rate-sensitive products 64% 62% 57% 52% 50% 54% 53% 54% 60%
Loss-sensitive products 28% 27% 30% 34% 39% 40% 46% 46% 40%
Alternative market products 8% 11% 13% 14% 11% 6% 1% 0% 0%
---- ---- ---- ---- ---- ---- ---- ---- ----
Total 100% 100% 100% 100% 100% 100% 100% 100% 100%
==== ==== ==== ==== ==== ==== ==== ==== ====
</TABLE>
- ------------------------------------
(1) 1998 data is through June 30, 1998.
Rate-Sensitive Workers' Compensation Products
Rate-sensitive products include fixed-cost policies and dividend paying
policies. The premium charged on a fixed-cost policy is based upon the manual
rates filed with and approved by the state insurance department and does not
increase or decrease based upon the losses incurred during the policy period.
Under policies that are subject to dividend plans, the customer may receive a
dividend based upon loss experience during the policy period. With the enactment
of regulatory reform in several states in which the Property and Casualty Group
does business, the Property and Casualty Group has become more interested in
this type of business and increased its writings of rate-sensitive accounts in
such jurisdictions in 1997 and 1998.
Loss-Sensitive Workers' Compensation Products
The Property and Casualty Group's loss-sensitive products adjust the amount
of the insured's premiums after the policy period expires based upon the
insured's actual losses incurred during the policy period. These loss-sensitive
products are generally subject to less price regulation than rate-sensitive
products and reduce, but do not eliminate, risk to the insurer. Under these
types of policies, claims professionals and actuaries periodically evaluate the
reserves on losses after the policy period expires to determine whether
additional premiums or refunds are owed under the policy. Such policies are
typically open for adjustments for an average of five years after policy
expiration. The Property and Casualty Group generally restricts such loss-
sensitive products to accounts developing annual minimum premiums in excess of
$100,000.
Alternative Market Workers' Compensation Products
Since 1992, the Property and Casualty Group has developed a variety of
alternative market products for larger accounts, including large deductible
policies and offshore captive programs. Typically, the Property and Casualty
Group receives a lower up-front premium for these types of alternative market
product plans. However, under this type of business, the insured retains a
greater share of the underwriting risk than under rate-sensitive or loss-
sensitive products, which reduces the potential for unfavorable claim activity
on the accounts and encourages loss control on the part of the insured. For
example, under a large deductible policy, the customer is responsible for paying
its own losses up to the amount of the deductible for each occurrence. The
deductibles under such policies generally range from $250,000 to $1.0 million.
In addition to these products, the Property and Casualty Group
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<PAGE>
offers certain workers' compensation services to its clients unbundled from the
insurance products. See "PMA Management Corp."
PMA One
In 1997, the Property and Casualty Group developed PMA One, a new product
that provides for group integrated occupational and non-occupational disability
coverages. The Property and Casualty Group believes that it can be successful
in this product line as it will utilize its expertise in managed care to reduce
disability periods. The Property and Casualty Group recorded premiums of $1.1
million for the six months ended June 30, 1998 for PMA One.
Workers' Compensation Residual Market Business
Workers' compensation insurers doing business in certain states are
required to provide insurance for risks which are not otherwise written on a
voluntary basis by the private market ("residual market business"). This system
exists in all of the states in which the Property and Casualty Group does
business, except Pennsylvania and Maryland. In these two states, separate
governmental entities write all of the workers' compensation residual market
business. In 1997, the Property and Casualty Group wrote $5.2 million of
residual market business, which constituted approximately 3% of its voluntary
net workers' compensation premiums written. The Property and Casualty Group
wrote $1.6 million of residual market business for the six months ended June 30,
1998 compared to $2.5 million for the six months ended June 30, 1997. Based upon
data for policy year 1997 reported by the National Council on Compensation
Insurance, the percentage for the industry as a whole, in all states, was 9.7%.
Commercial Lines
The Property and Casualty Group writes property and liability coverages for
larger and middle market accounts that satisfy its underwriting standards. See
"Underwriting" below. These coverages feature package, umbrella and commercial
automobile business. During the present soft market, prices for commercial
coverages have been particularly competitive. The Property and Casualty Group
intends to continue offering these products, but generally only if they support
the core workers' compensation business. As a result, the Property and Casualty
Group has been selectively non-renewing accounts that do not meet its
underwriting standards. In addition, effective January 1, 1997, the Property
and Casualty Group has reduced its retention on commercial casualty lines of
business to $175,000 per risk from $500,000 per risk. See "The Company's
Reinsurance Ceded" below.
Home Office and Field Operations
As of June 30, 1998, approximately 230 employees worked in the home office
located in Blue Bell, Pennsylvania, and approximately 660 employees were
assigned to field offices located throughout the states in which the Property
and Casualty Group does business.
Senior executives, financial operations, management information systems,
human resources, actuarial services and legal services are headquartered in the
home office. The
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<PAGE>
definition of overall underwriting standards and major account and alternative
market underwriting support also take place in the home office. The home office
works in conjunction with senior managers from the field to establish the
Property and Casualty Group's business plan and underwriting standards, which
are then implemented by the field organization.
The field organization currently consists of three regional offices in
Valley Forge, Pennsylvania, Harrisburg, Pennsylvania and Richmond, Virginia, as
well as branch offices in each of Georgia, Maryland, New Jersey, Pennsylvania,
Virginia and North Carolina. In addition, the Property and Casualty Group
operates smaller satellite offices in Ohio and New York. The branch offices
deliver a full range of services directly to customers located in their service
territory, and the satellite offices offer primarily underwriting and claim
adjustment services.
Distribution
The Property and Casualty Group distributes its products through
approximately 20 direct sales employees and approximately 240 independent
brokers and agents. The direct sales employees are generally responsible for
certain business located in Pennsylvania. For the year ended December 31, 1997,
these employees produced $39.2 million in direct premiums written, constituting
13% of the Property and Casualty Group's direct written business. For the six
months ended June 30, 1998, these employees produced $16.9 million in direct
premiums written, constituting 12% of the Property and Casualty Group's direct
written business. The brokers and agents write business throughout the
marketing territory. In 1997, the top ten brokers and agents accounted for 28%
of the Property and Casualty Group's business, the largest of which accounted
for not more than 8% of its business. All brokers and agents are required to
submit business to the Property and Casualty Group's underwriting process before
business may be accepted.
The Property and Casualty Group monitors several statistics relating to its
producer force, including the number of years the producer has been associated
with the Property and Casualty Group, the percentage of the producer's business
that is underwritten by the Property and Casualty Group, the ranking of the
Property and Casualty Group within the producer's business, and the
profitability of the producer's business. The distribution network generally
consists of large regional agents and brokers, local agents and national brokers
that specialize in larger to middle market accounts that require the variety of
workers' compensation, commercial lines and alternative market products offered
by the Property and Casualty Group.
Underwriting
Home office underwriters, in consultation with casualty actuaries,
determine the general types of business to be written using a number of
criteria, including past performance, relative exposure to hazard, premium size,
type of business and other indicators of potential loss. The home office
underwriting team also establishes classes of business that the Property and
Casualty Group generally will not write, such as most coastal property
exposures, certain hazardous products and activities and certain environmental
coverages. The home office establishes the overall business goals and the
underwriting authority for each regional and
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branch office. It also identifies specific types of business that must be
referred to home office underwriting specialists and actuaries for individual
pricing; including large accounts over a specified dollar limit and alternative
market workers' compensation products. In 1997, the Property and Casualty Group
changed the reporting structure so that underwriters and risk-control
professionals in the field report functionally to the Chief Underwriting Officer
rather than to branch managers with marketing responsibilities; however,
underwriters also work as a team with the field marketing force to identify
business that meets prescribed underwriting standards and to develop specific
strategies to write the desired business. In performing this assessment, the
field office professionals also consult with actuaries who have been assigned to
the specific field office regarding loss trends and pricing and utilize
actuarial loss rating models to assess the projected underwriting results of
accounts. The Property and Casualty Group's underwriting management averages 22
years of experience in the property and casualty industry.
The Property and Casualty Group also employs credit analysts. These
employees review the financial strength and stability of customers whose
business is written on loss-sensitive and alternative market products and
specify the type and amount of collateral that customers must provide under
these arrangements.
Rehabilitation and Managed Care
The Property and Casualty Group uses a variety of managed care techniques
to reduce costs and losses. Disability management coordinators and point-of-
service case managers, all of whom are registered nurses, work together with
claims professionals to provide expeditious medical and disability management to
injured workers and to investigate injuries. The case managers and
professionals also help employers identify opportunities that allow injured
employees to make a gradual transition to full-time, full-duty jobs. The
Property and Casualty Group also has contracts with First Health Group, Inc. for
most of its marketing territory and with other preferred provider networks
consisting of medical practitioners and hospitals selected for their expertise
in treating injured workers. Specialties include occupational medicine, physical
medicine, orthopedics and neurology. There are also preferred pharmacy networks
to reduce the cost of medication. In addition, the Property and Casualty Group
uses an outside network to check medical bills for accuracy, duplication,
unrelated charges and overcharges. Questionable bills are forwarded to the Cost
Containment Unit, which is staffed by registered nurses and resolves disputed or
suspect charges.
Claims Administration
Claims services are delivered to customers primarily through employees in
the field offices. Certain specialized matters, such as asbestos and
environmental claims, are referred to a special unit in the home office. The
Property and Casualty Group maintains a centralized call center for loss
reporting and has automated and centralized the processing of claims payments in
its Allentown, Pennsylvania facility. This centralization allows the claims
adjusters to reduce substantially the time that they spend with clerical and
repetitive functions. The Property and Casualty Group also employs in-house
attorneys who represent customers in workers' compensation cases and other
insurance matters.
The Property and Casualty Group has a separate, anti-fraud unit that
investigates suspected false claims and other irregularities and cooperates with
regulatory and law enforcement officials in prosecuting violators.
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PMA Management Corp.
PMA Management Corp. offers claims, risk management and related services
primarily to self-insureds on an unbundled basis. In addition, PMA Management
Corp. offers "rent-a-captive" products for certain insureds and associations.
The purpose of a rent-a-captive program is to offer a customer an alternative
method of managing its loss exposures by obtaining many of the benefits of a
captive insurer without establishing and capitalizing its own captive; in
effect, the insured is "renting" a captive facility that the Company has already
established. Under this arrangement, the client purchases an insurance policy
from the Pooled Companies and chooses a participation level. The Pooled
Companies then cede this portion of the premium and loss exposures to a Bermuda
subsidiary of PMC. The client participates in the loss and investment
experience of the portion ceded to the Bermuda subsidiary through a dividend
mechanism. The client is responsible for any loss that may arise within its
participation level, and such potential obligation is typically secured through
a letter of credit or similar arrangement. The Company's principal sources of
income from its rent-a-captive program are the premium income on the excess risk
retained by the Pooled Companies and captive management fees earned by PMA
Management Corp.
Run-off Operations
As a part of the Property and Casualty Group's 1996 restructuring plan, the
Property and Casualty Group established the Run-off Operations principally to
manage the capital supporting workers' compensation loss reserves from accident
years 1992 and prior. Such reserves primarily relate to the period of time from
1987 to 1991 when the Property and Casualty Group wrote a much higher volume of
business and experienced poor underwriting results. The reserves are mainly
indemnity related and are relatively mature. The Run-off Operations consist of
PMA Cayman, MASCCO and PMA Life.
MASCCO is a Pennsylvania insurance company and a wholly owned subsidiary of
the Company. Prior to December 31, 1996, MASCCO was a party to a pooling
agreement with the Pooled Companies. Effective December 31, 1996, and with the
approval of the Pennsylvania Insurance Commissioner MASCCO withdrew from the
pooling agreement and ceased writing any new business. The Pooled Companies also
ceded to MASCCO the indemnity portion of Pennsylvania workers' compensation
claims for accident years 1991 and prior. Pursuant to a surplus maintenance
agreement between PMC and the Pennsylvania Insurance Commissioner, MASCCO is
required to discount its reserves utilizing a rate of not more than 5%, maintain
a reserve to surplus ratio not in excess of 8 to 1 and continue to invest its
assets only in investment grade securities. At June 30, 1998, MASCCO had $97.0
million in total assets and $80.1 million in total reserves and its reserve to
surplus ratio was 5 to 1. Substantially all of MASCCO's assets are held in trust
for the benefit of the Pooled Companies.
PMA Cayman was incorporated in Grand Cayman, and had no material operations
until 1996. In 1996, the Pooled Companies ceded to PMA Cayman substantially all
of their remaining liability for workers' compensation claims for accident years
1991 and prior. In 1997, the Pooled Companies also ceded to PMA Cayman a
portion of their workers' compensation reserves from accident years 1992 to
1996. At June 30, 1998, PMA Cayman had $233.0 million in total assets and
$215.5 million in total reserves. Substantially all of PMA
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Cayman's assets are held in trust for the benefit of the Pooled Companies. The
Company entered into a letter of intent to sell PMA Cayman. The transaction is
subject to the customary closing conditions, including regulatory approvals, and
is expected to be completed in the third quarter of 1998. In connection with the
announced sale, the Company recorded a $2.4 million pre-tax loss in the second
quarter, which is included in "Net Realized Investment Gains."
PMA Life is a Pennsylvania life insurance company that derived all of its
insurance revenues from intercompany structured settlement annuity transactions
with the Pooled Companies. In 1997, the Property and Casualty Group reinsured
substantially all of PMA Life's insurance liabilities with a third party
reinsurer and the Property and Casualty Group no longer places insurance
business with PMA Life. At June 30, 1998, PMA Life had assets of $22.9 million
and $17.7 million in total reserves.
The following table reflects the components of the Property and Casualty
Group -- Run-off Operations' operating results for the six months ended June 30,
1998 and 1997 and for the year ended December 31, 1997:
(dollar amounts in thousands)
Year
Six Months Ended Ended
June 30, December 31,
-------------- ------------
1998 1997 1997
---- ---- ----
Net investment income.................. $11,303 $14,972 $28,131
Net premiums earned(1)................. -- 814 (51,622)
------- ------- --------
Total operating revenues............... $11,303 15,786 (23,491)
------- ------- --------
Losses and LAE incurred................ 9,401 15,097 (27,460)
Operating expenses..................... 1,474 1,796 4,042
------- ------- --------
Total expenses......................... $10,875 $16,893 $(23,418)
------- ------- --------
Pre-tax operating income (loss)........ $428 $(1,107) $(73)
======= ======= ========
- ----------------------------
(1) Amount represents net premiums earned during the first six months of 1997
for PMA Life prior to the reinsurance transaction mentioned above, after
which PMA Life was placed into run-off.
Caliber One
In 1997, the Company established a specialty insurance operation, Caliber
One. In starting Caliber One, the Company's intention was to expand PMC's
access to the insurance market by offering products and marketing to classes of
business in which neither PMA Re nor the Property and Casualty Group were
involved. The Company has hired an experienced senior underwriting professional
to be the Chief Operating Officer of this unit as well as other individuals with
experience in underwriting and claims management for specialty insurance. See
"Management."
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<PAGE>
Products, Underwriting and Distribution
Caliber One's present focus is on excess and surplus lines of insurance for
difficult risks that are typically declined by the standard market. Caliber One
offers liability coverages for low frequency/high severity classes, including
pharmaceuticals, chemicals, machinery manufacturers, toy makers, medical product
manufacturers and other difficult-to-insure product liability risks. In
addition, Caliber One markets environmental impairment liability coverages,
clinical trials coverage for emerging biotechnology products and intellectual
property rights liability coverages as well as property coverages for
unprotected and vacant buildings. Caliber One's policy forms contain
appropriate and flexible manuscript endorsements and exclusions, and in some
cases, will contain defense costs within the policy limits rather than offering
such coverage on an unlimited basis. Through June 30, 1998, Caliber One had
$1.6 million and $917,000 in gross premiums and net premiums written,
respectively.
The underwriting of these specialty products involves a significant amount
of judgment. The senior underwriters that Caliber One has hired have a
significant amount of experience in dealing with esoteric high severity risks,
and average 16 years of specialty insurance experience. The underwriting
process involves reviewing the claim experience of an account, if any, the claim
experience of the particular class or similar classes and responding to special
risks that an account has through the use of policy features that can be changed
for the circumstances, such as retentions, exclusions and endorsements. Caliber
One's underwriting teams for casualty products have been divided into three
regions within the United States, each led by a regional underwriting vice
president who reports to the Chief Operating Officer. For property products,
one underwriting team supports the activities of the three regions.
Caliber One distributes its excess and surplus lines products on a
nationwide basis through approximately 30 appointed surplus lines brokers. For
most product offerings, Caliber One does not grant underwriting or binding
authority to its brokers.
Acquisition of Caliber One Indemnity Company
In December 1997, PMA Re acquired 100% of the common stock of a Delaware
domiciled insurance company which it renamed Caliber One Indemnity Company. PMA
Re paid $16.0 million to acquire the company and made an $11.3 million capital
contribution to bring Caliber One Indemnity Company's statutory surplus to $25.0
million, the minimum surplus level required by several states to be an
authorized excess and surplus lines carrier. Caliber One Indemnity Company was
essentially a shell company, as affiliates of the former parent had taken over
the business that had been previously written. In addition, an affiliate of the
former parent entered into a reinsurance transaction immediately prior to the
acquisition whereby such company assumed all of the Company's existing loss
reserves and is providing protection against adverse loss reserve development
and uncollectible reinsurance of up to $68.5 million. Also, PMA Re has entered
into a surplus maintenance agreement with Caliber One Indemnity Company whereby
PMA Re will maintain Caliber One Indemnity Company's statutory surplus such that
the amount is not less than $25.0 million and so that the net premiums written
to surplus ratio does not exceed 1.0 to 1.0.
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Caliber One Indemnity Company is presently authorized as an excess and
surplus lines carrier in 38 states, and it is management's intention to be
authorized in 49 states so that products can be offered on a national basis.
Caliber One Indemnity Company has obtained an "A" (Excellent) rating from A.M.
Best.
The Company's Reinsurance Ceded
The Company follows the customary insurance practice of reinsuring with
other insurance companies a portion of the risks under the policies written by
the Insurance Subsidiaries. This reinsurance is maintained to protect the
Insurance Subsidiaries against the severity of losses on individual claims and
unusually serious occurrences in which a number of claims produce an aggregate
extraordinary loss. Although reinsurance does not discharge the Insurance
Subsidiaries from their primary maximum liabilities to their policyholders for
the full amount of the losses insured under the insurance policies, it does make
the assuming reinsurer liable to the Insurance Subsidiaries for the reinsured
portion of the risk.
The Insurance Subsidiaries' reinsurance ceded agreements generally may be
terminated at their annual anniversary by either party upon 30 to 90 days'
notice. In general, the reinsurance agreements are of the treaty variety, which
cover all underwritten risks of the types specified in the treaties. Presently,
the maximum gross lines that PMA Re will write are $5.0 million for property
covers, $1.0 million for property catastrophe covers and $7.5 million for
casualty covers. Net retentions on any one claim are $750,000 for property
covers and $1.5 million for casualty covers.
PMA Re maintains property catastrophe retrocession programs in an aggregate
amount of $48.0 million in excess of $2.0 million for multiple claims arising
from two or more risks in a single occurrence or event.
PMA Re also maintains casualty retrocession programs. PMA Re has a
casualty retrocession contract, written on a funds withheld basis, which covers
individual casualty losses and provides low-layer clash protection. For
individual losses, the contract covers $6.0 million in excess of $1.5 million on
a per occurrence basis. The contract has clash limits for losses arising from
two or more risks of $1.3 million in excess of $1.5 million. The term of the
contract is three years, and the term aggregate limit is $25.0 million plus the
amount of funds withheld.
In addition to the above programs, PMA Re maintains casualty clash
protection of $17.5 million in excess of $2.8 million per occurrence.
Effective January 1, 1998, PMA Re's workers' compensation program was
modified to include coverage of $98.0 million excess of $2.0 million per
occurrence, $98.5 million excess of $1.5 million per program per occurrence and
$18.5 million excess of $1.5 million per person per occurrence.
The Property and Casualty Group has its own ceded reinsurance program, and
carries excess-of-loss per occurrence reinsurance for $103.5 million over a net
retention of $1.5 million on workers' compensation. The Property and Casualty
Group also carries excess-of-loss per risk reinsurance for $4.8 million ($49.8
million per occurrence) over a net retention of $175,000
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on other casualty lines; $2.0 million on automobile physical damage and $19.5
million ($48.5 million per occurrence) on property claims over its combined net
retention of $500,000. A property catastrophe program with a per occurrence
limit of $27.7 million in excess of an $850,000 retention is maintained to
provide protection for multiple property losses involved in one occurrence. The
Property and Casualty Group also maintains reinsurance protection for its
umbrella risks at $9.0 million over a net retention of $1.0 and purchases
facultative reinsurance for certain other risks.
Effective January 1, 1998, Caliber One maintains reinsurance protection of
$4.5 million excess of $500,000 per policy. For primary coverages, the
reinsurance is written on an excess of loss basis, and for excess coverages, the
reinsurance is written on a surplus share basis. Caliber One Indemnity Company
is also reinsured by an affiliate of its former parent relating to all business
written prior to its acquisition by PMA Re in December 1997.
The Company actively manages its exposure to catastrophic events. In the
underwriting process, the Company generally minimizes the accumulation of
insurable values in catastrophe prone regions. Also, in writing property
reinsurance coverages, PMA Re typically requires per occurrence loss limitations
for contracts that could have catastrophe exposure. Through per risk
reinsurance, the Company also manages its net retention in each exposure. As a
result, the Company's loss ratios have not been significantly impacted by
catastrophes, and management believes that the Company has adequate reinsurance
to protect against the estimated probable maximum gross loss from a catastrophic
event; however, an especially severe catastrophic event could exceed the
Company's reinsurance and retrocessional protection and materially adversely
impact the Company's financial position.
The Company performs extensive credit reviews on its reinsurers, focusing
on, among other things, financial capacity, stability, trends and commitment to
the reinsurance business. Prospective and existing reinsurers failing to meet
the Company's standards are excluded from the Company's reinsurance programs.
In addition, the Company requires letters of credit to support balances due from
reinsurers not authorized to transact business in the applicable jurisdictions.
Loss Reserves
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 the insurer and the insurer's payment of that loss. Liabilities for
reinsurers generally become known more slowly than for primary insurers and are
generally subject to more unforeseen development.
To recognize liabilities for unpaid losses, insurers establish reserves,
which are balance sheet liabilities representing estimates of future amounts
needed to pay claims with respect to insured events which have occurred,
including events that have not been reported to the insurer. Reserves are also
established for LAE representing the estimated expenses of settling claims,
including legal and other fees, and general expenses of administering the claims
adjustment process.
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When a claim is reported, claims personnel establish a case reserve for the
estimated amount of the ultimate payment. The estimate reflects the informed
judgment of such personnel, based on general corporate reserving practices and
the experience and knowledge of such personnel regarding the nature and value of
the specific type of claim. Reserves are also established on an aggregate basis
to provide for losses incurred but not yet reported to the insurer, for the
overall adequacy of case reserves and the estimated expenses of settling claims.
Such reserves are estimated using various generally accepted actuarial
techniques.
As part of the reserving process, historical data is reviewed and
consideration is given to the anticipated impact of various factors such as
legal developments, changes in social attitudes and economic conditions,
including the effects of inflation. This process relies on the basic assumption
that past experience, adjusted for the effect of current developments and likely
trends, is an appropriate basis for predicting future events. The reserving
process provides implicit recognition of the impact of inflation and other
factors affecting claims payments by taking into account changes in historic
payment patterns and perceived probable trends. There is generally no precise
method, however, for subsequently evaluating the adequacy of the consideration
given to inflation or to any other specific factor, since the eventual
deficiency or redundancy of reserves is affected by many factors, some of which
are interdependent.
Estimating the Company's ultimate claims liability is necessarily a complex
and judgmental process as the amounts are based on management's informed
estimates and judgments using data currently available. As additional
experience and data become available regarding claims payment and reporting
patterns, legislative developments and economic conditions, the estimates are
revised accordingly. If the Company's ultimate net losses prove to be
substantially greater than the amounts recorded in the financial statements, the
related adjustments could have a material adverse impact on the Company's
financial condition and results of operations.
The components of the Company's incurred losses and LAE for prior accident
years as of December 31, 1997, 1996 and 1995 excluding accretion of discount,
are as follows (favorable loss reserve development is denoted by the bracketed
figures):
(dollar amounts in millions)
Year Ended December 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
PMA Re............................ $(32.1) $(35.3) $(15.0)
The Property and Casualty Group:
Workers' compensation........... (44.1) 110.0 54.7
Asbestos and environmental...... -- 60.4 23.4
Other losses and LAE............ 5.0 21.0 (11.6)
------ ------ ------
Total........................... (39.1) 191.4 66.5
------ ------ ------
Other............................. (14.8) -- --
------ ------ ------
Total............................. $(86.0) $156.1 $ 51.5
====== ====== ======
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In 1997, the Company had favorable loss and LAE development of $86.0
million, of which $51.8 million had offsetting impacts to earned premiums. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." The Company's losses and LAE were impacted by significant loss
reserve strengthening for the Property and Casualty Group in 1996, partially
offset by favorable development for PMA Re.
In 1997, the Property and Casualty Group recorded a reserve release of
approximately $53.9 million on prior year losses and LAE, excluding the
accretion of discount. The release primarily arises from favorable reserve
development of $9.0 million related to retrospectively rated policies for
accident years 1991 and prior and favorable development of $28.0 million arises
from retrospectively rated policies pertaining to accident years 1992 through
1996. The Property and Casualty Group also recorded favorable development on
guaranteed cost workers' compensation reserves for accident years 1991 and prior
of $7.1 million, partially offset by reserve strengthening in commercial multi-
peril business for accident year 1996 of $5.0 million. Furthermore, incurred
losses on prior accident years were also affected by the cession of prior year
reserves included in the PMA Life transaction of $14.8 million. In 1996 and
1995, the loss ratio included $191.4 million and $66.5 million, respectively, of
strengthening of unpaid losses and LAE of prior accident years.
The following table shows the composition of changes in the reserves for
losses and LAE for each of the three years ended December 31, 1997:
(dollar amounts in thousands)
Year Ended December 31,
-------------------------------------
1997 1996 1995
----------- ----------- -----------
Balance at beginning of period.......... $2,091,072 $2,069,986 $2,103,714
Less: Reinsurance recoverable on unpaid
losses and LAE......................... 256,576 261,492 247,856
---------- ---------- ----------
Net balance at beginning of period.... 1,834,496 1,808,494 1,855,858
---------- ---------- ----------
Losses and LAE incurred, net:
Current period........................ 341,880 323,069 357,787
Prior periods......................... (86,006) 156,074 51,491
Accretion of discount (includes
($35,000) effect of the change in the
discount rate for the Property and
Casualty Group's workers'
compensation unpaid losses from 4% to
5% in 1995).......................... 51,407 57,480 13,300
---------- ---------- ----------
Total losses and LAE incurred, net...... 307,281 536,623 422,578
---------- ---------- ----------
Losses and LAE paid, net:
Current period........................ (72,399) (72,194) (71,126)
Prior periods......................... (398,475) (438,427) (398,816)
---------- ---------- ----------
Total losses and LAE paid, net:......... (470,874) (510,621) (469,942)
---------- ---------- ----------
Net balance at end of period............ 1,670,903 1,834,496 1,808,494
Reinsurance recoverable on unpaid
losses and LAE......................... 332,284 256,576 261,492
---------- ---------- ----------
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Balance at end of period................ $2,003,187 $2,091,072 $2,069,986
========== ========== ==========
The following table shows how the Company's losses have been paid and
reserves re-estimated over time compared to the liability initially estimated:
Consolidated Loss and Loss Adjustment Expense Development
<TABLE>
<CAPTION>
(dollar amounts in millions)
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
------ ------ ------ ------ ------ ------ ------ ------ ------ ------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Initial estimated liability
for unpaid losses and
LAE net of reinsurance
recoverables................... $1,246 $1,457 $1,632 $1,735 $1,824 $1,941 $1,932 $1,856 $1,809 $1,835 $1,671
Amount of reserve paid,
net of reinsurance through:
- - one year later............... 305 322 445 471 491 442 408 399 438 399 ---
- - two years later.............. 504 601 772 842 849 779 746 764 780
- - three years later............ 692 826 1,043 1,134 1,127 1,067 1,056 1,073
- - four years later............. 834 1,011 1,258 1,353 1,365 1,329 1,331
- - five years later............. 956 1,166 1,421 1,539 1,585 1,574
- - six years later.............. 1,063 1,284 1,553 1,715 1,789
- - seven years later............ 1,143 1,380 1,685 1,882
- - eight years later............ 1,214 1,479 1,817
- - nine years later............. 1,288 1,584
- - ten years later.............. 1,367
Reestimated liability, net of
reinsurance as of:
- - one year later............... 1,280 1,468 1,696 1,795 1,967 1,998 1,932 1,907 1,965 1,749 ---
- - two years later.............. 1,304 1,512 1,743 1,950 2,068 2,007 1,983 2,073 1,867
- - three years later............ 1,339 1,553 1,876 2,034 2,082 2,061 2,164 1,987
- - four years later............. 1,359 1,607 1,938 2,041 2,135 2,258 2,078
- - five years later............. 1,368 1,652 1,935 2,123 2,302 2,170
- - six years later.............. 1,391 1,649 1,985 2,273 2,209
- - seven years later............ 1,393 1,684 2,098 2,205
- - eight years later............ 1,425 1,784 2,052
- - nine years later............. 1,504 1,752
- - ten years later.............. 1,485
Indicated deficiency
(redundancy)................... $ 239 $ 294 $ 420 $ 471 $ 385 $ 229 $ 146 $ 131 $ 58 $ (86) $ --
Net liability - December 31.... $1,932 $1,856 $1,809 $1,835 $1,671
Reinsurance recoverables....... 219 248 262 257 332
Gross liability - December 31.. $2,151 $2,104 $2,070 $2,091 $2,003
Reestimated net liability...... $2,078 $1,987 $1,867 $1,749 $1,671
Reestimated reinsurance
recoverables.................. 178 221 254 251 332
Reestimated gross liability.... $2,256 $2,208 $2,120 $1,999 $2,003
</TABLE>
The columns in the above exhibit are not mutually exclusive. For example,
if a reserve established in 1987 for a claim incurred during that year had been
re-estimated during 1989, the re-estimate would be reflected in the table for
each of the statement years from 1987 and 1988 during calendar years 1989
through 1997. Conditions and trends that have affected the reserve development
reflected in the table may change and care should be exercised in making
conclusions about the relative adequacy of reserves from such development.
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<PAGE>
The 1996 aggregate workers' compensation adverse development was allocated
$102.0 million to Pennsylvania and $8.0 million to all other states in which the
Company's does business. Of the $102.0 million, the allocation by year is as
follows: prior to 1987: $16.0 million; 1987 to 1991: $101.0 million and 1992 and
subsequent years: ($15.0 million). In 1995, substantially all of the workers'
compensation adverse development related to accident years 1987 to 1991 in
Pennsylvania. For accident years prior to 1992, the traditional paid loss
development schedules for workers' compensation had begun to exhibit an
increasing trend in loss development factors by 1993. This trend was initially
attributed to an increase in commutation activity. In 1995, management began to
question whether loss data was developing in a manner that was consistent with
the conclusion that the loss development trends were impacted solely by
commutation activity. As a result, management began to accumulate additional
data in order to determine whether there were additional causes of the increase
in the paid loss development data, and management obtained claim count data that
was far more detailed than had been historically utilized in the reserve setting
process. This data indicated that the paid loss development factors were not
only impacted by commutation activity, but also by a decline in the claims
closure rate in Pennsylvania. Management believes that the decline of the
closure rates was due to several interrelated factors. One factor related to
the fact that efforts to rehabilitate claimants and return them to work were not
as successful as anticipated. For accident years 1987 to 1991, in particular,
extensive efforts were made by the Company to rehabilitate claimants and return
them to work at either full or modified duty. By late 1995 and into 1996, it
was recognized by a review of a slow down in the claims closure pattern that
these rehabilitation efforts were not impacting the closure rates as expected.
Another factor negatively impacting claims closure rates related to the economic
conditions in Pennsylvania in the early 1990's. During the period from 1990 to
1994, economic conditions in Pennsylvania were considered to be depressed in the
Company's major industry niches for workers' compensation insurance
(construction and heavy manufacturing). Payrolls in these industries were
stagnant, and in many cases, employment was flat or declining. The Company
believes that in periods of declining employment opportunities, there is a
tendency for indemnity periods to increase, which occurred for workers who
suffered injuries in these industries.
The above factors, when considered with the fact that the benefits period
in Pennsylvania was unlimited, caused the Company to believe that a substantial
portion of claimants from the pre-1992 period, who had already been out of work
five to nine years, would not return to work in any capacity. In late 1995 and
during 1996, management undertook an effort to quantify the impact of the
declining closure rates versus the increase in commutation activity. During the
fourth quarter of 1995, management strengthened the Property and Casualty
Group's workers' compensation reserves by $54.7 million; however, the
quantification of the effect of the claims closure rate was an extremely complex
process and as such, the data was not fully understood at that time. As the
data under analysis was more mature and refined in 1996, management determined
that the workers' compensation loss reserves for Pennsylvania in the pre-1992
accident years needed to be increased substantially; therefore, the Property and
Casualty Group increased its workers' compensation reserves by $110.0 million.
Benefit reforms enacted by states in which the Property and Casualty Group
transacts business, most significantly Pennsylvania, have had a beneficial
impact on more recent accident year loss ratios. Prior to 1996, the principal
revisions of the Pennsylvania system
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<PAGE>
included medical cost containment measures and an expansion of the period of
time during which the insurer may require an employee to accept medical
treatment from the employer's list of designated health care providers. In July
1996, Pennsylvania enacted Act 57, a workers' compensation reform bill which is
expected to reduce substantially indemnity benefit periods in Pennsylvania. In
addition to regulatory reforms, the loss ratios have been favorably impacted by
the conversion to loss-sensitive and alternative market products. Such a trend
is evidenced by the fact that accident year pure loss ratios (losses recorded
for the year in which the event occurred expressed as a percentage of the earned
premiums for that year) for workers' compensation have been generally lower in
more recent accident years, as the following chart indicates:
Property and Casualty Group's Workers' Compensation Undiscounted Accident Year
------------------------------------------------------------------------------
Pure Loss Ratios as of December 31, 1997
----------------------------------------
Accident Years Loss Ratios
-------------- -----------
1990 100%
1991 86%
1992 80%
1993 64%
1994 64%
1995 63%
1996 63%
1997 66%
In addition, management took several steps to reduce the outstanding claims
associated with the Pennsylvania workers' compensation business written through
1991. A formal commutation program was initiated in the fourth quarter of 1996
and continued into late 1997. Commutations are agreements with claimants whereby
the claimants, in exchange for a lump sum payment, release their rights to
future indemnity payments from the Property and Casualty Group. Under
Pennsylvania workers' compensation laws, the claimant and the Pennsylvania
Workers' Compensation Board must approve all such commutation arrangements. The
Property and Casualty Group paid $101.1 million and $17.8 million in 1997 and
the fourth quarter of 1996, respectively, to commute workers' compensation
indemnity claims. Savings associated with these claims were consistent with
management's expectations. The number of open claims for accident years 1991
and prior was substantially reduced as a result of the commutation program.
This reduction in open claims is expected to reduce the possibility of any
further adverse development on such reserves, although there can be no assurance
that the level of commutations will have a significant impact on the future
development of such reserves.
Estimating reserves for workers' compensation claims can be more difficult
than many other lines of property and casualty insurance for several reasons,
including (i) the long payment "tail" associated with the business; (ii) the
impact of social, political and regulatory trends on benefit levels for both
medical and indemnity payments; (iii) the impact of economic trends and (iv) the
impact of changes in the mix of business. At various times, one or a
combination of such factors can make the interpretation of actuarial data
associated with workers' compensation loss development more difficult, and it
can take additional time to recognize changes in loss development patterns.
Under such circumstances, adjustments will
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<PAGE>
be made to such reserves as loss patterns develop and new information becomes
available and such adjustments may be material.
The adverse development in reserves associated with asbestos and
environmental claims is the result of a detailed analysis completed in 1996 of
loss and LAE reserves associated with asbestos and environmental liability
claims. The reserving for asbestos and environmental claims has undergone
change at both the Company and in the insurance industry in general. For
environmental and asbestos liability claims, reserving methodology has been
evolving into accepted industry practice in the recent past. The Company's
actuaries were able to apply these methods to the Company's loss reserves in
1997 and 1996. To reserve for environmental claims, the Company currently
utilizes a calendar year development technique known as aggregate loss
development. This technique focuses on the aggregate losses paid as of a
particular date and aggregate payment patterns associated with such claims.
Several elements including remediation studies, remediation, defense,
declaratory judgment and third party bodily injury claims were considered in
estimating the costs and payment patterns of the environmental and toxic tort
losses. Prior to the development of these techniques, there was a substantial
range in the method of reserving for environmental and toxic tort liabilities.
The methods employed by the Company prior to the review performed in 1996
included a review of aggregate loss and loss adjustment paid and case incurred
data along with resulting "survival ratios" to establish IBNR for environmental
and toxic tort claims. For asbestos claims, the Company had previously reserved
costs to defend, and any indemnification payments anticipated on, claims for
which it had received notice that it was a responsible party, plus a bulk factor
applied to the estimated case reserves to provide for potential development of
indemnification and defense cost related to such claims. In 1996, the Company
performed a ground up analysis of asbestos loss reserves using an actuarially
accepted modeling technique. Using historical information as a base and
information obtained from a review of open claims files, assumptions were made
about future claims activity in order to estimate ultimate losses. For each
individual major account, projections were made regarding new plaintiffs per
year, the number of years new claims will be reported, the average loss severity
per plaintiff and the ratio of loss adjustment expense to loss. In many cases
involving larger asbestos claims, the Company reserved up to the policy limits
for the applicable loss coverage parts for the affected accounts. Policy terms
and reinsurance treaties were applied in the modeling of future losses.
Estimation of obligations for asbestos and environmental exposures continues to
be more difficult than for other loss reserves because of several factors,
including: (i) evolving methodologies for the estimation of the liabilities;
(ii) lack of reliable historical claim data; (iii) uncertainties with respect to
insurance and reinsurance coverage related to these obligations; (iv) changing
judicial interpretations and (v) changing government standards.
The Company's asbestos-related loss reserves for the years ended December
31, 1997, 1996 and 1995 were as follows:
(dollar amounts in thousands)
1997 1996 1995
-------- --------- --------
Gross of reinsurance:
Beginning reserves......................... $80,055 $ 27,611 $13,969
Incurred losses and LAE.................... 2,435 62,854 22,482
Calendar year payments for losses and LAE.. (5,764) (10,410) (8,840)
------- -------- -------
Ending reserves............................ $76,726 $ 80,055 $27,611
======= ======== =======
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<PAGE>
Net of reinsurance:
Beginning reserves......................... $53,300 $ 23,443 $ 8,168
Incurred losses and LAE.................... (36) 39,427 21,826
Calendar year payments for losses and LAE.. (4,686) (9,570) (6,551)
------- -------- -------
Ending reserves............................ $48,578 $ 53,300 $23,443
======= ======== =======
The Company's environmental-related loss reserves for the years ended
December 31, 1997, 1996 and 1995 were as follows:
(dollar amounts in thousands)
1997 1996 1995
-------- -------- --------
Gross of reinsurance:
Beginning reserves............................. $35,626 $20,134 $20,952
Incurred losses and LAE........................ 1,130 22,143 3,516
Reserves acquired through purchase of Caliber
One Indemnity Company(1).................... 13,060 -- --
Calendar year payments for losses and LAE...... (4,708) (6,651) (4,334)
------- ------- -------
Ending reserves................................ $45,108 $35,626 $20,134
======= ======= =======
Net of reinsurance:
Beginning reserves............................. $34,592 $20,134 $20,952
Incurred losses and LAE........................ 1,068 21,109 3,516
Calendar year payments for losses and LAE...... (3,965) (6,651) (4,334)
------- ------- -------
Ending reserves................................ $31,695 $34,592 $20,134
======= ======= =======
- ----------------------
(1) Such acquired reserves have been reinsured by an affiliate of the former
parent. See "Caliber One."
Of the total net asbestos reserves, $6.7 million, $6.8 million and $6.7
million related to established claims reserves at December 31, 1997, 1996 and
1995, respectively, and $41.9 million, $46.5 million and $16.7 million related
to IBNR at December 31, 1997, 1996 and 1995, respectively. Of the total net
environmental reserves, $11.2 million, $12.5 million and $10.3 million related
to established claims reserves at December 31, 1997, 1996 and 1995,
respectively, and $20.5 million, $22.1 million and $9.8 million related to IBNR
at December 31, 1997, 1996 and 1995, respectively. All incurred asbestos and
environmental losses were for accident years 1986 and prior.
Management believes that the Property and Casualty Group's reserves for
asbestos and environmental claims are appropriately established based upon known
facts, existing case law and generally accepted actuarial methodologies.
However, due to changing interpretations by courts involving coverage issues,
the potential for changes in federal and state standards for clean-up and
liability and other factors, the ultimate exposure to the Property and Casualty
Group for these claims may vary significantly from the amounts currently
recorded, resulting in a potential future adjustment in the claims reserves
recorded. In addition, issues involving policy provisions, allocation of
liability among participating insurers, proof of coverage and other factors make
quantification of liabilities exceptionally difficult and subject to adjustment
based upon newly available data.
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<PAGE>
In 1996, Commercial Lines experienced reserve strengthening of $21.0
million compared to a reserve release of $11.6 million in 1995. The reserve
strengthening in 1996 was principally due to a re-estimation of loss adjustment
costs associated with general liability claims. Through 1991, the Property and
Casualty Group's mix of general liability insurance policies were weighted
towards the manufacturing classes of business. Subsequent to 1991, the Property
and Casualty Group's mix of business became more heavily weighted towards the
construction and contracting classes of business. These particular classes of
business have experienced losses due to construction defects and similar matters
that have taken longer to emerge than the classes of business previously written
by the Property and Casualty Group. Defense costs associated with these claims
have also exceeded the original estimate of the Property and Casualty Group's
management, which was based on the patterns of indemnification payments
associated with the earlier classes of business written. When this issue was
discovered, the Property and Casualty Group factored the increased defense costs
and the emergence pattern in determining a more appropriate reserve amount for
loss handling costs. The release of reserves in 1995 was primarily due to
favorable loss experience in commercial automobile business.
Unpaid losses on workers' compensation claims for the Company were
approximately $816.0 million and $1,012.0 million, net of discount of $460.2
million and $514.2 million, at December 31, 1997 and 1996, respectively. The
approximate discount rate utilized was 5.0% at December 31, 1997 and 1996. In
1995, the Property and Casualty Group's domestic insurance subsidiaries changed
the discount rate with respect to their workers' compensation unpaid losses from
approximately 4% to 5% for SAP and GAAP purposes. This change was approved and
is permitted by the Pennsylvania Insurance Department. The effect on losses
incurred in 1995 was a reduction of $35.0 million. Loss reserves on other lines
of business as well as reserves for LAE for all lines of business are not
discounted.
For the six-month period ended June 30, 1998 and 1997, respectively,
accretion of discount amounted to $14.4 million and $23.8 million. As of June
30, 1998, the total discount was approximately $437.0 million, comprised as
follows: the Pooled Companies, $114.6 million; MASCCO, $55.4 million, PMA
Cayman, $226.2 million; other Property and Casualty Group entities, $6.5 million
and PMA Re, $34.3 million.
PMA Re has reported net favorable development of unpaid losses and LAE of
$23.3 million in 1997, $28.6 million in 1996 and $15.0 million in 1995. Such
favorable development is attributable to losses emerging at a lower rate than
was anticipated when the initial accident year reserves were established.
At December 31, 1997, the Company's loss reserves were stated net of $59.9
million of salvage and subrogation, of which $50.8 million related to the
Property and Casualty Group, which was comprised of $46.0 million related to
workers' compensation and $4.8 million related to Commercial Lines. The
anticipated salvage and subrogation was $9.1 million for PMA Re. Incurred
salvage and subrogation (increased) reduced losses and LAE by ($18.5) million,
($0.6) million and $9.5 million in 1997, 1996 and 1995, respectively. The
Company's policy with respect to estimating the amounts and realizability of
salvage and subrogation is to develop accident year schedules of historic paid
salvage and subrogation by line of business, which are then projected to an
ultimate basis using actuarial projection techniques.
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<PAGE>
The anticipated salvage and subrogation is the estimated ultimate salvage and
subrogation less any amounts received by the Company. The realizability of
anticipated salvage and subrogation is reflected in the historical data that is
used to complete the projection, as historic paid data implicitly considers
realization and collectibility.
Recent Developments
PMA Re and the Property and Casualty Group posted favorable loss reserve
development during the six-month period ended June 30, 1998 of $8.3 million and
1.7 million ($1.5 million excluding Run-off Operations), respectively.
PMA Re's favorable loss reserve development is attributable to losses
emerging at a lesser rate than was expected when the reserves for the applicable
accident years were established, resulting in downward revisions of loss reserve
estimates.
The favorable development of the Property and Casualty Group's loss
reserves is primarily attributable to recently established programs to control
medical costs further and reductions in LAE for workers' compensation. Medical
costs have improved primarily due to the Property and Casualty Group's
affiliation with a national preferred provider organization, which became
effective January 1998. This affiliation has enabled the Property and Casualty
Group to lower its cost in providing medical benefits to injured workers. Loss
adjustment expenses have decreased primarily due to continued use of certain
claims resolution practices. By using techniques such as managed care and
commutations, the Property and Casualty Group has reduced the amount and number
of outstanding claims and the amount of time that a claim remains open, which in
turn has lowered costs associated with managing open claims.
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<PAGE>
Competition
The domestic property and casualty insurance and reinsurance industries are
very competitive and consist of many companies, with no one company dominating
the market. In addition, the degree and nature of competition varies from state
to state for a variety of reasons, including the regulatory climate and other
market participants in each state. In addition to competition from other
insurance companies, the Property and Casualty Group and Caliber One compete
with certain alternative market arrangements, such as captive insurers, risk-
sharing pools and associations, risk retention groups, and self-insurance
programs. PMA Re competes with other reinsurers in the brokered market as well
as reinsurers that directly underwrite reinsurance business. Many of the
Company's competitors are larger and have greater financial resources than the
Company.
The main factors upon which entities in the Company's markets compete are
price, service, product capabilities and financial security. The Property and
Casualty Group, PMA Re and Caliber One attempt to price their products in such a
way that the prices charged to their clients are commensurate with the overall
marketplace while still meeting return targets. Given the present soft pricing
environment, competing solely on the basis of price has become increasingly
difficult for the Property and Casualty Group and PMA Re, and both have had to
reject risks submitted and non-renew certain accounts in recent years, as the
market rates for such risks did not provide the opportunity to achieve what
management considers to be an acceptable return.
In terms of service, management maintains service standards to ensure that
clients are satisfied with the products and services provided by the Company.
Such standards have been designed to emphasize prompt turn-around time for
underwriting submissions, access to information, claims handling and the quality
of other services. Management periodically participates in surveys of
intermediaries and clients to gain an understanding of the perceptions of the
Company's service compared to its competitors.
Management attempts to design products that meet the needs of clients in
the Company's markets. In recent years, the Property and Casualty Group has
developed products that reflect the evolving nature of the workers' compensation
market. Specifically,
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<PAGE>
management has increased its focus on rehabilitation and managed care to keep
workers' compensation costs lower for the employers. In addition, the Property
and Casualty Group has introduced and refined alternative market products, as
well as unbundled risk management and claims administration services. See "The
Property and Casualty Group." PMA Re has also expanded its product line in
recent years to satisfy the needs of its client base. Products introduced by PMA
Re in the last two years include facultative reinsurance, finite risk
reinsurance and integrated capital management (which involves providing
reinsurance as well as some type of direct investment in a ceding company). See
"PMA Re." For Caliber One, it is management's intention to design products that
meet the needs of new classes of business and that cover emerging risks. See
"Caliber One." Management continues to review new product opportunities for the
Property and Casualty Group, PMA Re and Caliber One.
For many intermediaries and clients, financial security is measured by the
ratings assigned by independent rating agencies. Therefore, management believes
that the ratings assigned by independent rating agencies, particularly A.M.
Best, are material to the Company's operations. A.M. Best has currently assigned
an "A+" (Superior) rating to PMA Reinsurance Corporation, an "A-" (Excellent)
rating to the Pooled Companies and an "A" (Excellent) to Caliber One Indemnity
Company. A.M. Best's ratings are based on an analysis of an insurance company's
perceived financial strength and its ability to pay obligations to its
policyholders and are not directed toward the protection of investors. No
assurance can be given that PMA Reinsurance Corporation, the Pooled Companies
and Caliber One Indemnity Company can maintain these ratings. The Company is
also presently seeking ratings of its insurance subsidiaries from Standard &
Poor's and Moody's. In addition, there can be no assurance that ratings to be
received from Standard & Poor's and Moody's will not have a detrimental effect
on the Company's competitive position.
Employees
As of June 30, 1998, the Company had 986 full-time employees. None of the
employees of the Company is represented by a labor union and the Company is not
a party to any collective bargaining agreements. The Company considers its
employee relations to be good.
Properties
The Company's headquarters are located in a four story, 110,000 square foot
building in Blue Bell, Pennsylvania. PMA Re's headquarters are located in
78,000 square feet of leased space in Mellon Bank Center, Philadelphia,
Pennsylvania.
Through various wholly owned subsidiaries, the Company also owns and
occupies additional office facilities in three other locations and rents
additional office space for its insurance operations in 15 other locations. The
Company believes that such properties are suitable and adequate for its current
business operations.
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<PAGE>
Legal Proceedings
The Company's insurance subsidiaries are defendants in actions arising out
of their insurance business and from time to time are involved in various
governmental and administrative proceedings. These actions include lawsuits
seeking coverage for alleged damages relating to exposure to asbestos and other
toxic substances and environmental clean-up actions under federal and state law.
In the opinion of management, the resolution of these matters will not have a
material adverse effect on the Company's financial condition, results of
operations or cash flows. See "Business-Loss Reserves" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
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<PAGE>
SUPERVISION AND REGULATION
General
PMA Reinsurance Corporation is licensed or accredited to transact its
reinsurance business in, and is subject to regulation and supervision by 50
states and the District of Columbia. The Pooled Companies are licensed to
transact insurance business in, and are subject to regulation and supervision by
45 states and the District of Columbia. Caliber One Indemnity Company is
licensed in one state and is approved as a surplus lines carrier in 38 states,
Puerto Rico and the District of Columbia. The Company's insurance subsidiaries
are authorized and regulated in all jurisdictions where they conduct insurance
business. Inasmuch as PMA Reinsurance Corporation and the Pooled Companies are
domiciled in Pennsylvania, however, the Pennsylvania Insurance Department
exercises principal regulatory jurisdiction over them, and the Delaware
Insurance Department exercises principal jurisdiction over Caliber One Indemnity
Company. The extent of regulation by the states varies, but in general, most
jurisdictions have laws and regulations governing standards of solvency,
adequacy of reserves, reinsurance, capital adequacy and standards of business
conduct. In addition, statutes and regulations usually require the licensing of
insurers and their agents, the approval of policy forms and related material
and, for certain lines of insurance, including all lines of business written by
the Pooled Companies, the approval of rates. Property and casualty reinsurers
and excess and surplus lines carriers are generally not subject to filing or
other regulatory requirements applicable to primary standard lines insurers with
respect to rates, policy forms or contract wording. The form and content of
statutory financial statements are regulated. State insurance departments in
jurisdictions in which the Company's insurance subsidiaries do business also
conduct periodic examinations of their respective operations and accounts and
require the filing of annual and other reports relating to their financial
condition.
Approximately once every three to five years as part of their routine
regulatory oversight process, state insurance departments conduct detailed
examinations of the books, records and accounts of insurance companies domiciled
in their states. Such examinations are generally conducted in cooperation with
the departments of two or three other states under guidelines promulgated by the
NAIC. The Pennsylvania Insurance Department last issued examinations reports
for PMA Reinsurance Corporation and the Pooled Companies as of December 31,
1992, and the Delaware Department of Insurance last conducted an examination of
Caliber One Indemnity Company as of December 31, 1996. No adjustments to
previously filed statutory financial statements were required as a result of
such examinations. In addition, there were no substantive qualitative matters
indicated in the examination reports that had or are expected to have a material
adverse impact on the operations of PMA Reinsurance Corporation, the Pooled
Companies or Caliber One Indemnity Company. The Pennsylvania Insurance
Department is currently conducting examinations of PMA Reinsurance Corporation
and the Pooled Companies as of December 31, 1997. The Pennsylvania Insurance
Department has raised no material issues in connection with the pending
examination. In supervising and regulating insurance companies, including
reinsurers, state insurance departments, charged primarily with protecting
policyholders and the public rather than investors, enjoy broad authority and
discretion in applying applicable insurance laws and regulations for the
protection of policyholders and the public.
Every state in which the Company's insurance subsidiaries are licensed
administers a guaranty fund, which provides for assessments of licensed insurers
for the protection of policyholders of insolvent insurance companies. There has
been an increase in the number of insurance companies that are under supervision
that has resulted in an increase in the
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<PAGE>
amount of assessments to cover losses to policyholders of such companies.
Assessments can be partially recovered through reduction in future premium taxes
in some states. In these situations, the assessments are generally capitalized
and amortized against future reductions in income taxes. The Company's insurance
subsidiaries have made accruals for their portion of assessments related to such
insolvencies based upon the most current information furnished by the guaranty
associations. During the five years ended December 31, 1997 and the six months
ended June 30, 1998, the amount of such insolvency assessments paid by the
Company's insurance subsidiaries has not been material. Management cannot
reasonably predict the amount of future assessments, if any.
Recently, the insurance regulatory framework has been placed under
increased scrutiny by various states, the federal government and the NAIC.
Various states have considered or enacted legislation which changes, and in many
cases increases, the state's authority to regulate insurance companies.
Although legislation has been under consideration for several years in Congress,
which, if enacted, would result in the federal government assuming some role in
the regulation of insurance companies, management does not expect the current
Congress to enact federal insurance regulation. The NAIC, in conjunction with
the state regulators, has been reviewing existing insurance laws and
regulations. The NAIC recently approved and recommended to the states for
adoption and implementation several regulatory initiatives designed to reduce
the risk of insurance company insolvencies. Through the NAIC accreditation
program, these recommendations for state legislation have taken an increased
significance. Two such initiatives that have been adopted by the NAIC are risk-
based capital standards ("RBC") and a model investment law.
Insurance Holding Company Regulation
The Company and its insurance subsidiaries are subject to regulation
pursuant to the insurance holding company laws of Pennsylvania and Delaware.
These state insurance holding company laws generally require an insurance
holding company and insurers and reinsurers that are members of such insurance
holding company's system to register with the state regulatory authorities, to
file with those authorities certain reports disclosing information including
their capital structure, ownership, management, financial condition, certain
intercompany transactions including material transfers of assets and
intercompany business agreements, and to report material changes in such
information. Such laws also require that intercompany transactions be fair and
reasonable and that an insurer's surplus as regards policyholders following any
dividends or distributions to shareholder affiliates be reasonable in relation
to the insurer's outstanding liabilities and adequate for its financial needs.
Under Pennsylvania and Delaware law, no person may acquire, directly or
indirectly, a controlling interest in the capital stock of the Company unless
such person, corporation or other entity has obtained prior approval from the
Commissioner(s) for such acquisition of control. Pursuant to Pennsylvania
and Delaware law, any person acquiring, controlling or holding with the power to
vote, directly or indirectly, ten percent or more of the voting securities of an
insurance company, is presumed to have "control" of such company. This
presumption may be rebutted by a showing that control does not exist in fact.
The respective Commissioner(s), however, may find that "control" exists in
circumstances in which a person owns or controls a smaller amount of voting
securities. To obtain approval from the Commissioner(s) of any acquisition of
control of an insurance company, the proposed acquirer
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<PAGE>
must file with the Commissioner(s) an application containing information
regarding the identity and background of the acquirer and its affiliates, the
nature, source and amount of funds to be used to effect the acquisition, the
financial statements of the acquirer and its affiliates, any potential plans for
disposition of the securities or business of the insurer, the number and type of
securities to be acquired, any contracts with respect to the securities to be
acquired, any agreements with broker-dealers and other matters.
Other jurisdictions in which the Company's insurance subsidiaries are
licensed to transact business may have requirements for prior approval of any
acquisition of control of an insurance or reinsurance company licensed or
authorized to transact business in such jurisdictions. Additional requirements
in such jurisdictions may include re-licensing or subsequent approval for
renewal of existing licenses upon an acquisition of control. As further
described below, laws also govern the holding company structure payment of
dividends by the Company's insurance subsidiaries to the Company.
Restrictions on Subsidiaries' Dividends and Other Payments
PMC is an insurance holding company whose assets consist principally of all
of the outstanding common stock of its insurance subsidiaries. PMC's ongoing
ability to pay dividends to its shareholders and meet its other obligations,
including operating expenses and any principal interest on debt (including the
Junior Subordinated Debentures), is primarily dependent on the receipt of
sufficient funds from its insurance subsidiaries in the form of dividends, net
payments under a tax-sharing agreement between PMC and its subsidiaries and
loans. The payment of dividends by PMC's subsidiaries to PMC is regulated under
the insurance laws of Pennsylvania and Delaware (such laws are substantially
similar). In addition, to the extent tax-sharing payments and loans exceed
certain threshold amounts, notice to and non-disapproval by the Pennsylvania
Insurance Commissioner would be required. Under Pennsylvania law, PMC's
Pennsylvania-domiciled subsidiaries (PMA Reinsurance Corporation and the Pooled
Companies) may pay dividends only from unassigned surplus and future earnings
arising from their businesses and must receive prior approval of the
Pennsylvania Insurance Commissioner to pay a dividend if such dividend would
exceed certain statutory limitations. The current statutory limitation is the
greater of (i) of 10% of the insurer's policyholders' surplus, as shown on its
last annual statement on file with the Pennsylvania Insurance Commissioner or
(ii) the insurer's statutory net income for the previous calendar year.
Pennsylvania law gives the Pennsylvania Insurance Commissioner broad discretion
to disapprove requests for dividends in excess of these limits. Based upon this
limitation and the 1997 statutory results of PMA Reinsurance Corporation and the
Pooled Companies, PMA Reinsurance Corporation and the Pooled Companies have the
legal capacity to pay $48.7 million in dividends in the aggregate to PMC in 1998
without obtaining the approval of the Pennsylvania Insurance Commissioner.
Through September 1, 1998, $18.0 million of dividends had been declared, of
which $10.0 million has been paid. Pennsylvania law also provides that following
the payment of any dividend, the insurer's policyholders' surplus must be
reasonable in relation to its outstanding liabilities and adequate for its
financial needs, and permits the Pennsylvania Insurance Commissioner to bring an
action to rescind a dividend which violates these standards.
Caliber One Indemnity Corporation is a Delaware-domiciled insurance
subsidiary of PMA Reinsurance Corporation. As a subsidiary of PMA Reinsurance
Corporation, Caliber One Indemnity Corporation's dividends are not directly
available to PMC.
In the event that the ability of either the Pooled Companies or PMA
Reinsurance Corporation to pay dividends or make other payments to PMC in the
future is reduced or eliminated, PMC'S ability to pay
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principal and interest on and redeem the Junior Subordinated Debentures could be
materially and adversely affected, depending upon the extent of such reduction.
The Pennsylvania Insurance Commissoner could use his or her broad discretionary
authority to seek to require PMC to apply payments received from one insurance
subsidiary for the benefit of another insurance subsidiary of PMC.
In addition to regulatory restrictions on dividends, the Company's Credit
Facilities also impose restrictions on the ability of the Company's insurance
subsidiaries to pay dividends. Under these restictions, the statutory surplus of
PMC's insurance subsidiaries (as measured each calendar quarter) must not be
less than $450 million and such subsidiaries must annually maintain certain
minimum ratios of adjusted surplus to risk-based capital (300% for PMA
Reinsurance Corporation and 230% for the Pooled Companies in 1998, increasing to
240% thereafter). As of June 30, 1998, the Company's insurance subsidiaries
reported combined statutory surplus of $561.1 million, and, as of December 31,
1997, PMA Reinsurance Corporation's risk-based capital ratio was 355% and the
Pooled Companies' ratios ranged from 293% to 324%.
Risk-Based Capital
The NAIC has adopted risk-based capital requirements for property/casualty
insurance companies to evaluate the adequacy of statutory capital and surplus in
relation to investment and insurance risks such as asset quality, asset and
liability matching, loss reserve adequacy and other business factors.
Under RBC requirements, regulatory compliance is determined by the ratio of
a Company's total adjusted capital, as defined by the NAIC, to its authorized
control level, also as defined by the NAIC. Companies below prescribed trigger
points in terms of such ratio are classified as follows:
Company action level............. 200%
Regulatory action level.......... 150%
Authorized control level......... 100%
Mandatory control level.......... 70%
At December 31, 1997, the ratios of the Pooled Companies ranged from 293%
to 324%, PMA Reinsurance Corporation's ratio was 355% and Caliber One Indemnity
Company's ratio was 1,922%. As a result, the RBC requirements are not expected
to have an adverse impact on the operations, financial condition or operating
results of the Company's insurance subsidiaries.
RBC requirements for property and casualty insurance companies allow a
discount for workers' compensation reserves to be included in the adjusted
surplus calculation. However, the calculation for RBC requires the phase-out of
non-tabular reserve discount previously taken for workers' compensation
reserves by 1998. As a result, this phase-out negatively impacts the RBC ratios
of companies that write workers' compensation insurance and discount such
reserves on a non-tabular basis to companies that write other types of property
and casualty insurance. Management believes that the Pooled Companies will be
able to maintain their RBC in excess of regulatory requirements through prudent
underwriting and claims
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handling, investing and capital management. However, no assurances can be given
that developments affecting the Property and Casualty Group, many of which could
be outside of management's control, including but not limited to changes in the
regulatory environment, economic conditions and competitive conditions in the
jurisdictions in which the Property and Casualty Group writes business, will
cause the Pooled Companies' RBC to fall below required levels resulting in a
corresponding regulatory response.
IRIS Ratios
The NAIC has developed a series of twelve ratios (the "IRIS ratios")
designed to further assist regulators in assessing the financial condition of
insurers. These ratio results are computed annually and reported to the NAIC and
the insurer's state of domicile. In 1997, each of the Pooled Companies reported
unusual values in two ratios related to loss reserve development and one ratio
related to historical profitability. In 1996, each of the Pooled Companies
reported unusual values in three ratios relating to reserve development and two
ratios relating to historical profitability. Such unusual values occurred
directly as a result of the reserve strengthening and asset valuations that
occurred in 1996. In 1997, MASCCO reported unusual values in three ratios,
relating to volume and historical profitability primarily as a result of its
status as a run-off company. In 1996, MASCCO reported unusual values in three
historical profitability ratios, directly as a result of a large intercompany
reinsurance transaction that occurred at the year end of 1996.
MANAGEMENT
The executive officers and directors of the Company are as follows:
Name Age Position
- --------------------------- --- ----------------------------------------------
Frederick W. Anton III..... 64 Chairman of the Board
John W. Smithson........... 52 President and Chief Executive Officer
Francis W. McDonnell....... 42 Senior Vice President, Chief Financial Officer
and Treasurer
Vincent T. Donnelly........ 45 President and Chief Operating Officer - The
Property and Casualty Group
Stephen G. Tirney.......... 45 President and Chief Operating Officer - PMA Re
Ronald S. Austin........... 41 President and Chief Operating Officer -
Caliber One
Paul I. Detwiler, Jr....... 65 Director
Joseph H. Foster........... 70 Director
Anne S. Genter............. 63 Director
James F. Malone III........ 55 Director
A. John May................ 69 Director
Louis N. McCarter III...... 69 Director
John W. Miller, Jr., M.D... 64 Director
Edward H. Owlett........... 71 Director
Louis I. Pollock........... 68 Director
Roderic H. Ross............ 68 Director
L.J. Rowell, Jr............ 66 Director
Frederick W. Anton III has served as Chairman of the Board since 1995 and
as a director of the Company since 1972. Mr. Anton's current term as a director
of the Company expires in 2000. Mr. Anton served as Chairman of the Board and
Chief Executive Officer from 1995 to May 1997, as President and Chief Executive
Officer from 1981 to 1995, as President
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of The Property and Casualty Group from 1972 to 1989 and as Secretary and
General Counsel of PMAIC from 1962 to 1972.
John W. Smithson has served as President and Chief Executive Officer of the
Company since May 1997, and as a director of the Company since 1987. Mr.
Smithson's current term as a director of the Company expires in 1999. Mr.
Smithson has served as President and Chief Operating Officer of the Company from
1995 to May 1997, as Chairman, President and Chief Executive Officer of PMA Re
from 1984 to 1997 and as Chairman, President and Chief Executive Officer of the
Property and Casualty Group from April 1995 to 1997, and was employed by PMAIC
from 1972 to 1984. Mr. Smithson is a designated Chartered Property-Casualty
Underwriter.
Francis W. McDonnell has served as Senior Vice President and Chief
Financial Officer of the Company since 1995 and as Treasurer since 1997, and has
served as Senior Vice President and Chief Financial Officer of PMA Re since
1995. From 1993 to 1995, Mr. McDonnell served as Vice President Finance of PMA
Re. Prior to joining PMA Re in 1993, Mr. McDonnell served in various
controllership positions with Reliance Insurance Company from 1985 to 1993. Mr.
McDonnell is a certified public accountant and a designated Chartered Property-
Casualty Underwriter.
Vincent T. Donnelly has served as President and Chief Operating Officer of
the Property and Casualty Group since February 1997. Mr. Donnelly served as
Senior Vice President - Finance and Chief Actuary of the Property and Casualty
Group from 1992 to 1997. Prior to joining the Property and Casualty Group, Mr.
Donnelly served as Vice President and Actuary of Continental Insurance Company
from 1987 to 1992 and as Actuary of American International Group, a property and
casualty insurance company, from 1978 to 1987. Mr. Donnelly is a Fellow of the
Casualty Actuarial Society and a member of the American Academy of Actuaries.
Stephen G. Tirney has served as President and Chief Operating Officer of
PMA Re since 1997. Mr. Tirney served as Executive Vice President of PMA Re from
1993 to 1997, as Senior Vice President of PMA Re from 1989 to 1993 and has been
an employee of PMA Re since 1976.
Ronald S. Austin was hired in 1997 as the President and Chief Operating
Officer of Caliber One. From 1988 to 1997, Mr. Austin served as an officer and
director of General Star Management Company, a member of the General Re Group.
Paul I. Detwiler, Jr., a director since 1984, is Chairman of the Board of
New Enterprise Stone & Lime Co., a quarrying and construction company. Mr.
Detwiler's current term as a director of the Company expires in 1999. Mr.
Detwiler is also a director of Keystone Financial, Inc.
Joseph H. Foster, a director since 1982, has been a partner of White &
Williams, a law firm, since 1958. Mr. Foster's current term as a director of the
Company expires in 2000.
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Anne S. Genter, a director since 1991, has served as President of Anne S.
Genter Interior Design, an interior design company, since 1975. Ms. Genter's
current term as a director of the Company expires in 1999.
James F. Malone III, a director since 1974, has been a partner of Malone,
Larchuk & Middleman, P.C., a law firm, since 1997 and from 1980 to 1997 was a
partner of Dickie, McCamey & Chilcote, P.C., a law firm. Mr. Malone's current
term as a director of the Company expires in 2000.
A. John May, a director since 1977, has been a partner of Duane, Morris &
Heckscher LLP, a law firm, since 1963. Mr. May's current term as a director of
the Company expires in 1999.
Louis N. McCarter III a director since 1975, has been President of the
McCarter Corp., a manufacturer of specialized mixing machinery, since 1954. Mr.
McCarter's current term as a director of the Company expires in 2001.
John W. Miller, Jr., M.D., a director since 1988, has been a physician and
has served as President of Ear, Nose and Throat Associates of Lancaster since
1970. Dr. Miller's current term as a director of the Company expires in 2001.
Edward H. Owlett, a director since 1964, has been a partner of Owlett,
Lewis & Ginn, P.C., a law firm, since 1981. From 1960 to 1981, Mr. Owlett served
as a partner of Cox, Wilcox, Owlett & Lewis, a law firm. Mr. Owlett's current
term as a director of the Company expires in 2001. Mr. Owlett is also a
director of Citizens and Northern Corporation.
Louis I. Pollock, a director since 1984, has served as President and Chief
Executive Officer of Morris Coupling Company, a manufacturer of pipe and tubing,
since 1957. Mr. Pollock's current term as a director of the Company expires in
2001.
Roderic H. Ross, a director since 1981, has served as Chairman of the Board
and Chief Executive Officer of Keystone State Life Insurance Company since 1985.
Prior to 1985, Mr. Ross held various positions at Philadelphia Life Insurance
Company and was an employee of Philadelphia Life Insurance Company from 1970 to
1984. Mr. Ross' current term as a director of the Company expires in 1999. Mr.
Ross is also a director of Hunt Manufacturing Co. and PNC Bank Corp.
L. J. Rowell, Jr., a director since 1992, was Chairman, President and Chief
Executive Officer of Provident Mutual Life Insurance Company from 1992 until his
retirement in July 1996. Prior to 1992, Mr. Rowell held various positions at
Provident Mutual and was an employee of Provident Mutual from 1980 until July
1996. Mr. Rowell's current term as a director of the Company expires in 2000.
The Board of Directors of the Company is divided into three classes, and
the directors of each class are elected for a term of three years and until
their successors are elected and qualified or until their earlier death,
resignation or removal. Prior to each election of a class of directors, the
Board of Directors must fix the size of that class of directors at a minimum of
four and a maximum of eight directors. Every director must be a shareholder of
the
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Company. No person may be considered as a candidate, and no votes may be counted
for any person, unless written notice of such person's nomination or candidacy
has been filed with the Secretary of the Company not less than 60 days prior to
the date of election; provided, however, that nominees selected by the then
existing Board of Directors or nominating committee appointed by the Board of
Directors may be candidates and voted for without such notice.
DESCRIPTION OF THE CAPITAL SECURITIES
The trust agreement between PMC as Depositor, Bank of New York (Delaware),
as Delaware Trustee and Bank of New York as Trustee authorized and created the
Issuer. The Amended and Restated Trust Agreement among PMC as Depositor and Bank
of New York as Property Trustee and the Administrative Trustees named therein is
referred to herein as the "Trust Agreement". The Trust Agreement will be
qualified under the Trust Indenture Act. The Property Trustee, Bank of New York,
will act as the indenture trustee for purposes of compliance with the provisions
of the Trust Indenture Act. The Capital Securities and the Common Securities
(together, the "Trust Securities") will be issued by the Administrative Trustees
on behalf of the Issuer pursuant to the terms of the Trust Agreement. The
Capital Securities represent undivided beneficial interests in the Issuer and
entitle the holders thereof to a preference in certain circumstances with
respect to distributions and amounts payable on redemption or liquidation over
the Common Securities, as well as other benefits as described in the Trust
Agreement. The following summaries of certain provisions of the Trust Agreement
do not purport to be complete and are subject to, and are qualified in their
entirety by reference to, all the provisions of the Trust Agreement, the form of
which is filed as an exhibit to the Registration Statement of which this
Prospectus forms a part, and the Trust Indenture Act. Wherever particular
sections of the Trust Agreement are referred to, such sections are incorporated
herein by reference. Section references used herein are references to provisions
of the Trust Agreement, unless otherwise noted.
General
The Issuer is a Delaware statutory business trust. PMC, the Depositor, will
own, directly or indirectly, all of the outstanding Common Securities of the
Trust. The Common Securities rank pari passu, and payments will be made thereon
pro rata, with the Capital Securities except as described under "--Subordination
of Common Securities." (Section 4.03.) The Junior Subordinated Debentures will
be owned by the Property Trustee and held in trust for the benefit of the Trust
and the holders of the Trust Securities. (Section 2.09.) Pursuant to the
Guarantee, PMC fully and unconditionally guarantees the payment of distributions
(as defined below) and amounts payable on redemption of the Capital Securities
or liquidation of the Issuer, but does not guarantee such payments when the
Issuer does not have funds available to pay such amounts.
The Trustees
Pursuant to the Trust Agreement, the number of the Issuer's trustees (the
"Trustees") initially will be four. (Section 8.17.) In addition to the Property
Trustee, the Issuer will have three Administrative Trustees who will be officers
or employees of, or otherwise affiliated
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with PMC. The Administrative Trustees are authorized and directed to conduct the
affairs of the Issuer and to operate the Issuer such that the Issuer will not be
deemed to be an "investment company" required to be registered under the
Investment Company Act or fail or cease to qualify as a grantor trust for United
States federal income tax purposes and so that the Junior Subordinated
Debentures will be treated as indebtedness of PMC for United States federal
income tax purposes. In this connection, PMC and the Administrative Trustees are
authorized to take any action, not inconsistent with applicable law, the
certificate of trust of the Issuer or the Trust Agreement, that each of PMC and
the Administrative Trustees determines in its discretion to be necessary or
desirable for such purposes, as long as such action does not adversely affect,
in any material respect, the interests of the holders of the Capital Securities.
(Section 2.07(d).)
Subject to the specific authority and duties of the Property Trustee, the
Trust Agreement provides the Administrative Trustees with exclusive and complete
authority to operate and carry out the purposes of the Issuer. As among the
Trustees, the Administrative Trustees have the power, duty and authority to act
on behalf of the Issuer with respect to (A) the issuance and sale of the Trust
Securities, (B) to cause the Issuer to enter into, and to execute, deliver and
perform on behalf of the Issuer, certain agreements necessary or desirable in
connection with the purposes and function of the Trust, (C) assisting in any
registration of the Capital Securities under the Securities Act and under state
securities or blue sky laws, and the qualification of the Trust Agreement under
the Trust Indenture Act, (D) assisting in any quotation or listing of the
Capital Securities upon the Nasdaq National Market or such securities exchange
or exchanges as determined by PMC and the registration of the Capital Securities
under the Securities Exchange Act, and the preparation and filing of all
periodic and other reports and other documents pursuant to the foregoing, (E)
the sending of notices (other than notices of default) and other information
regarding the Trust Securities and the Junior Subordinated Debentures to the
holders of Trust Securities, (F) the appointment of certain agents in accordance
with the Trust Agreement and (G) certain other functions relating to the
registration of stock transfers, the winding up and liquidation of the Issuer
and the execution of documents and actions incidental to the foregoing. As set
forth in greater detail below, the Property Trustee has the power, duty and
authority to act on behalf of the Issuer with respect to (A) establishment of a
payment account, (B) the receipt of the Junior Subordinated Debentures, (C) the
collection and distribution of amounts due under the Junior Subordinated
Debentures, (D) the exercise of all of the rights, powers and privileges of a
holder of the Junior Subordinated Debentures, (E) the sending of notices of
default and other information regarding the Trust Securities and the Junior
Subordinated Debentures to the holders of the Trust Securities, (F) the
distribution of the Trust Property in accordance with the Trust Agreement and
certain other functions relating to the winding up and liquidation of the Issuer
and the protection and conservation of the Trust Property after an Event of
Default (as defined below). (Section 2.07(a).)
The Property Trustee, other than during the occurrence and continuance of
an Event of Default, undertakes to perform only such duties as are specifically
set forth in the Trust Agreement and, after such Event of Default, must exercise
the same degree of care and skill as a prudent person would exercise or use in
the conduct of his or her own affairs. Subject to this provision, the Property
Trustee is under no obligation to exercise any of the powers vested in it by the
Trust Agreement at the request of any holder of Capital Securities unless it is
offered reasonable indemnity against the costs, expenses and liabilities that
might be
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incurred thereby. (Section 8.01(a) and (c).) If no Event of Default has
occurred and is continuing and the Property Trustee is required to decide
between alternative causes of action, construe ambiguous provisions in the Trust
Agreement or is unsure of the application of any provision of the Trust
Agreement, and the matter is not one on which holders of Capital Securities are
entitled under the Trust Agreement to vote, then the Property Trustee shall take
such action as is directed by PMC and if not so directed, shall take such action
as it deems advisable and in the best interests of the holders of the Trust
Securities and will have no liability except for its own bad faith, negligence
or willful misconduct. (Section 8.03.)
Distributions
The Capital Securities represent undivided beneficial interests in the
assets of the Issuer, and the distributions on each Capital Security will be
payable at a rate per annum of __% of the stated amount of $1,000 per Capital
Security (the "Liquidation Amount"). The amount of distributions payable for
any period will be computed on the basis of a 360-day year of twelve 30-day
months. (Section 4.01(b).) See "Description of the Junior Subordinated
Debentures--Interest" and "Description of the Junior Subordinated Debentures--
Option to Extend Interest Payment Period."
Distributions on the Capital Securities will be cumulative, will accumulate
from the date of original issuance and will be payable semi-annual in arrears,
on ____ and ____ of each year, commencing ________, 1999 (each a "Distribution
Date"). In the event that any date on which distributions are otherwise payable
on the Capital Securities is not a Business Day, payment of the distribution
payable on such date will be made on the next succeeding day that is a Business
Day (and without any additional distribution or other payment in respect of any
such delay) except that, if such Business Day is in the next succeeding calendar
year, payment of such distribution shall be made on the immediately preceding
Business Day, in each case with the same force and effect as if made on the date
such payment was originally payable. "Business Day" means any day other than a
Saturday or Sunday, or a day on which banking institutions in The City of New
York are authorized or required by law or executive order to remain closed or a
day on which the principal office of the Property Trustee or Debenture Trustee
(as defined herein) is closed for business. (Section 4.01(a).)
PMC has the right under the Indenture pursuant to which it will issue the
Junior Subordinated Debentures, so long as no Event of Default under the
Indenture (also referred to herein as a "Debenture Event of Default" and defined
below, see "Description of the Junior Subordinated Debentures--Debenture Events
of Default and Consequent Rights of Certain Holders") has occurred and is
continuing, to defer the payment of interest at any time and from time to time
on the Junior Subordinated Debentures for a period not exceeding 10 consecutive
semi-annual periods with respect to each deferral period (each, an "Extension
Period"), provided that no Extension Period may extend beyond 2028, the Stated
Maturity of the Junior Subordinated Debentures. As a consequence of any such
election, the Issuer will defer semi-annual distributions on the Capital
Securities during any such Extension Period. Distributions to which holders of
the Capital Securities are entitled will accumulate additional distributions
thereon at a rate per annum of ___% thereof, compounded semi-annually from the
relevant payment date for such distributions. The term, "distributions" as used
herein shall include any such additional distributions. In the event that PMC
exercises this right, during such Extension Period PMC may not, and shall cause
any subsidiary of PMC not to,
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(i) declare or pay any dividends or distributions on, or redeem, purchase,
acquire or make a liquidation payment with respect to, any of PMC's capital
stock or (ii) make any payment of principal, interest or premium, if any, on or
repay, repurchase or redeem any debt securities of PMC that rank pari passu with
or junior in interest to the Junior Subordinated Debentures or make any
guarantee payments with respect to any guarantee by PMC of the debt securities
of any subsidiary of PMC that by their terms rank PARI PASSU or junior in
interest to the Junior Subordinated Debentures (other than (a) dividends or
distributions in Common Stock or Class A Common Stock of PMC, (b) payments under
the Guarantee, and (c) purchases of Common Stock or Class A Common Stock related
to the issuance of Common Stock or Class A Common Stock under any of PMC's
benefit plans for its directors, officers or employees). Prior to the
termination of any such Extension Period, PMC may further extend the interest
payment period, provided that no Extension Period together may exceed 10
consecutive semi-annual periods or extend beyond the Stated Maturity of the
Junior Subordinated Debentures. Upon the termination of any Extension Period and
the payment of all amounts then accrued and unpaid (together with interest
thereon at the rate of ___% per annum compounded semi-annually to the extent
permitted by applicable law), PMC may elect to begin a new Extension Period.
There is no limitation on the number of times that PMC may elect to begin an
Extension Period. See "Description of the Junior Subordinated Debentures--
Interest" and "Description of the Junior Subordinated Debentures--Option to
Extend Interest Payment Period."
It is anticipated that the income of the Issuer available for distribution
to the holders of the Capital Securities will be limited to payments under the
Junior Subordinated Debentures in which the Issuer will invest the proceeds from
the issuance and sale of the Capital Securities and the Common Securities. See
"Description of the Junior Subordinated Debentures." If PMC does not make
interest payments on the Junior Subordinated Debentures, the Property Trustee
will not have funds available to pay distributions on the Capital Securities.
The payment of distributions (if and to the extent the Issuer has funds legally
available for the payment of such distributions and cash sufficient to make such
payment therefor at such time) is guaranteed by PMC as set forth herein under
"Description of the Guarantee."
Distributions on the Capital Securities will be payable to the holders
thereof as they appear on the register of the Issuer on the relevant record
dates, which, as long as the Capital Securities remain in book-entry-only form,
will be one Business Day prior to the relevant Distribution Date. Subject to any
applicable laws and regulations and the provisions of the Trust Agreement, each
such payment will be made as described under "--Book-Entry-Only Issuance--The
Depository Trust Company" below. In the event the Capital Securities do not
remain in book-entry-only form, the relevant record date shall be the date
fifteen (15) days prior to the relevant Distribution Date. (Section 4.01(d).)
Redemption
Mandatory Redemption
Upon the repayment or redemption, in whole or in part, of the Junior
Subordinated Debentures at Stated Maturity or upon earlier redemption as
provided in the Indenture (each, a "Redemption Date"), the proceeds from such
repayment or redemption shall be applied by
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the Trustee to redeem a Like Amount of Capital Securities, upon not less than 30
nor more than 60 days' notice. See "Description of the Junior Subordinated
Debentures-- Optional Redemption." "Like Amount" means (i) with respect to a
redemption of Trust Securities, Trust Securities having a Liquidation Amount
equal to the principal amount of Junior Subordinated Debentures to be
contemporaneously redeemed in accordance with the Indenture and the proceeds of
which will be used to pay the Redemption Price of such Trust Securities, and
(ii) with respect to a distribution of Junior Subordinated Debentures to holders
of Trust Securities in connection with a dissolution or liquidation of the
Issuer, Junior Subordinated Debentures having a principal amount equal to the
Liquidation Amount of the Trust Securities of the holder to whom such Junior
Subordinated Debentures are distributed. If less than all of the Junior
Subordinated Debentures are to be repaid or redeemed on a redemption date then
the proceeds from such repayment or redemption shall be allocated to the
redemption pro-rata of the Capital Securities and the Common Securities. The
amount of the premium, if any, paid by PMC upon the redemption of all or any
part of the Junior Subordinated Debentures to be repaid or redeemed on a
Redemption Date shall be allocated to the redemption pro rata of the Capital
Securities and the Common Securities.
PMC has the right to redeem the Junior Subordinated Debentures (i) on or
after ____, 2008, in whole at any time or in part from time to time, subject to
the conditions described under "Description of Junior Subordinated Debentures--
Optional Redemption", or (ii) at any time prior to ____, 2008, in whole but not
in part, within 90 days following the occurrence of a Tax Event or an Investment
Company Event (each, as defined below, a "Special Event") and subject to the
further conditions described under "Description of the Junior Subordinated
Debentures--Optional Redemption."
The Redemption Price, in the case of a redemption under (i) above (which
includes redemption at Stated Maturity), shall equal the following prices
expressed in percentages of the Liquidation Amount together with accrued
distributions to but excluding the Redemption Date. If redeemed during the 12-
month period beginning __________ 1:
Year Redemption Price
---- ----------------
2008 ................. 10x.xxxx%
2009 ................. 10x.xxxx%
2010 ................. 10x.xxxx%
2011 ................. 10x.xxxx%
2012 ................. 10x.xxxx%
2013 ................. 10x.xxxx%
2014 ................. 10x.xxxx%
2015 ................. 10x.xxxx%
2016 ................. 10x.xxxx%
2017 ................. 10x.xxxx%
and 100% on and after _________ 1, 2018.
Special Event Redemption or Distribution of Junior Subordinated Debentures
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If prior to __________, 2008 a Special Event shall occur and be continuing,
PMC has the right within 90 days following the occurrence of such Special Event
to redeem the Junior Subordinated Debentures in whole (but not in part) and
thereby cause a mandatory redemption of the Capital Securities and Common
Securities in whole (but not in part) at the Redemption Price set forth below.
If a Special Event were to occur, there can be no assurance that PMC would have
sufficient funds to effectuate an optional redemption of the Junior Subordinated
Debentures and pay the Redemption Price. PMC's ability to exercise its option
to redeem the Junior Subordinated Debentures may be limited by the terms of its
then-existing borrowing and other agreements. At any time, PMC has the right to
terminate the Issuer and, after satisfaction of the liabilities of creditors of
the Issuer as provided by applicable law, cause a Like Amount (defined above) of
the Junior Subordinated Debentures to be distributed to the holders of the
Capital Securities and Common Securities in liquidation of the Issuer (after
which such Capital Securities and Common Securities will no longer be deemed to
be outstanding). If PMC does not elect either option described above, the
Capital Securities will remain outstanding and, in the event a Tax Event has
occurred and is continuing, Additional Sums (as defined below) may be payable on
the Junior Subordinated Debentures. "Additional Sums" means the additional
amounts as may be necessary in order that the amount of distributions then due
and payable by the Issuer on the outstanding Capital Securities and Common
Securities shall not be reduced as a result of any additional taxes, duties and
other governmental charges to which the Issuer has become subject as a result of
a Tax Event.
"Investment Company Event" means the receipt by the Issuer of an opinion of
counsel experienced in such matters to the effect that, as a result of the
occurrence of a change in law or regulation or a change in interpretation or
application of law or regulation by any legislative body, court, governmental
agency or regulatory authority (a "Change in 1940 Act Law"), the Issuer is or
will be considered an "investment company" that is required to be registered
under the Investment Company Act of 1940, as amended (the "Investment Company
Act"), which Change in 1940 Act Law becomes effective on or after the date of
original issuance of the Junior Subordinated Debentures. PMC has the right,
within 90 days following the occurrence of an Investment Company Event, to
redeem the Junior Subordinated Debentures in whole (but not in part).
"Tax Event" means the receipt by the Issuer of an opinion of counsel
experienced in such matters to the effect that, as a result of (a) any amendment
to, clarification of, or change (including any announced prospective change) in,
the laws (or any regulations thereunder) of the United States or any political
subdivision or taxing authority thereof or therein, or (b) any official
administrative pronouncement (including any private letter ruling, technical
advice memorandum or field service advice) or regulatory procedure ("an
Administrative Action") or judicial determination, regardless of whether such
judicial decision or Administrative Action is issued to or in connection with a
proceeding involving PMC or the Issuer and whether or not subject to review or
appeal, which amendment, clarification, change, Administrative Action or
decision is enacted, promulgated or announced, in each case, on or after the
date of issuance of the Junior Subordinated Debentures, there is more than an
insubstantial risk that (i) the Issuer is, or will be within 90 days of the date
of such opinion, subject to United States federal income tax with respect to
interest income received or accrued on the Junior Subordinated Debentures, (ii)
interest payable by PMC on the Junior Subordinated Debentures is not, or within
90 days of the date of such opinion, will not be, deductible by PMC, in whole or
in part, for United States federal income tax purposes or (iii) the Issuer is,
or will be within 90 days of the date of such opinion, subject to more than a de
minimis amount of other taxes, duties or other governmental charges. PMC has the
right, within 90 days following the occurrence of a Tax Event, to redeem the
Junior Subordinated Debentures in whole (but not in part).
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The Redemption Price, in the case of a redemption following a Special Event
prior to _____ 1, 2008 (as described above) shall equal for each Capital
Security, the Make-Whole Amount for a corresponding $1,000 principal amount of
Junior Subordinated Debentures together with accrued distributions to but
excluding the Redemption Date. The "Make-Whole Amount" shall be equal to the
greater of (i) 100% of the principal amount of such Junior Subordinated
Debentures or (ii) as determined by a Quotation Agent (as defined below), the
sum of the present values of the principal amount and premium payable as part of
the Redemption Price with respect to an optional redemption of such Junior
Subordinated Debentures on _____ 1, 2008, together with scheduled payments of
interest from the Redemption Date to ____ 1, 2008 (the "Remaining Life"), in
each case discounted to the Redemption Date on a semi-annual basis (assuming a
360-day year consisting of 30-day months) at the Adjusted Treasury Rate (as
defined below).
"Adjusted Treasury Rate" means, with respect to any Redemption Date, the
Treasury Rate (as defined below) plus (i) _____% if such Redemption Date occurs
on or before _______ 1, 1999 or (ii) ______% if such Redemption Date occurs
after _________ 1, 1999.
"Treasury Rate" means (i) the yield, under the heading which represents the
average for the immediately prior week, appearing in the most recently published
statistical release designated "H.15(519)" or any successor publication which is
published weekly by the Federal Reserve and which establishes yields on actively
traded United States Treasury securities adjusted to constant maturity under the
caption "Treasury Constant Maturities," for the maturity corresponding to the
Remaining Life (if no maturity is within three months before or after the
Remaining Life, yields for the two published maturities most closely
corresponding to the Remaining Life shall be determined and the Treasury Rate
shall be interpolated or extrapolated from such yields on a straight-line basis,
rounding to the nearest month) or (ii) if such release (or any successor
release) is not published during the week preceding the calculation date or does
not contain such yields, the rate per annum equal to the semi-annual equivalent
yield to maturity of the Comparable Treasury Issue, calculated using a price for
the Comparable Treasury Issue (expressed as a percentage of its principal
amount) equal to the Comparable Treasury Price for such Redemption Date. The
Treasury Rate shall be calculated on the third Business Day preceding the
Redemption Date.
"Comparable Treasury Issue" means, with respect to any Redemption Date, the
United States Treasury security selected by the Quotation Agent as having a
maturity comparable to the Remaining Life that would be utilized, at the time of
selection and in accordance with customary financial practice, in pricing new
issues of corporate debt securities of comparable maturity to the Remaining
Life. If no United States Treasury security has a maturity which is within a
period from three months before to three months after ____ 1, 2008, the two most
closely corresponding United States Treasury securities shall be used as the
Comparable Treasury Issue, and the Treasury Rate shall be interpolated or
extrapolated on a straight-line basis, rounding to the nearest month using such
securities.
"Quotation Agent" means Goldman, Sachs & Co. and their successors;
provided, however, that if the foregoing shall cease to be a primary United
States Government securities dealer in New York City (a "Primary Treasury
Dealer"), PMC shall substitute therefor another Primary Treasury Dealer.
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"Reference Treasury Dealer" means (i) the Quotation Agent and (ii) any
other Primary Treasury Dealer selected by the Debenture Trustee after
consultation with PMC.
"Comparable Treasury Price" means (A) the average of five Reference
Treasury Dealer Quotations for such Redemption Date, after excluding the highest
and lowest such Reference Treasury Dealer Quotations or (B) if the Debenture
Trustee obtains fewer than three such Reference Treasury Dealer Quotations, the
average of all such Quotations.
"Reference Treasury Dealer Quotations" means, with respect to each
Reference Treasury Dealer and any Redemption Date, the average, as determined by
the Debenture Trustee, of the bid and asked prices for the Comparable Treasury
Issue (expressed in each case, as a percentage of its principal amount) quoted
in writing to the Debenture Trustee by such Reference Treasury Dealer at 5:00
p.m., New York City time, on the third Business Day preceding such Redemption
Date.
With certain limited exceptions, after the liquidation date fixed for any
distribution of Junior Subordinated Debentures to holders of Capital Securities
(the "Liquidation Date") (i) the Capital Securities will no longer be deemed to
be outstanding, (ii) The Depository Trust Company ("DTC") or its nominee, as the
record holder of the Capital Securities, will receive a registered global
certificate or certificates representing the Junior Subordinated Debentures to
be delivered upon such distribution, (iii) any certificates representing Capital
Securities not held by DTC or its nominee will be deemed to represent Junior
Subordinated Debentures having a principal amount equal to the stated
Liquidation Amount of the Capital Securities, and bearing accrued and unpaid
interest in an amount equal to the accumulated and unpaid distributions on such
Capital Securities until such certificates are surrendered and (iv) all rights
of the holders of Capital Securities will cease, except the right of such
holders to receive Junior Subordinated Debentures upon surrender of the
certificates representing Capital Securities. (Section 9.04(c).)
There can be no assurance as to the market prices for the Capital
Securities or the Junior Subordinated Debentures that may be distributed in
exchange for Capital Securities if a termination and liquidation of the Issuer
were to occur. Accordingly, the Capital Securities that an investor may
purchase, or the Junior Subordinated Debentures that the investor may receive
upon termination and liquidation of the Issuer, may trade at a discount to the
price that the investor paid to purchase the Capital Securities offered hereby.
Redemption Procedures
Capital Securities redeemed on each Redemption Date shall be redeemed at
the Redemption Price stated above with the proceeds from the contemporaneous
redemption of Junior Subordinated Debentures. Redemptions of the Capital
Securities shall be made and the Redemption Price shall be payable on each
Redemption Date only to the extent that the Issuer has funds available for the
payment of such Redemption Price. (Section 4.02(c).) See also "--Subordination
of Common Securities."
If the Property Trustee gives a notice of redemption in respect of Capital
Securities, then, by 12:00 noon, New York time, on the Redemption Date, to the
extent that funds are available, the Property Trustee will, so long as the
Capital Securities are in book-entry-only
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form, irrevocably deposit with DTC funds sufficient to pay the applicable
Redemption Price and will give DTC irrevocable instructions and authority to pay
the Redemption Price to the holders of the Capital Securities. See
"--Book-Entry- Only Issuance--The Depository Trust Company." If the Capital
Securities are no longer in book-entry-only form, the Property Trustee, to the
extent funds are available, will irrevocably deposit with the paying agent for
the Capital Securities funds sufficient to pay the applicable Redemption Price
and will give such paying agent irrevocable instructions and authority to pay
the Redemption Price to the holders thereof upon surrender of their certificates
representing Capital Securities. Notwithstanding the foregoing, distributions
payable on or prior to the Redemption Date for any Capital Securities called for
redemption shall be payable to the holders of such Capital Securities on the
relevant record dates for the related Distribution Dates. If notice of
redemption shall have been given and funds deposited as required, then upon the
Redemption Date, all rights of holders of such Capital Securities so called for
redemption will cease, except the right of the holders of such Capital
Securities to receive the Redemption Price, including any distributions payable
in respect of the Capital Securities on or prior to the Redemption Date but
without interest on such Redemption Price, and such Capital Securities will
cease to be outstanding. In the event that any date fixed for redemption of
Capital Securities is not a Business Day, then payment of the Redemption Price
payable on such date will be made on the next succeeding day that is a Business
Day (and without any interest or other payment in respect of any such delay),
except that, if such Business Day falls in the next calendar year, such payment
shall be made on the immediately preceding Business Day in each case, with the
same force and effect as if made on such date. In the event that payment of the
Redemption Price in respect of any Capital Securities called for redemption is
improperly withheld or refused and not paid either by the Issuer or by PMC
pursuant to the Guarantee described under "Description of the Guarantee,"
distributions on such Capital Securities will continue to accumulate, at the
then applicable rate, from the original Redemption Date to the date of payment,
in which case the actual payment date will be the date fixed for redemption for
purposes of calculating the Redemption Price. (Section 4.02(d).)
Payment of the Redemption Price on the Capital Securities and distribution
of Junior Subordinated Debentures to holders of Capital Securities shall be made
to the record holders thereof as they appear on the register for the Capital
Securities on the relevant record date, which shall be one Business Day prior to
the relevant Redemption Date or Liquidation Date, as applicable; provided,
however, that in the event that the Capital Securities do not remain in book-
entry-only form, the relevant record date shall be the date 15 days prior to the
Redemption Date or Liquidation Date, as applicable. (Section 4.02(e).)
If less than all the outstanding Trust Securities are to be redeemed on a
Redemption Date, then the aggregate Liquidation Amount of Trust Securities to be
redeemed shall be allocated pro rata among the Common Securities and the Capital
Securities according to their relative aggregate Liquidation Amounts. The
particular Capital Securities to be redeemed shall be selected on a pro rata
basis (based upon Liquidation Amounts) not more than 60 days prior to the
Redemption Date by the Property Trustee from the outstanding Capital Securities
not previously called for redemption, by such method (including, without
limitation, by lot) as the Property Trustee shall deem fair and appropriate and
which may provide for the selection for redemption of portions (equal to $1,000
or an integral multiple of $1,000 in excess thereof) of the Liquidation Amount
of Capital Securities of a denomination larger than $1,000. See "--Book-Entry
Only Issuance--The Depository Trust Company." The Property Trustee shall
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promptly notify the Securities Registrar in writing of the Capital Securities
selected for redemption and, in the case of any Capital Securities selected for
partial redemption, the Liquidation Amount thereof to be redeemed. For all
purposes of the Trust Agreement, unless the context otherwise requires, all
provisions relating to the redemption of Capital Securities shall relate, in the
case of any Capital Securities redeemed or to be redeemed only in part, to the
portion of the Liquidation Amount of Capital Securities which has been or is to
be redeemed. Bank of New York is the initial Securities Registrar. (Sections
4.02(f) and 5.04.)
Subject to applicable law (including, without limitation, United States
federal securities law), PMC or its subsidiaries may at any time and from time
to time purchase outstanding Capital Securities by tender, in the open market or
by private agreement.
Subordination of Common Securities
Payment of distributions on, and the Redemption Price of, the Trust
Securities, as applicable, shall be made pro rata based on the Liquidation
Amount of the Trust Securities; provided, however, that if on any Distribution
Date, Redemption Date or Liquidation Date any Event of Default (as defined
below, see "--Events of Default; Notice") under the Trust Agreement resulting
from a Debenture Event of Default (as defined below) shall have occurred and be
continuing, no payment of any distribution on, or Redemption Price of, or
Liquidation Distribution (as defined below) in respect of any Common Security,
and no other payment on account of the redemption, liquidation or other
acquisition of Common Securities, shall be made unless payment in full in cash
of all accumulated and unpaid distributions on all outstanding Capital
Securities for all distribution periods terminating on or prior thereto, or in
the case of payment of the Redemption Price the full amount of such Redemption
Price on all outstanding Capital Securities, or in the case of payment of the
Liquidation Distribution the full amount of such Liquidation Distribution on all
outstanding Capital Securities, shall have been made or provided for, and all
funds available to the Property Trustee shall first be applied to the payment in
full in cash of all distributions on, or the Redemption Price of, Capital
Securities then due and payable. (Section 4.03(a).)
In the case of the occurrence of any Event of Default under the Trust
Agreement resulting from a Debenture Event of Default, the holder of the Common
Securities will be deemed to have waived any right to act with respect to any
such Event of Default under the Trust Agreement with respect to the Common
Securities until the effect of all such Events of Default have been cured,
waived or otherwise eliminated. Until any such Events of Default under the
Trust Agreement with respect to the Capital Securities have been cured, waived
or otherwise eliminated, the Property Trustee shall act solely on behalf of the
holders of the Capital Securities and not the holder of the Common Securities,
and only the holders of the Capital Securities will have the right to direct the
Property Trustee to act on their behalf. (Section 4.03(b).)
Liquidation Distribution upon Termination
Pursuant to the Trust Agreement, the Issuer shall be terminated by the
Trustees on the first to occur of: (i) the expiration of the term of the Issuer;
(ii) the occurrence of certain events of bankruptcy or insolvency in respect of,
or the dissolution or liquidation of, PMC; (iii) the distribution of the Junior
Subordinated Debentures to the holders of Capital Securities and
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Common Securities if PMC, as Depositor, has given written direction to the
Property Trustee to terminate the Issuer (which direction is optional and wholly
within the discretion of PMC, as Depositor); (iv) the redemption of all of the
Trust Securities and (v) the entry of an order for dissolution of the Issuer by
a court of competent jurisdiction. (Sections 9.01 and 9.02.)
If a termination event specified in clause (ii), (iii) or (v) above occurs,
the Issuer shall be liquidated by the Trustees as expeditiously as the Trustees
determine to be possible by distributing, after satisfaction of liabilities to
creditors of the Trust as provided by applicable law, to each holder of Capital
Securities and Common Securities a Like Amount of Junior Subordinated
Debentures, unless such distribution is determined by the Property Trustee not
to be practical, in which event such holders will be entitled to receive out of
the assets of the Issuer available for distribution to holders after
satisfaction of liabilities to creditors, an amount equal to, in the case of
the Capital Securities, the aggregate of the Liquidation Amount plus
accumulated and unpaid distributions thereon to the date of payment (such amount
being the "Liquidation Distribution"). If such Liquidation Distribution can be
paid only in part because the Issuer has insufficient assets available to pay in
full the aggregate Liquidation Distribution, then, subject to the next
succeeding sentence, the amounts payable by the Issuer on the Capital Securities
shall be paid on a pro rata basis (based on Liquidation Amounts). The holder of
the Common Securities will be entitled to receive Liquidation Distributions upon
any such liquidation pro rata with the holders of the Capital Securities, except
that if a Debenture Event of Default has occurred and is continuing, the Capital
Securities shall have a priority over the Common Securities. (Sections
9.04(a)and 9.04(d).)
Events of Default; Notice
Any one of the following events constitutes an "Event of Default" under the
Trust Agreement with respect to the Capital Securities issued thereunder
(whatever the reason for such Event of Default and whether it shall be voluntary
or involuntary or be effected by operation of law or pursuant to any judgment,
decree or order of any court or any order, rule or regulation of any
administrative or governmental body):
(i) the occurrence of a Debenture Event of Default under the
Indenture (as defined in "Description of Junior Subordinated Debentures--
Debenture Events of Default and Consequent Rights of Certain Holders"); or
(ii) default by the Issuer in the payment of any distribution when
it becomes due and payable, and continuation of such default for a period of 30
days; or
(iii) default by the Property Trustee in the payment of any
Redemption Price of any Trust Security when it becomes due and payable; or
(iv) default in the performance, or breach, in any material respect,
of any covenant or warranty of the Trustees in the Trust Agreement (other than a
covenant or warranty a default in the performance of which or the breach of
which is dealt with in clause (ii) or (iii) above), and continuation of such
default or breach for a period of 60 days after there has been given, by
registered or certified mail, to the defaulting Trustee or Trustees by the
holders of at least 25% in aggregate Liquidation Amount of the outstanding
Capital
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Securities a written notice specifying such default or breach and requiring it
to be remedied and stating that such notice is a "Notice of Default" under the
Trust Agreement; or
(v) The occurrence of certain events of bankruptcy or insolvency
with respect to the Property Trustee and the failure by PMC to appoint a
successor Property Trustee within 60 days thereof. (Section 101.)
Within five Business Days after the occurrence of any Event of Default, the
Property Trustee shall transmit notice of any Event of Default actually known to
the Property Trustee to the holders of Trust Securities, the Administrative
Trustees and PMC, as Depositor, unless such Event of Default shall have been
cured or waived. (Section 8.02.) Each of PMC, as Depositor, and the
Administrative Trustees on behalf of the Trust is required to provide annually
to the Property Trustee a certificate as to whether or not they are in
compliance with all of the conditions and covenants applicable to them under the
Trust Agreement. (Section 8.15.)
If a Debenture Event of Default has occurred and is continuing, the Capital
Securities shall have a preference over the Common Securities as described
above. See "--Liquidation Distribution Upon Termination." The existence of an
Event of Default does not entitle the holders of Capital Securities to
accelerate the maturity thereof.
Removal of Trustees
Unless a Debenture Event of Default shall have occurred and be continuing
the holder of the Common Securities may remove any Trustee at any time. The
holders of at least a majority in aggregate Liquidation Amount of the
outstanding Capital Securities may remove the Property Trustee or if a Debenture
Event of Default has occurred and is continuing, the Property Trustee, may be
removed at such time by the holders of a majority in aggregate Liquidation
Amount of the outstanding Capital Securities with or without cause. In no event
will the holders of the Capital Securities have the right to vote to appoint,
remove or replace the Administrative Trustees, which voting rights are vested
exclusively in PMC as the holder of the Common Securities. No resignation or
removal of any Trustee and no appointment of a successor Trustee shall be
effective until the acceptance of appointment by the successor Trustee in
accordance with the applicable provisions of the Trust Agreement. (Section
8.10.)
Merger or Consolidation of Trustees
Any entity into which the Property Trustee, the Delaware Trustee or any
Administrative Trustee that is not a natural person may be merged or converted
or with which it may be consolidated, or any entity resulting from any merger,
conversion or consolidation to which any such Trustee shall be a party, or any
entity succeeding to all or substantially all of the corporate trust business of
any such Trustee, shall be the successor of such Trustee under the Trust
Agreement, provided such entity shall be otherwise qualified and eligible.
(Section 8.12.)
Merger, Consolidation, Amalgamation or Replacement of the Issuer
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The Issuer may not merge consolidate amalgamate with or into, or be
replaced by, or convey, transfer or lease its properties and assets
substantially as an entirety to any corporation or other entity, except as
described below. The Issuer may, at the request of PMC, with the consent of the
Administrative Trustees and with the consent of the holders of at least a
majority in aggregate Liquidation Amount of $______ the Capital Securities or
the Property Trustee, merge, consolidate, or amalgamate with or into, or be
replaced by or convey, transfer or lease its properties and assets substantially
as an entirety to a trust organized as such under the laws of any state;
provided, that (i) such successor entity either (a) expressly assumes all of the
obligations of the Issuer with respect to the Capital Securities or (b)
substitutes for the Capital Securities other securities having substantially the
same terms as the Capital Securities (the "Successor Securities") so long as the
Successor Securities rank the same as the Capital Securities rank in priority
with respect to distributions and payments upon liquidation, redemption and
otherwise, (ii) PMC expressly appoints a trustee of such successor entity
possessing the same powers and duties as the Property Trustee as the holder of
the Junior Subordinated Debentures, (iii) the Successor Securities are listed or
quoted, or any Successor Securities will be listed or quoted upon notification
of issuance, on any national securities exchange, the Nasdaq National Market or
other organization on which the Capital Securities are then listed or quoted, if
any, (iv) such merger, consolidation, amalgamation, replacement, conveyance,
transfer or lease does not cause the Capital Securities (including any Successor
Securities) to be downgraded by any nationally recognized statistical rating
organization, (v) such merger, consolidation, amalgamation, replacement,
conveyance, transfer or lease does not adversely affect the rights, preferences
and privileges of the holders of the Capital Securities (including any Successor
Securities) in any material respect, (vi) such successor entity has a purpose
identical to that of the Issuer, (vii) prior to such merger, consolidation,
amalgamation, replacement, conveyance, transfer or lease, PMC has received an
opinion from independent counsel to the Issuer experienced in such matters to
the effect that (a) such merger, consolidation, amalgamation, replacement,
conveyance, transfer or lease does not adversely affect the rights, preferences
and privileges of the holders of the Capital Securities (including any Successor
Securities) in any material respect and (b) following such merger,
consolidation, amalgamation, replacement, conveyance, transfer or lease, neither
the Issuer nor such successor entity will be required to register as an
investment company under the Investment Company Act and (viii) PMC or any
permitted successor or assignee owns all of the Common Securities of such
successor entity and guarantees the obligations of such successor entity under
the Successor Securities at least to the extent provided by the Guarantee.
Notwithstanding the foregoing, the Issuer shall not, except with the consent of
holders of 100% in Liquidation Amount of the Capital Securities, consolidate,
amalgamate, or merge with or into or be replaced by or convey, transfer or lease
its properties and assets substantially as an entirety to any other entity or
permit any other entity to consolidate, amalgamate merge with or into, or
replace it if such consolidation, amalgamation, merger, replacement, conveyance,
transfer or lease would cause the Issuer or the successor entity to be
classified as other than a grantor trust for United States federal income tax
purposes. (Section 9.05.)
Voting Rights
Except as provided below and under "Description of the Guarantee--
Amendments and Assignment" and "Description of the Junior Subordinated
Debentures--Modification of the
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Indenture" and as otherwise required by law and the Trust Agreement, the holders
of the Capital Securities will have no voting rights. (Section 6.01(a).)
The Trust Agreement may be amended from time to time by PMC, the Property
Trustee and the Administrative Trustees, without the consent of the holders of
the Capital Securities (i) to cure any ambiguity, correct or supplement any
provision in the Trust Agreement that may be inconsistent with any other
provision or to make any other provisions with respect to matters or questions
arising under the Trust Agreement, which shall not be inconsistent with the
other provisions of the Trust Agreement or (ii) to modify, eliminate or add to
any provisions of the Trust Agreement to such extent as shall be necessary to
ensure that the Issuer will be classified for United States federal income tax
purposes as a grantor trust at all times that any Trust Securities are
outstanding or to ensure that the Issuer will not be required to register as an
"investment company" under the Investment Company Act; provided, however, that
in the case of either clause (i) or clause (ii), such action shall not adversely
affect in any material respect the interests of any holder of Capital
Securities, and any amendments of such Trust Agreement shall become effective
when notice thereof is given to the holders of Trust Securities. The Trust
Agreement may be amended by PMC, the Property Trustee and the Administrative
Trustees with (i) the consent of holders representing not less than a majority
(based upon Liquidation Amounts) of the outstanding Trust Securities and (ii)
receipt by the Trustees of an opinion of counsel to the effect that such
amendment or the exercise of any power granted to the Trustees in accordance
with such amendment will not affect the Issuer's status as a grantor trust for
United States federal income tax purposes or the Issuer's exemption from status
as an "investment company" under the Investment Company Act, provided that
without the consent of each affected holder of Trust Securities, such Trust
Agreement may not be amended to (i) change the amount or timing of any
distribution on the Trust Securities or otherwise adversely affect the amount of
any distribution required to be made in respect of the Trust Securities as of a
specified date or (ii) restrict the right of a holder of Trust Securities to
institute suit for the enforcement of any such payment on or after such date.
(Section 10.03.)
So long as any Junior Subordinated Debentures are held by the Property
Trustee, the Trustees shall not (i) direct the time, method and place of
conducting any proceeding for any remedy available to the Debenture Trustee, or
executing any trust or power conferred on the Debenture Trustee with respect to
the Junior Subordinated Debentures, (ii) waive any past default that is waivable
under Section 513 of the Indenture, (iii) exercise any right to rescind or annul
a declaration that the principal of all the Junior Subordinated Debentures shall
be due and payable or (iv) consent to any amendment, modification or termination
of the Indenture or the Junior Subordinated Debentures, where such consent shall
be required, without, in each case, obtaining the prior approval of the holders
of at least a majority in Liquidation Amount of the outstanding Capital
Securities; provided, however, that where a consent under the Indenture would
require the consent of each holder of Junior Subordinated Debentures affected
thereby, no such consent shall be given by the Property Trustee without the
prior consent of each holder of Capital Securities. The Trustees shall not
revoke any action previously authorized or approved by a vote of the holders of
Capital Securities except by subsequent vote of the holders of Capital
Securities. The Property Trustee shall notify all holders of the Capital
Securities of any notice of default received from the Debenture Trustee. In
addition to obtaining the foregoing approvals of the holders of the Capital
Securities, prior to taking any of the foregoing actions, the Trustees shall, at
the expense of PMC, obtain an
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opinion of counsel experienced in such matters to the effect that the Issuer
will not fail to be classified as a grantor trust for United States federal
income tax purposes on account of such action. (Section 6.01(b).)
Any required approval of holders of Capital Securities may be given at a
separate meeting of holders of Capital Securities convened for such purpose or
pursuant to written consent. The Administrative Trustees will cause a notice of
any meeting at which holders of Capital Securities are entitled to vote, or of
any matter upon which action by written consent of such holders is to be taken,
to be given to each holder of record of the outstanding Capital Securities in
the manner set forth in the Trust Agreement. (Sections 6.02 and 6.06.)
No vote or consent of the holders of Capital Securities will be required
for the Issuer to redeem and cancel Capital Securities in accordance with the
Trust Agreement. Notwithstanding that holders of Capital Securities are entitled
to vote or consent under any of the circumstances described above, any of the
Capital Securities that are owned by PMC, any Trustee or any affiliate of PMC or
any Trustee, shall, for purposes of such vote or consent, be treated as if they
were not outstanding. (Section 1.01.)
Co-Trustees and Separate Trustee
Unless an Event of Default under the Trust Agreement shall have occurred
and be continuing, at any time or times, for the purpose of meeting the legal
requirements of the Trust Indenture Act or of any jurisdiction in which any part
of the Trust Property may at the time be located, the Administrative Trustees
and PMC shall have power to appoint, and upon the written request of the
Administrative Trustees, PMC, as Depositor, shall for such purpose join with the
Administrative Trustees in the execution, delivery, and performance of all
instruments and agreements necessary or proper to appoint one or more persons or
entities approved by the Property Trustee either to act as co-trustee, jointly
with the Property Trustee, of all or any part of such Trust Property, or to act
as separate trustee of any such property, in either case with such powers as may
be provided in the instrument of appointment, and to vest in such person(s) or
entity(s) in such capacity, any property, title, right or power deemed necessary
or desirable, subject to the provisions of the Trust Agreement. If the Depositor
does not join in such appointment within 15 days after the receipt by it of a
request so to do, or in case a Debenture Event of Default has occurred and is
continuing, the Property Trustee alone shall have power to make such
appointment. (Section 8.09.) "Trust Property" means (a) the Junior Subordinated
Debentures, (b) any cash on deposit in, or owing to, the payment account
maintained by the Property Trustee, (c) all proceeds and rights in respect of
the foregoing and any other property and assets for the time being held or
deemed to be held by the Property Trustee pursuant to the trusts of the Trust
Agreement and (d) the rights of the Property Trustee under the Guarantee.
Book-Entry Only Issuance--The Depository Trust Company
DTC will act as securities depositary for the Capital Securities. The
Capital Securities will be issued only as fully registered securities registered
in the name of Cede & Co. (DTC's nominee). One or more fully registered global
Capital Security certificates will be issued, representing in the aggregate the
total number of Capital Securities, and will be deposited with DTC. (Section
5.11.)
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DTC is a limited purpose trust company organized under the New York Banking
Law, a "banking organization" within the meaning of the New York Banking Law, a
member of the Federal Reserve System, a "clearing corporation" within the
meaning of the New York Uniform Commercial Code, and a "clearing agency"
registered pursuant to the provisions of Section 17A of the Exchange Act. DTC
holds securities that its participants ("Participants") deposit with DTC. DTC
also facilitates the settlement among Participants through electronic
computerized book-entry changes in Participants' accounts, thereby eliminating
the need for physical movement of securities certificates. Direct Participants
include securities brokers and dealers, banks, trust companies, clearing
corporations, and certain other organizations ("Direct Participants"). DTC is
owned by a number of its Direct Participants and by the New York Stock Exchange
Inc. (the "New York Stock Exchange"), the American Stock Exchange, Inc. and the
National Association of Securities Dealers, Inc. Access to the DTC system is
also available to others such as securities brokers and dealers, banks and trust
companies that clear through or maintain custodial relationships with Direct
Participants, either directly or indirectly ("Indirect Participants"). The
rules applicable to DTC and its Participants are on file with the Commission.
Purchases of Capital Securities within the DTC system must be made by or
through Direct Participants, which will receive a credit for the Capital
Securities on DTC's records. The ownership interest of each actual purchaser of
each Capital Security ("Beneficial Owner") is in turn to be recorded on the
Direct and Indirect Participants' records. Beneficial Owners will not receive
written confirmation from DTC of their purchases, but Beneficial Owners are
expected to receive written confirmations providing details of the transactions,
as well as periodic statements of their holdings, from the Direct or Indirect
Participants through which the Beneficial Owners purchased Capital Securities.
Transfers of ownership interests in the Capital Securities are to be
accomplished by entries made on the books of Participants acting on behalf of
Beneficial Owners. Beneficial Owners will not receive certificates representing
their ownership interests in Capital Securities, unless use of the book-entry
system for the Capital Securities is discontinued.
DTC has no knowledge of the actual Beneficial Owners of the Capital
Securities; DTC's records reflect only the identity of the Direct Participants
to whose accounts such Capital Securities are credited, which may or may not be
the Beneficial Owners. The Participants will remain responsible for keeping
account of their holdings on behalf of their customers.
Conveyance of notices and other communications by DTC to Direct
Participants, by Direct Participants to Indirect Participants, and by Direct
Participants and Indirect Participants to Beneficial Owners and the voting
rights of Direct Participants, Indirect Participants and Beneficial Owners will
be governed by arrangements among them, subject to any statutory or regulatory
requirements as may be in effect from time to time.
Redemption notices shall be sent to Cede & Co. If less than all of the
Capital Securities are being redeemed, DTC will reduce the amount of the
interest of each Direct Participant in such Capital Securities in accordance
with its procedures. DTC's current practice is to determine by lot the amount
of the interest of each Direct Participant to be redeemed.
Although voting with respect to the Capital Securities is limited to the
holders of record of the Capital Securities, in those cases where a vote is
required, neither DTC nor Cede & Co.
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will itself consent or vote with respect to Capital Securities. Under its usual
procedures, DTC would mail an omnibus proxy to the Property Trustee as soon as
possible after the record date. The omnibus proxy assigns Cede & Co.'s
consenting or voting rights to those Direct Participants to whose accounts the
Capital Securities are credited on the record date (identified in a listing
attached to the omnibus proxy).
The Issuer will make distribution payments on the Capital Securities to
DTC. DTC's practice is to credit Direct Participants' accounts on the relevant
payment date in accordance with their respective holdings shown on DTC's records
unless DTC has reason to believe that it will not receive payments on such
payment date. Payments by Participants to Beneficial Owners will be governed by
standing instructions and customary practices and will be the responsibility of
such Participant and not of DTC, the Issuer or PMC, subject to any statutory or
regulatory requirements as may be in effect from time to time. Payment of
distributions to DTC is the responsibility of the Issuer, disbursement of such
payments to Direct Participants is the responsibility of DTC, and disbursements
of such payments to the Beneficial Owners is the responsibility of Direct and
Indirect Participants.
A global security shall be exchangeable for Capital Securities registered
in the names of persons other than DTC or its nominee only if (i) DTC properly
notifies PMC, the Trustees, and the Registrar and Transfer Agent that it is
unwilling or unable to continue as a depositary for such global security and no
successor depositary shall have been appointed, or if at any time, DTC ceases to
be a clearing agency registered under the Exchange Act, at a time when DTC is
required to be so registered to act as such depositary, (ii) the Issuer in its
sole discretion determines that such global security shall be so exchangeable
or (iii) there shall have occurred and be continuing a Debenture Event of
Default. Any global security that is exchangeable pursuant to the preceding
sentence shall be exchangeable for definitive certificates registered in such
names, as DTC shall direct. It is expected that such instructions will be based
upon directions received by DTC from its Participants with respect to ownership
of beneficial interests in such global security. In the event that Capital
Securities are issued in definitive form, such Capital Securities will be in
denominations of $1,000 and integral multiples thereof and may be transferred or
exchanged at the offices described below.
In the event Capital Securities are issued in certificated form, the
Liquidation Amount and distributions will be payable, the transfer of the
Capital Securities will be registrable and Capital Securities will be
exchangeable for Capital Securities of other denominations of a like aggregate
Liquidation Amount, at the corporate office of the Property Trustee, or at the
offices of any paying agent or transfer agent; provided that payment of any
distribution may be made at the option of the Administrative Trustees by check
mailed to the address of the persons entitled thereto or by wire transfer. In
addition, if the Capital Securities are issued in certificated form, the record
dates for payment of distributions will be the date 15 days prior to the
relevant Distribution Date (whether or not a Business Day).
The information in this section concerning DTC and DTC's book-entry system
has been obtained from sources that the Issuer and PMC believe to be reliable.
Neither the Issuer nor PMC has any responsibility for the performance by DTC or
its Participants of their respective obligations as described hereunder or under
the rules and procedures governing their respective operations.
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Registrar and Transfer Agent
Bank of New York will act as Securities Registrar and Transfer Agent for
the Capital Securities. (Section 5.04.)
Registration of transfers and exchanges of Capital Securities will be
effected without charge by or on behalf of the Issuer, but the Securities
Registrar may require payment (with the giving of such indemnity as the Issuer
or PMC may require) of a sum sufficient to cover any tax or other governmental
charge that may be imposed in connection with any transfer or exchange. The
Securities Registrar will not be required to register the transfer of any
Capital Securities that have been called for redemption. (Section 5.04.)
Miscellaneous
Payment And Paying Agency
Payments in respect of the Capital Securities shall be made to DTC (so long
as the Capital Securities are held by DTC), which shall credit the relevant
participants' accounts at DTC on the applicable Distribution Dates or, if the
Capital Securities are not held by DTC, such payments shall be made at the
corporate office of the Property Trustee, or at the offices of any paying agent
or transfer agent; provided that payment of any distribution may be made at the
option of the Administrative Trustees by check mailed to the address of the
person entitled thereto as such address shall appear on the Security Register or
by wire transfer. The Paying Agent shall initially be Bank of New York, and
any co-paying agent chosen by Bank of New York and acceptable to the
Administrative Trustees and PMC. The Paying Agent shall be permitted to resign
as Paying Agent upon 30 days' written notice to the Administrative Trustees, the
Property Trustee and PMC. In the event that Bank of New York shall no longer
be the Paying Agent or a successor Paying Agent shall resign or its authority to
act be revoked, the Administrative Trustees shall appoint a successor to act as
Paying Agent (which shall be a bank or trust company acceptable to the Property
Trustee and PMC). (Sections 4.04 and 5.09.)
Holders of the Capital Securities have no preemptive or similar rights.
(Section 5.14(a).)
The Issuer may not borrow money or issue debt (other than the Capital
Securities and the Common Securities) or mortgage or pledge any of its assets.
DESCRIPTION OF THE GUARANTEE
Set forth below is a summary of information concerning the Guarantee that
will be executed and delivered by PMC for the benefit of the holders from time
to time of the Capital Securities. The Guarantee will be qualified under the
Trust Indenture Act, and Bank of New York will act as indenture trustee (the
"Guarantee Trustee") under the Guarantee for purposes of compliance with the
Trust Indenture Act. The terms of the Guarantee will be those set forth in such
Guarantee and those made part of such Guarantee by the Trust Indenture Act.
This summary does not purport to be complete and is subject in all respects to
the provisions of, and is qualified in its entirety by reference to, the
Guarantee, the form of which is filed as an
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exhibit to the Registration Statement of which this Prospectus forms a part, and
the Trust Indenture Act. Whenever particular provisions in the Guarantee are
referred to herein, such provisions are incorporated by reference herein.
Section references used herein are references to provisions of the Guarantee
unless otherwise noted. The Guarantee Trustee will hold the Guarantee for the
benefit of the holders of the Capital Securities.
General
PMC will irrevocably and unconditionally agree, to the extent set forth
herein, to pay the Guarantee Payments (as defined below) in full to the holders
of the Capital Securities (without duplication of amounts theretofore paid by or
on behalf of the Issuer), as and when due, regardless of any defense, right of
set-off or counterclaim which the Issuer may have or assert other than the
defense of payment. The following payments with respect to Capital Securities,
to the extent not paid by or on behalf of the Issuer (the "Guarantee Payments"),
will be subject to the Guarantee: (i) any accumulated and unpaid distributions
required to be paid on the Capital Securities, to the extent the Issuer shall
have funds available therefor at such time, (ii) the Redemption Price with
respect to any Capital Securities called for redemption by the Issuer, to the
extent the Issuer shall have funds available therefor at such time and (iii)
upon a voluntary or involuntary dissolution, winding-up or termination of the
Issuer (other than in connection with a redemption of all of the outstanding
Capital Securities or the distribution of Junior Subordinated Debentures to the
holders of Capital Securities as provided in the Trust Agreement), the lesser of
(a) the aggregate of the Liquidation Amount and all accumulated and unpaid
distributions on the Capital Securities to the date of payment to the extent the
Issuer shall have funds available therefor at such time and (b) the amount of
assets of the Issuer remaining available for distribution to holders of Capital
Securities after satisfaction of liabilities to creditors of the Issuer as
required by applicable law. PMC's obligation to make a Guarantee Payment may be
satisfied by direct payment of the required amounts by PMC to the holders of
Capital Securities or by causing the Issuer to pay such amounts to such holders.
(Section 5.01.)
The Guarantee will be a full and unconditional guarantee on a subordinated
basis with respect to the Capital Securities issued by the Issuer from the time
of issuance of the Capital Securities, but will apply only to the extent that
the Issuer has sufficient funds to make such payments, and is not a guarantee of
collection of payment. If PMC does not make interest payments on the Junior
Subordinated Debentures held by the Issuer, it is expected that the Issuer will
not pay distributions on the Capital Securities and will not have funds
available therefor. The Guarantee will rank subordinate and junior in right of
payment to all Senior Debt of PMC.
"Senior Debt" means the principal of (and premium, if any) and interest, if
any (including interest accruing on or after the filing of any petition in
bankruptcy or for reorganization relating to PMC whether or not such claim for
post-petition interest is allowed in such proceeding), on Debt, whether incurred
on or prior to the date of the Guarantee or thereafter incurred, unless, in the
instrument creating or evidencing the same or pursuant to which the same is
outstanding, it is provided that such obligations are not superior in right of
payment to the Guarantee or to other Debt which is pari passu with, or
subordinated to, the Guarantee; provided, however, that Senior Debt shall not be
deemed to include (i) any Debt of PMC which, when incurred and without respect
to any election under Section 1111(b)
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of the Bankruptcy Code, was without recourse to PMC, (ii) any Debt of PMC to any
of its subsidiaries, (iii) Debt to any employee of PMC, (iv) trade accounts
payable of PMC, (v) accrued liabilities of PMC or any of its subsidiaries
arising in the ordinary course of business of PMC, (vi) the Junior Subordinated
Debentures, and (vii) the Guarantee. "Debt" for purposes of the Guarantee, has
the same meaning as that specified under "Description of the Junior Subordinated
Debentures--Subordination" below.
PMC's obligations under the Trust Agreement, the Guarantee, the Indenture,
the Junior Subordinated Debentures and the Expense Agreement taken together
provide a full, irrevocable, and unconditional guarantee on a subordinated basis
by PMC of all of the Issuer's obligations under the Capital Securities. See "--
Status of the Guarantee."
PMC is an insurance holding company and substantially all of the operating
assets of PMC are owned by its consolidated subsidiaries, principally PMA
Reinsurance Corporation and the Pooled Companies. PMC relies primarily on the
receipt of sufficient funds from PMA Re and the Pooled Companies in the form of
dividends, net payments under tax-sharing agreements or loans to meet its
obligations for payment of principal and interest on outstanding debt
obligations (including the Junior Subordinated Debentures) and corporate
expenses. Accordingly, PMC's obligations under the Guarantee will be effectively
subordinated to all existing and future liabilities of PMC's subsidiaries, and
claimants should look only to the assets of PMC for payments thereunder.
Pennsylvania law limits the payment of dividends by PMA Reinsurance Corporation
and the Pooled Companies. PMA Reinsurance Corporation and the Pooled Companies
have the ability to loan funds to PMC subject to certain regulatory
restrictions. See "Risk Factors--Subordination of the Guarantee and the Junior
Subordinated Debentures," "--Holding Company Structure and Restrictions on
Subsidiary Dividends" and "Supervision and Regulation".
Certain Covenants of PMC
In the Guarantee, PMC will covenant that, so long as any Capital Securities
remain outstanding, PMC will not, and will cause its subsidiaries not to, (a)
declare or pay any dividends or distributions on (other than dividends or
distributions in Common Stock or Class A Common Stock of PMC), or redeem,
purchase, acquire or make a liquidation payment with respect to, any of PMC's
outstanding capital stock or (b) make any payment of principal, interest or
premium, if any, on or repay, repurchase or redeem any debt securities that rank
pari passu with or junior to the Junior Subordinated Debentures or make any
guarantee payments with respect to the foregoing if at such time (i) PMC shall
be in default with respect to its Guarantee Payments under the Guarantee, (ii)
there shall have occurred and be continuing any Debenture Event of Default or
(iii) PMC shall have given notice of its selection of an Extension Period and
such period, or any extension thereof, is continuing. (Section 6.01.)
Amendments And Assignment
Except with respect to any changes that do not materially adversely affect
the rights of holders of Capital Securities (in which case no consent of holders
of Capital Securities will be required), the terms of the Guarantee may be
amended only with the prior approval of the holders of not less than a majority
of the Liquidation Amount of the outstanding Capital Securities. (Section 8.02.)
All guarantees and agreements contained in the Guarantee shall bind
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the successors, assigns, receivers, trustees and representatives of PMC and
shall inure to the benefit of the holders of the Capital Securities then
outstanding. (Section 8.01.)
Events of Default
An event of default under the Guarantee (a "Guarantee Event of Default")
will occur upon the failure of PMC to perform any of its payment obligations
thereunder or to perform any non-payment obligations thereunder if any such non-
payment remains unremitted for 30 days. (Section 1.01.) The holders of a
majority in Liquidation Amount of the Capital Securities have the right to
direct the time, method and place of conducting any proceeding for any remedy
available to the Guarantee Trustee in respect of the Guarantee or exercising any
trust or power conferred upon the Guarantee Trustee under the Guarantee.
(Section 5.04.)
Any holder of Capital Securities may institute a legal proceeding directly
against PMC to enforce the holder's rights under such Guarantee without first
instituting a legal proceeding against the Issuer, the Guarantee Trustee or any
other person or entity. (Section 5.04.)
PMC will be required to provide annually to the Guarantee Trustee an
officer's certificate as to PMC's compliance with all conditions and covenants
under the Guarantee. PMC will also be required to provide annually to the
Guarantee Trustee an officer's certificate as to PMC's compliance with all
conditions precedent, if any, provided for in the Guarantee that relate to any
action to be taken by the Guarantee Trustee at PMC's request. (Sections 2.04 and
2.05.)
Information Concerning the Guarantee Trustee
The Guarantee Trustee, other than during the occurrence and continuance of
a Guarantee Event of Default, undertakes to perform only such duties as are
specifically set forth in the Guarantee and, in case a Guarantee Event of
Default has occurred (that has not been cured or waived), the Guarantee Trustee
must exercise such of the rights and powers vested in it by the Guarantee, and
use the same degree of care and skill in its exercise thereof, as a prudent
individual would exercise or use under the circumstances in the conduct of his
or her own affairs. (Section 3.01(c).) Subject to this provision, the Guarantee
Trustee is under no obligation to exercise any of the powers vested in it by the
Guarantee at the request of any holder of Capital Securities unless it is
provided with reasonable indemnity against the costs, expenses and liabilities
that might be incurred thereby. (Section 3.02. (a)(v).)
Termination of the Guarantee
The Guarantee will terminate and be of no further force and effect upon (i)
full payment of the Redemption Price of all Capital Securities, (ii) the
distribution of Junior Subordinated Debentures to holders of Capital Securities
in exchange for all of the Capital Securities or (iii) payment in full of the
amounts payable in accordance with the Trust Agreement upon liquidation of the
Issuer. Notwithstanding the foregoing, the Guarantee will continue to be
effective or will be reinstated, as the case may be, if at any time any holder
of Capital Securities must restore payment of any sums paid with respect to the
Capital Securities or the Guarantee. (Section 7.01.)
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Status of the Guarantee
The Guarantee will constitute an unsecured obligation of PMC and will rank
(i) subordinate and junior in right of payment to all Senior Debt of PMC in the
same manner as the Junior Subordinated Debentures, (ii) pari passu with any
similar guarantee agreements issued by PMC on behalf of the holders of capital
securities issued by a business trust or similar entity whose common securities
are owned, directly or indirectly, by PMC and (iii) senior to PMC's Common Stock
and the Class A Common Stock. The Trust Agreement provides that each holder of
Trust Securities by acceptance thereof accepts the subordination provisions and
other terms of the Guarantee. The Guarantee will constitute a guarantee of
payment and not of collection (i.e., the guaranteed party may institute a legal
proceeding directly against PMC to enforce its rights under the Guarantee
without first instituting a legal proceeding against any other person or
entity). (Section 5.05.)
The Guarantee will be held for the benefit of the holders of the Capital
Securities. The Guarantee will not be discharged except by payment of the
Guarantee Payments in full to the extent not paid by the Issuer or upon
distribution to the holders of the Capital Securities of the Junior Subordinated
Debentures. The Guarantee does not place a limitation on the amount of
additional Senior Debt that may be incurred by PMC. PMC expects from time to
time to incur additional indebtedness constituting Senior Debt. (Sections
3.01(a) and 5.05.)
Governing Law
The Guarantee Agreement will be governed by, and construed in accordance
with, the laws of the State of New York. (Section 8.06.)
The Expense Agreement
Pursuant to the Expense Agreement entered into by PMC under the Trust
Agreement (the "Expense Agreement"), PMC will irrevocably and unconditionally
guarantee to each person or entity to whom the Issuer is or becomes indebted or
liable, the full payment of any and all indebtedness, expenses or liabilities of
the Issuer including, without limitation, the fees, expenses and indemnities of
the Trustees, other than obligations of the Issuer to pay to the holders of any
Capital Securities or other similar interests in the Issuer of the amounts due
such holders pursuant to the terms of the Capital Securities or such other
similar interests, as the case may be. The Expense Agreement will be enforceable
by third parties.
DESCRIPTION OF THE JUNIOR SUBORDINATED DEBENTURES
Set forth below is a description of specific terms of the Junior
Subordinated Debentures in which the Issuer will invest the proceeds of the
issuance and sale of the Trust Securities. The Junior Subordinated Debentures
will be qualified under the Trust Indenture Act. The following description does
not purport to be complete and is qualified in its entirety by reference to the
description in the Indenture, (the "Indenture"), between PMC and Bank of New
York, as trustee with respect to the Junior Subordinated Debentures (the
"Debenture Trustee"), the form of which is filed as an exhibit to the
Registration Statement of which this Prospectus forms a part, and the Trust
Indenture Act. Whenever particular provisions in the
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Indenture are referred to herein, such provisions are incorporated by reference
herein. Section references used herein are references to provisions of the
Indenture unless otherwise noted.
Under certain circumstances involving the termination of the Issuer, after
satisfaction of liabilities to creditors of the Issuer as required under
applicable law, Junior Subordinated Debentures may be distributed to the holders
of the Capital Securities in exchange for the Capital Securities in liquidation
of the Issuer. See "Description of the Capital Securities--Redemption--Special
Event Redemption or Distribution of Junior Subordinated Debentures" and
"Description of the Capital Securities--Liquidation Distribution upon
Termination."
General
The Junior Subordinated Debentures will be limited in aggregate principal
amount to a sum equal to the aggregate stated Liquidation Amount of the Capital
Securities plus PMC's concurrent investment in the Common Securities. The Junior
Subordinated Debentures will be unsecured subordinated obligations of PMC which
rank junior to all PMC's Senior Debt (as defined below).
The Junior Subordinated Debentures will initially mature on ____, 2028 (the
"Stated Maturity").
PMC is an insurance holding company and substantially all of the operating
assets of PMC are owned by its consolidated subsidiaries, principally PMA
Reinsurance Corporation and the Pooled Companies. PMC relies primarily on the
receipt of sufficient funds from PMA Reinsurance Corporation and the Pooled
Companies in the form of dividends, net payments under tax-sharing agreements or
loans to meet its obligations for payment of principal and interest on its
outstanding debt obligations (including the Junior Subordinated Debentures) and
corporate expenses. Accordingly, PMC's obligations under the Junior Subordinated
Debentures will be effectively subordinated to all existing and future
liabilities of PMC's subsidiaries, and claimants should look only to the assets
of PMC for payments thereunder. Pennsylvania law limits the payment of dividends
by PMA Reinsurance Corporation and the Pooled Companies. PMA Reinsurance
Corporation and the Pooled Companies have the ability to loan funds to PMC
subject to certain regulatory restrictions. See "Risk Factors--Subordination of
the Guarantee and the Junior Subordinated Debentures", "--Restrictions on
Subsidiary Dividends and Other Payments" and "Supervision and Regulation."
Optional Redemption
The Junior Subordinated Debentures are redeemable prior to maturity at the
option of PMC (i) on or after ____, 2008, in whole at any time or in part from
time to time, or (ii) prior to ____, 2008, in whole (but not in part) and within
90 days following the occurrence of a Special Event, in each case at the
Redemption Price described below.
The Redemption Price in the case of a redemption under (i) above shall
equal the following prices, expressed in percentages of the principal amount,
together with accrued interest to but excluding the Redemption Date. If
redeemed during the 12-month period beginning _________ 1:
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Year Redemption Price
---- ----------------
2008................... 10x.xxxx%
2009................... 10x.xxxx%
2010................... 10x.xxxx%
2011................... 10x.xxxx%
2012................... 10x.xxxx%
2013................... 10x.xxxx%
2014................... 10x.xxxx%
2015................... 10x.xxxx%
2016................... 10x.xxxx%
2017................... 10x.xxxx%
and 100% on and after __________ 1, 2018.
The Redemption Price, in the case of a redemption following a Special Event
as described under (ii) above, shall equal the Make-Whole Amount (as defined
under "Description of the Capital Securities--Redemption"), together with
accrued interest to but excluding the Redemption Date.
Junior Subordinated Debentures in denominations larger than $1,000.00 may
be redeemed in part but only in integral multiples of $1,000. (Section 1203.)
Unless PMC defaults in payment of the Redemption Price, on and after the
Redemption Date, interest ceases to accrue on such Junior Subordinated
Debentures or portions thereof called for redemption. (Section 1206.)
For so long as the Issuer is the holder of all the outstanding Junior
Subordinated Debentures, the proceeds of any such redemption described above
will be used by the Issuer to redeem Capital Securities in accordance with their
terms. PMC may not redeem the Junior Subordinated Debentures in part unless all
accrued and unpaid interest has been paid in full on all outstanding Junior
Subordinated Debentures for all semi-annual interest periods terminating on or
prior to the Redemption Date. (Section 1207.)
Notice of any redemption will be mailed at least 45 days but not more than
75 days before the Redemption Date to each holder of Junior Subordinated
Debentures to be redeemed at its registered address.
Distribution of Junior Subordinated Debentures
Under certain circumstances involving the termination of the Issuer, Junior
Subordinated Debentures may be distributed to the holders of the Capital
Securities in liquidation of the Issuer after the satisfaction of liabilities to
creditors of the Issuer as provided by applicable law. If distributed to holders
of Capital Securities in liquidation, the Junior Subordinated Debentures will
initially be issued in the form of one or more global securities and DTC, or any
successor depositary for the Capital Securities will act as depositary for the
Junior Subordinated Debentures. It is anticipated that the depositary
arrangements for the Junior Subordinated Debentures would be substantially
identical to those in effect for the
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Capital Securities. There can be no assurance as to the market price of any
Junior Subordinated Debentures that may be distributed to the holders of the
Capital Securities. See "Description of the Capital Securities--Redemption--
Special Event Redemption or Distribution of Junior Subordinated Debentures" and
"Description of the Capital Securities--Liquidation Distribution upon
Termination." For a description of DTC and the terms of the depositary matters,
see "Description of the Capital Securities--Book-Entry-Only Issuance--The
Depositary Trust Company."
Interest
The Junior Subordinated Debentures shall bear interest at the rate of ___%
per annum. Such interest is payable semi-annual in arrears on ___ 1 and ____ 1
of each year (each, an "Interest Payment Date"), commencing ______ 1, 1999, to
the person in whose name each Junior Subordinated Debenture is registered at the
close of business on the Business Day next preceding such Interest Payment Date.
(Sections 301 and 307.) It is anticipated that, until the liquidation, if any,
of the Issuer, each Junior Subordinated Debenture will be held in the name of
the Property Trustee in trust for the benefit of the Issuer and the holders of
the Capital Securities.
The amount of interest payable for any period will be computed on the basis
of a 360-day year of twelve 30-day months. (Section 310). In the event that any
date on which interest is payable on the Junior Subordinated Debentures is not a
Business Day (as defined above), then payment of the interest payable on such
date will be made on the next succeeding day that is a Business Day (and without
any interest or other payment in respect of any such delay), except that, if
such Business Day is in the next succeeding calendar year, such payment shall be
made on the immediately preceding Business Day, in each case with the same force
and effect as if made on the date the payment was originally payable. Accrued
interest that is not paid on the applicable Interest Payment Date will bear
additional interest on the amount thereof (to the extent permitted by law) at
the rate per annum of ___% thereof, compounded semi-annually. The term
"interest" as used herein shall include semi-annual interest payments, interest
on semi-annual interest payments not paid on the applicable Interest Payment
Date and Additional Sums (as described below), as applicable. (Section 301.)
Option To Extend Interest Payment Period
So long as no Event of Default under the Indenture has occurred and is
continuing, PMC shall have the right at any time during the term of the Junior
Subordinated Debentures to defer the payment of interest on such Junior
Subordinated Debentures from time to time for a period not exceeding 10
consecutive semi-annual periods (each, an "Extension Period"), provided that no
Extension Period may extend beyond the Stated Maturity of the Junior
Subordinated Debentures. PMC shall have the right to make partial payments of
interest on any Interest Payment Date. At the end of any such Extension Period,
PMC must pay all interest then accrued and unpaid (together with interest
thereon at the rate of ___% per annum, compounded semi-annually, to the extent
permitted by applicable law). During an Extension Period, interest will
continue to accrue and holders of Junior Subordinated Debentures (or holders of
Capital Securities while outstanding) will be required to accrue interest income
for United States federal income tax purposes. See "United States Federal
Income Taxation--Original Issue Discount." However, during any such Extension
Period, PMC
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shall not, and shall cause any subsidiary of PMC not to, (a) declare or pay any
dividends or distributions on, or redeem, purchase, acquire or make a
liquidation payment with respect to, any of PMC's capital stock or (b) make any
payment of principal, interest or premium, if any, on or repay, repurchase or
redeem any debt securities of PMC that rank pari passu with or junior in
interest to the Junior Subordinated Debentures or make any guarantee payments
with respect to any guarantee by PMC of the debt securities of any subsidiary of
PMC that by their terms rank pari passu or junior in interest to the Junior
Subordinated Debentures (other than (a) dividends or distributions in Common
Stock or Class A Common Stock of PMC, (b) payments under the Guarantee and (c)
purchases of Common Stock or Class A Common Stock of PMC related to the issuance
of Common Stock or Class A Common Stock under any of PMC's benefit plans for its
directors, officers or employees). Prior to the termination of any such
Extension Period, PMC may further extend the interest payment period, provided
that such Extension Period, together with all such previous and further
extensions thereof, shall not exceed 10 consecutive semi-annual periods or
extend beyond the Stated Maturity of the Junior Subordinated Debentures. Upon
the termination of any Extension Period and the payment of all interest then
accrued and unpaid (together with interest thereon at the rate of ____% per
annum, compounded semi-annually, to the extent permitted by applicable law), PMC
may elect to begin a new Extension Period, subject to the above requirements. No
interest shall be due and payable during an Extension Period, except at the end
thereof. PMC must give the Debenture Trustee and the Administrative Trustees
notice of its election to begin any Extension Period at least one Business Day
prior to the earliest of (i) the date interest on the Junior Subordinated
Debentures would have been payable except for the election to begin such
Extension Period or (ii) the date the distributions on the Capital Securities
are payable or (iii) the date the Administrative Trustees are required to give
notice to the New York Stock Exchange, the Nasdaq National Market or other
applicable self-regulatory organization or to holders of the Capital Securities
of the record date or the date such distributions are payable, but in any event
not less than one Business Day prior to such record date. The Debenture Trustee
shall give notice of PMC's election to begin any Extension Period to the holders
of the outstanding Capital Securities. There is no limitation on the number of
times that PMC may elect to begin an Extension Period. (Section 301.)
Set-Off
Notwithstanding anything to the contrary in the Indenture, PMC shall have
the right to set-off any payment it is otherwise required to make thereunder
with respect to any Junior Subordinated Debenture and to the extent PMC has
theretofore made, or is concurrently on the date of such payment making, a
payment under the Guarantee or under the provisions of the Indenture which
permit any holder of the Capital Securities, upon the occurrence of a Debenture
Event of Default (as defined below) relating to nonpayment of interest or
principal on the Junior Subordinated Debentures to institute suit for the
enforcement of the payment of interest or principal. (Section 311.) This
provision prevents double collection from PMC of identical amounts due under the
various provisions of the Indenture and the Guarantee. To the extent PMC makes
a payment of unpaid distributions to holders of Capital Securities under the
Guarantee, PMC is not then also required to make a like payment of interest on
the Junior Subordinated Debentures (since such interest payment would be paid
out to such holders as the same unpaid distribution). Likewise, if holders of
Capital Securities bring an action directly against PMC under the Indenture and
collect unpaid distributions in such
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action, PMC may deduct the amounts so paid from any aggregate amount it owes on
the Junior Subordinated Debentures. Therefore, to the extent PMC makes payments
directly to holders of Capital Securities under the Guarantee or the Indenture,
the Property Trustee may not also collect such amounts under the Junior
Subordinated Debentures.
Subordination
The Junior Subordinated Debentures are subordinate and junior in right of
payment to all Senior Debt (as defined below) of PMC as provided in the
Indenture. No payment or distribution on account of principal of (or premium,
if any) or interest, if any, on, the Junior Subordinated Debentures or on
account of the purchase or other acquisition of Junior Subordinated Debentures
by PMC or any subsidiary may be made (a) in the event and during the
continuation of any default in the payment of principal of (or premium, if any)
or interest on any Senior Debt, or if the maturity of any Senior Debt has been
accelerated because of a default until such event of default shall have been
cured or waived or shall have ceased to exist and such acceleration shall have
been rescinded or annulled or (b) in the event of any judicial proceeding with
respect to any such default in payment or such event of default. (Section 1104.)
In the case of the pendency of any liquidation, reorganization, bankruptcy,
insolvency, receivership, arrangement, adjustment, composition or other judicial
proceeding relative to PMC, all principal of, and premium, if any, and interest,
if any, on all Senior Debt must be paid in full or provision must be made for
such payment in cash or cash equivalents or otherwise in a manner satisfactory
to the holders of Senior Debt, before the holders of the Junior Subordinated
Debentures are entitled to receive or retain any payment or distribution
thereon. (Section 1102.) In the event that, notwithstanding the foregoing, any
payment or distribution of cash, property or securities shall be received or
collected by a holder of the Junior Subordinated Debentures in contravention of
the foregoing provisions, such payment or distribution shall be held for the
benefit of and shall be paid over to the holders of Senior Debt or their
representative or representatives or to the trustee or trustees under any
indenture under which any instrument evidencing Senior Debt may have been
issued, as their respective interests may appear, to the extent necessary to pay
in full all Senior Debt then due, after giving effect to any concurrent payment
to the holders of Senior Debt, but only to the extent that the holders of the
Senior Debt (or their representative or representatives) notify the Trustees in
writing, within 90 days of such payment, of the amounts then due and owing on
such Senior Debt and only the amounts specified in such notice to the Trustees
shall be paid to the holders of such Senior Debt. Subject to the prior payment
of all Senior Debt, the rights of the holders of the Junior Subordinated
Debentures will be subrogated to the rights of the holders of Senior Debt to the
extent of the payments or distributions made to the holders of such Senior Debt
until all amounts owing on the Junior Subordinated Debentures are paid in full.
(Section 1106.)
"Debt" means with respect to any entity, whether recourse is to all or a
portion of the assets of such entity and whether or not contingent, (i) every
obligation of such entity for money borrowed; (ii) every obligation of such
entity evidenced by bonds, debentures, notes or other similar instruments,
including obligations incurred in connection with the acquisition of property,
assets or businesses; (iii) every reimbursement obligation of such entity with
respect to letters of credit, bankers' acceptances or similar facilities issued
for the account of such entity; (iv) every obligation of such entity issued or
assumed as the deferred purchase price of property or services (but excluding
trade accounts payable or accrued liabilities arising in the ordinary course of
business); (v) every capital lease obligation of such entity; and (vi) every
obligation of the type referred to in clauses (i) through (v) of another entity
and all dividends of another entity the payment of which, in either case, such
entity has guaranteed or is responsible or liable for, directly or indirectly,
as obligor or otherwise. (Section 101.)
"Senior Debt" means the principal of (and premium, if any) and interest, if
any (including interest accruing on or after the filing of any petition in
bankruptcy or for reorganization relating to PMC whether or not such claim for
post-petition interest is allowed in such proceeding), on Debt, whether incurred
on or prior to the date of the Indenture or thereafter incurred, unless, in the
instrument creating or evidencing the same or pursuant to
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which the same is outstanding, it is provided that such obligations are not
superior in right of payment to the Junior Subordinated Debentures or to other
Debt which is pari passu with, or subordinated to, the Junior Subordinated
Debentures; provided, however, that Senior Debt shall not be deemed to include
(i) any Debt of PMC which, when incurred and without respect to any election
under Section 1111(b)of the Bankruptcy Code, was without recourse to PMC, (ii)
any Debt of PMC to any of its subsidiaries, (iii) Debt to any employee of PMC,
(iv) trade accounts payable of PMC, (v) accrued liabilities arising in the
ordinary course of business of PMC, (vi) the Junior Subordinated Debentures, and
(vii) the Guarantee.
PMC is an insurance holding company and substantially all of the operating
assets of PMC are owned by its consolidated subsidiaries, principally PMA
Reinsurance Corporation and the Pooled Companies. PMC relies primarily on the
receipt of sufficient funds from PMA Reinsurance Corporation and the Pooled
Companies in the form of dividends, net payments under tax-sharing agreements or
loans to meet its obligations for payment of principal and interest on
outstanding debt obligations (including to Junior Subordinated Debentures) and
corporate expenses. Accordingly, PMC's obligations under the Junior Subordinated
Debentures will be effectively subordinated to all existing and future
liabilities of PMC's subsidiaries, and claimants should look only to the assets
of PMC for payments thereunder. Pennsylvania insurance law limits the payment of
dividends by PMA Reinsurance Corporation and the Pooled Companies. PMA
Reinsurance Corporation and the Pooled Companies have the ability to loan funds
to PMC subject to certain regulatory restrictions. See "Risk Factors--
Subordination of the Guarantee and the Junior Subordinated Debentures," and
"--Holding Company Structure--Restrictions on Subsidiary Dividends and Other
Payments" and "Supervision and Regulation".
The Indenture does not limit the aggregate amount of Senior Debt that may
be issued. After the completion of this Offering and the repayment of debt with
the proceeds thereof, PMC will have approximately $104.5 million of principal
amount of indebtedness for borrowed money constituting Senior Debt. PMC expects
from time to time to incur additional indebtedness constituting Senior Debt.
Certain Covenants of PMC
PMC will covenant in the Indenture that if and so long as (i) the Issuer is
the holder of all of the outstanding Junior Subordinated Debentures, (ii) a Tax
Event (as defined above) has occurred and is continuing and (iii) PMC has not
redeemed the Junior Subordinated Debentures pursuant to the Indenture or
terminated the Issuer pursuant to the Trust Agreement, PMC will pay to the
Issuer, for so long as the Issuer is the registered holder of any Junior
Subordinated Debentures, such additional amounts as may be necessary in order
that the amount of distributions then due and payable by the Issuer on the
outstanding Capital Securities and Common Securities of the Issuer shall not be
reduced as a result of any additional taxes, duties and other governmental
charges to which the Issuer has become subject from time to time as a result of
a Tax Event (the "Additional Sums"). (Section 1005). PMC will also covenant that
it will not, and it will not permit any subsidiary to, (a) declare or pay any
dividends or distributions on, or redeem, purchase, acquire or make a
liquidation payment with respect to, any of PMC's outstanding capital stock or
(b) make any payment of principal, interest or premium, if any, on or repay,
repurchase or redeem any debt securities that rank pari passu with or junior to
the Junior Subordinated Debentures or make any guarantee payments with respect
to any guarantee by PMC of the debt securities of any subsidiary of PMC that by
their terms rank pari passu or junior in interest to the Junior
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Subordinated Debentures, (other than (a) dividends or distributions in Common
Stock or Class A Common Stock of PMC, (b) payments under the Guarantee, and (c)
purchases of Common Stock or Class A Common Stock related to the issuance of
Common Stock or Class A Common Stock under any of PMC's benefit plans for its
directors, officers or employees) if at such time (i) there shall have occurred
and be continuing any event that, with the giving of notice or the lapse of
time, or both, would constitute a Debenture Event of Default and in respect of
which PMC shall not have taken reasonable steps to cure, (ii) PMC shall be in
default with respect to its payment of any obligations under the Guarantee or
(iii) PMC shall have given notice of its selection of an Extension Period as
provided in the Indenture and shall not have rescinded such notice and such
Extension Period, or any extension thereof, shall be continuing (Section 1006.)
PMC will also covenant (i) to maintain directly or indirectly 100% ownership of
the Common Securities of the Issuer (provided, however, that any permitted
successor of PMC may succeed to such ownership), (ii) not to voluntarily
dissolve, wind-up or terminate the Issuer, except in connection with a
distribution of the Junior Subordinated Debentures to the holders of the Capital
Securities in exchange for the Capital Securities and in liquidation of the
Issuer or in connection with certain mergers, consolidations or amalgamations
permitted by the Trust Agreement and (iii) to use its reasonable efforts,
consistent with the terms and provisions of the Trust Agreement, to cause the
Issuer to remain a business trust and to be classified as a grantor trust for
United States federal income tax purposes, except in connection with a
distribution of the Junior Subordinated Debentures to the holders of the Capital
Securities in liquidation of the Issuer. (Section 1006.)
Debenture Events of Default And Consequent Rights of Certain Holders
The Indenture provides that any one or more of the following described
events, that has occurred and is continuing constitutes an "Event of Default"
(also referred to herein as a "Debenture Event of Default") with respect to the
Junior Subordinated Debentures:
(a) failure for 30 days to pay interest on the Junior Subordinated
Debentures when due (subject to the deferral of any due date in the
case of an Extension Period); or
(b) failure to pay principal (or premium, if any) on the Junior
Subordinated Debentures when due whether at Stated Maturity, upon
redemption, by declaration or otherwise; or
(c) failure to observe or perform in any material respect any other
covenant contained in the Indenture for 90 days after written notice
to PMC from the Debenture Trustee or the holders of at least 25% in
aggregate principal amount of the outstanding Junior Subordinated
Debentures; or
(d) Certain events in bankruptcy, insolvency or reorganization of PMC.
(Section 501.)
Each of the above events is a Debenture Event of Default regardless of the
reason for such Event of Default and whether it shall be voluntary or
involuntary or be effected by operation of law or pursuant to any judgment,
decree or order of any court or any order, rule or regulation of any
administrative or governmental body. (Section 501.) There is no
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requirement that any such event must be declared by anyone to be a Debenture
Event of Default.
The holders of a majority in principal amount of the outstanding Junior
Subordinated Debentures have the right to direct the time, method and place of
conducting any proceeding for any remedy available to the Debenture Trustee,
under certain conditions. (Section 512.)
Acceleration of Maturity; Rescission and Annulment
The Debenture Trustee or the holders of not less than 25% in principal
amount of the outstanding Junior Subordinated Debentures may declare the
principal of all the Junior Subordinated Debentures due and payable immediately
upon the occurrence and continuation of a Debenture Event of Default, and should
the Debenture Trustee or such holders of Junior Subordinated Debentures fail to
make such declaration, the holders of at least 25% in aggregate Liquidation
Amount of Capital Securities then outstanding shall have such right. The holders
of a majority in principal amount of the outstanding Junior Subordinated
Debentures may rescind and annul such declaration. If the holders of a
majority in principal amount of the outstanding Junior Subordinated Debentures
fail to annul such declaration and its consequences, the holders of a majority
in aggregate Liquidation Amount of the Capital Securities may rescind and annul
such declaration and its consequences. (Section 502.)
Waiver of Defaults
Subject to certain limitations, the holders of not less than a majority in
aggregate principal amount of the outstanding Junior Subordinated Debentures
affected thereby may, on behalf of the holders of all the Junior Subordinated
Debentures, waive any past default under the Indenture and its consequences,
except a default in the payment of principal of or interest on any Junior
Subordinated Debentures (unless such default has been cured and a sum sufficient
to pay all matured installments of interest and principal due otherwise than by
acceleration has been deposited with the Debenture Trustee) or a default in
respect of a covenant or provision of the Indenture which under the Indenture
cannot be modified or amended without the consent of the holder of each
outstanding Junior Subordinated Debenture affected. If the holders of such
Junior Subordinated Debentures fail to waive such default, the holders of a
majority in aggregate Liquidation Amount of the Capital Securities shall have
such right. (Section 513.) PMC is required to deliver annually to the Debenture
Trustee a certificate stating whether or not to the best knowledge of the
signers thereof PMC is in default in the performance, observance or fulfillment
of or compliance with any of the material terms, provisions, covenants and
conditions of the Indenture (without regard to any period of grace or
requirement of notice provided under the Indenture) and, if PMC shall be in
default, specifying all such defaults and the nature and status thereof of which
they may have knowledge. (Section 1004.)
Creditor's Rights of The Debenture Trustee
In case a Debenture Event of Default shall occur and be continuing, the
Debenture Trustee will have the right to declare the principal (or specific
portions thereof) of and the interest on the Junior Subordinated Debentures, and
any other amount payable under the Indenture, to be forthwith due and payable
and to enforce its other rights as a creditor with
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respect to the Junior Subordinated Debentures. If the Debenture Trustee obtains
a judgment against PMC following the occurrence of a Debenture Event of Default,
the provisions of Pennsylvania law regulating insurance holding companies would
limit the ability of the Debenture Trustee to realize upon the assets of PMC by
conveying or transferring the capital stock of PMA Reinsurance Corporation or
the Pooled Companies owned by PMC. Any conveyance, transfer, assignment, or
alienation of a ten percent or greater interest in the voting shares of PMA
Reinsurance Corporation or any of the Pooled Companies would require the prior
approval of the Pennsylvania Commissioner. See "Supervision and Regulation."
Rights of Holders of Capital Securities to Direct Action
As explained more fully above (see "--Debenture Events of Default and
Consequent Rights of Certain Holders" and--Waiver of Defaults"), holders of less
than all of the outstanding Junior Subordinated Debentures or holders of less
than all of the Capital Securities may waive any past default (with certain
limited exceptions identified above). If so waived, any such Debenture Event of
Default shall cease to be "continuing" for purposes of the Indenture. However,
such holders may not waive any default in the payment of principal of or
interest on any Junior Subordinated Debentures unless such default has been
cured and a sum sufficient to pay all matured installments of interest and
principal due otherwise than by acceleration has been deposited with the
Debenture Trustee. If a Debenture Event of Default has occurred and is
continuing and such event is attributable to the failure of PMC for 30 days to
pay interest on or the failure of PMC to pay principal of the Junior
Subordinated Debentures on the date such interest or principal is otherwise
payable, any holder of Capital Securities may institute a suit directly against
PMC for enforcement of payment to such holder of the principal of and interest
on such Junior Subordinated Debentures having a principal amount equal to the
aggregate Liquidation Amount of the Capital Securities of such holder (a "Direct
Action") (Section 508). PMC may not amend the Indenture to remove the foregoing
right to bring a Direct Action without the prior written consent of the holders
of all of the outstanding Capital Securities. (Section 902). If the right to
bring a Direct Action is removed, the Issuer may become subject to the
regulatory obligations under the Exchange Act.
The holders of the Capital Securities would not be able to exercise
directly any remedies other than those set forth in the preceding paragraph
available to the holders of the Junior Subordinated Debentures unless there
shall have been a Debenture Event of Default and the holders of the Junior
Subordinated Debentures fail to exercise such remedies. See "--Debenture Events
of Default and Consequent Rights of Certain Holders" "--Acceleration of
Maturity; Rescission and Annulment" and "Debenture Events of Default and
Consequent Rights of Certain Holders", and --"Waiver of Defaults".
Form, Exchange and Transfer
The Junior Subordinated Debentures will be issuable only in registered
form, without coupons, and only in denominations of $1,000 and integral
multiples thereof. (Section 302.)
Subject to the terms of the Indenture, Junior Subordinated Debentures may
be presented for registration of transfer (duly endorsed or with the form of
transfer endorsed thereon duly executed) at the office of the Security Registrar
or at an office or agency of PMC designated by PMC for such purpose. No service
charge will be made to a holder of Junior
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Subordinated Debentures for any registration of transfer or exchange of Junior
Subordinated Debentures, but PMC or the Security Registrar may require payment
of a sum sufficient to cover any tax or other governmental charge that may be
imposed in connection therewith. Such transfer or exchange will be effected upon
the Securities Registrar or PMC, as the case may be, being satisfied with the
documents of title and identity of the person making the request. PMC has
appointed the Debenture Trustee as Securities Registrar. (Section 305.) PMC may
at any time designate additional transfer agents or rescind the designation of
any transfer agent or approve a change in the office through which any transfer
agent acts. (Section 1002.)
Neither PMC nor the Securities Registrar will be required (i) to issue,
transfer or exchange any Junior Subordinated Debenture during a period beginning
at the opening of business 15 days before the day of selection for redemption of
any such Junior Subordinated Debentures pursuant to the Indenture and ending at
the close of business on the day of mailing of notice of redemption or (ii) to
transfer or exchange any Junior Subordinated Debentures so selected for
redemption, in whole or in part, except the unredeemed portion of any such
Junior Subordinated Debentures being redeemed in part. (Section 305.)
Payment And Paying Agents
Payment of interest on a Junior Subordinated Debenture on any Interest
Payment Date will be made to the person in whose name such Junior Subordinated
Debenture (or predecessor security) is registered at the close of business on
the Business Day next preceding such Interest Payment Date except in the case of
interest which is payable but is not paid or provided for on such Interest
Payment Date. (Section 307.)
Principal of and any interest on the Junior Subordinated Debentures will be
payable at the office of such Paying Agent or Paying Agents as PMC may designate
for such purpose from time to time, provided, however, that at the option of
PMC, payment of any interest may be made (i) by check mailed to the address of
the person entitled thereto as such address shall appear in the Securities
Register or (ii) by wire transfer in immediately available funds at such place
and to such account as may be designated by the person entitled thereto as
specified in the Securities Register. Bank of New York will act as Paying
Agent with respect to the Junior Subordinated Debentures. PMC may at any time
designate additional Paying Agents or rescind the designation of any Paying
Agent or approve a change in the office through which any Paying Agent acts.
(Section 301.)
Modification of The Indenture
From time to time, PMC and the Debenture Trustee may, without the consent
of the holders of Junior Subordinated Debentures, amends waive or supplement the
Indenture for specified purpose, including, among other things, curing
ambiguities, defects or inconsistencies (provided that any such action does not
materially adversely affect the interest of the holders of any Junior
Subordinated Debentures or the holders of Capital Securities so long as they
remain outstanding) and qualifying, or maintaining the qualification of, the
Indenture under the Trust Indenture Act. The Indenture contains provisions
permitting PMC and the Debenture Trustee, with the consent of the holders of not
less than a majority in principal amount of the outstanding Junior Subordinated
Debentures, to modify the Indenture in a manner adversely affecting the rights
of the holders of the Junior Subordinated
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Debentures; provided that no such modification may, without the consent of the
holder of each outstanding Junior Subordinated Debenture affected thereby, (i)
except as set forth in "--Option to Extend Interest Payment Period" above,
change the Stated Maturity of, the principal of, or any installment of interest
on, any Junior Subordinated Debenture or reduce the principal amount thereof, or
the rate of interest thereon or reduce any premium payable upon the redemption
thereof or change the place of payment where, or the coin or currency in which,
any Junior Subordinated Debenture or interest thereon is payable, or impair the
right to institute suit for the enforcement of any such payment on or after the
Stated Maturity thereof (or in the case of redemption, on or after the
Redemption Date), or modify the provisions of the Indenture with respect to the
subordination of the Junior Subordinated Debentures in a manner adverse to the
holders thereof (except such change or extension as is contemplated thereby,
(ii) reduce the percentage in principal amount of the outstanding Junior
Subordinated Debentures, the consent of the holders of which is required for any
waiver provided for in the Indenture or (iii) modify certain provisions of the
Indenture providing for waiver of defaults, waiver of covenants and modification
of the Indenture, except to increase the percentage or to provide that certain
other provisions of the Indenture cannot be modified or waived without the
consent of the holder of each outstanding Junior Subordinated Debenture affected
thereby; provided, that, so long as any of the Capital Securities remains
outstanding, (a) no such modification may be made that adversely affects the
holders of the Capital Securities in any material respect, and no termination of
the Indenture may occur, and no waiver of any Debenture Event of Default or
compliance with any covenant under the Indenture shall be effective, without the
prior consent of the holders of at least a majority of the aggregate Liquidation
Amount of the outstanding Capital Securities unless and until the principal of
and any premium on the Junior Subordinated Debentures and all accrued and unpaid
interest thereon have been paid in full and (b) where a consent under the
Indenture would require the consent of each holder of Junior Subordinated
Debentures, no such consent will be given by the Property Trustee without the
prior consent of each holder of the Capital Securities. (Section 902.)
Consolidation, Merger And Sale
PMC, without the consent of the holders of any outstanding Junior
Subordinated Debentures, may consolidate with or merge into, or convey, transfer
or lease its properties and assets substantially as an entirety to any person,
and may permit any person to consolidate with or merge into, or convey, transfer
or lease its properties and assets substantially as an entirety to PMC, provided
(i) that any successor person must be a corporation, partnership, trust or other
entity organized and validly existing under the laws of any domestic
jurisdiction and must expressly assume PMC's obligations on the Junior
Subordinated Debentures and under the Indenture, (ii) that immediately after
giving effect to the transaction no Debenture Event of Default, and no event
which, after notice or lapse of time or both, would become a Debenture Event of
Default, shall have occurred and be continuing, (iii) that such transaction is
permitted under the Trust Agreement and the Guarantee and does not give rise to
any breach or violation of, the Trust Agreement or the Guarantee and (iv) that
certain other conditions as prescribed by the Indenture are met. (Section 801).
The general provisions of the Indenture do not afford holders of Junior
Subordinated Debentures protection in the event of a highly leveraged or other
transaction involving PMC that may adversely affect holders of the Junior
Subordinated Debentures. Since the Indenture
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does not limit the aggregate amount of Senior Debt that may be issued and the
Junior Subordinated Debentures are subordinate to all Senior Debt, including
such Debt incurred after the date of the Indenture (see "--Subordination"
above), if the PMC chooses to engage in a highly leveraged transaction whereby
it would incur a substantial amount of Debt, the obligations under the Junior
Subordinated Debentures would become more deeply subordinated and the holders of
the Junior Subordinated Debentures would not be able to avoid this consequence
provided that the conditions set forth in the immediately preceding paragraph
are met. Similarly, PMC could be involved in a reorganization, restructuring,
merger or similar transaction that could adversely affect the holders of the
Junior Subordinated Debentures but, provided that the conditions set forth in
the immediately preceding paragraph are met, such holders could not avoid such
adverse affects.
Satisfaction and Discharge
Under the terms of the Indenture, the Indenture will cease to be of further
effect and PMC will be deemed to have satisfied and discharged the Indenture
(except as to PMC's obligations to pay all other sums due pursuant to the
Indenture and to provide the officers' certificates and opinions of counsel
described therein), if all Junior Subordinated Debentures not previously
delivered to the Debenture Trustee for cancellation have become due and payable,
or will become due and payable at their Stated Maturity within one year of the
date of deposit, and PMC deposits with the Debenture Trustee, in trust, cash, or
cash equivalents in an amount sufficient to pay all the principal of, premium,
if any, and interest on the Junior Subordinated Debentures to the date of such
deposit or to the Stated Maturity, as the case may be. (Section 401.)
Governing Law
The Indenture and the Junior Subordinated Debentures will be governed by,
and construed in accordance with, the laws of the State of New York. (Section
112.)
Miscellaneous
PMC will have the right of all times to assign any of its rights or
obligations under the Indenture to a direct or indirect wholly-owned subsidiary
of PMC, provided that, in the event of any such assignment, PMC will remain
liable for all such obligations. The Issuer may not assign any of its rights
under the Indenture without the prior written consent of PMC. The Indenture is
not otherwise assignable by the parties thereto. Subject to the foregoing, the
Indenture will be binding upon and inure to the benefit of the parties thereto
and their respective successors and assigns. (Section 109.)
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RELATIONSHIP AMONG THE CAPITAL SECURITIES, THE JUNIOR
SUBORDINATED DEBENTURES AND THE GUARANTEE
Full and Unconditional Guarantee
Payments of distributions and other amounts due on the Capital Securities
(to the extent the Issuer has funds available for the payment of such
distributions) are irrevocably guaranteed by PMC as and to the extent set forth
under "Description of the Guarantee." Taken together, PMC's obligations under
the Junior Subordinated Debentures, the Indenture, the Trust Agreement, the
Expense Agreement, and the Guarantee provide, in the aggregate, a full,
irrevocable and unconditional guarantee of payments of distributions and other
amounts due on the Capital Securities. No single document standing alone or
operating in conjunction with fewer than all of the other documents constitutes
such guarantee. It is only the combined operation of these documents that has
the effect of providing a full, irrevocable and unconditional guarantee of the
Issuer's obligations under the Capital Securities. If and to the extent that
PMC does not make payments on the Junior Subordinated Debentures, the Issuer
will not pay distributions or other amounts due on its Capital Securities. The
Guarantee does not cover payment of distributions when the Issuer does not have
sufficient funds to pay such distributions. In such event, the remedy of a
holder of Capital Securities is to institute a legal proceeding directly against
PMC under the terms of the Indenture for enforcement of payment of such
distributions to such holder. The Indenture likewise provides for such a direct
action by holders of the Junior Subordinated Debentures. The obligations of PMC
under the Guarantee are subordinate and junior in right of payment to all Senior
Debt of PMC.
Sufficiency of Payments
As long as payments of interest and other payments are made when due on the
Junior Subordinated Debentures, such payments will be sufficient to cover
distributions and other payments due on the Capital Securities, primarily
because (i) the aggregate principal amount of the Junior Subordinated Debentures
will be equal to the sum of the aggregate stated Liquidation Amount of the
Capital Securities and the Common Securities; (ii) the interest rate and
interest and other payment dates on the Junior Subordinated Debentures will
match the distribution rate and distribution and other payment dates for the
Capital Securities; (iii) PMC shall pay for all and any costs, expenses and
liabilities of the Issuer except the Issuer's obligations to holders of its
Capital Securities under the Capital Securities and (iv) the Trust Agreement
further provides that the Issuer will not engage in any activity that is not
consistent with its limited purposes.
Notwithstanding anything to the contrary in the Indenture, PMC has the
right to set-off any payment it is otherwise required to make thereunder with
and to the extent PMC has theretofore made, or is concurrently on the date of
such payment making, a payment under the Guarantee. See "Description of the
Junior Subordinated Debentures--Set-Off."
Enforcement Rights of Holders of Capital Securities
A holder of any Capital Security may, to the extent permissible under
applicable law, institute a legal proceeding directly against PMC to enforce its
rights under the Guarantee
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without first instituting a legal proceeding against the Guarantee Trustee, the
Issuer or any other person or entity.
A default or event of default under any Senior Debt of PMC would not
constitute a default or Debenture Event of Default under the Indenture. However,
in the event of payment defaults under, or acceleration of Senior Debt of PMC,
the subordination provisions of the Indenture provide that no payments may be
made in respect of the Junior Subordinated Debentures until such Senior Debt has
been paid in full or any payment default thereunder has been cured or waived.
Failure to make required payments on Junior Subordinated Debentures would
constitute a Debenture Event of Default.
Limited Purpose of Issuer
The Issuer's Capital Securities evidence a beneficial interest in the
Issuer, and the Issuer exists for the sole purpose of issuing its Capital
Securities and Common Securities and investing the proceeds thereof in the
Junior Subordinated Debentures. A principal difference between the rights of a
holder of a Capital Security and a holder of a Junior Subordinated Debenture is
that a holder of a Junior Subordinated Debenture is entitled to receive from PMC
the principal amount of and interest accrued on the Junior Subordinated
Debentures held, while a holder of Capital Securities is entitled to receive
distributions from the Issuer (or, to the extent such distributions are not made
by or on behalf of the Issuer, from PMC under the Guarantee) if and to the
extent the Issuer has funds available for payment of such distributions.
Rights Upon Termination
Upon any voluntary or involuntary dissolution, winding-up or termination of
the Issuer, after satisfaction of the liabilities of the Issuer to creditors as
required by applicable law, the holders of Capital Securities will be entitled
to receive, out of assets available for distribution to holders, the Liquidation
Distribution in cash or Junior Subordinated Debentures. See "Description of the
Capital Securities--Liquidation Distribution upon Termination." Upon any
voluntary or involuntary liquidation or bankruptcy of PMC, the Property Trustee,
as holder of the Junior Subordinated Debentures, would be a subordinated
creditor of PMC, subordinated in right of payment to all Senior Debt, but
entitled to receive payment in full of principal, premium, if any, and interest,
before any shareholders of PMC receive payments or distributions. Since PMC is
Guarantor under the Guarantee and has agreed, under the Expense Agreement, to
pay for all indebtedness, expenses and liabilities of the Issuer (other than the
Issuer's obligations to Capital Security holders under the Capital Securities),
the positions of a holder of Capital Securities and a holder of Junior
Subordinated Debentures relative to other creditors and to shareholders of PMC
in the event of liquidation or bankruptcy of PMC would be substantially the
same.
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UNITED STATES FEDERAL INCOME TAXATION
General
The following is a summary of certain of the material United States federal
income tax consequences of the purchase, ownership and disposition of Capital
Securities, based upon the opinion of Duane, Morris & Heckscher LLP, counsel to
PMC. Unless otherwise stated, this summary deals only with Capital Securities
held as capital assets by a holder that purchase the Capital Securities upon
original issuance at their original issue price and that is (i) a citizen or
resident of the United States, (ii) a domestic corporation, (iii) an estate the
income of which is subject to the United States federal income tax without
regard to its source or (iv) a trust if a United States court is able to
exercise primary supervision over administration of the trust and one or more
United States persons have authority to control all substantial decisions of the
trust (a "United States Holder"). This summary does not address all the tax
consequences that may be relevant to holders that may be subject to special tax
treatment such as, for example, banks, real estate investment trusts, regulated
investment companies, insurance companies, dealers in securities or currencies,
traders that elect to mark to market, tax-exempt investors, persons whose
functional currency is other than the United States dollar, persons who hold
Capital Securities as part of a straddle, hedging or conversion transaction or,
except as specifically described herein, foreign taxpayers. In addition, this
summary does not address any aspects of state, local or foreign laws. This
summary is based on the Internal Revenue Code of 1986, as amended (the "Code"),
Treasury regulations promulgated thereunder and administrative and judicial
interpretations thereof, as of the date hereof, all of which are subject to
change, possibly on a retroactive basis. Each holder should consult its tax
advisor as to its particular tax consequences of acquiring, holding, and
disposing of the Capital Securities, including the tax consequences under state,
local and foreign laws.
Classification of the Junior Subordinated Debentures
It is a condition to the issuance of the Capital Securities that Duane,
Morris & Heckscher LLP, counsel to PMC, render its opinion to the effect that,
under current United States federal income tax law, the Junior Subordinated
Debentures held by the Trust will be classified for United States federal income
tax purposes as indebtedness of PMC. Accordingly, corporate United States
Holders of Capital Securities will not be entitled to a dividends-received
deduction with respect to any income recognized with respect to the Capital
Securities.
Classification of the Trust
Duane, Morris & Heckscher LLP, counsel to PMC and the Trust, has rendered
its opinion to the effect that, under current United States federal income tax
law, the Trust will be classified for United States federal income tax purposes
as a grantor trust and not as an association taxable as a corporation.
Accordingly, for United States federal income tax purposes, each United States
Holder of Capital Securities will generally be considered the owner of an
undivided interest in the Junior Subordinated Debentures, and each United States
Holder will be required to include in its gross income any interest paid or
accrued or any original issue discount ("OID") accrued with respect to its
allocable share of those Junior Subordinated Debentures. Investors
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should be aware that the foregoing opinions of Duane, Morris & Heckscher LLP
will not be confirmed by the IRS by private ruling or otherwise, and will not be
binding on the Service or the courts. By its acceptance of a Capital Security, a
holder agrees to treat the Capital Security and the Junior Subordinated
Debentures consistently with the foregoing opinions.
Interest Income and Original Issue Discount
PMC has the option, under the terms of the Junior Subordinated Debentures,
to defer payments of interest by extending interest payments for up to 10 semi-
annual periods. See "Description of the Junior Subordinated Debentures--Option
to Extend Interest Payment Period." Under applicable Treasury regulations (the
"Regulations"), a contingency that stated interest will not be timely paid that
is "remote", because of the terms of the relevant debt instrument, will be
ignored in determining whether such debt instrument is issued with original
issue discount ("OID"). As a result of the terms and conditions of the Junior
Subordinated Debentures that prohibit certain payments with respect to PMC's
capital stock and indebtedness if PMC elects to extend interest payment periods,
PMC believes that the likelihood of its exercising its option to defer payments
is remote. See "Description of the Junior Subordinated Debentures--Option to
Defer Interest Payment Period." Based on the foregoing, PMC believes that the
Junior Subordinated Debentures will not be considered to be issued with OID at
the time of their original issuance and, accordingly, a United States Holder
should include in gross income such holder's allocable share of interest on the
Junior Subordinated Debentures in accordance with such holder's normal method of
accounting for tax purposes.
If the option to defer any payment of interest was determined not to be
"remote" or if PMC exercises its option to defer any payment of interest, the
Junior Subordinated Debentures would be treated as issued with OID at the time
of issuance or at the time of such exercise, as the case may be, and all stated
interest on the Junior Subordinated Debentures would thereafter be treated as
OID as long as the Junior Subordinated Debentures remained outstanding. In such
event, all of a United States Holder's taxable interest income with respect to
the Junior Subordinated Debentures would be accounted for as OID on a constant
yield method regardless of such holder's method of tax accounting, and actual
distributions of stated interest would not be reported as taxable income.
Consequently, a United States Holder would be required to include OID in gross
income even though PMC would not make any actual cash payments during an
Extension Period.
The IRS has not addressed the Regulations in any rulings or other
interpretations, and it is possible that the IRS could take a position contrary
to the interpretation herein.
Because income on the Capital Securities will constitute interest or OID,
corporate United States Holders of the Capital Securities will not be entitled
to a dividends received deduction with respect to any income recognized with
respect to the Capital Securities.
Market Discount and Premium
United States Holders of Capital Securities other than holders that
purchased the Capital Securities upon original issuance at their original issue
price may be considered to
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have acquired their undivided interest in the Junior Subordinated Debentures
with market discount, amortizable bond premium or acquisition premium as such
terms are defined for United States federal income tax purposes. Such holders
are urged to consult their tax advisors as to the income tax consequences of
the acquisition, ownership and disposition of the Capital Securities.
Receipt of Junior Subordinated Debentures or Cash Upon Liquidation of the Trust
Under certain circumstances, as described under the caption "Description of
the Capital Securities--Redemption--Special Event Redemption or Distribution of
Junior Subordinated Debentures" and "Description of the Capital Securities--
Liquidation Distribution upon Termination," Junior Subordinated Debentures may
be distributed to holders in exchange for the Capital Securities and in
liquidation of the Trust. Such a distribution would generally be a non-taxable
event to each United States Holder, and each United States Holder would have an
aggregate tax basis in the Junior Subordinated Debentures equal to such holder's
aggregate tax basis in its Capital Securities. A United States Holder's holding
period in the Junior Subordinated Debentures so received in liquidation of the
Trust would include the period during which such holder held the Capital
Securities. If, however, the liquidation of the Trust were to occur because the
Trust is subject to United States federal income tax with respect to income
accrued or received on the Junior Subordinated Debentures, as would be the case
if, for example, the Trust were treated as an association taxable as a
corporation, the distribution of Junior Subordinated Debentures to a United
States Holder by the Trust would be a taxable event to the Trust and each United
States Holder, and each United States Holder would recognize a gain or loss as
if the United States Holder had exchanged its Capital Securities for the Junior
Subordinated Debentures it received upon liquidation of the Trust. A United
States Holder will include interest in income in respect of Junior Subordinated
Debentures received from the Trust in the manner described above under
"--Interest Income and Original Issue Discount."
Under certain circumstances described herein (see "Description of the
Capital Securities"), the Junior Subordinated Debentures may be redeemed for
cash and the proceeds of such redemption distributed to holders in redemption of
their Capital Securities. Such a redemption would be a taxable event to each
United States Holder, and a United States Holder would recognize gain or loss as
if it sold such redeemed Capital Securities for cash. See "-- Sales of Capital
Securities."
Sales of Capital Securities
A United States Holder that sells Capital Securities will recognize gain or
loss equal to the difference between such holder's adjusted tax basis in the
Capital Securities and the amount realized on the sale of such Capital
Securities. Assuming that PMC does not exercise its option to defer payment of
interest on the Junior Subordinated Debentures, and the Junior Subordinated
Debentures are not considered issued with OID, a holder's adjusted tax basis in
the Capital Securities generally will be its initial purchase price. If the
Junior Subordinated Debentures are deemed to be issued with OID, a holder's
adjusted tax basis in the Capital Securities generally will be its initial
purchase price, increased by OID previously includible in such gross income to
the date of disposition and decreased by distributions or other payments
received on the Capital Securities since and including the date the Junior
Subodinated Debentures were treated as issued with OID. Such gain or loss will
generally be capital gain or loss and will generally be long-term capital gain
or loss if the Capital Securities have been held for more than one year. Long-
term capital gain of a non-corporate United States Holder is generally subject
to a maximum tax rate of 20%.
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The Capital Securities may trade at prices that do not accurately reflect
the value of accrued but unpaid interest with respect to the underlying Junior
Subordinated Debentures. A United States Holder that disposes of Capital
Securities between record dates for payments of distributions thereon will be
required to include accrued but unpaid interest on the Junior Subordinated
Debentures through the date of disposition in income as ordinary income, and to
add such amount to such holder's adjusted tax basis in the pro rata share of the
underlying Junior Subordinated Debentures deemed disposed of. To the extent
that the selling price is less than such holder's adjusted tax basis (so
determined) a United States Holder will recognize a capital loss. Subject to
certain limited exceptions, capital losses cannot be applied to offset ordinary
income for United States federal income tax purposes.
United States Alien Holders
For purposes of this discussion, a "United States Alien Holder" is any
corporation, individual, partnership, estate or trust that is, for United States
federal income tax purposes, a foreign corporation, a nonresident alien
individual, a foreign partnership, or a nonresident fiduciary of a foreign
estate or trust. The discussion assumes that income with respect to the Capital
Securities is not effectively connected with a trade or business in the United
States in which the United States Alien Holder is engaged.
Under current United States federal income tax law, and subject to the
discussion of backup withholding in the following section: (1) payments with
respect to principal and interest (including OID) by the Trust or any of its
paying agents to any holder of Capital Securities that is a United States Alien
Holder will not be subject to withholding of United States federal income tax;
provided that, in the case of interest, (a) the beneficial owner of the Capital
Securities does not actually or constructively own 10% or more of the total
combined voting power of all classes of stock of PMC entitled to vote, (b) the
beneficial owner of the Capital Securities is not a controlled foreign
corporation that is related, directly or indirectly, to PMC through stock
ownership and (c) either (A) the beneficial owner of the Capital Securities
certifies to the Trust or its agent, under penalties of perjury, that it is a
United States Alien Holder and provides its name and address or (B) a securities
clearing organization, bank or other financial institution that holds customers'
securities in the ordinary course of its trade or business (a "Financial
Institution"), and holds the Capital Securities in such capacity, certifies to
the Trust or its agent, under penalties of perjury, that such statement has
been received from the beneficial owner by it or by a Financial Institution
between it and the beneficial owner and furnishes the Trust or its agent with a
copy thereof and (2) a United States Alien Holder of Capital Securities will
generally not be subject to withholding of United States federal income tax on
any gain realized upon the sale or other disposition of a Capital Securities
(however, gains recognized by an individual United States Alien Holder that
holds the Capital Securities as a capital asset and is in the United States for
183 or more days in the taxable year of sale may be subject to United States
federal income tax).
Backup Withholding Tax And Information Reporting
Under current United States federal income tax law, information reporting
requirements apply to interest (including OID) and principal payments made to,
and to the proceeds of sales before maturity by, certain non-corporate persons.
In addition, a 31% backup
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withholding tax applies if a non-corporate person (i) fails to furnish such
person's Taxpayer Identification Number ("TIN") (which, for an individual, would
be his or her Social Security Number) to the payor in the manner required, (ii)
furnishes an incorrect TIN and the payor is so notified by the Service, (iii) is
notified by the Service that such person has failed properly to report payments
of interest and dividends or (iv) in certain circumstances, fails to certify,
under penalties of perjury, that such person has not been notified by the
Service that such person is subject to backup withholding for failure properly
to report interest and dividend payments. Backup withholding does not apply with
respect to payments made to certain exempt recipients, such as corporations and
tax-exempt organizations.
In the case of a United States Alien Holder, backup withholding and
information reporting do not apply to payments of principal and interest with
respect to a Capital Security with respect to which such Holder has provided the
required certification under penalties of perjury that such Holder is a United
States Alien Holder or has otherwise established an exemption, provided that
certain conditions are satisfied.
In general, (i) principal or interest payments with respect to a Capital
Security collected outside the United States by a foreign office of a custodian,
nominee or other agent acting on behalf of a beneficial owner of a Capital
Security and (ii) payments on the sale, exchange or retirement of a Capital
Security to or through a foreign office of a broker are not subject to backup
withholding or information reporting. However, if such custodian, nominee,
agent or broker is (i) a United States person, (ii) a controlled foreign
corporation for United States federal income tax purposes, (iii) a foreign
person 50% or more of whose gross income is effectively connected with the
conduct of a United States trade or business for a specified three-year period
or (iv) with respect to payments made after December 31, 1999, a foreign
partnership, if at any time during its tax year, one or more of its partners are
United States persons (as defined in United States Treasury regulations) who in
the aggregate hold more than 50% of the income or capital interest in the
partnership or if at any time during its tax year, such foreign partnership is
engaged in a United States trade or business, such custodian, nominee, agent or
broker may be subject to certain information reporting (but not backup
withholding) requirements with respect to such payments.
Backup withholding tax is not an additional tax. Rather, any amounts
withheld from a payment to a person under the backup withholding rules are
allowed as a refund or a credit against such person's United States federal
income tax, provided that the required information is furnished to the Service.
Possible Tax Law Changes
Prospective investors should be aware that Enron Corporation has filed a
petition in the United States Tax Court challenging the proposed disallowance by
the IRS of the deduction of interest expense on securities issued by Enron
Corporation in 1993 and 1994 that are similar to, although different in a number
of respects from, the Junior Subordinated Debentures. It is possible that a
decision in that case could give rise to a Tax Event, which would permit PMC to
cause a redemption of the Capital Securities, as described more fully under
"Description of the Capital Securities--Redemption--Special Event Redemption or
Distribution of Junior Subordinated Debentures." Prospective investors should
also be aware that legislation has been proposed by the Clinton Administration
in the past that, if enacted,
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would have denied an interest deduction to issuers of instruments such as the
Junior Subordinated Debentures. No such legislation is currently pending. There
can be no assurance, however, that similar legislation will not ultimately be
enacted into law, or that other developments will not occur on or after the date
hereof that would adversely affect the tax treatment of the Junior Subordinated
Debentures or the Trust. Such changes also could give rise to a Tax Event.
CERTAIN ERISA CONSIDERATIONS
Each fiduciary of a pension, profit-sharing or other employee benefit plan
subject to the Employee Retirement Income Security Act of 1974, as amended
("ERISA") (a "Plan"), should consider the fiduciary standards of ERISA in the
context of the Plan's particular circumstances before authorizing an investment
in the Capital Securities. Accordingly, among other factors, the fiduciary
should consider whether the investment would satisfy the prudence and
diversification requirements of ERISA and would be consistent with the documents
and instruments governing the Plan.
Section 406 of ERISA and Section 4975 of the Code prohibit Plans, as well
as individual retirement accounts and Keogh plans subject to Section 4975 of the
Code (also "Plans"), from engaging in certain transactions involving "plan
assets" with persons who are "parties in interest" under ERISA or "disqualified
persons" under the Code ("Parties in Interest") with respect to such Plan. A
violation of these "prohibited transaction" rules may result in an excise tax or
other liabilities under ERISA and/or Section 4975 of the Code for such persons,
unless exemptive relief is available under an applicable statutory or
administrative exemption. Employee benefit plans that are governmental plans (as
defined in Section 3(32) of ERISA), certain church plans (as defined in Section
3(33) of ERISA) and foreign plans (as described in Section (4)(b)(5) of ERISA
are not subject to the requirements of ERISA or Section 4975 of the Code;
governmental plans may be subject to similar provisions under applicable state
laws.
Under a regulation (the "Plan Assets Regulation") issued by the U.S.
Department of Labor (the "DOL"), the assets of the Issuer would be deemed to be
"plan assets" of a Plan for purposes of ERISA and Section 4975 of the Code if
"plan assets" of the Plan were used to acquire an equity interest in the Issuer
and no exception were applicable under the Plan Assets Regulation. An "equity
interest" is defined under the Plan Assets Regulation as any interest in an
entity other than an instrument which is treated as indebtedness under
applicable local law and which has no substantial equity features and
specifically includes a beneficial interest in a trust.
Pursuant to an exception contained in the Plan Assets Regulation, the
assets of the Issuer would not be deemed to be "plan assets" of investing Plans
if, immediately after the most recent acquisition of any equity interest in the
Issuer, less than 25% of the value of each class of equity interests in the
Issuer were held by Plans, other employee benefit plans not subject to ERISA or
Section 4975 of the Code (such as governmental, church and foreign plans), and
entities holding assets deemed to be "plan assets" of any Plan (collectively,
"Benefit Plan Investors"), or if the Capital Securities were "publicly-offered
securities" for purposes of the Plan Assets Regulation. No assurance can be
given that the value of the Capital Securities held by Benefit Plan Investors
will be less than 25% of the total value of such Capital
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Securities at the completion of the initial offering or thereafter, and no
monitoring or other measures will be taken with respect to the satisfaction of
the conditions to this exception. In addition, no assurance can be given that
the Capital Securities would be considered to be "publicly-offered securities"
under the Plan Assets Regulation. All of the Common Securities will be purchased
and initially held by PMC.
Certain transactions involving the Issuer could be deemed to constitute
direct or indirect prohibited transactions under ERISA and Section 4975 of the
Code with respect to a Plan if the Capital Securities were acquired with "plan
assets" of such Plan and the assets of the Issuer were deemed to be "plan
assets" of such Plan and the assets were deemed to be "plan assets" of Plans
investing in the Issuer. For example, if PMC is a Party in Interest with
respect to an investing Plan (either directly or by reason of its ownership of
its subsidiaries), extensions of credit between PMC and the Issuer (as
represented by the Junior Subordinated Debentures and the Guarantee) would
likely be prohibited by Section 406(a)(1)(B) of ERISA and Section 4975(c)(1)(B)
of the Code unless exemptive relief were available under an applicable
administrative exemption (see below). In addition, if PMC were considered to be
a fiduciary with respect to the Issuer as a result of certain powers it holds
(such as the powers o remove and replace the Property Trustee and the
Administrative Trustee), the optional redemption or acceleration of the Junior
Subordinated Debentures could be considered to be prohibited transactions under
Section 406(b) of ERISA and Section 4975(c)(1)(E) of the Code. In order to avoid
such prohibited transactions, each investing Plan by purchasing the Capital
Securities will be deemed to have directed the Issuer to invest in the Junior
Subordinated Debentures and to have appointed the Property Trustee.
The DOL has issued five prohibited transaction class exemptions ("PTCEs")
that may provide exemptive relief if required for direct or indirect prohibited
transactions that may arise from the purchase or holding of the Capital
Securities if assets of the Issuer were deemed to be "plan assets" of Plans
investing in the Issuer as described above. Those class exemptions are PTCE 96-
23 (for certain transactions determined by in-house asset managers), PTCE 95-60
(for certain transactions involving insurance company general accounts), PTCE
91-38 (for certain transactions involving bank collective investment funds),
PTCE 90-1 (for certain transactions involving insurance company separate
accounts), and PTCE 84-14 (for certain transactions determined by independent
qualified professional asset managers).
Because the Capital Securities may be deemed to be equity interests in the
Issuer for purposes of applying ERISA and Section 4975 of the Code, the Capital
Securities may not be purchased or held by any Plan, any entity whose underlying
assets include "plan assets" by reasons of any Plan's investment in the entity
(a "Plan Asset Entity") or any person investing "plan assets" of any Plan,
unless such purchaser or holder is eligible for the exemptive relief available
under PTCE 96-23, 95-60, 91-38, 90-1 or 84-14 or another applicable exemption.
Any purchaser or holder of the Capital Securities or any interest therein will
be deemed to have represented by its purchase and holding thereof that it either
(a) is not a Plan or a Plan Asset Entity and is not purchasing such securities
on behalf of or with "plan assets" of any Plan or (b) is eligible for the
exemptive relief available under PTCE 96-23, 95-60, 91-38, 90-1 or 84-14 or
another applicable exemption with respect to such purchase or holding. If a
purchaser or holder of the Capital Securities that is a Plan or a Plan Asset
Entity elects to rely on an exemption other than PTCE 96-23, 95-60, 91-38, 90-1
or 84-14, PMC and the Issuer may require
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a satisfactory opinion of counsel or other evidence with respect to the
availability of such exemption for such purchase and holding.
Due to the complexity of these rules and the penalties that may be imposed
upon persons involved in non-exempt prohibited transactions, it is particularly
important that fiduciaries or other persons considering purchasing the Capital
Securities on behalf of or with "plan assets" of any Plan consult with their
counsel regarding the potential consequences if the assets of the issuer were
deemed to be "plan assets" and the availability of exemptive relief under PTCE
96-23, 95-60, 91-38, 90-1 or 84-14 or any other applicable exemption.
VALIDITY OF SECURITIES
Certain matters of Delaware law relating to the validity of the Capital
Securities, the enforceability of the Trust Agreement and the formation of the
Issuer will be passed upon by Duane, Morris & Heckscher LLP, counsel to PMC and
the Issuer. The validity of the Guarantee and the Junior Subordinated Debentures
will be passed upon for PMC by Duane, Morris & Heckscher LLP and for the
Underwriters by Sullivan & Cromwell, New York, New York. Sullivan & Cromwell
will rely on the opinions of Duane, Morris & Heckscher LLP as to matters of
Delaware and Pennsylvania law. Certain matters relating to the United States
federal income tax considerations will be passed upon for PMC by Duane, Morris &
Heckscher LLP. A John May, a director of the Company, is a member of Duane,
Morris & Heckscher LLP. Mr. May beneficially owns an aggregate of 257,200 shares
of the Company's Common Stock and 66,200 shares of the Company's Class A Common
Stock. Of these shares, 11,250 shares of Common Stock and 2,650 shares of Class
A Common Stock are owned jointly by Mr. May and his wife; 1,550 shares of Class
A Common Stock are owned by Mr. May's wife as custodian for their minor
grandchildren and 17,250 shares of Class A Common Stock are held by a
partnership of which Mr. May is a general partner. Members of Duane, Morris &
Heckscher LLP hold an aggregate of 259,700 shares of Common Stock and 67,170
shares of Class A Common Stock of the Company.
UNDERWRITING
Subject to the terms and conditions of an underwriting agreement (the
"Underwriting Agreement"), PMC and the Issuer have agreed that the Issuer will
sell to each of the Underwriters named below, and each of such Underwriters, for
whom Goldman, Sachs & Co., Merrill Lynch, Pierce, Fenner & Smith Incorporated
and First Union Capital Markets, a division of Wheat First Securities, Zc. are
acting as representatives, has severally agreed to purchase from the Issuer, the
respective number of Capital Securities set forth opposite its name below:
Underwriter Number of Capital Securities Purchased
-------------------- --------------------------------------
Goldman, Sachs & Co.
Merrill Lynch, Pierce,
Fenner & Smith Incorporated
First Union Capital Markets
Under the terms and conditions of the Underwriting Agreement, the
Underwriters are committed to take and pay for all the Capital Securities
offered hereby, if any are taken.
The Underwriters propose to offer the Capital Securities in part directly
to the public at the initial public offering price set forth on the cover page
of this Prospectus and in part to certain securities dealers at such price less
a concession of $___ per Capital Security. The Underwriters may allow, and such
dealers may reallow, a concession not in excess of $______ per Capital Security
to certain brokers and dealers. After the Capital Securities are released
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for sale to the public, the offering price and other selling terms may from time
to time be varied by the representatives.
In view of the fact that the proceeds from the sale of the Capital
Securities will be used to purchase the Junior Subordinated Debentures issued by
PMC, the Underwriting Agreement provides that PMC will pay as Underwriters'
Compensation for the Underwriters' arranging the investment therein of such
proceeds an amount of $___ per Capital Security for the accounts of the several
Underwriters.
In connection with the Offering, the Underwriters may purchase and sell the
Capital Securities in the open market. These transactions may include over-
allotment and stabilizing transactions and purchases to cover short positions
created by the Underwriters in connection with the Offering. Stabilizing
transactions consist of certain bids or purchases for the purpose of preventing
or retarding a decline in the market price of the Capital Securities, and short
positions created by the Underwriters involve the sale by the Underwriters of a
greater number of the Capital Securities than they are required to purchase from
PMC in the Offering. The Underwriters may also impose a penalty bid, whereby
selling concessions allowed to broker-dealers in respect of the Capital
Securities sold in the offering may be reclaimed by the Underwriters if such
Capital Securities are repurchased by the Underwriters in stabilizing or
covering transactions. These activities may stabilize, maintain or otherwise
affect the market price of the Capital Securities, which may be higher than the
price that might otherwise prevail in the open market, and these activities, if
commenced, may be discontinued at any time. These transactions may be effected
in the over-the-counter market or otherwise.
Because the National Association of Securities Dealers, Inc. ("NASD") is
expected to view the Capital Securities offered hereby as interests in a direct
participation program, the offering is being made in compliance with Rule 2810
of the NASD's Conduct Rules. Offers and sales of Capital Securities will be
made only to (i) "qualified institutional buyers", as defined in Rule 144A under
the Securities Act of 1933, as amended (the Act") or (ii) institutional
"accredited investors", as defined in Rule 501(a)(1)-(3) of Regulation D under
the Act.
PMC and the Issuer have agreed that, during the period beginning from the
date of this Prospectus and continuing to and including the earlier of (i) the
termination of trading restrictions on the Capital Securities, as determined by
the Underwriters, or (ii) 30 days after the closing date, they will not offer,
sell, contract to sell, or otherwise dispose of any Capital Securities, any
other interests of the Issuer, or any capital stock or any other securities of
the Issuer or PMC which are substantially similar to the Capital Securities,
including but not limited to any guarantee of such security, or any securities
convertible into or exchangeable for or representing the right to receive,
Capital Securities, preferred stock or such substantially similar securities of
either the Issuer or PMC, without the prior written consent of Goldman, Sachs &
Co., except for the Capital Securities offered in connection with this Capital
Offering, the Common Securities and the Guarantee.
- 178 -
<PAGE>
There is no established public trading market for the Capital Securities.
The Underwriters have advised PMC that they intend to make a market in the
Capital Securities, but are not obligated to do so and may discontinue market
making at any time without notice. No assurance can be given as the liquidity of
the trading market for the Capital Securities.
The Issuer, PMC and PMA Reinsurance Corporation have agreed to indemnify
the several Underwriters against certain liabilities, including liabilities
under the Securities Act.
Certain of the Underwriters or their affiliates have provided from time to
time, and expect to provide in the future, investment or commercial banking
services to PMC and its affiliates, for which such Underwriters or their
affiliates have received or will receive customary fees and commissions.
EXPERTS
The consolidated financial statements and schedules of the Company as of
December 31, 1997 and 1996 and for each of the years in the three-year period
ended December 31, 1997, have been included herein and in the Registration
Statement in reliance upon the reports of PricewaterhouseCoopers LLP,
independent accountants, appearing elsewhere herein, and upon the authority of
said firm as experts in accounting and auditing.
- 179 -
<PAGE>
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents have been previously filed by the Company with the
Commission and are hereby incorporated by reference in this Prospectus as of
their respective dates:
(i) the Company's Annual Report on Form 10-K for the year ended
December 31, 1997 (filed March 23, 1998);
(ii) the Company's Quarterly Reports on Form 10-Q for the quarters
ended March 31, 1998 (filed May 15, 1998) and June 30, 1998
(filed August 13, 1998);
(iii) information included under the captions "Beneficial Ownership of
Common Stock," "Section 16(a) Beneficial Reporting Compliance,"
"Election of Directors," "Information Regarding Management"
(except for information under "Report of Compensation Committee
on the Compensation of Executive Officers of the Company for the
Year Ended December 31, 1997" and "Comparison of Total Return on
the Company's Class A Common Stock with Certain Indices" which
shall not be deemed incorporated by reference in this
Prospectus) and "Certain Transactions" of the Company's
definitive proxy statement (filed March 26, 1998); and
(iv) The Company's Current Reports on Form 8-K dated February 5, 1998
and February 9, 1998.
In addition, all documents filed by the Company with the Commission
pursuant to Section 13(a), 13(c), 14 or 15(d) of the Exchange Act subsequent to
the date of this Prospectus and prior to the termination of the Offering shall
be deemed to be incorporated by reference in this Prospectus and to be a part
hereof from the date of filing of such documents. Any statement or information
contained herein or in a document incorporated by reference herein shall be
deemed to be modified or superseded for purposes of this Prospectus to the
extent that a statement or information contained herein or in any other
subsequently filed document that is also incorporated by reference herein
modifies or replaces such a statement or such information. Any such statement or
information so modified or replaced shall not be deemed, except as so modified
or replaced, to be a part of this Prospectus.
The Company will furnish without charge, including any beneficial owner, to
each person to whom this Prospectus is delivered, upon written or oral request,
a copy of any and all of the documents that have been incorporated by reference
in this Prospectus, other than exhibits to such documents, unless such exhibits
are specifically incorporated by reference into the documents that this
Prospectus incorporates. Requests should be submitted by telephone to (215)
665-5046 or in writing to Pennsylvania Manufacturers Corporation, 1735 Market
Street, Philadelphia, Pennsylvania, 19103-7590, Attention: Investor Relations.
- 180 -
<PAGE>
GLOSSARY OF CERTAIN INSURANCE AND OTHER DEFINED TERMS
Actuarial
analysis..... Evaluation of risks in order to attempt to assure that
premiums and loss reserves adequately reflect expected future
loss experience and claims payments; in evaluating risks,
mathematical models are used to predict future loss experience
and claims payments based on past loss ratios and loss
development patterns and other relevant data and assumptions.
Affiliate..... With respect to any Person, any other person which directly or
indirectly controls, is controlled by or is under common control
with such Person.
Adverse....... loss development Increases in losses and ALAE exceeding
anticipated loss and ALAE experience over a given period of time.
Aggregate
excess
reinsurance
arrangements. Reinsurance arrangements under which a reinsurer assumes the
risks and/or loss reserves of certain business of a ceding
company in their entirety.
Allocated loss
adjustment
expenses
("ALAE")..... Allocated loss adjustment expenses include all legal expenses and
other expenses incurred by a company in connection with the
investigation, adjustment, settlement or litigation of claims or
losses under business covered. ALAE does not include costs of "in
house" counsel, claims staff or other overhead or general expense
of the reinsured.
A.M. Best..... A.M. Best Company, Inc. A.M. Best financial condition ratings
are opinions of an insurance company's financial strength,
operating performance and ability to meet its obligations to
policyowners. Such ratings are based upon a comprehensive review
of a company's financial performance, which is supplemented by
certain data, including responses to A.M. Best's questionnaires,
quarterly NAIC filings, state insurance department examination
reports, loss reserve reports, annual reports and reports filed
with state insurance departments. A.M. Best undertakes a
quantitative evaluation based on profitability, leverage and
liquidity and a qualitative evaluation based upon a company's
book of business or spread of risk, the amount, appropriateness
and soundness of reinsurance, the quality, diversification and
estimated market value of its assets, the adequacy of its loss
reserves and policyowners' surplus and the experience and
- 181 -
<PAGE>
competence of its management. A.M. Best Company, Inc. uses the
following rating scale:
A++ and A+ Superior
A and A- Excellent
B++ and B+ Very Good
B and B- Adequate
C++ and C+ Fair
C and C- Marginal
D Very Vulnerable
E Under State Supervision
F In Liquidation
Annualized
premium...... The expected premium payment for a 12-month period for each
policy, excluding single premium policies. Actual premium
payments may be higher or lower than annualized premiums.
Attachment
point........ The amount of losses above which excess of loss reinsurance
becomes operative.
Automatic
facultative
arrangements. Facultative insurance contracts whereby the ceding company has
the right, but not the obligation, to cede risks to a reinsurer
and the reinsurer is obligated to accept such risks pursuant to
the contract terms.
Broker;
intermediary. One who negotiates contracts of reinsurance between a primary
insurer or other reinsured and a reinsurer on behalf of the
primary insurer or reinsured. The broker receives from the
reinsurer a commission for placement and other services rendered.
Broker
reinsurer.... A reinsurer that markets and sells reinsurance through brokers
rather than through its own employees.
Case reserves. Loss reserves established with respect to individual reported
claims.
Casualty
insurance
and/or
reinsurance.. Insurance and/or reinsurance that is concerned primarily with the
losses caused by injuries to third persons (in other words,
persons other than the policyholder) and the legal liability
imposed on the insured resulting therefrom.
Catastrophe
reinsurance.. A form of excess of loss property reinsurance that, subject to a
specified limit, indemnifies the ceding company for the amount of
loss in excess of a specified retention with
- 182 -
<PAGE>
respect to an accumulation of losses resulting from a
catastrophic event. The actual reinsurance document is called a
"catastrophe cover."
Cede; ceding
company;
cedent....... When a company reinsures its risk with another, it "cedes"
business and is referred to as the "ceding company" or the
"cedent".
Claim closure
rate......... The number of closed lost time workers' compensation claims
divided by total reported lost time workers' compensation claims
by accident year as of a given evaluation date.
Clash cover... A form of excess of loss casualty reinsurance policy covering
losses arising from a single set of circumstances covered by more
than one primary policy. For example, if an insurer covers both
motorists involved in an accident, a clash cover would protect
the insurer from suffering a net loss in the full amount of both
parties. The clash cover would pay to the insurer a portion of
the loss in excess of the coverage of one of the two parties.
Combined
ratio........ A combination of the underwriting expense ratio, the loss and
LAE ratio, and the policyholder dividend ratio. The loss and LAE
ratio measures the ratio of net incurred losses and LAE to net
earned premiums. The underwriting expense ratio measures the
ratio of underwriting expenses to net premiums written. The
policyholder dividend ratio measures policyholder dividends as a
percent of net premiums earned. Generally, companies that write
predominately long-tailed liability risks will have a higher
combined ratio than those companies writing predominately
property risks.
Commutation... An agreement with a claimant whereby the claimant, in exchange
for a lump sum payment, releases his or her rights to future
indemnity payments.
Direct
reinsurer,
direct
underwriter,
direct writer A reinsurer that markets and sells reinsurance directly to its
reinsureds without the assistance of brokers.
- 183 -
<PAGE>
Excess and
surplus lines Surplus lines risks are those risks not fitting normal under-
writing patterns, involving a degree of risk that is not
commensurate with standard rates and/or policy forms, or that
will not be written by standard carriers because of general
market conditions. Excess insurance refers to coverage that
attaches for an insured over the limits of a primary policy or a
stipulated self-insured retention. Policies are bound or accepted
by carriers not licensed in the jurisdiction where the risk is
located, and generally are not subject to regulations governing
premium rates or policy language.
Excess of loss
reinsurance.. The generic term describing reinsurance that indemnifies the
reinsured against all or a specified portion of losses on
underlying insurance policies in excess of a specified dollar
amount, called a "layer" or "retention." Also known as
nonproportional reinsurance or stop loss coverage.
Facultative
reinsurance.. The reinsurance of all or a portion of the insurance provided by
a single policy. Each policy reinsured is separately negotiated.
GAAP.......... United States generally accepted accounting principles for
property and casualty insurance companies
Gross premiums
written...... Total premiums for direct insurance and reinsurance assumed
during a given period.
Incurred but
not reported
- 184 -
<PAGE>
("IBNR")
reserves..... Loss reserves for estimated losses that have been
incurred but not yet reported to the insurer or reinsurer.
Incurred
losses....... The total losses sustained by an insurance company under a
policy or policies, whether paid or unpaid. Incurred losses
include a provision for claims that have occurred but have not
yet been reported to the insurer ("IBNR").
IRIS ratios... Financial ratios annually calculated by the NAIC to assist state
insurance departments in monitoring the financial condition of
insurance companies.
Layers........ The division of a particular reinsurance program delineated by an
attachment point and a maximum limit. Often, a reinsurance
program will be divided into several layers, with the lower
layers (See "Low or working layer excess of loss reinsurance")
typically having higher premiums and higher claim frequency and
the higher layers typically having lower premiums and claim
frequency.
Loss
adjustment
expenses
("LAE")...... The expenses of settling claims, including legal and other fees
and the portion of general expenses allocated to claim settlement
costs.
Loss ratio/
pure loss
ratio........ Loss ratio is equal to losses and LAE divided by earned premiums.
The pure loss ratio refers to losses divided by earned premiums.
Undiscounted loss ratios refer to loss ratios that do not
consider the net effect of discounting of loss reserves; the
Company's current practice is to discount loss reserves for
workers' compensation insurance.
Loss reserves. Liabilities established by insurers and reinsurers to reflect the
estimated cost of claims payments that the insurer or reinsurer
ultimately will be required to pay in respect of insurance or
reinsurance it has written. Reserves are established for losses
and for LAE and consist of case reserves and IBNR reserves.
Low or working
layer excess
of loss
reinsurance.. Reinsurance that absorbs the losses immediately above
the reinsured's retention layer. A low layer excess of loss
reinsurer will pay up to a certain dollar amount at which point a
higher layer reinsurer (or the ceding company) will be liable for
additional losses.
- 185 -
<PAGE>
Manual rates.. Refers to insurance rates for lines and classes of business
approved and published by state insurance departments.
Manual rate
level or
average
manual
rate level... Refers to the manual rates for lines and classes of
business relative to a benchmark; within this document, the term
refers to the manual rates, as compared to other periods, such as
a prior policy year.
Moody's....... Moody's Investors Service, Inc. Moody's financial strength
ratings are opinions of an operating insurance company's ability
to discharge senior policyowner claims and obligations pursuant
to its insurance policies. Moody's financial strength ratings are
based on information provided by the company and federal and
state regulators. Moody's Investors Service, Inc. uses the
following rating scale:
Aaa Exceptional
Aa1, Aa2 and Aa3 Excellent
A1, A2 and A3 Good
Baa1, Baa2 and Baa3 Adequate
Ba1, Ba2 and Ba3 Questionable
B1, B2 and B3 Poor
Caa Very Poor
Ca Extremely Poor
C Lowest
NAIC.......... The National Association of Insurance Commissioners, an
association of the chief insurance supervisory officials of each
state, territory and insular possession of the United States.
Net leverage.. Sum of net premiums written and liabilities divided by surplus.
Net premiums
earned....... The portion of net premiums written that is recognized for
accounting purposes as income during a period.
Net premiums
written...... Gross premiums written for a given period less premiums ceded to
reinsurers during such period.
Operating
ratio........ The combined ratio reduced by the net investment income ratio.
The net investment income ratio is the ratio of net investment
income to net premiums earned. The ratio measures a company's
operating profitability, exclusive of realized gains and federal
income taxes.
- 186 -
<PAGE>
Per occurrence A form of insurance or reinsurance under which the date of the
loss event is deemed to be the date of the occurrence, regardless
of when reported and permits all losses arising out of one event
to be aggregated instead of being handled on a risk-by-risk
basis.
Premium....... Payments received on insurance policies issued or reinsured by an
insurance company.
Primary
insurer...... An insurance company that issues insurance policies to the
general public or to certain noninsurance entities.
Pro rata
reinsurance.. A generic term describing all forms of reinsurance in which the
reinsurer shares a proportional part of the original premiums and
losses of the reinsured. Pro rata reinsurance also is known as
proportional reinsurance, quota share reinsurance and
participating reinsurance.
Property
insurance
and/or
reinsurance.. Insurance and/or reinsurance that indemnifies a person with an
insurable interest in tangible property for his property loss,
damage or loss of use.
Pure loss
ratio........ See "Loss ratio/pure loss ratio" above.
Reinsurance... The practice whereby one party, called the reinsurer or assuming
company, in consideration of a premium paid to such party, agrees
to indemnify another party, called the reinsured, for part or all
of the liability assumed by the reinsured under a policy or
policies of insurance that it has issued. The reinsured may be
referred to as the original or primary insurer, the direct
writing company or the ceding company. Reinsurance provides a
primary insurer with three major benefits: it reduces net
liability on individual risks; it helps to protect against
catastrophic losses and it helps to maintain acceptable surplus
and reserve ratios. Reinsurance provides a primary insurer with
additional underwriting capacity in that the primary insurer can
accept larger risks and can expand the volume of business it
writes without increasing its capital base. The ceding company
remains liable on its obligations under the policies reinsured if
the reinsurer fails to pay claims on a reinsured policy.
Reserves...... Liabilities established by insurers to reflect the estimated
discounted present value of costs of claims, payments or contract
liabilities and the related expenses that the insurer
- 187 -
<PAGE>
will ultimately be required to pay in respect of insurance it has
written.
Retention,
retention
layer........ The amount or portion of risk that an insurer or reinsurer
retains for its own account. Losses in excess of the retention
layer are paid by the reinsurer or retrocessionaire. In
proportional treaties, the retention may be a percentage of the
original policy's limit. In excess of loss business, the
retention is a dollar amount of loss, a loss ratio or a
percentage.
Retrocession;
retrocession-
aire......... A transaction whereby a reinsurer cedes to another reinsurer (the
"retrocessionaire") all or part of the reinsurance it has
assumed. Retrocession does not legally discharge the ceding
reinsurer from its liability with respect to its obligations to
the reinsured.
Risk-based
capital
requirements
or RBC....... Regulatory and rating agency targeted surplus based on the
relationship of statutory surplus, with certain adjustments, to
the sum of stated percentages of each element of a specified list
of company risk exposures.
Risk-exposed.. Reinsurance coverages that attach within the underlying policy
limits of the ceding company, which differs from catastrophe
reinsurance and clash coverages.
Semiautomatic
facultative
arrangements. Facultative reinsurance contracts where the ceding company has
the right, but not the obligation to cede risks to a reinsurer
and the reinsurer is obligated to accept such risks as long as
they are within stated criteria. If a risk falls outside such
criteria, the reinsurer has the option of either: (i) accepting
the risk, (ii) declining the risk, or (iii) repricing the risk.
SFAS.......... Statement of Financial Accounting Standards.
Standard
& Poor's..... Standard & Poor's Ratings Group. Standard & Poor's claims-paying
ability ratings are opinions of an operating insurance company's
financial ability to meet its obligations under its insurance
policies. Standard & Poor's claims-paying ability ratings are
based on current information provided by the subject insurance
company and other reliable sources. Standard & Poor's Rating
Group uses the following rating scale:
- 188 -
<PAGE>
AAA Superior
AA+, AA and AA- Excellent financial security
A+, A and A- Good financial security
BBB+, BBB and BBB- Adequate
BB+, BB and BB- Financial security may be adequate
B+, B and B- Vulnerable
CCC Extremely Vulnerable
R Regulatory actions
A\\pi\\, BBB\\pi\\,
BB\\pi\\ and B\\pi\\ Qualified solvency ratings
Statutory
accounting
principles.
("SAP")...... Recording transactions and preparing financial statements
in accordance with the rules and procedures prescribed or
permitted by state insurance regulatory authorities including the
NAIC, which in general reflect a liquidating, rather than going
concern, concept of accounting.
Statutory
reserves..... Monetary amounts established by state insurance law that an
insurer must have available to provide for future obligations
with respect to all policies. Statutory reserves are liabilities
on the balance sheet of financial statements prepared in
conformity with SAP.
Statutory or
policy-
holder's
surplus;
statutory
capital and
surplus...... The excess of statutory admitted assets over statutory
liabilities (including loss reserves) as shown on an insurer's
statutory financial statements.
Stop loss..... See "Excess of loss reinsurance".
Survival ratio For asbestos and environmental (A&E) claims, the survival ratio
is equal to the average normalized loss and LAE payments for A&E
over three years divided by loss reserves established for A&E.
Treaty
reinsurance.. The reinsurance of a specified type or category of risks defined
in a reinsurance agreement (a "treaty") between a primary insurer
or other reinsured and a reinsurer. Typically, in treaty
reinsurance, the primary insurer or reinsured is obligated to
offer and the reinsurer is obligated to accept a specified
portion of all such type or category of risks originally written
by the primary insurer or reinsured.
Underwriting.. The insurer's process of reviewing applications submitted for
insurance coverage, deciding whether to accept all or
- 189 -
<PAGE>
part of the coverage requested and determining the applicable
premiums.
Underwriting
cycle........ An historical pattern in which property and casualty insurance
and reinsurance premiums, profits and availability of
coverage rise and fall with some regularity over time.
Underwriting
expenses..... The aggregate of policy acquisition costs, including commissions,
and the portion of administrative, general and other expenses
attributable to underwriting operations.
Unearned
premium...... The portion of a premium representing the unexpired portion of
the exposure period as of a certain date.
Unearned
premium
reserve...... Liabilities established by insurers and reinsurers to reflect
unearned premiums that are refundable to policyholders if an
insurance or reinsurance contract is canceled prior to expiration
of the contract term.
- 190 -
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
<TABLE>
<CAPTION>
<S> <C>
Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheet at June 30, 1998 F-2
Consolidated Statements of Operations for the six months ended June 30, 1998
and 1997 F-3
Consolidated Statements of Comprehensive Income for the six months ended June
30, 1998 and 1997 F-4
Consolidated Statements of Cash Flows for the six months ended June 30, 1998
and 1997 F-5
Notes to Consolidated Financial Statements F-6
Audited Consolidated Financial Statements
Consolidated Financial Statements:
Report of Independent Accountants F-9
Consolidated Balance Sheets at December 31, 1997 and 1996 F-10
Consolidated Statements of Operations for each of the three years in the
period ended December 31, 1997 F-11
Consolidated Statements of Changes in Shareholders' Equity for each of the
three years in the period ended December 31, 1997 F-12
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 1997 F-14
Notes to Consolidated Financial Statements F-15
</TABLE>
F-1
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
(Unaudited)
(in thousands, except share data) June 30,
1998
-------------------
<S> <C>
Assets
Investments:
Fixed maturities available for sale, at fair value
(amortized cost of $1,955,206) $ 1,995,653
Equity securities, at fair value (cost of $5) 15
Short-term investments, at amortized cost which approximates fair value 163,635
-----------
Total investments 2,159,303
Cash 7,585
Investment income due and accrued 20,808
Uncollected premiums (net of allowance for uncollectible accounts
of $18,495) 293,303
Reinsurance receivables (net of allowance for uncollectible reinsurance
of $2,085) 347,821
Property and equipment (net of accumulated depreciation
of $49,822) 37,901
Deferred income taxes, net 62,978
Deferred acquisition costs 53,363
Other assets 92,351
-----------
Total assets $ 3,075,413
===========
Liabilities
Unpaid losses and loss adjustment expenses $ 1,939,568
Unearned premiums 243,012
Long-term debt 203,000
Dividends to policyholders 10,779
Funds held under reinsurance treaties 75,806
Taxes, licenses and fees, and other expenses 52,543
Other liabilities 54,322
-----------
Total liabilities 2,579,030
-----------
Shareholders' Equity
Common stock, $5 par value (40,000,000 shares authorized;
14,765,020 shares issued and 14,329,013 outstanding) 73,825
Class A common stock, $5 par value (40,000,000 shares authorized;
9,677,925 shares issued and 9,356,995 outstanding) 48,389
Additional paid-in capital - Class A common stock 339
Retained earnings 359,486
Unrealized gain on investments available for sale
(net of deferred income taxes of $(14,160)) 26,297
Notes receivable from officers (198)
Treasury stock, at cost:
Common stock (436,007 shares) (5,582)
Class A common stock (320,930 shares) (6,173)
-----------
Total shareholders' equity 496,383
-----------
Total liabilities and shareholders' equity $ 3,075,413
===========
</TABLE>
See accompanying notes to the consolidated financial statements.
F-2
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
for the six months ended June 30
(in thousands, except per share data) 1998 1997
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
Revenues:
Net premiums written $ 257,038 $ 253,125
Change in net unearned premiums (28,977) (25,870)
Change in accrued retrospective premiums (6,485) (4,854)
--------- ---------
Net premiums earned 221,576 222,401
Net investment income 65,200 68,459
Net realized investment gains (losses) 11,263 (1,931)
Service revenues 5,090 5,038
--------- ---------
Total revenues 303,129 293,967
--------- ---------
Losses and expenses:
Losses and loss adjustment expenses 172,757 193,134
Acquisition expenses 51,763 46,469
Operating expenses 37,500 36,905
Dividends to policyholders 8,130 6,617
Interest expense 7,463 8,222
--------- --------
Total losses and expenses 277,613 291,347
--------- --------
Income before income taxes and
extraordinary item 25,516 2,620
Provision (benefit) for income taxes:
Current 691 (353)
Deferred 3,380 (2,304)
--------- --------
Total 4,071 (2,657)
--------- --------
Income before extraordinary item 21,445 5,277
Extraordinary loss from early
extinguishment of debt (net of
income tax benefit of $2,549) -- (4,734)
--------- --------
Net income $ 21,445 $ 543
========= ========
Earnings per common and equivalent share:
Basic:
Earnings before extraordinary loss $ 0.90 $ 0.22
Extraordinary item -- (0.20)
--------- --------
Net income $ 0.90 $ 0.02
========= ========
Diluted:
Earnings before extraordinary loss $ 0.87 $ 0.21
Extraordinary item -- (0.19)
--------- --------
Net income $ 0.87 $ 0.02
========= ========
</TABLE>
See accompanying notes to the consolidated financial statements.
F-3
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
<TABLE>
<CAPTION>
For the six months ended June 30
(in thousands) 1997 1998
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
Net income $21,445 $ 543
------- -------
Other comprehensive income (loss), net of tax:
Unrealized losses on securities:
Holding gains (losses) arising during the period 16,399 (8,230)
Less: reclassification adjustment for (gains)
losses included in net income (8,908) 950
------ -------
Other comprehensive income (loss) 7,491 (7,280)
------- -------
Comprehensive income (loss) $28,936 $(6,737)
======= =======
</TABLE>
See accompanying notes to the consolidated financial statements.
F-4
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
For the six months ended June 30
(in thousands) 1998 1997
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 21,445 $ 543
Adjustments to reconcile net income to net cash flows used by
operating activities:
Depreciation 2,773 3,945
(Accretion) amortization (1,307) 3,160
Provision (benefit) for deferred income taxes 3,380 (2,304)
Extraordinary loss from early extinguishment of debt -- (4,734)
Net realized investment (gains) losses (11,263) 1,931
Change in uncollected premiums and unearned premiums, net (9,321) (16,998)
Change in dividends to policyholders 579 883
Change in reinsurance receivables (56,740) (26,482)
Change in unpaid losses and loss adjustment expenses (27,346) (38,281)
Change in investment income due and accrued 3,010 4,333
Other, net 1,251 (15,789)
--------- ---------
Net cash flows used in operating activities (73,539) (89,793)
--------- ---------
Cash flows from investing activities:
Fixed maturity investments available for sale:
Purchases (927,342) (771,135)
Maturities or calls 84,915 75,400
Sales 802,825 790,994
Net sales of short-term investments 101,572 81,974
Net purchases of property and equipment (2,053) (2,239)
--------- ---------
Net cash flows provided by investing activities 59,917 174,994
--------- ---------
Cash flows from financing activities:
Dividends paid to shareholders (4,059) (3,982)
Proceeds from long-term debt -- 210,000
Repayments of long-term debt -- (211,650)
Repayments of notes receivable from officers -- 507
Treasury stock transactions, net (6,882) 486
--------- ---------
Net cash flows used in financing activities (10,941) (4,639)
--------- ---------
Net (decrease) increase in cash (24,563) 80,562
Cash January 1 32,148 7,176
--------- ---------
Cash June 30 $ 7,585 $ 87,738
========= =========
Supplementary cash flow information:
Cash received for income taxes $ -- $ (2,900)
Cash paid for interest $ 7,467 $ 12,161
</TABLE>
See accompanying notes to the consolidated financial statements.
F-5
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(dollar amounts in thousands, except per share data)
1. General
The accompanying consolidated financial statements include the accounts of
Pennsylvania Manufacturers Corporation (PMC) and its wholly and majority owned
subsidiaries (the Company). PMC is an insurance holding company that sells
property and casualty reinsurance and insurance through its insurance
subsidiaries. PMC's insurance subsidiaries are domiciled in Pennsylvania, except
for its excess and surplus lines affiliate which is domiciled in Delaware, and
certain foreign subsidiaries.
Reinsurance -- PMC's reinsurance subsidiary, PMA Reinsurance Corporation (PMA
Re), emphasizes risk-exposed, excess of loss reinsurance and operates in the
brokered market. PMA Re's business is predominantly in casualty lines of
reinsurance.
Workers' Compensation and Primary Standard Insurance -- PMC's property and
casualty insurance subsidiaries (the Property and Casualty Group) write workers'
compensation and other standard lines of commercial insurance primarily in the
Mid-Atlantic and Southern regions of the U.S.
Specialty Property and Casualty -- In January of 1998, the Company's specialty
insurance unit, Caliber One, commenced writing business. It is management's
intention that Caliber One will write primarily casualty business through
surplus lines brokers on a nationwide basis. Caliber One's excess and surplus
lines insurance affiliate, Caliber One Indemnity Company, is presently
authorized as a surplus lines carrier in 37 states, Washington, DC, and Puerto
Rico, with applications either pending or being prepared for the remaining
states.
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles (GAAP) for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. It is management's opinion that all adjustments, including normal
recurring accruals, considered necessary for a fair presentation have been
included. Certain reclassifications of prior year amounts have been made to
conform with the 1998 presentation. Additionally, net premiums written were
adjusted to include $6,485 for the six months ended June 30, 1998 and $4,854 for
the six months ended June 30, 1997 representing estimated retrospective policy
adjustments related to the current accident year and retrospective policy
adjustments paid. These adjustments were made for presentation purposes only
and do not impact the Company's reported revenues, financial position or results
of operations as these adjustments have no effect on net premiums earned.
Operating results for the six months ended June 30, 1998, are not necessarily
indicative of the results to be expected for the full year. For further
information, refer to the December 31, 1997, audited consolidated financial
statements and footnotes thereto included elsewhere in this Prospectus.
F-6
<PAGE>
2. Per Share Data
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS No. 128"),
which supersedes Accounting Principles Board Opinion No. 15, "Earnings Per
Share," and Related Interpretations. The Company adopted SFAS No. 128 during
1997. In accordance with SFAS No. 128, all prior period data presented has been
restated to conform with the provisions of this statement. SFAS No. 128
replaces the presentation of primary earnings per share with a presentation of
basic earnings per share and requires the presentation of both basic and diluted
earnings per share on the face of the income statement. SFAS No. 128 also
requires a reconciliation of the numerators and denominators used in the basic
earnings per share calculation to the numerators and denominators used in the
diluted earnings per share calculation. Such reconciliation is provided below:
<TABLE>
<CAPTION>
For the six months ended
1998 1997
---- ----
<S> <C> <C>
Numerator:
Control number - income
before extraordinary loss........... $ 21,445 $ 5,277
Denominator:
Basic shares - weighted average
Common and Class A common
shares outstanding.................. 23,770,912 23,832,562
Dilutive stock options................ 887,999 672,330
----------- -----------
Total diluted shares.................. 24,658,911 24,504,892
=========== ===========
</TABLE>
Basic earnings per share: For the six months ended June 30, 1998 and 1997,
basic earnings per share calculations were based upon the weighted average
number of common and Class A common shares outstanding for the period.
Diluted earnings per share: For the six months ended June 30, 1998 and 1997,
diluted earnings per share calculations were based upon the weighted average
number of common and Class A common shares outstanding during the periods and
the assumed exercise price of dilutive stock options, less the number of
treasury shares assumed to be purchased from the proceeds using the average
market price of the Company's Class A common stock.
3. Accounting Pronouncements
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Comprehensive Income" ("SFAS No. 130"), which establishes
standards for the reporting and disclosure of comprehensive income and its
components (revenues, expenses, gains and losses). SFAS No. 130 requires that
all items required to be recognized under accounting standards as components of
comprehensive income, be reported in a financial statement that is displayed
with the same prominence as other financial statements. Comprehensive income
includes a reclassification adjustment for net realized investment gains
included in net income of $8,908 (after income taxes of $4,797) for the six
months ended June 30, 1998 and net realized investment losses of $950 (after
income taxes of $512) for the six months ended June 30, 1997. The new standard
requires only additional disclosures in the consolidated financial statements;
it does not affect the Company's financial position or results of operations.
F-7
<PAGE>
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 131, "Disclosures About Segments of an Enterprise and Related
Information" ("SFAS No. 131"), which establishes standards for the way that
public business enterprises report information about operating segments in
annual financial statements and interim financial reports issued to
shareholders. SFAS No. 131 also establishes standards for related disclosures
about products and services, geographic areas and major customers. In
connection with the adoption of SFAS No. 131, the Company has identified four
reportable segments: (i) PMA Re, which provides reinsurance products and
services; (ii) the Property and Casualty Group, which writes workers'
compensation and other standard lines of commercial insurance and includes run-
off operations; (iii) Caliber One, which writes specialty insurance focusing on
excess and surplus lines; and (iv) Corporate and Other, which is primarily
comprised of corporate overhead and the operations of the Company's properties.
Pursuant to the adoption of SFAS No. 131, the Company has restated the
information for the six-month period ended June 30,1997 for comparability,
primarily related to certain corporate expenses that were previously allocated
to the operating segments. SFAS No. 131 requires only additional disclosures in
the consolidated financial statements; it does not affect the Company's
financial position or results of operations. Supplemental financial information
for the annual periods prior to the date of adoption of SFAS No. 131 are as
follows:
<TABLE>
<CAPTION>
Year ended December 31
1997 1996 1995
---------------- ---------------- -----------------
<S> <C> <C> <C>
Pre-tax operating income (loss):
PMA Re $45,957 $ 44,807 $ 39,793
The Property and Casualty Group:
Excluding Run-off Operations (3,607) (215,669) (3,885)
Run-off Operations (73) - -
---------------------------------------------------------
Total (3,680) (215,669) (3,885)
Corporate (9,954) (6,464) (14,184)
---------------------------------------------------------
Total pre-tax operating income (loss) $32,323 $(177,326) $ 21,724
=========================================================
</TABLE>
The difference between this supplemental financial information and the
information in the Company's audited financial statements included elsewhere in
this Prospectus is primarily related to certain corporate expenses that were
previously allocated to the operating segments. The amount of this adjustment
was $6,513 ($1,155 allocated to PMA Re and $5,358 to the Property and Casualty
Group), $5,974 ($2,024 allocated to PMA Re and $3,950 to the Property and
Casualty Group) and $770 ($350 allocated to PMA Re and $420 to the Property and
Casualty Group) for the years ended December 31, 1997, 1996, and 1995,
respectively. Amounts for previous years were not material; accordingly, no
adjustments have been made.
In January 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 97-3,
"Accounting by Insurance and Other Enterprises for Insurance-Related
Assessments" ("SOP 97-3"). SOP 97-3, which is effective for fiscal years
beginning after December 15, 1998, provides guidance for determining when an
insurance company should recognize a liability for guaranty fund and other
insurance related assessments and how to measure that liability. While the
Company is presently evaluating the impact of SOP 97-3, the adoption of SOP 97-3
is likely to result in an increase in the Company's liabilities for such
assessments, although such increase is not expected to exceed $5,000. If
material, the impact of adopting SOP 97-3 will be reflected as a cumulative
effect of an accounting change in the first quarter of 1999.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS No. 133"), which establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
"derivatives") and for hedging activities. SFAS No. 133 requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. If certain
conditions are met, a derivative may be specifically designated as (i) a hedge
of the exposure to changes in the fair value of a recognized asset or liability
or an unrecognized firm commitment, (ii) a hedge of the exposure to variable
cash flows of a forecasted transaction, or (iii) a hedge of the foreign currency
exposure of a net investment in a foreign operation, an unrecognized firm
commitment, an available-for-sale security, or a foreign-currency-denominated
forecasted transaction. The accounting for changes in the fair value of a
derivative (that is, gains and losses) depends on the intended use of the
derivative and the resulting designation. SFAS No. 133 is effective for all
fiscal quarters of fiscal years beginning after June 15, 1999. While the
Company is presently evaluating the impact of SFAS No. 133, the adoption of SFAS
No. 133 is not expected to have a material impact on the Company's financial
condition or results of operations.
4. Sale of Subsidiary
The Company entered into a definitive letter of intent, dated June 26, 1998, to
sell PMA Insurance, Cayman Ltd., one of the run-off entities included in the
Property and Casualty Group's Run-off Operations. The transaction is subject to
customary closing conditions, including regulatory approvals, and is expected to
be completed in the third quarter of 1998. In connection with the announced
sale, the Company recorded a pre-tax loss of $2,442 in the second quarter of
1998, which is included in "Net Realized Investment Gains."
F-8
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
Pennsylvania Manufacturers Corporation:
We have audited the accompanying consolidated balance sheets of
Pennsylvania Manufacturers Corporation and subsidiaries as of December 31, 1997
and 1996, and the related consolidated statements of operations, shareholders'
equity and cash flows for each of the three years in the period ended December
31, 1997. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Pennsylvania Manufacturers Corporation and subsidiaries as of December 31, 1997
and 1996, and the consolidated results of their operations and their cash flows
for each of the three years in the period ended December 31, 1997, in conformity
with generally accepted accounting principles.
/s/ Coopers & Lybrand L.L.P.
One South Market Square
Harrisburg, Pennsylvania
February 6, 1998
F-9
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, December 31,
(in thousands, except share data) 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Investments:
Fixed maturities available for sale, at fair value (amortized cost:
1997-$1,900,594; 1996-$2,164,391) $1,929,518 $2,126,120
Equity securities, at fair value (cost: 1997-$5; 1996-$259) 13 262
Short-term investments, at amortized cost which approximates fair value 265,207 134,971
-------------------------------
Total investments 2,194,738 2,261,353
Cash 32,148 7,176
Investment income due and accrued 23,818 30,268
Uncollected premiums (net of allowance for uncollectible accounts:
1997-$18,406; 1996-$18,877) 252,425 285,982
Reinsurance receivables (net of allowance for uncollectible
reinsurance: 1997-$2,096; 1996-$3,901) 332,406 257,983
Property and equipment (net of accumulated depreciation:
1997-$42,771; 1996-$41,219) 38,621 50,861
Deferred income taxes, net 70,391 101,642
Deferred acquisition costs 45,288 44,006
Other assets 67,423 78,245
-------------------------------
Total assets $3,057,258 $3,117,516
-------------------------------
LIABILITIES
Unpaid losses and loss adjustment expenses $2,003,187 $2,091,072
Unearned premiums 211,455 205,982
Long-term debt 203,000 204,699
Dividends to policyholders 10,200 12,524
Funds held under reinsurance treaties 69,545 86,804
Taxes, licenses and fees, and other expenses 49,410 39,226
Other liabilities 32,114 51,381
-------------------------------
Total liabilities 2,578,911 2,691,688
-------------------------------
Commitments and contingencies (Note 13)
SHAREHOLDERS' EQUITY
Common stock, $5 par value (40,000,000 shares authorized;
15,286,263 shares issued and 14,850,789 outstanding - 1997;
16,095,416 shares issued and 15,670,052 outstanding - 1996) 76,431 80,477
Class A common stock, $5 par value (40,000,000 shares authorized;
9,156,682 shares issued and 9,117,735 outstanding - 1997;
8,247,804 shares issued and 8,173,023 outstanding - 1996) 45,783 41,239
Additional paid-in capital - Class A common stock 339 -
Retained earnings 343,368 336,921
Unrealized gain (loss) on investments (net of deferred income taxes:
1997-$(10,126); 1996-$13,394) 18,806 (24,874)
Notes receivable from officers (198) (1,162)
Treasury stock, at cost:
Common stock (1997-435,474 shares; 1996-425,364 shares) (5,572) (5,408)
Class A common stock (1997-38,947 shares; 1996-74,781 shares) (610) (1,365)
-------------------------------
Total shareholders' equity 478,347 425,828
-------------------------------
Total liabilities and shareholders' equity $3,057,258 $3,117,516
-------------------------------
</TABLE>
See accompanying notes to the consolidated financial statements.
F-10
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
for the years ended December 31,
(in thousands, except per share data) 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------------
REVENUES:
<S> <C> <C> <C>
Net premiums written $418,282 $ 443,475 $489,876
Change in net unearned premiums (5,331) (12,400) (924)
Change in accrued retrospective premiums (37,000) (10,500) (4,000)
-----------------------------------------
Net premiums earned 375,951 420,575 484,952
Net investment income 136,698 133,936 139,355
Net realized investment gains 8,598 2,984 31,923
Service revenues 10,311 9,189 5,106
-----------------------------------------
Total revenues 531,558 566,684 661,336
-----------------------------------------
LOSSES AND EXPENSES:
Losses and loss adjustment expenses (includes $(35,000)
effect of the change in discount rate on the Property and
Casualty Group's workers' compensation unpaid losses from
4% to 5% in 1995) 307,281 536,623 422,578
Amortization of deferred acquisition costs 93,501 90,292 87,207
Operating expenses 75,139 97,856 81,161
Dividends to policyholders 14,716 16,255 16,743
Interest expense 15,768 17,052 18,734
-----------------------------------------
Total losses and expenses 506,405 758,078 626,423
-----------------------------------------
Income (loss) before income taxes and extraordinary item 25,153 (191,394) 34,913
-----------------------------------------
Provision (benefit) for income taxes:
Current (4,506) (44,572) (4,570)
Deferred 9,906 (11,488) 15,353
-----------------------------------------
Total 5,400 (56,060) 10,783
-----------------------------------------
Income (loss) before extraordinary item 19,753 (135,334) 24,130
Extraordinary loss from early extinguishment
of debt (net of income tax benefit of $2,549) (4,734) - -
-----------------------------------------
Net income (loss) $ 15,019 $(135,334) $ 24,130
-----------------------------------------
EARNINGS (LOSS) PER COMMON AND EQUIVALENT SHARE
Basic:
Earnings (loss) before extraordinary item $ 0.83 $ (5.68) $ 1.01
Extraordinary item (0.20) - -
-----------------------------------------
Net earnings (loss) $ 0.63 $ (5.68) $ 1.01
-----------------------------------------
Diluted:
Earnings (loss) before extraordinary item $ 0.80 $ (5.68) $ 0.97
Extraordinary item (0.19) - -
-----------------------------------------
Net earnings (loss) $ 0.61 $ (5.68) $ 0.97
-----------------------------------------
</TABLE>
See accompanying notes to the consolidated financial statements.
F-11
<PAGE>
<TABLE>
<CAPTION>
COMMON STOCK CLASS A COMMON STOCK
----------------------------------------------------
(in thousands, except share and per share data) SHARES AMOUNTS SHARES AMOUNTS
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance-January 1, 1995 17,606,850 $88,034 6,736,370 $33,682
Net income
Common stock dividends declared ($.32 per
share)
Class A common stock dividends declared
($.36 per share)
Conversion of common stock into Class A
common stock (562,270) (2,811) 562,270 2,811
Unrealized gain on investments available for
sale (net of tax effect of $(36,063))
Repayment of notes
Purchase of treasury shares, net
Effect of other treasury stock transactions
- -----------------------------------------------------------------------------------------------------------
Balance-December 31, 1995 17,044,580 85,223 7,298,640 36,493
Net loss
Common stock dividends declared ($.32 per
share)
Class A common stock dividends declared
($.36 per share)
Conversion of common into Class A
common stock (949,164) (4,746) 949,164 4,746
Unrealized loss on investments available for
sale (net of tax effect of $22,823)
Repayment of notes
Purchase of treasury shares, net
- -----------------------------------------------------------------------------------------------------------
Balance-December 31, 1996 16,095,416 80,477 8,247,804 41,239
Net income
Common stock dividends declared ($.32 per
share)
Class A common stock dividends declared
($.36 per share)
Conversion of common stock into Class A
common stock (809,153) (4,046) 809,153 4,046
Class A common stock issued under
stock option plans and other issuances
of Class A common stock 99,725 498
Unrealized gain on investments available for
sale (net of tax effect of $(23,520))
Repayment of notes
(Purchase) reissuance of treasury shares, net
- -----------------------------------------------------------------------------------------------------------
Balance-December 31, 1997 15,286,263 $76,431 9,156,682 $45,783
- -----------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to the consolidated financial statements.
F-12
<PAGE>
<TABLE>
<CAPTION>
ADDITIONAL
PAID IN
CAPITAL- UNREALIZED NOTES
CLASS A GAIN (LOSS) RECEIVABLE
COMMON REATINED ON FROM
STOCK EARNINGS INVESTMENTS OFFICERS
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance-January 1, 1995 $ - $ 463,952 $(49,465) $(4,374)
Net income 24,130
Common stock dividends declared ($.32 per
share) (5,396)
Class A common stock dividends declared
($.36 per share) (2,505)
Conversion of common stock into Class A
common stock 66,976
Unrealized gain on investments available for
sale (net of tax effect of $(36,063))
Repayment of notes 478
Purchase of treasury shares, net
Effect of other treasury stock transactions
- -----------------------------------------------------------------------------------------------------------------
Balance-December 31, 1995 - 480,181 17,511 (3,896)
Net loss (135,334)
Common stock dividends declared ($.32 per
share) (5,138)
Class A common stock dividends declared
($.36 per share) (2,788)
Conversion of common into Class A
common stock
Unrealized loss on investments available for
sale (net of tax effect of $22,823) (42,385)
Repayment of notes 2,734
Purchase of treasury shares, net
- -----------------------------------------------------------------------------------------------------------------
Balance-December 31, 1996 - 336,921 (24,874) (1,162)
Net income 15,019
Common stock dividends declared ($.32 per
share) (4,842)
Class A common stock dividends declared
($.36 per share) (3,147)
Conversion of common stock into Class A
common stock 339
Class A common stock issued under
stock option plans and other issuances
of Class A common stock 43,680
Unrealized gain on investments available for
sale (net of tax effect of $(23,520))
Repayment of notes
(Purchase) reissuance of treasury shares, net (583) 964
- ------------------------------------------------------------------------------------------------------------------
$339 $ 343,368 $ 18,806 $ (198)
- ------------------------------------------------------------------------------------------------------------------
<CAPTION>
TREASURY STOCK, AT COST
-------------------------------------------------------
COMMON STOCK CLASS A COMMON STOCK
-----------------------------------------------------
SHARES AMOUNTS SHARES AMOUNTS TOTAL
<S> <C> <C> <C> <C> <C>
Balance-January 1, 1995 388,514 $(4,706) 200,498 $(2,261) $ 524,862
Net income 24,130
Common stock dividends declared ($.32 per
share) (5,396)
Class A common stock dividends declared
($.36 per share) (2,505)
Conversion of common stock into Class A
common stock -
Unrealized gain on investments available for
sale (net of tax effect of $(36,063)) 66,976
Repayment of notes 478
Purchase of treasury shares, net 4,050 (63) 150,442 (2,355) (2,418)
Effect of other treasury stock transactions (277,532) 3,541 3,541
- ----------------------------------------------------------------------------------------------------------------------------
Balance-December 31, 1995 392,564 (4,769) 73,408 (1,075) 609,668
Net loss (135,334)
Common stock dividends declared ($.32 per
share) (5,138)
Class A common stock dividends declared
($.36 per share) (2,788)
Conversion of common into Class A
common stock -
Unrealized loss on investments available for
sale (net of tax effect of $22,823) (42,385)
Repayment of notes 2,734
Purchase of treasury shares, net 32,800 (639) 1,373 (290) (929)
- ----------------------------------------------------------------------------------------------------------------------------
Balance-December 31, 1996 425,364 (5,408) 74,781 (1,365) 425,828
Net income 15,019
Common stock dividends declared ($.32 per
share) (4,842)
Class A common stock dividends declared
($.36 per share) (3,147)
Conversion of common stock into Class A
common stock -
Class A common stock issued under
stock option plans and other issuances
of Class A common stock 837
Unrealized gain on investments available for
sale (net of tax effect of $(23,520)) 43,680
Repayment of notes 964
(Purchase) reissuance of treasury shares, net 10,110 (164) (35,834) 755 8
- ----------------------------------------------------------------------------------------------------------------------------
435,474 $(5,572) 38,947 $ (610) $ 478,347
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
F-13
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
for the years ended December 31,
(in thousands) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 15,019 $ (135,334) $ 24,130
Adjustments to reconcile net income (loss) to net cash flows
(used) provided by operating activities:
Depreciation 8,672 12,511 7,652
Amortization 4,054 7,243 35
Provision (benefit) for deferred income taxes 9,906 (11,488) 15,353
Extraordinary loss from early extinguishment of debt (4,734) - -
Net realized investment gains (8,598) (2,984) (31,923)
Change inuncollected premiums and unearned premiums, net 39,030 17,983 22,381
Change in dividends to policyholders (2,324) (632) 910
Change in unpaid losses and loss adjustment expenses (87,885) 21,086 (33,728)
Change in investment income due and accrued 6,577 5,188 4,961
Change in deferred acquisition costs (1,282) (6,105) (5,665)
Other, net (85,795) (23,413) 11,807
------------------------------------------------
Net cash flows (used) provided by operating activities (107,360) (115,945) 15,913
------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Fixed maturity investments held to maturity:
Maturities or calls - - 3,809
Fixed maturity investments available for sale:
Purchases (1,963,492) (1,227,173) (2,147,600)
Maturities or calls 168,304 52,280 75,861
Sales 2,072,842 1,210,114 2,085,864
Equity securities:
Purchases - (5,196) (18,104)
Sales 254 16,984 28,793
Net (purchases) sales of short-term investments (130,391) 78,935 (35,445)
Sale of corporate properties 7,145 - -
Net purchases of property and equipment (3,577) (6,723) (6,017)
Purchase of Caliber One Indemnity Company (15,990) - -
Cash acquired in purchase of Caliber One Indemnity Company 4,509 - -
------------------------------------------------
Net cash flows provided (used) by investing activities 139,604 119,221 (12,839)
------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt 210,000 26,000 125,000
Repayments of long-term debt (211,699) (25,149) (125,127)
Dividends paid to shareholders (7,965) (7,926) (7,885)
Proceeds from exercised stock options and
issuance of Class A common stock 837 - -
Treasury stock transactions, net 591 (929) 480
Repayments of notes receivable from officers 964 2,734 478
-------------------------------------------------
Net cash flows used by financing activities (7,272) (5,270) (7,054)
------------------------------------------------
Net increase (decrease) in cash 24,972 (1,994) (3,980)
Cash January 1 7,176 9,170 13,150
------------------------------------------------
Cash December 31 $ 32,148 $ 7,176 $ 9,170
------------------------------------------------
SUPPLEMENTARY CASH FLOW INFORMATION:
Amounts (received) paid for income taxes $ (19,112) $ 5,525 $ (951)
Amounts paid for interest $ 19,776 $ 16,622 $ 15,062
Fair value of securities transferred from held to maturity
classification to available for sale classification $ - $ - $ 1,238,077
</TABLE>
See accompanying notes to the consolidated financial statements.
F-14
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
(Dollar amounts in thousands, except share and per share data)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements include the accounts of
Pennsylvania Manufacturers Corporation (PMC) and its wholly and majority owned
subsidiaries (the Company). PMC is an insurance holding company that sells
property and casualty reinsurance and insurance through its insurance
subsidiaries. PMC's insurance subsidiaries are domiciled in Pennsylvania,
except for its newly established excess and surplus lines writer, discussed
below, which is domiciled in Delaware, and certain foreign subsidiaries.
Reinsurance -- PMC's reinsurance subsidiary, PMA Reinsurance Corporation (PMA
Re), emphasizes risk-exposed, excess of loss reinsurance and operates in the
brokered market. PMA Re's business is predominantly in casualty lines of
reinsurance.
Workers' Compensation and Primary Standard Insurance -- PMC's property and
casualty insurance subsidiaries (the Property and Casualty Group) write workers'
compensation and other standard lines of commercial insurance primarily in the
Mid-Atlantic and Southern regions of the U.S.
Specialty Property and Casualty -- During 1997, the Company established a
separate specialty insurance operation focusing on excess and surplus lines,
Caliber One Management Company (Caliber One). In December 1997, PMA Re acquired
100% of the outstanding common stock of Caliber One Indemnity Company (formerly
known as Lincoln Insurance Company) for approximately $16,000 and made a capital
contribution of approximately $11,300 to Caliber One Indemnity Company. All of
Caliber One Indemnity Company's acquired loss reserves were reinsured by an
affiliate of Caliber One Indemnity Company's former parent in conjunction with
the purchase. The reinsurance obtained in conjunction with the purchase covers
adverse development and uncollectible reinsurance in an amount equal to the
stated amount of the reserves acquired, plus an additional $68,500. Management
believes that the reinsurance obtained as part of the purchase will be adequate
to cover any future reserve development or uncollectible insurance on the
acquired reserves. PMA Re intends to maintain Caliber One Indemnity Company's
surplus at not less than $25,000, the minimum capital and surplus required for
many states in order to be an eligible surplus lines carrier. Management
anticipates that Caliber One will primarily write multi-line business consisting
of primary and excess commercial general liability, professional liability,
excess automobile and certain property exposures. Because Caliber One's results
were not significant in 1997, Caliber One's financial information has been
included within the Corporate and Other segment, including pre-opening costs of
approximately $900, which have been expensed as incurred.
The Company's significant accounting policies and practices are as follows:
A. BASIS OF PRESENTATION -- The consolidated financial statements have been
prepared in accordance with generally accepted accounting principles (GAAP).
All significant intercompany accounts and transactions have been eliminated in
consolidation. The preparation of consolidated financial statements in
conformity with GAAP requires management to make certain estimates and
assumptions that affect the amounts reported in its consolidated financial
statements and accompanying notes. Actual results may differ from those
estimates. These consolidated financial statements vary in certain respects
from statutory accounting practices prescribed or permitted by the Pennsylvania
Insurance Department and the Delaware Insurance Department, (collectively SAP).
Prescribed SAP includes state laws, regulations and general administrative
rules, as well as a variety of NAIC publications. Permitted SAP encompasses all
accounting practices that are not prescribed. The NAIC has a project to codify
SAP, the result of which is expected to constitute the only source of prescribed
SAP. The project, when completed, will change the definitions of what comprises
prescribed versus permitted SAP and may result in changes to the accounting
policies that insurance companies use to prepare SAP financial statements. See
Note 18 for additional SAP information and a reconciliation of SAP net income
and surplus to GAAP net income and shareholders' equity.
F-15
<PAGE>
B. INVESTMENTS -- Fixed maturity investments include U.S. Treasury securities
and obligations of U.S. Government agencies, obligations of states and political
subdivisions, where applicable, corporate debt securities and mortgage-backed
securities. Under SFAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities," fixed maturities which the Company may hold for an
indefinite period of time are classified as available-for-sale and, accordingly,
are carried at fair value with changes in fair value, net of income tax effects,
reflected in shareholders' equity. Fixed maturities which the Company has the
positive intent and ability to hold to maturity are carried at amortized cost.
In 1995, the Company re-evaluated the classifications of its fixed maturity
investments. As a result, effective June 30, 1995, the Company reclassified its
entire held-to-maturity portfolio, which had an amortized cost of $1,241,774, to
the available-for-sale designation in order to match more closely the Company's
investment strategy. This reclassification resulted in a $1,238,077 increase in
available-for-sale securities and a $2,403 unrealized loss (net of deferred
taxes), with no impact on net income. As of December 31, 1997, the Company's
entire fixed income portfolio remains designated as available for sale.
Equity securities for all periods are stated at fair value with changes in fair
value, net of income tax effects, reflected in shareholders' equity.
Realized gains and losses, determined by specific identification, are reflected
in income in the period in which the sale transaction occurs.
C. PREMIUMS -- Premiums, including estimates of additional premiums resulting
from audits of insureds' records, are earned principally on a pro rata basis
over the terms of the policies. Premiums applicable to the unexpired terms of
policies in-force are reported as unearned premiums. Estimated premiums
receivable on retrospectively rated policies are reported as a component of
uncollected premiums (See Note 1-P).
The Company follows Emerging Issues Task Force Consensus Position No. 93-6,
"Accounting for Multiple Year Retrospectively Rated Contracts by Ceding and
Assuming Enterprises" (EITF 93-6). EITF 93-6 requires that the Company reflect
adjustments to future premiums, as the result of past experience under multiple
year reinsurance contracts, in earnings currently. The impact of EITF 93-6 has
been immaterial.
D. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES -- Unpaid losses and loss
adjustment expenses are stated net of estimated salvage and subrogation and are
determined using claims adjusters' evaluations, estimates of losses and loss
adjustment expenses on known claims, and estimates of losses and loss adjustment
expenses incurred but not reported (IBNR). IBNR reserves are calculated
utilizing various actuarial methods. Unpaid losses on certain workers'
compensation claims are discounted to present value using the Company's payment
experience and SAP mortality and interest assumptions (See Note 3). The methods
of making such estimates and establishing the resulting reserves are continually
reviewed and updated and any adjustments resulting therefrom are reflected in
earnings currently.
E. DEFERRED ACQUISITION COSTS -- The costs of acquiring new and renewal
business are deferred and amortized over the period during which the related
premiums are earned. Such costs include direct acquisition costs, including
commissions, brokerage, and premium taxes as well as other policy issuance costs
and underwriting expenses that directly relate to and vary with the production
of business. The Company determines whether deferred acquisition costs are
recoverable considering future losses and loss adjustment expenses, maintenance
costs, and anticipated investment income. To the extent that deferred
acquisition costs are not recoverable, the deficiency is charged to income
currently.
F. DIVIDENDS TO POLICYHOLDERS -- The Property and Casualty Group issues certain
workers' compensation insurance policies with dividend payment features. These
policyholders share in the operating results in the form of dividends declared
at the discretion of the Company's board of directors. Dividends to
policyholders are accrued during the period in which the related premiums are
earned and are determined based on the terms of the individual policies.
G. INCOME TAXES -- The Company accounts for income taxes under SFAS No. 109,
"Accounting for Income Taxes." SFAS No. 109 is an asset and liability approach,
whereby deferred tax assets and liabilities are recorded to the extent of the
tax effect of differences between the financial statement carrying values and
tax bases of assets and liabilities. A valuation allowance is recorded for
deferred tax assets where it appears more likely than not that the Company will
not be able to recover the deferred tax asset. In addition, PMC and a majority
of its subsidiaries have a written tax-sharing agreement which allocates to
F-16
<PAGE>
each entity subject to the agreement its Federal income taxes on a separate
return basis. The benefit of any net operating losses is retained by PMC.
H. PROPERTY AND EQUIPMENT -- Property and equipment are stated at cost, less
accumulated depreciation. Depreciation is calculated on the straight-line
method utilizing useful lives ranging from 3 to 40 years. During 1996, the
Property and Casualty Group changed the depreciable lives for its mainframe
computer equipment from five years to three years. The effect of this adjustment
was to increase 1996 depreciation expense by approximately $4,800.
I. PER SHARE INFORMATION -- In February 1997, the Financial Accounting
Standards Board issued SFAS No. 128, "Earnings Per Share", which supersedes
Accounting Principles Board Opinion No. 15, "Earnings Per Share," and Related
Interpretations, and which the Company adopted during 1997. In accordance with
SFAS No. 128, all prior period data presented has been restated to conform with
the provisions of this statement. SFAS No. 128 replaces the presentation of
primary earnings per share with a presentation of basic earnings per share and
requires the presentation of both basic and diluted earnings per share on the
face of the income statement. SFAS No. 128 also requires a reconciliation of
the numerators and denominators used in the basic earnings per share calculation
to the numerators and denominators used in the diluted earnings per share
calculation. Such reconciliation is provided in Note 16.
Basic earnings per share: For years 1997, 1996 and 1995, basic earnings per
share was based upon the weighted average number of common and Class A common
shares outstanding for the period.
Diluted earnings per share: For years 1997 and 1995, diluted earnings per share
was based upon the weighted average number of common and Class A common shares
outstanding during the year and the assumed exercise price of dilutive stock
options, less the number of treasury shares assumed to be purchased from the
proceeds using the average market price of the Company's Class A common stock.
In 1996, diluted earnings per share was based upon the weighted average common
and Class A common shares outstanding during the year; the assumed exercise
price of stock options using the average market price of the Company's Class A
common stock was not taken into consideration as these stock options would have
had an anti-dilutive effect on the net loss per share (See Note 16).
J. STOCK-BASED COMPENSATION -- The Company has chosen to continue to account
for stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations. Accordingly, compensation cost for
stock options is measured as the excess, if any, of the quoted market price of
the Company's Class A common stock at the date of the grants over the amount an
employee must pay to acquire the Class A common stock.
K. COMPUTER SOFTWARE COSTS RELATED TO THE YEAR 2000 -- In 1996, the Company
adopted Emerging Issues Task Force Consensus Position No. 96-14, "Accounting for
the Costs Associated with Modifying Computer Software for the Year 2000" (EITF
96-14). EITF 96-14 states that external and internal costs specifically
associated with modifying internal-use software for the Year 2000 should be
charged to expense as incurred. In accordance with EITF 96-14, the Company
charged approximately $2,000 and $1,800 to operating expenses during the years
ended December 31, 1997 and 1996, respectively, for costs associated with
modifying internal-use software.
L. SERVICE REVENUES -- Service revenues are earned over the term of the related
contracts in proportion to the actual services rendered.
M. RECLASSIFICATIONS -- Certain prior year amounts have been reclassified to
conform to the current year presentation. Additionally, in 1995, the Company
elected to change its method of reporting cash flows from the direct method to
the indirect method.
N. RECENTLY ISSUED ACCOUNTING STANDARDS -- In June 1996, the Financial
Accounting Standards Board issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." SFAS No.
125, which is effective for transfers and extinguishments occurring after
December 31, 1996, provides consistent standards for distinguishing transfers of
financial assets that are sales from transfers that are secured borrowings. The
Property and Casualty Group's domestic insurance subsidiaries participated in a
transfer arrangement of certain accounts receivable. This arrangement has been
terminated
F-17
<PAGE>
as a result of SFAS No. 125. The termination did not have a material impact on
the Company's financial condition or results of operations.
During 1997, the FASB issued SFAS No. 130, "Comprehensive Income," which
establishes standards for the reporting and disclosure of comprehensive income
and its components (revenues, expenses, gains and losses). SFAS No. 130
requires that all items that are required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements. In addition, the FASB issued SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information," which establishes standards
for the way that public business enterprises report information about operating
segments in annual financial statements and interim financial reports issued to
shareholders. SFAS No. 131 also establishes standards for related disclosures
about products and services, geographic areas and major customers. The Company
will adopt the provisions of these pronouncements in 1998. The adoption of
these pronouncements will not have an impact on the Company's financial position
and results of operations, but may change the presentation of certain of the
Company's financial statements and related notes and data thereto.
O. LONG-LIVED ASSETS -- It is management's policy to review long-lived assets,
such as the Company's properties, for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Such changes in circumstances include such things as significant
decline in market value or change in use of the asset. Periodically, management
reviews appraisals and/or cash flow projections from properties and other long-
lived assets and compares such amounts to the carrying values to determine
whether or not there has been an impairment. If such an impairment exists, it
is management's policy to write down the carrying value of the asset to fair
value less costs to carry and dispose of the asset, where applicable.
P. ACCRUED RETROSPECTIVE PREMIUMS -- Accrued retrospective premiums, which are
a component of uncollected premiums, are based upon actuarial estimates of
expected ultimate losses and resulting estimated premium adjustments relating to
retrospectively rated policies. The change in accrued retrospective premiums is
a component of net premiums earned. The estimated ultimate premium adjustments
under retrospectively rated policies are recorded in the initial accident year
based upon estimated loss experience on the underlying policies and adjusted in
subsequent periods in conjunction with revisions of the estimated underlying
losses on such policies. In addition, accrued retrospective premiums are
increased (decreased) based upon retrospective policy adjustments paid (billed);
such adjustments actually billed or paid do not impact premium revenues as the
Company records an offsetting amount through net premiums written.
The following sets forth the components of the change in accrued retrospective
premiums for each of the past three years:
<TABLE>
<CAPTION>
For the years ended December 31,
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Estimated retrospective policy
adjustments related to current
accident year.......................... $(12,460) $(18,767) $(12,941)
Revision of estimate of retrospective
policy adjustments related to
prior accident years................... (44,719) (9,888) (4,845)
Retrospective policy adjustments paid.... 20,179 23,155 13,786
Uncollectible write-off.................. -- (5,000) --
-------- -------- --------
Total.................................... $(37,000) $(10,500) $ (4,000)
======== ======== ========
</TABLE>
In 1997, 1996 and 1995, the Property and Casualty Group reduced accrued
retrospective premiums by $37,000, $10,500 and $4,000, respectively. The
primary reason for the additional reduction in 1997 relative to 1996 was a
$44,719 revision of estimate of accrued retrospective premiums, primarily due to
the favorable development of claims liabilities for more recent accident years
($35,719) and the commutation of claims for accident years 1991 and prior in
1997 ($9,000). The reduction for policy years 1991 and prior primarily relates
to the commutation program for such years initiated in late 1996. In July 1997,
the Property and Casualty Group completed a formal program where it commuted a
large number of claims associated with workers' compensation claims from
accident years 1991 and prior, including loss reserves associated with
retrospective policies (See Note 3). The commutation program resulted in
current
F-18
<PAGE>
payments to claimants which were less than the carried reserves. As a result of
the differences between the current commutation payments to claimants and
carried reserves on such claims, management reduced its estimate of amounts
recoverable under retrospectively rated policies and also recognized a reduction
in losses and LAE associated with such policies. The reduction related to 1992
through 1996 policy years was primarily related to a corresponding amount of
favorable development on underlying loss reserves for such years (See Note 3).
The effects of the commutations on these prior loss reserves, as well as the
intent of the Property and Casualty Group to continue utilizing early
intervention techniques such as commutations on claims from more recent accident
years, have led to a re-estimation of policy liabilities for these more recent
accident years, and a re-estimation of amounts due under retrospectively rated
policies for these more recent accident years.
Management believes that it has made a reasonable estimate of the Company's
accrued retrospective premiums. While the eventual ultimate receivable may
differ from the current estimates, management does not believe that the
difference will have a material effect, either adversely or favorably, on the
Company's financial position or results of operations.
2. INVESTMENTS
The Company's investment portfolio is well diversified and contains no
significant concentrations in any specific industry, business segment, or
individual issuer. The Company principally invests in U.S. Treasury securities
and obligations of U.S. Government agencies, high-quality obligations of states
and political subdivisions and corporations, and mortgage backed securities.
Equity securities consist entirely of common stocks of financial institutions,
public utilities, and industrial and service entities.
F-19
<PAGE>
The amortized cost and fair value of the Company's investment portfolio are as
follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
<S> <C> <C> <C> <C>
DECEMBER 31, 1997
Fixed maturities available for sale:
U.S. Treasury securities and obligations of
U.S. Government agencies....................... $1,105,689 $17,267 $ 3,390 $1,119,566
Corporate debt securities....................... 675,218 12,845 392 687,671
Mortgage backed securities...................... 119,687 2,657 63 122,281
---------- ------- ------- ----------
Total fixed maturities available for sale......... 1,900,594 32,769 3,845 1,929,518
Equity securities................................. 5 8 -- 13
Short-term investments............................ 265,207 -- -- 265,207
---------- ------- ------- ----------
Total investments................................. $2,165,806 $32,777 $ 3,845 $2,194,738
========== ======= ======= ==========
DECEMBER 31, 1996
Fixed maturities available for sale:
U.S. Treasury securities and obligations of
U.S. Government agencies....................... $1,640,881 $ 4,045 $42,182 $1,602,744
Obligations of states and political subdivisions 77,562 194 1,229 76,527
Corporate debt securities....................... 372,620 3,203 2,977 372,846
Mortgage backed securities...................... 73,328 728 53 74,003
---------- ------- ------- ----------
Total fixed maturities available for sale......... 2,164,391 8,170 46,441 2,126,120
Equity securities................................. 259 3 -- 262
Short-term investments............................ 134,971 -- -- 134,971
---------- ------- ------- ----------
Total investments................................. $2,299,621 $ 8,173 $46,441 $2,261,353
========== ======= ======= ==========
</TABLE>
The amortized cost and estimated fair value of fixed maturities at December 31,
1997, by contractual maturity, are shown below. Expected maturities will differ
from contractual maturities because the issuers may have the right to call or
prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
---- -----
<S> <C> <C>
1998.......................................... $ 129,047 $ 128,919
1999-2002..................................... 634,888 633,643
2003-2007..................................... 394,704 396,459
2008 and thereafter........................... 622,268 648,216
Mortgage backed securities.................... 119,687 122,281
---------- ----------
$1,900,594 $1,929,518
========== ==========
</TABLE>
Net investment income consists of the following:
<TABLE>
<CAPTION>
For the years ended December 31,
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Fixed maturities......................... $128,400 $131,530 $129,883
Equity securities........................ -- 148 503
Short-term investments................... 7,282 7,711 11,764
Other.................................... 4,422 3,251 4,303
-------- -------- --------
Total investment income................ 140,104 142,640 146,453
Investment expenses...................... 3,406 8,704 7,098
-------- -------- --------
Net investment income.................. $136,698 $133,936 $139,355
======== ======== ========
</TABLE>
F-20
<PAGE>
Net realized investment gains consist of the following:
<TABLE>
<CAPTION>
For the years ended December 31,
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Realized gains:
Fixed maturities......................... $20,899 $12,762 $37,900
Equity securities........................ -- 4,351 3,117
Other.................................... -- 4 --
------- ------- -------
20,899 17,117 41,017
------- ------- -------
Realized losses:
Fixed maturities......................... 12,203 12,861 5,956
Equity securities........................ -- 436 2,200
Other.................................... 98 836 938
------- ------- -------
12,301 14,133 9,094
------- ------- -------
Total net realized investment gains........ $ 8,598 $ 2,984 $31,923
======= ======= =======
</TABLE>
On December 31, 1997, the Company had securities with a total amortized cost and
fair value of $30,925 and $31,105, respectively, on deposit with various
governmental authorities, as required by law. In addition, at December 31,
1997, securities with a total amortized cost and fair value of $11,603 and
$11,547, respectively, were pledged as collateral for letters of credit issued
on behalf of the Company.
Change in unrealized appreciation (depreciation) of investments consists of the
following:
<TABLE>
<CAPTION>
For the years ended December 31,
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Fixed maturities available for sale........ $67,195 $(62,457) $ 99,874
Equity securities.......................... 5 (2,751) 3,165
------- -------- --------
Change in unrealized appreciation
(depreciation) of investments....... $67,200 $(65,208) $103,039
======= ======== ========
</TABLE>
During 1997, the Company established a securities lending program through which
securities are loaned from the Company's portfolio to qualifying third parties,
subject to certain limits, via a lending agent for short periods of time.
Borrowers of these securities must provide collateral equal to a minimum of 102%
of the market value and accrued interest of the loaned securities. Acceptable
collateral may be in the form of either cash or securities. Cash received as
collateral is invested in short-term investments, and all securities received as
collateral are of similar quality to those securities lent by the Company.
Additionally, the Company limits securities lending to 40% of statutory admitted
assets of its insurance subsidiaries, with a 2% limit on statutory admitted
assets to any individual borrower. The Company receives either a fee from the
borrower or retains a portion of the income earned on the collateral. Under the
terms of the securities lending program, the Company is indemnified against
borrower default, with the lending agent responsible to the Company for any
deficiency between the cost of replacing a security that was not returned and
the amount of collateral held by the Company. In 1997, the Company recognized
income from securities lending transactions of $524, net of lending fees, which
was included in investment income. The Company had approximately $175,000 of
securities on loan as of December 31, 1997.
F-21
<PAGE>
3. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity in the liability for unpaid losses and loss adjustment expenses (LAE)
is summarized as follows:
<TABLE>
<CAPTION>
For the years ended December 31,
1997 1996 1995
--------------- --------------- ---------------
<S> <C> <C> <C>
Balance at January 1......................................... $2,091,072 $2,069,986 $2,103,714
Less: reinsurance recoverable on unpaid losses and LAE....... 256,576 261,492 247,856
---------- ---------- ----------
Net balance at January 1..................................... 1,834,496 1,808,494 1,855,858
---------- ---------- ----------
Losses and LAE incurred, net:
Current year............................................... 341,880 323,069 357,787
Prior years................................................ (86,006) 156,074 51,491
Accretion of discount (includes ($35,000) effect of the
change in the discount rate for the Property and Casualty
Group's workers' compensation unpaid losses from 4% to 5%
in 1995).................................................. 51,407 57,480 13,300
---------- ---------- ----------
Total losses and LAE incurred, net........................... 307,281 536,623 422,578
---------- ---------- ----------
Losses and LAE paid, net:
Current year............................................... (72,399) (72,194) (71,126)
Prior years................................................ (398,475) (438,427) (398,816)
---------- ---------- ----------
Total losses and LAE paid, net............................... (470,874) (510,621) ( 469,942)
---------- ---------- ----------
Net balance at December 31................................... 1,670,903 1,834,496 1,808,494
Reinsurance recoverable on unpaid losses and LAE............. 332,284 256,576 261,492
---------- ---------- ----------
Balance at December 31....................................... $2,003,187 $2,091,072 $2,069,986
========== ========== ==========
</TABLE>
The Company's results of operations included a decrease in estimated incurred
losses and LAE related to prior accident years of $86,006 in 1997, and an
increase of $156,074 and $51,491 in 1996 and 1995, respectively.
During 1997, PMA Re recorded favorable reserve development on prior accident
years of approximately $32,100. PMA Re has consistently recorded favorable
reserve development on prior accident years for the past several years. The
remaining decrease in estimated losses and LAE on prior accident years during
calendar year 1997 can be attributed primarily to the following: the cession of
prior year reserves by PMA Life Insurance Company to a third party reinsurer of
approximately $14,800 (See Note 5); favorable reserve development at the
Property and Casualty Group in conjunction with the formal commutation program,
discussed below, of approximately $9,000 pertaining to retrospectively rated
policies for accident years 1991 and prior; favorable reserve development at the
Property and Casualty Group of approximately $28,000 related to retrospectively
rated policies pertaining to accident years 1992 through 1996; and favorable
development on pre-1992 workers' compensation reserves of $7,100, partially
offset by reserve strengthening in commercial multi-peril business for accident
year 1996 of $5,000.
The increase in estimated incurred losses and LAE during 1996 is primarily due
to a loss reserve strengthening charge of $191,400. This loss reserve
strengthening was associated with the following lines of business:
<TABLE>
<CAPTION>
1996
------------
<S> <C>
Workers' compensation..................... $110,000
Asbestos and environmental................ 60,400
Other lines of business................... 21,000
--------
$191,400
========
</TABLE>
The 1996 aggregate workers' compensation adverse development was allocated
$102,000 to Pennsylvania and $8,000 to all other states in the Company's
marketing territory. Of the $102,000, the allocation by accident year is as
follows: prior to 1987: $16,000; 1987 to 1991: $101,000; and 1992 and subsequent
years: $(15,000). In 1995, substantially all of the workers' compensation
adverse development related to accident years 1987 to 1991 in Pennsylvania. For
accident years prior to 1992, the traditional paid loss development schedules
for workers' compensation had begun to exhibit an increasing trend in loss
development factors by 1993. This trend was initially attributed to an increase
in commutation activity. In 1995, management began to question whether loss
data was developing in a manner that was consistent
F-22
<PAGE>
with the conclusion that the loss development trends were impacted solely by
commutation activity. As a result, management began to accumulate additional
data in order to determine whether there were additional causes of the increase
in the paid loss development data; management obtained claim count data that was
far more detailed than had been historically utilized in the reserve setting
process. This data indicated that the paid loss development factors were not
only impacted by commutation activity, but also by a decline in the claims
closure rate in Pennsylvania. Management believes that the decline of the
closure rates was due to several interrelated factors. One factor related to the
fact that efforts to rehabilitate claimants and return them to work were not as
successful as anticipated. For accident years 1987 to 1991, in particular,
extensive efforts were made by the Company to rehabilitate claimants and return
them to work at either full or modified duty. By late 1995 and into 1996, it was
recognized, by a review of a slow down in the claims closure pattern that these
rehabilitation efforts were not impacting the closure rates as expected. Another
factor negatively impacting claims closure rates related to the economic
conditions in Pennsylvania in the early 1990's. During the period from 1990 to
1994, economic conditions in Pennsylvania were considered to be depressed in the
Company's major industry niches for workers' compensation insurance
(construction, heavy manufacturing). Payrolls in these industries were stagnant,
and in many cases, employment was flat or declining. The Company believes that
in periods of declining employment opportunities, there is a tendency for
indemnity periods to increase, which occurred for workers who suffered injuries
in these industries.
The above factors, when considered with the fact that the benefits period in
Pennsylvania was unlimited, caused the Company to believe that a substantial
portion of claimants from the pre-1992 period, who had already been out of work
five to nine years, would not return to work in any capacity. In late 1995 and
during 1996, management undertook an effort to quantify the impact of the
declining closure rates versus the increase in commutation activity. During the
fourth quarter of 1995, management strengthened the Property and Casualty
Group's workers' compensation reserves by $54,700; however, the quantification
of the effect of the claims closure rate was an extremely complex process, and
as such, the data was not fully understood at that time. As the data under
analysis was more mature and refined in 1996, management determined that the
workers' compensation loss reserves for Pennsylvania in the pre-1992 accident
years needed to be increased substantially; therefore, the Property and Casualty
Group increased its workers' compensation reserves by $110,000 in 1996.
Workers' compensation reform legislation enacted in Pennsylvania in 1993 and
1996 introduced various controls and limitations on medical and disability
benefits. Management believes that these reforms have had and will continue to
have a favorable impact on workers' compensation loss ratios for accident years
1993 and subsequent. In addition, management took several steps to reduce the
outstanding claims associated with the Pennsylvania workers' compensation
business written through 1991. A formal commutation program was initiated in
the fourth quarter 1996 and continued into late 1997. Commutations are
agreements with claimants whereby the claimants, in exchange for a lump sum
payment, will forego their rights to future indemnity payments from the Property
and Casualty Group. Under Pennsylvania workers' compensation laws, all such
commutation arrangements must be approved by the claimant and the Pennsylvania
Workers' Compensation Board. The Property and Casualty Group paid approximately
$101,100 and $17,800 in 1997 and the fourth quarter of 1996, respectively, to
commute workers' compensation indemnity claims. Savings associated with these
claims were consistent with management's expectations. The number of open
claims for accident years 1991 and prior was substantially reduced as a result
of the commutation program. This reduction in open claims is expected to reduce
the possibility of any further adverse development on such reserves, although
there can be no assurances that the level of commutations will have a
significant impact on the future development of such reserves.
Estimating reserves for workers' compensation claims can be more difficult than
many other lines of property and casualty insurance for several reasons,
including (i) the long payment `tail' associated with the business; (ii) the
impact of social, political and regulatory trends on benefit levels; (iii) the
impact of economic trends; and (iv) the impact of changes in the mix of
business. At various times, one or a combination of such factors can make the
interpretation of actuarial data associated with workers' compensation loss
development more difficult, and it can take additional time to recognize changes
in loss development patterns. Under such circumstances, adjustments will be
made to such reserves as loss patterns develop and new information becomes
available and such adjustments may be material.
The adverse development in reserves associated with asbestos and environmental
claims during 1996 was due to the completion of a detailed analysis of loss and
LAE reserves associated with asbestos and environmental liability claims in
1996. The reserving for asbestos and environmental claims has undergone
F-23
<PAGE>
change at both the Company and in the insurance industry in general. For
environmental and asbestos liability claims, reserving methodology has been
evolving into accepted industry practice in the recent past; the Company's
actuaries were able to apply these methods to its loss reserves in 1997 and
1996. To reserve for environmental claims, the Company currently utilizes a
calendar year development technique known as aggregate loss development. This
technique focuses on the aggregate losses paid as of a particular date and
aggregate payment patterns associated with such claims. Several elements
including remediation studies, remediation, defense, declaratory judgment, and
third party bodily injury claims were considered in estimating the costs and
payment patterns of the environmental and toxic tort losses. Prior to the
development of these techniques, there was a substantial range in the nature of
reserving for environmental and toxic tort liabilities. The methods employed by
the Company prior to the review performed in 1996 included a review of aggregate
loss and loss adjustment paid and case incurred data along with resulting
"survival ratios" to establish IBNR for environmental and toxic tort claims. For
asbestos claims, the Company had previously reserved costs to defend, and any
indemnification payments anticipated on, claims for which it had received notice
that it was a responsible party, plus a bulk factor applied to the estimated
case reserves to provide for potential development of indemnification and
defense costs related to such claims. In 1996, the Company performed a ground up
analysis of asbestos loss reserves using an actuarially accepted modeling
technique. Using historical information as a base and information obtained from
a review of open claims files, assumptions were made about future claims
activity in order to estimate ultimate losses. For each individual major
account, projections were made regarding new plaintiffs per year, the number of
years new claims will be reported, the average loss severity per plaintiff, and
the ratio of loss adjustment expense to loss. In many cases involving larger
asbestos claims, the Company reserved up to the policy limits for the applicable
loss coverage parts for the affected accounts. Policy terms and reinsurance
treaties were applied in the modeling of future losses. Estimation of
obligations for asbestos and environmental exposures continues to be more
difficult than other loss reserves because of several factors, including: (i)
evolving methodologies for the estimation of the liabilities; (ii) lack of
reliable historical claim data; (iii) uncertainties with respect to insurance
and reinsurance coverage related to these obligations; (iv) changing judicial
interpretations; and (v) changing government standards.
The Company's asbestos-related losses were as follows:
<TABLE>
<CAPTION>
For the years ended December 31,
1997 1996 1995
-------------- -------------- --------------
Gross of reinsurance:
<S> <C> <C> <C>
Beginning reserves............................... $80,055 $ 27,611 $13,969
Incurred losses and LAE.......................... 2,435 62,854 22,482
Calendar year payments for losses and LAE........ (5,764) (10,410) (8,840)
------- -------- -------
Ending reserves.................................. $76,726 $ 80,055 $27,611
======= ======== =======
1997 1996 1995
-------------- -------------- --------------
Net of reinsurance:
Beginning reserves............................... $53,300 $23,443 $ 8,168
Incurred losses and LAE.......................... (36) 39,427 21,826
Calendar year payments for losses and LAE....... (4,686) (9,570) (6,551)
------- ------- -------
Ending reserves.................................. $48,578 $53,300 $23,443
======= ======= =======
</TABLE>
F-24
<PAGE>
The Company's environmental-related losses were as follows:
<TABLE>
<CAPTION>
For the years ended December 31,
1997 1996 1995
-------------- -------------- --------------
Gross of reinsurance:
<S> <C> <C> <C>
Beginning reserves............................... $35,626 $20,134 $20,952
Incurred losses and LAE.......................... 1,130 22,143 3,516
Reserves acquired through purchase of Caliber
One Indemnity Company(1).................. 13,060 -- --
Calendar year payments for losses and LAE........ (4,708) (6,651) (4,334)
------- ------- -------
Ending reserves.................................. $45,108 $35,626 $20,134
======= ======= =======
Net of reinsurance:
Beginning reserves............................... $34,592 $20,134 $20,952
Incurred losses and LAE.......................... 1,068 21,109 3,516
Calendar year payments for losses and LAE....... (3,965) (6,651) (4,334)
------- ------- -------
Ending reserves.................................. $31,695 $34,592 $20,134
======= ======= =======
</TABLE>
(1) Such acquired reserves have been reinsured by an affiliate of the former
parent (See Note 1).
Of the total net asbestos reserves, approximately $6,700, $6,800, and $6,700
related to established claims reserves at December 31, 1997, 1996, and 1995,
respectively, and $41,900, $46,500, and $16,700 related to incurred but not
reported losses at December 31, 1997, 1996, and 1995, respectively. Of the
total net environmental reserves, approximately $11,200, $12,500, and $10,300
related to established claims reserves at December 31, 1997, 1996, and 1995,
respectively, and $20,500, $22,100, and $9,800 related to incurred but not
reported losses at December 31, 1997, 1996, and 1995, respectively. All
incurred asbestos and environmental losses were for accident years 1986 and
prior.
Management believes that its reserves for asbestos and environmental claims are
appropriately established based upon known facts, existing case law, and
generally accepted actuarial methodologies. However, due to changing
interpretations by courts involving coverage issues, the potential for changes
in federal and state standards for clean-up and liability and other factors, the
ultimate exposure to the Company for these claims may vary significantly from
the amounts currently recorded, resulting in a potential adjustment in the
claims reserves recorded. Additionally, issues involving policy provisions,
allocation of liability among participating insurers, proof of coverage, and
other factors make quantification of liabilities exceptionally difficult and
subject to adjustment based upon newly available data.
In 1996, other commercial lines for the Property and Casualty Group experienced
reserve strengthening of $21,000, as compared to a reserve release of $11,600 in
1995. The reserve strengthening was principally due to a re-estimation of loss
adjustment costs associated with general liability claims. Through 1991, the
Property and Casualty Group's mix of general liability insurance policies were
weighted towards the manufacturing classes of business. Subsequent to 1991, the
Property and Casualty Group's mix of business became more heavily weighted
towards the construction and contracting classes of business. These particular
classes of business have experienced losses due to construction defects and
similar matters, that have taken longer to emerge than the classes of business
previously written by the Property and Casualty Group. Defense costs associated
with these claims have also exceeded the original estimate of the Property and
Casualty Group's management, which was based on the patterns of indemnification
payments associated with the earlier classes of business written. When this
issue was discovered, the Property and Casualty Group factored the increased
defense costs and the emergence pattern in determining a more appropriate
reserve amount for loss handling costs. The release of reserves in 1995 was
primarily due to favorable loss experience in commercial automobile business.
Unpaid losses on workers' compensation claims for the Company include
approximately $816,000 and $1,012,000, net of discount of $460,230 and $514,248,
at December 31, 1997 and 1996, respectively. The approximate discount rate used
was 5% at December 31, 1997 and 1996. In 1995, the Property and Casualty Group
changed its discount rate with respect to its workers' compensation unpaid
losses from approximately 4% to 5% for SAP and GAAP purposes. This change was
approved and is permitted by the Pennsylvania Insurance Department. The effect
on net income (net of tax effect of $12,250) in 1995 was $22,750 ($0.96 per
basic share and $0.92 per diluted share).
F-25
<PAGE>
The Company's loss reserves were stated net of salvage and subrogation of
approximately $59,900 and $75,000 at December 31, 1997 and 1996, respectively.
The following table presents the salvage and subrogation by segment and product
line:
<TABLE>
<CAPTION>
December 31,
1997 1996
---------- ----------
<S> <C> <C>
Property and Casualty Group:
Workers' compensation $46,000 $61,900
Other Commercial Lines 4,800 3,900
------- -------
Total Property and Casualty Group 50,800 65,800
PMA Re 9,100 9,200
------- -------
Total salvage and subrogation $59,900 $75,000
======= =======
</TABLE>
The Company's policy with respect to estimating the amounts and realizability of
salvage and subrogation is to develop historical accident year schedules of paid
salvage and subrogation by line of business, which are then projected to an
ultimate basis using actuarial projection techniques. The anticipated salvage
and subrogation is the estimated ultimate salvage and subrogation less any
amounts received by the Company. The realizability of anticipated salvage and
subrogation is reflected in the historical data that is used to complete the
projection, as historical paid data implicitly considers realization and
collectibility.
4. DEFERRED ACQUISITION COSTS
The following represents the components of deferred acquisition costs and the
amounts that were charged to expense:
<TABLE>
<CAPTION>
For the years ended December 31,
1997 1996 1995
----------- ----------- ----------
<S> <C> <C> <C>
Balance at January 1........................... $ 44,006 $ 37,901 $ 32,236
Deferral of acquisition costs.................. 94,783 96,397 92,872
Amortization of deferred acquisition costs..... (93,501) (90,292) (87,207)
-------- -------- --------
Balance at December 31......................... $ 45,288 $ 44,006 $ 37,901
======== ======== ========
</TABLE>
5. REINSURANCE
In the ordinary course of business, PMC's reinsurance and insurance subsidiaries
assume and cede reinsurance with other insurance companies and are members of
various pools and associations. The reinsurance and insurance subsidiaries cede
business, primarily on an excess of loss basis, in order to limit the maximum
net loss from large risks and limit the accumulation of many smaller losses from
a catastrophic event. The reinsurance and insurance subsidiaries remain
primarily liable to their clients in the event their reinsurers are unable to
meet their financial obligations.
Amounts receivable from reinsurers related to paid and unpaid losses are
displayed separately on the consolidated balance sheets, net of an allowance for
uncollectible accounts.
F-26
<PAGE>
The components of net premiums earned and losses and LAE incurred are as
follows:
<TABLE>
<CAPTION>
For the years ended December 31,
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Earned Premiums:
Direct.......................... $ 277,871 $299,386 $370,590
Assumed......................... 216,357 209,688 149,838
Ceded........................... (118,277) (88,499) (35,476)
--------- -------- --------
Net............................... $ 375,951 $420,575 $484,952
========= ======== ========
Losses and LAE Incurred:
Direct.......................... $ 244,429 $420,157 $317,552
Assumed......................... 166,202 163,799 127,910
Ceded........................... (103,350) (47,333) (22,884)
--------- -------- --------
Net............................... $ 307,281 $536,623 $422,578
========= ======== ========
</TABLE>
The Company performs extensive credit reviews on its reinsurers, focusing on,
among other things, financial capacity, stability, trends, and commitment to the
reinsurance business. Prospective and existing reinsurers failing to meet the
Company's standards are excluded from the Company's reinsurance programs. In
addition, the Company requires letters of credit to support balances due from
reinsurers not authorized to transact business in the applicable jurisdictions.
At December 31, 1997, the Company had reinsurance recoverables due from the
following unaffiliated single reinsurers in excess of 3% of shareholders'
equity:
<TABLE>
<CAPTION>
Gross amount due
Reinsurer to the Company A.M. Best Rating
- --------- -------------- ----------------
<S> <C> <C>
United States Fidelity and Guaranty Company......... $74,041 A
Essex Insurance Company............................. 36,807 A
American Re-Insurance Corporation................... 35,411 A+
Kemper Reinsurance Corporation...................... 21,853 A
London Life International Reinsurance Corporation 16,212 A+
Continental Casualty Company........................ 15,209 A
</TABLE>
The Company maintained funds held to collateralize the above balances in the
amount of $66,891 at December 31, 1997. The Company believes that it would have
the right to offset the funds withheld from a reinsurer against the balances due
from such reinsurer in the event of insolvency.
During 1997, PMA Life Insurance Company reinsured the majority of its in force
annuity business with a third party reinsurer via a quota-share reinsurance
agreement for approximately $15,400. The transaction effectively makes PMA Life
Insurance Company a dormant company.
All of Caliber One Indemnity Company's acquired loss reserves were reinsured
with an affiliate of its former parent in conjunction with its purchase by PMA
Re, as discussed in Note 1. Management believes that such reinsurance is
adequate to cover any future reserve development or uncollectible reinsurance on
the acquired reserves.
F-27
<PAGE>
6. LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
December 31,
1997 1996
---- ----
<S> <C> <C>
Senior notes 9.53%, due 1997......................... $ -- $ 7,143
Senior notes 9.60%, due 2001......................... -- 46,428
Senior notes 7.62%, due 2001, Series A............... -- 71,000
Senior notes 7.62%, due 2000, Series B............... -- 36,000
Revolving credit agreement, expiring in 1998......... -- 44,000
Revolving credit facility, expiring in 2002(1)....... 203,000 --
Mortgage notes....................................... -- 128
-------- --------
Long-term debt....................................... $203,000 $204,699
======== ========
</TABLE>
(1) Maturing in an installment of $15,500 in 1999 and annual installments of
$62,500 commencing in 2000 through 2002.
On March 14, 1997, the Company refinanced substantially all of its existing
credit agreements not already maturing in 1997 through the completion of a new
$235,000 revolving credit facility (New Credit Facility). Utilizing the New
Credit Facility, the Company refinanced the following obligations:
<TABLE>
<S> <C>
Senior notes 9.60%, due 2001......................... $ 46,428
Senior notes 7.62%, due 2001, Series A............... 71,000
Senior notes 7.62%, due 2000, Series B............... 36,000
Revolving credit agreement, expiring in 1998(1)...... 36,000
--------
Total................................................ $189,428
========
</TABLE>
(1) The Company repaid $8,000 of the revolving credit agreement prior to March
14, 1997.
The early extinguishment of the senior note agreements resulted in an
extraordinary loss of $4,734 ($7,283 pre-tax). The New Credit Facility bears
interest at LIBOR plus 0.70% on the utilized portion and carries a 0.275%
facility fee on the unutilized portion. The spread over LIBOR and the facility
fee are adjustable downward based upon the Company's debt to capitalization
ratios in the future. As of December 31, 1997, the interest rate on the
utilized portion of the New Credit Facility was 6.61%.
In November of 1996, the Company entered into a letter of credit agreement with
a group of banks, which currently extends through November of 1998. The
original agreement allowed the issuing bank to issue letters of credit having an
aggregate outstanding face amount up to $75,000. Effective March 14, 1997, this
facility was reduced to an aggregate outstanding face amount not to exceed
$50,000. The agreement requires the Company to pay a commitment fee during the
existence of the agreement equal to 0.1875% per annum on the average daily
available amount. At December 31, 1997 and 1996, the aggregate outstanding face
amount of letters of credit issued was $46,881 and $47,461, respectively. This
agreement primarily secures reinsurance liabilities of the insurance
subsidiaries of the Company.
The debt covenants supporting the revolving credit facility and the letter of
credit agreement contain provisions which, among other matters, limit the
Company's ability to incur additional indebtedness, merge, consolidate and
acquire or sell assets. The debt covenants also require the Company to satisfy
certain ratios related to net worth, debt-to-capitalization, and interest
coverage. Additionally, the debt covenants place restrictions on dividends to
shareholders (See Note 15).
F-28
<PAGE>
The Company has entered into an interest rate swap agreement in its management
of its existing interest rate exposures. This transaction effectively changed
the Company's interest rate exposure on a portion of the New Credit Facility,
which has a floating rate, to a fixed obligation as follows:
<TABLE>
<CAPTION>
Notional Principal
Balance at
Debt Agreement December 31, 1997 Fixed Rate Floating Rate
- -------------- ----------------- ---------- -------------
<S> <C> <C> <C>
Revolving Credit Facility, 2002 $150,000 7.24% 6.61%
</TABLE>
The variable rate resets every three months. This agreement involves the
exchange of interest payment obligation without the exchange of underlying
principal. The differential to be paid or received is recognized as an
adjustment of interest expense. In the event that a counterparty fails to meet
the terms of the agreement, the Company's exposure is limited to the interest
rate differential on the notional principal amount ($150,000). Management
believes such credit risk is minimal and any loss would not be significant.
7. STOCK OPTIONS
The Company currently has six stock option plans in place for options granted to
officers and other key employees for the purchase of the Company's Class A
common stock, under which 3,864,903 Class A common shares are reserved for
issuance. The stock options are granted under terms and conditions determined
by a committee appointed by the Company's board of directors. Granted stock
options have a maximum term of ten years, vest over periods ranging between zero
and five years, and are typically granted with an exercise price equal to the
fair market value of the stock. Information regarding these option plans for
1997, 1996, and 1995 are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
-----------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Options outstanding,
beginning of year...... 3,242,160 $ 12.43 3,087,260 $ 11.80 2,926,000 $ 10.41
Options granted.......... 324,500 17.00 325,000 17.00 775,000 15.59
Options exercised........ (162,248) (8.78) (99,150) (8.33) (205,199) (8.66)
Options canceled......... (286,800) (11.53) (70,950) (11.55) (408,541) (10.65)
--------- ------- --------- ------- --------- -------
Options outstanding,
end of year............ 3,117,612 $ 13.18 3,242,160 $ 12.43 3,087,260 $ 11.80
========= ======= ========= ======= ========= =======
</TABLE>
<TABLE>
<S> <C> <C> <C>
Option price range at
end of year............ $8.00 to $17.00 $8.00 to $17.00 $6.60 to $16.00
Option price range for
exercised shares....... $8.00 to $15.00 $6.60 to $10.00 $6.60 to $11.50
Options available for
grant at end of year... 747,291 921,566 425,616
</TABLE>
F-29
<PAGE>
Stock options outstanding at December 31, 1997 and related exercise price and
weighted average remaining life information is as follows:
<TABLE>
<CAPTION>
Weighted
Options Options Average
Outstanding at Exercisable at Remaining Life
Exercise Prices December 31, 1997 December 31, 1997 (in years)
- --------------- ----------------- ----------------- ----------
<S> <C> <C> <C>
$8.00............................. 254,357 246,857 3.49
10.00............................. 438,690 438,690 4.46
11.50............................. 799,000 799,000 5.65
12.75............................. 271,500 271,500 6.17
15.00............................. 296,580 287,580 7.45
16.00............................. 411,485 283,735 7.43
17.00............................. 646,000 228,725 9.15
--------- ---------
3,117,612 2,556,087
========= =========
</TABLE>
The fair value of options at date of grant was estimated using a binomial model
with the following weighted average assumptions:
<TABLE>
<CAPTION>
1997(1) 1996(2) 1995(3) 1995(4)
------- ------- ------- -------
<S> <C> <C> <C> <C>
Expected life (years)............. 10 10 10 10
Interest rate..................... 6.3% 6.3% 6.1% 6.2%
Volatility........................ 18% 18% 18% 18%
Dividend yield.................... 2.3% 2.3% 2.3% 2.3%
</TABLE>
(1) Options granted on September 3, 1997
(2) Options granted on July 23, 1996
(3) Options granted on June 5, 1995
(4) Options granted on September 1, 1995
The Company has adopted the disclosure-only provision of SFAS No. 123,
"Accounting for Stock-Based Compensation". Accordingly, no compensation cost
has been recognized for the stock option plans. Had compensation costs for the
Company's stock option plans been determined based on the fair value at the
grant date for awards granted during the year, pretax income would have been
reduced by $1,878 ($1,221 after tax, or $0.05 per basic share), $2,079 ($1,352
after tax, or $0.06 per basic share), and $4,308 ($2,800 after tax, or $0.12 per
basic share) in 1997, 1996, and 1995, respectively.
8. INCOME TAXES
The components of income tax provision (benefit) from continuing operations are:
<TABLE>
<CAPTION>
For the years ended December 31,
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Current:
Federal.................................... $(4,506) $(44,572) $(4,570)
------- -------- -------
(4,506) (44,572) (4,570)
------- -------- -------
Deferred:
Federal.................................... 9,906 (11,488) 15,353
------- -------- -------
9,906 (11,488) 15,353
------- -------- -------
Income tax provision (benefit) from
continuing operations....................... $ 5,400 $(56,060) $10,783
======= ======== =======
</TABLE>
F-30
<PAGE>
The components of income tax benefit from extraordinary item are:
<TABLE>
<CAPTION>
For the years ended December 31,
1997 1996 1995
--------- ---------- ----------
<S> <C> <C> <C>
Current:
Federal.................................... $ (374) $ -- $ --
------- ---------- ----------
(374) -- --
------- ---------- ----------
Deferred:
Federal.................................... (2,175) -- --
------- ---------- ----------
(2,175) -- --
------- ---------- ----------
Income tax benefit from
extraordinary item.......................... $(2,549) $ -- $ --
======= ========== ==========
</TABLE>
A reconciliation between the total provision (benefit) for income taxes and the
amounts computed at the Statutory Federal income tax rate of 35% for the years
1997, 1996 and 1995 is as follows:
<TABLE>
<CAPTION>
For the years ended December 31,
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Computed at the Statutory tax rate............. $ 8,804 $(66,988) $ 12,220
(Decrease) increase in taxes resulting from:
Excludable dividends......................... -- (36) (107)
Tax-exempt interest.......................... (61) (4,547) (12,917)
Losses of foreign reinsurance affiliate...... -- 16,060 8,469
Reversal of income tax accruals.............. (3,703) -- --
Other........................................ 360 (549) 3,118
------- -------- --------
Provision (benefit) for income taxes........... $ 5,400 $(56,060) $ 10,783
======= ======== ========
</TABLE>
The tax effects of significant temporary differences between the financial
statement carrying amounts and tax bases of assets and liabilities that
represent the net deferred tax asset are as follows:
<TABLE>
<CAPTION>
December 31,
1997 1996
----------- -----------
<S> <C> <C>
Allowance for uncollectible accounts.......... $ 6,839 $ 9,037
Unearned premiums............................. 13,756 13,386
Discounting of unpaid losses and LAE.......... 63,743 51,086
Unrealized depreciation of investments........ -- 13,394
Depreciation.................................. -- 5,646
Postretirement benefit obligation............. 5,139 5,111
Tax carryforwards............................. 46,088 67,014
Other......................................... 18,919 9,458
-------- --------
Gross deferred tax asset...................... 154,484 174,132
-------- --------
Deferred acquisition costs.................... (15,723) (15,352)
Pension asset................................. (371) (1,348)
Depreciation.................................. (574) --
Unrealized appreciation of investments........ (10,126) --
Losses of foreign reinsurance affiliate....... (55,087) (55,790)
Other......................................... (2,212) --
-------- --------
Gross deferred tax liability.................. (84,093) (72,490)
-------- --------
Net deferred tax asset........................ $ 70,391 $101,642
======== ========
</TABLE>
At December 31, 1997, the Company had approximately $109,622 of net operating
loss carryforwards (expiring in 2011), approximately $7,532 of alternative
minimum tax credit carryforwards (which do not expire) and approximately $188 of
general business credit carryforwards (expiring in 2010 and 2011).
Under SFAS 109, a valuation allowance should be provided to offset the effects
of a deferred tax asset if management believes that it is more likely than not
that the benefit of a deferred tax item will not be
F-31
<PAGE>
realized. Management believes that the benefit of its deferred tax asset will be
fully realized, and therefore has not provided for a valuation allowance.
U.S. Federal tax return examinations have been completed for the years 1992 and
1993. The examinations for years 1994 and 1995 are currently in progress. In
management's opinion, the ultimate resolution of these matters will not have an
adverse impact on the Company's financial position or results of operations.
9. EMPLOYEE RETIREMENT, POSTRETIREMENT, AND POSTEMPLOYMENT BENEFITS
During 1996, the Property and Casualty Group initiated a Voluntary Early
Retirement Program ("VERIP"). Eligibility to participate in the VERIP was
contingent upon an employee's age and years of service with the Company. Of the
approximately 85 employees eligible to participate in the VERIP, approximately
50 employees opted to participate. At December 31, 1996, the Company accrued
$7,635 in connection with the VERIP. The components of this accrual are as
follows:
<TABLE>
<S> <C>
Pension costs..................................................... $4,300
Postemployment costs.............................................. 2,360
Postretirement costs.............................................. 975
------
$7,635
======
</TABLE>
The Company did not offer a VERIP in 1997, and as such, did not incur any VERIP
expenses. The Company did, however, incur certain restructuring and other
charges during 1997 (See Note 20).
A. PENSION AND RETIREMENT PLANS -- The Company sponsors a qualified non-
contributory defined benefit pension plan (Qualified Pension Plan) covering
substantially all employees. After meeting certain qualifications, an employee
acquires a vested right to future benefits. The benefits payable under the plan
are generally determined on the basis of an employee's length of employment and
career average salary. The Company's policy is to fund pension cost accrued in
accordance with the Employee Retirement Income Security Act of 1974. The
Company also maintains a non-qualified unfunded supplemental defined benefit
pension plan (Non-qualified Pension Plan) for the benefit of certain key
employees.
The following tables set forth the amounts recognized in the Company's financial
statements with respect to the Qualified and Non-qualified pension plans:
<TABLE>
<CAPTION>
For the year ended December 31, 1997 For the year ended December 31,
1996
Non- Non-
Qualified Qualified Qualified Qualified
Plan Plan Total Plan Plan Total
------------ ----------- --------- ---------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Service cost-benefits earned
during the period......... $ 1,375 $ 93 $ 1,468 $ 1,665 $ 98 $ 1,763
Interest cost on projected
benefit obligation........ 3,034 166 3,200 2,948 150 3,098
Actual return on plan assets . (2,490) -- (2,490) (2,830) -- (2,830)
Net amortization and
deferral.................. (884) 93 (791) (842) 94 (748)
VERIP......................... -- -- -- 4,300 -- 4,300
------- ---- ------- ------- ---- -------
Net pension cost.............. $ 1,035 $352 $ 1,387 $ 5,241 $342 $ 5,583
======= ==== ======= ======= ==== =======
For the year ended December 31,
1995
Non-
Qualified Qualified
Plan Plan Total
---------- --------- --------
<C> <C> <C>
Service cost-benefits earned
during the period......... $ 1,132 $ 108 $ 1,240
Interest cost on projected 2,770 158 2,928
benefit obligation........ (8,712) -- (8,712)
Actual return on plan assets .
Net amortization and 5,803 94 5,897
deferral.................. -- -- --
VERIP......................... ------- ------ -------
$ 993 $ 360 $ 1,353
Net pension cost.............. ======= ====== =======
</TABLE>
F-32
<PAGE>
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
Non- Non-
Qualified Qualified Qualified Qualified
Plan Plan Total Plan Total
---------- ---------- --------- ---------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Actuarial present value of:
Vested benefit obligation......... $36,405 $ 1,238 $37,643 $41,932 $ 1,069 $43,001
Non-vested benefit obligation..... 3,919 79 3,998 3,487 68 3,555
------- ------- ------- ------- ------- -------
Accumulated benefit obligation........ $40,324 $ 1,317 $41,641 $45,419 $ 1,137 $46,556
======= ======= ======= ======= ======= =======
Projected benefit obligation.......... $44,653 $ 2,472 $47,125 $49,331 $ 2,133 $51,464
Fair value of Pension Plan assets..... 40,600 -- 40,600 46,739 -- 46,739
------- ------- ------- ------- ------- -------
Excess of projected benefit obligation
over Pension Plan assets........ (4,053) (2,472) (6,525) (2,592) (2,133) (4,725)
Unrecognized net loss (gain).......... 4,830 29 4,859 588 (63) 525
Unrecognized transition asset......... (810) 1,123 313 (1,081) 1,216 135
Unrecognized prior service benefit.... (1,101) -- (1,101) (1,199) -- (1,199)
------- ------- ------- ------- ------- -------
Pension liability..................... $(1,134) $(1,320) $(2,454) $(4,284) $ (980) $(5,264)
======= ======= ======= ======= ======= =======
</TABLE>
Qualified Pension Plan assets consist of equity securities, fixed maturity
securities, fixed income contracts, and the Company's common stock.
Actuarial assumptions utilized by the Qualified and Non-qualified Pension Plan
are as follows:
<TABLE>
<CAPTION>
For the years ended December 31,
1997 1996 1995
--------- --------- --------
<S> <C> <C> <C>
Discount rate..................................... 7.0% 7.5% 7.0%
Rate of compensation increase..................... 4.5% 5.0% 5.0%
Expected long-term rate of return on plan assets.. 8.0% 8.0% 8.0%
</TABLE>
The Company also maintains a voluntary defined contribution savings plan
covering all employees who work a minimum of 20 hours per week. The Company
matches employee contributions up to 5% of compensation. Contributions under
such plans charged to income were $1,735, $2,153 and $1,726 in 1997, 1996 and
1995, respectively.
B. POSTRETIREMENT BENEFITS -- In addition to providing pension benefits, the
Company provides certain health care benefits for retired employees.
Substantially all of the Company's employees may become eligible for those
benefits if they have worked fifteen or more years with the Company and have
attained the age of fifty while in the service of the Company. For employees
who retire on or subsequent to January 1, 1993, the Company will pay a fixed
portion of medical insurance premiums. Retirees will absorb future increases in
medical premiums.
The funded status of this liability is as follows:
<TABLE>
<CAPTION>
December 31,
1997 1996
-------- ---------
<S> <C> <C>
Accumulated postretirement benefit obligation:
Retirees and dependents.......................... $ 6,076 $ 6,931
Fully eligible active employees.................. 1,214 952
Active employees not fully eligible.............. 2,383 1,871
------- -------
Total............................................ 9,673 9,754
Unrecognized prior service cost.................. 1,317 1,436
Unrecognized net gain............................ 3,455 4,031
------- -------
Accrued postretirement benefit liability......... $14,445 $15,221
======= =======
</TABLE>
F-33
<PAGE>
The components of postretirement benefit cost include the following:
<TABLE>
<CAPTION>
For the years ended December 31,
1997 1996 1995
--------- --------- ----------
<S> <C> <C> <C>
Service cost.......................... $ 237 $ 248 $ 330
Interest cost......................... 655 561 658
Amortization.......................... (242) (251) (209)
VERIP................................. -- 975 --
----- ------ -----
Postretirement benefit cost........... $ 650 $1,533 $ 779
===== ====== =====
</TABLE>
Assumptions used in the computation of the funded status and postretirement
benefit cost are as follows:
<TABLE>
<CAPTION>
For the years ended December 31,
1997 1996 1995
--------- --------- ----------
<S> <C> <C> <C>
Discount rate......................... 7.5% 7.0% 7.0%
Health care inflation rate:
Next year........................... 7.5% 8.0% 8.5%
Ultimate............................ 5.5% 5.5% 5.5%
</TABLE>
The assumed health care cost trend rate used to measure the expected cost of
benefits covered by the plan has been established at 7.5% for 1998 and is
expected to decline gradually to 5.5% in 2002 and remain at that level
thereafter. The health care cost trend rate assumption has a significant effect
on the amounts reported. A 1% increase in the trend rate for health care costs
would have increased the accumulated postretirement benefit obligation by $405
and the annual service and interest cost by $27.
C. POSTEMPLOYMENT BENEFITS -- SFAS No. 112, "Employers' Accounting for
Postemployment Benefits," establishes the accounting standards for employers who
provide benefits to employees subsequent to their employment, but prior to
retirement. These benefits include severance, long-term and short-term
disability payments, salary continuation, postemployment health benefits,
supplemental unemployment benefits, and other related payments. SFAS No. 112
requires that benefit obligations attributable to prior service and/or that
relate to benefits that vest or accumulate must be accrued presently if the
payments are probable and reasonably estimable. Postemployment benefits that do
not meet such criteria are accrued when payments are probable and reasonably
estimable. In connection with the VERIP described above, the Company recorded
$2,360 of postemployment costs in 1996. While a VERIP was not offered in 1997,
the Company incurred approximately $7,000 of severance and other restructuring
charges during 1997 (See Note 20).
10. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table represents the carrying amounts and estimated fair values of
the Company's financial instruments. Estimated fair value is defined as the
amount at which the instrument could be exchanged in a current transaction
between willing parties. Certain financial instruments, specifically amounts
relating to insurance contracts, are excluded from this disclosure.
F-34
<PAGE>
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Financial assets:
Fixed maturities available for sale...... $1,929,518 $1,929,518 $2,126,120 $2,126,120
Equity securities........................ 13 13 262 262
Financial liabilities:
Long-term debt........................... 203,000 203,000 204,699 218,101
Interest rate swap agreements............ -- 3,388 -- 52
</TABLE>
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate
values:
<TABLE>
<CAPTION>
<S> <C>
Fixed maturities: The fair values are estimated based upon quoted market prices.
Equity securities: The fair values are estimated based upon quoted market prices.
Long-term debt: The fair value is estimated using discounted cash flow calculations
based upon the Company's current incremental borrowing rate for
similar types of borrowing facilities or the rate utilized to
prepay obligations, where applicable.
Interest rate swaps: The fair values are estimated by obtaining quotes from dealers.
Guarantees: The fair values are determined based upon the likelihood of the
Company being required to satisfy the underlying obligations.
Management believes that it is a remote possibility that the
Company would have to act upon any guarantees. Therefore, the fair
value of the guarantees is zero.
Other financial instruments
(excluded from the above table): The carrying values approximate the fair values.
</TABLE>
11. DISCLOSURE OF CERTAIN RISKS AND UNCERTAINTIES
A. BUSINESS SEGMENTS AND CONCENTRATIONS -- As stated in Note 1, PMC is an
insurance holding company that sells property and casualty reinsurance and
insurance through its insurance subsidiaries.
The following summarizes the relative importance of the segments and lines of
insurance in terms of net premiums written:
<TABLE>
<CAPTION>
Percent of the Company's
Net Premiums Written
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
PMA Re-total................................... 42.5% 37.0% 31.2%
PMA Re-casualty reinsurance lines.............. 28.4 27.5 21.9
The Property and Casualty Group-total.......... 57.5 63.0 68.8
The Property and Casualty Group-workers'
compensation................................. 43.2 45.6 42.8
</TABLE>
PMA Re distributes its products through major reinsurance brokers. PMA Re's top
five such brokers accounted for 90.8% of PMA Re's gross premiums in force at
December 31, 1997.
The Property and Casualty Group's operations are concentrated in six contiguous
states in the Mid-Atlantic and Southern regions of the U.S. As such, economic
trends in individual states may not be independent of one another. Also, the
Property and Casualty Group's products are highly regulated by each of these
states. For many of the Property and Casualty Group's products, the insurance
departments of the states in which it conducts business must approve rates and
policy forms. In addition, workers' compensation benefits are determined by
statutes and regulations in each of these states. While the Property and
Casualty Group considers factors such as rate adequacy, regulatory climate, and
economic factors in its underwriting
F-35
<PAGE>
process, unfavorable developments in these factors could have an adverse impact
on the Company's financial condition and results of operations.
The Company actively manages its exposure to catastrophic events. In the
underwriting process, the Company generally avoids the accumulation of insurable
values in catastrophe prone regions. Also, in writing property reinsurance
coverages, PMA Re typically requires per occurrence loss limitations for
contracts that could have catastrophe exposure. Through per risk reinsurance,
the Company also manages its net retention in each exposure. In addition, PMA
Re maintains retrocessional protection of $46,000 excess of $2,000 per
occurrence, and the Property and Casualty Group maintains catastrophe
reinsurance protection of $27,700 excess of $850. As a result, the Company's
loss ratios have not been significantly impacted by catastrophes, and management
believes that the Company has adequate reinsurance to protect against the
estimated probable maximum gross loss from a catastrophic event; however, though
management believes it is unlikely, an especially severe catastrophic event
could exceed the Company's reinsurance and/or retrocessional protection, and
adversely impact the Company's financial position, perhaps materially.
B. USE OF ESTIMATES IN THE PREPARATION OF THE FINANCIAL STATEMENTS -- The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses during
the period. Actual results could differ from those estimates.
Unpaid Losses and Loss Adjustment Expenses -- At December 31, 1997, the Company
carried $2,003,187 of unpaid losses and loss adjustment expenses. Unpaid losses
and loss adjustment expenses 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 the Company. 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 the Company and the Company's payment of that loss. In
general, liabilities for reinsurers become known more slowly than for primary
insurers and are subject to more unforeseen development. As part of the process
in determining these amounts, historical data is reviewed and consideration is
given to the impact of various factors, such as legal developments, changes in
social attitudes, and economic conditions. In addition, estimating reserves for
workers' compensation claims can be more difficult than many other lines of
property and casualty insurance for several reasons, including (i) the long
payment `tail' associated with the business; (ii) the impact of social,
political and regulatory trends on benefit levels for both medical and indemnity
payments; (iii) the impact of economic trends; and (iv) the impact of changes in
the mix of business. At various times, one or a combination of such factors can
make the interpretation of actuarial data associated with workers' compensation
loss development more difficult, and it can take additional time to recognize
changes in loss development patterns. Under such circumstances, adjustments
will be made to such reserves as loss patterns develop and new information
becomes available and such adjustments may be material.
Management believes that its unpaid losses and loss adjustment expenses are
fairly stated at December 31, 1997, in accordance with GAAP. However,
estimating the ultimate claims liability is necessarily a complex and judgmental
process inasmuch as the amounts are based on management's informed estimates and
judgments using data currently available. As additional experience and data
become available regarding claims payment and reporting patterns, legislative
developments, and economic conditions, the estimates are revised accordingly.
If the Company's ultimate net losses prove to be substantially greater than the
amounts recorded at December 31, 1997, the related adjustments could have a
material adverse impact on the Company's financial condition and results of
operations (See also Note 3).
C. YEAR 2000 ISSUE -- The unprecedented advances in computer technology over
the past several decades have resulted in dramatic changes in the way companies
do business. Most of these developments have been tremendously beneficial, but
some have proven costly, as businesses have struggled to adapt to various
features of the new technological landscape. One such well-publicized problem
has arisen out of the worldwide use of the so-called "Year 2000" programming
convention, in which two digit numbers were generally used instead of four digit
numbers to identify the years used in dates. As a consequence, most computers
require relatively costly reprogramming to enable them to correctly perform date
operations involving years 2000 or later, a problem anticipated to have
substantial repercussions on the business world, since computer operations
involving date calculations are pervasive.
F-36
<PAGE>
With the assistance of outside consulting groups, the Company began evaluating
and reprogramming its own computer systems to address the Year 2000 problem in
late 1995. Management anticipates that by no later than year end 1998, it will
have completed substantially all necessary programming work so that Year 2000
issues are not likely to result in any material adverse disruption in the
Company's computer systems or its internal business operations. The cost of
this work through year-end 1997 has been approximately $3,800. The Company
estimates that the total remaining cost will be approximately $1,300, and will
be expensed in 1998.
Many experts now believe that Year 2000 problem may have a material adverse
impact on the national and global economy generally. In addition, it seems
likely that if businesses are materially damaged as a result of Year 2000
problems, at least some such businesses may attempt to recoup their losses by
claiming coverage under various types of insurance policies. And, although
management has concluded that under a fair reading of the various policies of
insurance issued by it no coverage for Year 2000 problems should be considered
to exist, it is not possible to predict whether or to what extent any such
coverage could ultimately be found to exist by courts in the various
jurisdictions. Accordingly, important factors which could cause actual results
to differ materially from those expressed in the forward looking statements
include but are not limited to the inability of the Company to accurately
estimate the impact of the Year 2000 problem on the insurance, or other business
operations, of the Company.
12. TRANSACTIONS WITH RELATED PARTIES
The Company's largest shareholder is PMA Foundation (the "Foundation"), formerly
known as Pennsylvania Manufacturers' Association, which is a not-for-profit
corporation qualified under Section 501(c)(6) of the Internal Revenue Code,
whose purposes include the promotion of the common business interests of its
members and the economic prosperity of the Commonwealth of Pennsylvania. As of
December 31, 1997, the Foundation owned 4,561,225 shares of common stock (30.7%
of the class) and 912,225 shares of Class A common stock (10.0% of the class),
which constitutes 29.5% of the total number of votes available to be cast in
matters brought before the Company's shareholders. All of the members of the
Company's Board of Directors currently serve as members of the Foundation's
Board of Trustees. Also, Frederick W. Anton III, Chairman of the Company,
serves as President and Chief Executive Officer of the Foundation. The Company
and certain of its subsidiaries provide certain administrative services to the
Foundation for which the Company and its subsidiaries receive reimbursement.
Total reimbursements amounted to $34, $82, and $269 for the years ended December
31, 1997, 1996, and 1995, respectively. The Foundation also leases its
Harrisburg, Pennsylvania headquarters facility from a subsidiary of the Company
under a monthly operating lease presently requiring rent payments of $20 per
month and reimburses a subsidiary of the Company for its use of office space in
the Blue Bell, Pennsylvania facility. Rent and related reimbursements paid to
the Company's affiliates by the Foundation amounted to $250, $247, and $294, for
the years ended December 31, 1997, 1996, and 1995, respectively.
In addition, the Company has arranged an executive loan program with a financial
institution whereby such institution will provide prime rate personal loans to
officers of the Company and its subsidiaries collateralized by common stock and
Class A common stock at a maximum 50% loan to value ratio. The Company has
agreed to purchase any loan made under this program from the financial
institution in the event that the borrower defaults on such loan. The amount of
loans outstanding at December 31, 1997 under this program was $4,642.
The Company incurred legal and consulting fees aggregating approximately $6,506,
$7,917, and $6,279 in 1997, 1996 and 1995, respectively, from firms in which
directors of the Company are partners or principals.
The Company has notes receivable from officers which are accounted for as a
reduction of shareholders' equity in the accompanying balance sheets. Such
notes receivable had balances of $198 and $1,162 as of December 31, 1997 and
December 31, 1996, respectively. The interest rate on the notes range between
6.0% and 8.0%.
F-37
<PAGE>
13. COMMITMENTS AND CONTINGENCIES
For the years ended December 31, 1997, 1996 and 1995, total rent expense was
$5,745, $6,114 and $4,536 respectively. At December 31, 1997, the Company was
obligated under noncancelable operating leases for office space with aggregate
minimum annual rentals as follows:
<TABLE>
<CAPTION>
For the years ended December 31,
<S> <C>
1998.................................. $ 3,972
1999.................................. 2,940
2000.................................. 1,811
2001.................................. 1,820
2002.................................. 1,566
Thereafter............................ 2,133
-------
Total................................. $14,242
=======
</TABLE>
In the event a property and casualty insurer, operating in a jurisdiction where
the Company's insurance subsidiaries also operate becomes or is declared
insolvent state insurance regulations provide for the assessment of other
insurers to fund any capital deficiency of the insolvent insurer. Generally,
this assessment is based upon the ratio of an insurer's voluntary premiums
written to the total premiums written for all insurers in that particular
jurisdiction. The Company is not aware of any material potential assessments at
December 31, 1997.
The Company has provided guarantees of approximately $11,048 related to loans on
properties in which the Company has an interest.
The Company is named in various legal proceedings arising in the normal course
of business. In the opinion of management, the resolution of these matters will
not have a material adverse effect on the Company's financial condition, results
of operations, or cash flows.
14. SALE OF UNCOLLECTED PREMIUMS
Insurance subsidiaries of PMC, from time to time, engage in the practice of
selling uncollected premiums to a third-party financial institution. No such
sales were transacted during 1997. The proceeds received from such sales were
$10,628 and $19,509 in 1996 and 1995, respectively. These receivables were
excluded from uncollected premiums in the accompanying balance sheets. However,
the Company had recorded an allowance for doubtful accounts related to the
estimated uncollectible accounts since the Company had retained risk under the
recourse provisions. At December 31, 1997, the Company had no contingent
obligations outstanding related to the sale of uncollected premiums.
15. SHAREHOLDERS' EQUITY
The Company has two classes of common stock, Class A common stock and common
stock. The Company's common stock and Class A common stock generally vote
without regard to class on matters submitted to shareholders, with the common
stock having ten votes per share and the Class A common stock having one vote
per share.
With respect to dividend rights, the Class A common stock is entitled to cash
dividends at least 10% higher than those declared and paid on the common stock.
The Company's bylaws limit the classes of persons who may own the common stock.
Holders of common stock may elect to convert any or all such shares into Class A
common stock on a share-for-share basis.
Under the insurance laws and regulations of Pennsylvania, PMC's insurance
subsidiaries may not pay dividends to PMC without prior regulatory approval,
over a twelve-month period in excess of the greater of (a) 10% of the preceding
year-end's policyholders surplus or (b) the preceding year's SAP net income, but
in no event to exceed unassigned funds. At December 31, 1997, the maximum
amount available to be paid as dividends from the Company's insurance
subsidiaries to PMC, without the prior consent of the Pennsylvania Insurance
Department, was $51,220.
F-38
<PAGE>
PMC's dividends to shareholders are restricted by its debt agreements. On March
14, 1997, the Company refinanced certain debt agreements through the completion
of the New Credit Facility (See Note 6). Under the terms of the New Credit
Facility under the most restrictive debt covenant, the Company could pay
dividends of approximately $14,500 in 1998.
PMA Re intends to maintain Caliber One Indemnity Company's surplus at not less
than $25,000, the minimum capital and surplus required for many states in order
to be an eligible surplus lines carrier (See Note 1).
16. EARNINGS PER SHARE
In accordance with SFAS No. 128 discussed in Note 1-I, the Company is required
to present a reconciliation of the numerators and denominators used in the basic
earnings per share calculation to the numerators and denominators used in the
diluted earnings per share calculation. The computation of diluted earnings per
share is similar to the computation of basic earnings per share except that the
denominator is increased to include the number of additional common shares that
would have been outstanding if all dilutive potential common shares, such as
outstanding stock options with exercise prices below the average market price,
had been issued. For all years presented, there were no differences in the
numerator for the basic and diluted earnings per share calculation. For
entities that report an extraordinary item, as the Company did in 1997, SFAS No.
128 requires that income before extraordinary item be used as the control number
in determining whether or not potential common shares are dilutive. The
Company's income (loss) before extraordinary item, which was equal to net income
in 1996 and 1995, and a reconciliation of the denominator of the basic and
diluted earnings per share computations are presented below.
<TABLE>
<CAPTION>
1997 1996 1995
------------------ ------------------- ------------------
<S> <C> <C> <C>
NUMERATOR:
Control number - income (loss)
before extraordinary item........... $ 19,753 $ (135,334) $ 24,130
DENOMINATOR:
Basic shares - weighted
average common and
Class A common shares outstanding... 23,855,031 23,800,791 23,816,088
Dilutive stock options................ 712,347 -- 965,861
----------- ----------- -----------
Total diluted shares.................. 24,567,378 23,800,791 24,781,949
=========== =========== ===========
</TABLE>
Options to purchase 646,000 shares of Class A common stock at $17.00 per share
were outstanding at December 31, 1997, but were not included in the computation
of diluted earnings per share because the options' exercise price was greater
than the average market price of the Class A common shares. Options to purchase
3,242,160 shares of Class A common stock at prices ranging between $8.00 and
$17.00 were outstanding during at December 31, 1996, but were excluded from the
computation of diluted earnings per share as they would have been anti-dilutive.
F-39
<PAGE>
17. BUSINESS SEGMENTS
Operating revenues, income (loss) before income taxes, and identifiable assets
of the Company's business segments were as follows:
<TABLE>
<CAPTION>
For the year ending December 31,
1997 1996 1995
---------------- ---------------- ---------------
<S> <C> <C> <C>
OPERATING REVENUES (1)
PMA Re
Net premiums earned................................... $163,603 $ 151,974 $139,345
Net investment income................................. 52,270 48,676 45,166
-------- --------- --------
215,873 200,650 184,511
-------- --------- --------
The Property and Casualty Group
Net premiums earned - workers' compensation.... 152,773 176,380 243,175
Net premiums earned - commercial lines......... 59,575 92,221 102,432
-------- --------- --------
Net premiums earned - total.................... 212,348 268,601 345,607
Net investment income................................. 82,098 82,455 92,275
Service revenues...................................... 10,311 9,189 5,106
-------- --------- --------
304,757 360,245 442,988
-------- --------- --------
Corporate, Other and Consolidating Eliminations
Net investment income................................. 2,330 2,805 1,914
-------- --------- --------
2,330 2,805 1,914
-------- --------- --------
Total operating revenues.................................. $522,960 $ 563,700 $629,413
======== ========= ========
(1) Operating revenues exclude net realized investment gains.
<CAPTION>
For the year ending December 31,
1997 1996 1995
---------------- ---------------- ---------------
<S> <C> <C> <C>
INCOME (LOSS) BEFORE INCOME TAXES
PMA Re.................................................... $ 44,802 $ 42,783 $ 39,443
The Property and Casualty Group........................... (9,038) (219,619) (4,305)
Corporate, Other and Consolidating Eliminations........... (3,441) (490) (13,414)
-------- --------- --------
Pre-tax operating income (loss) before interest expense... 32,323 (177,326) 21,724
Net realized investment gains............................. 8,598 2,984 31,923
Interest expense.......................................... (15,768) (17,052) (18,734)
-------- --------- --------
Total income (loss) before income taxes................... $ 25,153 $(191,394) $ 34,913
======== ========= ========
<CAPTION>
December 31,
1997 1996
--------------- --------------
<S> <C> <C>
IDENTIFIABLE ASSETS
PMA Re................................................... $1,126,176 $1,031,149
The Property and Casualty Group.......................... 1,863,975 2,050,648
Corporate, Other and Consolidating Eliminations.......... 67,107 35,719
---------- ----------
Total identifiable assets................................ $3,057,258 $3,117,516
========== ==========
</TABLE>
F-40
<PAGE>
18. SAP INFORMATION
SAP net income (loss) and capital and surplus for PMC's domestic insurance
subsidiaries as reported to the Insurance Departments of Pennsylvania and
Delaware are as follows:
<TABLE>
<CAPTION>
For the years ended December 31,
1997 1996 1995
--------------- ---------------- ---------------
<S> <C> <C> <C>
SAP NET INCOME (LOSS)
PMA Re................................................... $ 25,752 $ 26,338 $ 36,854
The Property and Casualty Group.......................... 10,785 (191,640) 30,925
-------- --------- --------
Total(1)................................................. $ 36,537 $(165,302) $ 67,779
======== ========= ========
(1) Caliber One Indemnity Company had no SAP net income or loss during 1997.
December 31,
1997 1996 1995
-------- --------- --------
SAP CAPITAL AND SURPLUS
PMA Re(1)................................................ $271,154 $ 260,853 $254,088
The Property and Casualty Group.......................... 281,071 279,764 402,968
-------- --------- --------
Total.................................................... $552,225 $ 540,617 $657,056
======== ========= ========
</TABLE>
(1) The SAP capital and surplus of PMA Re includes PMA Re's investment in
Caliber One Indemnity Company, equal to Caliber One Indemnity Company's SAP
capital and surplus of $25,039 at December 31, 1997.
A reconciliation of PMC's domestic insurance subsidiaries' SAP net income (loss)
and capital and surplus to the Company's GAAP net income (loss) and
shareholders' equity is as follows:
<TABLE>
<CAPTION>
For the years ended December 31,
1997 1996 1995
---------------- ---------------- ---------------
<S> <C> <C> <C>
NET INCOME (LOSS)
SAP net income (loss):
Domestic insurance subsidiaries......................... $ 36,537 $(165,302) $ 67,779
GAAP adjustments:
Change in deferred acquisition costs.................... 1,282 6,105 5,665
Benefit (provision) for deferred income taxes........... 4,725 11,488 (15,353)
Allowance for doubtful accounts......................... 307 (5,317) 4,105
Retirement accruals..................................... 275 (76) (3,613)
Other................................................... 549 (938) (306)
-------- --------- --------
GAAP net income (loss) - domestic insurance subsidiaries.. 43,675 (154,040) 58,277
Other entities and eliminations........................... (23,922) 18,706 (34,147)
Extraordinary loss (4,734) -- --
-------- --------- --------
GAAP net income (loss)................................... $ 15,019 $(135,334) $ 24,130
======== ========= ========
</TABLE>
F-41
<PAGE>
<TABLE>
<CAPTION>
December 31,
1997 1996 1995
--------------- --------------- ---------------
<S> <C> <C> <C>
SHAREHOLDERS' EQUITY
SAP capital and surplus:
Domestic insurance subsidiaries............................ $ 552,225 $ 540,617 $ 657,056
GAAP adjustments:
Deferred acquisition costs................................. 45,288 44,006 37,901
Deferred income taxes...................................... 52,571 101,642 67,331
Allowance for doubtful accounts............................ (19,700) (26,214) (20,897)
Retirement accruals........................................ (10,653) (14,571) (14,495)
Reversal of non-admitted assets............................ 21,330 25,599 32,841
Unrealized gain (loss) on fixed maturity investments
available for sale..................................... 19,380 (38,271) 24,186
Other...................................................... 3,254 (338) 958
--------- --------- ---------
GAAP shareholders' equity - domestic insurance subsidiaries. 663,695 632,470 784,881
Other entities and eliminations.............................. (185,348) (206,642) (175,213)
--------- --------- ---------
GAAP shareholders' equity.................................... $ 478,347 $ 425,828 $ 609,668
========= ========= =========
</TABLE>
19. SUBSEQUENT EVENTS
In February of 1998, the Company's Board of Directors authorized a plan to
repurchase, over the next two years, up to a maximum of 1,500,000 shares of
common stock and Class A common stock, in an amount not to exceed $25,000.
Repurchases may be made, from time to time, at the discretion of the Company in
the open market or directly from shareholders at prevailing market prices. The
1.5 million share limit equated to approximately 6.25% of the total common and
Class A common stock outstanding at December 31, 1997.
Effective February 5, 1998, the Company's Class A common stock began trading on
the Nasdaq National List under the ticker symbol, "PMFRA". Previously, the
Company's Class A common stock traded on the OTC Bulletin Board under the same
ticker symbol.
20. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
As noted in Note 19, the Company's Class A common stock began trading on the
Nasdaq National List during 1998. As of December 31, 1997 and 1996, neither
class of common equity was traded on an established exchange. Transactions in
the common stock were conducted privately among persons qualified to own the
common stock. No price information was available for such transactions.
Throughout 1997 and 1996, Class A common stock traded under the symbol, "PMFRA",
on the OTC Bulletin Board through approximately ten broker/dealers who
voluntarily made a market in Class A common stock. The stock price data
presented below for 1997 and 1996 for the Class A common stock are based upon
over-the-counter market bid quotations, which reflect interdealer prices,
without retail mark-up, mark-down or commission, and may not represent actual
transactions. As of February 28, 1998, the Company had 186 and 404 record
holders of common stock and Class A common stock, respectively.
Over the past two years, the Company's operating results have been impacted by
restructuring charges and other special items. During 1997, the Company
incurred restructuring and other charges of approximately $775, $3,500, $2,660
and $5,165 for the first, second, third and fourth quarter, respectively.
During 1996, the Company incurred approximately $31,700 of restructuring and
other charges, excluding loss reserve strengthening, during the fourth quarter.
The Company recorded $10,000 and $181,400 of loss reserve strengthening in the
third and fourth quarters of 1996, respectively (See Note 3).
F-42
<PAGE>
The following tables provide a summary of quarterly financial information:
<TABLE>
<CAPTION>
1997
- -------------------------------------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net premiums written $149,882 $ 98,389 $104,487 $ 65,524
======== ======== ======== ========
Net premiums earned $107,950 $114,451 $ 62,970 $ 90,580
Net investment income 35,847 32,612 34,353 33,886
Net realized investment (losses) gains (1,251) (680) 5,531 4,998
Service revenues 2,548 2,490 2,674 2,599
-------- -------- -------- --------
Total revenues 145,094 148,873 105,528 132,063
-------- -------- -------- --------
Losses and loss adjustment expenses 94,904 98,230 47,785 66,362
Operating expenses 35,281 48,093 38,858 46,408
Dividends to policyholders 3,257 3,360 3,566 4,533
Interest expense 4,334 3,888 3,803 3,743
-------- -------- -------- --------
Total losses and expenses 137,776 153,571 94,012 121,046
-------- -------- -------- --------
Income before income taxes and
extraordinary item 7,318 (4,698) 11,516 11,017
Provision (benefit) for income tax 2,561 (5,218) 4,172 3,885
-------- -------- -------- --------
Income before extraordinary item 4,757 520 7,344 7,132
Extraordinary item, net of tax (4,734) - -- --
-------- -------- -------- --------
Net income $ 23 $ 520 $ 7,344 $ 7,132
======== ======== ======== ========
SUPPLEMENTAL OPERATING INCOME (LOSS)
DATA:
Operating income (loss) before interest
expenses and income taxes(1) $ 12,903 $ (130) $ 9,788 $ 9,762
Operating income after interest
before income taxes(1) $ 8,569 $ (4,018) $ 5,985 $ 6,019
Operating income after income
taxes(1) $ 5,570 $ 962 $ 3,749 $ 3,883
- -------------------------------------------------------------------------------------------
PER SHARE DATA:
Basic:
Income before extraordinary
item $ 0.20 $ 0.02 $ 0.31 $ 0.30
Extraordinary item (0.20) -- -- --
-------- -------- -------- --------
Net income $ -- $ 0.02 $ 0.31 $ 0.30
======== ======== ======== ========
Operating income after income taxes(1) $ 0.23 $ 0.04 $ 0.16 $ 0.16
======== ======== ======== ========
Diluted:
Income before extraordinary item $ 0.19 $ 0.02 $ 0.30 $ 0.29
Extraordinary item ( 0.19) -- -- --
-------- -------- -------- --------
Net income $ -- $ 0.02 $ 0.30 $ 0.29
======== ======== ======== ========
Operating income after income taxes(1) $ 0.23 $ 0.04 $ 0.15 $ 0.16
======== ======== ======== ========
- -------------------------------------------------------------------------------------------
CLASS A COMMON STOCK PRICES:
High $ 16.125 $ 16.000 $ 16.750 $ 18.000
Low $ 15.625 $ 14.000 $ 15.000 $ 16.000
Close $ 16.000 $ 15.000 $ 16.750 $ 16.000
</TABLE>
(1) - Operating income (loss) excludes net realized investment (losses) gains.
F-43
<PAGE>
<TABLE>
<CAPTION>
1996
- -----------------------------------------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net premiums written $147,444 $ 96,336 $116,745 $ 82,950
======== ======== ======== =========
Net premiums earned $117,937 $102,226 $106,034 $ 94,378
Net investment income 33,420 32,511 32,732 35,273
Net realized investment gains (losses) 943 (1,412) 5,972 (2,519)
Service revenues 1,748 2,264 2,642 2,535
-------- -------- -------- ---------
Total revenues 154,048 135,589 147,380 129,667
-------- -------- -------- ---------
Losses and loss adjustment expenses 99,943 85,512 97,013 254,155
Operating expenses 38,310 42,012 40,748 67,078
Dividends to policyholders 3,122 2,730 3,566 6,837
Interest expense 4,472 4,358 4,331 3,891
-------- -------- -------- ---------
Total losses and expenses 145,847 134,612 145,658 331,961
-------- -------- -------- ---------
Income before income taxes and
extraordinary item 8,201 977 1,722 (202,294)
Provision (benefit) for income tax 2,572 (139) (734) (57,759)
-------- -------- -------- ---------
Net income (loss) $ 5,629 $ 1,116 $ 2,456 $(144,535)
======== ======== ======== =========
SUPPLEMENTAL OPERATING INCOME (LOSS)
DATA:
Operating income (loss) before interest
expenses and income taxes(1) $ 11,730 $ 6,747 $ 81 $(195,884)
Operating income (loss) after interest
before income taxes(1) 7,258 2,389 (4,250) (199,775)
Operating income (loss) after income
taxes(1) 5,016 2,034 (1,426) (142,898)
- -----------------------------------------------------------------------------------------------
PER SHARE DATA:
Basic:
Net income (loss) $ 0.23 $ 0.05 $ 0.11 $ (6.07)
======== ======== ======== =========
Operating income (loss) after income
taxes(1) $ 0.21 $ 0.09 $ (0.06) $ (6.01)
======== ======== ======== =========
Diluted:
Net income (loss) $ 0.22 $ 0.05 $ 0.10 $ (6.07)
======== ======== ======== =========
Operating income (loss) after income
taxes(1) $ 0.20 $ 0.08 $ (0.06) $ (6.01)
======== ======== ======== =========
- -----------------------------------------------------------------------------------------------
CLASS A COMMON STOCK PRICES:
High $ 20.500 $ 18.500 $ 17.500 $ 17.500
Low $ 18.250 $ 16.500 $ 17.000 $ 15.625
Close $ 18.875 $ 17.000 $ 17.500 $ 15.750
</TABLE>
(1) - Operating income (loss) excludes net realized investment gains (losses).
F-44
<PAGE>
No person has been authorized to give any information or to make any
representations other than those contained in this prospectus, and, if given or
made, such information or representations must not be relied upon as having been
authorized. This prospectus does not constitute an offer to sell or the
solicitation of an offer to buy any securities other than the securities to
which it relates or an offer to sell or the solicitation of an offer to buy such
securities in any circumstances in which such offer or solicitation is unlawful.
Neither the delivery of this prospectus nor any sale made hereunder shall, under
any circumstances, create any implication that there has been no change in the
affairs of PMC since the date hereof or that the information contained herein is
correct as of any time subsequent to its date.
TABLE OF CONTENTS
-----------------
Page
Available Information........................................
Prospectus Summary...........................................
Risk Factors.................................................
The Company..................................................
The Issuer...................................................
Ratio of Earnings to Fixed Charges...........................
Capitalization...............................................
Use of Proceeds..............................................
Accounting Treatment.........................................
Selected Consolidated Financial and Operating Data...........
Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................
Business.....................................................
Supervision and Regulation...................................
Management...................................................
Description of the Capital Securities........................
Description of the Guarantee.................................
Description of the Junior Subordinated Debentures............
Relationship Among the Capital Securities, the Junior
Subordinated Debentures and the Guarantee..................
United States Federal Income Taxation........................
Certain ERISA Considerations.................................
Validity of Securities.......................................
Underwriting.................................................
Experts......................................................
Incorporation of Certain Documents by Reference..............
Glossary of Certain Insurance and Other Defined Terms........
Index to Consolidated Financial Statements................... F-1
$ 100,000,000
PMC Capital I
___% Capital Securities,
Series A
Fully and unconditionally
guaranteed, as described herein, by
Pennsylvania Manufacturers
Corporation
--------------------
PROSPECTUS
--------------------
Goldman, Sachs & Co.
Merrill Lynch & Co.
First Union Capital Markets
<PAGE>
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
Item 14. Other Expenses of Issuance and Distribution.
- ------- -------------------------------------------
The following table sets forth an itemized statement of all estimated
expenses to be paid by Pennsylvania Manufacturers Corporation (the "Company") in
connection with the issuance and distribution of the Capital Securities being
registered other than underwriting discounts and commissions:
Securities and Exchange Commission registration fee......... $ 29,500
NASD filing fee............................................. 10,500
Trustees' fees and expenses................................. *
Legal fees and expenses..................................... *
Accountants fees and expenses............................... *
Printing and engraving expenses............................. *
Rating agencies' fees....................................... *
Blue sky fees and expenses.................................. *
Miscellaneous............................................... *
____________
Total............. $ 500,000
===========
* TO BE FILED BY AMENDMENT
Except for the Securities and Exchange Commission registration fee, all
fees and expenses are estimated and subject to future contingencies.
Item 15. Indemnification of Directors and Officers.
- ------- -----------------------------------------
As authorized under the Pennsylvania Business Corporation Law of 1986, as
amended, the Company's Bylaws provide that the Company shall indemnify any
director or officer, and may indemnify any other employee or agent, who was or
is a party to, or is threatened to be made a party to or who is called as a
witness in connection with, any threatened, pending or completed action, suit or
proceeding, whether civil, criminal, administrative or investigative, including
an action by or in the right of the Company by reason of the fact that he is or
was a director, officer, employee or agent of the Company, or is or was serving
at the request of the Company as a director, officer, employee or agent of
another corporation, partnership, joint venture, trust or other enterprise,
against expenses, including attorneys' fees, judgments, fines and amounts paid
in settlement actually and reasonably incurred by him in connection with such
action, suit or proceeding, unless the act or failure to act giving rise to the
claim for indemnification is determined by a court to have constituted willful
misconduct or recklessness.
In addition, pursuant to the authority of Pennsylvania law, the Bylaws of
the Company also eliminate the monetary liability of directors to the fullest
extent permitted by Pennsylvania law, unless the breach or failure to perform
his duties constituted self-dealing, willful misconduct or recklessness;
provided, however, that this elimination of monetary liability does not apply to
the responsibility or liability of a director under any criminal statute or the
liability of a director for the payment of taxes pursuant to local, state or
federal law.
II-1
<PAGE>
The Company also maintains officers and directors liability insurance in
the amount of $25 million.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 (the "Act") may be permitted to directors, officers or controlling
persons of the Company pursuant to the foregoing provisions, the Company has
been informed that in the opinion of the Securities and Exchange Commission (the
"Commission") such indemnification is against public policy as expressed in the
Act and is therefore unenforceable.
Item 16. Exhibits.
- ------- --------
Exhibit No. Description of Exhibit
----------- --------------------------------------------------------
* 1.1 Form of Underwriting Agreement among the Issuer, the
Company and Goldman, Sachs & Co., Merrill Lynch, Pierce,
Fenner & Smith Incorporated and First Union Capital
Markets as representatives of the Underwriters
** 3.1 Amended and Restated Articles of Incorporation of the
Company
3.2 Amended and Restated By-laws of the Company (filed
herewith)
3.3 Certificate of Trust of the Issuer (filed herewith)
3.4 Trust Agreement (filed herewith)
* 3.5 Form of Amended and Restated Trust Agreement
* 4.1 Form of Indenture between the Company and Bank of New
York as Indenture Trustee
* 4.2 Form of Capital Security (included in Exhibit 3.5)
* 4.3 Form of Junior Subordinated Debenture (included in
Exhibit 3.5)
* 4.4 Form of Guarantee Agreement between the Company and
Bank of New York
* 5.1 Opinion of Duane, Morris & Heckscher LLP re legality of
securities offered hereby
* 5.2 Opinion of Duane, Morris & Heckscher LLP re certain
matters of Delaware and Pennsylvania Law
* 8.1 Opinion of Duane, Morris & Heckscher LLP re certain tax
matters
** 10.1 Employment Agreement dated April 1, 1995 between the
Company and Frederick W. Anton III
II-2
<PAGE>
** 10.2 Employment Agreement dated May 1, 1995 between the
Company and John W. Smithson
** 10.3 The PMC EDC Plan Trust Agreement dated as of 1994
** 10.4 The PMC Supplemental Executive Retirement Plan (SERP)
dated July 1995
** 10.5 The Company's Amended and Restated 1987 Incentive Stock
Option Plan
** 10.6 The Company's Amended and Restated 1991 Equity Incentive
Plan
** 10.7 The Company's Amended and Restated 1993 Equity Incentive
Plan
** 10.8 The Company's Amended and Restated 1994 Equity Incentive
Plan
** 10.9 The Company's 1995 Equity Incentive Plan
** 10.10 The Company's 1996 Equity Incentive Plan
** 10.11 Federal Tax Allocation Agreement
** 10.12 Office lease between Nine Penn Center Associates, L.P.,
as Landlord, and Lorjo Corp., as Tenant, covering
premises located at Mellon Bank Center, 1735 Market
Street, Philadelphia, Pennsylvania, dated May 26, 1994
** 10.13 Credit Agreement dated as of March 14, 1997 by and among
the Company, The Bank of New York, First Union National
Bank of North Carolina, Fleet National Bank, PNC Bank,
National Association, Mellon Bank, N.A., CoreStates
Bank, N.A. and Dresdener Bank AG, New York Branch and
Grand Cayman Branch
** 10.14 Master Agreement dated as of February 7, 1997 between
the Company and First Union National Bank of North
Carolina
** 10.15 First Amended and Restated Letter of Credit Agreement by
and among the Company, the Bank of New York, Mellon
Bank, N.A., Fleet Bank, National Association, PNC Bank,
National Association and First Union Bank of North
Carolina
*** 10.16 Amendment No. 1 to Tax Allocation Agreement dated
January 7, 1998
II-3
<PAGE>
*** 10.17 Caliber One Indemnity Company Purchase Agreement dated
December 15, 1997
*** 11.1 Statement regarding computation of per share earnings
12.1 Statement regarding computation of earnings to fixed
charges (filed herewith)
*** 21.1 Subsidiaries of the Company
23.1 Consent of PricewaterhouseCoopers LLP (filed herewith)
* 23.2 Consent of Duane, Morris & Heckscher LLP (included in
Exhibits 5.1, 5.2 and 8.1)
24.1 Powers of Attorney (included as part of signature pages
hereto)
* 25.1 Statement of Eligibility of Bank of New York as to the
Guarantee
* 25.2 Statement of Eligibility of Bank of New York as to the
Capital Securities
* 25.3 Statement of Eligibility of Bank of New York as to the
Junior Subordinated Debentures
* 25.4 Statement of Eligibility of Bank of New York (Delaware)
as Delaware Trustee
*** 27 Financial Data Schedule
______________
* to be filed by Amendment.
** incorporated by reference to like-numbered exhibit in the Company's
Form 10 Registration Statement as filed with the Commission on June 26,
1997.
*** incorporated by reference to like-numbered exhibit in the Company's
Annual Report on Form 10-K for the year ended December 31, 1997 and
the Company's Report on Form 10-Q for the quarter ended June 30, 1998.
The following financial statement schedules are included:
<TABLE>
<CAPTION>
<S> <C>
Consolidated Financial Statement Schedules:
Report of Independent Accountants S-1
Schedule I- Summary of Investments Other Than Investments in Related Parties S-2
Schedule II- Condensed Financial Information of Registrant as of December 31,
1997 and 1996 and for the years ended December 31, 1997, 1996, and 1995 S-3
Schedule III- Supplementary Insurance Information for the years ended December
31, 1997, 1996, and 1995 S-6
Schedule IV- Reinsurance for the years ended December 31, 1997, 1996, and 1995 S-7
Schedule V- Valuation and Qualifying Accounts for the years ended December
31, 1997, 1996, and 1995 S-8
Schedule VI- Supplementary Information Concerning Property & Casualty
Insurance Operations for the years ended December 31, 1997, 1996, and 1995 S-9
</TABLE>
Item 17. Undertakings.
- ------- ------------
A. The undersigned registrant hereby undertakes that, for purposes
of determining any liability under the Securities Act of 1933, each filing of
the registrant's annual report pursuant to Section 13(a) or Section 15(d) of the
Securities Exchange Act of 1934 that is incorporated by reference in the
registration statement shall be deemed a new registration statement relating to
the securities offered therein, and the offering of such securities at that time
shall be deemed to be the initial bona fide offering thereof.
II-4
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
Our report on the consolidated financial statements of Pennsylvania
Manufacturers Corporation and subsidiaries has been included in this
Registration Statement on page F-9. In connection with our audit of such
financial statements, we have also audited the financial statement schedules
listed in the index in Item 16 of this Registration Statement.
In our opinion, these financial statement schedules referred to above, when
considered in relation to the basic financial statements taken as whole, present
fairly, in all material respects, the information required to be included
therein.
/s/ Coopers & Lybrand L.L.P.
One South Market Square
Harrisburg, Pennsylvania
February 6, 1998
S-1
<PAGE>
Pennsylvania Manufacturers Corporation
Schedule I
Summary of Investments-Other Than Investments in Related Parties
December 31, 1997
<TABLE>
<CAPTION>
Amount at
which shown in
Type of investment Cost Value the balance sheet
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(Dollar amounts in thousands)
Fixed maturities:
Bonds:
U.S. Treasury Securities and obligations of U.S.
Government agencies $ 1,105,689 $ 1,119,566 $ 1,119,566
Corporate debt securities 675,218 687,671 687,671
Mortgage-backed securities 119,687 122,281 122,281
----------- ----------- -----------
Total fixed maturities 1,900,594 1,929,518 1,929,518
----------- ----------- -----------
Equity securities:
Common Stocks:
Industrial, miscellaneous and all other 5 13 13
----------- ----------- -----------
Total equity securities 5 13 13
----------- ----------- -----------
Short-term investments 265,207 265,207 265,207
----------- ----------- -----------
Total investments $ 2,165,806 $ 2,194,738 $ 2,194,738
=========== =========== ===========
</TABLE>
S-2
<PAGE>
Pennsylvania Manufacturers Corporation
Schedule II
Balance Sheets
(Parent Company Only)
<TABLE>
<CAPTION>
as of December 31 (in thousands, except share data) 1997 1996
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash $ 253 $ -
Investments in subsidiaries 632,680 584,608
Deferred tax asset, net 29,163 36,602
Related party receivables 7,074 727
Other assets 22,545 21,096
----------------------
Total assets $ 691,715 $ 643,033
======================
LIABILITIES
Long term debt $ 203,000 $ 204,571
Related party payables - 1,605
Dividends payable to shareholders 2,008 1,983
Other liabilities 8,360 9,046
----------------------
Total liabilities 213,368 217,205
----------------------
SHAREHOLDERS' EQUITY
Common stock, $5 par value (40,000,000 shares authorized;
15,286,263 shares issued and 14,850,789 outstanding - 1997
16,095,416 shares issued and 15,670,052 outstanding - 1996) 76,431 80,477
Class A common stock, $5 par value (40,000,000 shares authorized;
9,156,682 shares issued and 9,117,735 outstanding - 1997
8,247,804 shares issued and 8,173,023 outstanding - 1996) 45,783 41,239
Additional paid-in capital - Class A common stock 339 -
Retained earnings 343,368 336,921
Unrealized gain (loss) on investments of subsidiaries (net of
deferred income taxes: 1997 - $(10,126); 1996 - $13,394) 18,806 (24,874)
Notes receivable from officers (198) (1,162)
Treasury stock, at cost:
Common stock (1997 - 435,474 shares; 1996 - 425,364 shares (5,572) (5,408)
Class A common stock (1997 - 38,947 shares; 1996 - 74,781
shares) (610) (1,365)
----------------------
Total shareholders' equity 478,347 425,828
----------------------
Total liabilities and shareholders' equity $ 691,715 $ 643,033
======================
</TABLE>
These financial statements should be read in conjunction with the Consolidated
Financial Statements and the notes thereto.
S-3
<PAGE>
Pennsylvania Manufacturers Corporation
Schedule II
Statements of Operations
(Parent Company Only)
<TABLE>
<CAPTION>
for the years ended December 31, (in thousands) 1997 1996 1995
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Net investment income $ 263 $ 354 $ 217
Net realized investment gains - 35 4
Management fees 8,977 5,974 350
Other related party income - 263 1,642
-----------------------------------
Total revenues 9,240 6,626 2,213
-----------------------------------
Expenses:
General expenses 9,375 7,082 6,982
Interest expense 15,764 17,039 18,712
-----------------------------------
Total expenses 25,139 24,121 25,694
-----------------------------------
Loss before income taxes and equity in earnings (losses) of subsidiaries (15,899) (17,495) (23,481)
Benefit for income taxes (14,271) (60,345) (13,210)
-----------------------------------
(Loss) income before equity in earnings (losses) of subsidiaries and
extraordinary item (1,628) 42,850 (10,271)
Equity in earnings (losses) of subsidiaries 21,381 (178,184) 34,401
-----------------------------------
Income (loss) before extraordinary item 19,753 (135,334) 24,130
Extraordinary loss from early extinguishment of debt
(net of income tax benefit of $2,549) (4,734) - -
-----------------------------------
Net income (loss) $ 15,019 $ (135,334) $ 24,130
===================================
</TABLE>
These financial statements should be read in conjunction with the
Consolidated Financial Statements and the notes thereto.
S-4
<PAGE>
Pennsylvania Manufacturers Corporation
Schedule II
Statements of Cash Flows
(Parent Company Only)
<TABLE>
<CAPTION>
for the years ended December 31, (in thousands) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows From Operating Activities:
Net income (loss) $ 15,019 $(135,334) $ 24,130
Adjustments to reconcile net income to net cash flows provided
by operating activities:
Equity in (earnings) losses of subsidiaries (21,381) 178,184 (34,401)
Net realized investment gains - (35) (4)
Provision (benefit) for deferred income taxes 9,614 (19,822) 7,000
Extraordinary loss from early extingusihment of debt (4,734) - -
Dividends received from subsidiaries 22,500 53,634 103,213
Other, net 5,331 (33,283) (20,384)
-----------------------------------
Net cash flows provided by operating activities 26,349 43,344 79,554
-----------------------------------
Cash Flows From Investing Activities:
Cash contributions to subsidiaries (11,000) (50,000) (61,000)
Sales of fixed maturity investments, net - 45 2,122
Sales (purchases) of equity investments, net - 70 (16)
-----------------------------------
Net cash flows used by investing activities (11,000) (49,885) (58,894)
-----------------------------------
Cash Flows From Financing Activities:
Change in related party receivables and payables (7,952) 10,863 (12,939)
Proceeds from issuance of long-term debt 210,000 26,000 125,000
Repayments of long-term debt (211,571) (25,000) (125,000)
Dividends paid to shareholders (7,965) (7,926) (7,885)
Proceeds from exercised stock options and issuance of Class A
common stock 837 - -
Treasury stock transactions, net 591 (929) 480
Repayments of notes receivable from officers 964 2,734 478
-----------------------------------
Net cash flows (used) provided by financing activities (15,096) 5,742 (19,866)
-----------------------------------
Net increase (decrease) in cash 253 (799) 794
Cash January 1 - 799 5
-----------------------------------
Cash December 31 $ 253 $ - $ 799
===================================
</TABLE>
These financial statements should be read in conjunction with the Consolidated
Financial Statements and the notes thereto.
S-5
<PAGE>
Pennsylvania Manufacturers Corporation
Schedule III
Supplementary Insurance Information
<TABLE>
<CAPTION>
Future policy
benefits, losses, Net
Deferred policy claims, and loss Unearned Premium investment
(in thousands) acquisition costs expenses premiums revenue income(1)
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1997:
The Property and Casualty Group $20,010 $1,353,917 $115,998 $212,348 $ 82,098
PMA Re 25,278 622,484 95,457 163,603 52,270
Corporate and Other - 26,786 - - 2,330
- -----------------------------------------------------------------------------------------------------------------------------------
Total $45,288 $2,003,187 $211,455 $375,951 $136,698
===================================================================================================================================
Year ended December 31, 1996:
The Property and Casualty Group $23,488 $1,501,897 $127,986 $268,601 $ 82,455
PMA Re 20,518 589,175 77,996 151,974 48,676
Corporate and Other - - - - 2,805
- -----------------------------------------------------------------------------------------------------------------------------------
Total $44,006 $2,091,072 $205,982 $420,575 $133,936
===================================================================================================================================
Year ended December 31, 1995:
The Property and Casualty Group $20,747 $1,518,163 $124,988 $345,607 $ 92,275
PMA Re 17,154 551,823 67,734 139,345 45,166
Corporate and Other - - - - 1,914
- -----------------------------------------------------------------------------------------------------------------------------------
Total $37,901 $2,069,986 $192,722 $484,952 $139,355
===================================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
Benefits, claims, Amortization of Other
losses and settlement deferred policy operating Net premiums
(in thousands) expenses acquisition costs expenses(2) written
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Year ended December 31, 1997:
The Property and Casualty Group $ 193,530 $48,343 $57,206 $240,348
PMA Re 113,931 45,158 11,982 177,934
Corporate and Other (180) - 5,951 -
- ----------------------------------------------------------------------------------------------------------------------------------
Total $ 307,281 $93,501 $75,139 $418,282
==================================================================================================================================
Year ended December 31, 1996:
The Property and Casualty Group $ 424,900 $52,706 $86,003 $279,422
PMA Re 111,937 37,586 8,344 164,053
Corporate and Other (214) - 3,509 -
- -----------------------------------------------------------------------------------------------------------------------------------
Total $ 536,623 $90,292 $97,856 $443,475
===================================================================================================================================
Year ended December 31, 1995:
The Property and Casualty Group $ 319,644 $53,420 $57,486 $337,116
PMA Re 103,947 33,787 7,334 152,760
Corporate and Other (1,013) - 16,341 -
- ----------------------------------------------------------------------------------------------------------------------------------
Total $ 422,578 $87,207 $81,161 $489,876
==================================================================================================================================
</TABLE>
(1) Net investment income is based on each segment's invested assets.
(2) Other operating expenses are allocated primarily on the specific
identification basis. When indirect expenses cannot be directly related to
a segment, these expenses are allocated depending on the nature of the
expense.
S-6
<PAGE>
Pennsylvania Manufacturers Corporation
Schedule IV
Reinsurance
<TABLE>
<CAPTION>
Ceded to Percentage of
Direct other Assumed from amount assumed to
(dollar amounts in thousands) Amount companies other companies Net amount net
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1997:
Premiums:
Property and liability insurance $ 277,871 $ 118,277 $ 216,357 $ 375,951 58%
========= ========= ========= ========= =========
Year Ended December 31, 1996:
Premiums:
Property and liability insurance $ 299,386 $ 88,499 $ 209,688 $ 420,575 50%
========= ========= ========= ========= =========
Year Ended December 31, 1995:
Premiums:
Property and liability insurance $ 370,590 $ 35,476 $ 149,838 $ 484,952 31%
========= ========= ========= ========= =========
</TABLE>
S-7
<PAGE>
<TABLE>
<CAPTION>
Pennsylvania Manufacturers Corporation
Schedule V
Valuation and Qualifying Accounts
Description Balance at beginning of Charged to cost and Deductions - write-offs
period expenses uncollectible accounts
<S> <C> <C> <C>
Year ended December 31, 1997:
Allowance for uncollectible accounts:
Uncollected premiums $18,877 - 471
Year ended December 31, 1996:
Allowance for uncollectible accounts:
Uncollected premiums $16,330 19,532 16,985
Year ended December 31, 1995:
Allowance for uncollectible accounts:
Uncollected premiums $22,402 - 6,072
</TABLE>
<TABLE>
<CAPTION>
Description Balance at end of period
<S> <C>
Year ended December 31, 1997:
Allowance for uncollectible accounts:
Uncollected premiums $18,406
Year ended December 31, 1996:
Allowance for uncollectible accounts:
Uncollected premiums $18,877
Year ended December 31, 1995:
Allowance for uncollectible accounts:
Uncollected premiums $16,330
</TABLE>
S-8
<PAGE>
Pennsylvania Manufacturers Corporation
Schedule VI
Supplemental Information Concerning Property and Casualty Insurance Operations
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
Discount on
Reserves for
Reserves for Unpaid Unpaid Claims and
Deferred policy Claims and Claim Claim Adjustment
Affiliation with Registrant acquisition costs Adjustment Expenses Expenses(1) Unearned Premiums Earned Premiums
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Consolidated property-casualty
subsidiaries:
Year Ended December 31, 1997 $45,288 $2,003,187 $ 460,230 $ 211,455 $375,951
Year Ended December 31, 1996 $44,006 $2,091,072 $ 514,248 $ 205,982 $420,575
Year Ended December 31, 1995 $37,901 $2,069,986 $ 587,025 $ 192,722 $484,952
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
Claims and claim adjustment
expenses incurred related to
---------------------------- Amortization of
Net Investment Prior deferred policy Paid claims and Net Premiums
Affiliation with Registrant Income Current Year Years(2) acquisition costs adjustment expenses Written
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Consolidated property-casualty
subsidiaries:
Year Ended December 31, 1997 $134,368 $ 341,880 $(86,006) $93,501 $470,874 $ 418,282
Year Ended December 31, 1996 $131,133 $ 323,069 $156,074 $90,292 $510,621 $ 443,475
Year Ended December 31, 1995 $137,441 $ 357,787 $ 51,491 $87,207 $469,942 $ 489,876
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) - Workers' compensation reserves discounted at approximately 5%.
(2) - Excludes accretion of loss reserve discount of $51,407, $57,480 and
$13,300 in 1997, 1996 and 1995, respectively.
S-9
<PAGE>
B. Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to directors, officers and controlling
persons of the registrant pursuant to the foregoing provisions, or otherwise,
the registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and will
be governed by the final adjudication of such issue.
C. The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the
Securities Act of 1933, the information omitted from the form of prospectus
filed as part of this registration statement in reliance upon Rule 430A and
contained in a form of prospectus filed by the registrant pursuant to Rule
424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part
of this registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the
Securities Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that time
shall be deemed to be the initial bona fide offering thereof.
II-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, Pennsylvania
Manufacturers Corporation certifies that it has reasonable grounds to believe
that it meets all of the requirements for filing on Form S-3 and that it has
duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the city of Philadelphia,
Pennsylvania on September 15, 1998.
PENNSYLVANIA MANUFACTURERS
CORPORATION
By:/s/ John W. Smithson
--------------------------------------
John W. Smithson, President and
Chief Executive Officer
Know all men by these presents, that each person whose signature appears
below constitutes and appoints Francis W. McDonnell and Edward S. Hochberg, and
each or any of them, as true and lawful attorneys-in-fact and agents, with full
power of substitution and resubstitution, for him or her, and in his or her
name, place and stead, in any and all capacities, to sign any or all amendments
(including post-effective amendments) to this Registration Statement, as well as
any related registration statement or amendment thereto filed pursuant to Rule
462 promulgated under the Securities Act of 1933, and to file the same, with all
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises, as fully to all
intents and purposes as he or she might or could do in person, hereby ratifying
and confirming all that said attorneys-in-fact and agents, or any of them or
their substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities and on the dates indicated.
Signature Title Date
- -------------------------- ---------------------------- ------------------
/s/ Frederick W. Anton, III Chairman of the Board and September 15, 1998
- --------------------------- a Director
Frederick W. Anton, III
/s/ John W. Smithson President, Chief Executive September 15, 1998
- --------------------------- Officer and a Director
John W. Smithson (principal executive officer)
/s/ Francis W. McDonnell Senior Vice President, Chief September 15, 1998
- --------------------------- Financial Officer and
Francis W. McDonnell Treasurer (principal financial
and accounting officer)
II-6
<PAGE>
/s/ Paul I. Detwiler, Jr. Director September 15, 1998
- --------------------------
Paul I. Detwiler, Jr.
/s/ Joseph H. Foster Director September 15, 1998
- --------------------------
Joseph H. Foster
Director September __, 1998
- --------------------------
Anne S. Genter
/s/ James F. Malone, III Director September 15, 1998
- --------------------------
James F. Malone, III
/s/ A. John May Director September 15, 1998
- --------------------------
A. John May
/s/ Louis N. McCarter, III Director September 15, 1998
- --------------------------
Louis N. McCarter, III
/s/ John W. Miller, Jr. Director September 15, 1998
- --------------------------
John W. Miller, Jr.
/s/ Edward H. Owlett Director September 15, 1998
- --------------------------
Edward H. Owlett
/s/ Louis I. Pollock Director September 15, 1998
- --------------------------
Louis I. Pollock
/s/ Roderic H. Ross Director September 15, 1998
- --------------------------
Roderic H. Ross
Director September __, 1998
- --------------------------
L.J. Rowell, Jr.
II-7
<PAGE>
Pursuant to the requirements of the Securities Act of 1933, PMC Capital I
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and that it has duly caused this
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the city of Philadelphia, Pennsylvania on September 15,
1998.
PMC CAPITAL I
By Pennsylvania Manufacturers Corporation,
as Depositor
By: /s/ Francis W. McDonnell
---------------------------------------
Francis W. McDonnell,
Senior Vice President,
Chief Financial Officer and Treasurer
II-8
<PAGE>
EXHIBIT INDEX
-------------
Exhibit No. Description of Exhibit
----------- --------------------------------------------------------
* 1.1 Form of Underwriting Agreement among the Issuer, the
Company and Goldman, Sachs & Co., Merrill Lynch, Pierce,
Fenner & Smith Incorporated and First Union Capital
Markets as representatives of the Underwriters
** 3.1 Amended and Restated Articles of Incorporation of the
Company
3.2 Amended and Restated By-laws of the Company
3.3 Certificate of Trust of the Issuer (filed herewith)
3.4 Trust Agreement (filed herewith)
* 3.5 Form of Amended and Restated Trust Agreement
* 4.1 Form of Indenture between the Company and Bank of New
York as Indenture Trustee
* 4.2 Form of Capital Security (included in Exhibit 3.5)
* 4.3 Form of Junior Subordinated Debenture (included in
Exhibit 3.5)
* 4.4 Form of Guarantee Agreement between the Company and
Bank of New York
* 5.1 Opinion of Duane, Morris & Heckscher LLP re legality of
securities offered hereby
* 5.2 Opinion of Duane, Morris & Heckscher LLP re certain
matters of Delaware and Pennsylvania Law
* 8.1 Opinion of Duane, Morris & Heckscher LLP re certain tax
matters
** 10.1 Employment Agreement dated April 1, 1995 between the
Company and Frederick W. Anton III
** 10.2 Employment Agreement dated May 1, 1995 between the
Company and John W. Smithson
** 10.3 The PMC EDC Plan Trust Agreement dated as of 1994
** 10.4 The PMC Supplemental Executive Retirement Plan (SERP)
dated July 1995
** 10.5 The Company's Amended and Restated 1987 Incentive Stock
Option Plan
** 10.6 The Company's Amended and Restated 1991 Equity Incentive
Plan
** 10.7 The Company's Amended and Restated 1993 Equity Incentive
Plan
** 10.8 The Company's Amended and Restated 1994 Equity Incentive
Plan
** 10.9 The Company's 1995 Equity Incentive Plan
** 10.10 The Company's 1996 Equity Incentive Plan
** 10.11 Federal Tax Allocation Agreement
** 10.12 Office lease between Nine Penn Center Associates, L.P.,
as Landlord, and Lorjo Corp., as Tenant, covering
premises located at Mellon Bank Center, 1735 Market
Street, Philadelphia, Pennsylvania, dated May 26, 1994
** 10.13 Credit Agreement dated as of March 14, 1997 by and among
the Company, The Bank of New York, First Union National
Bank of North Carolina, Fleet National Bank, PNC Bank,
National Association, Mellon Bank, N.A., CoreStates
Bank, N.A. and Dresdener Bank AG, New York Branch and
Grand Cayman Branch
** 10.14 Master Agreement dated as of February 7, 1997 between
the Company and First Union National Bank of North
Carolina
** 10.15 First Amended and Restated Letter of Credit Agreement by
and among the Company, the Bank of New York, Mellon
Bank, N.A., Fleet Bank, National Association, PNC Bank,
National Association and First Union Bank of North
Carolina
*** 10.16 Amendment No. 1 to Tax Allocation Agreement dated
January 7, 1998
*** 10.17 Caliber One Indemnity Company Purchase Agreement dated
December 15, 1997
*** 11.1 Statement regarding computation of per share earnings
12.1 Statement regarding computation of earnings to fixed
charges (filed herewith)
*** 21.1 Subsidiaries of the Company
23.1 Consent of PricewaterhouseCoopers LLP (filed herewith)
* 23.2 Consent of Duane, Morris & Heckscher LLP (included in
Exhibits 5.1, 5.2 and 8.1)
24.1 Powers of Attorney (included as part of signature pages
hereto)
* 25.1 Statement of Eligibility of Bank of New York as to the
Guarantee
* 25.2 Statement of Eligibility of Bank of New York as to the
Capital Securities
* 25.3 Statement of Eligibility of Bank of New York as to the
Junior Subordinated Debentures
* 25.4 Statement of Eligibility of Bank of New York (Delaware)
as Delaware Trustee
*** 27 Financial Data Schedule
______________
* to be filed by Amendment.
** incorporated by reference to like-numbered exhibit in the Company's
Form 10 Registration Statement as filed with the Commission on June 26,
1997.
*** incorporated by reference to like-numbered exhibit in the Company's
Annual Report on Form 10-K for the year ended December 31, 1997 and
the Company's Report on Form 10-Q for the quarter ended June 30, 1998.
<PAGE>
Exhibit 3.2
AMENDED AND RESTATED BYLAWS OF
PENNSYLVANIA MANUFACTURERS CORPORATION
ARTICLE 1
Corporate Office
----------------
Section 1.1 The Corporation shall have and continuously maintain in the
Commonwealth of Pennsylvania a registered office at an address to be designated
from time to time by the Board of Directors which may, but need not, be the same
as its place of business.
Section 1.2 The Corporation may also have offices at such other places
as the Board of Directors may from time to time designate or the business of the
Corporation may require.
ARTICLE 2
Shareholders; Share Certificates
--------------------------------
Section 2.1 No person, firm, association, corporation or other entity is
qualified to own any shares of Common Stock, $5.00 par value, ("Common Stock")
of the Corporation except:
(1) PMA Foundation.
(2) A member of PMA Foundation.
(3) A former member of PMA Foundation who resigned in good standing, but
only in respect to Common Stock of the Corporation owned by such
former member of PMA Foundation on the date of resignation.
(4) The Corporation or Pennsylvania Manufacturers' Association Insurance
Company.
(5) An officer, proprietor or partner of a member of PMA Foundation or a
retired officer, proprietor or partner of a member or former member of
PMA Foundation but only in respect to Common Stock of the Corporation
owned by such retired officer, proprietor or partner on the date of
retirement.
(6) A director or officer of the Corporation, Pennsylvania Manufacturers'
Association Insurance Company or PMA Foundation.
(7) A retired director or officer of the Corporation, Pennsylvania
Manufacturers' Association Insurance Company or PMA Foundation but
only in respect to Common Stock of the Corporation owned by such
retired director or officer on the date of retirement.
(8) The surviving spouse of a deceased person who, at the time of his or
her death, was qualified to own Common Stock of the Corporation, but
not a surviving spouse of a person who became qualified to own Common
Stock of the Corporation solely by reason of the provisions of this
Subsection (8).
<PAGE>
(9) A person, firm, association, corporation or other entity who was a
shareholder of record of Pennsylvania Manufacturers' Association
Insurance Company on April 1, 1982.
(10) Any child or grandchild of a shareholder of Pennsylvania
Manufacturers' Association Insurance Company of record on April 1,
1982.
(11) A trustee under a written trust solely for the benefit of a
person qualified under these Bylaws to own Common Stock of the
Corporation or a spouse, child or grandchild of such qualified
person.
(12) Employees of the Corporation or any of its affiliates who are not
officers of any of these entities, but whose duties require the
exercise of executive and administrative responsibilities, shall be
deemed qualified to own Common Stock of the Corporation. By resolution
of the Board of Directors dated May 19, 1983 as amended by resolution
of the Board of Directors dated February 27, 1996.
(13) A spouse of a person who owned Common Stock of record on December 8,
1990 is qualified to own shares of the Corporation's Common Stock. By
resolution of the Board of Directors dated December 8, 1990.
(14) Such other classes of persons as are from time to time approved by the
Board of Directors of the Corporation.
Nothing set forth in this Section 2.1 shall prohibit any person from owning
any shares of Class A Common Stock, $5.00 par value, ("Class A Common Stock") of
the Corporation.
Section 2.2 All shares issued by the Corporation shall be represented by
certificates. The share certificates of the Corporation shall be numbered and
registered in a share register as they are issued; shall state that the
Corporation is incorporated under the laws of the Commonwealth of Pennsylvania;
shall bear the name of the registered holder, the number and class of shares and
the designation of the series, if any, represented thereby, the par value, if
any, of each share or a statement that the shares are without par value, as the
case may be; shall be signed by the President or a Vice President, and the
Secretary or the Treasurer or any other person properly authorized by the Board
of Directors, and shall bear the corporate seal, which seal may be facsimile
engraved or printed. Where the certificate is signed by a transfer agent or a
registrar, the signature of any corporate officer on such certificate may be a
facsimile engraved or printed. In case any officer who has signed, or whose
facsimile signature has been placed upon, any share certificate shall have
ceased to be such officer because of death, resignation or otherwise before the
certificate is issued, such share certificate may be issued by the Corporation
with the same effect as if the officer had not ceased to be such at the date of
its issue.
Section 2.3 Duplicate certificates may be issued for those lost or
destroyed, under such terms as may be prescribed by the Board of Directors.
Section 2.4 No person, firm, association, corporation or other entity,
except PMA Foundation shall at any time hold more than seven percent of the
outstanding Common Stock of the Corporation. Nothing set forth in this Section
2.4 shall limit in any respect any person's ownership of shares of Class A
Common Stock of the Corporation.
- 2 -
<PAGE>
Section 2.5 Upon surrender to the Corporation of a share certificate
duly endorsed by the person named in the certificate or by attorney duly
appointed in writing and accompanied where necessary by the proper evidence of
succession, assignment or authority to transfer, a new certificate shall be
issued to the person entitled thereto and the old certificate canceled and the
transfer recorded on the share register of the Corporation. A transferee of
shares of the Corporation shall not be a record holder of such shares entitled
to the rights and benefits associated therewith unless and until the share
transfer has been recorded on the share transfer books of the Corporation. No
transfer shall be made if it would be inconsistent with the provisions of (i)
Article 8 of the Pennsylvania Uniform Commercial Code or (ii) Article 2 of these
Bylaws.
Section 2.6 The Common Stock of the Corporation shall be owned by and
shall be transferable only to a person, firm, association, corporation or other
entity qualified to own Common Stock under these Bylaws.
If any shareholders of the Corporation shall cease to be qualified to own
Common Stock under these Bylaws or if the executor or administrator of any
shareholder, or the grantee or assignee of any Common Stock sold on execution,
or for debt, or as the result of bankruptcy or insolvency proceedings, or if any
other person, firm, association, corporation or other entity who is not
qualified to own Common Stock under these Bylaws shall become the holder of
Common Stock, then in any such case, unless a transfer of such Common Stock
shall be made within six months to a person qualified, such holder shall be
required to offer to sell such Common Stock to PMA Foundation at a price to be
agreed upon by the holder and PMA Foundation. If the holder and PMA Foundation
are unable to agree upon a price, a committee of arbitrators shall be appointed
to appraise the fair market value of the Common Stock. The number of
arbitrators shall be three, and shall be appointed as follows: one member of the
committee shall be appointed by the Executive Committee of PMA Foundation, and
one member by the holder of the Common Stock. The two members so appointed
shall appoint a third member of the committee. The committee shall then, by a
majority agreement appraise the fair market value of the Common Stock.
Thereafter, PMA Foundation shall have the option to purchase such Common Stock
at the fair market value as appraised by the majority of the three appointees.
If within 30 days after the appraisal of the fair market value of the Common
Stock and the presentment thereof to PMA Foundation, PMA Foundation does not
exercise its option to purchase, then the Corporation shall have the option to
purchase such Common Stock at the appraised fair market value, and if within 30
days after the presentment of such Common Stock to the Corporation for purchase,
the Corporation does not exercise its option to purchase, then the holder of
such Common Stock shall be deemed the qualified owner thereof until such time as
the holder transfers such Common Stock to a person, firm, association,
corporation or other entity who is qualified to own Common Stock under these
Bylaws.
It shall be the duty of any unqualified holder of Common Stock to comply
with the provisions of this Section 2.6, and no dividends shall be paid on
account of such Common
- 3 -
<PAGE>
Stock held by any unqualified holder after a holding period of six months in the
absence of compliance with the provisions of this Section 2.6.
No transfer of any interest in Common Stock of the Corporation shall be
effective for any purpose unless such transfer is made in accordance with the
provisions of this Section 2.6. Nothing set forth in this Section 2.6 shall
limit the transfer of any shares of Class A Common Stock of the Corporation.
Section 2.7 Upon issuance of each certificate of Common Stock a receipt
shall be taken as follows:
"Received Certificate No. , subject to the conditions and
restrictions therein referred to and to the Bylaws of this Corporation
to which the undersigned agrees to conform. This agreement shall be
binding upon the heirs, executors, administrators and assigns of the
undersigned."
Section 2.8. All certificates of Common Stock, in addition to the usual
and necessary matters, shall contain the following printed thereon:
"The ownership and transfer of Common Stock in this Corporation is
limited by the Bylaws printed on the back of this certificate."
Upon the back of each certificate of Common Stock shall be printed Sections
2.1, 2.4 and 2.6 of Article 2 of these Bylaws.
ARTICLE 3
Shareholders Meetings
---------------------
Section 3.1 All meetings of the shareholders shall be held at such time
and place, within or without the Commonwealth of Pennsylvania, as may be
determined from time to time by the Board of Directors and need not be held at
the registered office of the Corporation.
Section 3.2 An annual meeting of the shareholders for the election of
directors and the transaction of such other business as may properly be brought
before the meeting shall be held in each calendar year at such time and place as
may be determined by the Board of Directors.
- 4 -
<PAGE>
Section 3.3 Special meetings of the shareholders may be called at any
time by (i) the Chairman or President (ii) the Board of Directors or (iii)
shareholders entitled to cast at least one-fifth of the votes that all
shareholders are entitled to cast at the particular meeting. The request of any
person who has called a special meeting of shareholders shall be addressed to
the Secretary of the Corporation, shall be signed by the persons making the
request and shall state the purpose or purposes of the meeting. Upon receipt of
any such request it shall be the duty of the Secretary to fix the time and
provide written notice of the special meeting of shareholders, which shall be
held not more than 60 days after the receipt of the request. If the Secretary
shall neglect or refuse to fix the time or provide written notice of the special
meeting, the person or persons making the request may fix the time and provide
written notice of the special meeting.
Section 3.4 Written notice of each meeting other than an adjourned
meeting of shareholders, stating the place and time, and, in the case of a
special meeting of shareholders, the general nature of the business to be
transacted, shall be provided to each shareholder of record entitled to vote at
the meeting at such address as appears on the books of the Corporation. Except
as otherwise required by Article 22 hereof, such notice shall be given, in
accordance with the provisions of Article 21 of these Bylaws, at least (i) ten
days prior to the day named for a meeting to consider a fundamental change under
Chapter 19 of the Pennsylvania Business Corporation Law of 1988 (the "BCL") or
(ii) five days prior to the day named for the meeting in any other case.
Section 3.5 Whenever the Corporation has been unable to communicate with
a shareholder for more than 24 consecutive months because communications to the
shareholder are returned unclaimed or the shareholder has otherwise failed to
provide the Corporation with a current address, the giving of notice to such
shareholder pursuant to Section 3.4 of these Bylaws shall not be required. Any
action or meeting that is taken or held without notice or communication to that
shareholder shall have the same validity as if the notice or communication had
been duly given. Whenever a shareholder provides the Corporation with a current
address this Section 3.5 shall cease to be applicable to such shareholder. The
Corporation shall not be required to give notice to any shareholder pursuant to
Section 3.4 hereof if and for as long as communication with such shareholder is
unlawful.
Section 3.6 The Board of Directors may provide by resolution with
respect to a specific meeting or with respect to a class of meetings that one or
more shareholders may participate in such meeting or meetings of shareholders by
means of conference telephone or other communications equipment by means of
which all persons participating in the meeting can hear one another.
Participation in the meeting by such means shall constitute presence in person
at the meeting. Any notice otherwise required to be given in
- 5 -
<PAGE>
connection with any meeting at which participation by conference telephone or
other communications equipment is permitted shall so specify.
ARTICLE 4
Quorum of Shareholders
----------------------
Section 4.1 A meeting of shareholders duly called shall not be organized
for the transaction of business unless a quorum is present.
Section 4.2 The holders of a majority of the outstanding voting power of
the shares of stock of the Corporation, appearing either in person or by proxy,
shall constitute a quorum for the transaction of business at any annual or
special meeting of the shareholders.
Section 4.3 The shareholders present at a duly organized meeting can
continue to do business until adjournment notwithstanding the withdrawal of
enough shareholders to leave less than a quorum.
Section 4.4 If a meeting of shareholders cannot be organized because a
quorum is not present those present in person or by proxy, may, except as
otherwise provided by statute, adjourn the meeting to such time and place as
they may determine, without notice other than an announcement at the meeting,
until the requisite number of shareholders for a quorum shall be present in
person or by proxy.
Section 4.5 Notwithstanding the provisions of Sections 4.1, 4.2, 4.3 and
4.4 of these Bylaws:
(1) Any meeting at which directors are to be elected may be adjourned
only from day to day, or for such longer periods not exceeding 15 days each
as the shareholders present and entitled to vote shall direct.
(2) Those shareholders entitled to vote who attend a meeting called
for election of directors that has been previously adjourned for lack of a
quorum, although less than a quorum as fixed in these Bylaws, shall
nevertheless constitute a quorum for the purpose of electing directors.
(3) Those shareholders entitled to vote who attend a meeting that has
been previously adjourned for one or more periods aggregating at least 15
days because of an absence of a quorum, although less than a quorum is
fixed in these Bylaws,
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shall nevertheless constitute a quorum for the purpose of acting upon any
matter set forth in the notice of the meeting if the notice states that
those shareholders who attend the adjourned meeting shall nevertheless
constitute a quorum for the purpose of acting upon the matter.
Section 4.6 Except as otherwise provided by statute, the Articles of
Incorporation or these Bylaws, at any duly organized meeting of shareholders the
vote of the holders of a majority of the votes cast shall decide any question
brought before such meeting.
ARTICLE 5
Proxies
-------
Section 5.1 Every shareholder entitled to vote at a meeting of
shareholders, or to express consent or dissent to corporate action in writing
without a meeting, may authorize another person or persons to act for him by
proxy. Every proxy shall be executed in writing by the shareholder or his duly
authorized attorney-in-fact and filed with the Secretary of the Corporation. A
proxy, unless coupled with an interest shall be revocable at will,
notwithstanding any other agreement or any provision in the proxy to the
contrary, but the revocation of a proxy shall not be effective until written
notice thereof has been given to the Secretary of the Corporation. An unrevoked
proxy shall not be valid after three years from the date of its execution unless
a longer time is expressly provided therein. A proxy shall not be revoked by
the death or incapacity of the maker, unless before the vote is counted or the
authority is exercised, written notice of such death or incapacity is given to
the Secretary of the Corporation.
Section 5.2 Where two or more proxies of a shareholder are present, the
Corporation shall, unless otherwise expressly provided in the proxy, accept as
the vote of all shares represented thereby the vote cast by a majority of them
and, if a majority of the proxies cannot agree whether the shares represented
shall be voted or upon the manner of voting the shares, the voting of the shares
shall be divided equally among those persons.
ARTICLE 6
Record Date
-----------
Section 6.1 The Board of Directors may fix a time prior to the date of
any meeting of shareholders as a record date for the determination of the
shareholders entitled to notice of, or to vote at, the meeting, which time,
except in the case of an adjourned
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meeting, shall not be more than 90 days prior to the date of the meeting of
shareholders. Only shareholders of record on the date so fixed shall be entitled
to notice of, or to vote at, such meeting, notwithstanding any transfer of
shares on the books of the Corporation after any record date fixed as aforesaid.
The Board of Directors may similarly fix a record date for the determination of
shareholders of record for any other purpose, such as the payment of a
distribution or conversion or exchange of shares.
ARTICLE 7
Record of Shareholders
----------------------
Section 7.1 The Treasurer shall have charge of the share transfer books
of the Corporation and shall maintain an alphabetical record of the shareholders
with their addresses and the number of shares held by each.
ARTICLE 8
Judges of Election
------------------
Section 8.1 Prior to any meeting of shareholders, the Board of Directors
may appoint judges of election, who may but need not be shareholders, to act at
such meeting or any adjournment thereof. If judges of election are not so
appointed, the presiding officer of any such meeting may, and on the request of
any shareholder or his proxy shall, make such appointment at the meeting. The
number of judges shall be one or three. No person who is a candidate for an
office to be filled at the meeting shall act as a judge of election.
Section 8.2 In case any person appointed as a judge of election fails to
appear or fails or refuses to act, the vacancy so created may be filled by
appointment made by the Board of Directors in advance of the convening of the
meeting or at the meeting by the presiding officer thereof.
Section 8.3 The judges of election shall determine the number of shares
outstanding and the voting power of each, the shares represented at the meeting,
the existence of a quorum and the authenticity, validity and effect of proxies.
The judges of election shall also receive votes or ballots, hear and determine
all challenges and questions in any way arising in connection with the right to
vote, count and tabulate all votes, determine the result and do such other acts
as may be proper to conduct the election or vote with fairness to all
shareholders. The judges of election shall perform their duties impartially, in
good faith, to the best of their ability and as expeditiously as
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practicable. If there are three judges of election, the decision, act or
certificate of a majority shall be the decision, act or certificate of all.
Section 8.4 On request of the presiding officer of the meeting or of any
shareholder, the judges of election shall make a report in writing of any
challenge, question or matter determined by them and execute a certificate of
any fact found by them. Any report or certificate made by them shall be prima
facie evidence of the facts found by them.
ARTICLE 9
Consent of Shareholders in Lieu of Meeting
------------------------------------------
Section 9.1 Any action required or permitted to be taken at a meeting of
the shareholders may be taken without a meeting if, prior or subsequent to the
action, a written consent or consents thereto signed by all of the shareholders
who would be entitled to vote at a meeting for such purpose shall be filed with
the Secretary of the Corporation.
Section 9.2 Any action required or permitted to be taken at a meeting of
the shareholders or of a class of shareholders may be taken without a meeting
upon the written consent of shareholders who would have been entitled to cast
the minimum number of votes that would be necessary to authorize the action at a
meeting at which all the shareholders entitled to vote thereon were present and
voting. The consents shall be filed with the Secretary of the Corporation. If
a written consent or consents are signed by fewer than all of the shareholders
who would be entitled to vote at a meeting for such purpose, the action shall
not become effective until ten days after written notice of the action has been
given to each shareholder entitled to vote thereon who has not consented
thereto.
ARTICLE 10
Directors
---------
Section 10.1 The business and affairs of the Corporation shall be managed
under the direction of a Board of Directors of not less than 12 or more than 24
directors. The Board of Directors shall be divided into three classes, and
directors of each class shall be elected for a term of three years and until
their successors are elected and qualified or until their earlier death,
resignation or removal. A decrease in the number of directors
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shall not have the effect of shortening the term of any incumbent director.
Prior to each election of a class of directors, the Board of Directors shall fix
the size of that class of directors at a minimum of four and a maximum of eight
directors. The Board of Directors may exercise all such powers of the
Corporation and do all such lawful acts and things as are required or permitted
to be exercised and done by statute, the Articles of Incorporation or these
Bylaws.
Section 10.2 In all elections of directors, each shareholder, or his
proxy, shall be entitled to the number of votes to which the shares of stock
owned by him are entitled to cast under the Articles of Incorporation of the
Corporation and may cumulate his votes as provided in the Articles of
Incorporation. All elections shall be by ballot.
Section 10.3 Every director shall be a shareholder in the Corporation.
When first elected to the Board of Directors, each director shall be regularly
engaged in a business, trade, or profession and shall be a resident of a
jurisdiction in which the Corporation is transacting business. No person shall
be elected a director who is or becomes 70 years of age prior to or during his
first term in office as a director. No person shall be considered as a
candidate, nor shall any votes be counted for any person, unless written notice
of the nomination of the candidacy shall have been filed with the Secretary of
the Corporation for the information of the shareholders not less than 60 days
prior to the election; provided, however, that nominees selected by the then
existing Board of Directors, or by a Nominating Committee appointed by the Board
of Directors and consisting of four directors continuing in office, may be
candidates and voted for without such notice.
Section 10.4 A meeting of the Board of Directors may be held immediately
following the annual meeting of shareholders at which directors have been
elected without the necessity of notice to the directors. At the first regular
meeting of the Board of Directors after each annual meeting of shareholders, the
Board of Directors shall elect a Chairman of the Board of Directors, a
President, a Secretary, a Treasurer and such other officers as the Board of
Directors shall determine. The President and Secretary shall be natural persons
of full age. The Treasurer may be a corporation, but if a natural person shall
be of full age. The Chairman of the Board of Directors and the President shall
be, and each other officer may be, a director of the Corporation. The offices
of Secretary and Treasurer may be filled by one person.
Section 10.5 Regular meetings of the Board of Directors shall be held at
least four times each year at times and places within or without the
Commonwealth of Pennsylvania designated by the Board of Directors. One or more
directors may participate in any meeting of the Board of Directors, or of any
committee thereof, by means of a conference telephone or similar communications
equipment by means of which all persons
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participating in the meeting can hear one another. Participation in a meeting by
such means shall constitute presence in person at the meeting.
Section 10.6 A special meeting of the Board of Directors may be called at
any time by the Chairman of the Board on 24 hours' notice to each director,
either by telephone, or if in writing, in accordance with Article 21 of these
Bylaws and shall be called by him or, in his absence, by the Secretary, upon the
written request of three members of the Board of Directors. Such special
meeting of the Board of Directors shall be held at a time and place designated
by the Chairman of the Board, or, in his absence, the Secretary.
Section 10.7 A majority of the directors then in office shall constitute
a quorum at any regular or special meeting of the Board of Directors, and the
acts of a majority of the directors present and voting at a meeting at which a
quorum is present shall be the acts of the Board of Directors, except as may be
otherwise specifically provided by statute or by the Articles of Incorporation
or by these Bylaws.
ARTICLE 11
Removal of Directors
--------------------
Section 11.1 Unless otherwise provided in the Articles of Incorporation,
or in Article 11, Section 11. 3 of these Bylaws the entire Board of Directors,
or any class of the Board of Directors or any individual director, may be
removed from office by vote of the shareholders entitled to vote thereon only
for cause. Notwithstanding the foregoing, an individual director shall not be
removed (unless the entire Board of Directors or class of Directors is removed)
from the Board of Directors if sufficient votes are cast against the resolution
for such director's removal which, if cumulatively voted at an annual or other
regular election of directors, would be sufficient to elect one or more
directors to the Board of Directors or a class thereof. If any directors are so
removed, new directors may be elected at the same meeting.
Section 11.2 The Board of Directors may declare vacant the office of a
director who has been judicially declared of unsound mind or who has been
convicted of an offense punishable by imprisonment for a term of more than one
year.
Section 11.3 The Board of Directors may be removed at any time with or
without cause by the unanimous consent of shareholders entitled to vote thereon.
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ARTICLE 12
Vacancies in the Board of Directors
-----------------------------------
Section 12.1 Vacancies in the Board of Directors occurring for any
reason, including vacancies resulting from an increase in the number of
directors, shall be filled by a majority vote of the remaining members of the
Board of Directors, though less than a quorum, or by a sole remaining director,
and each person so elected shall be a director to serve for the balance of the
unexpired term and until his successor has been elected and qualified or until
his earlier death, resignation or removal.
Section 12.2 When one or more directors resign from the Board of
Directors effective at a future date, the directors then in office, including
those who have so resigned, shall have the power by a majority vote to fill the
vacancies, the vote thereon to take effect when the resignations become
effective.
ARTICLE 13
Action by Written Consent
-------------------------
Section 13.1 Any action required or permitted to be taken at a meeting of
the Board of Directors may be taken without a meeting if, prior or subsequent to
the action, a consent or consents thereto signed by all of the directors is
filed with the Secretary of the Corporation.
ARTICLE 14
Compensation of Directors
-------------------------
Section 14.1 Directors, as such, may receive a stated salary for their
services or a fixed sum and expenses for attendance at regular and special
meetings, or any combination of the foregoing as may be determined from time to
time by resolution of the Board of Directors, and nothing contained herein shall
be construed to preclude any director from receiving compensation for services
rendered to the Corporation in any other capacity.
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ARTICLE 15
Committees
----------
Section 15.1 The Board of Directors may, by resolution adopted by a
majority of the directors in office, establish one or more committees consisting
of one or more directors as may be deemed appropriate or desirable by the Board
of Directors to serve at the pleasure of the Board. Any committee, to the
extent provided in the resolution of the Board of Directors pursuant to which it
was created, shall have and may exercise all of the powers and authority of the
Board of Directors, except that no committee shall have any power or authority
as to the following:
(1) The submission to shareholders of any action requiring approval of
shareholders;
(2) The creation or filling of vacancies in the Board of Directors;
(3) The adoption, amendment or repeal of these Bylaws;
(4) The amendment or repeal of any resolution of the Board of Directors
that by its terms is amendable or repealable only by the Board of
Directors; and
(5) Action on matters committed by the Bylaws or resolution of the Board
of Directors to another committee of the Board of Directors.
Section 15.2 At the first meeting following each annual meeting of
shareholders, the Board of Directors shall elect an Executive Committee of not
more than four (4) directors and not more than six (6) directors, a Finance
Committee of not less than four (4) directors and not more than six (6)
directors, an Audit Committee of a maximum of three (3) directors and a
Compensation and Stock Option Committee of a maximum of three (3) directors.
These committees shall meet at the call of the Chairman of each such committee.
A majority of the elected and, to the extent applicable ex officio, members of
the committees shall constitute a quorum. At least one third of the total
number of the members of each committee so appointed shall be persons who are
not officers or employees of the Corporation or any entity controlling,
controlled by or under common control with the Corporation and who are not the
beneficial owners of a controlling interest in the voting stock of the
Corporation or any such entity.
Section 15.3 The Executive Committee shall have supervision of all
business of the Corporation and shall have the authority in between the time of
regular meetings of the Board of Directors as specified in Article 10, Section
10.5 hereof, to exercise all powers of the Corporation and do all such lawful
acts and things as are required or permitted to be exercised and done by
statute, the Articles of Incorporation or these Bylaws. The Executive Committee
shall have the power to create offices and titles as deemed desirable or
advisable. The holders of such offices need not be directors of the
Corporation.
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Section 15.4 The Finance Committee shall review the investment results of
the Corporation's assets and perform such other duties as the Board of Directors
or the Executive Committee may prescribe.
Section 15.5 The Audit Committee shall consist of a maximum of three (3)
members of the Board of Directors, none of whom shall be an officer or employee
of the Corporation or of any entity controlling, controlled by or under common
control with the Corporation and who are not beneficial owners of a controlling
interest in the voting stock of the Corporation or any such entity. The Audit
Committee shall recommend the selection of independent certified public
accountants and review the scope and results of the independent audit and the
management recommendations made by the independent certified public accountants.
Section 15.6 The Nominating Committee shall consist of no fewer than four
(4) members of the Board of Directors continuing in office, none of whom shall
be an officer or employee of the Corporation or of any entity controlling,
controlled by or under common control with the Corporation and who are not
beneficial owners of a controlling interest in the voting stock of the
Corporation or any such entity. The Nominating Committee shall nominate persons
for election for director by the shareholders and shall review and report on the
qualifications of candidates otherwise nominated for director.
Section 15.7 The Compensation and Stock Option Committee shall consist of
a maximum of three (3) members of the Board of Directors, none of whom shall be
an officer or employee of the Corporation or of any entity controlling,
controlled by or under common control with the Corporation and who are not
beneficial owners of a controlling interest in the voting stock of the Company
or any such entity. The Compensation and Stock Option Committee shall evaluate
the performance of officers deemed to be executive officers of the Corporation
and recommend to the Board of Directors compensation of the executive officers.
The Compensation and Stock Option Committee may invite the Chairman of the Board
and the President of the Corporation to attend its meetings and provide relevant
information for the Committee's review, provided however, that the Chairman of
the Board and the President may not vote on matters coming before the Committee.
ARTICLE 16
Liability of Directors
----------------------
Section 16.1 A director of the Corporation shall stand in a fiduciary
relation to the Corporation and shall perform his duties as a director,
including his duties as a member of
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any committee of the Board of Directors upon which he may serve, in good faith,
in a manner he reasonably believes to be in the best interests of the
Corporation, and with such care, including reasonable inquiry, skill and
diligence, as a person of ordinary prudence would use under similar
circumstances. In performing his duties, a director shall be entitled to rely in
good faith on information, opinions, reports or statements, including financial
statements and other financial data, in each case prepared or presented by any
of the following: (i) one or more officers or employees of the Corporation whom
the director reasonably believes to be reliable and competent in the matters
presented; (ii) legal counsel, public accountants or other persons as to matters
which the director reasonably believes to be within the professional or expert
competence of such persons; or (iii) a committee of the Board of Directors upon
which he does not serve, duly designated in accordance with law, as to matters
within its designated authority, which committee the director reasonably
believes to merit confidence. A director shall not be considered to be acting in
good faith if he has knowledge concerning the matter in question that would
cause his reliance to be unwarranted.
Section 16.2 In discharging the duties of their respective positions, the
Board of Directors, committees of the Board of Directors and individual
directors may, in considering the best interests of the Corporation, consider
the effects of any action upon employees, upon suppliers and customers of the
Corporation and upon communities in which offices or other establishments of the
Corporation are located, and all other pertinent factors. The consideration of
these factors shall not constitute a violation of Section 16. 1 of this Article
16.
Section 16.3 Absent breach of fiduciary duty, lack of good faith or self-
dealing, actions taken as a director or any failure to take any action shall be
presumed to be in the best interests of the Corporation.
Section 16.4 A director of the Corporation shall not be personally liable
for monetary damages as such for any action taken, or any failure to take any
action, unless: (i) the director has breached or failed to perform the duties of
his office under Sections 16.1 through 16.3 of this Article 16; and (ii) the
breach or failure to perform constitutes self-dealing, willful misconduct or
recklessness.
Section 16.5 The provisions of Section 16.4 of this Article 16 shall not
apply to: (i) the responsibility or liability of a director pursuant to any
criminal statute; or (ii) the liability of a director for the payment of taxes
pursuant to local, state or federal law.
Section 16.6 Notwithstanding any other provisions of these Bylaws, the
approval by the affirmative vote of the holders of a majority of the outstanding
voting power of the shares of stock of the Corporation shall be required to
amend, repeal or adopt any
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provision as part of these Bylaws that is inconsistent with the purpose or
intent of Sections 16.1, 16.2, 16.3, 16.4, 16.5 or 16.6 of this Article 16, and,
if any such action shall be taken, it shall become effective only on a
prospective basis from and after the date of such shareholder approval. The
provisions of Section 16.1, 16.2, 16.3, 16.4 and 16.5 were originally adopted by
the shareholders of the Corporation on April 27, 1987.
ARTICLE 17
Officers
--------
Section 17.1 The Corporation shall have a Chairman of the Board, a
President, a Secretary and a Treasurer or persons who shall act as such,
regardless of the name or title by which they may be designated, elected or
appointed and may have such other officers and assistant officers as the Board
of Directors may authorize from time to time. The Chairman of the Board or the
President shall be the chief executive officer of the Corporation, as the Board
of Directors may determine from time to time. Each officer shall hold office at
the pleasure of the Board of Directors and until his successor has been elected
and qualified or until his earlier death, resignation or removal. Any officer
may resign at any time upon written notice to the Corporation. The resignation
shall be effective upon receipt thereof by the Corporation or at such subsequent
time as may be specified in the notice of resignation.
Section 17.2 Except as otherwise provided in the Articles of
Incorporation, an officer shall perform his duties as an officer in good faith,
in a manner he reasonably believes to be in the best interests of the
Corporation and with such care, including reasonable inquiry, skill and
diligence, as a person of ordinary prudence would use under similar
circumstances. A person who so performs his duties shall not be liable by
reason of having been an officer of the Corporation.
Section 17.3 Any officer or agent of the Corporation may be removed by
the Board of Directors with or without cause by a vote of not less than two-
thirds of the whole Board. The removal shall be without prejudice to the
contract rights, if any, of any person so removed. Election or appointment of
an officer or agent shall not of itself create contract rights. If the office
of any officer becomes vacant for any reason, the vacancy may be filled by the
Board of Directors.
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ARTICLE 18
Duties of Officers
------------------
Section 18.1 The Chairman of the Board shall preside at all meetings of
the Board of Directors and at all meetings of the shareholders, appoint all
committees not otherwise provided for in the Bylaws and shall be ex officio a
member of all committees other than the Audit Committee, the Nominating
Committee, and the Compensation and Stock Option Committee.
Section 18.2 In the absence of the Chairman of the Board, the President
shall preside at all meetings of the Board of Directors and at all meetings of
the shareholders. Except as otherwise provided herein, the President shall have
general supervision and control of all the employees of the Corporation; shall
be responsible for the general and active management of the business of the
Corporation; shall see that all orders and resolutions of the Board of Directors
are put into effect, subject, however, to the right of the Board of Directors to
delegate any specific powers, except such as may be by statute exclusively
conferred on the President or on any other officer or officers of the
Corporation; shall have the authority to execute bonds, mortgages and other
contracts requiring a seal, under the seal of the Corporation, except where
required or permitted by law to be otherwise signed and executed and except
where the signing and execution thereof shall be expressly delegated by the
Board of Directors to some other office or agent of the Corporation; and shall
be ex officio a member of all committees other than the Audit Committee, the
Nominating Committee, and the Compensation and Stock Option Committee.
Section 18.3 In the absence of the President, the Executive Vice
President, if any, shall assume the duties of the President. The Executive Vice
President, if any, shall perform such duties as may be assigned to him by the
Corporation's chief executive officer, the Board of Directors or the Executive
Committee of the Board of Directors.
Section 18.4 The Vice Presidents shall perform such duties as may be
designated from time to time by the Corporation's chief executive officer, the
Board of Directors or the Executive Committee of the Board of Directors.
Section 18.5 The Secretary shall act under the direction and
superintendence of the Corporation chief executive officer; attend all the
meetings of shareholders, directors and committees, and keep in suitable books
the minutes thereof; superintend the keeping and have charge of the seal, books,
papers and records pertaining to his office, sign such documents as shall
require his attention, issue notices for all meetings; make or superintend the
making of monthly and annual statements to the Board of Directors,
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which shall fully show the current business and condition of the Corporation and
perform generally all the duties incident to the office of Secretary.
Section 18.6 The Treasurer or his designee shall receive and take care of
all moneys, securities and evidences of indebtedness belonging to the
Corporation; maintain day by day records of his transactions and deposit the
daily receipts in a General Account in the name of the Corporation in such bank
or banks or such depositories as the Board of Directors or the Executive
Committee may direct. All checks or other orders on such banks or depositories
for the payment or transfer of money shall be signed by the Treasurer or his
designee and by another officer of the Corporation.
In addition to the aforesaid General Account the Treasurer or his designee
shall maintain Special Accounts as the Board of Directors or the Executive
Committee may from time to time create in banks for current payments; such
deposits shall be made in the name of the Corporation and shall be replenished
from the General Account as may be necessary to maintain working balances in
such Special Accounts. All checks or drafts drawn against such Special Accounts
shall be signed by such officer or officers or employees as may from time to
time be authorized by the Board of Directors or the Executive Committee of the
Board of Directors.
Section 18.7 The Assistant Secretary shall, in the absence of the
Secretary, perform the duties of the Secretary and such other duties as may be
assigned to him by the Secretary.
Section 18.8 The Assistant Treasurer shall, in the absence of the
Treasurer, perform the duties of the Treasurer and such other duties as may be
assigned to him by the Treasurer.
Section 18.9 All officers and employees shall give bond for the faithful
performance of their duties in such amount as is required by the Board of
Directors or the Executive Committee of the Board of Directors.
ARTICLE 19
Indemnification of Officers, Directors, Employees, and Agents
-------------------------------------------------------------
Section 19.1 The Corporation shall indemnify any director or officer, and
may indemnify any other employee or agent who was or is a party to, or is
threatened to be made a party to or who is called as a witness in connection
with, any threatened, pending or completed action, suit or proceeding, whether
civil, criminal, administrative or
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investigative, including an action by or in the right of the Corporation by
reason of the fact that he is or was a director, officer, employee or agent of
the Corporation, or is or was serving at the request of the Corporation as a
director, officer, employee or agent of another corporation, partnership, joint
venture, trust or other enterprise, against expenses, including attorneys' fees,
judgments, fines and amounts paid in settlement actually and reasonably incurred
by him in connection with such action, suit or proceeding unless the act or
failure to act giving rise to the claim for indemnification is determined by a
court to have constituted willful misconduct or recklessness.
Section 19.2 The indemnification and advancement of expenses provided by,
or granted pursuant to, this Article 19 shall not be deemed exclusive of any
other rights to which those seeking indemnification or advancement of expenses
may be entitled under any Bylaw, agreement, contract, vote of shareholders or
disinterested directors or pursuant to the direction, howsoever embodied, of any
court of competent jurisdiction or otherwise, both as to action in their
official capacity and as to action in another capacity while holding such
office. It is the policy of the Corporation that indemnification of, and
advancement of expenses to, directors and officers of the Corporation shall be
made to the fullest extent permitted by law. To this end, the provisions of this
Article 19 shall be deemed to have been amended for the benefit of directors and
officers of the Corporation effective immediately upon any modification of the
BCL or the Directors' Liability Act of the Commonwealth of Pennsylvania (the
"DLA") which expands or enlarges the power or obligation of corporations
organized under the BCL or subject to the DLA to indemnify, or advance expenses
to, directors and officers of corporations.
Section 19.3 The Corporation shall pay expenses incurred by an officer or
director, and may pay expenses incurred by any other employee or agent in
defending a civil or criminal action, suit or proceeding in advance of the final
disposition of such action, suit or proceeding upon receipt of an undertaking by
or on behalf of such person to repay such amount if it shall ultimately be
determined that he is not entitled to be indemnified by the Corporation.
Section 19.4 The indemnification and advancement of expenses provided by,
or granted pursuant to, this Article 19 shall, unless otherwise provided when
authorized or ratified, continue as to a person who has ceased to be a director,
officer, employee or agent and shall inure to the benefit of the heirs,
executors and administrators of such person.
Section 19.5 The Corporation shall have the authority to create a fund of
any nature, which may, but need not, be under the control of an independent
trustee, or otherwise secure or insure in any manner, its indemnification
obligations, whether arising under these Bylaws or otherwise. The authority
shall include, without limitation, the
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authority to: (i) deposit funds in trust or in escrow, (ii) establish any form
of self-insurance, (iii) secure its indemnity obligation by grant of a security
interest, mortgage or other lien on the assets of the Corporation or (iv)
establish a letter of credit, guaranty or surety arrangement for the benefit of
such persons in connection with the anticipated indemnification or advancement
of expenses contemplated by this Article 19. The provisions of this Article 19
shall not be deemed to preclude the indemnification of, or advancement of
expenses to, any person who is not specified in Section 19.1 of this Article 19
but whom the Corporation has the power or obligation to indemnify, or to advance
expenses for, under the provisions of the BCL or the DLA or otherwise. The
authority granted by this Section 19.5 shall be exercised by the Board of
Directors of the Corporation.
Section 19.6 The Corporation shall have the authority to enter into a
separate indemnification agreement with any officer, director, employee or agent
of the Corporation or any subsidiary providing for such indemnification of such
person as the Board of Directors shall determine up to the fullest extent
permitted by law.
Section 19.7 As soon as practicable after receipt by any person specified
in Section 19.1 of this Article 19 of notice of the commencement of any action,
suit or proceeding specified in Section 19.1 of this Article 19, such person
shall, if a claim with respect thereto may be made against the Corporation under
Article 19 of these Bylaws, notify the Corporation in writing of the
commencement or threat thereof; however, the omission so to notify the
Corporation shall not relieve the Corporation for any liability under Article 19
of the Bylaws unless the Corporation shall have been prejudiced thereby or from
any other liability which it may have to such person other than under Article 19
of these Bylaws. With respect to any such action as to which such person
notifies the Corporation of the commencement or threat thereof, the Corporation
may participate therein at its own expense, and except as otherwise provided
below, to the extent that it desires, the Corporation jointly with any other
indemnifying party similarly notified, shall be entitled to assume the defense
thereof, with counsel selected by the Corporation to the reasonable satisfaction
of such person. After notice from the Corporation to such person of its
election to assume the defense thereof, the Corporation shall not be liable to
such person under Article 19 of these Bylaws for any legal or other expenses
subsequently incurred by such person in connection with the defense thereof
other than as otherwise provided below. Such person shall have the right to
employ his own legal counsel in such action, but the fees and expenses of such
legal counsel incurred after notice from the Corporation of its assumption of
the defense thereof shall be at the expense of such person unless: (i) the
employment of legal counsel by such person shall have been authorized by the
Corporation; (ii) such person shall have reasonably concluded that there may be
a conflict of interest between the Corporation and such person in the conduct of
the defense of such proceeding; or (iii) the Corporation shall not in fact have
employed
- 20 -
<PAGE>
legal counsel to assume the defense of such action. The Corporation shall not be
entitled to assume the defense of any proceeding brought by or on behalf of the
Corporation or as to which such person shall have reasonably concluded that
there may be a conflict of interest. If indemnification under Article 19 of
these Bylaws or advancement of expenses are not paid or made by the Corporation,
or on its behalf, within 90 days after a written claim for indemnification or a
request for an advancement of expenses has been received by the Corporation,
such person may, at any time thereafter, bring suit against the Corporation to
recover the unpaid amount of the claim or the advancement of expenses. The right
to indemnification and advancement of expenses provided hereunder shall be
enforceable by such person in any court of competent jurisdiction. The burden of
proving that indemnification is not appropriate shall be on the Corporation.
Expenses reasonably incurred by such person in connection with successfully
establishing the right to indemnification or advancement of expenses, in whole
or in part, shall also be indemnified by the Corporation.
Section 19.8 The Corporation shall have power to purchase and maintain
insurance on behalf of any person who is or was a director, officer, employee or
agent of the Corporation, or is or was serving at the request of the Corporation
as a director, officer, employee or agent of another corporation, partnership,
joint venture, trust or other enterprise against any liability asserted against
him and incurred by him in any such capacity, or arising out of his status as
such, whether or not the Corporation would have the power to indemnify him
against such liability under the provisions of this Article 19.
Section 19.9 Notwithstanding any other provisions of these Bylaws, the
approval by (i) the affirmative vote of the holders of a majority of the
outstanding voting power of the shares of stock of the Corporation or (ii) a
majority vote of the members of the Board of Directors shall be required to
amend, repeal or adopt any provision as part of these Bylaws which is
inconsistent with the purpose or intent of this Article 19, and, if any such
action shall be taken, it shall become effective only on a prospective basis
from and after the date of such approval. The provisions of Sections 19.1,
19.2, 19.3, 19.4, 19.5, 19.6, 19.7 and 19.8 were originally adopted by the
shareholders of the Corporation on April 27, 1987.
ARTICLE 20
Fiscal Year
-----------
Section 20.1 The fiscal year of the Corporation shall be determined by the
Board of Directors.
- 21 -
<PAGE>
ARTICLE 21
Manner of Giving Written Notice; Waivers of Notice
--------------------------------------------------
Section 21.1 Whenever written notice is required to be given to any
person under the provisions of these Bylaws, it may be given to the person
either personally or by sending a copy thereof by first class or express mail,
postage prepaid, or by telegram (with messenger service specified), telex or TWX
(with answer back received) or courier service, charges prepaid, or by
telecopier, to his address (or to his telex, TWX, telecopier or telephone
number) appearing on the books of the Corporation or, in the case of written
notice to directors, supplied by each director to the Corporation for the
purpose of the notice. If the notice is sent by mail, telegraph or courier
service, it shall be deemed to have been given to the person entitled thereto
when deposited in the United States mail or with a telegraph office or courier
service for delivery to that person or, in the case of telex or TWX, when
dispatched.
Section 21.2 Any written notice required to be given to any person under
the provisions of statute, the Corporation's Articles of Incorporation or these
Bylaws may be waived in a writing signed by the person entitled to such notice
whether before or after the time stated therein. Except as otherwise required
by statute, and except in the case of a special meeting, neither the business to
be transacted at, nor the purpose of, a meeting need be specified in the waiver
of notice. In the case of a special meeting of shareholders, the waiver of
notice shall specify the general nature of the business to be transacted.
Attendance of any person, whether in person or by proxy, at any meeting shall
constitute a waiver of notice of such meeting, except where a person attends a
meeting for the express purpose of objecting, at the beginning of the meeting,
to the transaction of any business because the meeting was not lawfully called
or convened.
ARTICLE 22
Amendments
----------
Section 22.1 Neither this Section 22.1 nor Article 2 of these Bylaws may
be altered, amended or repealed unless approved by the affirmative vote of the
holders of two-thirds of the outstanding Common Stock of the Corporation, voting
as a separate class, at any annual meeting of shareholders or at a special
meeting of shareholders called for that purpose, provided that 30 days' notice
of the proposed amendments shall have been mailed to the last recorded address
of each shareholder as furnished to the Corporation, and that the same shall
have been submitted to the Board of Directors at least 30 days prior to such
meeting.
- 22 -
<PAGE>
Section 22.2 Neither this Section 22.2 nor Article 16 of these Bylaws may
be altered, amended or repealed unless approved by the affirmative vote of the
holders of a majority of the outstanding voting power of the shares of stock of
the Corporation at a duly organized meeting of shareholders called for that
purpose, provided that 30 days' notice of the proposed amendments shall have
been mailed to the last recorded address of each shareholder as furnished to the
Corporation, and that the same shall have been submitted to the Board of
Directors at least 30 days prior to such meeting.
Section 22.3 Neither this Section 22.3 nor Article 19 of these Bylaws may
be altered, amended or repealed unless approved by: (i) the affirmative vote of
the holders of a majority of the outstanding voting power of the shares of stock
of the Corporation at a duly organized meeting called for that purpose, provided
that 30 days' notice of the proposed amendments shall have been mailed to the
last recorded address of each shareholder as furnished to the Corporation, and
that the same shall have been submitted to the Board of Directors at least 30
days prior to such meeting, or (ii) a majority vote of the members of the Board
of Directors at any regular meeting or any special meeting duly convened after
notice to the directors of that purpose, subject to the power of the
shareholders to change such action by the affirmative vote of the holders of a
majority of the outstanding voting power of the shares of stock of the
Corporation at any duly organized meeting called for that purpose.
Section 22.4 All provisions of these Bylaws other than Articles 2, 16 and
19 and Sections 22.1, 22.2 and 22.3 may be altered, amended or repealed: (i) by
the affirmative vote of the holders of a majority of the outstanding voting
power of the shares of stock of the Corporation at a duly organized meeting
called for that purpose, or (ii) by a majority vote of the members of the Board
of Directors at any regular meeting or any special meeting duly convened after
notice to the directors of that purpose, subject to the power of the
shareholders to change such action by the affirmative vote of the holders of a
majority of the outstanding voting power of the shares of stock of the
Corporation at any duly organized meeting called for that purpose.
- 23 -
<PAGE>
EXHIBIT 3.3
CERTIFICATE OF TRUST
OF
PMC CAPITAL I
THIS CERTIFICATE OF TRUST of PMC Capital I (the "Trust"), dated September
15, 1998, is being duly executed and filed by the undersigned, as trustee, to
form a business trust under the Delaware Business Trust Act (12 Del. Code
Section 3801, et seq.).
1. Name. The name of business trust being formed hereby is PMC Capital I.
2. Delaware Trustee. The name and business address of the Trustee of the
Trust with a principal place of business in the State of Delaware is The Bank of
New York (Delaware), White Clay Center, Route 273, Newark, Delaware 19711.
3. Effective Date. This Certificate of Trust shall be effective as of
its filing.
IN WITNESS WHEREOF, the undersigned, being the sole trustee of the Trust,
has executed this Certificate of Trust as of the date first above written.
THE BANK OF NEW YORK (DELAWARE),
not in its individual capacity but
solely as trustee of the Trust
By: /s/ Mary Jane Morrissey
-------------------------
Name: Mary Jane Morrissey
-----------------------
Title: Authorized Signatory
-----------------------
<PAGE>
EXHIBIT 3.4
TRUST AGREEMENT
This TRUST AGREEMENT, dated as of September 15, 1998 (this "Trust
Agreement"), between PENNSYLVANIA MANUFACTURERS CORPORATION, a Pennsylvania
corporation (the "Depositor"), and THE BANK OF NEW YORK (DELAWARE), a Delaware
banking corporation (the "Trustee"). The Depositor and the Trustee hereby agree
as follows:
1. The trust created hereby (the "Trust") shall be known as "PMC Capital
I" in which name the Trustee, or the Depositor to the extent provided herein,
may engage in the transactions contemplated hereby, make and execute contracts,
and sue and be sued.
2. The Depositor hereby assigns, transfers, conveys and sets over to the
Trustee the sum of $10. The Trustee hereby acknowledges receipt of such amount
in trust from the Depositor, which amount shall constitute the initial trust
estate. The Trustee hereby declares that it will hold the trust estate in trust
for the Depositor. It is the intention of the parties hereto that the Trust
created hereby constitute a business trust under Chapter 38 of Title 12 of the
Delaware Code, 12 Del. C. Section 3801 et. seq. (the "Business Trust Act"), and
that this document constitutes the governing instrument of the Trust. The
Trustee is hereby authorized and directed to execute and file a certificate of
trust with the Secretary of State of the State of Delaware in accordance with
the provisions of the Business Trust Act.
3. The Depositor and the Trustee will enter into an amended and restated
Trust Agreement, satisfactory to each such party and substantially in the form
included as an exhibit to the 1933 Act Registration Statement (as defined
below), to provide for the contemplated operation of the Trust created hereby
and the issuance of the Capital Securities and Common Securities referred to
therein. Prior to the execution and delivery of such amended and restated Trust
Agreement, the Trustee shall not have any duty or obligation hereunder or with
respect to the trust estate, except as otherwise required by applicable law or
as may be necessary to obtain prior to such execution and delivery any licenses,
consents or approvals required by applicable law or otherwise.
4. The Depositor and the Trustee hereby authorize and direct the
Depositor, as the sponsor Trust, (i) to file with the Securities and Exchange
Commission (the "Commission") and execute, in each case on behalf of the Trust,
(a) the Registration Statement on Form S-3 (the "1933 Act Registration
Statement"), including any pre-effective or post-effective amendment to the 1933
Act Registration Statement (and any registration statement filed pursuant to
Rule 462 promulgated pursuant to the Securities Act of 1933, as amended),
relating to the registration under the Securities Act of 1933, as amended, of
the Capital Securities of the Trust and possibly certain other securities and
(b) a Registration Statement on Form 8-A (the "1934 Act Registration Statement")
(including all pre-effective and post-effective amendments thereto) relating to
the registration of the Capital Securities of the Trust under Section 12(g) of
the Securities Exchange Act of 1934,
<PAGE>
as amended; (ii) to file with The Nasdaq National Market or other national stock
exchange (each, an "Exchange") and execute on behalf of the Trust one or more
listing applications and all other applications, statements, certificates,
agreements and other instruments as shall be necessary or desirable to cause the
Capital Securities to be listed on any of the Exchanges; (iii) to file and
execute on behalf of the Trust such applications, reports, surety bonds,
irrevocable consents, appointments of attorney for service of process and other
papers documents as shall be necessary or desirable to register the Capital
Securities under the securities or blue sky laws of such jurisdictions as the
Depositor on behalf of the Trust, may deem necessary or desirable and (iv) to
execute and deliver on behalf of the Trust that certain Underwriting Agreement
relating to the Capital Securities, among the Trust, the Depositor and the
several Underwriters named therein, substantially in the form included an
exhibit to the 1933 Act Registration Statement. In connection with the filings
referred to above, the Depositor hereby constitutes and appoints Francis W.
McDonnell and Edward S. Hochberg, and each of them, as its true and lawful
attorneys-in-fact and agents, with full power of substitution and
resubstitution, for the Depositor or in the Depositor's name, place and stead,
in any and all capacities, to sign any and all amendments (including post-
effective amendments) to the 1933 Act Registration Statement (and any
registration statement filed pursuant to Rule 462 promulgated pursuant to the
Securities Act of 1933, as amended) and the 1934 Act Registration Statement and
the 1934 Act Registration Statement and to file the same, with all exhibits
thereto, and other documents in connection therewith, with the Commission, any
Exchange and administrators of state securities or blue sky laws granting unto
said attorneys-in-fact and agents full power and authority to do and perform
each and every act and thing requisite and necessary to be done in connection
therewith, as fully to all intents and purposes as the Depositor might or could
do in person, hereby ratifying and confirming all that said attorneys-in-fact
and agents or any of them, or their respective substitute or substitutes, shall
do or cause to be done by virtue hereof.
5. This Trust Agreement may be executed in one or more counterparts.
6. The number of Trustees initially shall be one (1) and thereafter the
number of Trustees shall be such number as shall be fixed from time to time by a
written instrument signed by the Depositor which may increase or decrease the
number of Trustees; provided, however, that to the extent required by the
Business Trust Act, one Trustee shall either be a natural person who is a
resident of the State of Delaware or, if not a natural person, an entity which
has its principal place of business in the state of Delaware and otherwise meets
the requirements of applicable Delaware law. Subject to the foregoing, the
Depositor is entitled to appoint or remove without cause any Trustee at any
time. The Trustees may resign upon 30 days' prior notice to the Depositor.
7. This Trust Agreement shall be governed by, and construed in accordance
with, the laws of the State of Delaware (without regard to conflict of laws
principles).
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Trust Agreement to
be duly executed as of the day and year first above written.
PENNSYLVANIA MANUFACTURERS
CORPORATION, as Depositor
By: /s/ Edward S. Hochberg
---------------------------
Name: Edward S. Hochberg
--------------------
Title: Vice President of Finance
-----------------------------
THE BANK OF NEW YORK (DELAWARE),
as Trustee
By: /s/ Mary Jane Morrissey
-------------------------
Name: Mary Jane Morrissey
---------------------
Title: Authorized Signatory
---------------------
<PAGE>
Exhibit 12.1
STATEMENT REGARDING COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (1)
(dollar amounts in thousands)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, YEAR ENDED DECEMBER 31,
1998 1997 1997 1996 1995 1994 1993
----------- ----------- ------- ---------- ------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
EARNINGS
Pre-tax income including net realized
investment gains (losses) $25,516 $ 2,620 $25,153 $(191,394) $34,913 $65,380 $ 89,621
Fixed charges 8,411 9,199 17,664 19,070 20,231 14,550 13,356
---------------------------------------------------------------------------
Earnings including net realized
investment gains (losses) (a) $33,927 $11,819 $42,817 $(172,324) $55,144 $79,930 $102,977
===========================================================================
Pre-tax income excluding net realized
investment gains (losses) $14,253 $ 4,551 $16,555 $(194,378) $ 2,990 $17,859 $ 19,823
Fixed charges 8,411 9,199 17,664 19,070 20,231 14,550 13,356
---------------------------------------------------------------------------
Earnings excluding net realized
investment gains (losses) (b) $22,664 $13,750 $34,219 $(175,308) $23,221 $32,409 $ 33,179
===========================================================================
FIXED CHARGES
Interest expense and amortization of
debt discount and premium on all
indebtedness $ 7,463 $ 8,222 $15,768 $ 17,052 $18,734 $13,051 $ 11,650
Interest portion of rental expense 948 977 1,896 2,018 1,497 1,499 1,706
---------------------------------------------------------------------------
Fixed charges (c) $ 8,411 $ 9,199 $17,664 $ 19,070 $20,231 $14,550 $ 13,356
===========================================================================
Ratio of earnings to fixed charges
including net realized investment
gains (a)/(c) 4.0x 1.3x 2.4x (2) 2.7x 5.5x 7.7x
Ratio of earnings to fixed charges
excluding net realized investment
gains (b)/(c) 2.7x 1.5x 1.9x (3) 1.1x 2.2x 2.5x
</TABLE>
(1) For purposes of determining this ratio, earnings (loss) consist of income
(loss) before income taxes and extraordinary loss (1997), plus fixed
charges. Fixed charges consist of interest expense and the portion of
operating leases that management believes is representative of the interest
factor.
(2) Earnings (including net realized investment gains) were insufficient to
cover fixed charges by $191.4 million in 1996.
(3) Earnings (excluding net realized investment gains) were insufficient to
cover fixed charges by $194.4 million in 1996.
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the inclusion in this Registration Statement on Form S-3 of our
reports dated February 6, 1998, on our audits of the consolidated financial
statements and financial statement schedules of Pennsylvania Manufacturers
Corporation and subsidiaries as of December 31, 1997 and 1996, and for each of
the three years in the period ended December 31, 1997. We also consent to the
reference to our firm under the captions "Experts."
/s/ PricewaterhouseCoopers LLP
One South Market Square
Harrisburg, Pennsylvania
September 15, 1998
